Welcome to The GERM Report by Dan Graeber, a commentary on the intersection between geopolitical events and the price of oil. GERM stands for Geopolitical Energy and Risk Monitoring. Our indicator is based on the expected price volatility by the end of the current trading week.
Risk level: Orange-High
RED: Severe (+/- 4%) ORANGE: High (+/- 2%) YELLOW: Elevated (+/- 1%) BLUE: Guarded (+/- ½%)
THE BOOSTER SHOT
- National power in a late-cycle economy erodes.
- OPEC may have flooded the market again.
- 21st century mercantilism signals eroding interdependence.
Crude oil prices again charted new quarterly lows with Brent moving below $70 per barrel in intraday trading last week. Waivers granted for eight Iranian oil customers and an increase in the forecast for US crude oil production next year indicate at least a short-term market move toward the supply side of the equation. Meanwhile, a late-cycle economy suggests demand pressures may ease, though holiday-driven demand from the United States could alleviate some of that over the next few weeks. OPEC is finding itself nevertheless forced to ponder a cut in supply, with or without Iran and Venezuela, in order to offset emerging market trends. Crude oil prices ended the week in clear bear market territory. Brent lost 3.64 percent to close trading on Friday at $70.18 per barrel, more than $15 per barrel lower than its early October peak.
The US Energy Information Administration last week raised its forecast for US crude oil production in 2019 by 300,000 barrels per day to 12.06 million bpd. Demand, meanwhile, was lowered by 100,000 bpd to 1.4 million bpd. From OPEC, Saudi Arabia has pumped more oil than it has in decades and Libya is finally showing signs of consistency. All this comes as, despite early-year fears, Iran continues to float vessels for eight of its customers, even if its ships are blinking their AIS signals.
In the economy, US gross domestic product increased 4.2 percent in the second quarter. The advanced estimate for the third quarter shows a 3.5 percent gain and the latest GDPNow forecast from the Atlanta Fed shows fourth quarter growth at 2.9 percent. Speaking last week, JP Morgan Chase Co-President Gordon Smith said the US economy was exceptionally strong, though that could be indicative of late-cycle expansion.
"There is a great deal of volatility in the equity markets, a great deal of conversation around how late we are in the cycle and worry about the cycle," he said. "That will ultimately lead to business confidence deteriorating, it will ultimately lead to [corporate] reductions in spending, that will ultimately lead to a shorter work week for hourly-paid people, which will ultimately lead to unemployment beginning to rise, and we would've developed our own recession."
The phases of the economic cycle are a reflection of national power. Charles F. Doran, the director of global theory at Johns Hopkins University, observed that national capability, relative to others, tends to follow a generalized pattern that mirrors the phases of the economic cycle in that nations ascend, mature and decline. The four critical points of his power cycle are where “exaggerated fear, misperception and foreign policy over-reaction” are the most likely.
“The result is that the probability of major war is highest during that period of history in which a principal actor (or actors) finds itself in a post-critical interval,” he wrote.
Overlaying the phases of the economic cycle on Doran’s power cycle indicates the United States is near the upper turning point. This helps explain American behavior under President Donald Trump as the likelihood of war usually coincides with systemic changes in the international arena. If a nation believes the only way to prevent its own decline is to put others at a disadvantage, the values that support peaceful relationships on the global stage might erode.
When the benefits of global interdependency are no longer apparent, a mercantilist defense takes hold and nations may withdraw. Once the power leading the way in the international system, the United States under President Trump has expressed no desire for command in the conventional American sense. Advocating for a way to build up the domestic industries, Alexander Hamilton in 1791 called for a form of economic nationalism as a way to ensure American self-sufficiency. Today, protectionism and nationalism go hand in hand.
Speaking on Armistice Day in Paris, French President Emmanuel Macron warned of the moral erosion that comes through nationalism.
“Patriotism is the exact opposite of nationalism: nationalism is a betrayal of patriotism,” Macron said. “In saying ‘our interests first and who cares about the others,’ we erase what a nation has that’s most precious, what makes it live, what is most important: its moral values.”
The United States, despite Macron’s criticism of Trump’s self-embraced nationalism, is still an influential global power. The Trump administration convinced OPEC and Russia to open the spigots during the summer to offset the expected loss of Iranian barrels. OPEC leaders during the weekend suggested the market wasn’t as oversupplied as data would suggest, pointing instead to cyclical factors that could evaporate by the second half of 2019. But if the economists are right and this is a late-cycle phase, OPEC may have already flooded the market. It may take awhile for the glut to drain if JP Morgan’s Smith is accurate with his forecast of a deteriorating economy.
Expect some repercussions from OPEC’s weekend meeting and political kickback from Trump skipping Armistice Day remembrances in Monday trading. This week will also be rather reactionary with the publication of the monthly market reports from the IEA and OPEC. European economic trajectory will become evident on Wednesday when Germany and the collective eurozone release data, respectively, on GDP. Wednesday also brings a measurement of the consumer price index in the United States. Late-week inventory levels may provide a short-term glance as well for what to expect during the upcoming holiday season in the United States. Expect big swings this week in the dark-Orange level for Brent crude oil prices, though $70 per barrel is still looking floorish.
Graph taken from Doran, C.F.(1983) War and Power Dynamics: Economic Underpinnings. International Studies Quarterly, 27, 419-441