The story of today is the price of oil. A month ago it looked as though it couldn’t go any lower as US wells were pegged to a production price of about $80 per barrel. Now, it’s at $60 per barrel. There are signs that many US wells will indeed keep operating as improvements in efficiency and a lower operating cost once the sunk costs once well is started leave room for more profit even at this low price. Cheap oil may be here to stay longer than we thought.
But with that, we still have the problems in Russia. The Ruble has fallen off a cliff, a problem often blamed on the price of oil. It’s deeper than that, and the flailing Russian response has in some ways made things worse. The currency has lost about 60% of its value in one year, versus about 40% for oil.
That’s not to say there aren’t threats as well as opportunities in the US beyond oil itself. Cheap oil changes a lot of games, and is worth thinking through.
Let’s assume for a moment that West Texas Intermediate (WTI) crude oil is going to rebound a bit, but remain in the $60-$80 per barrel range for at least a year. We can assume that because we don’t know exactly why OPEC has refused to cut production it is probably true that they have a longer-term plan or problem. On the other hand, if they intend to shake out either Russia, Iran, US production, or all three it will take time. The strategy has been engaged and probably won’t be dropped for a while.
What does that mean? Cheap energy means a big savings for the US economy, which can only be bullish over the long haul. We consumed 6.89B barrels of petroleum products in 2013, so a savings of $20-$30 per barrel is $138-$207B per year, or upwards of 1.3% of GDP. It’s a big number.
There is also the chance that a lot of junk bonds will fail, as reported earlier.
Then again, according to one study, the oil boom has created as many as 2M jobs and increased the total product of the economy by $300B or so. It also contributes to the infrastructure that encourages manufacturing growth. So if oil becomes so cheap it reduces US production there is a bit of a problem.
The biggest problem, however, remains in Russia. Their exports of oil were pretty much the only thing that has kept the nation afloat, a horribly delicate position that was bound to end badly at some point. Between the low price of oil, sanctions over Ukraine, and a generally weak economy to start with there is reason to believe that Russia is in danger of a complete collapse this Winter – one even harder than we forecast in October.
The freefall of the Ruble has been staggering in its ferocity. We can’t know yet how it will play out in the domestic economy and then in their politics, but it won’t be good. The problem is that banks in Russia were not particularly healthy to start with, so a strong disturbance like this may be enough to start a chain of failures. That’s when it really affects the people of Russia. The ultimate response will take some time to play out, but probably will be nasty.
If there is a general collapse all bets are off as to how the nation, or specifically Putin, respond. Will he focus on internal problems and stop messing with neighbors? Or will he seek distractions and reinforcement that the problems are all made by the West? This could be a bad time to be Russia’s neighbor, as if things in Ukraine could get worse.
What we do know is that the crisis we can see coming will strike in the Winter – when it will hurt the most and when a military distraction is less likely to take place. By the time they might be ready to invade Kazakhstan or some other place the people of Russia might finally be sick of the whole act. An implosion might result.
No matter what, there is a lot to think through as cheap oil changes everything. It may yet be a boom for the US, despite the increasing reliance on our domestic oil industry for jobs and income. Then again, it may not affect domestic production that much, giving us the best of both worlds. It may make the world more dangerous, however, if Russia lashes out again.
We will know a bit more in a month. For now, enjoy the cheap gasoline and pray for peace.