Oil Market Implications of Iran Sanctions Snapback

CSIS Briefs

The Issue

  • The Trump administration’s plans to reinstate sanctions on petroleum-related transactions with Iran has already removed a significant amount of oil from the market.
  • The announcement that the administration will grant eight jurisdictional waivers takes pressure off the near-term oil price scenario and indicates the amount of oil to come off the market next week is largely priced in already.
  • Uncertainty still exists over how much of Iran’s remaining approximately 1.5 million barrels per day (b/d) in crude and condensate exports will come off the market both next week and over the long run due to three factors:
    • (1) Lack of clear guidance from the United States regarding sanctions implementation now and going forward beyond getting to zero as quickly as possible;
    • (2) Determining how the administration will deal with countries that do not comply;
    • (3) Ongoing and intensifying Iranian efforts to avoid international monitoring of exports, such as turning off AIS transponders on oil tankers.
  • The administration has been quick to point out that it is working to ensure oil market stability through liaising with other producing countries and aided by U.S. production growth. All things considered, this may be possible as long as no additional and substantial oil supply disruptions take place, which is far from guaranteed.

In Depth

On November 5, following a 180-day wind-down period, U.S. sanctions on Iran’s petroleum-related transactions will come into effect. These sanctions have caused significant reductions in Iran’s oil exports, as both countries and companies take up proactive measures to either reduce or eliminate their imports by the deadline. The administration announced it will grant temporary waivers for 8 jurisdictions based on actions they have already taken to reduce imports of Iranian crude, noting that two of those eight jurisdictions will reduce petroleum imports to zero over a short period of time. This announcement provides only a temporary window of clarity in that even waivers must be renewed, and the administration policy is to move toward zero imports of Iranian crude as quickly as possible.

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Iranian exports of crude oil and condensate averaged roughly 2.5 million barrels per day (b/d) in both 2017 and the first half of 2018. Since President Trump’s announcement in May, exports have steadily declined to between 1.7 – 1.9 million b/d in September (depending on the source of data) and are estimated to have fallen to 1.5 million b/d in October. As a result, average exports in Q3 were roughly 500 thousand b/d below where they would have likely stood without sanctions and 1 million b/d below in October. To date, the largest reductions have come from South Korea, which according to Bloomberg data has not imported Iranian crude or condensate since July, along with Japan and the European Union, where buyers have continued to wind down their imports to zero. While China and India’s imports in Q3 stood at a similar level to that in the first half of the year, imports for both countries in August and September fell below their average but rebounded strongly in China to 742 kb/d in October.

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There are, however, large variations in the export numbers as reported by Platts, Bloomberg, and TankerTrackers. The task of tracking Iran’s exports has become increasingly difficult, with more than 40 percent of known vessels switching off their AIS transponders in September, while other tactics of disguising exports have become apparent such as oil tanker lightering (transferring cargoes between vessels). The discrepancies in the data center around China and India, and that is where the main uncertainties will likely remain for Iranian exports, with China rejecting the U.S. request to cut imports and the Indian government to date providing no solid public indication that it will actively seek to reduce imports. In addition to the tactics deployed by Iranian tankers to disguise export levels to retain customers, the National Iranian Oil Company (NIOC) is offering some of the steepest discounts for its heavy and light crudes to that of comparable grades since at least 2000.

