How Mike Pompeo Sparked the Oil Collapse and Changed Russian and Saudi Politics

greg beier macroESG.com 13 may 2020 9:30pm 

The oil market crash of 2020 is a classic story of global power dynamics at work.

This is a follow-up to the analysis of the oil market on futureblog.org published on September 15. 2019

 Pompeo Lit the Fuse

When Secretary of State Mike Pompeo met the President of Belarus on February 2nd (the first SecState visit in 28 years) and offered him unlimited energy supplies at a “fair market price,” I believe this statement initiated the collapse in crude oil prices. His offer to a former Soviet vassal state forced Russia into a cooperative relationship with Saudi Arabia to drive the US shale oil producers out of business because Russia is a vast land power with enormous borders and uses energy supplies to influence its neighbors - it needs to maintain this leverage. Saudi would benefit from higher energy prices for its newly public company, Aramco, the largest listing of all time.

To put this change in perspective, Russia had to put aside its historical enmity with the Saudis as the Saudis were, in fact, responsible for engineering the crash in oil prices in 1986 that ultimately brought the Soviet Union down a few years later. Now, Russia and Saudi are on the same side in engineering another great oil crash.

The front month of WTI was trading around $52 on Feb. 3rd on the Monday following the weekend meeting of Pompeo in Belarus and then traded down to $49 on Feb. 4th and up to $55 on Feb. 20th after which the price gently fell over into a collapse.

Of course, the pandemic was gathering steam and it was under this pretext of a weaker market that two long-time enemies teamed up to get rid of a major supplier that was troublesome to them.

My belief is that both parties saw that the price of crude was weak to start with and it was clear that it was going to go down anyway with the pandemic, so why then not the make most of it, and drive the price right into the ground through engineering a panic and keep it there? And, I believe, this is exactly what happened.  The Russian – Saudi price war that was reported in the press is theater, making both leaders look tough to their domestic constituents, and giving them an excuse to run the US shale business out of business.

I believe that the Russians had a greater need than the Saudis and they likely initiated the oil coup conversation. I believe that this is why Crown Prince MBS made the first move as a show of good faith when he had two of the most powerful princes in Saudi Arabia detained for an alleged coup attempt on March 6th. Both men had previously been possible contenders for the throne and  were now taken completely out of circulation. This cleared the way for MBS, on March 8th, to initiate the crude oil price war.

Putin, meanwhile, surprised the world when he announced on March 10th that he was reversing his plan announced earlier in the year to exit direct presidential rule and become a Senior Leader – I kept thinking of him becoming like an ayatollah maintaining the final word without having to do the day work. A plan was announced that he would become president for many more years and Russian political theater was organized to make this happen via voting. Putin said he needed to do this to maintain security – and I believe that this is true – as Pompeo threatened the energy influence policy that Russia had successfully used for years to manage its borders and neighbors.

So, if you are going to crash the price of oil and you are the head of a petro-state like Russia or Saudi Arabia, you better make sure that your grip on power is iron tight so you can ride out the storm. And that is exactly what transpired.

Now, I could be wrong in my analysis and the Saudis and the Russians could have each acted unilaterally, and simply fallen into this price war abyss. But, I doubt it. They both needed to act – America was changing the power dynamics so greatly that it began to threaten their positions. It was already bad enough, from their perspective, that global warming had sparked the clean energy revolution and it was only a matter of time before innovation turned their fossil fuel wealth into stranded worthless assets. They needed to push the Americans out of oil for a while, make some money, and exert some power.

To repeat myself, if Pompeo hadn’t been pursuing such an aggressive carbon-based energy foreign policy, I doubt that the Russians would have felt so threatened. But, when combined with the utterly rare opportunity to use the coronavirus pandemic slow-down in demand that was 100% coming anyway to strike a mortal blow against the US shale producers – yes, I believe that they took that chance. An alliance was formed.

I believe that these two events are tied together and set the stage for the current Russia-Saudi Arabia oil price war. Both men are taking a big risk driving energy prices down to the floor, but they eliminated rivals and cemented power. Or, perhaps the whole thing is a ruse to acquire power domestically and vanquish an economic competitor? With the US shale players hobbled, prices would bounce up nicely to their old range once the surplus stocks were used up.

So – where does this put us now? Recent statements by the Saudis in support of the oil price are for domestic consumption. The Saudi government can blame the Russians and the Russians can blame the Saudis, plus, of course, all of the other producers.

I don’t believe for one minute that they are going to let up on the US. Why should they? The US has already taken Iran’s supply out of the equation and crushed Venezuela.  

And to make matters totally poetic, the price of oil went negative for the first time in American history – in the land that started the oil revolution – two days before the 50-year anniversary of Earth Day. After many years of environmentalists discussing Peak Oil (Supply), with technology change and the carbon crisis, perhaps the real issue is Peak Oil Demand had just been hit.

I have heard interviews of the heads of the major US shale oil producers who claim to have their production sold forward into the start of 2021. That means that the only way that this price manipulation can work is if the Saudis and the Russians can keep prices down through the end of the year. And, this is what I am monitoring  

The shale bust doesn’t really hit the swing election states for 2020 with the exception of Texas. I think the bigger effect is starting a credit default spiral in the private debt, high yield, and real estate markets.  

As I wrote in September, declining crude prices will have a deleterious impact on the electric car business – and it is an official strategic objective of the Russian government to suborn the transition to renewable energy. I believe that the decline of crude prices will have the greatest impact is in very poor countries because they don’t have the money to pay for the transition to renewables. 

Investment Opportunities?

Nothing that is at the moment obvious. The Big Short is over in crude oil. I believe that oil will remain stuck around where it is at for the rest of the year. But there are always unintended developments from such a bold move as this.  The one surprise was the trouble in the repo markets in the week following the attack on Saudi Arabia. I believe that the Saudis pulled their petrodollars out of the repo markets and brought the cash home, in case things heated up even more.

Historical Perspective

The entire energy price problem didn’t start because the middle east producers raised prices in the early seventies. They raised their oil prices then to compensate for the decline in the US dollar as a result of the excessive fiscal and monetary stimulus of LBJ and Nixon that ultimately forced a devaluation in the US dollar.

My Persistent Worry

And, this is exactly what gets me nervous now. The United States is running very hard on excessive monetary and fiscal stimulus too. I’m worried about the dollar as the reserve currency.