17/6/2014: Gas, Oil, Russia, Ukraine & Europe: couple of links

An interesting report from Bloomberg on Russia's demand for oil exploration and production JVs with Western companies: here.
One core reference is to the new/old Bazhenov superfield which I covered before here.
Meanwhile, I commented before that Ukraine gas supply disruption is a distinct issue from the European gas supplies, as Ukraine has a separate contract relating to gas transit and this contract has always been paid in full and there are no arrears on it. Ukraine legally does not own the gas it transits. In other words, any disruption to supply of gas to Europe via Ukraine can only come from Ukrainian authorities appropriating gas that belongs to other countries. I expect this to be highly unlikely, especially since Ukraine has pumped in gas reserves sufficient to last it through mid-December 2014.
To confirm this, here is the EU Commission position on the issue of security of supply to European customers. 
And Gazprom position on the issue: "Russian gas transit supplies via Ukraine are being delivered in routine mode. The daily gas amount stands at slightly more than 185 million cubic meters. An emergency headquarters started working in Russian energy giant Gazprom, monitoring the situation every day. If Gazprom finds that gas intended for Europe is left in Ukraine, Russia will increase gas supplies via Nord Stream and Yamal-Europe projects, Miller said. The upstream throughput capacity of Ukrainian gas delivery system makes 288 billion cubic meters and the downstream one amounts to 178.5 billion cubic meters. The country’s gas transportation system consists of 72 gas compressor stations, 110 shops and 1,451 gas hubs. The length of gas pipelines makes 38,600 kilometers."

Predictably, Ukraine blames 'terrorists' (aka 'separatists') for today's explosion. Report here. However, not known for its pro-Russian views, Euronews had to acknowledge that "...explosion was far from the violence in east Ukraine..." Never mind, we know Ukraine has no extremists on the other side of the ethnic divide... why, none at all... and none of them would ever want to do any harm to Gazprom lines to Europe... why, never, of course. It is just so slightly inconvenient that Mr Yatsenuk's own backers - Euro Maidan - are on the record saying they are in favour of blowing up pipelines: http://euromaidanpr.wordpress.com/2014/04/13/plan-b-flatten-belgorod/.

Nice touch there ahead of spreading uranium, and shelling Russian cities (the brave folks would obviously expect Russia to not retaliate),

Truth is - we simply do not know who blew up the pipe, and it is unlikely we will ever find out.

15/6/2014: Russia-Ukraine Gas Deal: They Are Where They Were...

So yesterday's (almost/nearly)last-ditch efforts to sort out as deal between Russia and Ukraine ended, predictably, in the same stalemate. The meeting was held in Kyiv/Kiev (or whatever we should call it nowadays). European Energy Commissioner Guenther Oettinger attended, seriously phased by the possibility that Ukraine (no, not Russia) will shut off transit of Russian gas to the EU (note: Russia is not threatening to stop supplies to its non-Ukrainian buyers, so let's dispense with this bit of propaganda).

We do not know if talks will resume today. Gazprom said yesterday that no new date for talks has been fixed, but that can change any time.

So here is where we are:

Last week, Gazprom offered Ukraine exactly the same gas contract terms that were extended to Yanukovych, including the discounts. That's official: President Putin confirmed as much in public. Gazprom agreed to delay gas payments until June 16th to sort out new contract.

The discount advanced to Ukraine was $100 per thousand cubic meters (mcm) and the first price offer was $385 mcm net. Again, this was confirmed by Russian President.

Ukrainian response was that they wanted lower price and they wanted that lower price fixed over a long-term contract. We do not know how long of a fix Ukraine expected (may be, Kiev wanted something similar to Chinese deal - which came at around $350-380 mcm but covers larger volumes and options to increase these volumes further), plus involves a counterpart (China) that never failed to pay on contracts. History of Ukraine-Russia dealings on gas has been checkered at best (see this note which only touches on some top level points relating to 2009 gas deal and more here on 3 years of consecutive violation by Ukraine of the gas purchase contract: here, albeit I do find the 2009 contract to be harsh for Ukraine).

So back to the current saga. $385 mcm is lower than price Poland pays for Russian gas, which comes at a price of around $465 mcm, and is slightly above the price paid by Germany or $370 mcm (though Germany has direct access to Russian-controlled, jointly enveloped Nord Stream pipeline).

Relating to Ukraine's demands/concerns with contract duration, President Putin instructed the Government to develop an option to fix contract terms 'for a certain period' - again, we are unclear as to what duration this period refers to or what duration fix Ukraine wants.

Specifically, president Putin said: “I would like to ask the government and the head of the cabinet to think on how it could be possible at the level of the government of the Russian Federation or upon agreement with the government of Ukraine freeze these terms and make them absolutely guaranteed and free from changes for a certain period…" Ukraine's concern that the $100 mcm discount offered can be unilaterally canceled: “We have never done so. We have always demonstrated that our agreements are reliable to the maximum."

Putin's point makes sense: he offered Ukraine exactly the same terms and conditions for gas pricing as Yanukovich faced prior to Kharkiv Accords. But Kiev has some valid points too - Khrakiv Accords have been annulled by Russia on foot of Crimean crisis (see below). So it's a Russian offer of 'Yanukovich deal, pre-2010' vs Kiev counter 'Yanukovich deal post-2010'.

In response, Ukrainian PM Yatsenyuk claimed that "Russia proposed to reduce the gas price. Still, our stance was and now consists in changing the contract, and not agreeing to a decision made by the Russian government regarding the change of gas price… We are holding short: we change the contract and set a market price. We have paid the market price of $286. We are ready to pay all debts according to this price, and other proposals are unacceptable.”

