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: Red
RED: Severe (+/- 4%) ORANGE: High (+/- 2%) YELLOW: Elevated (+/- 1%) BLUE: Guarded (+/- ½%)
THE BOOSTER SHOT
- Impact of Saudi Aramco drone strikes will be durable.
- The US economy is stuck in a liar paradox.
- The US Fed may be running out of ammo.
Drone strikes on Saudi Aramco during the weekend sidelined a notable chunk of global energy supplies, sending Brent prices soaring in early Monday trading. Brent crude oil prices were down last week, however, as forecasters at the EIA, IEA and OPEC all said the current level of production from the OPEC+ group was too high to prevent stocks from building next year. OPEC economists painted something of a mixed picture, with the Brazilian economy one of the few bright spots. Global growth was revised down. In the international arena, though back in vogue this week, the geopolitical risk premium eroded after US President Donald Trump sacked National Security Advisor John Bolton allegedly over disagreements over the “maximum pressure” campaign on Iran. The irony now is the tangled web of geopolitical connections and fluid alliances in the Yemeni conflict raises the risk of strategic mistakes, with or without Bolton. The higher oil and retail fuel prices that result from this will do very little to arrest economic momentum pointing to recession. With that in mind, the economic focus this week will almost certainly be on the US Fed’s rate decision on Thursday.
The IEA was the outlier last week in that it kept its forecast for demand unchanged, as both the EIA and OPEC anticipate a slow down ahead. That said, all three expect a glut. Brent crude oil prices suffered a steady series of losses, ending the week down 2 percent to $60.15 per barrel.
The departure of John Bolton from the White House on Tuesday erased some of the risk premium supporting crude oil prices. White House rhetoric on Iran changed from heavy-handed to handshake in a matter of days, though war may be on the tip of the lip again. Seeking to project an image of unity, meanwhile, Saudi Arabia’s new oil minister, Prince Abdulaziz bin Salman, said OPEC+ policy should be OPEC+ policy, and not Russia-Saudi policy announced days before all the players are seated at the table. The new minister, the first royal to hold the office, has a knack for diplomacy that will be tested in the wake of the Aramco strikes. The IEA in its report last week said oil operations in the Middle East, for better or worse, “appear to be normal.”
Strategic concerns in the Middle East will almost certainly show up at the pump this week, making the state of a global economy teetering on recession all the more alarming. After European lending rates moved into negative territory last week, Trump said European Central Bank policies were hurting US exports because of the depreciation of the euro. US trade pressure may be the result of self-inflicted wounds, however. That leaves it to US Fed Chief Jerome Powell to mop up the mess, with another cut already baked in. The broader market, oil included, may be in damned-if-you-do, damned-if-you-don’t territory, however. Even a faint reference to a negative interest rate would signal that a last-ditch effort is needed to keep the US expansion going, but would also signal a downturn is imminent. Lower rates would encourage consumer spending and thereby give crude oil prices a boost because of the surge in demand, though higher oil prices are a double-edged economic sword.
If Trump manages to go into the 2020 re-election campaign with an Iranian handshake and lower retail gasoline prices, it will look like a success. Few presidents win another term in office if the economy tanks. US retail sales in August were better than expected and the University of Michigan’s consumer survey on Friday showed an unexpected level of optimism. That contrasts with the latest ABC News/Washington Post survey that found 60 percent of respondents expect a recession. That helps explain retail sales figures, as back-to-school shoppers and big spenders stock up on pre-tariff goods, but it doesn’t explain the University of Michigan survey. This presents us with something of a dilemma. By most metrics, the US economy is on the decline. OPEC economists revised their 2019 expectations lower and see expansion at only 1.9 percent next year, just below Trump’s target threshold. Voters, however, only see what they want to see. Hegel helped explain a sort of confirmation bias by noting that people tend to only accept information that conforms to their preexisting world view. To not do that, to not verify the notion of self, is a form of social suicide. The age of Trump, meanwhile, is the age of the liar paradox, where truth is false and false is truth. By saying the economy is doing well while figures show it’s not, Trump can take advantage of anchoring bias with cries of “fake news” and hijack the paradoxical narrative to make a bad economy good. That gives us an explanation for the U of M’s consumer sentiment reading. And if at the deep levels of his subconscious mind, Fed Chairman Jerome Powell is indeed swayed by the politicization of the central bank, cutting rates too low will leave policymakers with no ammo to fire once the US economy does enter recession. If the election goes as the economy goes, a Trump voted out of office will claim victory for presiding over the waning cycles of expansion while his predecessor works to clean up the mess. He wins either way.
Crude oil prices on Monday are obviously impacted by the weekend Houthi strikes on Saudi Aramco facilities and markets may see that premium last through the week. We’ll see if the Europeans are buying the spin on Tuesday with a reading of consumer sentiments. On Wednesday, we’ll get a peek at just how bad the Brexit economy will be when the British government releases data on consumer prices. Later, it will be all Fed all the time. And it’s a quiet end to the week, with the only major data point Friday being the Baker Hughes rig count. Due largely to the Saudi Aramco strikes, a Red alert is in place for the week, with Brent expected to move by plus or minus 4 percent at least.