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
RED: Severe (+/- 4%) ORANGE: High (+/- 2%) YELLOW: Elevated (+/- 1%) BLUE: Guarded (+/- ½%)
THE BOOSTER SHOT
- Brent is trying to find a floor around $70.
- US economic data show a mixed picture.
- Outages mean market supply is getting tighter.
The US Treasury Department on Friday issued an advisory to financial institutions outlining money-laundering and other illicit activity used by the Venezuelan government of Nicolas Maduro. That came three days after Washington endorsed a bid by opposition leader Juan Guaido to topple Maduro's government, a bid that ultimately failed. Meanwhile, the US State Department said it was continuing a campaign of “maximum pressure” on Iran by modifying sanctions on the country’s civilian nuclear programs. A US carrier strike group is also on its way to the Middle East.
Pressure on both countries is part of Washington’s efforts to change the conduct or bring about regime change in two of the founding members of OPEC. All this comes amid a tight market for crude oil and the pending end to refinery maintenance season, which could trigger a widespread surge in demand. Washington is looking for assurances that its foreign policy objectives succeed without unwanted side-effects such as an economic backslide. Power is the ability to change behaviors, though that change can often bring about unintended consequences.
US economic data painted a mixed picture last week. The ISM manufacturing survey showed continued expansion, but at the slowest pace since the fourth quarter of 2016. April non-farm payrolls surprised to the upside, though the total percentage of participation in the workforce slipped. Strength in US oil production balanced supply-side issues elsewhere. Brent lost 1 percent from Monday’s open to end trading for the week at $70.85 per barrel, in line with last week’s Yellow alert.
Washington policy is designed to remove Maduro from power and get Iran to change its behavior by using economic pressure. That requires deft political maneuvering as the strength of the US economy, an essential element for President Trump’s re-election efforts, may depend upon it. Last Monday, motor club AAA noted that the national average retail price for a gallon of gasoline was at its highest point for the year, 20 percent higher than one month ago and nearly 30 percent higher than at the start of the year. A Commerce Department report on state GDP shows that many states with the highest gasoline prices, such as California with a $4.10 per gallon average, are growing slower than states with the lowest gasoline prices, such as Texas with a $2.61 per gallon average. The “Trump economy,” according to the White House, is nevertheless soaring to new heights. No incumbent president has lost a re-election bid in a growing economy since the 1940s. Historically, incumbents also tend to do well in times of war.
Robert Keohane and Joseph Nye in their seminal Power and Interdependence: World Politics in Transition note that power is the ability to get another power to do something it would otherwise not do. “Power can also be conceived in terms of control over outcomes,” they wrote. By these definitions, the Trump administration not only needs to get Iran and Venezuela to do something they would otherwise not do, but also control the resulting consequences and outcomes.
On interdependence, Keohane and Nye mention sensitivity – how quickly does change in one country bring about change in another – and vulnerability – an exposure to risk. The United States may be sensitive to higher oil prices that come from tighter sanctions on Iran, but Iran is vulnerable because of its dependence on oil for revenue. Vulnerability, according to Keohane and Nye, “focuses on which actors … can set the rules of the game.”
Manipulating interdependent relationships, and the world is still interdependent despite Trump’s penchant for zero-sum wins, carries a high degree of risk and it’s here where keen foreign policy actions become important because the strategy of one power is met with a counterstrategy by the other. Meanwhile, “military power dominates economic power,” shows that manipulation requires a careful hand. Washington in the 1940s tried to use its power to change Japanese behavior through economic embargo. The counterstrategy from Japan was the attack on Pearl Harbor. An attempt to exploit sensitivities without understanding the vulnerabilities, and vice versa, can easily backfire. And in many cases, a vulnerable power has nothing to lose.
Brent futures are trading in backwardation, with the December contract selling for about $3 per barrel below the spot price. Saudi Arabia, meanwhile, is expected to produce more oil, but largely to satisfy domestic demand rather than satisfy Trump. Saudi Aramco has also raised its official selling price in June to Europe and Asia, which may force importers to draw more on storage. The end of refinery maintenance season is right around the corner, and so too is summer driving season. Add it all up, and the market is tightening even with US shale production. Heeding Keohane and Nye’s advice on manipulation is therefore paramount for the Trump administration. Underlying US economic data show a slowdown is imminent, so the White House needs to understand the consequences of manipulating Iran and Venezuela. If the efforts backfire, Trump will no longer be able to campaign on the economy and instead may be forced to campaign on war.
It will be a relatively quiet week on the data front. On Monday, Germany released data on services PMI for April. Information on month-on-month factory orders in the German economy is released Tuesday. On Wednesday, it's import, export and general trade data from China. US Fed Chair Jerome Powell delivers opening remarks at the Fed Community Development Conference in Washington on Thursday. Also out Thursday are data on the US trade balance. Friday brings the April reading of the consumer price index in the US economy. The price for Brent still has room to move before it hits a level of support, but it may be another week of calm. A Yellow alert is in place, with the price of oil expected to move by about plus or minus 1 percent.