Hope and a Kiss

Oil prices had demonstrated tremendous strength despite the global slowdown maintaining $100 and above. This happened principally due to China’s energy intensive growth and global monetary expansion. However, oil prices have been on a downward tear for the last few weeks crashing new technical levels. OPEC countries, Russians and Venezualans (and some large banks) are sweating how this massive downward revision will impact their economic stability and the geopolitics they practice.

But first how it came to this. North America has witnessed a massive revolution in energy driven by shale and oil sands. US today has begun to produce almost twice the volume oil it produced in 2005 (5 million barrels per day) and Canada has added almost 1mbpd.  This US production is poised to expand with some estimates of shale standalone being 12mbpd. In addition Canada oil sands could add another 2mbpd over the next 4-5 years. This is in the context of US consumption being ~19mbpd. EU and Japanese demand has declined by 1mbpd each in the last 5 years and US automotive efficiency has increased by 25% since 2008 keeping global demand fairly static at 90mbpd. This decline will surely make shale gas finds unviable and impact future investments in the sector. But what it importantly does is put a cap to prices in the sector. "We think the world has plenty of oil at $90 going forward," Morse (Citibank) writes, "but supply may be less adequate on a sustainable basis at prices much below $70...even though on a shorter-term basis, US shale production can continue to grow robustly even at lower prices."

As I have written previously, Saudi is the lowest cost producer and is able to balance its budget at $85 at current production levels (they have a swing capacity of around 1mbpd). Anything below puts a significant stress on OPEC and Russians. Russians will surely remember the economic crises leading to a break-up that low oil prices brought in the 1980s while Iranians apparently have already cut their budget to Hamas by a third.

This fall in prices if it lasts in excess of 6 months and begins to seem more enduring will begin to change geopolitical behavior globally. Americans already are moving towards reconciliation with Iran, despite Saudi reservations, changing the contours of the middle-east and higher oil production will begin to reduce cost of production in the US reviving manufacturing impacting exporting nations like China and Germany.  Saudi and the Iranians will have to turn their focus on internal stability and have lesser economic ability to fuel the various clandestine programs. Russians typically always prioritize politics to economics but theirs is now an economy more integrated than any time before in history, it will be interesting to see their moves in Ukraine. “Oil creates the illusion of a completely changed life, life without work, life for free. Oil is a resource that anaesthetises thought, blurs vision, corrupts.” ― Ryszard Kapuściński, Shah of Shahs

The deflationary push of oil prices and commodities ranging from iron, cotton and sugar is likely to lead to rate reduction to stimulus measures in EU, Japan, China, Australia and Brazil. Japan has already added to its QE program and China has reduced interest rates (driven more by a massively slowing economy though). Oil prices will provide an added push to the USD leading to further depreciation in commodity prices and creating pressure on global liquidity, consequently emerging market financial assets.

By the turn of the 20^th century, oil has been a key determinant of a nations’ prosperity and even its survival. And, as the tide turns, its impact will play out.

“Never let a fool kiss you or a kiss fool you”

Building an Alternate Vision of India

"The empires of the future are empires of the mind." - Winston Churchill

"Determine that the thing can and shall be done and then we shall find the way." - Abraham Lincoln

The Nehruvian consensus that built India over the last 6 decades has been given a pause if not a full-stop. This was defined principally by socialism, controlling the commanding heights of the economy and non-alignment. Each of these elements spawned their own direct and side effects. Socialism morphed by 2004 to massive distributive agenda by the UPA that nearly bankrupted the fiscal, ‘controlling the commanding heights’ into a halfway free economy with crony capitalism and non-alignment to giving up India’s strategic interests and defense preparedness. In essence it evolved into a state under UPA to where managing the environment to prolong the existence while the state satraps extracted their pound of flesh in exchange. Regionalism has always been strong since the early ages and India has been for most of its history been ruled by multiple kingdoms which have in the new age arrived in the form of regional parties that espouse their identities and interests.

