The Strategic Shifts Caused by Nord Stream 2 and What the United States Can Do Moving Forward

Photo by Chris LeBoutillier from Pexels

By Shawn Rostker
Staff Writer

The Russian Federation has a history of using energy policy as a coercive tool of foreign policy. This practice dates back to the late 1980’s before the collapse of the Soviet Union. It continued through the early years of the newly formed Russian state as it sought to rebuild from economic ruin. Moscow, in its contemporary form, continues to exercise this practice as it seeks to capitalize on its natural abundance of oil and natural gas reserves. Currently, Russia boasts the world’s largest proven reserves of natural gas with roughly 48 trillion cubic meters. According to the Central Intelligence Agency’s most recent figures it is also the world’s number one annual exporter of natural gas at over 210 billion cubic meters. While the playbook may not be new, the Russian state is not the same player that the Soviet Union was. The Soviet Union struggled to implement these tactics effectively due to an incompetent central planning system, disjointed leadership structures, and their failure to adequately maintain technological progress due to a lack of incentive schemes. Over the course of the last twenty years, however, Russia has consolidated its energy industries under state purview, established a vertically-oriented ladder of leadership, provided incentive and opportunity for innovation, and strengthened its economic might through integration into global markets. These characteristics enable Russia to behave more subversively within bilateral partnerships. 

Continue reading “The Strategic Shifts Caused by Nord Stream 2 and What the United States Can Do Moving Forward”

VENEZUELANS DESERVE THE WORLD BUT GET MADURO

By Kristopher Klein
Staff Writer

The collapse of OPEC may have been averted, but look out for political turmoil across its struggling member states.

Venezuelan President Nicolas Maduro recently toured OPEC member states as well as Russia to urge a cut in output. His tenacity has waned, however, as Saudi Arabia remains staunchly in favor of maintaining production. With the cut in production off the table, Maduro has shifted focus to political repression and shying away from economic reforms.

A few weeks have gone by since I published an article on how the sudden decline in oil prices was making oil export-dependent governments nervous about their annual budgets. When governments of oil-dependent nations write their budgets for the year, they typically base these off of a predicted price for their oil exports. The decline in prices has shredded the budget of Venezuela specifically, which assumed a $60 per barrel price for the year.

It was expected that the national governments of OPEC member states might react to budgetary woes by demanding that OPEC cut output or threaten to leave the cartel. However, that was not to be and the politicians of Venezuela would now rather resort to temporary fixes and political distractions than real economic reform.

Political Turmoil

Last week I watched with both dismay and amazement at the sheer audacity of Venezuelan President Nicolas Maduro as he had a chief opposition politician, the mayor of Venezuela’s capital city Caracas, hauled away to prison under allegations of supporting an American plot to take over the government.

Venezuela’s socialist elite has accepted that they will most likely fail to convince OPEC to act in order to change the price of oil, and has instead opted to short-change the people of Venezuela. The regime’s strategy is to make do with what OPEC hands them and maintain power by limiting the political alternatives of Venezuelans in an attempt to distract them from the reality of Venezuela’s damaged economy.

The tactic of drumming up foreign policy woes to take attention away from a flailing domestic economy is alive and well in politics. Maduro suppresses social unrest by portraying himself as a fearless protector of the Bolivarian legacy against the evil North American machine, like his predecessor Hugo Chavez. By accusing an opposition politician of plotting to help Americans overthrow the regime, Maduro gets rid of a prominent political opponent and keeps the Venezuelan people checking over their shoulders for the gringo conspiracy.

Prospect of Needed Economic Reforms Fading

The real problem this political turmoil presents is the death of any possibility of real economic reform. The introduction of economic reforms requires the government to feel secure enough in its political and financial position to implement reforms. Also, some social willingness to sacrifice for the reforms in the short term is necessary. Furthermore, reforms take time so a country needs an opposition willing to sit on its hands for at least a short while rather than charging incompetency if reforms do not immediately produce noticeably positive results. Venezuela seems to meet none of these requirements.

