Russia: oil, debt and ruble. Outlook for 2016

As ruble slumps to record low and oil price drops below US$35, government officials make skeptical forecasts, let alone “non-systemic” analysts. What is in fact happening in the currency market and what are the prospects of the Russian ruble and economy, in general?

It should be noted that the December fall of ruble was predetermined - without no additional movements in economy – by the schedule of the foreign debt (mostly corporate) payments. The peak of the payments is in December – US$24.605 billion. For comparison the previous peaks fell on February and March – US$18.815 billion and US$14.174 billion, respectively. Last December cost the Russian economy US$33 billion.

Next year, the payments will sharply decrease. For instance, in January, it will make up about US$6 billion. The debt pressure on the ruble rate for 2016 will be weaker by about 1.5-fold than last year – the payment will total US$89.33 billion versus US$146.3 billion.

In other words, in case of stable economy, the current anti-records would be a local fluctuation. However, Russia’s foreign exchange market experienced a triple impact: debt payments have peaked, U.S. Federal Reserve System hiked the rate, and oil prices have crashed.

On December 16, the Federal Reserve increased the rate from 0.25% to 0.375%. The last time the Federal Reserve increased the rate in mid-2006. However, in 2007-2008 it was slumping dramatically up to 0.25% in December 2008. Since then, within nearly six years, the global economy lived in conditions of near zero interest rates. Since October 2014, it has been anticipating an increase in the interest rate, which prompted a dramatic increase in the dollar rate, outflow of the capital from developing markers and a wave of devaluation of alternative currencies of the “developing” countries, first.

However, the current increase in the rate is “minimalistic” and the market took a cue from growth expectations (for known reasons, it is about the Russian market first of all). Historically, a soaring rate would often result in … a drop in the dollar rate amid expectations of slackening economic growth in U.S. This time, the given effect was tangibly devaluated by the expectations of further ultra-soft monetary policy.  In other words, a direct effect of the Federal Reserve rate increase on the foreign exchange rates was knowingly limited.  

At the same time, for the market of raw materials, including the oil market, that was in a comatose state, it became a “the straw that broke the camel's back.” 

First, as it was mentioned above, raw-materials markets have been in anticipation of an increase of the Federal Reserve’s rate since October 2014. Second, they have been in the regime of general unfavorable economic environment. For instance, China as the main driver of the growth of the raw material prices in 2000s saw a slackening GDP growth - to 6.9% in Q3, which has become the minimum since 2009. Export reduction, oversaturated real estate market that triggered an unprecedented China decline of the steel production are just few of the indicators of systemic problems accumulated in China (first, the economy of “the  Celestial Empire” has increased to a certain limit for the current state of life and needs structural changes). A range of other, yet not so long ago dynamically developing markets, for instance the Brazilian and the “notorious” Turkish markets, did not look better.

Simultaneously, the developed markets experienced stagnation that was regularly replaced with uncertain growth. For instance, Japan’s economy was evidently slipping into recession in Q2 and in the beginning of Q3.

As a consequence, the prices of all raw materials and law-added value products slumped.  For instance, the steel price fell from about US$500 to US$210 per ton within a year, regularly crashing even more dramatically. Iron showed a similar dynamics.  Aluminum price fell from US$2.1 thousand to US$1.5 thousand per ton, while copper price shrank from US$7 to US$4.6.  The FAO Food Price Index proved at the same level as in 2009.

The petroleum market generally saw the same dynamics as the raw materials markets did in 2015, with the only difference that normally it was not anticipated.  OPEC as usually came out as the most successful cartel agreement in history, but this time the Saudis have successfully violated it.  As a consequence, oil and gas occurred in the “grinder” of the classical market pricing. By August, surplus supply totaled 3 million barrels/day – the level of 1998 - by data of the International Energy Agency.  Then it was a result of the OPEC’s decision to increase quotas by 10%. Total demand for oil in 1997 was 75 million barrels/day.

OPEC’s December 4 meeting had no practical results. It just confirmed the intention of Saudis to abide the old strategy and registered surplus supply that has now reached about 2 million barrels/day. OPEC’s daily total recovery reached record-breaking 31.695 million barrels.

There were some less significant factors that have influenced the pricing anyway:  oil recovery in U.S. has increased suddenly (by 11,000 barrels to 9.176 million barrels a day), rig count stopped falling.

