By Tornike Sharashenidze
When Russia invaded Georgia oil prices were skyrocketing. The same was true about oil prices when Russia annexed Crimea. These two cases are not sufficient to establish a statistical relationship between energy market and Russian behavior but it is definitely enough to argue that a richer Russia tends to be more aggressive.
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Now as fuel prices have fallen sharply we still see an aggressive Russia. But on the other hand one may argue that Russia would not do the same one year ago (annex Crimea) if oil prices were around $50 (as they are now). It is true that Putin gives no sign of backing in the Ukraine but he may not have made the very first step had not he enjoyed oil windfall in 2014. When in response to Crimea (and later to Donbass) the West imposed economic sanctions, Russia did not budge. Everybody understood that the sanctions would cause some problems but the Russian economy would stand as long as fuel prices stood the ground.
So the Russian officials and state-controlled media simply laughed at the sanctions. Their impact seemed to be too low. Russia paid some price but that price was ridiculous for something like Crimea. The sanctions looked like a lipstick service that was to help the West simply save its face.
But when oil prices crumbled the laugh gradually dwindled. Now the question is for how long it will continue. Russia is already struggling but so far is surviving thanks to “Crimea is ours” frenzy and reserve funds. But if oil prices do not recover for another couple of years then Russia will run out of its already depleting reserve funds (and “Crimea is ours” will die away with time too) and its economy will collapse. Russia exports up to 6 million barrels every day. That means that if annual oil prices fall on average by, let’s say, $40 then Russia will lose up to 90 billion in 2015 (drop by a single dollar will cost exactly $2 190 000 000 per year). It is almost 5% of Russian GDP (which is slightly more than 2 trillion). Combined with the impact of sanctions it should have a devastating effect indeed.
So the question is for how long. To answer this we will have to find out what has caused the sharp decline in oil prices. In Russia now almost everyone starts to remember about the US-Saudi anti-Soviet conspiracy (under president Reagan) which pushed down oil prices (after the Saudis started to overproduce) and contributed to the collapse of the Soviet Union which badly depended on oil exports (but not as badly as current Russia does). Maybe the anti-Soviet, sorry anti-Russian, scheme is back and the Americans once again are out there to ruin Russia like they already ruined the Soviet Union.
Probably not. That sounds like a typical Soviet conspiracy theory. There is another theory, more plausible one. It says that the Saudis started to overproduce again but this time they are not in plot with the Americans, they actually are trying to kill shale oil industry on in the US that is making the latter a direct competitor to the Saudis. At the same time Saudis are hurting Russia and Iran too and they have various reasons for doing that (Shiite Iran is a traditional foe while Russia has been supporting Syrian regime). But still the main target is shale oil production while Iran and Russia may be secondary targets of the new Saudi policy.
Even if we accept this theory then oil prices will still remain at lower level for quite a long period because of the following.
Let’s assume the Saudis are overproducing and testing the resilience of shale oil industry in the US. As we see shale oil is resisting quite successfully (its production has slowed down but not significantly) so it looks like shale oil industry can survive when barrel goes bellow $50. We can assume that it can not survive when prices fall further, say bellow $40. So what should we expect when if happens. The answer is very simple. Shale oil industry will crumble but it will be the Russian economy that will suffer. As for the US economy it will be hardly hurt. Of course the jobs created by shale oil industry will go but economy will still benefit thanks to cheap energy, trade deficit will shrink and dollar will strengthen. With time prices will go up again (provided that shale oil industry is still dead) and exceed first 40 and then 50 dollars. But in that case shale oil industry will recover again, oil supplies will increase and consequently prices will drop. And so on and so on.
In fact shale oil industry may recover before prices go up. That is because technologies tend to get cheaper with time. A few years ago the US stopped to import natural gas thanks to shale gas revolution. It was a remarkable achievement but when some analysts started to speculate that the US would do the same trick with oil too they were ridiculed: shale oil technologies looked to be way more expensive than those of shale gas. Because of this assumption shale oil revolution looked to be much more distant prospect and its proponents were hardly taken seriously. Now thanks to shale oil the US soon may overtake the Saudis as world’s largest oil producer.
So no matter what the Saudis are doing – whether they are really overproducing to kill shale oil industry or not – the fact is that shale oil has changed the world energy market. Technologies will get cheaper and the US (as well as Canada and later some other countries) will start to produce more. So the oil market will never be the same again. In fact oil may stop to be a strategic resource because it will be in abundance.
This is bad news for oil exporting/authoritarian countries and Russia looks to be especially endangered. This is because Russia is much bigger than Arabic countries, because Russia is much more ambitious than any other oil exporting country – it spends enormous resources for asserting its position in international organizations and in the neighborhood; nowadays it also spends a lot (it still has to be estimated how much) in “hybrid war” against the Ukraine. Plus, the Russian economy is less diversified than that of Arabic countries that have developed service industry and accumulated money in different foundations.
No doubt the Russians understood the danger when oil prices started to fall amid the war in the Eastern Ukraine. When a few months ago OPEC gathered to discuss oil production quotas the Russians leaders (including Putin himself) contacted the organization and promised to cut oil production if OPEC would do the same. It was something special. Since mid 90-ies OPEC and Russia used to be fierce competitors. When fuel prices fell sharply OPEC started to cut oil production to boost the prices. Almost immediately after each OPEC cut Russia would increase its oil production. It was a smart move since Russia was benefiting from higher fuel prices (caused by OPEC cuts) and it was occupying the market share that OPEC would lose after cutting production. This game came to its end after 2003. The American invasion into Iraq boosted oil prices drastically and there was no need for cutting fuel production anymore. Russia flourished and Putin’s rhetoric became increasingly bellicose. Prices remained at high level until late 2008 when world financial crisis undermined stock markets including commodities. Russia survived the fallback thanks to its reserve funds. The crisis ended sooner than Russian funds and by 2010 oil prices started to climb again pushing up Russian economy too.
But let’s get back to the recent OPEC meeting. The fact that this time Russia promised in advance to cut production itself was remarkable indeed. But even more remarkable was the fact that OPEC refused to make cuts and finally left everything unchanged. One may assume that OPEC did this to test further shale oil industry. But if this is true it will not make Russia better off in any way (as we discussed it above). Another way to explain OPEC’s decision is that the organization realized that it could not benefit from oil cuts anyway. Such a decision would boost prices but consequently it would further boost shale oil industry too and the US producers would occupy the market share OPEC would lose (just like Russia used to do before). It would end up in falling prices again which would make OPEC cut production again. And so on and so on.
That means the following: shale oil revolution is changing energy market not only in terms of prices. There are new market players out there. OPEC does not hold the master key anymore and so it can not dictate prices anymore. Now it is more complicated. As new leading players have entered the game has changed. The master key is shared now by OPEC and the US. So if Russia is endangered it will have to contact both OPEC and the much-hated Americans too.
This is because the most plausible theory explaining drop in oil prices is that shale oil is out there and that it was started in the US. Well, where else?