Where that price of $286 mcm came from is anyone's guess. Until the overthrow of Yanukovich's Government, Kiev paid $268.5 mcm which was a special concessionary price set under the agreement in November 2013 that shelved the Ukraine's association agreement with the EU. In Q2 2014, following Russia non-recognition of the Yatsenyuk Government in Kiev, the agreement was voided and Ukraine was switched back to 2009 agreement on pricing at $385.5 mcm. This is quite reasonable: agreement on $268.5 mcm was based on specific deal struck with Yanukovich and there is no ground, in my view, on which it should translate to a government that was not recognised by Russia. Hence, 2009 deal applied, and $385.5 mcm was legit.

Now onto a tricky bit of the deal. In 2010, under the so-called Kharkiv Accords, Ukraine signed a deal with Russia that suspended $100 mcm export duty from shipments of gas to Ukraine (internal consumption, not transit). This was done in exchange for Ukraine extending the duration of Russian lease on Crimean naval facilities from 2017 to 2042. Note: $100 mcm discount did not reduce the cost of lease paid by Russia to Ukraine, but simply underpinned extension of contract duration.

What happened next is dodgy: on April 2, 2014, President Putin signed a law annulling the Kharkiv Accords. Crimea was no longer a 'leased land' and the $100 mcm discount on export duties was gone. The price of Russian gas shot straight up from $385.5 mcm to $485.5 mcm. My view is that this was wrong.

Following Russia: $385.5 mcm offer and Ukraine's initial counter at $268.5 mcm, Kiev said on Friday that it was ready to pay $326 mcm, but only over an interim period of 18 months - a period it claimed will be required to negotiate a long-term price agreement.

Now things get a bit more convoluted. Per June 11 reports, (see here), Ukrainian Minister of Energy and the Coal Industry Yury Prodan said "Ukraine believed the temporary price for Russian gas could be the mean price of $268-$385 per 1,000 cubic meters of gas until the issue is resolved in the Stockholm International Arbitration Court." Which puts pre-negotiations offer at $326.5 mcm - on-the-dot with second round counter-offer from Ukraine. So the second round offer was there before the first round offer. But to confuse things even more, the $326mcm price was not even Kiev's idea, but the EU's idea: see here.


All around - a big mess...

Per latest:  Sunday talks failed to take place...

14/6/2014: Risk Profile for Russian Economy Shows New Strains

Quick update from my Russia Deck on ECR outlook for Russian economy's risk profile:

Click on the image to enlarge

Worth noting: this performance is not as dramatic as one could have expected given the intensity of the conflict ongoing in Ukraine and the fall-out predicted by many analysts from Crimean crisis and sanctions.

14/6/2014: BlackRock Institute Survey: EMEA, June 2014

BlackRock Investment Institute released its latest Economic Cycle Survey for EMEA region.

Per BI: "With caveat on the depth of country-level responses, which can differ widely, this month’s EMEA Economic Cycle Survey presented a mixed outlook for the region.

The consensus of respondents describe Russia, South Africa, Slovenia, Croatia, and the Ukraine to be in a recessionary state, with an even split of economists gauging Kazakhstan to be a in a recessionary or contraction.

Note: Red dot represents Czech Republic, Hungary, Romania, Israel, Egypt, Poland and Slovakia

Over the next two quarters, the consensus shifts toward expansion for only Kazakhstan.

At the 12 month horizon, the consensus expecting all EMEA countries to strengthen or remain the same with the exception of Israel, Kazakhstan, Slovenia, South Africa and the Ukraine.

Globally, respondents remain positive on the global growth cycle with a net 71% of 41 respondents expecting a strengthening world economy over the next 12 months – an 7% decrease from the net 78% figure last month. The consensus of economists project mid-cycle expansion over the next 6 months for the global economy."


Note: these views reflect opinions of survey respondents, not that of the BlackRock Investment Institute. Also note: cover of countries is relatively uneven, with some countries being assessed by a relatively small number of experts.

21/5/2014: Few Slides Covering Russian Banks

Few slides from my bigger and newer Russia Deck - these covering Russian banks:

 In the above, note the nonperforming loans... Ugly does not even begin to describe Ukrainian situation. Russia's NPLs, however, are benign by comparative to rest of the FSU...

 Summary as is in both above and below...

17/5/2014: Foreign Affairs on the rise of Ukrainian ultra-nationalism

These days, it is rare to see any seriously argued articles about the role of ultra-nationalism on the Kiev-side of the Ukrainian civil war (that's right - it is now a full-blown civil war). But here is a very good article on the subject published in highly reputable and usually highly critical of Russia Foreign Affairs: http://www.foreignaffairs.com/articles/141405/alina-polyakova/on-the-march?sp_mid=45902074

It is objective, in my view, and it is factual. It does not assert that ultra-nationalism has a broad support in public opinion, but it does show that it is gaining ground and is one of the stronger forces behind the political leadership in modern 'Western' Ukraine.

And further:

Read the whole article!

9/5/2014: Latvian Military Report on the Lessons from Russia-Ukraine Crisis

National Defence Academy of Latvia, Center for Security and Strategic Research, recently published a hugely insightful analysts of Russia-Ukraine conflict. The paper, titled "RUSSIA’S NEW GENERATION WARFARE IN UKRAINE: IMPLICATIONS FOR LATVIAN DEFENSE POLICY" (http://www.naa.mil.lv/~/media/NAA/AZPC/Publikacijas/PP%2002-2014.ashx) achieves several things.

Firstly, it outlines step-by-step what appears to be a shift in conflict strategy adopted by Russia. This is summarised in Figure 1 below and in 10 points list on page 6 of the report.

Secondly, it outlines existent weaknesses in Nato's legal framework. In particular, these weaknesses relate to Article 5 clause operationality in the case of modern conflict that involves no formal military presence on Nato territory. De fact, the report acknowledges that Ukraine conflict to-date does not amount to a normal, legally definable war.

