Doubling the Deficit

Death of Iran's Nuclear Deal Could Set Oil Bulls Loose

Trump will surely want to find a way of killing Iran's exports.
Simon Dawson/Bloomberg

Former Secretary of State Rex Tillerson put a brake on President Donald Trump's desire to tear up the Iran nuclear deal. Rather than go against his top diplomat's advice, the president got rid of him, making it more likely that he will now pull the U.S. out of the agreement as early as May 12, the next deadline for him to extend the waiver on the sanctions that are suspended by it.

The State Department doesn't seem to be entirely behind killing it. “We believe we can work within the nuclear deal,” Brian Hook, director of policy planning, said after Friday's quarterly meeting of the joint commission overseeing the 2015 agreement. If his former boss's fate is anything to go by, Hook's time at Foggy Bottom may be limited. President Trump appears determined to nix it.

But there would be no point for the U.S. to withdraw if everybody else was just allowed to go on buying Iranian oil. If he does succeed in imposing new measures to slash the country's exports -- as he will surely seek to do -- the result would be a slump in Iranian flows that would make the decline in Venezuelan supply look modest by comparison.

Stockpile See-saw

Global oil stockpiles are expected to begin drawing down again in the second half of 2018

Source: OPEC

And if he does it at his next opportunity, Iranian oil flows could begin to dry up just at the time when both OPEC and the IEA see the global oil market returning to supply shortage. In 2012, the imposition of tough sanctions targeting Iran's oil industry cut the country's exports by around 1 million barrels a day. A repeat would double the expected supply deficit in the second half of this year.

The government in Tehran argues that it is not seeing any of the benefits of inward investment that it was promised in return for giving up its nuclear program, though I've noted it is making slow progress in attracting investment from Russian and Chinese companies. However, the relaxation of sanctions has allowed it to boost oil production and sales by more than a million barrels a day from the beginning of 2016.

Bounce Back

Iran's oil production recovered quickly after sanctions were eased, but remains at risk if they are re-imposed

Source: Bloomberg

That recovery has come with a partial realignment of the country's oil flows. While the biggest jump in Iran's post-sanctions oil sales was to countries in the European Union -- principally Italy, Spain, Greece and France -- it's recovered only about three quarters of its pre-sanctions oil sales to that market. It has fared even less well in the developed Asian markets of Japan and South Korea, which together bought around half a million barrels a day of Iranian crude before sanctions were imposed. Combined crude oil shipments to these two countries now run at around half that level. 1 In contrast, China and India have both become more enthusiastic buyers of Iranian crude, as their demand for imported oil soars.

The sanctions that bit so heavily into Iran's oil exports in 2012 had broad international support -- President Barack Obama convinced the European Union to ban imports, while Asian buyers were persuaded to reduce their purchases of Iranian oil by the threat of losing access to the U.S. banking system. Obama imposed sanctions on foreign banks 2 that "knowingly conducted or facilitated any significant financial transaction with the Central Bank of Iran or another Iranian financial institution designated by the Secretary of the Treasury," though they got six-month waivers if they showed that they've "significantly reduced" Iranian crude purchases.

Before, During and After

Iran has struggled to restore fully it oil sales to buyers in Europe, Japan and Korea after the easing of sanctions

Source: Bloomberg, CGES

Note: Six-month average Iranian crude oil exports to key destinations

Both those restrictions were lifted as part of the Joint Comprehensive Plan of Action, as the nuclear deal is formally known. It is unlikely that the EU would be willing to re-impose its sanctions at the behest of President Trump. So how can he ensure that U.S. withdrawal from the nuclear deal has a real impact on Iran's oil exports?

One approach would be to impose similar banking sanctions, though he might balk at reviving his predecessor's approach. It's not a perfect solution, as, according to Credit Suisse analysts, buyers from China and India could switch to making payments in their local currencies, bypassing the U.S. banking system altogether. Still, their purchases probably couldn't increase enough to offset the likely drop in sales to Europe that would result.

Who's Buying

China and India are the biggest buyers of Iranian crude, followed by four European countries

Source: Bloomberg tanker tacking.

Note: Average from the start of October to mid-March

Alternatively, Trump could seek to target insurers who provide cover for Iranian crude cargoes and the ships that carry them. U.S.-domiciled reinsurers can’t participate in coverage of Iran’s fleet because of other sanctions, and have been replaced with others from Europe to provide cover for Iranian cargoes. He would have to find a way of targeting foreign insurers, perhaps by denying them access to the U.S. market if they take on Iranian risk.

I don't pretend to know how President Trump will seek to give his withdrawal from the JCPOA real teeth, but I'm pretty certain he will try. Doubling the global supply deficit would allow Saudi Arabia and Russia to reverse most of the output cuts they have made since the beginning of last year. It would also severely reduce the amount of available spare oil production capacity, just as geopolitical risks are rising. That will surely be bullish for oil prices.

This column does not necessarily reflect the opinion of Bloomberg LP and its owners.
  1. South Korea is the biggest buyer of Iranian condensate, a form of light crude oil produced from gas fields.

  2. National Defense Authorization Act for Fiscal Year 2012

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Julian Lee in London at

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Jennifer Ryan at

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