Sunday, December 14, 2014

Something to Worry About: Russia

Yes, there are geopolitical reasons to worry about Russia’s behavior.

Yes, obviously, Russia’s economy is heavily dependent on oil production, and it’s possible we’re in for a sustained price drop.

N.B. I’m not sure about that at all, but I keep hearing that when it comes to horizontal drilling (aka fracking) that the simple textbook explanation that the shutdown price is the same as the “open up” price fails badly. Fixed costs are so high in horizontal drilling that the divergence is something like $40/barrel. If this is the case, then the production from horizontal drilling in the U.S., that is pushing down global crude oil prices, is likely to be sustained, since those U.S. producers won’t be the first to shut down.

After all that, here’s the thing. Macroeconomically, what we look at in assessing the stability of a government’s current fiscal situation is the rate at which it can borrow money. Since bond prices are inversely related to rates, when investors accept lower prices to get rid of the bonds they don’t want … interest rates rise. Here are interest rates on 10 year Russian government bonds:


And why have interest rates been generally rising since early in 2013? What happened then?

Ah … that we the financial crisis in Cyprus … when it was revealed that one source of instability in Cyprus was that Russian kleptocrats were depositing huge sums of presumably ill-gotten gains in the poorly structured Cypriot banking system. And most of the “haircut” at the end of that crisis fell on large depositors — mostly Russians.

Since then we’ve had oil pipeline problems with Ukraine, leading to another Ukrainian revolution, the Russian annexation of the Crimea, the Russian paramilitary involvement in eastern Ukraine, the shootdown of a Malaysian passenger jet, and now steeply declining world oil prices.

Keep an eye on this one.

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