Risk level: Red
RED: Severe (+/- 4%) ORANGE: High (+/- 3%) YELLOW: Elevated (+/- 2%) BLUE: Guarded (+/- 1%)
THE BOOSTER SHOT
-Russia clinging to century-old ambitions.
-Trump’s health likely has a two-day shelf life in oil-market news
The obvious market factor this week is the health of US President Donald Trump. As is typical when discussing the health of a sitting head of state, the messages during the weekend were mixed, though the consensus is the president is indeed ill – and a carrier. That creates a profound level of uncertainty in an election race that ends in just 28 days. The price for Brent crude oil fell 4% on Friday after Trump was whisked away to a military complex near the White House. There was, however, a premium on support last week, with the US employment outlook disappointing many investors. We also continue to have a supply-side problem with the return of Libyan barrels. In the geopolitical arena, meanwhile, trouble in the Caucasus is looking reminiscent of the map leading up to World War I.
A wave of layoffs in the oil sector and furloughs from top airlines last week bruised hopes of durable economic recovery. That is only compounded by the fact that US political leaders are unable to overcome bipartisan issues to pass another round of much-needed stimulus. Even US Federal Reserve officials have said it’s up to US lawmakers to prop up the economy, but so much for that. Discounting the sell-off on Friday, oil was on pace for a sharp downturn and in line with our Yellow Alert until the October Surprise. In the end, the price for Brent crude oil dropped 6.3% on the week to finish trading Friday at $39.27 per barrel.
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Trump had difficulty breathing and was running a mild fever Friday as he was taken to Walter Reed National Military Medical Center after testing positive for the novel coronavirus. Several members of Trump’s inner circle also tested positive, triggering fears of super-spreader activity in the upper echelon of the US political class. The uncertainties are endless, from the death of a political leader less than a month before elections to the shape of the nation’s highest court. The doubts meant risky assets like oil fell out of favor. Crude oil prices tumbled on Friday, though it was largely a knee-jerk reaction as investors moved to safer shores. Already in the week, oil companies from Royal Dutch Shell to Norwegian major Equinor were shedding staff and Fitch Ratings downgraded its outlook for American Airlines, showing products like jet fuel will just wind up back in the refinery as a blendstock rather than a product of choice. We’ll see Thursday how the situation looks when OPEC releases its world outlook. In comments leading up to the event, OPEC Secretary General Mohammad Barkindo acknowledged the stubbornness of the pandemic was extraordinary “and causing major disruption to economies, industries and businesses.”
Given their personal, political and bodily similarities, comparisons have been made between Trump and British Prime Minister Boris Johnson, who contracted COVID-19 at the early stages of the pandemic. There were 18 days between when Johnson tested positive and when he was released from hospital April 12. Brent crude oil rallied some 14% during that time, not on Johnson’s health but on word that the United States helped broker an oil truce between Russia and Saudi Arabia, which at the time were in a battle for market share. We may be in “who knows” territory, though late-week chart patterns for Brent were similar to a band of mild consensus in early September, when the global benchmark was stuck in the upper $30s.
We’ve noted for much of the year that Russia has pursued a long-desired expansion beyond its traditional belt of influence in Eastern Europe. Keen to establish a firm foothold in the European economy, Russia got support for its ambitions to connect the second string of its Nord Stream gas pipeline in the Baltic Sea to the European content when Denmark recently signed off on transit agreements for gas flow. Initially hailed as a boost to energy security given its avoidance of geopolitically sensitive territory in Ukraine, Nord Stream now poses a threat to the advent of US liquefied natural gas exports to Europe. Oil dominance is largely out of the question for the United States. Much has been said about the recent rise in US crude oil exports, but most of that stays in the Americas or winds up in Asia, not Europe. Traders expect US LNG exports to see support given the swings in global natural gas prices, so the competition between the United States and Russia for market share can only increase.
