OIL Wars

[Mega]

World on the brink of oil war as Opec bickers over price

Oil prices ended last week in freefall as the world’s largest group of producers from petro-states in the Middle East dithered over whether to cut output

Oil tankers dropped anchor off the coast of Fujairah in the Gulf of Oman Photo: Alamy









By Andrew Critchlow, Commodities Editor

10:50AM BST 04 Oct 2014

241 Comments


A secretive group of the world’s most powerful oil ministers will soon gather in Vienna to take arguably one of the most important decisions that could affect the still fragile world economy: whether to cut production of crude to defend prices at $100 per barrel, or keep open the spigots as winter looms among the biggest energy-consuming nations?


A sudden slump in the price of crude has exposed deep divisions within the Organisation of Petroleum Exporting Countries (Opec) ahead of its final scheduled meeting of the year next month to decide on how much oil to pump.


Some members, led by Iran, have called for immediate action to stem the drop in oil prices, while the Arab sheikhdoms of the Gulf have so far argued that it could be another three months before it becomes clear whether the group should cut production for the first time since December 2008.


Whatever they decide, oil remains the lifeblood of the global economic system due to its direct impact on inflation and input prices. Brent crude – a global benchmark of oil drawn from 15 fields in the North Sea, dipped last week to multi-year lows below $92 per barrel as a perfect storm of a strong US dollar, oversupply in the system and declining demand shattered confidence in the market. Brent has tumbled 20pc in the last three months after touching $115 per barrel in June.



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In the US – the world’s biggest consumer – crude for November delivery at one point last week dropped below the psychologically important $90 pricing level, raising fears that a prolonged slump could put many of America’s shale drillers out of business. Shale oil, which can cost up to $80 per barrel to produce, has spurred an energy revolution in the US, which has started to threaten the dominance of producers in the Middle East.

However, at current price levels many of these new so called “tight oil” wells are approaching the point when they will soon become unprofitable.

Like the situation in the US, falling oil prices are also a double-edged sword for Britain’s economy and investors. Although George Osborne, the Chancellor, is less reliant on tax revenues from the North Sea than some of his predecessors, prices are approaching the point when many of the developments planned offshore west of Shetland by international oil companies could be placed on ice.
A sharp drop-off in domestic oil production and associated tax receipts from the North Sea would give Mr Osborne an unwelcome hole to fill in the government’s public finances heading into next year’s general election. However, falling oil prices will help to keep inflation low.

For Britain’s motorists the current declines have been good news that has trickled through to the price of petrol on forecourts. A litre of unleaded petrol in the UK has fallen a few pence over the past month to an average of around 127.21p on average, a figure last seen in 2011, just before Mr Osborne raised the value added tax on fuel to 20pc, from 17.5pc.

All eyes are now firmly focused on the next move by Opec, which controls 60pc of the world’s oil reserves and about a third of daily physical supply. The group has been branded an unaccountable “cartel” by free-market critics in North America who claim its system of limiting production by setting an output ceiling and quotas is tantamount to price rigging.

Although this is an accusation that the group’s secretariat which is based in Vienna strongly denies, its mostly unelected group of policymaking oil ministers undeniably pull the strings of the global energy industry in the same way that central bankers can control currencies.

Opec states have largely managed to maintain cohesion over the last decade as prices over $100 per barrel have enriched their economies and encouraged adherence to quotas. This consensus is now starting to break down, creating more uncertainty in the market and a potentially destabilising situation for the global economy.

Next month’s meeting promises to be the most tense held since the onset of the Arab Spring in 2010, with the Shi’ite Muslim faction of Iran and Iraq already appearing to line up against Saudi Arabia and the United Arab Emirates (UAE).

Iran’s Oil Minister Bijan Zanganeh has placed his cards on the table early by calling for Opec to urgently cut output to stem the sharp recent decline in prices, which threatens the Islamic Republic’s fragile economy after years of restrictive sanctions.


According to research from Deutsche Bank, Iran has the highest fiscal break-even price for its budget at over $130 per barrel of Brent, compared with the UAE at around $70 per barrel and Saudi Arabia at about $90.

However, the Gulf’s Arab states are all sitting on huge cash piles that are held overseas through sovereign wealth funds and foreign currency assets that can be drawn upon to help them weather any short-term drop in oil export revenues.

