Despite the panels devoted to the current crisis, war with Iran, and ongoing closure of the Strait of Hormuz, there was nothing approaching a reckoning with our predicament which has since expanded dramatically. You lose a flow of ten million barrels a day and a fifth of the global trade in LNG, things break hard and fast. Many seemed to mistake crisis for opportunity. Sure, gas players are going to see margins soar as they bring product to market. Sure, oil producers will enjoy the whirlwind as physical markets West of Suez level with those East of Suez in a race to buy barrels. But whatever new oil and gas projects investors back today will, at best, meet existing demand that is now being destroyed.

It will take years to build new infrastructure in many cases, infrastructure competing with whatever governments can burn, install, or run to secure energy. Coal, renewables, batteries, nuclear, everything is back on the table, yet everything leads back to the same conclusion. Importing just-in-time energy is a terrible choice in a world where the United States does not preserve freedom of navigation, where drones and missiles en masse have destroyed the fiction of untrammeled unipolar American dominance. Those who insist on promoting “pragmatism” are fighting the last war. They cannot fathom that the prime drivers of clean energy adoption are economics, speed, flexibility, and innovation, not ideology. While ideology has some role to play in policy, it is reliably those clinging to traditionally higher-margin sources of energy production, investment, and business models who are most emotional in railing against renewable dominance as some woke conspiracy, even if they never utter the words. Power that’s cheap to install, quick to deliver, and increasingly cheap to hedge and manage is pragmatic. Chasing financing worth over $10 billion for an import-export terminal whose costs compound between infrastructure, supply contracts, and new levels of geopolitical risk doesn’t look so pragmatic.

In private, everyone I spoke to or overheard seemed paralyzed by the realization that something fundamental has been irreparably damaged, something we dared not name. We found ourselves reluctant to even say ‘China’ onstage. The mood made it feel unseemly to interrupt the LARPing about our resolve to compete for the future. Even the mining and metals attendees, for all their gratitude for governments’ sudden desire to help, were staring at their shoes. They had more to say about what they didn’t want, didn’t like, or couldn’t do without help than how they intended to compete. Instead of boldly committing to build like their Chinese counterparts, they spoke of their shareholders’ demands, the costs of infrastructure development, difficulties with permitting. Their competitors don’t waste their breath doing so.

The mighty roughnecks, miners, and traders who meet the globe’s voracious appetite for molecules of every sort seemed small, almost cowed even as they spoke of building. None admitted aloud that their appetite for mining mergers was self-defeating, that their calls for more oil and gas investment are already too late. The more they consolidate copper, critical minerals or push new exploration plays with grand ambitions, the more Chinese competitors with a real appetite for risk will build instead. Investors will claim they want to fuel and wire the world when they want governments to guarantee their returns. I say this as someone who supports de-risking private investment for key components of industrial policy. But you need to want it, not cower in fear of the next earnings call.

This was just my second time at CERAWeek. Last year, the same undercurrents were present. This year, they’d gone from gentle irritant to a self-imposed straitjacket, as though a Great Wall had descended upon Houston, separating it from the rest of the world. If we take my conversations from the week as indicative of market discourse for energy in the United States, it has become insular and parochial to the point of losing touch with global realities. Arguments about intermittency a decade old are rehashed, other countries’ experience ignored. Vanishingly few conversations I was in or overheard grasped the noumenal truth of Energy Dominance: other countries don’t want to be dominated. Molecules are now an explicit source of leverage and coercion in the hands of American policymakers just as they were for Moscow and now are for Tehran. Cleantech IP and factories may cluster in China, but there are more pathways to mitigate that dependency. We still speak as though people give a damn what Washington promises or America Inc. can deliver. Those bonds have been broken. Energy is now a weapon, not some neutrally traded good. Whether in crisis simulations or the halls of power, Americans must accept the rest of the world wants to de-risk from us as much as China.

There’s false comfort in experience, a confidence that we’ve seen enough to map whatever is happening today onto our own pasts or previous instances of History. But as my father liked to repeat, honoring his PhD advisor, the implications of the obvious are not themselves obvious. Energy folks are full of such confidence because without energy, the global economy grinds to a halt. No one can deny this. But the implications of interruptions to the flow of energy markets for macroeconomics and geopolitics elude an industry still convincing itself today’s shock is bullish for oil and gas when it’s actually bullish for everything else.

Today’s shock exposes the fragility of our really-existing supply chain for oil and natural gas. It turns out that when those with their finger on the button play games, they’re intermittent too. When faced with interruptions of such immense scale, there aren’t good options. The conference attendees could be forgiven for their defensive crouch, clinging to irrational optimism. Markets have never seen a demand adjustment on the scale necessary to rebalance from the current shock. The best analog I can think of is not the crises of the 1970s, but rather the Asian Financial Crisis and its sister catastrophe in Russia.

Currency shortages inspired a generational lesson across the economies affected in 1997-98. Each one learned painfully from the wisdom of speculators. Were these nations to allow cross-border flows of capital without much hindrance, their only insurance could be to sit upon massive reserves of foreign currency to mobilize in a crisis. With those reserves, they could intervene in currency markets and prevent a rapid depreciation whenever foreigners decided to bet against them. The structural effect of these events locked in the preference for Russia and Asian exporters to engineer consistent trade surpluses, securing this hard currency. Never again would foreign speculators be allowed to threaten the national welfare so easily. National leaders were content to make the ensuing distortions faced by the global economy everyone else’s problem. They’d take care of their own first.

The crisis had significant downstream political consequences, nowhere more violently for geopolitics than Russia. China was technically unaffected by the runs on the currency, but in the aftermath, it fused its industrial aspirations with a larger regime of macroeconomic management to destabilizing effect for the global economy. Stability flowed through exchange rate management. China used capital controls and a lopsided growth model. Initially dependent on the rise of manufacturing exports, the economy became dependent on high levels of investment once the export engine failed to uplift the broader economy efficiently. Russia used austerity and a lopsided growth model that never recovered from its export-dependence, one exacerbated by the fact that Russia’s key export was energy, a commodity with volatile prices. China over-invests where Russia under-invests. But the political economy of both systems is strongly tied to the formation of trade surpluses and, whenever possible, budget surpluses. Both models for economic growth were victims of their own success. Both regimes have struggled to find new models while navigating the economic distortions created by their preference for reserve accumulation.

The current energy shock is more akin to the financial heart attacks seen in 1997-1998 than previous supply shocks. Instead of stashing currency to survive, energy must be hoarded, husbanded, procured in new ways. Governments that survive will take the logic of reserve accumulation and apply it to energy, energy security, and foreign policy in new ways. One can build energy reserves by stockpiling crude oil, natural gas, and coal. But none of these provide safety unless you produce them at home. When physical shortages on this scale emerge, even the closest of allies panic and turn to interventions that may threaten your supply. Resilience therefore means building out as much solar, wind, battery, and nuclear capacity as fast as possible. These value chains pose their own constraints, but the need to establish redundancy and minimize trade dependence strikes at one of the core conceits of the Pax Americana that US policy is killing — energy systems will not be protected as a public good and freedom of navigation will not be guaranteed. Rebuilding energy security will eventually recast security relations in ways we cannot yet accept or understand.

This race for security differs radically from the 1970s and early 1980s. A world where electrons don’t just meet marginal energy demand, but destroy existing molecule demand at an accelerating pace is destabilizing. China’s capacity to deflate prices globally is an energy weapon. Oil, gas, and mining companies must contend with a new energy landscape. Manufacturing learning curves, material and market innovation, and security priorities insensitive to costs will shatter business models or expectations rooted in a world still policed by American power. We can little afford to keep up with the roughneck rhubarb, rooms full of people saying the right words to appear as though they’re having a conversation. Most of the conversation is happening elsewhere, in conditions of even greater scarcity. The race for AI launched debates about how to best meet the future’s energy needs in the US, debates the Trump administration has never entered in good faith. One can’t race for molecules that don’t exist. That means building a different future. As we mumble into catastrophe, I can’t help but think it’s been a good ride. It may never be this good again for oil and gas.

We are part of one civilization – Western civilization. We are bound to one another by the deepest bonds that nations could share, forged by centuries of shared history, Christian faith, culture, heritage, language, ancestry, and the sacrifices our forefathers made together for the common civilization to which we have fallen heir.

And what of that civilization? We share histories, heroes, villains, and beliefs. But they are never neutral implements in the mouths of politicians, in classrooms, in the screeching about our common identity under attack. Calling upon Europe to be proud of its past is a contrivance that suits Rubio perfectly, peddling a sanitised vision of pure countries once untainted by mass migration. Yet he is silent on the architecture of civilization that produced the belief that homogenous European homes were a natural state: the forced relocation of millions of ethnic minorities in reformed central and Eastern European states following Nazi Germany’s surrender.

The hysteria of the American body politic is not a new phenomenon. It’s human to cling to articles of faith in the nation’s capacity to renew itself, that the irrationality, greed, venality, and thuggish regime — yes, it’s a regime — that is now ensconced in the executive branch is merely a dream from which we will all wake up. That so many in and adjacent to the American policy world remain committed to the absurd proposition that there is anything redeemable in what’s unfolding should be a mark of dishonor. Their intellectual cowardice and emotional distress betray a need for comfort food. They can’t stomach what Trumpism has wrought. These souls seeing signs of salvation in the “ideological victory” of the Trump administration in Europe are completely blind to how pyrrhic a victory it may prove. They complain that America has borne too many burdens for too long and act as though the project of American primacy delivered nothing for its engineers, its guarantors, for America’s absurd wealth. Satisfied with their outrage, they wash their hands of having utterly failed to imagine how to invest us poor voters in their foreign adventurism or retrenchment, in their versions of an industrial renaissance, in their idle art of the possible.

Civilization is not a common good, nor do its proponents in Washington project a vision blessed by those it governs. Lacking legitimacy, it turns to force and graft and greed to sustain itself, feasting on the public it claims to defend while preparing violence and coercion until it is well and truly stopped. If Rubio’s pretty talk of civilization matters, why the deafening silence for how his rhetoric marks an American turn towards petty interventions into the Continent’s politics for its own gain in much the same way Putin himself once spoke of Ukraine:

I am confident that true sovereignty of Ukraine is possible only in partnership with Russia. Our spiritual, human and civilizational ties formed for centuries and have their origins in the same sources, they have been hardened by common trials, achievements and victories. Our kinship has been transmitted from generation to generation. It is in the hearts and the memory of people living in modern Russia and Ukraine, in the blood ties that unite millions of our families. Together we have always been and will be many times stronger and more successful. For we are one people.

America is cruel to be kind. That is the logic of those invested in Trump’s foreign policy, now apparently cheerleading the lawless and pointless war on Iran. America shall perform power, not be its faithful shepherd. None now clinging to foolish hopes project confidence despite their bluster about the lazy Europeans or the avarice of foreigners. Call it renewal or reclaiming past greatness, the knee-jerk breakdown of reason in American policymaking is justified through appeals to vacuous tripe like "hemispheric dominance.” Where once it was American slaveholders screaming for such hemispheric dominance to advance their cause against the pernicious British Empire setting slaves free, now it’s a clanjamfrey of narcissists, predators, and seekers of power wearing a collective trench coat, pretending to believe. They don’t care if they’re caught in the act. Rather they want to be, showing just how irrelevant protest or resistance are to their plans.

What civilization is shared in their philosophy across the Atlantic, I do not know. Whether it’s right-wing appeals to fascist iconography, the family, and the specter of the immigrant other or the leftists over in the UK moaning about cosmopolitanism, I wonder what I, a completely secular Jew, am supposed to see in the inheritance of a civilization that almost destroyed world Jewry in a single generation. That I find so much to hold onto says more about the liberalism that civilization made possible than the future its plodding revisionists claim to imagine, a future that is merely one endless, present crisis.

Putinism and Trumpism are the same crisis. What Rubio cites as civilization is a polite disguise for the nastier mud pit in which wannabe leaders, chancers, and billionaires fight for their pocketbooks and impunity. Controlling access to resources through the fiscal scythe of austerity, the gutting of public goods, and the use of state power to discipline and punish those who refuse to obey unites the logic of both systems. They are separated by degrees of moral descent and capacity to ignore and reshape fetters on their power. The irony is that where Russia’s regime faces few constraints domestically beyond its fear of instilling a mass public consciousness against the war after over 20 years spent atomizing society, it is stuck lashing out with what remains after expending itself so disastrously in Ukraine. America’s new regime still faces a host of domestic hurdles even as it slowly boils the nation like so many frogs. It is unhinged in its capacity to press a button and shatter myriad norms and balances of international forces for destabilizing ends all the president’s men cannot explain or justify.

Being an American these days living far from home is a trial I never expected. I’m tethered to my screen as federal agents tear-gas a corner of my old neighborhood in Chicago, hound people only guilty of parking violations for the crime of not being white, or murder a citizen in cold blood in broad daylight without any punishment. Watching the inchoate violence unleashed at home turned outwards, now without any defined victory in the Middle East, makes clear there is no comfort of distance for Americans anywhere. The regime’s useless idiots cite foreign pathologies as cause for violence, brutality, or cruelty in our engagement with the world and fellow human beings. Meanwhile they succumb to those same pathologies completely in pursuit of their own power at our expense. Trumpism and Putinism are the monoculture none of us asked for. Empire and prosperity do not break overnight. But plant enough bad days and times of trouble come for us all.

Oil and the Damage Done

The announcements from BP, Shell, and Exxon were a shock to the system, but the exit of western oil majors from the Russian oil sector is a comparatively small problem compared to demand-side effects from sanctions. According to Russian energy expert Mikhail Krutikhin, half of the 6 million barrels a day of oil and refined products Russia normally exports are already off the market. The IEA similarly forecasts a shortfall of 3 million barrels per day of production from Russia may in April as buyers continue to shun Russian crude cargoes. Halliburton, the world’s second largest oilfield service providers, has decided to pull out of the Russian market completely and Schlumberger, the world’s largest oilfield services firm, has ceased all new investments and technology deployment in observance of existing sanctions. Production costs are rising and access to technology and expertise is being constrained. Though foreign service providers only accounted for 18% of the market as of 2020, they generally provide the highest end technological and technical support.

Add to this that Russia lacks significant crude oil storage capacity. All production must be sold, not stored. If buyers shun purchases, Russian exporters can store crude at sea in a tanker – an increasingly difficult proposition as insurers and banks also don’t want to be exposed to reputational or direct sanctions risks – or throttle production at existing oil fields. Self-sanctioning is a far greater problem than the otherwise limited effects of US, Canadian, and UK import bans that reshuffle trade flows.

The longer an oil well is not producing nor is permanently ‘plugged,’ the greater the likelihood that the cement casing lining the well fails, risking the integrity of the well for production. Back in 2015, a survey of Russian oil companiesfound well casing failure rates ranging from 1.7-4.1%, a figure that has likely climbed at the oldest, most depleted fields. If firms can’t find buyers for even 1 million barrels a day for long enough, the rates of well casing failure and the costs of maintaining wells otherwise not producing will begin to rise as wells have to be idled. Inactivity will take thousands of barrels of production offline permanently in relatively short order only to see that figure balloon as the problem drags on. Since Russian oil exports are being priced at discounts of $20-30 a barrel relative to the Brent crude benchmark, the state and oil firms are also benefiting less financially from what they are capable of selling on the market.

Finally, the near total cessation of international air travel and incoming strains on domestic carriers’ capacity to fly routes due to lost access to components and repair parts will crush domestic demand for jet fuel. Refineries have to vary what capacity they utilize to yield the mix of refined products necessary to meet demand from wholesalers and retailers, a constant balancing act between different units using different processes and temperatures to yield the right products. Jet fuel is a middle distillate that is quite volatile, so most production is consumed within about three months. If you can’t store it for long, your only options are to repurpose it for other products or reduce your runs of jet fuel and try to reconfigure your operations accordingly, risking losses and imbalances of refined products. A common approach is to blend jet fuel into diesel, but collapsing incomes, consumer spending, and investment plans will undoubtedly drag down diesel demand as well. Reports are now emerging that Russian refiners are cutting production from lack of storage capacity while fuel prices for drivers remain elevated with production for the first half of March down 6% vs. February, a figure sure to rise into April. These factors can contribute to inflation and create future bottlenecks for consumers and industries without state support.

A Messy Divorce

Gas exports to Europe remain steady, but have come under pressure from new initiatives led by the European Commission to slash Russian gas imports by two-thirds this year, diversify supply away from Russian pipeline gas, and reduce fossil gas consumption 30% by 2030. The Commission’s announcement included expected plans to require national gas storage to be at least 90% full by October 1 of every year, undercutting potential leverage from supply disruptions or Gazprom’s insistence that long-term contracts rather than spot trading supplies be used to meet import needs. Europe is broadly abandoning assumptions that Russia is a reliable energy security partner.

EU governments have agreed to jointly buy LNG and gas supplies this years to coordinate supply. After officially halting certification of Nord Stream 2, several projects now being fast-tracked by the German government are expected to provide over 10% of Germany’s natural gas needs if fully utilized. Germany vice chancellor Robert Habeck has followed up with visits to Norway and Qatar, signing an agreement for a long-term energy partnership with Qatari counterpart Emir Sheikh Tamim bin Hamad al-Thani to snap up LNG cargoes. Bulgarian Deputy Prime Minister Assen Vassilev announced that the state would not seek to renew its contract with Gazprom at the end of the year, instead betting on other suppliers and the Bulgaria-Greece interconnector to manage in the near-term. Italian energy firm Snam is in talks with Spanish counterparts to build a new offshore pipeline to build better links between the Spanish market – supplied dominantly by LNG and North African pipeline imports – with the rest of the EU. Eni is also fast-tracking a new upstream project with Algerian Sonatrach to launch new oil & gas production by Q3 2022 and expand Algerian exports to Italy. The Dutch government is also trying to increase the import capacity of the Gate terminal at Rotterdam for LNG and contracting floating terminal capacity. These are being announced alongside Belgium’s decision to extend the use of nuclear power to 2035, countless renewables projects being permitted, Poland’s recent announcement of a $1 billion commitment from US partners to invest in a nuclear plant with mining firm KGHM, and the Czech Republic’s exclusion of Rosatom from tenders to build a new nuclear plant at Dukovany.  

European energy politics and markets are in rapid flux. We are seeing what an energy ‘divorce’ looks like, even if the goal to reduce imports for 2022 faces considerable uncertainty and may not be feasible. Gazprom cannot redirect the scores of unused bcm of export capacity it has to European markets to China or LNG terminals. That means thousands of kilometers of pipeline, compressor stations, and gas fields not utilized to their capacity pose an increasingly heavy drag on Gazprom’s balance sheets as European imports decline. New routes can and will probably have to be built, including the Power of Siberia 2 via Mongolia. However, export prices and profit margins realized for production from Yamal and Europe-facing fields would be considerably lower due to the sheer distances involved for delivery. Gazprom suffered numerous problems with labor, inefficient investment, and cost overruns at Chayanda – the main field supplying the current Power of Siberia pipeline – which doesn’t speak to a flexible response in the event that European purchases of natural gas decline precipitously. Rosatom may not be an important source of export earnings – its export portfolio probably only generates a few billion dollars in profit a year – but these changes are similarly affecting its capacity to profit off of decarbonization efforts since deals in developing countries typically require state-backed concessionary loans, minimal returns on investment, and increasing pushback on the “Build, Own, Operate” model that Rosatom prefers.

Coal and Russia’s ‘Rust Belt’

Coal markets are now suffering the same turmoil as oil & gas. Immediately after the announcement of western financial sanctions, China’s state banks began refusing to extend letters of credit to finance imports of Russian commodities and coal shipments started falling. President Biden’s March 19 phone call with President Xi reiterated American intentions to apply secondary sanctions to Chinese firms and banks breaking with the existing regime against the backdrop of a scramble for coal. The National Development and Reform Commission has called for China’s regions and miners to increase coal production capacity by 300 million tons annually, a volume equivalent to the entirety of China’s import needs. Beijing’s policy pivot seems intent on maintaining the country’s Australian import ban while displacing Russian imports. Whatever hopes Russian policymakers had of increasing coal exports to China by 2024 to offset expected losses in Europe are being crushed.

Coal mining forms an important link in the regional chain of hydrocarbon dependencies and industrial relations underpinning the regime’s political economy. Coal mining provides comparatively cheap inputs for domestic steelmakers and industry, jobs for relatively unpopulous regions dependent on resource exports, and demand for Russia’s heavier industrial base. Bulk cargo gondola cars are a particularly prominent example since coal in Russia is transported primarily by rail to domestic depots and ports. Prior to the invasion of Ukraine, miners in the Kuzbas were complaining to MinTrans that they could not move 17,000 railwagons full of coal due to inadequate rail capacity from Russian Railways’ oft-delayed, underinvested expansions of the Trans-Siberian and Baikal-Amur Mainline. At the same time, the rail network struggled in 2021 with a cumulative deficit of over 36,700 gondola cars and expectations of gondola car demand in the range of 20,000 per annum for 2022-2026. Exporters in general, and coal exporters in particular given the sheer physical volume they require, underpin the profitability of the factory base spread across the Volga-Urals region and Western Siberia manufacturing rolling stock and similar heavy kit and equipment used for freight and railway construction and maintenance.

Russia’s ‘Rust Belt’ has been propped up through the direct and indirect demand generated by commodity exporting industries for most of the last 25 years and now faces novel risks. Underinvestment in rail capacity created bottlenecks that prevented Russian coal miners from fully reaping the benefits of last fall’s coal demand surge in China and achieving their export aims. That’s now collided with the very real possibility that the exporters sustaining industrial demand for older Soviet plants that frequently rely on procurement orders via state monopolies or parastatal firms underwritten through commodity exports won’t be able to provide enough demand to maintain existing productive capacity that’s been mired in stagnation for the last decade. Annual seasonal cycles of railwagon surpluses and deficits that filter into the transport costs and capacity for basic goods including wheat shipments in dry bulk cars may turn to a large, persistent deficit into next year that will increase food prices as well. Higher transport costs then affect orders further across supply chains given the dominant role of railfreight for deliveries at 1,000 km or more, which accounts for a very large proportion of deliveries on the domestic market. Railfreight also becomes more attractive economically against long-haul truck deliveries as diesel and benzine prices have risen since 2020 in real terms and were forecast to rise this year above the Bank of Russia’s now completely irrelevant inflation target of 4%. The main offset for higher fuel prices proposed has been the nullification of all tolls paid to the Platon system on federal highways, itself a rentier goldmine for clan Rotenberg introduced amid recession in 2015-2016.

H2 No

The oil shock of 2014-2015 and sanctions targeting Arctic projects put a large damper on a bevy of offshore oil & gas projects that it was hoped would help the Russian economy to break out of its 1-2.5% annual GDP growth ceiling without a structural adjustment towards consumption-led growth. Prior to the invasion of Ukraine, Gazprom was aiming to become the world’s largest exporter of carbon-neutral ‘blue’ hydrogen with an explicit aim to account for 20% of global supply through 2050. The thinking was three-fold: prevent the depreciation of natural gas assets – namely pipelines – that require significant capex and opex, capture a new market expected to raise tens of billions of dollars, and work in an area where cooperation with European partners could bridge the sanctions regime and broader chill on foreign investment into the Russian economy since 2014.

For a global snapshot, the Hydrogen Council estimated that as of July 2021, approximately $500 billion in investment into hydrogen projects through 2030 had been announced. $150 billion of that was considered ‘mature’ meaning that projects were in the planning stages, nearing, or else taking final investment decisions. The world’s largest hydrogen project was announced by US startup Green Hydrogen International in South Texas called Hydrogen City, a massive hydrogen project with considerable salt cavern storage capacity using solar and wind power to produce 2.4 mtpa of green hydrogen. The project is backed by Australian businesses. In mid-February, the Australian Hydrogen Energy Supply Chain (HESC) pilot project – a pilot project that cost about $500 million – sent its first cargo of liquefied hydrogen to Japan. German vice chancellor Robert Habeck also signed a blue hydrogen supply agreement with the UAE while visiting the Gulf and Saudi Arabia just announced the construction of a $5 billion hydrogen plant in Neom.

The Hydrogen Council’s figures are surely over-optimistic and a great deal of uncertainty remains over how hydrogen markets develop, not least because hydrogen is not nearly as energy dense as natural gas. But a huge wave of investment and deal-making is taking place without any substantive hope of Russian participation. Australian Miner Fortescue set a very stretch target of 15 mtpa of green hydrogen production by 2030 a year ago and is now confident that’s no longer a ‘stretch’ because of the degree of investor and market interest. Smaller pilot projects using hydrogen as feedstock for operations or else laying the foundation for hubs in Queensland are afoot as well. Prior plans from Gazprom to refurbish and repurpose existing natural gas infrastructure for hydrogen exports grow now seem highly unlikely in the absence of foreign partners and interested foreign buyers. These initiatives could have generated trillions of rubles in construction and procurement contracts and support new manufacturing investment as well exploiting localization and import substitution subsidy and policy schemes. That’s now gone and, in its wake, the global market for hydrogen is moving on quickly.

The New Oil Diplomacy

Moscow also can’t dismiss the direction of travel for efforts by the Biden administration to push a deal with Iran over the finish line and to begin speaking with Maduro in Venezuela once more. For now, any prospective Iran deal is hostage to the idiocy of the US Congress and Biden’s hunt for a larger deal. De-listing the IRGC signals a desire and belief that something beyond a technical agreement over nuclear weapons capabilities is possible. Were the IRGC to be de-listed, presumably Biden is opening the door to complete the withdrawal from Iraq he has likely wanted since coming into office as well as securing a potential exit from Syria. An agreement with Iran and any sanctions relief for Veneuzela would return several hundreds of thousands of barrels of crude to market relatively quickly, but take a much longer time to lead to durable supply increases, though any Iran deal now seems dead thanks to the efforts of US hawks and diplomacy in the Gulf. All the same, the administration has little choice so long as US shale drillers are restrained by the interests of investors and bankers in New York and considerable squeezes for supply chains, namely piping, drilling equipment and parts, rolled steel, and even labor. The recent decision to relaunch leasing for oil & gas projects on federal lands is another useful move, even if quite limited in effect, to deflate the persistent industry myth that the White House was standing in the way of drilling.

Saudi Arabia has reacted with toothless talk of launching “petroyuan” in its oil export trade with its real strategy: increasing its output ceiling by 1 million barrels per day in the next 5 years to 13 million bpd and, most importantly, substituting as much oil-fueled domestic power generation with natural gas as fast as possible to retain export capacity. Though MbS may wish to communicate that Saudi Arabia isn’t responsible for stabilizing the market so long as rocket attacks continue on oil facilities with comparatively limited effect, the real thrust of Saudi policy is to kick Russia while its down. The United Arab Emirates are now fast-tracking project plans intended to increase oil output by 1 million barrels per day by 2030, lifting production from 4 to 5 million bpd.

The shutdown of the Caspian Pipeline Consortium’s pipeline throughput capacity at Novorossiysk is another body blow to short-run supply, taking 1 million barrels per day of Kazakh crude exports off the market for what looks like 2-3 weeks. In truth, there is no short-term solution aside from cutting demand or the misery that is demand destruction. Diesel prices have shot up on shortages also influenced by the uneven ramp up of refined products throughput from last year into this year due to the loss of jet fuel and gasoline demand. There is no clear solution there without some planning mechanism and capacity to rapidly stand up production that, as yet, is lacking at the international level and in many cases at the national level.

Presidents lack any ready instruments aside from jawboning and backroom deals, whether that be through the delivery of Patriot missile systems, an offer of sanctions relief in exchange for something, or else a round of grip, grin, and grandstand appealing to domestic energy industry players who love to howl about energy independence when Democrats are in power. Whether or not the press team at the White House and the inner sanctum of the Biden administration have any clue how to sell these policies and security partners in the Middle East attempt to ally with hawks in Congress to block progress, it’s significant that this crisis has given rise to a degree of creativity and rapid reaction we would not have expected prior to February 24. Prior releases from the Strategic Petroleum Reserve were of limited use, but in diplomatic terms, also signaled a willingness to cooperate with China as well as partners to bring barrels to market in an attempt to reduce bargaining power of OPEC+. No matter how prices come down to earth – right now, there is clear statistical evidence that retail fuel demand is beginning to flag vs. December 2019 from high prices – the geopolitical balance of power between consumers and producers will have once more changed in unexpected ways ultimately to the detriment of Russian foreign and domestic policy.

The Energy Doom Loop

One of the greatest disservices ever done to the analysis and understanding of the political economy of Russia was the meme proffered by countless voices echoing the late Senator John McCain: Russia is nothing but a gas station. This is, in plain terms, completely false. Russia is not a classic petrostate. It did not come into its geopolitical power or aspirations on the basis of its petroleum exports, nor is the economy as concentrated in the energy sector as one would presume assuming the categorical implications of ‘petrostates.’ Instead, it’s best to think of the Soviet Union’s dependence on oil & gas as a long-running process that began in the mid-50s with the development of deposits surveyed during the Great and Patriotic War, first oil export deals undercutting OPEC’s pricing power, and desire to significantly expand the national petrochemical industrial base in support of agriculture. By the 1960s, they were a crucial source of export earnings to cover food imports and fertilizer and chemical feedstock and inputs for other industries. By the 1970s, the cumulative windfalls from the first and second oil shocks allowed the state to lean on oil & gas as supports for what would prove to be the festering decay of the nation’s economic base, over-built heavy industry, and massively under-developed light goods and consumer durables sectors constrained by the absence of strong demand. The absence of price signals guiding capital expenditures and operational expenditures domestically, presence of price signals affecting the attractiveness of exports and budget planning, mismanagement of existing oil & gas fields, and rising costs of newer oil & gas finds and provinces all collided. The cost of supporting the sector otherwise underpinning a significant part of the budget and domestic industries skyrocketed and then prices crashed in 1986. Whenever anyone tries to sell you a bridge talking up Russia’s petrostate problems, remember it was a highly urbanized, educated, and industrialized economy when the political system became ‘addicted.’

Russia’s Soviet inheritance was therefore an extractives and energy sector that could sustain a wide range of industries, provide export-driven demand, and churn out fiscal resources. First, pre-war claims that Russia could simply trudge through a structural decline in demand for its hydrocarbon exports were terribly flawed. Since the triple shock of sanctions, oil price collapse, and banking sector crisis in 2014-2015, austerity policies intended to reduce Russia’s comparative dependence on oil & gas revenues meant capping social spending, continuing elevated levels of defense expenditure until 2017 when they leveled off, and most importantly increasing the comparative tax burden on households, businesses, and consumption through changes in rates and improvements for tax collection. From the perspective of the state budget, resource dependence fell. In reality, the opposite happened due to Russian macroeconomic policy. By 2019, extractive industries saw investments approximately 20% higher in real terms per Rosstat relative to 2013. They were even higher – 26% above 2013 levels – in 2018 when the Trump administration reimposed sanctions on Iran, targeting oil exports. In 2020, they were still roughly 16% higher than 2013. Manufacturing investment levels hung between 17% and 7% down in real terms from 2013, generally trending at about 8% lower than pre-Crimea levels headed into COVID. Retail only saw one year of investment elevated above 2013 levels – 2018 – in a short-lived blip of an 8% increase. Transport and storage investments trailed terribly with an average falloff of 25-33% relative to 2013 in real terms. Cumulative investment levels in real terms were 99.6% what they were in 2013 as of 2019, yet with significantly elevated shares for natural resource extraction and growing sectors like IT wit comparatively worse performance for almost any sector dependent on domestic consumption and demand.

These are just snapshots but they make an important point clear: the economy’s relative level of investment into natural resources continued to grow while sectors focused on domestic demand fell. Demand for Russian exports was sustaining investment, but failed completely to sustain real incomes because austerity policies prevented a more expansive redistribution from being used post-Crimea. The implications are quite worrisome. Even marginal declines in oil production, coal exports and production, or natural gas exports create knock-on effects across Russia’s regions that the regime can only offset through a combination of command economics and fiscal expansion. Fewer wells to drill means less cement, less steel, less labor, and less services needed. That then means fuel retailers sell less locally, manufacturers see fewer domestic orders and imports would have once filled that gap, fewer jobs available in regions often struggling with depopulation or else so remote as to have few settlements outside of industrial city clusters. Tax receipts decline since regional governments take the lion’s share of regionally domiciled corporate tax revenues levied by federal law in the fiscal system, fewer VAT revenues, lower income tax revenues, and worse.

The regime’s “oil-proofing” policies were also linked to the decision to float the ruble, with the value of the ruble managed through fiscal rules dictating that all revenues realized per barrel above the cutoff of $42/bbl of Urals blend (+ an inflation adjustment from its adoption) would be parked aside in the National Welfare Fund or otherwise sterilized through the treasury. The idea was to decouple the ruble from the oil price, but what it actually did was expose the ruble to far greater geopolitical risk and simply decouple the two when oil prices rose and link them once more when they fell. As we’ve seen, the role of energy in the real economy actually expanded in investment terms after 2014. Price declines tended to worsen the effect. Instead of a fiscal or financial fortress, the regime built a hydrocarbon prison through its own orthodoxy.

