Stratfor sent this free analysis via e-mail yesterday. As much as people complain about "foreign oil dependencies", I guess that it's greater trouble to be an oil producer, than an oil importer.
THE GEOPOLITICAL INTELLIGENCE REPORT
Calculating the Political Effects of Falling Oil Prices
May 17, 2005 22 40 GMT
By George Friedman and Peter Zeihan
The international system has been operating with two major focuses when it comes to oil prices. The first is that oil prices are high, and that in all likelihood they will continue to rise. Some analysts have recently thrown around upper limits in the range of $105. The second focus has been on the effect of high oil prices in consumer countries. One of the puzzles has been that global markets have not buckled under the weight of rising energy prices, but seem to have weathered the storm. Many have even thrived: overall global growth in 2004 was the fastest in over 20 years.
We have always been skeptical about some of the fantastic expectations for energy prices, and the events of the past week prompt us to restate three views. First, in historical terms, oil prices are not extraordinarily high. Second, it is not at all self-evident that oil prices will continue to rise or even hold their highs. Third, the most important question is not the potential effect of higher oil prices in consuming countries, but their effect in producing countries.
Oil prices, measured by NYMEX light crude, reached an intraday peak of nearly $60 a barrel at the beginning of April. On May 13, they hit an intraday low of just under $48 dollars a barrel. This means that in the past six weeks or so, oil prices have fallen by nearly 20 percent. We do not know what they will do next, but of this we are absolutely certain: oil prices have fallen dramatically of late. There is another thing we know, which is that major media have taken no notice of this drop. While oil speculators have been hammered, the major media continue to talk about soaring oil prices. The idea that we have high oil prices which will only go higher is an idee fixe among most people.
Expressed in real dollars (adjusted for inflation), $60 was the high point for crude prices after 1984 -- a cyclical high. However, it was barely half the price of oil in 1979, when -- in inflation-indexed terms -- it reached the all-time high of $95 a barrel. In other words, in real terms, oil prices are not that high now, and they are falling.
Now, we can debate where oil prices will go in the future -- but if we and other analysts knew that, we would not be scribbling for a living. We can only go by what we have seen, and that gives us three points:
- Oil prices, in real terms, were at 20-year highs for most of 2005, but were always far from their 30-year highs.
- Oil prices have been falling fairly dramatically for several weeks.
- The current price (not the fantasy price) of oil is, historically, modest.
It is, therefore, not surprising that global stock markets and economies have not collapsed under the weight of surging prices. Oil prices have risen from their lows but have not reached extraordinary heights. Moreover, the stock markets appear not to have been convinced that even these prices were sustainable. In this, the markets were certainly correct, even if things might change.
That means, from a geopolitical point of view, that the focus ought to be redefined. We thus far have been obsessed with the effect of higher oil prices on consuming economies. We now need to flip the question: Whether oil prices hold at current levels or drop precipitously, what are the potential effects on producing countries? Assume that oil prices move back down into the $30s or even $20s, what happens then?
We are talking here not chiefly of economic effects, but of political ones. Expectations about the future of energy prices are built into the political systems of key producing countries. If those expectations are not fulfilled -- or if the assumption becomes that they won't be fulfilled -- anticipatory political maneuvering will begin. In other words, politics follow the expected direction of things.
The events of the last week may not have substantial economic effects in either producing or consuming countries. But they could have substantial effects in the producing countries if the expectations of political actors change dramatically. A political group that expected to benefit from rising prices might change its strategy dramatically if it ceases to expect benefits -- and in some cases, those changes could be dramatic.
Russia
For example, in Russia, President Vladimir Putin finds himself in a bit of a bind. Like Yeltsin before him, he is trapped between the nationalists on one side and the liberals on the other. Also like Yeltsin, Putin has had to reach out for the support of the nation's oligarchs to maintain power.
That puts him under double constraints. On one hand, Putin needs to keep the oligarchs reasonably happy; but on the other, the oligarchs tend to sock their money away -- abroad -- as a matter of course, and particularly whenever Russia's macroeconomic picture darkens. In the aftermath of the Yukos dismemberment, capital flight has returned to highs seen in the 1990s -- and this at a time of rapid growth and high oil prices. Just imagine the oligarchs' panic when oil prices head south.