Thirdly, Latvian potential response to the second issue above is to attempt to address the existent and severe national imbalances that exist between ethnically Latvian population and population that is Russian-speaking (encompassing many more ethnicities other than Russians). In this, the report de facto acknowledges that there are political, cultural, social and economic disadvantages that are being placed on ethnic minorities in Latvia today.

Fascinating as this is, my focus here in on the report's coverage of the events in the conflict, contained in the first part of the paper. In this:

1) The report clearly shows that Russia's position in the region as a country with natural geopolitical interest toward neutrality and/or alliance with neighbouring states is in direct confrontation to Western European and US ambitious in that region.

2) The report also places Russian geopolitical interests in the region as ethically and legally senior to those of Western Europe and the US.

3) The report clearly identifies a major problem created by the Nato Eastward expansion during the 1990s as a legitimate threat to Russia.

4) The report also shows that Russian acceptance and endorsement of February 21st was a major concession on Russian side and that the February 21 accord was a constructive engagement for all sides concerned that could have led to fundamental change in leadership, reforms and stabilisation in Ukraine. The report clearly puts blame for violation of February 21st agreement at the feet of Maidan leaders.

5) The report clearly states that Yanukovich Government was overthrown under the threat of a coup from Maidan: "…the opposition continued to push for Yanukovitch's resignation. Speaking to the crowd from the stage on Maidan, Volodymir Parasiuk declared that if Yanukovitch did not resign by 10am on 22nd February an armed coup would occur. Police withdrew, leaving government buildings, including the President's residence, unguarded. A new coalition was created in the Ukrainian parliament, with 28 members of its members leaving the pro-Russian Party of Regions' faction."

6) The above quote clearly shows that Yanukovich's flight to Russia was carried out due to security forces withdrawal and direct threat to his life, which makes impeachment proceedings against him (based on the claim that he abandoned the seat of Government for personal reasons) invalid. It also shows that Maidan was the direct source of current interim Government - as opposed to democratic process legitimacy.

7) On Maidan snipers, the report does not endorse the official Kiev position, but gives two theories currently working their way through various media channels: "Snipers started shooting at both protesters and the police, with two versions emerging of what was happening. One, supported by Russia, was that the opposition, backed by Western countries was behind the shootings; the other, was that the snipers were from the Ministry of Internal Affairs and the SBU, acting on Soviet era type plans, with the objective of escalating the conflict, thus justifying an operation to end the protests." The problem is that, as report notes, the second version is not consistent with the outcome: "If this was true, the result was the opposite, since it gave more power to the opposition…"

8) On legitimacy of the Kiev Interim Government: "First, Russia considered Yanukovitch's impeachment to be illegal, therefore the new government was not legitimate. According to the Constitution of Ukraine, the procedure to impeach the President must observe the following procedure: a.) the President is formally charged with a crime; b.) the Constitutional Court reviews the charge; c.) the Parliament votes. The impeachment takes place only if there is a three-fourths majority." The problem is that (a) and (b) were not followed through, as far as I am aware. Crucially, there is a cooling-off period over which the Supreme Court can produce its verdict on validity of impeachment. This also was not followed through, as far as I am aware.

The report does not endorse Russian actions, but it presents the basis for them - calmly and without hysteria and subjective claims that usually accompany these in the media.


The report summarises six reasons why Russia had to act in Crimea [comment is mine]:

"Ukraine always represented a red line for Russia; therefore, it decided to act to preserve its regional interests.

• First, and most important, its military interests. Crimea has been the base of the Russian Black Sea fleet for more than 250 years. An anti-Russian government could cancel the agreement which permits Russia to have military bases there. [This is significant as it is supported by the evidence of past Ukrainian demands relating to naval bases leases and disputes the common claim that Russian bases were not subject to political threats from Kiev. They were and the only way of securing them in March 2014 was to take them over. Alternative was to withdraw from Black Sea bases and face zero presence in the Black Sea arena. Does anyone rationally expects Russia to accept such an outcome?] 
• Second, because it considers Crimea’s becoming a part of Ukraine in 1954 a mistake, since it has always been a part of Russia. [This is not an unreasonable argument from Russian side. But it does present a problem as to the previous international agreements entered into by Russia with respect to Ukraine. Of course, Moscow's response to this is that as long as Ukraine had neutral and legitimate Government, the old treaties applied. Change in the underlying conditions warrants change in treaties status and validity.] 
• Third, to give a clear message to the West that the Ukrainian issue is a real red line and it should remain in the Russian sphere of influence. 
• Fourth, to show that Russia is to be respected and considered to be of a similar stature to the United States. It does not want to be integrated into the West, but to be an independent actor. [And this status of an independent state, in Moscow's view, requires maintenance of deep territorial buffer between Nato and Russia - the buffer that shrunk from 1,600 km distance between Nato territory and St Petersburg - major Russian city - in 1989, to 160 km now] 
• Fifth, to divert public attention from Russia's own internal social and economic problems… 
• Sixth, to make clear that any attempt to split off from the Russian Federation will not be tolerated."

On Crimea operations, the report states that "…although it is true that the number of troops stationed [in Crimea before and during the referendum] increased, this is still within the limits of the bilateral agreement between Russia and Ukraine." The report does not reference legality of the troops actions in Crimea.

The report describes the outcome of the Crimean campaign as follows: "Its success can be measured by the fact that in just three weeks, and without a shot being fired, the morale of the Ukrainian military was broken and all of their 190 bases had surrendered. Instead of relying on a mass deployment of tanks and artillery, the Crimean campaign deployed less than 10,000 assault troops – mostly naval infantry, already stationed in Crimea, backed by a few battalions of airborne troops and Spetsnaz commandos – against 16,000 Ukrainian military personnel. In addition, the heaviest vehicle used was the wheeled BTR-80 armored personal carrier."

