If you missed the big story of this week I wouldn’t blame you. It’s a big story, bigger than riots in D.C.
Russia became the de facto controller of the marginal barrel of oil.
This is a bigger story than what happened on Capitol Hill on Wednesday because that was a continuation of a story whose end was already written.
Joe Biden will be President. The Era of Trump is over.
Now that has far-reaching effects on a number of markets, including oil. But, again, we’ve known Biden was taking office, if we’re being honest with ourselves, since election night when the civil war in the U.S. officially began.
So, we’ve known that Trump’s push to become the controller of oil markets was coming to an end. We’ve also known since the Coronapocalypse that U.S. oil production had peaked and could only go down from there.
Yes Russia’s production dropped by a similar amount, around 2 million barrels per day, averaging 10.27 millions of barrels per day in 2020. But the difference here is not in how much is produced but in what it costs to produce those barrels.
And not just any barrel, but the marginal barrel… the last barrel.
Because he who has the lowest marginal cost of production ultimately can and will be the price setter for any commodity. Russia has, by far, the lowest cost of production of the major producers when adjusted for currency effects.
The 2020 EIA report on breakeven oil prices — the price needed to balance the country’s current account — for major producers sheds some light on the subject, but everything is normalized to dollars in terms of cost. Under that analysis Russia comes in at around $42 per barrel and Saudi Arabia at around $64 per barrel.
But that doesn’t reflect the economic reality of each producer unless they are dependent on dollars to source their expenses. Russia is most definitely not in that position. The oil industry there is homegrown.
Expenses are paid in rubles, parts are manufactured locally, and this is where the big advantage lies. I’ve been banging the drum for three years now that Russia’s currency is its ultimate weapon in the oil price wars.
Because Russia with its homegrown oil industry is far less exposed to a dollar drop in the price of oil to maintain internal production costs. The ruble rises when oil prices fall and the income is buffered by this while expenses stay relatively constant.
On the other hand the Saudi riyal is still pegged to the U.S. dollar and is trapped by it. The same goes for U.S. domestic producers, who have had it even worse now that the debt-fueled mania of the Trump years is over.
Access to cheap capital is over. Rates will rise in the U.S. over the next two years. There was just a major technical breakout on the 10 year Treasury note.
These things combined, along with Russia’s flexible taxing regime on oil profits, give them a sincere advantage over their rivals.
So, what happened this week that was so important? The Saudis unilaterally offered to cut production by 1 million barrels per day. While, at the same time, OPEC+ accepted that both Russia and Kazakhstan would increase their production at their January meeting. It doesn’t matter that it was a paltry 75,000 barrels per day.
What matters is the message.
Saudi Arabia is no longer the price setter through massive market share in oil. Period. They surrendered to the Russians.
Oil markets rallied on the news and Brent Crude is setting up today to close the week on a technical breakout above $50 per barrel.
With the Obama restoration completed in the U.S. it also means that the U.S. won’t be running interference for the Saudis through idiotic foreign policy boondoggles like endless sanctions on Iran and Venezuela.
Nor will U.S. domestic policy be supportive of the oil and gas industry under an Obama restoration. The opposite will occur. Texas will become a pariah state targeted for retribution for backing Trump and forcing the Supreme Court to openly abdicate its responsibilities under the Constitution.
The era of Iran and Venezuela being complete pariahs is over. Iran’s oil is already returning to the market as China turns to them as a major supplier.
The $400 billion investment deal they signed with Iran implies a massive return on investment through oil sales.
That leaves the Saudis in no position to do anything other than try to desperately keep the price of oil from returning to the $30’s.
Now, once the money printing and conversion of the U.S. to full-blown MMT insanity is complete under the Democrats, nominal oil prices will likely soar in dollar terms.
But that will not be based on a demand-pull scenario but rather a cost-push one of the type we’re already seeing in industrial metals, grains and timber as supply shocks continue to buffet the global economy and the so-called first world is locked in their homes.
Lastly, this capitulation by the Saudis is acknowledgment that 2021 oil demand will not recover from the worst of the 2020 version of the Coronapocalypse.
All of these factors together put Russia in the driver’s seat o be the price-maker in the oil space and everyone else a price-taker.
It’s a subtle transfer of power based on its ability to operate a reasonably independent economy and political system now mostly decoupled from not only the U.S. dollar but also the U.S. dominated global institutions like the IMF, SWIFT and the World Bank.
Because of this expect an Obama 3rd term to be even more belligerent towards Russia than we saw under Trump, if that is at all possible.
The Russians beat the Saudis this week. Now their attention will turn to the U.S.