Meanwhile, Putin is losing the public's trust. The New Year's effort by the Kremlin to cut expenditures and to monetize social benefits -- econ-speak for giving people a monthly check rather than free electricity, rent and bus fare -- led to an unprecedented eruption of protests, forcing the government to hand out another $8 billion in benefits to the country's veterans and elderly. Without public trust or a major political faction in his pocket, Putin is forced to attempt a complex balancing act.
Therefore, the Russian government, much like its Chinese counterpart, finds itself held hostage to its economic growth and the resulting social expectations -- and that growth is a result largely of oil prices. In order to head off a nationalist uprising, Putin has little choice but to buy off disaffected portions of the population. That takes money.
Putin does, however, have two things going for him. First, Russia is the world's largest exporter of natural gas, giving the government another financial leg (even if one indexed to crude prices) on which to stand. Second, Putin's financial planning has been the most solid in recent history. Since he became president in 2000, high oil prices have helped him run an extremely tight ship financially. Moscow is even paying off a fairly large chunk of its Paris Club debt ahead of schedule, and ferreting away loads of cash for the future. The state's currency reserves now stand at a record $144 billion, and a rainy day fund -- for use when oil prices turn south -- now holds $30 billion.
Putin is certainly worried about the trend turning negative, but he -- more than any other oil-dependent world leader -- has financial wiggle room.
Nigeria
At another extreme is Nigeria. Unlike many other producing countries, Nigeria is a highly evolved kleptocracy in which oil money lubricates everything, and yet the deaths of thousands of people during periods of civil unrest -- in times fat and lean -- are perfectly normal.
Unlike Russia, Nigeria is barely making a dent in its international debt. Though it is true that currency reserves have risen by nearly $10 billion during the past year, we consider such thriftiness quite un-Nigerian, since Abuja's primary plan is to seek substantial debt forgiveness despite record revenes. The government knows full well that, unlike many petroleum economies, Nigeria can both sustain and withstand a substantial amount of chaos.
While a price collapse in another environment, such as Venezuela, could lead to social disorder, Nigeria already has social disorder -- and has repeatedly demonstrated that the political system can survive such conditions. The government is already so inured to the chaos that a loss in revenues will simply mean one more disabling element in the existing environment. In fact, the Nigerians have a tried-and-true method for dealing with it: more deficit spending, followed by appeals for more debt forgiveness. Nigerian bureaucrats are already exploring how to issue new debt most efficiently.
Kazakhstan
Kazakhstan is another story. Though Kazakhstan and Russia produce roughly the same amount of crude on a per capita basis, they are not equally vulnerable to price pressures. A price drop certainly would impact its spending patterns, but Astana has three advantages Moscow lacks.
First, while oil income remains critical to the Russian budget, most of it goes to the oligarchs who control Russia's oil companies. In Kazakhstan, what is not siphoned off by President Nursultan Nazarbayev's family makes it directly into the state coffers. Nazarbayev's siphoning can be held in check without threatening any forces beyond his own family.
Second, Nazarbayev is concerned that his regime might be the next target in the ongoing wave of "velvet revolutions" sweeping the former Soviet Union. That has led him to be more generous with state payouts than in the past. Finally, unlike Russia -- where the trend is toward barring foreign participation in the energy sector, and therefore toward flat production -- Kazakhstan is aggressively seeking foreign investment and is actively participating in multiple export projects. As a result, Kazakh oil output is accelerating quickly -- and the state's finances are stabilizing -- regardless of price movements.
Venezuela
Meanwhile, high spending and dwindling oil output put Venezuela in perhaps the worst political position. President Hugo Chavez will aggressively push for OPEC to reduce production, since his mismanagement has already reduced Venezuelan output by some 800,000 bpd under the cartel's existing quota regime. Should OPEC slash quotas, Caracas will not have to adjust its own plans a whit. Similarly, Chavez will threaten to cut off exports to the United States and nationalize the Venezuelan holdings of American companies -- anything to "talk up" the price of crude.
