Complex Made Simple

Showdown showtime: The May 2 zero Iran oil exports deadline is here, carries repercussions

Will the US dictate OPEC production policy and how will markets, locally and globally, react now that sanctions threaten anyone importing from Iran

Oil economists estimate Iran’s exports will fall at least 500 – 600,000 barrels a day in the next two months China is the world’s largest purchaser of Iranian crude oil and has actually increased its purchases to 700,000 barrels a day Iraq has increased oil output to 4.3 million barrels a day, second only to Saudi Arabia in OPEC

By Matein Khalid: Chief Investment Officer and Partner at Asas Capital

The Trump White House’s decision to end sanctions waivers to eight countries (China, Japan, India, South Korea, Turkey, Italy and Greece) on May 2 has triggered a new geopolitical shock to the crude oil market. After a free fall late last year, Brent crude is up 33% to $72 a barrel as I write. The oil market is unsettled because of supply disruption in Venezuela and Libya. In addition, last October’s Saudi-Russian led OPEC plus output cut has tightened the global oil supply-demand equation, even though the US Dollar Index is well above 97 and IMF has cut global growth forecasts to 3.3%. Washington’s decision to end Iran sanction waivers will have a seismic impact on both international relations and the global energy market.

Saudi Arabia is obviously the major beneficiary of Trump’s new policy shift. The kingdom has a budget break even price of $85 Brent and it has endured the biggest loss in market share and lost petrocurrency revenues from multiple OPEC and non-OPEC output cut pacts – with Nigeria, Russia and Iraq acting as classic “free riders”. It will take Saudi Arabia at least a few months to raise output once the waivers expire on May 2 and the OPEC ministerial meeting in June could even witness tensions between Riyadh and Moscow since the Kremlin has also complained about lost market share due to the output cut pact with OPEC.

Trump has sworn to reduce Iran’s oil exports to “zero”, a scenario that raises the risks of retaliation by Iran in the Middle East. In the past, the Iranian regime has threatened to mine the Straits of Hormuz and unleash Hezbollah’s 100,000 missile arsenal against Israel if the US Navy attacked its assets in the Gulf. Any military hostilities could mean an oil price panic akin to 1973 (the October war in the Sinai/Gulan), 1979 (the overthrow of the Shah from his Peacock Throne) and 1990 (Saddam’s invasion of Kuwait). 

US sanctions have led to a precipitous fall in Iranian exports since Trump took office in January 2017. Oil economists estimate  Iran’s exports will fall at least 500 – 600,000 barrels a day in the next two months. This means Washington will pressure Saudi Arabia to increase production since no other oil exporter in the world has its spare capacity, I expect Saudi Arabia, UAE and Kuwait will increase output this summer to compensate for the loss of Iranian crude. However, this process takes time and will not prevent a gasoline price spike in the United States. An embattled Trump faces a re-election campaign and cannot afford an oil shock triggered recession. So Trump will not hesitate to order oil sales from the US Strategic Petroleum Reserve if panic grips the oil market.

China is the world’s largest purchaser of Iranian crude oil and has actually increased its purchases to 700,000 barrels a day. President Xi Jinping will not risk the collapse of a new trade pact with Washington by continuing to buy Iranian oil, though clandestine/barter deal on discounted cargoes may well continue. Turkey, facing a financial and political crisis, cannot afford to defy the Trump White House. Japan, South Korea, Italy and Greece are treaty allies of the United States. India cannot risk being blackballed by Washington from the international banking system and Modi will play ball with Trump. As with Dr. Mossadegh in 1953, the Americans will pressure Iran’s oil exports as a potential catalyst for regime change.

Iraq is the new strategic prize in the Middle East energy Great Game. Iraq has increased oil output to 4.3 million barrels a day, second only to Saudi Arabia in OPEC, despite the traumas of sectarian civil war, systemic corruption and Daesh terror. No less than 20% of the increase in global oil supply in the past year can be attributed to Iraq, making it a pivotal state in Arab/energy geopolitics. However, Iraq faces a fragile security and foreign policy environment due to the presence of pro-Iranian militias, infiltration of Revolutionary Guards intelligence assets in its state institutions and tense Baghdad-Erbil relations. The West, Saudi Arabia, Egypt and the UAE can and must embrace Iraq as a diplomatic/economic ally in their coalition against terror in the Middle East.