US decision on Iran bringing forward a heavy calendar of geopolitical risks

President Trump announced that he will withdraw on the Iranian nuclear deal today. President Trump’s vocal opposition to the deal and lack of European sanctions on Iran’s missile program.

However, it is not clear whether the US will exit the Iran deal altogether or offer a window for negotiation with other signatories. Further, even if sanctions are re-imposed, the impact on the oil market may not be immediate and we tentatively expect that several hundred thousand barrels of Iranian exports could eventually be at risk. While other participants have expressed their commitment to preserve the Iran deal, which suggests a smaller potential decline in exports than the 1 mb/d loss in 2012-15, the effectiveness of recent US secondary sanctions on Rusal create an offsetting risk that unilateral action by the US results in a collapse in exports. Alternatively, US secondary sanctions could target non-oil sectors of the Iranian economy.

Given our view that the rally in crude oil prices this year has been driven by tightening fundamentals and not an elevated geopolitical risk premium, we believe that an announcement that does not lead to an immediate loss of Iran exports or creates a window for further negotiations would only generate a modest negative price impact initially. In particular, the precipitous decline in Venezuela production has already crystalized the feared production losses out of Iran, with this potential disruption still to play out and be fully priced in.

Although we have not assumed a loss of Iran production in our base case forecast, if other OPEC members do not respond to offset it. In fact, growing geopolitical tensions in key oil producing countries like Iran, Saudi Arabia, Venezuela, Libya and Nigeria create risks of additional production losses in the face of depleted inventory buffers, leaving price risks to our summer $82.5/bbl Brent forecast skewed to the upside.

President Trump’s announcement, raises the likelihood that the administration may not renew sanction waivers for another 120 days. In addition, President Trump has repeatedly stated his disapproval of the agreement, has recently appointed vocal Iran hawks – John Bolton as National Security Advisor and Mike Pompeo as Secretary of State, and there has been a lack of progress in securing a commitment from European countries to introduce sanctions on Iran’s missile program.

Despite a raised likelihood that the US does not renew the waiver on US secondary sanctions, it is not clear that the US will exit the deal altogether and when such sanctions could re-start. European participants to the JCPOA reiterated their support for the deal on Monday and have paid visits to Washington recently to try to preserve the deal. Today’s announcement could therefore potentially instead create a countdown to the US reinstating secondary sanctions in order to kickstart a formal review of the agreement with other signatories, for example remove the sunset provision (which Trump opposes) or include Iran’s ballistic missile program, according to media reports.

US pulls out of the Iran deal and secondary sanctions are reintroduced, the impact on the oil market may not be immediate and potentially not as large as the 1 mb/d of lost exports in 2012-2015, although there again, uncertainty remains high. First, a unilateral exit by the US would not lead to a reintroduction of UN and European sanctions (with the former instead requiring evidence of violation by Iran be presented to the UN Security Council). As a result, some European refiners may decide not to stop importing Iranian crude if their exposure to the US is negligible (the EU accounts for 25% of Iran’s 2.6 mb/d crude exports). Second, key to the global oil market will be whether displaced European exports end up simply redirected to India and China to replace declining Venezuela production, with India recently indicating its desire to increase imports from Iran. Third, secondary sanctions may not have an immediate impact on the oil market as they historically offered exemptions and a phase-in period and only required that countries reduce Iranian crude imports by 20% every 180 days. Fourth, Trump’s recent tweet condemning OPEC’s influence in supporting oil prices suggests he may be wary of actions that could push prices even higher or even be aiming for other OPEC members to offset potential Iranian losses.

Despite these mitigating factors, it is important to emphasize that the most recent secondary sanctions imposed by the US, this time on Rusal, lead to an immediate global disruption of aluminum trade flows, suggesting a high level of efficiency even without coordination with other countries. The effectiveness of economic sanctions combined with President Trump’s concerns over higher oil prices could also lead to US secondary sanctions targeting instead non-oil sectors of the Iranian economy, which would weaken economic activity, while in fact incentivizing Iran to increase oil production.

Importantly, we do not believe that the rally in oil prices so far this year reflects an elevated geopolitical risk premium, limiting the downside to prices if today’s announcement leaves for a negotiation window with other signatories or a delayed snap-back of US sanctions. Specifically, the rally in Brent crude oil prices has tracked that of crude timespreads. Further, the backwardation in the Brent forward curve is consistent with the current level of OECD inventories. Finally, short-dated call skew in the Brent option market has declined over the past several weeks, suggesting limited interest in purchasing limited loss exposure to higher oil prices. In particular, the precipitous decline in Venezuela production has already crystalized the feared production losses out of Iran, with this potential disruption still to play out and be fully priced in, in our view.

Ultimately, growing geopolitical tensions in key oil producing countries like Iran, Saudi Arabia, Venezuela, Libya and Nigeria create risks of additional production losses in the face of depleted inventory buffers, leaving price risks to our summer $82.5/bbl Brent forecast skewed to the upside. There are also rising tensions between Israel and Iran, with direct confrontation taking place in Syria and the Israeli administration alleging that Iran had entered the JCPOA under false pretense. Further, if repeated Houthi attacks on Saudi Arabia escalate into a direct conflict between Saudi Arabia and Iran, this could create a dramatic impact on the oil market if local producing or refining assets were impacted. The Venezuela elections could further lead to the introduction of US sanctions, while elections in Nigeria later this year could result in disruptions as well. Net, a rebalanced oil market will face a heavy calendar of geopolitical risks in coming months. This reinforces our view that oil price volatility is set to continue to increase.