With Trump having started the 6 month process of pulling out from the Iranian nuclear deal (or rather as Steven Mnuchin admitted, Trump's true intention is merely renegotiating the existing deal and "entering a new agreement") the biggest concern among traders and analysts is what impact the Trump decision will have on Iran's oil exports.
As a reminder, some such as Barclays have suggested that Iran's oil production may not be affected at all; others such as UBS predict the sanctions could lead to the reduction of oil exports by 200-500kb/d over the next 6 months. Meanwhile, Deutsche Bank notes that because of the 180-day wind down period, neither Iranian oil production nor exports will drop before the 5 November 2018 effective date. In fact, if behavior follows the example from 2012, there is the possibility of a short spike in Iranian exports just before the effective date, after which a slow decline may set in.
As Goldman explains this morning, the final impact on Iran oil will likely be somewhere inbetween, with the ultimate impact on Iran production rather negligible for the foreseeable future. The reason for that is that following the announcement, other signatories of the deal reiterated their support for the agreement as well as their desire to revisit it. President Macron said that France, Germany and the UK regretted the decision and the EU vowed to uphold the Iran nuclear accord. Russia announced that the US alone would not be able to overturn the deal and its Deputy Foreign Minister said it was willing to support France's proposal for new negotiations. At the same time, Iran announced that it will remain in the nuclear deal and will start talks with European nations, China, and Russia.
So with the support of the other deal signatories in place, Goldman's Damien Courvalin writes that the impact on Iranian production may be more limited than implied by the US secondary sanctions, and certainly less than the 1mmb/d decline seen in 2012-15 which many use a benchmark for what happens next.
After all, as shown in the chart below, the bulk of Iranian exports is shipped to Asian countries - most of whom have already said they will continue importing Iranian oil - while the handful of European nations that received Iran crude will likely continue to do so in the future, once they request, and are granted, sanctions waivers.
Here is another breakdown, courtesy of Bloomberg:
For Iran's clients what happens this time will likely echo the last episode earlier this decade, when Iran was also sanctioned by the US. Back then countries were given exemptions by the U.S. - reviewed every 180 days - if they “significantly” reduced imports from the Islamic Republic. While a specific quantity of reductions that would make buyers eligible for waivers wasn’t announced, a slew of nations including China, India and South Korea received them.
Overnight, Japan became the first country to confirm that it will seek a waiver. The nation plans to find out whether its current import volume is enough to get an exception or whether it needs to further reduce purchases, Bloomberg reported.
Meanwhile, nations such as China, India and Turkey will most likely oppose outright the U.S. move and keep current levels of Iranian crude purchases; still some smaller US allies including South Korea may comply, unless they get a waiver, over concerns of they could lose a security umbrella against North Korea, according to MUFG Bank.
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Separately, and in another deja vu to the last Iran sanctions, in order to skirt the U.S. financial system, Asian buyers could also resort to using currencies other than the dollar to pay Iran for their oil purchases. Payments may be routed through either local or foreign banks that don’t have close ties to America.
India initially paid Iran via a Turkish bank before routing payments through a domestic financial institution the last time sanctions were in place. The nation, along with China, also sought to get around the restrictions by trading oil with the Persian Gulf state for local currencies and goods including wheat, soybean meal and consumer products.
The EU could seek to protect its entities operating in Iran by offering currencies other than the U.S. dollar through institutions including the European Investment Bank, MUFG’s Khoman said. Indian oil buyers said they can continue to make payments in euros as long as the European Union doesn’t impose sanctions on the Persian Gulf state.
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As a result of these unknowns, and given this uncertain impact on global oil supplies, Goldman writes that, like Barclays, it has not assumed a loss of Iran production in its base case supply forecasts yet, and adds the following:
while we view yesterday's decision as introducing upside risks to our Brent price forecasts (3-mo at $82.5/bbl), there remain potential mitigating
- factors. First, the US could release SPR barrels to help compensate for lost Iranian production, with Iran demand also set to decline due to the sanctions.
- Second, Section 1245 of the National Defense Authorization Act for Fiscal Year 2012, which governs the implementation of oil sanctions on Iran, specifies that their implementation requires an assessment as to "whether the price and supply of petroleum and petroleum products produced in countries other than Iran is sufficient to permit purchasers to reduce significantly in volume their purchases from Iran".
Our outlook for a tight oil market in 2H18-1H19 could therefore leave the magnitude of the required Iran import reductions below the 20% targeted in 2012. Medium term, we would expect to see a greater shale supply response to high oil prices, especially once pipeline bottlenecks in the Permian ease (2H19).
That said, there are clear upside risks to the oil prices, among which the hawkish tone of President Trump, the re-introduction of all the past secondary sanctions, the guidance to begin implementation immediately and finally, the high efficiency exhibited by the latest round of US unilateral sanctions on Rusal all raise the risk that Iranian production declines sharply even despite this foreign support.
Of course, a worst case scenario, where as much as 1mmb/d in Iranian production is taken offline, will merely boost production from the likes of Saudi Arabia which have substantial excess capacity to pick up the slack. Some more from Goldman:
Importantly, it is unlikely that a sharp decline in Iranian exports translates into a commensurate decline in global supplies. The US Treasury Secretary commented that the US has had conversations with various parties that would be willing to increase oil supplies to offset Iranian losses. In particular, Saudi Arabia's energy ministry issued a statement saying that the country was committed to supporting the stability of the oil market after the US decision to withdraw and that the Kingdom would work with major producers and consumers with and outside OPEC to curb the effects of any supply shortages (also helping limit the offsetting beneficial impact of higher oil prices for Iran in our view).
Saudi Arabia had already boosted its oil output during the last round of sanctions. Admittedly, there is no guarantee that Saudi Arabia would deliver a perfect offset to lost Iranian volumes, especially given its assessment that the rebalancing of the oil market is not yet achieved. And even if Saudi Arabia did match Iran's production losses, it would simply reduce an already relatively low level of production spare capacity.
Curiously, the biggest risk for an upside price spike has little to do with Iran, and everything to do other potential supply choke points: growing geopolitical tension in other key oil producing countries like Saudi Arabia, Venezuela, Libya and Nigeria create risks of additional production losses in the face of depleted inventory buffers, according to Courvalin.
For example, yesterday also saw a military confrontation between Israel, Syria and Iran. The situation in Venezuela has already led to a 600 kb/d decline in production over the past six months (more barrels than presently at risk in Iran), with no sign of any slowdown in production declines. In fact, the seizure of Venezuelan assets this week has lead to a stall in local exports.
In addition, Vice President Mike Pence announced renewed sanctions on Venezuela yesterday while asking that Venezuela suspend its May 20 presidential elections.
To summarize, while Goldman does not believe that the Iran deal alone will result in production declines, the bank concludes that elevated oil geopolitical risks exacerbate the upside risks to Brent forecasts and reinforce its view that oil price volatility will continue to increase.