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
- A 30-year-old theory on the policy of threat explains geopolitical behavior today.
- An IEA warning of a "crucial period" ahead foreshadows shifts in power.
- The United States is influential in gas, but cedes authority on oil to OPEC+.
Last week's market was driven more by competing narratives from the EIA, OPEC and IEA than Hurricane Florence, the first major hurricane of the 2018 Atlantic hurricane season. Expecting the loss of Iranian barrels to offset fears about a global slowdown from emerging markets, EIA raised its 2018 and 2019 forecasts for the price of oil by 1.2 percent from its August report. OPEC, for its part, said it was pumping enough to keep the market stable, while the IEA warned of "a very crucial period for the oil market."
Meanwhile, as Senate leaders expressed concern about Russian influence in the European gas market, US Energy Secretary Rick Perry was thanking the Kremlin for keeping the oil spigot open wide enough to offset waning Iranian exports. That's reflective of a shifting and uncertain landscape in the global balance of power and signals volatility ahead. We were more or less within range of our scale of volatility with our Orange alert for last week. The price for Brent crude oil ended the week up 1.64 percent to finish trading Friday at $78.09 per barrel.
US Sen. Lisa Murkowski, R-Alaska, testified in a hearing last week that Russia is using its natural gas as a "geopolitical weapon" in the European market. Twice in the post-Soviet era, in 2006 and 2009, Russia halted flows through Ukraine, disrupting pipeline deliveries to the European market. With its rich shale natural gas resources, Murkowski said it was the United States that would serve as the balancer overseas, tacitly through liquefied natural gas.
On oil, however, the situation is remarkably different. Last week, EIA confirmed US oil production passed Saudi Arabia's for the first time in more than 20 years and surpassed Russia for the first time since 1999. That makes the United States the current world leader in crude oil production. That, however, does not make the United States a world leader in oil market influence. In an interview with Reuters, Perry said he did not see a threat from higher oil prices because Russia and Saudi Arabia were ready to respond. While the United States leads in production, market control is left to others.
Speaking on the necessity of US engagement in the world, President Kennedy said that what happens in Europe, Latin America, Africa or Asia directly impacts US national security. Security at home, he said, means ensuring security abroad.
"If the United States were to falter, the whole world, in my opinion, would inevitably begin to move toward the Communist bloc," he said.
Stephen M. Walt, an international affairs specialist at Harvard University's John F. Kennedy School of Government, observed that states either balance, meaning they ally in opposition to a primary threat, or they bandwagon, meaning they ally with the principal threat. The most powerful nations are the ones that attract the most allies. When power fades, Walt said, allies have a tendency to defect to new sources of strength.
Oil markets face an important test in November when US sanctions hit Iran, the third-largest producer in OPEC. Iran's OPEC governor Hossein Kazempour Ardebili said US action on Iran has opened the door for Russia and Saudi Arabia to hijack the global oil market. In relationships among nations, there is a clear attraction to strength. In terms of the oil market, Russia and Saudi Arabia have it in spades.
While taking center stage in the natural gas markets, the United States has ceded its leadership position for oil to Russia and Saudi Arabia, which collectively oversee the OPEC+ agreement. Iran's comment on hijacking only reinforces that sentiment. For emerging markets, meanwhile, their leaders have taken to balancing against the United States in favor of a seat next to Russia.
In the shifting geopolitical alignment, knowing when to accommodate and when to oppose is important for success. Walt noted that taking the wrong approach in a balancing or bandwagoning world can be catastrophic.
"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.
This is not so much a commentary on U.S. power as it is an examination of the shifting geopolitical landscape. Leaving most of its multilateral agreements in shreds, the Trump administration has shown a preference for a more one-on-one strategy of dominance. On Monday, the president said his trade policies have put the country "in a very strong bargaining position." But that position has also triggered declines in some emerging markets, contributing to concerns about the health of the global economy and oil demand.
Walt proposed his theories on balancing and bandwagoning in 1985, long before the wave of populism swept through international politics. Shifts in power are inevitable and maneuvering through them requires deft leadership. Getting it wrong, as Walt observed, can be damaging. For better or for worse, change in any form is disruptive.
With attention centered on emerging markets, the lack of spare capacity, and the possibility of escalating trade tensions, we're issuing a Yellow alert for the week, expecting the price of Brent crude oil to move by about plus or minus 1 percent. Oil prices could rise on declining inventories, but ease back on macroeconomic issues.
The OECD on Monday noted that growth slowed dramatically in Turkey in the second quarter of the year, and to a lesser extent in India. Apart from that, it's a relatively slow week. European Central Bank President Mario Draghi speaks Tuesday in Paris and Wednesday in Berlin. Mid-week also brings a rate decision from the Bank of Japan and the consumer price index for the United Kingdom.