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
- Great powers are now in decline.
- The 7 percent bruise to Brent has yet to heal.
- Maritime risks in the Middle East are growing.
National security issues took a backseat to domestic affairs again in the United States as the nation remained consumed by the firearms debate. In foreign affairs, it was largely business as usual, with the Trump administration working vigilantly to tighten the financial screws on its adversaries. Meanwhile, as the US president touted his personal relationship with North Korea’s leader, Pyongyang maintained a posture of resiliency by testing new missiles. In the Persian Gulf, the US agency in charge of maritime affairs said US-flagged vessels should notify the US Fifth Fleet in advance of plans to traverse the sensitive waterway. In the markets, a downturn in the British and Chinese economies showed the potential for global recession is real. A nation with a strong economy should invest that strength into building the ingredients of national power, such as technology and industries. Because the technologies of modern warfare are tied to the ability to invest, a weakening global economy suggests that power, and the ability to project it, is waning.
The decline in the value of the Chinese renminbi relative to the greenback sent equities tumbling last week. With President Trump saying a deal with Beijing was unlikely, the threats from the US-Chinese trade war are more severe now than the threat of war in the Persian Gulf. In energy markets, a surprise build in US crude oil inventories dealt a decisive blow to benchmark indices. Two straight days of 2 percent gains in the price of Brent was not enough to put the global benchmark in the black. In the end, Brent was down 5.4 percent on the week to close at $58.29 per barrel.
The British Office of National Statistics reported last week the nation’s economy contracted for the first time since 2012. After a strong start to the year, manufacturing in the British economy has started to wane. The International Monetary Fund on Friday reported that China’s economy is expected to decline from a GDP growth rate of 6.6 percent last year to 6.2 percent in 2019. And despite the US president’s claims that China is purposely manipulating its currency, the IMF said there was little evidence to suggest the People’s Bank of China was intervening in the foreign exchange.
Geography, access to raw materials and industrial capacity are elements of national power, according to Hans Morgenthau, the father of realist thinking in international relations theory. Writing in Politics Among Nations, he states that heavy industries are among the essential elements of national power. Since military strength depends on economic strength and the ability to make things from helmets to helicopters, these elements are essential to national power. “It is inevitable,” Morgenthau observed, “that the leading industrial nations should be identical with great powers.” Those great powers are now in decline.
The IMF in its annual review of the Chinese economy noted the US-Chinese trade war holds no quarter. Apart from trade itself, the conflict damages everything from cybersecurity to industrial policy. Looking beyond 2019, the IMF said it expected China’s economy to soften further to about 5.5 percent GDP growth as the focus of its economy shifts from the industrial sector to the services sector. For the British economy, the Office of National Statistics noted that the services sector was the only sector to make a positive contribution to GDP in the second quarter. In the United States, the world’s leading economy, manufacturing continues to grow, but it’s growing at a slower and slower rate.
If the essential elements of national power are industrial and manufacturing capacity, then economic data would suggest the power of the international community’s strongest members is waning. That gives marginal actors room to grow. During the weekend, Yemeni separatists captured the port city of Aden. Backed by the UAE, a strengthening separatist movement could invoke a strong response from their Saudi-led opponents and plunge Yemen deeper into civil war. Already a proxy conflict for major powers in the region, instability in Yemen could lead to instability in the Red Sea just as major powers are wary of conflict in the Persian Gulf. That, in turn, jeopardizes Saudi plans to increase pipeline flows to the Red Sea to avoid exposure to the Iranian conflict. That means, geopolitically speaking, the risk to oil in one of the world’s most vital maritime regions is increasing. These risks are not because of conflict among major powers, but because many of the leading powers are distracted by instability and economic risks at home. While problems at home might help explain the tendency to embrace protectionism, that inward look is distracting to some of the most important global managers.
The week starts off with a look at delinquencies in US mortgages. On Tuesday, watch for sentiment about the health of the German economy. With Britain on the decline and Italy already weak, the health of the German economy may be the factor to watch in terms of European vitality. Data on consumer prices in the British economy and German GDP are released on Wednesday. Figures for US industrial activity will be issued on Thursday. The week ends with the release of the University of Michigan’s gauge of consumer sentiment. The bulls may run at the start of the week with Brent trying to work its way back to the $60 mark, though sells signals are still lit up. Expect another week of volatility in the price of oil, with Brent moving by at least plus or minus 2 percent perhaps into deep Orange territory.