"Addicted to oil"?

An interesting article exploring the potential pitfalls of a petrodollar-addicted economy - and noting the discount to the RTS resulting from the uncertainty associated with the 2008 political succession:

Market Comment: The trouble with oil
Alfa, Russia (via bne)
Monday, April 2, 2007

[...] The focus today will be on oil. The trouble with the current rise is that Russian equities, on balance, no longer benefit from it. Quite the opposite - the rising price presents a clear threat to global equity markets at a time when investors are preoccupied with worries over the US economy and global growth.

Despite the more than 8% rise in the price of oil last week, the local bourses ended the week with sliding prices and only a small gain (the RTS rose 1.1% while MICEX ended 0.2% lower) for the week. The reason is because since mid-2006 the main driver of the local equity markets has been the trend in global emerging markets. Ever since the re-weighting of Russia in the GEM index (as a result of the removal of restrictions on Gazprom shares), the RTS has moved more in line with MSCI GEM. At the end of 2006 Russian equities accounted for 10% of the GEM universe, and the valuation of the market, based on 2007 earnings, was considered to have closed to an appropriate discount (10%) given the uncertainty associated with oil vulnerability and the political succession.

Hence the current rise in the price of oil presents much more of a risk to the market than it provides a favorable backdrop:

• Rising oil threatens economic growth in the global economy and causes inflationary pressures. Therefore while the US Fed may not be inclined to raise rates because of the threat to growth, it cannot easily start to cut either because of the inflation threat.

• This means that one of the optimistic assumptions that supported equities during last December's strong run, i.e. falling rates in 2007, is less sure and allows the more bearish investors to again focus on the poor growth indicators.

• Rising oil does not materially affect the earnings growth of either the oil shares or the market because of the high incremental tax take by the state.

• High oil does of course add to federal budget earnings and helps boost the Stabilization Fund. But since January the ruble is now much more highly correlated on a trend basis with the oil price (see later).

This means that higher oil also pushes the ruble higher and the broader effects (i.e. more speculative flows and greater liquidity) increase inflationary pressures.

• For export earners, i.e. mainly the extractive industries, that means a margin squeeze as dollar-based revenues are reduced and domestic costs are increased.

• If the price of oil spikes, or even creeps, much higher, it will add to the weight of worries already depressing international equity markets.

That could very easily result in another round of fund redemptions from nervous investors - especially if there is also some other negative indicator in the global economy (i.e. a bad US housing or payroll report this week) at the same time. [...]