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Free Market Foreign Policy

by Jason Gay

As we see the Russian bear market develop, there will likely be an effort by some to claim credit and expertise. Most notably, the White House will certainly push the narrative—either overtly or through “authorized leaks”—that the President’s policies have led to the Russian problems and this was the strategic response to the invasion of Ukraine envisioned all along.

First, for perspective, it has been over a month since we reached the point where the market value of a single company, Apple, was greater than the entire Russian stock market; the Russian stock market is relatively small. Some would lead you to believe that this decline has come because of the sanctions imposed by the US and Europe in response to the invasion of Ukraine. Minimal research demonstrates this correlation hardly has any indication of causation. 

Most notably, the Russian market index, RSX, has been falling consistently since April 2011. There has been a near-steady decline in the Russian market for over three and one-half years, with a notable rebound in the market once it was apparent there would be no larger-scale conflict following the Russian invasion of Ukraine.

The truth is that the Russian market largely follows the value of crude oil. Natural resources account for nearly 19 percent of the Russian economy, compared to just over one percent for the United States. This disparity means that the US economy as a whole can see a boom from cheaper transportation whereas it is crippling for a Russian government that receives over 50 percent of its revenues from oil and gas and an economy that sees 70 percent of its exports accounted for in the form of oil and gas.

The question is, then, did White House policies contribute to the disruption of the crude oil market and the drop below $60? The answer is, simply, no.

In reality, the drop in oil has occurred in spite of, not because of, US government policies. Delaying Keystone, freezing and then slowly resuming offshore oil permitting after rigs had already left, and slowing the permitting of onshore oil production should have served to decrease US production and increase prices.

The industry, however, has successfully counteracted efforts to reduce production. Production on private leases has increased substantially, largely due to technological improvements in oil and gas production in shale plays.

Meanwhile, OPEC nations have chosen not to reduce production in response to US increases. While OPEC usually tailors production to maintain a target price level, there seems to be a different goal in the current policy. OPEC is not pleased with US increases in production—production over which they have no control—and their policy seems to be aimed at reducing US production.

It remains more expensive to produce oil and gas from US shale than in the Middle East. Lower prices make US production less profitable. OPEC may be choosing to sustain lower profits in an effort to make US production unprofitable, or at least drive down the profitability of their competition.

Additionally, low crude oil prices are destructive for the economy of Iran, a Russian ally and major threat to several OPEC nations. OPEC may also see this as a front on which to fight Iran.

The long term impacts on Russia and Iran remain to be seen, especially as we see Russia respond with dramatically increased interest rates in an effort to stabilize the Ruble that mirrors failed attempts in 1989. Regardless of OPEC’s motives, the combined decisions of OPEC and private companies producing oil and gas in the United States are the primary drivers of the collapse of the Russian market, not weak sanctions enacted by the US and Europe.

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Saturday, 23 September 2017
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