Geopolitical landslides Around Georgia

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Emzar Jgerenaia

„There is a resemblance between tragic persons of Batista and Yanukovych?!”
Sergey Chernyshev

After 70 years allies and Germany met each other face-to-face once again in Normandy; Germany and Russia have exchanged the roles. Now West has to struggle with Russia and save the world. Will the landing force be successful against the enemy this time too?
The political temperature reaches maximum, and not because there are local elections and anybody cares who steps on the scene. No, everything is clear here – Dream will win almost all the sits for Governor and Mayor Elections. Representatives of parties of National Movement and Burjanadze will have about 10-10% in the Sakrebulo, and the grumbling regarding elections will be overlapped by the agiotage of concluding association agreement with the EU on 27th of June.

Europe’s recent elections and arguments around it aren’t decisive either. It’s true that the supporters of deepening European integration could not receive the majority of votes, but German/French Europe will contradict to Cameron/Hugarian alliance and turn the ship into the right direction. Elections of the president of Ukraine were not unexpected as well as unprecedented 3-day elections in Egypt. The rising of common global politico-economic temperature is related to the expectation what would be the next step of Putin who is longing to be the second Stalin, Ermakov or Cathrine the Great.

Pretty smart people in Georgia and abroad are claiming that Putin defends Russia and builds an iron fence around so that Moscow not to face the Ukraine’s fate. These people also argue that Russia always used to win in the war with the West and it will win this time too with the help of China; that the west is captive of stagnation, debts and heavy social liabilities; West needs Russia for its oil and market more than Russia needs the West, therefore, it is not afraid of sanctions. But another part of the society, with whom I strongly agree, reckons that – Putin is doomed and it will be a beginning of new Russia.
Hun tribes were attacking the Chinese people and the latter built a huge wall, which has nothing special about it except for the size and the fact that 100 thousands of Chinese were buried in it and still it was unable to save China. Not because Huns conquered it. No, the Huns divided into two and moved to the West, went through Siberia, current Ukraine and the Central Asian territories, Europe and almost conquered Rome. Their leader, Attila was standing at the Roman outskirts and did not enter it. Instead he went to the Atlantic and somewhere in the middle of France, in 451 he was defeated in the struggle with Rome, which was also in poor state. China was defeated by internal crisis and not Attila. The reason of the crisis was that China spent all its resources in the war with the Huns and the construction of the wall and not in solving domestic economic problems. China has opted for self-isolation and, eventually, it became victim of this isolation.

Similarly, the protecting and isolating walls were built around its dominion by the Roman Empire: the military ports, fortresses, retaining walls, but it did not help, and it was destroyed by the northern tribes, while the South East part of Byzantium – was demolished by Turks with the help of Christian Crusaders. But I can say that Constantinople was destroyed by its own internal economic problems.

There are a total of 5 centuries that Russia exists and the fact that so far it’s been always winning is a complete nonsense and demagogy. Byzantium and Rome were winning in the course of 8 centuries as well. Empires are born, evolve, reach its peak and die. This is not the peak for Russia, the peak was during Stalin’s time. Now it has Bear’s trend. Since 2001, it has made slightest adjustment, but they were false and very short-lived corrections. Now it will definitely return to the Bear trend.

Modern Russian philosopher Sergey Chernyshev writes that Russia’s primary enemy is not an antimissile system and NATO’s broadening, but drop of economic growth pace. In addition, it should be noted that labor productivity in Russia is 20-times less than in the U.S. and 10-times less than in Europe. On the one hand, there are some of its citizens and the government enriched with “easy” money, including Putin, on the other hand, there is an extremely depleted emotional people of Russia, 70% of which might be happy with the Crimean occupation, but I’m sure in light of tomorrow’s hardship that will follow this horrible predatory imperialistic step people will say – why the hell we wanted this, we’ve got our comeuppance!

Russia, its government and people, Putin himself, have only one enemy – the economic downturn. In this case, the West can play crucial role by means of declared or non-declared sanctions. Russia is actually funded by the West as 70% of its income is derived from energy export.

Myth 1 –Russian people can endure all hardship. Russia is not fully engaged in the performance of exchange of stocks and economic cycle and market twists and turns do not fully affect it.

