As soon as word spread that Saudi Arabia’s Aramco cut prices, rather than production, for its US customers – though it raised prices for Asian and European customers – the price of WTI swooned $2 a barrel on Monday, then continued to plunge on Tuesday, briefly dropping below $76 a barrel, before recovering a smidgen. Prices not seen since mid-2012.
The Saudi price cut came on top of lagging economic growth and iffy demand in China and possibly a triple-dip recession in Europe, layered with what increasingly smells like an oil glut in the US where production from shale has been skyrocketing. If this price environment gets worse – and that seems to be the trend for the moment – the heat will spread to the US fracking industry.
Shale oil drillers will bleed, and some of them will crumble under the pile of debt they have issued. Plenty of investors – including those with conservative-sounding bond funds that are larded with energy junk bonds, and those with equity funds that have picked up the slew of recent energy IPOs – will lose their shirts. And if it lasts long enough, some states where oil has become the new economic lifeblood will get hit too. But mostly, in the vast and diversified US economy, it will be a minor squiggle, counterbalanced in part by the benefits of lower energy prices for consumers and businesses.
For Russia, the plunge in oil prices has a broader meaning. Russia’s economy and government have both become dependent on the hard-currency revenues generated by oil and gas exports. And the ruble has been plunging in sync with the price of oil:
Strong correlation between Ruble and Oil highlights #Russia‘s “one trick pony” economy. pic.twitter.com/7EUWvWBA8A
— Holger Zschaepitz (@Schuldensuehner) November 4, 2014
Russian energy companies are getting hit by a double-whammy. They borrowed in dollars and euros, and have to service that debt in those currencies. But now the sanctions strangle their ability to raise dollars and euros in foreign capital markets on which they’ve become dependent. Like their corporate brethren around the world, they have to borrow money to service or roll over the money they already borrowed. That must happen in dollars and euros. And now, the sanctions strangle their ability to service their mountain of debt.
Those sanctions hit just when the plunge in oil prices has started to cut into revenues from exports of oil and natural gas (whose price is linked to the price of oil). In conjunction with the sanctions, the drop in oil prices, if it continues, may well turn into a fiasco for Russia.
Despite Russia’s still high but dropping foreign exchange reserves and still strong balance sheet, its credit rating has come under pressure [Why Moody’s Cut Russia to Two Notches above Junk]. And here is the uncomfortably rising probability of default that CDS traders now assign to Russian 5-year debt – a dizzying 16.9%:
Another 1998-ish Ruble crisis in the making? Lower oil prices drive #Russia‘s 5yr default probability to 16.9%. pic.twitter.com/OgEnyBCfrV
— Holger Zschaepitz (@Schuldensuehner) November 4, 2014
Oil producers have become fat from the high oil and gas prices of recent years. But those prices have come at the expense of consumers and businesses. Now, those folks are breathing a sigh of relief. The balance of power is shifting, if only briefly.
And so the plunge in the price of oil reverberates around the world. Companies, industries, governments, and entire countries have built their future on high and eternally rising prices. That prices could plunge this quickly, and to this level, and perhaps much lower, has not been built into their scenarios. And now they have to face the consequences.
But in Russia, the oil price problems have become entangled with the ruble that has been falling from record low to record low. There are many losers when a currency gets smashed. Read… Russia Wins the Currency War, Even if it Doesn’t Want to
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Oil prices are volatile, and always have been. I wouldn’t be surprised to see $50 pb before the year is done. So, just how dumb do you have to be to make long-term investment decisions on the assumption prices will stay around $100 pb? 2012 was only two years ago.
Half the world can default and the US stock market will rocket up. Dow 30K, here we come!!!!
I think the idea of Russia defaulting is a double edge sword. If there is a default and much of their debt is with western banks would it be logical to assume that a default would trigger a credit event on the credit default swaps? That would lead to a cascade of failures in western banks abroad as well as those in Russia with large western exposure? If the west cannot fathom a default on Cyprus or Greek debt they definitely cannot handle a default on Russian debt.
Why cannot people keep clear heads. This is a war started by the USA against Russia after the Shochi Winter Olympics. First, it was snubbing the Olympics by no-show. Next, it was the Putsch purchased in the Ukraine for US$5 billion. Then, it was the hot war fueled by Blackwater-type mercenaries. An airplane get shot down but hits the wrong soil. Crimea get re-integrated into Russia. Most of the World can not pronounce the names of the Ukrainian cities – most of the USA has no clue where the Ukraine is. The Ukraine is hopelessly corrupt and financially bankrupt. Russian gas is threatened to get cut off from the Ukraine. Then, the Soroses of the world start shorting the Ruble. Next comes a 25% plunge in the value of crude (occurring after “Peak Oil”). Now, the Russians, being eminent chess-players, did not anticipate and plan for all of that. Are they caught with their drawers down, dumb and stupid (and drunk). They did not hedge the price of their outputs of gas and oil with Glencore and possibly the FX trading value of the Ruble as well. This is the Stalingrad which they are going to lose. Gold now has no value and silver less. The only repository of dignity and worth is in the USA and the US Dollar. All of this occurred in 8 months of 2014. The folks who read Wolf Street are those who crave insight and distance from mainstream media. Think back to where everything was in November 2013. Think about the status today. Who is the most desperate nation on the face of the earth. Eventually, the bully get kicked in the balls and get bloodied. The former weakling repeat and rinse. If you are less than 80 years old, where will you be in 10 years. How will you position yourself, assuming that you have means to get re-positioned. What are you going to do to help your family – what is your survival plan. Without attempting to predict anything, if you have no debt, then no creditor can take any thing from you (except for the US Government – we have been living under Martial Law since 9/11). Good Luck to all.
