‘Russia is going to be in a very difficult fiscal situation by 2017. By the end of next year there won’t be any money left in the oil reserve fund,’ says Unicredit
Russia has fallen into full-blown depression and faces a mounting fiscal crisis as oil and gas revenues plummet.
Output from country’s state-owned gas giant Gazprom has collapsed by 19pc over the past year as demand shrivels in Europe, falling to levels not seen since the creation of the company at the end of the Cold War.
A report by Sberbank warned that Gazprom’s revenues are likely to drop by almost a third to $106bn this year from $146bn in 2014, seriously eroding Russia’s economic base.
Gazprom alone generates a tenth of Russian GDP and a fifth of all budget revenues. It will be several years at best before the country benefits from a new pipeline deal with China.
Russia is already in dire straits. The economy has contracted by 4.9pc over the past year and the downturn is certain to drag on as oil prices crumble after a tentative rally. Half of Russia’s tax income comes from oil and gas.
Core inflation is running at 16.7pc and real incomes have fallen by 8.4pc over the past year, a far deeper cut to living standards than occurred following the Lehman crisis. This time there is no recovery in sight as Western sanctions remain in place and US shale production limits any rebound in global oil prices.
“We’ve seen the full impact of the crisis in the second quarter. It is now hitting light industry and manufacturing,” said Dmitri Petrov from Nomura.
“Russia is going to be in a very difficult fiscal situation by 2017,” said Lubomir Mitov from Unicredit. “By the end of next year there won’t be any money left in the oil reserve fund and there is a humongous deficit in the pension fund. They are running a budget deficit of 3.7pc of GDP but without developed capital markets Russia can’t really afford to run a deficit at all.”
A report by the Higher School of Economics in Moscow warned that a quarter of Russia’s 83 regions are effectively in default as they struggle to cope with salary increases and welfare costs dumped on them by President Vladimir Putin before his election in 2012. “The regions in the far east are basically bankrupt,” said Mr Mitov.
Russian companies have to refinance $86bn in foreign currency debt in the second half of this year. They cannot easily roll this over since the country is still cut off from global capital markets, so they must rely on swap funding from the central bank.
The authorities can cover part of this from the country’s current account surplus, but a “financing gap” of $10bn to $15bn a quarter remains. This implies a slow depletion of the central bank’s foreign reserves.
The official reserves have dropped from $524bn to $361bn since the Ukraine crisis first erupted in late 2014. Unicredit said the true figure is nearer $340bn once other commitments are stripped out.
Companies and banks have already slashed their hard currency debt by $170bn in a drastic deleveraging over the past 18 months. This whittles away the dollar debt burden, but at a terrible long-term cost for Russia’s productive economy.
“Frankly, I don’t think they can weather this crisis. There has been almost no investment in new oil production except in Western Siberia. They are still relying on old Soviet wells,” said Mr Mitov. The depletion rates in the traditional fields of Western Siberia are running at 8pc-11pc a year.
“They can’t keep up production without access to foreign imports and technology, so we think there could be a fall in output of 5pc to 10pc by 2018,” he said.
Lukoil’s vice-president, Leonid Fedun, said in March that Russia’s oil output could fall 8pc by the end of next year, taking 800,000 barrels a day (b/d) out of global markets, with major implications for the balance of supply and demand.
Any such loss would be corrosive for Russia. It has not happened yet. Russian producers have taken advantage of a new tax regime to raise output this year to 10.7m b/d, close to the post-Soviet peak. But they are relying on legacy investments and imported machinery that must be replaced sooner or later.
Mr Putin’s long-term strategy depends on opening up the Arctic and the vast shale reserves of the Bazhenov basin and the Volga-Urals. Drilling in these regions is covered by sanctions, forcing Western firms to freeze joint ventures.
Russia lacks the technology to make these projects viable. Average fracking costs in Russia are three times higher than those of cutting-edge drillers in the US.
The oil slump is, in one key sense, worse than in January, when markets thought it was a short-term shock triggered by Saudi policy. This time futures contracts are factoring in no real recovery in prices for two to three years.
The Russian authorities have the crisis under control for now. They have allowed the rouble to fall rather than burning up reserves, providing a cushion for the budget and for oil and gas producers. But this policy is inflationary, and politically toxic.
The underlying strain remains. Russia bet its future on oil, gas and the commodity boom, letting its manufacturing base atrophy in the glory days of the strong rouble.
It has now been left high and dry by the commodity slump, a textbook case of the Resource Curse. Western sanctions have tightened the vice. “The real problem is that Russia’s economy is going nowhere,” said Mr Mitov.
