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: RED
RED: Severe (+/- 4%) ORANGE: High (+/- 2%) YELLOW: Elevated (+/- 1%) BLUE: Guarded (+/- ½%)
THE BOOSTER SHOT
- US-Saudi tit-for-tat keeps oil prices in check.
- Lower-for-longer never went out of fashion.
- A fear premium drove the price of oil higher in September.
Crude oil prices once again were hit by an act of capitulation, with Brent closing below $60 per barrel in a holiday-lightened trade week. We are back to early-2018 themes in the oil market, with US shale once again helping to push the equation toward the supply side. Meanwhile, a US courtship with Riyadh, against the dark underbelly of the Khashoggi killing, is keeping verbal intervention in play. Oil prices, President Trump said last week, should be “much lower” than what they already are. Capital discipline, improved break-evens and plain old market tolerance suggest that early October calls for $100 oil were naive at best. The conversation about oil markets has shifted and it’s shifted because of the change in cognitive processing.
Total US crude oil inventories last week were about 6 percent above the five-year average for this time of year, indicating late-fall concerns about a supply shortage were misguided. Writing in the Financial Times, Christyan Malek at JPMorgan stated the “lower for longer” mantra is back in vogue. But the wide-angle view suggests maybe the summer-long fears of a shortage were more of an anomaly that sent fear into the market because of the emotional appeal of negativity.
Delivering the commencement address at Yale University in 1962, President Kennedy said it is not lies that strike the greatest blow, but the myth they perpetuate.
“We subject all facts to a prefabricated set of interpretations,” he said. “We enjoy the comfort of opinion without the discomfort of thought.
Malek comments as much about the narrative surrounding the price of oil as he does on fundamentals. The “prefabricated set of interpretations” on Iranian sanctions and Trump’s rhetorical pressure on Venezuela injected an emotional premium into the price of oil. Emotions influence decision-making before logic does. The narrative, Malek said, that generated forecasts of $100 oil was “fueled by fears that the market could be heavily undersupplied.”
When examining interpretations of rhetoric, the abstraction of ideas becomes muddied by the intersection of logic and emotional response. Logic tells me cold is a description related to temperature; it is the emotional response that assigns the attributes of cold. A past experience with cold may be associated with a negative experience. In the rhetorical trickery of the human language, c-o-l-d is equal to “bad.” Negative emotions like this are associated with life satisfaction and tend to linger more than other emotions. And, as President Kennedy alluded to, those emotions guide decisions more than logic. So when the market becomes “fueled by fears,” those fears are amplified to create a false reality. The true reality, as the current market narrative shows, is that the Trump administration could never risk the supply-side shortage that tough Iranian sanctions would create.
Early-2018 themes are still running through the market. Permian shale productivity has only improved, while major market players like Russia show no signs of letting up. Supply-side fears generate concerns about life in a global economy that is cycling toward a downturn. Logically, however, there is ample supply of oil to feed the lower demand expected in a late-cycle economy. Short-term supply shocks could jolt the price of oil higher, though most modeling indicate that October spikes to $80-something oil were irrational anomalies. The lower-for-longer mantra may have seemed passé in the run up to October, but logic dictates it was never out of style.
Brent crude oil is officially in a bear market after losing a whopping 11.9 percent last week. Pay attention to ECB President Mario Draghi’s speech Monday in Brussels for signs of how the European economy will cope with Brexit. After the spend-heavy US holiday last week, the gauge of consumer confidence on Tuesday could indicate whether or not low oil prices are indeed a de facto tax break for everyday Americans. With GDPNow forecasts indicating a gradual slowdown, the Wednesday report for third quarter GDP could add fuel to the fire burning on Wall Street. With Trump again turning his anger at the US Fed, minutes published Thursday will at least be good theater. On Friday, world leaders arrive in Buenos Aires for a G20 meeting that could look like the G19 given Trump’s distaste for multilateralism. There are, meanwhile, already the usual sources close to OPEC thinking and talking about the next meeting in December. With buybacks expected, it may be Red ahead, with oil prices taking a wild ride this coming week.