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. Related: Will Saudi Arabia's Geopolitical Strategy Backfire?
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. Related: Can The U.S. Bring Iranian Oil Exports To Zero?
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.
By Nick Cunningham of Oilprice.com
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Nick Cunningham is an independent journalist, covering oil and gas, energy and environmental policy, and international politics. He is based in Portland, Oregon. More
Comments
Rouhani’s economic problems were compounded by political ones, namely trusting that the United States will adhere to international agreements. He did not realize that in the United States, an American president can annul an international agreement signed in the name of America by his predecessor. For this the hardliners in Iran are asking for his head.
I am on record having been saying for quite a while that US sanctions against Iran will fail miserably and the Iran will not lose a single barrel of oil from its oil exports. Unfortunately, authors of articles on the oilprice.com and experts have been parroting the assertions that sanctions will cost Iran’s crude oil exports between 500,000 barrels a day (b/d) to 1 million barrels a day (mbd) without providing any shred of evidence or a convincing analysis.
My reasoning is based on five market realities. 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 reality is that China which is being subjected to intrusive 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.
A fourth reality is that China can singlehandedly neutralize US sanctions by deciding to buy the entire Iranian oil exports amounting to 2.5 mbd as a retaliation against escalating US trade war against it and paying for them in petrodollar.
A fifth reality is that 95% of Iran’s oil exports go to countries who declared that they will not comply by US sanctions, namely China (35%), India (33%), the European Union (20%) and Turkey (7%). The remaining 5% of Iran’s oil exports goes to South Korea and Japan who have already said they will apply for a US waiver and most probably they will get.
India will never halt its imports of Iranian crude no matter what pressure the United States puts on it. India announced that it doesn’t recognize any sanctions but UN sanctions and that it will ignore US sanctions on Iran and continue to import Iranian crude. 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.
The claim that South Korea, India, Turkey and China have reduced their purchases of Iranian crude is a pure fabrication and part of a psychological warfare against Iran. Average daily exports vary from month to month because of maintenance work or because major customers might have taken advantage of lower oil prices and bought more than their needs in one month and have had therefore to reduce their purchases a bit in the following month. Therefore, the author will be well-advised to take average daily exports over a longer period of time before making unsubstantiated claims.
Dr Mamdouh G Salameh
International Oil Economist
Visiting Professor of Energy Economics at ESCP Europe Business School, London
The tariff war with China will probably keep oil prices from rising more than $10 a barrel next year. I will be shocked if Xi surrenders to Donald Trump. That could embolden his rivals in China by making him look weak. The Chinese people won't like it either.