Petro Pressure: Between Russia and Saudi Arabia

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What a great world we would live in if only all our enemies collectively went to war with one another and left the United States undisturbed.  As unrealistic as such a plan for world peace may be, as more and more of the US' rivals grow strong economies, these same anti-US nations will find themselves creating friction between each other over limited global resources.  While neither Russia nor Saudi Arabia have had many good things to say about the United States throughout their histories, they've not had much of any reason to villify each other.  As both nations see their prime export, petroleum, crash in value to below $40 per barrel, however, there's suddenly a lot of reason to think that both these big fish cannot coexist in an increasingly small pond.  While Russia and Iran have been able to come to fruitful agreements about oil supply and shipments, Russia has no such friendly intentions with the Saudis, with the prospect of a trade war on the horizon.

No Love Lost

The history of the Russian and Saudi governments forms a loose and rather thorny relationships.  During the Second World War, the USSR relied on Saudi Arabia for their oil pumps because the Soviet access of petroleum from the Balkans and Romania ran dry after the Nazi invasion, but the Saudi government sent no armed forces to contest the German forces in west Asia.  During the Cold War, the Soviet government sought to create alliances with Arab nations as a hedge against American and Israeli interests in the Middle East.  While some such countries bought into this alliance full-bore, most notably Egypt financing the construction of the Aswan High Dam with Soviet cash, the kingdom of Saudi Arabia deeply mistrusted the anti-religious rhetoric of communism and preferred to allow the United States to build military bases for safety rather than turn to the USSR for help.  The creation of OPEC undermined the Soviet petrodollar (or rather petroruble), with Ronald Reagan famously claiming that the outflow of cheap oil did more to destabilize the USSR by draining $20 billion per year from the Soviet economy.  After the conclusion of the Cold War, Russia and the Saudis by and large stayed out of each other's way, especially as oil trading above $100 per barrel led to vast revenues for both sides.  Today, oil at $100 per barrel seems as far removed from the present day as Columbus sailing across the Atlantic.

Orders From The Top

Gazprom represents not only the largest oil company in the world but an instrument of the Kremlin itself.  The state-owned petroleum firm, which supplies Europe with one in three barrels of oil, likely has more power than any other business on planet Earth.  That means that the first deputy chief of Gazprom, Vadim Yakovlev, has the ability to make many people pay attention whenever he speaks.  Yakovlev gave an interview with Reuters and said that the Saudis would "try to test new levels of resiliance" on the global oil market during the decline of oil in mid-August, noting further that the Saudi over-supply gambit has largely failed to push the US shale-oil business to the point of collapse (despite 50% of shale-oil firms going out of business since 2014).  Yakovlev further boasted that the continuation of price wars between the Saudi oil industry and the Russian petrodollar would bode well for Gazprom and the Russians, saying that Russia is "very well insulated...we won't be the victims" and that the Saudis would be in "deep water." 

Can Two Nations Make Up?

Since the Saudis and the Russians export more oil than the next five nations combined, there's no doubt that a mutually-beneficial plan to limit supply would go a long way towards propping oil back up and maintaining price certainty.  Yet in this game of global chicken, that's a plan that neither nation appears to be terribly interested in.  Yakovlev believes that it would hurt Russia in both the short and long run to limit their supply without drastically benefiting the Saudi government, making it a no-win proposition for Russian interests.  As such, Gazprom will continue to pump the oil without so much as a hiccup, much like Soviet output duing the 1980s oil crash never so much as wavered.  Gazprom's output has risen the most out of any Russian oil firm, indicating that the state-run company isn't worried about their cash flow.  79 million tons of oil (tons, not barrels) will flow from Gazprom wells in 2015, with the company hoping to push output to 100 million tons by 2020 by drilling in new Arctic deposits.  While these deposits are hotly contested by Scandanavia, Canada, and the US, Russia has pushed the hardest to develop rich new fields that are just off the coast of Siberia, despite the projections that oil trading below $50 per barrel would make offshore drilling unprofitable.  As a result, neither Saudi Arabia nor Russia appear ready to take their foot off the pedal any time in the near future.

  • The Takeaway: if you think that oil sits in a state of oversupply, just wait until the biggest players in the market trip over themselves in order to push more and more oil out of their wells.  The Russian and Saudi price war will only push the commodity down, possibly to as low as thirty dollars per barrel.  Despite the bump of the past week, oil has little long-term future prospects.  Short-selling petroleum commodities represents the best way to profit from oil, since greater and greater quantities will hit the market with each passing day.  Look to sell as far out as you are comfortable with, since oil may rise in the short term due to volatility but will drop over the course of six months and beyond.
  • American oil producers that have no government backing, other than energy subsidies, will find themselves hard-pressed to compete with foreign state-sponsored entities.  If you hold oil stocks in your portfolio, consider dropping them (even at a loss) as the dual threat of falling prices and rising supply puts major producers in a pinch.

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