Michael McTague: One Singular Sensation, Part I

Michael McTague  |

Image: Samuel Bailey (sam.bailus@gmail.com) - Own work, CC BY-SA 3.0, commons.wikimedia.org/w/index.php?curid=8462300.

February 2020 — Myth Buster

Investors fret when countries that should diversify their industrial bases take no meaningful action. In this new series, we sink our teeth into such singular industry nations as Russia, Saudi Arabia and Nigeria. Many countries endowed with huge natural resources rake in revenue from the world’s appetite for what comes out of the ground, out of the ocean and from under mountains.

Russia is the focus of this entry. Oil rich, the nation lives off all kinds of natural resources. But the scaled down centerpiece of the former Soviet Union lags in management and organizational skill. Despite millions of acres of farmland, they stumble over harvesting, shipping and distributing food to a substantial population (145 million, ranking ninth worldwide). While their national revenue comes from their cherished resources, they have dumped raw sewage on caviar beds and allowed US mink farms to out-produce them. Even more importantly, Russia has never built up its general manufacturing and business capability.

Military Spending or Consumer Spending?

The reasons are legendary, including a tremendous focus on military power in previous decades combined with a massive distrust of private industry and the creation of personal wealth. The country’s xenophobia also kept it from picking up good ideas from other nations, even those looking to expand their own markets.

From the perspective of a reasonable investor, one would like to find good opportunities to invest in industries and infrastructure. At least, one would like to invest in bonds issued by well managed nations that are improving their industrial capabilities.

Emerging nations, especially the famous BRICS (Brazil, Russia, India, China and South Africa) have enticed investors to take notice. For a time, Russia enjoyed a good economic run. Then, problems set in for most of this unruly group of would-be compatriots. Russia stands out as the most troubling and the country from which we can learn the most because it reveals so many mistakes.

While a handful of people buy mink coats, and a few bon vivants order caviar for cocktail parties and imbibers light up at the mention of Smirnoff, Russia’s economic success rests on oil and gas. If Russia encompassed a small population, it could do very well. But its many inhabitants cry out for more industry.

A key problem for Russia is the sharp drop in oil prices. According to macrotrends.net, oil cost $113 a barrel in May 2011; in early November 2019 it stood at $56 a barrel. In such a predicament, the smart thing to do would be to cut production. Conversely, Russia increased oil production from 9,493,000 barrels per day (rounded) in 2009 to 10,527,000 in 2019. Clearly, wisdom was lacking in this decision. Desperate for cash, they lacked the wherewithal to plan for a wider industrial base. A vicious cycle ensues. They milk their most precious natural resource regardless of business conditions.

Here are the four largest business entities in the country and their values:

1

Gazprom (OGZPY)

Oil and gas

$112.2 billion

2

Lukoil (LUKOY)

Oil and gas

$93.85 billion

3

Rosneft (OJSCY)

Oil and gas

$86.22 billion

4

Sberbank of Russia (SBRCY)

Finance

$53.7 billion

Yes, oil and gas companies need to work with banks. Also, isn’t this reminiscent of Saudi Arabia’s corporate structure? Oil and gas along with banking! Almaz-Antey, a Cold War carryover, is Russia’s largest arms manufacturer and one of the world’s largest. Manufacturing prowess is absent.

Trade Surplus Offers Little Good News

For 2018, Russia enjoyed a trade surplus. For most emerging economies, that would represent a real positive. They sell more abroad than they buy. Falling imports also contributed to the surplus. This is not, however, a great sign for any economy. It means that people have less money to spend on attractive international products. In fact, personal income has fallen for five straight years.

Almost half of Russia’s exports go to the European Union. And 60% of Russia’s exports are oil/gas. A substantial portion of Russia’s exports is are machinery, which supports the infrastructure for oil/gas. According to Offshore Technology, the Yamal-Europe Pipeline ranks as the world’s second longest: 2, 623 miles, connecting Western Siberia natural gas to Austria, stretching across Russia, Belarus, Ukraine and Slovakia. It also ranks as the world’s widest pipeline, able to carry 33 billion cubic meters of natural gas through 14 compressor stations.

Given Russia's population and its earlier success as an emerging economy, automobile manufacturers -- Volkswagen, Renault, Ford and General Motors -- have long eyed the country as an attractive opportunity. In fact, vehicles rank among its largest imports, over $28 billion in 2018. If, however, Russia had developed a manufacturing capability to match its prowess in energy production, it would not be an attractive market to outside manufacturers.

Absent Safety Nets

Another consequence of so much reliance on oil and gas is the dearth of funds to provide the kind of safety nets that resemble wealthy countries. According to Expatica, Russian healthcare, although free, reveals poor infrastructure. Many rural areas have no local hospitals. Unemployment insurance is shrinking because of a falling ruble and increasing budget deficits.

Russia’s paltry $11,200 per capita annual income, according to the International Monetary Fund (IMF), puts it behind Chile ($15,400), a nation that not long ago moved into the lauded emerged market category. Despite Russia’s vast natural resources and massive infrastructure to get the resources to willing buyers, it has never moved its economy or its population very far up the economic ladder.

The title of this myth comes from “A Chorus Line.” Stay tuned. Our series exposes the realities of countries bound to one industry. The oil glut ripped off oil’s financial glamour. More damage comes from pumping oil at bargain prices as if the Russians were in New Jersey (just a joke!). Next month, we will focus on another single industry nation.

**********************

Michael McTague, Ph.D. is Executive Vice President at Able Global Partners in New York, a private equity firm.

___

Equities Contributor: Michael McTague, PhD

Source: Equities News

DISCLOSURE: The views and opinions expressed in this article are those of the authors, and do not necessarily represent the views of equities.com. Readers should not consider statements made by the author as formal recommendations and should consult their financial advisor before making any investment decisions. To read our full disclosure, please go to: http://www.equities.com/disclaimer. The author of this article, or a firm that employs the author, is a holder of the following securities mentioned in this article : None


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