Thus is not true, as Russia and the world have changed over time. Russia has huge debts of the West:

1. Firms;
2. State;
3. People.
According to the Agency for Housing Mortgage Loans, (Expert 8, February, 17 2014, p.4), the population in 2013 took credits in amount of 2.65 trillion Rubles for the construction of apartments and almost the same amount of consumer credit. It’s about 90 billion dollars, or 50% of the entire balance of payments surplus. In total, according to the Central Bank data, the crediting of the population by April 1, 2014 reached 116 billion Rubles. Therefore, any economic downturn, loss of jobs and decline in living standards – will cause serious dissatisfaction and social tensions. The Russian people were not bothered with this before, and it was indifferent to economic fluctuations, endured poor conditions and poverty.

In the beginning of 2000ies, when Putin came to power, as the legal successor to the Soviet Union immediately repaid the 15 billion dollar debt, and thus in his opinion became independence from the West. But in the first quarter of 2014, Russia’s state debt reached 77.8 Millard dollars. Of this, 298.2 billion dollar debt belongs to state companies and banks (such as Gazprom, ZberBank or VTB), 351 billion to private companies and banks. Russia’s total foreign debt amounts 727 billion dollars, that is – 37% of GDP. Almost immediately after Ukrainian events Russia’s state rating was reduced according to S&P estimates to BBB, which is close to the trash category. In addition, interest rate of bond coupons, nominated in Euro increased from 4% to 6%, which means that Russia will have to pay more and more for their service. Despite the fact that Russia has USD 180-billion balance of payments surplus, inflation – 5-6%, and Russia’s budget deficit and debt target indicators are better than that of Brazil’s, due to these sanctions, and future expectations its rating is much lower than of Brazil’s.

According to IMF data, Russia has attracted investment of USD 400 billion in 2011-2013, with an average of 133 billion per year. This equals to about 7% of GDP in this period. Given that 43% of investments are from offshore-registered companies and only 10% is from G-7-countries, this might damage Russia seriously. Investment hunger is expected by the end this year. However, the country needs investments of 150 billion USD in order to maintain 6% – growth and life conditions of an average European country in 20 years.

Therefore, Russia cannot withstand Western pressure now and in the next 3-4 years, great changes are awaiting for it, myth of its invincibility will be destroyed.

Myth 2 – Partnership with China, i.e. Russia discovered Europe’s alternatives. However, in reality, this is blackmail against sanctions. Putin and Miller visited China in May, and allegedly finished 10-year negotiations on gas supply and its price. As “Expert”‘s publications reports (author Pavel Bykov), they signed a century agreement with CJU Cipin. Primary issue of this contract was construction of gas processing plant near Belogorsk, where it will be possible to obtain 2.4 million tones of methane from mixtures polyethylene and ethanol. According to the Russian side, this is similar to world’s giant projects like Dow Chemical and Saudi Aramco. However, in Tobolsk the company “Sibur” developed similar project. In addition, they agreed on the idea of building a pipeline and ​​Russia plans to build a pipelines trough most difficult area of Lake Baikal-Amur by 2018, that according to all the experts, to say it mildly, is a fairy tale.

The main issue is gas prices, prime cost of which is $ 270-290 per 1,000 cubic meters, and Russia sells it to China for $ 330-380, but the latter has not signed this agreement yet. China is waiting for a lower price; and while speaking of Russian – Chinese masquerade, I recalled gas and oil prices, which is the last and only support of Russia. Russia is losing this only foundation, that becomes the main cause of the disaster.

According to experts, the oil market is experiencing the year of 1979. Price drop is inevitable. Now the main thing is, the price falls to $60 or $80 will be maintained. In recent years, cost of oil production has increased, and is therefore of great contradictions between OPEC and developed countries. OPEC’s reserves are growing, as well as consumption of Canadian shale gas and bitumen. The world oil market is entering stagnant period. China is a wise country, it needs West like a fresh air, and in spite of having competition with it, China will not and cannot play Russia’s game. The second myth is ruined as well.
Myth 3 – The West is so dependent on Russia for energy, it cannot go against Russia.

The level at oil market – the liquid hydrocarbon production growth, along with energy efficiency, already satisfies the world oil demand and forces OPEC countries to lower supply or increase reserves. The world oil market is entering a long period of stagnation.

The factor preventing price growth and playing crucial role in long-term price reduction will be excess supply of oil on the market. Since 1999, in the course of 15 years, the market price of oil was at least twice as high as the average cost of production.

