16 Dec 2014

The Putin doctrine – unplugged

Just before he took power, in 1999, Vladimir Putin announced that oil, gas and mineral revenues would be crucial to Russia’s future in the first half of the 21st century.

It would fund the reconstruction of its military, fuel long-term growth at between 4 and 6 per cent a year, and create a newly-enriched middle class to fill the gap between the poor and the oligarchic elite.

That was the Putin doctrine – and tonight it lies in ruins. The collapse of the rouble was fuelled by the collapsing price of oil. But if you look beyond that you see a mixture of macroeconomic factors and aggressive moves in the game of geopolitics, which over the past 24 hours Putin has essentially lost.

Two thirds of Russia’s exports come from oil and gas. And though the gas price has fallen by only a quarter, compared to oil collapsing almost by half, the sudden loss of revenues in the space of six months changes the whole picture of the Russian economy.

It’s when you then ask “why oil?” and “why now?” that the geopolitics and the macroeconomics become intertwined.

First, the world economy is slowing. That means lower demand for oil. I spoke to a senior European central banker last week who said he thought demand was collapsing faster than people thought, and having the bigger impact on the oil price than supply.

To those closer to the oil industry, however, it seems like the supply shock is the killer. The USA has become the biggest producer, and is set to be self-sufficient.

Opec’s decision to go on pumping oil, in November, faced with collapsing demand, was designed to do exactly what has happened – sink the oil price to the point where only the big Gulf producers can break even, harming their competitors and, in the process, sabotaging the expensive end of the US shale-oil industry.

Those close to finance emphasise that, as the fundamentals of the world economy slowed, the financiers who had been speculating on higher oil now speculated on lower oil, as always amplifying the speed and direction of movement.

A slowing world economy on its own would not have tanked oil or the rouble, so my money is on the supply shock as the key factor.

And here’s where it gets murky. Some analysts see the Saudi-inspired decision to go on pumping as an economic move: maintain your market share at the price of taking a hit on profits is an old competitive gambit.

Others see the Saudis retaliating against the US shale oil splurge: so the low price makes many recently developed wells in the USA unprofitable and could drive them to shut down, rebalancing the market in Opec’s favour.

But the deep paranoia scenario runs as follows, as put to me by an oil industry insider.

After Russia annexed Crimea and backed the uprising in eastern Ukraine, this pushed the west into sanctions on a scale it had not previously signalled, especially after Russian-backed fighters shot down the Malaysian jet MH17, murdering 298 civilians.

These sanctions progressively convinced Putin he had to change the rules of the global game. He would up the military pressure on Nato, while forging a strategic alliance with China.

Part of that strategic shift was to divert gas supply deals from Europe towards China, with the specific aim of becoming China’s supplier of choice for Liquefied Natural Gas.

Some in the US oil industry believe that would have represented a killer blow to the US fracking industry. See here.

Workers put the final touches on a natural gas well platform owned by Encana south of Parachute, Colorado

Fracking has created an oversupply of gas in the USA – so the US industry needed to supply China. But if Russia supplied China with LNG at cheaper prices, the US fracking industry would take a major hit.

So on this reading, the Saudi move to crater the oil price reads as follows: the USA goes on pumping oil, even into a system where refineries are full and the price is collapsing; meanwhile America maintains its ban on exporting oil.

The price collapses, and so to does the rouble. Then under the combined weight of oil and the rouble, the Russian banks – which cannot refinance because of the sanctions – are also placed under pressure.

If true, then Putin has effectively lost not just a short-term diplomatic conflict over LNG and oil, but seen the whole basis of his system removed.

Sure the oil price can come back – when the world economy recovers, or when Opec decides to cut production quotas, or if speculators start cornering the market at some future point.

But by then – if we read back to the Putin doctrine as announced in 1999 – Vladimir Vladimirovich is gone. With its foreign exchange reserves draining fast, and inflation amid a sharp recession next year, there is no more money to fuel the tank battalions and propaganda channels.

If there is one thing we have learned in our encounters with the Russian kleptocracy, it is that they are more interested in money than politics.

But if politics gets in the way of money they become interested in politics. There are already signs tonight of splits within the Putin inner circle – but the bigger threat is this.