Iran, possibly supported by Iraq, will push hard for a change in Opec’s production targets at the meeting and a cut to its overall output by 500,000 barrels per day (bpd) from the 30m bpd limit that it currently sets for members. The latest figures suggest that level has already been breached with Opec members perhaps pumping as much as 1m bpd above the group’s agreed quota.

“Considering the downward trend in prices, Opec members should try to temper production to avoid further price instability,” Mr Zanganeh was quoted saying by Iranian state media at the end of last month, even before crude fell to its current lows.

Mr Zanganeh is at odds with his most powerful rival in Opec, Saudi Arabia’s influential oil minister, Ali Naimi, who has so far dismissed calls for an emergency meeting to be held ahead of November. Nevertheless, the kingdom has taken the precaution of trimming its own output and reducing the price of crude it offers to customers in Asia in an apparent move to defend its market share.

According to Opec figures, Saudi Arabia cut its output over the summer by more than 400,000 bpd to 9.6m bpd. Although the kingdom’s dominant role in global oil markets is increasingly being challenged by the rise of US shale, Saudi retains its place as the swing producer due to the almost 3m bpd of physical capacity it currently holds in reserve.

Demand for crude normally spikes during the northern hemisphere’s winter season and some Opec officials have argued that the group should wait to see if there is a repeat of the “polar vortex” conditions that shut down the eastern seaboard of the US and led to a brief contraction in the country’s economy in the first quarter.

“Winter is coming,” a senior Opec delegate from the Arab side of the Gulf recently pointed out to The Sunday Telegraph when asked about the meeting. “This softness in the market is not long enough to be called a correction so let’s wait until we’re sure it is a correction before taking any action.”

“Within Opec we are not concerned about the price; what concerns us is that the market is well supplied,” he said.

Saudi enjoys some of the lowest production costs, excluding capital expenditure on new projects, in the region of $2 per barrel, giving it a large margin to soak up a sudden drop-off in price. This compares with estimated production costs in the North Sea which are in the region of $50 per barrel, according to Oil & Gas UK figures. This leaves drillers offshore in Britain more susceptible to price fluctuations.

To further complicate the forthcoming meeting, Arab Gulf states remain deeply suspicious of Iran as the leadership in Tehran edges towards a settlement with Western powers over its nuclear programme. An end to Tehran’s economic isolation could trigger the opening up of its oil industry to foreign investment, a move that would bring more crude onto an already flooded market.
Iran is currently producing around 3m bpd of crude but it is thought with access to Western technology this figure could be easily doubled.

Combined with Iraq, which aims to eventually increase production capacity to as much as 9m bpd by the end of the decade, both countries could challenge the current dominant position of Saudi Arabia and the Arab Gulf states within Opec.

The looming issue of global over-capacity has been further complicated by the sudden return to the market of light, sweet Libyan crude. Exports from Es Sider have returned to levels of around 800,000 bpd over the last month, adding to the pressure on Brent. In the background is the surge in US shale oil production and the mounting pressure on President Barack Obama to lift the US crude export ban that has been in place since the 1970s to guarantee America’s energy security.

Fracking has helped the US achieve its highest oil production levels since 1986 over the last two months at a rate of 8.5m bpd. The threat of a full lifting of the ban on exports has also helped the US to drive down the price and potentially cripple the Russian economy. Moscow is largely dependent on crude sales for foreign currency earnings and oil trading at around $80 per barrel for a period of months could bring the country to its knees.

Indeed, losing market share to shale drillers in the US and the potential growth of unconventional oil and gas in other regions is a risk that traditional Opec producers are increasingly having to confront. Recent data from the US Department of Energy has revealed that Nigeria, also a member of Opec, has dropped out of the list of countries supplying America with oil.

According to Deutsche Bank analysis “tight oil” in North America would be unlikely to attract investment at a cost of $90 per barrel, close to its current levels. Certain members of Opec are also keen to see countries like the US take more responsibility for maintaining price stability instead of solely focusing on increasing production.

The German investment bank estimates that if Opec fails to cut production in response to the current trend in falling oil prices then around 9pc of US “tight oil” output would be immediately rendered uneconomic at a level of $90 per barrel. This figure would rise to 39pc should prices slump as low as $80 per barrel.

However, some officials within the group already believe that the US should itself shoulder some of the burden.

“The culture of blaming Opec needs to change,” said the Opec delegate. “The responsibility for the market has to be shared.”

