By Mihir Kapadia, CEO of Sun Global Investments.

Economic Sanctions are always driven by political concerns, and this is especially likely to be the case where President Trump is concerned.  Any decision by him to impose sanctions is bound to be a big political statement, intended to carefully meet the approval of his electoral base on an international stage. His recent announcement to withdraw from the Joint Comprehensive Plan of Action (JCPOA) was   a major act of political showmanship and its impact is certainly going to be an economic clampdown on Iran.

The energy sector has been Iran’s engine for economic growth for decades, contributing the biggest chunk to the government’s purse due to the exports  of about   1.5 million barrels per day of crude oil  until the first half 2012.  When the West imposed sanctions midway in 2012, aimed at curbing Iran’s nuclear program, the oil industry was directly affected, with an exponential fall in exports due to the uncertain trading environment. Iran’s oil industry’s decline came at a time when Iran was in fact the second largest crude exporter from the OPEC cartel, and when oil prices were at a rapid upward trajectory.

 

The Missteps of 2014

As one of the largest producers within the OPEC, the sudden demise of Iranian exports provided a perfect opportunity for OPEC to re-balance the markets through consolidation. However, as oil prices then were inching towards the $100 mark in 2013, OPEC and its leading producers (led by Saudi Arabia) were keen to monetise the rising prices and generate profits through further production. This contributed to the over-production and subsequent oil glut which brought the formerly high flying oil markets crashing down to $28 in 2016.

The significant overproduction of oil during a period of weak demand led OPEC back to the drawing board to re-think production strategies, ultimately resulting in the historic production cutback deal in 2017 which is widely credited for the current high oil prices.

 

European Show of Support

The impending US sanctions have once again created a cautious undertone for foreign businesses operating in Iran. The prospect of renewed sanctions from the US has caused not only concerns for organisations, but further uncertainty as the US’s allies in the EU and abroad remain committed to the JCPOA deal.

The united front presented by the original JCPOA signatories – UK, Russia, France, China, Germany and the EU, has complicated International diplomacy as it now creates a complex web for businesses that seek engagement with Iran. The lack of clarity on what the US sanctions mean for Iran and its position in the international trade market means the country is a difficult environment for international businesses and organisations to operate in.   As US financial institutions dominate the re-insurance and banking payments – reflecting the global role of the US dollar – international businesses will continue to remain hesitant to engage with Iran due to fears of US retribution.

Some of Europe’s biggest firms who rushed to do business with Iran after the nuclear deal now find themselves forced to choose between investing there or trading with the US. This includes Iranian oil & gas customers, who would prefer to engage with a safer alternative from within the OPEC cartel or newer exporters such as the US. With President Trump’s administration having also targeted the national Iranian oil company, Naftiran Intertrade Company, and the National Iranian Tanker Company, existing Iranian oil importers also face a tough scenario to circumvent the US sanctions; effectively ceasing Iran’s trading capacities.

 

The US threat

Commodity markets often perform better during turbulent global geo-political times, and for oil, the past few months have been significant in terms of the support for prices due to the uncertainty in the Middle East – including on Trump’s hostility towards Iran. As President Trump carried the anti-Iran rhetoric, it created the expectation amongst some analysts of a market consolidation that would provide support for prices. While there is a great degree of uncertainty on the future of JCPOA, the biggest deterrent to the oil markets currently has been the aggressive increase in oil production in the US, which is expected to be the single largest producer by the end of the year. With prices strengthening toward the $80 mark, US shale producers are expected to ramp up production to counter a higher Brent oil price.

 

OPEC: The balance ahead

While the recovery of oil prices can only be credited to OPEC’s historic accord (along with occasional market support provided by geo-political events), the commodity’s future will continue to be primarily dependent on OPEC’s internal stability. For OPEC, Iran had always been a difficult member nation, as it was quite vocal against extending the production cutback accord. However, with one of the world’s largest exporter of crude under sanctions (targeting especially the oil industry), OPEC finds itself in a peculiar place. While in the near term, the tighter markets (boosted by the loss of Iranian exports) will help support oil prices, the loss in Iran’s contribution is expected to be filled by OPEC.  Though Saudi Arabia and other key OPEC members have been vocally committed to the production cutback, other members of the cartel may seek to restore the output to the pre-cuts level.

 

This article first appeared in Oil Review – Volume 21, Issue 4 2018

Latest Update: Jul 18, 2018