An American Gift Is Behind the Scenes of the Pending Russian Oil Move
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An American Gift Is Behind the Scenes of the Pending Russian Oil Move

by | published April 17th, 2019

Over the past several days indications have emerged that Russia may be breaking with Saudi Arabian-led OPEC over crude oil production cuts.

Or perhaps that is merely the conclusion Moscow wants us to draw.

Because what’s about to happen is a nice windfall provided to Putin’s government…

By the White House.

Let me set the stage for you…

Strained Reasoning

First, we had public statements from Russian Finance Minister Anton Siluanov that the Kremlin has limited the effect oil prices have on the central budget.

Then, Siluanov maintained that this same national budget was based on oil exports priced at only $40 a barrel.

Now, both statements would indicate Russian officials had intentionally severed the nation’s revenues and expenditures from oil almost altogether. That would be a very important development and a major change from how finances have been structured.

If true.

Yet it appears strained reasoning at best.

It is true that the current budget has been calculated using a lower expected price than in the past for Urals Blend Export Crude, the primary Russian export grade trading at a significant discount to Brent (which is the most often used global pricing benchmark set daily in London).

That export price, however, has only been met in the last few weeks, meaning the budget has remained in deficit for most of the last year. Better overall budgetary improvement has resulted from two non-oil considerations:

  • Higher rates of tax collection (especially the value added tax, or VAT), and
  • Delays (or effective cancellations) in selected budgetary expenditures.

Both these elements, rather than oil prices, have been the primary budgetary levelers.

But they have come at their own cost…

The Russians Have a Problem… Or Two

An average of Russian media surveys puts popular support for President Putin at about 60%.

That would be a very healthy figure in the West. But it is really approaching his lowest levels since 2013 and comprise a drop of some 20% in less than a year.

Additionally, oil export proceeds above the cutoff (essentially, $57 a barrel for Urals Blend) are expected to be folded into the National Wealth Fund (NWF) – essentially the Russian version of sovereign wealth fund. Such funds are expected to segregate oil export profits for designated investment use.

In Russia’s case, NWF revenues are expected to address the ongoing problems in meeting national pension payments.

Essentially, Moscow has taken addressing the pension (and some other social welfare program needs) out of the regular budget to be met from a fund financed by higher oil prices.

The anecdotal evidence I receive from Russian colleagues and contacts indicates on-time pension payments continue to be a problem, and upon occasion, resulting in public displays embarrassing to the government.

But the problem runs deeper.

Expenditures off the Books

Russia still runs a number of programs off the books that have nothing to do with social welfare. These are also financed out of oil and natural gas exports, but via proceeds largely kept out of the country.

If these opaque expenditures from trading revenue kept abroad had also been from a NWF-like or other sovereign wealth fund clone, it would at least follow what is done in most other countries where proceeds from raw mineral sales are used as investment.

These nations are well aware that injecting hard currency (most oil and gas sold worldwide is denominated in dollars) directly back into their domestic economy is inflationary, thereby increasing the cost of producing oil/gas and lowering the profit margins for the next sale.

Pensions remain among the most inflation-generating of government expenditures. That’s because the stipends are not saved (which would withdraw the currency from the economy) but are immediately spent on staples (food, housing, clothing) in market exchange.

This strategy is immediately inflationary.

Add to this the further problem that the NWF is itself a domestic institution, making anything it does likely to heat up prices.

It is for this reason that the continued existence of such “off-budget” expenditures and those funded through NWF are providing undercurrent support for domestic inflation and another round of testing the foreign exchange value of the ruble.

With Every Conflict Comes Rising Stars in the Defense Industry…

The U.S. isn’t only dealing with Russia on a financial oil and energy front.

We’re also dealing with China on a geopolitical front.

Confrontations in the South China Sea between the U.S. and China have been escalating, with U.S. bombers flying overhead and Chinese warships sailing silently.

China has been getting more aggressive, and sending its most sophisticated warships to this highly disputed region, and the U.S Navy is getting even more uneasy about it.

Which means that defensive action must be taken.

Now, that doesn’t mean the U.S. is accepting defeat. Not even close.

But defensive technology is always a good strategy when it comes to conflicts like this.

And this contractor has the Pentagon locked in on its technology – technology that could beat the Chinese at their own game.

These also temper how one reads Russian numbers.

For 2018, official figures indicate that budgetary expenditures came in at 16% of GDP, the lowest figure since 2006. Yet more of those expenditures remain outside the budget, and not all of them are actually paid. The situation is better than in the recent past, but hardly what the Russian officials are pedaling.

Added to all of this are statements from several of my sources over the last week that Russia may begin pulling back from the production cut agreement made with Saudi Arabia and OPEC. That caused a brief pull back in crude prices. However, the oil price is again moving back up.

Russian officials understand that they have some flexibility.

It’s really quite straightforward.

Playing Around with Sanctions

As I have noted previously in Oil & Energy Investor, declining oil production in Venezuela, Libya, Nigeria, and even Mexico, has provided opportunity for others to increase volume without adversely impacting price.

Then there is the looming renewal of U.S. sanctions against Iranian oil sales, set to kick in the first week of May.

Those should have taken hold early last November, but at the eleventh-hour Washington provided a 180-day exemption to the eight largest importers of Iranian crude. They may cut further into global supply, assuming the White House actually moves forward with them this time.

Meanwhile, other U.S. sanctions have begun to take an additional bite out of Venezuelan oil exports, further exacerbating the situation there.

And it is here that Trump Administration policy has provided an unanticipated gift to Putin.

The Unintentional Consequences of U.S. Sanctions

Despite many believing the White House will not deliver again on the full punishment against Teheran and will temper the sanctions against Caracas in advance of a desired regime change there, Europe is taking no chances.

This is the U.S. gift to Russia.

Europe has been pulling back from buying Iranian and Venezuelan oil, opting to replace it with imports from Russia. This window may not be open very long, but while it is there, Moscow intends to sell more oil to Europe.

In my judgment, this is the real reason for a likely increase in Russian oil exports.

A greater part of the European market has opened, thanks to oil players there not wanting to chance becoming subject to U.S. secondary sanctions for importing Iranian or Venezuelan production.

This short-term opportunity will improve Russian revenue, and it is already having an effect.

While oil traders never provide transparent Urals Blend prices, several have been telling me for the last two weeks that they expect the Urals discount to Brent will shrink by at least 30%.

Russia has the prospect of selling more oil to Europe at a better price. The Europeans, meanwhile, have limited immediate realistic alternatives. There is excess U.S. shale oil available, but unfortunately, it is too expensive to move large additional amounts to the continent.

Certainly, such a very nice largess to the Kremlin is an unanticipated result from U.S. policy decisions targeted elsewhere.

Sincerely,


Kent

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