With the recent elections, environment and ideology has turned favorable to building a stronger India. The national elections have for the first time since independence resulted in a majority to an alternate ideology and to man who that has no baggage of the freedom struggle or Nehruvian thought. With the BJP ruling not only the center but substantial parts of the country, Modi has the power to enforce his will. It will face resistance not only from the entrenched people in bureaucracy, government controlled corporates, media among other organizations. Political resistance will also be stiff as the hitherto the regional satraps which had considerable power and say and now they have nothing for the next five years except the fear that they may lose the states they govern as well.

Since coming to power it has begun to curtail the various distributive programs by UPA (MNAREGA and energy sector subsidies) with next attempt to push ahead basic infrastructure (i.e. coal, GST, roads). The decline in Chinese consumption has already led to a massive decline in commodities. These will help significantly in reducing our cost of infrastructure. The critical thing would be to institutionalize the decision-making in key sectors through setting up regulators backed by laws. This would in essence ensure transparency and continuity of thought making political interference much less easier. Whether the BJP and Modi have the courage to give up the powers they gained will define their legacy?

The commanding heights or the public sector behemoths like Air India or BSNL need to be privatized. These are the hotbeds of significant corruption and drag economic growth by under-utilizing assets.  Government as we all know needs no presence in the sector airlines or telecom especially when it will be a dead brand within the decade. Entrenched interests and labor unions will undoubtedly resist.

The most important function of the state is to guard its borders and in that context it is the key role the leader plays. The Indian elite have been fed with a massive dose of ‘pacifism’ and have understood India’s strategic dimension. Curzon (I think 1905) stated,” The central position of India, its magnificent resources, its teeming multitude of men, its great trading harbors,... all these assets are of precious value. On the West, India must exert a dominant influence over the destinies of Persia and Afghanistan; on the north it can veto any rival in Tibet; on the north-east it can exert pressure on China, and it is the guardians of the autonomous existence of Siam (Thailand).”  Nehru displayed his abysmal understanding in three key occasions – the referral of Kashmir to the Security Council, his lack of understanding of Chinese strategic thought and when USSR asked Nehru regarding India’s membership to the Security Council he basically preferred China not India! The Congress for the fear of the Bofors re-run has in the last decade given up on building the armed forces by delaying critical orders and never has in the past six decades has any government given a serious thought to building domestic manufacturing in this area. No eminent power can be at the mercy of international supplies in situation of crises (for those who know Nehru’s letter during Chinese war to Kennedy). As India stands today, it has a fairly difficult neighbor-hood:

• West Asia is facing the ‘double whammy’ of Islamic State and now a massively decline in oil prices which will create massive impact on the budgets of the Middle Eastern states. Saudi Arabia which is the cheapest producer in the Middle East has a budget breakeven at around $85;
• Afghanistan and Pakistan our most proximate and most critical border continuous under tremendous turmoil; and
• On the west, China while has built massive infrastructure and military capability is facing its own downward cycle economically and politically (i.e. HK protests) after 3 decades of incredible growth.

Modi has since election revived India’s interest and vice versa in states like Japan, US, Vietnam and Australia. It has changed India’s defence posture from ‘minimal deterrence’ to ‘adequate deterrence’ and is now focusing on building border infrastructure. While it has changed the terms of engagement with Pakistan, it is a neighbor and India’s as the dominant state in the neighbor-hood needs to acquire the capability to change its behavior. West Asia is where Modi seems to following the policy of staying away. But with our old relationship with Iran and our significant interest in Middle Eastern energy, no policy is a 'non-answer'.

I had written in October 2013,”In effect the 4 key tenets of the state – security, governance, economics and unity - have been undermined, corrupting the functioning of the state. The tryst of the Indian state with its destiny continues to yearn for fulfillment…even in 2010 the World Bank reported that 32.7% of the total Indian people fall below the international poverty line of US$1.25 per day (PPP) while 68.7% live on less than US$2 per day.” In essence a small beginning has been made but Modi needs to change the direction and character of the Indian state.