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. Last Updated: 07/27/2016

Spread-Eagled on an Oil Rig

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The current government discourse on Russia's relations with OPEC is reminiscent of the imperial double eagle, with each head spouting something in total contradiction with what its contralateral twin is saying; much of the analytical writing on this subject is tending toward the surreal.

First things first. As any half-bright 11-year-old knows, the Russian economy is heavily dependent upon hydrocarbons: Two-thirds of all exports, a huge chunk of government revenues, and essentially all the cash in the local economy come from the sale of oil and gas. While I have long argued against the prevailing belief that Russia's impressive recovery from the '98 crash is solely a function of strong oil prices, it is nevertheless patently obvious that hydrocarbon prices have provided a huge boost. Optimistically, the one thing differentiating Russia from the modern industrial economies is a good 10 years of development and at least $500 billion in investment, and oil and gas exports are the one obvious source. To gratuitously imperil this huge potential cash flow in return for a pat on the head from the industrialized countries and the dubious pleasure of watching OPEC squirm would be patent madness.

Various chest-thumping politicos have asserted that OPEC countries have the most to lose, since oil is their sole resource (as opposed to Russia, where it is merely the major one). How unfortunate, then, that Saudi misery is not a bankable commodity for Russia! Before embarking on a "Mexican standoff," hoping that your opponent will back away first, it behooves you to first ascertain that his back is not already up against the wall. The OPEC countries simply do not have the option of giving in and cutting production alone; to do so would only impoverish them further, as non-OPEC countries would quickly pump more oil to compensate. Moral issues aside, it is simply unrealistic for Russia to expect to be allowed to free ride forever. The notion that Russia can simply pretend to cut and OPEC will fail to notice is amusingly naive. Russia will need to play fair.

It has been argued that, were Russian oil companies to cut back their investment programs, capital expenditure and economic growth would come to a grinding halt, while company valuations would suffer substantial damage. These fears seem seriously misguided: Planned investment in optimizing existing fields could simply be channeled toward development of new oil properties with a longer payback period. Furthermore, outside the oil sector, Russia certainly suffers no dearth of investment opportunities, mostly awaiting the rebirth of a banking system and a more predictable legal framework. Given the immense capital required to rebuild the Russian physical and social infrastructure over the coming decade, as well as the fact that foreign investors are not quite beating down the doors of Russian manufacturers, any restructuring will depend upon cash from oil exports. As for company valuations, it is not intuitively obvious that a company producing 100 barrels at $15 is more valuable than one producing 95 barrels at $25.

Andrei Illarionov has argued that a collapse in oil prices would actually be good for Russia, since it would prevent the "Dutch disease," i.e. dollar inflows from oil exports causing overvaluation of the currency, thus squeezing out local manufacturers. Theoretically, this could be a danger at prices above $30 per barrel. However, as the ruble exchange rate is blatantly and openly manipulated by the Central Bank, we would first like to see the Central Bank trying to push it down, not up. Nothing suggests that a drop in oil prices below $10 would magically lead to world-class manufacturing facilities springing up in the tundra, and Illarionov's fears that Russia would sicken of the Dutch disease apparently lead him to prefer to see the patient die of malnutrition -- provided, that is, that he dies in perfect health.

A deal will be reached. Anyone who had the pleasure of watching Mikhail Kasyanov negotiate the London Club deal will remember the initial threats of default and devastation -- the financial equivalent of mutual nuclear annihilation -- followed shortly thereafter by a more sharing-and-caring stance, facilitating the final deal. The days of Russia's superpower arrogance are past. President Vladimir Putin is wondrously aware of the limits of Russian power, and the long road that lies ahead. Provided that Russia cooperates with the other oil producers, the breathtaking resurgence of Russia's economy is set to continue -- 2002 promises an embarrassment of riches.

Eric Kraus is an economic strategist in Moscow. He contributed this comment to The Moscow Times.