As each of these structural dependencies, relationships, and flaws interact, there emerges the risk of an energy “doom loop.” The notional “doom loop” in banking refers to the over concentration of European banks’ portfolios in European sovereign debt, creating a vicious cycle of contraction when the solvency of sovereigns in the Eurozone was at issue. Any hit to a sovereign credit rating or the pricing of default risks via the bond market would encourage a contraction in lending activity, worsening the already significant damage of the Global Financial Crisis. In the Russian case, that doom loop is more akin to the over-concentration of private sector consumption, fiscal revenues, state procurements, and various rents in the energy sector. The continued increase in oil drilling activity, deployment of horizontal drilling, and company-level benefits from the devaluation of the ruble at the end of 2014 allowed oil & gas firms to offset the depth of the stagnation visited upon by the Russian economy by policy choice more than by sanctions. There are countless possible scenarios that could now play out, but it’s safe to assume a significant decline in oil exports – and therefore production – this year, gas export constraints because of Gazprom’s own refusal to supply via spot trades in Europe and now idiotic attempts by Putin to suggest they break their contracts and only take payment in rubles, and a slow but accelerating fall off in investment for the extractive sector in 2022 and in the years ahead relative to the pre-war ‘ceiling’ or potential they had. Russia’s economic potential and the capacity of the regime to transfer rents from the sector elsewhere decline precipitously the greater the share of oil production affected.

The expected decline in demand for domestic industries serving exporters also runs up against the novel nature of the current economic shock. With so many key technological inputs now sanctioned or self-sanctioned and numerous foreign industrial firms and consumer and retail brands ending services in Russia, fiscal attempts to subsidize domestic substitutes and offset the degree of pain felt by consumers will be inflationary because of the disconnect between what’s available domestically and what’s reliant on imported components or entirely imported. As of 2021, the average Russian household spent roughly 37-38% of their income on food and basic goods and the supposed hydrocarbon windfall so many bang on about regarding Russia’s current account doesn’t exist in a vacuum. Surging natural gas prices abroad coupled with surging fertilizer prices abroad, forcing domestic producers to demand more on the domestic market or else opt to export. Export bans may increase domestic supply by force, but fertilizer prices are very high domestically and subsidized loan programs and soft price control measures to keep them lower in the sector are either running out or not working. Households are going to see even more of their now declining incomes going towards food. Disruptions for exports by ban or, in the case of agriculture, loss of Black Sea export capacity ends up reducing what exporters plant and harvest down the road as well as the productive capacity fertilizer producers maintain. The effects pile on emanating outwards from the energy sector.

We have already seen evidence of movements back towards sectoral planning. The Central Bank is being tasked with direct FX liquidity management for imports, there’s now movement to reinstitute some degree of nationalized control and planning capacity for rail logistics, and an otherwise paltry support package of 1 trillion rubles. The regime depended on the energy sector to maintain the coalition of stagnation it pivoted to in 2012 after Bolotnaya. Past iterations of autarky necessitated Russia export commodities to raise capital to pay for technological imports or food. The former has been disrupted by sanctions, the latter now irrelevant but feeding into domestic food prices through the integration of Russian fertilizer and food production onto global markets with prices set regionally and globally. Russia’s integration into global commodities markets is now its biggest weakness, not its greatest strength. The Russian economy today is more isolated than the Soviet Union was in economic terms. Whatever the return to soft or harder forms of planning and command look like, we can be certain that Russian economic policy has no intention of shifting to a demand-led view of how it can achieve growth. The rents, as they say, are too damned high.

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Crisis? What crisis?

I started out today thinking I’d do the usual roundup, but realized I wanted to breathe a bit and reflect instead. It’s been somewhere around 205-210 days excluding weekends and public holidays since I launched this newsletter. I’ve taken some time off around Christmas and in May into early June so let’s call it 185sh days OGs and OFZs has gone out. At an average length of about 3,000 words, that’s about 555,000 words of headline chasing, summary, and analysis. That is quite mad. While I’d already had the delusions to start working on a potential book as a means of keeping myself during the months I thought I couldn’t legally work due to the complications of the visa application process, by no means was what I had in mind set in stone. My overall goal initially was to push back on the idea that Russia was a resurgent power by linking its domestic political economy to the evolution of its foreign policy, but that was also a direct reaction to having lived in Washington D.C. during the worst of the moral panic about Russia and seeing just how twisted the analysis of Russia, Eurasia, and the myriad complexities of power politics had become. Declinism has a history stretching back to the 70s and while I agree that China’s rise is qualitatively different, it is striking that even the best historical minds on this stuff tend to buy into the hype of Russia’s challenge to American power on top of China. I originally wanted to go back to 1985 and think big picture about oil, monetary politics, all of it before deciding far too late that 1998 was a much better jumping off point and the 98’ financial crisis a much better framing device. I also didn’t yet understand how COVID and climate could go so well hand in hand shredding the shibboleths and recycled thinking of both the transatlantic policy firmament separating us mere proles from the movers and shakers and the academic and business commentariat engaged in sorting the basics of what the hell is actually going on. Talking about climate as a national security, foreign policy, or economic issue isn’t new. Somehow our political leaders have proven incapable at finding half-decent language to communicate the connections between all three, ceding the messaging to evangelists who have the right aims but rarely the political nous or nuance to fashion acceptable compromises or move things much further than outside of urban strongholds. I’m speaking mostly of the United States here, though even in the UK with an otherwise terrible ruling party decent on climate issues, their plans are pathetically lacking in scope and ambition.

I was never a big supporter of the Green New Deal as it was framed during the 2019-2020 Democratic primary season in the US for a lot of reasons. Estimations about new jobs created are wildly inaccurate and optimistic in most cases, outright bans on oil & gas extraction just lead to huge price surges for the working poor, lost jobs, and more difficulty managing base load capacity, and the most ardent proponents of green ‘developmental states’ seem stunningly disinterested in domestic politics of resource extraction among resource exporters. That’s not to say I disagree with massive spending bills and budgets in the US and Europe to massively increase investment into greening infrastructure, improving heating and power efficiency in homes and buildings, trying to increase density in and around cities, and overhauling power grids. But rather that the political approaches taken have always been lacking, and in the US specifically, the failure to exploit Big Oil’s open acceptance of a carbon price as a rhetorical tool to neutralize other regulations was disastrous. Had reformers taken them at their word with an initial $30-40 a ton price and bracket it into some sort of cap system around 2016, the conversation today would probably be in a different place. As a member of the Young Fabians and the Executive Committee for the Economics and Finance Network, I push the line about green jobs in the UK not out of a staunch belief all those jobs materialize, but as a means of changing the window for fiscal policy in general. Tracking Russia and Eurasia over the last 9-10 months have significantly strengthened my belief that domestic economic structures, policy choices, and trends can achieve far more than demonstrative geopoliticking to counter states like Russia and rebuild industrial capacities otherwise handed to China. Climate justice feels good but fosters the false belief that there is a perfect energy transition in which the fossil fuel complex and nuclear industry don’t play large roles. It also is a useless narrative when the demand it creates exacerbates resource conflicts or strengthens autocratic regimes elsewhere depending on the distribution of key natural resources since they’re fixed assets.

A particularly good essay Tweeted out by Adam Tooze written by Lance Taylor for New Economic Thinking illustrates the pitfalls of the approach to energy transition you internalize when you work in the energy sector as a consultant. To put it as simply as possible, roughly two-thirds of the energy generated in the American economy is “rejected” i.e. goes unused or lost as a result of the laws of thermodynamics and inefficiency, thereby creating welfare mismatches between the intended effects of something like a carbon price and its actual effect on net emissions. Since electric vehicles still use electricity, for instance, they can achieve over 10% emissions reductions but that’s far from enough to significantly achieve 2050 net zero targets. The economy broken up by “quads” (quadrillion British Thermal Units) in terms of energy consumption is a great graphic from the piece to capture the problem:

Taxing carbon, no matter how much you raise and redistribute, can affect the the quantity of emissions from any given power source but not the level of waste built into our energy systems. The effect on consumption may therefore be decently significant at the household or consumer level, but not in relation to the amount of emissions created by energy systems relative to unused energy. This is a global problem. Google a bit and you’ll see it regularly appear that the world actually wastes more energy than it consumes. We can’t realize 100% utilization no matter what we do. What we can do, however, is to minimize waste by capturing as much of the energy lost as possible — usually heat — and reusing it somehow. That doesn’t work for a car engine, even if it’s an electric vehicle, but it’s vital for power generation and heating. Finding ways of capturing some of the heat generated and releasing it into, say, district heating at a lower but still warm temperature is probably the most obvious example. There’s also the expansion of combined cycle plants using both steam and gas turbines together to increase the efficiency of total power generated. Fixing the emissions problem is ultimately going to be about making massive energy efficiency gains, including through the promotion of greater residential density and public transit. But you can’t square these objectives with a global approach without some mechanism to price carbon to force alignment over time and spur private investment into efficiency gains alongside regulatory changes and state investment. Ask someone in the industry and while you’ll get some of this or that about limiting methane emissions, carbon capture, tech deployment for extraction, and so on, the magic bullet is carbon pricing because that’s easiest to provide research products for. You can model the financial effect of a carbon tax or similar instrument on internal rates of return for project far more easily than estimating regulatory impacts from rules that mandate insanely high energy efficiency targets by 2030. Fewer assumptions have to be made. The result is a patchwork set of solutions that improve things, just not with the systematic intensity needed and implicitly and explicitly built around the provision of ‘green assets’ for investors or ‘greening’ private investment.

I’ve avoided the language of New Deal and WWII mobilization coded into climate change politics from the Left here because my experience in consulting, even if limited, also taught me that we tend to significantly underestimate the pace of technical change even amid slack economic conditions. Batteries aren’t going to save all of us by themselves, but their costs have declined far faster than projections back in 2010 assumed:

It’s trends like this that make me more bullish on the potentially positive effects of what otherwise looks like paltry climate action. US Democrats’ laser focus on social programs is an electoral gambit as much as a reflection of party priorities. It plays better for the midterms to have programs out the door that are funded immediately and up and running. Infrastructure takes years to see and, setting aside Congressional dysfunction, is probably likelier to be doled out in chunks even with a potentially large set of bills this year. Granting more fiscal and monetary power to local authorities to invest in the infrastructure needed to help sustain innovation, demand, and raise residential density is as important as any federal line item. And these otherwise distant fights are where much of the contours of great power competition are being drawn. Want to bring semiconductors back to the US and Europe? Build more infrastructure to sustain demand for goods and inputs that need them while using carbon-based trade mechanisms to speed up domestic regulatory alignments. Want to weaken Russia’s ability to leverage its energy wealth (even if the energy weapon is more narrative invention than hardbound fact)? Then build more nuclear, dig deep into efficiency gains, deploy more batteries, and drive electric cars. Want to handle increasingly common supply chain shocks and local crises due to extreme weather? Build more resilience and expect interest rates and insurance costs to get crazy. Climate politics are about security, stability, and power in most senses of each term. I’m not gunning to write a magnum opus on that topic, at least not yet, but this year has made it impossible to construct a full account of the last 50 years of power politics without linking the various choices made and not made on climate issues together nor can one propose a future “grand strategy” without centering the ripple effects of climactic shock. Pricing carbon and redistributing the proceeds to those most negatively affected is a necessary, but not sufficient condition to achieve the kinds of transformation needed. And it’s for that reason that the need to find ways to articulate the position of carbon autocracies in a world where renewed ‘democratic action’ on climate is becoming more urgent each day. I’m looking forward to bringing more of these disciplinary problems and approaches into dialogue in the months ahead. Russia and Eurasia are in serious trouble and we do enough sleepwalking as it is into crisis after crisis. Hopefully you’ll stick around to see what comes of the exercise.

Like what you read? Pass it around to your friends! If anyone you know is a student or professor and is interested, hit me up at @ntrickett16 on Twitter or email me at nbtrickett@gmail.com and I’ll forward a link for an academic discount (edu accounts only!).

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A reminder that this will be the last week on Substack for OGs and OFZs. My reasoning and what to expect for pricing and paywalling going forward are broken down here. I’ll begin the move to Ghost at week’s end and will aim to be up and running again around August 16 after a much needed honeymoon in Chicago. If you want to get your first 3 months’ subscription discounted at Ghost, subscribe sometime this week for the monthly plan or else the annual plan, which will rollover whenever it’s renewed — I’m still working out the logistics for how those rollovers work but will provide all of the relevant promo codes, probably via Substack or else personal email (reach me at nbtrickett@gmail.com) before launching on Ghost.

A good New York Times piece on the health costs and related effects of rising temperatures offers some important food for thought on Russia and Eurasia, generally left out of the statistical overviews in these write-ups. How will medical services handle heat stress for elderly Russians as extreme weather becomes more common and what stress effects in Russia, and globally, will come about as air conditioning and climate control in homes, workplaces, and offices becomes more important?

One study by Randazzo, De Cian, and Mistry found that households using air conditioning consume 35-42% more electricity. In late June, Russia achieved a post-Soviet record for energy consumption as a result of heatwaves — 122.68 gigawatts, beating out the 2019 record by 2.3 gigawatts. As of today, power prices at auction have reached historic highs because of the heat. Rising temperatures are triggering more demand and causing price inflation for electricity. Here’s the price in rubles per megawatt-hour:

Modernizing the power grid is an urgent priority to head off more inflation and adapt as fast as possible.

What’s going on?

1. For the first time since September 2020, Rosstat registered consumer price deflation of 0.01%. Belousov promises and Rosstat delivers. To be fair, the Central Bank has noted that inflationary forces have peaked and food prices levels had ticked down based on commodities in recent weeks. Food price deflation came a few weeks earlier this year than usual based on annual patterns, something to ponder for both climate change and attempts to impose price controls while producer prices have climbed significantly:

   Title: Dynamics of observed and expected inflation, % in annual terms

   Purple = observed inflation Red = expected inflation

   

   Surveys show much higher levels of inflation than the official data suggests — consumers thought it was at 14.9%, not 6.5% in June. And 1 in 6 respondents from the CBR’s survey think prices have risen 30% or more in the last year. We still don’t know how the high producer costs filter into consumer costs since there’s always a lag there. It’s good news that price increases have slowed. The question is how much of that is deflationary, how much of that is a matter of food production cycles, and how much of that is distributed to lower income Russians vs. higher income Russians.

2. Tajikistan has mobilized reserves including anyone up to the age of 55 in response to the collapse of talks between Kabul authorities and the Taliban to negotiate a ceasefire for Eid al-Adha and drills start today. Russian foreign minister Sergei Lavrov elegantly parsed words by saying Russia isn’t planning any strikes into Afghanistan, a far cry from a categorical denial that the Russian military will do so if conditions warrant it. Saying “you’re confusing us with the Americans” cause we aren’t planning anything is a decent way of buying space to respond to a border incident if need be. A few days ago, 340 ethnic Kyrgyz who fled Afghanistan into Tajikistan were returned. General Mark Milley, US chairman of the Joint Chiefs of Staff, admits that a total Taliban takeover of Afghanistan is possible, but we shouldn’t read into that yet the expectation it will come to pass. Milley made a point of telling the press that the Taliban are doing what they can to stoke the narrative of inevitable victory. They get strategic communications. The end isn’t yet written, and it’s quite possible a longer-term unstable equilibrium emerges over the next few months. Lavrov’s visit to Tashkent also included a reiteration of Russia’s interest taking part in the TAPI pipeline, a project that’s been killed countless times given the difficulties ensuring Afghan transit to link Turkmenistan to Pakistan and then convince India that it’s ok to allow Pakistan to control import infrastructure. 1,500 Russian and Uzbek troops are carrying out drills from July 30 to August 10 in Surxondaryo Region close to Termez. This is all contingency planning now and maintaining as many options as possible without signaling a clear commitment to any intervention into the civil war in Afghanistan.

3. Efforts are now underway to reexamine and rewrite the Belarusian constitution to line up a national referendum next year akin to what Putin and the Kremlin’s technologists did during late June and the start of July last year. The aim would be to extend his current 5-year term from the 2018 elections all the way to 2033, avoiding any potentially embarrassing campaign headaches or opposition crackdown during an electoral season and giving him free reign to plan an exit if he wants to step down at some point. The situation should draw attention to the political economy of his rule in the years ahead given the tandem stagnation of the Belarusian and Russian economies. For context on the scale of transfers from Russia to Belarus, the IMF estimates that Belarus received a combined $106 billion between 2005 and 2015. The $500 million dollar tranche Moscow offered Minsk early in the summer wasn’t intended to setup investment. It was crucial to help Belarusian firms and the Belarusian state pay off debts owed to Russian companies. We can see in the year-on-year 1Q balance of payments data taken at a high level — I broke out Russia, Ukraine, and then the rest — what the economic dynamic looks like (LHS is US$ blns):

   

   Russia is basically the only significant source of foreign borrowing and that borrowing then helps finance the export surplus with CIS partners and European buyers. Belarus is a net creditor if you subtract the Russia data from the rest. The same maladies driving Russia into stagnation affect Belarus, with the exception that transfers have allowed the state to maintain, on paper at least, a better real wage environment and proportionally better benefits. Locking in Lukashenko’s rule will deepen this dynamic over time, thus raising the stakes for Moscow.

4. Exports of agricultural equipment are up 35% to the princely total of 10 billion rubles ($135.6 million), primarily to CIS states followed by the EU. Bad news is that export growth has slowed thanks to a strengthened ruble and rising input prices. Shipments of reapers are up 94%, plows are up 85%, balers are up 72%, sprayers are up 71%, agricultural tractors are up 48%, and harrows are up 37%. Rosspetsmash chalks up market dynamics to grain prices and the effectiveness of state support. The story caught my eye because of the potential impact of supply chain disruptions, pressure for supply chain resiliency during COVID, and the issue of domestic productive capacity. That exports are so low isn’t an indictment of the effectiveness of state industrial policies — domestic demand has risen dramatically for higher-end equipment over the last decade. Just look at the energy-intensity of production from the Rosstat data. But you run into other issues like branding, the durability of longer-term producer-customer relationships, and the challenge of getting your foot in the door into supply chains for repair and maintenance. It’s good to see that the sector has managed to start yielding export growth for value-added outputs that aren’t just commodities. However, the new price control regime that’s emerging domestically and efforts to create built in “inflation buffers” that automatically apply stabilizers via export duty hikes or shifts in subsidy support in relation to relative price levels ends up affecting exports. I don’t have any evidence that it’s the case right now, but I suspect that some increases in exports now or in the future can come about as a result of idiosyncratic declines in demand at the regional level within Russia due to dry weather and growing seasons, thus pushing firms to find buyers abroad whenever there’s slack. CIS importers are generally facing high(er) inflation levels right now and need cheap plant to maintain operations. That’s great for Russian industries, less good for CIS states who are trying to break from economic dependence on commodities unless Russian producers invest more into foreign production. Of course, these exports may also end up taking a hit due to climate change down the road.

COVID Status Report

24,471 new cases and 796 deaths were recorded in the last day. Regional cases finally dropped but were offset by a rise in Moscow. The biggest announcement comes from Putin — he wants vaccinations sped up so that 80% of Russians are vaccinated by November 1. Health minister Mikhail Murashko has noted the infection rates have dropped, but his own figures cite 890,000 Russians currently infected — that’s twice the level reported by the Operational Staff data. At the same time, the ministry dismissed the 29 million infections figure as “fantasy.” If that’s the case, there’s no coherent cause to believe herd immunity can be achieved without vaccinations, so. you get Putin’s call to mobilize. The dissonance between the Operational Staff and MinZdrav suggests stunning degree of internal incoherence, and also highlights how the narratives the regime has deployed at various points to please the public fold in on themselves. Older assertions that collective immunity could be achieved with infections imply cases are much higher than reported, but when cases reported rise, then you highlight the failure of vaccinations and so on. But apparently 17 regions are close to reaching 60% collective immunity according to an interview given by Tatiana Golikova. The significance of that figure is unclear, but hey, it’s happening. Oh, and even better, Brazil’s “gamma” variant has now been found in Russia. At least the caseload seems its still on a stagnant trajectory, even if total cases are twice as high as the Operational Staff wants you to believe.

The Fire This Time

We aren’t out of the woods yet from COVID by any stretch. Caseloads outside of developed markets with higher vaccine penetration rates continue to climb and we see new variants every other week, it feels like. Coming out of COVID, there are scores of as yet unanswered or else too infrequently asked questions about what global growth looks like that will shape a fair bit of the policy options Russia and other Eurasian states have available in the years to come. I don’t necessarily agree with his causal explanations, but I’m always happy to see Robin Brooks raising the point that emerging markets face a problem now similar, though not identical, to the taper tantrum crisis of 2013. His major point recently is the structural issue of emerging market growth and the link between monetary instability and attempts to stimulate domestic demand:

As we can see, growth has structurally declined since 2010 for emerging markets as the cumulative effects of European austerity, China’s domestic imbalances, unnecessary slack in the US economy, and political and monetary restraints on emerging markets’ economic policies took their tool. Russia’s in an even more fickle position since positive growth is still a function of commodity prices despite its efforts to diversify. US stimulus can drive growth in the year or 3 ahead if Biden actually pulls it off, but that’ll primarily result in US consumption lifting up foreign exporters and commodity demand rather than rebalancing. Rebalancing requires all of the world’s largest economies to take on the entrenched political coalitions that benefited from older development models we can visibly see no longer produce the same levels of growth. We tend to link these imbalances in an American or European context to deindustrialization and the financialization of economies, yet neither provide us particularly useful prisms for analysis when considering the global economy as a closed system:

Deindustrialization and financialization are more about the changing geography of where things are made than the number of factories and factory jobs, though this will also change in the years ahead depending on advances in automation, protectionist policies aligning with the climate agenda, or else the potential for as yet unseen radical transformations of political economy as a result of conflict and climate catastrophe. Crucially, Russia and former Soviet states in Eurasia skipped out on the process entirely. Most endured some level of deindustrialization after the collapse of the USSR for a variety of reasons: the loss of planning within one market crushed demand and shattered supply chain stability, monetary pressures made commodity exports more attractive, institutions were rapidly deformed and reformed depending on which political interest groups were most powerful during the transition, and industries had never faced true import competition before or operated in countries with fully or partially liberalized capital accounts. The “lost 90s” from 1991-1998 wiped out crucial time to get involved in these processes even as western firms tried to open up capacity in Russia to serve Russian consumers, often making use of Soviet-era plant that had been privatized and repurposed rather than built anew. We can also see how long-term effects of specialization within the global economy tend to reinforce underlying specializations among less developed/developing economies. This from new work put out by Isabella Weber at al:

The global economy was in need of rebalancing pre-COVID, especially if large developmental gains are to be made at the global level. But COVID, like the last financial crisis, has reinforced divides and relative levels of specialization for states trying to manage foreign-currency debt burdens. Russia’s a peculiar case because the decisive shift in its underlying political economy was to ride the simplification of its economy in the 2000s to achieve political and monetary stability and sovereignty only to then flip a switch having joined the WTO in 2012 to utilize its commodity exports as a driver to finance import substitution for more advanced goods. Lots of developing economies have historically used forms of protectionism to climb the value ladder. None to my knowledge attempted to do so with an economy trapped in stagnation, not just lower growth, because of their own policy choices with a weakening domestic demand base and geopolitical pretensions to challenge the strongest structural power in the international system. All happy export-led success stories are similar, Russia’s failures are its own. But I think it’s important to contextualize its stagnation as part of a broader process in which the inequality between developed and developing states as well as domestically within both poses serious problems for commodity-export growth, problems that a green boom will alter considerably as demand growth for metals and minerals and goods rises to replace existing stock as often as to “grow” output capacity or consumption. Where does that leave emerging markets? In trouble unless more is done to help them expand domestic demand, something Russia’s fantastic at weakening in the furtherance of frequently short-sighted political goals.

Like what you read? Pass it around to your friends! If anyone you know is a student or professor and is interested, hit me up at @ntrickett16 on Twitter or email me at nbtrickett@gmail.com and I’ll forward a link for an academic discount (edu accounts only!).

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A reminder that this will be the last week on Substack for OGs and OFZs. My reasoning and what to expect for pricing and paywalling going forward are broken down here. I’ll begin the move to Ghost at week’s end and will aim to be up and running again around August 16 after a much needed honeymoon in Chicago. If you want to get your first 3 months’ subscription discounted at Ghost, subscribe sometime this week for the monthly plan or else the annual plan, which will rollover whenever it’s renewed — I’m still working out the logistics for how those rollovers work but will provide all of the relevant promo codes, probably via Substack or else personal email (reach me at nbtrickett@gmail.com) before launching on Ghost.

Thanks to Tatiana Evdokimova, we can see that austerity’s off to a rollicking start in 2021 because of the fast oil price recovery. Thanks to US stimulus efforts, things have settled:

Revenue collection is overshooting while spending is steadily falling off of the 2020 high last summer. What’s perhaps more fascinating to see is how much expenditure undershot from 2006-2010 against targets in the first half of the year. That doesn’t mean those trends hold out for annualized figures, but it does suggest that the Russian economy suffered unnecessarily from pent up budget-driven demand until 3Q when oil prices were steadily rising and external debts were steadily paid being paid off. Stagnation then imposed a new level of discipline from 2013 onwards. It’s tragic that 2020 was the only year to even out budget execution so well and avoid the usual 4Q dash for cash. And all of this still factors in trillions of rubles that have gone unspent since 2014 without any clear justification aside from the presumable fear that real investment would lead to real corruption and the need to maintain an extra cushion against sanctions despite having other tools available.

What’s going on?

1. Roman Abramovich’s RFP Group has reportedly walked away from investing $1 billion into a pulp and paper mill on the Amur river in northern Khabarovsk krai. There used to be a mill in the area in the Soviet period that went under, and it turns out we know why: the economics offer almost no return per company sources. The hope from Yuri Trutnev, the regime’s minder for the Far East, was to build a mill that could process 400-600,000 cubic meters of wood a year. The firm’s view is small investments into pellet production make more sense. That’s a problem for Moscow for two reasons: the Far East’s share of regional revenues for its annual budgets fell by 14% between 2016-2020 and the state’s plan to tackle illegal logging operations with Chinese operators requires more capacity to refine timber into products. It turns out the export ban on roundwood wasn’t an inflation-control measure so much as a means of reining in regional firms getting too chummy with Chinese outfits that’ll sell raw products to Chinese mills just over the border without paying taxes in Russia. Expecting the 2022 ban, those Chinese mills have moved over the border into Russia where they utilize lots of manual labor and don’t follow recycling and waste removal regulations. They’re undercutting any new competition at the same time the Russian Far East needs more value-added industries that pay taxes and reduce regional budgetary exposure to commodity price swings. Funny how all of these things come together. The new plan to create a state export monopolist makes more sense in light of these challenges — you create a political interest group locally and regionally to crack down on the illegal trade, create a new source of budgetary rents, and allow for more manual control over exports. The more things change, the more they stay the same.

2. The Higher School of Economics has published its monthly update on trade in the national current account adjusted for seasonality and it shows us a few things — the ruble depreciation last year wasn’t just about oil (political risk and imports were big too) and we’d expect more ruble weakness right now based on trade since imports are currently recovering faster than exports. Since December 2020, trade turnover is up 23.6% in monetary terms. So what’s going on with the import recovery and is it good news?

   Title: Dynamic indicators of foreign trade, 2013-2021 (% vs. Jan. 2013)

   Black = trade balance Red = export Cyan = import

   

   The short answer is that the import recovery is likely unequal, credit-driven for households, and otherwise led by exporters or manufacturers. The % share of overdue credit fell .58% between December and June — 7.26% to 6.68% — because of the huge expansion of consumer borrowing. Consumers now owe a combined 12.55 trillion rubles ($168.42 billion) and borrowed 1.18 trillion rubles ($15.84 billion) between December and June alone. You get a bifurcating effect with rising interest rates since only those left who are still creditworthy get loans, which reduces the % overdue but sidesteps the underlying problem that demand is weakening and defaults for those being denied will likely rise. In the first half of 2021, a post-2013 record of about 545,800 small businesses went under. That’s almost double the figures for Jan.-June in 2020. At the same time, there were a record 60,000 mortgage issuances in Moscow. These all may seem disparate, but they point to a considerable K-shaped recovery based on one’s socioeconomic class and home given that 7 in 10 Russians are consciously saving with concern about earnings, rising prices, or else another shock like COVID down the line.

3. Rusal and Oleg Deripaska, Putin’s favorite blogger, are now warning that the incoming export duties on metallurgical products taking effect on August 1 may reduce production by hundreds of thousands of tons. The sector is appealing to MinEkonomiki to request MinPromTorg, who’ve in turn made it clear they won’t budge. Deputy director Roman Andriushin told journalists that the nature of the duties isn’t clear, which is to say that no one really knows why the duties are supposed to help achieve their intended policy goal. Rusal stands to lose 24% of its EBITDA from the duties and is by far the biggest loser from the sector. As a reminder, the duties are set at 15% of the price of any given metal per ton and then adjusted based on each specific metal, most likely determined by increases in relative price levels domestically and available stockpiles. Andriushin makes a stronger point that the company already operates by price reporting requirements and price increase limits set by a 2013 Federal Anti-Monopoly Service (FAS) decision and also allow domestic consumers to agree to long-der supply contracts with indexed prices and hedging mechanisms to protect against large fluctuations. That’s a long way of saying that there are already legal instruments and decisions intended to manage large upwards price increases in place that, while ineffective during COVID, probably make more sense than export duties. I find this situation rather comical as an American who was in Washington D.C. when everyone had pet theories about why Rusal got off relatively easy in the end with the US Treasury. That a company singled out as an arm of the regime led by a Kremlin insider is now so openly being thrown under the bus by regime domestic policy priorities goes to show just how warped the Western media’s looking glass can become because of the relative disinterest in the heterogeneity of the Russian economy and how it intersects, shapes, and is shaped by regime politics and interest group coalitions.

4. The Federal Anti-Monopoly Service (FAS) just authorized Sibur’s acquisition of 100% of the voting shares in TAIF, merging two big rubber and polymer producers on the Russian market. FAS had some stipulations that point to how the ongoing consolidation of Russia’s largest corporations and strategic sectors, admittedly uneven but structurally a trend since 2014, runs against the imperative to manage domestic price levels for political purposes. First, Sibur has to supply a plan to FAS laying out its trade policy for any goods it produces for which it accounts for over 50% of the domestic market. That’s not a huge problem since the two firms specialize in different product segments so the acquisition won’t give them crazy pricing power. Sibur has to prioritize domestic consumers for supply contracts and sales. There’s a bit about ensuring counter-agents’ rights and also a requirement that pricing following transparent indices linked to exchange prices or over-the-counter trade prices wherever the good in question is being consumed and/or produced and utilize long-term contracts. Since the state can’t stop global price levels from changing, it’s trying to lock in the largest firms into long-term indexed deals that often offer a time lag of some sort before an upwards price adjustment, giving the state more time to react if need be and moderating price level changes during periods of high upwards or downwards price volatility. That’s always been a bugbear for Rosneft and other SOEs. But the explicit point about ensuring competition while prioritizing domestic consumers takes on new significance in a context where the state’s made it clear that it’s willing to impose restrictions and duties on exports in an ad hoc fashion when needed. Investors and firms will in a fair number of cases be biased towards justifying projects economically based off domestic demand levels given greater policy uncertainty, and that undermines some aspects of business planning for the export sector. We shouldn’t make too much of that change, it’s just important to recognize the degree to which preferences for autarky are affecting regulatory and business decisions.

COVID Status Report

23,704 new cases and 783 deaths were recorded in the last day. The drop-off in the official data implying a peak shows up in the publicly available estimate for the R rate to capture how many new infections happen per new case — despite an R being near or at 1 for much of May, case fatality was clearly rising over that period. These reporting gaps come as the Operational Staff’s official data now marks 150,000+ deaths from COVID and new research comparing Russian mortality data to world data from the Fund for the Liberal Mission suggests that as much as 45% of Russians may be infected with MinZdrav registries reporting over 29 million cases thus far. The methodology has to be checked, but that scale seems appropriate given data distortions, underreporting, and the extent to which we don’t have a complete view of reporting pressures, lack of capacity, testing availability etc. It’s great to see vaccine take-up rise, but Kazakhstan’s at a higher % now than Russia, see just how quickly Turkey surged by comparison, and how slow Ukraine’s rollout is going:

I’d be really curious to see the first academic treatments of why different regions have differential take-up rates, the role of federal transfers, geography, and other questions of political economy at the local and regional level when things settle down. Excess mortality data for April-August/September will make for grim reading.

