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: Yellow
RED: Severe (+/- 4%) ORANGE: High (+/- 2%) YELLOW: Elevated (+/- 1%) BLUE: Guarded (+/- ½%)
THE BOOSTER SHOT
- New sulfur limits will have a political impact.
- How sweet it is to have the right kind of oil.
- Sanctions are the least of the worries for some producers.
The market focus pivoted quickly last week from the Saudi Aramco IPO to word of a thaw in the trade war between China and the United States. Those all involve some of the largest economies in the world, though it is the lesser powers on the international stage that are immersed in turmoil. From Latin America to the Middle East and Africa, social unrest is unsettling some of the legacy regimes. Few of those movements, however, have brought about political change. What is changing is the flow of oil, with the International Maritime Organization’s tighter restrictions on sulfur emissions marginalizing grades that would normally be a strong source of revenue. That revenue is related to power and some of the major oil players may be facing issues beyond their control.
Crude oil prices moved quietly through the first part of the week, nudged Wednesday not by trading of Aramco shares but by the build in US oil inventories. The big factor, however, was an announcement that Beijing and Washington agreed to some of the terms of a bilateral trade agreement, averting a major installation of new tariffs. But details of the agreement were slim and subsequently muted any major rally. In the end, Brent crude oil prices closed the week up just 1.3 percent to $64.93 per barrel.
Winston Churchill observed that “nothing in history was ever settled except by wars.” That would help explain why the new phase of social unrest has yet to bring about any major regime change. In Algeria, voters trickled in to cast their ballots for a president to replace long-time leader Abdelaziz Bouteflika, yet none of the candidates represented any meaningful departure from the political status quo. In Venezuela, an opposition movement that brought thousands to the streets has faded away as the political machine assembled by Hugo Chavez survives in his former foreign minister, Nicolas Maduro. The heavy-handed response to Iraqi protests, meanwhile, prompted former Oil Minister Adil Abdul-Mahdi to give up the premiership, though he was not firmly established in his seat to begin with. What has been consistent for many of those countries up until now has been the flow of oil, though that will change with the new fuel restrictions for maritime shippers. That change could have sweeping consequences that extend beyond oil.
The so-called IMO 2020 rule, which formally enters into force in January, tightens the sulfur limit on marine fuels from 3.5 percent to 0.5 percent. To meet that limit, simple refineries will have to shift their crude oil diet from sour to sweet. That leaves Algeria and Libya among the few countries that are both embroiled in turmoil and producing the sweet crude oils desired in the new low-sulfur world. ClipperData figures show Algeria exported sweeter crude to the tune of 650,000 barrels per day, while Libya churned out close to 930,000 bpd on average this year. For the former, a secure political future is necessary to protect the steady flow of oil in 2020. For the latter, oil is the spoil for the victor of a civil war brewing for close to a decade. Regimes such as the one held by Nicolas Maduro are not so fortunate. Already buckled by the hard power of US economic sanctions, Venezuela has little to offer in a low-sulfur world as it produces a heavy-sour grade of crude oil almost exclusively. For Maduro, his fate may rest in the changing dynamics of the oil market.
In any system, change is characterized by the ebb and flow of dominance. In this dynamic, what was once an anomaly can become commonplace over the course of successive iterations, and the IMO rule is no exception. The ability to adapt to this change is essential for survival. The process of this evolution, meanwhile, is defined by a regular cycle of ascendance, maturation and decline. What a particular power will do in any given situation is a function of this cycle. A declining power will respond to a stimulus one way, while a rising power will respond differently to the same stimulus. In the low-sulfur world, power is synonymous with the ability to cater to changing needs. Those like Algeria may fare better than Venezuela. Those with the tools to succeed will continue to do so. The rest will either adapt or die.
The next couple of weeks will be relatively quiet given the upcoming holiday season. On Monday, we get a look at the PMI in the United States, and presumably that reading will give markets something to cheer about. Data on industrial production in the United States follows Tuesday and with tariffs on steel, it could be a down day. The Bank of Japan makes a rate decision on Wednesday and we will see how well the British economy is weathering the Brexit storm with figures on consumer prices in November. And back to the states to end the week, with Friday bringing the latest figures for GDP. All told, barring any major shock, the pushes should balance the pulls this week, with Brent moving in the Yellow territory of plus or minus 1 percent.