Oil: Will Putin Be Second Time Lucky Weaponizing Global Supply?

Keeping Russians happy as elections approach or kicking Joe Biden between the legs over Ukraine?  Vladimir Putin reckons he can do both — if ​​oil prices cross $100 a barrel to limit any damage to the Russian economy from his chokes on supply.

Just six months ago, the West was relieved to see the Russian leader frustrated in his attempts to weaponize energy in the war against Ukraine.

Despite some early “successes” in causing panic across Europe when he partially turned off Russian gas supply to the bloc during the 2022/23 winter on the excuse of maintenance — and drove prices of heating fuels to record highs — it was Mother Nature, ultimately, that beat Putin. 

More specifically, it was warm weather that delivered victory to his European rivals, who didn’t need Russian gas as much as he thought. In the warmth of that winter — and multiple setbacks to his forces dealt by the allied nations helping Kiev — the Kremlin boss stewed, red-faced, waiting for another opportunity.

That seems to have come now.  

The Context

This week, Russia announced a ban on the export of diesel and petrol as crude prices hovered at or above $90 a barrel. Since last month, Moscow has also colluded with Saudi Arabia to contribute 300,000 barrels a day of its own oil to the kingdom’s bid to choke the global market with a daily cut of 1.0 million barrels. 

The cumulative Saudi-Russian reduction of 1.3 million barrels per day has several things riding on it.

At the apex is a plan to make the world pay as much as possible for the multi-trillion dollar remodeling of the Saudi economy to make it free from its dependence on oil. And the Saudi way of achieving that — ironically — is to keep oil prices in the triple digits over the next few years (despite the denials of its energy minister). 

Also equally important, only slightly less perhaps, is Saudi Crown Prince Mohamad bin Salman’s desire to be one with Putin and China’s Xi Jin Peng in targeting Biden. An enemy of an enemy is a friend, as the saying goes. Like the Russians and Chinese, Crown Prince MbS, as he is known, has his own reasons for despising Biden, not in the least for the U.S. president’s attempt in trying to make a pariah once of both Saudi Arabia and him over the murder of journalist Jamal Khashoggi, which the CIA says was ordered by the royal. 

Aside from being united against Biden, the three are banded together by another common goal: To see the dollar perish as the world’s reserve currency — an initiative called de-dollarization — and be replaced by an acceptable alternative (MbS harbors dreams that it’ll be the Saudi riyal someday while Xi thinks the Chinese yuan is already there  — despite neither state having the economic/financial/monetary transparency that would command the confidence of the world for such a reserve currency). 

It is de-dollarization to some extent that drove Saudis most recently to join the BRICS trade pact, co-founded by Russia and China along with Brazil and South Africa. While BRICS nations fight many battles against the dollar, they are most driven in trying to break the petro-dollar hegemony: i.e., selling oil in any currency other than the dollar. 

But the ‘SRC Buddy Club’ of Saudi-Russia-China isn’t without troubled history or even present complications. 

Until a few years ago, Russia supported Iran and the Houthi rebels in the Yemen conflict against Saudi Arabia and the UAE. Before their current high-fiving, the Saudis waged an oil price war against the Russians after the outbreak of the COVID-19 pandemic. China may have brokered the peace talks between the Saudis and the Iranians this year, but Riyadh’s bid for higher and higher oil prices hardly seems to be the way to thank Beijing for that, especially with the Chinese being the world’s number one oil consumers. 

Still, MbS, Putin, and Xi have decided to forgive any transgressions against each other, past or present, explaining why Saudi Arabia and China have not criticized the Ukraine invasion from Day One. Since then, they have been more focused than ever against their common enemies. Notwithstanding official and diplomatic relations, that would be Biden first, America next, and the West last.  

That might be perfect for Putin. 

Putin's Angle

The Kremlin said the ban was “temporary” and designed to address rising energy prices in Russia, but gave no timeframe for when the measures would end and carved out only limited exceptions such as its own overseas military bases. But the timing will raise suspicions in Western capitals that Putin is again leveraging Russia’s power over energy markets.

