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Unrelieved Reliance: Russia's Pre-Election Budget Spending May Require Adjustment as Slowing Global Demand Threatens Soaring Oil Prices

Recent volatility in global crude and commodity prices may force Russia to revise its oil-dependent budget, experts say. Over the past several weeks, lingering uncertainty in global crude oil demand has sent jitters through the commodity markets, offsetting any longer-term bullish views that crude oil prices may continue their upward spiral. Both the West Texas Intermediate (WTI) light sweet crude and ICE Brent suffered heavy losses on Thursday, prompting warnings from industry analysts that last week's heavy commodity selloff could become a trend.

The global commodities rout has also cast a long shadow over Russia's 2011 federal budget. The assumptions underpinning the budget, experts now say, are at risk of being overwhelmed by market events if the commodity price ructions turn into a sustained rout.

Russia's Economic Development Ministry responded to a precipitous rise in oil and gas prices this year by raising its forecast for the average 2011 oil price by 30 percent, to $105 per barrel from $81 per barrel. The higher oil price assumption was expected to boost oil and gas revenues by 1.14 trillion rubles ($40.37 billion), Finance Minister Alexei Kudrin told legislators last month. In a bit of good news, Russia's Urals crude stayed almost unchanged at $111.1 a barrel on Friday, holding on to gains the previous day on fears that June export volumes could dip. The fears hinge on two destabilizing factors that could work to influence the Ural crude price. Firstly, the Urals brand oil supplies through the Novorossiysk pipeline are expected to slow in June because of Russia's new regulations that make it difficult to transfer export rights from one company to another. On the other hand, market players expect domestic runs to rise after the government ordered full supplies of gasoline to local markets to avoid shortages and public discontent.

But despite Russia's strong position, the balance of analysis appears to suggest that the soaring commodity prices were unsustainable, at least in the long run. With the oil prices on a downward spiral, the Russian government's only option is to review its basic budget spending, which was based on the assumption that Russian oil will sell for an average of $105 a barrel, analysts say. In the two weeks ending Friday, May 13, Brent dropped about ten percent to close at $113.83 a barrel on ICE, while WTI plunged 12 percent to $99.65 a barrel at NYMEX, NASDAQ EconMatters reported Saturday. The dominant downtrend in oil prices has continued despite the ongoing geopolitical tension in the Middle East and North Africa, which was expected to keep crude prices sky-high.

Oil futures also faced renewed selling pressure from some bearish reports that hit the market last week. EIA data showed an unexpected rise in gasoline reserves to 1.3 million barrels ­ the first weekly increase in about three months ­ while crude oil stockpiles continued to build. A Bloomberg survey released last week shows that global investors have tempered their optimism about the U.S. and world economies, and plan to put more of their money in cash and less in commodities over the next six months. Europe's debt problems are also giving the U.S. currency a boost, as weak economic figures trigger investor worries about the global recovery. Last week's reports on consumer spending and jobs in the United States show that shoppers are spending more, but mostly on gas and food.

Various reasons have been advanced to explain the inevitability of the oil price collapsing in the longer term, among them the persistent high prices of oil. The Paris-based International Energy Agency announced on Thursday that it was lowering its global oil demand growth forecast for the year by 190,000 barrels per day, attributing the demand destruction to persistent high prices and lower growth projections for developed economies. "A four-dollar gallon gasoline is likely to yield an anaemic U.S. driving season," said the agency, which has been pointing to the softening trends in crude consumption for the last two months. The financial information Web site MarketWatch reported last week that some refiners said their fuel sales in April had fallen by as much as four percent from March, as high prices prompted consumers driving less. The Short Term Energy Outlook released last Tuesday by the U.S. Energy Information Agency (EIA) also points to falling demand. The EIA now projects that total world oil consumption will grow by only 1.4 million barrels per day in 2011­ some 0.1 million barrels per day lower than projected only last month.

The IMF is also predicting a likely deceleration in growth on the back of higher energy prices. In its latest report, the IMF warned that higher than expected commodity prices could cause major social concerns. "Fears have turned to commodity prices," Olivier Blanchard, the chief economist at the IMF, warned. "Commodity prices have increased more than expected, reflecting a combination of strong demand growth and a number of supply shocks. These increases conjure the specter of 1970s-style stagflation, but they appear unlikely to derail the recovery."

A major concern for Russia is that China and other top oil-consuming nations would tighten their fiscal policies and slow down to fight inflation. China's Central Bank on Thursday raised lenders' reserve requirements for the fifth time this year, stoking concern that anti-inflation policies may slow growth in the world's second-biggest economy. "China's inflation data shows that the country will need to do more tightening," said James Holt, the Sydney-based director of BlackRock Investment Management Ltd., Bloomberg reported. Various forecasts of slower growth in global gross domestic product (GDP) and oil demand are another factor that could put downward pressure on crude prices. In its latest World Economic Outlook (WEO), published in April, the IMF predicts global GDP in 2011 and 2012 could reach 4.4 percent and 4.5 percent respectively, unchanged from its January forecast. IMF also expects real GDP in advanced economies and emerging and developing economies to expand by only about 2.5 percent and 6.5 percent respectively in this year and next.

Another piece of bad news for the oil market is the decision by the Federal Reserve to end its quantitative easing program on schedule in June. The economic support program, which consists of buying $600 billion in Treasury bonds, has helped boost the money supply and weaken the U.S. dollar, making commodities such as oil cheaper for investors with other currencies. Ending the program next month could mean that investors will be less inclined to own assets that don't pay anything, such as commodity futures. Traders are currently struggling to gauge the impact on crude markets. "The major policy that has shaped oil prices is winding down," energy risk manager Cameron Hanover said in a report. "As long as the Fed does not come up with a third round of quantitative easing, the major reason for oil price strength will be gone."

However, Russia could yet benefit from lower global oil prices as it struggles to diversify its resource-based economy, analysts say. "For the Russian economy at any given period, falling oil prices are of course bad because this reduces revenues from the main source," said Alexander Shtok, an expert with the 2K Audit-Business Consultations firm. "However, in global terms, more moderate oil prices should stimulate the development of other sectors of the economy."

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