The Coming Oil Crash

Good news! Gas prices could go down to $2 a gallon by autumn -- and that's bad news for Vladimir Putin.

My mom out in California is elated -- gasoline prices in her neighborhood are below $4 a gallon for the first time in four months. Less so are the world's petro-rulers, who are watching the price of oil -- their life blood -- plunge at a rate they have not experienced since the dreaded year 2008. Industry analysts are using phrases such as "devastation" and "severe strain" to describe what is next for the petro-states should prices plummet as low as some fear. No one is as yet forecasting a fresh round of Arab Spring-like regime implosions. But that's the nightmare scenario if you happen to run a petrocracy.

To understand why your average oil king is right to be worried at the moment, grab your calculator. The price of U.S.-traded oil fell to $83.27 a barrel on Monday, and global benchmark Brent crude to $96.05 a barrel; now juxtapose that against the state budgets of Iran, Russia, and Venezuela, which require more than $110-a-barrel Brent prices to break even, according to generally accepted estimates, and you'll see the problem.

Given this already-existing revenue gap, one might fairly wonder what would happen if, as Citigroup's Edward Morse says is possible, prices drop another $20 a barrel for an extended length of time. Oil economist Philip Verleger's forecast is even gloomier -- a plunge to $40 a barrel by November. Or finally, what Venezuelan Oil Minister Rafael Ramirez fears -- $35-a-barrel prices, near the lows last seen in 2008. In Russia, for instance, "$35 or $40, or even $60 a barrel, would be devastating fiscally," says Andrew Kuchins of the Center for Strategic and International Studies. That could damage the standing of President Vladimir Putin, since his "popularity and authority are closely correlated with economic growth," Kuchins told me in an email exchange.

With few exceptions, the same goes for the rest of the world's petro-rulers, whose oil revenue supports vast social spending aimed at least in part at subduing possible dissatisfaction by their populace. Saudi Arabia can balance its budget as long as prices stay above $80 a barrel, according to the International Monetary Fund, although projected future social spending obligations will drive its break-even price to $98 a barrel in 2016.

Of the major petro-states, only Qatar -- with a requirement of about $58-per-barrel to balance its budget -- appears to have sufficiently disciplined state spending to weather all but the most dire forecasts.

The biggest uncertainty in the global oil market isn't whether oil prices will drop further -- they seem likely to -- but how long they will stay down. In short, how long, and at what scale, are the petrocracies likely to suffer? This state of affairs is a woeful blow to petro-rulers after nine years of mostly nirvana. The year 2003 started with oil at about $33 a barrel, after which prices went mainly up, peaking in July 2008 at $147 a barrel. They bounced back nicely even after the global financial crisis sent prices plummeting below their 2003 level, to about $31 a barrel in December 2008. When the Arab Spring unfolded, first Libya and then Iran triggered worried looks on trading desks in London and New York, and the price spiked to about $128 a barrel. My mom saw the average price of gas in California rise to $4.36 a gallon. But then the concern of war between Iran and Israel all-but vanished, and prices since have been on a seemingly relentless decline.

Now, a convergence of forces is weighing on petro-rulers' nerves: Europe's economic crisis; a slowdown in Chinese growth including the demand for oil; a steep decline in U.S. oil consumption with a simultaneous rise in domestic oil production; and a determined effort by petroleum colossus Saudi Arabia to build up global inventories.

It is perhaps the last data point -- Saudi Arabia's aggressive actions to lower prices by pumping some 10 million barrels a day -- that might seem baffling given Riyadh's economic stake in the oil game. But Verleger, the Colorado-based oil economist, says the Saudi rationale is clear, and linked to the kingdom's traditional long game.

In an email exchange, Verleger pointed me to an interview he did a few days ago with Kate Mackenzie at the Financial Times. First, he explains, the Saudis are out for blood when it comes to fellow petro-states Russia and Iran, the former for failing to help calm the fury in Syria, and the latter for refusing to go to heel and give up its nuclear ambitions; in both cases, the Saudis think lower prices will produce a more reasonable attitude. In addition, Saudi Arabia is terrified of a current U.S. boom in shale oil; it is hoping that lower prices will render much of the drilling in North Dakota's Bakken Shale and Canada's oil sands uneconomical. Finally, the Saudis are well aware that low oil prices helped to turn around the global economic downturn in 1998 and 1999, and they hope to help accomplish the same now, and perhaps win new affection from the world's leading economies.

