Oil market geared for instability in foreseeable future

There are industry predictions of a potential return to $100 a barrel crude prices next year.
Sunday 20/05/2018
Iranian oil workers gather at an oil refinery south of the capital Tehran. (AP)
Uncertain times ahead. Iranian oil workers gather at an oil refinery south of the capital Tehran. (AP)

Regardless of the yet-to-be-seen political ramifications resulting from US President Donald Trump’s decision to withdraw from the Iran nuclear deal and impose new sanctions on Tehran, oil markets could be in for a bumpy ride for the foreseeable future.

Oil prices are currently in a holding pattern until the Trump administration’s policy towards Iran and its oil exports becomes more articulated and it’s clear that the threat of renewed sanctions isn’t a bargaining tool for Washington to attempt to renegotiate the Iranian nuclear deal in the Trump administration’s favour. The oil markets also need time to assess how Iran’s largest crude customers plan on responding to US sanctions being levied on the Gulf nation.

US Treasury Secretary Steve Mnuchin set the clock ticking in a statement he released on May 8 that stipulated that the US government would reimpose US nuclear-related sanctions on the Iranian regime “subject to certain 90-day and 180-day wind-down periods,” with the six-month wind down including oil-related purchases. That means that countries buying crude from Iran have some breathing room to begin cutting their purchases and finding alternative supplies and to begin negotiating with the Trump administration on potential waivers. China, Iran’s single biggest crude buyer, has pledged it will continue to purchase Iranian barrels regardless of US sanctions.

There are industry predictions of a potential return to $100 a barrel crude prices next year, depending on just how much Iranian oil gets taken off the markets and how quickly and sufficiently replacement barrels can be provided by other suppliers. On the flip side, some market analysts foresee prices tumbling below $30 a barrel should producers use the Iranian sanctions as an excuse to drop out of an ongoing supply restraint agreement in place since early 2017.

Prices had been steadily rising in the lead-up to Trump’s May 8 announcement about the United States pulling out of the nuclear deal and the threat to levy new “powerful” sanctions on Iran. The actual news helped push prices up sharply for US benchmark crude West Texas Intermediate to more than $71 a barrel and UK benchmark crude Brent to $78 a barrel before they fell back on suggestions that world powers who helped architect the 2015 nuclear deal were committed to saving the agreement. The markets also responded to reassurances from Tehran’s chief geopolitical rival, Saudi Arabia, that the kingdom would boost output to help fill in for lost Iranian barrels resulting from renewed US sanctions.

In late 2016, Riyadh helped cobble together an output agreement with some of its fellow members of OPEC and independent producers that sought to shore up flagging global oil prices by withholding 1.8 million barrels per day (bpd) of crude from the markets.

That cooperation has dramatically reduced the global oil glut and strengthened oil prices. A risk of Saudi Arabia offsetting lost Iranian exports with its own higher volumes is a collapse of that production restraint accord between OPEC and independent producers, translating into oil markets suddenly being awash with large quantities of crude.

Iranian Oil Minister Bijan Zanganeh in an interview on Iranian state television on May 10 accused “some OPEC members” of “acting as tools for carrying out US policies.” Zanganeh suggested that the Trump administration was collaborating with certain countries to secure higher oil prices that would boost US shale oil production to strengthen the American economy.

Because it is early days in the aftermath of Trump’s sanctions announcement, industry estimates of the anticipated cut in Iranian exports are all over the place, ranging 200,000-500,000 bpd in the preliminary stages to over time potentially reaching 1 million bpd.

In the previous US sanctions regime, the Obama administration provided waivers to foreign countries if they demonstrated they were significantly reducing their crude imports from Iran, with these exemptions reviewed every 180 days. China, India, South Korea, Japan, Taiwan and Turkey were granted waivers under that sanctions regime.

It is unclear to what extent the Trump administration is planning on targeting Iranian oil exports and whether it will similarly offer waivers to foreign countries that wish to continue to import crude from Iran. Some Iranian crude buyers who don’t wish to run afoul of the Trump administration will likely start ratcheting down their purchases over the next three to six months as a demonstration of good faith in anticipation of waiver discussions.

Iran’s crude exports total around 2.6 million-2.7 million bpd with 1.8 million bpd dedicated to Asian customers. Of that Asian volume, China accounts for roughly 40%. Given the tense trade relations between Washington and Beijing and China’s position of rejecting unilateral sanctions in general, it would be shocking if Beijing would cave to US sanctions impacting its ongoing purchases of Iranian crude. Japan, which bought around 170,000 bpd of Iranian crude last year, has indicated it will request a waiver from the Trump administration, wanting a determination of whether its current Iranian volumes were sufficient enough to gain an exemption.

Those seeking to defy reimposed American sanctions are likely to face similar economic restrictions contained in the previous US sanctions, which denied foreign financial institutions doing trade with Iran’s central bank access to the US banking system. This would affect any foreign firms that perform significant dollar transactions, access US banks or have other business in the United States.