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
- Beijing doubles down on the win-win system.
- Washington no longer has a vested interest in the Persian Gulf.
- Short-term gains, but long-term concerns with the US Fed rate decision.
Geopolitical issues took a back seat last week as the headline news reels focused on testimony from former FBI Director Robert Mueller. While tensions continued to simmer in the Persian Gulf, the attention in Washington was focused at home. Meanwhile, it was left once again to Great Britain to take up the security mantle in the Strait of Hormuz after President Trump said his country was far less reliant on regional oil suppliers than in the past and maritime safety was a concern only for those less dependent than his. To a large degree, that means countries such as India and China should be eager to fill any security vacuum. Last week, a White Paper from Beijing reminded the world that Chinese security forces provided escorts in the Gulf of Aden in 2015. With China’s reach and growing ambitions, the Middle East may become more of an Asian priority than a US one.
Revised figures from the US Commerce Department last week showed GDP expanded 2.5 percent in the fourth quarter, compared with the previous estimate of 3 percent year-on-year. While second quarter figures were higher than expected at 2.1 percent, it still indicates the US economy is performing worse than the president had hoped. Crude oil prices rebounded incrementally last week, with Brent moving up 1.6 percent to finish trading Friday at $63.30 per barrel.
Trump suggested last week that security in the Persian Gulf region should be handled by those who need it most. Already the largest crude oil producer in the world, the US energy sector is less exposed to shocks from the Middle East than it was under President Carter, who tied US national interests directly to security in the Persian Gulf. For the first six months of the year, total US crude oil from Arab Gulf suppliers was around one million barrels per day on average, about 30 percent lower than the same period for 2015. For India, the first-half pace was closer to 2.5 million bpd and 20 percent higher than four years ago. China, meanwhile, imported oil from the region at an average of 4.1mn bpd, 20 percent higher than in 2015. Trump is right to say the United States is less dependent on regional suppliers and therefore less exposed to security risks in the area. But regardless of who gets the oil, influence in the area should remain a national concern. Ceding control over an area through which some 20 percent of global oil supplies move means giving up considerable geopolitical leverage
In terms of natural gas, China last week completed its connection to Russia’s Power of Siberia pipeline, a 2,500-mile project the Kremlin described as a way to tie the Russian energy sector to two poles of the economic world – Europe and Asia. Politically speaking, it also establishes a more concrete connection between two poles of power in the international arena. China is already doing its part to make sticky-power connections to the West through its Belt and Road Initiative. The mega-infrastructure project connects China to 65 other countries that the World Bank said accounts for more than 30 percent of global GDP and 75 percent of known energy reserves. In both economic and military matters, interdependence is a priority in a multipolar world. Great powers in a multipolar world learn to depend on each other for support and security. In this geopolitical setting, collaboration between two or more of the great powers, in this case Russia and China, tilts the balance of power in their favor.
Beijing last week published a national defense strategy that defines China as a major strategic competitor. The paper is critical of current US policy that emphasizes a go-it-alone strategy over multilateral cooperation, a risky move in a game with many powerful players who are still willing to collaborate. In what may be a veiled swipe at President Trump, the white paper notes that while a country may be strong, “bellicosity will lead to its ruin.” Instead, Beijing emphasizes that in “an increasingly multipolar world, peace, development and win-win cooperation remain the irreversible trends of the times.” Viewed in terms of strategy, a multipolar world may offer too many options and create too many sources of tension. But in terms of stability, interdependent relationships produced shared results, though some of these results are potentially lopsided. Yet, these are the type of results that can lead to a balanced system. In a multipolar world, a nation can either lead by managing the many layers of connectivity and help define the rules of the game, or refuse to play and marginalize itself from the international community.
The week starts off with manufacturing data for July from the Dallas Federal Reserve. After ECB Chair Mario Draghi said last week the outlook for the regional economy was getting “worse and worse,” it may be worth paying attention to the Pacific region when the Bank of Japan announces its rate decision on Monday. The malaise consensus could be muddied Tuesday with a reading of US consumer confidence in July. With China posting its worse GDP reading in a generation, focus on Wednesday will be on its manufacturing PMI. Wednesday also brings GDP data for the eurozone. And not to be outdone, the US Federal Reserve announces its rate decision on Wednesday. It’s the Bank of England’s turn on Thursday. Finally, on Friday comes a look at the US employment picture for July. The market is expecting a rate cut from the US Federal Reserve this week, which may trigger a short-term rally in risk assets, but will also raise questions about long-term economic health. For crude oil, sell signals are flashing across the board. Bearish trends may reverse this week, especially with the multiple rate decisions, so an Orange alert is in place, with Brent expected to move by plus or minus 2 percent.