Apr. 30th, 2016

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The Western image of Russia and Putin in recent years has been very negative. President Obama has publicly called Vladimir Putin a “schoolboy who slouches in his chair in the back of the room“ and derided his country as a mere “regional power.”

This begs the question: how Russia could again become a major power after the disintegration of the Soviet Union in 1991? How could Putin do this without an agrarian or consumer revolution and with the massive drop in the price of oil? If Putin is a terrible leader, then how can you explain successful interventions in Georgia (2008), Crimea (2014), Ukraine (2014-2016) and Syria (2015-2016)?

Putin, however, is actually a very shrewd leader with a brilliant Foreign Minister, Sergei Lavrov, who relies on a capable Foreign Ministry. Putin has rebuilt Russia’s military capability by spending $49B a year on security. Russia retains 1,790 strategic nuclear weapons. With over 140 million people and 13 million college graduates, Russia has nearly a million first-class scientists, engineers and technicians, most of whom work for the military.

Many former great powers are now no longer major powers. Japan, which smashed the Russian army in the 1904 Sino-Japanese War, occupied much of China from 1937-1945 and has a four trillion dollar economy is no longer a great power. After its defeat in World War II capped by the American dropping of atomic bombs on Hiroshima and Nagasaki and American post-war occupation, Japan has sworn off further intervention in the world and refused to acquire nuclear weapons.

Europe, which once teemed with great powers such as Germany, France, England and Austro-Hungary, now has gone in another direction. Germany soundly beat the Russians in every World War I battle and came close to doing the same in 1941 and 1942. Today with weak power projection the three main powers have less than 1,000 mainline battle tanks and few aircraft carriers. Weak economic growth (1.5%/year), disputes among its 28 members, migration from the Middle East, serious problems with weaker members such as Greece, promote domestic over international issues.

China, with its ten trillion dollar GDP, over two trillion dollars of exports, over three trillion dollars in its reserve fund, 1.35 billion people and 3.7 million square miles of territory, is a future great power. It has made huge economic progress since Deng Xiaopong launched the Four Modernizations in 1978.

Yet, its remaining problems are staggering: enormous air pollution, 675 million peasants, huge governmental corruption, authoritarian one party dictatorship, lack of rule of law, rapidly aging population, hundreds of thousands of children raising themselves and only $7,500 GDP/capita. Its military, while boosted by 150 billion dollars of spending, still needs another decade to become a truly modern force.

India has 20 percent illiteracy, 300 million people without electricity and a $1,300 GDP/capita that is less than three percent of the United States. It faces Pakistan soon with 200 atomic bombs. India, with over a billion people, will be a major power but not for several decades.

Then there is the United States, the sole global superpower since victory in the Cold War and one of two superpowers in the world since 1945. Its 18 trillion dollar economy, 17 of the world’s top 20 universities, world leadership in high technology, over 550 billion dollars in military spending and 330 million people give it serious advantages over Russia. But, with the rise of popular neo-isolationist Presidential candidates, the slowest economic recovery since the Great Depression, decline in its manufacturing sector, administration talk of reducing the size of the American military to the 1940 level, and the Obama semi-withdrawal from the Middle East, the door that had been shut to Russia has been open.

The unthinkable has become a reality. Russia, seemingly finished after its defeat in the Cold War, now is emerging as a prospective great power challenging the West. Russia has done the unthinkable—become a great power filling the void left by other former great powers that have now shrunk in size, power and influence.
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Russian President Vladimir Putin is on the verge of realizing a decade-old dream: Russian oil priced in Russia.

The nation’s largest commodity exchange, whose chairman is Putin ally Igor Sechin, is courting international oil traders to join its emerging futures market. The goal is to increase revenue from Urals crude by disconnecting the price-setting mechanism from the world’s most-used Brent oil benchmark. Another aim is to move away from quoting petroleum in U.S. dollars.

If Russia is going to attract international participation in Russian-based pricing, the Kremlin will need to persuade traders it’s not simply trying to push prices up, some energy analysts said. The government is dependent on oil revenue to fund its budgets.

“The goal is to create a system where Russian oil is priced and traded in a fair and straightforward way,” said Alexei Rybnikov, president of the St. Petersburg International Mercantile Exchange, or Spimex, in a phone interview.

Russia, which exports about half its crude, has long complained about the size of the discounts for lower quality Urals oil compared to North Sea Brent prices, which are assessed by the Platts agency. With world oil prices down by half in the past two years and Russia facing the prospect of its worst budget deficit as a percentage of its economic output since 2010, it needs every dollar of petroleum revenue it can get. Having its own futures market would improve Russian oil price discovery as well as help domestic companies generate extra revenue from trading, said Rybnikov.

Bloomberg LP, the parent of Bloomberg News, competes with Platts and other companies in providing energy-market news and information.

Kremlin Involvement

“The reality is that the Kremlin is always likely to be heavily involved in the Russian oil industry,” said Richard Mallinson, an analyst at Energy Aspects Ltd. “That creates the concern that the proposals might be structured to try to achieve higher prices, which is not consistent with efficient price discovery.”

The Russian government’s system of approvals for shipping crude from different ports and pipelines could also mean subdued interest from western refiners, because some export volume adjustments could be politically motivated, said Ehsan Ul-Haq, senior oil market analyst at KBC Energy Economics. The volatility of the Russian ruble, which will be used for futures margins, also causes concern among companies.

To attract traders, the Bank of Russia is preparing legislative amendments to grant non-Russian firms access to exchange-traded commodities and their derivatives, the financial industry regulator said in an e-mail. The bank will assist Spimex in starting futures to price oil for exports.

Western Agencies

Russia’s largest oil companies, including Rosneft OJSC, Lukoil PJSC, and Gazprom Neft PJSC support the new futures and may become market makers, Spimex President Rybnikov said. He declined to name any trading firms outside of Russia, saying that the exchange has been in a dialogue with many market participants.

Gazprom Neft has been involved in futures development since 2015, it said in an e-mail. Lukoil will be willing to participate in the futures market if it makes economic sense, the company said in an e-mail. A Rosneft spokesman declined to comment.

Spimex has been Russia’s largest oil product platform since trading started in 2008 after the government obliged companies to sell between 5 and 10 percent of their domestic transport fuel supplies there. Producers sold about 533 billion rubles ($7.8 billion) of products, or more than 15 percent of all fuel delivered to the local market, at the bourse last year.

The initial futures contract will be worth 1,000 barrels traded in U.S. dollars with a minimum delivery of 720,000 barrels to the Russian ports on the Baltic Seas, according to its specifications. Russia planned to export about 1.5 million barrels of crude a day from its Baltic oil terminals in March.

Previous Efforts

Moscow is not alone in its push to change global oil pricing. China, which vies with the U.S. as the world’s biggest crude importer, has spent two decades trying to introduce its own oil futures contact, now expected this year. Iran and Venezuela, members of the Organization of Petroleum Exporting Countries, have called for trading oil in other currencies than U.S. dollars.

The Kremlin plan echoes the New York Mercantile Exchange’s efforts to offer Russian export oil futures in late 2006. Nymex, now part of CME Group Inc., discontinued the contract six years later because it wasn’t popular among traders, JBC Energy GmbH said.

“Some market participants might be wary of embracing the new futures contracts as a benchmark due to concerns about the Russian government’s high degree of involvement in the oil sector,” said Eugene Lindell an analyst at Vienna-based JBC. “It remains questionable as to what extent Spimex can provide a better overall trading framework.”

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