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PetroRubles: Russia's St. Petersburg Exchange

This report provides brief information behind the interest to organize oil and commodities exchange in St. Petersburg.  Russia in recent times has been one of the major energy producers in the world, therefore a natural interest to develop a trading platform for the products produced within the country.  Government officials…

This report provides brief information behind the interest to organize oil and commodities exchange in St. PetersburgRussia in recent times has been one of the major energy producers in the world, therefore a natural interest to develop a trading platform for the products produced within the country.  Government officials are attracted to setting up the exchange in order to strengthen Russian currency internationally.  The trades on the new exchange will be denominated in Rubles.  This report provides facts related to the issues described above and is not an attempt to solve global crisis.
In the past, Urals brand oil was traded based on the derivative valuations of Brent oils; however, now the Russian Export Blend Crude Oil (REBCO) futures contracts proposes a change, suggesting alternative pricing for Russian oil products.  The two oil products are of a different quality as Russian oil is sour and heavy, Ural oil is sweet and light crude.  Basic principles of economics recognize that prices for products are based on supply and demand; however, some products within the same category may be priced differently based on quality and brand.  The same basic explanation applies to oil, supply, demand and quality differentiation determine market prices of the product.
The aforementioned price discrepancy presents a problem for both the oil companies as well as the Russian government as it taxes based on the world market price of petrol1 .  Presently, petrol-product transactions are done direct with refiners but price agreements are brokered by middlemen, who dictate the transaction terms. REBCO futures contracts have been proposed and developed for price discovery and independence of Russian Blend oils from Brent brand, which might lead to price increases for the product. Automatic guarantees are not provided in any market; however REBCO would allow greater transparency.  One of the organizers of REBCO, Vladimir Pluzhnikov from Expertica, stated oil producers are not pleased with the traders offering non-market based prices for oil. Trading in New York and St. Petersburg would benefit oil producers. Former Minister of Finance and Economics German Gref will be one of the organizers for the exchange in St. Petersburg .  REBCO has been trading on the NYMEX CME Globex system since October, 2006.  REBCO trades in lots of 1,000 barrels and includes Free On Board physical deliveries in Primorsk , Russia .  Prices are quoted in USD and to open positions margins are required.  REBCO trades under the symbol RE2.

Tax Code

Russian officials are currently working on the reform of the tax code for oil producers, to stimulate further growth in the sector. In recent years the rate of increase in production has dwindled, largely due to taxes3.  The current tax system has a high marginal tax rate and is based on revenues not profits or output volume. Another determinant of the tax rate is the market prices.  Above the market price of USD 25 the marginal tax rate increases and reaches 89 percent of export revenues. Total tax share comes to 78 percent after the refinement of the products (William Mauldin). This creates a high tax system for newly developed projects before it becomes profitable and discourages new ventures that require high level of capital investments4.  In order to increase output new fields in remote areas need to be developed.  Innovative equipment is required for efficient production and refining of oil. The tax system currently discourages such high levels of investments by the oil sector, since it will be penalized by taxes before ROI is yielded5. The Russian government has been trying to improve the tax system through various methods such as:  reduction of excise duties on refined products and extension of tax holiday, to name a few.  The improvements in the tax code will encourage investments in sophisticated technology required for new oil field developments.  A domestic exchange and a tax reform will prove beneficial to oil producers and other economy participants. 

Issues and Requirements to Ensure Successful Trading

The Russian government has been working to improve various issues pertaining to contract laws and property rights to ensure safe and successful trading of the oil futures.  After World Competitiveness Index compiled by the World Economic Forum placed Russia into 59th spot6, it raised awareness and concerns for Russian officials.  Russia’s current Minister of Economic Development and Finances has addressed the issues and proposed various solutions on how to improve the system in order to ensure safety of foreign and domestic investors7.  Russian legal authorities are also taking necessary measures to protect investors and traders, specifically in the fields of futures and forward contracts.  Previous events in the financial markets jeopardized the soundness of the markets in Russia.  Some of the investment vehicles that were non-deliverable in nature were considered a form of gambling by the court system.  Since then the government is determined to amend the civil code to ensure safety and stability of the financial markets to avoid similar problems8.

