It seems highly likely at this point that President Donald Trump will withdraw from the 2015 Iran nuclear deal by the May 12 deadline. The implications of such action for global oil markets would be far-reaching and is one of the primary drivers of prices today.
It is important to remember that Trump’s withdrawal would not be a surprise. As I mentioned above, traders have already factored new sanctions into prices. Benchmark Brent oil prices have risen to their highest levels in more than three years – around $75 a barrel – on the expectation of fewer available Iranian barrels. There’s still some room left in the market for prices to go higher once the news becomes official, but that will take some time to materialize.
The biggest concern is the extended loss of about 500,000 barrels a day of Iranian production on the global market, which is already facing tighter supply because of the OPEC-led supply cut agreement and robust demand from Asia. Demand worldwide, according to Goldman Sachs, grew at the fastest rate in nearly eight years during the first quarter.
Estimating exactly how much Iranian oil will fall out of the market should Trump renew sanctions is not an exact science, but it would be substantial no matter how you slice it. Add in Venezuela’s problems and the world is facing a sizable shortfall.
The rapid ramp up of Iranian production and its resumption of export activities after the lifting of sanctions two years ago was nothing short of astounding. OPEC’s third-largest producer has roughly doubled its exports to 2.2 million barrels a day. Europe quickly reemerged as a major buyer of Iranian oil, importing in the neighborhood of 500,000-600,000 barrels a day.
If Trump pulls out of the deal, that trade is likely to dry up. Maybe not immediately, but expect to see a gradual withdrawal by European refiners and traders in the coming months as they realize the complications involved with dealing with Iran and the potential for them to be shut out of U.S. financial markets for sanctions violations. European oil majors Total and Eni, for instance, are two of the largest buyers of Iranian crude but have significant assets here. They are not likely to continue that trade and put at risk more lucrative business ventures and relationships in America.
Rapidly growing countries like China and India, which have fewer assets in the United States or less regard for America’s sanctions policy, can be expected to pick up some of the slack – most likely for a healthy discount from Iran for the added risk. China, in particular, is a country to watch given its ongoing trade spat with President Trump. For those more closely aligned with the United States, say Japan or South Korea, the decision to keep buying Iranian crude will be more difficult and hinge heavily on Washington’s willingness to offer waivers to sanctions.
How much of Iran’s exports to the European market can be replaced by Asian buyers is a critical question that should be watched closely. Perhaps more essential, however, is the extent to which Trump understands the impact of his Iran policy on oil prices. The president recently lashed out on Twitter at OPEC for causing “artificially high” oil prices. In Trump’s view the cartel orchestrated higher oil prices through its production cut deal with Russia and other non-OPEC producers.
Trump’s sensitivity to rising oil prices probably has more to do with the upcoming midterms that global economics. But growing geopolitical risks, specifically the Iran issue, have been driving prices higher, too.
How high could prices go? A prominent hedge fund manager recently suggested the world was on its way to $300 a barrel. That’s outlandish. But Saudi Arabia has been keen to keep the OPEC deal in place for as long as possible as it prepares to offer shares of its state-owned oil giant, Aramco, to outside investors. The kingdom’s leader insists that current prices are not hurting demand, suggesting the Saudis believe there is room for prices to climb still higher – perhaps as high as $100 a barrel. Such a price point would not be good in the long-term for the Saudis or for U.S. producers since it would reignite support for government subsidies and private investment in renewables, electric vehicles and other energy alternatives to oil.
A possible middle path that’s not been widely discussed it the potential for President Trump to scratch the nuclear agreement but keep Iranian oil flowing with waivers for U.S. allies. That would help keep oil prices in check but it would also give Tehran a steady source of income to finance its nuclear program.
The best hope for U.S. consumers to stop runaway prices at the pump is continued expansion of the homegrown shale sector. American producers are well on their way this year to hitting a record 11 million barrels a day in production – thanks in no small part to the country’s prolific shale plays.
The United States is the only sector of the global oil industry that has significantly ramped up capital expenditures since oil prices began to recover. Investment by U.S. producers is forecast to increase by 15% to $184 billion before the end of 2018, according to one annual survey. Capital expenditures across the rest of the industry is expected to be flat or, at best, show only modest growth. International players like Exxon Mobil, Chevron, BP, Shell and Chevron have said they have no intention of ratcheting up capital spending in the coming years, regardless of prices.
Such reluctance to invest puts the onus squarely on the shoulders of America’s shale producers. Higher prices will increase access to capital markets for the sector, but it will have to be balanced with the vow of many oil companies to show discipline and provide shareholders with payouts. The trend at the moment is investors demanding more “value” than “volume” from shale companies. Those with the best rock should be able to pull off delivering more of both. For that to happen, though, the build-out of critical infrastructure like pipelines, processing terminals and export facilities must keep pace.
If prices keep rising, the resulting tide should lift all boats, even if it leaves President Trump feeling a bit seasick.