Why oil prices are keeping Putin up at night

My mom out in California is elated — gasoline prices in her neighborhood are below $4 a gallon for the first time in four months. Less so are the world’s petro-rulers, who are watching the price of oil — their life blood — plunge at a rate they have not experienced since the dreaded year 2008. Industry analysts are using phrases such as “devastation” and “severe strain” to describe what is next for the petro-states should prices plummet as low as some fear. No one is as yet forecasting a fresh round of Arab Spring-like regime implosions. But that’s the nightmare scenario if you happen to run a petrocracy.

To understand why your average oil king is right to be worried at the moment, grab your calculator. The price of U.S.-traded oil fell to $83.27 a barrel on Monday, and global benchmark Brent crude to $96.05 a barrel; now juxtapose that against the state budgets of Iran, Russia, and Venezuela, which require more than $110-a-barrel Brent prices to break even, according to generally accepted estimates, and you’ll see the problem.

Given this already-existing revenue gap, one might fairly wonder what would happen if, as Citigroup’s Edward Morse says is possible, prices drop another $20 a barrel for an extended length of time. Oil economist Philip Verleger’s forecast is even gloomier — a plunge to $40 a barrel by November. Or finally, what Venezuelan Oil Minister Rafael Ramirez fears — $35-a-barrel prices, near the lows last seen in 2008. In Russia, for instance, “$35 or $40, or even $60 a barrel, would be devastating fiscally,” says Andrew Kuchins of the Center for Strategic and International Studies. That could damage the standing of President Vladimir Putin, since his “popularity and authority are closely correlated with economic growth,” Kuchins told me in an email exchange.

With few exceptions, the same goes for the rest of the world’s petro-rulers, whose oil revenue supports vast social spending aimed at least in part at subduing possible dissatisfaction by their populace. Saudi Arabia can balance its budget as long as prices stay above $80 a barrel, according to the International Monetary Fund, although projected future social spending obligations will drive its break-even price to $98 a barrel in 2016.

 

Of the major petro-states, only Qatar — with a requirement of about $58-per-barrel to balance its budget — appears to have sufficiently disciplined state spending to weather all but the most dire forecasts.

The biggest uncertainty in the global oil market isn’t whether oil prices will drop further — they seem likely to — but how long they will stay down. In short, how long, and at what scale, are the petrocracies likely to suffer? This state of affairs is a woeful blow to petro-rulers after nine years of mostly nirvana. The year 2003 started with oil at about $33 a barrel, after which prices went mainly up, peaking in July 2008 at $147 a barrel. They bounced back nicely even after the global financial crisis sent prices plummeting below their 2003 level, to about $31 a barrel in December 2008. When the Arab Spring unfolded, first Libya and then Iran triggered worried looks on trading desks in London and New York, and the price spiked to about $128 a barrel. My mom saw the average price of gas in California rise to $4.36 a gallon. But then the concern of war between Iran and Israel all-but vanished, and prices since have been on a seemingly relentless decline.

Now, a convergence of forces is weighing on petro-rulers’ nerves: Europe’s economic crisis; a slowdown in Chinese growth including the demand for oil; a steep decline in U.S. oil consumption with a simultaneous rise in domestic oil production; and a determined effort by petroleum colossus Saudi Arabia to build up global inventories.

It is perhaps the last data point — Saudi Arabia’s aggressive actions to lower prices by pumping some 10 million barrels a day — that might seem baffling given Riyadh’s economic stake in the oil game. But Verleger, the Colorado-based oil economist, says the Saudi rationale is clear, and linked to the kingdom’s traditional long game.