Only time will tell whether the recent collapse in the oil price has been caused by a concerted effort by the United States and Saudi Arabia to put pressure on Russia and possibly Iran. Whether it is true or not the impact of the falling oil price is already enormous. Iran which generates 75% of its fiscal income from oil suddenly will not be able to balance its government books next year meaning that more than ever it needs to reach a deal over its nuclear program that would end sanctions limiting its oil exports. The Russian case though is even more extreme and dangerous as President Vladimir Putin is being pushed into an increasingly tight corner. Since September the Russian ruble has already lost almost half its value against both the U.S. dollar and euro and there has been record flight of private sector capital out of Russia in Q4 (could be as high as $50bn). The reaction of the Russian central bank has been to increase interest rates by a massive 6.5% to 17.0%. The goal of the snap decision was to stop the outflows of capital out of Russia, restore confidence in the currency and to calm the markets down but instead we got massive intraday volatility (16 December) with the rubble closing 5.7% lower against the dollar having been at one point in the trading session 23% down!
The issue for Russia is that the economy is highly dependent on the export of energy commodities. Oil, gas, petroleum products and coal made up 70% of all exports in 2013 with nearly half of government’s tax income coming from mineral extraction taxes and customs duties on oil and natural gas. In June the Brent oil price was $114 and as we come to the end of 2014 the price is below $60. To make matters worse the majority of Russia’s gas export contracts to Europe are nearly all tied to the oil price which means that gas revenues are also set to fall. Spot prices in Europe are already beginning to reflect this and are down 18% year to date with coal prices close behind (16% down).
Not surprising the Russian central bank is very concerned about the economic situation. Not only are they projecting inflation to reach 11.5% in 2015 but they are also expecting a 4.5% fall in GDP next year. However, it could be much worse and it’s hard to ignore a sense of déjà vu; back to 1998 when Russia experienced crippling inflation and economic disaster as it defaulted on its national debt. In the political turmoil that followed Boris Yeltsin resigned as President and Vladamir Putin took his place. And with 1998 still fresh in the heads of the average Russian it will be extremely difficult for President Putin to persuade them that the rubble is a solid store of value. And if he looses that battle and then the support of his followers slackens then Mr Putin has a real problem, like Yeltsin before him.
What is likely is to happen is that the Kremlin will continue to blame the West for its woes and with nothing to lose will likely become more aggressive. This is not a good situation for Europe which is Russia’s third biggest trading partner which relies on Russia for 40% of it natural gas imports, 35% of its oil imports and a quarter of its coal imports (see import dependence for EU countries below).
It is also not good for the Ukraine and is definitely not good for Russian democracyas we will probably see a return to a comprehensive Soviet style police state. Once President Putin goes down this path we all have a real problem and so what Germany, the EU and the U.S. have to do is make sure that does not happen. And at the same time they should be able to use the opportunity to come to a successful end to the Ukrainian crisis.