Risk level: RED
RED: Severe (+/- 4%) ORANGE: High (+/- 3%) YELLOW: Elevated (+/- 2%) BLUE: Guarded (+/- 1%)
THE BOOSTER SHOT
-JPMorgan goes all in on oil price rally forecast.
-Global distraction is adding a risk premium to the market.
Another week, another dramatic rise in the price of crude oil. Even with stark warnings from finance officials about the state of the global economy, commodities and equities were in rally mode on hopes the coronavirus was fading. Now, however, the World Health Organization is reporting the largest single-day spike in new cases for the year and some US states are considering a reversion to lockdown. With the world’s superpowers focused on internal matters, meanwhile, the throne of global hegemony remains empty. That serves as a welcome distraction for adventurism from countries eager for advantage, from Iran to North Korea to Egypt. With nobody at the wheel, there is a real potential for a severe derailment in geopolitical affairs. For oil demand and the global economy, a geopolitical derailment could expose the lack of fundamentals behind the recent rallies. It may seem like a buyer’s market, but buyer beware.
The structure for Brent crude oil futures prices moved into backwardation last week, signaling the severe supply-side pressures from April are a thing of the past. The price for the global benchmark for crude oil shot up 8.9% to finish the week at $42.19 per barrel. Tailwinds kicked up last week on word that OPEC+ cheaters Iraq and Kazakhstan would honor their commitments, and even going above and beyond to play catchup. Oil demand so far in June, meanwhile, has proven better than expected, leading some importers such as China to take advantage of relatively cheap oil.
JPMorgan’s Christyan Malek poured fuel on the market fire last week by suggesting the price for Brent could spike into the triple digits as the pendulum shifts further away from the supply-side pressures that pushed US crude into negative territory in April. A call for $190 per barrel oil from March still stands, he told CNN Business last week.
“Do we think it’s sustainable? No. But could it get to those levels? Yes,” he said.
That call is highly unlikely, however. Economists at the Organization of Petroleum Exporting Countries reported last week that the contango structure for oil had flattened out considerably, showing the oversupply concerns are fading and the market is balancing out. Nevertheless, demand for OPEC crude oil was revised down by 700,000 barrels per day to 23.6 million bpd, nearly 6 million bpd lower than last year. For the world’s largest economy, US Federal Reserve Vice Chair Richard Clarida said demand is likely to remain relatively absent until the third quarter. Fed Chair Jerome Powell said a V-shaped economic recovery is unlikely and Loretta Mester, the president of the Federal Reserve Bank of Cleveland, said all of the jobs gained during the largest economic expansion in history are gone. The US employment rate is 13% lower than in February, and “the deterioration in the labor market is even sharper than these numbers indicate,” she stated.
Cabin fever, however, is supporting a rally in crude oil prices as demand for consumer fuels spikes. China is expected to take in some 20% more barrels of oil than it did in May and the estimated 2.4 million barrels of gasoline stored offshore Singapore and Malaysia is finding a home as regional demand picks up. Venezuela, a founding member of OPEC and one of the richest countries in the world in terms of oil reserves, is even in on the game, playing cat-and-mouse with US sanctions to secure gasoline shipments from Iran. Steady economic pressure from the United States and its own isolation from the international community has left the downstream sector in Venezuela in ruins, handicapping its ability to produce its own consumer fuels. Now, the Iranian cargo vessel Golsan is set to dock in Venezuelan waters to deliver parts for the countries crumbling refining sector. Iran, for its part, is celebrating the one-year anniversary of the downing of a US drone near the Strait of Hormuz. But for all intents and purposes, Washington is too distracted to care.
Libyan watchers, meanwhile, spent much of the year wondering when its 1 million bpd in production would come back. Secondary sources reporting to OPEC put Libyan production at a meager 82,000 bpd last month. Its return would seriously thwart efforts to balance a fragile market. To ignore Libya is to ignore history. Libya was the scene of a proxy war between Axis and Allied powers during the second world war and, in some aspects, it’s a proxy war that never ended. Rogue Field Marshal Khalifa Haftar has tried to take control over much of Libya with a campaign arising from a rival government in the east of the country. Many Western allies, however, have been steadfast in their support of the UN-backed government seated in Tripoli. With the world’s leading superpowers distracted by economic malaise and the global pandemic, it’s left to secondary powers such as Turkey and Egypt to fight for influence. Whoever wins will secure control over the largest oil deposits in North Africa and influence over important waters in the Mediterranean.
In Asia, the prospects for North Korean détente are gone. Washington, meanwhile, continues to lob economic arsenal at China despite recent trade breakthroughs. China, for its parts, has proceeded without interference with its Belt and Road Initiative, which could be seen as Beijing’s answer to The Marshall Plan that infused Pax Americana into the global system. Writing in Foreign Affairs, Michele Flournoy, once the seventh-highest ranking official at the US Defense Department, said distracted powers are prone to making mistakes.
“The more confident China’s leaders are in their own capabilities and the more they doubt the capabilities and resolve of the United States, the greater the chance of miscalculation—a breakdown in deterrence that could bring direct conflict between two nuclear powers,” she wrote.
The international system has been defined by the ebb and flow of the struggle for power between adversaries. The power of a state, meanwhile, also tends to follow a regular ebb-and-flow pattern and survival in many ways is dependent on familiarity with where on that cycle a state power exists. Getting it wrong can be disastrous. Forced unexpectedly to search for new foreign policy roles, a state feels threatened by uncertainty and is vulnerable to overreaction and even exploitation. The triple threat of economy weakness, a global viral pandemic and low oil prices creates a high degree of uncertainty. And despite the economic headlines of stock market rallies, that uncertainty presents a clear and present danger.
There are signs the global economy is rebounding, but it’s rebounding from unprecedented lows. US mortgage delinquencies last month were the highest since 2011 and, even with low interest rates, new home sales are expected to decline. US consumer fuel watcher GasBuddy, meanwhile, reported gasoline demand on Sunday was down 1.1% from the previous week and down 18% year-on-year. Pay attention Tuesday to readings of manufacturing levels in the euro-area, particularly in powerhouse Germany, which seems to be staging a comeback. US manufacturing PMI, meanwhile, is expected to move closer to the 50 mark that separates growth from contraction. Wednesday brings the usual EIA data, as well as a gauge of confidence in the French business sector. Consumer confidence in Germany comes next on Thursday, as are accounts of the latest meeting from the European Central Bank. But the big deal Thursday is the latest reading on US GDP, which is expected to show a 5% contraction. And the week ends with a flurry of data from the US, as well as a reading of consumer confidence from the University of Michigan. The Red alert holds for the foreseeable future, with Brent expected to move by at least 4% on the week.