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Russia, Oil, China and the Dollar
As the year winds down, a Gordian knot tying Russia, oil prices and China together is receiving a great deal of attention. Let's see if we can unravel some of the confusing twists and turns.
We turn first to China's offer of assistance to Russia. The idea that Russia could activate its CNY150 bln (~$24 bln) currency swap line with China is capturing the imagination of many.
Could China be challenging the IMF as several media reports suggest? Hardly. It can only be a challenge if there the IMF was a viable alternative. To contrary, it does not appear the IMF is an alternative to Russia. The sanctions would likely mean that any formal request to the IMF would be rejected.
China has also recently come to the assistance of two other economic pariahs, Argentina, and Venezuela. The sums appear modest (~$2.3 bln and ~$4 bln) the terms and conditions unknown. However, the overall point remains valid. China is not competing with the IMF because the IMF does not appear to want that business.
Nor is the China-Russia three-year swap line a very useful assistance tool for Russia under present circumstances. What will the CNY150 bln, or more do for Russia? Does it have yuan-denominated debt that is maturing? Does it buy many goods from China that it could use the yuan instead of hard currencies? It can sell the yuan and buy dollars or euros, but then it has a currency mismatch.
Under a swap agreement, Russia would be obligated to return the CNY150 bln no matter how many roubles it costs to secure. If it were to activate the swap today, it would be paying almost 8.8 roubles per yuan. At the end of H1 14, there a rouble could buy 5.4 yuan.
Does the possibility of operationalizing the swap line reaffirm the significance of China's swap lines as a parallel financial architecture to the dollar? Probably not. If a swap line was not in place, China quickly establish a loan facility. Better for Russia than a swap line or loan would be for China to fund infrastructure projects, such as gas pipeline and railway projects in the east, and perhaps a deeper port in Crimea.
Chinese officials seem willing to help Russia, especially to the extent that it frustrates the US (the enemy of my enemy is my friend), but it also realizes that some of Russia's problems are of its own doing. Chinese officials that have spoken about being prepared to give some financial assistance if Russia requests, realize that Russia's economic structure is not conducive for strong sustained growth and that it relies too much on low-value added commodity (energy) exports.
There had been some hope that the economic pressure would soften Russia's stance. Even though Putin's press conference last week was strident, he did refrain from referring to east Ukraine as "Novorossiya" (New Russia) has he had earlier this year. Putin also seemed to drop his demand for Ukraine federalism. Some European countries, like France, seemed to want to consider easing the sanction regime. However, Ukraine's parliament's decision earlier today to drop its non-aligned status can only aggravate Russia as it is widely understood to be a step closer to NATO membership.
This will likely stiffen Russia's resolve. It already feels put upon having NATO on it borders. The threat of Ukraine joining NATO is not just adding insult to injury, but feeds into the Russian sense of being encircled. Rather than capitulating, Putin may be emboldened, sensing less to lose.
Russia could be among the biggest beneficiaries of higher oil prices. Brent crude oil prices have stabilized around $60 a barrel in recent days. However, the risk is still on the downside. The Saudi oil minister was quoted in the media indicating that its decision not to cut production regardless of the price. "Whether it goes down to $20, $40, $50, $60 is irrelevant." He explained that if Saudi Arabia, or OPEC cut its output, the price will go up and the Russians, the Brazilians, US shale oil producers will take my share."
Saudi Arabia clearly wants to reduce the supply of oil by squeezing out the high cost producers. US shale producers, like Canada's tar sands and Brazil's deep water fields are high cost producers. Given the amount of oil being produced, and possibility that US will relax its ban on oil exports, US shale producers are the most immediate threat.
The US shale industry is predicated on three factors. High oil prices is one of them. It is necessary but insufficient. It has been financed by cheap credit. It has also made possible by a greater disregard to health and environmental issues. These factors are changing. Oil prices have fallen sharply, making some projects less economically feasible. The price of credit has risen and reportedly is less available. Health and environmental issues were behind NY state's decision to ban fracking entirely.
Shale wells deplete quickly and permits for new wells are needed to replace the older ones. It is such spending plans that are being hit. Already more than dozen companies have announced cuts in spending plans. This will not impact US shale production until late 2015, and maybe not until 2016.
The issue that the highly respected Antaloe Kaletsky raises is whether the US shale producers can replace OPEC in general, and Saudi Arabia in particular, as the swing producer. He argues that it is fairly easy to turn off or ramp up shale production, and that in truly competitive market, Saudi Arabia and other low cost producers would maximize output.
Kaletsky paints a scenario that shale producers reduce supply when demand is weak and ramp up output when demand is strong. That their low cost of production (what he calls 'marginal') is $40-$50 a barrel and that this could become the ceiling not the floor going forward. He recognizes the possibility that OPEC re-establishes oligopolistic control. He asks, "So which of these arguments will prove right: The bearish case for $20-$50 trading range based on competitive market pricing? Or a bullish one for $50 to $120 based on resumed OPEC dominance? Ask me again once the price of oil has fallen to $50--a stayed there for a year or so."
What does it mean to talk about oil being in a competitive market, when many of the world’s largest producers are state-owned? This is true not just in OPEC and Russia, but also Norway, Mexico, and Brazil. And what if the central bank buys government bonds and pushes down interest rates to levels that it may make sense to borrow funds (and get favorable tax treatment for that debt) and press water and other chemicals into shale formations to extract oil?
Kaletsky may be exaggerating the flexibility of US shale producers, especially in an environment of falling oil prices and rising interest rates. The overhead for next year’s output is already in place. The relatively high fixed costs mean that many will produce even at a loss, if necessary. Next year could be the peak in shale production. Already the EIA is cutting its longer-term forecasts. Between OPEC and US shale producers, we don’t have to wait for oil prices to fall to $50 and stay there to expect US shale producers to cry uncle before the Saudis.
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Happy New Year ! 2015 will be an interesting year with major unknowns,
Ukraine collapse oi rebirth
Oil price decline consequences
Global growth decline impact
Bubbles driven by debt expansion
Reliance on derivatives to pass on risk
Continuing ME turmoil
Currency war sparked by Japan
And now Russian energy trade sanctions based on US torture. What could go wrong??
I agree with the author about shale oil; IMHO it has "Enron" written all over it.
Otherwise I agree with falak pema.
EU In Total Horror As Russia Prepares New “Anti Nazi (torture) Law”......
A stunning report prepared by the Ministry of Foreign Affairs (MoFA) circulating in the Kremlin today states that European Union (EU) foreign diplomats were left in “total horror” this past week after being alerted by their Russian counterparts to the catastrophic effects upon the NATO Alliance due to a proposed Federation Council (FC) law outlawing the sale of energy supplies to any nation that is now/or has been engaged in Nazi-like torture of prisoners of war or its own citizens.
According to this report, the Federation Council (the upper house of the parliament of the Russian Federation) began the adoption of this new “Nazi Law” under orders given by President Putin after the United States refused to heed Russia’s 14 December warning of retaliation against the imposition of additional sanctions by President Obama’s signing of a new Russian sanctions law on 18 December.
The proposed new “Nazi Law” being written by the FC, this report continues, would specifically forbid the sale of Russian natural gas, oil, oil by-products (and other such natural resources of the Federation) to any nation, or military alliance of nations, that: 1.) Has failed to support the United Nations resolution condemning attempts to glorify Nazism ideology and denial of German Nazi war crimes; 2.) Has used Nazi torture techniques against POW’s and/or civilians; and 3.) Has conducted mass executions of unarmed civilians.
http://www.whatdoesitmean.com/index1827.htm
Interesting if true.
I believe that source is the notorious Sorcha Faal...in the eyes of the internet, not the most credible. However, does usually seem to be some truth in the write-ups, but usually splattered with some pretty out there falsities.
Will be interesting to monitor those claims. Appreciate the post.
Double post.
I have always held the view that Oil and gas; given their primary place in the economy in ALL sectors : agri, industrial, service, and Internet; given their intimate implication with nation-state power structures, as strategic inhouse --as undersoil-- source of power; like armaments; cannot and should not be treated as a free market commodity; anymore than strategic weapons should be. This is especially true since 1974 made it more expensive.
They should be controlled as a world commodity and traded with parsimony. How we set about that is a matter of detail and POLITICAL will. Since 1945 we have a conclave to resolve that collectively (which we don't use efficiently 'cos of veto and need for unanimity).
The prime objective should be to limit the use of black gold to essential needs; aka making it the high plateau of energy source that, say renewables, should match; not the floor level source simply because its cheap in Saud! An accident of nature and a scheme of political Rule Britannia cum Pax Americana run hegemony since post Ottoman period.
That latter strategy now being proclaimed again is privileging the short term to kill the long term for a vital resource that is not easy to come by on a cheap and EI/EO + basis, as we move down this industrial curve that ONLY began two hundred years ago !
But this is something the greedy, imperial minded will never accept. The age of more expensive oil began in 1974. The world knew then that Oil was not unlimited and cheap. It's parsimonious use went belly up in 1982-2003. And now Saud wants to make it go belly up again.
Whatever our views on the ecological consequences of fossil imprint, (which I feel will be inevitably ominous even as of today given its recent profligate history), just the energy argument in itself pleads for making Oil the most expensive expendable of last resort, not the contrary.
I agree with Sheikh Yamani who was kicked out for saying that in 1986. (All to please Reagan's USSR agenda and Saud's proxy war against Iran via Saddam) !
As yesterday, as today, whatever they say before the media, the truth is OIL and POWER are eternal bedfellows in this world (until the renewable appears).
Like Silk or Gold/Silver and Empires of old.
The “weapon of oil” that brings chaos
Used by the Saudi Arabia and the US against Syria,Iran and Russia
http://failedevolution.blogspot.gr/2014/10/the-weapon-of-oil-that-brings...
This BS is getting stale. Try something new...
USA is the swing producer in energy now. Been true all year.
Just stick with the dollar economies.
swinging more likely from the gallows!