Almost every market other than traditional safe havens is down this week, including stocks, crude oil, the British pound and today, the US dollar. Whether or not the G20 finance heads and central bankers meeting this week see it as a crisis, the real issue goes beyond monetary policy. So what is up, really?
By Vikram Rangala
Wednesday, February 24, 2016
Nearly every stock exchange around the world continued down on Wednesday. The reason most people gave was a drop in oil prices after Saudi oil minister Ali Ibrahim Al-Naimi said in a speech in Houston, no less, that his nation would not cut production and most likely neither would other OPEC or even non-OPEC producers.
SAUDI SQUEEZE PLAY
Instead, he said that higher-cost oil producers, particularly in North America, would “need to either bring costs down or liquidate.” Shale oil costs around $60 a barrel to produce, twice the current price. Saudi oil has a break-even cost of around $15 a barrel. Al Naimi said this directly to the executives his state-run monopoly has just defeated in a price war. It was a polite (actually not so polite) way of telling high-cost producers not to let the door hit them on their way out of the oil business.
In the long run, squeezing the competition out could lead to higher oil prices and might boost markets that are tied to oil. And with continued low unemployment in the US and cheap gas, Americans may eventually start spending like people with jobs and extra cash should spend. But in the near term, look for US energy companies to struggle, lay off workers, and damage the stock of financial firms that invested or loaned to them.
The real danger of low oil prices, however, is to oil-dependent economies. The Saudis are gambling that their low production costs and cash reserves, not to mention American defense help and foreign investment, will help them ride out cheap oil. Meanwhile, they are making major investments in solar power so that by 2050 they won’t need oil except to export.
PUTIN’S PROBLEMS & THE SYRIAN SOLUTION
Russia, on the other hand, is less prepared. Nearly half its revenue comes from crude and natural gas. Russia’s 2015 budget was based on getting at least $50 a barrel. That budget was drafted in 2014, when oil was almost $100 a barrel. The average price in 2015 ended up being just $50.75 and in real terms, even less for the sour crude oil Russia exports.
Even if the price rises from $30 to $40 later this year, it means severe deficits for Russia, which is in a recession. 2016 brings additional pressures. First, Iranian oil is returning to the world market and Iran’s export crude is a direct competitor to Russia’s. Second, Russia is about to have an election. Vladimir Putin is expected to run for another term and will spend to keep his constituencies happy, dipping into Russia’s $120 billion reserve. The money may last long enough to get Putin reelected, but after that he will almost certainly have to raise taxes, scaring away investment capital and hurting GDP.
So what does a near-dictator with a struggling, oil-based economy do to shore up support before an election? Go to war, of course. Putin’s popularity soared when he invaded Ukraine. Now he has a full-blown proxy war in Syria, with the US arming rebel groups opposed to Russia’s guy, Bashar al-Assad. Both sides oppose Islamic State and Al Qaeda, which oppose each other. And European countries, busy dealing with refugees and the threat of terrorism, are less able to counter Russia’s expansionism. It’s a win-win for Russia in which everybody loses.
WHAT’S REALLY GOING DOWN
The US defense budget for 2016 includes new technologies like swarming drones and human-machine hybrids, designed to outspend and intimidate Russia and China. While some companies might benefit from increased defense spending in the US and countries like Russia and China looking to maintain parity, an end to the post-Cold War peace dividend would be a long-term drain of productivity and resources away from other innovation. Ultimately, losses like that are the true cost of the end of oil profitability.
The oil slump and the slump in stocks, the dollar, and the pound are all happening as the G20 finance ministers meet to coordinate policies to renew global economic growth. The real solution is a more fundamental change in capitalism, not just adjustments in interest rates or currency valuations. You can see the proof of that when you look at what’s up when everything else is down.
WHAT’S REALLY UP?
So what is up? The safe havens of gold, bonds, and the yen are all higher as investors move money out of stocks. They’re not any more valuable. Their main value is being disconnected from all the stuff that’s down.
And the VIX is up, meaning fear and uncertainty are up and confidence is down.
We don’t trust each other, to put it simply. Global trade is at its lowest since the 2008 crisis. Cargo ships are being scrapped at twice the previous record rate set in 1986. We don’t trust each other as trading partners, and new evidence shows we don’t trust each other as lending partners, either.
Global capital flows are as bad as in 2008. Countries that depend on international investment and exports will suffer compared to countries with healthy domestic capital and demand. Russia is about to lose international investors and customers, just as its main source of income is drying up.
So what’s really up while all these markets are down? Risk. Risk of war, civil unrest, and fear-based politics. The solution? Solar energy and electric cars. I am not kidding. Without oil at the heart of our economic destiny, human beings would have a chance to prove what else we’re good at besides digging holes and fighting over what comes out of them. That would be a much happier challenge to take on than what the G20 leaders are discussing this week.
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