The Geopolitical Energy and Risk Monitoring Report
Welcome Dan Graeber’s weekly commentary on the intersection between geopolitical events and the price of oil. The color-coded indicator reflects the expected price volatility by the end of the current trading week.
Risk level: Orange
RED: Severe (+/- 4%) ORANGE: High (+/- 3%) YELLOW: Elevated (+/- 2%) BLUE: Guarded (+/- 1%)
THE BOOSTER SHOT
- Risk remains despite waning fear of war.
- Middle East aspirations are centuries old.
- There is no such thing as energy independence.
Iranian airstrikes on US military interests in Iraq pushed the two nations close to war last week, though the situation quickly deescalated after President Trump determined that no real harm was done. By the end of the week, talk had shifted from fears of World War III to the impending impeachment trial in the US Senate. Geopolitically, meanwhile, the strategic map of the Middle East and Balkans is looking more like the decades leading up to World War I, with Russia working to expand its reach beyond its traditional belt of influence. For crude, the risk premium dissolved rather swiftly as the threat of state-to-state conflict receded. But this is not your father’s war era and risk is by no means going away.
Crude oil prices spiked more than 4% on Tuesday evening in the United States after the Iranian military carried out strikes on US strategic interests in Iraq. With no American casualties, however, a President Trump averse to war offered no military response. The risk premium evaporated just as quickly as it surfaced and Brent ended the week down some 5.3%, with most of that decline in response to a surprise build in US crude oil inventories on Wednesday.
The threat of a direct US military confrontation with Iran is over, though that does not mean that threat itself is no longer apparent. Iran lacks the means to put up any sort of real fight against the mighty American military, though it does control a vast global army of proxy forces that can make a nightmare for US strategic planners. Uncertainty from both sides, meanwhile, can lead to mistakes and Iran admitted to a big one with its acknowledgment that 167 people died needlessly when its forces fired a Soviet-built surface-to-air missile at Ukraine International Airlines Flight 752. Collateral damage like this may become the norm as engaged parties remain on edge in the turning tide of influence in the Middle East. With supplies abundant, events like these are the driving factors behind the price of oil.
Much to the joy of US policy planners, Iranians reportedly responded with anger against the government for the way it handled the Ukrainian air tragedy. Those protests, however, have been relatively subdued and by no means indicate regime change is imminent. In Iraq, a parliament already leaning toward Tehran has called for the departure of American forces, though Washington seems only interested in sovereign decisions from Baghdad that go in its favor. Iraqi policymakers also seem keen on Russian air defense systems, leaving Washington in an even more awkward position in the Middle East. Russia’s S-400 missile defense system is trending in the region, solidifying the Kremlin’s grip on long-aspired territory in Turkey and elsewhere. It should be no surprise then that it was Moscow, not Brussels or Washington, that was able to use its influence to broker a fragile cease-fire in Libya, another member of OPEC exposed to risk. In the run up to World War I, the Kremlin fought desperately to fill the void left by the waning Ottoman Empire. Two world wars later and containing Russian influence became the central pillar of US national security. With Washington now looking for an off ramp, the threat of war may be over, but the battle for influence continues.
For oil, President Trump said the United States is energy independent and no longer in need of Middle East oil, a stark reversal from March when he complained to OPEC that oil prices were too high. Claims of energy independence gives Trump cover to make good on his pledges to wind down the long-term US military presence in the region. And indeed, the US market has become less dependent on oil from the Middle East. Figures from ClipperData show US imports of oil from OPEC members in the Middle East and North Africa last year were some 37% lower than in 2015, the first full year for US oil exports under the Obama administration. That has not, however, diminished the exposure of the US economy to the global energy market, and Trump’s plea to OPEC in March is Exhibit A. In September, as crude oil prices spiked considerably after Iranian attacks on Saudi Aramco facilities, the average retail price for a gallon of regular unleaded gasoline in the United States edged up some 3%. The latest federal data show disposable income is not keeping pace with inflation and the most recent payroll picture depicted some softening. A survey from the Kansas City Fed, meanwhile, showed drilling and business activity in the shale heartland is in the midst of “continued” and “significant” deceleration. Indices measuring wages in the sector declined and sentiments ran counter to the president’s most recent narrative. “Middle East conflicts/demand are driving our expectations,” one survey respondent said.
The week began with a reading of the impact of US-Chinese trade tensions as Beijing released trade balance figures on Monday, and Washington and Beijing this week are set to sign a limited trade agreement. We will also get a better look at US economic pressures with data Tuesday on consumer prices. Expectations so far are for an increase. Figures on European GDP are released Wednesday as are US inventories on clean and dirty petroleum products. Back to China on Thursday with fourth quarter GDP numbers. The week ends with a gauge of US consumer sentiment from the University of Michigan on Friday. Sell signals are still apparent for oil and bearish trends are expected should economic data this week disappoint. But anything can happen and there are no more black swans. An Orange alert is in place for the week, with the price of Brent expected to move by at least 2% in the days ahead.