China’s Meltdown Spells Even More Peril for Petro-States
Oil prices were already fighting a massive hangover. Now, market convulsions in China threaten oil-dependent regimes from Russia to Venezuela.
The Chinese contagion that sparked “Black Monday” is especially worrisome for crude oil prices, which this summer were thought to have finally found a floor after a year of steady price declines. But that floor suddenly looks rotten: U.S. benchmark crude prices fell well below $40 a barrel on Monday, their lowest levels since the depths of the global financial crisis.
Though oil prices inched back up again on Tuesday, they are still at six-year lows. With question marks hanging over the world’s second-largest economy, hopes for a rebound in oil prices are fading — and that’s going to make for a painful reckoning everywhere from Moscow to Maracaibo.
Monday’s global market slide, which saw huge drops in stocks from New York to Shanghai, was fueled by worries over China’s economic outlook. “Black Monday,” though largely erased in the United States by market gains early Tuesday, continued in China, forcing the government to slash interest rates and underscoring the degree to which one of the world’s engines of growth has suddenly become an engine of uncertainty.
That’s troubling for oil-rich countries like Russia and Venezuela, which harnessed years of breakneck Chinese growth to power their own rise — but now face the specter of a prolonged slump that could hammer already tottering economies.
“I don’t want to use the phrase ‘nail in the coffin,’ but China is sort of piling onto the oil supply situation by adding some pretty material demand concerns,” said Richard Morse, a commodities analyst at Citigroup.
The oil rout is hammering Russia: The ruble on Monday hit yearly lows and is now worth half what it was last year. Coupled with Western sanctions, the Russian economy and budget are under severe pressure, which in turn creates all kinds of political headaches for President Vladimir Putin.
“Is Putin willing to hurt the interests of 45 million pensioners by trimming spending or the military-industrial complex, which is the main pillar of his support?” asked Alexander Kliment, director of Russia and emerging markets strategy at Eurasia Group, a risk consultancy.
Things are even worse in other struggling petro-states. Venezuela’s disintegrating economy, coupled with plunging oil prices, has investors seriously worried about default and even societal collapse. Nigeria, already under attack from Boko Haram terrorists, will likely have to devalue its currency in a bid to cope with collapsing oil prices, which will stoke inflation and threatens even more domestic instability. Lower oil prices just aggravate already terrible political situations in places like Libya and Algeria, threatening further domestic unrest.
Even Saudi Arabia, an oil titan with hundreds of billions of dollars in its rainy day fund, faces credit downgrades, double-digit deficits, and concerns over fiscal stability. Bloomberg reported that Saudi officials are seeking to slash spending by as much as 10 percent to cope with oil’s collapse.
Other oil producers all face different variations of the same headache, from Iraq’s vanishing budget (which complicates the fight against the Islamic State), to slower growth in Mexico, to job losses in the U.S. oil patch. The pain is spreading far and wide: Canadian oil-sands producers can’t cope with cheap oil, Norway is bracing for sluggish growth, and the United Kingdom is shedding thousands of North Sea oil jobs.
The real irony, though, is what lies behind the current global market panic: the Chinese economic slowdown. For years, Russia and Venezuela, as well as Middle Eastern and African oil producers, watched happily as China’s voracious appetite for raw materials like oil pushed crude prices up to record levels. That oil windfall fattened petro-state coffers, bolstered their confidence, and helped shape their geopolitical strategies.
Russia’s pivot to Asia was predicated, in large part, on never-ending Chinese demand for energy. And Putin’s economic “miracle” in the 2000s, not to mention his reelection as president, would have been a lot tougher without $100-a-barrel oil. Currently, though, some of Russia’s huge energy deals with China are on hold due to low oil prices.
Venezuela’s troublemaking throughout its neighborhood, especially under former leader Hugo Chavez, was underwritten by hundreds of billions of dollars in oil revenue, even as the economy was propped up by huge loans from China. Iran, too, found in China its biggest single customer — and one willing to keep buying large volumes of oil even when international sanctions limited Tehran’s exports. Saudi Arabia’s newly expansive foreign policy, including vast amounts of financial support for Egypt, Pakistan, and others, rode the crest of a petro-windfall, again girded by Chinese thirst for fuel.
