Oil Prices Used as a Weapon

Today’s Markets and Money certainly has plenty to talk about: records are happening all over the place. Oil prices had their biggest one day drop in two years yesterday and German bond yields hit a record low. Let’s start with oil.

On the New York Mercantile Exchange light sweet crude for November delivery hit US$81.84. Brent traded at its lowest price since late 2010.

As far as you and I are concerned, lower oil is good news — unless you have energy stocks in your portfolio — as it puts more money back in our pocket at the pump. But oil producing countries get very nervous, because their revenue drops right in front of their eyes.

The budget for the Saudi kingdom, for example, is 90% dependent on oil. It needs a price of US$80–90 to balance its budget, according to the Wall Street Journal.

Saudi Arabia is not alone. Professor Steve Hanke has put together a handy graph showing why he believes 11 of the top oil producers in the world now have a problem:

Oil Prices 6 month vs country break even prices

Source: the World Post

Of course, a government budget and the actual cost base to extract the oil are two different things. Most of these countries have more of a problem with government spending than the price of oil.

You’ll notice Russia is on the list. The Wall Street Journal reports Moscow and Beijing have just signed 40 agreements across energy, finance and technology as ‘the Kremlin looks to deepen its strategic ties with its eastern neighbor to counter isolation from the West.

Perhaps the most important one is the ‘three-year local currency swap worth 150 billion yuan ($25 billion) aimed at increasing trade in domestic currencies and cutting reliance on the U.S. dollar.

That reliance on the US dollar is an ongoing strategic weakness for Russia. Its currency, the ruble, is down 18% against the US dollar since the beginning of the year.

Don’t forget the sanctions currently imposed on Russia mean dollars and euros are in very short supply for Russian banks and companies. Without access to global capital markets, they can’t borrow what they need while the sanctions are in place. The pressure on the ruble isn’t going to ease off. Russian firms have to roll over $34 billion in US dollar denominated debt and interest in December.

I’m sure that’s just the way the US likes it. Greg Canavan explored the politics of energy playing out across the Middle East in yesterday’s Markets and Money. The US is bringing a lot of pressure to bear on Russia and its allies.

It’s the China angle, however, that interests me.

Geopolitical analyst George Friedman likes to point out that the US foreign policy strategy centres around disrupting alliances like Russia and China — the two major powers on the Eurasian landmass — from forming. But what is the wedge the US can lever to disrupt relations between China and Russia. Japan? Mongolia? I don’t know, but my money is on something happening.

It’s similar to the reason US foreign policy will be very accommodating to Poland; because it splits the potential for Russian energy to unite with German manufacturing in a more significant way.

Whether the Germans and Russians could ever do such a thing based on their history of war and mistrust is the objection to that idea. But then again, in 1814, the British burned the fledgling town of Washington in the US. About 100 years later, US troops were fighting for the UK in Europe. What’s that old British line about the only alliance idea is to have no fixed alliances?

The Germans won’t be displeased about the oil price, of course. Germany is chronically short of energy supplies, except coal. That’s one reason it’s investing so heavily in alternative energies. With oil down, energy importing countries like Germany are seeing costs lowered for the moment.

That’s not the only thing. Now German government debt is yielding just 0.84%. That a record low. Record lows are also the case for Austria, Finland and the Netherlands. The spectre of deflation is across Europe and investors are getting the jitters.

There is a caveat to this, however. The land market in Germany — which nobody mentions in these discussions — is booming.

For example, rents are up 43% in Berlin over the last five years, according to Bloomberg. It’s actually leading to violence as residents in public housing are getting shunted out to make way for high end construction.

From Bloomberg: ‘The real estate gold rush, epitomized in Kreuzberg, is palpable across the city. Construction cranes frame the skyline where new ministries, shopping malls and office districts are rising.

85% of people in Berlin rent. The national rate for Germany is 54%. That’s high because Germany actually makes some attempt to limit house price rises, unlike the US, UK and Australia, which makes renting more appealing.

Germany has successfully exported its way out of the trouble over the last few years. Car sales to China have been particularly strong. They’re coming off the boil a bit as China slows down. But there’s a link between German exports and Berlin rents.

Why do you care? On Saturday, I’ll show you a new Credit Suisse report on Australia that gives you the answer.


Callum Newman+
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Originally graduating with a degree in Communications, Callum decided financial markets were far more fascinating than anything Marshall McLuhan (the ‘medium is the message’) ever came up with. Today Callum spends his day reading and researching why currencies, commodities and stocks move like they do. So far he’s discovered it’s often in a way you least expect.

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