Late last year Maduro removed Rafael Ramirez from office, president of Venezuela’s state-owned petroleum company PDVSA and vice president for the economy. Before his removal Ramirez advocated for unifying Venezuela’s multiple exchange rates into one.

In Venezuela, importers of essentials like food and medicine can buy U.S. dollars from the government at a rate of 6.3 bolivares fuertes (Bf.) per dollar. Importers of other goods can buy dollars at a rate of 11 Bf. per dollar. Private exchanges used to sell dollars for around 50 Bf. per dollar, but have now been replaced by a free-floating exchange rate that trades at around 175 Bf. per dollar. There is also a substantial black market for dollars that sells at around 79 Bf. per dollar.

Ramirez wanted to unify these multiple exchange rates into one exchange rate that would be free-floating and make some goods more expensive for Venezuelans to buy in the short term. This of course would have cost Maduro some political support with the Venezuelan people, so naturally Ramirez had to be removed from his politically powerful positions involving oil and the economy.

Maduro’s government seems to be quite anxious about its current situation, something that does not bode well for the prospect of endorsing bold economic reforms. Venezuela’s Parliamentary elections in December 2015 make the likelihood of the government producing reforms even less likely. In the meantime they will try to implement some moderate reforms like introducing one free-floating currency but leaving the others as is. As Venezuela runs out of foreign currency reserve, they will also have to seek money to keep the entire system running until after elections.

Cap-in-Hand to the Richest Strongman of Them All

Nicolas Maduro recently made a trip to Beijing to secure investment from who has become the world’s most magnanimous dictator, Xi Jinping. The investments made by China, in effect, prevent reform from occurring in Venezuela.

The Maduro government stands in the way of reforms that many economists see as necessary for Venezuela to unlock sustained economic growth. Perhaps it would be the universe’s way of demanding reforms if the Venezuelan government were to run out of cash. They would be forced to accept conditions of economic reform placed on loans from the IMF or World Bank or risk being replaced at the polls by a government willing to reform.

However this near-inevitability has been avoided by China’s political involvements in the region. In January, China agreed to invest $20 billion in Venezuela to help counteract the effects of the collapse in oil prices. The $20 billion in investment is a lifeline for the Maduro regime and possibly all it needed to avoid having to make politically painful reforms. By providing the Venezuelan government with investments without first stipulating conditions of reform, China has essentially nixed an opportunity to push the Venezuelan government toward economic reform. This is not, however, the first time China has prevented reform in Venezuela.

Since 2007, China has extended credit to the Venezuelan regime to the tune of $50 billion. The tactic of offering loans and investment to a Latin American regime struggling with Western countries over loan conditions seems to work for China politically. Loans and investments will help China cement its relationship with a nation strategically placed in the Western hemisphere. However, in the end, China’s strategy loses money that it could have made if those investments were enhanced by a better market climate, one that would also bring the Venezuelan people faster economic growth.

It is unlikely that the current regime will seriously tackle economic reform or begin to improve the tense political situation in the country. More moderate politics could help underpin global confidence in Venezuela’s legal system, a must for sustained economic growth in a country with a relatively small economic market. For now all the rest of the world, and the people of Venezuela, can do is to hope for a change of heart from the Maduro regime after this year’s parliamentary elections in December.

Image by Alex Lanz

OIL PRICE WAR STIRS FEUD WITHIN OPEC

By Kristopher Klein
Staff Writer

What happens to a cartel when there is substantial competition from outside? The answer depends on patience.

The Organization of Petroleum Exporting Countries (OPEC) has been the most influential component of setting oil prices since their founding in 1960. As an organization OPEC has helped raise the price of oil above $100 per barrel for the past near-decade. Large importers of oil, such as the United States, have put up with rising prices, unable to stop OPEC from colluding in their own interest. However with the recent rise in competition from North American shale oil producers, that era has come to a swift and decisive end.

