Russia commands an interesting position in the world these days. On one hand, Vladimir Putin's star has risen on the international scene. Alliances with Iran and China mean that the Russian leader continues to be a powerful and influential force with on the international scene. The sanctions on his nation remain because of Russian aid to rebel forces in Ukraine but we have not heard much about that recently. What we have seen is Putin's presence in Syria, his participation in the war against terrorism and his role as a conduit to the government in Iran. As Iran's status in the Middle East grows so does Russian influence in the region.
At home, things remain problematic for the Russian leader. Aside from the pressure of sanctions, falling commodity prices have caused real weakness in the raw material rich nation's economy. The Eurasian brown bear has been a symbol for Russia dating back to the 16th century. The symbol has survived from the days of the Tsars, the Soviet Union to the present day Russian Federation. The bear market in commodities has been a thorn in the side of the Russian bear.
Russia has suffered two-fold
In the years following glasnost and the Gorbachev and Yeltsin leadership, the Russian economy improved. The economy became even more capitalist than communist and investment in the nation boomed. As Vladimir Putin took power, Russia was in the best economic condition in decades. Moscow became a cosmopolitan city that rivaled major European cities. The bull market in commodity prices resulted in billions of investment dollars flowing into the nation. After all, Russia is a commodity-producing powerhouse. Vast reserves of metals, minerals, energy and other raw material production resulted in an economic boom. In 2011, the bull market in commodities ended. In the years that followed, the boom came to a grinding halt. Then came Ukraine.
Sanctions have weighed on the Russian economy. The bear market in commodities has made a bad situation worse when it comes to the domestic economy. All one has to do is look at a chart of the Russian currency, the ruble, to see the devastating effect of sanctions and lower commodity prices. Click to enlargeAt the height of the bull market in raw material prices, the ruble exchange rate against the U.S. dollar stood at below 30 rubles to the dollar. Recently, a dollar bought almost 80 rubles. Last month the exchange rate fell to the lowest level during the life of the Russian Federation at just over 85 rubles to the dollar. Today, it remains close to those lows. Sanctions and falling commodity prices has been a double whammy for the Russian economy.
Putin could have more power than OPEC in the future
Putin has chosen to flex his muscles in the Middle East but his power transcends that region. While sanctions over Ukraine remain in place, the world has quickly put that aside focusing instead on other more pressing issues. Russia is a powerful nation, from a military perspective. Putin is a leader who is firmly in charge of every aspect of his nation. Putin, the autocrat, has total control.
When it comes to commodity production, the most powerful oligarchs remain in Putin's camp. In Russia, an association and support for the leader has allowed the mega-rich in the country to stay that way. His foray into the political quagmire of the Middle East is no accident. Putin, the visionary, sees a potential for Russia to rise again.
Russia is the second largest producer of crude oil in the world, second only to Saudi Arabia. Putin's alliance with Iran, another major oil producer, is a chess move against the Saudis for control. Now that the price of oil has declined to levels not seen in years, many oil-producing nations are hurting. Russia is hurting as well. However, for a leader like Vladimir Putin the current price of crude oil is an opportunity -- a chance to exert influence and seize even more power. Between Iran and Russia, daily oil production is greater than total Saudi output.
OPEC, the oil cartel, has not been able to do anything about falling prices. While supplies have grown, OPEC has stood on the sidelines and output from member nations has increased. At first, the cartel led by Saudi influence, stated that falling prices would put shale oil out of business allowing the member nations to increase market share. While U.S. production is bound to fall with rig counts, which last week fell to 467 in operation, the price of oil continues to fall. In January, oil plunged to just above $26 per barrel -- a far cry from prices north of $100 per barrel less than two short years ago. Meanwhile, the weaker economic members of OPEC have been clamoring for a production cut for quite some time. The powerful members of the cartel have not agreed. Since it became evident that the non-nuclear proliferation agreement would free Iran from sanctions, the relationship between Iran and Saudi Arabia has deteriorated. In 2015, the two began a proxy war in Yemen as Shiite rebels backed by Iran deposed the government supported by the Saudis. Yemen shares a long border with Saudi Arabia. Iranian influence in the neighboring country is a little too much for the new Saudi government to stomach.