Lviv and Let Live

There’s been the expected outpouring of frustration at the deal announced between Washington and Berlin over Nord Stream 2 that, as usual, launders all of the empirically incorrect strategic tropes about the project, exaggerates the relevance of kleptocracy to its completion, ignores the original context for transit via Ukraine, and substitutes hard conversations for easy ones. None of this is to say there aren’t political stakes to the project or that it isn’t geopolitical in nature. Of course it is. It still has a market basis, none of these arguments are applied to the Southern Gas Corridor despite Baku’s active exploitations of the same kleptocratic influence networks, and the issue of Germany killing its nuclear power ambitions also somehow never comes up. No one should pretend this was a stunning coup for Zelensky’s government and reform efforts in Ukraine, it’s not a betrayal or calamity and represents material progress and decent news for Ukraine. So what was agreed? Here’s the Wall Street Journal version. This is what people panicking today are focused on because they prefer hyperventilation to the slow boring of diplomacy:

1. $50 million for green energy infrastructure in Ukraine

2. Germany talks up energy in the Three Seas initiative

3. Try to ensure access to $3 billion in annual transit fees from Russia (unclear mechanism)

4. US retains prerogative to apply sanctions if Russia uses pipelines coercively

5. No kill switch for its use from Germany

6. Germany doesn’t stop future energy sanctions if need be

Here’s the Bloomberg version:

1. Merkel agreed Germany would sanction Russia in response to coercive energy diplomacy, including pushing the EU to sanction energy exports directly

2. The lack of explicit sanctions language is intended to allow for ambiguity so Moscow can’t predict the response

3. US and Germany would promote green investments including a $1 billion green fund with an initial German investment of $175 million into said fund

4. Germany would commit to use political leverage to get Gazprom to extend its transit contract up to 10 years after the current one expires in 2024

5. The US retains freedom of action from prior sanctions warnings to impose additional sanctions as needed and would rescind existing waivers if energy is used as a coercive tool

The outrage came from assuming the WSJ account was more substantively true and a Politico piece revealing that State Department officials were doing their job by asking Zelensky’s team in Kyiv to not come out swinging against the deal while finalizing it. I think it’s pretty obvious the Bloomberg reporting is closer to reality given Blinken’s understanding of the failures of US coercive efforts against Soviet natural gas exports via pipeline in 1982-1983 and the fact that Germany actually made significant political concessions. Those concessions will likely be handed to an incoming CDU leader, Armin Lanschet, who’ll lack the same level of institutional and political capital and be forced to do more to define himself and German foreign policy after Merkel leaves the scene. For a great thread covering why the decline in Gazprom’s delivery volumes via Ukraine is a market concern as a result of choices made by Ukrainian regulators, I give you the one, the only Laurent Ruseckas:

The key point later on in the thread is that the GTSOU in Ukraine offered Gazprom pipeline capacity that was interruptible, and therefore not guaranteed, at the same price as guaranteed capacity when one would normally offer a discount since there is no guarantee deliveries will always arrive. Dependence on Russia isn’t materially affected since Europe is just buying gas via a different pipeline, market integration across the EU continues to deepen, Ukraine hasn’t bought supplies direct from Russia in years, and there’s never been any evidence the Russian military would suddenly support a massive offensive once the pipeline is completed. One can talk about bribes and corruption buying influence in Germany, but no one wants to link the excessive political power of German exporters and bankers in the Eurozone, its inequalities, and the failure to adjust fiscal policy after 2008 to the straitjacket European states have placed on substantive ‘greening’ gains for years, going so far as to kill nuclear plants that would otherwise compete with imported gas volumes. It also misrepresents the increasingly interconnected nature of natural gas markets as LNG production has risen globally. Japan just revised its 2030 energy mix targets and now plans to reduce annual LNG power generation demand by 50% in the next decade:

Japan accounted for 20% of global LNG import demand last year. This is a huge announcement that’ll redirect more deliveries to China and other markets with rising LNG consumption needs as well as free up more supply cross-regionally to make its way to Europe. And demand isn’t set to grow in Europe much anymore, if at all, based on likely demand post-COVID (from the IEA) though these are from June 2020:

Zelensky is going to get a White House visit where Biden will have to announce something to show progress. We don’t know if late July is still in the cards, but the timing would certainly be auspicious now. Ukraine, the US, Poland, and Lithuania are holding military drills in late July too. At some point, the screeching around the pipeline has to stop. The new complaints that the project represents strategic corruption seem to skip over that the 2006 transit dispute was resolved through the creation of a trading entity to the benefit of oligarchs friendly with Moscow in Ukraine, literally strategic corruption. If anything, this was an attempt to cut Ukrainian elites out of the rents. Look at German household electricity prices against the EU-27:

After taxes and VAT, Germans pay more for power than anyone else. No wonder German politicians want to ensure they get more pricing power by acting as a market gas hub linked to Russia and the North Sea. The US just pulled off a diplomatic coup — Germany’s moved on what was a red line for its own policy considerations for the last 5 years, the US isn’t fronting much else, and sanctions instruments have been agreed to as a means of backstopping German efforts to maintain transit. In short, I’ve got no idea what the screaming is about. It’s not perfect. Nothing ever is. But Kyiv came out about as well as possible given the circumstances.

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A reminder that this will be the last week on Substack for OGs and OFZs. My reasoning and what to expect for pricing and paywalling going forward are broken down here. I’ll begin the move to Ghost at week’s end and will aim to be up and running again around August 16 after a much needed honeymoon in Chicago. If you want to get your first 3 months’ subscription discounted at Ghost, subscribe sometime this week for the monthly plan or else the annual plan, which will rollover whenever it’s renewed — I’m still working out the logistics for how those rollovers work but will provide all of the relevant promo codes, probably via Substack or else personal email (reach me at nbtrickett@gmail.com) before launching on Ghost.

Kremlin aide Andrei Belousov reportedly promised to Putin that real incomes would rise and inflation would be reined in by the end of the year to 5% in annualized terms at a meeting of the Council on Strategic Development and the National Projects. Real incomes will be up by 3% and price increases won’t undo the gains of a labor market significantly tightened from the loss of cheap, exploitable migrant labor. I’d love to know what he’s drinking. Timing is everything:

It takes time for today’s prices to filter into tomorrow’s costs and companies try to delay passing on prices initially before being forced to. There are also variables that can’t be accounted for with policy. Dry weather and drought in the US and Canada will probably push up grain prices once the summer crop is harvested and it’s also affected the availability of feed in some regions in Russia just as fertilizer prices keep climbing. Though the rate of price increases may be easing, the only way to really bring inflation down at this point will be weakening the recovery. Short-term price control measures will provide occasionally good news in the weekly data, but worsen the problem of timing — firms holding prices down take losses and eventually have to mark them up. What seems likely at the moment is the plan is to do precisely that — weaken the recovery with rate hikes and no new fiscal impulse while using the one-time payments to families in the data to show things are improving by August and then find a new way to deliver better stats. Housing prices are finally expected to fall 5-10% in the months ahead as rising rates are now scaring off consumers from subsidized mortgages. That will be good for inflation figures, but shows a lack of spending power and limited if any real income gains are doing that work. In other words, they have to decide between killing inflation and providing a strong enough base for real income gains amid slightly higher inflation due to stronger growth whose benefits don’t just flow to exporters and state officials. They can’t have it both ways.

What’s going on?

1. Vedomosti has confirmed that the government signed off on a plan to “mobilize revenues” for the 2022-2024 budget on July 1, tasking MinFin, MinEkonomiki, MinTrans, MinEnergo, the Federal Tax Service, the Customs Service, and the Ministry of the Interior are all being asked to pitch in to reshape the tax code for the non-oil & gas sector(s) of the economy. First up, an increase in severance taxes for the metallurgical sector to collect more resource rents from metals & mineral extraction for production the state did not raise taxes on during COVID including precious metals producers who’ve benefited from export license liberalization. Most recently MinPromTorg has proposed simplifying export procedures for platinum and rare earth metals. Expect a lot more action on that side since the sector-wide mineral extraction tax (MET) for the metallurgical firms averages about 8% vs. 40-60% for oil & gas companies and the move’s expected to raise 100 billion rubles ($1.34 billion) for 2021-2023. Second up, higher export duties for ferrous and non-ferrous metals to further capture the windfall from higher prices and tame inflation for another 160 billion rubles ($2.15 billion). Apparently Economy Minister Maxim Reshetnikov made clear it was best to go after the metals firms since and the oil & gas firms pay enough as it is. Third, there’s renewed talk of selling small stakes in smaller state-owned firms, selling state-owned land, and increasing dividend repayments to the state budget. Fourth, the government sees aligning with Pillars 1 and 2 of the OECD’s global tax coordination push as useful — Pillar 1 established standards for the national taxation of giant supranational digital firms and Pillar 2 falls under the coordination of a minimum corporate profit tax rate of 15%. Finally, they want to improve the administration of fines for traffic and transport violations. These are intended to raise a combined 400 billion rubles ($5.37 billion) and it’s not clear why that figure specifically is necessary. What seems likelier to me is an overshoot under the guise of an otherwise staid set of reforms based on market conditions and the OECD alignments in particular while avoiding consumption taxes.

2. The government has worked out changes to the system of vertical administration over regional districts through the government and Kremlin’s appointed ‘curators.’ As of now, prime minister Mikhail Mishustin has 8 deputies who handle the larger regional blocs individually who shadow 8 tasked with the same from the Kremlin. There’s plenty of overlap going on too. From Mishustin’s side, Viktoria Abramchenko is handling Siberia, Yuri Borisov is handling the Urals, Tatiana Golikova is handling the Northwest, Dmitry Grigorenko is handling the Central district, Aleksandr Novak was handed the North Caucasus, Marat Khusnullin was given the South, Dmitry Chernyshenko took the Volga region, and Yuri Trutnev retained his long-time role handling the Far East. According to the new push, their main jobs are managing social development — handling local concerns, preventing income declines, warding off excessively wasteful budget spending, and intervening in local and regional fights over resources so they don’t have to come to Mishustin or Putin’s desk:

   

   What’s rather hilarious is that three governors seem to have had anonymous sources leak to Vedomosti that they have no idea how the new system is actually supposed to affect decision-making or work in practice. It was announced at the Direct Line on June 30 without any prep, it seems. That the Kremlin has accepted a new “dual” system gives Mishustin a greater formal and informal role resolving regional matters and carries a clear logic as an extension of his Coordination Center — data collection, crisis management, and now social policy implementation will be vertically organized through his office. In other words, it’s now entirely on his team to keep the people happy or at least complacent enough while the Kremlin focuses all of its domestic energy on settling elite disputes or, in the case of tax reform, providing an avenue to protect the interests of big business or alternately browbeat them to action. That’s a long-term trend, but probably made far more palatable given Mishustin’s relative public popularity and lack of a clear, defined base of elite support outside of the regime’s technocratic cadres.

3. Stevedores working at Russia’s southern ports are upset that Russian Railways hasn’t shipped planned volumes of coal using their facilities. The rail monopolist counters that loading has picked up in the south, with coal volumes doubling over 2020. Yet ports have had problems since the end of spring and by July, ports weren’t receiving as much as half of declared volumes. Coal shipments via rail in the North Caucasus are down significantly. To get a sense of the disruptions, Tuapse received just 56 rail wagons of 122 booked, Novorossiysk received 56 of 82, and Taganrog received 10 of 17. Rising coal prices led to shifting export priorities — Asian markets took precedence and China’s ban on Australian imports has shown that Russia’s infrastructure network, by dint of its size and state of development, isn’t great at handling large market shifts. The more direct proximate cause recently has been the oil price recovery and surge in earnings from shipments of crude oil and refined products to southern ports. The lack of coal shipments now threatens these stevedores’ earnings and employment, a great example of how swings on commodity markets and climate priorities can quickly become sources of labor-capital conflict in Russia because of the political management of employment and cross-sector demand. RZhD is promising it’s on the case, highlighting modernization works to expand export capacity for rail via southern ports up to 125 million tons annually and using some statistical trickery to throw critics off the scent. Southern loadings in the aggregate are up 22% to 46.2 million tons so far, coal is up 80% to 14.5 million tons, and coal is up 93.4% to 1.4 million tons for the first two weeks of July. Just one problem. The stevedores working the warehouses and wharves know that only 44% of the coal that’s been booked has actually come through while no other good has had any trouble. It’s expected warehouses will swallow losses through September.

4. The Association of Retail Trading Companies (AKORT), an organization that includes giants Magnit, the X5 Group, and Lenta, and the Association of Internet-Trading Companies (AKIT) including Wildberries, Ozon, and “Utkonos” are warning that proposed regulations from MinPrirody making producers responsible for targets recycling goods and packaging will lead to empty shelves and a reduction of consumer choice. Basically, the technical requirements will be costly enough that retailers will have to cut down on what they offer because of attempts to create a goods registry against which inspectors and federal/regional agencies can assess their performance. MinPrirody intends to create a register for included goods and packaging used by firms that are “greenlit” for sale because they meet the necessary specifications, then by default banning the sale of any goods or packaging not included in the register. It’d be a blunt weapon to wield over firms rather than a scalpel, and one that would also undoubtedly raise some problems for implementation and enforcement. Retailers point out that there isn’t even a unified registry in existence identifying which firms make which products that would be included or banned from the registry and at present, only 3-5% of producers meet the standards the regulatory change would set. Why? Because existing regulations are already poorly administered, Russia’s a massive country, and you’re asking companies to invest a bunch without necessarily realizing significant returns because of the structure of things like power markets, transport costs and subsidies, and competition for customers on a market with stagnant or falling incomes. The companies are probably complaining far beyond what’s merited. In practice, firms are already supposed to declare the goods and packaging they make and use. Entering that into an electronic system would be relatively straightforward. But every company knows that the list would be leveraged by competitors and the state when convenient, creating an environment where policy implementation is massively undermined because of the lack of trust between business and the state. Luckily MinPromTorg is now incorporating sectoral concerns and complaints into its proposals. Worth watching how this plays out since these types of impasses will become more commonplace whenever the national decarbonization strategy is finally adopted.

COVID Status Report

23,770 new cases and 784 deaths were recorded in the last day. Cases in Moscow keep falling a bit faster than regional cases rise but the Operational Staff data shows that’s largely peaked now. If you look at the case fatality rate, the implication is that infections are still rising unless the new variant is actually deadlier or else that at-risk populations have been hit harder this time than in the past:

The fact that economists now estimate that the 3rd COVID wave will only take 0.1% off of GDP this year isn’t evidence of success or particularly strong economic resilience, but export dependence. Putin just doubled down on rhetoric that Russia recovered quickly cause of “flexible” macroeconomic policy, which is a tragically unfunny joke given that even Brazil outdid Russian stimulus in GDP terms. The fact that less capital is leaving the country via tourism is also helping around the edges. Over 6 million Russians have now officially been diagnosed with COVID-19 at some point, a far cry from the implied infection numbers if Russia really has achieved 60% collective immunity. Looks like Turkey might shut its borders to Russian tourists and others soon enough cause of Delta variant concerns, but it’s not the plan yet.

What to expect when you’re not expecting

Conditions in Afghanistan continue to deteriorate, most visibly with rockets landing near the Presidential Palace in Kabul as president Ashraf Ghani and other leaders marked the start of Eid al-Adha and the brief kidnapping and torture of the daughter of Afghanistan’s ambassador to Pakistan. Russia, Tajikistan, and Uzbekistan are launching joint drills on the Tajik-Afghan border from August 5-10 with the Russian military now positioning tanks and other heavier assets in country to prepare. Authorities in Kabul say they’ve retaken the Spin Boldak-Chaman border crossing, but the Taliban naturally denies this since it’s able to exploit foreign media’s lack of awareness of Afghanistan’s geography, regional differences and divisions, and the practical reality of politically controlling territory to exaggerate its otherwise impressive gains on the battlefield thus far.

Over the weekend, Kommersant let slip that Moscow might be cracking the door open to allowing the US to conduct some operations out of its bases in Tajikistan and Kyrgyzstan so long as it could secure buy-in from CSTO partners and strictly limit the scale of whatever the US would do and place at said bases. Unnamed sources claim the topic was raised at the June meeting between Biden and Putin in Geneva. Personally, I think it’s wishful thinking — it’s much more likely the notion was planted by the diplomatically inclined in Moscow who understand the logistical challenges a larger role managing Afghanistan’s borders and internal conflicts entails than evidence of a real change in policy. The National Security Council regularly entertains bizarre diatribes about NATO’s biological weapons ambitions against Russia and more thanks to Nikolai Patrushev and while the Ministry of Defense has gotten comfortable coordinating activity to avoid military confrontation with the US in Syria, no military enjoys the specter of managing a battle space with multiple participants who aren’t allies frequently acting at cross purposes even when interests broadly align. There’s no political cost to raising the option with Biden and his team, but Moscow would set very strict conditions that would make it quite difficult for any American administration to agree to. The question then becomes why air it publicly now? One word: China.

“The United States, which created the Afghan issue in the first place, should act responsibly to ensure a smooth transition in Afghanistan . . . It should not simply shift the burden onto others and withdraw from the country with the mess left behind unattended.” That’s Chinese foreign minister Wang Yi on the withdrawal. It turns out Beijing likes it when its competitors provide security for its exaggerated development promises of roads, rails, pipelines, mines, and more. Neither government appears to have had any clear plan for what to do in the event this happened. But now that Moscow is actually stepping up and sending men, materiel, and committing intelligence assets to handle the problem, what does Beijing do (at least publicly)? Nothing of substance. More of the same timid promises of investment if the Taliban can secure it, more talk of the China-Pakistan Economic Corridor (CPEC) and expanding its remit, and more promises of support to Dushanbe that hide behind invocations of the Shanghai Cooperation Organization (SCO) and multilateralism to dodge admitting the obvious. China has no intention of committing real resources until it absolutely has to do so. Threatening a US return to Central Asian bases would, in fact, serve its interests, but dangling it in this way reinforces that China can no longer rely on the United States to pick up the tab handling this problem.

At the same time this drama has played out, there was fleeting hope that the Biden administration had gotten serious about withdrawing the remaining contingent of US troops from Iraq. It’s an evergreen topic in Washington and talks had been noted publicly in April. The escalation of what are, crudely speaking, nuisance rocket attacks on US bases in Iraq parallel growing political pressure from Baghdad to leave. Iraqi officials from the Prime Minister’s office leaked to the media that the withdrawal of combat troops had already been discussed, a claim flatly denied by an unnamed senior US official in an incident that spoke volumes about the state of play for Biden on the issue. He’s trapped in the middle of brutal budget reconciliation negotiations for a $3.5 trillion spending package paired with a bipartisan infrastructure bill now being undermined by Republicans’ refusal to increase funding for the IRS to provide revenues and trying to work out ways to advance talks with Iran that now look definitively stalled for the next month. If it looks like the US is pulling out the remaining 2,500 combat troops in Iraq — a presence that largely exists to be shot at by militias since ISIS has been defeated in Syria and Iraq — and Washington’s lobbies grab it as proof that the US has been forced out, the White House would rather not waste the political capital fighting that fire at the moment. The latest airstrikes on ‘pro-Iran’ militias fit into that political logic. They accomplish nothing significant strategically and little tactically. The fact that no senior Pentagon official has gone officially on the record in the relevant coverage suggests that Biden wants to pull it off. It’s a matter of timing and balancing it against other priorities. Lloyd Austin, the current defense secretary, oversaw the pre-Trump drawdown. The next round of talks with officials in Washington will have to resolve this diplomatic incident and ‘reset’ things on whatever path Biden really wants.

The arc of US policy isn’t hard to intimate, the question is whether it can be executed. If the US presence in Iraq is reduced to an advisory role and it reduces the logistical burden of running air support and air strikes, that means more assets focused on Syria, parked at bases in Jordan, Kuwait, or Qatar when needed, or else more kit rotated to other theaters, refurbished, and replenished. Without the same US backstop, however, that leaves yet more room for uncertainty in the face of instability that Russia has to worry about. Lukoil is trying to unload its headaches onto Chinese firms, but Rosneft controls strategic export infrastructure from Kurdistan and Gazpromneft (if I recall correctly) still has claims for several blocs negotiated with both Erbil and Baghdad. This map is old but all of the Turkey bound oil and natural gas export pipelines are now majority owned by Rosneft as part of an evolving prepayment deal to lift crude volumes back in 2017-2018 that backstopped Rosneft’s CEFC China Energy supply deals. Rising Russian crude volumes delivered east meant finding new supply to sell to Europe:

Add in that OPEC production will only rise in importance in the years ahead — Lukoil VP Leonid Fedun thinks OPEC may control 70-80% of all output in a radical supply/demand reduction scenario — the security of supply in Iraq and the region paradoxically matters more for price stability at the same time it’s less salient for consumers. This “double drawdown” was the core thrust of the Obama administration’s strategy that was undermined by the politics of the surge in Afghanistan and incredibly difficult environment passing anything after 2010. It’s symbolic, but the Biden administration just moved its first prisoner out of Guantanamo Bay. The legacy lives on and is visible in US strategy. Taking a wide view of it, Moscow may soon have to face the prospect of offering more for regional security if Iraqi officials get their way and the US reduces its presence and role further. Fears of instability and the desire to fill any vacuum will also follow economic needs. There’s no meaningful decline in the significance of oil prices and output for Russia’s business and investment cycles on the horizon. And as we’ve seen, stagnation and the new commodity cycle have forced the state to look at new ways to mobilize other resource rents where possible and since 2013-2014, oil rents have been insufficient to generate growth without broader range in macroeconomic policy. Washington is stumbling into a half-decent strategy while Russia stumbles into roles it probably preferred to avoid if possible and China still has no clear vision of what kind of security role it intends to play across Eurasia.

Like what you read? Pass it around to your friends! If anyone you know is a student or professor and is interested, hit me up at @ntrickett16 on Twitter or email me at nbtrickett@gmail.com and I’ll forward a link for an academic discount (edu accounts only!).

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A reminder that this will be the last week on Substack for OGs and OFZs. My reasoning and what to expect for pricing and paywalling going forward are broken down here. I’ll begin the move to Ghost at week’s end and will aim to be up and running again around August 16 after a much needed honeymoon in Chicago. If you want to get your first 3 months’ subscription discounted at Ghost, subscribe sometime this week for the monthly plan or else the annual plan, which will rollover whenever it’s renewed — I’m still working out the logistics for how those rollovers work but will provide all of the relevant promo codes, probably via Substack or else personal email (reach me at nbtrickett@gmail.com) before launching on Ghost.

For those curious, I recommend watching or reading Alexei Kudrin’s interview with Kommersant for its series on the 30th anniversary of the collapse of the USSR. He flags his relationship with Anatoly Chubais and becoming a part of that social circle of reformer economists in 1988-89 with the expectation that they’d reform the Soviet economy and not that of an independent Russia. He again makes clear that the liberal bloc of advisers, financiers, and economists who managed to retain some form of orbit around Putin and his Petersburg connections as they came into positions of authority during and after the 1998 financial crisis fundamentally saw the collapse of the USSR as a political consequence of various forces and choices responding to the economic stagnation of society. He also makes clear that the creation of reserve funds were primarily intended to be a currency management system and only secondarily a rainy day fund — this makes a lot more sense when you consider the unnecessarily stringent limits placed on spending money from the National Welfare Fund and related sources of accumulated foreign currency earnings. There’s a constant fear of imports displacing domestic production, but that runs into some clear policy contradictions because the suppression of domestic demand, intended to encourage price stability, undermined the diversification of the economy. That dynamic is only more acute now. It’s rather laughable to tout post-Crimea successes at the macro level — there are plenty of sector-specific success stories, though often via subsidy and trade restriction. Rosstat data messes the story up. In 2017, oil & gas accounted for 16.9% of GDP. In 2018, it was 21.1%. In 2019, it was 19.2%. In 2020, it fell closer to 15% in absolute GDP generated terms but it’s clear that dependency is not best described merely by the sectoral share of produced output, particularly since it plays such an important role sustaining key imports elsewhere by providing foreign currency earnings and liquidity. The ruble floats now so why sit on those liquid reserves? There are plenty of reasons, but it’s useful to see that the contemporary political logic of accumulation for the regime’s purposes has deep ideological roots in the preferred methods liberal economists opted for to manage oil wealth, and ultimately failed as the economy’s. complexity steadily declined post-98’ through the 2008-2010 crisis period and has been stagnant since if not fallen slightly more.

What’s going on?

1. Evidence is piling up that the positive spin on the economy from MinEkonomiki is mostly playing with data to hide the truth. A new NielsenIQ survey shows improving optimism — a rating of 90 vs. 89 last time, but still a net negative rating since it’s under 100 — but that 71% of Russians are still saving on where they can. 68% are spending less outside the house, 67% are cutting back on clothing purchases, 61% on eating out, 54% on annual vacation, 46% on takeout and prepared foods, and 41% on electronics. In June, banks only accepted 36.9% of applications for consumer autoloans to buy cars, the lowest figure seen since April and May 2020. Creditworthiness seems to be falling again. Debts for utilities have declined slightly thanks to write-offs, but households owe a combined 1.3 trillion rubles ($17.45 billion) for unpaid utility bills, a 5.9% increase year-on-year. Bakers are warning that state subsidies are inadequate to hold bread prices down and price increases in the range of 7-12% are likely for retailers in August. MinSel’khoz thinks flour and other inputs will get cheaper, so that fear is made up. What’s likely happening is that producers are now using the specter of further price increases as political leverage to try and offset past losses in case prices don’t rise, or else adapt as they do seem to keep heading upwards. If real incomes are increasing, most households aren’t getting the memo and business costs aren’t falling yet. My question is how does the 29% of Russians not saving breakdown? Does it include pensioners who literally can’t spend less because they already don’t really go out or buy prepared food? More likely that group is primarily government officials who’ve rewarded their excellent stewardship of the nation with wage hikes and, ironically, the core constituency of better off service workers based in large cities who the regime stopped courting politically after 2011. I’d need to look more at the data to be sure, but that’s my intuitive sense. Worse is probably coming, with inequality and averages hiding the damage, but there may be some turnaround after August depending on how long the current COVID wave peaks in place.

2. This is from Friday, but worth contextualizing with other news from last week. Producer price inflation has reached record levels not seen since 2000 — they’re up 35% year-on-year as of May. It’s even worse for Kazakhstan, Turkey, and Brazil, but slightly better in Ukraine:

   

   That inevitably leads to higher consumer prices with a lag time as firms eat losses in hopes of retaining customers and riding out the surge of rising prices. These figures dropped just as S&P decided to rate Russia’s sovereign credit rating as a BBB-, the last level for investment grade borrowers before reaching junk status. Finance minister Anton Siluanov says it’s proof that macro policy has been good despite the 3rd week in a row in which there’s very little demand on the primary market for OFZ issuances because, spoiler alert, banks don’t want to hold sovereign debt as a safe asset to back other lending when the economy’s not in great shape despite some positive indicators for wages due to labor market tightness. Inflation’s going to keep rising per Central Bank assumptions, though the rate of increase should moderate. There’s no evidence anywhere that fiscal policy is to blame for these problems and it’s now nudging the ratings agencies to push Russia closer to junk territory. It’d be delicious, if tragic, irony to see Russia’s sovereign rating take that hit as a result of its failure to spend.

3. MinEkonomiki is open to using the WTO’s dispute settlement mechanism and an arbitration panel to resolve its issues with the European Commission’s carbon border adjustment mechanism (CBAM) proposals. It’s to be expected given the complexity of the instrument and EU’s approach trying to coax and coerce trade partners into what it considers to be an adequate level of alignment (not necessarily harmonization or equivalence of carbon standards per my understanding, but I’d need to look more closely at the latest). Unfortunately, Moscow has an uphill fight ahead of it. The EU and Russia have repeatedly gone to WTO arbitration panels since Crimea as a result of Russia’s unilateral counter-sanctions on EU food imports. In several cases, Russia has lost its appeals to appellate bodies and then failed to implement measures in the timeline nominally agreed with the EU. Worse, the WTO took a big hit when the Trump administration quashed the appellate body on December 10, 2019 in a bid to free up the United States’ ability to add and retract tariffs as it pleases. Russia’s banking on the power of multilateral institutions it has little interest in maintaining and explicitly politicized as a result of its “sovereign” turn regarding trade and industrial policy since 2013. What’s more, the introduction of decarbonization into the agenda this year has upended key assumptions about the national projects that had otherwise been intended to drive Russian economic growth pre-COVID. We can’t yet see the full outline of the effects but it’s starting to look like the EU’s climate agenda is ironically what’s brought much more firmly into the American camp on Russia foreign policy. Since decarbonization quickly became a priority for European firms already facing stricter regulatory pressures and carbon prices, they started to change their attitudes on the foreign policy implications as have European governments, even with the current backlash against the reality that energy prices will rise and affect those who are poorest. The question is whether the impasse is resolved amicably with rising investment levels and action or through disorder that threatens to further weaken growth between both the Eurozone/EU importing economies and in Russia itself.

4. The attempts to fix domestic fertilizer are now having a negative effect on harvest planning — growers are warning they might not be able to buy enough fertilizer at current price levels in August-September, which will then lower agricultural yields next year. Though it was agreed there’d be a price freeze after a meeting between the government and largest producers on July 16 and that small(er)holder farmers are to receive a 5% discount on fertilizer, the ministries in Moscow still have to work out the details. The trouble is that even with prices frozen, firms will have to cut back on purchases. That could lead to yield declines by as much as 20-30% by next summer. Whereas fertilizer accounted for about 15% of production costs coming into the COVID crisis, the cost of fertilizer has doubled since last July — prices are up 30-70% since the beginning of the year for different types on the St. Petersburg Exchange. The overall lesson is that inflation control measures taken today aren’t working, and can end up worsening future inflation since “inflation” writ large is distributed between different sectors and political groups. When commodity prices rise, extractive firms initially benefit before they feedback into finished products. When wages rise, labor benefits unless/until consumer inflation wipes out gains. These rates of increase are happening differentially depending on sector and even among fertilizers. The following are avg. domestic prices in rubles/ton over the last year:

   Red = nitrogen minerals/chems Black = Potassium minerals/chems Grey = ammophos Blue = anything containing nitrogen, ammophos, and potassium Orange = anything containing nitrogen and phosphorus Light Blue = nitrophoska

   

   Investment is the solution. Fertilizer manufacturer has received 1.3 trillion rubles in investment since 2013, and is hoping for another 2 trillion through 2028. Domestic production has continually risen, reducing currency risks and similar cost concerns, but it’s not enough to ward off global price increases creating sectoral cost mismatches.

COVID Status Report

24,633 new cases and 719 deaths were recorded in the last day. The regional case curve is flattening according to the official data so it looks like we’re close to peak figures or else have peaked, but I suspect a handy data intervention has taken place. Week-on-week case growth slumped to just 1.4% despite the absence of national lockdown measures and uneven regional policies — to be fair, there’s been considerable efforts taken to do things like prevent mass spreader events in general:

We’ll be uncovering the extent of the damage done by the pandemic for a long time because of the statistical chaos. Rosstat’s latest mortality release for 2020 shows that average lifespans in Chechnya, Lipetskaya oblast’ just north of Voronezh in the Black Earth region, and Dagestan fell 3.4-4% last year. In Chechnya, excess mortality hit 47% while people lived 3.77 years shorter on average. It’s difficult to believe that Russia has achieved an adequate 60% collective immunity through infections if only because we’ve seen that people infected with past variants who aren’t vaccinated are at significantly higher risk from new strains. That said, it is quite possible the caseload’s peaked in which case that’s the probably the best explanation.

Crisis Brides

OPEC+ appears to have sorted out a tentative agreement to resolve the impasse we’d seen the last few weeks. Starting in August, output will rise 400,000 barrels per day, the production baselines for the UAE, Saudi Arabia, Russia, Iraq, and Kuwait will be raised, and the original deal expiring in April 2022 will be extended to December 2022. Everyone saves face, the oil market kisses $100 a barrel goodbye, and US shale drillers can’t eat up some of the marginal gains later in the year thanks to excessive restraint. All told, the net adjustment upwards for baselines is worth 1.6 million barrels per day (LHS is mbpd):

The oil market has woken up to falling prices for Brent crude which are now hanging around $71 a barrel. Warnings about a rapidly tightening market are now probably going to give way to a more balanced perspective — since any shortfalls of supply can be readily met by OPEC+ for now, there’s no “real” supply squeeze. It’s a matter of maintaining a decent price band and avoiding another price collapse. OPEC’s July report flags the 800 pound gorilla in the room — China’s slowdown:

Russia’s current plan, per Aleksandr Novak, is to return to pre-COVID production levels by May 2022 by increasing production 100,000 barrels per day each month starting in August. That’s a net plus for Russian firms like Lukoil looking to sell down assets in Iraq and focus efforts closer to home as well as Rosneft, which always wants to push output as high as possible. Ironically, the positive push from a production rise for Rosneft’s Vostok Oil likely brings forward political conflict between firms. Transneft is expected to lose out on shipments of as much as 25 million tons of crude annually once Rosneft’s oil terminal supporting the project is completed. It’s expected to suck out 15-16 million tons of oil from the Vankor cluster and another 10 million from new output — Vankor volumes account for 3.4% of Transneft’s total crude shipments. Since tariff rates are tightly regulated and Transneft’s investment plans have historically been whittled down after grand announcements, marginal changes in earnings make a significant difference. What’s been a distributional fight between states over their share of the recovery pie will soon shift into domestic fights between firms trying to best position themselves for a market where output is more or less “normal.” The latest update from Minchenko Consulting for its “Politburo” reports on the regime’s insiders notes that Igor Sechin is the only figure from the inner circle with exclusive access to Putin. I’d hate to own anything he wants as production rises once more or else be pleading my case to save my own bottomline. Oil quality is also an issue. Tatneft and Lukoil were hit hardest by the removal of tax breaks for the extraction of high-viscosity oil to top up the budget. Vagit Alekperov has made clear he won’t invest into new production of that type unless they reinstate the tax breaks, which also probably explains why Lukoil has pivoted to focus on offshore developments in the Caspian and Gulf of Mexico — in Russia, offshore tax schema are more forgiving than onshore and Lukoil’s always focused on minimizing its tax burden unlike Rosneft and other SOEs in terms of its investment strategy.

