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
- Saudi Arabia caught between a rock and a hard pace.
- The lowest common denominator might not be attractive for OPEC.
- Enough is enough for Qatar; Canada forced to cut on its own.
It was the handshake heard around the world. At the opening of the G20 meeting in Buenos Aires, the bromance between Russian President Vladimir Putin and Saudi Crown Prince Mohammad bin Salman let the world know who was in charge of the oil markets. An OPEC advisory group has already indicated a need to trim at least 1 million barrels of oil per day from October levels to balance an oversupplied market. This summer, such a proposal would have been ludicrous in the face of US sanctions on Iran. Russia has freedom of action, but Saudi Arabia’s ability to maneuver in a multilateral world could suggest OPEC’s final agreement is limited to strong words that mask vulnerabilities.
Economic headwinds prompted OPEC economists to revise their forecast for global oil demand growth for next year to about 1.36 million bpd. With the EIA pegging US crude oil production at 11.7 million bpd for the week ending November 23, and Saudi Arabia churning out more oil to appease a President Trump who sees low gas prices as a de facto tax break, the market favors the supply side. It was a wild ride that went nowhere for Brent crude oil prices last week. A 2.9 percent spike was erased by the end of the week to leave Brent at $58.71 per barrel on Friday.
Speaking to reporters in Buenos Aires during the weekend, Putin said the agreement to keep production levels in check would continue.
“There is no final decision on volumes, not yet,” he said. “But we, together with Saudi Arabia, will do this, and whatever final figure we will decide upon, we agreed that we will monitor the market situation and promptly respond to it.”
Putin is fine with oil priced at around $60 per barrel. The situation is much different for Saudi Arabia, however. Riyadh needs to keep President Trump from harping about the price of oil, while keeping its own purse full. That may require Brent priced at closer to $90 per barrel, a level that’s sure to frustrate a US president facing a cyclical slowdown. Taking it on the financial chin, however, may be a necessary move if MbS wants to keep the pressure off from the killing of journalist Jamal Khashoggi.
Saudi Arabia’s freedom of action is limited by its multilateral obligations to the market and to President Trump. Some form of supply cut may be necessary, but agreements at this weekend’s OPEC meeting in Vienna may be diluted in order to keep everyone happy. That, however, might not be an easy task. Remarking on the constraints of interconnectivity, the IR theorist Kenneth Waltz observed that clarity of purpose fades as the number of parties grows.
"Parties engaged in cooperative endeavors must look for a common denominator,” he wrote in his seminal Theory of International Politics. “They risk finding the lowest one and easily end up in the worst of all possible worlds."
An abbreviated G20 communique, which was about half as long as the 2016 one under former President Obama, is a case-in-point example of the argument from Waltz. The joint declaration only took “note” of tense global trade relations and contains its own special language on Trump’s doubts about climate change, avoiding many of the taboo issues like protectionism. From global trade, to OPEC’s balancing act, the lowest common denominator may not be the best possible choice.
Qatar’s decision Monday to leave OPEC after nearly 60 years, meanwhile, could indicate that management fatigue is finally setting in. With the market clearly in the hands of Russia, Saudi Arabia and the United States, some other OPEC players may follow suit and play hardball for political gain this weekend. Such is the fate of multilateral games.
Markets got a big boost Monday from the temporary cease-fire in the US-Chinese trade war. More support is coming from Alberta’s decision to trim oil production by 8.6 percent. Watch for early-week clues from a Canadian economy coping with sub-$20 per barrel oil and dual manufacturing indices from Canada and the United States. By Tuesday, there should be the usual sources familiar with OPEC thinking speaking in the media about the upcoming Vienna meeting. That should be enough for a verbal premium for the price of oil. On Wednesday, US Fed Chairman Jerome Powell testifies before a joint economic committee. The week ends with a consumer price index in a Mexican economy one week into the AMLO presidency. Friday also brings the latest US unemployment snapshot and a gauge of consumer sentiment from the University of Michigan. Volatility should favor the bulls this week, so a run of Red is expected.