The bulls have gained the upper hand in oil markets of late, with estimates of $90 oil before the end of the year. The driving factor behind this renewed bullishness is the re-imposition of sanctions on Iran that threaten to significantly impact Iranian exports. While this bullish sentiment is certainly justifiable, there are also plenty of bearish catalysts looming over markets that should not be ignored. The most important of these catalysts is the possibility of an all-out trade war between China and the U.S., an outcome that is very much plausible. Oil prices in the coming months are likely to be influenced most heavily by these two contrasting factors – with Iranian sanctions sending prices up while trade war escalations sending them down.
The U.S. and Iran saga has had a grip over oil markets for the last three months. Oil prices spiked in May when Trump announced that he was imposing sanctions on Iran and leaving the Joint Comprehensive Plan of Action (JCPOA). Now, as the first round of sanctions goes into effect, the relationship between Iran and the U.S. has become increasingly strained. The second round of sanctions, which is going to focus on the energy sector, will have a much higher impact than the current round. According to different estimates, sanctions could take anywhere from 1.5 to 1 million barrels out of the market. This combined with the recent worries about spare capacity and the ongoing tension in the Arabian Peninsula (between Yemeni Houthis and KSA) may well drive prices towards the much-hyped $90 mark.
While there is certainly a possibility of a more than one million bpd decline in Iranian oil, there are some who suggest the decline will be significantly less than that. It is important to note that India and China account for almost 50 percent of Iranian oil exports between them and likely have the ability to boost their imports.
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The stance of India is a little vague, but they have cleared that they will only comply with UN mandated sanctions and are reportedly looking to find alternate ways of payment in order to continue buying oil from Iran. China has clearly stated that it will not implement any cut in its imports from Iran. EU, accounting for another big chunk of Iran’s oil, wants to retain the current Iran deal and is trying its best to rescue it.
So, while Iranian sanctions may excite oil bulls, they remain very much a wild card for oil markets.
The second major factor to watch in today’s oil markets is the ongoing trade war between China and the U.S. President Trump recently escalated this trade war with a second round of sanctions on $16 billion worth of Chinese products. China has said that it will retaliate with $60 billion of its own tariffs and has made it clear that it will not back down. It is generally accepted that trade wars are bad for the global economy, and the oil market is no exception. Oil prices tanked 3 percent in a single day after Trump announced the $16 billion tariffs. As these tariffs continue to escalate the impact on oil markets will likely grow.
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Shan Saeed, Chief Economist at IQI Global, Malaysia and APEC region, is very bullish on oil and sees it at $100, claiming that “Geopolitical risk and tight supply constraint have given oil prices a new head to stay on the bullish course. Understanding geography is a real virtue for sophisticated investors”. On the demand side he added that “demand for oil would touch 100 million barrel per day by Q-3/2019.”
The influence of sanctions on oil prices, however, is subject to the response of China, India, the EU and Iran itself. Bulls may well have an argument, but they lack any sort of certainty when it comes to quantifying the impact of sanctions. The outcome of the trade war by comparison, is quite certain: lower oil prices. It is this certainty that might give oil bulls pause for thought as the end of the year looms.
While other factors such as inventory figures, rig count, global demand and supply will continue to shape oil markets, it is the above-mentioned major factors that are going to have a significant and sustainable effect.
By Osama Rizvi for Oilprice.com
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The fact that oil prices have been hovering around $72-$75 a barrel for more than a month is because the global oil market has not re-balanced completely yet. There is still a small amount of glut capable of taking care of outages in Venezuela, Libya and elsewhere. This small glut may have been augmented by both Saudi Arabia and Russia adding some 300,000-400,000 barrels a day (b/d) between them in recent times. Another factor is that oil prices don’t like uncertainty. The risk of a full-blown trade war between China and the US has cast dark clouds over global trade and created uncertainty.
Still, neither US sanctions on Iran nor the escalating trade war between the US and China could lead to a steep surge in oil prices for the following reasons.
US sanctions against Iran are doomed to fail and Iran will not lose a single barrel of its oil exports.
My reasoning is based on three assumptions. The first is that the overwhelming majority of nations of the world including US allies and major buyers of Iranian crude are against the principle of sanctions on Iran as unfair and will not therefore comply with them and will continue to buy Iranian crude whether in violation of the sanctions or by a US waiver as would be the case with Japan, South Korea and Taiwan.
The second is the petro-yuan which has virtually nullified the effectiveness of US sanctions and provided an alternative way to bypass the sanctions and petrodollar.
A third assumption is that China which is being subjected to heavy US tariffs and Russia which has been battling US sanctions since 2014 will ensure the failure of US sanctions against Iran as a sort of retaliation against US tariffs and sanctions against them. The US would be making a huge mistake were it to underestimate the power of the Russian-Chinese strategic partnership which has led to the successful launching of China’s crude oil future contract (the petro-yuan).
The US Administration’s claim that it will be able to persuade Iran’s oil customers to cut their crude imports from Tehran by as much as 1 million barrel a day (mbd) is more of self-delusion and wishful thinking coming from an administration that has antagonized virtually everybody including its own close allies.
If the escalating tariffs start to seriously hamper China’s exports to the US, China could easily switch to other markets around the globe. China’s economy is far more integrated in the global trade system than the US economy and also bigger by 24%. Therefore, tariffs or no tariffs, the Chinese economy needs a huge amounts of oil to keep functioning.
China’s oil imports are projected to top 10 mbd in 2018 driven by a very healthy economic growth for a mature economy projected at 6.7% this year and declining oil production from China’s two largest oilfileds: Daqing and Shengli.
With India, it is far better to watch what it does rather than what it says. While Indian officials utter soothing words for the Americans, India increased its crude oil imports from Iran during the April-June period this year thus enabling Iran to overtake Saudi Arabia as India’s number two supplier. In June 2018 India imported 705,000 b/d of Iranian crude compared with 464,000 b/d in June 2017. This is not the action of a country planning to comply with US sanctions on Iran.
Iran is reported to have offered India “virtually free shipping and an extended credit period of 60 days,” as enticements intended to continue buying Iranian crude.
Dr Mamdouh G Salameh
International Oil Economist
Visiting Professor of Energy Economics at ESCP Europe Business School, London
Your points, all of them are very valid. India however is still confused. I personally think it might give up in the end. Iran has also started to cut Official Selling Prices for various countries in order to salvage whatever sales they can before the sanctions.
I think and I agree nothing is going to happen practically.....but yes...sentiments would stir and we might see a jump of $3-$4 in prices before the sanctions.