Oil shocks can overhaul the global economic order at alarming speed and another one is under way. While oil-importing countries will love the cheap energy bills, the price plunge threatens to lay waste to a few oil exporters that, only a year ago, were riding high as wave after wave of petrodollars sloshed onto their shores and drained into government and private bank accounts.
The most prominent victim in the making is Russia. But there are others, including oil-rich, cash-poor Venezuela, whose economy is already at the point of collapse.
Russia is a textbook example of the dangers of relying on a single commodity. Oil and natural gas account for three-quarters of its exports and more than half of its budget revenues. When oil prices are robust, so is Russia. When they are weak, Russia is in trouble. In 1998, when oil prices sank to $10 (U.S.) a barrel, Russia defaulted on its debt. A decade later, when they reached $147 a barrel, Russia was among the hottest emerging markets and the streets of Moscow and St. Petersburg were clogged with BMWs while oligarchs such as Roman Abramovich collected mega-yachts, soccer teams, fashion models and other trophies.
This week, after a price plunge that has seen oil go from $110 to less than $60 in six months, the Russian economy and its private companies found themselves again in peril. “Black Tuesday” saw the ruble swing by 36 per cent in the wrong direction between dawn and dusk. The fall, the biggest one-day drop since the 1998 default, came even though the Russian central bank, in a desperate and doomed effort to prop up the currency, had jacked up interest rates by 6.5 percentage points to an astonishing 17 per cent. “The situation is critical,” the central bank’s vice-chairman, Sergei Shvetsov, said that day. “What is happening is a nightmare that we could not even have imagined a year ago.”
Two days later, on Thursday, Russian President Vladimir Putin used his annual year-end news conference to try to calm the markets and the masses. He blamed a good part of Russia’s problems on the American- and European-led economic sanctions, the result of Russia’s aggression in Ukraine. He predicted Russia’s downturn will be short-lived, that the economy will adapt and diversify, and that the world will again come begging for its energy. “Our economy will overcome the current situation,” he said. “How long will it take? I believe about two years is the worst situation.”
Mr. Putin’s pitch failed. Even as he was trying to talk up the market, the ruble slid again and U.S. and European car makers suspended exports to Russia because the ruble’s wild price swings made retail pricing impossible. In spite of Mr. Putin’s soothing words, investors know that Russia’s fate is not in its own hands, that the oil price is not being determined at the trading desks in Moscow or London or New York. It is being determined in Riyadh, the Saudi capital, where the decision not to reduce the Organization of Petroleum Exporting Countries’ output in the face of waning global growth and soaring U.S. shale-oil production has sent prices spiralling down.
The fear in the West is that a deep Russian recession will trigger social upheaval and erratic or provocative policy responses from Mr. Putin. “Putin’s response geopolitically is a complete unknown,” says George Magnus, an independent economist who is the former chief economist of Swiss banking giant UBS. “Nationalistic distractions should not be ruled out.”
Oil shocks are nothing new. They happen once every decade or less and, depending on whether the shock sends the prices soaring or sinking, they transfer massive amounts of global wealth from oil-consuming to oil-exporting countries or vice versa. They can be politically motivated, the result of market forces or both. In each oil-shock scenario since the 1970s, OPEC, the oil cartel led by the Saudis, which is now responsible for about one-third of global production, has played a starring role.
The first oil shock, the result of the 1973-74 Arab oil embargo, quadrupled oil prices and tilted energy’s power base in favour of Saudi Arabia and the other OPEC biggies. The second came in 1986, when OPEC gave up defending prices and allowed them to drop precipitously, just as it is doing now, setting the stage for a quick bounce back. The third, in the late 1990s, sent prices plummeting again, putting OPEC under enormous strain and bankrupting Russia (a non-OPEC member), which by then was competing with the Saudis for the title of biggest oil exporter.
The fourth, in the two years before the 2008 financial crisis, sent oil prices to a record $147, a level that would have been unsustainable even if the crisis did not happen. The OPEC countries and Russia were swimming in petrodollars and the price rise gave Alberta the brawny confidence to turn the oil sands into the world’s single biggest resources project.
The current shock is threatening to take all that oil wealth away from the oil-exporting countries and transfer it in the form of low energy prices to oil importers such as India, China, Japan and the European Union. If prices stay low – they’re down about 45 per cent since June – there will certainly be more winners than losers since low prices give families and businesses extra disposable income, as if they were handed a tax cut. But the pain suffered by Russia and the weakest members of OPEC – notably Venezuela, Nigeria, Iran, Iraq and Libya – will not be a pretty sight. The result could be social and regional instability as their governments impose austerity or kill suddenly unaffordable social programs such as fuel subsidies.
