U.S Sanctions, Oil Markets and Geopolitics
posted by Karim Pakravan on April 24, 2019 - 3:58pm
Last October, the Trump administration imposed sanctions on Iran’s oil exports, with the stated goal of bringing these exports to zero. However, pre-election concerns about the potential impact on gasoline prices led to the U.S. granting waivers to eight buyers of Iranian oil (China, India, S. Korea, Turkey, , Taiwan, Japan, Greece and Italy). These waivers expired on May 1st, and in an effort to increase pressure on Iran, the Trump administration announced that it would not renew these waivers. Oil prices reacted immediately, with Brent prices jumping by $2.00 to over $74/barrel (bbl)--their highest level in six months. This price reaction illustrates the dilemma facing the Trump administration: shutting off the second largest OPEC oil producer from global oil markets will create a supply shock and could lead to significantly higher oil prices, a tricky outcome in the current election cycle. At the same time, offsetting the loss of Iranian oil production requires a complex balancing of economic and geopolitical interests, with significant unexpected consequences. With these points in mind, we should first look at the impact of the U.S. decision on oil markets.
Oil Markets: Following the sharp fall in oil prices in the last two months of 2018, OPEC (led by the Saudis) and Russia agreed to cut oil production by 1.2 million barrels per day (MBD)), with the brunt of the cutbacks falling on Saudi Arabia. Actually, Saudis cut production by more than was required under the agreement. At the same time, sanctions were constraining Iranian production and exports, leading to an overall 1.7 MBD cut in OPEC output between November 2018 and March 2019. The bulk of the cutback came from Saudi Arabia, which reduced output from an all-time high of 11.1 MBD in November to 9.8 MBD in March. Oil prices (Brent) recovered from a low of about $50/bbl at the end of 2018 to $60/bbl at the end of March 2019.
Iran saw its output decline from a high of 3.8 MBD in mid-2018 to 2.7 MBD in March 2019, and its official exports fell from 2.5 MBD to 1.1 MBD over the same period. In addition, it is estimated that Iran smuggles another 300 thousands of barrels per day (TBD). The non-renewal of waivers was met by condemnation from both the European Union and China, and it is likely that at least China will refuse to abide fully by the U.S. sanctions regime. Furthermore, Iran will continue to find channels to export some oil. Nevertheless, the global oil supplies could drop by up to 1MBD. Moreover, the collapsing Venezuelan crude production and the renewal of the civil war in Libya are putting additional pressure on global oil supplies. The Trump administration claims that Saudi Arabia and the United Arab Emirates have committed themselves to make up the loss of Iranian output, but so far both countries have been very cautious in their response, reflecting the geo-political complexities of the oil issue. The surging U.S. production is helping meet demand. U.S. crude production from both conventional and shale sources has risen by almost 2.9 MBD, to 12.1 MBD, since its low point in mid-2016—crude output was up by 0.5 MBD since the end of 2018, and is scheduled increase by 1 MBD in 2019. Overall, markets are expected to be in balance at the $70-80/bbl price level.
Saudi Arabia: In the first place, the Saudis would welcome oil prices in the $70-80 range, as that would help the country to stabilize its foreign exchange reserves and fund the ambitious development plans of the Crown Prince Mohammad bin Salman (aka MS). Furthermore, Saudi Arabia clearly has the capacity to sharply increase output, and will be under pressure to do so by the Trump administration. At the same time the Kingdom (in particular the ambitious MBS) is likely to use its leverage for an even greater degree of influence over the Trump administration, especially regarding pressure on Iran, the war in Yemen and U.S. support for MBS.
Russia: Russia would also be a major beneficiary of higher oil prices, and may object to a unilateral increase in oil production by the Arab OPEC members. A flooding of the markets by the Saudi will jeopardize the OPEC-Russia coordination
China: China has strongly objected to the U.S. move. It is currently engaged in a major round of trade negotiations with the United State, and is likely to use them as leverage in countering the impact of U.S. sanctions.
The European Union: the EU has also objected to the U.S. move and is intent on preserve ng the JCPOA. However, the Europeans are unlikely to defy the United States and continue buying Iranian oil.
Iran: Iran has limited options in countering the impact of U.S. sanctions. Diplomatically and economically, it remains relatively isolated, and support from China, Russia or the EU is lukewarm at best. At the same time, it can count on the support of some of the OPEC members (in particular Qatar and Kuwait). The Iranian IRGC (Revolutionary Guards, aka Sepah) has threatened to close the Straits of Hormuz, but is unlikely to act on the threat. Nevertheless, Iran could deploy its cyber capabilities against Saudi Arabia (as it has done once in the past and cause temporary disruptions in oil supplies. The country should be able to export some oil through third parties, but would suffer economically as its oil exports dwindle. Nevertheless, the economic “collapse” predicted by the Trump administration is unlikely to happen.