The success of the commodities exchange is not guaranteed and is viewed with some skepticism from professionals.  However, Russia has experienced success with MICEX which was recently added to top 20 Global exchanges.  MICEX’s USD/Ruble futures contracts have recently exceeded Chicago’s Mercantile Exchange in volume of trades.  The volume on the RTS exchange is up from USD 59 billion in 2005 to USD 432 billion in the three quarters of 2007. The above examples indicate more than hopeful future for the commodities exchange in Russia, a place that still offers high returns with a diminishing amount of risk9. 

The launch of REBCO in New York has not been as triumphant as it was hoped to be since price discovery of new products often takes years, for example the price search for Brent took three years.  Introduction of a new product requires patience from the investment community.  In a short time, REBCO product has become known to investors, even though trading on NYMEX has encountered problems with physical deliveries.  For this particular reason St. Petersburg exchange would improve trading and deliveries of REBCO10.  

Russian officials have been discussing the launch of a domestic oil futures exchange in St. Petersburg since 2005. Nine bids were submitted for tender to the Ministry of Economic Development and Trade from July 27 through October, 29 of 200711.  On November 14, 2008 Ministry of Economic Development and Trade of Russia (MEDT) declared Saint Petersburg Stock Exchange (SPBEX) the winner, based on its competency and knowledge in sales of natural resource products.  SPBEX is prepared to invest USD 10 million into the development of this sector of trade. Russian officials previously decided that at least 15 percent and up to 25 percent of government petroleum orders have to be purchased through the exchange.  The requirement applies to any organization where State involvement is above 25 percent3.  This would support trading volume on the exchange which would be worth around USD 14.5 billion.   Some have also suggested that government may require oil producers to sell 20 percent of their products on the exchange. Operations on the trading floor are planned to commence in the Q1 of 200812.  In Russia SPBEX is regarded to be the 3rd by volume of activity. MEDT is in the process of establishing an exchange to trade various futures for natural resources including REBCO13.  Exporting countries that establish exchanges domestically have a better opportunity to hedge against future price volatility.  Derivative instruments improve forecasts of future prices vs. the spot markets.  Currently, exporting countries are limited to the exchanges in New York, London and Dubai. 

Effects on Currency

The discussion in regards to establishing the exchange began in 2005 and by 2006, Putin announced that it would be in the best interest of the country to establish the exchange domestically and trade in domestic currency.  Putin stated that it would lead to strength and improve convertibility of the Ruble globally14.  An oil exchange would also allow Russia to become one of the major global financial centers. Oil traded in rubles would motivate the demand for rubles internationally.  This would not make rubles a reserve currency for the world, but it would surely boost its strength and acceptance.  The transformation could take a few years and requires continued economic growth of at lest 7 percent annually15.  This Economic growth has been accomplished in recent years and ruble has seen gains.  Emerging and transitional economies’ experience has been short compared with mature economies, for this reason the success of ruble as reserve currency is unlikely.  Although currencies do fluctuate but the ultimate strength of it does depend on long term political and economical stability. 

Opposition of stronger domestic currency comes from domestic exporters, who fear decline in demand from abroad and a wider trade deficit gap.  However, stronger currency leads lower interest rates for the nation. Therefore lowers the cost of borrowing and doing business.  Other oil exporting countries have proposed oil pricing in a currency other than US dollars.  But the proposal was met with opposition from Saudis, who fear that would lead to further decline of the dollar and would eliminate the values of their currency reserves.  None the less, the world’s largest natural gas exporter, Gazprom, has announced that it plans to sell its products in rubles in the near future.  Rosenft and Lukoil also plan to offer ruble-denominated contracts16.  Costs are paid in rubles and revenues are received in dollars, which creates a narrower gap for the companies. The plan appears beneficial, at the time when the value of exports has decreased due to depreciating dollar and costs have gone up due to appreciated ruble17.

Source: www.asiaecon.org |



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