Putin halted a mass protest movement in 2011-12 with a mixture of repression, money and ultimately foreign wars.

The foreign wars are going disastrously – who now will fund the basket-case economy of Donetsk and the civilian bombing runs of Syria’s air force? The repression is going strong. But the money will disappear.

As a result, every certainty about Russia has gone.

I don’t usually subscribe to conspiracy theories about history – knowing how easily the cock-up mechanisms work in economics. But if the Saudis and the USA have in fact colluded to inflict economic pain on Putin (at the price of inflicting it on their own industries), then it’s been a master-stroke.

Except for one thing. Vladimir Putin’s is an authoritarian rule that cannot bend. If it breaks, the collateral damage could be very messy.

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14 reader comments

  1. Margaret Nelson says:

    Is no one interested in reducing the consumption of fossil fuels?

    1. Tom Ferrour says:

      Margaret, the human race does have an interest in reducing the use of fossil fuels but that interest is not reflected in the economic system. It is only the workers in the energy industry who have the potential to change that system by direct action.

  2. Paddy Briggs says:

    Crude Oil and Oil Products are internationally traded and it is no longer possible for OPEC, or anyone else, to set the price – that price is broadly set at the intersection of the global Supply and Demand curves. Natural Gas is much more Regional. US Gas prices are determined locally within the US and there is little significant import/export to affect them. For Russia there is little or nothing they can do to influence Oil prices. Their export Gas prices (to Europe) are affected by the Oil price, with time lags. Europe can import Gas as LNG and this puts some pressure on pipeline (eg Russian) prices. Russia can turn off supplies. But that power is limited.

  3. The Slog says:

    I think this is about as wrong as wrong could be. But we all have our own opinions.

    Mine is this: the EU stuck its stupid nose into Ukrainian affairs – so we’re clear here, a country not even in the EU let alone the eurozone – in a bid to continue its egomanic imperial policy of brainless expansion.

    The only reason Putin has “lost” is because he is outnumbered by Dollar weight. In every other respect, he won.

  4. Philip Edwards says:

    “I don’t usually subscribe to conspiracy theories about history…”

    Yeah, right.

    Odd this piece should appear just after the Feinstein Committe does a number on the CIA.

    But that’s a “consipracy theory” too I suppose.

  5. Boffy says:

    The over supply is a logical conclusion of the expansion of production over the last 15 years, which was itself a response to steadily rising prices and costs of production. The same thing can be seen in copper prices and other primary products, and a similar pattern can be seen in every previous long wave cycle. Copper prices followed pretty much an exactly same pattern after WWII, rising steadily, before plateauing as the Summer phase of the cycle began in the early 1960’s, and then falling as the Autumn and Winter phases of the cycle began, before shooting up again after 1999, as the new Spring phase of the current long wave cycle began.

    The fall in the Rouble – as opposed to the fall in the price of oil – is not all bad news for Russia. The Rouble, as with many emerging market currencies was previously over valued. It was a consequence of QE in the US, which reduced the value of the dollar, pumped dollars into the global economy, causing these other currencies to rise, their inflation to fall, and their interest rates to follow suit. The ending of QE has reversed that process, which is why inflation in these economies as risen, as their currencies have fallen relative to the dollar, meaning their import prices rise, and thereby causing them to face rising interest rates.

    If we take Russia, its main export is oil and gas, priced in dollars. If we ignore the fall in the oil price itself, a fall in the value of the Rouble against the Dollar does not change how many dollars Russia gets for a barrel of oil – because oil is priced in dollars not Roubles. Suppose a barrel of oil is $100, and suppose $1 = 50 Roubles. When Russia converts the $100 it gets for the barrel of oil into Roubles, it gets 5,000 Roubles. Now, if the Rouble falls to 100 Roubles to the dollar, it still gets $100 for each barrel of oil it sells, but now when it converts these $100 into Roubles, it gets 10,000 not 5,000.

