Although it took weeks for the US and the UK to formally ban Russian crude in retaliation for Vladimir Putin’s decision to invade his neighbor, a buyers’ strike was already well underway by the time Joe Biden told Americans the US was done “subsidizing” the Kremlin’s war of conquest in Ukraine.
The SWIFT expulsion and the West’s dramatic decision to seize Russia’s foreign currency reserves effectively rendered the country’s commodities contraband, leading to wide discounts and a bifurcated market — there’s Russian commodities and then there’s everything else. Zoltan Pozsar likened the situation to the subprime crisis. “Russian commodities are like subprime collateral and all other stuff is prime,” he said, in a provocative new piece outlining what he called “a new world monetary order.”
In their own take, Goldman’s Damien Courvalin and Callum Bruce warned of a “potentially enormous oil supply shock.” On the bank’s estimates, “more than half of March loadings remain unsold,” which Courvalin and Bruce said is “consistent with the exceptional discount of Russian export barrels relative to Brent.”
If things continue along this trajectory, seaborne exports of Russian oil and petroleum products could fall by 3 mb/d, Goldman reckoned. That would be “the fifth largest one-month disruption” since World War II. The figures (above) give you a sense of things.
From there, Courvalin and Bruce outlined the potential for a self-fulfilling prophecy.
“With its foreign assets frozen, the Russian Central Bank is closing its capital account, implying a potential drop in commodity exports to match imports,” they wrote, noting that,
Even if Russian oil and gas companies act as custodians for the FX surplus generated by energy exports, current sanctions would prevent transfer of these surpluses to the Central Bank or Treasury to make sovereign debt payments or pay other receipts. In addition, there would remain the threat of potential future Western seizure of these accumulated corporate foreign FX reserves. As a result, while a balanced capital account would still allow for exports, trade would progressively be forced to match imports on a nominal $ basis.
That’s a problem. Why? Well, because as exports decrease, so does global supply. As supply falls, prices rise, which could compel Russia to export even fewer barrels in order to ensure the nominal value of exports is constant.
“In effect, a closed capital account creates a backward bending supply curve for Russian commodity exports — less supply raises prices, which incentivizes even less supply,” Goldman went on to write, on the way to postulating “a potentially large fall in global oil supply that would redraw the global energy map.”
Like Pozsar, Courvalin and Bruce see China playing a major role. The logistics of Beijing absorbing Russian crude formerly imported by Europe and the US are challenging, but hardly insurmountable. One source of friction is a near two-week increase in transit time assuming all flows are redirected. Another involves sourcing the required ships and still another inefficiency arises when you consider that Russian crude would displace other Chinese imports.
Ultimately, though, Goldman said the “hurdle to a full redirection of crude flows is political rather than physical.”
“While oil trades are exempt from current economic sanctions, the use and handling of Russia’s CNY proceeds and the associated FX reserves could (initially) leave China reluctant to increase imports at a time when Russia is becoming a global pariah,” Courvalin and Bruce remarked, noting that China hasn’t really dialed up imports from Iran and Venezuela in recent years.
But Goldman did mention a “potential outcome where China guarantees Russia full use of its banking system, protecting CNY reserves,” a scenario that would surely prompt Russia to max out oil sales.
The bank’s conclusion, as it relates to China’s role in a redrawn global energy map, suggests all sides have incentives to see Russian flows redirected. “For the West, it would help achieve the clearly stated goal of not disrupting global energy supplies,” Goldman said. “For Russia, it would lessen the impact of sanctions and reinforce its ‘no limits partnership’ with China [which] could extend its sphere of economic influence as well as guarantee a significant supply of discounted crude.”
In my own view, that’s hardly an “everybody wins” outcome. The benefits for Beijing are clear enough. But the West won’t be excited about the idea of a petroyuan system tailored to Moscow, and it’s at least possible that the US (and its reserve currency-issuing allies) could threaten China’s access to dollars, pounds and euros in retaliation for propping up Putin’s regime. As for Moscow, does the Kremlin really want to turn Russia into a Chinese client state?
Becoming a Chinese client state seems to be Putin’s least bad option.
“ Becoming a Chinese client state seems to be Putin’s least bad option.”
Sure from a logical perspective. But the prism of Russian Exceptionalism is rooted in White Supremacy and right wing religious extremism. For Putin, and the Russians that “believe” in the cause, this is a Holy War to re-establish the “traditionalist” Christo-Rus Emprire, literally. Both dynamics make the Chinese client state status untenable for Putin.
Just like most Americans do not agree with the extremist version of American Exceptionalism, there are a significant portion of Russian society that reject Putin’s Holy War. The only end game is a Russian Spring.
Back when I was involved in these things, my Russian colleague used to tell me that his country’s greatest fear was not NATO, but millions of Chinese lining up on the border with Russia and walking northwards.
