The potential has not yet been realized. How the OPEC + deal could affect the ruble

Marcel Salikhov, President of the Institute published an author's column for RBC on the topic “The potential has not yet been realized. How the OPEC + deal could affect the ruble”.

Despite the fears of the players, the OPEC + alliance withstood. Economist Marcel Salikhov believes that the oil deal, combined with decreasing political risks, will help to strengthen the exchange rate up to 70-72 rubles per dollar by the end of the year.

After protracted negotiations and internal disagreements, the OPEC + countries were still able to reach an agreement. From January 2021, OPEC + will increase production by a total of 0.5 million barrels per day. Thus, the total volume of reducing production compared to the times before the pandemic will be 7.2 million barrels per day instead of the current 7.7 million.

The oil producers' dilemma

According to the initial agreements of OPEC +, reached back in April, it was planned to increase production by 1.9 million barrels per day from the beginning of 2021. However, the second wave of the pandemic and quarantine restrictions imposed by different countries have complicated the plans. A sharp increase in supply in terms of declining demand could lead to a collapse in prices.

As with central banks, the core of the OPEC + policy is the competent management of market expectations. The market regulator must be well aware of what the expectations are at the moment of making a decision and be able to adjust them in the direction it needs. And the market reaction to the OPEC + decision gives every reason for optimism. Although the parties to the deal will nevertheless increase production from January, prices remained at high enough levels. Brent crude by the end of last week rose in price to almost $ 50 per barrel and reached pre-crisis levels of early March.

The market feared the collapse of the OPEC + agreement, as happened in March, and the start of a new price war. A number of countries have already begun to announce publicly the possibility of withdrawing from the agreement. Discontent was expressed by the UAE, Kuwait, Iraq. They did not like the fact that Saudi Arabia was incurring relatively small costs from production cuts. For example, in November, UAE oil production was 29% lower than in March 2020, while Saudi Arabia's - only 8%. This created a sense of the unfairness of the existing agreements.

However, the quarrel was avoided. The general level of discipline of the alliance members remains quite high, despite some exceptions. World oil reserves continue to decline. That is, production cuts allowed to reduce the supply below the indicators of the collapsed demand. All this points to a fairly high efficiency of the OPEC + strategy.

Exporters will maintain flexible policy to manage cutbacks, revising them once a month. In fact, this is the minimum period that passes, on average, between oil production at the field and its delivery to the consuming refinery. Whatever decisions OPEC + makes today, at best it will affect the actual oil shipments just in a month. If in January prices remain close to current levels, then it would be wise for the participants in the transaction to increase production again and look at the market reaction. If prices fall, then there is a possibility to keep the current restrictions for February.

At the same time, one should not expect oil prices to rise above $ 50 per barrel next year. In order to achieve the current result, the OPEC + countries had to “remove” 7% of world production from the market. Therefore, any significant increase in prices will create incentives to reduce the scale of cuts. The OPEC + countries have significant unutilized production capacity and associated costs. Therefore, at an acceptable level of prices, the primary task will be to restore production to pre-crisis levels.

Consequences for the ruble

Despite the oil rally, the ruble remained rather weak in November. At the beginning of the month, weakening the ruble was primarily due to the presidential elections in the United States and fears of new sanctions. Then, despite the victory of Joe Biden, who is considered to be a supporter of a tougher policy towards Russia, the ruble began to strengthen.

This effect is partly due to the general shift in market sentiment following the news of the high efficacy of the COVID-19 vaccines under development; partly - the opinion formed among the players that the likelihood of tough sanctions against Russia in the coming months is small. The new administration will be more focused on domestic issues. In the field of foreign policy, the priorities will most likely be to improve relations with the EU, as well as with Iran and Cuba - in these areas there are more chances of achieving a quick breakthrough. Biden will deal with the "Russian" issue, but not anytime soon.

For the ruble, this means that short-term political risks are not as great as it seemed a month or a month and a half ago. The rise in oil prices is causing an influx of foreign currency into the Russian market and contributing to strengthening the ruble. According to our calculations, the current elasticity of the Russian currency exchange rate with respect to oil prices is approximately 0.1. This means that with a 10% increase in oil prices, one can expect a 1% strengthening of the ruble, all other things being equal. This is a rather low sensitivity of the exchange rate for such an economy dependent on raw materials exports as the Russian one.

In recent years, due to preservation of the floating exchange rate and transition to the inflation targeting regime, the influence of the factor of oil prices on the exchange rate dynamics has decreased. Factors related to the general risk appetite in the global financial markets, as well as the interest rate differential in Russia and other countries, began to play a major role. Now both of these factors remain positive for the ruble and contribute to its short-term strengthening.

Nevertheless, oil continues to have a significant impact on the exchange rate dynamics. News of the agreement reached by OPEC + caused a rapid and sharp strengthening of the ruble. It became clear that the “tail risk” of the collapse of the agreement did not materialize, and this caused a jump in the attractiveness of ruble assets.

We believe that the potential for ruble appreciation has yet not been realized. The current equilibrium value relative to the prevailing oil prices, inflation and interest rates is in the range of 70-72 rubles. If optimism persists in world markets, a similar value of the dollar exchange rate can be expected in December.