Wednesday, December 17, 2014

Cratering Oil Prices - What It Means For US and What It Means For Russia

After a few weeks of lazy hiatus ('I'm gonna blog tonight, I swear....' only to have my head hit the pillow at 9:15 each night), I'm back with hopefully a well-timed post about the downward spiraling oil price and what it means for the markets, namely the US, Russia, and Saudi Arabia. While the low-info voters are distracted with race-baiting and organizing meaningless protests to honor their slain heroes Mike 'Thug' Brown and Eric 'Arrested 31 Times' Garner (though for the record, the grand jury got it wrong on Garner), bigger stakes are in play on the global stage. That's where I choose to focus my attention.

So if you are out of the loop, I did a post in September about the ongoing Ukraine crisis and how we got there. Instead of repeating myself, please find the link below, since things are getting a lot hotter and heavier:

Updates on monetary systems referenced in above post - Russia has fast-tracked their SWIFT alternative transaction platform to May 2015 with a slight chance of even sooner. Southstream energy pipeline to Southeast Europe has been cancelled in light of sanctions. Capital expenditure rerouted to - you guessed it - Turkey. Behold the 'Turkstream' deal of December 2014. Turkey - the group spurned repeatedly by the EU for membership, the secret home base for ISIS, the group that facilitated the gold-for-oil hocus pocus between Iran/Russia once Iran got sanctioned for its nuclear weapons program. I'm telling you, folks, Turkey is flipping East. Very soon.

Anyway, we are engaged in a non-shooting Economic War with Russia right now. Sanctions started in the Spring after Putin took Crimea (without firing a shot). Then they intensified after MH17 got shot down (by Ukrainians, it now appears). Now we are in an environment where Russia has dumped its US Treasuries, US/Europe are cutting business ties with Russia, France has halted the delivery of two Mistral amphibious assault ships to Russia, the Russian ruble has crashed more than 50% since late September, currency brokers REFUSING to settle USD/Ruble transactions and thereby automatically closing out existing positions. Russian interest rates went up overnight by 70%  (10% to 17%) to stem the currency dumping, and the US will be voting to officially provide LETHAL aid to Ukraine by the end of the week. To employ the overused line from Anchorman - 'things escalated pretty quickly.' So what prompted this acceleration of chaos? Why, the cratering price of oil!

The currency war is playing out similarly to what was 'floated' in Jack Ryan: Shadow Recruit, with roles reversed somewhat:

The US and Saudis are attached at the hip when it comes to punishing Russia (though Saudi Arabia wants to punish in the short term while slowly pivoting East when the time is right. US wants Russia completely obliterated). Brent crude (sweet crude global benchmark) trades at a handle of around $60, down from $100 in mid-September, which is a 40% decline in three months! Don't tell me its supply and demand related, this is strictly punishment to keep Russia in check. Here's the aspiration - since Russia relies heavily on energy revenues (70%!!!!), stopping Putin's gravy train on the tracks will slow down his 'aggression' in the Ukraine.

So Saudi Arabia pushes OPEC to leave production as is (cutting production would result in an uptick in oil price, increasing supply or leaving as is would put downward pressure on oil prices). This means Russia gets less oil revenues, and their budget projections are all out of whack, since they probably assume $90-$100 oil when making their revenue targets. This also slows the Russian economy as well as GDP growth forecasts, spooks the Russian stock market, puts added downward pressure on the ruble, resulting in intense selling, panicked Russian central banks upping the interest rates on bonds, pisses off the citizens, makes them question whether Putin is an effective leader, military and local upstarts consider a coup, and voila - civil unrest in Russia, Putin loses control of his country, and can only reclaim credibility by tucking his tail between his legs and pulling any and all military personnel along the Ukraine border. We are in a full-fledged currency war. This worked in the 1980's to bring down the USSR and again in the late 1990's with the ruble. It's the best way to neuter a country without using bullets and missiles, which are ugly and hard to get people to support.

Let's put this in perspective, though. Saudi Arabia is playing both sides. Pretending to hurt Russia, but also smirking as lower oil prices means their main competitor (US) will suffer because of a negatively impacted shale industry here. Thus, continued dependence on Middle East oil. Mainstream media tells you that oil decreases mean lower gas prices, which is great, but it also means 1) looming global slowdown, 2) lower revenue sticker shock to shale companies in the US (remember how we just celebrated this past summer passing Saudi Arabia as top global oil producer due to our shale deposit explosions in Texas and North Dakota?). This results in more and more oil rigs taken offline since the break-even point for many of these is between $80-$100. NOT <$60. 3) According to Deutsche Bank AG, since 2010, energy producers have raised more than $550 billion in energy bonds at ZERO % BORROWING COST (thanks Bernanke/Yellen). Plummeting oil price means bond issuers run the risk of not meeting debt obligations. Think of this as a commodities/energy market subprime loan about to go bust. But thanks to the Federal Reserve's QE meaning easy money for capital formation and zero % interest rates, borrowers could get their hands on whatever amount of liquidity they wanted. Now that QE is over (or passed to Japan within 24 hours of 'ending') and rumors abound of an interest rate hike around June 2015, the Federal Reserve is out of magic bullets, and guess what usually rears its ugly head every 7.5 years? An economic recession! 2015 is smack-dab in that timeframe.