I’m going to disagree with this article. First off, Russia’s debt is miniscule compared to western nations, default isn’t a serious concern.
Secondly, in the “vast and diversified US economy,”……………………..of 1985 maybe. Has this writer been asleep the last 30 years while the US shipped most of its vastness and diversity overseas?
The US is now a world leader in “diverse” industries such as mobile apps, financial engineering, social media, and of course accounting fraud.
With all its problems, the US economy is still the vastest economy in the world, and a highly diverse one. In addition to all the things you mentioned, the US is the largest energy producer the world, the largest agricultural producer, it has the largest service sector, including lawyers, the largest healthcare sector, including life sciences companies, and on and on…. Even manufacturing. Yes, there is more production of manufactured goods by value than ever before; the sector just doesn’t employ a lot of people anymore (but lots of robots).
It’s a $17-trillion economy – and that means a lot more than apps, smartphones, and financial engineering. California alone has a larger economy than Russia!
The size of an economy is important but equally important is the composition and quality of the economy. Not much talked about that these days. How resourceful are the citizens. How much of the economy is fluff. And of course, how is the size of the economy actually measured. I contend that the GDP of the US is a highly inflated bogus number. It is reported high to inflate the importance of the US and of course to make other metrics look better (e.g., debt to GDP ratio).
So the Russian economy may be smaller than California (hard to believe) but even if true, I wonder how much more resourceful the Russian’s are versus Californians? Just wondering.
Good point. The total quality of the US economy is not good when its based on what even one of the .001% (Paul Singer) finally admits are fake numbers.
More related to quality is the fact that only 1% are beneficiaries and 90% are enslaved to it and imprisoned by it.. When too many people lose faith in the precept that it is a fair economy that will reward merit and hard work it becomes shaky. It is shaky.
Mike, now you made me look it up :-)
California, if it were a country, would be the 8th largest economy in 2013, ahead of Russia and Italy.
Not all that long ago, it seems, it would have been number 6, but China has blown past it and Brazil has edged it out. That said, in 2013, CA was only a hair behind Brazil. But with Brazil’s current downturn, CA might end up in 7th place for 2014.
Here is the link:
http://www.ccsce.com/PDF/Numbers-July-2014-CA-Economy-Rankings-2013.pdf
Russia is a natural resources export economy. A declining Ruble balances the decline in exports and provides liquidity to the economy. This is much more important than the loans the West made to Russian resource companies – loans are always renegotiated and will be here (there is no peaceful alternative).
Any nation will “manage” the trend. That’s no big deal. Throttle down hard currency costing imports. Drop the value of one’s currency and export price in the hardest currencies. Textbook policy in a difficult situation and much more responsible than what Europe is doing.
Crude oil and natural gas (NG) should have a high degree of correlation based on the known fact that crude oil produces 6x the energy of natural gas.
Because the price of NG in the US is slightly above than $4 the energy equivalent price of crude oil should be at most $25. Although there are other factors that distort the ratio, until 2009 that distortion caused oil usually to be traded at 8-12x the price of NG.. Under the historical distortion pattern oil should not be more than $50.
Thus it is fair to question whether the current price of oil that far exceeds the historical ratio is much too high, or whether we have now entered a new normal higher price distortion level in favor of oil.
But in Europe the price of NG is about 10 US$ per BTU, in Japan 16. The extremely low NG prices in the US reflects the fact that the production from the new boom in shale gas is locked in the US, it cannot be exported at present. It is the US which is abnormal here, the old correlation matches much better in Europe and Japan. You should be happy for as long as it will last.
I bought a tank of gas, at $2.89 gal , on election day expected it to go higher the next day. Sometimes things really are that simple.
It is extremely common for people who go around pissing off everybody around them, to have unfortunate accidents happen to them ….
Arabs will destroy shale oil drillers in the US and rise up prices. Arabs already said that prices will go up in the second half of the next year. Obviously they have a plan. Russia is not going to default and she knows what exactly is going on.
It is absolutely nesessary to understand that situation with falling oil prices is not related to so called “falling” rouble. What’s going on is the following: there are companies in Russia that heavily borrowed in dollars and euro in foreign financial markets. They have to make payments on the loans until the end of the calendar year. So called sanctions attempted to cut the ability for those companies to refinance their debts. At the moment these companies are not able to refinance so they are purchasing dollars and euro on the internal market thus creating a perfect set up for currency speculations, – and this is exactly what is going on. Demand for limited amounts of currencies creates hype and abnormal deviations in currency valuation. It is absolutely clear that internal problems of these companies are not related to so called problems with rouble devaluation due to the sanctions effect. Another fact is that these companies could simply go into default and stop payments on those debts,-which is the most likely outcome in present situation.
PEAK CHEAP OIL https://www.youtube.com/watch?v=0uKihKkx0eY
An outstanding presentation