by Michael Roberts
Crude oil prices have dropped to five-year lows in just a few
months. And the reason is clear: it’s supply and demand! On the
supply-side, the most significant development has been the accelerating
expansion of shale oil and gas production in North America, mainly in
Oil and gas reserves are trapped in layers of shale rock and can be
released by a process of hydraulic water pressure called fracking. By
sinking hundreds of rigs in quick succession, shale rock can produce
significant supplies of tight oil and natural gas – and this process in
North Dakota, Texas and other areas has turned US oil production round.
US oil output up to now had been based in traditional deep oil reserves
in Texas, Louisiana and the Gulf of Mexico. US production was in
decline from the mid-1970s to around 4mbd and falling. But with shale,
annual output has rocketed back to 9mbd, near previous peaks. Fracking
for tight oil and gas is now spreading across the globe as those
countries with large shale reserves look to exploit it in Poland, China,
Europe and even the UK.
The other side of the price equation is demand. Global demand for
energy, particularly oil, has slowed. That’s mainly because global
economic growth has slowed since the Great Recession ended. China has
led the way with slowing growth, along with the other large emerging
economies, like Brazil and India; and the major advanced capitalist
economies remain in ‘low gear’ (see my post, http://thenextrecession.wordpress.com/2014/11/08/the-world-economy-in-low-gear/).
Industries are increasing their use of fossil fuels at a slower pace
than expected, while transport demand is in decline (Americans are
driving less). Energy conservation has been stepped up and energy
intensity (energy per unit of output) is falling everywhere. All the
international energy agencies now expect oil and gas prices to stay at
these new lows for some years ahead.
The biggest losers are those countries that rely on energy exports to
make their money: Saudi Arabia, the rest of the Arab oil states,
super-rich Norway, super-poor Venezuela, Mexico and, above all, Russia.
The Saudis have launched a counter-offensive. With more than five
times the reserves of American shale, they are taking on the shale
producers by increasing production in order to drive down the price to
the point where shale producers start losing money (their production
costs are way higher than the Saudis: about $50/b to $25/b). So far
this has not worked and shale production continues to rise. But the
Saudi policy is destroying the revenues of other OPEC producers like
Venezuela – and Russia.
Putin may have faced up to ‘the West’ over Ukraine and refused to budge but, as I argued in a previous post (http://thenextrecession.wordpress.com/2014/11/10/from-poroshenko-to-putin-its-all-downhill/),
the West has been winning the economic battle and the oil price has
been the major weapon. The collapse in the oil price has exposed the
weakness of the Russian economy.
Just a year ago, Russia’s stockpile of dollars from energy exports
stood at more than $515bn. Now as oil revenues have dissipated and
sanctions on Russia imposed by the West over Ukraine have been applied,
Russia’s trade surplus has diminished and the flight of capital by
oligarchs and others out of Russia and the rouble has rocketed to $120bn
a year. As a result, FX reserves have dropped below $400bn and the
rouble has plunged in value to the dollar by 40% this year, invoking a
sharp rise in the inflation of prices in Russian shops and shortages of
$400bn is still a large reserve and the Russian central bank has
tried to prop up the rouble by selling its dollars and buying the
Russian currency in FX markets. But it did not work. Then the central
bank just let the ruble go to save dollars. And the rouble plunged
further. Now it has started buying roubles again with its reserves to
stop the fall, again to no avail.
Central bank policy is all over the place. And this is worrying Putin
who has begun to criticise his own bank appointees. The problem is
that much of these reserves cannot be used to prop up the currency
because enough must be kept to cover payments for essential imports (the
IMF recommends at least three months worth of imports). If reserves
drop below that level, the rouble will go into even more meltdown as
foreign lenders (mainly European banks) pull out their money. Also the
fall in the ruble means that all those Russian companies with big dollar
debts and loans, particularly Russian banks, face huge dollar bills
that they cannot meet.
According to the Russian Central Bank, the country has to repay $30bn
of debt this month and another $138 bn in the next 18 months. Only 2%
of this debt is owed by the government, while non-financial enterprises
accounted for more than 60%, the rest mostly belong to the banking debt,
including Russia’s largest bank – the state-owned bank Sberbank.
So they are asking for (and getting money) from the government to
bail them out. State oil giant Rosneft, for example, has asked for
$44bn, equalling more than half the remaining balance in the so-called
Wellbeing Fund that’s earmarked to support the pension system. VTB Bank
and Gazprombank have already gotten more than $7 bn from the Wellbeing
Fund and are asking for billions more. If FX reserves and wealth funds
are used up to bail out the banks, then planned infrastructure projects
will be dropped and pensions will come under threat. And the
three-month import limit will get closer. At current rates of decline
in FX reserves, that limit could be reached by summer 2015.