We can also see from the latest OPEC report how the organizations view on the distribution of demand recovery is evolving and why that spells trouble for Russia:

In % terms, the US+Europe share of demand and China+Asia-Pacific share of demand are basically flat through 2021-2022 while it’s the “rest” led by India, the Middle East, Latin America, and smaller consumers in Africa and elsewhere not gaining yet either. Note that OPEC doesn’t use the same categories as BP so Asia-Pacific is really Japan-South Korea primarily. The point is that developed market recoveries are still pacing global growth and the net gains to demand it seems, which means that marginal shifts in road fuel use, public transit, and similar demand destroying activities and investments can begin to have a negative effect on cumulative demand within about 2-3 years’ time. There’s little reason to believe developing markets are headed for a new wave of strengthening, oil-intensive growth even with the pathway dependencies on coal still in place. Vaccine nationalism and the numerous logistical hurdles facing mass vaccine production ramp ups will create a longer “trough” for recessionary effects from COVID due to higher mortality rates, higher infection rates, and the limited state capacity in many countries to address those shortfalls:

OPEC+ has decided on the best worst course of action available to it. Now the distributional fights will shift to the domestic side, where companies and individuals want more in a world stumbling into structural demand decline. The Ministry of Finance awaits at the ready to tell elites the state can only do so much to help. We’ll soon find out just how much value can be extracted in these conditions.

Like what you read? Pass it around to your friends! If anyone you know is a student or professor and is interested, hit me up at @ntrickett16 on Twitter or email me at nbtrickett@gmail.com and I’ll forward a link for an academic discount (edu accounts only!).

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Substack has the benefit of being free up front, charging no fee, and providing a streamlined interface with a tiny bit of marketing capabilities. The trouble, as usual, lies in the fine print. Substack takes 10% of whatever you charge and passes on an addition 2.9% to Stripe for processing your payments. In other words, their profits off your labor scale regardless of the relative costs for them to manage your account. That’s great when you’re just starting and not worried about paid subscriptions, but adds up quickly once you decide to make the pivot to paywalling more content and expanding your paid subscription base. Ghost is a different story. They charge flat fees that don’t scale too much. Since this will always be a niche publication, doesn’t quite fit into a purely business mold, and I don’t have the pedigree to be a Matt Klein or some similar analyst and commentator, I don’t need a huge mailing list and it benefits me to hold onto every cent I can since I can’t charge too much.

That also goes to a decision I’ve made that I need to begin paywalling content and increase the cost per month from $5 to $8 with a 20% discount for an annual subscription ($76.80). It adds up fast on my end, believe me. Reality is that it usually takes me about 4 hours of “good” work or 5-5.5 hours of “bad” work to finish on most days. Sometimes it zooms by quick, occasionally it takes a little longer, but that’s the general timeframe. Sometimes that work directly overlaps with another project I’m on so the extra time isn’t an issue. Regardless, that’s half of most people’s official working day and it represents a distillation of a fair bit of scanning and reading, occasional data pulls (though I reduced that over time), and now 5 years’ professional experience, two master’s programs’ worth of content knowledge, self-study, and crippling Twitter addiction to pull together. It’s always been and will be a labor of love, but it has to be properly monetized going forward. Anyone who’s already paid for an annual subscription will retain that subscription until the year elapses at which point they’ll have to renew. Anyone on a monthly subscription at $5 will be free to email me at nbtrickett@gmail.com to request a promo code for Ghost that will give another 4 months at $5 before the upwards adjustment kicks in. For anyone on an academic discount, please email me and I’ll send you a new promo code to keep the % rate adjusted to the new base cost of $8 a month or $76.80 a year — $1.60 a month or else $15.36 a year. Anyone otherwise on a gift promo from when I launched can similarly contact me to extend it.

When I started this, my real aim was just to keep myself busy. I’d been unemployed for abut 5 months at that point and had only just realized I could still legally work in the UK as my visa application was being processed. It was as much about keeping my mind active and getting back in touch with work I’d really enjoyed when I did it with FPRI as anything else. It also was an excuse to get back into the kinds of analysis that had inspired my initial book idea, a process that led to over 30,000 words’ worth of drafting and redrafting ideas and sections until I realized the parameters of the project and the gap in the discourse I wanted to fill in the last 3 months. My eventual hope was to bring back daily coverage on Russia with non-Russia stories since there aren’t many outlets doing that work for English speakers from a political economy perspective. The energy transition and COVID storylines were salient issues that I either had a particularly keen interest in and continue to be defining features of how we should be thinking about Russia and Eurasia as a set of interlocking economic and political interests, systems, classes, and institutions. I wanted to be on the ground floor of that conversation. I think I succeeded, but failed to do nearly enough self-promotion. It became all the more difficult once I started doing regular project work in November-December 2020.

I haven’t made nearly as much progress trying to expand the conversation on Russia, including challenging the bizarre degree to which Western observers, frequently from non-economics backgrounds, internalize the economic logic the regime’s institutions and leaders provide uncritically all the while ranting that the US Congress or UK parliament have been beholden to the neoliberal turn in policy and so on. We’ve ceased to think seriously about Russia and Eurasia as an economy and economic system, and become far more comfortable thinking in terms of security or sociology or political science or whatever equity analysts want to talk up. All of these disciplines and areas matter. But when it comes to economics and to a lesser extent our historical understanding and contemporary analysis, there’s been a collective failure to integrate the Russian and Eurasian experience into broad discussions of macroeconomic theory and the evolution of economic policy consensus over time. It wasn’t necessarily my initial intention, but it’s become more and more apparent to me that policymakers, analysts, and academics do amazingly fantastic work on the region and on the rest of the globe that isn’t synthesized often enough. A US stimulus bill, German regulatory imperative, Chinese steel giant’s default, lawsuit in a London court, and Japanese development loan to Tajikistan can all be linked by visible or else palimpsestic chains of asset custody, political will, supply, and consumption. As much as academics have done a great job expanding and reframing our understanding approaches to Central Asia to push back against the orientalizing tropes of what I calll peripheralism, the same logics need to be applied more openly to Russia. And the analyses of the link between economic interest groups and security policy in Russia equally apply across Eurasia and come into deeper conversation with the remarkable work done in economic history and there disciplines now actively engaged in the project of reshaping developed economies after COVID.

I also haven’t broken through to a large enough audience yet. Paradoxically, not paywalling content has probably contributed to that for the simple reason that everyone’s already inundated with newsletters and posts. When something’s free, it’s disposable. People take for granted the huge amount of work that goes into it. Mass matters but occupying a niche is more important and exclusivity can help. Regardless, I have to do a much more proactive and better job “selling” the output. Paywalling carries the obvious risk that lots of people unsubscribe when they can’t get their fix for free anymore. That’s why I’ve settled on an approach intended to build on what I think the real “value-add” of what this has morphed into over these last months. Friday newsletters will go out to everyone regardless of their subscription status, I’ll occasionally unlock others when major stories break, and will post one non-newsletter item a month for free with each additional one subsequently paywalled. Here are a few ideas I’ve been kicking around about what those non-newsletter posts look like:

1. Collaborating with specialists and academic friends, putting out weekly and monthly roundups of major news from the Duma and Eurasian parliaments, including a bit of analysis around things like changes in taxation when applicable

2. Doing interviews with a wide range of area experts as well as people from other disciplines and area specializations, whether by email or recording a Zoom/Skype interview and posting it with a transcript of either everything or salient bits

3. If this reaches enough people, hosting an event and using that as a launchpad for collaborations and threads to follow

4. Posting draft excerpts of book writing — I’m finally soliciting feedback on my chapter outline, refining the pitch, and about to go for it so might as well!

5. Building out more regular data analysis and updates, but in a more targeted manner and also drawing on international context, US, EU, and China macro and so on rather than just posting what Rosstat, Belstat, or other agencies have published in a (relative) vacuum

6. Book reviews, but more in the style of the LRB — trying to bring works from varying fields into conversation with each other

7. Posting roundups of differing viewpoints or even debates between experts from Russia, the US, Europe, China, and Asia-Pacific more broadly on economic, political, and security issues

The work and broader circle of contributors likely needed will probably end up changing the pricing structure over time depending on the size of the readership, but for now I’m limited by Ghost. Unlike Substack, you can’t launch multiple newsletters and pricing is fixed instead of having a tier system. My ultimate goal, however, is to make Russia and Eurasia “interesting” again by bringing the space into broader conversations taking place right now. What began as a personal project to keep me sane feels like it needs a more directed purpose now. I know that some people will unsubscribe or else are too busy to read regularly. I’m happy to discuss ways to make the product useful for you and projects that might be of use to you, potential collaborations, or else chances to promote your own work on the platform. My hope is to find ways to make staying on as valuable as reasonably possible acknowledging that the sheer amount of time this work can take and opportunity costs of doing it rather than other things add up.

I’ll include a link to this a reminder about the change at the top every day next week. I really hope you stick with OGs and OFZs as it transitions. You won’t regret it.

Like what you read? Pass it around to your friends! If anyone you know is a student or professor and is interested, hit me up at @ntrickett16 on Twitter or email me at nbtrickett@gmail.com and I’ll forward a link for an academic discount (edu accounts only!).

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A quick note on yesterday’s long column. On the back of the napkin calculation on foreign ownership, I included foreign bond ownership as though it were securities so the figure is much, much lower than just under 8% (probably more like 2ish%). But it is important to flag that foreigners aren’t buying US Treasuries much anymore in net terms and are moving into Chinese bond issuances for return, a dynamic that poses similar issues in terms of macroeconomic management, but very different ones for internal credit risks linked to financial asset values. My apologies.

US oil output is finally recovering from its low base as prices remain higher overall despite having fallen off pre-OPEC+ meeting highs. Per the latest EIA release, output is up 500,000 barrels a day in the last month putting a little more pressure on OPEC+’s pricing calculus. Rigs are climbing and even more importantly rig efficiency is now at all-time highs after drillers spent last year gaming out how to best generate more positive cashflow to return money to Wall Street (h/t to Rory Johnson at Commodity Context):

Platts is expecting another 360,000 barrels a day to come onstream this year and 940,000 next year at US shale plays. Even if they’ve reached peak productivity, that’s a decent chunk of the remaining OPEC+ output cuts. The losses from hedging will eventually ease and the big uptick in efficiency makes the relative cost of drilling another well lower, also rendering traditional metrics like drilled but uncompleted wells not quite as helpful for assessing the direction of travel in terms of net output. Seems like the market’s misunderstanding the significance of shale once again. It doesn’t have to grow past 2019 to derail the tenuous pricing balance built into Russian and Saudi targets. It just has to chip away at any supply shortfall while the bump in developed market demand slows — US gasoline stocks unexpectedly rose yesterday, for instance, and developed markets are likelier to sink public money into activity that ends up destroying future demand than most emerging markets.

What’s going on?

1. Here’s some food for thought — a poll conducted by the University “Synergy” (I’m looking into the background more too) found that 45.1% of Russians want the state to manage inflation by using price control measures similar to those in the USSR. 20.1% support direct price-setting for goods in stores. 96.2% have noticed rising food prices. Setting aside that these kinds of polls can be a bit pushy and it’s not like many of these people necessarily understand the internal dynamics and problems with a Soviet-style system for price management, it does suggest that the government won’t necessarily lose public support over its various market interventions despite their general ineffectiveness. Right now, Levada polling shows slightly more people aren’t happy with government action than happy with it (50% vs. 47%):

   

   I’m curious to see how this social dynamic plays out with business lobbies. If the public is fine seeing the state slap business around and blame it for these problems and public dissatisfaction with falling or stagnant incomes mounts amid higher inflation, the political incentive is to slap business around. The investment pressure campaign speaks to that problem. The more they do so, the more likely they are to reinforce stagnation without some sort of demand stimulus or else rising investment could create competition between sectors and further bid up prices. In other words, the Kremlin and political technologists have built a political coalition that can justify mismanagement as much as it rewards competence.

2. In positive news, Russia’s GDP consensus forecasts are trending upwards for 2021-2022. In bad news, the composition of growth might not be as rosy past the burst from US stimulus and reopening(s). The question is will real wages and real incomes keep pace with price increases since the positive indicators for demand have been debt-led and concentrated among those who’re better off and investment indicators are still riding the short-term bump from the annual February-March peak in the budget cycle and the recovery in oil prices. The following is % annual growth:

   

   The restrictions on travel are actually propping up growth — in an open borders scenario, Russian tourism outflows cost the balance of payments $15-20 billion (1.1-1.48. trillion rubles) most of which could otherwise be spent domestically. The new consensus for 2021 around 3.5% is 0.3% from MinEkonomiki’s recent upwards revision, and I suspect the consensus is as positive as it is because of the imbalances within the Russian economy — the current COVID wave and potential further waves until the population achieves collective immunity have a much larger impact on domestic goods and services demand whereas exports, many of whom are still seeing higher prices, will keep going strong.

3. This is more off the beaten path than usual but a great intervew from Novaya Gazeta on the work done by Earthsight uncovering Russia’s largest illegal logging operation in Irkutsk oblast’ and common illegal practices. 15,000 hectares of forest were illegally logged under the guise of a “sanitation harvest” — when loggers take down strips of forest to ward off insects and disease that might spread — and then sold to IKEA. Effectively, loggers regularly get around logging bans with local prosecutors and authorities by claiming it’s all done in the name of maintaining the health of forests. Whereas deforestation globally is primarily a result of agricultural enterprises for the production of beef, palm oil, and soy, BCG and the World Wildlife Fund found in a study that in Russia it’s forest fires and illegal logging that are to blame. Irkutsk oblast’ has accounted for about 12% of forests slated for sanitation harvests in the last decade, with that figure rising to 17% in some years. Translation: loggers and the network around former regional minister for the forestry complex Sergei Sheverdu were cutting deals in violation of competition requirements — firms bid to “rent” state-owned land for cutting and clearing and are supposed to be completely transparent — and loggers never even bothered to bring in a forest pathologist to determine whether or not a sanitation harvest was necessary. Topping it off, the fines assessed for violations are far, far smaller than the value of the timber felled, perpetuating the cycle of land misuse. I grabbed this because it’s a good example of not only how institutional dysfunction and capture by business interests exploiting rents from public property — not at all an exclusively Russian phenomenon — interact with the incentives in a political economy built around the export of natural resources in a system where the state and individuals simultaneously act to extract maximal value for themselves. If they finally launch the state timber export monopolist, then the state will be contracting volumes of timber to sell abroad from individuals exploiting the state forestry ministry and regional authorities. It’s a fantastic example of the ouroboros logic of really-existing state capitalism in Russia, especially when commodity prices rise.

4. The lack of demand for Russian sovereign debt continues. Coverage continues to blame US sanctions and the expectation of key rate hikes — I’m sympathetic to the latter point but find the invocation of the former needs more nuance mostly state banks that were buying from abroad anyway. Non-residents just sold off another $4.5 billion in Russian bonds, but 85% of those were corporate which suggests that it’s about the Russian economy — Congress isn’t talking sanctions and the White House would need another trigger to justify more action. Yesterday, MinFin offered 40 billion rubles ($538 million) worth of OFZs and only 14.2 billion rubles ($191.28 million) were snapped up. Non-residents have completely abandoned the primary market, hence my comment about state banks. The inability to use deficit financing parallels the beginning of cuts to expanded social spending and support linked to last year’s spending surge. Health spending has been cut 13% despite the current wave, the social budget has been cut 4.8% YTD, and regional transfers are down with the biggest winners are big infrastructure projects thanks to a roughy 500 billion ruble ($6.73 billion) increase in spending on the national economy. But overall, MinFin’s talk of a budget surplus for 2022 has gone from rhetoric to action at precisely the moment the state has to spend money to convince resident investors and non-resident investors alike to actually buy its sovereign debt. Incoming rate hikes and high inflation are definitely scaring off interest, but both could have been better managed with a larger state stimulus spend doing stuff like buying commodities at the beginning of the crisis to form state reserves that could then be released over time or, like China did, buying oil cheap and then releasing or else reselling it as prices. Wholesale benzine prices are now at historic highs because of the effects of tax reform efforts to encourage refinery modernization coupled with imbalances in supply availability and occasional incentives to export — the damping mechanism helps refiners or vertically-integrated firms financially, but isn’t great at making sure enough fuel is available. The next rate hike will probably draw more interest in, we just don’t know if and when inflation’s peaking yet.

COVID Status Report

25,293 new cases and another record 791 deaths were recorded in the last day. Based on the breakdown of reported deaths now shown by RBK to distinguish Moscow and St. Petersburg from the rest of Russia, the overall infection rates are likely worse than official data suggests unless Delta is actually deadlier than other variants:

Red = Russia Black = Moscow Purple = St. Petersburg

Based on the official data, the R is estimated at 1.08, which isn’t crazy. But the case fatality rate keeps climbing — in late December/early January it was in the range of 1.7-1.8%, climbed further, and now has reached 2.47% which I think implies a higher rate of infection for the whole time, though the current surge would be terrible for anyone older who isn’t vaccinated. Pilots are now lobbying to have access to foreign vaccines to help manage the health protocol issues that inevitably arise as borders are opened and quarantine and vaccination measures finalized to try and bring back tourism in Europe and elsewhere. Promoters are pushing for “COVID-free” concerts using QR-codes, vaccination certificates, or negative PCR tests within 3 days of the event to let people in. These adaptations will probably help push up vaccinations. Waiting for more on how the rollout of foreign vaccines goes.

Dude, where’s my carbon tax?

Finally, after months of bad punditry and the slog of political projections and constant hopes for better, we have a roughly agreed $3.5 trillion Democratic reconciliation bill to pair with the $579 billion bipartisan “hard” infrastructure bill. It seems that the European experiment sorting out a Carbon Border Adjustment Mechanism (CBAM) has finally rubbed off on the American policy conversation. Thanks to Rachel Ziemba catching and posting on Twitter, I saw the New York Times’ writeup of Democratic plans that included a vital new policy mechanism: an import tariff (or tax) for goods from countries that lack sufficiently aggressive climate change policies. As Rachel noted:

We don’t yet know what the final US policy specifically aims to achieve, only that it’s called a “polluter import fee.” It’s easier for Democrats to rally around an external carbon pricing mechanism than a domestic carbon tax for a variety of fairly straightforward political reasons, as well as the legacy of Trump’s trade wars and the Left’s parallel efforts to torpedo the Trans-Pacific Partnership and its Trans-Atlantic cousin TTIP. Let’s start with jobs — manufacturing is still the 5th largest employer by sector in the US proving jobs for 11.9 million people. Consider the political map as well. I mocked up the following using NAM’s data to show % share of Gross Regional Product for states and 2020 employment, focusing on politically vital states for Democrats to win seats in and for the 2024 presidential election with significant industrial sectors. I used 2020 data despite it being an outlier for employment since politics is always relative and about the latest reference point, not past trends. We’d often see higher relative shares for state output in past years as well as higher employment despite the relative resiliency of goods production last year since US exports took a much larger hit whereas imports were sustained via stimulus effectively:

Any viable path to retaining power in Washington given the Republican Party’s in-built electoral advantage requires more of the union manufacturing vote that went for Trump in 2016 and 2020, many of whom voted for Obama and most of whom are better off economically than many of their neighbors given sectoral wages. These manufacturers didn’t actually benefit from Trump’s tariff wars, but that was also because of a lack of fiscal stimulus and business incentive to reshore supply chains. The current disruptions taking place during reopening as a result of last year and businesses’ struggle to stay afloat over the last 18 months have led many to reconsider the value of sourcing their inputs nationally, thus avoiding the risks from border closures or interruptions to very long supply chains. Trump worsened manufacturing output with the economic policies his administration put in place despite the labor market heating up for lower wage workers by 2019:

That coalition was hoping he’d help, and while many stuck with him in 2020, that was as much a result of the Democratic Party’s cumulative messaging after 2016 blaming white working class voters in key states like Ohio for being racists rather than examining much larger questions of political coalitions built on material interests alongside the observed rise of identity as a focal point for politics. That identity approach can’t adequately explain why in Ohio and Pennsylvania, more union households voted Republican than Democrat despite past support — Trump won 57% of Ohio union households in 2020. They matter again. Using import fees on pollution in concert with a more clearly delineated industrial strategy and business environment that supports businesses thinking hard about supply chain resiliency make sense as Democrats struggle to hold together a voting coalition laden with contradictions facing an unfair electoral map.

As this policy shift moves forward, there’s more scope for Washington and Brussels to coordinate policies. That’s a huge problem for Russian exporters since they can’t rely on the lobbying power of American industry to unintentionally help their cause contesting EU policy shifts. The updated CBAM product list from the European Commission includes aluminum (and alloys), iron, steel, products made from them, fertilizers, cement, and electricity. A MinEkonomiki review of the updated proposal puts annualized export earnings losses at $7.6 billion. That’s not fatal but a lot of money that’s sorely needed for investment purposes. And the problems aren’t just coming from American Democrats cobbling together voters for 2022 and 2024. China’s emissions trading scheme launches tomorrow, covering the 2,225 coal and gas-fired power generating plants across the country. The scheme only applies to the thermal power sector for now, and will be expanded slowly over time when other sectors like steel and nonferrous metals now experimenting with pilot schemes are deemed ready. The current price level from pilot schemes has been a miserly $6.20 a ton, way less than anything seen in Europe. All firms that emitted more than 26,000 tons of CO2 in any single year between 2013-2019 will eventually be added.

There’s little cause to assume Beijing intends to move quickly and jack up carbon prices, nor are Chinese authorities happy with EU carbon tariffs and presumably now the potential for similar mechanisms from the US. The EU and US absorb most of China’s goods exports and the interplay between US trade deficits, legacies of EU austerity, and China’s refusal to accept slower but healthier growth rates will take a hit from these tariffs if applied. We can see now that while China’s domestic economy appears to be slowing down, its exports are rising again and again unbalancing recovery:

In Moscow, there’s still a lack of clarity about the scale of the investments and change in fiscal and regulatory approach needed. The decarbonization strategy will be quite useful when it drops since MinEkonomiki was adamantly against a domestic carbon tax last fall with a carbon trading scheme potentially more aggressive in practice. Indicators are, however, that as pro-inflationary pressures are seen to be easing by the Central Bank, the demand to return to budget surplus is again eating into grand investment plans. MinTrans has slashed its expenditure plans through 2030 from 45-54 trillion rubles ($607.5-729 billion) to 29.3 trillion rubles ($395.6 billion). Every bit of smart infrastructure investment can help ease the strain of emissions reduction. Based on past experience from 2012 when a similar level of spending was announced through 2020, there’s no evidence these plans will be realized no matter how much carbon pressure builds up geopolitically.

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According to the latest Rosstat release, over 75% of households are facing financial difficulties. RBK (shoutout to Ivan Tkachev) put together a fantastic breakdown of the problem — the COVID shock has, on net, worsened the evolving balance sheet crisis Russians have been facing since the 2014 recession. There’s a huge gap between perceptions of what’s necessary to make ends meet and actual median wages. The following is the amount every member of a family needs based on polling in 000s of rubles/month:

Top to bottom: Families with children that have a disability, multi-child families, young families with kids, young families, families without children, pensioners

53.7% of the population live on 27,000 rubles or less a month. So if we take that as a baseline for comparison, over half the country is living 14,000 rubles a month short compared to the standards of living respondents think is fit for a pensioner. 80.1% of the population lives on less than 45,000 rubles a month. To be clear, these surveys reflect perceptions and not “hard” realities — we should always trust what people do more than they say. Even acknowledging the methodological limitations of polling and these surveys in a Russian context or otherwise, it’s clear that the Russian economy is now completely incapable of delivering real incomes that allow the majority of the population to feel comfortable. These political dynamics aren’t sustainable indefinitely, not in the sense of mass revolt but rather elite returns. In the same way that some financiers and asset owners finally realized during the COVID shock that they can actually benefit, conditions depending, if consumers and employees have more money to spend, Russia’s elites look abroad for opportunity because it often nets better returns. The poorer Russians become, the less attractive investments serving Russian demand become and the more intense the political pressure to compete for control of assets and industries that export and rely on external demand. The regime’s political model is not designed to handle conditions of growth. Households take out debt in response and are stuck defining down what ‘success’ looks like. Watch this year’s real wage data to see if labor shortages trigger a shift. I think it’s likelier price increases outstrip most of the wage gains, and expect those gains to be unevenly distributed by sector as well.

What’s going on?

1. It seems that Audit Chamber head Kudrin’s reaching the limits of not only his influence as Moscow’s liberal “namer and shamer” for waste, economic, and fiscal policy, but the logic of the liberal reform instincts that guided efforts to change policy from the late 1980s through the 2000s. In an interview with RIA Novosti, Kudrin made clear that in his view the new push in the government to adjust excise taxes and related tax measures to increase revenues further is misguided. The potential for revenue gains from any increase in consumption taxes has largely been exhausted. What does that mean? Russian households and consumers have reached the point where increases in consumption taxes are likelier to discourage consumption because of costs rather than increase revenues. It’s a classic problem for tax policy — policymakers have to balance the increased rate of taxation with any potential fall in consumption from higher taxes. That Kudrin believes consumption taxes are done lifting revenues reinforces the view that state policy is failing to save and lift real incomes. Real wages are rising these days, but because of how important social transfers are to the national income — about 20-21% in total — and cost disease — wages are rising in sectors that aren’t improving productivity right now as well due to tight labor markets — real incomes aren’t keeping pace. The only way to sustainably fix that problem is to raise domestic demand, which at this point requires more spending in the form of income support, social transfers, and services and hard infrastructure investments to improve output. Privatization isn’t a panacea since it just ends up transferring ownership of assets in a political system where property rights are frequently at risk and lobbies and personal agendas and interests freely capture formal and informal institutions alike. I’d expect any additional consumption tax hikes to negatively affect consumption whenever we see the final proposal the government’s now working through.

2. The budget’s back in surplus through the first half of 2021 erasing most of the comparative deficit it ran for the same time period in 2020. For Jan.-June, the state took in 11.3 trillion rubles ($152.55 billion) and spent 10.6 trillion rubles ($143.1 billion) exceeding spending levels in 2019 and 2020 per the Kommersant writeup. The oil price recovery, higher VAT tax rate, and tariffs on imports all kicked in to help push up revenues:

   Blue = revenues Purple = expenditures

   

   We can see the arc of austerity politics clearly here. Revenues rose far more than expenditures between 2016-2019, spending increased about 25% year-on-year for 2020, and has settled higher for this year with the expectation that it’ll probably drop some next year or else revenues will be increased further using tax increases over any increase in expenditures. You also get some accounting tricks skewing some of the data — in March, the last tranche of 200 billion rubles ($2.7 billion) for the government’s purchase of a controlling stake in Sberbank from the Central Bank went into the Treasury, but that money came from the National Welfare Fund. Another 146 billion rubles ($1.97 billion) came from Nornickel’s fine for the massive oil spill and environmental damage incurred last May by the company in Norilsk. State finances are in great shape in terms of revenue/expenditure balances, but it can’t borrow because it’s not spending. The irony is it could spend a bit more fairly comfortably ahead of the elections without too much concern for rising OFZ yields.

3. Aleksandr Lukashenko’s snap visit to St. Petersburg brought good tidings for him and his inner circle in Minsk — Gazprom won’t index 2022 prices and keep natural gas prices at 2021 levels (an already heavily discounted $128.50 per cubic meter), agreements to keep looking at fixes for the losses Belarus will incur from Russia’s oil sector tax maneuver, and talked about more loans the Belarusian state desperately needs. Putin and Lukashenko have now met 6 times since February 2020, an obvious symbol of the extent to which the mismanagement of the Belarusian economy, its dependence on transfers from Russia, and now sanctions pressure from the West have made the fate of the regime in Minsk a problem (and constant headache) for Moscow. Things were bad enough that Lukashenko authorized the confiscation of currency and imposition of select capital controls back in late April including restricting purchases of foreign currency, and that order took effect just before he popped over to St. Petersburg. Annualized inflation just hit 9.9%, outpacing price increases seen in Russia. The meeting also came about because of the unhinged nature of Lukashenko’s improvisatory appeals for help — threatening to deny transit to German goods headed to Russia (or China) wasn’t about threatening Europe in a Blazing Saddles-style move whereby he holds a gun to his own head. It was aimed at the Kremlin who are highly cognizant that any interruption of goods from Europe would worsen their own domestic inflation problem and, to a lesser extent, Beijing concerned about the protean politics of the Belt and Road Initiative. The Eurasian Economic Commission has been obligated to examine the legal and market foundations for sanctions on German transit. This was a Hail Mary for political attention and an indication that behind the facade, the regime’s acutely aware of its financial limitations. At this point, only a revolution in Russian economic growth could really alter Belarus’ trajectory.

4. Let the bidding begin! After the myriad problems modernizing the Baikal-Amur Mainline (BAM) and Trans-Siberian have emerged and the new route from El’ga to the Sea of Okhotsk to export coal proposed, Al’bert Avdolyan has stepped forward to try and save the day. Avdolyan, owner of the firm A-Property which controls 95% of the shares in the El’ga coal field, would build a privately-owned route the 500 kilometers to port at an estimated cost of $2.5-3 billion for an estimated capacity of 30 million tons annually. The route could replace the proposed 3rd stage of the BAM’s modernization and expansion, easing some of the pressure on Russian Railways (RZhD) to deliver. It’d halve the distances for coal shipments from El’ga now going to Vanino-Sovgavansky and cut them five-fold for anything shipped via Primorsky Krai and be completed in about 5 years’ time. Best of all, it’d aim to do all of this without federal subsidies or support in various guises. Anyone who thinks Avdolyan is proposing as an act of patriotism doesn’t understand the politics of infrastructure ownership in Russia — it’s a great opportunity to embarrass RZhD and, more importantly, seize control of a strategic asset while doing the Kremlin a favor. I expect we’ll see more of these types of proposals as a result of Putin’s explicit pressure to mobilize the national “investment resource.” State stinginess and the conviction that any significant increase in direct spending leads to more theft incentivizes private actors with stakes in major projects like this to step forward. State-owned firms already pay for infrastructure in a lot of remote regions and benefit from de facto local monopolies that way. There’s a major problem if this proliferates too widely, however. The state effectively owns “everything” insofar as it can claim anyone’s cash or assets at a moment’s notice. But its monopoly on final property rights, so to speak, is challenged if too much political power is diffused to private actors who form natural interest groups or alliances with local and regional political and economic actors. It can circumvent that problem when state-owned entities headquartered in Moscow or St. Petersburg make all the final personnel and investment decisions. That isn’t to say this project represents a significant change from the status quo, but it does indicate that the entrepreneurship around the investment mobilization problem facing the Kremlin and government is well underway.

COVID Status Report

23,827 new cases and a record 787 deaths in the last day with the official data now showing a clearer trend from the regional figures towards flattening. Cases are still rising in St. Petersburg despite the notable drop-off in Moscow — they hit 1,942 in Piter in the last day. We’re already seeing political pressure around the campaign season affect rationales for COVID restrictions. The governor of Ryazan oblast’, Nikolai Liubimov, just opted to ease restrictions on conferences, gatherings, and public pickets and related permitted political activity ahead of September. While this dynamic plays out in Russia, we’re seeing cases trend higher in Kazakhstan and Georgia:

The cumulative shock to Eurasia is going to grow and grow. Not only has COVID introduced a new dilemma — already exhausted resource-led growth models at the regional level will become the default preference for investment as decarbonization raises demand for other commodities — but the long-run scarring from slower vaccination campaigns and limited fiscal capacity will lower post-crisis growth. Topping it off, Russia’s failure to adequately help its own households will double the impact of China’s imbalanced recovery and Europe’s underspending on Eurasia’s growth prospects. In effect, Moscow’s austerity politics ripple out across Central Asia and, to a lesser extent, the South Caucasus by denying them the opportunity to try and export non-resource goods into the Russian market. That approach faces limits — Russian consumers are quite brand conscious, for instance. Any slowdown in Sputnik deliveries to Russia’s near abroad as a result of its political needs worsens the problem. I’m afraid only a big shift in China can reverse the trend at this point.