Now that I've demonstrated what the impacts are with plummeting oil prices, what will Russia do now that it is the cornered bear being poked with sticks by the international community? Putin still has a few options:

1) Cyberattack the hell out of us. He's done it before and he can do it again, Whether it's our biggest corporations, our stock market exchanges, our commodities markets, our government systems. He has the resources and we are ripe for the pickens.

2) Closer ties with China, coordinated economic warfare against US. Russia has already dumped its treasuries. China continues to dump its treasuries. Both continue to hoard any and all gold. I've spoken about the BRICS nations and 130+ others just waiting on the sidelines to flip and dump the dollar. I've spoken about the alternative institutions and payment mechanisms to sidestep the dollar and its settlement cohorts. Did you know Russia approached China to work together to flood the market with Fannie/Freddie shares, maximize Wall Street turmoil, increase bailout burden and exacerbate the 2008 Financial Crisis in the US? Did you know Russia and China salivate at the idea of a gold-backed BRICS currency? Did you know China has been buying up US real estate in various parts of the country in lieu of a game-changing bulk treasury dump? Did you know a Chinese real estate conglomerate bought JP Morgan's US HQ and now own its gold vault at fire sale prices? Sleep with one eye open if you are a USD loyalist.

3) Go scorched earth, pluck US allies and make them flip East. I've already mentioned in previous posts that Saudi Arabia, Germany, and Turkey are 'at odds' with the US/EU as it relates to foreign policy, over-indebtedness, EU flirtation but rejection, growing calls for gold repatriations, funding of ISIS, and bailing out other EU countries. Germany has had enough, and relies on Russia for energy, while Russia relies on Germany for well-made vehicles, machinery, and chemical products. Turkey has had enough, because they never seem to get invited to the EU dance, and they've just signed the Turkstream energy deal with Russia. Saudi Arabia, while at constant loggerheads with Russia, is the scared bully who doesn't know whether to stick by the US in the short-term or completely flip to Russia so that the Ruskies can act as their new military protector in the event of ISIS gains, civil unrest from depleted Saudi oil revenues, and a shattered oil industry as a whole. Getting Germany, Turkey, and Saudi Arabia to change sides 1) guts the EU and will probably encourage it to fold 2) undermine ISIS containment and 3) officially end the petrodollar scheme of energy settlement if Saudi Arabia presses the 'FU' button and flips East.

4. Continue to play chicken with the West. Russia can technically survive without unrest as long as oil trades above $40/$50. They have $450 billion of foreign cash reserves. They have 1.2k tons of gold, and all of the BRICS systems in place (IMF replacement, World Bank replacement, Bank of International Settlements replacement, SWIFT payment replacement, BRICS currency as dollar replacement). They've signed epic energy deals with China, India, and now Turkey. The cash flow will continue to be there. Wait out the storm, let Hussein Obama and the West tire out and admit defeat over Ukraine. Another unique play (suggestion courtesy of former assistant Treasury Secretary and co-founder of Reaganomics, Paul Craig Roberts) would be to buy some paper gold contracts on the market and then DEMAND PHYSICAL DELIVERY once they expire. We couldn't do it, because we don't have physical possession of the gold we currently have 'registered'. Thus the repatriation requests by Germany, France, Holland, and recently Switzerland (failed referendum on full gold repatriation notwithstanding). Won't that make for some interesting TV?

5. Start World War III. A highly likely scenario. Putin would curb-stomp NATO if they ever touched his soldiers. He would ratchet up relations with Iran and China, he would cyber-attack the US to bring us to our knees (the 'Hands Up Don't Shoot' crowd would riot due to EBT not functioning, yeah I said it), detonate an EMP above the East Coast US, move on and reclaim the Novorossiya region of Ukraine, snatch Estonia and Transnistria, and sabre-rattle against Poland. As mentioned above, the US will have voted to provide Ukraine lethal aid in their quest to contain Putin, This could be seen as an act of war to the Russians, who will undoubtedly up the ante with increased military buildup. You can bet a false flag in the Middle East will be used to turn public opinion (yet again) on Putin and his ilk (most likely Iran, since we've been trying to hit them since 2005). So let's say the winter months features escalation, and no military movements. All of a sudden, late Q1 2015, ISIS attacks a pipeline, or Iran-linked terror groups are implicated in a high civilian casualty event. Or another plane magically gets 'shot down' at the border. Remember, we tried this in Syria in 2013 and lied about Assad using chemical weapons attacks (was later determined to be US-funded rebels). We need Assad out of power to contain Russia's expansion. We need Iran nuke-free to contain their expansion. We have a need to 'stir things up' in the region to satisfy the neocons in Washington.

My bets are on Option #5 with Option #3 as a backup. Putin will not go down quietly, and never underestimate a well-timed economic crisis/ebola crisis/terrorist crisis to paralyze US in the midst of all this so that our response is muted. Stay tuned, 2015 is going to be a wild year.