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: Yellow-Elevated
RED: Severe (+/- 4%) ORANGE: High (+/- 2%) YELLOW: Elevated (+/- 1%) BLUE: Guarded (+/- ½%)
THE BOOSTER SHOT
- Saudi Arabia sidelines oil in Trump payback.
- Cyclical market factors are gaining momentum.
- Crude oil prices may have hit bottom.
Crude oil prices hit bottom during an act of capitulation that saw Brent charting sub-$65 per barrel territory at its low. More signs of a late-cycle economic swing and lower demand forecasts compounded short-term oversupply issues to drag on the market last week. Meanwhile, Saudi Arabia, feeling sucker punched by the Trump administration, has said it may idle at least a half million barrels per day and is already sending less oil to the United States. On the geopolitical front, a zero-sum playbook is apparent at the White House, while other players find themselves bound somewhat to the constraints of interdependence. Crude oil prices likely found their floor during Wednesday’s plummet, though the extent of the rebound back may be limited. Brent lost 4.87 percent last week to close trading on Friday at $66.76 per barrel.
The United States, Russia and Saudi Arabia are producing enough oil to more than outpace demand, according to the International Energy Agency. That bodes well politically for US President Donald Trump and his mission to keep the price of oil low enough to suppress any constituent uprising in response to higher gasoline prices. Trump’s grand victory during the summer was convincing Saudi Arabia that Iranian crude oil exports would be zeroed out by early November, leaving the market short by about 1 million barrels per day. Riyadh scored points by appeasing Trump with more oil. Trump scored points by keeping oil prices low. But because of the surprise waivers, Riyadh feels cheated. Tankers continue to load apace in Iran over the last week or so (including Sea Shark, below) and Saudi Arabia is now pledging to erase the glut. In a direct pay-back move, Saudi Arabia is sending fewer cargoes of oil to the United States.
Such is the fate of political strategies that value short-term wins over long-term advantages. Washington scored a political win during the summer, but it is now Riyadh’s turn to play. Less oil to the United States may result in a drain on US crude oil stockpiles and send the price of oil higher just in time for the holiday travel season. If prices do track higher and travel demand pressures mount up, consumers may have less discretionary cash on hand. There are already signs of broader income inequality and any cyclical slowdown could be exacerbated by higher oil prices, pushing the economy over the curve toward recession. The US economy is strong, but will it be strong enough to buck the cycle come general election season?
The Trump administration has so far struck a realist tone with its me-first foreign policy agenda. Realism holds there is no higher authority on the international stage than the nation state. In such a condition, there is no other power that can be relied on to ensure survival, so prosperity depends on self-help strategies. Neorealist thinker Kenneth Waltz said that whether states “live, prosper, or die depends on their own efforts.” But the realist strategy of self-help is by its nature selfish. For Rousseau, the “consuming ambition” of selfish behavior leads to greedy over-reach. “A surplus awakens greed; the more one gets, the more one desires,” he wrote. Greed, he added, is “unlimited and ungovernable.” This leaves policy vulnerable to the siren song of vanity. During the weekend, US Vice President Mike Pence lobbed fire at China, pledging to up the ante in the trade war. Washington remains convinced that trade wars are easy to win, but everything rides on that bet in a zero-sum game.
On the alternate front, the interconnected world of liberalism constrains this “consuming ambition” and leads to non-zero-sum results, where everyone can win. Waltz in his defense of the stability of an international system with two dominant powers said, however, that clarity of purpose diminishes as the number of major players increases. While the constraints of an interconnected, multipolar world can create rigidity and stability, these multiple connections limit maneuverability. Writing in the late 1970s, Robert Keohane and Joseph Nye remarked that these overlapping connections can “make a nightmare” out of policy planning. Because the global oil market is interconnected, Saudi policy is constrained to some degree. Should it choose to respond directly to US trickery on Iran and try to balance the oil market, the correct strategy is complicated. Can Riyadh risk invigorating shale with higher oil prices? Further, any market-wide response to an oversupply situation would need to be appropriate, a difficult maneuver when considering waivers and Iran’s proficiency at cheating.
It may be something of a quiet week because of the long Thanksgiving holiday weekend in the United States. Keep a close eye on the NAHB Housing Market Index late Monday for signs of US economic cooling. With Brexit on the radar, testimony Tuesday from Bank of England governors will be good political theater at the very least. That will be followed Wednesday by a forecast of economic growth in the euro area from the OECD. From then on, markets will calm down over the US holiday. It may be a soft enough week to consider a Yellow alert for the price of oil, with movement of around plus or minus 1 percent.