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Oil Crisis Leaves Russia With a Mess – and You With an Opportunity

by | published January 20th, 2016

The Russian financial situation is heading south again… and fast.

Crude oil prices of less than $30 a barrel are bad enough, but Russia’s high-sulfur export blend, the Urals Export Blend Crude (UEBC), can’t even fetch that.

Instead, UEBC is trading at $26 a barrel – or less.

Natural gas is faring even worse.

For a country like Russia – which remains dependent on oil and natural gas exports to prop up an unwieldy central budget – this is very serious indeed.

There is only one way out of this mess… and one very simple way for you to profit in the meantime.

But first, here’s the truth about Russia’s energy-dependent economy…

Cheap Natural Gas Is Hurting Russia – And It’s About to Get Worse

Natural gas is now so cheap that Gazprom (OTC: OGZPY), Russia’s state-controlled – and the world’s largest – gas behemoth, is barely recouping extraction costs. The value of Gazprom depository receipts traded in London and New York are down 36% and 49%, respectively, in barely a year.

The price of exported gas is adjusted based upon a basket of crude oil and oil product prices. As both have been going down, so also has the revenue realized from selling gas abroad.

In addition, competition from elsewhere – especially North African and other shipments of liquefied natural gas (LNG) – are reducing reliance on Gazprom’s long-term, take-or-pay contracts (which require the buyer to import a set amount per month or pay as if they had).

That competition will increase as American LNG exports are phased in.

Even Gazprom acknowledges that the U.S. will account for at least 6% of the world’s LNG market by 2020, up from 0 today. That merely accentuates the Russian export quandary. The much ballyhooed agreement to export gas to China will not result in a net addition of sold volume anytime soon.

Now, the price of this gas has not been disclosed publically. You can be sure that Beijing will be pushing for a lower price than what Russia currently charges Western Europe.

And my sources attest to the lower than expected proceeds moving to Moscow.

The country’s domestic situation is also deteriorating.

Russia’s Fuel Subsidies Are Hurting More Than They Are Helping

Russia subsidizes oil products and natural gas domestically to cushion the impact on consumers. That limits the ability of companies like Gazprom or Rosneft (the dominant state oil company) to offset revenue losses abroad by increasing domestic consumption.

As an example, the central portion of the country – including Moscow and the primary population centers of “European” Russia – is currently experiencing brutal cold and snow fall. Over the past few days, that has extended to the Pacific coast around Vladivostok.

As you would expect, domestic natural gas usage is approaching all-time highs.

Yet Gazprom is losing money because government regulations prevent it from setting a market price for gas that reflects this demand.

The price of gas in Russia is supposed to be undergoing a phased move to market levels. Alas, intensifying economic problems have obliged the Kremlin to delay implementation of this plan.

Which brings us to the main crisis now underway in Russia…

The Ruble is Crashing

The Russian currency, the ruble, is rapidly losing ground, with the currency down to almost 82 rubles to the dollar – and over 89 to the euro – in trading this morning.

The situation has deteriorated over the past year, as the ruble has descended from an average of 32 rubles to the dollar. It has made imports virtually impossible to afford and created shortcomings all up and down the trading curve.

That spells havoc for the Russian economy.

Normally, the Russian Central Bank (RCB) would use substantial hard currency reserves to prop up the ruble by buying the currency. That is now becoming unsustainable, because these reserves themselves depend on oil and gas exports.

The low prices Russia has realized have deeply cut the RCB’s ability to prop up the ruble against a continued onslaught on the currency’s value.

Here’s the problem in a nutshell…

Russia’s Central Bank Is Making Things Worse – But There’s a Way to Profit

Every time a central bank intervenes to artificially set the value of a local currency, traders on the other side see an opportunity to press the matter. This does two things. First, it sets the central bank move as the “new normal,” requiring the bank to expend more hard currency tomorrow to maintain the level realized today – and the same again the day after.

Second, it reduces the actual market costs of assets denominated in the local currency. This increases the buying power and impact of foreign currency inside the country even more.

The last time there was a steep drop in the value of the ruble (down to the low 60s to the dollar, or a third less than the current level) the RCB’s actions included requiring exporters to exchange hard currency proceeds at an abnormally low exchange rate and restricting access to dollars and euros.

Both measures had an immediate negative impact on Russian oil companies – the first cut deeply into revenues; the second made the next exports even more expensive because the trade in oil is denominated in dollars, not rubles.

By restricting access to foreign currency, the RCB has just made the sale of oil abroad even less profitable for Russian companies.

The result has been a chilling effect on the Russian economy as a whole – having nothing to do with the weather.

There is an easy way to gauge this result by using one thumbnail indicator – the Direxion Daily Russia Bear 3X ETF (NYSEArca:RUSS).

As the name implies, this exchange-traded fund rises three times faster than the Russian market falls. It is up 14% though noon today alone, 26.3% for the week, and 65% for the month.

This ETF remains the best way for a retail investor to profit from a weakening Russian economy.

But it must be used very carefully – if the Russian market recovers, RUSS will decline three times faster than the recovery.

As for a way out of this mess, it is, as I’ve said before, the introduction of oil production limits. That is the most direct way of increasing prices and lowering the drain on the ruble.

Unfortunately, that would require coordination between the world’s major oil producers, but Saudi Arabia has yet to show a willingness to seriously consider bringing this about.

[Editor’s Note: In case you missed it, you can read Kent’s take on how badly the oil “crunch” is affecting Saudi Arabia itself here.]

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  1. gunther wilfinger
    January 21st, 2016 at 08:48 | #1

    waiting for your info

  2. Garry Heninger
    January 21st, 2016 at 08:50 | #2

    What should I buy

  3. Charles Torrey
    January 21st, 2016 at 11:11 | #3

    What is your most current estimate for the price of oil per barrel in 2016 based on current anticipated demand, anticipated reduced production, anticipated Iranian production, and without OPEC adjusting their production.
    Thank You
    Charles Torrey

  4. Thomas Davis
    January 30th, 2016 at 18:34 | #4

    On another thought…seems to me America’s solution to the Saudi attack on our fracking industry, would be as simple theoretically as the U.S. Govt.(EPA) getting the hell out of the way and the industry itself further developing the technology to bring the expense down closer to what it is for the Saudi’s to produce…I’m sure more erudite men than myself are already at work on this.

  5. Jim Vasko
    February 22nd, 2016 at 19:52 | #5

    @Thomas Davis
    You raise a very interesting and “key” issue for North American Oil extraction. We frack and crack and drill deep wells on land and in the Gulf of Mexico. The Saudis on the other hand almost find their oil as easily as Jed Clampett. I think we would be hard pressed to improve technology to the point where our extraction costs versus the Saudis’ are equalized. I am not an oil expert, so this is a “poor man’s” view of a complex industry, and I would certainly welcome improved technologies and better extraction efficiencies in North American Oil fields.

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