In other words, Ukrainian forces were not outnumbered by Russian forces. Nor were they overpowered. Instead, someone should ask serious questions as to whether lack of legitimacy and/or leadership from Kiev led to the situation where 16,000 Ukrainian troops in Crimea were simply unable/unwilling to engage 10,000 Russian troops and pro-Russian militias.

6/5/2014: BlackRock Institute Survey: EMEA, April

BlackRock Institute published their April 2014 survey of economic conditions in EMEA region. Here are some takeaways:

1. "The consensus of respondents describe Russia, Slovenia, Croatia, Turkey and Turkey to be in a recessionary state, with an even split of economists gauging Kazakhstan and Egypt to be a in a recessionary or contraction."
2. "Over the next two quarters, the consensus shifts toward expansion for only Egypt."
3. "At the 12 month horizon, the consensus expecting all EMEA countries to strengthen or remain the same with the exception of Slovenia, Turkey, Russia and the Ukraine."

Russian economy specifics:

• "How do you think Russia's economy will develop over the next 12 months?" 72% of respondents expect economy to become weaker or a lot weaker
• "At this time, in which phase of the economic cycle would you say Russia's economy is?" 100% of respondents estimate that the Russian economy is currently in a recession.
• "Over the next 6 months, in which phase of the economic cycle would you say Russia's economy will be?" 86% of respondents expect Russian economy to remain in a recession.
• 57% of respondents estimate that currently Russian economy is operating with a positive or zero output gap.
• 71% of respondents estimate that currently Russian economy operates at above trend inflation that is increasing.

"Globally, respondents remain positive on the global growth cycle with a net 78% of 40 respondents expecting a  strengthening world economy over the next 12 months – an 9% decrease from the net 87% figure last month. The consensus of economists project mid-cycle expansion over the next 6 months for the global economy."

Note: Red dot represents South Africa, Czech Republic, Hungary, Romania, Israel, Poland and Slovakia.

Note: these views reflect opinions of survey respondents, not that of the BlackRock Investment Institute. Also note: cover of countries is relatively uneven, with some countries being assessed by a relatively small number of experts

2/5/2014: Ethnic Russians in Ukraine are Centuries-Old, Not Decades-Deep...

As someone just remarked on twitter, the proverbial sh*t just got real in Ukraine. And mightily it did - Ukrainian authorities report 31 dead in clashes in largely Russian-speaking Odessa. Other sources report 'dozens killed' - e.g. http://www.bbc.com/news/world-europe-27259620.

Here are two stills from the live broadcast by a Ukrainian channel of events in Odessa, showing the civilian firetruck being used by the pro-Kiev forces to attempt to break through opposition barricades. The broadcast showed personnel with what appeared to be field helmets on hiding under the cover of the truck.

Odessa is a serious flash point for three major reasons:

1. It is largely Russian-speaking and highly ethnically diverse. The city has a very old Jewish diaspora (greatly reduced by the nazis during the WWII) and of its large (1 million) population, roughly 60% are ethnic Ukrainians, followed by 29% of Russians. It also has Armenian, Albanian, Azeri, Crimean Tatar, Bulgarian, Romanian etc diasporas. Even a Greek diaspora. The city is very much reflective of the current ethnic tensions - although majority of population is not ethnically Russian, main spoken language remains Russian, despite the language not being recognised as official. Historically, like most of Eastern Ukraine, Odessa was Russian - it was Russian in the 19th century when the city was the fourth largest in the Russian empire after Moscow, St Petersburg and Warsaw. Crucially to its history, Odessa was Russian ethnically all the way until mid 20th century. Notice that this is a direct contradiction to the extreme nationalist views being propagated in Ukraine that Russian population of Eastern and Southern Ukraine represented 'new colonisers' who arrived there after Stalin-induced Soviet Union-wide famine of the 1920s.
2. Odessa is culturally and strategically aligned with Crimea (via sea linkages) and its Oblast borders Transnistria region of Moldova.

The push point in the conflict is, in my view, moving closer and closer to an open confrontation between Russia and Ukraine. 

And here is a voting map from the last elections, showing just how closely the South-Western Ukrainian area - including Odessa region - is aligned with the Eastern Ukraine:

Here is a handy map showing movements of Russian and Ukrainian troops (http://www.washingtonpost.com/blogs/worldviews/wp/2014/05/02/map-how-ukraine-and-russia-are-moving-toward-war/):

How did the Russians get into Ukraine, you might ask? Well, here is a handy guide (see note below):

• Eastern Ukraine was added to Russian Empire in 1654-1667 with western border defined by River Dniper. These parts were first incorporated into the Ukrainian territories in 1919-1920 and then in 1922 Treaty that created the USSR. Here are the lands lost in the Polish War by Polish-Lithuanian Commonwealth and gained by Ukraine via Russia: http://en.wikipedia.org/wiki/File:Polish-Lithuanian_Commonwealth_1635.svg
• Today's Western Ukraine was formed during one of the subsequent three partitions of Poland: http://en.wikipedia.org/wiki/File:Rzeczpospolita_Rozbi which also added significantly to the Ukrainian territories claimed today.
• In 1783 Russia added Crimea and other parts of Tatar Crimean khanite, including Odessa.
• Irony has it, as http://www.britannica.com/EBchecked/topic/612921/Ukraine/30071/Ukraine-under-direct-imperial-Russian-rule points, it was Russian imperial control that allowed Ukrainians to settle into Crimea and Southern Ukrainian territories. 
• After WW2, Soviet Union largely expanded Ukrainian territory adding over 65,000 square miles and 11 million population (an increase of over 1/3 on pre-war period. The main expansion took place along the Curzon Line at the expense of Poland, Romania, Czechoslovakia.
• Lastly, in February 1954, Russian Republic (RSFSR) 'gifted' Crimea to the Ukraine - from legally Russian territory (sub-part of the USSR). Only 22% of Crimean population at the time was Ukrainian (the rest were Tatars, other ethnic minorities and those, who Kiev supporters today frequently call post-genocide occupants of Ukraine coming from Russia, but in reality are Russian ethnicity residents of Crimea and Eastern Ukraine since 17th century).

