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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