Welcome to The Geopolitical Energy and Risk Monitoring Report (GERM) by Dan Graeber, a commentary on the intersection between geopolitical events and the price of oil. Our indicator is based on the expected price volatility by the end of the current trading week.
Risk level: Yellow
RED: Severe (+/- 4%) ORANGE: High (+/- 2%) YELLOW: Elevated (+/- 1%) BLUE: Guarded (+/- ½%)
THE BOOSTER SHOT
- Sanctions bite, but they rarely draw blood.
- Zero-sum games always have a loser.
- A realist policy doesn’t necessarily connect with reality.
It was the tale of two markets last week, though the bears ultimately swatted down the bulls as economic concerns finally took hold. The price for Brent crude oil hit highs not seen since November after the EIA reported a massive draw on US crude oil inventories, but crashed down by the end of the week in response to bad economic news. The bellwether of economic malaise last week was the deep slump in Germany’s manufacturing index, which hit its lowest point since 2012. This followed a long stretch of gains in the price of oil, gains that were supported by US sanctions on Iran and Venezuela as well as continued OPEC discipline. Combined, the tight market may force the Trump administration to make tough choices on the foreign policy front.
The disconnect discussed last week between the actual market and economic conditions is gone. The price for Brent crude oil closed Wednesday up 2 percent from the week’s open, but those gains were erased by the close of trading on Friday. Brent finished the week down 0.16 percent from the start of trading March 18 to end the week at $67.03 per barrel.
President Trump on Friday continued his journey through the land of confusion by seemingly challenging his own Treasury Department with an announcement that recent sanctions on North Korea would be reversed. That came on the same day the Treasury Department imposed additional sanctions on Iran and Venezuela. While continuing to finance the largest military in the world, the Trump administration has so far favored economic force over armed force to get its way.
The president in his National Security Strategy pledges allegiance to the doctrine of realism. “It is realist,” the strategy reads, “because it acknowledges the central role of power in international politics.” That power is hard in its manifestation, working to coerce US adversaries to change their behavior. Hard power, according to Joseph Nye, is “the ability to use the carrots and sticks of economic and military might to make others follow your will”. When sanctioning Venezuelan oil company PdVSA in January, US Treasury Secretary Steven Mnuchin said the way out was to transfer control over to National Assembly President Juan Guaido, thus ending the Maduro regime. Simply stated in The Financial Times, Mnuchin said the aim of sanctions on Iran was to “change the behavior” of its leaders.
Realism is a zero-sum game, where the line between the winners and losers is clearly demarcated. But in an interconnected and liberal world order, consequences are usually non-zero sum, with policy implications spilling over a wide area. Sanctioning two of OPEC’s founding members, Venezuela in particular, strikes a self-imposed blow to the US energy sector. Many of the refiners along the US Gulf Coast rely in the heavier grade of oil that Venezuela produces. Even with imports drying up, Venezuela is still the sixth leading source when it comes to supplying the US market this year. And nearly two months after recognizing Guaido as the legitimate leader, Nicolas Maduro remains in power, continuing to enjoy support from the military and still leaning financially on Russia and China, two of the leading challengers to US power.
Sanctions are cheap but effective ways of displaying power. Washington has threatened secondary sanctions, which would coerce not only adversaries, but friends alike into doing Trump’s bidding. Those sanctions could force India to change course on oil supplies, but it would be a difficult course to follow. Meanwhile, leaving the global market without both Venezuelan and Iranian barrels in the era of OPEC discipline threatens to severely limit oil supplies, even with robust US production. That’s a political risk for a president worried about retail gasoline prices. That means Washington may have to make a tough choice between which adversary it wants to hurt the most – Iran or Venezuela. Come May, when US waivers on Iranian sanctions expire, the administration may find that it’s forcing its own hand on foreign policy.
Sanctions work, but they only work so far. With the US enjoying supreme financial power, tight sanctions send a clear signal about the intent of US foreign policy. The Trump administration means what it says when it talks of changing behavior, but without even harder displays of power, it might not get what it wants. Regime change is messy and sanctions alone do not topple leaders. Meanwhile, the gaffe on North Korean sanctions shows two can play at Trump’s game to some degree. Kim Jong Un’s charm offensive, something of a display of soft power, shows Trump can be had. Whatever the strategy, coercion is the ultimate goal. The dark side of hard economic power is that, with sanctions, the powerful are really showing the issue is not serious enough to spill blood.
In early March, the Federal Reserve Bank of Dallas said existing home sales fell 2.4 percent in January. Pay attention Monday when it releases March data on manufacturing. Tuesday is rich with data, from US housing starts to French GDP. And speaking of Europe, Brexit is getting uglier by the day, so Bank of England Deputy Governor Ben Broadbent’s speech on Tuesday may be worth watching. On the back of weak German manufacturing, ECB President Mario Draghi’s briefing Wednesday in Frankfurt will be a big deal. And on Thursday, it’s the big reveal for the US economy with another reading of fourth quarter GDP. With heavy oil scarce, a look at Canadian GDP on Friday could be telling for the market. Expect a lot of volatility with all that data this week. But a Yellow alert is in place, with Brent expected to move by 1 percent.