How Politics Make for Strange “Oil Fellows” – Part II

Last time we traveled back through the Cold War to the latter period of the nineteenth century with a certain novel written by Charles Dudley Turner and his neighbor Mark Twain.

We ended by seguing to some interesting developments in the oil market emerging over the last couple of weeks.

This time we will begin a bit further back… all the way back to the 5th century B.C.

In the latter half of that century the Peloponnesian War between Athens and Sparta became the first major power clash in Western history. Its ultimate defeat would permanently drop Athens from the list of dominant militaries.

Yet the war had a very deliberate and limited nature in the early stages. As chronicled by the historian Thucydides, the leaders on both sides – Pericles in Athens and Brasidas in Sparta – were careful to avoid crippling their adversary.

Each spring, Spartan forces would march into Attica (the expansive interior territory controlled by Athens) and lay waste to fields. But they would avoid destroying olive trees to prevent the collapse of the Athenian economy (it takes twelve years for an olive tree to bear commercial fruit).

Similarly, the Athenian navy would land late each summer and attack Spartan villages by the Peloponnesian coast. However, they would avoid killing youth, thereby guaranteeing the Spartans would be able to field future armies (Spartan youths entered into active military training for service at age twelve).

Here’s when that changed… and what it means for OPEC’s oil strategy…

The Parallels Between Ancient Greece and the Cold War

The limited nature of the war ended when the great figures on both sides fell (Pericles to the plague ravaging Athens; Brasidas at the battle of Amphipolis) and those having lesser leadership ability (but massive political ambitions) took up the reins of rule.

Thucydides wryly noted that wars begun for lofty reasons, if extended over any period of time, will descend into simple violence and excessive use of power. By that point, you cannot prevent the collapse, only determine in which direction the tragedy played out.

The Cold War we all thought had ended in December 1991 was like that. While both the U.S. and the Soviet Union would talk of total victory, raising armies (and collecting allies) to win an all-out war, we were also conscious of what Soviet head Nikita Khrushchev had said in July 1963 – “The survivors of a nuclear war would envy the dead.”

In some matters, such as the survival of Berlin, the stakes were high. But even at the darkest hour, each side provided the other a certain amount of leverage. This was a game of chess, not a bulldozer contest.

If nothing else, it allowed one to fight this kind of war and still hold some regard for basic human nature.

Well, as discussed here earlier in the week, we are back in the Cold War (perhaps never really having left it). Yet, once again, at least at the outset, there are indications it is a limited fight. And, as I suggested at the end of the last Oil & Energy Investor, this time a limitation centers on the subject of oil.

More precisely, the price of oil.

Why the U.S. and Russia see Eye to Eye on Oil

Both the U.S. and Russia have been targets of the OPEC decision to maintain production levels, thereby driving global oil prices south. In the U.S., the target has been to make shale and tight oil producers to blink first and begin cutting production. Meanwhile, OPEC (primarily the Saudis) want to block Russian exports to Asia.

In both cases, the weapon is price. Lowering market prices will make American extensive, deep, horizontal, fracked drilling too expensive. Similarly, the price provided in Asia would end up being below the level necessary to provide adequate Russian revenues.

However, the cost has been high within OPEC. On several occasions recently I have noted in Oil & Energy Investor that all cartel members are suffering from significant revenue cuts and budgetary imbalances. This has resulted in excess production and exports, pushing the price down even further.

U.S. producers have cut forward capital commitments for new projects and have retired over half of the rigs operating in the fields. Nonetheless, production has shown a stubborn resistance to remain high.

In the case of Russia, a state-controlled oil sector has used a decline in the ruble exchange rate as a way of making its domestic production effectively cheaper.

Both nations recognize that a strong internal oil industry has fundamentally positive employment and tax base consequences. And so it happened. The renewing adversaries entered into a dual-track policy to save a common interest.

As a new Cold War period accelerated, Moscow and Washington were brought together on a common purpose. The “strange bedfellows” referred to by Warner in 1870 had been transformed into the “strange oilfellows” of 2015.

OPEC Negotiations Behind the Scenes

We have already discussed the OPEC initiative to discuss extraction volumes with other producing countries. This “announcement” (actually an op-ed appearing in an OPEC monthly publication) was followed the next day by some very public statements by Russian oil officials declaring that they would not succumb to either OPEC pressure or any attempt to remove them from the Asian market.

The next day discussions began between an ad hoc Russian delegation and members of the OPEC Secretariat in Vienna. Moscow has for years sent an observing team to all OPEC meetings and has developed an ongoing mutual channel for discussions.

On the other hand, Washington has never done so, choosing to regard OPEC as a body often at odds with American policy interests.

However, the U.S. has always had one ace in the hole when it came to dealing with the cartel – the organization’s production leader and dominant member, Saudi Arabia.

When the new Saudi King Salman came to Washington last Thursday to begin meetings at the White House, oil was on the agenda. Of greater interest, however, are the joint planning sessions that preceded the summit between Saudi and American specialist staffs. Aside from Yemen and the Iranian nuclear deal, the only other matter on the agenda was how to allow the Saudis a declaration of victory that they won and start reducing production (thereby increasing market price).

The Saudi entourage was huge, even larger than normal. They completely bought out the Four Seasons in Georgetown (on Pennsylvania Avenue, 12 blocks from the White House).

Once again, we may benefit from common interests limiting a Cold War.

At least initially.

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