Oil Still Calls the Shots

Oil prices, which have rebounded to the level of $70 per barrel from an average of $49 per barrel in the first half of 2009, have once again made us reconsider the assumption that Russia is purely an oil play. Despite the price rise, the country has not been able to show any signs of macroeconomic recovery in 2009. Furthermore, May’s minus 11 percent year-on-year GDP estimate by the Finance Ministry suggests the economy is still on a recessionary slope.

However, our analysis suggests the price change on oil is still a dominant factor in determining Russian economic performance — in the past decade, rising oil prices contributed to 55 percent of the total growth of the GDP. According to a model that we used, each 1 percent change in oil prices leads to a 0.1 percent change in economic growth the same year and 0.2 percent growth cumulatively over the next six years. This implicitly means that an increase in oil prices will certainly lead to some recovery — but with a lag caused by the process of redistributing oil revenues through the oil & gas sector and, most importantly, the budget, for which these revenues may comprise around 40-50 percent of total revenues in the mid-term.

With 90 percent of oil revenues above the price of $25 per barrel being taxed away by the state, it is in fact the recipients of the budget funds that are the main beneficiaries of oil price growth. The state plays a major role in the economy, employing and indirectly supporting over 60 percent of the total population (public servants, pensioners and children), financing 32 percent of total fixed capital investments from the consolidated budget, and consuming a huge share of goods and services produced (17 percent of GDP in 2008). The oil and gas sector is more of a donor under this taxation system. Although we acknowledge that the state may take a more differentiated approach to taxing the oil and gas sector, we do not believe in a dramatic reduction of tax burden due to a tough fiscal situation and very probable sustained budget deficit in the coming decade.

Thus, paradoxically, it is not the oil and gas sector that reaps the most benefits from oil price growth, but the sectors oriented on domestic consumers and servicing the government, such as consumption itself (both production and trade), infrastructure and materials, which may be best exposed as they benefit both from increasing government demand and increased export revenues, with which commodity prices are tightly correlated.

From the viewpoint of equity markets, we recommend playing this through either high market beta stocks (oil price movement describes 82 percent of MSCI Russia performance), or through stocks with high correlation to oil prices. Our analysis shows that materials stocks (such as Uralkali, Evraz, Severstal, Norilsk Nickel, and MMK) are even more sensitive to oil prices than the oil and gas stocks themselves. Among consumer sector high beta/high oil correlation picks we highlight Sollers, AvtoVAZ, Sberbank and X5, while in the oil and gas universe those would be Tatneft, Gazprom, Novatek and Rosneft.