While the U.S. economy is reveling in low oil and gas prices, Russia is breaking down.
Over the last two weeks, it’s been playing military and economic shenanigans in a last-ditch effort to crawl out of the hole it largely dug for itself.
But from what I’ve seen, Putin is an emotional and fickle leader, meaning it’s very possible the country’s aggressive actions could escalate.
This could cause the price of global crude oil to spike – or crash. Which way will this already-volatile market go?
That Escalated Quickly
Russia’s recent erratic actions are concerning.
On December 12, an invisible (to radar) Russian surveillance plane nearly collided with a commercial aircraft in international airspace near southern Sweden. Russia denied any wrongdoing, of course.
But the incident exacerbated concern in the Baltics over signs of assertive Russian behavior in air force activity and displays of military prowess, including Russian planes regularly violating the national airspace of neighboring nations.
In fact, NATO officials are likening this period to the Cold War.
Also on December 12, the U.S. Senate passed the Ukraine Freedom Support Act bill, which requests further sanctions against Moscow and up to $350-million worth of military gear delivered to the war-torn Ukraine through 2017.
The bill would also permit Obama to punish Gazprom (OGZPY), Russia’s natural gas provider, if it holds back supplies to the Ukraine, Moldova, and Georgia.
The stricter sanctions would affect the numerous weapons companies that sell to Russia.
While it remains to be seen whether or not the Senate bill will pass, Russia’s Deputy Foreign Minister Sergei Ryabkov told the Interfax news agency that Russia “will not be able to leave this without a response,” pointing to vague countermeasures.
Backing that statement up, Putin plans to spend 3.3 trillion roubles on defense in 2015, despite efforts to adopt an austerity budget for next year. Russia’s defense budget is the third largest globally, behind the United States and China.
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Then, on December 16, Russia’s Central Bank tipped the scales in dramatic fashion.
In an attempt to spark capital inflows and save the ruble from sinking further, it made a drastic interest rate move, raising the key rate from 10.5% to 17%.
The move caught the currency markets by surprise. But in the end, it failed, with the ruble tumbling another 19% that day, versus the U.S. dollar.
The multiple economic sanctions imposed by the United States and Europe, coupled with the rate hike, will likely cause a sharp contraction in Russia’s already-frail economy, which could move the price of oil up or down.
So, Rally or Bust?
Prior to these events, Russia was already suffering from weak growth. Part of that is due to the ongoing Ukrainian crisis and Western sanctions, but Russia had also planned for $100-per-barrel oil in its 2015 budget.
Now, we’re approaching almost half that price… and oil revenue accounts for roughly 45% of Russia’s income.
Thus, military might, a collapsing ruble, crumbling oil prices, and more sanctions equal a recipe for disaster for Russia and its people.
Here are the two scenarios that could play out.
First, should accelerated Russian military activity wreak havoc in the Baltics, a rapid trend reversal in oil prices could result.
This is because, despite sanctions, Russia is still a major influence on the flow of crude oil.
Preliminary data for 2013 shows that Russia was the world’s third-largest producer of oil after Saudi Arabia and the United States, with average production at 10.5 million barrels per day through September 2013.
The second scenario takes the first to the extreme – heightened geopolitical tension and perceived danger in the skies spins out of control, causing people to stop flying. This had happened before: After 9/11, global oil prices plummeted.
It’s unlikely that either scenario will play out to the extreme. Nevertheless, investors should keep in mind that Russia is in serious trouble, and thus the markets are acting downright spooked.