Now, though, the Chinese economic roller coaster is screaming downhill, frightening traders, spooking markets, and further slashing the price of oil that ultimately underpins those economies. The biggest problem is that no one knows with certainty just what is going on in the Chinese economy. Official government data shows GDP growth exactly at target levels of 7 percent, but other indicators — from steel and copper consumption to electricity use — suggest China’s slowdown may be even greater than feared.
China’s economic woes are directly affecting oil markets, because lower growth translates into lower demand for oil and thus lower prices. Crude fell a whopping 6 percent and 7 percent in New York and London, respectively, Monday in large part because of fears that the Chinese market meltdown is a sign that the economy is in much worse shape than official statistics suggest. And even some of the steps that China has taken to deal with the economic slowdown, such as devaluing the renminbi, are bad news for oil producers: A weaker currency makes imported oil more expensive, which could further dampen Chinese purchases and weigh even more on already battered oil prices.
And that’s just what big oil producers don’t need. Thanks to years of high oil prices, underpinned by seemingly bottomless Chinese demand, OPEC countries and Russia skewed their spending plans. Iran needs oil at about $137 a barrel to balance its budget, according to estimates provided by the commodities team at Citigroup; Saudi Arabia needs $105 a barrel; and Russia needs at least $90 oil. Countries that thrived thanks to China’s boom, in other words, are now shuddering thanks to China’s bust, just as they can least afford it.
“The whole paradigm is changing. You had 15 years when massive natural resource rents made it possible for these countries to sustain political stability, and now that’s all slowing down,” said Kliment of Eurasia Group.
Of course, oil’s slump isn’t just due to the Chinese slowdown; oil producers inside and outside of OPEC have kept pumping full bore over the past year, creating a supply glut that pushed prices down from highs of about $115 a barrel last summer. And China’s woes don’t just hit petro-states. Australian ore and coal miners, Brazilian soybean growers, and Argentine ranchers all thrived from feeding the Chinese market for more than a decade, and now are all hunkering down.
It is hard to overstate China’s role in reshaping oil markets since the beginning of the century. Until 1993, China was self-sufficient in oil. By 2000, it was importing 1.3 million barrels a day. By the end of 2014, it was importing 7.1 million barrels a day, as much as the United States. That massive increase in demand for oil outstripped the world’s ability to provide it, which ultimately led to record-high oil prices just before the financial crash in 2008 and triple-digit oil as recently as last summer.
China still consumes loads of oil, second only to the United States. Despite the slowdown, China’s economy is still the second largest in the world. But Chinese oil consumption, like Chinese consumption of other things, such as steel, copper, and electricity, isn’t growing anywhere as fast as it used to. In July, Chinese oil consumption fell compared to the previous month; for the year so far, Chinese demand for oil seems to have increased less than 5 percent — or half what it did during the halcyon days.
Yet OPEC and other big oil producers are still pumping as if there is a bottomless pit of Chinese demand out there still waiting to snap up every available barrel of oil. OPEC production hit a three-year high in July. Russia, which isn’t a member of OPEC, is pumping at about the highest levels since the end of the Soviet Union. Even the United States, which can’t even export the stuff, is still pumping with abandon, despite the precipitous fall in crude prices.
Big producers have kept the spigots wide open to maintain their market share; OPEC countries have tried to drive U.S. drillers — who need pricier oil to be profitable — out of business.
It hasn’t worked yet. U.S. producers were expected to pack up and go home when oil fell below $80 a barrel, or if not then certainly at $70, and definitely at $60 a barrel. But it hasn’t happened — U.S. production has crept upward all year. Big gains in drilling efficiency have allowed many U.S. producers to stay profitable with much lower prices than they and everyone else thought just a year ago, even though plenty of oil companies have slashed payrolls and curbed spending. And that, in turn, keeps pushing oil prices ever lower.
“Absent lots of money to keep people happy, lots of countries are going to face serious problems,” Kliment said.
Photo credit: JUAN BARRETO/AFP/Getty Images
Keith Johnson is a senior staff writer at Foreign Policy. Twitter: @KFJ_FP