DIE BY THE SWORD
October 8, 2014 § 7 Comments
There is that movie soundtrack by Paul McCartney which goes “Live and let die”. If the current drop in oil prices (see figure below) is sustained for any significant length of time, the effect on countries will be highly variable. A sustained Brent oil price below $90 per barrel will do potentially grievous harm to the Russian economy with or without the financial burden of aggression in the Ukraine. The latest Russian budget was premised upon oil at $100, and given that over 40% of treasury coffers are filled with oil and gas revenue, a sustained price below $90 would be very difficult to swallow. Some reports have it that every $1 drop in Brent results in a $2.1 billion annual drop in revenue. In fact in an earlier blog I had mused on the option of release of the Strategic Petroleum Reserve (no longer needed in the US due to burgeoning domestic oil production), to drive down prices, or the mere threat to do so, to influence Russian aggression.
The US on the other hand will broadly be unaffected. A steady Brent price between $80 and $90 (if there is such a thing as steady oil pricing) could dampen some of the shale oil ardor. Shale oil prospects are highly variable with respect to breakeven price, but the vast majority of them make good returns at $80 per barrel pricing. Particularly if oil export were to be permitted, the net effect would be minimal. This is because US shale oil currently sells at a discount to Brent of well over $10, and export would afford it full Brent pricing. Allowing exports would markedly improve the resiliency of US shale oil production relative to softness in world oil pricing.
Many oil producing countries could be placed in an untenable situation were the Brent prices to stay below $90 for extended periods of time. The Gulf monarchies have spent lavishly on their populations especially following the Arab Spring. Good numbers are hard to come by, but Saudi Arabia is believed to need a $90 price as a minimum to sustain the social benefits. That number is higher in some of the other OPEC members such as Venezuela and Algeria, as also in Iran.
The drops in oil price do not appear to be any country’s doing. As we previously reported, world oil production dropped by 2 MM bpd over the last two years and was entirely made up by new US production from shale deposits. But more recently supply has also picked up elsewhere, especially Libya. Demand on the other hand has reduced, especially in the US. The trend towards demand reduction will continue at least in the US, where methane and ethane will displace oil in transportation and as the feedstock for chemicals such as olefins. Although unintended, a sustained drop in oil prices will serve the political interests of US and its allies vis a vis containing Russian aggression in the Ukraine. A sustained loss of oil and gas export related revenue, in conjunction with economic sanctions, would make military expenditures in the Ukraine affair essentially infeasible. The most related aspect of the sanctions is that with loss of revenue the Russian oil firms would need to borrow and foreign capital would simply not be available.
This is somewhat ironic because Russia has threatened to use curtailment of gas supplies to Europe as an imposition of political will. I have maintained in these pages that energy is a much more powerful weapon than armies for exacting pain for behavior seen as detrimental to the interests of a producing country, in this case Russia. In other words they would be living by the sword of energy. It seems now that there is a risk of dying (thrown into a deep recession) by that very sword, even if it was wielded unintentionally and by no one in particular.