Russia seen hunkering down for $40 oil

MOSCOW (Bloomberg) -- Perhaps the Bank of Russia knows something the world doesn’t. As the Organization of Petroleum Exporting Countries and its allies prepare to meet for a review of their production cuts this weekend, the central bank of the world’s biggest energy exporter is hunkering down for years of oil near $40/bbl.

While analysts in a Bloomberg survey see the price of benchmark Brent crude -- which trades at a small premium to Russia’s Urals export blend -- rising 16% from current levels by the end of the year, oil’s 10% decline in March alone amid supply woes is making the market nervous. Russia, a key partner in the deal and a participant in the talks in Kuwait, might only add to those jitters.

“The Finance Ministry, the cabinet and the central bank are leaning on the cautious side in terms of their expectations regarding growth, driven still to a large degree by oil,” said Piotr Matys, an emerging-market currency strategist at Rabobank in London. “It’s better to be conservative and to be surprised on the upside than too optimistic and end up disappointed.”

Policy makers in Moscow said on Friday they see Urals at an average of $50/bbl this year, but falling to $40 at end-2017 and then staying near that level in 2018-2019. As the central bank honed its forecasts, it also gingerly resumed monetary easing, pointing to the “uncertainty” in the oil market as a factor for its “conservative” forecasts.

Russia’s Finance Ministry similarly highlighted the $40 level in January when it announced that the central bank will start buying foreign currency on its behalf when crude exceeds that level in order to insulate the exchange rate from oil volatility. The price of $40 is additionally being used to calculate the country’s budget in 2017-2019.

'Upside surprises'

Even as oil has recovered, Russia’s tendency to stick with the more conservative scenario is “positive” as it “leaves room for upside surprises,” according to Viktor Szabo, a bond fund manager at Aberdeen Asset Management Plc.

Forecasting oil is no game for the Bank of Russia. Its 65% plunge in 2014 and 2015 battered the nation’s currency, forced an emergency rate increase in the middle of the night and pushed Russia into recession. The share of oil and gas revenue was at 36% of budget income in 2016.

Even as the historic OPEC supply-cut deal helped halt oil’s collapse, pushing it up to $55/bbl and setting the stage for Russia’s economic recovery, the central bank is taking nothing for granted.

The correlation between the ruble and oil has declined this year, falling to the lowest since August 2015, according to data compiled by Bloomberg. As crude slid below $50/bbl this week, the Russian currency barely budged, weakening less than 1%, because its carry-trade appeal largely offset the dimming outlook for energy.

While OPEC won’t formally decide until May whether to prolong the deal, which lasts through June, officials will meet this weekend in Kuwait to discuss its progress. Oil will tumble to $40 if OPEC doesn’t extend its agreement later this year, one of the most prominent producers in the U.S. shale patch said this month.

“Once (actually more than once) bitten, twice shy,” said  Elina Ribakova, an economist at Deutsche Bank AG in London. “The central bank and the Finance Ministry are sticking to the conservative $40 oil scenario because they want to be ready for and protect themselves against the worst-case scenario.”