No. 3, 2009

The 13th St. Petersburg International Economic Forum and the search for ways out of the crisis

For the first time in recent years, the St. Petersburg International Economic Forum greeted its guests not with bright sunshine and white nights, but with leaden skies and pouring rain. Russian President Dmitry Medvedev found this somewhat symbolic, since a cold rain was falling not only on the city at the mouth of the Neva, but also on the world economy, the problems of which the participants of this prestigious event had gathered to discuss.

Confident tone of the talks

The difference between the current, 13th forum and its predecessors was readily visible even to the unaided eye: it had been transformed from a primarily "status" event, offering an opportunity to show off one's triumphs and achievements to the public (and to business rivals and cronies), into a rather deep and not very joyous or optimistic discussion of the problems faced by the Russian and world economies. Nowadays, with fewer social gatherings for the rich and powerful on the fringes of the forum, it has become almost indecent to show off one's wealth and "coolness" behind the scenes. The talks therefore became somewhat more pointed and stuck as closely as possible to the practical problems of industry and the financial world. In doing so, though, did they produce any better results?

Incidentally, the event's most important tradition remained intact: leading figures from the Russian government used the opportunity to announce selected results from the country's development and to outline strategic tasks for the future. This year, President Dmitry Medvedev once again delivered the keynote address - which, as usual, became the forum's main event. The President rightly noted that the forum was taking place at a very difficult time, perhaps in one of the most dramatic periods of the world economy's development, and that this served to create a matching environment and mood. No country has been able to close itself off from what is truly a global crisis. Modern communications and financial technologies made possible the unbelievable speed with which the crisis has spread to all nations. Only through joint actions will it be possible to extricate ourselves.

Dmitry Medvedev sees the artificially maintained unipolarity of the world economy, and the preservation of a monopoly in its key segments, as the fundamental reasons for the current crisis. International financial institutions, which ought to be predicting events and ensuring that any actions are coordinated, have proven to be unwieldy, inflexible, and dilatory.

How does the President propose that we break out of the crisis? First of all, agreement must be reached on a procedure to develop new standards for regulating financial markets and institutions. Second, international financial institutions must be reformed. Finally, new game rules are also needed in the field of energy. In this regard, Dmitry Medvedev noted: "We have already sent our proposals concerning new legal frameworks for international energy cooperation to all of our partners. We believe these initiatives will be received positively, and that our joint work will lead to the adoption of mutually beneficial international agreements, and the drafting of new rules for energy cooperation or amendments to existing energy agreements - amendments that would address the concerns of the greatest possible number of nations."

"I believe the main problem in regulating this field is not that there are no rules, but that these rules are unfortunately of a unilaterally-oriented nature," Dmitry Medvedev later emphasized. "We must create universal rules that will satisfy everyone. Otherwise, these rules will not be followed. Instead of normality, we will have crises and disorganization in the energy sphere, and we cannot allow this to happen."

Against the backdrop of most of the other speakers' presentations, one got the impression that Russia's President was about the only person who saw clearly what should be done in today's difficult circumstances. Other speakers voiced more questions than answers, and their speeches were tinged with a spirit of doubt, rather than of confidence.

Seesawing crisis prices

So far as individual industries were concerned, discussions of the situation therein frequently did not follow the same scenario as that of the abovementioned discussion of macroeconomic topics. That is, Russia would present a detailed plan for action while the experts continued to have their doubts. Events dedicated to the problems of the energy industry were one clear example of this.

In St. Petersburg, RF Vice-Premier Igor Sechin described the basic lines of the country's energy policy. "This year will be the first since 1945 that has registered a drop in global GDP. The financial crisis has impacted the entire world economy. We have no illusions that the crisis is over. All of this is naturally reflected on the world oil market, and it affects both producers and consumers. No one can say what the price of oil will be, or what factors will determine it.

Under these conditions, it is hard for consumer nations to launch mechanisms for restoring consumer demand, and hard for consumers to plan investments in the oil industry and the development of new oil fields," he noted.

In Igor Sechin's opinion, no one should be fooled by the temporary stabilization of prices on the world oil market. First of all, global demand continues to decline. Experts estimate that it is likely to go down this year by 1.5-2 million barrels each day. Commodity reserves remain at a critically low level: 60-62 days' worth, though this figure stood at 72 days when the fall in prices bottomed out. It is not clear when sustained economic growth will begin again in the United States and the other developed countries. Under these conditions, the risk of a further drop in prices remains very high.

International oil companies are reducing their long-term investment in geological exploration by more than 20%. This naturally cannot help but lead to a fall in production capacity and, logically, to a reduction in supplies of crude and a rise in oil prices. The forecast made by the Saudi Arabian oil minister therefore sounds very realistic: quotations for crude will go as high as $150 per barrel in another two years.

Sechin believes that the reason for this instability lies largely in the very architecture of the global oil market. The existing international trading and monetary system is not suited to the needs of the global economy's sustainable development. It has become outdated, and is extraordinarily far from being self-regulatory. Coordinated measures are therefore needed to stabilize it.

In addition, the politicization of the oil industry continues. The situation with the Odessa-Brody pipeline is just one of many examples. All over the world, regardless of the form of property involved, the oil and gas complex is regulated quite strictly by the government. This serves to make the problem of politicization even more intense.