Consistently high and rising prices caused launch of processing of significant reserves, which were previously considered unprofitable. Also, the growth of costs led to the intensification of extraction. The whole number of countries was able to provide market with new, significant volume of oil and gas. Shale gas revolution in the United States -the result of gas price reduction (from 550 to 70-150 USD per thousand cubic meters) draw attention of producers of shale gas reserves to shale oil production.

Canada began active producing and processing of natural bitumen. Australia started to explore ways to production of shale gas liquefaction. According to the forecast, in 2017-2018 the country becomes a world leader in the export of liquefied natural gas and thus overtaking the present leader – Qatar.
At the same time, we can see Brazilian Shelf and opportunities of considerable production growth in Africa. In the course of five years, Mexico can become an active player of world oil market, even though it has not been considered as a prospective player yet. In addition, the active exploration and development of hydrocarbon reserves have begun the countries such as: Italy, Great Britain, Hungary, and Romania. This tendency has reached such considerable scales that despite increased oil consumption in developing countries, additional volumes produced exceed the consumed volume. The oil prices have become stable and even started to decrease. With this Russia is facing huge problem, in addition with cancelation of South and North stream projects. As for shale gas, Russia has missed the opportunity of leadership, both in Arabian Peninsula and Iran. However, various circumstances (Arabic revolutions wave, Libya’s civil war and production fall, tensions between Sunni and Shia states, Syria’s civil war, the real dangers of war in Iran and Israel, as well as an embargo on Iran’s oil exports) did not allow prices reduction. It’s hard to imagine that all the events have happened in the same region in the course of the last two years, with high concentration of oil production, but there has been no dramatic increase in price, let’s say at least $ 150 a barrel – oil prices have remained stable at about the same level.

The rapid growth of production in countries that previously were not serious players in the global oil market and its growth prospects were balanced by the unstable political situation in oil-producing region. However, this equilibrium is much more fragile than it appears at first glance.

World economic growth factors and oil price.

Growth of production is not the only reason that could lead to a significant drop in world oil prices. First of all this will be supported by developed of high-tech multi-step processing. Simple distillation of oil results in a significant amount of small waste of petroleum fractions and heavy waste of crude oil – mazut and tar, which contain long chain of aromatic hydrocarbons and are just used in production of asphalt, fuel oil, etc.

However, it is possible to process this heavy waste through “dissolving” the long chains of aromatic hydrocarbons, for which various machinery of cracking and reforming is used. In light of technological developments, it is possible to obtain 90% volume of light oil and increase the total volume of recycling up to 97%. In this case, it is possible to obtain more oil products from 1 ton of crude oil at the expense of deeper processing. In the energy statistics of the United States there is a separate graph referred to as “deep-processing profits” and extra 1 million barrels of light oil can be produced annually.
Of course, the depth of oil refining in developed countries today is quite large, but the developing countries have a growth opportunity. Secondly, the high oil prices were resulted in a series of state economic programs in the fields of – energy saving, stringent ecological requirements to vehicles, industry and communal households. Moreover, both energy-dependent as well as independent countries become involved in this.

Demonstrative example of this is the United States, where the program of energy saving and reduction of dependence on oil imports until 2020 was adopted even before increase in oil production (one of the promises of Barack Obama’s pre-election campaign). Thanks to this and previously implemented programs, the United States has been able to dramatically reduce oil consumption – from 939 million tons in 2005 to 819 million tons in 2012, i.e. 120 million tons per year. The same reduction in the volume of consumption has been achieved in the European Union as well.

Thirdly, a massive development of various alternative energy technologies has began around the world. In light of low oil prices many of them were considered economically inexpedient, but work in this direction was not ceased on political grounds.

For example, Japan was financing research program on methane hydrates for 18 years, which is located on the seabed, and last year its production was launched. The government declared that it will start industrial production of raw materials within future five years. China has been so successful in production of photovoltaic elements (solar panels) that it lowered the world price twenty times over the past two years. In addition, China is actively building a coal gasification plants and attracts U.S. companies for processing non-traditional sources.

