As we enter the holiday season we have several events of interest as to where they will take us in the oil business: The OPEC meeting Thursday this week, November 30, at which Russia, a non-member, will probably dominate and try to establish discipline among the members to maintain production cuts; Economic results for the US which will have a strong influence on Federal Reserve considerations pertaining to interest rates at their meeting on December 16; and Chinese intentions to start an oil trading contract priced in yuan backed by gold on the Shanghai Exchange late in the month.
We can expect some changes and that, of course, leads to a review of policies and thinking about what should be done.
After World War II, an administrative structure for international financial and political relationships was formed with the Bretton Woods agreement followed with the World Bank, the International Monetary Fund, the UN, NATO, and eventually GAAT, the WTO, and various other agreements governing international trade, finance, and other relationships. The United States established a strategy of Containment for dealing with the Soviet Union and coordinated financial, political, economic, foreign, and military policies with that strategy. In the 1970s, following the Vietnam War and the Arab Oil Embargo those policies came into considerable disarray and diminished strategic focus. Ronald Reagan terminated many of the short-term patchwork policies enacted during those years. When asked what his strategy was for dealing with the Soviet Union he famously responded “We win, they lose”. With that modified and re-stated strategy he established and again coordinated various social, economic, financial, foreign, commercial, military, scientific, and political policies – the various tools of the government and many of private enterprise – to achieve that objective, successfully.
It seems we had no replacement strategy after the end of the Soviet Union, however, or policies for helping the newly formed states emerging from the Soviet Union; we ignored them to find their way on their own and gloated over their humiliation. We also ignored the emerging economic power of China and its potential repercussions. All these new countries were naively expected to join a worldwide brotherhood of nations and benignly accept the post-WWII arrangements established and dominated by the US.
Unsurprisingly, that did not happen; the world is in a state of turmoil, change, and conflict. International relationships and institutions in which the US has participated for decades are in a state of transition; some of them will end, some will be altered, and some new ones will form. Power is moving from some areas of the world to others, re-aligning relationships, and altering economies. Because of the size, critical nature, and pervasive worldwide presence of the oil business and its customers, this turmoil brings volatility and uncertainty to oil markets and prices with all their impact on economies.
A general perception is that the US is losing its leadership position. As Charles Krauthammer commented, however, “Decline is a Choice”. The US still leads in technological development, military capability, and economic flexibility. The US can maintain its position but it must resolve to do so with determination, accept the realities of a changed world, build on its strengths, formulate new strategies, and adapt policies to those strategies.
International power and political relationships are in a period of change, much of the world is unstable, new non-violent forms of conflict are available (electronic, cyber, social media), and adversaries are using them. They are testing the US and each other. Terrorism is now ubiquitous. Wars are interminable. The United States can expect to be in a prolonged period of continuous conflict of various types which will vary from nuisance interventions and hacking to belligerent competition to active armed engagement.
Since the fall of the Soviet Union the US seems to have followed various individual financial, commercial, foreign, military, etc., policies with no overall unifying strategy. Each of those policies is based on, and may be justified by, a narrow range of considerations; but they are not coordinated in accordance with an overall spectrum of objectives and may have widespread unexpected impact. Policies are made seemingly with no understanding of the interconnectedness between various government policies with each other and with American business interests.
Government policy makers do not seem to realize American business activities are a major portion of American international presence and activity. American companies normally hire local employees, contract for local services and suppliers, and interact with local companies and businesses on a daily basis. Their management and employees typically are much more in touch with local culture, people, and the daily economy than government employees and in many countries are the only contacts locals have with Americans. Oil companies, because of the nature of their business, generally have offices in cities and towns but also operate in rural areas and deal with a cross-section of the local society on many levels. Americans living in and doing business in a country can provide valuable insights for formulating policy and also advise regarding policy consequences on the local economy, American companies, and our own economy. To ignore such insights is shortsighted.
Recent US policy making with narrowly limited objectives and inputs has led to instability and prolonged conflict in many areas, volatile oil markets and prices, and a world full of unforeseen, unintentional, and detrimental consequences – in short, a mess.
By Janet Yellen’s own testimony, when the Federal Reserve decided to stop Quantitative Easing in 2014 it did not consider the ramifications of the resulting 60% decrease of oil prices and the effects on alliances, economies, societies, or financial relationships of oil producing countries. Obviously, she did not understand the international oil business; things have not changed much since the confused policy making of the 1970s.
