The GERM Report

Risk level: Yellow

RED: Severe (+/- 4%) ORANGE: High (+/- 3%) YELLOW: Elevated (+/- 2%) BLUE: Guarded (+/- 1%)

THE BOOSTER SHOT

-US energy goals are a fool’s errand

-Brent won’t be in black because OPEC is back

OPEC curtailments eased back as of Saturday as the cartel anticipates a slow rise in demand through the second half of the year. According to media reports, and to no real surprise, Russia had already produced more than its fair share last month. The market, however, is showing clear signs of contraction, with the United States, European and Asian economies all feeling the pressure of the pandemic. Geopolitical opportunism, meanwhile, continues to run hot, which could add a bit of a risk premium to the price of oil. That said, the economic headwinds are blowing hard and its undermining even the most ambitious of strategies – US energy dominance.

In a clear indication that Brent crude oil was range-bound for much of July, the global benchmark for the price of oil gained only a 0.09% during the week ending July 31 to finish at $43.30 per barrel. A sizeable draw on US commercial crude oil inventories was balanced by economic malaise last week. For the month, Brent gained about 5%.

The two dozen or so parties to an OPEC-led program to keep barrels out of a depressed market started to relax during the weekend. Early reports indicate that much of the increase will be used for domestic consumption and not for exports, though how much refinery input can be expected amid recessionary strains is an open question. By way of example, the United States put some 14 million barrels per day into its refineries during the week ending July 24. That’s about a percent higher than the previous week, but some 17% lower than during the same period last year. US crude oil imports were about 14% lower over the four-week average than during the same period last year. From Saudi Arabia, the United States took in about 116,000 fewer barrels per day, or roughly 28% less, than it did during the same week. OPEC agreed to trim production by a collective 10 million bpd or so. Where the extra 2 million bpd will go in August is anyone’s guess, though it’s sure to provide headwinds to the price of oil.

There are, meanwhile, clear indications that the global pandemic is not yet under control. Outside of the headlines detailing the failed US response and countries from Kazakhstan to Bolivia are reporting thousands of new cases every day. That’s having clear indications on global demand. For the oil sector, Olivier Le Puech, the head of global oilfield services provider Schlumberger, said the industry has already been through “the most challenging quarter in past decades.” In manufacturing, the road ahead is so uncertain that top brass at the Caterpillar behemoth didn’t even bother with forward guidance in its latest earnings report. Nevertheless, there are fewer positive signals than negative ones in the global economy. The Organization for Economic Cooperation and Development finds the unemployment rate among its 37 members is expected to hit 10% this year, double the rate from 2019, and climb as much as 12% should, and this seems likely, a second pandemic wave hit. Those still on the payroll, the OECD estimated, are working 10 times fewer hours than during the first few months of the financial crisis of the middle aughts.

“A jobs recovery is not expected until after 2021,” the organization estimated.

Some 800 redundancies are expected from a weekend decision from Marathon Petroleum, the largest US refiner by volume, to close down two small refineries in the southwest United States. That decision followed a proclamation last week from US President Donald Trump that he convinced Saudi Arabia and Russia to end an early-year battle for market share and coordinate on production restraint. Speaking from the Texas shale patch, the president promised to defend US energy jobs from the “zealots, radicals, and extremists” he claims are trying to shut the industry down.

“We will defend your jobs, and we will defend the Lone Star State,” he said. “And we will defend America’s newfound energy independence.”

Ed Longanecker, the president of the Texas Independent Producers and Royalty Owners Association, said Trump’s visit was a sign of the importance of the oil and gas sector in this administration. That said, the industry has “borne the brunt” of the quarantine economy.

“To further illustrate the impact of these market factors, the Texas upstream sector experienced a decline of almost 40,000 jobs between January and June of this year, meaning the impact of the downturn will be more severe on an annualized basis,” he added. 

In June, the Texas Alliance of Energy Producers revised its so-called Petro Index, which measures the health of the oil and gas economy in the state, to its lowest point since the last price crash in 2014-16. Karr Ingham, the head of the alliance, said the pandemic was a “gut-punch” to the sector. Total US crude oil production, meanwhile, is down some 7.5% from this time last year. In 2019, the Federal Reserve Bank of Dallas estimated the range at which Texas shale producers would break even would be between $23 and $70 per barrel, with the median falling somewhere around $50 per barrel. The last time West Texas Intermediate, the US benchmark for the price of oil, closed above $50 per barrel was in late February, long before the pandemic struck the United States.

Energy independence is a myth. Despite a week-on-week decline, the United States imported nearly 70% more crude oil from Saudi Arabia in the four-week period ending July 24 than it did during the same period last year. And despite some overhauls, many of the US refineries are tooled to process heavier crudes, not the light, sweet stuff produced domestically. With courts blocking the export-dominant Keystone XL pipeline, the president gave the approval for TC Energy to send an estimated 29% more Canadian barrels through the existing Keystone network to the Midwest and Gulf Coast. With Saudi Arabia capable of pulling barrel out of the ground for around $3 a barrel, energy dominance too is a myth. The United States will remain at least somewhat dependent on foreign oil for the foreseeable future and that has profound impact on geopolitical affairs.

A general strategy that prioritizes domestic economic revival in the United States could help explain the Trump administration’s departure from the global stage. This administration has yet to see a multilateral agreement it didn’t like. But without a clear doctrine of his own, the dogma of his secretary of state, Mike Pompeo, holds sway and that principle is almost completely focused on China. Distractions at home and the Chinese obsession leaves the United States exposed on its eastern flank. Russian natural gas monopoly Gazprom is making progress on building a second leg of its Nord Stream pipeline to Europe despite US objections, which have only become more aggressive since US LNG exports became a thing. Instead of deterrence, however, Trump is ceding the strategic upper hand in German, the landing zone for the Russian gas pipeline. In North Africa, Russian mercenaries continue to threaten oil facilities in Libya and the conflict there looks like a game of Risk, with global adversaries jockeying for control. Tensions are now spilling over to Central Asia, with fighting returning to the border between Azerbaijan and Armenia. The United Arab Emirates has got in the game, warning Turkey to “to stop intervening in Arab affairs.”

Thomas Hobbes in The Leviathan warned that a system without a dominant overseer would make life “nasty brutish and short.” The end of the bipolar era that came after the collapse of the Soviet Union is morphing into a multipolar arena, though the demarcations are not yet clear. The US alienation of Europe leaves a clear opening for Russia to expand beyond its traditional sphere of influence, while China has only become more emboldened. Despite Trump’s claims, there is no such things as independence in the multilateral order. To pursue that aim is not only a fool’s errand, but one which retreats from legacy doctrines that made the United States the pre-eminent superpower in the first place.

Indian manufacturing is expected to show a slight improvement on Monday, and we’ll see if Russian can follow suit. Most of the European indices show manufacturing on the positive side of growth. Negotiations in the United States over pandemic relief, however, will likely dominate the headlines as partisan bickering leaves US households dangling over an economic cliff. Canada reports on PMI on Tuesday and Wednesday brings the latest GDP reading from Indonesia. Balance of trade metrics in North America are out mid-week, as are the obligatory data on US commercial oil and gas inventories. Rate decisions from India and the United Kingdom come out on Thursday, as are weekly jobless claims in the United States. The July report on jobs and wages in the United States ends the week. With OPEC+ restraint easing and no pandemic relief in sight for the US economy, expect the price of crude oil to fall this week by at least 2%, a Yellow alert on The GERM Report’s scale.