It’s Déjà Vu All Over Again as the Russian Ruble Crashes
Battered by sanctions, the Russian ruble has fallen to historic lows against the U.S. dollar.
The last time the ruble slid this far was in the late 1990’s when I was still writing for an inside market publication called Russia Crisis Watch during theRussian financial crisis.
Three times a week Crisis would document the “real” condition of the Russian economy, while providing market intelligence from a network inside and outside the country.
But since the statistics coming from official sources in Moscow were highly suspect, our single greatest problem was the need to develop accurate data.
So I began to develop independent ways of valuing assets, especially oil and gas flows. It was one of the few ways in which I could put a “dollar sign” on market valuations as a whole.
Today, it feels like old times again as the ruble continues to plunge…
As the Pressure Cranks Up, Western Sanctions Start to Sting
So far, the current sanctions have delivered two primary consequences.
First, an expanded restriction of Russian bank access to outside financial markets has increased the cost of doing business internationally. On top of that, both companies and investors have been making a broad-based reassessment about the advisability of making commitments there.
Both of these are causing an increase in the effective hard currency costs to Russian financial institutions and companies. That accelerates the downward pressure on the real value of the ruble.
Yet, a dose of reality is certainly appropriate here.
Having had firsthand experience in the design and application of economic sanctions, I can tell you that one overarching reality is crucial: Economic sanctions are not enough to bring about the demise of the offending country.
They failed with U.S. policy against Japan before World War II (in fact, the attempt to bankrupt the Japanese economy may have actually hastened the conflict in the Pacific). They delivered limited success during the aftermath of the Berlin Blockade in 1948.
And, if sanctions couldn’t bring down the government in Tehran, they are not about to accomplish “regime destruction” anywhere else.
In this case, sanctions against the Kremlin are meant to increase the pain of continuing their current policy of destabilizing Kiev. Don’t look at them as a weapon in some new kind of Cold War. In a conflict like this, sanctions have a more limited tactical objective.
Rather, the goal here is to turn up the pressure. So far, Moscow’s stock markets have declined by double digits along with the weakening ruble. As a result, the Russian Central Bank (RCB) has embarked on a heavy injection of hard currency to buttress the domestic currency.
Of course, the RCB does have a war chest to use here. But relying on currency support from sources outside free market exchange always presents an artificial expectation among traders.
So the “acceptable” currency peg rate will now be based on the rate of central bank intervention, not where the market would put it…assuring even more depreciation in the value of the ruble.
What the Falling Ruble Means to the Energy Markets
All of this has consequences for energy markets.
Aside from upsetting the bottom lines of outside companies either working in Russia or having designs to do so, the most direct effect is on the raw materials themselves.
Russia is the world’s largest non-OPEC seller of conventional crude oil and is still the global leader in natural gas exports. But both of these commodities are denominated in dollars when sold internationally.
As the value of the ruble versus the dollar declines, on paper these commodities become cheaper to produce. The spread between what it costs to get volume out of the ground as compared to what is obtained when it is sold abroad increases. That would seem to provide an expanded potential to profit
But it’s not that simple, especially when two other factors are considered. First, the foreign sale has to be pre-financed. That requires that both sides have to access international banking. These days that is becoming increasingly more difficult for Russian exporters who must transfer oil and gas produced in rubles to an export consignment denominated in dollars.
An additional step or two has to be introduced, whereby rubles must first move through a fiduciary conduit someplace else and then be converted into dollars for the actual trade. That adds significantly to the cost of the transaction, and thereby cuts into profits.
When you also have a central budget that is dependent on those exports for most of its ready access to tax receipts, the problem quickly creates fundamental revenue concerns well beyond those of selected companies.
Second, Russia is dependent upon foreign sources for specialized equipment, technology, expertise, and investment to keep its oil and gas sector operating. The traditional Western Siberian production basins are rapidly maturing, with production decline estimates increasing.
To offset this, Moscow has to move north of the Arctic Circle, out onto the continental shelf, and into Eastern Siberia. The capital needed for all of this is staggering, and access to outside know-how is crucial.
Both the investment and needed technology in this case bring hard currency considerations with them. Attracting essential outside capital becomes more difficult as the equation of converting a declining ruble into what it can be repatriated later becomes less clear.
When it comes to the technology, it must be either paid for outright with foreign currency reserves or covered by the value of product produced. Both of these have now become more expensive from the Russian standpoint due to the weakness in the ruble and the corresponding increased expenses of converting it into hard currency.
That is why OPEC and the U.S. are watching the financial developments in Russia very closely. There may be some short-term advantages in making it more expensive for the Kremlin to export oil and gas.
But longer term, there is no genuine advantage in removing too much Russian volume from the market. That would simply destabilize global prices and the uncertainty would provide another unsavory round of volatility.
The object of the sanctions is to bring Moscow to the table, not drive Russia to its knees. Balance is needed.
Some 17 years ago, I needed to come up with ways of factoring a devalued ruble into the actual value of Russian exports.
It looks like the time has come to dust off those old algorithms.