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
- Maximum US pressure means economic pressure.
- Iran is better at cheating sanctions than playing by the rules.
- Is soft power a thing of the past?
Crude oil prices once again were something of a surprise on the technical side, with Brent breaking below the 200-day moving average November 1. Against the looming snap-back of oil-related sanctions on Iran, there are supply-side pressures weighing on the market. The three largest oil producers in the world -- Russia, Saudi Arabia and the United States -- signaled they were pumping near record levels, US oil inventories are swollen and scheduled sales from the US Strategic Petroleum Reserve are underway.
On Friday, US Secretary of State Mike Pompeo added that eight customers will get waivers to continue buying Iranian oil. And despite signs of a robust US economy, the global marketplace is showing signs of decline. The scale used for The GERM Report does not cover the 6.1 percent drop in the price of Brent crude oil last week. The global benchmark finished trading Friday at $72.83 per barrel. So much for the predictions of $100 oil.
Pompeo on Friday said the Trump administration estimates Iranian crude oil exports are down by about “three to five times” more than analysts expected.
“We exceeded our expectations for one simple reason: Maximum pressure means maximum pressure,” he said.
That pressure comes in the form of what Eurasia Group President Ian Bremmer and its chairman, Cliff Kupchan, in 2015 dubbed the weaponization of finance. Because military adventurism is costly in terms of real and political capital, nation states may be inclined to utilize the hard power of economic strength to get their way. Bremmer and Kupchan described the weaponization of finance as ”the systematic use of carrots (access to capital markets) and sticks (varied types of sanctions) as tools of coercive diplomacy.”
The economic carrot-and-stick approach today may be part of the Trump administration’s goal of leveling the playing field with China and other trade giants accused of cheating the system to the detriment of the US economy. Under the Obama administration, according to the Eurasia Group, financial weapons were used to pressure adversaries like Russia and “other perceived rogue states” through financial means. The ultimate threat from the weaponization of finance was cutting US enemies off from economic infrastructure. Under Trump, Russia is not so much in the direct line of financial fire, but Iran.
Taking his turn at the podium last week, US Treasury Secretary Steven Mnuchin said Washington “advised” the SWIFT regime in Belgium it too would be hit with sanctions if it stood in the way of the Trump administration’s pressure on Iran. Along with the remaining signatories, China and Russia, the British, French and German governments said they would work to ensure there are financial channels available to allow for the continuation of Iranian oil and natural gas exports, but with SWIFT under threat, that effort may be complicated. While the Europeans insist the agreement that let Iranian oil move through the market is still in force, their diplomatic effort to save the deal was met with a non-waiver guarantee from Washington for all but two EU members. “Maximum pressure” from Washington signals that, despite its retreat from the liberal world order, it’s still in control over some of its aspects.
Gone from the diplomatic playbook of the United States, however, is an appeal through soft power. In an era where nationalism, populism and, yes, geopolitical xenophobia are commonplace, the quest for cultural and ideological appeal is out of fashion. Coined in the 1980s, Joseph Nye described soft power as one of ideals. “If [a nation’s] culture and ideology are attractive,” he said, “others will more willingly follow.” Culture and ideology in the modern political era, at least as far as the United States is concerned, is anything but attractive.
The same factors of globalization that gave room for the United States to extend its leverage overseas also led to lopsided and unsteady growth. By betting on global institutions, meanwhile, some of the elements of sovereignty became weaker, leaving states longing for more of a deterministic agenda. It’s not so much a priority to make the world safe for democracy, but to make the nation itself, to coin a phrase, great again.
The Eurasia Group warned the weaponization of finance was prone to miscalculation and unintended consequences. Wielded initially by a former constitutional law professor, the new weapon of war is in the hands of an unpredictable, by design, President Trump. A go-it-alone America is creating a dangerous vacuum and the warning issued by Bremmer nearly four years ago resonates loudly today.
“Russia is lashing out, the Middle East is fragmenting, Islamic radicalism is expanding, and Europe faces challenges on all of these fronts,” he wrote. “I’m very far from a pessimist, but for the first time since starting the firm in 1998, I’m starting to feel a serious undercurrent of geopolitical foreboding.”
The latest GDPNow model from the Federal Reserve Bank of Atlanta shows the US economy slowing down in the fourth quarter. Supplies, meanwhile, are surging and another draw from the US Strategic Petroleum Reserve is forthcoming. The Trump administration will be able to claim a win with its base because consumers won’t feel the pain at the pump as initially feared, but the downturn in the price of oil may have more to do with cyclical and fundamental market factors than US foreign policy. Iran, for its part, may be better at dodging sanctions than it is at playing by the book so the loss in barrel terms won’t be as severe as first expected.
Equity markets typically do well after elections, though these are anything but typical times. Whichever way you cut it, though, Tuesday’s election in the United States will be pivotal. With markets flirting with a bear cycle, meanwhile, a Thursday rate decision from the US Federal Reserve will be an important factor to watch this week. Friday brings a gauge of US consumer sentiment from the University of Michigan. But barring any sort of unexpected event, it will be the outcome of the US elections and the ripple effect of US sanctions that will weigh most on the price of oil. Brent could fall even further at the start of the week, but late-week political factors remain the question mark. There has to be a bottom, so an Orange alert is in place for this week.