Weekend Economists Light the Candles December 19-21, 2014

[Demeter]

6. "We must now examine the reason for the drop in oil prices."

A Drop of a Political Nature?

Multiple indications show this drop as being of a political nature. Some OPEC leaders have alluded to a possible speculation too. It is known that huge quantities of “paper-Oil” were in some Banks books and that these banks were going “short” on this trade. But, still, there is quite clearly a political bias in this speculation.

An attempt by the United States to destabilize Russia is often conjectured. Such an attempt may have occurred, but reality is much more complex. One must know that the threshold of profitability for the new sources of fossil fuels lies at 70 USD a barrel for oil sands (mostly exploited in Canada) and at 65 USD the barrel for shale oil. With an oil price that could hit below 60 USD a barrel, the OPEC countries are actually attacking the North American oil industry. Besides, it is significant that the large Russian oil companies, Rosneft, Loukoil, remain fairly silent about the present evolution of prices. One may well ask if there is not a tacit understanding between Saudi Arabia and Russia to evict, or at least to set limits to, a new actor on the fossil fuel market.

But this attack could have other consequences. The shale oil and gas sector has developed on loans covering 80% to 90% of the investment costs. These could make out over 300 billions in liabilities for American banks. These debts inevitably turn into “dubious loans” (or “non performing loans”) from the moment that one descends significantly below the threshold of profitability. But banks have, as a matter of course, securitized this loans, by emitting CDS’s in which these loans act as collateral. If we are stuck too long with a price that is too low, one cannot exclude a new financial crisis in the American banking system. We notice moreover that the potential risk hovering over the shale oil industry has already been anticipated in part, for operating licences in the United States have gone down 50% during the third quarter of 2014. We can therefore conclude that if oil prices maintain themselves at a very low level until next June, we will probably witness a blood bath in the shale oil industry, with very grave consequences for the banks. I point out in passing that the estimate of 65 USD as a threshold of profitability is an estimate given in oil industry circles, based on the technical conditions of extraction. It does not include financial costs. We can therefore expect the American government to blow the whistle to put an end to the price drop no later than the end of this winter, if it doesn’t want to have a major crisis on its hands. But extracted volumes will go down, too. Production in the United States, after experiencing a peak at the beginning of 2015, should go down significantly during the second semester of 2015. This means that we can expect a new rise in prices during the second semester of 2015, probably in the direction of 70-75 USD the barrel.

This is Not a Replay of 1998

This poses no problem to Russia, whose reserves are such at present (450 billion dollars just for the Central Bank) that it can face an important drop in prices, albeit of a limited duration. One must note also that the repayment of loans by Russian companies for 2015 does not exceed 120 billion dollars. This remains far below the reserves of the Central Bank of Russia as well as of those of the finance ministry. Should it turn out to be necessary, these companies will find among the state actors the money which they need to repay their loans. But this would then imply an extension of the authority of the State over the economy. Yet, in no case should it lead to a “default,” as in 1998, neither of the State (which is very little in debt, and whose debts are essentially held by Russian actors, such as Sberbank) nor of the private sector, which is in fact in possession of vast assets in dollars and which is therefore solvent in the long term. The question of short term liquidity being manageable by way of an appeal to the public sector. The very idea of Russia getting struck into the same crisis pattern than in August 1998 sounds very, very strange. This is probably another case of ideology-driven statements, or ones made by people with no information at all on the actual situation of current Russia.

The image of a Russian default continues to haunt the minds, when the situation is actually quite different at present, as shown by the ample currency reserves. But one may ask if this default of 1998, in which American banks and European banks generally lost a lot of money, is not still being « reproached » to Russia. As a matter of fact, this default allowed Russia to save itself from the depressionist trap in which it had found itself since 1992. It was the founding act of the economic renewal, and of course also of the political renaissance, of the country. We remember the decision of the then Prime-Minister, Evguenny PRIMAKOV, to send Russian paratroopers to protect Serbian populations at the time of the intervention of NATO in Kosovo. One can see in this a first adumbration of the “return of Russia” which is at present embodied by Vladimir Putin, and which has still not been admitted by the ruling circles of the United States and their satellites in Europe....