Oil and gas redraw world strategic alliance map

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When markets enter periods of volatility, it is reasonable for investors and observers to scurry about looking for the ‘cause’ (there is usually thought to be only one). 

It makes for effective media grabs: ‘The Australian dollar fell today on fears of a Chinese slow down/rising American employment/The Reserve Bank’s possible lowering of interest rates/strength in the US stock market/weakness in local bank stocks/increased fears of global warming etc. etc.’

But it is almost always fallacious. Heavily traded markets do not set prices with one motive – there is no such thing as the ‘mind’ of a market -- they reflect multiple motives.

As the Nobel prize economist Eugene Fama observes, it is wise to assume that the market is efficient in the absence of a better model. At the very least it is a way to avoid two of the most common cognitive biases: illusory correlation, the often false belief that because two things occur at the same time they must be causally linked; and illusory superiority, the belief that you know better than everybody else.

The sudden, and precipitous, fall of the oil price since mid-2014 does seem to be an exception, however. It does seem to be managed. The price is down almost 60 per cent since June, causing ructions in the global energy market. It has long been manipulated by OPEC, and there is a history of manipulation of the oil market for political ends, dating back to the stagflation of the 1970s when OPEC brought on a quadrupling of the oil price.

Two motives behind the current volatility are worth entertaining, although the evidence must be considered less than conclusive. One is that it is an attempt by OPEC to weaken the high cost producers, especially those in America using fracking: the process of extracting oil or gas by injecting liquid at high pressure into fissures in the rock. For the first time since the 1950s, America has become a net exporter of some hydrocarbons, greatly reducing its dependency on Middle East supply. In 2013, US oil companies began applying to export crude oil, an unthinkable prospect before fracking technology became widespread. According to the US Energy Information Administration, American oil production rose in January to 9.21 million barrels a day, the highest level since 1983.

The problem for the American producers is that most require an oil price of about $US100 a barrel to be profitable. At the current level of about $60 they are well out of the money. Not surprisingly, they are having difficulty finding finance; many smaller American oil companies are being locked out of the debt markets. The Saudis have not responded in their usual way by dropping production when there is extra supply, pushing the price down. Some analysts believe the price may fall below $US30 before eventually stabilising at around $US75.

The other possible motive is an effort by the West and its allies to put pressure on Russia. A common figure being cited is that Russia needs an oil price of $US105 a barrel to balance its budget. The fall in the rouble is also being cited as a sign of Russia’s weakening economic position; a punishment for what has happened in the Ukraine.

If this is a motive behind the oil price drop it is based on some pretty poor analysis. For one thing, how many Western governments are balancing their budgets? None. And going into further debt is hardly a serious problem for Russia. According to the World Debt Clock the country’s debt is only 11 per cent of GDP. That is half Australia’s level, and Australia is supposed to have unusual fiscal rectitude amongst OECD countries. In the United Kingdom, the debt is 90 per cent of GDP and in the United States it is 104 per cent of GDP.

It is true that the fall in the rouble increases the cost of servicing that debt, but it is from a low base. The weaker currency also has the effect of reducing the cost of production, meaning that Russian producers can be profitable with a lower US dollar oil price.

What is certain is that the sanctions against Russia have pushed Russia and China much closer together. Russia is set to provide two fifths of China’s gas needs after the completion of two massive pipelines. This will easily replace what they have lost in supplying Europe and deliver what the Chinese most crave: security of supply. Meanwhile, Russia has cut off 60 per cent of its supplies of gas into Europe, re-routing it to Turkey, and saying that Europe will have to build its own infrastructure to transport it to the Continent.

There are many other signs of a growing closeness between China and Russia. China is planning to build a high-speed railway from Beijing to Moscow. The Chinese foreign minister Wang Yi last December said China was willing to help Russia if it got into economic trouble. Chinese president Xi Xing Ping has called for the country to have a 'louder voice’ to rival American influence and is looking to the BRIC countries to expand its interests. 

This intensifying alliance between two of the world’s military superpowers is surely the most significant geo-political and geo-economic shift of the century. In trying to put pressure on Russia, America and Europe would not have anticipated the creation of a China-Russia bloc. But that is what is occurring, and the consequences will be profound. 


David JamesDavid James is a business journalist with a PhD in English literature. He edits Personal Super Investor.

 

 

Topic tags: David James, economics, international politics, Russia, China, oil, gas

 

 

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Existing comments

This is a thought provoking article that highlights the complexity and inter-dependencies of the world's major oil suppliers and consumers. The developing Russian/Chinese relationship is intriguing.
Phil Keet | 13 February 2015


Spot on David. My surmise is the Saudis, who are the most powerful player in OPEC, had two aims: one economic against the USA and Canada's new oil industry and the other political against Russia, one of Syria's strongest allies. With "friends" like the Saudis the West needs to be extremely careful. A Russia-China alliance would be extremely powerful: economically, politically and militarily. As a loyal ally of the USA we'd better get our economic, political and military assets up to scratch. The world is changing. Again.
Edward Fido | 15 February 2015


One wonders how strategic alliance maps will be redrawn in a couple of decade's time when all oil and gas use has ceased.
David Arthur | 17 February 2015


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