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
- Putin’s OPEC statement means Vienna hotels have spare capacity.
- The liberal order is dead. Long live the liberal order.
- Brzezinski’s worst nightmare is a recurring one.
Two days before the start of the OPEC+ forum in Vienna, Russian President Vladimir Putin declared from the sidelines of the G20 summit in Japan that a rollover of the production agreement was in the bag. The cuts that helped pull the price of oil away from $30 per barrel could now extend into the first quarter of 2020. Among OPEC members alone, that means the Kremlin has influence over what to do with an estimated 80 percent of the world’s proven oil reserves. An oft-quoted statement given to The Financial Times finds the Russian president declaring the liberal world order to be out of fashion, yet Putin seems to understand that self-help actions do not need to focus exclusively on just one round of play. Meanwhile, Russia and China agreed to work toward new levels of military cooperation, while the Europeans finally realized their dream of breaking into the South American economy. The unipolar moment realized after the collapse of the Soviet Union is over and a new multipolar era has begun.
Crude oil prices ended June up 9 percent as Middle East tensions overshadowed economic concerns and the flood of oil from the United States. The Dallas Fed last week said global GDP is expected to grow at 3.6 percent this year, down 0.7 percent from two years ago. Trade tensions are clearly dragging on growth and the OPEC+ decision could create further headaches for consumers by way of higher gasoline prices. A big swing Wednesday in the price of Brent masked an otherwise quiet week as traders waited for G20 discussions and Vienna decisions. Brent finished the week up 2 percent, in line with the Orange alert last week.
It was Putin, not the Russian energy minister, who signaled the multilateral production agreement would hold, possibly into the first quarter.
“The cuts will be in the previously agreed volume,” he said. “As to for how long, we will have to think about it, whether for another six or nine months – maybe up to nine months.”
The Kremlin has pulled off a coup of sorts with its seat at the OPEC table. The decision to join the production group is understandable, given Russia’s vast oil and natural gas reserves. For the Russian economy, higher oil prices mean higher revenue. Even with a strong first quarter for oil, the Russian Central Bank said growth was slower than expected. The ruble has recovered from recent collapse, though Gov. Elvira Nabiullina said higher oil prices have certainly helped. In his sweeping interview with The Financial Times, Putin touted a sort of me-first strategy, noting that political issues were secondary to contractual issues, particular in countries such as Venezuela. That mirrors some of the rhetoric from the Trump White House, though Putin was also quick to highlight the benefits of cooperation. On cooperation with China, the Russian president said there was no malign agenda, rather their positions aligned on a number of issues.
Zbigniew Brzezinski’s worst nightmare was a strong Russian-Chinese relationship, particularly in a relationship that extends into Middle East affairs. Brzezinski worried that a strengthening Russia and a dominant China could move into any US vacuum that emerged in the Muslim world. Writing in 2016 in The American Interest, the former national security advisor said that Russia and China would be the “geopolitical beneficiaries” of US retreat. Europe, meanwhile, would be left “searching for patrons” in this new world order. Instead of dissolution, however, Europe has shown moxie, with the slow rollout of INSTEX, a financial system that could side-step some of Trump’s economic restrictions, and through a breakthrough free-trade agreement with Mercosur, the South American trade bloc. Russia and China have been able to stand up to the United States, still the world’s military and economic leader, while Europe has shown it’s able to go it alone.
In terms of oil, Russia has been able to position itself as a major force of control in global production, though OPEC’s market share is fading. The upcoming IMO sulfur cap, meanwhile, may make US shale oil an even more attractive commodity. But a lot depends on demand. Already, the US Federal Reserve has acknowledged that economic headwinds are blowing and trade tensions are certainly a concern. During the weekend, the United States and China agreed to continue with trade negotiations, with Washington conceding in the battle over Chinese tech giant Huawei. A lot also depends on the international system. The world is multipolar, with Russia and China forming one vertex, the United States forming another and Europe the third.
Writing in the journal International Security, Stephen M. Walt of the realist school wrote that states either balance — oppose the biggest threat — or bandwagon — side with the biggest threat. Walt argued that following balancing policies in a bandwagoning world leaves allies discouraged by the complacent view of threats. A state following a bandwagoning policy in a balancing world, meanwhile, will face stronger and stronger opposition. Getting the threat calculus right is the key to successful foreign policy.
Expect crude oil prices to edge higher at the start of the week after Putin’s scoop on OPEC decisions and a cease-fire in the US-Chinese trade war. The Dallas Fed has already indicated manufacturing, a central component of national power, is starting to slow so Monday’s notice from the Institute of Supply Management may be more revealing that at first blush. It’s Canada’s turn with manufacturing data on Tuesday. From there, however, the week gets light because the Independence Day holiday makes for a four-day weekend for some, but still expect some volatility because of the OPEC+ meetings on Monday and Tuesday. A Yellow alert is in place for the holiday-shortened trade week, with oil prices expected to move by about plus or minus 1 percent.