Any college-level economics course will review the concept of collusion among cartel members and the decision each cartel member makes about whether to remain in the cartel or to go out on their own.

The difference between these strategies is a matter of weighing short-term profit versus long-term profit. If the cartel remains intact, producers will be able to collude to raise prices to artificially high levels and thereby make more profits. However, if a producer leaves the cartel they can lower their price and temporarily receive a larger share of the market (i.e. more customers) and thereby make a lot of profit in the immediate future.

But the betrayal of the second strategy has consequences. If the integrity of the cartel is undermined, greater competition between all members will force producers to charge a fairer price and lose the profits they could have made through continuing to collude to raise prices.

Thus, it is a matter of patience and how soon a cartel member needs to receive their profits that determines strategy. A member who is very eager to receive short-term profits is a greater risk of leaving than a member who can afford to wait for higher profits in the long-term.

Competition from outside this cartel lowers prices and raises the risk of a cartel member, in a pinch from lower profits, making a quick dash for more revenue (either per unit or overall) by either cutting production in order to raise the price or increasing production to gain market share.

The United States has been increasing its production of shale oil since a jump in production in late 2014. Greater supply of oil, combined with slower growth in the economies of Europe and East Asia, has created a global supply glut and falling prices.

In late December the United States decided to lift its ban on the export of oil. But the United States imports more oil than it exports, so what effect could that really have? As it turns out, the United States is one of the only countries capable of refining the crudest oil into a product for the global market, so a lot. John Auers, executive vice president at Dallas-based Turner Mason & Co was quoted as saying that, “U.S. refineries built out their capacity to run heavy barrels. Refineries in the rest of world aren’t built to run heavy barrels.” That means lifting the ban on exporting oil has allowed the United States to begin refining very crude oil from around the world before then exporting refined gasoline back around the world at a price that can compete with the OPEC cartel.

The result of competition from the United States has led to a collapse in the price of oil from above the $100 per barrel level that OPEC loves so much, to around $45 per barrel today. Some OPEC members are seriously hurting. If the pain does not end soon, political turmoil could arise from within OPEC.

OPEC member Venezuela calculated its 2015 budget on the idea that oil prices would remain at about $60 per barrel and that any excess revenue would be used to help run social programs. With the price of oil now just above $45 per barrel, Venezuela looks to run a deficit this year, which will force them to limit funding to social programs.

On January 10, Venezuelan President Nicolas Maduro and Iranian President Hassan Rouhani vowed to cooperate to stabilize falling oil prices. Five days later, Maduro and Russian President Vladimir Putin, whose country is not a member of OPEC, held a “detailed discussion” about the global oil market, without releasing any details.

Saudi Arabia has repeatedly rejected calls from OPEC members for the cartel to cut production in order to defend the price of oil. Saudi Arabia has saved much of the revenue it earned from higher oil prices and now has a reserve large enough to wait a while before cutting production, a move they hope will lead to a cut in production from North American shale oil producers.

However, not every member of OPEC has the reserves that Saudi Arabia and its neighbors on the Arabian Peninsula have built up over time. Without a rise in the price of oil very soon those countries, such as Venezuela and Algeria, will come under significant pressure to find a means of changing their fortunes.

Could this fall in the price of oil and Saudi Arabia’s refusal to cut production endanger the cohesiveness of OPEC as a price-influencing entity, or perhaps even mean a collapse of the cartel altogether? It very well may. In fact, OPEC seems already to be losing its control of prices that at one time were to the penny. According to Kuwaiti Oil Minister Ali Saleh al-Omair, “OPEC would have to accept any market price for oil, whether it were $100, $80 or $60 per barrel.”

North American competition has, at least for a time, defanged OPEC and clipped the wings of global oil prices. If the American market can sustain production and OPEC is forced to proceed as a price-taker rather than price-maker, OPEC members will begin to wonder why they participate in the cartel at all.

Image by Iguanasan