US ends Iran sanction waivers: What it means for oil and endgame explained

President Donald Trump caught the oil market by surprise on April 22 by declaring that the US will end all Iran sanction waivers after May 2. The waivers, issued to eight countries for an initial period of 180 days when Washington imposed sanctions against Iran’s oil and shipping sectors starting November 5 last year, were widely expected to be renewed.

Iran has been exporting around 1.1 million b/d of crude and 200-300,000 b/d of condensates to China, India, Japan, South Korea and Turkey under the existing sanction waivers. Another 300,000 b/d of Iranian oil has been probably finding its way into the global markets by circumventing the sanctions, though the destinations are not known.

Trump and US Secretary of State Mike Pompeo both expressed confidence that Saudi Arabia, the UAE and Opec in general will help offset the loss of Iranian barrels from next month. Saudi Energy Minister Khalid al-Falih said the Kingdom will coordinate with fellow producers to ensure that the oil market does not go out of balance.

Iran, for its part, remained dismissive. Tehran again condemned the US sanctions as illegal, while its Islamic Revolutionary Guard Corps threatened to block the Strait of Hormuz, a vital passageway for nearly 20% of the world’s crude and refined products.

Benchmark Brent and WTI crude prices, which have been hitting successive new five-month highs since the start of April on deliberate as well as unavoidable tightening of supply from the Opec/non-Opec combine, closed at six-month peaks of $74.04/barrel and $65.70/barrel respectively on Monday, following the US announcement.

How much higher can oil prices go?

The nearly 3% surge in crude prices since Monday has staying power for the time being. A continued spike from current levels, however, is unlikely because Opec is expected to step in to ease any increased supply tightness. As expected, the US has leaned on Saudi Arabia (this time around, Washington appears to have roped in the UAE too) to ensure that the Kingdom and Opec compensate for the loss of Iranian barrels. The oil market will be looking for a formal reassurance from Opec and its non-Opec allies on their commitment to raise supply, before we see a downward correction in prices. All in, Opec+ efforts should compensate for a decline in Iranian supply and keep Brent anchored around $70/barrel.

Are iranian oil exports set to drop to zero?

The Trump administration is full of surprises and there is a minute chance that Tehran may agree to come to the negotiating table with Washington, prompting the latter change course. However, we would rule out any reversals on the waivers decision for the time being. Based on the White House statement and tweets and comments from Trump and Pompeo on the issue on Monday, it does not look like Washington has left itself any wiggle room, either. However, it is not possible to draw a straight line between the US standing its ground to penalise any entity continuing to trade with Iran, and the latter’s oil exports dropping to zero. Iran can be expected to do everything in its power to try and retain its existing customers. Iran’s crude buyers have found ways to organise payments and insurance for the oil shipments under the current US sanctions and previous rounds of international sanctions. However, refiners choosing to import Iranian crude in defiance of US sanctions and other parties and intermediaries involved in such trade risk being locked out of the US financial system. That would be a major deterrent. Could Iran still continue to sneak out some oil exports? That is a possibility, though it will likely be no more than 300,000 b/d at the most.

Could Opec+ make up for the lost barrels?

The short answer is yes. The producers’ group is able and willing. Saudi Arabia, the de facto leader of Opec, is under pressure from Trump to ensure that the market does not go out of balance if more than a million barrels a day of Iranian oil disappear, starting next month. The Saudis are not in a position to ignore Washington, especially after elements in the Kingdom were found to have orchestrated the gruesome murder of US-based Saudi journalist Jamal Khashoggi last October. As 11 of Opec’s 14 members and their 10 non-Opec allies led by Russia are curbing output by a collective 1.2 million b/d under their agreement of last December, an output boost of more than 1 million b/d would need to be formally agreed by all the producers. Saudi Arabia could unilaterally put nearly 500,000 b/d more of its own crude into the market, as it has been pumping below its quota by that amount. However, the other producers within Opec and non-Opec, especially Russia, will want a share of any additional increase. The ability to pump more is not an issue. Opec has a sustainable spare production capacity of about 3.3 million b/d, according to the International Energy Agency.  

Will Iran block  the Strait of Hormuz?

It’s an old, oft-repeated threat from Iran, but one that has never been carried out. The narrow waterway at the mouth of the Persian Gulf provides passageway to nearly 20% of the world’s crude and refined products consumption. The strait sees its share of naval drills and Iranian missile tests and has witnessed a stand-off between the US and Iranian navies in April 1988. However, it has never been blockaded. The latest threat from Iran’s Islamic Revolutionary Guard Corps, which was blacklisted by the US as a “terrorist organization” earlier this month, to close the strait, was an expected retaliatory move. If Iran does carry out the threat, it would trigger a full-fledged war in the Middle East. Aside from Iran, its oil-producing neighbours Iraq, Saudi Arabia, Qatar and the UAE rely on the waterway for inbound and outbound oil and gas shipments. The oil market is not pricing in such an eventuality yet.

What is the endgame?

The US wants to force Iran to the negotiating table over 12 key demands it had listed last year. These include Iran accepting new limits on its nuclear program, ending its ballistic missile testing, and halting interference in the affairs of its neighbouring countries. The Iranian government has so far scoffed at the idea, refusing to engage with the US. Tehran has also categorically said it will not contemplate any modifications to the nuclear deal, which it signed with the US, UK, Russia, France, China and Germany in 2015, bringing an end to years of stringent multilateral sanctions against it. Meanwhile, Trump is likely feeling the pressure to show results after a year of walking out of the nuclear deal, and ahead of the 2020 presidential elections in the US. Will Iran relent? It is hard to see that happening, given the lack of even the slightest conciliatory gestures from Tehran over the past several months. But a near-collapse of its oil exports would hit the Iranian economy harder than ever before, which could force a change in the government’s stance.
The author is founder of Vanda Insights - a Singapore-based provider of global oil markets macro-analysis. Views expressed are her own