Here is a summary map of what shaped the territory of the Ukraine prior to 2014:

These changes in the territories clearly indicate that ethnically Russian population is not a phenomena of colonisation post 1922 famine, but an outcome of centuries old movements of people with changes and reshaping of national, political, economic and cultural boundaries.

In my view, nationalist Kiev position resisting the initiation of the democratic process on federalisation of Ukraine is not sustainable. Ukraine now has to move fast into securing a roadmap to

1. Orderly elections in May (the timing is unfortunate, but the commitment is irreversible); 
2. Followed by pre-committed regional referenda on membership in the Ukrainian Federation (respecting any region that votes to exit); and
3. Pre-committed process of democratic federalisation post exits of the secessionist regions.

I would have preferred to see Ukraine remain fully unified, territorially unaltered state with greater autonomy extended to the regions that wish to have it. I think that such Ukraine was possible under February 21st agreement, violated by the Maidan forces and by the current leadership in Kiev.

Alas, with every day passing, this hope of a unified Ukraine is becoming less and less feasible in the longer run and Kiev's insistence on avoiding orderly, democratic federalisation now threatens to lead to a civil war in the short run.

I hope I am wrong in this assessment...

Note: I do not care to make any of the above points to justify territorial break up of Ukraine. I never supported such a break-up in the first place. I am, however, interested in pointing out that nationalist rhetoric treating ethnic Russians (or any other ethnic group living in Ukraine) as being 'foreign' presence in the country is absurd, vile and does not contribute to the cause of unifying Ukraine and helping it preserve its own territorial integrity.

And, I am no less concerned about emerging Russian nationalism - not only in Ukraine, but also in Russia proper. This, however, is a matter for separate posts, maybe in some near future.

27/4/2014: Ukraine-Slovakia Agreement on Reversed Shipments of Gas

Per today's reports (see: http://www.rosbalt.ru/main/2014/04/27/1262169.html), Ukraine reached an agreement with Slovakia for reverse-delivery of natural gas via Vojany-Uzhgorod pipeline. Shipments can start in October with maximum delivery of 3 billion cubic meters per annum, and from March 2015 the capacity can be raised to 10 billion cubic meters per annum.

As the article notes, from April 2, Russian President Vladimir Putin signed the decree annulling Kharkiv agreements that provided a discount on gas price for delivery to Ukraine of USD100 per 1,000 cubic meters, so starting from Q2 2014 Ukraine delivery is priced at USD385.5 per 1,000 cubic meters from USD268.5

Following this, on April 3, head of Gasprom Aleksey Miller said that taking into the account arrears on past gas deliveries, Ukraine gas deliveries will be priced at USD485 per 1,000 cubic meters.

Here is my earlier note on Ukrainian arrears relating to Russian gas deliveries and Ukrainian Government debt held by Russia: http://trueeconomics.blogspot.ie/2014/04/1042014-game-of-chicken-ukraine-debts.html.

22/4/2014: On Irish Taxes, Quangos, Trade and other recent links

Some interesting links from recent media reports:

1. Apparently, completely unpredictably, unexpectedly, shockingly abruptly etc etc etc... but Ireland-based MNCs are allegedly concerned with the OECD (aka G7-G20 prompted, EU-supported) efforts to reforms international tax systems to close off the more egregious loopholes in corporate taxation: http://www.independent.ie/business/world/major-companies-concerned-over-oecds-plans-for-global-tax-reform-30202748.html Now, with the IBEC, DofF, and everyone else in irish Officialdom repeatedly declaring that our tax regime is above the water and thus not in the firing line, one must wonder just why are these companies concerned with the OECD moves?
2. On a related note, I just posted a new paper I wrote for the Cayman Financial Review on the above topic - see link here: http://papers.ssrn.com/sol3/papers.cfm?abstract_id=2427359
3. Unrelated to taxation issues, but related to fiscal policies of the Irish state, a note from the Irish Times on Government's heroic struggle with one electoral objective they set before 2011 GE: the objective of rationalising the massive spread of quangoes in Irish public policy ecosystem: http://www.irishtimes.com/news/politics/coalition-s-quango-cull-falls-well-short-of-promises-1.1768500. Core facts pointed out in the article are: The Government promised to abolish 100-145 quangoes right before it came to power in Q1 2011. Three years later, 45 have been either abolished or planned for abolition, of which only 20 are likely to be completely shut by the next GE in Q1 2016 net of new created. To-date, only 28 bodies have been abolished, 17 more are set to be culled in the remaining tenure. And 33 new agencies have been created or planned for creation. Net impact: of 732 quangoes in existence in mid-2012, we are likely to have 720 quangoes in existence in mid-2016. 
   
4. Now, recall that we are being repeatedly told that life outside the Euro for Ireland means kissing good bye our wonderful exporting capabilities. Here is a chart showing current account balance for Ireland and Germany (two star performers in the euro area in terms of trade) as contrasted by Denmark (a non-euro country that should be suffering from the trade deprivation due to its absence from the euro club). It turns out Denmark consistently outperforms Ireland in terms of current account surplus... So next time one of the Government parties' candidates start talking about Ireland's alleged benefits from the euro membership, do suggest they should take a trip to Denmark...
   
