The Geopolitical Energy and Risk Monitoring Report
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
- Conflict resolves the question of who’s in charge.
- A geopolitical risk premium will override economic malaise.
- War is out of fashion, but it may be inevitable.
The slowest economic growth rate for China in 27 years set the tone for last week. Meanwhile, a surge in crude oil production and exports from the United States, plus steady output from OPEC players such as Iraq, leaves the market clearly weighted toward the supply side. Against this backdrop, the International Energy Agency revised its 2019 forecast for global oil demand growth to 1.1 million barrels per day, down about 25 percent from the forecast for 2019 made last year. Speaking Friday, IEA Executive Director Fatih Birol said that demand had slowed considerably. The IEA’s sentiment backs up expectations of a slowdown in growth, an expectation supported by yield inversions since at least the fourth quarter. On Friday, economists at the University of Michigan said consumers were now expecting a period of stagflation ahead. Stagflation, a period of high inflation and stagnant economic growth, is a phenomenon that can be accompanied by a sudden spike in the price of oil. On Friday, the Iranian military intercepted two British vessels in the Persian Gulf, raising geopolitical tensions and sending oil prices higher.
The fallout from a tropical storm in the US Gulf of Mexico and Iran’s actions in the Persian Gulf, however, were not enough to offset weak economic data. The US Federal Reserve’s Beige Book last week showed something of an economic disconnect, with expansion expected despite concerns about US-Chinese trade tensions. In the end, the price for Brent crude oil lost 6.3 percent to finish the week at $62.47 per barrel.
Geopolitical risk is a real concern this week. In a move that shows containing Iran will not be easy, the Islamic Republic Guard Corps seized British oil tanker Stena Impero and briefly detained VLCC Mesdar in the Persian Gulf. Mesdar was eventually allowed to proceed, though Stena Impero was detained for supposedly turning off its AIS transponder in international waters, a tactic Iran itself has used to mask oil shipments in defiance of US sanctions. After speaking with his Iranian counterpart, British Foreign Secretary Jeremy Hunt acknowledged that Iran felt justified in taking tit-for-tat actions after Grace I was seized off the coast of Gibraltar for transporting oil for Syria in violation of European sanctions. This, Hunt said, raises serious questions about the safety of British and international shipping through the Strait of Hormuz. The end game, however, was not one of reciprocal actions that could lead to war, but de-escalating an already tense situation, he said.
Last week’s analysis focused on the influence of superpowers in the Persian Gulf, noting Winston Churchill made early British claims to the region through government investments in the Anglo-Persian Oil Co., which later became BP. As the head of the British Navy, Churchill established a link between strategic, national and commercial interests in the Persian Gulf. Later, it was left to the US military to make its claim to the region in an effort to deter Soviet expansion. The region once again requires a protector because of the instability caused by the Trump administration’s decision to walk away from a multilateral nuclear agreement that contained Iran. But defensive measures could be met with offensive moves. In the post-9/11 world order, war is out of fashion, but it may be inevitable. In times of uncertainty, Churchill as prime minister said that war was a method of geopolitical recalibration.
“People talked a lot of nonsense when they said nothing was ever settled by war,” he said. “Nothing in history was ever settled except by wars.”
Wars resolve the question of who’s in charge, and the latest actions in the Persian Gulf suggest it is Iran that is in charge so far. That’s unsettling to a status quo that holds the United States as the pre-eminent power in the region, with its mighty Fifth Fleet patrolling the Arabian Sea, the Persian Gulf and the Red Sea. In order to increase its security, a rising power will try to expand its political, economic and territorial control. In the era of nationalism and protectionism, however, expansion and external control are not priorities for the United States. One side may over-reach and the other side may be over-confident. When war breaks it, it is often the result of miscalculating one’s position relative to others. Local security issues such as maritime safety in the Persian Gulf can easily lead to military action, and war planners seldom get the conflict they expect. But this case is unique. The Trump administration may not want war, but it does increase electability. The so-called devil theory of imperialism holds that economic sectors that support the military, like manufacturing, benefit from war. Manufacturing strength is synonymous with national strength. What’s good for manufacturing is also good for the economy and Trump is quick to laud economic success. Further, in campaign rhetoric, an incumbent will always run a campaign of fear, seeking to cast change as risky business. War with Iran would lead to higher oil prices, which would support the US oil industry and in turn perhaps isolate the US economy from shock. War with Iran could bring both the economic success and the constituent mentality that would keep Trump in power.
It’s a bit of a slow week in economic news, so expect geopolitical risk to add a premium to the price of oil. Don’t expect much from Washington on the Persian Gulf, however, as Trump will be distracted by the testimony of former FBI Director Robert Mueller. Data are published Tuesday on manufacturing in the Richmond Fed district and existing US home sales for June. Watch for German data on manufacturing on Wednesday. Pay attention Thursday given the release of key indices such as the rate decision from the European Central Bank and US durable goods orders for June. The week ends with a reading of annualized US GDP for the second quarter. Sell alarms are still ringing for Brent on the week and patterns still suggest a downturn, though tensions in the Persian Gulf are likely to be supportive early in the week. An Orange alert is in place, with the price of oil expected to move by plus or minus 2 percent.