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
- Oil markets continue to tighten ahead of US sanctions on Iran.
- Reconfigured North American trade relations still face hurdles.
- Saudi Arabia continues to wield considerable national power with its oil.
Late-week US pleas for the maintenance of global oil supplies and talk of $100 per barrel oil helped drive the price of oil to fresh highs during the last trading week in September. Questions over the fate of multilateralism and the lack of long-term buffers in an oil market facing an Iranian deficit, meanwhile, suggest there is a real risk premium building in the market.
We wondered last week if $80 per barrel was the new floor or a tested ceiling and got our answer on Friday when Brent closed at $82.72 per barrel. We were too optimistic about stability last week with a call for a movement in the price of oil of plus or minus 2 percent. Brent moved up nearly 5 percent, beyond our scale, climbing from $78.97 per barrel at the start of the week to close at highs not seen since late 2014. We're expecting more of the same for the coming week as trade tensions ease in North America.
Dubbed the US-Mexico-Canada Agreement, the three North American trading partners reached a multilateral agreement that ended speculation over the fate of a new world order ushered in by its predecessor, NAFTA, nearly a quarter century ago.
"USMCA will give our workers, farmers, ranchers, and businesses a high-standard trade agreement that will result in freer markets, fairer trade and robust economic growth in our region," a trilateral statement read. "It will strengthen the middle class, and create good, well-paying jobs and new opportunities for the nearly half billion people who call North America home."
The deal settles some issues related to the automotive sector and dispute resolution mechanisms, but leaves answered the fate of aluminum and steel tariffs imposed by the US government. Those tariffs were aimed at building up a US manufacturing sector diluted by globalization, something the Trump administration has scorned. Those same tariffs, however, have led to questions about the ability to build the US energy infrastructure necessary to keep up with oil production.
Writing in the late 1940s, Hans Morgenthau, a founding father of the realist doctrine of international relations to which the Trump administration subscribes, observed that because the technology of modern warfare requires things like airplanes, highways, trucks and other products of industry, the capacity to manufacture such products was an element of national power.
"It is inevitable that the leading industrial nations should be identical with great powers," he wrote.
Even with a reformulated trade agreement in hand, US federal data show manufacturing as a percentage of the total workforce will decline at least through the middle of the next decade. It is the services sector, not the good-producing sector, that is expanding the most in terms of employment.
Nevertheless, with GDP growth at a four-year high, US President Donald Trump took to the podium at last week's UN General Assembly meeting to tout his success. Striking a tone similar to Morgenthau's realist doctrine, Trump said the United States "will always" act in its own interests first. With US oil production accelerating, Morgenthau said that hydrocarbons were a unique asset for bolstering national power even further.
"A state which is powerless in all other aspects, which is not a major force in terms of traditional power, can exert enormous – and under certain conditions even decisive – power over nations" if they hold considerable amounts of oil, he wrote.
The US Energy Information Administration estimates total US oil production will average 11.5 million barrels per day next year, putting it on the same page as Saudi Arabia and Russian when it comes to output. But that production does not yet give the United States the advantage that Morgenthau envisioned and on Saturday, the Trump administration turned to Riyadh in a plea for market stability.
By November, an estimated 1 million bpd will be gone from the market when US sanctions on Iran go into force. It's unclear whether or not Russia or Saudi Arabia can bring more oil to the market in short order. Any release of oil from US strategic reserves, meanwhile, would only have a short-term impact. In its gauge of consumer issues, the US government identified the increase in the price of gasoline, up 12.5 percent from last year, as one of the largest factors behind a rising consumer price index. US sanctions on Iran will be imposed before the midterm elections and possibly lead to even higher retail gasoline prices to the frustration of American voters. And should the political tide shift toward the Democrats, the Trump administration will face a test in passing the USMCA when it goes before Congress next year.
The headlines this week will focus on the short-term optics behind the USMCA, but that will quickly fade as the theatrics of the FBI investigation into Supreme Court nominee Brett Kavanaugh retake center stage. Meanwhile, Iran continues to cling to regional engagement by examining its role in global financial regimes. We continue, however, to see tighter conditions ahead and will stick with an Orange alert for the week, anticipating a price movement of plus or minus 2 percent.
Markets will likely be reactive to North American trade developments, with Brent testing the $83 per barrel mark on Monday. After abandoning the phrase "accommodative" from rate decisions, US Federal Reserve Chairman Jerome Powell speaks Tuesday before the National Association for Business Economics in Boston. Wednesday brings the latest EIA inventory estimate. The week ends with the September estimate for US employment.