Why Putin Will Push Us into the Lava

March 11, 2022

Hey um . . . these charts are a bit odd.

What?

Global inventory charts. They shouldn’t be like this.

What do you mean?

Well, draws like these shouldn’t be happening now. This time of year.

Yeah. Odd. So what’re you thinking?

I don’t know. What if my son is right? The floor is lava?

Because think about this.

Right before the invasion, oil prices were climbing steadily higher on the back of draws. Draws that shouldn’t be happening during the slower winter season. Yet, keep fast forwarding, and we again see this chart.

Inventories are drawing at nearly the same pace as they should during the high demand season (summer/fall). Okay maybe it’s a data blip. What if we pulled contemporaneous data for 1/2 of OECD inventories. Subscribers know we’ve been tracking that for awhile.

Nope same thing. The average is about a 2M bpd draw in the last 4 weeks.

So what’re we saying? Well . . . again, the floor is lava.

Said another way, even if the geopolitical premium were to fade, the floor for oil prices would still ~$100/barrel. Hence while we trade above that, as each day passes, the floor is moving higher, and we’ll increasingly hop off of the higher floor as we move into the spring and H2 2022.

What’s a bit frightening in all of this is that the Western sanctions of Russian barrels? Those sanctions have yet to officially begin. Sure traders and buyers have started shunning the barrels, but the real impact has yet to start. We’re closely watching Chinese inventories. If they’re the buyers of last resort, and are willing to acquire the Russian barrels over and above their normal buying patterns, Chinese inventories should increase as they hoard the cheap barrels. Similarly we’re looking at Russia’s inventories. Russia doesn’t have much storage capacity (we know this because even during 2020 when COVID peaked, Russian oil storage never vaulted higher), which means they were forced to eventually shut-in wells. For now both inventory levels seem subdued. Oil on water has leapt higher though, so if that doesn’t clear (or if it does clear) we’ll know if the barrels are clearing, being stored, or backing up to shut-in production.

If storage doesn’t climb, we’re almost certain Russia will be forced to shut-in production. So even if peace breaks out and Russia rejoins the international community, their production may not revert to pre-invasion levels as shutting-in fields adversely affects the pressure of the reservoirs and well productivity. Try tightening a Coke bottle after opening it, the pressure is never quite the same.

So although oil prices were hovering ~$93/barrel prior to the invasion, even if peace breaks out, the structural shortage is already roiling the markets. Oil prices should be ~$100/barrel with current inventory levels and draws. We are in an energy crisis, we are woefully short of supplies even without the invasion, and we will see demand and prices climb higher in the coming months. Short-term we’ll bounce along with the geopolitical volatility, but that floor is rising . . . and it’s lava.

Kleptocracy

Our thoughts this week also turned to Russia’s oligarchs and the country’s kleptocracy. Kleptocracy, as you know is when a few people in political power manage to steal public resources. Embezzling, misappropriating, and the outright theft of government funds and assets. Russia’s political system is essentially a kleptocracy, one headed by Russia’s President Vladimir Putin, a mafia don if there ever was one. Part of the West’s strategy to counter Putin’s attack on Ukraine is to tighten the economic noose around Russia, crater the economy and weaken his support structure.

To that end, the West has sanctioned numerous Russian oligarchs, and begun confiscating homes, yachts, and other tangible assets (all likely purchased using proceeds from ill gotten gains), in the hopes that they’ll voice opposition to the invasion and question Putin’s leadership. Regime change, plain and simple. Leaving aside the dilemma of confiscating without trial what are technically private assets (albeit likely misappropriated), or disproportionately impacting the Russian people for the actions of an autocrat, we pondered if the oligarchs would ever really turn and bite the hand that allows it.

Russia’s political system is designed so that the oligarchs pay-to-play. Essentially, bribing their way up the heirarchy. You set-up an enterprise and Putin becomes your partner. The more profitable you are, the more he takes. It’s an offer you can’t refuse because first, it’s literally an offer you can’t refuse, second, you’re using the country’s assets which he controls, and third, and pay attention here as this is very important, you gain “protection” from oh I don’t know, let’s call it the ever changing political/economic/PERSONAL risks in life that may just harm you.

