Streetwise Professor

April 13, 2020

Vladimir and Igor Tap Out and Turn Down the Oil Taps

Filed under: CoronaCrisis,Energy,Politics,Russia — cpirrong @ 6:36 pm

A little more than a month ago, when the China virus was first wreaking havoc in the oil market, Vladimir Putin and Igor Sechin demurred when the Saudis requested an extension of OPEC+ oil cuts. Furious, the Saudis retaliated by promising to ramp up oil production by more than 1mbpd, and prices truly cratered.

No problem!, said Vladimir and Igor. This is part of our master plan to destroy US shale! (Never mind such “logic” is right out of Economics for Mouth Breathers.) Furthermore, Russia has ample financial reserves, and its government can ride out a long stretch of low prices. (The Russian people? Ha! Demonstrating the state-centric nature of Russian policymakers.) The ruble crashed. No worries! In fact this is GREAT for Russian oil producers, because their costs are in rubles and the weakening of the currency cushions the impact of a lower dollar oil price on revenues. (The Russian populace? Again Vova and Igor DGAS.)

But despite the bold talk (which in some ways reminded me of the old story about G. Gordon Liddy holding his palm over an open flame to prove how he could take pain without cracking), the magnitude of the collapse, and the possibility that it would endure, obviously caused considerable consternation in the Kremlin.

The first indication was when the Russians claimed that the Saudis had taken their action to harm US oil producers, a complete flip for Russia’s bragging that that’s why they were taking the hard line.

In the past few weeks, Trump cajoled the parties to the bargaining table, and yesterday–after overcoming a Mexican holdout–the parties agreed to a deal. And what a deal it is, involving Russia agreeing to cut production by 2.5mbpd–almost 23 percent–an amount 4 times what they refused to accept a little more than a month ago. (I also note that it flies in the face of repeated Russian statements over years saying that it was operationally impossible for them to cut more than trivial amounts.)

The Russians had insisted on formal commitments from the US to cut. Trump–who brokered this deal–said that US production would fall due to price declines. (True dat–I’ll try to provide some estimates tomorrow.). The Russians said that wasn’t good enough (apparently demonstrating an ignorance of the limited ability of the US government to force output reductions)–they wanted mandated cuts. But in the end, the deal was done, absent any formal US commitments.

In other words, Putin and Sechin cried uncle. Hell, they tapped out like an MMA fighter in a chokehold. This makes a mockery of their bold front of a month ago. I think it reveals that they were truly shocked by the Saudi reaction, and were desperate to find a way out, but they didn’t want to show it. They needed some sort of fig leaf, and Trump gave them one.

Now this is being spun as some sort of Putin master plan to curry favor with Trump to gain negotiating leverage on other issues.

All together now: Suuuurrrre it is, Vova. Suuurrrre. Trump don’t owe you–you owe him.

I oppose the deal, despite the fillip it will provide to the US oil industry. Artificially boosting oil prices will harm already devastated consumer economies (including the US). Further, this will potentially rejuvenate OPEC post-crisis. Again that would be good for the US oil industry, but not for the US.

I also wonder whether Putin (and the Saudis) will come back later with proposals to get the US government to take measures to reduce output in a coordinated fashion. Just how that would be done is rather mysterious. The only plausible measure that I could think of would be some sort of tax (either on production, or on exports). But this would require Congressional action–it’s not something Trump or any president could negotiate unilaterally–and I don’t see that happening.

But that’s for the future. In the present, Putin and Sechin reaped what they sowed. They thought they could force the Saudis into bearing the brunt of supporting oil prices, while they could continue to produce at capacity. The Saudis responded like it was 1986, and the resultant collapse in prices brought the brilliant schemes of the KGB masterminds crashing down. In the end, they had to capitulate. No matter how hard they try to spin it, it’s obvious that they did.

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  1. Any odds on Putin maintains the agreed cuts?

    Comment by The Pilot — April 13, 2020 @ 8:38 pm

  2. Will this deal have serious impact on 2020 election in the USA? Fracking industry is very important in Pennsylvania and this deal obviously helps it. Pennsylvania is one of the swing states in presidential election and the deal can help Trump..

    Comment by mmt — April 14, 2020 @ 5:32 am

  3. Given that Putin is sitting in a bunker and not even trying to do anything about the virus (other than cranking up the production of BS to capacity) Russian oil production will be decreased by natural causes, no deals required. The oil revenue loss can always be compensated by forcing whatever remains of the Russians to eat less, though.

    Comment by Ivan — April 14, 2020 @ 6:44 am

  4. The markets don’t seem impressed with the deal, despite their initial flurry of excitement. I doubt even a full scale war in the Gulf would have that any effect on oil prices, given the huge hole the global economy currently finds itself in.