5. An absolutely brilliant short summary of Economics as a field of inquiry in 297 words by Professor Thomas Sargent http://www.vox.com/2014/4/19/5631654/this-graduation-speech-teaches-you-everything-you-need-to-know-about It is superb.
6. On artsy side of things, a stunning and powerfully original statement from China for Milan Expo 2015: http://www.dezeen.com/2014/04/01/china-pavilion-expo-milano-2015/ 
   
7. A set of excellent, insightful essays and articles on Ukrainian crisis or more significantly - on Russia's position vis-a-vis the West: http://www.reuters.com/article/2014/04/18/us-ukraine-putin-diplomacy-special-repor-idUSBREA3H0OQ20140418 and http://www.foreignaffairs.com/articles/141018/mitchell-a-orenstein/get-ready-for-a-russo-german-europe and http://euobserver.com/foreign/123879

18/4/2014: Ukraine's Trade Flows in One Inforgraphic

Via Bloomberg - a neat summary of Ukraine's external bilateral trade flows:

Which, of course, shows just how feeble are all the claims about the 'replaceability' of Russian markets for Ukrainian economy. When you take out the Customs Union's total flows of USD 15.71 billion, the entire EU trade flows (for top 20 countries) amount to USD 10.99 billion and these include revenues earned from transit of Russian gas and resales of Russian gas, oil and petrochemical products too. So yes, yes, y.e.s... folks - Russia is obviously a problem for Ukraine's economy and Brussels is obviously a solution... unless you dust out a calculator and tally things up...

16/4/2014: Tearing Up Ukraine Well Before Crimea

Per Foreign Affairs (hardly a pro-Russian platform): two maps of two consecutive Governments in Ukraine showing the drivers of national rifts between Western and Eastern Ukraine:

Yanukovich Presidency (last Government Cabinet)

Maidan (Yatsenyuk Government Cabinet)

I don't see Russian tanks in either of them. But I do see venal incompetence and nationalist preferences in both that are intrinsic to two, allegedly, different Governments.

As I noted before, Ukraine needs a Government of National Unity, not a pro- or anti- Moscow/Maidan/EU/Nato/US/China/Japan/UN/IMF/... Government.

10/4/2014: Game of Chicken: Ukraine-Debts-Russia-Gas-Europe...

What's the story about Ukraine's gas debts? Here are some facts as reported by the Russian Minister for Energy Aleksander Novak and Gasprom's Deputy Chairman of the Board Vitaliy Markelov yesterday, with data as of April 9:

• Total Ukrainian arrears on gas amount to USD2.238 bn which is approximately USD830 million above the levels at the end of December 2013. This relates to sales of gas prior to price increases.
• To cover winter demand, Ukraine needs reserves of 18 billion cubic meters of gas, with current shortfall at around 11.5 billion. Shortfall value at current prices is between USD4 and 5 billion, depending on timing of purchases.
• Contracts for gas deliveries include a clause allowing Russia to demand pre-payment for purchases. Prime Minister, Dmitriy Medvedev stated that Russian side now has full basis for switching to pre-payments system, as Ukraine failed to cover imports of gas for March. President Putin adopted a delay in triggering pre-payment conditions. In response, as reported by Minister for Foreign Affairs, Lavrov, Ukraine notified Russia that imports of Russian gas will be paid for on the basis of Ukrainian-own prices. In addition, Ukraine's Minister for Energy and Coal Industry, Yuri Prodan threatened to interrupt transit of Russian gas to European customers.
• According to Prime Minister Medvedev, total Ukraine's debt owed to Russia is at USD16.6 billion. This comprises: USD2.2 debt on gas imports, USD11.4 billion general debt and USD3 billion in 2013 euro bonds. Minister for Finance, Anton Siluyanov also reported that Ukraine requested from Russian Government to aid in purchasing another USD3 billion tranche of eurobonds.
• Russia also confirmed that there have been no interruptions in Russian imports from Ukraine and there are no arrears or late payments on shipments from Ukraine which amount to around USD15 billion.
• Russia agreed to a tri-party negotiations on gas exports to Ukraine and transit issues, including Ukraine, EU and Russia, but refused to allow the US to participate in negotiations directly.

So we are down to the 'Game of Chicken' and Russia is quite confident it can manage any head-on collision. 

3/4/3014: Latest Country Risk Updates: April 2014

Latest updates to ECR Euromoney Country Risk scores (higher score implies lower risk):

Two notable sets of changes:

1. Russia and Ukraine scores continue to fall, with Ukraine still leading Russia
2. Euro area 'periphery' scores continue to rise, with Portugal and Ireland showing biggest improvements.

27/3/2014: Troika of Sorts for Ukraine: IMF's chip are on the table

IMF announced the agreement to provide USD14-18 billion in Stand-by Arrangement with Ukraine.

This is a 'troika'-like arrangement:

• 2 year stand-by line of credit
• Total package of USD27 billion
• IMF share of the package USD14-18 billion
• Main funding vis bi-lateral and multilateral agreements
• Presumably multi-lateral will envolve EU
• Bilateral packages are for US and possibly Russia

Macro analysis:

“Ukraine’s macroeconomic imbalances became unsustainable over the past year. The (until recently) pegged and overvalued exchange rate drove the current account deficit to over 9 percent of GDP, and a lack of competitiveness led to the stagnation of exports and GDP. With significant external payments and limited access to international debt markets, international reserves fell to a critically low level of two month of import in early 2014. The 2013 fiscal deficit was 4½ percent of GDP, and the government accumulated sizeable expenditure arrears. The 2013 deficit of the state-owned gas company Naftogaz reached nearly 2 percent of GDP, driven by the sharp increase in sales at below-cost prices. Without policy action, the combined budget/Naftogaz deficit would widen to over 10 percent of GDP in 2014."

So in other words, 2013 combined deficit was around 6.5% of GDP, but 2014 deficit - following 'some stabilisation' (see below) is to reach 10% of GDP. I wonder why?.. Is it down to expected price increases on gas and oil? Or is it down to the havoc wrecked by Maidan protesters? It is certainly not down to the Crimean crisis, since removal of Crimea off Kiev's books should save the Ukrainian Government money.