On the demand side, a number of leading energy think tanks have recently revised their estimates for demand based on the unexpected slowdown of the Chinese economy in the second half of the year. These worries escalated in August with the latest data showing a slowdown in industrial production in the world’s second-largest economy.

China has picked up much of the slack as the US has moved over the last five years to reduce its dependence on Middle East oil and a longer term slowdown could trigger Opec nations to slash output aggressively to defend prices.

Beijing is now viewed by many Gulf oil producers as a more important energy trading partner than the US, which has been the traditional focus since the end of the Second World War.

The International Energy Agency – the world’s top oil watchdog – revised down in September its forecast for demand for both 2014 and 2015 in response to China’s sudden slowing. The Paris-based group cut 900,000 bpd from demand growth this year and 1.2m bpd from its forecast in 2015, when it expects the total global draw on oil to be in the region of 93.8m bpd.

To complicate the decision that Opec oil ministers face in November, the region is now confronted by the sinister rise of the Islamic State jihadists in northern Iraq and a bitter row between some of its Arab Gulf members over the support of extremists. In Iraq and Syria, the group known as Isil, is itself thought to be profiting from the sale of oil to the tune of $2m a day.

Given that Gulf states have pulled in the major powers led by the US and the UK into taking military action against Isil they may feel obliged to keep pumping at current rates, at least while Western forces carry out strikes and destroy the biggest single threat to their own borders.


“Nothing has changed on the international stage since our last meeting,” said the Opec delegate, adding. “Arguably, it has just got worse.”

[don]

Re: OIL Wars

Imagine that at the start of 2014 you were an investor who liked to dabble in the commodity markets. You could sniff something going seriously wrong in Ukraineand you were alarmed by early reports of groups of militants marauding across northern and western Iraq.

With hopes that the global economy would continue to strengthen, the smart money would have been on oil prices continuing to climb. That’s what geopolitical tension plus robust demand usually means.

On this occasion, though, the smart money was wrong. After standing at well over $110 a barrel in the summer, the cost of crude has collapsed. Prices are down by a quarter in the past three months. More oil has been pumped at a time when the global recovery has faltered, with traders caught unawares by the slowdown in China and renewed stagnation in the eurozone.

That, though, is not the whole story. The fourfold increase in oil prices triggered by the embargo on exports organised by Saudi Arabia in response to the Yom Kippur war in 1973 showed how crude could be used as a diplomatic and economic weapon. History is repeating itself.

Think about how the Obama administration sees the state of the world. It wants Tehran to come to heel over its nuclear programme. It wants Vladimir Putin to back off in eastern Ukraine. But after recent experiences in Iraq and Afghanistan, the White House has no desire to put American boots on the ground. Instead, with the help of its Saudi ally, Washington is trying to drive down the oil price by flooding an already weak market with crude. As the Russians and the Iranians are heavily dependent on oil exports, the assumption is that they will become easier to deal with.

John Kerry, the US secretary of state, allegedly struck a deal with King Abdullah in September under which the Saudis would sell crude at below the prevailing market price. That would help explain why the price has been falling at a time when, given the turmoil in Iraq and Syria caused by Islamic State, it would normally have been rising.

The Saudis did something similar in the mid-1980s. Then, the geopolitical motivation for a move that sent the oil price to below $10 a barrel was to destabilise Saddam Hussein’s regime. This time, according to Middle East specialists, the Saudis want to put pressure on Iran and to force Moscow to weaken its support for the Assad regime in Syria.

Turning on the oil spigots comes at a cost. The Saudis, like all other producers, have become accustomed to oil above $100 a barrel. The Arab spring in Libya and Egypt raised fears that the political unrest would spread. Oil revenues financed higher public spending, so Saudi Arabia needs the price to be above $90 a barrel to balance the books.

But a bit of pain is acceptable. The Saudis are gambling that they can live with a lower oil price for longer than the Russians and the Iranians can, and that therefore the operation will be relatively short-lived.

There is no question that this new manifestation of cold war muscle is hurting Russia. Oil and gas account for 70% of Russia’s exports and the budget doesn’t add up unless the oil price is above $100 a barrel. Moscow has foreign exchange reserves, but these are not unlimited. The rouble fell by 10% last week. That adds to the debt servicing costs of Russian firms, and the central bank is under pressure to push up interest rates, which should help stabilise the currency, but only at the expense of a deeper recession.

