There seems to be in some circles this strange belief that Russia is somehow all-powerful because they have gas and oil and thus the Western world can only cower in fear of the almighty Russian bear turning off the oil and gas taps.
Conveniently scary story that, I’m sure the same people who buy that malarky are the ones who bought the FoxNews Al-Qaeda suitcase nuke stories as well.
A quick wake up call to these people: If Russia would stop selling oil and gas to Europe, you know what? Russia would not get any money.
But they’ll sell to the Chinese! They cry. Ah, how wrong they are and I’ll come to that later in this post. First, let’s have a brief look at Russia’s economic situation if they were to start using oil as a weapon.
Russia is a kleptocracy plagued by serious economic disparity and endemic corruption. In other words it’s a traditional emerging market with all the problems such a market entails, but to some people for some strange reason it seems like a superpower.
Bah-humbug says I.
But don’t take my word for it, take someone’s who is much smarter than I, The Streetwise Professor. He penned a short, clear, fact based article on this subject, the jist of which is that for Russia “Using the Energy Weapon is Economic Suicide”. You really should read his post, now!
If you then find yourself starting to geek out a bit (like I did) you might want to follow up by reading a thorough analysis “Crimeanomics favours the West”. It’s written by UBS analysts, so as articles go it’s what you’d expect, a bit boring. But the underlying numbers and data are interesting.
Russians Selling Oil to The Chinese
Right then, let’s get back to the US dollar and the Chinese, who are going to buy all this Russian oil as we in Europe go back to living in igloos and trading squirrel furs with each other to survive because the Russians didn’t pump gas to Germany.
I have one word for these people who think that changing from the US dollar as an oil currency is a simple matter. That word is hedge.
How are the buyers and sellers of Russia’s “traded in any currency other than US Dollars” oil going to hedge their oil exposure? If you are wondering what the heck I’m on about, allow me to elaborate.
Many things happen and a lot of time transpires from the time that oil is extracted to the time you pump it into your car in the form of petrol this causes the price of oil to go up and down. We pros prefer to use the word volatility because it makes us sound like we know what we are talking about (and you don’t).
Because of the uncertainty in the price of oil a there emerged a futures market. The futures market is used as insurance by all participants in the petroleum sector to protect (hedge) against price swings. (It’s pretty basic stuff, here you’ll find a good example of how hedging works).
The global oil futures market is valued at tens of billions of US dollars. Why US dollars? Because that’s what the contracts are denominated in. So here we are, back to the US dollar again.
So for all of those who think "Eeeek Russia, ooh how strong" please explain to me how Mr. Oilagotski from Russia and Mr. Wan-Sum-Lube from China are going to do business without a proper working futures market in an appropriate currency?
If the Russians and Chinese want to end US dollar hegemony in the oil markets they need to come up with a working market that participants can use to hedge their inventories and purchases. Without that it’s just two-way bartering, slower and more cumbersome than the current system.