Market Mechanisms, Bazaar Rules

Viktor Chernomyrdin has a rather legendary status as the ungrammatical godfather of the expression “хотели как лучше, но получилось как всегда” — we wanted better, but it turned out as always. Uttered in August 1993 in regards to monetary reform, to Russianists and the Russia-curious, its become a handy way of winking to Russians that you have some semblance of understanding of post-Soviet Russian’s idioms for life in conditions tending towards crisis. Chernomyrdin is the George W. Bush of Russian politics, the man who knew too little about slinging sentences properly together. Slightly less famous, though no less perfect, was his quip in 1992 “Я – за реформы, за рынок, но не за базар” — I’m for reforms, for the market, but not for a bazaar.

Setting aside the evident course of Russia’s market and legal institutions since the 1998 ended the Soviet economy’s period of unwinding post-collapse, China’s rise as a major player on world financial markets raises new questions about how Russian elites and policymakers think view global finance and the risk of excessive dependence on the Chinese market. No one’s expecting China to rewrite the rules of global finance. Financial elites centered in New York, London, Paris, Geneva, Frankfurt, Singapore, and Shanghai (as Hong Kong fades) share too much in common as do the elites and asset owners in export surplus countries, those seeking convenient offshore vehicles to stash wealth to escape the state’s reach or avoid domestic fights over resources, and the hundreds of millions of homeowners across national lines depending on the appreciation of what they own to manage their finances. Still, the weight of China’s financial markets will shift investor concerns about regulatory standards, the Chinese banking sector, how liabilities are structured, default risks, as well as the escalating political pressure between the US and China around issues like the right of Chinese tech firms to list on American exchanges. Global investors hold a combined exposure worth $800 billion in China as investments surge. We can see from past years that 2020 purchases were significantly outstripped by stock buys in 2018. 2021 purchases are outpacing everything on record since the 2015 stock market crash in China:

The sheer size of China’s economy, its potential future demand, and the geopolitical needs to more deeply integrate Chinese firms and financial markets into global markets and structures of power are feeding an investor frenzy. More recently, Chinese firms looking to list in the US are facing increased scrutiny from Chinese regulators as the Biden administration has expanded executive orders signed by Trump to ban Chinese firms linked to its military from inclusion in the S&P Dow Jones indices with parallel removals taking place from FTSE Russell indices from the London investment management firm. This has had no meaningful impact on net capital inflows, however. Foreigners own a relatively small share of China’s stock market — it’s a little less than 8% based on a back of the napkin calculation from where market valuation was last fall, but that could have risen since. In the US, that figure is closer to 35-40%. What really matters is that capital account liberalization in China has to be carefully managed, and brings with it diminishing capacity on the part of the People’s Bank of China (PBoC) to manage the exchange rate directly as well as credit risks and the potential for contagion from the collapse of creditworthiness and value of assets held by large Chinese firms. Corporate bond issuers in China defaulted on a record $18 billion in the first half of this year as the PBoC and authorities in Beijing are seemingly trying to clear out the worst offenders among the economy’s many inefficient behemoths burning lots of revenues to service debts while still preventing any broader sectoral fallout. Everyone knows the creditworthiness of Chinese firms are manipulated by regulators and ratings firms to hide the degree of risk, a practice mitigated by the extent to which domestic and international investors trust the PBoC to act effectively:

Credit ratings firm Dagong Global has just been sanctioned by the state for failure to adequately evaluate borrowers, making it clear that the PBoC and government officials are cognizant that they can’t allow firms to borrow freely without some form of significant budget constraint if they aren’t efficiently using capital, even if they’re important to sectoral initiatives central to geopolitical competition with the US. These dynamics point out the erroneous conceit of post-Crimea economic policy and attempts to escape the West’s economic orbit: these risks and challenges for Chinese monetary policy and macroeconomic management exert a growing influence on Russian policy, substituting one set of dependencies and absences of true ‘sovereignty’ for another.

The Ministry of Finance’s decision to de-dollarize the National Welfare Fund (NWF) creates new problems for Russian policymakers trying to mobilize national resources to achieve regime economic targets, as does the Central Bank’s rising share of yuan-denominated reserves. Consider just how much has been accumulated and left in liquid reserves in the NWF:

The balance of assets that are “tied” and liquid will now be more subject to fluctuations in the value of CNY as well as the CNY-ruble exchange rate and bilateral balance of payments whenever national currencies are used for transactions. Sitting on a rising share of (relatively) illiquid yuan-denominated assets also raises questions about liquidity. The Central Bank and MinFin refuse to spend rubles, thus reinforcing the issue of illiquidity because banks have no reason to keep buying bonds and sustaining money creation on the part of the state if that state simply chooses to accumulate reserves and rarely putting them to adequate use. And then you have the annoyance of converting any yuan that are held into rubles, which anyone following the long dollar shadow cast by Rosneft’s past transactions can tell you can lead to unexpected and immense squeezes on the banking sector’s foreign currency liquidity in a pinch when transactions used these resources are large enough, generally in service of private interests rather than the state. For now, Russians don’t want to hold CNY, nor do Russian businesses particularly want to unless it’s useful for a specific supply chain. What’s really happening is the state trying to force adoption indirectly and increase the transaction costs for business.

Just as Russia’s now struggling with the inflationary pressures presented by US fiscal policy and the market’s difficulty processing recent inflation data since the relative strength or weakness of the US dollar push commodity prices up or down, it’ll also have to contend with the ongoing deflationary pressures around the CNY so long as the PBoC manages capital inflows in such a manner to avoid too significant a currency appreciation in defense of Chinese exporters. Moscow’s attempted monetary “multipolarity” is replacing staid ‘market’ rules that accept the benefits of the US dollar within the limits imposed by sanctions with an uneven and unclear political framework that reiterates all of the same problems of monetary and economic sovereignty, but more stupidly. If post-Crimea sanctions were the foundational “tragedy” of the current state of affairs, then the countering attempts like this are farce. One hopes that the presidential administration and government understand that they have to keep a much closer eye on China’s financial markets now. The next crisis is far more likely to come from a wave of Chinese defaults and investor flight out of the country after years of rising foreign investor market share than anything in the US where regulators, for all their flaws, quash any potential collapse in financial asset values that would spillover into the real economy quickly. Businesses secure credit against the value of their shares all the time. That practice gets a lot hairier on a market like China once a run gets going. For now, the PBoC has complete control over anything that might arise and domestic debts can readily be restructured. The ubiquitous presence of global capital — necessary for China’s geopolitical rise — narrows room for true ‘sovereignty’ in those instances, and Russia will take the hit with everyone else if that crisis ever comes to pass. Russia’s opted for the geopolitical bazaar while pretending it wants a steady market.

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I’ll cover Lukashenko’s meeting tomorrow, as a heads up.

After pumping more liquidity into the financial sector, China’s decision to impose import duties on light cycle oil (LCO), mixed aromatics (MA), and diluted bitumen is finally having an effect on crude and oil products markets. State-owned refiners lobbied for the duties since they’d lost market share to teapot refiners dodging taxes using imports. The inclusion of diluted bitumen is also quite significant because bitumen blends have been used to disguise crude oil imports from sanctioned countries, particularly Venezuela whose chief export blend to the Chinese market — Merey — is very heavy and yields a lot of products like bitumen from the bottom of the barrel. China will be importing less crude and exporting fewer products as these tax changes take effect, but they also serve as a useful reminder of some of the limits facing OPEC+ if it has to adjust output upwards to demand levels higher than in 2019. The following cover Chinese crude imports in mbpd per official states and then based on tanker tracking stats (TT):

A lot of Iranian and Venezuelan crude has been marketed as Malaysian using tricks with transfers at sea, reclassifying crude using product blend labels, and other chicanery. Russia’s chief negotiator for nuclear talks Mikhail Ulyanov stressed yesterday he believes that Iran talks are about 90% of the way to an agreement. Clearly Moscow senses a diplomatic opening and is keen to return to the deal. But if that does happen, OPEC+ has a new problem — Russian firms are going to want to invest into upstream projects that’ll yield better returns than most of the greenfield projects available in Russia, save those part of already established oilfield “clusters.” Further, Tehran has every reason to try and get as much investment in the door as possible. As Nikolay Kozhanov writes, incoming president Ebrahim Raisi may be a conservative but the weight of domestic needs — high inflation, lower growth, and financial pressures — will keep the economy at the top of the policy agenda. Even lifting sanctions, however, won’t lead to an investment boom, nor are sanctions on Venezuela going anywhere. OPEC+ is finally acknowledging that some members can’t produce the baselines set by pre-crisis output levels going back to 2017-2018 anymore, nor has Russia produced near its baseline thus far. The effect is two-fold: the UAE may get the market share it wants by default and there’s actually more rigidity in the excess capacity available once demand returns to 2019 levels. If it doesn’t, which will only be possible if air travel is depressed for long enough to see the beginnings of demand decline for other petroleum fuels, then OPEC+ will be forced to hang together instead of hanging separately. If it does, then it’s hard to see how there won’t be a renewed scramble for market share trying to head off both US shale drillers and an increase in non-OPEC+ conventional and offshore output elsewhere from new finds.

What’s going on?

1. The pandemic has had a big impact on consumer preferences for data plans — 1 in 4 Russians living in a city of a million people or more now pay for limitless data, double the number who did pre-COVID. Operators are trying to limit the expansion of limitless plans because they’re overloading networks and offer limited profit upside since users can draw huge amounts of data past the cutoff from a paid “ration” plan without any change in cost. 69% of respondents to a TelecomDaily poll say that limitless plans should cost no more than 500 rubles ($6.77) a month in May. The stratification of plan usage is a direct result of working from home or wanting to escape town. Users either rely on WiFi more for their phones or want limitless data to make up for being out of the city in areas where coverage is worse and WiFi not always a given. There was a particularly strong increase in demand for special limitless plans to be applied to notebooks as people were self-isolating and taking other precautionary measures for work. If you look at monthly turnover for telecoms as a sector, it’s risen steadily since 2018. But now that the security establishment is trying to force telecoms companies to invest into more expensive and less efficient bandwidths for 5G and COVID’s stepping up pressure on existing infrastructure, there probably needs to be a considerable increase in investment hampered by the limited space to raise tariff rates without losing customers or else facing political pushback. It’s ultimately a problem of use — half of the subscribers paying for limitless data use as much data as the rest combined. That’s a large loss for companies and a decent indicator of where the future politics of data are headed as it becomes an increasingly vital public utility in a political system that has sought to generate data rents where possible to offset the declining value of rents elsewhere while strengthening the domestic telecoms sector.

2. Russia’s balance of payments is posting a solid recovery against 2020 with the Jan.-June figures showing a $43.1 billion surplus vs. a $25.1 billion surplus for the same time last year. Capital outflows dropped by about $3 billion year-on-year to $28.2 billion. The former shows what the price rise for most non-oil & gas commodities can do and the latter how negligible said commodity crunch has been to convince people to hold more capital in Russia proper despite what was billed as the start of a strong recovery with MinEkonomiki now forecasting nominal wage growth to hit 9.1% this year, ahead of inflation (for now). The LHS is % year-on-year growth and RHS is US$ blns:

   Blue = goods imports Orange = non-oil exports Light Blue = services imports Grey Blue = current account

   

   As we can see here, the value (and volume) of goods imports directly tracks with non-oil exports since 2016 — this intuitively makes sense since oil rents stopped creating shared income growth by 2013 and the ruble devaluation and real income decline have affected spending power for imports. Services imports are covered by oil & gas exports, and also often serve those industries or other extractive industries while Russia’s service exports primarily go to CIS markets. Now that more aggressive key rate hikes are on the way, the Ministry of Finance is defiantly setting a course towards a budget surplus, and there’s uncertainty about nominal wage growth matching inflation with labor shortages and supply chain pressures, the recovery of imports is probably going to be matched by exports since there isn’t enough domestically-driven growth to sustain an import expansion and readjustment of the balance of payments. Put another way, demand is weak, the outlook poor for most Russian businesses, household indebtedness at record highs, and the budget exiting deficit so higher import levels can’t be financed without more domestic growth. Rather the value now probably tracks rising prices for strained supply chains. Think cars, some consumer electronics, and similar goods.

3. Authorities and Central Bank have been in talks to allow banks to issue adjustable rate loans, including for mortgages, but limited to high-income Russians who are aware of the risks. By Thursday, the Central Bank is supposed to issue guidance on how to reduce risk for floating rate loans — these are the kinds of loans linked to broader market rates or indexed to an indicator or indicators in some fashion. For those who recall the subprime crisis in the United States, adjustable rate mortgages (ARM) played a central role because initially low rates would adjust upwards after having convinced people to buy at a lower rate than a standard 30-year mortgage. What caught so many people out was the upwards adjustment from the margin on top of the initial rate, which then dovetailed with worsening credit conditions. For ARM, the monthly payments change with interest rates and that’s implicitly the instrument discussed based on the Vedomosti writeup. As an example given, an interest increase from 7% to 9% on a 15-year maturity loan increases your monthly payments by 13% and total overpayment for the loan by 34%. By the looks of it, the government wants to set limits on the size of loans given such that adjustable rate loans must exceed a certain threshold in size to be determined by regional income levels. They’re only giving the richest Russians able to hedge interest rate risks access to these loans, but it’s unclear why they need this financial innovation at this stage, particularly since adjustable rates introduce more risk. On the whole, it’s a positive development insofar as Russian financial markets and banks need to do more to develop these types of offerings. That so few will have access to it suggests there are serious concerns about the quality of consumer debt portfolios and the need to manage the “debt comedown” whenever we can really say a “post-COVID” recovery begins in Russia.

4. Rosstat updated its data on oil & gas sectors’ share of GDP and found that it fell from 19.2% in 2019 to 15.2% during the COVID crisis in 2020. Perhaps indirectly, the data release reveals how empty the regime’s economic narratives post-Crimea proved to be of much content. Use World Bank data as a comparison — in 2019, oil rents accounted for less than 9.5% of GDP per its own calculations having peaked in 2000. While natural gas subsidies to other sectors can produce large figures, they probably can’t make up the rest of that % gap (though to be clear, they aren’t necessarily measuring the same thing). What it means, however, is that pre-crisis the oil & gas sector were still driving about 1/5th of economic activity with a higher proportion of tax revenues and leading role maintaining domestic investment levels as consumer spending power has fallen since 2014. Rosstat just admitted indirectly that the diversification process was held up by its own contradictions — a then suffering oil & gas sector had to provide wealth transfers to other sectors in desperate need of development via taxation or price subsidy, but ended up taking up a greater share of GDP since relative investment levels into oil & gas have risen compared to value-added production since 2014. The % share of the economy follows the oil price, reflecting stagnation:

   Dark Green = % share GDP Light Green = % share revenues in federal budget Grey = % share of goods exports Black = avg. price for Brent crude, US$/bbl

   

   In the absence of growth, the relative importance of the oil & gas sector has ironically grown in some respects while creating a constant problem for resource allocation: the best returns are probably still in those sectors, but they now face supply constraints (cheap greenfields for oil/OPEC+) and political pressures to create enough incentives to expand investment elsewhere.

COVID Status Report

24,702 new cases and another record 780 deaths were recorded in the last day. Mandatory vaccinations are just now beginning to have an effect on labor markets in the regions, though small thus far — only 11% of respondents from a SuperJobs survey said they’d been denied work because they weren’t vaccinated. The growth rate in the official data has come down significantly to just 8% week-on-week, which may then support the original thesis that cases could peak by mid to late July, though I remain skeptical that the official data is capturing the spread given what I’ve heard from unvaccinated 20somethings working in the services industry in the UK:

As we can see from the last wave, there’s plenty of scope for it to hover up and down for awhile to come, enough to warrant considering caseloads north of 30k are still quite possible. Lung transplants are effectively on hold across the nation as hospitals try to manage patient risks, health measures are still limited, and public health officials have failed miserably in their duty to enable the continued import of necessary medications or else the proper registration and production of Russian-made equivalents necessary to undertake these operations. MinZdrav has yet to authorize hospitals to use these medications in lung transplant operations after they’ve been legally acquired privately either. Rospotrebnadzor is making sure that no region holds events with 1,000 or more people. It’s something. The declining rate data is a bit skewed by falling cases in Moscow vs. everywhere else. 71% of Moscow government officials and bureaucrats are now vaccinated.

Club “Fed Up”

Meeting with G-20 finance ministers in Venice, Anton Siluanov warned that the continuation of anti-crisis measures threatened to worsen imbalances in the global economy. In Siluanov’s account, budget stimulus measures have triggered excessive inflation that threatens to runaway out of hand. To quote MinFin’s press release:

“The following normalization or even tightening of policy will lead to the necessity to react to changes on currency, financial, and commodity markets. All these factors will create additional volatility on markets and will likely contribute negatively to global economic growth.”

On the one hand, Siluanov is pointing to a clear and present danger for Russia’s economy and a challenge for others. Inflation levels have risen significantly with commodity prices, supply chain disruptions, surges in consumer demand, and labor market dislocations. Vaccine politics have left a massive gap between developed markets and developing ones, a gap further exacerbated by the much greater room for fiscal policy afforded to the United States, Eurozone or EU members, China, and Japan than most other markets, especially those dependent on foreign lenders and investors and resource or goods exports invoiced in US dollars or Euros. It’s also rather telling that he points to the volatility risk posed by tightening monetary and fiscal policy. Yet his actual complaint, going back to his quip about the ‘childish diseases’ of leftism run amok in the OECD, is that the countries driving global recovery aren’t tightening fast enough. Compare Siluanov’s concerns and criticism to what US Treasury Secretary Janet Yellen said to her European peers while visiting Brussels just after hitting up Venice:

“Going forward, it is important that member states seriously consider additional fiscal measures to ensure a robust domestic and global recovery . . . An essential part of a durable recovery is creating an EU fiscal framework with sufficient flexibility to allow countries to respond forcefully to crises.”

Siluanov wants stimulus to ease while Yellen, rightly, is calling for Europe to get its act together and actually spend instead of free riding off of its safety nets and the spillover of US stimulus on European exports and domestic demand. The Ministry of Finance’s view on the state of the recovery is completely at odds with how US Treasuries markets are pricing in global growth expectations, and with that inflationary pressures. 10-year yields are trending downwards, signaling bets on the “reflation trade” for strong growth and higher inflation are easing and ‘team transitory’ — those on Econ and IPE twitter who see current inflation levels as a transitory phenomenon — are being vindicated:

If Siluanov is so worried about about persistently high inflation from excessive stimulus, he has to contend with the logically fallacious constructs of Russian macroeconomic policy. First, monetary expansion of the kind undertaken during and after the Global Financial Crisis in 2008-2010 has no clear direct relationship with commodity prices. The commodity price cycle fell from its peak post-2008 despite a massive expansion in the money supply alongside inadequate levels of fiscal spending. Second, investors now expect inflation levels to fall because current stimulus plans are actually seen to be too small to create long-run inflation risks. The question then becomes inflation for whom as well as how it can be addressed. When it comes to commodities, investment into output is the only way forward or else a reduction of consumption as needed. It’s easier to invest into output when the cost of credit is lower and demand assured thanks to fiscal stimulus coming out of a crisis. It’s hilarious that Siluanov can say this with a straight face given MinFin can’t get state banks to buy OFZs precisely because of Russia’s miserly response. According to the Ministry view, Russia launched one of the largest budgetary stimulus programs in the G-20 worth a whopping 6.3% of GDP. The IMF’s analysis of fiscal responses in % GDP terms quickly reveals Siluanov is, to be polite, making **** up:

It wasn’t a G-20 leader overall, and his own count exceeds that of most independent observations and comes after repeated attempts on his part to use existing budget spending as ‘stimulus’ and probably factor in credit subsidy measures on par with budgetary spending, a practice other analyses generally distinguish from fiscal expenditure.

Siluanov’s G-20 comments come at the same time the National Security Council has been talking up Western attempts to foster an economic crisis in Russia. In direct terms, the tightening of oversight over dual use technologies coordinated between Washington and European capitals in the last weeks is an obvious culprit. Harder to swallow for Sovbez, however, is the reality of Russia’s position in global value chains, level of development, and what they entail for the differential experiences of higher inflation at the national level. From what I can glean, Siluanov’s complaints are really just an extension of the ever-expanding obsession among the securitocrats in Moscow to contextualize domestic policy failures and struggles in light of the West’s sanctions policy and anti-Russianness. We’ve reached the point where large stimulus spending backed by easy monetary policy intended to pursue near full or full employment in the United States is somehow a political technology being exploited by American elites to impoverish Russian citizens and strain the state’s financial resources to their limits.

Not only is this view childish and irrational, it belies an intellectual rear guard action to justify the long-standing Russian reception of the last financial crisis as an inflection point for Anglo-American capitalism. Blame speculators, easy money, the profligacy of governments unwilling to level with their own people about the costs of budget deficits and instead try to foist them onto challengers like Russia rather than govern prudently. 2008-2010 failed to give rise to a multipolar moment as intended by Moscow because, for all the American fiscal state’s shortcomings, the Federal Reserve saved the day while a US administration tried to reorient the country’s foreign commitments and reduce their relative burden more effectively. COVID has similarly failed to fracture the global distribution of power despite the pervasive pessimism last year as a result of the stunning failure of the American public health response under Trump. After beating expectations last year in GDP terms while botching the health response, Moscow is clinging to the illusion that it did a better job than its competitors or else only failed to do a better one because of their perfidy. The disconnect between where macroeconomic discourse has gone in the United States and Europe vs. Russia has never been this extreme from what I can tell. The closing of Russia’s “economic mind” is total. That doesn’t mean all economic ministries or ministers are now part of the security establishment, nor even that every decision has been truly securitized. But the dream is now to divorce the Russian economy from global forces entirely while sinking further into a model that will only enhance the national economy’s exposure to them. Control without planning, command without control, and all following a tired and disproven script written by Austrian school economists and the American offspring they inspired. Even Milton Friedman admitted that low interest rates may reflect a weak economy rather than loose monetary policy, a reality of the immense slack existing in the United States and other developed economies like Germany that have depended on trade surpluses maintained by suppressing domestic consumption. You’d think the Ministry of Finance would revisit that problem now that it’s tasked with deciding how to best structure the economic pain it plans to impose on households in the year ahead.

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The fault lines are more clearly emerging now among investment banks, squawking heads, and (wannabe) politicos as to how we can make sense of the current commodity price rally, and why a new cycle is so different than the 2000s cycle. Oil bulls keep banking on US shale driller restraint and ignore the structural problem that alongside upstream cost deflation, OPEC+ still has the excess capacity needed to meet demand as it normalizes and air travel is going to take a lot longer to get back to 2019 than every other derived consumption of crude oil. What’s more important in my view is the distribution of marginal demand changes as the correlation between classic macro factors and commodities shifts:

We’re already seeing a visible shift from Russian policy — transport subsidies for commodity exports are now being cut to make it less competitive against domestic consumption and try to rein in domestic prices. Metallurgical export and fertilizer subsidies are being completely axed, while other products that have risen in price are on the chopping block as well. Commodity bears rightly point to rising COVID infection rates and China’s GDP growth is slowing faster than expected on top of some concerns about the People’s Bank of China’s decision to cut capital reserve requirements for banks and pump ¥1 trillion of liquidity into the economy. That’s where US infrastructure talks come in. Developed markets are now in the driver’s seat for future marginal demand gains, and that’s why so much hinges on how much Washington spends this year as well as whether Europe’s never-ending austerity politics make way for much more expansive shared spending commitments. The bear/bull story is now about politics. Even when infection rates rise, most of the remaining consumption under lockdowns or even with falling incomes remains commodity intensive. This is why oil’s in such a weird place. China and the developing Asia-Pacific followed by Middle Eastern consumers have lifted oil demand since 2000 while it remained stagnant in developed markets. If the former slowdown now while developed markets commit money to reduce said oil consumption, it’s the rest of the energy, transport, and infrastructure commodity basket that benefits while oil nears its ceiling.

What’s going on?

1. Moldovan president Maia Sandu and her Party of Action and Solidarity (PAS) have won the parliamentary elections with just over 52% of the vote and 63 of 101 seats. Now the fun really begins with an explicitly pro-EU reformist party in power and a host of structural problems the political system has been completely incapable of making even marginal progress on over the last decade. In the next 5 years alone, it’s estimated that the population (2.63 million) will decline by 270,00 people despite expectations the economy will keep growing at or just above 4% annually. The only reason inflation hasn’t proven as ruinous since the COVID crisis began is that remittances accounted for about 15% of GDP as of 2020 and a majority of the remitted earnings are coming from the EU, in Euros when possible, and therefore offsetting potential losses in spending power using leu. No one should kid themselves that Chisinau is at the top of any priority list in major European capitals. Still, Sandu’s visit to Berlin a month ago and meeting with German president Frank-Walter Steinmeier — admittedly a generally ceremonial figure — were still important signs that her government will keep at it diplomatically with the EU. External aid and investment will be essential to any further reform process. The decision to lower the pension age last December repealing a past reform attempt only increases the pressure on the budget while also being quite popular give the large, aging political constituency dependent on fixed-incomes to survive as young Moldovans go to Romania and onwards elsewhere within the EU to find better opportunities where they can. These are the types of ready-made wedge issues that’ll come up quickly as the opposition, as disorganized as it often is, starts throwing post-election flaming darts at PAS.

2. State procurements are up year-on-year over 2020 in number as well as average cost as inflation begins to affect price assessments for tenders, with SOE procurements and costs rising faster than state procurements cost. Straight state orders are up 18% in volume and 8% in average cost vs. a 22% rise in volume for SOEs and 16% rise in costs. LHS is in 000s while RHS is in millions of rubles:

   Pink = state orders Red = avg. state tender cost Blue = SOE orders Black = avg. SOE cost

   

   First, we can see clearly that SOE procurement costs are, on average, way higher. That makes a lot of intuitive sense since SOEs tend to build elaborate preferential supply chains to enrich the right people or generate intermediate demand between each other and subsidiaries, whereas state procurements for smaller goods/services would be cheaper and entail arm’s length transactions more often. What’s more interesting is that February-March are generally the peak procurement months after a big drop-off in January from December. That means that the effect of state consumption on demand is strongest in those two months based on the usual budget cycle. Fitch has maintained Russia’s sovereign rating at BBB with a stable outlook, a rating that might have improved perversely had Russia spent more as noted in prior newsletters, but the timing within the year is important to consider too. MinEkonomiki’s improved economic growth forecast comes after the peak of the short-run boost to growth from budget procurements — admittedly SOEs spend more overall, but that also gets to the problem of fiscal stimulus for Moscow. If SOEs are the primary channel for stimulus measures, then spending has to be justified at the business level rather than, say, a step-change in infrastructure investment or healthcare spending that increases households’ relative spending power and lowers business transaction costs while employing more people (who at the moment, the labor market is short on).

3. MinEkonmiki rewrote its roadmap plan to improve energy efficiency across the Russian economy to include decarbonization in the latest sign that Moscow’s political institutions finally grasped they had to act before Europe, the US, and China wrong-footed them in turn as national and regional policy approaches develop. There aren’t any hard targets as the ministry intends to publish them after the 2050 Net Zero strategy is adopted by the government. So far, the focus seems to fall on industrial production, power generation and transmission, and utilities systems — there isn’t a grand electrification plan for electric vehicles buried in here or some new national urban and regional infrastructure initiative either. It’s the stuff that affects household expenses and Russia’s industrial exporters and it’s mostly about rewriting existing rules to create political tools to pressure firms to make investments with targeted state help that won’t generate a large increase in state investment. That includes upping fines for failure to lower emissions and strengthening energy efficiency planning requirements for any construction. In other words, it’s a Goldilocks approach not dissimilar from the new initiative to combine wealthier with poorer regions to transfer more resources out of the wealthier urban centers where voters already dislike or outright hate the regime or else are just keeping their heads down to help rural areas, smaller, poorer towns, and propping up the voting base the Kremlin has relied on since 2012. It serves a logical policy purpose and makes economic sense, but only comes together because it’s politically convenient.

4. SOE dividends will only pay out about 290 billion rubles ($3.89 billion) to the budget this year according to the head of Rosimushchestvo Vadim Yakovenko. Last year, they paid out 639.5 billion rubles ($8.58 billion). One has to hope that the reduced payments aren’t indicative of large losses on margin, and otherwise would correspond to a net increase in investment. One of the biggest problem with this specific aspect of Russia’s state capitalist model is that SOEs still need profits to pay out dividends. While most SOEs either serve state needs i.e. security and defense, strategic sectors like logistics, or are export-facing, they have a crucial impact leading some trends or forces on labor markets. According to new polling from Grant Thornton, only 27% of businesses are optimistic about the national economy in the year ahead and more importantly, only 7% are willing to raise wages faster than inflation and only 30% are willing to invest in IT. Baumol’s cost disease reason these factors come together — salaries in industries that have seen no real productivity gains tend to have to rise in response to salaries in industries that have to retain talent because labor costs are linked across labor markets. The fact that state officials saw their salaries frequently increase above inflation since the crisis began is a reverse case — there probably wasn’t a productivity increase for most public services — and SOEs have taken part in that dynamic at different points. Other businesses can’t raise wages without having adequate demand to be confident in their earnings, whereas SOEs sit on the most attractive market rents and have more flexibility to do so. It creates a tug of war dynamic that imposes additional costs to SMEs and newer firms in the long-run because working for state firms looks that much better when people know their salaries are likelier to keep pace or else beat inflation in a crisis. Not paying out dividends suggests something’s up with SOE plans this year, and it builds on the lack of confidence in the recovery now evident after the oddly euphoric takes from April-May confusing a low-base effect for success. Now that the National Welfare Fund is being used to dish out 1.6 trillion rubles ($21.44 billion) for civilian aircraft production and procurement, we’ll see how the new civilian aviation push handles cost increases for labor and falling consumer spending power over that timeline as businesses see gloomy days ahead.

COVID Status Report

25,150 new cases and 710 deaths were recorded in the last day. The rate of increase in regional cases is just slightly flattening but at a slower rate than the last wave. That should be a massive red flag — non-Moscow cases peaked at 21,750 on December 19, 2020 and they’re currently at 19,737. The rate of vaccine take-up has accelerated significantly and we’re now past 20% of the population with one dose inferred from the July 10 data:

After the initial moves last week to allow foreign vaccines to launch, we’re now seeing Moscow and Beijing setup potential joint vaccine recognition at the Eastern Economic Forum. That’s almost 2 months away but still a big deal. The CoviVac vaccine has surged in popularity, because of the hope that one shot will be enough for one’s immunity instead of 2 and a variety of bizarre fears about GMOs, other scientific memes, and distrust of Sputnik propaganda. Doctors and medical authorities are moving to be as strict as possible for those seeking vaccination exemptions, basically saying that only allergies or hypersensitivity are acceptable and most long-term conditions won’t be considered. Things are looking up for vaccines for now. The question is what happens when the vaccination wall of skeptics hits and how long it’ll take before vaccinations bring down rates enough to be visibly improving things at the national level.

Need for Weed

It’s not every day you see the president of a former Soviet state push for weed legalization, even if it’s initially for medical purposes. Ukrainian president Volodymyr Zelensky is pushing the Rada to pass a bill that would legalize medical cannabis in Ukraine while also taking up issues like reforming defense industrial enterprises. A poll late last year Zelensky ordered found just under 65% of respondents supported legalization. I can’t speak to the accuracy of the particular poll, but that offered enough ammunition to put it on the agenda since January. If the proposal passes, it’ll make a big difference for the Ukrainian economy and draw in a lot more westerners. Even if it’s for medical purposes, we know full well that there’ll be a multitude of ways around limits imposed and that drug laws will be enforced differentially, especially if large inflows of tourists are partaking. Consider the distribution of consumers in Europe based on admittedly high level polling from Prohibition Partners that would bet a bit of an outlier since it’s 2020 data:

These markets matter a great deal and can create decent sources of localized revenues. The world’s consumer of last resort, the United States, spent $17.5 billion last year on legal sales. It’s far more difficult to assess the value of the market in the EU, but it’s much less developed — enthusiastic growth projections have legal sales at just €3.2 billion by 2025 with an annual compound growth rate of over 60%. There’s clearly huge demand out there not being met and anyone looking for an excuse to bag some more tourists to spend money on your country’s hospitality sector and services while building up more public awareness of what your country has to offer in Europe can spot that. Zelensky needs a larger political constituency to help it build upon the reform gains its making now, particularly since the de-oligarchization process he’s launched has historically provided cover to simply replace one constellation of patronage networks with another.

US Secretary of State Tony Blinken set a clear checklist of reform priorities at the videoconference for the International Conference on Questions of Reform in Ukraine that the marijuana bill might indirectly ease politically:

1. Reform the Higher Council of Justice and Qualifications for Commissions of Judges

2. Make the nomination of the leadership for the National Anti-Corruption Bureau and Anti-Corruption Prosecutor’s Office transparent

3. Align corporate governance standards with the OECD

4. The demilitarization and depoliticization of the SBU

5. Actually prosecute corrupt officials

Corporate governance is by far the most important in practical terms. The OECD found that 86% of all 3,300 SOEs in Ukraine were still operating as state unitary enterprises instead of converted into state-owned shareholding structures that promote greater transparency. The result is that ministries and state organs exercise direct control and ownership over firms without any institutional separation creating hosts of conflicting interests. When it comes down to it, being able to assess who owns what, their legal responsibilities, their obligations to boards and shareholders, and the ability to safely transfer property without political interference are core to any sustainable reform coalition. The issue is sequencing and it takes years and years to carve away at entrenched interests, especially in a country like Ukraine where institutional weaknesses are amplified by a more regionally-centered elite system wherein the center lacks the same kind of veto power and dominance over decision-making as in Russia. There isn’t a power vertical one can build and maintain in the same manner.

