Friday Reads: Weaponized Oil and a tale of conspiracies

Good Morning!

So, I’m going to write briefly about something that’s been fascinating me lately.  That’s the incredible decrease in oil prices and the impact that it’s having on Russia and other oil producing nations outside of the Emirates and Saudi Arabia .  I’m a sucker for a good currency crisis since it’s basically right up my research alley.  

Also, oil has been one of those commodities that’s pretty much dominated my adult life.   I remember having to buy gas on even days because the Dealer’s tags on our cars ended in 8 during the oil crisis.  I know what it did to my dad’s business as a car dealer.  Basically, oil’s been the most fungible commodity in modern times.  No modern economy can live without it.   We’ve definitely fought wars to control it.  Oil’s being weaponized like never before.

There are several key factors driving down your gas at the pump. First, the global economy has slowed down so that the demand for oil has tapered off.  That’s one thing that’s been at play. But the more interesting factor has been the increase in supply which is related to the interesting way that Saudis have been ignoring  OPEC quotas and inching up the supply.  There’s been some rumors going around–actual conspiracy theories– that they are doing so for three reasons.  First, they want to make sure that the nascent tar sands oil industry in North America isn’t profitable.  Second, they want to hurt Iran, Syria, and Iraq and any other Shia nation involved with oil production.  The third reason is to get at Russia.  I want to share what I’ve found on these fronts with you.  It has the feel of a new kind of cold war and the opposite of the gas wars of the 1970s.

Russia just experienced a “Black Monday” in that the Russian Stock market has collapsed as has the ruble.  The Russia economy is heavily dependent on oil exports so any decrease in oil prices has an impact.  These continued price decreases have their economy on the verge of failure.  The entire situation has been exacerbated by UN Sanction against the country for its invasion and intervention in the Ukraine.  It’s not pretty.

In recent weeks, the fall in the Russian ruble and Russian stock markets closely tracked the declines in global oil prices. But everything changed on December 15. The oil price remained stable, but the ruble and the stock-price indices lost 30% in the subsequent 24 hours. An unprecedented effort by the Central Bank of Russia (CBR) in the wee hours of December 16 to stabilize the ruble, by hiking the interest rate from 10.5% to 17%, proved useless.

The cause of Russia’s “Black Monday” was readily apparent: the government bailout of state-owned Rosneft, the country’s largest oil company. Usually, bailouts calm markets; but this one recalled early post-Soviet experiments, when the CBR issued direct loans to enterprises – invariably fueling higher inflation. The CBR’s governor at the time, Viktor Gerashchenko, was once dubbed the world’s worst central banker.

In 2014, the CBR is more constrained than it was in Gerashchenko’s era: it cannot lend directly to firms. Yet it has also become more sophisticated at achieving the same ends that Gerashchenko sought.

In October, Rosneft issued $11 billion worth of ruble-denominated bonds (an unparalleled amount for the Russian market, equivalent to 70% of the total value of corporate bonds issued in Russia this year). The coupon on these bonds was actually 1.5 percentage points below sovereign bonds of similar maturity, which is also unusual, especially given that Rosneft currently is subject to Western sanctions.

Then, unnamed investors (allegedly the largest Russian state banks) benefited from the CBR’s decision on December 12 to allow these bonds to be used as collateral for three-year CBR ruble loans at the policy rate. Moreover, the CBR scheduled a special auction for such loans on December 15 – with the total amount of the loans similar to that of Rosneft’s bond issue. Thus, the CBR would be able to provide a massive pile of rubles to Rosneft at below-market rates. So why did the deal trigger a panic?

At first glance, this deal was intended to meet contemporary Russia’s most important economic challenge. Sanctions have cut off Russian banks and companies from Western financial markets. Russian companies have to repay or refinance about $300 billion of debt over the coming two years. Some of this debt is owed to Russian companies’ offshore owners, who will certainly be happy to roll it over. But in most cases, firms’ liabilities comprise real debt owed to major international banks.

 Global investors are anxiously awaiting some kind of strategy for recovery.  Actions by the Central Bank of Russia have been very curious.   All of the countries that depend on oil exports for huge amounts of their funding are in trouble.  Russia is probably just the most obvious of them.  This goes for Iran also. That’s because both of them are heavily weighed down by UN sanctions.