Putin‘s annual address to the Russian parliament last week showed he
was getting worried. He even offered a complete amnesty to oligarchs
who have been spiriting their money out of Russia like a waterfall in
the last few months. “I propose a full amnesty for capital returning to Russia,” Putin said. “I stress, full amnesty.” “It means,” he continued, “that
if a person legalizes his holdings and property in Russia, he will
receive firm legal guarantees that he will not be summoned to various
agencies, including law enforcement agencies, that they will not ‘put
the squeeze’ on him, that he will not be asked about the sources of his
capital and methods of its acquisition, that he will not be prosecuted
or face administrative liability, and that he will not be questioned by
the tax service or law enforcement agencies.”
In Russia, two of the major classes of people who have large amounts
of capital overseas are organized criminal groups and the so-called
oligarchs. In stressing that there would be no prosecution, Putin
appeared to explicitly leave the door open to money obtained illegally. “He’s talking to people who have engaged in corporate raiding,”
said Professor Louise Shelley, founder and director of the Terrorism,
Transnational Crime and Corruption Center at George Mason University in
Fairfax, VA. “There are thousands of cases where people who have
used criminal processes and false documents to acquire assets. He’s
talking to organized crime figures who have taken over businesses.” She added, “There are no large fortunes that are entirely clean money in Russia.”
Assuming the oil price stabilises at around $60/b next year, Putin
can avoid a debt crisis next summer, if he can squeeze Russian
corporations to buy roubles with their dollar export revenues (a form of
capital controls) and to bail out the banks with government reserves.
Putin is doing just that. But that does not save the domestic economy.
The sanctions plus the collapse in oil prices have pushed the Russian
economy into recession. The government admitted that the economy would
contract by about 1% next year, with investment falling 3.5% and average
household incomes down nearly 3% in a year! Indeed, for the first time
in 15 years, living standards for the average Russian will fall in
2015. A freeze on inflation-linked pay has been imposed and inflation is
rising at nearly 10% a year now.
Putin may be very popular because of his foreign policy over Ukraine
and ‘standing up’ to the West, but his popularity will now suffer
because of his domestic policy. Russian-style austerity is coming.
Whereas government spending has risen an average 10% a year in the past
decade, it will now be cut. Cutting military and police spending is
politically impossible because Putin needs the support of the security
establishment so he can rely on them in case of social unrest. This
means the government will have to target investments, benefits and
salaries. Last week, Putin announced a 5% cut in real terms from
2015-2017 by reducing “ineffective spending,” except for defence and
security. Putin used to promise Russians that their country would
overtake Germany as the world’s fifth-largest economy by 2020. In May
2012, he signed a decree pledging to increase real wages by half by
2018. Those promises are now dead in the water.
Putin continues to rely on his Ukraine policy for popularity and
Ukraine’s economy is in an even worse state. Ukraine’s central bank
reserves have dipped below the $10bn mark for the first time since 2005
after making a gas payment to Russia’s Gazprom (see my posts on
Ukraine). The IMF will probably hand over another $2.7bn in funding to
tide the Kiev government over. But it is clear that Ukraine needs
another $20bn over the next two years to handle the war in the east and
fund debt repayments. An IMF mission arrives tomorrow to plan a massive
austerity plan for the Ukrainian people in return for funding.
But probably the most important aspect of the collapse in the oil
price is the spectre of global deflation. World inflation has been very
low since the Great Recession, another indicator of the Long Depression
that the world economy has been locked into. But what inflation of
prices there has been has mainly been due to the sharp rise in energy
prices. Non-energy price rises have been minimal. Now, with the sharp
fall in energy and other commodity prices (metals, food etc), deflation
is the spectre haunting the globe.
Oxford Economics finds that if oil prices were to fall to as low as
$40/b, then 41 out of 45 countries it follows would experience
Some argue that this is good news. This is the line of some
neoclassical economists and the Austrian school. Falling prices,
particularly in energy and food, will raise consumer purchasing power,
and help boost demand and thus economic growth.
But for profitability, it is bad news. Inflation of corporate
producer prices is another temporary counteracting tendency to falling
profitability. If it disappears, then the downward pressure on
profitability from any new technology investment will be greater as
falling prices squeeze profit margins. In that sense, deflation is not
good news for the capitalist sector, especially if it is burdened with
heavy debts (small businesses in particular). So the crisis brewing for
Russian businesses may be followed by others. It could be another
factor leading to a new global slump, this time based in the
non-financial productive sector of capitalism.
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