May 2019 Volume 1

ECONOMIC UPDATE

Economic Update by Christopher Kuehl, Ph.D.

Short Items of Interest – US andGlobal Economy Calls to Expand Range of Steel Tariffs – As expected, the countries that export steel and aluminum to the US have bypassed some of these restrictions by sending more finished products made of that steel and aluminum. The US steel and aluminum producers as well as some of the manufactures are now asking the US to impose tariffs of these finished goods as well. This makes some sense, but it is hard to determine where this pattern ends. The producers will continue to seek opportunities to ship in assembles and products that are not covered by the tariff law, and it will become a chasing game of sorts. Chinese Steel Industry Under Assault – In past years, the Chinese government has done what it could to bolster the steel sector as these operations are generally in the rural areas and provide a lot of jobs. The sense is that there is less interest in the steel sector this time and the stimulus money is not heading that way. There will be shutdowns, and China may stop overproducing – a development thatwouldbeaccepted favorably in the global economy. Energy Spotlight Over the last few years, there has been more and more cooperation between the members of the Organization of the Petroleum Exporting Countries (OPEC) and Russia, but there has been no desire on the part of the Russians to subsume themselves to the control of OPEC. Several other oil states have the same attitude as OPEC is generally seen as a proxy for the

Saudi Arabian Ministry of Energy, Industry and Mineral Resources. It has not been all that sensitive to the needs of oil states that are not in the Middle East and North Africa. There also has long been tension between the biggest members of the group – Saudi Arabia and Iran. Russia has created something of an alternative to OPEC – a ten-nation alliance with far looser ties and requirements. It includes some of the former Soviet republics and some small producers in Africa, but the primary members are Russia, Kazakhstan and Mexico. These nations have been working with the OPEC states on a year-to year basis, but OPEC would like a longer-term agreement that ties the two groups together for as long as 10-20 years. Analysis: The aim of OPEC and Russia’s ten-nation alliance has been the same for the last year or two – restrict output enough to increase oil prices. Right now, the Brent Crude prices are in the low 60s and the West Texas Intermediate (WTI) is in the 50s. These prices have been even lower at times. The preferred price for OPEC and Russia would be closer to $80 to $90. It is not clear that even this grouping would have enough clout todriveprices that high if the US and Canadian oil producers elected to boost their output. It is useful to remember that an ideal price for oil from North Dakota is about $70, and these producers are not all that happy with the current price ofWTI. There are many motivations for the creation of an alliance like this one – not the least of which is the opportunity for OPEC to regain some control over the price per barrel.

Another factor that has allowed this alliance tomove towards completion is politics. Russia had been pushing for a closer relationship, but Saudi Arabia was reluctant to get closer to Russia given their long alliance with the US. The Khashoggi murder has strained relations between the US and Saudi Arabia, and suddenly, Crown Prince Mohammed bin Salman is far less concerned about what the US thinks. There is something similar taking place in Mexico. They have not wanted to join OPEC, but they also took an arm’s length stand on the Russian alliance until the election of Andres Manuel LopezObrador. Hehasbeen farmore interested in relations with Russia and far less concerned about what the US thinks andwants. It is a long way from forming an alliancetorestrictoil output anddrive prices up to get a desired outcome, but the US is now facing a more concentrated set of opponents. Chances are good that price hikes will be taking place, and perhaps as soon as the summer driving season. Worries about inflation have been somewhat subdued over the last year, because the price of gasoline at the pump has been down and even hitting ten-year lows. If that trend reverses, it can be expected that inflation will jump and quickly. This is the kind of surge that provokes quick action from the Federal Reserve System in terms of hiking rates.

FIA MAGAZINE | MAY 2019 9