But thus far, Russia’s foreign policy does not appear to have been affected. Support for President Bashar al-Assad of Syria remains strong and there were reports at the end of last week of Russian troops entering eastern Ukraine. It remains to be seen how Iran will react. In the meantime, the Middle East looks as unstable as it has ever done.

Provided it is sustained, a falling oil price will boost global growth. Andrew Kenningham at Capital Economics estimates that if the cost of Brent crude settles at $85 a barrel, the upshot will be a transfer of income from producers of oil to consumers of oil amounting to 0.9% of global GDP. As consumers tend to spend a higher proportion of their income than producers, demand will increase. The big winners will be the big oil consumers: China, India and Europe.

Simultaneously, inflation will fall. The drop in the oil price so far is enough to ensure that headline inflation is around half a percentage point lower in advanced countries next year. That would be enough to take inflation below 1% in the UK and below zero in the eurozone. Lower inflation should help to boost consumer and business spending because budgets will stretch further. For the US, the picture is more mixed. Washington’s willingness to play the oil card stems from the belief that domestic supplies of energy from fracking make it possible for the US to become the world’s biggest oil producer. In a speech last year, Tom Donilon, then Barack Obama’s national security adviser, said the US was now less vulnerable to global oil shocks. The cushion provided by shale oil and gas “affords us a stronger hand in pursuing and implementing our national security goals”.

Recent US production of crude has certainly been impressive, with a jump of almost 50% from 5.7m barrels a day in 2011 to 8.4m barrels a day in the second quarter of 2014. This increase in supply has meant that any reduction in supplies from Iran or Russia due to sanctions can be absorbed without disrupting the global economy.

But the sharp drop in the oil price will make some shale fields unviable. That is especially true of planned new developments, where a high price is needed to cover start-up costs. But it is also true of some of the more mature fields, where the rapid depletion of reserves has forced companies to go deeper – at greater expense – in search of supplies.

At the weekend, George Osborne announced that he supported the idea of putting revenues from shale production in the north of England into a sovereign wealth fund for the north. The idea would be to prevent the proceeds being squandered on day-to-day spending, which – sadly – is what happened to the revenues from the North Sea.

One side-effect of the US-Saudi attempt to drive down the oil price will be to prick the shale bubble.

[don]

OIL Wars - Wither China

The Sino-American comedy of errors
By Spengler

BEIJING - Everything in tragedy happens for a reason, and the result always is sad; most things in comedy happen by accident and the outcome typically is happy. Sino-American relations are not destined for conflict, although that is possible. The misunderstandings that bedevil relations between the world's two most powerful countries remain comedic rather than tragic. That probably is as good as it gets, for no amount of explanation will enable Chinese and Americans to make sense of each other.

Where the Chinese are defensive and cautious, the Americans tend to perceive them as aggressive; where the Chinese are expansive ambitious, the Americans ignore them altogether. The United States is a Pacific power accustomed to maritime dominance. To the extent that Americans focus on China's foreign policy, it is to express alarm at China's territorial claims on small uninhabited islands also claimed by Japan, Vietnam and the Philippines. Apart from some overheated and self-serving rhetoric from a few Chinese military leaders, though, the contested islands are of negligible importance in China's scale of priorities.

The issue may be moot by this writing: last week, China and Japan released a "Principled Agreement on Handling and Improving Bilateral Relations", following meetings between Japan's national security adviser, Shotaro Yachi, and Chinese State Councilor Yang Jiechi. The document promises to "establish crisis management mechanisms to avoid contingencies" and to employ "dialogue and consultation".

Neither Japan nor China had any interest in a military confrontation in the Pacific, although both sides employed the island disputes to play to their own nationalist constituencies. The Principled Agreement sends a signal that the Kabuki show had gone far enough.

A common American meme in response to supposed Chinese expansionism in the Pacific projected an Indian-Japanese military alliance to contain Chinese ambitions under US sponsorship. Although a few Indian nationalists enthused over the idea, it was an empty gesture from the outside. If India got into a scrap with China over disputed borders, for example, just what would Japan do to help?

The newly-elected Indian government under Narendra Modi never took the idea seriously. On the contrary, after President Xi Jinping's recent state visit to India, Modi envisions Chinese investment in urgently needed infrastructure. Economics trumps petty concerns over borders in the mountainous wasteland that separates the world's two most populous nations.

