Sunday, July 8, 2018

Risk level: ORANGE - High

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

THE BOOSTER SHOT

             The trade shot heard around the world could be negative for crude oil prices
             Iran says it may choke off the Straits of Hormuz if it's backed into the corner
             Libyan warnings of an economic domino-effect remain an underlying market factor


The foreign appetite for U.S. President Donald Trump's brand of politicking will be put to the test this week as he embarks on a tour of Europe. It was China on the radar, however, on Friday when the Trump administration fired more economic shots at its main economic competitor. Growing fears of a no-win war could dampen the momentum for economic growth going forward, as realized by the weaker opening for Brent crude oil on Friday. Given the president's ability to maneuver the narrative, any downturn in the price of oil from trade tensions could be used to support his claim that he's pulling the strings at OPEC. We'll find out this week when OPEC economists publish their first monthly market report since June's agreement to ease compliance with agreed production cuts. Europe, meanwhile, is working to salvage an Iranian deal abandoned by the president, whose decision to back out added a supply-side risk premium to the price of oil. Spare capacity is a looming fear, though the impact of protectionist trade policies could balance that out to prevent overheating. We were more or less on par with an Orange alert last week, with Brent ending the week down 2.9 percent to finish out at $77.13 per barrel.

Just after midnight in Washington D.C. on Friday, U.S. President Donald Trump signed off on 25 percent tariffs on Chinese goods worth an estimated $34 billion. China fired back almost immediately with a tit-for-tat move in response to what China's Ministry of Commerce said was the U.S. start of the largest trade war in economic history.

We are well aware at this point of the dangers of global trade war. There are no winners, even if, as the U.S. president has said, they're easy to win. In minutes from June meetings, the U.S. Federal Reserve struck an optimistic tone for growth in the world's largest economy and Friday's job figures added support to that outlook. Underneath the veneer, however, were concerns about the adverse effect of tariffs.

"Contacts in the steel and aluminum industries expected higher prices as a result of the tariffs on these products but had not planned any new investments to increase capacity," the meetings read.

That could limit the takeaway capacity in the U.S. energy sector and erode some of the gains the White House expects in the domestic market by reacting to what it sees as a long history of lopsided trade policies. Testifying before the U.S. House of Representatives in late June, Robin Rorick of the American Petroleum Institute said the U.S. energy sector will need $1.3 trillion in investments through 2035. Additional costs by way of tariffs could stifle investor confidence in the southern oil belts that support the president, and the FOMC minutes support that despondency. At a rally in Montana last week, the president was still cheered for his policies because, according to him, "we have all the cards." China has more cards to play of its own by way of a potential 25 percent tariff on imported U.S. crude, hitting a U.S. energy sector already pressured by tariffs on imported aluminum and steel.

What appears to be the truth and what's actually the truth are at odds in a political cycle where optics matter. Those optics will be viewed through a different lens when the president heads this week to the European continent. Waiting for him in London will be tens of thousands of protesters and a Europe growing weary of Trump's diplomatic style, which generated mixed results at best from the latest outreach with North Korea. On Friday, British leaders joined those from France, Germany, China and Russia at the table for a review of the U.N.-nuclear agreement unsigned by Trump in May. With some sanctions snapping back by August, the remaining parties to the agreement appear steadfast in their support. Expressing deep regret for U.S. action, the joint commission for the JCPOA said from Vienna the continuation of the flow of Iranian oil was part of the agreement and something they vowed to maintain. Whether or not that support can hold past November, when oil-related sanctions enter into force, remains to be seen. But U.S. considerations of case-by-case scenarios for Iranian oil customers, as well as Indian and Turkish insistence that they're protected from unilateral sanctions, suggests there may be some room to maneuver.

Perhaps it's indicative of the diplomatic challenges in broader terms for the Trump administration that, during 2015 negotiations for the JCPOA, hawkish former U.S. Secretaries of State Henry Kissinger and George P. Schultz wrote in The Wall Street Journal that re-imposing sanctions on Iran would not be automatic.

"Restoring the most effective sanctions will require coordinated international action," they wrote.

Meanwhile, Iran said it may take military action to disrupt the flow of oil through the Straits of Hormuz if its exports are blocked. If Iran can't export oil, Tehran seems to be saying, than it will be tough for others to do so as well. If Iran remains in the picture, the concerns about the lack of spare capacity would not be so great. If it doesn't stay in the game, geopolitical tensions will likely escalate by early 2019.

There remains, meanwhile, the Libyan wild card. Oil loading is suspended, but reports last week offered a sweeping range of figures for what the country was producing. All indications, however, are that Libyan production is well below recent peaks of around 1 million barrels per day. Mustafa Sanalla, the head of the U.N-backed National Oil Corp., met last week with Western diplomats to drum up support for an oil sector under threat from competing claims of authority. If Libya's economy falters, he warned, there may be a domino-effect across north Africa. While Libyan woes are nothing new, a further escalation here could add a significant risk premium to the price of oil.

We anticipate a bit of a slip in the price of oil on Monday as the market takes stock of the weekly gain in North American rig counts. We wouldn’t expect too much early-week movement, however, given the anticipation building ahead of the June market report from OPEC.  Tuesday will likely set the market headed in one direction or the other after the U.S. Energy Information Administration issues its monthly report. It raised its 2019 forecast for Brent by $2 per barrel in its last report. Direction will be tested again on Thursday with the release of the U.S. Consumer Price Index, especially given recent concerns about the cost of consumer fuels, and the release of The International Energy Agency's monthly report.

We're expecting concerns about the fallout of a Sino-U.S. trade war, which could lead to declining confidence in the overall economy, to dominate the front-end of the week. Recent talk of $100+ barrel aside, the immediate stage may be set for a search for a new course. Given the obvious impact of the EIA, OPEC, and IEA reports, we're expecting another volatile week for the price of crude oil and issuing an Orange alert. Brent could swing lower if monthly market reporting takes note of the headwinds from trade, or pump up on expectations of dwindling supplies in the second half of the year.

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