    If Russia comes to spend these Roubles abroad, buying dollar denominated commodities, it loses out. The price of imported goods rises. But, because it now gets twice as many Roubles for the sale of a barrel of oil as it did previously, this increases the currency circulating within Russia. It tends to cause prices to rise, and in the short term, profits along with it. As imported commodities are now more expensive, this provides a powerful stimulus for new capital to set up within Russia itself, to produce these commodities thereby providing import substitution, so as to benefit from these higher Rouble denominated profits, and to benefit from the protection against imported commodities that a lower Rouble provides.

    In other words, it could provide exactly the stimulus to growth and the development of a more diversified industrial base, that Russia requires. In fact, there is a strong argument that the high oil price was negative for Russia in the long term, for precisely that reason, i.e. that it inflicted on it the Dutch Disease of the 1970’s, whereby reliance on high levels of oil revenues causes the currency to be grossly overvalued, and thereby prevents the development of domestic industries.

    If I was Russia, I would not waste valuable reserves trying to defend the currency. Those reserves would be better used facilitating the development of a more diversified industrial base, using the advantages of protection that a lower currency provide.

  6. Jim Dobbin says:

    Interesting article with some fair arguments in relation to the possible reasons of why oil prices are failing and who stands to gain/loss.

    I’d like to pick up on a point though that demands some further clarification and that is this statement – “..especially after Russian-backed fighters shot down the Malaysian jet MH17, murdering 298 civilians.”

    May I ask how Paul Mason reached that conclusion and based on what evidence? This is a very bold statement for C4 to make so one can only imagine that it wouldn’t have been made without some hard evidence to back it up.

    May we see that evidence?

    1. Tom Ferrour says:

      I agree with Jim and would add that that whole paragraph has cause for concern. Paul Mason accuses Russia of “Invading Crimea”, language that is at least worryingly soft on the fascism of the Kiev regime.

  7. Joe Chambers says:

    I’m not sure if the article actually explained why Putin has lost the battle to supply LNG to China ahead of the US?

  8. Peter Allen says:

    What about the effects of the oil price on the US shale oil companies? I see that Max Keiser is arguing that their inability to extend their credit lines at current oil prices will have a significant effect on US finance as their junk bonds collapse together with all the debt collateralised on them – perhaps the Washington elite are shooting themselves in the foot?

    And yes, where is this elusive `evidence’ that Russian-backed fighters shot down MH17? This is not the first time you have made this statement with 100% certainty, Paul. You need to either back it up or moderate your language if you don’t want to become just another so-so propagandist in the mainstream media. I do hope that isn’t your aspiration because you seem to be getting dangerously close to it with some of your commentary on Russia and Putin.

  9. Boffy says:

    As I’ve described here the fall in the oil price could kill the bond market, because 16% of the US Junk Bond market is now accounted for by energy loans, and according to Deutsche Bank, a third of those bonds are already distressed and likely to default.

    However, much of the fixed capital is already sunk in relation to shale production. Provided variable costs are more than covered by revenue, that means that their is a current surplus that makes a contribution to those fixed costs. Consequently, its unlikely that existing production will simply be shut down, reducing supply and pushing prices back up.

    Rather what is likely to happen is that a lot of small producers will go bust as they default on their bond payments, their fixed capital will be written off, and the wells etc will simply be bought by large oil companies, that have huge cash reserves, at next to zero prices. Those large companies will then be able to run this production profitably, even at prices as low as $40 a barrel, and possibly lower, because all they will need to cover is the variable costs, i.e. mostly labour, and auxiliary materials.

  10. Gabriel Levy says:

    hi Paul, I think social unrest awaits … I’m not sure the choices facing Putin are quite as apocalyptic as you suggest, but they could be! G. Here’s my take: http://peopleandnature.wordpress.com/2014/12/17/the-spectre-of-social-unrest-is-haunting-putins-russia/

  11. Keith Myers says:

    Pedalling conspiracy theories for which there is no evidence is irresponsible. The oil market has become oversupplied by 1-2 million barrels per day (not by design but because that is what can happen in a complex global market).

    Saudi Arabia and its allies have decided to maintain production to preserve market share and shake out of the market high cost oil. The oil price fall has been exacerbated by short selling and could be volatile until the market is balanced again.

  12. Justin Baldwin says:

    I think there is a confluence of reasons: all of the above, and Iran’s bid for a nuclear military capability – financed via high oil prices.

Comments are closed.