The Tie That Binds

Whereas the macroeconomic hyperlinks between Russia and oil are well known, I imagine that it is beneficial to overview how they work. Because Russia produces so much oil and gas, it is the oil worth that determines export and government revenues. The ruble is used as a safety valve to regulate the influence of those factors on the economy, and that, in turn, determines absolutely the degree of dollar GDP.

THE Importance OF HYDROCARBONS

Russia produces just under 10 mln bpd of oil, as In poor health as 550 bln m3 of gas (additionally around 10 mln boepd) and enormous amounts of other commodities, which lately have broadly adopted oil costs up after which down. The percentage of Russian GDP made up of oil and gasoline is a moot point, as a lot of the hydrocarbon manufacturing is bought cheaply on the domestic market, enabling other sectors to reap the advantages. A method around this is to take a look at the overall worth at world market prices of the oil and gas sold. In 2008, this was $590 bln, or 36% of 2008 GDP; this yr, 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, generating export revenues of $280 bln from hydrocarbons in 2008, or 63% of total export revenues. Overall, commodities account for more than ninety% of exports. Consequently, it is the oil value that acts as the important thing determinant of the commerce and present account balances.

KEY RELATIONSHIPS

ˆ Oil determines the reference RTS Index degree. For a lot of its existence, a pretty good rule of thumb for the level of the RTS Index has been 22 times the oil price minus 200. This framework explains not solely the 2,000 point fall within 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 issue. Although spreads are themselves determined by the oil worth (if the oil worth rises $10/bbl from current ranges, they move by round 75 bps, and if it falls, they rise by twice this quantity), the addition of spreads improves the R2 of an index mannequin from 83% to 90%. A mannequin including spreads provides the truthful RTS Index degree as sixteen occasions the oil value

minus 250 plus 1,000 divided by the cash bond unfold.

– To quantify the hyperlinks; I calculate that RTS profits move up by around 9% for each 10% increase within the oil price. This is because 78% of the index is made up of commodity stocks, whereas the domestic stocks comprising the remainder of the index profit from the rising ruble, which moves up by a spherical three% f or e very 10% i ncrease in t he o il p rice. Furthermore, a s spreads are oil price dependent, so too is the P/E ratio, as fair value strikes 5% for each 10% move in oil.

– Take revenue except you might be an oil bull. At an RTS Index level of 800, the market is already pricing in $50/bbl oil and cash bond spreads of 400 bps, which are fairly near current ranges. A fall within the oil price to under $forty/bbl would drive the RTS Index down to beneath 600, whereas a break above $60/bbl would take it as much as 1,000. Traders who assume that the oil worth is more likely to fall again over

the summer should subsequently look to take profit now.

– The macroeconomic framework will remain oil price 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 got already proven, which means the ruble has to be used because the balancing issue between the oil value and the economy.

– What may break the link between Russia and oil. Previously, the hyperlink has been damaged on the upside by geopolitics (the events of September 11, 2001) or a strong independent theme (international stability and the rise of the center class in 2007) and on the downside by collapse (Russia’s default in 1998) or concern (the YUKOS case). Whereas US President Barack Obama’s reset of relations between the

US and Russia offers a good wind, it is unlikely to overwhelm the skepticism resulting from corporate governance scandals and low payout ratios, and the market is prone to struggle to flee from its oil value dependency for the time being.

Creator Field Jeffrey F. Combs has 1 articles online
Jeffrey F. Combs, fifty two, MBA, a veteran of Wall Road (Morgan, Stanley; Lehman Brothers) has been dwelling and investing in Russia since 1995. He is a frequent speaker at Investment Conferences, and thought of to be an authority on the Russian and CIS investment markets.

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