South Korea, which has its own energy sources, has decided to develop the most available source and is actively developing its high-efficiency coal combustion technology, which can achieve 65% efficiency. Russia is on the same trail and is actively developing its nuclear technology and soon, presumably will be the first country that will be able to close the nuclear cycle and launch a cost-effective processing of fuel from nuclear power station. The combination of these three factors and oil production growth lead to decreased oil prices.
World with its fuel prices now resembles the one in 1979. Six years before the crisis there was an assumption that sharp decline in oil prices – 60 dollars per barrel – is impossible because the price level, which provides the Petroleum Exporting Countries with a budget without deficit is significantly higher than that margin. However, this point of view, which has been just for the last 10-12 years, will be losing its urgency as the oil market transforms from “seller’s market” into “buyer’s market”.

Even one or two years ago, in response to falling oil prices the oil producers were actually able to cut the supply, which would allow them to restore satisfactory or even higher prices in quite a short period and avoid significant losses without losing significant share at the global marketplace. Now, reduction in supply might restore the prices, but market share will be lost.

Gross revenues of oil exporters will start to reduce anyway – either due to falling prices or physical decline delivered volume. According to approximate estimation, in the light of current oil prices the independent producers can supply additional oil to the market up to 0.7-0.9 million barrels per day. This means that if oil prices fall, let’s say to $80 per barrel, OPEC decides to implement quotas and existing supply will be reduced to 2 million barrels a day. Thus, during the year 0,7-0,9 million barrels of daily consumed oil will be supplied from OPEC non-member countries. Over last two years the world’s oil refining capacity amounted approximately 0,4-0,5 barrels per day. Therefore, an indicator, such as non-deficit oil prices for OPEC countries, is losing its relevance.

In BP’s recent overview of the energy situation in the world, the company’s analysts point out that up to 2020 reserve powers of the OPEC countries will be increased up to 7 million barrels per day and this will become a serious test for OPEC. The experience of the past decade shows that even with a relatively small amount of reserve capacity of OPEC, still the oil price was subjected to significant pressure from the stock markets. But we must remember that OPEC’s every attempt directed towards maintaining oil’s current high price only encourages search for and development of alternative technologies and suppliers. Of course, the price downturn might be hindered by the situation of financial markets – raw material markets have long become an integral part of it. Stock speculators can make the drop milder, but it is impossible to avoid it.

At some point it’s not excluded that they start to play on its reduction. On the whole it cannot be ruled out that today we are in 1979-80ies situation and, as in 1986, 6 years separate us from drop of oil prices.
Antithesis

According to another opinion widely circulated among the experts the significant drop in oil prices is impossible considering the high prime cost of producing non-traditional hydrocarbons (including shale, hard sandstone oil and high viscosity of bitumen oil).

Here are two things that are taken into consideration. First – development of unconventional hydrocarbon production technologies started in the conditions of highest oil prices, but these technologies were developing and now there are new technologies with a relatively low prime cost (that was supported by the failure of oil prices in 2009).

Second – hydrocarbon production is quite capital-intensive process and relatively major part of its prime cost is unrecoverable capital expenditures. After cutting the well the owner has no other way; if revenues from sold oil cover the operating costs he continues pumping of oil and incurring losses. Moreover, such entrepreneur will do his best to reduce operating costs and make the project profitable that becomes impulse for development of whole branch.
This is exactly what happened when gas prices fell six times in the U.S. A similar situation is observed with regard to the processing of bitumen oil deposits in Canada. If the oil pipelines, railways, ports and terminals have been built for oil transportation, they will be refining and transporting oil, even though the overall investment project may be unprofitable. Of course, in terms of low prices and the unprofitability of the project, new investments will not be made in non-conventional hydrocarbon processing, but the investments that have been already made in the field cannot disappear, and they will provide maximum opportunities for the supply of hydrocarbons to the world market. Though all this will be accompanied by a wave of bankruptcies, but will not prevent continued operation of built capacities – after change of owners and/or debt restructuring.

A clear example of this is gas production in the U.S. The boom in this field began when a gas price was $ 550 per thousand cubic meters in 1 (2007-2010), and production costs were under $200. When in the last two years gas prices reduced to $70 per thousand cubic meters (10.6 dollars per barrel of oil, respectively), and remained within this range about a year; the field did not stopped and continued production and become stable only last year. It’s not so bad considering that he price was reduced three times the compared to initial cost.

What can be the potential of reduction in oil prices, which will not result in a significant reduction of market supply? Barrels of high-viscosity oil from western Canada is sold for about 20 dollars cheaper than the Texas WTI-mix (i.e. 70-75 dollars per barrel), because there is no infrastructure for its handling and processing.

