AN OUNCE OF PREVENTION: THE IMPORTANCE OF CONSIDERING DIFFERENT SCENARIOS FOR OIL PRICE FLUCTUATIONS


22.01.07
MOSCOW. (RIA Novosti political commentator Alexander Yurov)

How right was the Russian Finance Ministry when it warned against the urge to spend all petrodollars immediately, and how wrong were those who said that oil prices would never go down and so Russia did not need an airbag in the form of the Stabilization Fund. Now, when it has become clear that oil prices can go down suddenly and that excessive optimism in the economy can bode ill for us, it is clear that the forecasts of Finance Minister Alexei Kudrin, who advocated moderation and precision in budget planning, were thoroughly considered. Indeed, how would we feel now, with oil prices plunging, if we did not have our airbag of oil export windfalls? The Stabilization Fund, which many, laughing at the ministry's fears, refused to take seriously not so long ago, is becoming a real lifebuoy.

The beginning of 2007 saw a sharp decline in global oil prices: on January 11, they fell below $52 per barrel for the first time in 19 months, and a week later, crude futures in New York dropped below $50. Experts blame these developments on the unusually warm weather in the United States and Europe, which has resulted in lower fuel consumption. Moreover, oil reserves in the U.S., one of the world's leading energy consumers, are 7.1% above the average for the last five years.

Andrei Klepach, head of macroeconomic forecasts at the Economic Development and Trade Ministry, says that no one expected that the winter would be so warm and that when the state budget was being drafted, oil prices were fluctuating around $70 per barrel. It is not that the government did not take precautions and plan for a possible decline, but when endorsing budget spending and revenues, they were guided by more obvious factors, such as Hurricane Katrina, U.S. policy towards Iran and oil output in the Middle East. The ministry did foresee a decline but expected it to be gradual, Klepach says.

Yet what Economic Development and Trade Ministry experts missed, their colleagues at the Finance Ministry saw coming. I can recall Kudrin's warning against idealizing the current macroeconomic situation and his proposal to be guided by a price of $40-50 per barrel, not ruling out short-term drops to $20-30 in the near term. Given the almost month-long decline in energy prices, the minister's opponents, who proposed to invest the Stabilization Fund in different projects, will finally get a dose of reality. After all, we have seen that oil prices will not always be high, but it would be difficult to cut funding for priority national projects or freeze retirement pension increases, especially with the election season ahead.

Fortunately, experts say that there will be no budget deficit as long as oil prices stay above $30. Only contributions to the Stabilization Fund will diminish, and if necessary, the fund will supply the necessary money for the budget. Russia has a significant safety net. The Stabilization Fund has accumulated 2.35 trillion rubles ($88.61 billion), growing by over 1 trillion rubles ($37.71 billion) over the last year. Part of this sum, which was invested in foreign currency in summer 2006, yielded revenues of almost 23 billion rubles ($867 million) in December alone.

Some experts estimate that should oil prices fall to $18-20 per barrel, the fund will be able to cover budget deficits for two or two and a half years. Others believe that it will last three to five years even in the event of a bigger price drop, but only if budget spending is restructured, i.e. the government will have to review its plans to raise social subsidies. In any case, the Stabilization Fund can serve as an airbag in the near term and cushion Russia against a possible crisis.

Analysts from the Institute of Economics of the Russian Academy of Sciences say, "The Stabilization Fund is designed to prevent a collapse of the country's budget if oil prices plummet." They point to the example of August 1998, when prices sank to $12 per barrel. There was no stabilization fund at that time in Russia, and the outcome is widely known: people's savings were wiped out and the state found itself on the brink of bankruptcy. So the Stabilization Fund is "a guarantee against all kinds of unexpected developments," an expert said.

However, the Russian Finance Ministry believes that a temporary decline in oil prices could even be good for the Russian economy. The subsequent decrease in the ruble’s exchange rate will be beneficial for Russian producers, and the economy will get rid of at least some of its oil dependence, speeding up diversification and reforms.

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