Tag: oil

BEAR MARKET FOR RUBLE REVEALS STRUCTURAL PROBLEMS FOR RUSSIAN ECONOMY

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By Evan Carlo
Staff Writer

What was considered a major economic and geopolitical threat to the United States just a few months ago is now on the verge of a financial crisis. Russia is facing severe economic repercussions due to the sudden decline in the value of its currency, the ruble.

The ruble rapidly collapsed in value from November 24 to December 16, as it soared from an exchange rate of 44.83 rubles for one U.S. dollar, to 67.91. The collapse in currency caused inflation to increase swiftly. Prices are up 10 percent at the time of this article. Russian citizens, unsure of the future value of their currency, are rushing to buy consumer goods now before inflation erases their purchasing power. The rapid changes in currency led foreign businesses, like Apple, to shut down operations completely in Russia.

Dealing with the crisis will require evaluating whether the depreciation in the ruble is caused simply by temporary factors that will dissipate soon, or if the currency crisis is a result of more structural flaws in the Russian economy.

In an attempt to reverse the fall in the ruble’s value, the Russian central bank hiked interest rates to 17 percent on December 16. Central banks raise higher interest rates in order to attract foreign capital, hoping to gain a higher return on investment in the country. More foreign capital raises demand for the domestic currency causing its value to rise. Raising interest rates is a common move by central banks facing a depreciating currency. It is only a temporary solution, as maintaining high interest rates indefinitely will hurt economic growth. Eventually interest rates must come down when enough capital has been accumulated to prevent a further fall in value for the currency.

However, raising interest rates was only temporarily successful as the ruble collapsed in value again from an exchange rate of 52.08 on December 25 to 63.14 on January 12. Forecasts by Goldman Sachs predict the ruble will continue to fall to an exchange rate of 70 in the next three months and remain at 60 in 12 months.

Raising interest rates is only a temporary and ineffective solution that does not address deeper economic problems in the Russian economy. While the falling value of the ruble can be partly blamed on economic sanctions placed on Russia by western countries, deeper economic issues are also responsible. These problems are structural and cannot be fixed through monetary policy. They must be addressed with political and economic reforms.

Russia’s Natural Resource Dependence Problem

One of the structural economic problems most responsible for the ruble depreciation is Russia’s over reliance on oil and natural resources for economic growth. Ever since Vladimir Putin strengthened state control over the energy sector, it has been a vital sector of both the overall economy and government. The state now controls a large share of the energy market and directly benefits from oil and gas production. Over half of Russia’s federal budget is funded by oil and gas rents.  Approximately 13.9 and 2.3 percent of Russia’s GDP consists of oil and natural gas rents respectively. This makes Russia more vulnerable to swings in commodity prices as falling oil prices will cause Russian businesses, and the Russian government, to lose money.

This is a big problem for Russia’s 2015 economic prospects since global oil prices have plummeted over the past year. Increased production in the United States combined with Saudi Arabia’s refusal to cut back on production has created a supply glut, forcing global oil prices to fall rapidly. The fall in oil prices has simultaneously caused the value of the ruble to fall.

The rapid fall in oil prices severely jeopardized an already flailing economy facing sanctions from western governments. It is estimated that Russia needs oil to stay at $105 a barrel in order for its government budget to break even. With prices at the time of this article at around $50, state-run Russian oil companies are facing tremendous losses that are impacting the government. Since the economy is highly dependent on oil, the price drops will affect the whole economy and will most likely send the country into recession.

As a result of the loss in revenue  and a lower valued ruble, Russia will have to cut back on its government expenditures, putting social and military programs in jeopardy. As oil prices go down, Russia receives fewer rents in the oil industry and therefore has less to spend on accomplishing its domestic and foreign political goals. This makes it less likely Russia will attempt an invasion of Eastern Europe if it cannot even fulfill its budget expectations. Russia is too dependent on oil to be a serious long-term geopolitical threat.

