Russia battens down the hatches, preparing budget for era of cheap crude

Russia battens down the hatches, preparing budget for era of cheap crude
After joining major global oil producers in production cuts to stabilize crude prices, Russia has prepared a conservative budget for the next three years based on oil prices of $40 per barrel.

This is well below the current $50 trading price for Brent crude, a benchmark linked to Russia's Urals blend.

Moscow and the Organization of Petroleum Exporting Countries (OPEC) agreed to look at extending output cuts by six months, aiming to keep prices at a reasonable level.

Russian Energy Minister Aleksandr Novak said it was too early to say if there would be an extension, although the pact was working quite well and all the participants were committed to a hundred percent compliance. Global oil stockpiles will grow in the second quarter of this year, predicts Novak.

Global oversupply, and the ten percent March decline in oil prices have rattled major exporters despite analysts’ optimistic forecasts suggesting Brent crude will rise 16 percent from current levels by the end of the year.

The jitters may only get worse with Russia, a participant in Sunday's OPEC talks in Kuwait and a key partner in the deal, not believing in a positive result.

“The Finance Ministry, the cabinet and the central bank are leaning on the cautious side in terms of their expectations regarding growth, driven still to a large degree by oil. It’s better to be conservative and to be surprised on the upside than too optimistic and end up disappointed,” said Piotr Matys, a UK-based emerging-market currency strategist at Rabobank, as quoted by Bloomberg.

Last week, Russian policy makers stated that they see Urals blend on an average of $50 per barrel this year, but declining to $40 at the end of 2017 and then sticking to that level in 2018-2019. The central bank’s recent move toward monetary easing was also tied to the “uncertainty” in the oil market.

“Once (actually more than once) bitten, twice shy. The central bank and the finance ministry are sticking to the conservative $40 oil scenario because they want to be ready for and protect themselves against the worst-case scenario,” said Elina Ribakova, an economist at Deutsche Bank in London.

A price of $40 was also used to set the country’s three-year budget in 2017-2019. At the same time, Russia’s Finance Ministry said in January that the central bank would start buying foreign currency if crude falls below $40 per barrel to protect the exchange rate against oil volatility.

Even as oil has recovered from last year's lows, Russia’s tendency to stick with the more conservative scenario is “positive” as it “leaves room for upside surprises,” said Viktor Szabo, a bond fund manager at Aberdeen Asset Management.

According to data from Bloomberg, the interdependence of the Russian currency and crude prices has been lower during the past year, falling to its lowest level since August 2015.

Despite the slump in oil prices, the Russian ruble has been one of the strongest global currencies over the last 14 months, gaining over 30 percent against the US dollar.

Foreign investors have been lured by the ruble's carry trade return that is able to balance a gloomy outlook for energy.

READ MORE: Russian ruble remains resilient to crude mood swings

Carry trade is a strategy that involves borrowing at a low interest rate, usually in the developed economies and re-investing in an asset that provides a higher rate of return like emerging markets.