Figure 1 from: International Studies Quarterly (1983) 27, 419-441 War and Power Dynamics: Economic Underpinnings CHARLES F. DORAN Johns Hopkins University

 

Risk level: Blue - Guarded

RED: Severe (+/- 4%) ORANGE: High (+/- 2%)  YELLOW: Elevated (+/- 1%)  BLUE: Guarded (+/- ½%)

 

We continue to see moderation ahead for the price of crude oil as traders take a wait-and-see approach ahead of the May 12 deadline for a U.S. decision on the Iranian nuclear deal. The price for Brent should stick within its current range. We were overly aggressive last week with our Yellow Alert as Brent ended the week down by about a half percent at $74.42 per barrel.

It's earnings season. Results were more or less mixed, with Exxon Mobil disappointing after posting solid gains in the fourth quarter with help from the U.S. tax reform. Chevron, meanwhile, saw share prices jump 0.9 percent to $126.62 after upstream earnings more than doubled from last year to $3.35 billion.  But it was French supermajor Total that offered one of the better peaks at market sentiment when it took notice of an environment that "remains nevertheless volatile with persistent uncertainty."

On Tuesday, British energy company BP publishes its quarterly earnings and markets are certain to move on comments from CEO Bob Dudley. The supermajor is already coming out of one of its strongest quarters in years, but Dudley's mind has been on the future. Speaking last week in London, the CEO said the shifting energy landscape meant oil will fade from the global energy mix.

"At some point oil will stop growing," he said. "But the pace of any subsequent decline is likely to be very slow, with the world needing a lot of oil for a long time to come."

Which brings us to the esteemed John Kemp. Citing Stein's Law -- If something cannot continue forever, it will stop – the Reuters oracle said the market is on an "unsustainable course," with no cushion for risk and few new sources of supply to meet the expected swell in demand during the summer. That could spell trouble ahead. Already, President Trump has suggested that oil prices may be too high, an indication he may be growing sensitive to consumer strains. That's becoming apparent as the U.S. economy grew at its slowest pace in a year in part because of lower consumer spending. That could be an indication of emerging demand trends and, from Kemp, "the higher prices rise and the longer they are expected to stay high, the bigger the eventual response from oil consumers."

Last week saw some of the geopolitical risk premium fade in response to historic handshakes on the Korean peninsula. Speaking on the thaw, U.S. Vice President Mike Pence said it was a small step that was big on talk, but short on action. Any move by North Korean leader Kim Jong Un, he said, "will be met with reservation, vigilance, and verification." And with the May 12 decision on Iran, reservation may be the operative word given doubts cast over the Joint Comprehensive Plan of Action. Why deal with North Korea on nuclear issues if the Trump administration is willing to walk away from the JCPOA? If Kemp is right, there may be an economic pitfall ahead as consumers shrink away from the higher oil prices that are likely to come.

With its balancing act, OPEC may now be caught in a pickle. Oil prices may be stuck now, but start to spike in the second week of May in anticipation of Trump's next move. Though OPEC leaders are adamant that they're not it in for the price, there may be a looming game of chicken as the price curve points to a moment where over- or under-steering could leave the market in the ditch.

Risk level: Yellow - Elevated

RED: Severe (+/- 4%) ORANGE: High (+/- 2%)  YELLOW: Elevated (+/- 1%)  BLUE: Guarded (+/- ½%)

We see some moderating trends in the risk premium for crude oil prices, though the line should still hold Brent crude oil in the low $70 per barrel range.

Fundamentals drove most of the rally in crude oil prices, with the U.S. Energy Information Agency reporting a drain on domestic inventories even as production continues to grow. Higher refinery runs and reduced imports contributed to the draw. By Friday, Schlumberger Chairman and CEO Paal Kibsgaard said global stocks weren't building in the first quarter and the oil market was clearly balanced.

But then U.S. President Donald Trump said the price of oil was too high, and artificially so, and Brent tanked for most of the morning before recovering ground by the close. For the week, however, oil prices were up roughly 3 percent, in line with our forecast from last week.

In Saudi Arabia, members of a committee monitoring the agreement said OECD commercial stocks declined 300 million barrels from their July 2016 levels, though more work was needed as inventories were still above the mark before the price of crude oil dropped below $30 per barrel. That would indicate sustained commitment with the agreement, though Kibsgaard cast a cloud over diminishing supply-side pressures by expressing concern about upstream weakness in the face of an "impending deficit" in crude.

