Reuters

(Reuters)

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Oil Price Plunge Thwarts Despots

Russia’s president Vladmir Putin is out trying to calm the waters, reassuring global investors that, despite U.S. and European sanctions, Russia’s “strategic course remains unchanged” and that his is “a country that is strong, flourishing, free, and open to the world.”

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But Putin’s optimism is based on just 1.2% GDP growth in 2015, likely overstated, which in turn is predicated on oil at $100 a barrel. Russia needs oil prices to stick above $100 to grow its economy and balance its budget, now in deficit mode. Oil, though, appears to be in free fall, and Russia now faces recession. Its government is in turmoil, given that nearly half its budget revenues comes from oil and gas, and a growing chunk of its GDP relies on the oil sector, about 30%.

Oil is now breaking down towards $87 a barrel, as a newly muscular U.S. dollar continues to strengthen, the U.S. shale oil boom continues apace and energy efficient vehicles take off. NYMEX crude just touched $85.60, the lowest level in nearly two years, since December 11, 2012. The U.S. Dollar Index has been on a 12-week winning streak, the longest for the index since its creation in 1973.  In turn, energy stocks are in free fall, with the S&P 500 energy sector plunging 3%, the steepest drop since April 2013. Gas prices are falling below $3 a gallon in numerous U.S. cities. Oil has been trending lower since last winter, it has largely stuck below $90 a barrel since January.

Supply continues to outstrip demand, given the economic downturn in Europe and other parts of the world. OPEC and the U.S. Energy Information Administration estimate demand at 900,000 to 1.05 million barrels a day this year, and about 1.2 million to 1.3 million barrels a day in 2015. 

Few geopolitical weapons can subvert despots, authoritarian governments, or even Mideast terrorist states quite like an oil price plunge. Case in point: The Soviet Union, where power increased when oil and gas prices rose.

When oil prices dropped, thanks in part to President Ronald Reagan’s policies, the cracks sped faster through the Soviet empire in the 1980s, as the country fell into insolvency. This is why Putin lately has been eyeing Crimea and Ukraine for their vast shale reserves, since Russia cannot control the price of oil, as Putin would a former Soviet satellite state.  

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But what exactly did Reagan have to do with the “oil as a weapon” story? He backed efforts at the Federal Reserve to stabilize the U.S. dollar while also pushing for a massive defense buildup. Oil is priced in U.S. dollars, and real oil prices started to take a deeper fall when then Federal Reserve chairman Paul Volcker raised interest rates, in turn strengthening the U.S. dollar.

Before then, oil had more than quadrupled to $86 a barrel by the time Reagan sat down in the Oval Office in January 1981 from about $18 less than a decade earlier, in 1972. That nosebleed price was unheard of in the early ‘70s, as oil had traded around that $18 range from 1950 to 1972. But that sudden spike higher in the late ‘70s was due to a crushing drop in the value of the U.S. dollar, battered by the costs of the Vietnam War.

During the ‘70s, the Soviet empire rose to dramatically greater heights, and after a December 1978 meeting, OPEC announced a whopping 15% price increase to be phased in over the ensuing 12 months.

That price spike hastened the beginning of the oil crisis that rattled the Carter Administration in 1979, a year that saw the fall of the Shah of Iran and war between Iraq and Iran, which slammed oil production. After the Shah fled Iran, and Sheikh Ruhollah Khomeini grabbed power in February, Iran’s oil output dropped by about a third, with Saudi Arabia and other OPEC countries battling to make up for lost supplies.

What else did Reagan do? He opened the supply hydrants by quickly deregulating the U.S. oil market, lifting government controls on U.S. oil prices. When Reagan finally left office, oil was at about $28 a barrel in the late ‘80s.  That price plunge pushed the Soviet Union into bankruptcy, and disintegration, in December 1991. The former Soviet states were then curtailed by low oil prices in the ‘90s, with real prices at about $27 a barrel.

But since then, the blowout in the U.S. balance sheet and the Federal Reserve’s massive expansion of its monetary stimulus had smacked the U.S. dollar vis a vis gold, dropping nearly 80% since the year 2000. Oil shot to $144 a barrel in July of 2008, and Putin was on the march, invading Georgia. Looks like things might be turning in the opposite direction for Russia, driven to distraction by plunging oil prices.

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