Trump's Hardline On Iran Catches Markets Off-Guard
Oil prices spiked on Monday on news that the Trump administration has opted to take a hardline on Iran, letting sanctions waivers expire at the end of the month.
The Washington Post reported on Sunday that the State Department was set to announce a decision against extensions on waivers after the initial six-month period expires. Secretary of State Mike Pompeo announced the decision on Monday. As a result, the eight countries that the U.S. granted waivers to – China, India, South Korea, Japan, Taiwan, Italy, Greece and Turkey – will have to completely halt their purchases of oil from Iran. If not, they could be hit by U.S. sanctions.
Whether or not to extend waivers had been a divisive issue within the Trump administration, with hawks like National Security Advisor John Bolton pushing for “maximum pressure,” while Secretary of State Mike Pompeo – who has a long track record hawkishness on Iran – was more sympathetic to a nuanced approach. The more aggressive wing appears to have won out.
“The policy of zero Iranian imports originated with Secretary Pompeo,” a senior State Department official told the Washington Post, hoping to downplay the differences between high-level officials. “He has executed this policy in tight coordination with the president every step of the way. Because the conditions to not grant any more SREs have now been met, we can now announce zero imports.”
Oil prices immediately shot up on the news, spiking by more than 2 percent. Trump administration officials dismissed concerns about the impact on the oil market, arguing that global supply exceeds demand and also that the U.S. had convinced Saudi Arabia and the UAE to ramp up production to offset the outages, according to the Washington Post.
But the decision to let the sanctions expire caught the oil market off guard. “This does bring a lot more uncertainty in terms of global supplies,” Olivier Jakob, analyst at Petromatrix, told Reuters. “It is a bullish surprise for the market.”
“Last summer didn’t go above $3 a gallon as a national average, but this summer, if we don’t have Iranian oil we probably do go over $3,” Tom Kloza, global head of energy analysis at the Oil Price Information Service, told the New York Times.
Three of the eight countries – Italy, Greece and Taiwan – have already zeroed out their purchases of Iranian oil. Turkey, South Korea and Japan will have to scramble to find alternatives, potentially at higher costs, but finding replacements is achievable. Still, Bloomberg reports that South Korea would be hit hard because it needs ultra-light condensate used in petrochemicals, although that is found in abundant supply in the U.S.
But the big question is how China and India will react. “China’s cooperation with Iran is open, transparent, reasonable and legitimate, and should be respected,” Foreign Ministry spokesman Geng Shuang said in response to news that the U.S. planned on letting waivers expire. China was allowed to import 360,000 bpd under U.S. waivers, while India was permitted 300,000 bpd.
The loss of Iranian oil will be hard to replace, but Washington is confident that its Gulf allies will cover the gap. Unlike last year, however, it is not clear that Saudi Arabia will preemptively increase production in order to compensate for hypothetical supply losses from Iran. Riyadh is not interested in another oil price crash.
Instead, while Saudi Arabia may have told American officials that it would increase production, it may only do so after the fact, so that it can calibrate its response. Reuters reported that sources familiar with Saudi thinking said that Saudi Arabia would only respond after it assessed the impact on the oil market from the expiration of sanctions. In other words, they may let the oil market continue to tighten before they add supply.
Topping it off, there is still a great deal of risk of a supply outage in Libya. President Donald Trump reportedly spoke with Khalifa Haftar in recent days, the head of the Libyan National Army, which could rattle oil markets further since it lends some sort of legitimacy to the LNA. The White House said that the two spoke of a “shared vision” for Libya, which raised eyebrows because official U.S. policy has been to support the Government of National Accord (GNA) in Tripoli and to call for a cessation of hostilities. The GNA said the Trump-Haftar conversation could push up oil prices. “Oil prices…usually rise if wars or unrest occur in oil-exporting countries,” Fayez al-Sarraj, prime minister of the U.N.-backed GNA, told the Wall Street Journalin an email.
However, even as the oil market faces higher prices, the longevity of the OPEC+ deal immediately comes into question. Russia has already sent signals that it is not on board with an “uncontrolled” price increase, as Vladimir Putin put it recently. If prices shoot up over the next few weeks, there will be immense pressure working against an OPEC+ extension when the group meets in Vienna in June. News that Saudi Arabia and the UAE have told Washington that they would increase production dramatically reduces the odds of an extension.
That, on its face, would suggest that the impact on oil prices from the expiration of Iran sanctions waivers could be limited. Saudi Arabia could replace lost Iranian supply barrel-for-barrel. However, while Riyadh could ramp up production, it would also need to do so at a cost to its spare capacity. Buyers won’t have trouble finding enough supply, but the loss of a big chunk of spare capacity has historically been a driver of higher prices and higher volatility.
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