The non-OPEC producing countries (Russia, Brazil and Norway, as examples) are starting to become backed into an economic corner.  In all of these countries, oil represents a major export and helps finance other economic activities.  For example, as Russia sells oil in the open market (priced in dollars) at $60 per barrel, the revenue in dollars is 50 percent less than was the case in June of this year.  Since June, the Russian Ruble has declined by 59 percent (to the U.S. dollar).  A “crash” in the value of any currency leads to very high inflation (imports are now more expensive than would have otherwise been the case), which leads to potential civil unrest.  On a global scale, the “wealth” of Russia as a nation, priced in Rubles, has declined by 59 percent in the last six months. 

 This is the stuff that leads to revolutions.  Oil, other commodities and vodka are about the only exports Russia creates and helps fund their country’s spending.  They are net importers of most all consumption goods (health supplies, food, etc.).  In their own currency, those imports are now 59 percent more expensive than they were this past summer.

To some, the problem Russia currently faces sounds like something Vladimir Putin created by his dalliances in the Crimea and Ukraine.  There is some truth to this as those actions led to economic sanctions unleashed by the West on Russia. The oil pricing issue is indirectly due to his destructive behavior.   What really matters to the rest of the world at this stage is the potential for economic weakness to spread to the rest of the world from Russia… monetary contagion, anyone?

How would this happen?  Why would the rest of the world be negatively affected by weakness in the Russian Ruble?  Russia’s economy is the world’s eighth largest (as measured by the IMF ), a little larger than Italy and a little smaller than Brazil.  At about $2.1 trillion in GDP, Russia is dwarfed by the United States at $17.5 trillion.  If Russia’s economy contracts by  4 percent (which potentially is in the cards for 2015), it will impact the world’s GDP by about $84 billion, or .1 percent.  No big deal.  However, let’s think not about the world’s income statement (GDP) but rather about the world’s balance sheet – the world’s banking system.

Most Russian national debt is priced in Rubles and the value of that debt has collapsed from six months ago when the Ruble was higher and Russian interest rates were dramatically lower.   Russia’s public debt is $216 billion.  The Russian benchmark interest rate was at 7.5 percent in June of this year – that interest rate is now 17 percent.

How much this impacts any other country has a lot to do on how many banks hold Ruble-denominated assets or liabilities.  The interesting thing is that Saudi Arabia seems no where done with its dalliance in increasing oil supply.  This particular bit of news is what motivated me to finally bring this up here.  The emirates and Saudi Arabia seem willing to dig into their own sovereign wealth and their countries’ spending to see this through.  They must be extremely serious about something. Is it the threat from Shia Muslims?  From US Fracking Oil?  Do they just plain hate the Russians?

Saudi Arabia’s Cabinet on Thursday endorsed a 2015 budget that projects a slight increase in spending and a significant drop in revenues due to sliding oil prices, resulting in a nearly $39 billion deficit

In a sign of mounting financial pressure, the Finance Ministry said the government would try to cut back on salaries, wages and allowances, which “contribute to about 50 percent of total budgeted expenditures.” That could stir resentment among the kingdom’s youth, who make up a majority of the population and are increasingly struggling to find affordable housing and salaries that cover their cost of living.

The price of oil— the backbone of Saudi Arabia’s economy — has fallen by about a half since the summer. Saudi Arabia is extremely wealthy, but there are deep wealth disparities and youth unemployment is expected to mushroom absent a dramatic rise in private sector job creation. The International Monetary Fund says almost two-thirds of employed Saudis work for the government.

A the height of Arab Spring protests sweeping the region in 2011, King Abdullah pledged $120 billion to fund a number of projects, including job creation and hikes in public sector wages. The move was largely seen as an effort to appease the public and blunt any challenges to monarchical rule.

Associate Fellow and energy researcher at Chatham House, Valerie Marcel, said massive government spending across the Gulf on public sector salaries is “really the thing that keeps the lid on the bottle.” She said that for now the Arab monarchies of the Gulf can afford to run deficits due to surpluses accumulated over the years from high oil prices.

Now that’s commitment. There’s actually some discussion around that the US and the Saudis basically colluded to drop oil prices.   This all is happening while OPEC has called for widespread production cuts.  Anyone with a little game theory background along with economics know that this is a deadly game.  The ones that cut their production will lose income.