On risk factors, North Korean leader Kim Jong Un declared victory while at the same time lauding a "fresh climate of détente and peace" on the Korean peninsula. Since the Winter Games, Kim's rhetoric has permeated more deeply into the international conversation in ways that would seem to thaw regional tensions. Ahead of possible direct talks with Trump, a first with a sitting U.S. president, he said Pyongyang would no longer need to test nuclear devices, intermediate or intercontinental missiles. Why? Because he sees North Korea as a nuclear-weapons state, putting the isolated regime in the same arena as the world's superpowers. The international relations theorist Hans Morgenthau said once that a state is a superpower if it's treated like one and clearly Kim feels his meetings in Washington mean that for him.

At the height of the tensions last year, when Kim was called Rocket Man by President Trump, the price of crude oil jumped more than 2 percent. "Détente and peace" may carry uncomfortable nuclear undertones in that North Korea is unlikely to denuclearize, but it beats trading insults with a finger on the button.

Meanwhile, some recessionary bells may be ringing for the world's leading economies. International Monetary Fund managers last week spent most of their Spring Meeting in Washington warning that protectionism could undermine the growth that's been obvious over the last few years. Trump's message to OPEC last week may have indicated a sign that consumers are getting squeezed by higher oil prices. Temporary tax relief for American consumers is going in the gas tank now, wage growth is lackluster and, by the IMF's read, most people aren't enjoying the benefits of economic growth. That means that, while supply-side pressures may be fading, demand could also weaken.

With a risk premium fading on signs of nuclear de-escalation, the trend for the price of crude oil could cool off ahead of the May decision from Washington on the Iranian nuclear deal. We give the market a code yellow as we expect the price for oil to search for direction in the coming sessions.

Risk level: Orange - High 

RED: Severe (+/- 4%) ORANGE: High (+/- 2%)  YELLOW: Elevated (+/- 1%)  BLUE: Guarded (+/- ½%)

We see a mid-term risk premium for crude oil prices supporting a band above the $70 per barrel mark for Brent crude oil.

Risk has been building for oil prices beyond what fundamentals would normally support, though indications last week did suggest the market is close to balance. Trade tensions between the two leading economies – China and the United States – could be negative for crude, though war drums in Syria are the clear driving factor.  

Addressing the 15-member U.N. Security Council on Friday, U.N. Secretary-General Antonio Guterres called for responsible strategies when considering action in Syria.

"Increasing tensions and the inability to reach a compromise in the establishment of an accountability mechanism threaten to lead to a full-blown military escalation," he said.

After Western-backed weekend strikes on targets in Syria, including in Damascus, the secretary-general urged restraint.

Gulfsands Petroleum was one of the remaining hold outs for formal energy work in Syria, though it declared force majeure more than six years ago. Conflict, however, could bring some of the world's leading oil producers into the fight. 

U.S. President Donald Trump turned his ire toward Russia when mulling missile strikes on Syria, leaving two of the world's leading oil producers bickering over turf in the Middle East. While neighboring Iraq is among the least compliant with OPEC's balancing effort, regional instability could rekindle the same Islamic State activity that threatened the northern oil fields before liberation last year. Iran, meanwhile, would certainly react to any escalation, though it too is bogged down by risk over its proxy war in Yemen with archrival Saudi Arabia. More than one analyst has said that nothing spells risk like a conflict involving the world's leading oil producers.

On the economic front, and outside of the supply-side risks, the Federal Reserve Bank of Boston said it was optimistic about the pace of the U.S. economy, but was worried about what's over the horizon. The potential for a U.S-Chinese trade war could carry a multibillion dollar price tag, cause disruptions to supply of goods for domestic manufacturers and lead to higher prices for consumer goods. That comes as wage growth in the U.S. economy has been increasing only on modest levels. On jobs, Boston Fed Chief Eric Rosengren said the unemployment rate is below what's considered "the natural state."

"Periods in which unemployment dipped significantly and persistently below the estimated natural rate historically have tended to generate conditions that resulted in a recession," he said.

On Friday, the International Energy Agency said it was leaving its global oil demand forecast in place at 1.5 million barrels per day, though lingering cold in parts of the United States spurred demand in the first quarter. Some of that, however, was offset by weaker Chinese data. On the supply side, the IEA said March levels dipped by 120,000 bpd as OPEC partners closed their spigots tighter. For global stocks - - the key metric on balance -- the IEA said levels could reach the five-year average by May, just in time for President Trump to consider sanctions waivers for Iran.

A balanced market has little room for geopolitical risk and for this reason, we give the market a code orange, expecting several sessions with risk premium near 2 percent for Brent.