Questions remain as to how well Russia's economy will be able to cope with low oil prices in 2016.
Russian Prime Minister Dmitry Medvedev, left, listens to CEO of Russian oil company Rosneft Igor Sechin during a visit to a far east plant Zvezda in Vladivostok, Russia. Photo: Sputnik via AP
Global oil prices are falling at an alarming rate. In the past week alone, the price per barrel has lost more than 8 percent – the biggest drop since March. The cost of the benchmark North Sea Brent blend, for February delivery, slumped below $37 a barrel, and there is currently no reason for the trend to slow down.
A major factor in this sharp decrease in the price of oil is a decision made by the Organization of Petroleum Exporting Countries (OPEC) on Dec. 4. Contrary to the expectations of many, far from reducing its production ceiling from 30 million barrels a day, OPEC raised it by 1.5 million barrels to the current level of actual production.
In doing so, OPEC effectively legitimized the situation in the global oil markets, which for two years now has been marked by a substantial excess of supply over demand. It is a basic law of economics that prices in such situations have nowhere to go but down.
Another factor here is a recent report from the International Energy Agency (IEA), which forecasts that the global oil market will remain oversupplied at least until late 2016 because of the inability of oil exporters to agree on cutting production.
A blow to Russia's budget
For many oil-producing countries, the current situation of falling oil prices is full of risk, and Russia, whose economy has been in a prolonged recession since last year, is no exception. And with oil prices falling below the $40 a barrel mark, the future would appear to be far from rosy for the Russian economy.
According to Russia's Ministry of Finance, the country's budget deficit will reach 1.5 trillion rubles (approximately $21 billion at today’s exchange rates) in 2016. In terms of the budget, this means an increase in the deficit to 5 percent of GDP, whereas in his recent address to the Federal Assembly President Vladimir Putin stressed that the deficit needed to be no higher than 3 percent.
Furthermore, the Ministry has repeatedly stated in the past that with oil prices at $40 a barrel or less, the government will be forced to take measures to raise income, to take a more conservative approach to spending, and introduce measures to stimulate economic growth.
In other words, budget cuts are expected, not least in welfare, which could hit ordinary people particularly hard. An alternative would be to reduce Russia's massive defense spending, but the government is hardly likely to do this, given the actual war with the unrecognized Islamic State of Iraq and Greater Syria (ISIS), the frozen conflict in Ukraine, and other terrorist and geopolitical risks.
Nothing left to chance
In a recent television interview, Prime Minister Dmitry Medvedev emphasized that, “If the need arises, if the times are hard, if we face a worst-case scenario on the oil and gas market, we’ll have to make adjustments. In this respect, the position of the Government will be absolutely realistic.”
It is worth noting that at the moment Russia's national currency is mirroring oil prices, falling day after day against the dollar and the euro. Today, the ruble is at more than 70 to the dollar, and more than 78 to the euro.
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That said, Deputy Finance Minister Maksim Oreshkin sees no macroeconomic reasons for the ruble to fall to 100 to the dollar in 2016. In terms of the balance of payments, the economy has adapted to oil prices in the region of $40-50 a barrel, so there should not be any more major fluctuations in the currency, he explained.
In the Finance Ministry's baseline forecast, with the price of oil at $50 a barrel, the ruble will be stronger in 2016 than forecast by the Ministry of Economic Development (63.3 rubles to the dollar), because of a decrease in capital outflows.
"The ruble could be significantly stronger in 2016 if we are talking about capital outflows at the same rates as we have seen in the second half of this year. The Ministry of Economic Development is assuming much higher capital outflows next year than we are expecting," says Oreshkin.
In his words, capital outflows from Russia in 2015 will not exceed $60 billion, and will be even less in 2016. This is despite the fact that capital outflows from Russia in 2014 amounted to a record $154 billion.
A world of cheap oil
Russian Finance Minister Anton Siluanov has already admitted that oil prices could even drop as low as $30 a barrel next year. The market is becoming increasingly convinced that the situation with excess supplies to the global market will continue for a significant part of next year as well, and this will continue to put pressure on prices.
The Finance Ministry expects oil prices to hover between $40 and $60 a barrel over the next seven years.
“As far as we can see, a serious increase in the price of oil – to more than $50 [a barrel] – cannot be expected. The oil industry is structurally changing. It could turn out that the global economy will not need as much oil in principle. We will live in a different world and under different conditions,” said Oreshkin last week.
It is no coincidence that Putin, in his address to the Federal Assembly, said that Russia needed to be prepared for the sanctions and the low commodity prices to last much longer.
As challenging as the situation is, there is some evidence that Russia is indeed prepared, believes Sergey Zhavoronkov, a senior researcher at the Gaidar Institute for Economic Policy.
The expert highlights the fact that although the fall in oil prices is not yet on the scale of the collapse of 2008, Brent prices at less than $40 a barrel still fall under the Bank of Russia's stress scenario. And since the financial authorities are considering such a scenario, it would probably not take them by surprise.
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The answer to the low prices includes the Reserve Fund, which, Siluanov estimates, amounts to 8.3 trillion rubles, or 11.3 percent of GDP. Such reserves, say Central Bank analysts, would enable Russia to withstand the current low oil prices even until mid-2017 to early 2018 without reducing spending.
At the same time, according to Zhavoronkov, what is happening to the Russian economy today is fundamentally different from all previous periods of low oil prices. The reason for this difference is the devaluation of the ruble by the Bank of Russia at the end of 2014.
In previous periods, devaluation followed low oil prices, but this time the Bank of Russia took the initiative and the risk, and has been proven correct. An all-purpose mechanism was conceived to help the economy withstand external shocks: floating the ruble. In effect, this mechanism protects the economy, enabling it to adapt to global changes.
Essentially, the devaluation of the ruble has helped the government to stave off some of the most disastrous effects of the fall in oil prices. As Chris Weafer, a partner at Macro-Advisory in Moscow, notes, every additional barrel sold produces the same revenue in rubles as before, allowing the government to keep the budget deficit in check.
Experts say that Russia's main challenge today is to maximize capital inflows and minimize the impact of the Western sanctions against Moscow that were imposed because of Russia's involvement in the conflict in Ukraine.
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As such, Russia is acting to diversify its market, moving away from Europe and seeking new partners in China and India. China, it may be recalled, is one of the world's biggest oil importers, and in recent months has signed several 'oil-for-loan' agreements with Russia. In May, Russia became the country's biggest oil supplier for the first time.
”If the current price of oil is maintained not for a few months, but for a long time, the Russian economy, as in 2015, will face increased risks of negative growth and a weaker ruble. But if oil recovers to closer to $50 a barrel, there will be some sort of micro-stabilization and nothing terrible will happen,” says Oleg Kuzmin, Chief Economist for Russian and the CIS at Renaissance Capital.
In this context, it is worth noting that both OPEC and the IEA forecast that in the medium term, oil prices will gradually increase between now and 2020, reaching $80 a barrel in five years' time.