Turning to the current price drop, the Saudis and OPEC have a vested interest in taking out higher-cost competitors, such as US shale oil producers, who will certainly be hurt by the lower price. Even before the price drop, the Saudis were selling their oil to China at a discount. OPEC’s refusal on Nov. 27 to cut production seemed like the baldest evidence yet that the oil price drop was really an oil price war between Saudi Arabia and the US.

However, analysis shows the reasoning is complex, and may go beyond simply taking down the price to gain back lost marketshare.

“What is the reason for the United States and some U.S. allies wanting to drive down the price of oil?” Venezuelan President Nicolas Maduro asked rhetorically in October. “To harm Russia.”

Many believe the oil price plunge is the result of deliberate and well-planned collusion on the part of the United States and Saudi Arabia to punish Russia and Iran for supporting the murderous Assad regime in Syria.

Punishing Assad and friends

Proponents of this theory point to a Sept. 11 meeting between US Secretary of State John Kerry and Saudi King Abdullah at his palace on the Red Sea. According to an article in the Wall Street Journal, it was during that meeting that a deal was hammered out between Kerry and Abdullah. In it, the Saudis would support Syrian airstrikes against Islamic State (ISIS), in exchange for Washington backing the Saudis in toppling Assad.

If in fact a deal was struck, it would make sense, considering the long-simmering rivalry between Saudi Arabia and its chief rival in the region: Iran. By opposing Syria, Abdullah grabs the opportunity to strike a blow against Iran, which he sees as a powerful regional rival due to its nuclear ambitions, its support for militant groups Hamas and Hezbollah, and its alliance with Syria, which it provides with weapons and funding. The two nations are also divided by religion, with the majority of Saudis following the Sunni version of Islam, and most Iranians considering themselves Shi’ites.

“The conflict is now a full-blown proxy war between Iran and Saudi Arabia, which is playing out across the region,” Reuters reported on Dec. 15. “Both sides increasingly see their rivalry as a winner-take-all conflict: if the Shi’ite Hezbollah gains an upper hand in Lebanon, then the Sunnis of Lebanon—and by extension, their Saudi patrons—lose a round to Iran. If a Shi’ite-led government solidifies its control of Iraq, then Iran will have won another round.”

The Saudis know the Iranians are vulnerable on the oil price. Experts say the country needs $140 a barrel oil to balance its budget; at sub-$60 prices, the Saudis succeed in pressuring Iran’s supreme leader, Ayatollah Ali Khamanei, possibly containing its nuclear ambitions and making the country more pliable to the West, which has the power to reduce or lift sanctions if Iran cooperates.

Adding credence to this theory, Iranian President Hassan Rouhani told a Cabinet meeting earlier this month that the fall in oil prices was “politically motivated” and a “conspiracy against the interests of the region, the Muslim people and the Muslim world.”

So, you can see, there’s a little bit of economy theory blended with conspiracy theory here.  Frankly, I”m all for Saudi Arabia crippling American Fracking even though I’m sitting in a state where things will only go from bad to worse in this situation. (Although I will mention I’m actively looking at real estate in Washington State right now.)

Despite repetition in countless media accounts and analysts’ notes over the past few weeks, though, the idea of a “sheikhs vs. shale” battle to control global oil supplies has precious little evidence behind it. The Saudi-led decision to keep OPEC’s wells pumping is a direct strike by Riyadh on two already hobbled geopolitical rivals, Iran and Russia, whose support for the Syrian government and other geostrategic machinations are viewed as far more serious threats to the kingdom than the inconvenience of competing for market share with American frackers.

Among the world’s oil producing nations, few suffer more from the Saudi move than Tehran and Moscow. At a time when both are already saddled with economic sanctions — Russia for its actions in Ukraine and Iran for its alleged pursuit of nuclear weapons technology — the collapse of oil prices has put unprecedented pressure on these regimes. For Russia, the crisis has hit very hard, with the ruble losing 40 percent of its value to the dollar since October. This is particularly problematic since Russian state-owned oil firms have gone on a dollar-borrowing spree in recent years; now, servicing that debt looks very ominous.

True, Saudi OPEC minister Ali al-Naimi insisted last month that the move was intended to target shale. But he would say that, wouldn’t he? After all, his OPEC counterparts were standing beside him — including the OPEC minister from Iran.

