After the $147-Barrel Bubble (Part I)

At the turn of the year, the political outlook for producer states looked grim. The oil price had dropped to below $40 per barrel, having stood at $147 per barrel a mere six months earlier, leaving a number of producers in bad financial shape.

High oil prices were supposed to lead to political stability and economic growth at home, while projecting power abroad.

This logic applied not only to the Persian Gulf, but in Venezuela, Russia, West and North Africa and, to a lesser extent, Gulf Cooperation Council (GCC) states. But as the oil price tumbled, it was expected that it would take a number of political casualties with it across “hydrocarbon” states. This has not been the case.

Governments from Caracas to Moscow have proven to be politically resilient in the eye of a sustained economic storm. Production cuts from OPEC played an important role in setting a price floor, but more importantly, producer states resorted to tried and tested power centralization rather than engaging in any kind of genuine political reform.

Iran provides the latest and most notable example of this trend, while Venezuela, Russia, Nigeria and, to a lesser extent, GCC states have not been afraid to batten down the political hatches.

How long political regimes in producer states could have survived without upward movements in oil price remains an open-ended question, but just as fiscal belts were being seriously tightened, prices firmed back to $65-75 per barrel. All producer states will thus leave 2009 on a stronger footing than they entered it.

Admittedly, a one-size-fits-all analysis across producer states doesn’t work. They all have radically different political and economic positions to defend on a domestic and regional basis. Indeed, they display different depths of foreign reserves and political aplomb to navigate crises.

For the GCC states, the response to falling prices was predominantly economic, injecting vast reserves to try and steady political ships while continuing towards economic diversification through counter-cyclical fiscal measures.

A strong security apparatus was maintained, but this was designed to deal with the symptoms of political unrest — rather than address the underlying causes. Similarly, in Russia, President Medvedev’s main task was to use a stabilization fund to pay off oligarchs and prop up the banking sector rather than worrying about quelling unrest among the masses.

Hugo Chavez had a tougher time in Venezuela. He revised his fiscal positions, but loosened monetary policy was never going to be enough to save his political skin. Only the passage of a long-standing constitutional proposal to indefinitely extend his political tenure beyond 2012 could do that.

In the Persian Gulf, President Ahmadenijad’s blend of “populism” and “potatoes” was insufficient to provide a convincing ballot in Iran. Now blunt repression has been used as the stop gap instead.

But the key point from the major price correction was not so much the short-term economic pain and political panic it inflicted on producer states, but the fact that regimes in the Middle East, North and West Africa, Latin America and Eurasia all managed to weather the political storm. Economic crises did not translate into the political abyss. This dynamic could now hold a number of critical lessons for the future.

The impact of political risk on price will wax and wane with the tightness of the oil market just as readily as political points are scored between consumer and producer states.

“Who’s up” and “who’s down” remains a function of how well resource wealth has been managed in the past. Yet having survived the shocks of 2008 and 2009, the key question is: Where will producer states go from here?

Any hopes they will diversify and restructure their economies away from oil and gas and allow for greater international upstream investment are likely to be dashed. Unlike previous “political risk cycles,” most producer states (putting inflationary pressures aside) are now viewing another potential sustained bull run in oil markets.

This will not be built on an edifice of market liberalization requiring an estimated $6.5 trillion of upstream investment in exploration and production over the next 20 years to meet demand — but on renewed resource nationalism based around stronger state control of resources and revenue streams to refill state coffers.

In effect, producer states will push their perceived strategic edge through sharpened resource nationalism, a greater focus on national oil company investment and political capping of reserves.

This has not been lost on traders. Short-term speculation and a weakened dollar have played a role in the bullish sentiment of late, but the real question being asked is whether the same structural factors leading up to the 2004-2008 spike will return once physical demand rebounds.

Editor’s Note: Read Part II here.