There also is a strategic dimension to the growing sense of agreement between China and India. From India's vantage point, China's support for Pakistan's army is a concern, but it cuts both ways. Pakistan remains at perpetual risk of tipping over towards militant Islam, and the main guarantor of its stability is the army. China wants to strengthen the army as a bulwark against the Islamic radicals, who threaten China's Xinjiang province as much as they do India, and that probably serves India's interests as well as any Chinese policy might.

Chinese analysts are dumbfounded about the US response to what they view as a sideshow in the South China Sea and only tangentially concerned about India. They struggle to understand why a vastly improved relationship with Russia has emerged in response to US blundering in Ukraine.

As a matter of diplomatic principle, China does not like separatists because it has its own separatists to contend with, starting with the Muslim Uyghurs in Xinjiang province. Washington thought that the Maidan Revolution in Kiev last year would take Crimea out of Russian control, and Russia responded by annexing the peninsula containing its main warm-water naval base.

When the West imposed sanctions on Russia in retaliation, Moscow moved eastwards - an obvious response, and one that strongly impacts Western power. Not only has Russia opened its gas reserve to China, but it has agreed to supply China with its most sophisticated military technology, including the formidable S-400 air defense system. Russia was reluctant to do so in the past given Chinese efforts to reverse-engineer Russian systems, but the Ukraine crisis changed that.

Western analysts, to be sure, now observe that the new Russian-Chinese rapprochement might be a challenge for the West. The New York Times devoted a front-page feature to the opinions of the usual suspects among Soviet watchers in its November 9 edition.

This was obvious months ago, and should have been obvious before the fact: the West merely threw B'rer Putin into the briar patch to his east. Of all the miscalculations in Western policy since World War II, this was perhaps the stupidest. The Chinese are left to scratch their heads about their unanticipated good luck.

It is wrong to speak of a Russian-Chinese alliance, to be sure, but there is a developing Sino-Russian condominium in Asia. The energy and defense deals between Moscow and Beijing are important in their own right, but they take on all the more importance in the context of what might be the most ambitious economic project in history: the New Silk Road. The Pacific holds little promise for China. Japan and South Korea are mature economies, customers as well as competitors of China.

Expansion in the Pacific simply has nothing to offer China's economy. What China wants is to be impregnable within its own borders: it will spend generously to develop surface-to-ship missiles that can take out US aircraft carriers, hunter-killer submarines, and air defense systems.

China's prospects are to the west and south: energy and minerals in Central Asia, food in Southeast Asia, warm-water ports on the Indian Ocean, a vast market, and access to world markets beyond. The network of rail, pipelines and telecommunications that China is building through the former Soviet republics and through Russia itself will terminate at the Mediterranean and provide a springboard for Chinese trade with Europe.

The whole Eurasian landmass is likely to become a Chinese economic zone, especially now that Russia is more amenable to Chinese terms. That the Americans would have helped bring this to fruition by tilting at windmills in Ukraine baffles the Chinese, but they are enjoying the result.

The economic impact of this is hard to fathom, but it is likely to extend Chinese influence westwards on a scale that the West simply hasn't begun to imagine. It is not at all clear whether China has a clear idea of what the implications of the New Silk Road might be. The implosion of America's geopolitical position has placed risks and opportunities at Beijing's doorstep, to Beijing's great surprise.

A year ago, Chinese officials privately reassured visitors that their country would "follow the lead of the dominant superpower" in matters relating to Middle East security, including Iran's attempts to acquire nuclear weapons. For the past several decades, China has allowed the US to look out for the Persian Gulf while it increased its dependency on Persian Gulf oil. By 2020, China expects to import 70% of its oil, and most of that will come from the Gulf.

The Chinese view has changed radically during the past few months, in part due to the collapse of the Syrian and Iraqi states and the rise of Islamic State. It is hard to find a Chinese specialist who still thinks that the US can stand surely for Persian Gulf security. Opinion is divided between those who think that America is merely incompetent and those who think that America deliberately wants to destabilize the Persian Gulf.

Now that the US is approaching self-sufficiency in energy resources, some senior Chinese analysts believe it wants to push the region into chaos in order to hurt China. One prominent Chinese analyst pointed out that Islamic State is led by Sunni officers trained by the United States during the 2007-2008 "surge" as well as elements of Saddam Hussein's old army, and that this explains why IS has displayed such military and organizational competence.

The complaint is justified, to be sure: General David Petraeus helped train the 100,000-strong "Sunni Awakening" to create a balance of power against the Shi'ite majority regime that the US helped bring to power in 2006. How, the Chinese ask, could the Bush administration and Petraeus have been so stupid? To persuade the Chinese that they were indeed that stupid is a daunting task.

