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
- Economic power is linked to national power.
- There’s a lesson in Keynes for national leaders.
- The bulls have more room to run.
In Washington, US President Trump has been touting the strength of the US economy. Yield inversions, late-cycle predictions and a miss on US GDP have so far not added up to the recession that many analysts feared. The economy, however, is cyclical. The economic forces of output and demand are highly volatile and erratic. This volatility can be controlled through smart policies. But as the economy is cyclical, so too is national power. And just like the economy, the trajectory of national power can only be controlled through smart policies.
The recent closure of the Houston Ship Channel, along with weather-related issues and refinery problems in the US, added support to the price of Brent. Those issues have compounded the momentum from OPEC discipline and a shortage of heavier grades of crude oil. While the United States is enjoying a prolonged production boom, the glut of light-sweet shale does little to address the loss from Venezuela. The price for Brent crude oil jumped beyond the scale of the GERM Report, gaining nearly 4.1 percent from the open on Monday. By the end of the trading day Friday, Brent was at $70.34 per barrel, its highest level since November.
US President Donald Trump on Friday said the US economy was performing “unbelievably well.” According to him, his policies were to thank for continued strength and, under former President Obama, “the economy never got going.” Accordingly, the United States is still enjoying supremacy. Nations that enjoy relatively strong rates of economic growth have increased capabilities and thus greater influence over the international order. A nation with a strong economy is a powerful nation. Power on the international stage manifests itself as the ability to get others to do something they otherwise wouldn’t do.
In terms of foreign policy, the United States is trying to exert its power through economic sanctions. Those sanctions bite hardest on Iran, Russia and Venezuela, arguably among the world leaders when it comes to oil. The Trump administration, while working to squeeze the Islamic republic, realizes it can’t erase its oil completely. Russia, meanwhile, enjoys an enviable position among OPEC member states, sitting on the committee monitoring the production agreement supporting prices, but not formally bound by the OPEC charter.
Venezuela, meanwhile, is a failed state, according to US Vice President Mike Pence. Once one of the main heavy oil suppliers to the United States, Venezuela has been leap-frogged by Mexico and Colombia. That leaves the US energy sector short of the heavy barrels that some of its refiners need. That in turn has led to seven straight weeks of an increase in retail gasoline prices. With refinery outages, flooding in the US Midwest and the brief closure of the Houston Ship Channel, US retail gasoline prices are rising faster than global crude oil prices.
British economist John Maynard Keynes said the forces of economic output and demand are highly volatile and erratic. This volatility can be reduced by smart monetary policy decisions by the central bank and the government. The same could be said for national power, which would be a highly volatile force without a Leviathan type figure at the helm. Economic power, meanwhile, is inextricably linked to national power. A strong economic power can not only utilize that capital to extend its influence in the global market, but also spend it on military machines. The international system has been characterized by the rise and fall of national powers and the corresponding behavior of other entities in that system.
In his theory linking national power to economic power, Charles F. Doran noted that national power, like the economy, follows a regular cycle of ascendance, maturation and decline. What a state wants to do – the way it behaves in the international community – is a function of this cycle. An ascendant state will seek to expand its position, while one in retreat will seek the safety of isolation.
On Friday, analysts at the Federal Reserve Bank of New York revised their 2019 real GDP growth forecast lower by a half percent. “We have seen a noticeable loss of momentum in the U.S. economy toward the end of last year and the start of this year, with growth of both consumer spending and business fixed investment slowing relative to their 2018 performance,” they wrote. If Washington manages its position poorly when dealing with its Iranian, Russian or Venezuelan adversaries, it could either misread its own strength or risk facilitating its own decline.
The trade week starts off with a look at the US manufacturing sector through factory orders in February. On Tuesday, we get to see how well the Mexican economy is performing by way of its year-on-year consumer price index for March. There’s a flurry of activity in Europe on Wednesday, with a rate decision and a key speech from the head of the ECB. With gasoline prices on an exponential rise in the United States, the Wednesday release of the consumer price index for March will verify whether President Trump is correct by saying there is no inflation. On Thursday, it’s China’s turn with CPI. Rounding it out for Friday, it seems rig counts are back in vogue. Finally, any deterioration in the situations in Libya or Venezuela will push oil prices higher. An Orange alert is in place this week, with crude oil prices expected to move by plus or minus 2 percent.