Another example -in the U.S. the price of local shale oil of different quality – before launch of a new railway and pipeline capacity in 2013 was about 50-60 dollars per barrel, because the transportation of raw materials from the place of production through traditional pipeline and railway was impossible. However, despite the price and the lack of infrastructure in the U.S. – the oil field for 2 years experienced non-stop growth- each year showing about 50 million tons production growth. Considering these factors, the level of profitability of shale gas production in the U.S. may be around 40 dollars a barrel, while in case of the high viscosity Canadian oil – 50 dollars a barrel. Average cost of production of hydrocarbons from traditional sources is about 15 dollars per barrel.

Players’ plans

The United States – is going to increase the volume of oil production in 2014. Meanwhile, the U.S. government this year is likely to cancel 40-year ban on oil exports because such restrictions inhibit the sector’s development. The start of exports from U.S. is expected to increase domestic prices by $10 a barrel and decrease world prices by $ 5 a barrel.

Canada. This country significantly slowed down the growth rate of oil production, however, it has a greater opportunity for growth than the U.S. The main obstacles are infrastructure limitations and necessity of shifting export flows from the south (U.S. market) to the west (Asia – Pacific Region), which requires construction of new oil and gas pipelines, ports, terminals, railways for liquefying gas and pumping oil.

The U.S. government has blocked construction of new cross-border pipelines due to ecological threats, which could have ensured exports of Canadian hydrocarbon. Canada’s oil production was focused on supplying the southern neighbor, but now it hinders national oil production of the U.S. Now the project which considers construction of oil pipeline from Albert province to port Kitimant on Canada’s west coast goes to public hearing. It will be launched in 2018. Completion of the pipeline without any doubts will lead to leap in Canada’s oil production; By this time it is expected to see Canada on Asian markets of liquefied natural gas and oil.

Mexico. The current government of Mexico has developed a cross-party consensus, as a result of which in December 2013 country’s constitution was amended and restrictions on the participation of foreign investors in oil and gas projects were cancelled. Mexico’s geological reserves allow it to not only double oil production in the coming 20-25 years, but also triple it. In this perspective, we expect increase of oil production by 7-10% per year – over two years. However, analysts do not make long-term forecasts about Mexico.

Africa. Here’s in comparison to 2000ies relatively little success has not been achieved. High oil prices resulted in formation of local business and financial capitals (Lagos, Addis – Ababa, Nairobi) with modern infrastructure. The strong growth trend is expected due to exports of different raw materials – including hydrocarbons. Although some internal problems persist in Congo, southern Sudan and the Niger River valley, but the investment made by China in exchange for resources enables to change the continent’s economic landscape drastically in current decade.

South America. A major player, on which depends additional supply of Latin oil to the world market is Brazil. The country began a very deep shelf oil production, that should bring results in the current year. Supply capacity in 2014 will be negligible, but within 5-year term Brazil can start supply of 2 million barrels of oil to the world market per day. In addition, development of oil production in Venezuela, which has the largest oil reserves in the world, has now reduced to only 120 million tons per year.

Trend of decreasing Russian influence and the Persian Gulf countries. Due to embargo Iran has significantly reduced export supply in the world market, but after abolition of sanctions, it is ready to boost oil production a day by 1.3 million barrels. Iraq is going to boost production to 0.5 million barrels a day already this year. As regards fall of oil production in Libya due to turmoil it is expected to be overcome by 50% already this year, which means an extra 0.5 million barrels a day will be supplied to the world market by the country. In addition, the ongoing negotiations between Saudi Arabia, Iran, Iraq, and Libya regarding distribution of quotas on production may be an indicator of long-term behavior of the cartel, since it requires reduction in production not from just individual participants, but from the entire organization.

Predicting oil prices is rather ungrateful activity and depends on many opaque, often more political than economic factors. It gives opportunity to make the high reliability forecast. Even if the sharp fluctuations in oil prices in the near future does not happen, but it falls to $80 – this will be enough for the collapse of Russia. Generally, the market dynamics will go downturn in the course of next 10-15 years. This could become a great challenge for the Russian authorities, because it is the beginning of an internal collapse and awakening of Caucasian volcano. Georgia will automatically receive territorial integrity and NATO membership.