China's attitude towards Washington has turned towards open contempt. Writing of the mid-term elections, the official daily newspaper Global Times intoned: "The lame-duck president will be further crippled ? he has done an insipid job, offering nearly nothing to his supporters. US society has grown tired of his banality."

But the decline of American influence in the region from which China obtains most of its oil is not a happy event for Beijing.

China did not anticipate the end of the free ride from the Americans, and it isn't sure what to do next. It has tried to maintain a balance among countries with whom it trades and who are hostile to each other. It has sold a great deal of conventional weapons to Iran, for example, and some older, less-sophisticated ballistic missiles.

But China has sold Saudi Arabia its top-of-the-line intermediate range missiles, giving the Saudis a "formidable deterrent capability" against Iran and other prospective adversaries. China obtains more oil from Saudi Arabia than any other country, although its imports from Iraq and Oman are growing faster. Because the latter two countries are closer to Iran, China wants to strike a balance.

Chinese opinion is divided about the implications of Iran acquiring nuclear weapons: some strategists believe that the balance of nuclear power in the region will suffice to prevent the use of such weapons, while others fear that a nuclear exchange in the Gulf might stop the flow of oil and bring down China's economy. China has joined the P-5 plus 1 negotiations (involving the UN Security Council permanent five members plus Germany) on Iran's nuclear status, but has not offered a policy independent of President Barack Obama's.

Meanwhile the rise of Islamist extremism worries Beijing, as well it should. At least a hundred Uyghurs reportedly are fighting with Islamic State, presumably in order to acquire terrorist skills to bring back home to China. Chinese analysts have a very low opinion of the Obama administration's approach to dealing with IS, but do not have an alternative policy. This is an issue of growing importance. Instability threatens the Silk Road project at several key notes.

China has no sympathy whatever for what analysts there like to call "political Islam". America's flirtation with the Muslim Brotherhood - both from the Obama administration and from mainstream Republicans such as Senator John McCain - strikes the Chinese as incompetence, or worse. But China has no capability to go after the Islamists, except for a very limited deployment of marines off the coast of Somalia.

China's policy-making is careful, conservative and consensus-driven. Its overriding concern is its own economy. The pace of transformation of the Middle East has surprised it, and it is trying to decide what to do next.

Its pro forma policy is to join the Iran talks, and offer to join the Quartet (the UN, the US, the European Union, and Russia) talks on the Israel-Palestine issue, but neither of these initiatives has much to do with its actual concerns.

What China will do in the future cannot be predicted. But it seems inevitable that China's basic interests will lead it to far greater involvement in the region, all the more so as the US withdraws.

Spengler is channeled by David P Goldman. He is Senior Fellow at the London Center for Policy Research and the Wax Family Fellow at the Middle East Forum.

http://atimes.com/atimes/China/CHIN-02-101114.html

[Mega]

Re: OIL Wars - Wither China

Hi Don
Must confess that i fell head long into the TRAP, thought 2014 would be 1973...........
Mike

[Mega]

Re: OIL Wars - Wither China

Russia braces for long economic war with the West

Russia's central bank warns that capital outflows will reach $128bn this year and slashes its growth forecast to zero for 2015 as the ceasefire collapses in Ukraine


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Britain, France and Germany all want broader 'Tier III' sanctions against sectors of the Russian economy Photo: Alamy



Image 1 of 3
US dollars versus the Russian rouble



Image 1 of 3
















By Ambrose Evans-Pritchard, International Business Editor

8:45PM GMT 10 Nov 2014

6 Comments


Russia is battening down the hatches for a long battle with the West, expecting sanctions to last until at least 2017 and admitting that capital flight has been significantly higher than previously claimed.

The central bank slashed its growth forecast for next year to zero and warned of near-recession conditions until late in the decade. It said capital outflows would reach $128bn this year.


The new realism ends the pretence that Russia is strong enough to weather the end of the commodity supercycle without suffering serious damage, or that Western sanctions are little more than an irritation. President Vladimir Putin had previously said the effect would dissipate within months.


It comes as the ceasefire in eastern Ukraine disintegrates and international monitors (OSCE) report large incursions of heavy weapons, tanks and troops moving into the Donbass region, clearly from Russia. The White House called it a “blatant violation” of the Minsk accord agreed in September.