Meanwhile, though, Verleger thinks that oil prices will crash. Markets overshoot when one is trying only to fine-tune them, as the Saudis are, he argues -- which is the basis for his forecasts of $40-a-barrel oil and $2-a-gallon gasoline by November.

To the degree that such fire-sale prices are long-lived, they could cause mayhem among petro-rulers. While Verleger thinks that the Saudis can maneuver prices back up when they want, the very nature of a crash demonstrates that markets can be uncontrollable. But the Saudis are willing to suffer the consequences, knowing that their own financial reserves (some $700 billion) give them staying power. "The Saudis are able to look at the long term," Phil Flynn, an analyst with Pricing Futures Group, told me.

Citigroup's Morse thinks that prices can fall further from where they are now, but not as low as Verleger forecasts because, he told me, today's market conditions are different from 2008 -- the decline in demand is not as steep, and inventories are not as large. Morse calculates that Brent can fall into the $70s-per-barrel range and U.S.-traded oil into the $60s-a-barrel range. "There is a good chance Saudi Arabia continues to produce enough to force [a rise in oil inventories]. And there's a good chance, between Europe and China, that demand growth could come to a halt," Morse said. OPEC might respond by reducing production, but its actions would be late. "Add to the scenario no more supply disruptions (or only modest ones) and no military conflict involving Iran," Morse said, "and prices could fall another $20 a barrel fairly easily."

Low oil prices can have serious social impacts simply because, with less free cash, people tend to start more closely scrutinizing their surroundings -- and when they become unhappy with what they see, they start looking for a scapegoat. The conditions that led to the string of Arab Spring ousters were not so much the lack of democracy as widespread public dissatisfaction with personal economic prospects. Analysts see similar vulnerabilities for the rulers of Iran, Russia, and Venezuela; when Venezuelan President Hugo Chávez can no longer milk the state oil company for public payouts, for instance, his political support could be in jeopardy.

Not everyone thinks the times will be so brutal for petro-rulers. Neil Beveridge of Bernstein Research told me that conditions may push down prices as low as around $90 a barrel, but no more than that. And the Energy Information Administration (EIA) on Monday estimated oil prices in the second half of 2012 at $95 a barrel.

The latter would be a heart-in-your throat, 10 percent plunge from the EIA's previous forecast. But it would be nowhere near the cliff that brings cold chills to the world's petro-rulers. As for my mom, either of these outcomes will make her merrier cruising the 405.

Miguel Villagran/Getty Images


Does Obama Have a Strategy for Africa?

Not yet.

Africa responded with joy when Barack Obama was elected. There was dancing in the streets of Liberia. Kenya declared his inauguration a public holiday. When Obama visited the continent in July 2009, far earlier in his term than the handful of other U.S. presidents that had actually traveled to Africa while in office, expectations only continued to rise. Obama's major address on Africa policy, delivered in Ghana, was generally well received, with African politicians across the spectrum broadly reassured by its themes of self-reliance and good governance. Many Africans (and many American Africa experts) assumed that, with a father born in Kenya, Obama's approach to Africa would be transformative.

Yet a number of forces, and some of the president's own decisions, have conspired to make this president's approach to Africa look a great deal like business as usual. Notably, Obama has put capable career officers in charge of the Africa bureaus at both State and the U.S. Agency for International Development. Putting career officers rather than hand-picked political appointees in these plum slots was a curious move, and virtually ensured that caution would be the watchword of our approach to the continent. (U.N. Ambassador Susan Rice certainly counts as a heavyweight political appointee with loads of Africa experience, but her portfolio on New York is so broad that she is no position to manage day-to-day Africa diplomacy.) The assistant secretary for Africa, Johnnie Carson, is a seasoned professional, as is Earl Gast at USAID. Carson was certainly a vast upgrade from Bush's assistant secretary for Africa, Jendayi Frazer. Frazer, a political appointee, all but left the bureau in smoking ruin, according to a highly critical Inspector General report issued shortly after she had left office.

