Russia On Oil Traders' Radar

Includes: BNO, ERUS, RSX
by: Tony Daltorio

While a possible conflict involving Iran is the foremost concern among oil traders, there is another possible risk that is quietly creeping on the oil markets - Russia and its upcoming presidential election on March 4.

Russia is the world's second largest oil producer and, so far this century, has been a depressant on oil prices. Since the early 2000s, the country has boosted production of oil to 10 million barrels a day from a low of 6 million barrels a day in 1996 after the collapse of the Soviet Union.

But now, the possibility is increasing that Russia will become, for the first time in more than a decade, a bullish force for oil prices.

Tens of thousands of its citizens have turned out for protests against the results of recent elections and the country's "managed democracy2." These protests were the largest demonstration in opposition to the Russian government since Boris Yeltsin took on the Supreme Soviet in 1993.

The risk is probably small that such demonstrations can eventually lead to strikes that would disrupt Russia's oil output. But a year ago, who would have thought that "Arab Spring" would develop and lead to an interruption of the oil flow from places such as Libya?

On the other hand, think about what the government will do to soothe the angry protestors. Much like Saudi Arabia has done, Russia may move toward the approach of adopting massive economic stimulus programs. This will most likely lead to a boost in domestic oil demand, cutting into the amount of oil that can be exported from Russia around the globe.

The International Energy Agency estimates that Russian oil output hit a post-Soviet high of 10.7 million barrels of oil a day in October 2011. But, as in most other emerging market economies, domestic oil demand in Russia is on the rise. Through November, local demand had hit 3.5 million barrels a day, up 5% from 2010.

The surge in oil consumption in Russia in 2011 has already hit oil markets. For example, higher domestic demand has been a major contributor to record premiums of Urals crude - the Russian benchmark - to Brent crude oil, which it turn trades at a premium to WTI crude. Lower fuel oil and diesel exports from Russia have also helped to push higher the price of both refined products in the global marketplace.

So how can investors take advantage of this possible change in the Russian oil dynamics?

First, investors can buy an ETF based on oil futures. Since there is no ETF on Urals crude oil, the next best choice is Brent crude and the United States Oil Brent Oil Fund (NYSE: BNO).

Investors should also consider buying individual Russia oil stocks or even an ETF for Russia. All Russian ETFs have heavy exposure to the domestic energy sector. Examples include the two largest Russia-focused ETFS: the Market Vectors Russia ETF (NYSE: RSX) with a 40 % exposure to the energy sector and the iShares MSCI Russia Capped Index Fund (NYSE: ERUS) with a 52% exposure to the energy sector.

Disclosure: I have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours.