We shouldn’t too surprised, the House of Saud financed 9/11, have hated US for decades and US “government” and the lapdog media believes them to be friends.
“It is our true policy to steer clear of permanent alliance with any portion of the foreign world.”
FAREWELL ADDRESS TO THE PEOPLE OF THE UNITED STATES | MONDAY, SEPTEMBER 19, 1796
Today, you get a two-fer. Since my dear friend Kenny Polcari has released new thoughts on the OPEC debacle – and since that was also the topic of my latest podcast, published yesterday, which you can listen to here – I am bringing you both his thoughts and mine, together.
In short, yesterday OPEC humiliated President Biden on a global stage by cutting oil production after he specifically lobbied them not to. There’s no “nice” way of putting it – they straight-up snubbed the U.S. and have now, in my opinion, made it officially clear that they 1) are not our friends, 2) do not care what we want, 3) do not take us seriously and 4) are not here to help us and/or Biden get re-elected by lowering prices.
To use Biden’s parlance, “Let me tell you something, Jack – we’re not in bed with the Saudis anymore. They are more allied with China and Russia than they have ever been, at arguably the most crucial moment in recent history for our global economy.”
As I pointed out last night on my podcast, there was nothing quite like the “fist bump heard round the world” a couple months ago when President Biden – who spends his time here domestically fighting for “equality” and human rights – decided to embrace the Saudis, and their track record of disapproving of gay rights, murdering journalists and multiple other human rights violations – instead of simply ramping up domestic oil production here in the U.S.
Biden probably went into the meeting he had with MBS months ago thinking we had some type of leverage, like we have had decades ago. The sad reality is that we simply don’t anymore: the Saudis have the oil, they have gold, and now they have allies just as big and powerful as the U.S. when combined. And those allies provide financial and military support at a crucial juncture for geopolitics.
Meanwhile, our President remains tone deaf and while his supporters remain immune to what can only be described as blatantly obvious double standards.
While the left hand, Biden was vilifying Exxon and Chevron here in the U.S., basically encouraging them to not bring more supply online, whilst blaming “gas station owners” and other people who don’t set the price of refined fuels.
With the right hand, he was fist bumping a man who publicly disapproves of gay rights and ordered the murder of a critical journalist, in order to try and get him to unleash more oil on the global stage.
And instead of him taking us seriously, he did the exact opposite of what Biden wanted yesterday – cut oil production, raising prices – and humiliated Biden on the global stage.
Now, as they beg OPEC, Venezuela and Iran for help to reduce onerous price and inflation consequences of their own policies ahead of 2022 midterm elections, they are likely to discover that maybe Putin and petroleum companies really aren’t their biggest problems after all.
As his administration now scrambles to solicit supply oil shortages from OPEC, Venezuela, and Iran to reduce skyrocketing energy costs ahead of Democrat congressional mid-term election casualties, let’s remember this contradicts former 2019 candidate Joe Biden’s campaign pledge that “I guarantee you we’re going to end fossil fuels.”
Let’s also recall that President Biden then inherited an America that was not only energy independent, but also a leading global oil and gas exporter, and that gas prices began going up long before Putin’s invasion of Ukraine recently provoked a bipartisan ban on Russian oil, gas and coal imports.
That ban was likely influenced by a March 8 Reuters/Ipsos poll which found that 80% of all likely voters surveyed responded that the U.S. “should not buy oil or gas from Russia during this [Ukraine] conflict, even if it causes American gas prices to increase.”
Simultaneously, inflation over the past year has risen to a 40-year high of 7.9%, most all occurring prior to the Ukraine conflict catastrophe.
Also, recall that immediately upon taking office, Joe Biden revoked a permit essential for the Keystone XL pipeline to deliver oil from Canada.
Shortly thereafter, his administration launched an effort to overturn an oil drilling program in the Arctic National Wildlife Refuge (ANWR) in Alaska, and empowered Department of Interior regulatory efforts to delay drilling permits.
Blaming U.S. companies—not Biden policies—for not producing more oil and gas, White House press secretary Jen Psaki asserted that there are 9,000 available unused drilling permits, while only 10% of onshore oil production takes place on federal land.
A big problem here, is that the companies first must obtain additional permits for rights of way to access leases and build pipelines to transport fuel, a requirement that the Biden administration’s Interior Department has made more difficult.
Next, the companies must build up a sufficient inventory of permits before they can contract rigs – requiring added regulatory difficulties of operating on federal lands.
For example, it takes 140 days or so for the feds to approve a drilling permit versus two for the state of Texas.
Massive injections of liquidity have caused a double side effect: rising malinvestment in nonproductive activities and now a large inflow of capital into so-called value areas: more money directed to relatively scarce assets. Energy has gone from a consensus underweight to a large overweight, exacerbating the price increase. The marginal barrel of oil has risen almost 60 percent in a year despite supply rising in tandem with demand.
High oil prices are a symptom of economic and monetary imbalances, not just a consequence of Organization of the Petroleum Exporting Countries (OPEC) decisions. Throughout history, we have seen how OPEC cuts have done little to elevate prices when diversification and technology added to rising efficiency.
Likewise, OPEC output increases do not necessarily mean lower prices, let alone reasonable ones. Increased OPEC output helps but does not solve price issues, even if they would probably like to.
The problem in the oil market has been created by years of massive capital misallocation and underinvestment in energy created by extremely loose monetary policies directed by governments that have penalized capital expenditure on fossil fuels for ideological reasons.
Misguided activism and political nudging in the middle of massive monetary injections have created massive bottlenecks and underinvestment that hinder both security of supply and a technically feasible competitive energy transition.
Massive injections of liquidity have caused a double side effect: rising malinvestment in nonproductive activities and now a large inflow of capital into so-called value areas: more money directed to relatively scarce assets. Energy has gone from a consensus underweight to a large overweight, exacerbating the price increase. The marginal barrel of oil has risen almost 60 percent in a year despite supply rising in tandem with demand.
According to JP Morgan, the required capital expenditure in energy required to meet demand is $600 billion for the period 2021–30. This “cumulative missing capex” is part of the problem.
The other important problem is artificial demand created by chains of stimulus plans. As I’ve explained before, adding enormous energy-intensive infrastructure plans to a reopening economy where some supply bottlenecks have been worsened generates the same effect on energy prices as a huge speculative bubble.
Political intervention has also created an important price impact on the marginal barrel of oil. Threatening to ban domestic development of energy resources in the United States or announcing the prohibition of fossil fuel investment, as has happened at some European summits makes the net present value of the long-term marginal barrel higher, not lower. Why? Because those threats are not made with sound technical analysis and robust supply and demand estimates, but with political agendas. Any serious engineer that understands the importance of security and supply and technology development understands that a successful energy transition to a greener economy requires solid and realistic targets and policies that will avoid an energy crisis. Those have been forgotten.
OPEC is benefitting from high oil prices but not as much as one would think. The OPEC Reference Basket (ORB) is $68.33 per barrel year-to-date, a 68.4 percent increase over the same period last year, but still massively below the elevated levels prior to the 2008 financial crisis. Furthermore, OPEC and non-OPEC supply have risen in tandem with demand. Global liquids production in October increased by 1.74 million barrels per day compared with the previous month, to an average of 97.56 million barrels per day. The US liquids production growth forecast for 2021 has been revised up by 19,000 barrels per day and is expected to be 17.57 million barrels per day in 2021. Imagine where oil and gas prices would be if the political threats to ban or severely penalize domestic production had been enforced.
Let us not forget that OPEC has also revised down the estimates of global oil demand to 96.4 million barrels a day in 2021. Supply remains ample and the United States administration should also see that Russia and the US are expected to be the main drivers of next year’s supply growth. Without Russia and the US, production prices would soar no matter what OPEC partners or Saudi Arabia alone do.
We are suffering from the combination of misguided energy policies, excessive money creation and ill-timed giant construction plans. OPEC and its partner Russia may alleviate this, but not change it dramatically. Furthermore, as time passes and underinvestment becomes more severe, OPEC’s ability to curb prices will weaken. We cannot forget that OPEC and Russia account for less than half of total world supply. They matter, but putting two million more barrels a day on the market will not solve the long-term price problem.
Energy prices will decline with more technology, investment, and diversification, not empty political threats. Author:
Any refiner knows that crude quality matters, but most policymakers certainly do not.
Only the market knows which crude grades need to be produced and in what quantities at a given time. Likewise, only the market knows which crude grades need to be exported or imported and in what quantities. Prices along the oil supply chain alone coordinate this process. Now more than ever, the market needs unfettered prices to tell producers which grades to produce and refiners which grades to refine.
The same goes for every other market and commidity.
Although the heads of the world’s largest oil-producing nations were quick to claim a diplomatic victory following the latest OPEC+ (Organization of the Petroleum Exporting Countries “plus” non-OPEC oil producers) output-cut agreement, crude prices are telling a different story. Prompt month Brent and WTI futures contracts are now trading nearly 20 percent below their early April highs, both returning to a supercontango forward curve price structure following the conclusion of the OPEC+ meeting. A contango price structure, where near-term prices plummet relative to prices further along the curve, is the market’s way of clearing. But political efforts to support crude prices from around the world continue to muddy the waters for those trying to efficiently and rationally reallocate capital in the industry.
With the long-awaited OPEC+ deal failing to balance the market, some Texas oil producers are hoping to rekindle a largely dormant regulatory body in the Texas Railroad Commission to coordinate output cuts in the heartland of US crude production for the first time since the 1970s. In addition, amid this week’s turn lower in oil prices, US tariffs on crude imports are reportedly still on the table as well as a newfound idea to potentially pay producers to shut in production. Although politicians and regulators are still busy trying to find regulatory cures, this historic moment in oil markets should serve as a lasting reminder of the limitations of political remedies and the need to allow market prices to be the ultimate arbiter of production levels. Efforts by US policymakers to boost crude prices and to throw a lifeline to high-cost US crude producers is the exact opposite of what prices are telling us the market needs at this time. Seeking to prop up the least efficient US oil producers through import penalties or production quotas risks further misallocations in the sector going forward. Let us address a few key points:
1. Higher Crude Prices Are Not What Is Needed Amid Sharp Fuel Demand Contraction
Much of the recent focus for US politicians and other representatives of oil-producing nations has been on getting crude prices higher. But nothing could be more unwarranted at this time. As fuel demand for transportation has ground to a halt globally over the past two months, refining margins have been crushed—particularly for gasoline and jet fuel. It is this record weakness in underlying demand for transportation fuels, and the accompanying weakness in refining margins, that has led to the rapid surplus of crude oil globally as refineries have cut throughput.
Therefore, global political efforts to send crude prices higher risk exacerbating demand contraction for crude oil in the near term as higher crude prices without higher refined fuel demand would further limit a refiner’s incentive to process crude.
2. The Market Is Trying to Do Its Job
Crude prices returned to a state of supercontango early this week, following the conclusion of the OPEC+ meeting. After narrowing to just –$3.96 in early April, the Brent 1–7 month time spread has widened back to –$9.51 as of the April 15 close. Prompt month WTI is at an even wider discount to prices further along the curve than it was prior to the OPEC+ agreement, with the 1–7 month time spread closing at a whopping –$13.54 on April 15. This historically steep discount for near-term crude reflects the market coordinating multiple needed processes simultaneously.
On the one hand, physical crude prices and prompt month futures prices are coordinating the process of shutting in production. With prompt month WTI trading at a $13.54 premium to current prices just six months from now, a steep contango price structure is the strongest signal a US producer can receive to shut off new supply today and reserve that production for a future date. To the extent that production cannot be immediately shut in, this same price structure incentivizes placing crude into storage rather than continuing to push it onto the market, further crushing physical prices.
On the other hand, and to reflect on the first point above, the steep discount in near-term crude prices is needed to begin to stimulate crude demand at refineries once again. Crude prices must drop faster than refined fuel prices or refiners will have no profit motive to begin to process the glut of crude. In order to clear, the crude market needs positive gasoline-refining margins and/or diesel margins high enough that the weak gasoline and jet fuel margins are not overwhelming. This can only be accomplished by allowing for weakness in crude prices.
WTI Crude Oil Forward Curve
3. Only the Market Knows Which Crudes Should Be Cut and in What Quantities
Any refiner knows that crude quality matters, but most policymakers certainly do not. Crude quality, which is to say the profile of a specific grade of crude based on both its API gravity and sulfur content, is of chief importance to a refiner. A crude refining slate consisting of various grades is chosen carefully, based in large part on a refinery’s physical sophistication (what they can run) and the cost of the crudes compared to their expected revenues (based on their relative yields of the refined products (what they want to run)). For example, with gasoline currently bearing the brunt of the demand-contraction pain, light, sweet crudes that yield high volumes of light distillates, such as the majority of US shale grades, are far less desired by refiners that can run heavy crudes and are optimizing their refining slate to target higher yields of diesel.
Only the market knows which crude grades need to be produced and in what quantities at a given time. Likewise, only the market knows which crude grades need to be exported or imported and in what quantities. Prices along the oil supply chain alone coordinate this process. Now more than ever, the market needs unfettered prices to tell producers which grades to produce and refiners which grades to refine. This is just another reason why blanket production cuts or quotas and penalties on crude imports are both risky and suboptimal. Only refiners and producers themselves are sophisticated enough and can respond in a timely enough fashion to optimize the supply chain. And let us not forget that this market function will be just as important as demand begins to recover in the coming months. Policy interventions risk not only skewing market prices today, but also causing misallocations longer term.
Conclusion
It is often forgotten that market prices are themselves the constant coordinators of commerce. “The market” is not just some amorphous entity in the imaginations of ideologues and traders. Markets are made up of the industrial players that have the most skin in the game and the most to lose from misallocating capital.
In times of high uncertainty and economic risk it is politically difficult to resist the temptation to intervene in markets in an effort to protect specific pieces of domestic industry, but policies enacted in panicked times can also produce large and lasting unintended consequences. As we hope for a slow return to normalcy in refined product demand as COVID-19 quarantines are lifted in the coming months, let us be cautious of policy prescriptions that can wind up further ailing the entire oil industry and consumers in the long run.
Putin just told the world he’s not riding his country’s oil and gas resources like a cash cow but rather as an important part of a different economic strategy for Russia’s development.
It’s like watching someone playing the first half of a game implying one strategy and making a critical shift to a different one halfway through, taking advantage of their opponents’ carelessness.
I am an avid board game player. I’m not much for the classics like chess or go, preferring the more modern ones. But, regardless, as a person who appreciates the delicate balance between strategy and tactics, I have to say I am impressed with Russian President Vladimir Putin’s sense of timing.
Because if there was ever a moment where Putin and Russia could inflict maximum pain on the United States via its Achilles’ heel, the financial markets and its unquenchable thirst for debt, it was this month just as the coronavirus was reaching its shores.
Like I said, I’m a huge game player and I especially love games where there is a delicate balance between player power that has to be maintained while it’s not one’s turn. Attacks have to be thwarted just enough to stop the person from advancing but not so much that they can’t help you defend on the next player’s turn.
All of that in the service of keeping the game alive until you find the perfect moment to punch through and achieve victory. Having watched Putin play this game for the past eight years, I firmly believe there is no one in a position of power today who has a firmer grasp of this than him.
And I do believe this move to break OPEC+ and then watch Mohammed bin Salman break OPEC was Putin’s big judo-style reversal move. And by doing so in less than a week he has completely shut down the U.S. financial system.
On Friday March 6th, Russia told OPEC no. By Wednesday the 11th The Federal Reserve had already doubled its daily interventions into the repo markets to keep bank liquidity high.
By noon on the 12th the Fed announced $1.5 trillion in new repo facilities including three-month repo contracts. At one point during trading that day the entire U.S. Treasury market went bidless. There was no one out there making an offer for the most liquid, sought-after financial assets in the world.
Why? Prices were so high, no one wanted them.
Not only did we get a massive expansion of the repo interventions by the Fed, but it was for longer duration. This is a clear sign that the problem is nearly without an end. Repos longer than three days are in this context a rarity.
The Fed needing to add $1 trillion in three-month repos clearly means they understand that they are looking out to the end of the quarter as the next problem and beyond that.
It means, in short, the world financial markets have completely seized up.
And worse than that…. It didn’t work.
Stocks continued to slide, gold and other safe-haven assets were hit hard by a reversal of capital outflows from the U.S. In the first part of the aftermath of Putin’s decision the dollar got whacked as European and Japanese investors who had piled into U.S. stocks as a safe-haven sold those positions and brought the capital home.
That lasted a few days before Christine Lagarde put on her dog and pony show at the European Central Bank and told everyone she didn’t have any answers other than to expand asset purchases and continue doing what has failed in the past.
This touched off the next phase of the crisis, where the dollar begins to strengthen. And that is where we are now.
And Putin understands that a world awash in debt is one that cannot withstand the currency needed to repay that debt rising sharply.
That puts further pressure on his geopolitical rivals and forces them to focus on their domestic concerns rather than the ones overseas.
For years Putin has been begging the West to stop its insane belligerence in the Middle East and across Asia. He’s argued eloquently at the U.N. and in interviews that the unipolar moment is over and that the U.S. can only maintain its status as the world’s only super power for so long. Eventually the debt would undermine its strength and at the right moment would be revealed to be far weaker than it projected.
This doesn’t sit well with President Trump who believes in America’s exceptionalism. And will fight for his version of “America First’ to the last using every weapon at his disposal. The problem with this ‘never back down’ attitude is that it makes him very predictable.
Trump’s use of sanctions on Europe to stop the Nord Stream 2 pipeline was stupid and short-sighted. It ensured that Russia would be merciless in its response and only delay the project for a few months.
Trump was easy to counter here. Sign a deal with Ukraine, desperate for the money, and redirect the pipe-laying vessel back to the Baltic to finish the pipeline.
And with natural gas prices in Europe already in the gutter from oversupply and a mild winter, there isn’t much time or money lost in the end. Better to take the world oil price down well below U.S. production costs which ensure that Trump’s prized LNG stays off the European market as the myth of U.S. energy self-sufficiency vanishes in a puff of financial derivative smoke.
Now Trump is facing a market meltdown well beyond his capacity to fathom or respond to. While Russia is in the unique position to drive costs down for so many of the people while riding out the shock to the global system with its savings.
Because money flows to where the best returns on it come, high oil and gas prices stifle development of other industries. Lowering the oil price not only deflates all of the U.S.’s inflated financial weapons it also deflates some of the power of the petroleum industry domestically. This gives Putin the opportunity to continue remaking the Russian economy along less focused lines. Cheap oil and gas means lower return on investment in energy projects which, in turn, opens up available capital to be deployed in other areas of the economy.
Putin just told the world he’s not riding his country’s oil and gas resources like a cash cow but rather as an important part of a different economic strategy for Russia’s development.
It’s like watching someone playing the first half of a game implying one strategy and making a critical shift to a different one halfway through, taking advantage of their opponents’ carelessness.
It rarely works, but when it does the results can be spectacular. Game, Set, Match, Putin.
$30 dollar oil will be great for the global economy (and in turn, a good global economy is good for oil). At a time when the global economy is visibly losing steam, when we’re overdue for another business cycle recession, and when nobody seems to have an answer, Moscow delivered what nobody else could — a massive economic boost for the whole world.
Sure there will be losers, chief among them US shale and the Saudis who need far higher prices to make their budgets work.
But then as a whole, the US shale has always been a loss-making enterprise for America. The scaling-down of shale is not bearish for the US at all. It’s bullish. If Putin can make Americans stop throwing more good money down the shale pit that’s not a bad thing, that’s a giant favor to the US and the health of its economy right there.
To say nothing of the effect of cheap energy itself. Personally I don’t think even $30 oil will be enough to avert a crash but if anything could, it would be that.
Similar story with the Saudis, if they have less money to throw around backing Salafists and bribing Washington, that’s not a bad thing. That’s a great thing for the world.
Some of Russia’s friends like Venezuela and Iran will be hurt as well, but ironically the fact the US has already cut down their imports to a fraction of their capacity means they have a lot less left to lose.
It certainly will kill the Trump administration’s fantasy of the US displacing Russia as the energy supplier to Europe.
Finally, unlike money printing, Putin’s cheap oil stimulus is not redistributive and is not inflationary. And unlike a low-interest rate stimulus, it doesn’t throw economic calculation off balance by falsifying the price of credit and conjuring up a false abundance of real-world capital.
For three years Russia went along with OPECE energy price-fixing because it represented the quickest way to replenish its FX reserves. Those reserves have now been rebuilt. In the meantime, Russia developed a number of new oil fields but couldn’t move on with exploiting them which made its effort rather pointless.
This is a classical win-win. Rather than looking to squeeze every last dime from the consumers in the short term, the oil producers will be helping them to thrive which in turn will make sure the demand keeps growing.
In fact, I’d argue that it is the single most powerful word in any language.
In the midst of the worst market meltdown in a dozen years which has at its source problems within global dollar-funding markets, Russia found itself in the position to exercise the Power of No.
Multiple overlapping crises are happening worldwide right now and they all interlock into a fabric of chaos.
Between political instability in Europe, presidential primary shenanigans in the U.S., coronavirus creating mass hysteria and Turkey’s military adventurism in Syria, the eastern Mediterranean and Libya, markets are finally calling the bluff of central bankers who have been propping up asset prices for years.
But, at its core, the current crisis stems from the simple truth that those prices around the world are vastly overvalued.
Western government and central bank policies have used the power of the dollar to push the world to this state.
And that state is, at best, meta-stable.
But when this number of shits get this freaking real, well… meeting the fan was inevitable.
And all it took to push a correction into a full-scale panic was the Russians saying, “No.”
The reality has been evident in the commodity markets for months. Copper and other industrial metals have all been in slumps while equity markets zoomed higher.
But it was oil that was the most confounding of all.
Most of 2019 we saw oil prices behaving oddly as events occurred with regularity to push prices higher but ultimately see them fall.
Since peaking after the killing of Iranian General Qassem Soleimani oil prices have been a one-way trade. Down.
Our inept leaders are trying to blame coronavirus as the proximate cause for all of the market’s jitters.
But that masks the truth. The problems have been there for months, pushed to the back burner by incessant Fed intervention in the dollar-funding markets.
The 2008 financial crisis was never dealt with, just papered over.
The repo crisis of last September never ended, it’s still there.
And it reappeared with ferocity this week as people sold dollars and bought U.S. treasuries pushing U.S. yields on the long end of the curve to absurd levels.
Credit markets are melting down. Stock markets are the tail, credit markets are the dog. And this dog was run over by a bus.
The Fed intervenes to keep short term interest rates from rising to preserve the fiction it is still in control.
The market wants higher rates for short-term access to dollars.
The Fed tried to help by cutting rates by 0.5% but all that did was tell people the Fed was as scared as they were. The selling resumed and gold bounced back to it’s recent high near $1690, only to be swatted down on the New York open this morning.
That didn’t work either.
OOPS!
And into this mess OPEC tried to save itself by asking for a historic production cut.
OPEC needs this cut to remain relevant. The cartel is dying. It’s been dying for years, kept on life support by Russia’s willingness to trade favors to achieve other geostrategic goals.
“Regarding cuts in production, given today’s decision, from April 1, no one — neither OPEC countries nor OPEC+ countries — are obliged to lower production,” he told reporters after the meeting.
OPEC’s Secretary General Mohammed Barkindo said the meeting had been adjourned, although consultations would continue.
“At the end of the day, it was the general, painful decision of the joint conference to adjourn the meeting,” he told reporters.
Earlier, Oanda analyst Edward Moya had suggested that a failure to reach an agreement could spell the end of OPEC+.
“No-deal OPEC+ means the three-year experiment is over. OPEC+ is dead. The Saudis are all-in on stabling oil prices and they may need to do something extraordinary,” he said.
There comes a point where negotiating with your adversaries ends, where someone finally says, “Enough.” Russia has been attacked mercilessly by the West for the crime of being Russia.
And I’ve documented nearly every twist and turn of how they have skillfully buttressed their position waiting for the right moment to get maximum return to reverse the tables on their tormentors.
And, to me, this was that perfect moment for them to finally say “No,” to get maximum effect.
When dealing with a more-powerful enemy you have to target where they are most vulnerable to inflict the most damage.
For the West that place is in the financial markets.
Remember, the first basic fact of economics. Prices are set at the margin. The only price that matters is the last one recorded.
That price sets the cost for the next unit of that good, in this case a barrel of oil, up for sale.
In a world of cartelized markets the world over, where prices are set by external actors, it is easy to forget that in the real economy (regardless of your political persuasion) the world is an auction and everything is up for bid.
High bid wins.
So, the most important geostrategic question is, “Who produces the marginal barrel of oil?”
For more than three years now, President Trump has supported his policy of Energy Dominance in a Quixotic quest for the U.S. to become that supplier. Trillions of dollars have been spent on building up domestic production to their current, unsustainable levels.
This policy pre-dates Trump, certainly, but he has been its most ardent pursuer of it, sanctioning and embargoing everyone he can to keep them off the bid.
What he could never do, however, was push Russia off that bid.
The reason U.S. production rates are unsustainable is because their costs are higher per barrel than the marginal price especially when all other prices are deflating. Simple, straightforward economics.
If they were, on balance, profitable then the industry as a whole would not have burned through a few hundred billion in free cash flow over the past decade.
That’s where the Russians’ power comes from. Russia is one of the lowest cost producers in the world. Even after paying their taxes to the government their costs are far lower, close to $20 per barrel break-even point, than anyone else in the world when one factors in external costs.
When you don’t owe anyone anything you are free to tell them, “No.”
Sure, the Saudis produce at similar cash costs to the Russians but once you factor in its budgetary needs, the numbers aren’t even close as they need something closer to $85 per barrel.
They can’t tell their people, “No,” you have to do without. Because the populace will revolt.
Russia can ride out, if not thrive, in this low price regime because :
the ruble floats to absorb price shocks in dollars.
A majority of their oil is now sold in non-dollar currencies – rubles, yuan, euros, etc. – to lessen their exposure to capital outflows
the major oil firms have little dollar-denominated debt
low extraction costs.
its primary governmental budget ebbs and flows with oil prices.
All of this adds up to Russia holding the whip hand over the global market for oil.
The ability to say, “No.”
And they will have it for years to come as U.S. production implodes. Because they can and do produce the marginal barrel of oil.
That is why oil prices plunged as much as 10% into today’s close on the news they would not cut production.
There is a cascade lurking beneath this market. There is a lot of bank and pension fund exposure in the U.S. to what is now soon-to-be non-performing fracking debt.
Liquidations will begin in earnest later this year.
But the market is handicapping this now.
I cannot overstate how important and far-reaching this move by Russia is. If they don’t make a deal here they can break OPEC. If they do make a deal it will come with strings that ensure pressure is lifted in other areas of stress for them.
The knock-on effects of oil plunging from $70 per barrel to $45 over two months will be felt for months, if not years.
And it is no shock to me that Russia held their water here. If they didn’t, I would have been surprised.
This was Putin’s opportunity to finally strike back at Russia’s tormentors and inflict real pain for their unscrupulous behavior in places like Iran, Iraq, Syria, Ukraine, Yemen, Venezuela and Afghanistan.
He is now in a position to extract maximum concessions from the U.S. and the OPEC nations who are supporting U.S. belligerence against Russia’s allies in China, Iran and Syria.
We saw the beginnings of this in his dealings with Turkish President Erdogan in Moscow, extracting a ceasefire agreement that was nothing short of a Turkish surrender.
Erdogan asked to be saved from his own stupidity and Russia said, “No.”
This condition of producing the marginal barrel of oil in a deflationary world places Russia in the driver’s seat to drive U.S. foreign policy behavior in an election year.
Talk about meddling in our elections!
The Achilles’ heel of the U.S. empire is the debt. The dollar has been its greatest weapon and it is still king. And it is a weapon with a great deal of power but wielded only against the U.S.’s allies, not Russia.
Markets will adjust and calm down in a few days. The panic will subside. But it will come back soon enough in a more virulent form. Today is a replay of 2007-08 but this time Russia is far better prepared to fight back.
And when that happens, I suspect it won’t be the Saudis or the Turks that come running to Russia to save them, but the U.S. and Europe.
At which point, I have to wonder if Putin will channel his inner Rorschach.
Were petrodollars and petrodollar recycling to disappear, it would have a twofold effect on US government finances: a sizable decline in petrodollar recycling would put significant upward pressure on interest rates. The result would be a budget crisis for the US government, as it would have to devote ever-larger amounts of the federal budget to payments on the debt. (The other option would be to have the US central bank monetize the debt by purchasing ever-larger amounts of it to make up for a lack of foreign demand. This would lead to growing price inflation.)
Further, if participants began to exit the petrodollar system (and, say, sell oil in euros instead) demand for dollars would drop, exacerbating any scenarios in which the central bank is monetizing the debt. This would also generally contribute to greater price inflation, as fewer dollars will be sucked out of the US by foreign holders.
The Iranian regime and the Saudi Arabian regime are longtime enemies, both vying for control of the Persian Gulf region. Part of the conflict stems from religious differences — differences between Shia and Sunni Muslim groups. But much of it stems from mundane desires to establish regional dominance.
For more than forty years, however, Saudi Arabia has had one important ace in the hole in terms of its battle with Iran: the US’s continued support for the Saudi regime.
But why should the US continue to so robustly support this dictatorial regime? Certainly, these close relations can’t be due to any American support for democracy and human rights. The Saudi regime is one of the world’s most illiberal and antidemocratic regimes. Its ruling class has repeatedly been connected to Islamist terrorist groups, with Foreign Policy magazine last year calling Saudi Arabia “the beating heart of Wahhabism — the harsh, absolutist religious creed that helped seed the worldviews of al Qaeda and the Islamic State.”
Saudis behind the Petrodollar
The answer lies in the fact that the Saudi state is at the center of US efforts to maintain the dollar as the world’s reserve currency, and to ensure global demand for US debt. The origins of this system go back decades.
