President Trump Lambasts OPEC, but Policies Also Impact Oil Prices
Earlier this week during his address to the United Nations General Assembly, President Trump repeated a familiar refrain criticizing the Organization for Petroleum Exporting Countries (OPEC) for the current level of elevated oil prices while seemingly linking continued U.S. military support for certain Middle East nations to production decisions and threatening that the United States would not “put up” with these prices much longer. At the same time, however, he appeared to walk back the most strident of his admonitions that purchasers of Iranian oil must cut their imports to zero, suggesting instead that they must “substantially” reduce their purchases.
Previous commentaries have routinely emphasized that oil prices are impacted by a variety of factors—most notably the “fundamentals” of supply, demand, and inventories but also reflecting world events and data releases, announced policies, and trader sentiment. This week’s activity demonstrates the roles of all three.
With respect to fundamentals, the president is correct in noting that OPEC—largely by successfully implementing their 2017-18 “freeze” initiative to eliminate the global stock overhang—has effectively rebalanced the global oil market and thus contributed to increasing oil prices. Coupled with continued strong demand and supply disruptions in places like the North Sea, Canada, Venezuela, and Libya, logistical issues in the United States, and concerns over the loss of Iranian barrels as a result of U.S. sanctions, oil prices have risen to four-year highs, now in excess of $80/barrel. And here’s where policy and sentiment take on increasing importance.
On May 8, consistent with his campaign pledge, the president announced the U.S. withdrawal from the Joint Comprehensive Plan of Action (JCPOA), the nuclear agreement endorsed by Iran, the United States, France, Germany, Russia, China, and the United Kingdom. Concurrent with that action, a series of U.S. sanctions were reimposed, and agencies began implementing those initiatives with 90- and 180-day winddown periods to allow markets and contractual agreements to readjust to the changes, and, in the case of oil, to allow purchasers to find alternate supplies.
In early August, sanctions were reinstated on Iran’s automotive sector and certain activities related to the issuance of sovereign debt, Iran’s trade in precious metals, selected commodities, and certain software used in industrial processes as well as the acquisition of U.S. bank notes by the Iranian government.
At that time, the administration reiterated its intent to reimpose (at the end of the 180-day winddown period, November 5) sanctions on Iran port operators, energy shipping and shipbuilding, Iran’s petroleum-related transactions, and transactions by foreign financial institutions with the central bank of Iran. Friends and foes alike were summarily warned that failure to comply with the sanctions and winddown activities would result in “severe consequences.”
The announcement caused allies, especially in the European Union, who supported the JCPOA, to move to enact blocking regulations to shield European companies from the impact of sanctions. Immediately following the announcement, The European Union, China, India, and Turkey indicated they intended to continue to import Iranian oil in defiance of the sanctions, but as a practical matter, most multinational companies who use the U.S. financial system or have a substantial presence in the United States are complying with the winddown.
Not surprisingly, the announcement also set off a barrage of waiver requests. Countries that were historical buyers of Iranian oil who thought they had until November to reduce import volumes were instructed by U.S. officials to begin reductions immediately; others thought that early compliance might tactically serve them better if they had to request waivers later.
Since the August announcement, the Trump administration has doubled down on the sanctions front—pressing Saudi Arabia and Russia to add additional supply while threatening importers with severe sanctions if they failed to reduce Iranian imports. The slowing down of U.S. production growth, due to weather and infrastructure constraints, has complicated matters as well despite the U.S. production surging to close to 11 million barrels per day (mmb/d).
In the intervening weeks, the U.S. government’slobbying effort has made considerable headway with South Korea, Japan and EU nations reducing Iranian volumes. Turkey remains defiant and China—while continuing to negotiate with the U.S. on trade and tariff issues—continues to buy from the Saudis, the United States, AND Iran. India appears reluctant (for now) to continue sizable Iranian imports but also hopes for waiver relief. We expect Russia to continue to be supportive of Iran (and would not be surprised to see discounted Iranian oil find its way into Russia—and possibly out as Urals blend) even as Russian producers continue to benefit from increased production volumes and higher prices.
Iran’s pre-sanctions oil production averaged between 3.8 and 3.9 mmb/d, but August figures suggest a reduction of more than 280mbd, pegging current output at a bit over 3.6 mmb/d. Tighter compliance with U.S. sanctions indicates that those volumes could be reduced further (to below 3 mmb/d) by 1Q19. But more importantly, Iranian crude and condensate exports are already showing signs of steeper reductions, with produced but unsold cargoes showing up increasingly as floating storage.
As of June, Iranian exports hovered around 2.2-2.4 mmb/d with 60 percent of the sales going to Asian buyers. Large European purchasers included Italy, Spain, France, Greece, and Turkey averaged around 175mbd. Current month (September) cargoes show significant reductions as loadings later in the month would fail to land before the early November deadline.
As a result, initial predictions of a sanctions-related loss of 500-700mbd of Iranian supply now appear to be low with more recent forecasts projecting reductions on the order of 700,000-1.0million barrels per day (which is still less than half of the “get to zero” target but substantial nonetheless). For market watchers and consumers, less severe export losses would be considered as welcomed news as there is simply not enough readily available spare capacity in the world to replace the loss of all Iranian barrels coupled with the potential for further reductions in Libya, Nigeria, Venezuela, and elsewhere! Consequently, an implied relaxation of sanctions enforcement would serve to moderate prices.
Over the last several weeks, the oil market has been in a continued state of flux but generally reflecting higher prices owing not only to the supply losses noted above but also to the threat of larger than anticipated reductions in Iranian shipments this fall and beyond. And while the OPEC/non-OPEC alliance had agreed to increase output this summer (coincident with a previous presidential tweet on the subject), last weekend’s gathering produced no additional volume commitments save for the repeated promise to keep markets adequately supplied. That said, we would nonetheless expect Russian and Saudi volumes to increase somewhat over the coming weeks as importers seek alternative barrels.
The most recent forecasts produced by the International Energy Agency (IEA), OPEC, and a number of other market-focused institutions now project that oil markets are likely to tighten further as we enter the fourth quarter of this year. But those same forecasts also suggest the recreation of surplus conditions early in 2019—causing a dilemma for OPEC members and reinforcing their decision to continue to monitor the market. Those projections could be even more negative for producer prospects should demand erode significantly as a consequence of escalating tariffs and extended trade wars.
Our previous commentaries have argued that oil prices reflect a combination of fundamentals and sentiment, including news events, perceptions of near- and longer-term policy pronouncements, and emerging issues that encompass things like sanctions, tariffs, trade wars, and geopolitical events that impact both supply and demand. Price activity over the past several weeks persuasively demonstrates that point and suggests an outlook of more of the same as the final months of 2018 play out.
Frank Verrastro is a senior vice president and trustee fellow with the Energy and National Security Program at the Center for Strategic and International Studies (CSIS) in Washington, D.C. Larry Goldstein is a senior associate with the CSIS Energy and National Security Program.
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