Saudi Arabia is still trying to find its way out of the aftermath of the oil price drop. In doing so, the King has changed the order of kingly succession, changed the direction of the economy, visited Moscow and made deals with the Russians. After hosting his Financial Investment Initiative Summit last month and portraying a rosy investment and social future for the Kingdom, the Crown Prince is putting many of his relations and business people under house arrest and confiscating their assets. Not all this, I am sure, was considered by the Fed when they stopped Quantitative Easing.
Over 300 US oil and gas companies have declared bankruptcy following the oil price decrease. Did Janet think about that when she decided to end QE?
Russia is a third-rate economy with severe demographic problems. That economy has large oil and gas components, however, and because Russian oil and gas supplies are critical to Europe and China Vladimir Putin has considerable leverage and he knows how to use it. The oil price drop cut Russian oil revenues by about 60%. It seems it would have been advisable to have thought beforehand about what Mr. Putin might do in response and plan our own responses and countermeasures to his actions. Russia was already subject to various sanctions because it annexed Crimea and encroached into Ukraine. Mr. Putin is obviously a coldly analytical and rational leader, not inclined to passivity, and punches far above his weight in geopolitical affairs. We should have expected him to take action carefully, methodically, and effectively.
Mr. Putin has responded by attempting to reduce his vulnerability to oil price changes; he is slowly and persistently extending his influence over non-Russian oil and gas sources, transportation and delivery systems, and the countries where they are located worldwide. He has pretty much surrounded Europe and moved into Venezuela, Nicaragua, and, of course, Cuba in our neighborhood. He also has maneuvered himself into the dominant position for extending OPEC production quotas later this week at OPEC’s November 30 meeting – and Russia is not even an OPEC member.
In this environment, the US needs new ideas, new procedures, and clear objectives and we need major changes in the way we form and conduct policies. To succeed in a tumultuous world, all tools of national influence, power, and engagement must be organized and used. The US must coordinate the various policies of government with each other and with private enterprise business interests. New policies must be formulated consistent with an overall strategy and executed by a nimble administrative system which can react quickly to a rapidly changing world.
Geopolitical policy formulation will require some fundamental considerations such as clarifying our objectives in Afghanistan, Syria, Iraq, Libya, and the Middle East in general. If our actions are based on considerations of oil supply the next question is “If the United States can access sufficient oil in the Western Hemisphere, why are we continuing to direct so much of our effort, cost, time, and lives so unsuccessfully to the Middle East?” Our recent actions in the Middle East seem only to contribute to instability.
The worldwide oil supply and market system is in near balance and has been for several years. Oil prices are determined on open exchanges by traders depending on data with margins of error greater than the margins of surplus or shortage of supply. Russia is establishing dominance over many of the supply and transport systems. China is establishing a new trading contract priced in yuan. The marginal pricing system leads to wide price swings amplified by rumors of expected actions by foreign unstable governments in conflict with one another and us. This price volatility whipsaws the US economy and the US oil industry. The United States needs to establish a new supply and market system with a limited number of reliable sources, long-term supply relationships, and more stable prices.
The oil business, as the largest component of international trade and as a critical component of geopolitical considerations, needs clarity as to the direction of US government foreign policy and its political, financial, fiscal, economic, and military ramifications which define the foreign business environment to operate forcefully and confidently internationally where most oil is produced.
American oil companies, along with Canadian, British, and Australian oil companies, are private enterprise organizations; they are organized, financed, managed, and operate as such. Because of government and societal sensitivities in most countries regarding foreign development of natural resources most of the rest of the world’s oil companies are either owned by, controlled by, or indirect agents of, their governments. Although those companies may maintain a façade of independent commercial operation, they have the authority of their governments controlling and supporting them. In many cases this dual role leads to conflicts of purpose for their management; business relations and normal competition thus can become adversarial.
A private enterprise company without backup support from their own government in an adversarial negotiation with one of these companies or governments will lose. American companies do not have backup support. The US State Department seems to make a point of not supporting US business interests under a general antipathy to private business and a stated policy of not becoming involved in commercial transactions. Because transactions between a US company and a foreign government and company are not between two purely commercial entities, that policy needs to change.
The US will need to deal with a limited number of friendly governments and their oil companies on a reciprocally beneficial basis to establish a reliable sustained oil supply and stable pricing system. Cordial relations and discussion on government and company levels will be required. Establishing an effective system will require participation by both private enterprise companies and the government and close coordination between them.
In short, the US needs to clarify its foreign policy objectives, the role of the oil industry and oil markets with regard to those objectives, coordinate government action and private enterprise business activities around a unifying strategy, and support American companies in their dealings with foreign governments, their agents, and their companies.