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The Tie That Binds

Whereas the macroeconomic hyperlinks between Russia and oil are well-known, I imagine that it is helpful to evaluate how they work. As a result of Russia produces so much oil and gasoline, it is the oil price that determines export and government revenues. The ruble is used as a security valve to regulate the impression of these factors on the economy, and that, in turn, determines the absolute level of dollar GDP.

THE Importance OF HYDROCARBONS
Russia produces just under 10 mln bpd of oil, as Ill as 550 bln m3 of gasoline (also round 10 mln boepd) and huge quantities of other commodities, which in recent times have broadly followed oil prices up and then down. The percentage of Russian GDP made up of oil and gasoline is a moot level, as a lot of the hydrocarbon production is sold cheaply on the domestic market, enabling different sectors to reap the advantages. One way round that is to take a look at the entire value at world market costs of the oil and gasoline offered. In 2008, this was $590 bln, or 36% of 2008 GDP; this year, I forecast it to be $340 bln, or 27% of 2009 GDP.

EXPORTS
Russia exports around 5 mln bpd of oil, 2.5 mln bpd of oil products and 200 bln m³ of gasoline, producing export revenues of $280 bln from hydrocarbons in 2008, or sixty three% of whole export revenues. Total, commodities account for greater than ninety% of exports. As a result, it is the oil worth that acts as the key determinant of the trade and present account balances.

KEY RELATIONSHIPS
ˆ Oil determines the reference RTS Index level. For a lot of its existence, a pretty good rule of thumb for the level of the RTS Index has been 22 instances the oil worth minus 200. This framework explains not solely the 2,000 point fall in the index in 2008<09, but also the 300 point bounce that we have enjoyed over the past couple of months.

ˆ Spreads are the principle secondary factor. Though spreads are themselves decided by the oil value (if the oil value rises $10/bbl from present levels, they move by round 75 bps, and if it falls, they rise by twice this amount), the addition of spreads improves the R2 of an index model from 83% to ninety%. A mannequin including spreads offers the fair RTS Index level as 16 times the oil value

minus 250 plus 1,000 divided by the cash bond spread.
– To quantify the hyperlinks; I calculate that RTS earnings move up by round 9% for every 10% improve in the oil price. This is because 78% of the index is made up of commodity stocks, whereas the domestic stocks comprising the rest of the index benefit from the rising ruble, which strikes up by a round 3% f or e very 10% i ncrease in t he o il p rice. Moreover, a s spreads are oil price dependent, so too is the P/E ratio, as honest value strikes 5% for every 10% move in oil.

– Take profit until you are an oil bull. At an RTS Index level of 800, the market is already pricing in $50/bbl oil and cash bond spreads of four hundred bps, which are pretty near present levels. A fall within the oil worth to underneath $40/bbl would drive the RTS Index right down to below 600, while a break above $60/bbl would take it up to 1,000. Investors who suppose that the oil worth is more likely to fall again over

the summer should therefore look to take revenue now.
– The macroeconomic framework will stay oil worth dependent. At market costs, Russia’s hydrocarbon manufacturing makes up one third of its total degree of GDP, in addition to half of federal authorities revenues and 60% of exports. As we’ve already shown, which means the ruble has to be used as the balancing factor between the oil price and the economy.

– What could break the link between Russia and oil. Previously, the link has been damaged on the upside by geopolitics (the occasions of September eleven, 2001) or a strong independent theme (world stability and the rise of the middle class in 2007) and on the downside by collapse (Russia’s default in 1998) or fear (the YUKOS case). While US President Barack Obama’s reset of relations between the

US and Russia supplies a good wind, it’s unlikely to overwhelm the skepticism ensuing from corporate governance scandals and low payout ratios, and the market is more likely to struggle to flee from its oil value dependency for the time being.

Author Box Jeffrey F. Combs has 1 articles online
Jeffrey F. Combs, 52, MBA, a veteran of Wall Road (Morgan, Stanley; Lehman Brothers) has been residing and investing in Russia since 1995. He is a frequent speaker at Funding Conferences, and thought of to be an authority on the Russian and CIS funding markets.

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