If you’re an oligarch, you’ve already mastered this game. According to the Boston Consulting Group, the 500 wealthiest Russian individuals control more wealth than the poorest 99.8% of Russians. Russia’s largest exports are commodities, which means the wealth is largely derived from the land, public resources controlled by a few select private individuals. Much of the wealth, however, is held outside of Russia, invested in US Dollars, Euros, Swiss Francs, the British Pound. It’s also laundered/converted into other assets such as real estate, sports teams, yachts, art, cars, etc.

But that’s precisely why we’re sanctioning the oligarchs you say. Sure, but any good attorney can give you a pitch deck on shelters you’ve never thought possible. We know, we used to create them. Off-the-shelf companies, Cayman, Bermudian, Swiss structures, friends and family stand-ins, cutouts, partial interests, trusts, etc., there’s more ways to shelter income in this murky world than there are ways to stop it, so to a certain extent, the oligarchs are insulated from the collapsing economy and will never starve.

In fact if you invert everything, as Westerners flee the Russian economy and prices of Russian assets collapse, the oligarchs can scoop up the assets for almost nothing. More likely, Putin will nationalize the abandoned interests, giving him more assets to dole out in exchange for loyalty once the invasion ends. Wait . . . doesn’t he control the timetable of that too?

Interesting.

So as an oligarch, we wonder. Why would they ever turn against him? It’s a lose-lose proposition. This is a system that demands loyalty, and if Putin does succeed (i.e., by simply not dying), you can almost guarantee your disloyalty will be dealt with later. No one is safe. In the US, administration officials like to say “we serve at the pleasure of the President.” In Russia, replace “serve” with “survive.” Go against him and there will be repercussions.

At the very least, the Russian assets you’ve accumulated will suddenly shrink as the fiefdom granted is redistributed among Putin’s more loyal followers. They all surely have memories of Mikhail Khodorkovsky, who owned 78% of Russia’s Yukos oil company and was in the early 2000s one of Russia’s wealthiest men. Charged with “financial crimes” for purportedly funding opposition candidates, he spent 10 years in jail and subsequently lost it all.

Alternatively, why would these oligarchs help the populace oppose Putin? Doing so also means they’d inevitably lose their positions, assets and freedom as the new regime that follows will surely confiscate what is rightfully theirs and punish those rightfully deserving. Given the outcry and revulsion over Russia’s invasion, Western governments will likely facilitate the repatriation of assets. Even more likely? The extradition of the person . . . because remember, the very word kleptocracy is derived from the Greek work kleptes, which means thief.

So no, we don’t think sanctioning Putin’s cadre of oligarchs will succeed in deterring his actions in the Ukraine.

Putin’s Game Continues

Putin’s next steps will depend entirely on his military progress in Ukraine. If his forces bog down into a long, drawn out resource draining insurgency campaign, then watch-out. He will weaponize all of the assets at his disposal. Oil, gas, agriculture and metals. It’s his only way to gain leverage to negotiate a face saving/palatable retreat. In fact, that weaponization has already begun as Russia just banned a list of exports until the year-end (agriculture/minerals) and delayed the implementation of the Iranian nuclear deal (oil). It’s just the beginning because time is of the essence as his domestic economy crashes. Eventually we will negotiate with him because we simply value human life more than he does. Until then, he will make you feel as much pain as he feels.

Recently PBS Frontline aired a documentary about Putin and the narrator along with an interviewee said the following

“There’s a story in his biography that Putin tells about himself. It happened in this building where he shared a one-room apartment with his parents, and it involved a cornered rat.”

“He said that, I learned very good, I learned forever, don’t try to push somebody into the corner. They will jump. Because when you don’t have much to lose, you just attack.”

Make no mistake, this is one baaaad man, oblivious to the suffering of others. Cornered, he will jump . . . and take us with him into the lava.

Just don’t count on the oligarchs to help.

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