The Fuse

Iran Sanctions Add More Risk to Oil Markets as OPEC Continues to Cut

by Matt Piotrowski | May 08, 2018

Update: President Trump announced Tuesday afternoon that the United States will withdraw from the Iran nuclear deal.

May is shaping up to be a pivotal month for global oil markets. U.S. crude prices hit $70 per barrel on Monday, both Iraq and Venezuela are holding elections soon, and U.S. summer driving season begins on Memorial Day weekend. Perhaps the most critical event this month will be President Donald Trump’s decision whether to pull out of the Iran nuclear deal and re-impose sanctions on Iranian oil exports. Leaving the deal may have large implications for oil markets, possibly removing 300,000 to 500,000 barrels per day at a time OPEC continues to reduce supply and Venezuela’s output is falling rapidly.

President Trump says he will announce his decision Tuesday afternoon, and it appears that his administration wants to reopen the nuclear deal to put pressure on Tehran. U.S. Secretary of State Mike Pompeo said at his Senate confirmation hearings last month that he sought to “fix” the agreement and work with U.S. allies to “achieve a better outcome and a better deal.” The Joint Comprehensive Plan of Action, the nuclear deal between Iran, China, France, Germany, Russia, the U.K. and the U.S., was agreed in 2015, lifting sanctions against Iranian oil exports in exchange for Tehran limiting its nuclear program.

Oil market analysts argue that restoring sanctions will be less disruptive than in 2012-15, estimating that exports would fall by 300,000 to 500,000 b/d.

The possible fallout of an increasingly likely U.S. withdrawal from the Iran deal has contributed to higher prices as of late. The exact impact of renewed sanctions is difficult to determine. When the EU agreed in 2012 to sanctions on Iranian oil, about 1.1 Mbd was eventually taken off the market. Besides EU countries, others in the international community also reduced or completely stopped buying from Iran. Since restrictions were lifted in early 2016, Iran’s oil production has fully recovered to 2011 levels of about 3.8 Mbd. Despite the lifting of sanctions, widespread investment in the Iran’s oil sector has failed to materialize, a situation that could worsen with sanctions re-imposed.

Oil market analysts argue that restoring sanctions will be less disruptive than in 2012-15, estimating that exports would fall by 300,000 to 500,000 b/d. The U.S. is likely to receive less support from the international community. Some buyers—chiefly India and China—may refuse to participate.

Nevertheless, reductions in Iranian supply would occur at an inopportune time. Global oil markets are contending with a number of uncertainties and risks. U.S. retail gasoline prices are already 44 cents per gallon higher than year-ago levels, largely because OPEC has successfully removed the supply glut by reducing output since January 2017. It is unlikely that Saudi Arabia—the only OPEC producer with significant spare capacity—will increase supply to offset any declines in Iranian production. After all, Venezuela’s output has fallen sharply and the Saudis have yet to make up for those lost volumes. A number of reports have suggested that Saudi Arabia is seeking to increase prices beyond current levels. “There is no intention whatsoever from Saudi Arabia to do anything to stop the rally” in oil prices, a senior Saudi government official told WSJ. “It is exactly what the kingdom wants.”

Ongoing conflict between two of OPEC’s largest producers will presumably keep tensions high in the Middle East.

The uncertainty about Iranian exports is also occurring at the same time the proxy war between the Riyadh and Tehran in the region is intensifying, adding to the geopolitical risk premium. Ongoing conflict between two of OPEC’s largest producers will presumably keep tensions high in the Middle East, with consequences that are likely reverberate throughout the international oil market.

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