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
- Trump wants to avoid war, but he might not get his wish.
- Ayatollah Ali Khamenei is not Kim Jong Un.
- Market history may repeat itself in the Persian Gulf.
On Sunday, a few short days after British naval forces seized a tanker suspected of violating European sanctions, Iran announced that it would enrich uranium beyond the limits imposed by the 2015 multilateral nuclear agreement. Justifying the move, Iran’s foreign minister said the Islamic republic reserves the right to protect itself against the “economic terrorism” employed by the United States. With its control over the global financial system, the United States can display an enormous amount of hard economic power. With few remedies of its own, Iran by contrast may be forced to lean on the very malign activity that Washington wishes to contain through economic pressure. Backed into a corner, Tehran may be playing into Washington’s hands and wind up pulling the trigger of unavoidable conflict. The risk premium is high. The ability to display force, either through economic or military means, is different from the ability to control outcomes. Changing behavior is never easy, is usually disruptive and the conquered are rarely controlled.
A trading week thinned out by the federal US holiday did little to ease volatility for the price of oil. Dreary US and Chinese economic figures, and a shoulder-shrug to the OPEC+ production curtailments, overshadowed geopolitical tensions last week. The price for Brent crude oil slumped 4 percent on Tuesday and never recovered. In the end, the global benchmark lost 3.5 percent on the week, closing out at $64.47 per barrel.
Western powers sent Iran a message last week with the seizure of Grace I, a tanker suspected of carrying Iranian oil to Syria. US National Security Advisor John Bolton, an advocate for toppling the Islamic republic, said the British action was “excellent news,” while Iran responded with threats against British tankers. During the conflict between Iran and Iraq in the 1980s, one of the first maritime casualties was Atlas I, a Turkish oil tanker hit by Iraqi bombs while loading off Kharq Island. Few of the vessels targeted during the tanker wars, however, were declared a total loss. And while initially leading to a spike in crude oil prices, a global glut and weak economic conditions limited the damage. Today, the United States is helping to saturate the market and the global economy is cycling toward recession. Market history may repeat itself.
Trump may want to have his cake and eat it too in the Middle East. His decision to leave the Iranian nuclear agreement sparked a chain of events that led to the current situation. Favoring economic power over militarism, the president is trying to force the Iranian regime to change by starving it financially. Current US foreign policy nevertheless emphasizes a type of hard power that puts the outcome of the maximum pressure campaign on Iran squarely in the risk-of-war category. The president wants to avoid war, but he might not get his wish without the leash that was the multilateral nuclear agreement constraining Iran. A powerful nation such as the United States has the ability to frighten other nations into submission, but rarely have powerful nations been able to control the aftermath. It is an extraordinary achievement to get others to voluntarily follow the rules favored by an aggressor, and the US track record here is no exception.
It is a trifecta week, with the EIA, IEA and OPEC all issuing their monthly market reports for July. Already showing strains, a trove of data on German industrial activity on Monday could offer clues about the health of the global economy in general. Pay attention Wednesday as US Fed Chief Powell testifies before the House Financial Services Committee. Wednesday also brings a reading of the consumer price index in China, followed by the same data set in the United States on Thursday. And against this backdrop is a low-pressure weather system in the southeastern United States that could strengthen as it moves toward the Gulf of Mexico. There are sell signals showing in the weekly forecast for the price of oil, though we remain in anything-can-happen territory. Unpredictability breeds volatility and an Orange alert is in place for the week, with the price of oil expected to move by plus or minus 2 percent.