May 8, 2018, by Grant Smith
President Donald Trump will announce on Tuesday whether the U.S. will leave the 2015 Iran nuclear agreement, a signature achievement by his predecessor that he’s long derided as “the worst deal ever.”
He could still surprise the world by agreeing to stay in the accord as diplomats try to negotiate side agreements to address his concerns, but foreign leaders and analysts say the president is likely to exit. That could result in renewed sanctions on the third-largest crude producer in the Organization of Petroleum Exporting Countries.
Oil futures rose above $70 a barrel in New York for the first time in more than three years on Monday as traders speculated about Trump’s intentions. If the president does decide to exit the nuclear deal, here’s what’s at stake for the market.
Why is this happening now?
Trump is required by law to periodically certify that Iran is complying with the 2015 agreement and whether to prolong waivers that eased U.S. and international restrictions on the Islamic Republic.
In October, the president said Iran had failed to live up to the spirit of the pact, but he stopped short of re-imposing U.S. sanctions on its energy industry. He decided in January to hold back from reimposing tough economic sanctions against Tehran, but only to give more time for Europe to “ fix the terrible flaws” in the agreement.
The next deadline is May 12, before which Trump must decide whether to renew the waiver that lifted Iranian oil sanctions.
What are the consequences for oil prices?
Global markets are already getting tight as OPEC and Russia cut production. The group has all but wiped out a stockpile surplus and intends to keep pushing inventories even lower. Iran is one of the world’s biggest oil exporters, shipping more than 2 million barrels a day to customers in Asia and Europe, so any loss of its supplies would increase the squeeze.
When then-President Barack Obama imposed sanctions on Iran in 2012, aided by a European Union embargo, the country’s crude exports were cut in half. It’s not clear the same thing would happen this time because France, Germany and the U.K. still support the nuclear deal.
If Trump allows the full force of sanctions to return — threatening to freeze any buyers of Iranian oil out of the U.S. banking system — it could be very difficult for companies to carry on doing business with Tehran. Still, the legislation gives his administration the leeway to waive those sanctions for individual countries that have “significantly reduced” their crude purchases.
The White House also has significant discretion over how quickly sanctions could be reimposed. Under the Obama administration, it was intended that buyers would only have to start reducing their volumes of Iranian crude 180 days after a “snap-back” was announced, Richard Nephew, a senior research scholar at Columbia University’s Center on Global Energy Policy who was part of the team that crafted the 2012 sanctions, said in a blog post. Trump could decide that reductions would have to begin almost immediately, he said.
These variables make it very difficult to gauge the impact on oil supplies and prices. Analysts surveyed by Bloomberg last month said the production impact could range between zero and 800,000 barrels a day.
“Because of the complexity and overlapping nature of the sanctions regime, the administration has many options with respect to re-imposing sanctions on Iran,” said Michael Cohen, an analyst at Barclays Plc.
For greater clarity, the market will have to wait for the U.S. president and Treasury to give a detailed account of their intentions at 2 p.m. in Washington on Tuesday.
Who else could be affected?
Iran is trying to attract about $200 billion of investment from international oil companies to boost energy output. Without that, production could begin to stagnate.
Trump’s disdain for the nuclear deal has already deterred investors from the country, the third-biggest producer in OPEC. Of the Western energy majors, only France’s Total SA has returned, and its gas venture is proceeding slowly. Iranian officials have complained that western oil companies are too cautious to return to the country, although there are signs that Russian companies are stepping in to fill the vacuum.
Total has the biggest financial stake of any international energy major, having pledged to invest $1 billion in the first phase of an offshore natural gas project. Overall investment in the project could reach $5 billion, and while the company is determined to press ahead, Chief Executive Officer Patrick Pouyanne has promised to review the legal consequences of any new U.S. restrictions.
How could OPEC react?
OPEC, Russia and their allies are voluntarily withholding about 1.8 million barrels a day of crude from the market. Could they end their production curbs prematurely to compensate for the loss of Iranian supplies?
Saudi Arabia has the largest spare capacity — two years ago it’s production was 760,000 barrels a day higher than the current level. The kingdom is no friend of Iran, but has also shown a preference recently for higher oil prices and tighter markets.
It’s not clear the rest of the group is capable of compensating for Iran, according to Bloomberg Oil Strategist Julian Lee. Much of Iraq’s spare capacity comes from facilities in the north that have been disrupted by a dispute with the Kurds. Output losses from fields in Angola and Venezuela are not reversible without significant time and investment.
Could history be a guide?
The Trump administration’s most recent foray in commodity-related sanctions doesn’t offer much comfort. The aluminum trade was thrown into turmoil in April when the U.S. Treasury effectively froze United Co. Rusal out of western markets. Prices jumped more than 25 percent as traders scrambled to find alternative supplies.
The comparison has its flaws. The Russian aluminum giant accounts for about 6 percent of global supply, compared with about 4 percent for Iranian crude. The specific nature of the market for the metal, in particular a key ingredient called alumina, exacerbated the impact of the sanctions.
And of course the U.S. Treasury eventually threw the aluminum market a lifeline, extending the period during which companies could keep trading with Rusal. Still, it took almost two weeks of convulsions to bring about that softer stance.