Weed clearly wasn’t on Blinken’s mind since his boss isn’t exactly a sterling progressive voice on the matter. He may have instructed the Federal government to stop contracting with private prisons, but that isn’t an abolition of the institutions that managed to turn the mass incarceration of non-violent drug offenders into a rentier’s dream. In the case of Ukraine, it’s a smart way to generate local revenues and reduce the scope for extractive behavior from policing institutions — the application of drug laws is often selective and smuggling and growing operations, when they exist, have to pay people to make the cops go away. If you create a legal channel for growing and distribution, even one that’ll encourage others to follow the letter of the law rather than its spirit, those types of problems and sources of graft become less prevalent. Roughly 1/10th of all Ukrainian prisoners are sentenced for drug possession. It may not be a huge number of people, but that is quite visible an issue. Combine that with poor public health services for addicts and it’s a big drain on public resources that skews lots of other institutional and personal incentives for the worse. Doing so creates that much more political capacity to address bigger problems. Blinken and the EU reps all made clear that judicial reform is the foundation upon which everything else must be built, but as a matter of practicality, one has to reshape interest groups and economic blocs to be able to pursue a systemic overhaul. You also need to create new groups if possible. 6 years ago, you even had a Vox op-ed talking up legalization as a means of reducing homicide, assault rates, and turning people off of harder drugs by making soft ones more accessible and managed. What makes this proposal important to flag is that its constituency is ultimately the voters, not a specific business or interest bloc, but it can become the latter over time as well.

It was a radically different context and unsuccessful, but Anatoly Chubais’ efforts to create a nation of shareholders in Russia were premised on being able smash the system of vested institutional interests by doing so. Pair this proposal with the first stages of the land reform and you can see that logically, smallholders and entrepreneurs might well try to get into the business quickly if the marginal returns are better than what they’re currently growing or else restrained from growing thanks to quota setting and other political decisions they can’t influence. Existing laws allow farmers to grow hemp for industrial purposes, but has massively hindered planting because quotas to grow more have rarely been approved. The lack of direct ownership of land impeded the institutional efforts needed to allow people to take risks with their own property for profit, within the reasonable limits one would expect from matters such as shared water supplies and properly managing waste runoff. It also has the added benefit of allowing smallholders to move up the value-chain and diversify business before land sales would be opened up to large investors in a few years’ time, marketing various CBD products and related services to consumers or other growers if the current quota system adapts to private ownership effectively. Even if it’s just medical legalization, one can see laws being managed to allow more growing for export. Once you have an export lobby, suddenly you have more businesses invested in improving ties with the EU — Russia isn’t legalizing anytime soon — and locals living in agricultural producing areas see the benefits of land privatization directly. I’m conjecturing a fair bit on how the laws shake out, but just think it’s refreshing to see political decisions being taken that escape the usual bounds of intra-elite political settlements that dominate in non-EU former Soviet states. Ukraine’s still stuck in a political halfway house, but at least they may soon soothe the pain with some decent bud to go with a dark beer and dinner while European tourists realize their money goes farther and there are avenues to find supply while taking in the sites.

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BP’s annual Statistical Review of World Energy report just dropped and it’s worth a look through for anyone intrigued by this kind of data gathering and big picture narrative work. Tl;dr — 2020 was a crazy year of outliers and extremes. One of the useful tidbits from more recent history, aside from oil demand growth structurally declining pre-COVID, is that in any given year post-2000 market participants tend to over-estimate overall power demand growth. But that dynamic doesn’t necessarily make sense in a post-COVID world because of a great deal of ‘greening’ requires rising electricity consumption to offset the use of other types of fuel sources, nor can it capture the pace of technological adoption and how that’ll effect demand. After all, we just lived through a 40-year super cycle of economic policymaking biased towards deflation over inflation broadly speaking. The % share for renewables vs. coal is useful to consider in that light:

Coal is declining more slowly or else at the same pace that renewables are rising. That’s not good enough, and some of that is a result of nuclear’s decline in the global energy mix, with Europe in particular decommissioning more nuclear capacity than hydrocarbon power generating capacity. Since China’s not committed to peak coal capacity until 2025, reductions are going to have to come elsewhere and fast. Development politics are about to get incredibly messy. According to BP’s chief economist Spencer Dale, you can infer a carbon price of $1,400 per ton from the decline seen last year relative to GDP. And that decline would only get us 85% of the way to a 2 degree scenario if it continued on trend. The scale of investment needs is immense.

What’s going on?

1. In the latest sign that Moscow’s scrambling to prepare for the energy transition, MinEkonomiki is now laying out plans to diversify the economies of Kemerovskaya oblast’ and Komi republic away from coal. The plan looks like a wishlist of 100 projects worth a combined 500 billion rubles ($6.72. billion) to be launched over the next 5 years. In Kemerovo, for instance, coal companies pay 40% of all tax receipts. Any major dip in export earnings has huge consequences for regional budgets (even if they’re scrambling to export more while they can). Econ minister Maxim Reshetnikov’s proposing to condition investments into further rail infrastructure paid for using federal resources with requirements that the regional governments invest into non-coal industries. Of the 100 projects proposed, 78 are located in Kemerovo and estimated to cost a combined 376.4 billion rubles ($5.01 billion) in non-budgetary investments through 2026. The biggest individual project is a proposed ammonia and urea plant for Roman Trotsenko, owner of SDS Azot and coal assets in Taimyr, projected to cost 105 billion rubles ($1.41 billion). Several others are listed, all of them touch on either commodities production and exports or modernizing existing infrastructure. Putin personally ordered the review for diversification purposes as part of the regime’s pivot on net zero pledges, recognizing that future declines in coal demand will pose serious socioeconomic problems for regions too dependent on coal. What’s happening so far, however, is indicative of the challenge of diversification we’ve seen elsewhere in the Gulf. When your best competitive advantages in trade are fixed assets like hydrocarbon reserves, the best investments for returns move up the value chain for that commodity — think ammonia or urea in this case. You capture more of the value and margins are better at the project level, but systemically, you aren’t doing as much diversifying as it may seem. Curious to see how MinEkonomiki and others square that circle now that the government is mandating earnings from higher coal exports to Asia be re-invested into local economies.

2. Regional budgets have recovered strongly from last year for Jan.-June, with net regional revenues reaching 6.699 trillion rubles ($89.9 billion). That’s a 19% increase over the same period in 2020 and a 22% increase over 2019. Taxes on profits are one of the biggest drivers and accounted for about 31% of the increase — regions with large metallurgical firms are the biggest ‘winners’. But from the examples given by Kommersant, the recovery has uneven implications and if profits are a big part of the story, then a fair part of the increase is also inflation related:

   Deficit/Surplus in blns rubles

   

   Expenditures at the regional level have only risen 7%. That’s logical from the regions’ perspective, but effectively the beginnings of another bit of austerity mandated from the center. The government’s already looking to delay and minimize attention from Rosstat releases ahead of the September elections in a tacit admission that lots of underlying economic data is not nearly as rosy as MinEkonomiki wants the public to believe — remember Reshetnikov literally proposed rewriting income formulae to make it appear as though real incomes weren’t still declining. There’s creeping fear of a large spike in corporate bankruptcies in 3Q, though that won’t affect profit taxes since the biggest winners so far are Russia’s exporters. Inflows of investment are minimal this year — just $30 million for the last week. It’s not looking great for domestic-facing businesses the rest of the year. Still, regional budgets are clearly in far better shape, which will avert more borrowing stress from the center.

3. Russian Railways has come up with novel policy tool — agreeing to future tariff discounts. For the first time, the monopoly has agreed to offer freight operators a 30.4% discount on tariffs for methanol shipments from the Skovorodino plant currently under construction from 2024-2030. The thinking is straightforward — make rail more competitive in the future to lock in a cargo base, reduce route competition, and revenues to be able to better plan future investments. The discount will only remain valid as long as the plant ships no less than 800,000 tons of methanol annually by rail. The plant is expected to have a production capacity of 1 million tons annually when it launches in 2024 to be doubled to 2 million tons. Japanese conglomerate Marubeni has already contracted 500,000 tons annually for 20 years from the plant. Overall, this new approach to dealmaking is good for Russia’s logistics network. It helps avoid bottlenecks and provides steady demand for future earnings and investments, both of which are all the more important because of Russia’s stagnation. Without growth, an increase in earnings for any given sector generally has to indicate an increased cost elsewhere and RZhD is designed to be run with low margins since it’s a public utility serving loads of remote markets with domestic trade imbalances. What I’d watch for, however, is the response from other sectors and companies looking for favorable treatment. Ever since the Platon system was introduced post-Crimea amid said stagnation, firms have become more and more cost conscious for logistics, with lots of gains coming from firm-level modernization and adoption of techniques common on developed markets. Once one company gets a deal, others will want in and any time output falls short because of supply chain bottlenecks or investment delays — more likely the lower investment levels have fallen — the bigger the relative hit for those companies. These blows, however, are softened for any firms relying primarily on exports instead of domestic demand.

4. In hopes of further improving the investment and business climate within the bounds of what’s possible, MinEkonomiki is suggesting that a new appellate legal organ be created to settle out-of-court disputes over the valuation of assets. Appraisers dealing with so-called “self-regulated organizations” (SRO) have complained about the process as it stands. Valuation assessments are a massive pain in Russia for myriad reasons — the cadastral registry is often a mess, there are situations where businesses, individuals, or entire towns make use of assets no one legally owns, there’s room within bounds for bribery and similar pressures to be exerted on assessors or judges though that applies mostly to salient cases where someone wants a tax break or to move an excessively large sum around, or else the regulatory environment for businesses change constantly. How can you properly assess the value of a business asset when next week, the government might decide out of the blue to slap a new tariff or tax on your production or, conversely, subsidize what you’re doing? The main criticism levied at the initiative is that it’s seeking to solve a problem that already has a solution within existing mechanisms — consumers can lodge complaints about valuations to SROs who then consider the complaint and pass it on to an independent internal council for decision if it merits consideration. A new process will just reduce the role of appraisers and liquidate SROs, reducing the power of independent market actors to provide these valuations. In the last two years, only a few dozen complaints have been considered according to Maxim Skatov from the SRO Union Federation of Appraisal Professionals. That could be cause the SRO process is terrible, but more likely consumers just don’t trust legal institutions enough when things are contested to want to bother with the headaches. A new process won’t fix the latter problem and speaks to constant impulse in Russian policy: proposing new institutional arrangements because root and branch reform is politically impossible. Too many bureaucrats sit on too many rents. It’s easier to try to reduce the bargaining power of one bloc by creating another.

COVID Status Report

A post-January record 25,766 new cases and 726 deaths were reported in the last day. 16.73% of the population have now received at least one dose — Moscow’s at just 23.71% which should be worrying given it has the best capacity of anywhere in the country to ramp up, buy more vaccines, or do whatever else is needed. The Moscow Times did a fantastic job connecting the dots on how Aurugulf Health Investments, the Russian Direct Investment Fund’s contractor for various vaccine supply deals with developing countries, was given exclusive rights to sell Sputnik-V vaccines to 3rd party countries. Led by Sheikh Ahmed Dalmook al-Maktoum, the deal effectively gave the Emirati middlemen a pricing monopoly allowing them to massively markup prices and pocket the difference. Russia’s vaccine diplomacy is falling apart just as it’s now dashing to convince more Russians to get their shots as cases rise:

Red = Russia Blue = Russia w/o Moscow Black = Moscow

Though the rate of rise in the regions is beginning to flatten slightly, it’s still far ahead of the last wave which strengthens the idea there’s a significantly higher peak to come. Anna Popova from Rospotrebnadzor went on record that no lockdowns or harsh COVID restrictions are necessary. They’re just going to ride it out while deaths and excess mortality figures keep climbing.

How much does an empire need?

Mikhail Mikhailovich Zadornov, former finance minister and now chairman of Otkrytiye Bank’s management board, gave an interview with Kommersant as part of its running series marking 30 years since the collapse of the Soviet Union. Zadornov hails from the wave of ‘liberalizers’ that eventually put forward the 500-day reform agenda along with the increasingly toxic Grigoriy Yavlinsky that politically morphed into Anatoly Chubais’ efforts to create a “shareholder democracy” that would lock in gains made for private property and the marketization of social and economic relations and policymaking in Russia. One salient point sticks out from the early part of the interview — Zadornov believes that a ‘Marshall Plan’ for Russia would have made the transition in 1992-1996 far more manageable and successful and would have been politically acceptable and possible had the USSR not collapsed into separate countries. If one were to offer a glib condensation of Zadornov’s guiding precepts by implication, he could be counted among Russia’s “imperial monetarists,” the various disciplines of Milton Friedman seen through the looking glass of the late Soviet economy (which was increasingly state capitalist rather than planned) who intuited, if never articulated, that fixing the Soviet economic and political system was far more manageable without the erection of borders, competing national elites with little incentive to forgo political power for the sake of markets, and the dissolution of countless supply chains. Zadornov was a core player in fashioning the post-default policy response and environment that established the deflationary economic paradigm Putin’s team inherited and eventually ‘perfected’ once it became politically necessary in 2011-2012. Even if this genus of liberals who wished to destroy the Soviet system abhorred conflict disagree with this or that military intervention, they at least saw the value of maintaining the Soviet economic space in a new form with inevitably imperial implications.

Later in the interview, he talks about ‘debt addiction’ and seems content that Russia’s escaped this trap by and large. He even seems confident that the expansion of mortgages among households with declining disposable incomes will end up improving their situation, a direct mirror to the logic of the Bush administration in the 2000s and the bargain struck by American elites for decades — Your wages won’t rise, but the value of your homes will in exchange. The most interesting point comes just after:

“I, as an economist, am saying that our sense of our own greatness utterly doesn’t correspond with our role in the world economy. It’s steadily declining and I, as an economist, might be exaggerating, but all military, political, geopolitical ambitions are limited by the size of your GDP. The defense budget is still about 3.5% of your GDP. If your economy isn’t growing, then all your ambitions…”

GDP is at best an imperfect proxy for a state’s ability to sustain its military power and geopolitical influence given the rise of cyber capabilities, asymmetric deployments of military personnel and weapons systems, strategic supply chains, and more. There’s also not necessarily so much of a debt problem as Zadornov would have us believe. But there are serious economic and political limitations on the projection of national power that the current COVID wave is making more observable and make his point more salient. State banks are effectively “boycotting” large purchases of Russian sovereign debt — demand for Russian debt has been minimal and demand relative to March and April has fallen over 90%. The question is why? Think of it this way. Why should state banks keep buying sovereign debt when they know a big rate hike is coming and consumer borrowing has probably peaked? As creditworthiness declines among borrowers, there’s more pressure to play it safe and more pressure to realize higher yields whenever the bank does decide to extend money, in this case buying a bond that’ll pay out over time. And further, why should state banks keep the state afloat if the state’s incapable of helping borrowers and the real economy in an effective fashion when it’s sorely needed? Last year and through the spring it made sense. Now that a new wave is kicking off and all the worse because household and SME company balance sheets are often in a more tenuous state, they’d be handing over rubles realizing lower returns as inflation keeps rising while the lending boom subsides without much non-export growth. The failure to spend money via budget deficit earlier has paradoxically made it harder to spend money now, imposing a harder budget constraint on the state than might otherwise have been necessary and worsening the likelihood that tax increases will outstrip expenditure increases once again. If banks expect bankruptcies and other longer-term scarring to be visible by the end of 3Q, of course they’d start laying off OFZs. “What have you done for me lately?” rules the day. Generating a budget surplus in these conditions will mean raising taxes.

This dynamic is playing out right as the situation in Afghanistan is falling apart. The US has left troops in Kabul with the promise of air support to ensure that president Ghani doesn’t fall, nor can the Taliban likely take Kabul. But they’ve begun to seize border crossings — they’ve reportedly seized Islam Qala through which most trade with Iran takes place after having seized several crossings with Uzbekistan and Tajikistan. They’ve got a chokehold on the various trade and smuggling rents now and Russian officials just met with a Taliban delegation that offered the usual assurances of protection for different ethnic groups, responsible governance, and whatever else Moscow wanted to hear as they’ve taken control of as much as 2/3 of the country. Foreign powers have to deal with them. The Iranian government hosted Taliban negotiators in Tehran as well while Ankara commits troops to protect the airport in Kabul. President Biden moved up the official withdrawal timeline slightly to August 31 while the White House scrambles to find countries to host the Afghans who’ve provided support to the coalition mission and will undoubtedly be targeted by the Taliban. The message is clear — the Afghan National Security Forces are running. It’s not the fault of the US or NATO mission at this point. 2 decades of investment, time, and training weren’t enough. There are countless things to criticize about the execution of the war in Afghanistan, but at some point, locals have to fight for their own country.

None of this is evidence that stability lies on the horizon. Moscow now wants assurances that northern Afghanistan won’t be used to attack into bordering Central Asian states. The Taliban have promised to not allow IS to do so, in fitting with past commitments and their actions with the US in the recent past. Foreign Minister Sergei Lavrov has made it clear that if attacks into Tajik territory take place, Russia will respond militarily. Moscow’s clearly got a full-blown security crisis on its hands now. All it’ll take is one local group trying to score some extra money or arms in a border raid to kick off a reaction that could quickly spiral into a diplomatic crisis with the Taliban. Kabul is trying to assure its neighbors that ANSF forces won’t keep pouring over borders, though it’s hard to imagine anyone takes them particularly seriously at this stage. And what’s more concerning is that Moscow’s diplomatic position on a resolution for the conflict — a coalition government in Kabul between the current administration and power blocs in the capital and Taliban — would be a death warrant for Ghani and his patronage networks. It’s not exactly like Bashar al Assad was keen to jointly govern and it’s not like anyone in Kabul who’s either profited off the war or else furiously hates the Taliban will go gently into that good night. In effect, Kabul will become a besieged island kept afloat through limited as necessary interventions by the US and presence of US/Turkish troops while Russia, Iran, and China maneuver with Pakistan and India to keep a lid on non-Taliban groups that pose a threat basing themselves in Afghanistan.

Afghanistan’s implosion is happening at a moment when the Russian state is struggling to borrow, facing an increasingly deadly wave of COVID, and the prospect of raising taxes while trying to deliver the right results in September’s Duma elections. Even the most ardent defenders of Russia’s enduring “great powerness” have to admit there’s a problem of political capacity here. When a great deal of a national foreign policy comes down to spinning plates in the air, there are only so many to add to the show before something slips and breaks. Biden’s speech on the withdrawal is worth a watch:

President Biden framed the entire speech around his visit to Kunar in 2008, one of if not the most dangerous places to deploy during the most intense phases of the US counter-terror and counter-insurgency mission in Afghanistan. What’s clear is that the White House has a strongly defined strategic sense of the withdrawal. Others may kick and scream about ceding defeat, the media, or cling to narratives about future terrorism threats or the protection of human rights. They pale in comparison to the basic political principle that American soldiers cannot ensure freedom for Afghans, only the Afghan people can, in the end, win any fight against the Taliban. The US has been mired in domestic political crisis for years now, a crisis that grinds on and leaves a slew of issues undecided to the detriment of the nation and global challenges like climate change. No doubt the administration is happy to hand off this particular plate to Moscow as the consequences of the decision become more stark with each passing day.

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How has the oil market taken to the OPEC+ fallout? Not great. Prices have actually fallen this week back under $75 a barrel for Brent as market participants realize that a refusal to agree to gradual output increases from August increases the odds of much sharper increases ahead of demand. The ICE Brent August contracts are now trading just under $73 a barrel:

It’d be falling faster if it weren’t for the fact that about 1/3 of US oil production is being sold at just $55 a barrel. US shale drillers had to hedge their bets and lock in prices amid uncertainty for their credit covenants when borrowing that saddles them with mounting (relative) losses the higher prices rise. The longer that OPEC+ members refuse to increase output per the original deal, the greater the pressure for shale drillers to increase their investment into output, even if at a more moderate pace than years past. The US oil rig count has risen 3 of the last 4 weeks and 212 units for the year thus far. If free cashflow from prices in the second half of the year matches gains made in the first, there’ll be $60 billion to give to investors, bump up salaries, and spend on output among shale drillers. Other firms within OPEC+ aren’t scared they’ll lose market share to shale because the market’s growing. They have to be worried about ceding market share if demand enters decline in the next few years since shale drillers now realize the benefit in cash flow terms from sitting back. Igor Sechin never likes the prospect of American oil power…

What’s going on?

1. For Jan.-May, pharmaceutical production fell 9.2% to 1.7 billion ‘packs’ according to RNC Pharma. That figure includes all COVID vaccines produced and puts output back around 2018 levels. But the decline in physical production came with a 25.9% increase in earnings — 239.1 billion rubles ($3.18 billion). Non-prescription medication output fell about 16% whereas prescription drugs fell just 1%, so we can see pharmaceutical firms prioritized medications for heavier conditions. Some of this fall has been consumer-driven. The shift to consume more expensive, more trustworthy brands took out sales for the lowest price segment of the market. Sales of anything worth around 50 rubles have fallen off with a countervailing 27% increase in demand for medications that cost 300-400 rubles. State procurements are another important component of the surge in earnings vs. fallen output. When Russian producers bid on state contracts to supply medications, they generally win cause they’re cheaper. But their cheaper production is still marked up relative to prices for what they sell wholesale to pharmacies:

   Cyan = blns rubles Red = blns packs

   

   Medical import substitution measures haven’t been terribly successful so far in terms of net output though changing consumer preferences from COVID may help. Curious to see how the recently signed law allowing firms to legally manufacture pirated medications plays into this and obvious efforts to encourage industrial espionage or else just take drugs licensed from foreign firms and steal the IP.

2. Inflation keeps picking up pace, hitting 5-year highs and finally reaching 6.5% in annualized terms. In the last month, the consumer “basket” inflation levels rose a post-2012 record 0.69%. The arc of the inflationary increase reconfirms that rising commodity prices, the new commodity cycle, and supply disruptions from COVID and faster-than-expected surges in demand globally, not as much in Russia, are to blame. Monetary tightening can only achieve so much to fix that problem:

   Grey = food Dark Blue = non-food goods Light Blue = services

   

   The government’s adding on as it has to. From July 1, electricity tariffs rose 4.3%, waste disposal rates rose 3.4%, and water supply rates rose 3-3.2%. The Central Bank and markets are still on course for a 1% rate hike and now seem to be expecting an end-of-year rate around 7.25%. That some are optimistic inflation is peaking says more about the health of the recovery in Russia (and elsewhere) than anything else. Seasonally-adjusted, TsMAKL shows that bankruptcies are only up 1.3% — I noticed the coverage quite elegantly side-stepped the bigger problem. Restructuring at lower rates will undoubtedly have saved a lot of businesses, but if earnings don’t fully recover, that situation can’t last. The overall decline in bankruptcies since 2016 probably has a lot more to do with interest rates falling than things going particularly well, sector depending of course. No one expects it yet, but if inflation keeps spiraling upwards, the rate correction will probably have to head closer to where it was in 2019 pre-COVID past 7.25%. The impact of rising credit costs will be felt quickly by any company looking at investments or barely staying afloat.

3. MinEkonomiki has finally sent the law establishing a carbon quota and trading scheme for Sakhalin to the government. The idealized goal is to achieve carbon neutrality by 2025 by setting emissions quotas for the largest firms and allowing firms that reduce their emissions to then trade their remaining cap space to other firms. Kaliningrad and Khanty-Mansiysk okrug want in on a quota system as well. The quota system initially only applies to firms responsible for at least 50,000 tons of carbon emissions or equivalents annually, with failure to meet quotas costing anywhere from $2 (global average price for greenhouse gas emissions) to €25 a ton (the latter is a long-term average of EU ETS prices). These numbers make it clear the law is not going to achieve carbon neutrality unless they get creative accounting for trees and other offsets. Finance minister Anton Siluanov is finally sounding the alarm that a stress test for energy transition scenarios revealed Russia would lose a ton of revenues and export earnings, prompting a new push to reform the tax system to make the transition as 'painless’ as possible. If you’re doing well, expect windfall taxes. If you’re a household, expect direct and indirect ways to tax you at a higher rate or else tax businesses at a higher rate without providing them adequate demand via fiscal stimulus to sustain investment and growth. Carbon quotas will introduce a new problem for graft and institutional governance — the politically connected will lobby for exemptions or subsidy/financial support for investments to meet said quotas. If the quota system ends up being successful, that’ll be welcome news and it must be acknowledged how politically significant the shift taking place is. Now comes the fun part of seeing how it translates into (mis)governance.

4. Russian Railways is now pushing to build a separate railway from Yakutia parallel to the Baikal-Amur Mainline (BAM) and Trans-Siberian to carry coal. A route to the Udskaya bay on the Sea of Okhotsk is one of the main possibilities being discussed. The intention is clear — avoid overloading the capacity of the “eastern polygon” — but the logic less so. Why can’t RZhD expand BAM and the Trans-Siberians’ respective capacities to avoid congestion? Plans to increase coal exports from Yakutia despite the global turn against emissions will bring foreign currency earnings, but further strain the balance of the national rolling stock fleet given differential tariff rates and the physical volume of coal. The parallel line is estimated to cost between 350-700 billion rubles ($4.65-9.3 billion), effectively the same price range as each stage of the BAM modernization project. The government’s apparently now hoping to fund the last stage of BAM works using the National Welfare Fund. If these plans are serious, then labor’s going to be an issue. Aside from prisoners and Putin’s own remarks about the need to mobilize military engineers to avoid further delays for BAM, there’s renewed pressure on Marat Khusnullin and the Ministry of Labor to attract more Belarusian, Uzbek, and Kyrgyz workers for railway construction needs. The gambit seems stupid, frankly. The returns and efficacy of the new route will hinge entirely on commodity market prices for a resource that may spike in price for the duration of the construction of said line, but may then face perpetual falling demand. At least BAM and the Trans-Siberian serve a more diverse set of goods markets. That’s not to say they shouldn’t necessarily build more rail capacity for export, rather that doing so in this manner will only deepen the economy’s resource export dependence. Instead of talking about oil windfalls or taxation, however, it becomes a matter of aligning global price levels and market share with how individual projects are paid for and maintained or the latest poorly-designed attempt to manage domestic inflation levels through export duties or curbs.

COVID Status Report

24,818 new cases and 734 deaths were recorded in the last day. Regional cases keep climbing even as Moscow appears to have stabilized. The EU has approached MinZdrav about the potential inclusion of Russian vaccination certificates into the EU’s COVID passport system to enable more travel, though France is adamant that Russian and Chinese vaccines not be recognized. I checked the latest Eurasianet update with JHU data since Moscow’s now scrambling to attract more migrant labor and I wanted a sense check of how cases are rising in the neighborhood, acknowledging differences in testing capacity. Worth noting also that both Azerbaijan and Kazakhstan have over 20% of their population with a single dose, outpacing Russia for rollout thus far:

Tajikistan has always been suspect due to capacity constraints and the refusal of state authorities to openly engage with how bad things were. Now it’s a concerning vector because more Russian troops (who’ve been vaccinated at least) are deploying and the increase in border crossings from Taliban seizures of territory and action in Afghanistan should be cause for public health concerns. I’m sure Uzbek authorities are already pondering what they can do if they get hit with an influx of refugees. Labor migration and really any migration within Eurasia or between member states of the EAEU is going to be politically fraught even if accepted or else not blocked for a long time.

It’s getting hot in here

A rather tedious Twitter exchange yesterday on Russia’s ability to ‘win’ or else benefit from climate change left a bitter taste in my mouth. Whenever the claim appears in headlines or policy puffery, the basic contention is that a warming climate will unlock huge tracts of newly arable land for Russia to exploit while others suffer. Never explicitly stated, proponents of the thesis seem to buy into a notional “fortress Russia” capable of insulating itself from the negative effects of climate change while reaping its benefits in basically one sector, though admittedly one that will be increasingly salient for security as the effects of climate change escalate. To stretch that a bit further, the implication is that Russia is a huge land power rich in resources and able to pull up the drawbridge on a host of global problems when it comes to domestic matters. It may be strictly true more arable land opens up — the findings are a bit contested in their significance and there are tradeoffs — but these assertions are comical. They seem to assume climate change has discrete, distinct effects that are somehow outside deeply and expansively embedded systems of interdependence within one economy, political system, or society and culture and between economies, systems, and states.

Today, Kommersant ran a piece on how abnormally high and drier weather has led to a 15% decrease in the procurement of livestock feed. Breeders are therefore budgeting for increased feed costs which could then lead to an 18% increase in costs of production for milk. To take the example used in this article, yields in Tiumen’ oblast’ dropped 40-50% because of the weather, which then has immediate knock-on effects for local producers who not only have to source feed from further away and manage the logistics, but are also potentially competing against foreign importers (probably not in this case, though) who will pay more. And it’s not like Tiumen’ is exactly far south. In theory, regions like it just north of Kazakhstan should benefit from the changing climate in the scenario painted by the climate “optimists”. Yet differential changes in climate and the increasing occurrence of abnormal weather would naturally lead to episodes like this one. It just so happens to be taking place in the middle of an inflationary wave as global commodity prices keep rising. The following was an extreme projection for a high temperature increase scenario 2090-2099 from the Voeikov Observatory in St. Petersburg:

We shouldn’t expect these to necessarily pan out, but more broadly, the relative increase in temperatures from current levels rises the further north and east you go except for that belt just above Kazakhstan/China and closer to the Sea of Okhotsk and the Pacific. With these disruptions, it’s certainly likely new land opens up for use — it should be noted, however, that new land opening up climactically does not mean the soil is going to be great quality. Black Earth is Black Earth. Russia may have a huge share of the world’s black soil area, but it’s clustered in southern Russia. Since the late 20th century, Southern Russia and Siberia — presumably the big ‘winner’ from climate change — have seen higher incidence rates for higher temperature anomalies. The risk is that southern agricultural breadbaskets begin to see a decline in rainfall during harvest seasons and an increase in winter or else a net decline. You might be able to open up lands further north, but none have the same qualities as chernozem. If dry spells become more common, then we’d expect to see bursts of price inflation for food become more common. How exactly does the existing inflation policy framework now trying to build a system of reactive export duties, taxes, subsidies, and other mechanisms function to address climate problems? Agriculture has been a resounding success story for growth in Russia, particularly since 2013. Right now, we’re seeing producers complain about rising fertilizer costs because commodity price cycles feed into sectors between each other altering production costs.

There’s another problem modeling tradeoffs from a changing climate — the later an economy waits to start investing into mitigation measures and newer infrastructure to handle changes as they come, the more expensive said investments become as the timelines get condensed, businesses and states have to react to increasingly extreme dislocations, and new land that hasn’t been utilized at all becomes more valuable and has to be unlocked. In other words, you need an investment boom to manage climate change just about everywhere. That means commodity prices — and related inflation — stay higher and everyone’s got to get building. Neither of those work well for the Russian economy or the regime as it’s currently constructed. Further, the size of the workforce is structurally declining. If agriculture keeps growing in an economy that’s got a relatively low ceiling for services since incomes keep falling, that will draw in labor that is deployed elsewhere. Of course, part of these labor shortfalls might be managed by increased labor migration and refugee flight from Central Asia or the South Caucasus, but then you have to consider social friction and the institutional challenge of incorporating arrivals into existing tax and welfare systems. The EAEU helps in that regard a bit, but it’s not a panacea. Oh, and they’ll have to build more than a pathetic 2,000 kilometers of new roads annually to plus up logistical access to rural areas where newer lands are meant to be exploited.

Climate change creates a host of systemic risks and shifts that Russia and other macroeconomically orthodox political systems are not designed to handle. Economies have to be run hotter to ward off the worst possible temperature increases and climate disruptions. It’s as yet speculative, but one can imagine that Russia’s defense manufacturers would try to cash in on any of these emergent projects as a means of off-setting export losses or budget restraint. New tech, new equipment, and the pressure to mobilize labor will all matter more. The correlation of domestic forces suggests climate change will become yet another rentier goldmine at the expense of the deflation forced upon other groups in society.

Like what you read? Pass it around to your friends! If anyone you know is a student or professor and is interested, hit me up at @ntrickett16 on Twitter or email me at nbtrickett@gmail.com and I’ll forward a link for an academic discount (edu accounts only!).

