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Oil prices: drawing tenuous links

It will take time – a considerable amount of time – to objectively reflect on 2014. Much will depend on what happens in 2015 which, as Dengi recently noted, is now a matter of widespread speculation. With this turbulent year drawing to a close, it is worth remembering that it had started out with the Russian 10 year bond trading at an almost all time low, with a yield of under 8%. By the end of the year, the yield has reached the mid teens.

From the elevated spirits of the run up to the Sochi Olympics, to the bewilderment of the severe, and seemingly unprovoked, slide of the national currency, the Russian economy has seen it all in 2014. But the fundamental, underlying question is: has the world’s 9th largest economy really changed that much in just twelve months, to justify such a spike in the sovereign’s yield?


Russian 10yr bond yield (2)

A good place to start looking for an answer is to consider the price of oil, which has recently commanded a lot of attention from the leading global newspapers. Is oil now really that cheap? I am not entirely convinced. If we were to plot the price of oil against gold (a defining measure of value over the past centuries) then the picture is quite different. In fact, some would go as far as to suggest that for approximately the last ten years the price of oil has been unnaturally high, and what we currently observe is simply a return to a more reasonable valuation in line with the historical average.

Macrotrends.org_Gold_to_Oil_Ratio_Historical_Chart (2)

Leaving this point aside for a moment, I feel it is important to note that the recent debates over the fall in USD denominated oil prices has focused on two broad areas: economics, particularly in relation to consumption, and politics, primarily focused on the governments of oil producing nations. These two themes have encouraged comparisons between the different oil-producing countries, and the apparent conclusion that Russia is going against the general trend.

Whilst the global effects of oil price fluctuations make international comparisons appealing, it is somewhat simplistic. In Russia’s case, commentators have ignored the key issue at the heart of the country’s current difficulties, namely – the fundamental shortcomings of the government’s policies since 2006, when it had paid off the last of the sovereign debts inherited from the USSR. Therefore, Russia’s present troubles are not directly linked to the drop in oil prices. In fact, if the current crisis and circumstances are addressed effectively, they can provide the country with a whole new set of growth opportunities, regardless of oil and minerals.

In relation to the media discussions, commentators have been quick to assess the immediate impact of oil prices on economic activity, particularly on consumption in various countries worldwide. A recent Financial Times article argues that falling oil prices have traditionally benefited the world economy as a whole, in part because populations, both end-consumers and industrial actors, have the capacity to increase spending. In the US, for example, falling petrol prices would be worth $500 per year to every household and benefit businesses as diverse as trucking and farming. Russia is likely to prove no exception to this rule. Once the wider economy adjusts to the new oil price (as the country’s latest budgeting for 2015 is already beginning to), both primary and secondary domestic producers are likely to witness a considerable improvement in margins. Petroleum was already cheap in Russia compared to many European countries, but the present situation could make it even less of a consideration for businesses in the coming year.

The second strand of the debate related to the oil price situation, is political. These debates largely concern the governments of oil-producing nations, with renewed speculation about ‘resource curses’, and the relationship between oil and institutional governance. On this matter, the FT offers a frustratingly simplistic view, stating that Russia has now become a “devalued and belligerent nation”. This misses the fact that Russia currently holds in excess of USD 100 billion(!) of US treasuries, which is a staggering one third of the holdings of major oil exporters combined (Ecuador, Venezuela, Indonesia, Bahrain, Iran, Iraq, Kuwait, Oman, Qatar, Saudi Arabia, the United Arab Emirates, Algeria, Gabon, Libya, and Nigeria)! Therefore, to draw a parallel with Venezuela, with the implication that the problems of each country are directly connected to their negative relationships with the West, seems to warrant further justification.

What is more important is the fact that such critique misses a key reason for the impact that the relatively insignificant correction of oil prices has had on the country. Two recent Vedomosti articles (here and here), which also draw parallels with Venezuela but in a more nuanced sense, suggest that it is in fact fundamental institutional problems, rather than low oil prices, which have had a considerable impact on the Russian economy. Both of the Vedomosti articles effectively dispel the idea of an ‘oil curse’. Maria Snegovaya usefully points out that the entire picture surrounding resource-exporting nations is more complicated than many think. Examples of successful oil-producing countries such as Norway and the USA show that oil is far from a curse.

Vladislav Inozemtsev, head of the Centre for Research on Post-industrial Society, further reinforces Snegovaya’s point, stating that it is not simply oil or “any easy source of revenue [which] can play the role of oil” which defines a country’s institutional strength or way of governing. Seeing the relationship between oil production and politics as primarily a question of responsible use of resources and revenues, Inozemtsev cites the various examples of Gulf countries where development and diversification of economies has occurred at a rapid pace. Indeed, in an expansion on this piece, he advocates the Emirates model as a possible means for Russia to take a more responsible approach to its resources moving forward.

Inozemtsev’s proposal is just one of many currently being put forward by those with expertise on Russia and its way out of this crisis. Indeed, the number of suggested approaches is matched only by the diversity of predictions about the coming two years cited above in Dengi, and the multitude of explanations for the current situation discussed recently in RBK Daily. Time will tell how Russia emerges from this storm, but what is clear in any case is that changes are due in some areas of the country’s economical and budgetary setup. With the shortcomings becoming more apparent in the current economic situation, now is an excellent opportunity to address them.

Let’s hope that the country’s government will make its New Year’s resolution and indeed commit to fostering a more vibrant and attractive investment environment both for the local and international investors. Happy New Year to everyone!

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