Oil Prices Used as a Weapon

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Today’s Daily Reckoning 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 Daily Reckoning. 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.

Regards,

Callum Newman+
For The Daily Reckoning Australia

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Callum Newman

Callum Newman

Callum Newman is the editor of The Daily Reckoning and Associate Editor of Cycles, Trends and Forecasts. He also hosts The Daily Reckoning Podcast. 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. To have Callum’s thoughts and insights on the current state of the currency, commodities and stock markets delivered straight to your inbox, take out a free subscription to The Daily Reckoning here.
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9 Comments on "Oil Prices Used as a Weapon"

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Ross
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Lord Palmerston (Ridley Bio p334): ‘I hold with respect to alliances that England is a power sufficiently strong, sufficiently powerful, to steer her own course, and not to tie herself as an unnecessary appendage to the policy of any other Government. I hold that the real policy of England – apart from questions which involve her own particular interests, political or commercial – is to be the champion of justice and right; pursuing that course with moderation and prudence, not becoming the Quixote of the world, but giving the weight of her moral sanction and support wherever she thinks that… Read more »
slewie the pi-rat
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a short game and a long game? what is this? golf? [in a hushed tone]: “as the group approaches the 18th tee, Dr. Faustus has the honor and will play first, on this wicked finishing hole, a Par 4 goat-leg to the right. “prez0 will be next, followed by The Pope, who gets one stroke per hole, and Queen Elizabeth, who gets two strokes per hole, will play last. “the stakes are a secret [alleged to benefit globalist tax-sheltered charities, of course] and the scores are worse lies than one is up against when hitting from one of the seemingly… Read more »
Ross
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You must have read Ridley’s bio on Palmerston Slewie …. that’s how they rolled when playing their “Great Game” … They said of Palmerston – “bully to the weak, and coward to the strong”. Especially so when the weak sat between British interests and the suppression of a rival great power. ie: like kicking Mehemet Ali out of Syria to buttress the Turk Sultan supposedly to contain the Russians from breaking out into Asia major. Those supposed Russian imperial designs on annexing India have been proved largely to have been a Brit Oxbridge narrative fantasy, but the western executive still… Read more »
lachlan
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Ol Ross, how you been?.
An interesting thing to observe, watch Zbig here defending the Palistinians https://www.youtube.com/watch?v=wsULAk9XPyY
Compare that with his Russophobe role towards Russia/Ukraine and his hard line on East Ukraine. Very interesting indeed this Jeckyl and Hyde phenomenon…

Ross
Guest
Nice to hear from you Lachlan. I’ve been well but am reading another bio on another runt lawyer … Barwick It is the Crimes Act debacle that led me there – we see the replay on Muslims and Bikies that we did back then on Communists. What Barwick got through despite us was down to circumstance and owning both houses. I quote Gough Whitlam’s retort in Parliament to Barwick which marked Barwick’s big snafu that ended his run at being PM: ‘I will not withdraw. This truculent runt thinks he can get away with anything.” The parallels with Henry Stimson… Read more »
Ross
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@Lachlan I forgot to mention to you and shortchanged on Rhodes scholar Abbott and the Catholic Ukie fascists … he apparently stands well with Queen Victoria – probably down to the skirt behind closed doors … “Eventually, Palmerston agreed (in 1848) reluctantly to submit the issue to a Conference of the great powers in Brussels. His position, as in Portugal in the previous year, was weakened by the attitude of the Queen. Victoria and Albert and no sympathy with the Italian Liberal and nationalist movement, and were annoyed at Palmerston’s proposal to dismember the Austrian Empire by transferring Lombardy to… Read more »
lachlan
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Yes I agree with your intuitions on Abbott’s motivations Ross and I checked out Tim’s comments…very interesting again.

lachlan
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Russia has been copping it since way back, I read into Palmerston for a little. Was Jasper a genuine conscientious objector or pacifist I wondered.

Harquebus
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A load of rubbish. Lower oil prices are due to demand destruction.
Soon, high cost producers will go out of business and then, we will see high prices and shortages. All part of the peak oil induced boom bust cycle.

wpDiscuz
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