US Economy Safety Margin Tested as Oil Prices Go Down

Strategic Culture
by Alexander DONETSKY

Oil prices fluctuations is a routine matter for world economy. After the abrupt fall in 2009 sparked by global financial crisis, the «black gold» spiked to over 100 dollars a barrel to stay stable in February 2011 to September 2014. 

The current 20% price fall with the volume of sales remaining the same results in only 5,8-5,9% profit fall for Russia because in 2013 the oil accounted for only 29, 1% of all its national exports. A large part of oil income does not go straight to the budget but to the National Reserve Fund and the National Wealth Fund. The export duties make up 18-36% of the price. The resource rent from extraction also goes to the funds. As a result, the 20% price results in 2-3 % of the total volume of exports. 

The funds mentioned above are not parts of the state budget. The Reserve Fund (3 544, 83 billion rubles) and the Wealth Fund with 3 276, 79 billion rubles – the both figures as of October 2014 – are fed from the same sources as the budget but the income is nominated in foreign bonds and currencies. In fact, the funds provide Russian investments into other countries’ economies. The fall of prices does not affect the economy of Russia but rather the economies of the countries the funds invest into by buying the bonds. 

The situation has changed a bit recently. President Putin has taken a decision to redirect the income flows from the funds to the Russian state budget to spur the national economy. 

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Normally the fall of oil prices is explained by great powers economic slowdowns, the increase of production by exporters or the forecasts predicting an emergence of a powerful actor able to dump the prices. 

Stock exchange rates immediately react to US economic indexes, but it’s not the case. According to Federal Reserve System’s report issued just a few days ago, the US economy goes through moderate, though not bright, economic growth against the background of much more vibrant rise in other countries. 

The European Union is going through rather hard times sparked by the US-imposed sanctions against Russia. There is no significant economic growth in Europe. The further pressure exerted by the United States and possible retaliatory measures taken by Russia may deteriorate the situation to make another European economic crisis a reality. 

Some time ago China was reported to overtake the U.S. to become the world’s largest economy in accordance with the International Monetary Fund estimates (the analysis is based on one data point that recasts GDP based on consumer purchasing power adjusted for local prices and wages).  It means that one of the largest oil consuming economies continues to make progress, so the exporters of «black gold» have nothing to worry about. 

The increase of Russian oil production could not affect the world prices much because the extraction grew by only 1, 2% during the recent 9 months. In September, when the oil prices fell to the lowest level, the OPEC production increased by only 1, 3%. 

There is one more factor to influence the price – an alleged emergence of a competitor using dumping tactics. In theory there is one – the US companies involved in shale oil extraction. The US oil producers say the reserves are enough to last for 200 years (58 billion tons). The Russian reserves are estimated to be 75 billion tons. In the near future neither Russia, nor the United States with its shale energy boom can increase the volume of sold oil to produce a significant price fall. 

Then there is only one cause left – politics. We saw it in the 1970s. Arab states brought down the oil prices as a result of US pressure inflicting huge losses on the Soviet budget. Almost each and everything became a deficit for Soviet citizens. I wouldn’t like to accuse the United States it is doing the same thing without a substantiated reason, but this situation is pretty similar to what happened then. The Cold War against Russia appears to return, there are attempts made to suffocate it economically by delivering a strike to affect the people’s well-being. 

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Speaking at the ASEM forum in Milan, Russian President Vladimir Putin noted that the world economy will not sustain oil prices at around 80 dollars per barrel. He is confident that in a short time the price of oil settles, adjusts, because «none of the market participants are interested in the price drops below $ 80». Putin also reminded that the Russian budget is planned on the basis of $96 per barrel. «In any case, I want to stress that Russia, the Russian Government, will undoubtedly fulfil all its social obligations. We have enough of a safety margin. Maybe we will need to adjust something in the budget. Maybe. Maybe we will even reduce some of our spending. But this will certainly not involve cuts in social spending. The Government of the Russian Federation will fulfil all its social obligations, and it is capable of doing this without any particular losses», said the President. 

80 dollars a barrel is not only a psychological index. For many OPEC members the further fall of prices may entail significant budget cuts and the following deterioration of living standards. Social instability is a direct threat to a state. 

Of course, China will benefit in case the energy prices go down but it does not serve the United States and Europe’s interests as they have become the consumers of China-produced commodities since a long time ago. It will hinder the plans to re-industrialize the United States and the European Union. 

US shale oil producers will suffer most. According to experts’ estimates, the cost of production is around 80-90 dollars a barrel, 4-5 times more than the traditional oil. It means that the current price – 85 dollars a barrel as of October 17 – makes the companies operate in the red. Some producers will have to suspend operations facing mass bankruptcy in case the oil price falls lower than 80 dollars as shareholders start getting rid of zero profit bonds. The shale oil «soap bubble» will blow like the housing construction industry «bubble» blew in 2008. Of course, as time goes by oil prices will go up but it’ll be a different world with some US oil producers non-existent anymore… 

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The oil has more negative surprises for the US, or the oil dollar to make it more precise. Prominent US trader Jim Sinclair called it the only valuable thing in the world. He believes that Russia can retaliate to badly damage the dollar, «Russia could retaliate in a way that would have a phenomenal impact on the U.S. dollar… Russia has the upper hand. They have it in their ability to turn the U.S. economy upside down and into collapse».  Actually that’s what is happening: the fall of oil price calculated in dollars took place simultaneously with the rise of the dollar rate to ruble benefiting Russian exporters who spend rubles not dollars. They win big. Russia has made the first tentative deals to sell energy in rubles to China. China has concluded a number of agreements switching from dollar to national currencies. The recent BRICS summit decided to switch to national currencies in mutual payments.

Nobody is interested in the impetuous collapse of US economy as a result of the dollar being pushed aside from the position of world reserve currency because the world financial system may go down crumbling. That’s why Russia and China are implementing the plan to create a new world reserve currency without haste and unneeded excitement responding to the US attempts to destabilize international situation by unleashing the full-scale war in Ukraine, making fall the oil prices critically important for Russian budget and staging the unrest in Hong Kong. As the sanctions were introduced, some Russian banks have already switched to Chinese banks granting credits in yuan and supporting the Chinese national UnionPay system as an alternative to US Visa and MasterCard. 

Strategic Culture