We noted in late September that pipelines are in some ways as good as territorial boundaries because they can be seen as a tacit demarcation of control over the economies in question. We see that playing out in Europe with the vast network of Russian pipelines traversing the fringe of the traditional belt of Soviet influence. Russia has long sought to lay down those territorial claims with oil and gas shipments through territory once considered part of the vast Ottoman Empire, which at its peak reached as far south as Basrah, extended toward Cairo and along the southern shores of the Mediterranean as far away as Algiers. Its decline in the waning decades of the 19th century and the start of the 20th century sparked a race for territorial control that eventually led to the first world war. Russia has never abandoned its pursuit of influence in the region. In 2008, flow through the Baku-Tblisi-Ceyhan pipeline, among the largest in the world, was disrupted when Russia made claims to territory in the former Soviet republic of Georgia. It succeeded through a tacit annexation of the enclaves of Abkhazia and South Ossetia inside Georgia’s internationally-recognized borders.
BTC and the South Caucasus pipeline run from the oil- and gas-rich Azeri waters of the Caspian Sea slightly northwest to the border of Georgia. BTC continues west until terminals on the Mediterranean port in Ceyhan along Turkey’s western border. BTC is controlled by a BP entity in Azerbaijan and the republic’s national oil company. A Turkish company is a minority stakeholder. Similar arrangements hold for the South Caucasus pipeline. Wary of the impact of growing regional conflict, Azerbaijan expressed concern over energy security given that both arteries run close to the volatile Nagarno-Karabahk region. The conflict there is nothing new, but the severity of the recent outbreak in violence is rather unprecedented. The history of the conflict in Nagarno-Karabahk gives us a clue about energy politics as well, with Russia seeking to establish territorial claims early in the 20th century, only to have British forces occupy the region after the Ottoman Empire collapsed after World War I.
But Russia never gives up. The region was a spoil for the victors of World War I and again in World War II, when an ascendant Germany grew wary of Russian ambitions in the Caucasus. Complicating the tensions now are the neo-Ottoman ambitions of Turkish President Recep Tayyip Erdogan, whose put his country on a path to regain influence over the vast parts of the former empire. From Libya, to Syria to Iraq, Erdogan may be on a similar path as post-World War I Germany. In the Caucasus, Turkey favors Azerbaijan, while Russia favors Armenia. The fault lines of the conflict have been there for at least a century. When World War I erupted in 1914, the United States was wary of international military engagement, but later acquiesced when its interests faced a direct threat from Germany. The United States under President Trump too has favored something of a splendid isolation by trying to disengage from what he sees as endless wars. That creates a scenario where lesser powers are emboldened. We see that in the so-called Arab pivot, where Israel was awarded diplomatic victory after diplomatic victory despite its neglect for the Palestinian cause. Russia and Turkey too see their immediate region as ripe for the picking.
History repeats itself. The map of interests in the region are similar to the Balkan Wars that were the prelude to World War I. Writing after World War II, as the demarcations between the great superpowers became clear, US diplomat George Kennan sought to cage the Russian bear by way of a “long-term patient but firm and vigilant containment” strategy that walled in the expansionary tendencies of the Soviet Union. That US vigilance is long over with. France is trying its hand at Hobbesian overseer in the region, but we wonder if the French experience in former colony Lebanon tells us anything about Parisian qualifications. As it stands, there is no material impact to the flow of oil in the region and any geopolitical premium may be priced in already. But assessing geopolitical risk is not easily summed up by the quantification crowd. This is 2020, after all. Risks are abundant and they’re risky to ignore.
We feel the health of the US president will dominate the headlines for the next two days, until US crude oil inventories distract sector trades by way of data from the American Petroleum Institute and the US Energy Information Administration. There’s no shortage of speeches again this week from federal reserve officials in the Americas and Europe. OPEC releases its annual world outlook report on Thursday, and we may see another downward revision to demand given the prospect of renewed lockdowns and diminished travel. And rig counts are a thing again, so we’ll see Friday if drillers in the United States are feeling cozy at current market levels. Also watch for traders to assess their positions on Friday given that it could be a bumpy ride this week. The jump in Brent early in Monday already suggests a Red alert is not out of the question, so expect the global benchmark to move as much as 4% on the week.