Republican candidates for next year’s presidential election have attacked the Biden administration over rising fuel prices, with frontrunner Donald Trump accusing them of neglecting the domestic oil industry.

The role of pump prices in tight U.S. elections is likely to be well understood in Moscow, raising the prospect of Putin trying to manipulate oil supplies to raise petrol prices next year. Trump has suggested that if elected he would force Ukraine to negotiate the end of the war. Reigniting an inflation-stoking rally in natural gas would also come at a challenging economic time for European leaders, who face their own threats from populist rivals.

Political survival isn’t a challenge just for Biden and the West’s leaders, it’s also for Putin, who faces an election at home in March. Russia, in recent months, has suffered shortages of gasoline and diesel. Wholesale fuel prices have spiked, although retail prices are capped to try to curb them in line with official inflation. The crunch has been especially painful in some parts of Russia's southern breadbasket, where fuel is crucial for gathering the harvest. 

Putin’s control over Russia is far more complete than that of his rivals. Still, weaponizing oil is still viewed by many analysts as more challenging than natural gas, as oil revenues are more important to Moscow’s budget. To counter that theory, the energy sector once thought weaponizing gas was unthinkable, and Putin has already shown how wrong that assumption is.

Another tricky issue is cutting enough production to hurt your enemies and not so much to cause problems for top consumers and allies China and India. Neither Russia nor the Saudis have displayed any restraint thus far with their cuts, which seem driven as much by their desire to show the world who’s boss as it is by economics.   

Also, Putin’s grip on power is tied to finding some kind of acceptable outcome from the war in Ukraine. Thus, it would not be surprising for the Kremlin’s most diabolical minds to continuously think of ways to create splits and fractures in the West and even form new alliances to achieve that.

In Trump’s case, he took great pains not to have a conflict with Putin during his time in office, a gesture reciprocated by the Russian. Crown Prince MbS’ cozy ties with Trump are also no secret, despite the ex-president’s dislike of high oil prices. As aforementioned, the Saudis and Russians have resolved to overlook the little things in the pursuit of their common goal. That raises interesting questions on how far the two would go in trying to influence the outcome of the 2024 U.S. election.

“Russia still wants to cause chaos, they still want to break the west’s resolve to support Ukraine,” Helima Croft, a senior analyst at RBC Capital Markets, said in comments carried by Financial Times. “[Putin’s] goal seems to be to make it to next year and see the impact on the U.S. presidential election.”

The International Energy Agency last year said Russian refiners produced “roughly double the diesel needed to satisfy domestic demand, and typically export half their annual production.”

Diesel is the workhorse fuel of the global economy, playing a crucial role in freight, shipping, and aviation. Derivatives of diesel such as heating oil are particularly susceptible to winter price surges. Germany and the north-east of the U.S. are both heavily reliant on fuel for heating homes.

Russia is the world’s second-largest seaborne exporter of diesel after the U.S., according to Kpler, a freight data analytics company, and before its invasion of Ukraine was the single biggest diesel exporter to the EU. The EU and U.S. have largely banned imports of Russian refined fuel since February, forcing Moscow to reroute its sales to Turkey and countries in North Africa and Latin America.

But Russian refined fuel sales, particularly diesel, remain a critical part of oil supplies. In August Russia exported more than 30 million barrels of diesel and gas-oil — a diesel proxy — by sea, according to Kpler.

The G7 advanced economies have also tried to impose a price cap on Russian oil sales, while Western countries have increased diesel imports from India and the Middle East.

Russia is a smaller exporter of petrol, exporting only 90,000 seaborne barrels a day in August, Kpler added.

Refined fuel markets are already relatively tight because of rising demand and refinery maintenance over the summer, with pump prices becoming a growing issue for Biden and other leaders.

So, the bottom line question:

Will Putin Get a Second Chance of Weaponizing Energy, This Time With Oil?

The short answer is yes; he already seems to have that opportunity. But how far it gets to go with that is a different matter altogether.