By 1974, the US dollar was in a precarious position. In 1971, thanks to profligate spending on both war and domestic welfare programs, the US could no longer maintain a set global price for gold in line with the Bretton Woods system established in 1944. The value of the dollar in relation to gold fell as the supply of dollars increased as a byproduct of growing deficit spending. Foreign governments and investors began to lose faith in the dollar, and both Switzerland and France demanded gold in exchange for their dollars, as stipulated by Bretton Woods. If such demands continued, though, US gold holdings would soon be depleted. Moreover, the dollar was losing value against other currencies. In May of 1971, Germany left the Bretton Woods system and the dollar fell against the Deutsche mark.
In response to these developments, Nixon announced the US would abandon the Bretton Woods system. The dollar began to float against other currencies.
Not surprisingly, devaluing the dollar did not restore confidence in the dollar. Moreover, the US had made no effort to rein in deficit spending. So the US needed to continue to find ways to sell government debt without driving up interest rates. That is, the US needed more buyers for its debt. Motivation for a fix grew even more after 1973, when the first oil shock further exacerbated the deficit-fueled price inflation Americans were enduring.
But by 1974, the enormous flood of dollars from the US into top-oil-exporter Saudi Arabia suggested a solution.
That year, Nixon sent new US Treasury secretary William Simon to Saudi Arabia with a mission. As recounted by Andrea Wong at Bloomberg the goal was to
neutralize crude oil as an economic weapon [against the US] and find a way to persuade a hostile kingdom to finance America’s widening deficit with its newfound petrodollar wealth. …
The basic framework was strikingly simple. The U.S. would buy oil from Saudi Arabia and provide the kingdom military aid and equipment. In return, the Saudis would plow billions of their petrodollar revenue back into Treasuries and finance America’s spending.
From a public finance point of view, this appeared to be a win-win. The Saudis would receive protection from geopolitical enemies, and the US would get a new place to unload large amounts of government debt. Moreover, the Saudis could park their dollars in relatively safe and reliable investments in the United States. This became known as “petrodollar recycling.” By spending on oil, the US — and other oil importers, who were now required to use dollars — was creating new demand for US debt and US dollars.
This dollar agreement wasn’t limited to Saudi Arabia, either. Since Saudi Arabia dominated the Organization of the Petroleum Exporting Countries (OPEC), the dollar deal was extended to OPEC overall, which meant that the dollar became the preferred currency for oil purchases worldwide.
This scheme assured the dollar’s place as a currency of immense global importance. This was especially important during the 1970s and early 1980s. After all, up until the early 1980s, OPEC enjoyed a 50 percent market share in the oil trade. Thanks to the second oil shock, however, much of the world began searching for a wide variety of ways to decrease dependency on oil. By the mid 1980s, OPEC’s share had fallen to less than one-third.
Today, Saudi Arabia ranks behind both Russia and the United States in terms of oil production. As of 2019, OPEC’s share remains around 30 percent. This has lessened the role of the petrodollar compared to the heady days of the 1970s. But the importance of the petrodollar is certainly not destroyed.
We can see the ongoing importance of the petrodollar in US foreign policy, which has continued to antagonize and threaten any major oil-exporting state that moves toward ending its reliance on dollars.
As noted by Matthew Hatfield in the Harvard Political Review, it is likely not a mere coincidence that an especially belligerent US foreign policy has been applied to the Iraqi, Libyan, and Iranian regimes. Hatfield writes:
In 2000, Saddam Hussein, then-president of Iraq, announced that Iraq was moving to sell its oil in euros instead of dollars.
Following 9/11, the United States invaded Iraq, deposed Saddam Hussein, and converted Iraqi oil sales back to the U.S. dollar.
This exact pattern was repeated with Muammar Gaddafi when he attempted to create a unified African currency backed by Libyan gold reserves to to sell African oil. Shortly after his announcement, rebels armed by the US government and allies overthrew the dictator and his regime. After his death, the idea that African oil would be sold on something other than the dollar quickly died out.
Other regimes that have called for abandoning the petrodollar include Iran and Venezuela. The US has called for regime change in both these countries.
Oil Exporters Control US Assets
Threats can be leveled in both directions, however. Last year, for example, Saudi Arabia threatened “to sell its oil in currencies other than the dollar” if Washington “passes a bill exposing OPEC members to U.S. antitrust lawsuits.” That is, the Saudi regime is aware that it has at least some leverage with the US because of the Saudi position at the center of the petrodollar system.
Saudi Arabia is one of few states that can even feign to call the US’s bluff on matters such as these. As has been made abundantly clear by US policy in recent decades, the US is more than willing to invade foreign countries that run afoul of the petrodollar system.
In the case of Saudi Arabia, however, the kingdom’s position as an Iran antagonist — and as the world’s third-largest oil exporter — means that the US is likely to avoid unnecessary conflict.
Moreover, it is likely that Saudi holdings of US debt and other assets are significant. When the Saudis make threats, this implicitly also “include[s] liquidating the kingdom’s holdings in the United States.” As Bloomberg reported, Saudi Arabia has also
We often hear about how China and Japan hold a lot of US debt, and therefore hold some leverage over the US because of this. (The problem here is that were foreigners to dump US assets, they would drop in price. If US debt drops in price, then the the debt must increase in yield, which means the US must then pay more interest on its debt.) But there is good reason to believe that Saudi Arabia is a major holder as well. It is difficult, however, to keep track of how large these holdings are because the Saudi regime has worked closely with the US regime to keep Saudi purchases of American assets secret. When the US Treasury reports on foreign holders of US debt, Saudi Arabia is folded in with several other nations to hide the precise nature of Saudi purchases. Nevertheless, as Wong contends, the Saudi regime is “one of America’s largest foreign creditors.”