“Following the intense economic and political turbulence of recent months, Ukraine has achieved some stability, but faces difficult challenges. To safeguard reserves and address currency overvaluation, the National Bank of Ukraine (NBU) floated the exchange rate in February. Measures implemented in February and March helped stabilize financial markets and ensured that critical budget payments have been met. Nonetheless, the economic outlook remains difficult, with the economy falling back into recession. With no current market access, large foreign debt repayments loom in 2014-15."

Now, key question here is why is Government deficit rising if currency is being devalued? Especially as official debt levels in the Ukraine are relatively low? Is it because Ukraine running huge current account deficit (even with subsidised prices for Russian gas)?


"Monetary policy will target domestic price stability while maintaining a flexible exchange rate. This will help eliminate external imbalances, improve competitiveness, support exports and growth, and facilitate the gradual rebuilding of international reserves.  The NBU plans to introduce an inflation targeting framework over the next twelve months to firmly anchor inflation expectations."

This is pure nonsense. Devaluation is bound to drive inflation up. Rebuilding economy will require lower interest rates, which will further support high inflation. What on earth can NBU do to set price stability as its objective? Dollarise the economy? Tried and failed in the form of pegs, and given the role of Maidan (populist movement) how can vast amount of pain be inflicted on the economy to drive price inflation to reasonable bounds?


"Financial sector reforms will focus on: (i) ensuring that banks are sound, liquid, and well-capitalized; (ii)  upgrading the regulatory and supervisory framework of the NBU, including complying with international best practice and supervision on a consolidated basis,  and (iii) facilitating resolution of non-performing loans in the banking sector."

The above reads like a Cyprus-Greece scenario. Good luck finding Russian oligarchs to hit with a deposit tax.


"The initial stabilization in 2014 will be achieved through a mix of revenue and expenditure measures. For 2015-16, the program envisions a gradual expenditure-led fiscal adjustment—proceeding at a pace commensurate with the speed of economic recovery and protecting the vulnerable—aiming to reduce the fiscal deficit to around 2½ percent of GDP by 2016."

Yes, I know… it is… austerity. Higher taxes, lower spending, followed by lofty lower spending and lower spending. I think we shall recall that the current Government has been installed into place by the populist uprising.


"A key step is the commitment to step by step energy reform to move retail gas and heating tariffs to full cost recovery, along with early action towards that goal."

Read: 40% hike in domestic gas prices is only the beginning.


In conclusion, IMF release focuses on real issues - institutional deficits in terms of governance, corruption, procurement, transparency. All are laudable and much needed.

The key takeaways:

1. The entire package is still up in the air as to bilateral and multilateral funding - sources, costs, etc;
2. The package still needs engagement from Russia - majority of the above fiscal measures will require serious pain to be imposed and this pain can be ameliorated by Russia restructuring Ukraine's debts and providing some transitioning assistance on energy front, as well as continuing to give Ukrainian firms access to its markets;
3. The package is cheap from IMF's point of view (small outlays over short term) but is heavy on Ukrainian reforms side (needed, but how feasible in the current political environment?);
4. This is not a Marshall Plan I called for - it lacks clarity on the final cost of funding (which should be close to zero) and it lacks maturity span (which should be 20 years or so);
5. Overall, the reforms sketched out above are likely to lead to another Orange/Maidan Revolution in few years time and the funding that backs them is unlikely to provide support for political stabilisation.

Let's wait for more details on the above points.




Details here (click on individual image to enlarge):

26/3/2014: Comment on Russia: Expresso, March 22

My comment to Portugal's Expresso on Russian economy:

22/3/2014: Russian Capital Flight and Current Account: Crimea's Punch

While sanctions against Russia have been pretty much anodyne to-date in direct economic impact terms, there are indirect effects worth considering that are worrying from the economy's perspective. Some of these are boiling down to capital flight vs inflows of funds from external balance of trade.

Chart below sets the stage through Q4 2013:

While we do not have full Q1 2014 data in what we do know is that outflow of capital has accelerated on Ukraine/Crimea news. Here's one report putting full year 2014 estimates at USD130bn so far, double 2013 recorded official outflows: http://www.themoscowtimes.com/business/article/goldman-puts-2014-capital-flight-at-130bln/496228.html. And the Central Bank has so far promised not to impose controls on outflows: http://www.reuters.com/article/2014/03/18/us-ukraine-crisis-capital-idUSBREA2H0NH20140318.

On the current account side, so far, there should be little impact. Gas flows to Europe not only remained un-impacted by the Crimean crisis, but through March 10th, these actually averaged a rise month-on-month, from around 440 thousand cubic meters per day in 2013 to around 476-477 thousand cubic meters. But the problem is that much of shipments via Ukraine is currently accumulating in the arrears account, which is hard to close in the environment of a crisis. Should Ukraine default on payments to Russia or delay these significantly, the current account side of the above funds flows will be hammered. In 2013 alone, absent the standoff in Crimea, Ukraine's unpaid arrears to Gasprom stood at USD3.3 billion. This was partially covered by a payment of USD1.28 billion made on February 14th, with current arrears of USD1.99 billion still outstanding for the balance on 2013, plus January-February 2014.

The overall arrears on Naftogaz (Ukraine's state gas imports agency) are a problem and are likely to feature in the IMF funding deal to be struck before the end of this month. Whether or not the IMF forces Ukraine to default (partially or fully) on its gas imports-related arrears is unknown, but there is some possibility this might happen.

However, as is (above chart), since 2013, Russian current account surplus already no longer covers capital outflows, which explains much of the rouble weakness in 2013 and ongoing weakness in 2014.