Many changes took place in the Middle East in 2015. The powerful Saudi King Abdullah died at 90.His half brother Salman a youngster at 80, took over. Iran, the opportunistic theocracy in the region, did a deal with the West and strengthened ties with Russia as the two nations supported the Syrian government led by Assad. Iran and Saudi Arabia are mortal enemies. Iran would like nothing more than to see the House of Saud fall and exert influence over the nation that contains the two holiest sites in Islam, Mecca and Medina. The Saudis were aggressive opponents of the deal the west made with Iran. Meanwhile, Saudi Arabia and Russia are both producing over 10 million barrels of crude oil each day. Enter Mr. Putin, with the Iranians on his side as the dealmaker with an iron fist. Low oil prices are an opportunity for Putin to influence OPEC policy and the future price of oil as well as the political powerbase in the region.
Last week, rumors swirled around the oil market about an emergency OPEC meeting to address low prices. Any production cut that lifts prices would benefit all producing parties. However, none stands to gain more than Putin's Russia. The divide between Iran and Saudi Arabia provides Russia with the chance to shape OPEC policy without even being a member of the cartel, just a voice in the Iranian oil ministers ear. Moreover, any success in terms of an increase in the price of the energy commodity will make Putin an effective powerbroker in the Middle East and strengthen his position at home.
The Russian economy is on the brink but they are used to that
While the Russian economy is on the brink of depression, Putin remains firmly in control of the military. The occasional critic of the sitting government in Russia tends to disappear. Many Russians remember the pre-Gorbachev days of suffering under harsh economic conditions. Russians are a hearty people and Putin knows this. Therefore, the leader has more time and patience in terms of his populous to deliver results. While other governments around the world would likely buckle under similar circumstances, Russia is different as Putin keeps power tightly in his grip. Even though Putin is moving to privatize many industries in Russia, including oil production, it would be naive to think that he will not exercise tight control via his network of oligarchs.
Meanwhile, in January the International Monetary Fund cut its growth projection for Russia in 2016. The IMF is looking for a 1% contraction in the Russian economy this year. Not good news for Russia or Mr. Putin but in every cloud there is a silver lining.
The ruble is hurting but it also helps
The chart of the ruble highlights the decline of the currency and the troubles in the Russian economy since 2014. The lower ruble does result in one positive for the nation. The U.S. dollar is the pricing mechanism for commodities around the world. Russia is a massive producer of commodities and even though these raw materials are in a bear market in dollar terms, they have all rallied in ruble terms. Additionally, domestic production costs are ruble based. This means that the cost of production of all commodities in Russia has fallen dramatically since the ruble's decline. While the ruble has made imports prohibitive, it has not been a bad thing for the export markets that Russians can still access. Russia is one of the biggest commodity producers in the world and it just so happens that the largest commodity consumer has not placed any sanctions on the Putin government.
Russian and the special relationship with the world's biggest commodity consumer
Many Russians are proud of their nation and Putin uses this nationalistic fervor to his advantage. Gaining influence in the Middle East is a feather in his domestic cap. On the world stage, Putin has even spoke out about the upcoming U.S. election stating that he views Donald Trump as "brilliant" and "talented". This could be a strategic message that the leader is looking for a better relationship with the next U.S. administration. If you believe in polls, Putin has an 80% approval rating in Russia. While one must view any polls in a nation like Russia with a grain of salt, if the domestic economy outperforms expectations, Putin will be a huge winner with his citizenry. Putin's mantra with his people is that the breakup of the Soviet Union was a mistake and that reform would have been a better course. This is a very popular view amongst Russians. Putin's standing and outspoken manner outside Russian borders serves the leader well at home.
As a dominant commodity-producing nation, Russia needs outlets to sell their output. Russia's new found relationship with China in the face of sanctions has resulted in important deals that provides cash flow from a nation that is the demand side of the equation when it comes to commodities. Russia and China have agreed to long-term agreements for the supply of energy and other raw materials to China. They have also agreed to swaps of technology, military equipment and even currency -- rubles for yuan. This is tantamount to a snub of the current administration in the U.S., sanctions and the dollar by both the Russian leader and the Chinese government.
As I wrote at the start of this piece, sanctions and falling commodity prices weigh heavily on the Russian economy. However, rich with commodity reserves Russia remains an important and powerful nation despite its current economic woes. Putin has proved himself time and time again as a smart, strategic, fearless and powerful player on the world stage. Chances are when the commodity bear turns bull once again the Russian bear will rise and Putin will still be at the helm.
The ruble is at the lowest level in modern history and Russian debt is at extremely low levels. I believe that we will look back that these days and wonder why we did not stick some Russian exposure in our portfolios. As a bonus, I have prepared a video on my website Commodix that provides a more in-depth and detailed analysis on Russia to illustrate the real value implications and opportunities.
Disclosure: I/we have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours.
I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.