    Comment by David Mercer — April 14, 2020 @ 9:24 am

  5. @The Pilot–Normally I would say no, but no doubt MbS has told Putin if he doesn’t he’ll go all 1986 again. After what happened last month that threat is credible. That fear, and that alone, is what will induce the Russians to live up to the agreement.

    Comment by cpirrong — April 14, 2020 @ 10:54 am

  6. Your analyisis leaves out the costs to Saudi Arabia of pursuing their strategy.
    How credible is it given its well-known weaknesses (pegged currency, 80 $ budget breakeven, explosive demographics…)..

    Are they really in a (relatively) better position than Russia?
    I have my doubts. Would be interesting to hear from you on that.

    Apart from the fact that no feasible cut would have balanced a market with this demand destruction (10 Million Barrels/day)

    Comment by viennacapitalist — April 15, 2020 @ 1:16 am

  7. @Viennacapitalist: I did a back-of-the-envelope a while back, looking at Russian and Saudi currency reserves, soverign wealth funds, extraction costs and budget breakeven. There is merit to both arguments: In the long term, I think that the Russians would survive better in an environment of low oil prices (for the reasons the Prof lists above – i.e. letting the people suffer). But in the short term, the Saudis can better cope with near-zero prices on account of having a bigger soverign wealth fund to rely on. I think this is why their gambit worked, and why their threat remains credible for as long as they have a big enough (and liquid enough) soverign wealth fund that they can force the Russian government into poverty before that fund runs out.

    Comment by HibernoFrog — April 17, 2020 @ 8:53 am

  8. @ HibernoFrog,
    The Russians have a flexible Exchange Rate, people are used to volatility, whereas the Saudis with their peg live in artificial stability. The Russians have had no issues letting their currency devalue (disclosure: Long Ruble since End 2014) when it is warranted by their terms of trade – which is exactly as it should be.
    This means that the shock to the economy (which is real, after all) is spread out over time allowing the private sector to adjust and take this Risk properly into account – the Saudi’s will be hit by this way more, if the situation continues.

    With the consequence that, since the Ruble devaluation in 2014, the economy has started to diversify, just as economic theory would predict – before it was a classical case of “dutch disease and Prices were ridiculous.

    As someone who goes to Russia on a regular basis, I can even see with my own eyes this has happened. For instance, last summer I noticed advertisements for Angus Steak everywhere, not just Moscow, even in the provinces. And steaks were as cheap as in Argentina on my round-the-world trip a decade ago. Food Prices generally are ridiculously cheap, courtesy of higher production across all agricultural products – a big difference to my first visits when oil was arount 100 bucks a barrell…

    Getting curious I started researching. I found out that the biggest private Angus herd in the world is in Russia. A single company called Mirotorg (whose meat I was Eating in Restaurants) has a herd of more than 1 Million (!!!) That’s 1 Million where there were None (0) in 2009 – they are even flying in Cowboys from Texas to teach how to herd cattle..Google it, if you do not believe me

    Significantly ncreased domestic production has kept Food Prices low (and hence limited inflation and unrest) despite a 60 percent (!!!) devaluation of the Ruble since 2014 –
    MbS will not have that advantage should the currency start to float – which it has, if oil stays at current Levels for longer

    My Point is: the Professor vastly underestimates that apart from the energy sector, where Sechin an his ilk are playing mad geopolitical games, the Russian economy is way more free market than most people think – which is a strength, no doubt. This is reflected in their attitude to their flexible exchange rate, their positive real interest rate and increasing sector diversification.
    The Saudis, as I understand, are a country of welfare recipients…
    how that is a positive, is beyond me…

    Comment by viennacapitalist — April 17, 2020 @ 12:12 pm

  9. @viennacapitalist – informative post. You learn something every day…

    Nice to see another contributor challenging Craig’s world view. It makes a change from the wall-to-wall sycophancy.

    Comment by David Mercer — April 18, 2020 @ 1:32 pm

  10. @ViennaCapitalist. 1. Fine. Move there. 2. You are way over-generalizing from my very specific criticism of Sechin (whom, you would know if you’ve followed this site, I have ridiculed for years as the idiot that he is) and Putin for the specific policy of triggering an oil price war based on a predatory pricing theory which standard economic analysis implies is insane, to a broad discussion of Russian economic policy. Whatever, dude. Further, who gets fucked from the flexible exchange rate? Ordinary Russians.

    Insofar as the Saudis are concerned, I did not discuss the impact of the price war on them at all. And I don’t really care.

