Putin’s energy empire has just hit the wall

1 Dec

When a sugar-daddy goes sour…

In recent years it seemed that Russia is the energy world’s sugar daddy. If there was a pipeline, refinery or an energy company for sale, Russian interest was taken for granted, with good reasons. Large, expensive projects came to life in Europe with Russian backing (think of North Stream, $20bn). And even larger projects seemed borderline possible, despite the huge price tag and the screaming lack of economic rationale (think of South Stream, price tag maybe $65bn).

And all this is abruptly finished now, unless oil prices miraculously jump back to previous levels. They don’t seem moving that way right now, Brent oil prices hammered by OPEC’s no cut to below $75 (and still falling)… This cuts Russian oil export revenues by more than $80bn, and if you add the decline of gas sales prices and the effect of economic sanctions, the total bill, even according to the Russian Finance Ministry, could be $140bn. Or more, as this prediction was made a few days ago when oil prices were higher… That is a lot of money, about 7% of GDP. Or just as a comparison, the current account surplus was $33bn in 2013, according to the IMF.

south_stream_balloon2Source: own pictures

The falling ruble is cutting real consumption and is boosting inflation to above 8%, and true to form, the possibility of both currency and price controls have been raised. But this does not change the fact that there is a huge cut on what Russia could spend, and especially what it could spend on financing acquisitions and projects abroad…

And not only will falling energy prices hit the current account, even capital flight is at a serious level – it is likely that the outflow will be well above $100bn this year. This capital flight will finance something abroad, but that something will not be politically motivated prestige investments with dubious returns. Indeed, large Russian companies are struggling with refinancing their maturing debts, despite the sanctions (not an easy task – Rosneft for example asked for $49bn in October from the Pension Fund).

The ultimate argument against gloom about Russia is often the large size of its FX reserves, still above $400bn. There is only one problem with this argument: if you drill a bit deeper, it turns out that when these reserves are needed, they may not be there, or in an illiquid form. When some of the Pension Fund may be invested in the Sochi Olympics that should not exactly count towards liquid assets in an emergency…The chart below is based on a good overview from the Peterson Institute.

Russia financial reserves_Nov 2014_engSource: Peterson Institute for International Economics, Central bank of Russia

Russia will have its hands full of trying not to go bankrupt, and will have no resources for economic expansion. The government may save the Pension Fund. But we leave it to the readers’ imagination what will happen to the financing of the South Stream pipeline and the proposed second nuclear power plant in Paks, Hungary…

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