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While uncertainties remain with India and China, for Japan, South Korea, and the European Union, things are much more clear-cut, wherein the absence of any significant reduction exception or SRE (often referred to as waivers) from the United States, imports will go to zero. Within the European Union, this is being driven by companies, which, despite the protestations of their governments against U.S. sanctions, will not run afoul of U.S. sanctions. Exports to the European Union fell to 333 thousand b/d in September and averaged just 97 thousand b/d in October. The same applies for South Korea and Japan—their imports are now at zero, while their governments have been awaiting a response on their request for a waiver (both of which now look likely to have been granted). Turkey received 129 thousand b/d in October by way of Tupras (a refiner), which has reportedly been in talks with U.S. officials to obtain a waiver. The Turkish government has voiced its opposition to U.S. sanctions, but with Tupras being a private company and having exposure to the U.S. financial system, it will not flout U.S. sanctions. That being said, the likelihood of a U.S. waiver being issued for Turkey looks probable given exorbitantly high prices for oil on the back of its weakening currency, along with its high reliance on Iranian oil imports and the growing list of bilateral issues with the United States that may have been factored in towards reaching a deal. The other main importers of note include the United Arab Emirates, Syria, and Taiwan. The UAE energy minister Suhail Al Mazrouei has made clear that the country will abide by the sanctions and has already reduced imports making it another possible candidate for a waiver, along with Taiwan which has done the same. Meanwhile, Syria whose imports have risen significantly to 97 thousand b/d in October, is likely to ignore the sanctions and even increase its imports further given the country’s close strategic alliance with Iran.

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All of the main importers of Iranian crude oil in the European Union, including Total in France, Saras and Lukoil in Italy, Repsol and Cepsa in Spain, and Motor Oil Hellas and Hellenic Petroleum in Greece, will now cease to receive any imports in the absence of waivers. All of the main importers in Japan and South Korea, including Hanwha Total, SK Energy, Cosmo Oil Corporation, and JXTG Nippon have also halted purchases. If Turkey and its sole refiner Tupras is not successful in its request for a waiver, it too is likely to bring its imports to zero given the company’s exposure to the U.S. financial system. Emirates National Oil Company (ENOC) of the UAE is government owned, and so it will abide by the instructions to comply with the sanctions. In India, private companies such as Reliance have already cut off its imports, and while Nayara Energy (formerly Essar Oil) is reportedly still buying on the spot market, it is likely to halt purchases in the absence of waivers following the November 4 deadline. Things are less clear with the remaining Indian importers such as Mangalore Refinery and Petrochemicals Limited (MRPL) and the Indian Oil Corporation, which are awaiting waivers, but already pay for some Iranian barrels in Rupees. India’s imports averaged 355 thousand b/d in October, and press reports indicate that India has agreed to an outline of a waiver with the United States that would permit purchases of approximately 300 thousand b/d for another 180 days. Chinese importers such as Sinopec, Zhuhai Zhenrong Corporation, and CNPC also have been paying for Iranian barrels with their own currency and have imported 714 thousand b/d in the first two weeks of October. In a bid to not confuse and strain ties further, while trade disputes are ongoing, the U.S. administration may grant a waiver to China, who would likely continue to import even in the absence of waivers.

All of these factors introduce a significant range of uncertainty into the estimates for how much more Iranian oil will come off the market once the sanctions go into effect. The most significant factor of uncertainty relates to the level of leniency in the waivers granted. Under the Obama administration, waivers were granted based on compliance with the sanctions as measured on the basis of an 18 percent purchase reduction on the total retail price paid (not just volumes). The Trump administration has held fast to the strategy of imposing “maximum pressure” on importers of Iranian crude and condensate to reduce their imports to zero, while considering significant reduction exceptions for individual countries on a case-by-case basis. The official guidance by the U.S. government is that its aim is to still get to zero oil purchases from Iran as quickly as possible, to compel Iran to abandon its “outlaw activities and to behave as a normal country. On Friday, November 2, 2018, Secretary of State Mike Pompeo and Secretary of the Treasury Steve Mnuchin gave an on-the-record call, in which they outlined that they expect to issue “temporary allotments to eight jurisdictions” that have demonstrated significant reductions in their crude oil imports and “cooperation on many other fronts.” They added that as part of those agreements two of the eight will go to zero, while the other six will import at greatly reduced levels. At the moment, India, South Korea, and Turkey all appear to be likely candidates to receive waivers. Not only are all these countries highly reliant on Iranian crude oil and condensate, but both South Korea and India are important allies of the United States and also key partners to the Trump Administration in the articulation of two major strategies—North Korea denuclearization and the Free and Open Indo-Pacific strategy. Japan also appears to be a likely candidate given its reductions, along with Taiwan and the UAE. The other possible candidates include China, Greece, Italy, and Spain. Assuming waivers are granted to the most likely candidates, we can expect Iran’s crude and condensate exports to stand somewhere around the 1.25 million b/d mark in November. The other major uncertainty relates to the ability of Chinese buyers to continue purchases in the face of sanctions and the possible absence of waivers. Finally, we can expect Iranian sanctions evasion efforts to intensify and price discounts to increase, which may help offset some of the losses.