The Russian economy has long been oriented towards extracting and exporting natural resources, rather than developing a diversified modern economy. Without other developed economic sectors, Russia is vulnerable to price swings in the commodity market and to eventual natural resources depletion. If Russia wants to prepare for the day it will run out of natural resources, it must diversify its economy.

Without a diversified economy, Russia will also be unable to attract foreign investors. The loss in oil prices and sanctions are causing investors to pull money out of the economy at an alarming rate. With less capital in the country, the Russian ruble fell rapidly as demand for the currency fell. Therefore, the currency crises cannot be blamed solely on temporary western sanctions, but on deeper structural problems that will need to be addressed.

Russian State Capitalist Structure

To address structural problems in the Russian economy, economic and political reforms will be necessary. Unfortunately the state capitalist system of Russia stands in the way of reform. The political institutions of Russia ensure Putin and the Russian elite capture the main benefits of oil profits for their respective agendas. The profits are used by the government for a variety of programs such as the oil stabilization fund, fuel subsidies and building the military.

Since the business elite and government benefit from this arrangement, this system creates incentives to develop an extractive economic system that focuses more on utilizing natural resources than developing the whole economy. The oil profits have not been used to try to diversify the economy and prevent Russia from being exposed to price swings. [1]

The oligarchic nature of Russia’s political system also directly affects investor confidence in the economy. Given the close nature of the state and private business, many investors are fearful that the state will favor selected businesses at the expense of the rest of the economy. Russia has already directly bailed out Gazprombank by injecting more than $700 million into the bank. The government further showed its commitment to helping out select businesses by allowing companies looking for loans to use the bonds of state-owned energy giant Rosneft, as collateral.

This move essentially  finances Rosneft with an influx of rubles. Such a move made investors worry that Russia will continue to bail out favored businesses during economic troubles,  jeopardizing the whole country. Such crony capitalism poses a huge threat to Russia,  as it not only guarantees Russia will remain an extraction economy, but it also makes investors fearful of competing against favored state businesses.

Future Energy Prospects

If oil prices rebound quickly, such as they did in 1998 and 2008, then Russia will recover. Russia will still be open to price swings in the future but, for the moment, will be able to continue to grow its economy.

However, it is unlikely that prices will be able to rebound enough. Since oil wells are difficult and costly to shut off, even with price decreases it is unlikely that production will stop and bring up prices. Crude Oil Brent Futures trades currently indicate that prices will not reach $60 a barrel until October 2016 and will not even reach $70 until as far out as 2023.

These prices are well below what the Russian government needs to break even on its budget. This will prompt budget cuts and reevaluations of what Russia hopes to accomplish in foreign relations. While this situation could change, the market predicts Russia is facing a bleak future. Without structural changes to the economy, the Russian bear will be vulnerable to future oil bear markets.

Image by World Bank Photo Collection

Notes

[1] Ebel, Robert E. The Geopolitics of Russian Energy: Looking Back, Looking Forward A Report of the CSIS Energy and National Security Program. Center for Strategic and International Studies. July 2009.

SCIENCE MATTERS: FACT-CHECKING KEYSTONE XL

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Segment of TransAlaskan Pipeline near Fairbanks

By David Dannecker
Senior Editor

The Keystone XL pipeline extension has been back in the news recently, thanks in part to an effort by Senator Mary Landrieu (D-LA) to hold a Senate vote on the project last month which ultimately failed by a razor-thin margin. For those who don’t know, the pipeline first proposed back in 2008 would run from Alberta to Nebraska, delivering crude oil from Alberta’s tar sands to refineries on the Gulf Coast. The project has been a major point of contention between environmentalists and the Canadian petrochemical company TransCanada since its first proposal. Polling suggests that the proposal enjoys majority support among Americans, although support has been slipping since a high about a year and a half ago. With the special interest proxy war in its seventh year, it is hard to get a handle on what the actual facts are surrounding Keystone XL and what effects it would have if it received the green light for construction. It seems that the level of misinformation in the debate could be a confounding factor when it comes to gauging public support; very few people are likely to know the details of the project, especially those that haven’t been following the issue. Figures for job creation vary wildly, as do claims about its safety, and the broader environmental impact the project could have. So without further ado, let’s delve into some of the arguments over Keystone XL.

