What affect will the Opec oil production cut deal have on the Russian budget?
The deal struck in the last days of November has already driven oil prices up by 10% in a week and at the time of writing the cost of a barrel was just shy of $55 – its highest level since July 2015. That is very good news for the Russian budget.
If the production cuts can be made to stick – a big if – then it is possible that oil prices will rise to over $60, investment banks have been speculating in the last week. There is a corrective cap on how far prices can rise, as over $50 US shale producers become profitable again and will start pumping to add to supply, thus pulling down the price.
Still, higher prices are obviously good for Russia, but just how big a difference will it make to the Russian budget in 2017? The official plan, which is receiving its second reading on December 6, assumes an average oil prices of only $40 – and that already looks modest. Since the crisis began, the share of oil and gas revenues in Russia’s total revenues has fallen dramatically from over 60% to between 30% and 40%.
“We believe that the effect on the deficit and net sovereign debt will be less pronounced than that currently envisaged by the draft budget,” says Alexander Ishakov, chief economist with VTB Capital.
The main problem for the finance ministry is how to close an estimate 3.2-3.7% of GDP budget deficit, or between RUB2 trillion and in the worst case scenario some RUB4 trillion hole in the national accounts.
The immediate affect of a $10 increase in the cost of oil will be to earn the Russian state an extra RUB1.1 trillion of revenues, which will significantly ease the pressure on the budget.
“The federal budget assumes RUB5.1 trillion from mineral extraction tax (MET) and export duty revenues from oil, gas and petroleum products,” says Ishakov. “This estimate is based on 11.0mmbbl/d of oil production and 5.4mmbbl/d of oil exports, and uses a USD/RUB exchange rate of 67.5.”
Russia is now pumping a post Soviet record 11.2mmbbl/d of oil and part of the problem of the Opec deal is that it is not clear from what level Russia is supposed to reduce its production by 300,000 per day. But assuming Russia chooses to cut from its record production level then these estimates above work as Russia would still be pumping 10.9mmbbl/d.
VTB says that if oil prices average $55 in 2017, and exports and extraction are both cut 0.3mmbbl/d to 10.7mmbbl/d and 5.1mmbbl/d, respectively, then the combined oil and gas revenues increase by RUB1.1 trillion to RUB6.1 trillion.
In addition to more cash flowing into the government coffers, rising oil and gas prices have a secondary spill over effect as money flows out of the sector into the rest of the economy. This “trickle down” effect drove much of Russia’s rapid growth in the noughties. VTB estimates that the indirect revenue to the government from the rise in energy prices is worth about RUB200bn.
“Growing oil prices tend to have spill over effects into non-oil and gas revenues. Oil price growth is usually channelled through a stronger real exchange rate into higher imports and consumption. The current budget draft for 2017 assumes non-oil and gas revenues at RUB8.4 trillion. Assuming that the sensitivity of this part of the federal budget revenues is equal to our estimate of the sensitivity of GDP growth to oil prices, we expect an extra RUB0.2 trillion in revenues relative to the budget draft,” says Ishakov.
Together these two sources of extra revenue would go a long way towards helping the finance ministry balance Russia’s budget. If the deficit can be contained to 3.2% of GDP, or about RUB2 trillion, then the additional RUB1.3 trillion will make it easy to find the remaining RUB700mn from a combination of domestic and international borrowing.
This year the finance ministry plans to borrow a total of RUB500mn from the domestic market and has already raised $3bn (RUB190bn) on the international capital markets. Next year’s budget allows the ministry to borrow a whopping RUB1 trillion on the domestic market and another $7bn (RUB450bn) on the international market – more than enough to cover the budget deficit if the deficit is contained to 3.2% and oil really does average $55.