Sunday, March 8, 2020

Russia uses America's own weapon against them as new oil gambit may be the key to collapsing the Western financial system

For those who do not remember details of the Cold War between the U.S. and former Soviet Union, it was a combination of a military buildup under President Reagan coupled with a depressing of the price of oil that eventually led to the Communist regime's demise.  Yet like a pendulum that swings to the opposite side when there is enough inertia, just 30 years later Russia has set themselves up to use the very same weapons that were used against them in order to bring harm or even destroy the financial systems of their adversaries.

This drop in oil price made it become much less profitable to drill new oil wells. Also, the Soviet Union was an oil exporter, and at a lower price, it earned less profit for the oil it exported. Given these headwinds, oil production stopped rising, and by 1988, began to fall. Oil production did not start rising again until the early 2000s, when oil prices began rising again and a different political system was in power. 
As oil production dropped in the 1988-1991 period, FSU oil exports plummeted. Given the combination of a low quantity of oil exported, and low sales price of oil exports, the FSU found itself in financial difficulty where it could not afford to pay for food imports, which it badly needed, and the country collapsed. -
Fast forward 29 years.

In a move that few could see coming, Russia on Thursday voted against OPEC's desire to reduce production and appears very ready to see the price fall even lower than Friday's market close of $42.
OPEC needs this cut to remain relevant. The cartel is dying. It’s been dying for years, kept on life support by Russia’s willingness to trade favors to achieve other geostrategic goals. 
I’ve said before that OPEC production cuts are not bullish for oil just like rate cuts are not inflationary during crisis periods. 
But finally Russia said No. And they didn’t equivocate. They told everyone they are prepared for lower oil prices. - Gold, Goats, and Guns
Yet this move did not come in a vacuum, as Russia's announcement comes when both the U.S. and Europe are at their most vulnerable... as in having to deal with crashing bond and equity markets, an escalating war within NATO between members Greece and Turkey, and a global pandemic labeled as the Coronavirus.

Invariably the foundation for this gambit opened itself up since OPEC was already on the way out, as seen just a few years ago when the Middle Eastern cartel willingly accepted Russian aid and guidance in what would become known as OPEC+1.  But thanks to a number of chaotic events such as the continuing conflicts in Iraq and Syria, economic sanctions against Iran, and Qatar leaving OPEC completely last year, what was once a coalition dominated by Saudi Arabia and Iran had almost overnight shifted to one being directed from offices located in Moscow.

In addition to all of this, we cannot forget the incredible growth of America's shale industry which by 2019 had overtaken even Russia in producing the most barrels of oil in a given day.  However in doing so, the U.S. leveraged the industry way too much as bank subsidization coupled with higher production costs put America too close to the edge if prices declined too much.

And with all of these black swans and white albatrosses circling the globe, a perfect storm emerged for Moscow to use now as the time in which they could exact revenge on Washington by using the very weapon (oil prices) that was a catalyst for their own collapse in 1991 and flip it towards bringing down the already tenuous global financial system.
When dealing with a more-powerful enemy you have to target where they are most vulnerable to inflict the most damage. 
For the West that place is in the financial markets. 
Remember, the first basic fact of economics.  Prices are set at the margin. The only price that matters is the last one recorded.  
That price sets the cost for the next unit of that good, in this case a barrel of oil, up for sale. 
In a world of cartelized markets the world over, where prices are set by external actors, it is easy to forget that in the real economy (regardless of your political persuasion) the world is an auction and everything is up for bid.
High bid wins. 
So, the most important geostrategic question is, “Who produces the marginal barrel of oil?” 
For more than three years now, President Trump has supported his policy of Energy Dominance in a Quixotic quest for the U.S. to become that supplier.  Trillions of dollars have been spent on building up domestic production to their current, unsustainable levels. 
This policy pre-dates Trump, certainly, but he has been its most ardent pursuer of it, sanctioning and embargoing everyone he can to keep them off the bid.
What he could never do, however, was push Russia off that bid. 
The reason U.S. production rates are unsustainable is because their costs are higher per barrel than the marginal price especially when all other prices are deflating.  Simple, straightforward economics.  
All of this adds up to Russia holding the whip hand over the global market for oil.
The ability to say, “No.” 
And they will have it for years to come as U.S. production implodes.  Because they can and do produce the marginal barrel of oil.   
That is why oil prices plunged as much as 10% into today’s close on the news they would not cut production. 
There is a cascade lurking beneath this market. There is a lot of bank and pension fund exposure in the U.S. to what is now soon-to-be non-performing fracking debt.
Liquidations will begin in earnest later this year.
And like clockwork, it appears that repercussions have already begun to emerge just three days after Moscow laid down the law over production cuts.


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