But such "solutions" ultimately depend upon actors that the Chavez government cannot control. Likewise, cutting spending is simply not an option. The government in Caracas remains in power because it continually pays bribes for the support of the populace, to the tune of some $32 billion per year at last measure. Cutting those payouts is simply not an option.
There are two things, therefore, upon which Chavez can fall back. The first is the country's central bank, which currently holds $19.1 billion in its net operating hard-currency reserves -- funds that Chavez already is attempting to tap. The second is the country's bolivar-dollar exchange rate: a 50 percent devaluation would double the country's oil income.
Inflation is the downside of either strategy. Dumping a few billion into an economy worth only $85 billion while devaluing the currency would be a horrendously inflationary move that almost inevitably would lead to social unrest. Chavez is pursuing ties to Cuba in part for this reason: Those links already comprise some 35,000 "advisers" whose purpose is to keep Chavez's Bolivarian revolution going at all costs. Chavez has also steadily militarized his politically loyal militias, aiming for a "reserve" of 1.5 million men.
Now call us kooky, but if you have 1.5 million guys running around with surplus FAL rifles when the social order gets a little questionable, what happens when you run out of money to pay them? Chavez is preparing for -- and contributing to -- what well could be a bloody future.
Middle East
Ultimately, of course, the Middle Eastern powers face the most dramatic choices. Within the region we must split the countries into two groups.
The first group is the smallish states characterized by hefty production levels relative to their populations: Kuwait, Libya, Qatar and the United Arab Emirates. In all four examples, the question is largely which pointless, grandiose projects -- such as Qatar's scheme to construct artificial islands in the shape of the world's countries -- should be cut.
The one possible exception to that rule may be Libya, but since its rehabilitation on the world stage, Tripoli's international adventurism -- and thus its adventurous budgetary outlays -- has already been grossly curtailed. That said, prices would have to plunge well below $25 before any of these states become even remotely concerned. Even Algeria, where oil income is critical to continued government efforts to gain the upper hand in its civil war, has always proven capable of finding international financing during lean times.
The second group comprises states with larger populations and more ambitious plans. These states are a different matter altogether. As far as the Middle East is concerned, the two most likely to feel the pinch of falling oil prices are Saudi Arabia and Iran.
Saudi Arabia
The Kingdom of Saudi Arabia is not in tremendous shape, and in traditional Arab fashion has dramatically stepped up spending to make up for problems at home. But unlike the various Persian Gulf statelets, Saudi Arabia has a fairly small financial cushion. For example, the Kuwaitis and Qataris produce on average more than four times as much crude per citizen as do the Saudis. A subsidy cut for cell phones in Kuwait City would be paralleled by a subsidy cut for public transport in Riyadh -- the difference between imposing a level of personal discomfort and provoking civil unrest.
So belt-tightening in Saudi Arabia would have political implications largely nonexistent in the rest of the Arab portions of the Persian Gulf. The Saudis are well aware that they will need to dismantle portions of their generous payouts. The dilemma is, cut the payments to whom?
The one group that Riyadh would not dare disinherit is the various tribal leaders who are not part of the House of Saud. The tribes of Arabia both helped to build up Islam as a force and Saudi Arabia as a state. Shutting them out would be tantamount to national and clan suicide, things that the Saudi royals are experts at avoiding.
In fact, the royal family is far more likely to shave down its own portion of the government take, rather than reduce payments to supporters outside of the family. Concerns about family infighting will, of course, limit the amounts cut and to whom, but the top leadership believes it is high time to trim the family dole -- and the monarchy will be looking particularly at ways in which a cut in stipends to specific individuals could also defang potential problem-makers.
Ultimately, however, Saudi charitable organizations are likely to suffer the lion's share of the subsidy cuts. After two years of on-and-off sparring and co-opting of al Qaeda supporters within the kingdom, Riyadh feels that it has finally managed to get a grip on the militant organization. With that grip in place, Riyadh can reduce the amount of cash it pays to groups with links to militancy, if the need arises, without risking an immediate backlash. And it could let up on spending for various religious causes that quite literally give potential militants something else to do with their lives, such as studying religious texts for four years at a time.
