The growing US-Iran tensions inflame the oil markets

The growing US-Iran tensions inflame the oil markets

June 8, 2018

Federico Ferrari

The US withdrawal from the nuclear agreement with Iran awakens the ghosts of 2012, when the European embargo brought the Brent benchmark above the 110 US $ / barrel threshold. The issue has a strong relevance to Italy, recipient of almost 8% of Iranian oil exports

 

Shortly after claiming the 2015 agreement with Iran - which freezed portions of the nuclear program in exchange for decreased economic sanctions - as the “worst deal ever”, at the beginning of May the White House announced its decision to unilateral retreat from it. Even though other signatories (i.e. the other members of the P5+1 Group, namely France, UK, China and Russia, plus Germany) rushed to declare their will to keep the deal alive, the consequences on oil market were immediately felt. The Brent benchmark gained almost 5 dollars in a few market sessions, breaking the 80 US $ / barrel threshold in the middle of May.

The oil market reaction is hardly surprising. In all likelihood, the reintroduction of US sanctions will entail their extension to the countries engaged in economic relations with Iran, then calling them to a choice. Either maintain their business ties with Iran, renouncing to all or part of the trade opportunities on the US market, or interrupt them and, in doing so, preserving their political and economic ties with the other side of the Atlantic. Even though Teheran represents a destination plenty of opportunities for the European (and Italian) manufacturing, it is hard to imagine that, given the commercial weight of the United States, some countries could choose the first path. From an economic point of view, the exit of the United States from the agreement could therefore be considered as a tout-court rupture of the same, whose consequences will spread to multiple levels; as for the oil market, it will likely bring the time back to 2012.

 
Fig.1: Iran oil production Millions barrels/day
The growing US-Iran tensions inflame the oil markets
Prometeia calculations on EIA data
 

The 2012 EU embargo to the country then led by M.Ahmadinejad zeroed the oil trade between Iran and its European partners, depriving the global oil balance of around 1 million barrels / day of crude oil. At the time, the sudden lack of the Iranian oil further weighted on a growing global oil deficit, lifting prices above the US $ 110/barrel threshold. It is then natural to draw a parallel with the 2012 scenario: what would happen if a similar quantity were taken away from the current supply-demand balance?

 
Fig.2: Iran oil export, by destination
The growing US-Iran tensions inflame the oil markets
Prometeia calculations on ITC data
 

Today, unlike then, there would be no lack of possibilities to avoid the price spikes, at least on paper. Indeed, since late 2016 Opec and Russia are pursuing a joint supply reduction policy, subtracting more than 1.2 million barrels per day - i.e. more than enough to compensate for the potential decline in Iranian oil supply - from the global oil market. Crucial in this sense will then be June 21 meeting, as the top producers will meet in Wien to shape their future supply strategies. The suspension of the output deal and the consequent reopening of the taps is the most likely outcome: reinforcing our view, is a statement by Saudi Arabia released shortly after the sanctions announcement, in which it promised to “mitigate” the impact of any potential supply shortages. We then expect markets to remain volatile in the near future, before relaxing somewhat in the summer months.

At the same time, there is a risk that the producers' cartel might choose to keep on with the current production scheme or, even if it decides to scrap it, it does so too slowly to compensate for the lower contribution of Iran, which should not be underestimated. Furthermore, it should be borne in mind that any intervention by the OPEC countries would inevitably reduce the size of the spare production buffer they keep unused, thereby reducing the possibility for further, future interventions. In short, whatever the outcome of the June 21 OPEC meeting, the US rejection of the Iranian nuclear agreement has made the global oil market far more volatile - and exposed to possible bullish risks - than it appeared just few weeks ago.