US stance on Iran may spur oil market volatility

"Drill, Baby, Drill" was the eye catching and popular phrase that gained further prominence after it was used by Republican Vice Presidential nominee Sarah Palin in her debate with Joe Biden in the 2008 US presidential elections.

This was to help spur US domestic oil production, particularly shale resources, and anything else that could "wean" the US from foreign oil imports. Sometimes slogans can become an embarrassment; Drill, Baby, Drill turned to Spill, Baby, Spill following the 2010 Deepwater Horizon oil spill at a BP offshore drilling rig in the Gulf of Mexico.

Catchy slogans can fire people’s imagination and sometimes lead to significant policy shifts, as was the case with the Republican Party’s support for US shale, coal and other conventional energy production. The results have seen US oil imports fall back, with China now overtaking the country as the world’s largest oil importer, and America acting as the global swing oil producer, taking that mantra from Opec. This has also unleashed a divisive debate on the effect of unbridled fossil fuel production on a fragile world environment. But the new US National Security Adviser John Bolton’s foreign policy optics are just as important - with significant implications to oil market price stability.

Mr Bolton will cast more doubt on the nuclear deal between Iran and major world powers, with potentially serious consequences for the crude market. A veteran of George W Bush’s administration known for his ardent support of the 2003 Iraq invasion, Mr Bolton described the accord with Iran as a “strategic" debacle. His appointment in April followed the firing of Secretary of State Rex Tillerson, a defender of the nuclear deal, who was replaced by another foreign policy hawk, Central Intelligence Agency director Mike Pompeo.

Not surprisingly, oil markets have reacted bullishly, with international benchmark Brent crude rising to around $75 a barrel since Mr Tillerson’s ousting. But some are cautioning that Mr Bolton’s trademark "fury and thunder" on Fox news when he was in the policy wilderness will be tempered as a National Security Advisor to a president who is still loathed to get entangled with international military escapades and has changed more advisers than any other president.

Mr Trump has caught his officials by surprise with his quick acceptance of a summit meeting with an equally erratic North Korean leader, Kim Jong-un. What’s at stake for the oil world? A sort of realism seems to be dawning on Mr Bolton as he has recently admitted that some of his former ideas have to be tempered and he has to take the lead from the US president.

But Mr Bolton and Mr Trump share a common cause on Iran and this has implications for oil policies and market stability. Mr Trump is required by law to certify every 90 days whether Iran is complying with the 2015 agreement that eased US and international restrictions on the Islamic Republic provided it curbs nuclear research. In October, the president said Iran had failed to live up to the spirit of the pact, but he stopped short of re-imposing sanctions on its energy industry. Mr Trump decided in January to hold back from imposing tough economic sanctions against Tehran, but only to give more time for Europe to fix the terrible flaws in the agreement.

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On May 12, he must decide again whether to recommit the US to the deal. Since US and international sanctions were eased in January 2016, Iran has regained its position as one of the world’s biggest oil exporters, shipping more than 2 million barrels a day to customers in Asia, Europe and Turkey, but not reaching a sustained 3 million barrels per day production despite being reluctantly granted exemption from the current Opec and non-Opec members' production cuts.

If the US were to force that amount of oil off the market again, it could turn a fast-shrinking surplus into a shortage and send prices higher - with some predicting a $100 range - and destabilise the careful balance of supply and demand that both Saudi Arabia and Russia are trying to achieve. At the same time, Iran is trying to attract investments from international oil companies to boost crude and condensate output by about 25 per cent to more than 5 million barrels a day. Without new investment from international companies production will stagnate.

Mr Trump’s opposition for the nuclear deal has already deterred investors from Iran and, of the western energy majors, only France’s Total has returned and its gas venture is proceeding slowly. Total has the biggest financial stake of any major, having pledged to invest $1 billion in the first phase of an offshore natural gas project. Overall investment in the project could reach $5bn and, while the company is determined to press ahead, chief executive Patrick Pouyanne (as reported by The National in March) has promised to review the legal consequences of any new US restrictions as Total is also heavily influenced by French political considerations.

If Mr Trump reinstates US sanctions, the measures could be unilateral, unlike the global effort that brought Iran to the negotiating table last time. During the most restrictive phase of US and international sanctions, from 2012 to 2015, buyers in Asia limited their purchases of Iranian oil, and the European Union imposed its own embargo on crude from the country.

However, nations that agreed then to buy less Iranian crude are signalling no willingness to cut back now. Washington’s leverage, even if it acts alone, is that crude sales are denominated in dollars, meaning any oil deals must go through the US banking system.

To prepare for such eventualities, the Iranians are now switching to the euro as a medium of trade. The US could also penalise American subsidiaries of foreign companies that invest in Iran or purchase its oil. Buyers might try to avoid punishment by paying in non-dollar currencies, like China’s yuan, or by working through companies that have no US subsidiaries. If Asian buyers failed to comply with new US curbs, Mr Trump might be in the position of having to impose penalties on China and allies such as South Korea and Japan, escalating tensions with these two allies who have enough trouble as it is with the dangerous stand-off between the US and North Korea and current tariff trade war disputes.

The impact on the market may not be quite so clear cut because killing the Iranian deal could also prompt Opec, Russia and their allies to prematurely end their production cut at the end of 2018 or before, and boost supply, as the group has voluntarily reduced production by more than 1.8 million barrels a day.

Any increased tension in the Arabian Gulf could lift Brent as high as $80 or more per barrel this year. But Mr Bolton’s narrative on Iran goes further than simply scuppering the Nuclear Agreement as three years ago, when in a New York Times article he opined that "to stop Iran’s bomb, bomb Iran" and argued that the only way to prevent Tehran obtaining nuclear weapons was a military strike as an example of effective action.

Mr Bolton’s appointment has lots of implications beyond just Iran. It also makes Mr Trump’s scheduled talks with Mr Kim riskier, as the North Korean leader might wonder if any agreement reached on a denuclearisation of the Korean peninsula is worth the paper it is written on.

However, the news that Mr Pompeo has secretly met with Mr Kim to prepare for the Trump summit has again illustrated that nothing is clear cut with the current American administration.

The visit by French President Macron to Washington to meet Mr Trump ahead of the Iran agreement certification might just open the possibility that it will be renewed, given the political capital that France under Mr Macron, and the UK to a lesser extent, have gained in supporting the US in the recent military strikes in Syria.

If that happens, the oil market’s jittery nerves will settle - until the next certification date looms.

Dr Mohamed Ramady is an energy economist and geo political expert on the GCC and former Professor at King Fahd University of Petroleum and Minerals, Dhahran , Saudi Arabia and co author of ‘ OPEC in a Post shale world – where to next ?’ . His latest book is on ‘Saudi Aramco 2030: Post IPO challenges ‘ .