“ Becoming a Chinese client state seems to be Putin’s least bad option.”
But not Russia-sans-Putin’s least bad option. Powerful Russians are presumably doing those sums now.
There’s one thing that China is more reliant on than all the oil in the world: dollars. It’s entire export-driven economy depends on them, it would collapse overnight if all its american dollars were made useless with a keystroke. It would be mass unemployment. China literally has no alternative, US consumption fuels China’s economy.
It would be horrific for the US as well, but the difference is that the US would merely be stuck looking for an alternative supply — China would be looking for another 350 million buyers. Domestic consumption is nowhere close.
Jon- bingo! There’s this myth that China is infallible. The fact is China is entirely dependent on the fiscal stability of the US and to a lesser extent Europe. The economic wobbles generated from the pandemic have created an minimal instability that is already causing the Chinese economy to fracture. The global fund USL war launched over the past 2 weeks will have significant economic impacts on China as well. And if China goes too far with supporting Russia, any trade embargo would crush China’s economy, over night.
It’s time to update the rote narrative a little. Trade as a percentage of Chinese GDP has steady fallen over the last 15 years. Last I looked, it was lower than Germany and not all that much higher than here in the USA.
I think a lot of geopolitical and balance of power issues are going to have to be discussed iat a high level in private. If things get crazy enough, the Chinese might consider Putin’s position to untenable, and then it’s a question of weather they ready to lead an alternative trade and currency regime. I say they arent’ remotely ready. You need a deep, wide and highly liguid set of bond markets, a clear rule of law, and the prospect of long term stable behaviour. I love the idea of poaching as many top flight Russians and Chinese as we can. I mean where would you rather live and raise your family?
China and Russia are moving in the wrong direction on “rule of law”, property rights, etc. It is almost like the first and only priority of Putin and Xi is to stay in office during their lifetime/protect their personal wealth – shocking!!
If the US can just keep from screwing up too badly and have an intelligent immigration policy (I am patiently waiting)- the US can continue to support and keep a strong King Dollar.
There are good reasons why emergence of yuan in either a petroyuan or a broader Eurorenminbi role is not going to happen anytime soon. Bretton Woods was a UN sponsored conference with 44 allied nations coming together with a common purpose, in a historical moment when they were acting as blood brothers who were still fighting a global war together, and operating with a free hand created by the relative vacuum of the war environment (quick exercise – name anything that was going on anywhere in 1944 that didn’t pertain to the war). I see charts purportedly illustrating the very slow emergence of yuan as a reserve currency and I suspect some get the idea that all it will take is the passage of time accompanied by steady pressure from the Chinese long game. I think that misses the demonstrated requirements of global alliance, shared purpose, and historical nexus to get to where China thinks it is going. Further, at the present historical nexus, China is actually reducing its chances of forming alliances that matter rather than increasing them.
Autocratic China will never have leverageable alliances in a free world and no matter how many railroad ties are laid under BRI, it will have no blood brothers. It will have instead one pariah with a bloody nose. The Ukraine war is more significant as an illustration of why global alliances matter than it is as an example of temporary market division leading anywhere new.
I’m with you UptownGuy. Appreciate the history and context to frame Bretton Woods. Thank you. And juxtaposed against the self-evident Chinese long game, your points are well-taken. My read is that if the Chinese truly have this long game in proper perspective and place their bets accordingly, they will piecemeal their cheap oil purchases from Russia, giving him excuses at every step. And in time, ultimately, they would tell Putin to go to hell.
BTW – Are you uptown in New York, Chicago, or neither?
Or just a huge Billy Joel fan?
“…. because as exports decrease, so does global supply. As supply falls, prices rise, which could compel Russia to export even fewer barrels in order to ensure the nominal value of exports is constant.”
Interesting dynamic I never thought of. This probably hasn’t come into play seriously since the mercantile days of empires. I can’t say for sure but I doubt if the US (Yellen, Biden) ever thought of this when they laid down the sanctions. Really interesting unintended consequence.
70 years ago my mom taught me to learn something new every day. Between this dynamic and something unrelated I learned from an ex-student, I’m up two things today.
My neighbor is a Fox news consumer who is currently angry at Biden for wrecking the oil industry.
I suggested that the oil industry has been going through structural changes for more than a decade and reminded him of oil futures that went negative as the pandemic unfolded, and further suggested Ukraine hasn’t helped with supply.
I was told I should work for Biden as a speech writer… I’d like a different neighbor!
As I filled my tank up the other day, I didn’t blame Biden or the oil companies and really didn’t assign blame to anything, but the cost of gas is shocking. I plan to drive less,.
In this polarized, crazy world, I do hope that sleepy Joe isn’t being set up in some global conspiracy, where thousands of people are dieing and millions displaced, in order to fulfill the wishes of Fox news consumers. Reality seems to be in short supply, just like gasoline.