Washington’s announcement that it will not extend its sanctions waivers for key importers of Iranian oil - China, India, Turkey, Japan and South Korea - raises the geopolitical stakes in the oil market and beyond.
While last week’s column argued - wrongly - that the waivers would most likely be extended, the view that oil price risks were weighted to the upside now looks something of an understatement.
Washington’s decision to engage in what is, in effect, gun boat diplomacy will have both short and long-term consequences.
The immediate impact was a $2/barrel jump in crude prices. Whether this is sustained or extended now depends critically on two factors: the degree to which importers of Iranian crude comply with the threat of sanctions; and the speed with which Saudi Arabia and other producers can ramp up production to address any shortfall.
Iran is currently estimated to be exporting just shy of 1 million b/d of crude, primarily to China, India and Turkey. Given the sharp cuts in Saudi output since the end of last year and spare capacity existing prior to that, the Kingdom should be able to provide the volumes required to replace lost Iranian barrels.
Moreover, Washington’s decision, with Saudi support, represents a green light for all producers to end restraint and produce whatever they can. Some have no capacity to do so, while for others – Venezuela and Libya – there is a real possibility that output will drop, making the task of adding barrels, led by Saudi Arabi, the other Arab Gulf kingdoms, Russia and, of course, US producers, a greater task.
As a result, when OPEC meets in June to discuss extending its current curbs on production, the deal agreed last December may already be in tatters.
What Saudi Arabia and Iran will have to say to each other over the OPEC table can only be imagined. OPEC currently brings together in supposed cooperation regional rivals fighting multiple proxy wars. By being the key facilitator behind the US move on sanctions, Saudi Arabia clearly stands to gain from Iran’s problems in terms of both higher oil prices and larger export volumes.
But it also looks like an attempt to deliver a knock-out blow designed to destabilise Iran internally and cripple its support for regional allies.
There is no predicting how a country under siege will react, nor how long it can resist. In the febrile atmosphere of the Middle East, Iran’s conservative theocracy could lash out. If it is prevented from exporting crude, it has less to lose from preventing others. It would only take a hint of conflict over the Strait of Hormuz to make ship insurance vanish. By using their big guns, Saudi Arabia and the US invite Iran to do the same.
Internal upheaval in Iran could be even worse – it has hardly gone well elsewhere. The Middle East and North African region is already unstable religiously, ethnically and politically. What stability there is reflects in part the uneasy balance of force between Iran and Saudi Arabia. Tip that balance decisively in favour of one or the other and the consequences could be both profound and unpredictable.
The sanctions waiver decision also throws down a gauntlet to China just as Washington and Beijing appear to be coming to a conclusion over their trade disputes. China sees US extraterritorial actions via control over the operational levers of the world financial system as wholly illegitimate. Acceding to US sanctions represents an affront to national sovereignty – a humiliation.
Both sides know that a trade deal is necessary to avoid further mutual economic pain and that the world economy remains in a fragile state. They also know that removing the sanctions waiver is still one step short of actually applying sanctions. Washington may see it as a means of extra leverage in the last stage of trade negotiations, but it is a very heavy-handed move.
China could save face by continuing to import some but less Iranian crude, and this may be accepted by Washington as sufficient to withhold sanctions enforcement.
Trump’s move will cause similar discontent within India and Turkey.
Coordinated resistance arguably stands a better chance of success, but widescale flouting of US sanctions would undermine US authority and could effectively call Trump’s bluff, perhaps giving him little option but to make good on the threat implied by the removal of waivers.
In terms of oil market stability, a gradual reduction of imports would give Saudi Arabia and others time to ramp up output. A slow build in output would boost prices. Riyadh may move reactively, waiting for evidence of lower Iranian exports, rather than proactively.
Either way, there will be long-term consequences. China is well aware that it lacks muscle in the global financial system. An aspect of its multi-faceted Belt and Road Initiative is the creation of a large regional sphere of economic and cultural influence based around China and the renminbi.
The last period of sanctions on Iran served to stimulate banking, insurance and reinsurance markets outside of their traditional centres. Chinese payments systems have progressed rapidly as it emerges as an IT power. US use of the dollar-dominated financial system as a weapon will only reinforce this trend, not just in China but India and Russia. Europe too has taken steps to address US extra-territorial financial actions, although there appears little appetite to test them.
At worst, by under-estimating China’s growing position as a world economic power, Trump may be gambling with the US’ hegemonic role in the world financial system and the dollar’s status as the world’s trading and reserve currency.
Russia, itself subject to US sanctions, although not on the same scale as Iran, will voice its opposition, but it stands to gain. A blind eye may now be turned to oil production over and above its commitments made under the OPEC plus deal. Each barrel of Russia’s huge volume of oil exports is already worth $2 more than it was a week ago. Moscow has built close relations with Saudi Arabia over recent years, despite also supporting Iran and Iranian allies, such as Syria’s Bashar al-Assad. It will use any Middle Eastern turmoil to extend its position as a power broker in the region.
Away from the geopolitics of the oil market, there will consequences elsewhere. Higher oil prices stimulate both investment in the sector and destroy demand. Each additional dollar on the price of oil brings closer, quicker life-cycle cost parity with electric vehicles, just as a range of new models around the $35,000 mark are being released to the car market. This may prove a significant long-term boon to China, which has invested so much in becoming a world leader in this area.
The volatility and uncertainty in the oil market will also not be lost both on those oil and gas companies that have gradually built major LNG portfolios and the expanding number of countries that import the fuel, not least China, but also Japan and South Korea. With the growth of spot market LNG trade, the disjunction between spot prices and long-term oil-indexed contracts will be ever more exposed. Buyers currently hold the whip hand in an over-supplied LNG market, so the impetus to disconnect LNG trade from oil will only grow.