Iran sanctions could tighten global oil significantly

The arrival of the proposed date for the US to re-impose sanctions on Iran came as little surprise, but the tone of President Donald Trump on the potential for future western business with the country was as dark as observers had feared.

“Anyone doing business with Iran will not be doing business with the US. I am asking for world peace, nothing less,” he thundered on Twitter the day after the US reintroduced sanctions on the country on 6 August, 90 days after walking away from the nuclear deal.

This first tranche of sanctions includes measures against the acquisition of US currency and on sovereign debt issuance by the Iranian government, and an embargo on the country’s automotive sector.

“I think this effectively closes the door on trade with Iran for the time being, at least from the perspective of a western corporate,” said a source familiar with international business in Iran.

Those measures on their own would be sufficient to stymie western investment in the country and to make the purchase of goods from the country difficult, but there is still the second milestone to pass in early November. This second tranche of sanctions encompasses Iranian petroleum products, transactions by foreign institutions with the Central Bank of Iran (CBI), and on the country’s port, shipbuilding and energy sector operators.

Coming as global supply and demand for crude oil are closer into balance than they have been in years, the impact could be substantial, according to the International Energy Agency (IEA).

The sudden disappearance of Iranian crude from the global market could cause prices to spike, particularly if it coincides with any other significant disruption or outage in the market.

“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 IEA said in its monthly oil market report last week.

SAUDI PRODUCTION INCREASES

Saudi Arabia, which has been at loggerheads with Iran over crude production since sanctions were lifted due to the former’s desire to tighten production and the latter’s focus on ramping up production and rebuilding its economy, has been quietly bolstering its own crude production of late.

The country has increased average crude output from 9.95m bbl/day in the first quarter of 2018 to around 10.44m bbl/day in June, slightly exceeding the average for 2016 and significantly outpacing 2017 output levels.

OPEC has declared itself ready to inject more oil into the system, and increased production by Saudi Arabia and Russia has gone a long way toward moderating pricing over the last month, with the cost of Brent crude falling from $79/bbl to $72/bbl.

However, production dropped month on month in July, according to OPEC data on Monday, indicating that the equilibrium the Kingdom is seeking will leave prices stable but firm. Nevertheless, the likely loss of Iranian petroleum sources will leave the market much more exposed to disruptions, and the prospect of higher prices could also slow demand next year, according to the IEA.

Despite the intensification of hostilities between the US and Iran, the European signatories to the Joint Comprehensive Plan of Action (JCPOA) are desperately seeking to support the deal.

INROADS INTO IRAN?

“The remaining parties to the JCPOA have committed to work on, inter alia, the preservation and maintenance of effective financial channels with Iran, and the continuation of Iran’s export of oil and gas,” said the EU, German, French and UK foreign ministers in a joint statement last week.

“On these, as on other topics, our work continues, including with third countries interested in supporting the JCPOA and maintaining economic relations with Iran.”

Although it seems unlikely that any large international corporations would be able to make inroads into Iran even under the protection of the EU, due to the US’ primacy as a market, policymakers are holding out hope that smaller firms could be prevailed upon to continue with plans to invest in the country.

The Commission has mooted the European Investment Bank (EIB) as a potential source of funding for projects in Iran, but the bank’s management has demurred from making any such commitments thus far.

If all of the bank’s governors, representatives of the EU 28 member states, agreed for the EIB to lend to projects in Iran, then the EIB would have to move forward with it, but it could stand to remove the US as a source of fundraising.

“A key point to note is that there is a gap between the EU’s political motivation to keep the JCPOA alive and the risk appetite of European companies,” said a source.

“Even if the EIB chooses to fund projects in Iran, unlikely … Given the bank’s risk appetite more generally, my view is that companies will still see the possibility of violating US sanctions as a threat greater than the protections any EU blocking regulations may be able to afford,” the source added.

LOOKING FORWARD

Deals are still being pursued further east, but even in those cases the routes taken to lock down product are circuitous and opaque.

The Indian government has purchased over 700,000 tonnes of fertilizers from Iran, but with a Dubai/United Arab Emirates (UAE) bill of lading, and the country is financing the deal in UAE dirham.

China has reportedly purchased Iranian crude siphoned through its China-Myanmar pipeline system.

But it remains to be seen whether even deals of this nature will be feasible in the future, particularly once the US-Iran petroleum embargo comes into effect.

Whether EU funding and sanctions-blocking measures bear limited fruit in preserving a degree of trade between the region and Iran, it is hard not to feel some sympathy for embattled Iranian President Hassan Rouhani.

After spending most of the capital accrued in his political life to push through the nuclear deal, Rouhani now potentially stands as a lame-duck leader a year into his second four-year term of office, and has been called upon by former president Mahmoud Ahmadinejad to resign.

Hardliners, meanwhile, are gaining influence.