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Household finances have finally hit what appears to be a tipping point for purchasing power. Sberbank’s consumer activity index hit a post-February low on July 3-4. In June, net consumer spending began to fall. Below is the Sber index, what’s relevant are relative levels and not the absolute measurements:

Annualized inflation at the end of June hit a 5-year high at 6.4%. Since a big chunk of the consumption surge in 1-2Q was debt-financed, the question is how long does it take for falling consumption to rein in inflation? That’s unclear since domestic demand has relatively little bearing on commodity price levels globally. Agroholdings are screaming about price increases for fertilizer and are moving beyond calling for price stabilization and actually asking for price decreases. Now Mishustin is calling for measures to control the increase in prices for PCR tests for COVID instead of just taking the position that the state will organize and pay for them. Supply bottlenecks correspond to demand, and demand shifts in accordance with the health of household finances. But things like food and transport are a constant. Moscow’s about to pay a heavy price for returning the budget to surplus in 2022 at the expense of demand, capacity investment, and household solvency as the weakest SMEs and companies go under. Refinancing at lower rates last year provided a lifeline, one that required a counterpart fiscal policy in place.

What’s going on?

1. Something’s rotten in the state of Russian Railways. At a Federation Council hearing on the realization of RZhD’s long-term development plans through 2025, deputy general director Anton Zubikhin of Sinara Transport Machines (CTM) complained that in the last 6 months, the rail monopoly has stopped buying new track-laying and surveying rolling stock used to build and maintain railways and expand rail capacity. Sinara accounts for about 85% of all track-layer production capacity in Russia, and there isn’t any evidence some other supplier suddenly leapt forward. Sales in 2019 and 2020 were worth about 20 billion rubles ($269 million) annually, but RZhD’s stated needs for said rolling stock fell 85% in 2020-2021. The Institute for the Problems of Natural Monopolies found just 4.18 billion rubles ($64.69 million) of track-layers were sold for Jan.-May, a 51% decline year-on-year against 2021 and a 37.9% decline against 2019 levels. Without another 10 billion rubles ($134.6 million) in orders, CTM is going to have lay off 7,000 people — about 20% of its employees. Once they go, the relative costs of increasing production capacity and strain on existing output increase if demand were to rise again. But the spending plans laid out by Russian Railways cut track-layer purchases down to 8.6 billion rubles as a budget item per Infoline-analysts, significantly less than the 12 billion rubles the company claims it budgeted — both figures represent a drop from 2019-2020. What does this mean? Seems that less construction work is being done, whether due to price increases for materials, shortages of labor, or else attempts to crack down on corrupt waste given the problems the Baikal-Amur Mainline and Trans-Siberian works have faced. The problem’s bigger, though: the failure to use the COVID shock to push for a much larger investment program when the cost of state and corporate borrowing was lowest last year to correct for the shock and existing infrastructure and manufacturing bottlenecks is creating a structural drag on growth outside of households and consumer-facing industries. The loss of those jobs would be a big blow to Russia’s industrial capacity to maintain its existing rail network, let alone expand it, and that brittle supply/demand balance only gets worse the less they do for investment and demand. I expect some sort of intervention.

2. As the mortgage subsidy program has been extended, with a minor upwards rate adjustment, Russian banks have issued a record volume of mortgages for the first half of 2021. Big banks have collectively issued a whopping 2.21 trillion rubles ($29.85 billion) to Russians looking to buy property. Sberbank and VTB are clearly lead the pack, with overall issuances in the realm of 2.5 trillion rubles ($33.77 billion). Sber and VTB account for 72% of that. The following is in billions of rubles:

   

   All told, it’s estimated that 500 billion rubles’ ($6.76 billion) worth of mortgages were issued in June. But this lending expansion is hitting up against the end of the bankruptcy moratorium and rising consumer indebtedness to pay for goods whose prices are rising all the time. 88,000 personal bankruptcies were declared for H1, an 110% increase year-on-year over 2020 data that showed a then 50% increase from 2019. Corporate bankruptcies are on the rise for the first time in 4 years — 9.2% to 4,920 cases total — as the moratorium has lifted and creditors surveyed showed a 30% increase in the intention to reclaim debts owed via legal proceedings. The more the banks issue these loans to prop up asset values for Russians as a salve for falling wages, the political tradeoff American authorities made with their housing push in decades prior, the greater the risk that rising costs of credit take out businesses and households alike whose creditworthiness keeps declining as Russians’ consumption falls. Financial fragility is a much greater problem after a debt-intensive recessionary shock whose mismanagement has led to economic scarring. June also saw record levels of cash loans — 622 billion rubles ($8.36 billion) for the month. Things aren’t looking great.

3. Forbes has some great scoops. The 100 wealthiest state officials and deputies got some nice raises in 2020 — they collectively earned 75.9 billion rubles ($1.02 billion), a 15.3% raise over 2019 while average real incomes declined about 3% for everyone else. The top 10 earners took home 43.7 billion rubles ($588.42 million) of that, 57.5% in total. Those top ten earners took home more money than the combined annual budgets of 13 Russian regions with a combined population of 6 million people. Chelyabinsk deputy and president of Yuzhuralzoloto Konstantin Strukov was #1 with a take home pay of 8.6 billion rubles ($115.9 million), a 66% raise over 2019. The head of Kamchatka krai, Igor’ Yevtushok, came in 2nd. The other details don’t matter a terrible amount. The deprivation imposed upon regional budgets isn’t just about political control — the Center can find other means to ensure complicity and compliance with important diktats and since everyone’s dirty, security services and anti-corruption investigations often do their job. Rather the problem is about efficacy. If Putin, others in the Kremlin, and across the government operate with an assumed overly hard constraint on state borrowing and spending, that doubles the pressure to crack down on excessive graft, which tends to be fueled by higher levels of state spending. But the lack of spending then empties out state capacities to govern over time and since property rights are politically contested and contingent, local businessmen, business, and security interests frequently enter politics to ensure their properties or businesses are safe, lobby for their friends, and prevent worse from the Center happening. As a result of these patronal systems, the incentives are greater to raise the pay of useful managers holding seats than to actually fund regional budgets adequately. And these figures in the regions aren’t saints of local government, they realize that state capture operates from below and middle out, not just from above.

4. VTB Kapital is warning that prices for coking coal — metallurgical coal used for steel-making — may rise 30-40% in 3Q because of the export targets that have continually been raised for the coal sector in recent years. It’s a double whammy for metallurgical firms in the making. Export duties intended to combat domestic price inflation for a range of metals take effect on August 1, but they don’t touch feedstock prices for domestic coal producers trying to seize the day since China’s banned Australian coal imports, raising prices globally and disrupting established trade flows. The result will be further increases in cost without the hope of realizing equivalent earnings from higher export prices and, more recently, the rise in the US dollar against other leading currencies. In the last month, FOB Australian hard coal prices have risen 22% to $181 per ton and CFR China coal contracts rose 12% to $303 a ton. Iron ore prices keep rising, too. Russkaya Stay’ estimates that current export tariffs will cost the sector about 150 billion rubles ($2.02 billion) in profits this year. VTB analysts suggest that domestic steel prices could fall 25-30% once the duties take effect, which is great news for Russia’s construction sector, decent news for housing prices, and politically mixed since it’ll encourage future interventions along similar lines. But the effects of the approach and the expected coal price rise will be uneven. Exporters can ride out lower domestic prices since they still earn decently abroad. If a firm relies entirely or mostly on Russian demand, however, that’ll end up squeezing their profits too. In economic terms, Moscow’s playing with differential capacity utilization — one sector of an economy running hot can mean another runs cold or faces problems. Rising tides do not necessarily, in fact, lift all boats, nor do falling tides beach them. The end result will be fewer profits to invest into production. China still holds a large excess of steel-making capacity that’s been supported by domestic over-investment, a combo that affects global supply/demand balances. Moscow’s living for today, not sectoral planning.

COVID Status Report

23,962 new cases and 725 deaths were recorded. The rate of increase seen across the regions is steeper than any prior wave (though testing is a part of that), worsened by the greater transmissibility of the Delta variant:

Red = Russia Blue = Russia w/o Moscow Black = Moscow

Mishustin has ordered the Healthy Ministry to work up a vaccination model to achieve 80-90% collective immunity, which raises the question why the hell they hadn’t already discussed at least the possibility internally for modeling purposes? He’s also finally taken a public stand recommending that regions place restrictions on mass events. We don’t which ones, but health minister Mikhail Murashko confirmed yesterday that foreign firms had applied to register their vaccines in Russia and that foreign vaccines “will be sold.” Restrictions for businesses are going to have to expand across the regions. In Saratov oblast’, for instance, they’ve reported a marked increase in infections among people working in service jobs. That’s almost certainly happening elsewhere where steps haven’t been taken yet. Reapplying restrictions without a new business support package that goes beyond tax breaks or inspection exemptions is a recipe for further economic mayhem at the local level, especially in smaller cities and towns that can’t rely on national demand for services like Moscow or St. Petersburg. At the current rate, regional cases will match their second wave peak within a few weeks. So far, it seems fairly likely that the next peak will surpass the winter and possibly by a significant margin. Vaccine take-up may blunt some deaths and hospitalizations, but 20-30% would still be a far cry from enough given the risks the Delta variant poses.

Ties That Don’t Bind

One of the main recurring themes of energy transition and green development coverage and debates is the political economy of what I offhandedly think of as “disjointed” development. Often implicit rather than stated, it manifests in many ways. The most obvious challenge comes from the fact that surges of green investment in a developed market lead to higher commodity prices that pressure resource exporters to reap more of the windfall. Shifting lobbying interests from entrenched commercial blocs that have benefited from lower fossil fuel prices in developed markets tend to get less attention. The Daily Shot posted a useful graph today showing the long arc of German industrial output, and why the German export machine that has driven the Eurozone’s external balance of payments and internal politics faces some serious post-COVID headwinds with roots pre-dating the current crisis environment by several years. German industrial production has returned to pre-COVID trends, slowing down considerably in June. That’s a huge problem — and a potential opportunity:

We can see the industrial output peaked in 2017-2018 and has since been on a steady decline. Some of that may be firms relocating production into China proper. Electric vehicle supply chains are also an important a headwind over time since EVs are mechanically simpler and therefore offer fewer component parts to manufacture and export. At the moment, supply chain bottlenecks biggest culprit whether they be difficulty booking containers or physical shortfalls of production for semiconductor parts and other electronic components. The trend, however, is there. Energy is a huge input cost for heavier industries and manufacturing since they’re energy-intensive ventures. The structure of costs matters a great deal. One of the biggest problems for Germany has been that natural gas continues to set the marginal wholesale price for power since it backstops whenever renewables can’t meet demand, so you get a case of “disjointed” development. The greater the share of renewables in the national energy, the more sensitive large consumers become in response to import price changes for natural gas. When you look at relative price levels for electricity over the last decade, you can see that price increases only start noticeably in mid to late 2017 and then pick up:

That coincides with renewable’s passing a threshold in terms of their net market share for power generation in Germany — that share rose from 33% in 2015 to 47% by 2019:

So we see Germany’s industrial production beginning to decline just as electricity prices start to rise, amplifying concerns about competitiveness. Think of it this way. German industrial manufacturers have been obsessed with securing low price, reliable natural gas supplies from Russia because the demand in Germany is there, they want to cap price increases since surcharges for renewables now account for 20ish% of consumer electricity rates — note that this balance is probably different for industrial consumers but still an important reference point — and German exports are the glue holding together the Eurozone’s balance of payments and internal flows of capital. Germany’s export surplus alone accounted for just over half of the Eurozone’s net surplus exports of goods and services in 2018-2019, and that was declining from 61.2% in 2014 just before the Eurozone fully stabilized. LHS is US$ blns:

Right now, European natural gas prices are breaking records and pricing and storage dynamics are setting up persistent high prices through winter. That intensifies the political pressure from German industry to lobby Berlin to go soft on Russia, and it’s also core to why the US backed off of killing Nord Stream 2. For all the howling about abandoning Ukraine, Germany’s export dependence and its centrality in locking the Eurozone into its persistent deflationary rut complicate the room for American policy to adjust. At the moment Gazprom’s ability to wield the ‘energy weapons’ has been defanged by antitrust action and market forces, there’s now a surge of concern about energy price inflation. This concern, however, is symptomatic of the conflicting timelines and vectors that affect the energy transition. Price pressures would ease relatively quickly if Germany availed itself of its considerable fiscal power to increase efficiency further, make more green investments, improve battery deployments and smart grids to best match supply with demand, support businesses, and reconsider its stance on nuclear power. The lesson is that what might appear to be resurgent Russian influence over energy markets in Europe and the ‘reactivation’ of one of its largest political and economic constituencies within the EU is about time horizons and decisions made in European capitals. In short, it’s a self-imposed problem, though no one should delude themselves that natural gas isn’t hugely important in the medium-term or irrelevant in market or political terms.

These disjunctures create paradoxical effects, doubling the extractive or political logic states like Russia have operated under and the price stability concerns consumers have had after decades of broadly low inflation outside of commodity price cycles. Like inflation, some of these disjunctures will be transitory and others not. Saudi Arabia isn’t going to be exporting tractors and leading frontier tech adoption. It’s going to be relying on its competitive advantages in oil & gas on a cost basis and its sunshine as fossil fuel demand enters decline. Russia’s in a more complicated position since its industrial exporters have long-standing ties to European industries now reexamining supply chains and their carbon and environmental externalities. Advances in one sector can undermine others domestically in Russia and other former Soviet states. There’s little hope at present Germany’s political establishment will break out of its ruinous economic consensus, which will lengthen the runway for Moscow’s ability to cultivate valuable business ties in Europe. The influence bought with molecules of natural gas, however, is waning. We now live in a world where fuel substitution is a much more meaningful threat to demand in the immediate term . High prices tend to cure high prices if they persist for too long. Democracies can eventually mobilize when the rents are too damn high.

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It turns out the gas explosion offshore in Azerbaijan was a mud volcano. I just missed the announcement before sending this out yesterday. So close, SOCAR I guess.

OPEC+ has officially failed to come to any agreement so we’re stuck with existing cuts until April 2022 until someone blinks. Talks were called off yesterday with no date set to pick them up again. We’re now facing the biggest ‘breakpoint’ for the market since Saudi Arabia called Russia’s bluff in March of last year. Whereas 2020 and the first few months of 2021 were all about demand uncertainty, it’s the imposition of supply uncertainty through producer restraint that’s now the problem. The EIA now forecasts that oil demand will average 97.7 million barrels per day for 2021 — the entirety of the gap with 2019 consumption will stem from lower jet fuel demand since international travel is taking and will take a long time to recover, especially with the US not signaling anything close to border normalization for now:

Even marginal output gains ahead of travel normalization could trigger another large stock build and tank the price. Though the UK is a relatively small market for oil demand, pure electric vehicle (EV) sales here now account for 11% of the market matching diesel’s share. In Europe broadly, plug-in electrics accounted for 16% of automotive sales in May. While still a tiny share of the market, Ford’s sales of EVs and hybrids was up 117% in June. EV sales in China were up 220% year-on-year for May, from a relatively low base but climbing fast. EVs only accounted for 4.6% of global sales in 2020, but even at a market penetration level of 10-15% globally, you’d begin to see more significant shifts in products demand at the regional level and slide of road fuel demand into structural decline since demand on developed markets has already peaked overall. Sales are minimal in India, the world’s leading demand growth market after China in recent years, but even there we’re seeing a new corporate push and political pressure to speed up the electrification of urban and near-urban road transport. Brent Crude has climbed past $77 a barrel and hit three-year highs. The longer this drags on, the likelier one of the ‘oil hawks’ like Sechin calls for another production ramp up. If that happens, or anyone else does the same, 2022 prices may end up looking lower than expected going into this summer.

What’s going on?

1. After telling the government to adopt a “take or pay” contracting system for shipments of coal to the East in his role as secretary of the presidential commission for the energy sector, Igor Sechin is now asking the government not to ignore other sectors’ needs. The prioritization of coal is creating risks for oil firms (read: Rosneft) trying to export more oil via the rail network, which in theory is another supply chain bottleneck story. It’s likelier that Sechin’s shifted on the issue because there won’t be mechanisms put in place to allow users to pay for priority, effectively privileging oil firms with better margins than coal miners though the rise in coal prices would undercut that difference a fair bit. The dispute goes back to March when Putin ordered that coal exports from the Kuzbass be increased from 53 to 68 million tons by 2024 — Russian Railways and coalers were supposed to work out long-term contracts to provide price and revenue stability to manage the increase using take-or-pay clauses or else an analog arrangement. That swiftly fell through because of the lack of clarity about the ‘balance’ of responsibility to meet contractual obligations, disagreements over linking supply contracts to capacity investment stipulations, and other business concerns. Sechin’s more recent letter from mid-June asserts that the non-system that’s slowly coming together risks the fundamental functioning of goods markets in Russia, a hefty charge given the solution he backed in March was expressly designed to construct a sort of market ‘bubble’ within which SOEs and coal mining firms could operate. At the end of 2020, Rosneft and other oil firms managed to close long-term capacity contracts for shipments in exchange for discounts. These discounts become an indirect (and relatively ineffectual) means of cost and price control, but they inevitably rob RZhD of profits which then increases pressure on the federal budget and reserves to finance modernization and capacity work or else wring out more from existing spending. They then reinforce the problem by forcing companies to compete over capacity that could have been expanded.

2. The budget rule designed to decouple the ruble’s exchange rate from the oil price has kicked back in with MinFin spending more to buy foreign currencies and intervene in the exchange rate. The ministry spent 222 billion rubles (about $3 billion) in June and is expected to spend 296 billion rubles (about $4 billion) in July in accordance with the rule. LHS is the difference between the price at which the rules takes effect and the current oil price while the RHS is the purchase or sale of current on the open market:

   Blue = $/bbl Red = US$ billions

   

   The budget rule has a lot to do with why geopolitical risks became the primary market mover for daily to weekly or monthly fluctuations in the exchange rate. ING estimates that the oil price recovery will boost the balance of payments surplus by about $10 billion from $55 to $65 billion. That inflow will have to be ‘sterilized’ with more currency interventions — they could reach $33 billion for the year. According to Dmitry Dolgin, that figure could be reduced by $3-5 billion if the government manages to invest an analogous amount from the National Welfare Fund in 2021-2023. But economic recovery in the second half of the year could pressure the balance of payments and create some currency risks because of the size of MinFin’s purchases. Last Friday, it looked like a surge in demand for rubles linked to Rosneft’s dividend payments was enough to pressure the ruble 1.7% downwards against the US dollar for the week. Currency risks are highly concentrated in Russia’s largest exporters, particularly ones that convert foreign currency earnings into ruble dividends. However, prolonged economic fallout from the current wave of the virus will probably undermine some of the expected import gains from higher oil prices.

3. Pollock exporters in the Far East are straining from the sales lost as a result of China’s import restrictions on Russian fish due to COVID health and safety concerns. The Association of Pollock Fishers (ADM) has sent a request to deputy director Konstantina Savenkova of Rossel’khoznador to streamline the paperwork necessary to export fish in the first place so that the excess catch going to waste and not sold in China can more easily be sold onto other markets. Russia is terrible at border compliance for exports, a system that has remained by design as a means of extracting administrative rents and, these days, making it easier to cut export flows in hopes of addressing domestic shortages. Based off the World Bank data, the 2019 world average time necessary to comply with border export requirements was 52.9 hours. In Russia, it was 66. It was 20.7 in China, 7.48 in the EU, and just 1.5 in the US. As a result of this self-imposed bottleneck, ADM warns that there’s an overload of refrigeration capacity in Vladivostok — one of the world’s biggest transit ports for illegal fishing operations — and Kamchatka. The All-Russian Association of Fisheries (VARPE) notes that this year, as much as 459,000 tons of Pacific salmon will be caught in the Far East amid the pressure on the refrigeration market. The refrigeration backlog is also a function of supply chain problems. Containers from Busan or Vladivostok shipping Russian fish cost $150-200 per ton, or about 10-15% of the market value of the product. ADM hopes to simplify the paperwork to target transit to Indonesia, Vietnam, and Thailand via South Korea. This long-winded saga dates back to October when the restrictions first appeared, and it goes to show the pitfalls of the Far East’s heavy dependence on export industries in a pinch.

4. For the first 5 months of this year, pharmacy sales in terms of physical turnover fell 14.9% year-on-year as more and more Russians prefer to order online. That’s 2.25 billion physical units sold. For comparison, turnover rose 4.8% in annualized terms for Jan.-May 2020 to 2.65 billion units. DSM Group’s Sergei Shulyak makes clear that consumers’ spending power continues to decline — last year Russians prioritized purchasing medicines that were prescribed by doctors and foregoing other pharmaceuticals that weren’t strictly necessary. Even that balance might be worsening now, though part of the story would be the decline in other seasonal viruses like the flu due to the unintended positive consequences of anti-COVID public health measures. Pharmacies are also noticing that Russians have begun to replace purchases of large quantities of cheap generics with purchases of fewer pills from the choicest brands known and trusted to be effective. Online sales grew 62% last year and it’s expected this year will show huge growth again. Stories like these tend to be useful leading indicators about household finances and the haphazard state of Russia’s ongoing import substitution efforts for medications, particularly since Putin just signed into law that firms can legally make medication using pirated patents to encourage more industrial espionage and entrepreneurship to steal know-how where possible. E-commerce platforms provide a chance to quickly search for trusted brands and, perhaps just as importantly, reduce the time people spend in public with others who might be sick. Even if Russians distrust vaccines, virtually everyone knows someone who got sick at this point and it’s hard to imagine that there isn’t some level of health anxiety working in tandem with the growth of e-commerce platforms given the new wave. Overall, incomes don’t appear to be rising. Rather things are getting worse.

COVID Status Report

23,378 new cases and yet another record 737 deaths were recorded in the last day. That’s the first time more than 700 deaths have been recorded in a single day. Authorities are now working out authorizing people to fly after they show their vaccination certificates. By my quick count, 27 regions now have some forms of restrictions in place but they’re all over the map in terms of strength and effectiveness — in Boronezh oblast’ you can’t go on business trips unvaccinated (that’s it) whereas in Bashkiria, you need proof of vaccination or immunity to go to museums, movie theaters, libraries, attend university classes in person, or else got to large restaurants or cafes (negative tests also work in the last case). Bizarrely, the German government has slackened quarantine and travel requirements for travelers from Russia to reduce the total amount of time spent in quarantine down to 5 days should they show negative tests. If vaccinated with an EU-approved vaccine — not Sputnik — it’s even easier. At least vaccinations are still picking up pace with about 16% of the population having received at least one dose. Delta variant has been vicious, appearing at just a few cases in mid to late May and becoming completely dominant by June 28:

The UK is now testing the effects of opening up travel and ending all mandated restrictions with cases rising. Thankfully we’re about a week or 10ish days away here from hitting 70% of the population with at least 1 dose, but ending masking reqs is a huge risk. Russia’s tourism sector will be suffering a lot longer I’m afraid.

Zombie Mobilizations and Other Maladies

The new National Security Strategy as prompted a bevy of responses to what is, fundamentally, a paranoid document showcasing the depths of strategic navel-gazing that have taken root among Moscow’s hawkish security elites, their minders and allies, and the political establishment more broadly. The obvious takeaway still bears repeating. There is now no room for accommodation and cooperation with the West in any meaningful sense, only selective concordats or relaxations of tension in a standoff that has taken on an existential and increasingly dangerous character. As Dmitri Trenin and others have noted, the introduction of Soviet-era terminology — the “mobilizational preparedness of the economy” in this case — indicate a new bunker mentality that paints the contemporary constellation of political, economic, demographic, ecological, and technological trends and forces as threats. I first wanted to flag a few smaller things I thought were curious, and then move onto to my larger point: the class interests of the Russian political system and its economy are foundational to the most bellicose and fatalistic components of this strategy document, indicating a crisis of wealth creation and distribution as much as a profoundly Darwinian and Hobbesian account of sovereignty in a war of all against all.

I was quickly struck by the persistence of the assertion of multipolarity from the outset because of its implications for Russian state power and wealth:

“The modern world is undergoing a period of transformation. The increase in the quantity of centers of world economic and political development, the strengthening of the positions of new global and regional leader-countries brings changes to the structure of world order the formation of new architecture, rules, and principles of the world system.”

COVID has shattered the prior supposition of an increasingly multipolar world, a point Putin rather gleefully made at his 2019 December mega press conference when he claimed that China’s economy had overtaken that of the US. Stunning failures and regional divisions between vaccination campaigns, however, reveal a world where in the next few years ahead, the gap between developed economies and developing economies may well grow since higher commodity prices trigger higher relative levels of inflation in countries that lack the same levels of monetary sovereignty and are taking longer to either recover or else protect their populations from infection. US growth in 2021 may end up beating China’s GDP growth and there’s a great deal of uncertainty ahead depending on its further spending plans. If the world order as it currently exists poses myriad threats and challenges as this document suggests, it is remarkable that the Moscow establishment are incapable of accepting a de facto emergent bipolar world system divided between the US and China and dotted with financial, industrial, and extractive ‘peripheries’ because of the persistent decline of Europe as a geopolitically relevant driver of global power relations since 2008, with the exception of particular regulatory initiatives. Multipolarity as it was intended is dead. There is yet no language to take its place. Later on:

“In conditions of stagnation and recession [for] the leading economies of the world, the decline of the stability of the world currency-financial system, and the ever-greater spread the exacerbation of the fight for access to markets and resources leads to the practice of using instruments of unscrupulous competition, and protectionist measures and sanctions, in this case in the financial and trade spheres.”

It goes on to note the open pressure exerted on Russia as though the West were trying to steal its resources, but just those few lines are incredibly revealing. The stagnation it mentions is due to a host of things but there are two ‘easy’ culprits — global economic imbalances within and between classes in countries that have concentrated too much wealth in the hands of a narrow class of asset owners and the deflationary economic paradigm that guided western economic orthodoxy (and now Russian orthodoxy) for over 40 years and is only now unraveling. Both of these driving forces lower growth, and with that inflation. Yet the entirety of the regime’s economic raison d’être is its ability to horde resources and assets for those politically connected, politically able, or else for the state to call upon in a crisis. No one disputes the lessons learned (or not) about systemic risk and instability from the Global Financial Crisis, yet the Federal Reserve, the ECB, the People’s Bank of China, and their peer central banks have done a remarkable job managing the COVID crisis. The most recent Federal Reserve stability report acknowledges the potential risks of rising interest rates linked to higher inflation in emerging markets including Russia pose to the US financial system, but the real worry is China. That Moscow remains silent on the financial risks that have built up within China and their global implications as more capital flows in and out due to a slow process of liberalization is quite telling. There isn’t actually any notional vision of where the global economy is headed, only catchphrases to win internal debates.

Flipping through later, the bits about the mobilizational potential of the economy are by far the most important things to look at in light of laying a wide array of socioeconomic goals intended to give Russians a decent life. We shouldn’t read this document as a strategy document. In actual fact, it contains precious little for us to intimate what decisions Moscow might take in response to any given situation or to proactively manage its biggest security threats that differs from prior conceptions. The rhetoric of economic mobilization has now entered into the official lexicon as a matter of the class interests of the individuals and blocs internally debating policy from political roles, heading key political or private institutions and firms, or else trying to read the room and use the general direction of travel — the securitization of everything — to achieve personal or policy ends. As I’ve written extensively, the absence of growth since 2013 fosters an extreme environment where economic profit and personal gain aren’t won by building profitable firms or engaging in productive economic activity. With politically irrelevant exceptions like restaurants or retailers, you have to find ways to get resources out of the state to grow or get paid. Rentiers rely on the presence of some sort of threat or galvanizing political or economic mission to justify the largesse of the state. That class of rentiers has evolved considerably since 2011, but 2013 is most useful to ‘periodicize’ the evolution of Russian political economy.

Sam Greene has written about the re-emergence of ‘estates’ in Russia in terms of social groupings distinct from class because they aren’t defined by their relationship to the means of production taking from Simon Kordonsky’s work. They instead provide service to the state and are awarded status in return. I find that framing quite limiting in light of documents like this one, which posit a political need to leverage and operate the means of production at the state’s convenience, yes, but also in an effective manner faced with various external and internal limitations. The state is not some solid edifice with definite shape here. Some individuals are able to capture component parts of the state or its “daughter companies” for themselves. Heading a firm like Rosneft, Gazprom, Novatek, Alrosa, or Almaz-Antey conveys huge personal power over the means of production even if they officially or practically belong to the state. Timothy Frye’s framework of the “legal dualism” of Russian property rights — the fact that some rights, particularly those less salient for political power, are decently protected whereas those that intersect with political necessity aren’t — lends itself to a further extension of that logic in light of Russia’s version of rentier state capitalism. The country’s uneven and combined economic development as a resource and capital exporter, to borrow a bit liberally from Trotsky, shaped a class of economic actors and interests from disparate sectors, all of whom were tasked with accruing and managing external rents — petrodollars and the like — mobilizing domestic rents — the defense sector and its post-2016 push into civilian production come to mind — or distributing and redistributing rents and credit — the state banks, largest private banks, and development institutions. This ‘dualism’ is embedded into which parts of the Russian economy are most integrated into global value chains and fiscally valuable, mostly its resource extraction and metallurgical firms, those that are politically distinct from global value chains for security reasons in the defense sector, and the Russian banks that can build up financial links internationally to shuttle money across borders and generate access to financial markets outside of London, Frankfurt, or New York. The political importance of a given sector ends up determining the extent to which political intervention and control is necessary, with some sectors safely in the hands of private operators and others formally held by the state. But internationally vital sectors are never left alone because of their salience for foreign policy and influence. Exporters, bankers, generals, and spooks share enough mutual interests to form a coherent coalition as various estates.

So what happens when an ‘estate’ of minders successfully lobby their personal interests to reshape institutional and normative assumptions for policymaking? They look a lot more like an economic class performing acts of proprietorship over key assets or sectors than an estate serving their lords. Within some limits, we can safely say the class of rentiers benefiting from the pursuit of autarky have seized dominant influence, if not power, over key decision-making institutions and fora to its own benefit. The inclusion of a wide range of economic concerns into the national security strategy all point to deep-seated fears stemming from the post-Crimea sanctions regime. The US has successfully exploited the power of the dollar system in the global economy to alter the economic preferences and possibilities for Russian investors and firms. That it did so in conditions of stagnation for the Russian economy doubles the incentive to construct a reactive security paradigm that creates rents and calls for the creation or reconstitution of new political and economic institutions and practices to manage the Russian economy’s exposure to forces like inflation, commodity prices, or the loss of access to strategic technologies. Mobilization requires political control and influence. Political control and influence in a system where property rights are contingent, formal institutions are generally weak, and political entrepreneurship is constantly encouraged generate graft and rent-seeking as a form of political or economic insurance policy. Once you securitize an industry or set of transactions, they either cannot fail lest they be perceived to be a breach of national security or they receive more resources. Opposition and paranoia about the West are good for business in today’s Russia given the dominance of the nation’s strategic sectors over its economic life. Strategy documents confirm that reality. We’re not just witnessing the ‘closing’ of the elite Russian mind when it comes to the West. We’re watching a regime reinvent the political foundations of wealth management and redistribution amid economic decline in real time. Mobilization is also about raising investment levels, as I’ve written at length about. That’ll be the true test of Moscow’s obsessive hunt for security and stability as it generates more insecurity and instability along the way.

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The OPEC+ standoff with the UAE over its plans to increase output in the face of soon-to-decline demand drags on. The White House made clear through spokesperson Jen Psaki that it’s worried about high gasoline prices, but there isn’t yet much evidence Biden and his team are expending much political capital to fight them. That’s probably because of the structure of consumer spending in the US amid evidence that low-end wages for service jobs are rising again. As Zach Carter notes, housing accounts for 37% on average of household spending followed by transportation at 16%. 10% for married parents goes to childcare vs. 34% for single parents. It comes down to political priorities. More expensive gas makes a difference, but far less of one when wages are improving for those most exposed to increases in costs and you need buy-in for Iran deal negotiations. That’s also why the bipartisan and reconciliation infrastructure are so important — they’ll include some funding to improve public transit, rail transit, and support the purchase of charging stations and the purchase of electric vehicles while also trying to build in more child tax credits and social spending to ease the burden of childcare. Russia’s in a fairly weak negotiating position now since investments are affected on a 1-2 year lag when prices crash. The following is OPEC upstream investment excluding supporting infrastructure:

The fact is that output has to rise in the near future to make upstream investments more sustainable and avoid instability. But OPEC members, namely Saudi Arabia, the UAE, and Kuwait, are in much better position than Russia on that front. They can more easily idle capacity and generally get more bang for their buck investing into newer production, though this is somewhat dependent on the project and company operator in Russia for comparison. That the UAE has been able to jam everything up goes to show that it can afford to gamble recklessly. If current cuts hold through April, it benefits far more in relative terms than Moscow and, conversely, benefits far more from decoupling output increases starting in August from the April 2022 deadline for current cut levels too since Russia’s only major greenfield project in the pipeline is Vostok Oil, and it has to be subsidized. The UAE wants to revise the baseline for output calculations from the 3-year old levels to April 2020 — only Saudi Arabia, the UAE, and Kuwait would benefit within the deal framework. Russia would theoretically gain too, but is also aware it may cede market share in the near future due to domestic output declines and doesn’t want to lose market share in China to Saudi Arabia.

What’s going on?

