Slipping on oil

US withdrawal from Iran nuclear deal is bad news

Oil prices rose to three-and-a-half year highs on Wednesday, after US President Donald Trump abandoned a nuclear deal with Iran and announced the “highest level” of sanctions against the Opec member. In taking this stand, which is in line with his campaign promise, Mr Trump has reversed his own cabinet’s assessment — just last month Mike Pompeo, the US secretary of State, asserted that there was no evidence that Iran was cheating on its commitments. He has also disappointed a lot of US allies in Europe. The 2015 accord, signed by Barack Obama, was not a bilateral one; five other countries — the UK, France, China, Russia and Germany — were involved. Mr Trump did not mince words, saying the  “decaying and rotten structure” of the deal could not prevent Iran from building a nuclear bomb and initiating a nuclear arms race in West Asia. 

The fallout of this decision will be a further disruption in supply, leading to more uncertainty on the crude oil price front. After the sanctions were lifted in 2015, Iran became the third-biggest exporter of crude within the Organization of the Petroleum Exporting Countries, behind Saudi Arabia and Iraq. The problem is that the news from Iran is not the only factor at play. As the global economy has rebounded over the past 18 months, the supply glut of 2014-16 has eased with inventories running down over time. On the supply side, the story has been far more complicated. For one, the 14-member strong Opec and Russia have cut back supply by at least 1.8 million barrels per day since the start of 2017. It is an open question whether these cuts will be reversed. Saudi Arabia, which is the unofficial leader of the Opec, will not mind higher oil prices at least in the short term, with Aramco, the national oil producing company, slated for a public offering in 2019.

There are other geopolitical risks to the supply of oil as well. Venezuela, which has already seen the biggest cut in supply — at the rate of 500,000 barrels a day — thanks to a massive political crisis, is also likely to attract US sanctions if President Nicolas Maduro does not quit power. Supplies from Libya, too, are disrupted due to the civil war. Add the Yemen conflict where Saudi Arabia is fighting Iran-backed Houthi rebels. A good pointer to the massive imbalance in the oil market is the large speculative positions that hedge funds and others have built up recently. Typically, the viability of shale oil in the US was supposed to work as a counter to higher oil prices, but reports suggest while shale supply is improving, massive infrastructural bottlenecks in the form of jammed pipelines will hamper exports at least till December. From India’s perspective, higher oil prices will mean further bad news. The earlier low crude oil prices kept the trade deficit under control as well as moderated inflation and the fiscal deficit. With that cushion gone, there is already considerable pressure on the external current account deficit front and macroeconomic vulnerabilities could be exposed further. The other challenge would be calibration of taxes on petroleum products in such a manner that consumers are protected without impairing the government's revenue target. But that is a tall order.