But here is the rub: Political appointees tend to gravitate to the extremes in the bureaucracy. They can be either really good or really bad at their jobs. Able career officers like Carson and Gast run the show well, avoid obvious mistakes, and make sure they don't get so far out in front on any given policy that it will be a career-killer when the next administration rolls around. It is not a bad formula for governing, but it is not a recipe for delivering new or entrepreneurial policy, and particularly not in a region that struggles to get the attention of senior policymakers even on the best of days.

The lack of political muscle at State and USAID on Africa has come at a time when the Pentagon is increasingly active across the continent. The Pentagon's Africa Command, known simply as Africom, is well-resourced (established in 2007, Africom already has more personnel than the total number of USAID international staffers working on the continent), and wading into policy debates in ways that the Pentagon rarely did in the past when it came to Africa. Private discussions with military officials from both countries suggest that Pentagon encouragement was key in prompting Kenya to break from its traditional practice of regional military non-intervention last year and invade Somalia as part of an open-ended commitment to crush al-Shabab militants using that country as a base. Just this last week, the Washington Post ran a front-page feature on the Pentagon's disquieting practice of relying on private contractors "to spy on huge expanses of African territory."

Again, we bump up against some of the limits of the president putting career appointees in his key Africa slots. Few career officers are going to lock horns with the behemoth that is the Department of Defense over Africa policy, even at moments when that policy appears to be driven more by short-term security imperatives than a long-term vision for economic and political growth on the continent. The U.S. military has done a superb job hunting down extremists in Africa, but as a sometimes eye-popping six-part feature in the Military Times made clear, the Pentagon brass often acts with only a very limited understanding of the continent's complicated history and local politics. (As one military officer in charge of targeting in the Horn of Africa told the author: "We didn't understand the culture, we didn't understand the people ... in a real sense we didn't understand the players and how they related in the various organizations inside the various cities in the Horn.")

That also underscores a broader point about why Africa has been less of a focus for the administration. With ongoing conflicts in Afghanistan, Iraq, Pakistan, Syria, and Yemen; a eurozone still on an economic knife's edge; the Iranian nuclear program; and deeply unsettled transitions across the Middle East, the administration has not had a great deal of extra bandwidth with which to work. Coming up with a sweeping new policy vision for Africa has doubtless felt like a luxury in the daily grind of waking up to multiple front-page international crises. No administration will ever admit to being distracted, but this one has better reason to be than most.

The administration did release a new Africa policy last week. You can be forgiven if you did not notice; its rollout was discrete to the point of stealth. Some water cooler speculation posited that the policy had been rushed to press to help mitigate fallout from the aforementioned Washington Post report on contractors conducting surveillance across the region. Others noted that Africa is the only region in the world where a U.S. president could wait until June of his re-election year to announce a new strategy without setting off howls of protest or attacks from rival campaign surrogates. The policy itself, with its emphasis on trade and democracy, is sensible and bland (sample: "The United States will partner with sub-Saharan African countries to pursue the following interdepen­dent and mutually reinforcing objectives: (1) strengthen democratic institutions; (2) spur economic growth, trade, and investment; (3) advance peace and security; and (4) promote opportunity and development"). It sounds a great deal like similar policies announced under Presidents Clinton and Bush.

Obama's request for expedited authority from Congress to consolidate and reform the six U.S. trade promotion agencies and create a one-stop-shop for American businesses looking to do more business abroad probably would have more impact on Africa than any other region. That proposal, however, appears to have disappeared without a trace into the fevered partisan swamp that is Capitol Hill these days. U.S. companies, some of which view Africa as primed for explosive growth despite its many market inefficiencies, worry that America is simply not looking far enough over the horizon and providing an attractive alternative to the Chinese capital that is flooding the region in mercenary exchange for access to natural resources.

Africa's continued growth has been a good news story in an era of grim economic news. At least 12 African countries have seen their economies expand by more than six percent a year for six or more years, according to the Economist. That, more than anything, argues why a truly transformed approach to Africa is vital. The continent is accelerating toward enormous change even as America's instruments of diplomacy, development, and defense still lack a master plan for assisting this change.

That said, continuity in America's approach to Africa is not the worst thing in the world, and the Obama administration has done a solid, workmanlike job on the continent. But truly transformative diplomacy will have to wait for another day.