1. The government is now discussing tax reforms intended to raise about 400 billion rubles ($5.46 billion) between 2022-2024. About 100 billion rubles ($1.37 billion) will come from an increase of the mineral extraction tax rate for precious metals, 90 billion rubles ($1.23 billion) from taxes on oil firms’ “additional income” above a target level, and 100 billion rubles ($1.37 billion) from improvements to the collection of excise taxes or else upwards adjustments on some goods. The other 110 billion rubles ($1.5 billion) will come from raising taxes on individuals and other measures. On that last front, the government’s commission for tax policy came out against a tax on luxury goods, including high-end real estate, cars, yachts, and private planes. For now, it seems they’re burying the negotiations into MinFin’s budget process for the next 3-year budget proposal to keep talk of any politically sensitive taxes ‘inside the family’ while the Duma’s on vacation. What was more interesting to see from the Vedomosti writeup is that MinEkon sees no need to tighten budget policy — they aren’t linking the budget to inflation problems — while MinFin has set out its view that last year’s expanded deficit and state spending contributed to rising price levels. Minister Maxim Reshetnikov is now trying to pull off an equivalent oil tax maneuver for the metallurgical sector so the state can properly reap the windfall profits from the new commodity price cycle while retaining enough space for firms to invest into output. There’s more to ponder — an increase in alcohol excise taxes would increase illegal consumption, for example — but my overall impression is that budget policy is likelier to be tightened by increases in taxation rather more than any decreases in spending at the moment.

2. As the government’s share of consumption of GDP has fallen with the snapback to budget consolidation, a burst in sales and the circulation of goods (and to a lesser extent services) picked up the slack in 1Q. Practically, that means the best of the COVID recovery is already behind us because the inventory that manufacturers and retailers had available to sell cleared in 1Q. Making more means absorbing higher input costs, which eventually have to be passed onto households. The following is the % structure of GDP:

   Seafoam = household consumption Black = non-commercial org consumption Yellow = change in material inventories Salmon = State consumption Light Blue = gross capital formation Darker Blue = Net Exports

   

   These are year-on-year comparisons for 1Q so they don’t capture the extent of changes perfectly well, but we can see the obvious problem. Any increase in household consumption since 1Q 2019 has been debt-financed. What’s even crazier is that capital investment as a % of GDP fell further this year in 1Q from 15.4% in 1Q 2020 to 14.9% while overall investment data has shown a slight increase (2%) as of June. What gives? By the look of it to me, companies are spending less on fixed assets — land, machinery, buildings — and more on things like intellectual property or else financial assets in response to business conditions and rising inflation. In short, they don’t believe the demand will be there to justify an expansion of capacity because the state refused to more proactively manage the recovery, instead trying now to manage cost increases from higher commodity prices or supply chain bottlenecks for imported gear like semiconductors. The increase in investment activity seen more recently is happening because businesses are trying to get ahead of the Central Bank’s rate hikes that’ll make credit more expensive. The recovery may well flame out this summer, especially with the terrible toll the Delta variant is now taking on lives, health, confidence, and certainty.

3. The withdrawal of US forces from Afghanistan is having its intended strategic effect. There’s a resurgence of concern in Moscow that the Taliban represent a serious threat to Russia. Foreign Minister Sergei Lavrov noted last week that IS was also a resurgent problem since it could ostensibly launch attacks from Afghanistan as a base — he of course did not note that the Taliban fight any IS presence regularly since, unlike Al Qaeda, they intend to setup an actual presence to govern rather than just act as a network aiming at far away targets. The Uzbek government has setup a tent city near Termez anticipating refugees and Afghan soldiers fleeing the Taliban will come in large numbers — Tashkent expressly takes the line that soldiers crossing the border without permission are in violation of international law whereas Tajikistan has done less to discourage them. Moscow’s made clear it’ll provide assistance to Dushanbe to police the border properly. At the current rate, we may begin to see the Ministry of Defense, Ministry of Foreign Affairs, and public-facing security officials lay more groundwork to justify military action into Afghanistan in response to threats from IS. At that point, something akin to targeted airstrikes supported by small incursions from ground units and/or groups of Taliban fighters against IS would be closer to reality. Once that happens, the reality of the US decision to withdraw will finally hit home — US competitors will have to shoulder at least some of the burden of managing Afghanistan, tying up precious resources while the US has more room to pivot its own to the Levant or East Asia. Officials in Kabul are currently in talks with Moscow to establish an intelligence exchange to potentially coordinate future efforts. The CIA has deep ties with Afghan intelligence. It’d be a golden opportunity to those in D.C. looking to make the most of a politically contentious but proper decision to reduce the American footprint to keeping Kabul safe, providing financial assistance, and targeted air support. The Kremlin’s announced a beefed up presence to monitor the situation from the Tajik border, but has yet to talk to Kabul about placing troops inside Afghanistan. How long that lasts is an open question.

4. The Federal Anti-Monopoly Service (FAS) and MinEnergo have worked out a joint order to set new guidelines for sales of coal on exchanges. The aim is to require the largest coal producers to trade 10% of their monthly sales via exchanges where buyers bid and trade contracts rather than through direct producer-buyer agreements outside SPIMEX in Moscow. New guidelines for exchange trading will then aid price discovery and help stabilize prices. Market participants will be able to assess their contracts for coal supplies in light of broader market movements, improving transparency and market efficiency by circumventing the incentives to inflate costs in local and regional corruption schemes or else use insider trading between a coal miner and a subsidiary to pass money around between asset owners. Instituting exchange contracts as a normative requirement will undercut the use of privately negotiated contracts traded over-the-counter (OTC) to this effect. There’s little doubt that corruption schemes jack up costs, however it’s unclear how this latest stab at speculation really fixes the problem. Cost increases should turn up in higher profits for producers who could be cajoled into producing more and reinvesting said profits into productivity gains. There might also be a bigger problem of firms misquoting actual production costs since wages tend to be politically suppressed and managed in the sector to limit labor bargaining power (within limits). Oil firms regularly inflate production costs to lower their tax burden and then announce lower production costs to foreign investors to make them happy. It’s a decent idea that may help around the margins. Fighting speculation as if it’s the proximate cause of all price instability doesn’t make sense, though.

COVID Status Report

24,535 cases — the 3rd day in a row with over 24,000 cases — and 654 deaths were recorded in the last day. Rospotrednadzor estimates COVID has cost the Russian economy 1 trillion rubles ($13.65 billion), an estimate that almost certainly understates the damage when you factor in Long COVID and losses associated with inefficient and sometimes half-baked economic measures on top of limited state support. The week-on-week rate of increase is coming down — hard to say it’s close to being ‘enough’ yet given gaps in testing and the continued upward trend seen for cases across the regions though the reintroduction of some restrictions is helping:

Russia set its official mortality record over the weekend — 697 deaths in one day — and the last 5 days have broken previous highs. Much of that is probably explained by terrible data from the 1st wave and mediocre data from the 2nd wave, as much as it deserves note. United Russia is following up on Putin’s Direct Line by consulting with experts on how to approach long-term recovery from COVID symptoms and after-effects. I’m relieved it’s on the policy agenda. Daily vaccination demand has hit 500,000 doses — a 5-fold increase over March levels. Hopefully production can keep pace. Levada found that 54% of Russians still aren’t ready to get vaccinated…

Iraq and Roll

According to Iraqi oil minister Ihsan Abdul Jabbar, BP and Lukoil — two of the biggest foreign partners for Iraq’s upstream oil sector — are looking to sell their assets tied up in the West Qurna fields and invest elsewhere. In BP’s case, it seems likely connected to pressures to meet climate targets and divest from dirtier projects where practices such as flaring are more commonplace. For Lukoil, it’s probably more to do with a change in portfolio preferences — it just acquired a 50% operator interest in a shallow offshore project in Mexico for $435 million after having closed a Sales and Purchase Agreement for 49.99% of a Caspian offshore bloc owned by Kazakhstan’s KazMunayGas. Both companies are looking to sell to Chinese firms. ExxonMobil has tried to sell its 32.7% stake in West Qurna 1 to 2 Chinese firms for $400 million, but had the deal held up by authorities in Baghdad concerned about the political significance of the transfer of assets given Washington’s role providing security for the state. Iraq’s oil ministry has made clear that the country has become unattractive for major oil companies because of failures to stick to contracts, frequently poor economics for projects based on payments per barrel extracted, and now the issue of carbon emissions affecting firm rationales. That Chinese firms — the big one so far is CNPC — are considering buying speaks to an acceleration of underlying pre-COVID trends. China’s the world’s largest importer, it’s domestic output has plateaued, and the COVID crash gave Chinese firms an opportunity to eye up investment opportunities other firms might otherwise pass on in order to advance national energy security priorities and deepen ties with regional governments.

At the beginning of January, China’s Zhenhua Oil co. reached a tentative deal with Baghdad that would have provided $2 billion upfront to secure 5-years’ worth of oil at a time when the national budget was straining from the 2020 price crash. The Iraqi dinar was devalued by 20% in December in a desperate bid to restore order to the nation’s balance of payments and budget by increasing the cost of imports and increasing relative earnings off of oil extraction and exports. As the OPEC+ cuts and then US recovery did their work and oil prices recovered, Baghdad reneged on the prepayment deal realizing it’d be foolish to lock in too low a price. But now its spotty record has caught up to it as western and Russian oil majors have to reconsider how to maximize profits and please investors in a world where the extraction of oil must become cleaner and faces rising scrutiny. The panic of The Terminally Online over an offshore spill and fire via leak in the Gulf of Mexico, though brought under control swiftly, raised a lot of uninformed takery regarding the viability of oil operations — capitalism was blamed, though naturally the company Pemex is state-owned. Yet the same people wringing their hands over the Pemex fire were silent when video surfaced that quite clearly shows a massive natural gas leakage and fire off the Azeri coast from gas fields managed by SOCAR. SOCAR has denied any trouble as a matter of course, but it has to — like Iraq, its western partners led by BP have reconsidered its role in their portfolios particularly as Baku renegotiated its production sharing agreements to increase its relative stakes and revenue take from projects. Pemex has to get help if it can’t sort out these problems effectively on its own as well.

A few weeks ago, a consortium led by China’s Silk Road Fund acquired a 49.9% stake in Aramco’s oil pipelines for $12.9 billion. It was a bit of paper pushing to raise cash for Riyadh, but underscores a crucial inflection point for both US and Russian foreign policy in the Middle East. US imports from the region have fallen. In January, the US imported no oil from Saudi Arabia for the first time in 35 years. The Biden administration has been pursuing a further withdrawal of US personnel out of Iraq while negotiating a timeline with the government in Baghdad in the interest of reducing its presence to focus on training and support and, crucially, allowing to shift more resources to focus on Syria and Libya based outside of Iraq at the variety of bases that have been expanded since 2016 across the region or else the Asia-Pacific. The omnipresence of American air capabilities in the Middle East is intended to act as a backstop easing the way. Having Russian and Chinese firms in Iraq isn’t new — they first won contracts for tenders back in 2008-2009 when they were first issued (which kind of dents the obnoxious war for oil narrative). What is new is that China has positioned itself as a lender and investor of last resort for Iraq. Moscow’s biggest economic gains all came in Iraqi Kurdistan led by Rosneft’s acquisition of pipeline infrastructure and some upstream awards, with similar awards to a few other Russian majors. Moscow provided a supply prepayment for $1 billion in 2017 to the government in Erbil to buy trust. As time goes on, China’s corporate presence across the region will probably keep growing. Its nationally-owned or backed companies don’t face the same political pressures from investors to go green, it has fewer issues buying into lower-return projects since it can comfortably finance activities and make use of its massive foreign currency reserves, and its import dependency keeps rising.

Evan Feigenbaum likes to joke that the United States should not simply become the Hessians of Asia, guns for hire in a pinch, but rather develop a complete approach that incorporates economic diplomacy and other factors to build a self-sustaining web of mutual interests across the continent. That’s what’s happened to US strategy in the Middle East — American soldiers and contractors are Hessians for governments dependent on external rents to sustain their internal political organization or else security. Oddly enough, it’s the approach that Moscow mirrored when it decided it had to take on a more proactive role starting with the intervention in Syria. There have been commercial contracts linked to these activities. We shouldn’t discount mercenary groups or contractors, for instance, securing exploration and extraction rights for oil in Syria (and attempt to replicate the model of security for assets further afield from Libya to Sub-Saharan Africa). Overall, however, these contracts are small potatoes. China’s not just stepped in to try and find bargains post-COVID, but also directing more of its investments towards green projects across the region. China’s a leading player for solar developments given its industrial heft for supply chains and interest in reducing Saudi, Emirati, and Middle Eastern oil consumption for power to reduce emissions and ensure the availability of cheap oil for export.

Whereas US strategies have become increasingly militarized ever since the Clinton administration adopted a policy of democratic enlargement followed by the Iraq Liberation Act of 1998 that formally established US policy would support efforts to remove the regime in Iraq, Russia’s presence across Eurasia from Central Asia to the Levant militarized as a result of its economic deficiencies and domestic institutional structures. This analysis can apply to the US — look only to the creation of the Department of Homeland Security and rise of the security contractor as an example — but is a much larger challenge for Russian policymakers. China overtook Russia as the economic prime mover of Central Asia by the time the Global Financial Crisis hit, the South Caucasus has since similarly felt the pull of China’s demand and search for assets to buy, and the Middle East has been reorienting its economic priorities eastwards ever since Chinese demand rose explosively. At each juncture, Russia’s best response has been to double down on its competitive advantages — existing elite ties, security relationships, and a willingness to get involved with narrowly defined missions. Since 2013, the exhaustion of domestic rents provided by oil-led growth gave rise to a resurgence of rent-seeking via foreign policy initiatives. A Saturday piece by Giorgii Kunadze for Novaya Gazeta. talks about the “mania of greatness” that has consumed Russian foreign policymaking. That certainly explains the psychology of many decisions. It does not, however, capture how incentives changed for so many constituent parts of the nation’s political economy. Economic sectors leapt for ever more trade protections, SOEs began to demand more and more bans on imports to lock in demand, private political entrepreneurs began to more actively chase glory raising havoc in far flung conflict zones, and the Ministry of Defense has had to eye roll at the appearance of mercenaries in Syria operating outside of its control and without respect to established rules of engagement to avoid direct conflict with the US and its NATO partners.

It’s impossible to untangle Russia’s sudden appetite for action from the underlying failure of its political establishment to create economic growth, as much as the psychological explanations of how figures like Putin or Patrushev make decisions can explain Russian policy outwardly. At the end of the day, however, it’s China and other large external investors willing to take gambles owning and operating the key infrastructure and extractive industries of the Middle East that benefit. Firms unencumbered by US sanctions or the same reputational risks, investors able to manage relationships with local militias, hire security contractors, and trust that their political counterparts on the ground have a decent enough relationship and understanding of the Iraqi security forces and role of American personnel and military formations to protect their investments. In the same way one can argue the US is footing the bill for conflicts China ought to be helping to pay for, so is Russia even if it’s doing so in opposition to erstwhile European powers and the United States. Geopolitical machinations have an underlying logic not entirely dissimilar from financial balance sheets. Every ‘asset’ gained carries with it a corresponding liability. Some liabilities are very easy to manage, some not. Some assets offer fantastic returns, others become sinkholes. On balance, Russian foreign policy has done relatively little to advance material gains aside from the performative component of playing the part of a major power. Moscow is underwriting an evolving, anarchic security system that local and regional actors exploit to secure their own ends, including the corruption and money flows tied to owning and holding oil assets. Iraq is a sign of the complexities of ‘green’ geopolitics to come as oil power takes on new meanings and forms in a world of rising non-fossil fuel commodity prices and demand paired with macroeconomic innovation foisted onto developing markets and countries like Russia from the US and EU.

Like what you read? Pass it around to your friends! If anyone you know is a student or professor and is interested, hit me up at @ntrickett16 on Twitter or email me at nbtrickett@gmail.com and I’ll forward a link for an academic discount (edu accounts only!).

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OPEC+ surprised again. The UAE held up what was otherwise an acceptable compromise to start raising output by 400,000 barrels per day each month starting in August. It wanted larger exemptions so it can begin to expand upstream investments to raise oil production by 1 million barrels per day in the next decade — up to 5 million bpd. Back to the drawing board today as the bloc figures out what can be agreed. If no pathway to an increase is agreed, we’re in dangerous territory for market stability. The problem isn’t necessarily how short the market currently is for supply, but rather that the default framework in place calls for no change in output till April 2022 if there’s no deal. Suddenly defections become a huge concern and global price inflation would be worsened for many emerging markets and import-dependent economies if prices kept rising past $80-85 a barrel, including Russia. Then there’s the issue of US output. Ignore Pantheon here — it’s the latest attempt to up Alaskan production, still a bit tentative for costs, and not particularly important for the point though could matter:

The core of US shale plays managed to get their breakevens down to the $45-60 dollar a barrel range with a far bit of offshore capacity in that range as well. If prices rise enough without any output increase from OPEC+ and the expectation they do nothing till April 2022, even relatively restrained shale drillers will have a reason to increase output to meet demand. Those investments operate on a 6-8 week timeline, not the years and years that conventional onshore and offshore projects are designed around. You can kill wasteful spending in shale, but you can’t kill its effect on oil price ranges structurally. Only modify it. Moscow is undoubtedly cognizant of this dynamic when pushing for more output sooner.

What’s going on?

1. Rosatom’s AEM-Tekhnologiya, a core part of its manufacturing division, is sinking 9.7 billion rubles ($131.82 million) into the modernization of plant between 2021-2023. The infusion represents a 60% increase on capex into production for 2018-2020 and a six-fold increase over 2015-2017 — the progression of spending makes sense when you recall that back in 2017-2018, Rosatom’s expenditure levels were slated to match or exceed those of Rosatom and Gazprom by 2021-2022 (if I recall correctly). Investments into the firm’s fixed capital hit 12.8 billion rubles ($173.87 million) for 2021 against just 4 billion rubles in 2018. Naturally nothing has been revealed as to whether it’s company money or debt paying for these upgrades and investments. Shockingly, AEM-Tekhnologiya is the only company in Russia that produces the full complement of parts and equipment for the nuclear steam generating installations that power nuclear reactors. Given that, these spending levels for capacity and productivity enhancement seem quite small comparatively. Vedomosti’s writeup uses the company and government line by playing up the fact that the IEA has called for a 4-fold increase in nuclear power plant construction through to 2030 to meet net zero goals. The intention per director Igor Kotov is to time the completion of these upgrades with the peak of the investment cycle in 2023-2025 when a bunch of Rosatom’s export catalog should, in theory, be moving into more active project phases past initial planning, duals over contractual terms, and various agreements to agree. The pressure’s on. Poland’s announcement last year it’d look to spend up t $40 billion on nuclear capacity to ease the replacement of its coal fleet came with a 2023 launch date for the first plant. Rosatom isn’t winning that tender, but it’s an important leading indicator for what might soon become broader willingness to (re)commit to nuclear, particularly if natural gas prices remain higher for longer.

2. The June release for IHS Markit’s industrial PMI ticked back under 50 again, signaling a fall in demand for Russian firms. It fell to 49.2 from 51.9 for May. Cost increases linked to inflation are the leading culprit as firms now have to pass on more costs to wholesalers and, by extension, consumers. The Gaidar Institute’s own measure of demand based on the ability of consumers to pay also indicated a downward trend compared to expectations for June, though still showing growth month-on-month:

   Balance = % Growth - % Decline — Blue = expected Red = actual

   

   Inflation is now eating the economic recovery alive with the added blows of political pressures to restrain spending and difficulty finding buyers for Russia’s sovereign debt at the moment. As inputs get more expensive, intermediate goods and inputs rise in price. Before you know it, manufacturing is struggling. Any of the positive momentum Reshetnikov and MinEkon were talking up from May is largely gone now with everyone well aware there’s no ‘breakthrough’ for growth on the way. What will Moscow policymakers do? So far, we’ve seen no evidence that any stimulus will be provided and instead efforts are centered on capping further price rises. The short answer is they’ll do nothing. I’m increasingly interested in the implications of Russia’s push for a much faster hike in oil output with OPEC+. There’s probably a (small) component of it hoping to get inflation under control more globally alongside the boost to domestic demand. But that would also require Gazprom increasing deliveries to Europe and a surge of capacity investment into other forms of extraction that’s now at risk thanks to the expanded use of export duties.

3. Yesterday, president Putin signaled that Moscow will expand its economic support to Belarus as needed in the face of mounting sanctions pressures from the West. Last August, that came out to a $1.5 billion infusion, $1 billion of which came from state funds and the rest from the Eurasian Stabilization Fund for which 90% of its capitalization is provided by Russian budget funds. The newer EU sanctions have limited Belarusian banks’ ability to raise funds abroad by capping maturities at 90 days for any loans made to the Belarusian state, its agents, and corporations or else any sovereign debt purchases. Over 90% of Belarus’ sovereign debt is denominated in foreign currencies — Minsk has about $3.3 billion in eurobonds outstanding at the moment and I’ll have to ask Max Hess for more details, but apparently the market’s pricing them at just slightly. better than Ethiopian issuances. All of this is to say that in the midst of an escalating return to economic crisis conditions in Russia, Moscow is closing ranks and not ceding an inch on Belarus. But there’s a brewing liquidity problem across the Belarusian economy. The National Bank suspended liquidity provisions to banks on a continuous basis at the end of last August and has extended said suspension indefinitely after initially suggesting it’d be lifted by mid-September last year. As inflation shot up and macroeconomic pressures have worsened since the COVID crisis began, the National Bank has had to limit the liquidity flowing into the banks to head off a collapse in the foreign exchange market since both households and firms, expecting a massive drop in the value of the Belarusian ruble, have every reason to buy foreign currency and wait for the devaluation to take place. At the same time, consumer debts have fallen 9 months in a row — people are paying down debts more than borrowing — and the more that trend continues, the worse off incomes and demand will be whenever the economy normalizes more. Things aren’t looking good and only Moscow can offer significant external help.

4. Ukrainian president Zelensky has made a huge splash today that deserves recognition: he’s managed to pass systemic land reform allowing private ownership of agricultural land in Ukraine that has now taken effect. This is a hugely positive sign for the country’s agricultural sector and exports, though its institutional consequences aren’t as clear yet. The reform is proceeding in two phases. Until 2023, only individuals can buy, sell, or lease up to 100 hectares of land at a time. Starting Jan. 1, 2024, legal entities can buy, sell, or lease up to 10,000 hectares at a time so long as they meet crucial conditions. The founders and/or members of the legal entity have to be Ukrainian citizens, foreign citizens can’t buy land (though this will be put to a referendum), foreigners will never be allowed to own land within 50 kilometers of Ukraine’s borders, companies without a readily identifiable beneficial owner will be barred from ownership, and individuals from “aggressor states” (read: Russia) will also be banned regardless of the referendum. There are tons of hurdles to clear, but it’s a huge deal given how deeply entrenched the problem of who controls what has been since Ukraine’s independence. The reform will, imperfectly, bring more money into state coffers as well as provide more transparency — shadow leasing schemes are commonplace and smallholders have historically struggled against larger agroholdings. This won’t fix that, but can provide more opportunity to consolidate plots or else actually receive some form of compensation instead of facing displacement without any property rights. There’s going to be a flood of legal queries and fights over whether owners and tracts of land are properly registered in the cadastre. If someone claims ownership illegally or else no one steps forward to claim said land as they privatize what was public property, that land will become communal property after 2025. One can imagine plenty of shenanigans with any transition. It’ll take some time, but land reform in Russia was integral to its eventual rise as a leading wheat exporter. The quality of land in Ukraine tends to be higher thanks to the black earth it possesses, giving it higher yields. Russia’s wheat exporters will hardly be ecstatic since they can’t buy into the gold rush ahead.

COVID Status Report

23,218 new cases and yet another record 679 deaths were recorded in the last day. Hospitals are so slammed with new patients that MinPromTorg is asking the metallurgical sector to reduce its consumption of oxygen for production in order to redirect more oxygen supplies to healthcare facilities in order to head off shortages. Authorities in St. Petersburg are now working how to vaccinate 400,000 migrant laborers as the scramble to dole out doses has become a prime concern for an already tight labor market still suffering from lower migration levels. Duma deputy Vitaliy Milonov has proposed to Labor Minister Anton Kotyakov that Russians getting vaccinated receive an extra paid day off to recuperate and encourage more people to get their vaccines. All hands on deck coming up with whatever sticks at this point. It’s also worth acknowledging the latest variant to worry about — the ‘lambda’ variant found in Latin America where case levels remain high and risks of contagion via travel remain (lambda has already been found in the UK):

Per the FT’s writeup, we don’t yet know if this new variant is more transmissible. It’s raised concerns because apparently its mutations are unusual. I flagged this cause it’s a healthy reminder that there really is no solution except to vaccinate everyone as fast as possible and then adjust accordingly, whether that be booster shots or, eventually, reconfiguring existing vaccines. And while Russia may have made decisions about opening or closing flight access on the basis of other country’s infection levels, it could end up a longer-term pariah for tourism unless it can sort out this situation effectively. At the same time, that won’t matter too much so long as incomes continue to fall.

It’s a Trap!

Oil dependency is a harsh mistress. For all of the clangorous thrumming about Russia’s successful efforts to wean itself off of oil, it’s still the thread that holds the budget and economic system that has sustained the regime together. That’s why I found Vladislav Inozemtsev’s latest for Riddle a great read — he well understands that a return to high oil prices would actually be terrible for the Russian economy’s prospects. I think he could take his argument a fair bit further than he does, and I also have a few significant points of disagreement worth working out as to why. Overall, the idea that commodity price cycles can convince a political leadership an aging, ineffective, and increasingly toxic economic model is sustainable has huge explanatory power for the course of Russian economic and security policymaking since the late 90s. You may be able to teach some old dogs new tricks, but you can’t retune entire fiscal, monetary, commercial, and financial structures built upon the premise that the state can soak the oil & gas sector to lighten the load for everyone else.

It never ceases to surprise me how much even the liberal critics of Russian economic policy and the Russian state seem to believe that changes in monetary policy, in this case the massive easing and provision of liquidity on the part of the Federal Reserve since this crisis began, magically inflate commodity prices by speculation. Inozemtsev indulges this narrative when explaining why oil prices have been rising since the start of the year:

“On the one hand, it is important to realise that the main reason for the current price rises is not a fundamental increase in demand but, rather, a speculative game triggered by a huge influx of money supply during the pandemic. The US ­alone has increased its public debt by USD 4.9 trillion since the beginning of 2020, while governments around the world have injected USD 12–17 trillion into the economy. Much of this money went to the stock and commodities markets, driving prices across almost the entire spectrum of positions. Not ­only oil and gas, but also metals, foodstuffs and fertilisers went up in price by 60 to 200% during the last year.”

This is bad logic that ignores longer commodity price and investment cycles and really needs to be explicated to capture where his argument falls short and could be all the more impactful hammering home an important thesis. The speculative trading of commodities is about betting on future prices and buying or selling physical volumes of commodities that only exist on paper. Financial speculators are, with the exception of those who use physical commodities as collateral or else also act as physical traders, buying and selling assets that are linked to commodities but not the commodities themselves on the premise that the value of those assets will rise or fall in the future. While net positions of capital on futures markets can be heavily weighted towards going long or short per price increases or decreases depending on the maturity of the futures contract traded, the reality is that someone’s taking an opposite position for any given speculator’s bet so it’s also not a one-way street. It’s easy to blame speculators because no one likes bankers, greed is easy to identify as sinful rather than structural, and they certainly don’t cover themselves in glory. But futures work differently than physical trading and there isn’t a clear pricing connection between investment from true speculators like hedge funds or more passive investors linked to the massive index fund industry (that also sours a bit on commodities whenever prices fall). Futures’ effect on prices is generally quite short-run when it’s found.

It’s really difficult to short a commodity in physical trading because shorting requires an absence of the good whereas betting on a future price increase is easy cause you can sit on the good as long as it doesn’t spoil but you don’t earn till you sell. On a futures market, shorting a commodity costs the same as going long. You’d think it’d increase price volatility but not significantly impact price discovery for physical goods since the paper market isn’t competing with the physical market for supply broadly and supply and demand fundamentals still matter a great deal to how speculators position themselves. That Inozemtsev opens with this point about oil prices, to my mind, reflects a sort of comfort zone for Russian economists and analysts. Speculation on physical goods prices happened on physical markets in the Soviet system because of the gap between the formal and informal pricing of goods that were often in short supply. ‘Speculation’ wasn’t trading paper futures, it would have been withholding goods to force prices up. But if any individual or enterprise did that, then they’d risk others stepping in and realizing price gains without taking that bet to begin with. By placing the focus on monetary policy and politics, it becomes an excuse to blame the Federal Reserve for its competence. Further, commodity production costs are heavily influenced by the cost of credit. The massive provision of liquidity and low rate environment make it easier for commodities producers to borrow and invest into production, admittedly more of a challenge for Russian firms limited in their ability to access credit abroad in US dollars. The very policies he’s blaming are deflationary in the long run and, indirectly and probably unintentionally, fit into a broader elite discourse that likes to blame Anglo-American capitalism for a host of global problems.

Once we account for this gap in the argument, the rest of it still makes decent points. The notional ‘industrial revolution’ Inozemtsev talks about is certainly a macro trend globally. Martin Sandbu’s counter in a column yesterday to the Russian position on the multiplication of discriminatory measures for trade in a net zero world — a trend that ultimately goes back to 2008-2009 — is, I think, a compelling way to reframe the problem. Assumptions about competition in the traditional free trade framework from which the WTO evolved aren’t designed to incorporate externalities and social costs that undercut domestic institutional arrangements. The result is that trade openness treats international and domestic trade as somehow equivalent when we well know the distributional consequences aren’t. Inozemtsev’s contention is that these pressures coincide with the risk that Russia runs into the problem facing Latin American resource exporters in the 70s and 80s — the explosion of US dollar denominated debt fueled by oil price increases (and other factors) in the 70s led to economic crises from which many countries struggled to recover. Russia’s debt levels aren’t that high in GDP terms and it’s borrowing in its own currency. The dynamics are different. What’s far more concerning is not that a renewed spike in oil prices suddenly “solves” the debt problem for the regime, but rather that it worsens the inflation problem:

Price expectations for businesses in the next 3 months — Grey = Consumer price expectations Red = value-added production Blue = Retailers Black = Everything

Businesses are looking to markup prices at levels they haven’t in 18 years. A lot of these price increases are ultimately about high commodity price levels and many goods dependent on imported components are facing the same bottlenecks everyone is thanks to reopenings and the strength of American consumer demand. Oddly, though, Inozemtsev’s argument sidesteps the problem that the energy transition and the industrial revolution he alludes to are going to require cheap credit to be able to scale the types of investments needed as quickly as possible. In a world like that, commodities will always be expensive if we accept the idea that speculators are to blame. But that’s not really why expensive oil is so bad for the regime in my view despite the cogent and valuable political point he raises in the article. Since Russian output has likely already peaked, a view that’s become more commonplace in the last few months, a large price increase is unlikely to bring a net increase to output since producers are relatively price insensitive for investment plans above $35 a barrel. A higher price with lower aggregate domestic output means a much stronger negative effect via inflation — fewer people will be employed or consuming related goods and services via intermediate demand from the oil sector while the state budget has to compensate refiners more to subsidize prices and industrial manufacturers feel the effects on their supply chains, including petrochemical products used for fertilizer.

Inozemtsev ends with a note about the West undermining the Bretton Woods agreement in an oddly ahistorical manner. Bretton Woods only ‘functioned’ for about a decade of its existence and it swiftly fell apart under the weight of its internal contradictions, worsened considerably by the effect of the Vietnam War on the US labor market and deficit, French intransigence, and the export-oriented political economy of West Germany. It’s not just that countries have been left out at the margins, it’s that the “non-system” since 1971 allows for a far greater degree of action on matters like climate than an otherwise ‘anchored’ monetary system tied to gold. His article is a great read to get a sense of what more liberal-minded economists in Russia may be reflecting on as we see the state finally react to the threat of decarbonization. None seem to be drawing links to the long-run risk of higher inflation as a result of the paradigm shifts taking place. Expensive oil is a problem for the Russian economy precisely because the regime has tried to escape oil dependence and failed. That leaves the economy in its own transitional Hotel California, able to take the initial macroeconomic measures to do so (even at the cost of greater geopolitical risk) but unable to leave that transitory stage where oil has ceased to provide any growth but still undergirds the macroeconomic settlement and system governing politics. Iika Korhonen perfectly captures the visual of this trap as laid out by Inozemtsev:

High oil prices sustained Russian growth from 2000-2011. Then they didn’t. 0.9% isn’t just anemic, it’s made the economy far more susceptible to commodity price swings. The piece is spot on about the lack of rents to finance modernization and the direction of the regime. It just stops short of really challenging the underlying assumptions about how Russia’s economy is governed that have left it in such a bind.

Like what you read? Pass it around to your friends! If anyone you know is a student or professor and is interested, hit me up at @ntrickett16 on Twitter or email me at nbtrickett@gmail.com and I’ll forward a link for an academic discount (edu accounts only!).

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There are a ton of things going into gross capital formation but just worth noting. Other stuff in there worth peaking at including another chart I plan to use. Hopefully you’re having a pleasant day or evening.