Having outlined the above problems, the Vice-Premier mentioned three main tasks that would, if not help to solve them, at least provide an impetus for their resolution.

The first task is to change the system of commercial oil categories, which is archaic and does not reflect the current structure of crude production. For example, the production of heavy, high-sulfur crude, for which there is no ready pegged price, is rising around the world. This is in turn responsible for a large part of the growth in worldwide demand. In Russia's Eastern Siberian oil fields, production of lighter types of crude is increasing, and there are too few price points for these as well. The Russian government is therefore going to support the creation of new fluid markers. This work should be accompanied by the creation of a new infrastructure of trading platforms and a single payment and settlement system.

The second task is to improve the pricing mechanisms. An equilibrium price for a commodity is known to be set by the relationship between supply and demand. That is, quotations in the case of oil ought to be backed up by a large number of real, and not virtual, market transactions. A situation in which financial institutions invest in commercial oil in order to maintain the value or provisioning of funds, leads to essentially negative consequences for both consumers and producers of crude. Determining speculative capital's exact role in oil price fluctuations is difficult, but, in the opinion of many independent experts, the actions of global financial players were indeed the main reason for the rise in quotations between 2002 and 2008. When the market peaked, the volume of open derivative positions stood at 10 billion barrels, while annual world production was 8.6 billion! It is therefore necessary that short-term speculative capital's participation in operations concerning oil be restricted with the help of one international instrument or another. Priority should be given to long-term contracts that might also be concluded as exchange transactions (or at least be registered with an exchange). This would allow us to consider real costs of oil production and transportation, and to draw up plans for investment in long-term projects.

The third task is to reduce the oil industry's systemic risks. In particular, it must be secured against instability in currency markets. Ways of reforming the existing system for pegging prices to a single currency must be discussed. Otherwise, the oil industry could find itself a hostage to the decisions of one country's government.

The reality of price fairness

In general, the speeches of other participants were devoid of any specific content matching that of the Russian vice-premier's report. Daniel Yergin, Chairman of Cambridge Energy Research Associates, believed that the oil price movement will depend on three factors: the size of investments, the magnitude of costs, and the routes of crude transit. The first factor is of decisive importance, since the development of new oil and gas fields and - most important - of the Arctic will be impossible without increased capital outlays. Daniel Yergin nevertheless declined to predict the course oil prices will follow.

Nobuo Tanaka, Executive Director of the International Energy Agency, an organization that is the developed countries' main think-tank in the field of energy, also refrained from making any concrete predictions. He only suggested that the price of oil will rise in the long term and then called for an increased focus on future planning. Nobuo Tanaka compared this process to driving an automobile: the driver must always look not just beyond the bumper but several hundred meters ahead, otherwise an accident is bound to occur. In the oil industry, the possibility of such an accident happening in the near future cannot be ruled out - by 2010, 67% of all currently producing fields will be unable to maintain today's level of output. Greater investment in geological exploration and the production of crude is therefore vital.

Edward Morse, Managing Director of Louis Capital Markets, noted that oil prices depend not on real economic factors but on the expectations of market players. They are therefore always unpredictable and resemble the finale to some kind of magic act. "We might call them ‘Houdini prices,'" Edward Morse joked. The problem is that we know too little about demand, and are unable to predict it. In terms of concrete forecasts, Morse limited himself solely to

suggesting that demand in the East will grow faster than in the West, and that Russia's intentions to reorient part of its exports to the Asian nations are entirely justified.

The Russian representatives at the forum were more daring in their forecasts. Vagit Alekperov, President of LUKOIL, said: "Today, there are no fundamental reasons for prices falling below $40... The situation that now prevails in the economies of the consumer nations - the United States, Europe, Japan - gives us an opportunity to analyze scenarios for our own development. On the one hand, energy efficiency and a transition to alternative sources of energy will soon be actively encouraged at the government level in the Western nations. On the other, Southeast Asia will show a rise in the consumption of energy resources. Other countries will stabilize or reduce their consumption of fossil fuels. On the whole, figures for the production and consumption of hydrocarbons are already drawing close to one another. Throughout a large part of the 20th century, new oil and gas fields were opened that compensated for the resources already spent. Unfortunately, no fields like those were opened in the last few decades, and no such rapid development has been seen (with the exception of the Caspian region in the 1990s). I therefore believe that around the world, and in Russia too, geological exploration must be encouraged, and reserves created that would allow all of us to look forward with confidence."

Despite some fuzziness in the assessments of a number of experts, however, discussion participants nevertheless arrived at a shared opinion regarding the so-called fair price for oil. During electronic voting that was held separately for the experts and oil company executives, both groups' points of view coincided: a realistic price for crude is $70 to $80 a barrel.

On the whole, and in spite of all its disagreements, the St. Petersburg International Economic Forum demonstrated that, in the midst of a global economic crisis, all of the world's main market players were ready for dialogue and collaboration. We cannot, after all, shelter under our individual national umbrellas in the face of a downpour of stagnation. We must create a durable common canopy that can withstand any blow dealt by the elements of the market.