    The Saudi response to the Russian (i.e., Sechin/Putin) “strategy” makes sense from a cartel enforcement perspective. Yes, it is costly in the short run, but it can be rational in the longer run. Further, it’s not as if this is unprecedented for the Saudis. Cf. 1986. Which totally fucked the Soviets, by the way. Which in turn means that Sechin and Putin were doubly idiotic not to consider that the Saudis would respond to them they way they did.

    Comment by cpirrong — April 18, 2020 @ 1:50 pm

  11. There is no reason for me to move anywhere from Vienna- by far the best place in the world- and i have been around
    I agree with you on Sechin-100 percent
    My point was that success of the strategy is dependent on overall economic resiliency- given the importance of oil for both economies- that’s why I brought the general economic perspective, dude.
    How can it be rational in the long run, if I am in a weaker economic position- this is not the Soviet Union which could not even produce enough food…
    But to a man with a hammer, every….
    And what‘s the alternative to a flexible exchange rate?
    Ordinary Russians are not screwed as much as you think, unless they travel abroad-as witnessed by low inflation since the devaluation- The point I tried to make…

    Comment by Viennacapitalist — April 18, 2020 @ 2:09 pm

  12. @ David

    Comment by Viennacapitalist — April 18, 2020 @ 2:19 pm

  13. @viennacapitalist

    “And steaks were as cheap as in Argentina” – The most likely reason being they were actually smuggled/relabeled Argentinian steaks. Hydrocarbons are, indeed, not the biggest part of Russian GDP – disinformation is.

    Since Putin banned the NATO food for his serfs, essentially two things have happened to food in Russia:

    1) landlocked Belarus has become the primary source of seafood 🙂 (i.e. European imports are still coming in with an extra layer of corruption for those who can afford them);

    2) imports of technical palm oil have gone through the roof, to the point that no traces of actual milk can be found in Russian dairy products 🙂 (i.e. for those who cannot afford the contraband, food quality has been going down steadily). Even pro-Russian residents of occupied Crimea, who can still remember what normal food tastes like, are complaining publicly.

    So yes, I would agree that Putin is likely to beat MbS long-term, ceteris paribus, because the Russians will put up with shit that the Saudis won’t. But I doubt ceteris are all that paribus out there.

    Comment by Ivan — April 18, 2020 @ 2:53 pm

  14. @Ivan
    The Steaks are Russian. Here is the Company Website in english:
    Here you have a newspaper article from “Frankfuter Allgemeine Zeitung” which was served as the basis for my resarch – unfortunately in German, but Google translate should work:
    And I will not even bother you with the steadily increasing wheat production statistics. you know, I am an Investor and used to Looking at facts and numbers..
    Unless you demonstrate how this is all fake, we should leave it at that.

    In Russia, Belorussian Food has the reputation (true or not, I have not verified) of being organic, that’s why everybody claims his food is from Belarus – it allows them to charge a higher Price. This has been the case even since my first visit more then 10 years ago – everybody in Russia knows this.
    It is actually the other way round: most belorussian labeled food is Russian – By the way, Belarus Imports way, way more from Russia that the other way round:

    Ordinary Russians do not eat seafood, they buy carp, Salmon and farm raised sturgeons, at prices where I can exclude the hypothesis of relabeled Imports: last summer I paid 1 buck for a Kilo of carp and 20 eurocents for a Kilo of Tomatoes – if somebody is importing and relabelling, he is doing that without profit. Apart from the fact that
    And food quality in Russia is definitely not bad at all…

    I cannot exclude the possibility that some Moscow snobs pay over the top for relabeled French cheese and I read recently that Russia is the only Country where farm raised Salmon is more expensive than wild one – that sounds plausible, the rest, I am afraid, is phantasy

    Comment by viennacapitalist — April 19, 2020 @ 12:25 am

  15. @Ivan
    The Steaks are Russian. See the Website of the company in English:
    See also this article from German Frankfurter Allgemeine Zeitung:
    Unless you show me that this is fake, we should consider that settled.

    In Russia,Belarus Food has a Reputation for beeing organic (don’t know whether that’s true). that’s why there is relabelling, it allows you to charge a higher Price. Most Russians are awere of it, as they are suspicious of Tiny Belarus pruducing that much Food. Alos: If there is a siginficant relabelling trade, it yet has to Show up in Belarus trade statistics with Russia, which continue to show a large deficit last time I checked

    About Palm oil, I do not know. Just never had the Impression that average Food Quality is bad. And ordinary Russians do not eat seafood from Europe, they buy locally sourced carps, Salmon and farmed sturgeon whose Prices are ridiculously cheap – if anyone is importing and relabeling, he is doing it not for Profit.

    But I believe it is plausible that there are Moscow Snobs who care enough About French Cheeese to do the relabeling effort…

    Comment by viennacapitalist — April 19, 2020 @ 2:33 am

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