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
- Pipelines are political tools.
- New kingmakers are emerging in the Middle East.
- Aramco IPO will be making a lot of noise.
The market focus last week was largely on dismal economic growth, with the US Federal Reserve deciding again to lower its lending rate in an effort to keep the US expansion going. In China, the second largest economy after the United States, the manufacturing PMI continues to linger below the 50 mark separating growth from contraction. On the demand side, economic weakness was verified by waning consumer confidence. In energy, the Kremlin continued to anchor its position in the Western sphere of influence with Danish approval of the second leg of its Nord Stream gas pipeline to Europe. Infrastructural connections such as Nord Stream 2 or China’s Belt and Road Initiative are examples of a type of systemic power that is hard to counter. And with its own political influence waning, Washington may need an ace up its sleeve to maintain its role in Europe and the Middle East.
The US jobs report surprised on the upside given recent strikes in the automotive sector, though it was an otherwise down week for economic news. For the sector as a whole, Exxon and Chevron were bellwethers of a sort as stubbornly low oil prices took their toll in third quarter growth. A rally on Friday for crude oil prices offset what was largely a bad week for commodities. Brent finished the week down only a half percent to $61.63 per barrel.
Expressing concern about Russia’s grip on the European natural gas sector, US Assistant Secretary for the Bureau of Energy Resources at the Department of State Francis Fannon warned that pipeline infrastructure was anchoring the Russian bear firmly in Western turf.
“They are not commercial projects; they are political tools,” he said in December.
Russia has granted Turkey its wish of becoming an important energy bridge between the East and West by pumping gas through the TurkStream pipeline. Last week, the Kremlin embedded itself deeper into the European energy sector with Danish consent for a parallel arm of its Nord Stream gas pipeline. Extending some 760 miles from Russia to the coast of Germany, the twin pipeline – the longest subsea pipeline in the world – started commercial operations in 2012. Construction on the second leg began last year. Nord Stream does give the European market a degree of energy security because it serves as a buffer against risky Soviet-era pipelines in Ukraine. But it also has a political element.
“Unlike the United States, Russia’s energy companies are an extension of the state, and the Russian state uses energy for coercive political aims,” Fannon said.
While blessed with vast amounts of natural gas, sending US shale gas as the super-cooled liquid form is less timely and expensive over long distances. Russia has few such limits. In 2009, it displayed its ability to exert considerable influence over the European market when it stopped sending gas through its pipeline network in Ukraine because of contract disputes between Russian gas monopoly Gazprom and Ukrainian gas company Naftogaz. That left European markets in the cold for nearly two weeks. Five years and one military conflict later and Russia was able to extend its geography deeper into Europe with the annexation of the Crimean Peninsula. And in the great game of geopolitical chess between the United States and Russia, it is Ukraine that sits at the center of an investigation that could bring down the US President.
Russia too has considerable influence in the oil sector with its seat at the OPEC table. Its role as a member of a joint committee monitoring compliance with OPEC+ production restraints gives the Kremlin a certain level of control over the price of oil. That means something for companies like Chevron and Exxon. Elsewhere, Russian energy companies are entrenched in areas where the United States now only enjoys modest political and military influence. US President Trump said it was US forces that will control Syrian oil, though its largely Russian energy companies that have a say over the regional infrastructure that could carry that oil. Russian oil company Rosneft, which pumps out about twice what Exxon does per day, has quietly taken control over oil export networks that stretch from the Kurdish north of Iraq to Turkey. In the south of Iraq, Russian oil company Lukoil is active in the West Qurna-2 project and its estimated 14 billion barrels of reserves. If, as the US State Department suggests, Russian energy companies are an extension of the state, then the Kremlin wields considerable influence in the European and Middle East energy markets.
Russia too scored a victory with the US decision to scale back operations in Syria, opening the door for the Kremlin to broker a deal to save its allies both in Syria and in Turkey. The regional agreements crowned the Kremlin as the power broker in a civil war that has befuddled two US presidents so far. In Iraq, meanwhile, the Iranian government continues to hold a good political hand. Last week, Reuters reported that Qasem Soleimani, the major general in command of Iran’s extraterritorial Quds Force, played kingmaker in Iraq when he encouraged Hadi al-Amiri, a one-time Iraqi transportation minister who fought on the side of the Iranians in the Iran-Iraq war, to remain loyal to embattled Prime Minister Adil Abdul-Mahdi at a time when the Iraqi political structure is crumbling. Soleimani was integral in the political agreement that brought Nouri al-Maliki to power. Maliki hails from the Dawa Party, which as an insurgent group supported the Islamic Revolution in Iran. One of the underlying incentives to bring Maliki to power was the construction of an oil pipeline from Iraq to the Syrian border. If built, the pipeline would be emblematic of the Shiite crescent that Iran has longed to achieve. With the Trump administration eager to avoid new wars, it is left with few options to exert leverage in the region. Interdependency and economic links are what gave the US the ability to project its influence over the horizon. With its focus on rebuilding domestic strengths lost to globalization, Washington’s only real ability to exert influence is through sanctions that do more to encourage retaliation than cooperation. The rest is left in the hands of others.
The news Monday will be dominated by the announcement that the process for the initial public offering for Saudi Aramco has started. And watch the algos as the United States and China trade claims of progress in reaching a cease-fire agreement over the trade war. Watch Monday for durable and factory goods orders in the United States. The ISM Non-Manufacturing Index is out on Tuesday. The balance of US gasoline, distillate and crude oil inventories are sure to be market movers on Wednesday. On Thursday, Moody’s will give its rating on the British economy and we also get a glimpse of China’s trade balance. The week ends with the University of Michigan’s survey of current conditions. Brent crude oil is approaching a level of resistance and it may be something of a bouncy week. Brent may be looking to break through a ceiling this week so an Orange alert is in place, with the benchmark expected to move by at least plus or minus 2 percent.