The rouble soared 3pc despite the bad news after Mr Putin vowed to “take action” to stabilise the currency and denied any plans to impose capital controls. The rouble closed at 45.74 against the dollar, still down 32pc this year and clearly still in danger.

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The central bank ditched its strategy of defending the currency with half-hearted measures, instead threatening liquidity curbs and a lightning strike on speculators to prevent an exchange rate crash.

The bank said the rouble would be allowed to float freely. This ends Russia’s dual-currency basket and its attempts to stem the currency slide with fixed dollops of intervention, $350m for every five kopecks, which became a one-way bet for traders. The bank has burned through $40bn of foreign reserves since the start of October.

Crucially, the bank vowed to act with force against “financial stability threats”. It will tighten rouble liquidity used by local speculators for bets on the dollar, evoking punishing memories of the 2008 crisis, when overnight rates briefly punched to 3,000pc and scorched those caught on the wrong side of the trade. “Rouble liquidity is being used for games on the currency markets,” said Elvira Nabiulina, the bank’s governor.

“The rouble is rallying because of a short squeeze but it doesn’t change the big picture,” said Tim Ash, at Standard Bank. “They’ve got their heads in the sand if they think this is driven by speculators. Fundamentals and war risk are behind this.”

One hedge fund manager said traders were wary of a sudden counter-strike by the authorities. “Russia can still put up a good fight. We can argue over whether Russia has enough reserves in the end, but it certainly has enough to destroy your position as a trader on any given day if it wants to. We’re not talking about Nigeria or Ghana here,” he said.

^{US dollar versus the Russian rouble}
Yet Russia remains in the eye of the storm as sanctions bite deeper and the collapse of oil prices change the economic landscape. Mr Ash said Russia was already suffering from the “Dutch Disease” before the invasion of Crimea, addicted to commodity exports that hollowed out the country’s industry and pushed the rouble too high. Non-oil exports have fallen from 21pc to 8pc of GDP since 2000.

Urals crude has fallen from $115 to $83 a barrel since June, prompting speculation by Mr Putin that the move is part of an orchestrated political campaign by Russia's enemies, clearly meaning the US and Saudi Arabia. Otkritie Capital, in Moscow, said the fall in crude is likely to pull down EU gas prices by 22pc next year due to linkage in Gazprom contracts. This will further erode Russia's foreign revenues.

Renaissance Capital said in a report that the marginal cost of new oil projects in Russia is around $90, warning that the country could lose 350,000 barrels a day of output next year if "economic logic" prevails.

The central bank has to pick between two poisons. The slide of the rouble is stoking inflation and asphyxiating companies with dollar debts, yet currency intervention entails monetary tightening and risks a banking crisis. The authorities learned the hard way in 2008 that selling reserves into a recession has ferocious side-effects. “The money base contracts and it crushes the economy,” said Lars Christensen, at Danske Bank. “We think Russia is already in recession, and contraction is going to get worse over coming quarters.”

The central bank expects oil to average $95 next year, an optimistic forecast as China steers its economy away from heavy industry, and renewed supply floods the market from Libya, Iraq and perhaps soon Iran. Deutsche Bank says the “fiscal break-even” price needed to balance the Russian budget and pay for the country’s growing military machine is around $100.

Mrs Nabiulina said foreign reserves will drop to $422bn by December, $35bn lower than previous estimates. This is still ample but not as large as it seems. Russian banks, companies and state entities have $731bn of external debt, mostly in dollars. They must roll over $162bn in the next few months, yet global capital markets remain almost entirely shut.

Oil giant Rosneft has requested $49bn in state aid, while VTB bank has reportedly sought $4.8bn. The bank’s president Andrei Kostin said it was thinking of switching VTB’s listing from London to “Chinese bourses” to make it easier to raise capital.

Lubomir Mitov, from the Institute for International Finance, said it would be “very dangerous” if reserves fell below $330bn. Foreigners have pulled back almost entirely and the financing gap has reached 3pc of GDP each year. A further fall in oil prices would push Russia into a current account deficit. “Russia is already in a perfect storm,” he said.

Circumstances are very different from 1998, when the crash in oil prices pushed Russia into default on its external debts. Yet the trauma of that episode is still fresh in people’s minds, and the illusion of high reserves can evaporate fast. “If they lose another 100bn in three months they’ve got a problem. People would start to panic, it could turn vicious very fast,” said Mr Ash.