So what is the possible impact of the risks to gas and oil trade from Russia on Russian economy? Here are some points:

1. Gas is far less important to Russian Government revenues than oil: Gas accounts for just around 20-22% of budget revenues. Russian Federal Budget is balanced at oil price of USD115/bbl, which is falling as rouble depreciates, and now probably set around USD110/bbl.
2. Balance of payments is under a greater threat from Ukraine crisis: gas accounts for 14% of Russian exports against 50% for oil and petroleum products.
3. Russia's oil exports are only about 8% exposed to Ukraine's transit (Druzhba pipeline) and shipments are declining (2013 transit of 15.6 million tonnes against 2014 planned transit of 15 million tonnes).

Mitigating factor to all of this is the South Stream pipeline which is scheduled to ship 63 bcm of gas cutting Russian exports transit dependence on Ukraine to roughly 50 bcm and is set to become operative around 2015.

Either way, the problem for Russia in the short term is capital flight. If Estimated losses of capital in Q1 2014 are to run at USD60-70 billion (note: Capital Economics forecasts the latter figure), given stagnant or declining current account surplus, monetary authorities have three tools at their disposal:

• Allow further devaluation of the rouble (chart below shows why that is unlikely to provide much of a cushion, given already massive devaluation to-date)
• Raise rates (current rates already biting hard into economy, with further uplifts risking to push economy into a recession)
• Capital controls (politically hard thing to swallow in the current investment environment: see second chart below) 

Which means that all three measures will be tried, with primary emphasis on devaluation. This in turn means that the investment case for Russia is still weak, despite a significant fall-off in equity valuations. Bottom fishing is some time off for investors.

20/3/2014: Latest Changes to Country Risk Ratings for Ukraine & Russia

Big drop in country risk scores for Ukraine and Russia today via @euromoney ECR :

Note: higher score implies lower risk.

Here is Ukraine's performance over time and comparative to ECE:

Note that current score is 30.43, lower than in the above chart.

And here is Russia's performance:

You can see the vast gap between two countries in terms of overall scores. Russia is running (still, even with latest decline) close to the world average and well ahead of regional average, while Ukraine clearly under-performs world and regional averages.

18/3/2014: Crimea's Fate Sealed, It's Time for Risk-on on Russia

Key takeaways on today's news from Crimea, so far:

• Crimea is now fully legally incorporated into the Russian Federation and this makes the region's split from Ukraine and accession to Russia irrevocable, no matter what sanctions are being put forward.
• President Putin's address to joint meeting of Russian Duma and Federation Council raised a number of very strong geopolitical points. The main one being the role played by the Nato expansion over the last 20 years in triggering the latest crisis. Despite this, President Putin clearly extended a proverbial olive branch to Nato and positioned this offer of continued cooperation on the shared interests footing (mutual respect and coexistence with recognition of the legitimacy of Russian 'Near Abroad' sphere of influence).
• The Crimean crisis was from the start largely a Russia-Ukraine issue. Thus, Western engagement in it became excessively overbearing on the one hand (starting with the EU pushing forward its own Neighbourhood policies toward Ukraine without having any respect for or consideration of the country's massive economic, demographic, cultural and political links with Russia and without engaging constructively with Russia on bilateral basis) and strategically weak and indecisive on the other (with EU offering no constructive platform for a dialogue with either Ukraine or Russia since November 2013).
• Overall, President Putin's speech was yet another signal to the West that he is ready to consider more constructive engagement and dialogue, and that Russia is not interested in any serious acceleration in the confrontation. The latter point was very clear from the onset of the Ukrainian crisis, not just during the Crimean crisis.
• President Putin is correct that the Crimean crisis was resolved without any loss of life, in contrast to Bosnia, Kosovo, etc.
• Putin's speech, by bringing Russia back on track to seek normalisation of its ties with Ukraine and the West, means that Europe and the US are once again being left without any visible strategic alternatives and puts Moscow one step ahead of them in this geopolitical game. Effectively, the US is now firmly stuck in the proverbial corner: it cannot de-escalate vis-a-vis Russia and it cannot accelerate current sanctions to anything more meaningful. Instead, it is now more likely the US will focus its resources on trying to salvage the current Government in Kiev.

Most significantly, Putin can now set out a number of contrasting and legitimising points to the accession of Crimea:

1. The referendum on Sunday stands in stark contrast to the lack of referenda when Crimea was 'gifted' to Ukraine in 1954 and when Ukraine and Russia (alongside with Belorussia) agreed to dissolve the USSR back in 1991.
2. Crimean accession was carried out on the request of the Crimean government that had effectively no less legitimacy than Kiev government has today. It was created on foot of a popular revolt by the democratically-elected parliament (although in the case of Crimea, as far as I am aware, opposition was present at the vote, unlike in the case of Ukraine).
3. Officially (and that is not to say that this is a complete truth, which we may know one day) Russian military presence in Crimea did not exceed the contractually allowed 22,000 troops. Hence, technically, there was no violation of sovereignty. There was no opposition from the Ukrainian army, further confirming the above point (even if this lack of opposition was driven by the confusing orders from Kiev). The role played by militias (subject to the first caveat above) is no different from the role Maidan forces played in Kiev... etc, etc… All of which (not to justify the events that took place) goes to confirm that there is very little difference (at this point in time) between what happened in Crimea and what happened in Kiev.
4. Whilst Ukrainian constitution does not recognise secession referenda held in a single region as valid, it is worth reminding that the same legal reasons for rejecting the Crimean independence were also raised in the event of secession of Ukraine (and Russian and Belorussia) from the USSR in 1991. It is, therefore, kind of hard for Kiev to have the old the cake and still keep it at the same time.

So today's news put the score at Russia 2: West 0. And with it, Russian markets should be shifting into a 'risk-on' mode over the near future.


Note: as I said before, my preference was and remains for the territorial integrity of Ukraine to remain intact. But setting aside my own preferences (and controlling in the above arguments for my imperfect knowledge of the events and facts on the ground), the current outcome is a new status quo. There is absolutely nothing anyone can or should do about it.