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Russian Angels and Global Demons – Troika Dialog sums up The Russia Forum 2010

February 17, 2010

“Concerns about global demons outweighed domestic factors at The Russia Forum in Moscow last week, as participants were relatively unexcited about short term growth and prospects for modernization,” write Chief Strategist at Troika Dialog Kinsmill Bond and Strategist Andrey Kouznetsov in Troika Dialog’s Strategy Monthly for February 2010. The authors say the Forum was a remarkable celebration of Russia’s potential in an uncertain world.

In their analysis of the Forum discussions, the authors point out: “Many companies spoke about how the crisis had obliged them to cut costs, reduce waste, focus operations and improve service. At the same time, government rhetoric has undergone a notable shift to focus on modernization and attracting investment flows.”

Speaking at The Russia Forum 2010 held from February 3 to 5, 2010, were roughly 200 notable politicians, economists and entrepreneurs from Russia and abroad. The main topics discussed at the Forum and during the panel sessions included the following:

Watch out for gas, as there is a real threat of a continuing gas glut. On the supply side, technology, as so often, has radically changed the rules of the game with shale gas and LNG. On the demand side, European demand is at the levels of 10 years ago, with weak prospects for growth, and the likelihood that policymakers will mandate growth to come from the renewables sector. Gazprom sells gas to Europe at $320 per 1,000 m3, when the European hub price is only $200 per 1,000 m3. The difference in price for the volumes sold to Europe amounts to $18 bln, which is nearly the level of Gazprom’s profit and over 1% of Russia’s GDP. Gazprom, of course, believes that it will not be obliged to reduce prices, but some panelists thought that they would have to.

The crisis had a silver lining for Russia. It is known that the crisis helped curb inflation, stopped excessive foreign borrowing before it got too dangerous, and reduced personnel turnover and hiring costs. But in addition to this, many companies spoke about the fact that it had helped them focus their businesses by removing products that had weak sales, streamlining operations, and shifting from land grabs to efficient growth.

Growth has picked up but is not yet great. Companies agreed that the bad times were behind them, as in sectors from media to building to retail to consumer, the corner was clearly turned by the summer. However, they were not especially positive about growth for the next few months, preferring to see 2011 as the year in which the economy would really start to grow rapidly again.

There are still some areas of tremendous potential. Low-penetration sectors, such as restaurants, retail, regional banks and broadband, still see excellent growth opportunities yet to come. A series of commentators reiterated that penetration in these areas was low and competition limited, creating the opportunity for superprofits.

Modernization is the buzzword, but not much has happened yet. The good news is that for the first time in years, there is broad agreement that the path of development for Russia needs to be different from the commodity-fueled excesses enjoyed during the good times. However, many commentators (led by Anatoly Chubais) noted that there was a major gap between theory and practice, and that few concrete ideas had yet been implemented. General ideas put forward at The Russia Forum by key officials such as Deputy Prime Minister Alexei Kudrin and Deputy Head of the Presidential Administration Igor Shuvalov were: relaxing controls on migration; improving policy so as to build a long-term domestic bond market; reducing red tape and administrative pressures, improving the investment climate, and increasing innovation.

Debt costs are falling and loan growth is coming. Bank representatives spoke of increasing competition for quality borrowers, creating a lowering trend in borrowing costs. Because downward inflation allows the Central Bank of Russia to further reduce the refinancing rate, Troika Dialog’s analysts anticipate a continued downward trend in borrowing costs. To be sure, this will exert downward pressure on bank margins this year, but it will simultaneously enable broadening of loan portfolios. A survey of forum delegates conducted by Troika Dialog revealed that Russian market participants remain doubtful about an impending lowering of borrowing costs, creating an opportunity for investors in longer-term domestic bonds. While the larger banks are still more cautious, the smaller banks see 15-20% loan growth as quite feasible this year.

Asia beats Europe. The global view, of course, is that Asia had a good crisis, is still growing and in good shape, while Europe is in all sorts of trouble and there are likely to be Sovereign defaults this year. As such, Russia’s shift to the East continues to draw much interest, and representatives of both the Hong Kong and Shanghai stock exchanges openly invited Russian companies to list there. Most commentators argued that the basic framework remains that Asia will grow and suppliers of raw materials to Asia (such as Russia and Brazil) will be insulated from the problems of the West by this growth.

Global fears dominate. Most commentators and investors continue to fear massive debt levels in the West, and believe that there are more problems to come. As a deep cyclical commodity market, Russia will continue to be swung around by the ebbing and flowing of these fears, even though its own debt position is admirable, because a second round of debt crisis in the West could damage global growth and hence the oil price.

The utility sector is still fraught with difficulty. Utility companies spoke about difficulties in obtaining payment, getting clarity on regulation, and making regulations work. Moreover, they reiterated that nearly half of the system was obsolete and would need replacing; required capital inflows remain enormous, which will dampen returns. Management teams still seem to have little concept of the IRR on new capex projects, or the need to pay investors for their capital.

Oil may settle lower than the consensus view. If the consensus view is that the oil price will follow the futures curve and stay permanently at a plateau above $70/bbl, then this view was heavily challenged at The Russia Forum, with much scorn poured upon the notion of peak oil. Supply is damaged by massive new supply from Iraq (up to 10 mln bpd) and the removal of constraints (shipping capacity) on deepwater supply, while demand is damaged by energy conservation (apparently 4 mln bpd in the OECD since the crisis started), the potential use of shale gas in the US (if the US truck fleet were converted to gas, that would save 2.5 mln bpd) and a greater focus on energy efficiency in China. On a separate note, it was mentioned that only five years ago, shale gas was thought to be irrelevant, and now it is a major factor in gas markets; the permanent risk is that something similar happens in oil, sparked by continued high prices.

 

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