The fact is, Saudi Arabia has little to fear from shale. Saudi Arabia’s huge reserves of conventional oil can and probably will be produced for decades after the shale boom has run its course — which the U.S. Energy Information Administration (EIA) expects to happen by 2050 or so — and at much lower costs.

So, that one could be just a conspiracy theory.  Anyway, it is very interesting situation that seems to converge economics with geopolitics.  It won’t be the first time that oil and other commodities have been used as weapons.  The Spanish Empire was taken down by its gold lust and hoarding by Good Queen Bess as one example.   It’s really interesting no matter what the rationale.

For all our worries over Russia, however, we in Britain should not lose sight of the humiliation of another swaggering and once-mighty force in world politics, the Organisation of Petroleum Exporting Countries (OPEC). When it burst on the world scene 40 years ago, OPEC terrified the wasteful West.

Over the previous decades, we had grown used to abundant oil, bought mostly from Middle Eastern producers — with little global muscle — at rock- bottom prices.

However, OPEC changed that. By restricting supply, the cartel quadrupled the oil price, from $3 to $12.

Saudis remain in a strong position because oil is cheap to produce there. Above, the country’s Minister of Petroleum and Mineral Resources Ali Ibrahim Naimi

That is only a fraction of today’s price — but the oil crisis sparked by the rocketing cost in 1974 was enough to lead to queues at filling stations and national panics in the pitifully unprepared industrialised world.

Four decades later, Saudi Arabia has become one of the richest countries in the world, with reserves totalling nearly $900 billion.

But the rest of the world is less at its mercy than it once was. Here in Britain, our energy consumption is dropping remorselessly — the result of increased energy efficiency.

Moreover, many other nations now produce oil. And oil can be replaced by other fuels, such as natural gas, which OPEC does not control.

Also, OPEC no longer has the discipline or the clout to dominate the market, and we in Britain are among the big winners from all this, reaping the benefits of lower costs to fill up our cars and power our industries.

At its meeting in Vienna last month, the OPEC oil cartel — which controls nearly 40 per cent of global production — faced a fateful choice.

Would it curb production and thus, by reducing supplies, try to ratchet the oil price back to something near $100 a barrel — the level most of its members need to balance their books? Or would it let the glut continue?

The organisation’s 12 member countries, including Saudi Arabia, Iran, Iraq, Kuwait, Venezuela and Nigeria, chose to do nothing, proving that its once-mighty power has withered. Oil prices subsequently fell even further.

One central problem is that several of OPEC’s members detest each other for a variety of reasons.

Above all, Saudi Arabia and its Gulf allies see Iran — a bitter religious and political opponent — as their main regional adversary.

They know that Iran, dominated by the Shia Muslim sect, supports a resentful underclass of more than a million under-privileged and angry Shia people living in the gulf peninsula — a potential uprising waiting to happen against the Saudi regime.

The Saudis, who are overwhelmingly Sunni Muslims, also loathe the way Iran supports President Assad’s regime in Syria — with which the Iranians have a religious affiliation. They also know that Iran, its economy plagued by corruption and crippled by Western sanctions, desperately needs the oil price to rise. And they have no intention of helping out.

The fact is that the Saudis remain in a strong position because oil is cheap to produce there, and the country has such vast reserves. It can withstand a year — or three — of low oil prices.

The fact is that the Saudis remain in a strong position because oil is cheap to produce there, and the country has such vast reserves. It can withstand a year — or three — of low oil prices.

In Moscow, Vladimir Putin does not have that luxury — and the Saudis know it.

They revile Russia, too, for its military support of President Assad, and for its sale of advanced weapons to Iran.

So there’s the piece on why Russian and Iran are targeted.  Anyway, unless you’re a CIA analyst specializing that area with access to all the back and forth, it’s hardly possible to untangle all these wicked webs.  It is evident, however, that the Saudis have some bones to pick with a lot of folks and picking away they are.

It will be interesting to watch this unfold.  I have no doubt this will have bigger implications and I also know that most folks aren’t following this.  I’m also pretty sure the usual news outlets are giving this short shrift. You can tell if you if follow any of my links because only one goes to the NY Times.  The rest are mags that are read by very few folks.

So …. What’s on your reading and blogging list today?