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Analysis: Russia's energy economic woes

For those on the sidelines, it's a simple question -- whether the Kremlin will risk 80 percent of its foreign earnings to score political leverage vs. the EU forgoing 42 percent of its natural gas imports. In such a lose-lose confrontation, a simple piece of advice for European investors -- stock up on sweaters.
by John C.K. Daly
Washington (UPI) Nov 14, 2008
Several months ago Russia's finances seemed unassailable -- record-high oil prices had brought an unprecedented amount of petrodollars to Moscow, and the state-owned Gazprom natural gas monopoly seemed well on its way to becoming a company with $1 trillion in capital.

Then came the global recession, and the Kremlin is being buffeted by falling prices and demand. How the government of President Dmitry Medvedev is responding provides an interesting contrast to Western governments' attempts to stabilize their national economies.

State intervention is unavoidable, if for no other reason than the Russian government now relies on commodities for 80 percent of its foreign earnings. Further prompting Medvedev's officials to intervene is the fact that the Russian electorate has vivid memories of earlier crises. In 1992, the first year after the December 1991 collapse of communism, inflation hit an eye-watering 2,300 percent. As the banking structure had yet to emerge fully from state control, the hyperinflation effectively wiped out the savings of the Soviet "middle" class. Six years later, during the August 1998 crisis, when Russia defaulted on its foreign loans, it happened again, when many Russians lost their savings so assiduously scraped together.

The last several years of steadily rising energy prices had been good to Russia, leaving it with the world's third-biggest foreign reserves, exceeded only by China and Japan, but the last two months have seen these tumble from $598 billion, losing nearly $110 billion.

In a striking element absent from Western current economic difficulties, part of the loss followed a massive capital flight following Russia's Aug. 7-12 brief military confrontation with Georgia. Within a month of the clash Russia's central bank was forced to prop up a collapsing Russian ruble. The Georgian conflict threw gasoline on an already volatile and weakened stock market, which, since hitting a peak of 2,498.10 on May 19, has more than halved.

Prime Minister Vladimir Putin in September insisted that the turbulence and downturn of Russian markets since June were not the result of the Russian government's fiscal policies or the Georgian conflict, maintaining instead that the domestic fiscal turbulence was caused by the "speculative" moves of Western institutions, which withdrew funds in response to the U.S. and European "mortgage crisis."

Whatever the real reason for the Russian meltdown, the West did have a role in Russia's current economic crisis, as Russia's banks, oil producers, miners and steel companies eagerly scrambled for the easy foreign credit terms proffered by Western financial institutions, which in turn believed that Russian loans were a "safe bet" because of the country's massive energy assets. The aforesaid institutions have now run up $510 billion in foreign debt, primarily in short-term loans.

While Russia's foreign currency reserves have provided an emergency fund to dip into if necessary, Medvedev's government's biggest concern at the moment is that Russians, remembering the fiscal chaos of 1992 and 1998, might make a massive run on the banks, with all the chaos that would ensue. Accordingly, the government has intervened to prop up the ruble, and contrary to the actions of Western governments in lowering interest rates, on Nov. 12 Russia's central bank raised interest rates a full point to 12 percent to prevent the ruble's collapse in the aftermath of a turbulent day on the Moscow markets. The move followed an earlier futile attempt by the central bank to prop up the ruble with an injection of $7 billion of foreign reserves the previous day, in addition to $77 billion over the last month.

As many in Europe and Washington have cautioned, Russia might use its dominance in the European energy market to make its displeasure with anti-Kremlin stances known. The Georgian crisis continues to throw its long shadow over Russian-EU relations. The month after the confrontation Putin threatened to diminish Europe's supplies of "oil, gas, petroleum chemicals, timber, metals and fertilizers" if the EU took an anti-Russian position in the Georgian imbroglio. Moscow must then have felt some quiet satisfaction when both the BBC and Human Rights Watch recently announced they were investigating the possibility that Georgian troops may have committed war crimes by bombarding the South Ossetian capital, Tskhinvali, in advance of its ill-fated military operation into the troubled separatist province.

Putin's warning has certainly resonated in European capitals: On Nov. 13, the day before a Russia-EU summit in France, the European Commission released a document highlighting an ambitious strategy intended to loosen Gazprom's domination of European gas imports. Six energy projects were included in the proposal for future development, among them two "absolute priorities" to connect Lithuania, Latvia and Estonia to European power grids while developing a Caspian "southern gas corridor" bypassing Russia and Iran, a policy steadfastly pursued by the Bush administration for the last eight years. Prior to his meetings in France with Medvedev for what undoubtedly will be called "frank and candid conversations," European Commission President Jose Manuel Barroso bluntly said, "We must not sleepwalk into Europe's energy dependence crisis."

In the sunset days of his administration President George W. Bush continues to promote free-market capitalism, despite the global economy's gyrations: During a speech at the Manhattan Institute in New York before Group of 20 leaders convene for discussions about the fiscal crisis, Bush maintained that capitalism remains the "best system" for producing economic growth.

Accordingly, the stage seems set for a bout of fisticuffs between Russia and the EU over energy, with America cheering the Europeans on from the sidelines. As Brussels enters its high-stakes poker game with the Kremlin, the stark fact remains that with the onset of winter, Europe currently gets 42 percent of its gas, a third of its oil and a quarter of its hard coal from Russia, which, should Russia turn "difficult," the United States would be in no position to cover. While the economic fallout from such a confrontation is unclear, energy shortages in Europe would hardly contribute to its economic recovery, and it is worth remembering that Gazprom's first deliveries to Western Europe began four decades ago when Leonid Brezhnev ruled the Soviet Union.

For those on the sidelines, it's a simple question -- whether the Kremlin will risk 80 percent of its foreign earnings to score political leverage vs. the EU forgoing 42 percent of its natural gas imports. In such a lose-lose confrontation, a simple piece of advice for European investors -- stock up on sweaters.

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IEA slashes 2009 oil price estimate to 80 dollars as recession lurks
Paris (AFP) Nov 13, 2008
The International Energy Agency (IEA) slashed its 2009 oil price forecast to 80 dollars from 110 dollars on Thursday, saying imminent recession is strangling demand in rich countries and crimping emerging economies.







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