What is different about the current shock is that, for the first time, the United States and Canada are the culprits, says Olivier Jakob, managing director of Swiss oil research firm Petromatrix and one of the few analysts who predicted the price plunge last summer.
“The extra supply that created the glut is coming from North America,” he said, referring mostly to the relentless rise of U.S. shale oil production. “Now OPEC is trying to shut down expensive production all over the place.”
The oil glut was made worse by the economic slowdown on large parts of the global map. Chinese growth, the driver of the recovery after the 2008 financial crisis, is still intact but slowing considerably. Europe is trapped in stagnation and Group of 20 economies such as Italy and Brazil went into recession this year. As a result, oil demand growth is waning and, as every energy trader knows, a small demand swing either way can have an outsized affect on prices.
The event that turned the fairly gradual price slide into a price slaughter happened in Vienna, on Nov. 27, when OPEC (read: Saudi Arabia) emerged from its meeting with no intent to reduce its production quota of 30 million barrels a day. Market forces would be allowed to take over and the price duly plunged.
Today, everyone from economists and energy traders to oil company bosses and finance ministers are trying to figure out what the OPEC game plan is, which means determining what the Saudi game plan is.
If it’s a market-share war, one driven by the Saudis’ desire to choke off expensive production wherever it lies, the Saudis may be bent on keeping prices down for years. Otherwise, what’s the point? If prices are allowed to bounce back in, say, six months, the expensive production like shale oil would simply spew forth again and OPEC would be back to square one. That’s why this comment on Thursday from Saudi oil minister Ali al-Naimi was met with some skepticism: “What we are facing now and what the world is facing is a temporary situation and will pass.”
The problem with keeping prices low for a long time is that it risks sabotaging the health of the weakest OPEC members. Saudi Arabia and its healthy Persian Gulf allies – United Arab Emirates, Qatar and Kuwait – have ample foreign exchange reserves, low national debt and exceedingly low pumping costs, meaning most of their oil wells can produce profits at $50 a barrel. Not so most of the OPEC countries beyond the Gulf, which generally require high prices to balance their budgets.
Venezuela looks like a basket case. Various sources say it needs about $120 a barrel to balance its budget. Since late November’s OPEC meeting, all of its key financial numbers have deteriorated at frightening speed. The credit default swaps, a form of insurance against sovereign bond defaults, have tripled to the point they are higher than those of Ukraine, a country being torn apart by civil war. Nigeria is also suffering as oil falls. In a note published this week, RBC Capital Markets called the country a “house of cards” and concluded that it is the OPEC country “probably at the greatest risk of significant social unrest in this price environment.”
Mr. Jakob, of Petromatrix, says the OPEC countries outside the Gulf “will participate against their will in the supply rebalancing of 2015.” Translation: Financial and social stress will conspire to destroy some of their production. The question is whether a country like Venezuela will require a bailout if its production collapses as prices plumb the depths.
The Western world’s leaders don’t seem to care much what happens to Venezuela and other members of the OPEC B-team. They’re focused on big, powerful, well-armed and apparently imperialistic Russia. While some stories in the West suggest Russia is in great peril at $60 oil, the reality is somewhat different. It is hard to compare the 1998 price collapse, the one that pushed the country into insolvency, with today’s. The first crisis was a sovereign crisis; this one is hitting the private sector hardest.
When oil recovered after the late 1990s rout, Russia all but eliminated its national debt and built vast currency reserves, which, at last count, were about $400-billion in spite of expensive interventions to defend the ruble. The state itself is in no danger of collapse, even if a deep recession hits. It is Russian industry, from banks to oil producers, that are wobbling. “Russian companies borrowed abroad in foreign currency,” says Mr. Magnus, the economist. “Paying it back could crucify them.”
If the ruble falls by 50 per cent, and it has, the cost of serving the foreign debt doubles. Russian companies, and a few state agencies, have nearly $700-billion in external debt. This month alone, $30-billion of that amount must be repaid, with another $100-billion coming due next year. The problem is made worse by the economic sanctions, which have made it all but impossible for Russian companies to finance themselves in Western markets.
The Russian state is already running to the rescue of its corporate children. A few days ago, Rosneft, the state-controlled oil giant, and the central bank cooked up a deal that was, in effect, a soft bailout of Rosneft. The company raised about $10-billion in ruble-denominated bonds at rates below those of Russian sovereign bonds. The bonds were then bought by the state banks, which in turn were swapped for dollar loans from the central bank.
Between low oil prices and sanctions, Russia faces economic and private-sector storms. Its fix-it plan is unknown, likely because it doesn’t exist.
Saudi Arabia has signalled that it might be willing to reduce oil output if Russia agrees to cuts too. Russia reportedly rejected the offer. That looks to have been a mistake on Russia’s part. Mr. Putin’s prediction of a Russian revival within two years already looks optimistic.Report Typo/Error