The Problem Grows as US Debt Grows
All else being equal, the US should be growing less dependent on foreign holders of debt. This should especially be true of Saudi and OPEC-held debt since the global role of OPEC and the Saudis has been diminishing in terms of global market share.
But all else isn’t equal, and the US has been piling on ever-larger amounts of debt in recent years. In 2019, for example, the annual deficit topped one trillion. In a past, less profligate age, this sort of debt creation would have been reserved only for wartime or a period of economic depression. Today, however, this immense growth in debt levels makes the US regime more sensitive to changes in demand for US debt, and this has made the US regime ever more reliant on foreign demand for both US debt and US dollars. That is, in order to avoid a crisis, the US must ensure that interest rates remain low and that foreigners want to acquire both US dollars and US debt.
Were petrodollars and petrodollar recycling to disappear, it would have a twofold effect on US government finances: a sizable decline in petrodollar recycling would put significant upward pressure on interest rates. The result would be a budget crisis for the US government, as it would have to devote ever-larger amounts of the federal budget to payments on the debt. (The other option would be to have the US central bank monetize the debt by purchasing ever-larger amounts of it to make up for a lack of foreign demand. This would lead to growing price inflation.)
Further, if participants began to exit the petrodollar system (and, say, sell oil in euros instead) demand for dollars would drop, exacerbating any scenarios in which the central bank is monetizing the debt. This would also generally contribute to greater price inflation, as fewer dollars will be sucked out of the US by foreign holders.
The result could be ongoing declines in government spending on services, and growing price inflation. The US regime’s ability to finance its debt would decline significantly, and the US would need to pull back on military commitments, pensions, and more. Either that, or keep spending at the same rate and face an inflationary spiral.
In May, President Trump pulled the United States out of the Iran nuclear deal despite Iran living up to its obligations and the deal working as planned. While the US kept in place most sanctions against Tehran, China and Russia – along with many European countries – had begun reaping the benefits of trade with an Iran eager to do business with the world.
Now, President Trump is threatening sanctions against any country that continues to do business with Iran. But will his attempt to restore the status quo before the Iran deal really work?
Even if the Europeans cave in to US demands, the world has changed a great deal since the pre-Iran deal era.
President Trump is finding that his threats and heated rhetoric do not always have the effect he wishes. As his Administration warns countries to stop buying Iranian oil by November or risk punishment by the United States, a nervous international oil market is pushing prices ever higher, threatening the economic prosperity he claims credit for. President Trump’s response has been to demand that OPEC boost its oil production by two million barrels per day to calm markets and bring prices down.
Perhaps no one told him that Iran was a founding member of OPEC?
When President Trump Tweeted last week that Saudi Arabia agreed to begin pumping additional oil to make up for the removal of Iran from the international markets, the Saudis very quickly corrected him, saying that while they could increase capacity if needed, no promise to do so had been made.
The truth is, if the rest of the world followed Trump’s demands and returned to sanctions and boycotting Iranian oil, some 2.7 million barrels per day currently supplied by Iran would be very difficult to make up elsewhere. Venezuela, which has enormous reserves but is also suffering under, among other problems, crippling US sanctions, is shrinking out of the world oil market.
Iraq has not recovered its oil production capacity since its “liberation” by the US in 2003 and the al-Qaeda and ISIS insurgencies that followed it.
Last week, Bloomberg reported that “a complete shutdown of Iranian sales could push oil prices above $120 a barrel if Saudi Arabia can’t keep up.” Would that crash the US economy? Perhaps. Is Trump willing to risk it?
President Trump’s demand last week that OPEC “reduce prices now” or US military protection of OPEC countries may not continue almost sounded desperate. But if anything, Trump’s bluntness is refreshing: if, as he suggests, the purpose of the US military – with a yearly total budget of a trillion dollars – is to protect OPEC members in exchange for “cheap oil,” how cheap is that oil?
At the end, China, Russia, and others are not only unlikely to follow Trump’s demands that Iran again be isolated: they in fact stand to benefit from Trump’s bellicosity toward Iran. One Chinese refiner has just announced that it would cancel orders of US crude and instead turn to Iran for supplies. How many others might follow and what might it mean?
Ironically, President Trump’s “get tough” approach to Iran may end up benefitting Washington’s named adversaries Russia and China – perhaps even Iran. The wisest approach is unfortunately the least likely at this point: back off from regime change, back off from war-footing, back off from sanctions. Trump may eventually find that the cost of ignoring this advice may be higher than he imagined.
The price of oil has been dropping for quite a while. Why no clamor from OPEC to reduce production? Because the US told them to keep quiet. It likely did not take much coaxing.
Saudi Arabia has two problems. US energy independence and Russian oil and gas production. Three problems if you count the cost of training and equipping Sunni terrorists. Training terrorists, even slobbering zealots, isn’t cheap these days. Read the rest of this entry »
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