In a little over two months, painful U.S. sanctions on Iran’s oil sector will take effect, but the Iranian economy is already showing signs of strain.
Iran’s currency, the rial, has fallen by more than half since the start of the year. There is now a thriving black market for U.S. dollars as the rial continues to plunge.
The turmoil has the government engaging in a bit of a circling firing squad. In July, the head of the central bank was sacked. In early August, the labor minister was ousted and just this past weekend the economy minister was removed.
The reshuffling and purging of top officials suggests that hardliners in Tehran are gaining ground against the government of President Hassan Rouhani, a moderate by comparison. “Rouhani’s failure to respond to the economic crisis with gut and grit has further isolated him,” Ali Vaez, the director of the Iran Project at the International Crisis Group, told the Wall Street Journal. “Even his erstwhile allies in the parliament are deserting what they believe is a sinking ship.”
But even though the economic indicators look poor, Rouhani’s real failure in the eyes of the hardliners has been political. That is, his government made the mistake of trusting the United States when it agreed to the 2015 nuclear deal. The Trump administration’s withdrawal from the pact earlier this year was proof in Tehran that opening up and negotiating with the U.S. on the nuclear program was a miscalculation. Rouhani has been in trouble since then, and the economic pain related to the re-implementation of U.S. sanctions is merely compounding the problem. In July, Iran saw its oil production fall by 56,000 bpd compared to a month earlier, and output is down 150,000 bpd compared to May. Early data from Reuters suggests that oil exports could fall to just 2.06 million barrels per day (mb/d) in August, down from 2.16 mb/d in July.
But the noose of sanctions is tightening, and the worst is yet to come. Estimates vary, but many analysts peg the losses due to sanctions at around 1 mb/d. Sharply lower oil exports will cut deeper into government revenues and weaken the currency even more (unless oil prices rise significantly to offset those losses). BMI Research expects Iran’s economy to contract by 4 percent in 2019.
Protests have spread across the country, and although they have been springing up in sporadic fashion, the anxiety has only increased over time.
The U.S. government insists that regime change is not official American policy, although no reasonable person with knowledge of the relationship would think that Iran could agree to the harsh demands laid out by the Trump administration. That raises questions about Washington’s ultimate objective.
For now, Washington seems content to watch Iran’s oil production and exports continue to fall, hoping that the political and economic cracks widen. U.S. sanctions will likely have a more severe impact this time around than they did in the years prior to the 2015 nuclear accord.
The impact on oil prices is hard to precisely pin down, but it is the most bullish factor facing the market for the foreseeable future. Global supplies are set to rise, but the prospect of Iran outages will prevent prices from falling too much. “The rising tide of oil supply should keep Brent crude oil prices in a $65 to $80/bbl range for now, until Iran sanctions start to bite in 1H19,” Bank of America Merrill Lynch wrote in a note. From there, prices could head higher.
“As oil sanctions against Iran take effect, perhaps in combination with production problems elsewhere, maintaining global supply might be very challenging and would come at the expense of maintaining an adequate spare capacity cushion,” the International Energy Agency said in its August Oil Market Report.
The big question is how much China and India will reduce their purchases of Iranian oil. In July, purchases by India and China actually increased, although that could be temporary. New Delhi appears more amenable than Beijing, reportedly offering the U.S. government to slash imports of Iranian crude in half if Washington granted a waiver for the rest. China, on the other hand, has sent signals that it will try to strengthen its relationship with Iran.
“While the Iranian sanctions issue certainly isn’t new news, suggestions out of the White House that waivers will be restricted appeared to augment last week’s price gains,” Jim Ritterbusch, president of Ritterbusch and Associates, said in a note a few days ago.