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Ни пуха ни пера

Ни пуха ни пера (pronounced: Ni púxa ni perá) is traditionally said to wish someone luck in Russian. Literally, the phrase translates to “no fluff no feathers” and is used the same way people say “break a leg” to wish someone bad luck when really they hope things go well. While the phrase is believed to ward off misfortune, it seems that Russia as a whole is in more trouble than a few words could fix.

With news from the World Bank last week of a revised outlook for 2015-16, Russia appears to be in an increasingly perilous position every day.  The new forecast from the World Bank expects the Russian economy to contract 2.9% in 2015, barely moving back into the black in 2016 with 0.1% growth, down from a 1.5% contraction and 0.3% growth, respectively. Expectations that Russia’s economy will contract further has lead Moody’s Rating Agency to also downgrade the country’s debt rating to just one notch shy of a junk rating.

The European Bank for Reconstruction and Development (EBRD) has also downgraded its forecast for Russia, saying it expects the country’s economy to shrink by nearly 5%. Piroska M. Nagy, EBRD Director for Country Strategy and Policy, says that the revised forecast is due in large part to the effect of falling oil prices on the region, but Russia will have to handle more than just a low price environment as the country tries to soften the blow of the oncoming recession.

Structural challenges leave Russia in a tough position

For the last 10 or 15 years, the trend in Russia has been towards massive state-owned “national champions,” or companies that would lead the industry. While not exclusive to the oil and gas industry, Russia’s state-run monopolies Gazprom (ticker: OGZPY) and Rosneft (ticker: RNFTF) are two of the largest. Vladimir Milov, former Russian Deputy Minister of Energy, said that the process of creating and maintaining these state goliaths has put the Russian oil and gas industry in a difficult position.

The capital required to bring all parts of Russia’s oil and gas industry under one umbrella has been tremendous. According to Milov, in a five-year period from 2004-09 the government spent $60 billion on major acquisitions, exceeding capital expenditures related to upstream production. Using funds to centralize industry has hurt Russian energy development in more ways than one. Along with compounding issues in the development of new fields, which OAG360® covered last week, the structural paradigm of “national champions” has created an industry that struggles to adapt.

One of the many drawbacks to a state-run monopoly is that they are often not forced to stay competitive. Milov said this is especially true when it comes to the companies’ marketing. The marketing of state controlled companies “is completely outdated,” he says. “It’s based on long-term take or pay contracts adjusted to the price of oil which is a non-competitive model.” He also points out that the marketing is subject to political needs, often hurting business.

According to Milov, “Gazprom’s exports to Europe in October and November have fallen 25% to 26% year-over-year. This is because of the overall inefficiencies of Gazprom’s marketing and Russia’s supply war with Ukraine.” In June of 2014, Gazprom shut off gas supplies to Ukraine, saying the country had failed to pay $2 billion for past gas deliveries. Milov maintains that the decision had less to do with debt and more to do with politics, however.

The effects of the shutoff were felt by more than just Europe and Ukraine though. Milov estimates that Gazprom’s exports fell by 12 to13 billion cubic meters (approximately 442 Bcf) in the Commonwealth of Independent States (CIS) alone, saying that it was “because of a political decision. It was not economical.”

The fall in exports abroad also mirrors declining sales at home for Gazprom. The former Deputy Minister of Energy puts Gazprom’s domestic sales down 12% year-over-year, following a steady decline from 2000 to 2010. Milov says this fall in domestic sales is in response to a “relentless” program of raising prices despite inflation.

Gazprom’s price rising was even noted as an issue to be addressed by President Putin himself. During a meeting of the Commission for Strategic Development of the Fuel and Energy Sector and Environmental Security, Putin said, “Representatives [from sectors other than oil and gas] are saying that the price formation methods for primary energy resources in some countries put their economies in a much more advantageous position than our economy’s real sector. This is something we cannot ignore.”

Even more concerning

Despite the inefficiencies created by the structure of Russia’s oil and gas industry, and the approaching production problems associated with Russia’s aging Soviet era oil fields, there still remains another problem looming even darker over the Russian oil and gas industry, and the country’s economy as a whole: sanctions.

Money from Western lenders has been driving economic growth in the past few years, with lending reaching $660 billion at its peak last year, according to Milov. “Sanctions have already had a huge impact on the Russian economy. They are extremely important. They are more important than oil prices.”

Stuart Bergman, Assistant Chief Economist and Director of the Economic & Political Intelligence Centre for Export Development Canada agrees that sanctions could strangle the Russian economy. “Investment is sorely needed across the oil and non-oil economy,” he told Oil & Gas 360® when asked about his outlook on Russia. “The longer this drags on, and Russia is restricted from access to international capital, the more it’ll be like trying to drink from a cup with a hole in it.”

As Russia comes face-to-face with the worst economic environment the country has seen since the global financial crisis on top of its main export losing more than half its value in the last six months, the blow dealt by sanctions will prove even more painful.  Next week we will explore in-depth the effects sanctions from the West are having on Russia’s economy, and its oil and gas industry.

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