Both the Saudis and Russians have common goals for their oil production cuts — that is, to maximize price-per-barrel, preferably at the higher end of the $100 range, create a deep enough supply deficit that will make it hard for the market to fall much from there, and cause commensurate pain to their enemies. 

Putin, particularly, has an overreaching ambition: To screw anyone and everyone who made the Ukraine war harder for Russia to fight.

In order for any of these to happen, price will be the ultimate arbiter. There are few who’d argue now that crude prices, especially that for global benchmark Brent, seem destined to hit $100 a  barrel or more in the not-too-distant future. But whether they get to stay at those highs is the question.

It might be wishful thinking to expect Mother Nature to deliver another benign winter that would keep down demand and prices for heating fuels and not magnify the current inventory tightness in oil. 

But it might not be unrealistic to expect central bankers to play God by intervening in markets when inflation gets out of control. 

Surging oil prices typically bring along with them surging inflation. Federal Reserve Chair Jerome Powell said this week that energy-driven inflation, led by the 30% rally in oil prices since June, was one of the U.S. central bank’s bigger concerns.

The U.S. pump price of gasoline, which serves as a political barometer during elections, has barely risen over the past three months, staying below $4 per gallon despite crude prices adding some $25 a barrel. And that, the American Automobile Association says, is due to ample inventories in the marketplace and relatively light demand.

Last year, gasoline at U.S. pumps hit a record high of just over $5 a gallon. Biden’s political rivals are hoping that increasing tightness in crude and fuel supplies will get the market back to those levels, something the Saudis and Russians would probably love to see too.

For much of the two past two years, the president fought gasoline price increases by releasing oil from the U.S. reserve. With some 200,000 million barrels or more drawn down from there and the reserve at 40-year lows now, that option doesn’t really look like an option for him now unless push comes to shove. 

Getting U.S. oil drillers to quickly ramp up production to make up the deficit also seems to be as much a political problem as one of supply dynamics. To begin with, the majority of the American oil industry is Republican-leaning.

The two sides never got off to a good start, with Biden being razor-focused on green energy in the early part of his term. Since then, U.S. drillers have cited his hostility towards them, preferring to return cash to shareholders than invest in new production. Essentially, the American oil industry now behaves like an extension of OPEC, with only U.S. antitrust laws preventing it from officially serving as members of the cartel.

Bottom Line: What Could Slow the Growth in Oil Prices? 

So, what can slow the growth in oil prices or even cap them from going higher? As said earlier, inflation and commensurate central bank action are the only things that might work.   

Economists fear that a renewed hawkish stance by the Fed will dampen global growth though many also agree that a lid has to be put on oil prices if the central bank is to achieve its target of bringing inflation back to annual growth of 2% from current levels of 3.7%.

The Fed raised interest rates 11 times between February 2022 and July 2023, adding a total of 5.25 percentage points to a prior base rate of just 0.25%.

This week, the dollar hit six-month highs while U.S. bond yields, led by the U.S. 10-year Treasury note, soared to 16-year peaks after the Fed projected another quarter-percentage point rate increase by the year-end, despite leaving rates unchanged for September.

“We are prepared to raise rates further, if appropriate," Powell told reporters. "The fact that we decided to maintain the policy rate at this meeting doesn't mean we have decided that we have or have not at this time reached that stance of monetary policy that we are seeking."

This week, the Bank of England kept rates unchanged as well, along with the Bank of Japan. The European Central Bank signaled it was done with hikes after raising rates by a quarter point for a tenth time. Inflationary pressure could still decide different outcomes for them months down the road.

The combination of higher interest rates, a higher dollar, and higher bond yields have often been a Kryptonite to any risk rally, including in commodities and oil. Each time all three worked in unison, to the extent of creating fears of recession, the economy slowed, applying brakes as well on demand. Oil longs would love to argue otherwise, of course.

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Disclaimer: The aim of this article is purely to inform and does not in any way represent an inducement or recommendation to buy or sell any commodity or its related securities. The author Barani Krishnan does not hold a position in the commodities and securities he writes about. He typically uses a range of views outside his own to bring diversity to his analysis of any market. For neutrality, he sometimes presents contrarian views and market variables.