How Trump is about to send world oil prices soaring even higher

From its office in Paris, out of sight of the drama of US President Donald Trump’s European adventure, the International Energy Agency’s Oil Market Report makes for sober reading. Its June report suggests that the oil market will be “finely balanced next year,” which is a polite way of saying that it will be turbulent and – in essence – a mess.

The embargoes of Iran and Venezuela have already set the oil market on edge, with Libya’s continued disruption making things very tight. Any further problem, the IEA says, and the price of oil is likely to spike out of control. Brent crude, the index for oil prices, could whip from today’s price of just above US$70 a barrel to $250 a barrel.

Trump’s war on Iran

The main point of disruption is the policy of the United States against Iran. In May, Trump jettisoned US commitments to the 2015 nuclear deal with Iran. He called for a total embargo of Iranian oil exports by this November.

Iran relies on the export of oil. In May, as a result of the nuclear deal, Iran’s oil exports rose to a high point of 2.7 million barrels per day (mbpd). In February, Iran’s Oil Ministry said the country had hoped to raise this to 4.7mbpd within the next four years. But now it is likely that Iran’s oil will be substantially offline. This will have catastrophic effects for Iran, certainly, but also for the price of oil outside Iran.

Iran has hoped that its Asian buyers – who purchase the bulk of Iranian oil – will not follow US sanctions. The Iranians have pinned their hopes on China, which buys most of the oil, as well as on India and Turkey. Already, Iran’s two other main buyers – Japan and South Korea – have begun to cut their oil imports.

China has indicated that it would not honor the US sanctions. It is likely that the so-called petro-yuan will become a lifeline for the Iranian economy. This new mechanism for pricing oil remains outside the US dollar’s institutions, and so not so exposed to US pressure.

India, vulnerable to US pressure, has said it would only buy Iranian oil if it is able to get a waiver against sanctions from the US government. Turkey has also indicated that it would like to get a waiver, although it is likely that Ankara will also try to push against the sanctions regime.

When Trump was in Europe, he reminded the Europeans about the sanctions and the new US posture toward Iran. European companies that are integrated into the US economy are unlikely to challenge the sanctions against Iran.

After Trump made his remarks in May, the presidents of Russia and  France said they would protect their companies from US sanctions, since they did not agree with the withdrawal from the nuclear deal. But neither Vladimir Putin nor Emmanuel Macron has the pulse of his own businesses. Total (France) and Severstal (Russia) have already walked away from doing business with Iran. More will follow.

The Iranian government is watching its buyers buckle under the pressure from Trump and the United States government. If Iranian oil exports decline to 700,000 barrels per day or even lower, its treasury will be swiftly depleted. Even that amount is only possible if China – which imports 650,000bpd – actually stands up to the United States.

Devaluation of the rial by the Central Bank of Iran in March and April – prior to Trump’s May announcement – already showed the vulnerability of the Iranian economy. Fleeing the cash economy, those Iranians with cash in hand have gone to the gold coin market, to the real-estate market and into unofficial foreign-exchange markets (a three-tier exchange rate system is now in operation – a harbinger of serious monetary problems). These Iranians are looking for somewhere to preserve their threatened value as the peril of economic collapse stares Iran in the face.

When prices rise …

This November, the United States will have a midterm election. It is an axiom of politics in the United States that high oil prices produce murder at the polls. Jimmy Carter faced re-election in 1980 with gasoline prices at $1.25 per gallon (or, adjusted for inflation to March 2018 dollars, at $3.89 per gallon, or $1.03 per liter). The gas price is currently at $2.88 – about a dollar less than the price faced by Carter in his ill-fated attempt at re-election.

The Trump administration has said that it wants purchases of Iranian oil to come to zero by November 4, 2018. Two days later, the US electorate will go to the polls. If prices rise as a consequence of the drawdown of purchases from Iran, it will have an impact on the polls. Trump and his team recognize the idiocy of lifting oil prices just before an important election. This is why the US government is pushing for at least three means to keep prices reasonably low.

1. Waivers. US Treasury Secretary Steve Mnuchin indicated this week that the Trump administration would “consider exceptions” to the sanctions regime against Iran. This would be a return to the policy followed by the Barack Obama administration – it allowed waivers to any country that could show that it was making good-faith attempts to cut its oil purchases from Iran. The standard was high – imports had to fall by 20% every 180 days. Mnuchin’s remarks suggest that the Trump administration will take some sort of action that mimics the Obama policy. Japan, South Korea and the Europeans have been eager for the Trump administration to make this gesture. It would at least put off their own problems with energy supply.
2. Strategic Petroleum Reserve. After the Oil Weapon had been unsheathed by the oil-producing countries in 1973, the US government began to hold a Strategic Petroleum Reserve. The government currently holds about 660 million barrels in its underground tanks in Louisiana and Texas. Last year, the US consumed 7.26 billion barrels of oil, or about 19.88 million barrels per day. That means that the US has about a month’s worth of oil in its Reserve. The Trump administration is considering a test sale of about 5 million barrels of oil and then releasing about 30 million barrels into the market. This is a very small amount, but it is highly symbolic.
3. OPEC+ increases. Saudi Arabia, which detests Iran, has already begun to violate limits imposed by the Organization of the Petroleum Exporting Countries and pump oil to keep prices down. In June, Saudi Arabia pumped 10.49mbpd (its OPEC limit is 10.06mbpd). The kingdom, suffering its own economic crisis, is nonetheless willing to cut off its nose to spite its face. Saudi Arabia claims that it has 2mbpd of excess capacity – not enough to plug a major hole in the world oil market. Nor do the other OPEC countries (the United Arab Emirates and Kuwait) that have said they would pump oil to make up for the slack supply. Nor does Russia (not an OPEC member), which has also indicated – despite the US sanctions against it – that it would pump part of its excess capacity of 300,000bpd.

Can these three approaches make up for the decline of 900,000bpd cut since September (two-thirds of this from Venezuela) and for the decline of a further 1mbpd from Iran after November? It is unlikely.

Underinvestment in the oil industry as well as new tensions in Libya further weaken confidence that oil prices can be held at a reasonable level. If oil prices rise and if there is pressure on impoverished states to cut oil subsidies, the kind of protests that took place in Haiti recently should be expected.

A shooting war

Last week, a senior Iranian military commander said his country would – if pressured – close its territorial waters to international oil tankers. A fifth of the world’s oil passes through the Strait of Hormuz, almost half of the oil brought to the surface in West Asia.

The legal ground for such a closure is not clear. Iran points to the 1958 Geneva Convention on the Law of the Sea, whose Article 16 says that coastal states might “take the necessary steps in its territorial sea to prevent passage which is not innocent.” Iran could make the case that the economic war on the country is being deepened by the transit of oil from Saudi Arabia, the UAE and Kuwait to international markets. The 1982 UN Convention on the Law of the Sea affirmed this notion of “innocent passage.”

But even if Iran is on solid ground, it would have a difficult time closing the Strait, which – at its narrowest – has a width of 55 kilometers. The US naval base in Bahrain is entirely there to keep the Strait open. The possibility of a small war or even a big war is not so far off.

This article was produced by Globetrotter, a project of the Independent Media Institute.