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According to the International Energy Agency (IEA)’s data, Iranian crude oil production fell in September by 180 thousand b/d to 3.45 million b/d, following a 150 thousand b/d reduction in August. To date, the remaining Organization of the Petroleum Exporting Countries (OPEC) members have successfully offset these losses, with Saudi Arabia and Iraq seeing significant gains since the June OPEC meeting. However, with the prospect of another 200 thousand b/d loss from Iran in October and similarly in November (with the potential for these losses to be steeper depending on the leniency of the waivers), the remainder of the group will have its work cut out in balancing the market. OPEC’s spare capacity, as according to IEA’s definition, was down to 2.13 million b/d in September but this includes the 400 thousand b/d of Iranian spare capacity created by the sanctions, as well as the 500 thousand b/d Neutral Zone, which has been held up in a political deadlock. Excluding the Neutral Zone and factoring in expected Iranian losses (and Saudi production increases) then spare capacity could be down below 800 thousand b/d by the end of November.

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The dilemma for Saudi Arabia is that while the call has mounted on OPEC to increase output in the final quarter of the year to balance the market, stocks have been building and prices falling, while the demand outlook has been revised downwards for next year. However, with further Iranian losses expected Saudi Arabia’s output will have to increase in order to balance the market. These increases will further reduce spare capacity, which leaves the oil market vulnerable to possible disruptions elsewhere. Venezuela has continued to see declines, while Libya and Nigeria have been fluctuating along with Angola and Iraq.

The most complicated aspect of this outlook is the positioning of the United States relative to Iran in light of the current difficulty with Saudi Arabia. When the Trump administration decided to withdraw from the Joint Comprehensive Plan of Action (JCPOA), Saudi Arabia was squarely in its corner and committed to defending oil market stability. While both of these conditions still remain, the Trump administration has put unprecedented public pressure on Saudi Arabia to backstop its policy of removing Iranian barrels from the market and to keep prices low and stable. At the same time, the bilateral relationship between the United States and Saudi Arabia has come under intense scrutiny and pressure resulting from the disappearance and death of Jamal Khashoggi. The situation is far from resolved and has thus far led U.S secretaries of state and defense to call for an immediate end to the hostilities in Yemen and the resumption of peace negotiations. It is safe to assume that Saudi oil policy will not be immediately affected by this situation, but the instincts of this administration to go after Iran as aggressively as it might want to could be dulled by the sense of instability or uncertainty in the region brought on by this affair. 

Beyond the immediate impact of the November 4 deadline, oil markets will be watching whether the administration clarifies the trajectory of import reductions expected going forward and the Iranian response. There has been some speculation that the easiest path forward for the Iranians is to pursue a North Korean-esque model of agreeing to talk as a way of halting the progression of sanctions. Most Iran experts, however, see this as highly unlikely (as did North Korean experts before the summit happened) and instead expect an escalation of tension and malign action in the region, which can certainly impact oil markets and regional stability. The administration has been quick to point out that it is working to ensure oil market stability through liaising with other producing countries and aided by U.S. production growth. All things considered this may be possible as long as no additional and substantial oil supply disruptions take place, which is far from guaranteed.

Andrew Stanley is an associate fellow with the Energy and National Security Program at the Center for Strategic and International Studies in Washington, D.C. Sarah Ladislaw is senior vice president and director of the CSIS Energy and National Security Program.
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Sarah Ladislaw

Sarah Ladislaw

Former Senior Associate (Non-resident), Energy Security and Climate Change Program

Andrew J. Stanley