Despite President Trump’s clear signals over the last month, his decision to leave the JCPOA nuclear deal has still managed to shock the market. It appears that the market, and most European politicians, didn’t believe that Washington would take the step to unilaterally leave the deal. In spite of intense European efforts to convince Washington to stay in the JCPOA deal and try to renegotiate with Iran, the U.S. president has presented the world with a clear message: The President will fulfill his electoral pledges regarding Iran. The global oil market had partially factored in a withdrawal by Washington, but the true impact of the deal remains unclear. In the coming months, Washington will reinstate all of the former sanctions on Iran, starting with the lighter ones, which are mainly meant to curtail Iranian oil exports. If all sanctions, as indicated by Washington after Trump announced the withdrawal from JCPOA on TV, are put in place then the global geopolitical landscape with change dramatically.
If a complete reimposition of sanctions become a reality, which would include the threat of action against European and Asian companies dealing with Iran, the oil market could hit a brick wall. Looking at current fundamentals, demand and supply are already reaching a point where additional changes in supply could lead to supply shortages. The removal of a potential 1 million bpd of Iranian oil before the end of 2018 would surely lead in the short-to-midterm to higher prices. Asian and European clients already expect such a price spike before the end of 2018. There is a chance that the market could mitigate some aspects of this supply shock, with Asian refiners already trying to shift purchases to other exporters. The key Asian importers of Iranian oil are China, India and Japan, all of whom are now eagerly targeting Iraq, Saudi Arabia and Russia for new supply options. The implementation of new sanctions on Iran and its customers will force the Islamic Republic to reassess its options. The same will be true for European oil importers, who have been very active on the Iranian front in recent years.
The real effects of decisions made by Trump will be felt within 180 days, as this is the official timeframe. However, based on remarks made by the U.S. Ambassador to Germany yesterday, straight after decision, Washington could decide to speed up the implementation time-frame. In a ceteris paribus situation, the removal of Iranian oil exports would be hitting the market at present very hard. Price volatility could be extreme, leading to price levels between $80-100 per barrel. The latter would, however, result in possible demand destruction in Asia, and lower economic growth in most Western countries, including the U.S.
Trump, and several OPEC producers, seem to have been discussing the prevention of a possible oil market collapse for a while now. Sources have indicated that Washington, Riyadh, Abu Dhabi and possibly Iraq and Russia, have been discussing behind closed doors how to counter a possible price hike due to loss of supply. Looking at the ongoing OPEC- Russia production cut agreement in place, some spare capacity exists in the market. The production cut agreement has taken more oil off the market than the 1+ million bpd of Iranian crude that is under threat. At present, Saudi production is set at 12.5 million bpd, while it currently produces just less than 10 million bpd. The Kingdom could quite easily increase its production to 10.5-11 million bpd, which would counter a possible Iranian supply decline.
Still, even if Russia, UAE and Saudi Arabia would be able to counter Iran’s production and export decline, the market will remain under severe pressure. OPEC producers, especially Venezuela, Nigeria, Libya and Iraq, are all struggling with instability and economic crisis. Oil production in Venezuela is almost at rock bottom, while Libya’s production is under constant threat from its civil war. Iraq’s expected production boost has not really materialized, while internal political and security challenges could lead to a break down of existing production too.
Even before the Iran situation, global oil markets were tightening at a rapid pace, with high volatility in both supply and price becoming increasingly likely. This could be good news for Iran, as the U.S. administration is required by law to assess the global oil market fundamentals before it is allowed to implement oil related sanctions. If the sanctions could be a real risk for the U.S. economy, several hurdles could emerge in regard to fully implementing Iranian sanctions.
From 2019 onwards, the sanctions will not only hit export volumes but total Iranian production capacity. New restrictions on oil-gas investments, the use of dollar denominated contracts, financing of trade and the possible leave of mainstream European oil and gas companies and oilfield services, will put Iran under severe pressure. Even with the possible help of Russia, China and Indian companies, the lack of knowledge and capabilities provided by Western companies cannot be replaced. Without finances and resources, Iran will return to the situation it was in before the JCPOA was signed. This time, however, there will be a much heavier financial drain on the economy due to Tehran’s engagement in Syria and its support of several other military proxies in Iraq, Lebanon and Yemen. With an already struggling economy, the country’s regime could be facing an immense crisis from within.
At the same time, the oil market will need to keep an eye on several other flashpoints. Even though OPEC and Russia, possibly supported by U.S. shale production, could stabilize the market and mitigate any negative effects, the Trump decision could also lead to further military confrontation in the region – hurting markets further. By openly taking such an aggressive stance against Iran, Washington has implicitly given its support to the anti-Iran Arab coalition (Saudi Arabia, UAE, Bahrain, Egypt) and Israel in their actions against Iran. The Arab Alliance, Israel and Washington, have the same end-goals, the removal of any Iranian influence or military involvement in Iraq, Syria, Lebanon and Yemen. Trump’s withdrawal from JCPOA is not based on the widely commented nuclear strategy of Iran, but on its heavy investment in its missile technology, navy and IRGC military capabilities. The possibility of a military confrontation between Arab/Israeli armies and Iran, and its proxies Hezbollah and IRGC led militias in Syria has increased exponentially. While direct military action against Iran is not yet likely, the fall-out for all parties involved could be disastrous. A military conflict in the Arab Gulf could lead to a full regional war and a blockade of vast volumes of crude oil and LNG to the market.
The chances of a total war in Syria, with possible fallout in Lebanon, are now growing by the day. It will depend on the assessments of Tehran and the willingness of the IRGC backed proxies, especially Hezbollah, if a new war is in the offing. Last night’s military moves by Israel, Iran and others in Syria, show that tensions are nearing boiling point. For Tehran, the JCPOA debacle could become an end-game scenario. Either the next couple of months will be the first step towards the end of the Khomeini-Khamenei theocracy in Iran, due to internal unrest and an imploding Iranian economy, or a fight for survival, starting in Syria and Lebanon. These scenarios should be playing a role in oil market forecasts for 2018-2020. Trump’s election promise has led to an end-game scenario not only for the theocratic regime in Iran but also for the U.S.-Russian power struggle in the region. A military confrontation, fought in Syria and Lebanon, as some predict, will push oil prices up regardless of whatever spare-capacity is there. JCPOA has never been able to truly put pressure on Iran to change, but it gave it some legitimacy and financial capabilities to proceed with its Khomeini’s Veliyat-e-Faqih regional power projections. For some, Trump has understood the concerns of the Arab powers, and Israel, and acted accordingly. Oil and gas are playing a role, but it is at present more a fight-for-survival in which oil and gas fundamentals are going to be drastically impacted if “Doomsday” comes.