Job creation is one of the primary arguments in favor of the pipeline. It’s true that infrastructure projects often are a big help toward creating jobs and spurring economic growth. However, reports of the number of jobs that Keystone XL could create are inconsistent. The figures on TransCanada’s website suggest an estimate of 9,000 construction jobs for the project, while other sources suggest a more modest 2,000 construction jobs, with those positions only lasting a couple of years. The State Department found that the number of permanent jobs created by Keystone XL (i.e. those jobs that would outlast the construction phase of the project) would equal a paltry 50 employees. To put those figures in some kind of context, the United States as a whole added 214,000 jobs in the month of October this year. Even the higher job estimates cited by TransCanada represent less than five percent of one month’s national job growth. If job creation is the main reason behind Republican support for the project, one has to wonder why other infrastructure initiatives with ostensibly greater job creation potential often meet with tepid Republican support at best.

Turning to claims about the pipeline’s safety, TransCanada appears confident that the new branch of the Keystone pipeline will be the safest ever constructed. Seeing as the new pipeline will have the benefit of the last few years of cutting edge technological advancements that weren’t available to the earlier phases of the pipeline, this may be the case. However, Media Matters points out that in spite of similar language before the original Keystone pipeline, it suffered a dozen spills in just its first year. Oil pipelines have a poor track record in the U.S. in general with over 110 million gallons spilled in the last 25 years. And while the pipeline has been rerouted to avoid the environmentally sensitive Sandhills area of Nebraska, the new route still threatens drinking water, including crossing an important aqueduct, which would be vulnerable to contamination should a spill occur in the vicinity. TransCanada has assured the public that it is committed to containment and restoration in the event of any spills or leaks, but even so, given the history of pipeline shortcomings and TransCanada’s own recent record of overselling the safety of its delivery infrastructure, treating safety claims with some modest skepticism seems appropriate.

What about the environmental impact of Keystone XL? Would it be the harbinger of climatic doom that environmentalists have painted it to be? Firstly, tar sands are one of the least efficient sources for obtaining fossil fuels. Because the crude oil is found in an amalgam of sand, clay, and bitumen, extraction is extremely difficult. The extraction process itself requires a great deal of natural gas and water to isolate the crude oil, and that’s before the transportation and refinement processes. So, yes, tar sands as a fuel source are pretty awful for the environment, and that’s not even taking into account the significant deforestation connected with mining tar sands. Some defenders of Keystone XL argue that Alberta’s tar sands are going to be utilized with or without Keystone, so the pipeline itself should be seen as a net zero as far as emissions go. It’s true that TransCanada is exploring other options for delivering the crude oil to refineries, including sending the oil by rail or by retrofitting Canadian pipelines to handle crude oil in a separate project known as Energy East. However, rail transport has been under increased scrutiny in the aftermath of a couple of explosive disasters, and neither of these alternatives would be as cost-effective as Keystone XL would be for TransCanada, which explains their dogged determination to see the proposal approved. Given the opposition that each of these approaches is facing, the development of Alberta’s tar sands is no sure thing. The value of extraction relies on the possibility and ease of subsequent transport, so while Keystone XL isn’t the only option Canadian energy companies have, its existence would likely facilitate and foster future development.

