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
RED: Severe (+/- 4%) ORANGE: High (+/- 2%) YELLOW: Elevated (+/- 1%) BLUE: Guarded (+/- ½%)
THE BOOSTER SHOT
- If power fades with distance, the tea leaves on Trump become interesting.
- There are only a few viable sources for heavy crude for the US.
- Knowing when to balance and when to bandwagon is key to peace.
The world-wide responses to the situation unfolding in Venezuela and the collapse of the Intermediate-Range Nuclear Forces treaty signal shifting polarity in the international system. Breaking the binds of interdependence through isolation, the Trump administration may be encouraging balancing behavior at best, and a security dilemma at worst. For oil, US sanctions against Venezuela may be something of a self-imposed embargo on the heavier crudes that Gulf Coast refiners desire. For those in the game of statecraft, policy that is out of step with the international order often has dire consequences.
The US Treasury Department last week hit Venezuela and state-run PdVSA with economic sanctions. Gary Simmons, a senior vice president at Valero, said the refiner was no longer taking “anything” from Venezuela, which supplied about 20 percent of the heavy oil running through its US refinery system. Figures from ClipperData, however, expose the extent of the vulnerability. US imports of Venezuela in January averaged 510,000 bpd, up 20 percent from January 2018. Canada, another main supplier of heavy crude, is just emerging from self-imposed restrictions in Alberta while, at 657,000 bpd, Saudi exports are at an eleven-month low, and down 5 percent from January 2018.
With the shortage, the price for Brent crude oil jumped nearly 5 percent on the week, closing the trading day Friday at $62.84 per barrel.
Last week’s GERM analysis pondered the fate of the Monroe Doctrine, starting with the Cuban Missile Crisis and ending with Russian oil company Rosneft’s 49.9 percent control over PdVSA subsidiary, and US-based refiner, Citgo. And “witch hunt” or not, the Mueller investigation into Russian meddling in US politics shows Moscow is hell bent on returning to the height of its former Soviet status.
One of the basic tenets of international relations is that "neighbors of neighbors are friends” and US support for Guaido may be emblematic of that because of the necessity to create a friendly Venezuela. But trade policy with US neighbors Canada and Mexico brings regional friendship into question. Internationally, leaving the INF treaty gives the United States the freedom necessary to build up the military arsenal necessary to challenge China and Russia, but it also encourages the latter two powers to form an alliance to balance against the United States. Defensive actions by one state can sometimes result in offensive reactions.
The ability to project power diminishes with distance, which may help explain why the Trump administration is withdrawing from Afghanistan and Syria while at the same time mentioning a military option for Venezuela. This in turn means China and Russia will protect their interests in Venezuela while seizing the opportunity in Central Asia and the Middle East. Considering Moscow’s historic aspirations in the region, Turkish support for Maduro shows Russia knows how to play its hand.
Writing in the journal International Security, Stephen M. Walt of the realist school wrote that states either balance -- ally in opposition to the biggest threat -- or bandwagon -- ally with the biggest threat. China, arguably the No. 2 in the international arena behind the United States, is exhibiting balancing behavior by lining up with a weaker Russia rather than hopping on the US bandwagon. This strategy was pursued by Henry Kissinger when he advocated détente with China, preferring to ally with the weaker side in a trio of leading powers. A supporter of détente in his own right, Zbigniew Brzezinski in one of his last scholarly articles wrote that a US pullout form the Muslim world would generate a “crisis of confidence” in America as stabilizer.
“In different but dramatically unpredictable ways, Russia and China could be the geopolitical beneficiaries of such a development even as global order itself becomes the more immediate geopolitical casualty,” he wrote in The American Interest.
Meanwhile, Walt argued that following balancing policies in a bandwagoning world leaves allies discouraged by the complacent view of threats.
“Conversely, following the bandwagoning prescription (employing power and threats frequently) in a world of balancers will merely lead others to oppose you more and more vigorously,” he wrote.
More often than not, he said, it is a world of balancers.
Venezuela may be the running theme in the market this week, especially if European nations enact their own set of sanctions. In terms of data, things are pretty light outside the typical look at US inventory levels mid-week. There are a handful of speaking events for banking chiefs, including Dallas Fed President Robert Kaplan on Thursday. Expect the bulls to run this week for crude oil in the Orange range, moving at least 2 percent.