Date: 03/27/22
Author: Kent Moors, Ph.D.
This has been an unusual week. It began with a call from a former colleague requesting some quick assistance in designing counters to the latest Russian hydrocarbon trading moves. It ended with some of that advice making its way into proposals made by the US delegation in Brussels.
In all of this, one matter is becoming clear. Moscow is finding it difficult to evade the Western sanctions and is realizing that what it regarded as its strong suit (outside dependence on its crude oil and natural gas exports) is less compelling than earlier thought.
As I observed to Sigma Trader and PRISM Profits subscribers in Friday’s weekly portfolio reviews, several developments related to a more desperate attempt by Moscow to deflect Western sanctions have emerged. While those sanctions will still take some time to have their most serious impact, the implications for forward crude oil and natural gas export contracts are already on the horizon.
In response, two moves by the Kremlin surfaced this week, one widely made public, the other occurring more in the penumbral area surrounding the combat over sanctions. The public decision has exporters like natural gas giant Gazprom and state oil major Rosneft requiring that all purchases of oil and gas be done only in rubles.
This would require that trading partners keep rubles in reserve for forward payments on consignments, while likewise allowing the Russian Central Bank (RCB) to support artificially the value of the domestic currency by setting favorable foreign exchange rates. The idea is to use hydrocarbons as a way of allowing the RCB to benefit in a way similar to what has taken place with the US dollar.
Since 1974 just about all global oil trade became based on the dollar. From that point on, prices per barrel were quoted in dollars, regardless of where the transaction took place or whose oil is involved. That meant an increasing amount of dollars had to be held in foreign banks to finance these transactions.
The age of what became known as petrodollars was borne. For the past 48 years, substantial amounts of dollars have been held in foreign bank accounts to facilitate the trade with the domestic currencies of producing and purchasing nations requiring increasing amounts of foreign hard currency (i.e., dollars) to facilitate exchange.
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The dollar had become the de facto global trading currency in the aftermath of World War II anyway, with the decision by the Nixon Administration to cut the currency from the gold standard being the final stage. Increasing amounts of assets, both financial and physical, were held in dollars around the world. That made it both a currency of choice and a ready base of liquidity. Both of these provided an apparent sense of stability and security to global financial networks.
Until, that is, the global credit crunch hit in 2008-2009. What had been the underpinning of a rapidly expanding network of financial transactions underwent a painful contraction as dollar-denominated assets worldwide suffered from an American collapse in subprime mortgages.
The aftermath has prompted some to look for alternatives to the dollar in energy transactions and some attempts in that direction have emerged. But once the smoke cleared, petrodollars remained as the primary foundation for trade.
Throughout, the US has been benefitting from something called seigniorage. The term refers to the advantage flowing to a government from the use of its currency. In the case of petrodollars, this has extended that advantage to every corner of the globe. It also has had another plus, one that has caught the eye of policymakers in Beijing (where a move to use yuan in energy transactions is emerging) and Moscow (with this week’s demand for trade denominated in rubles).
As long as more abroad need to keep your currency in their bank accounts to serve as a barometer of trade, and that currency does not repatriate (that is, it does not flow back to the domestic economy), it is not inflationary. A nation can then print more money and so long as it does not come back it is not contributing to national inflation.
Of course, this also requires that two other matters occur: there needs to be robust trade in other commodities and products also denominated in your currency; and international banking networks need to have a reason (beyond fiat) to hold your currency and develop a liquid exchange market in that currency. When it comes to the ruble, neither exists, with the cutting off of Russia from the global interbank SWIFT system precluding any emergence at this point.
No other nation would want to incur the wrath of sanctions. That would include the Chinese, the only other major international market player Moscow could use to pull this off. Most importing nations are thus far resisting the use of ruble demand.
The second Kremlin move has been below the surface. There are now indications arising in several quarters that the Russians are resorting to crypto currency as a way of bypassing the dollar basis of international banking. At least some of the late week improvements in the four indices I regularly review may be early indicators of this new wrinkle in the crypto market.
As I observed to subscribers Friday, all four are exhibiting stronger positive performances for the current rolling week daily average (adding the most recent closing value, deleting the earliest) than for any week in the last two months: Bitcoin USD (BTC-USD) 7.71 percent; Ethereum USD (ETH-USD) 6.95 percent; the broader CMC Crypto 200 Index (^CM200) 7.19 percent, and the meme Dogecoin USD (DOGE-USD) 9.48 percent.
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But remember, until there is an open and liquid market for crypto as the purchasing vehicle for a widely traded commodity like crude oil or natural gas, there will remain a roadblock to its seamless use as a surrogate for dollars.
The third development connected to the Russian use of hydrocarbons as a sanctions busting tool was the major counter announced Friday morning from the allied meetings in Brussels. The EU has agreed to ratchet up purchases of US oil and gas to offset weaning from Russian sourcing.
Setting up the background to this announcement is the point at which my efforts became involved. To make a policy commitment is one thing. To be able to carry it out is quite another.
Currently, there is not enough excess capacity available to make up for what Europe imports in Russian product. The EU is on record as committed to reducing dependence on Moscow oil and gas by two-thirds before the end of 2022. Nobody (including yours truly) understands how they will accomplish such an historic shift. Additionally, there will be a demand for significant upgrades on both ends (US export and EU import capacities).
So here is what is likely to happen, progressively rolling out over the remainder of this year. A system of contract swaps will be introduced in which a combination of existing conventionally pipelined consignments and liquefied natural gas (LNG) shipments will be involved. This will require some creative rebooking of trade from some locations to others. For that to work, adequate substitute sourcing needs to be identified or (as likely) moves into reduced usage initiated.
The gambit will see a temporary return to increasing coal usage and an expedition of renewable sources like solar and wind power into an already developed European hybrid system. This is not a broad-based reinvention of the wheel. Some proponents would like to see that (filed under the “necessity is the mother of invention” approach). But there is simply not enough time.
The situation demands a patchwork and eclectic approach with the “bigger picture” emerging later. Two conclusions, however, are already set.
First, Russia’s position in international energy trade will become smaller in what will be a very changed market. The Kremlin’s options are shrinking.
And second, my subscribers are already positioned to profit from the change.
Dr. Kent Moors
This is an installment of Classified Intelligence Brief, your guide to what’s really happening behind the headlines… and how to profit from it. Dr. Kent Moors served the United States for 30 years as one of the most highly decorated intelligence operatives alive today (including THREE Presidential commendations).
After moving through the inner circles of royalty, oligarchs, billionaires, and the uber-rich, he discovered some of the most important secrets regarding finance, geo-politics, and business. As a result, he built one of the most impressive rolodexes in the world. His insights and network of contacts took him from a Vietnam veteran to becoming one of the globe’s most sought after consultants, with clients including six of the largest energy companies and the United States government.
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