While disagreements over the merits of Keystone XL continue to exist, and are likely to persist until the project is either approved or denied for good, it is possible to isolate some plausible parameters to frame the debate. Sourcing tar sands for crude oil is bad for the environment. While Keystone is not the only option for crude oil delivery, it would likely speed up tar sand development in Alberta and so hasten the release of their greenhouse gases. The prospects for Keystone job creation are not likely to be very significant, and there are plenty of non-fossil-fuel-related infrastructure alternatives to consider if temporary job creation is the goal. It’s hard to predict the exact likelihood of pipeline malfunctions, since accidents are by their very nature unpredictable, but the position of the pipeline route and the recent history of pipeline technology do not support the idea that Keystone XL would be as safe as TransCanada claims. As the facts surrounding this project find their way into the public debate, we might expect that the polls will continue to decline. President Obama has recently signaled his own awareness of the project’s shortcomings. While the proposal itself is tied up while a legal challenge is settled in Nebraska’s Supreme Court, Obama’s opposition to Keystone XL looks like it will be the deciding factor, even in the face of a new Republican-controlled Congress. Since Canadian oil companies are the only certain beneficiaries of Keystone XL’s construction, the project seems unlikely to move forward, what with Obama positioning climate change as one of the defining issues of the final years of his presidency.

Image by Maureen

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BLACK GOLD: THE KEY TO SCOTTISH INDEPENDENCE?

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North Sea Oil Rigs

By James Kim
Contributing Writer

It is no surprise that gaining independence from the United Kingdom is no easy task. The United States had ten years of anarchy before ratifying the Constitution; India suffered a violent partition that divided her into two (eventually three) separate nations; and several newly formed countries of the developing world underwent and continue to endure civil wars and unstable governments. A referendum for Scottish independence has been scheduled for a vote later this year. Even though Scotland is a well-developed region with the highest per capita income in the whole of the U.K., that fact will not give her an exception from the difficulties of self-determination if the referendum passes in September.

However, there is a commonly held view among supporters of the independence movement and the Scottish National Party that petroleum would ease the troubles in the early days of home rule. Aberdeenshire, where most of the Scottish oil industry is headquartered, serves as a major SNP voting bloc and even forms the constituency for First Minister Alex Salmond, the main proponent for independence. Scotland’s petroleum reserves are located in the North Sea, which it shares with Norway. The Norwegian success with its lucrative resource has become a rallying cry for the independence movement, as unlike their prosperous Scandinavian neighbor, the Scots have no control over the tax revenues of the North Sea petroleum industry. London instead has the final say in wealth redistribution, leaving the Scots with only a fraction of their rewards. Relationship with the Westminster Parliament is becoming more contentious due to the domination of the Conservative Party, a political group long mistrusted by the majority of Scots. The Tories’ move to privatize the British postal service and even the NHS has frightened the socialist leaning Scots, who fear that their taxes would only be used against them. Thus, the rise of the independence movement is a response to the urgency of making sure that Scottish resources stay with the Scots.

Yet, oil cannot be viewed as a panacea to Scotland’s economic woes. OPEC recently released a statement that the discovery rate of new wells in the North Sea is at its lowest in three decades, initiating fears that production may have already reached peak capacity. To make matters worse, the Westminster Parliament stated that it would veto Scotland’s retention of the pound, a significant blow to the region’s financial security since oil is traded in American dollars. Losing a currency that has more value than the American greenback will create more obstacles than solutions for an independent Scotland.

Having a natural resource that everyone needs does not necessarily make a nation independent. While it does lead to a spirit of nationalism due its huge role in the local economy, oil also carries the risk of attracting foreign powers that want to possess all of its rewards. England knows that it will lose its tax benefits if Scotland gains full control over its own resources; a potential loss of billions of pounds forces Westminster to urge both the Conservatives and Labourers to hinder the SNP’s attempts at separation. However, Scotland also realizes that remaining in the union would prove to be a zero-sum game, as the price of the union means gambling with a hostile right-wing political party that has a sour history with the Scottish people. Despite the importance of black gold, it alone cannot break the stalemate between a compromised union and an uncertain independence.

Images by Berardo62