At the core, cuts to the family or tribal payouts would create a short-term political crisis, while cuts to Islamic charities would raise questions about long-term social stability. The House of Saud is notorious for avoiding short-term inconveniences at the risk of long-term crises.
Luckily, as the world's largest oil exporter and OPEC kingpin, Saudi Arabia need not be limited to simply cutting expenditures in order to deal with falling oil prices. The kingdom's internal oil wealth means that, in the event of a financial crunch, the country would be much more likely to turn to Saudi citizens (read, someone in the royal family) than to any international creditors to see it through.
Riyadh also has more traditional market-based options -- such as reducing OPEC quotas -- for keeping oil prices high. The only problem with slashing production, however, is that it can take more than two years for the effects to feed through the system and push prices up in any sustained way. That forces the Saudis to consider less orthodox options, should they not wish simply to cut their own spending.
Bear in mind that the Saudis are proven masters of milking crises for all they are worth, and then wrapping the "crisis" up quickly and -- from all outside perspectives -- decisively. Take, for example, the beheading of American hostage Paul Johnson in June 2004. With an hour of Johnson's death, Saudi security forces had swept in and killed all those responsible.
Was this luck? Or did the Saudis know precisely where Johnson and his captors were in the several-day crescendo leading up to his murder? If Riyadh finds itself under pressure, it has ways of stoking crises that can spook the markets and push prices higher, while making the regime ultimately appear to be large and in charge. Intentionally spooking the markets is a truly dangerous game to play, but it is something the Saudis apparently are confident enough to do when the lives of American citizens hang in the balance.
Iran
Iran is about to find itself in a very unusual bind. At the moment, everything that Tehran is trying to achieve geopolitically -- stability at home, nuclear capability, international recognition, regime consolidation, influence over Iraq, achieving status as a Middle East hegemon -- is predicated on financial stability. It takes money to pacify the population, build a nuclear program, engage in international commerce at sufficient levels to keep Europe's interest and tempt the Americans, and exert influence over neighboring countries.
Though Iran does have an economy independent of oil, oil output gives Tehran the ability to adopt proactive policies. More than any major exporter in the world save Saudi Arabia, Iran needs its oil income to project power. Therefore, a drop in prices will affect the extent to which, and speed at which, it can achieve its objectives.
Iran cannot stop spending without endangering its many current geopolitical goals. Unlike the Saudis or Russians, the Iranians have no significant internal pools of capital to tap -- and unlike the Nigerians or the Algerians, they cannot easily turn to international creditors either.
That leaves Tehran looking for ways to push prices up, and Iran has any number of means of doing that that are wrapped up in its current geopolitical ambitious. Hezbollah, for example, has its finger on the Arab-Israeli conflict, a perennial flashpoint for the oil markets. Using Hezbollah to provoke Israel into bombing Lebanon or Syria would do wonders for the tautness of oil traders' nerves.
Iran can maneuver its nuclear program in a similar manner. For Tehran, telling the EU-3 -- with whom it currently is engaged in negotiations -- to go suck a lemon, or to recommence its own uranium enrichment activities, would raise international tension and threaten a storm of military action within the Persian Gulf.
Likewise, pressuring Iraq or Azerbaijan on any issue under the sun raises the possibility that two major oil exporters could suddenly develop complications that affect global supply levels.
(c) 2005 Strategic Forecasting, Inc. All rights reserved.
I do hope that Chavez gets the "shock" of his life, but Iran does worry me so...
Why are these folks at STRATFOR incensed at Venezuela's government so-called buying support but nonchalant about the Nigerian government's method of maintaining power (murder?). Of more concern, why do governments of wealthier nations and the international financial markets so often reward depression and seek to punish any attempt by people to gain control over their lives? Head over to Narco News Bulletin for some news from the perspectives of people, not STRATFOR's alternate reality of power relationships where the people acted upon are not supposed to have control.
In any case, the desperation in STRATFOR's desire to derail the Bolivarian revolution in Venezuela and bring Iran under control probably is because they know that oil prices won't stay low for long.
Posted by: Benjamin Melançon | Monday, June 06, 2005 at 10:55 AM