Eventually, commercial oil reserves in U.S. began to grow at incredible rates – they increased by 9.3 million barrels within the first week of December amid the target of 2.8 million. In the second week of December, the reserves increased by 4.8 million barrels reaching astronomic levels – 490.66 million barrels. Petrol reserves increased by 1.73 million barrels, though most analysts forecasted a decline of the oil reserves by 1.8 million barrels.

As a consequence, yesterday, it was reported that U.S. cancelled the oil export embargo of 1975. The “physical” effect of that factor is equal to zero (it will allow balancing the North American oil market at best – U.S. will turn from a ‘gasoline pump’ into a raw exporter for Mexico). Meantime, the psychological effect of this factor may prove quite big. 

What will happen next? The bad news is that, first, the supply will be growing in the short-term outlook - Iran will increase oil exports in the near future. Second, sales problems may emerge. At present, the surplus commercial reserves in the OECD countries is 3 million tons (2.8 million was in 1998). The largest U.S. crude oil storage tank at Cushing is full by 80%. The oil storage facilities in EU are full by 97%. These facilities may be filled by 100% as early as in February. Actually, oil prices may crash to US$20 and lower at a short date.

As for long-term outlook, it is gloomier. The level of surplus oil recovery is almost similar to the one of 1998 and this veils the fact that in 2000-2010 the oil consumption increased from 74-75 million to 91 million barrels (in 2014). In other words, fundamental pressure on the market is much lower now.

Now, let’s have a look at the demand. The Federal Reserve has lately increased the economic growth forecast for 2016 from 2.3% to 2.4% (versus 2.5% in 2015).  This optimism may seem groundless – in October-November, industrial produce in U.S. saw negative growth rates (minus 0.4% and 0.6%, respectively).

Brussels is geared to a 1.7% growth. Japan managed to avoid recession in 2015.

Consensus-forecast of economists polled by Bloomberg anticipates a 6.5% growth for China in 2016, amid Chinese National Bank’s 6.6% growth forecast. At the same time, China seeks to increase the capacities of its oil storage facilities by 106.9 million barrels to the strategic level of 400 million barrels.

The economic forecasts for Mexico, Brazil and India are relatively favorable.

Generally, the International Energy Agency promises growth of demand by 1.2 million barrels/day in 2016.

As for oil recovery, it has actually peaked and will inevitably begin falling.  OPEC’s last recovery record was made at the expense of Iraq. Record-breaking export from Saudi Arabia was registered this spring and has not been outstripped yet, despite the growth in October. Such practice costs high to the Kingdom: the budget deficit forecasts for Saudi Arabia is 19.6% in 2016 (versus 21.6% in 2015).

International Energy Agency forecasts a reduction of the “stable” oil recovery in U.S. as early as in the beginning of the next year and a certain restoration at the end of 2016 (final losses will total 0.5 million barrels/day). Nevertheless, the Agency forecasts surplus oil supply and low prices throughout 2016.

If these forecasts are realistic, which it will mean for the Russian economy (given the decrease spending on the debt service)? Generally, US$40 per barrel is “apocalypses” in terms of the budget deficit of 5% of GDP or, which is more probable, budget cuts, reduction of the reserve fund to 200 billion rubles (it is noteworthy that these are by NO MEANS all reserves, but the most accessible “barrels”), increase of the dollar rate to more than 70 rubles, and continuing recession (by pessimistic forecasts – 0.7% of GDP). In case of apocalyptic scenario, next year will be a bit worse for Russia than 2015. However, in the background of the disastrous leaving year that “bit” will be nearly unobservable.

Relying on the IEA’s forecasts, one should take into account the specific reservations of its executive director, Fatih Birol, who told CNBC that low prices may attract some demand, so the market "may well see some surprises in the next few years balancing the market but with higher prices than we think for now." Actually, surprises are inevitable. They will happen soon rather than late. The oil race of 2015 is stalled. The Napoleonic plans to increase oil recovery in 2016 may fail and the oil recovery may suffer decline like it happened in Kazakhstan.

As much as the unexpected sustainability of non-traditional oil extractors that was secured by financial “steroids” in the leaving year may fail unexpectedly.  Finally, IEA’s assessments that Saudis are ready to continue the oil damping may be too optimistic – El Riyadh’s successes in the foreign fronts are more and more doubtful, expenses will sure be higher than envisaged and the directly accessible financial reserves will turn less than usually. Any of these factors is enough to trigger growth of oil prices.

Yevgeniy Pozhidayev