July 5, 2018
The Risks of the Trump Administration’s Whiplash Policy on Iranian Oil
By David Mortlock and Ellen Wald
On Tuesday, June 26, a senior State Department official told reporters that it was not likely to issue exceptions to US sanctions for countries that were significantly reducing its purchases of Iranian oil. This is a departure from the Obama Administration’s approach when these sanctions came into effect in 2012. As the official explained, the Trump Administration instead expects all current purchasers of Iranian oil to halt imports prior to November 4—otherwise, they face the threat of US sanctions against any entities involved in the imports, including financial institutions, refineries, shipping companies, and insurers.
The administration may have realized the challenge and consequences of this goal, and by July 2 the State Department’s head of policy and planning, Brian Hook, delivered a subtly different talking point, saying that the administration’s goal was to get to zero as soon as possible. The initial talking points may have rattled US officials for good reason. If successful in its initial approach, the administration would remove as much as 2.5 million barrels per day from global markets. Because the re-imposition of sanctions coincides with a significantly tighter oil market, removing this much oil from the global market would have an immediate and severe impact on oil prices. Oil prices rose as much as 3 percent when the Trump Administration announced the withdrawal from the JCPOA in early May, signaling the potential for even greater price increases if customers cease purchases of Iranian oil. However, should the Administration fail to convince buyers to halt purchases of Iranian oil prior to the deadline, it would face an ugly choice: whether to impose sanctions on major institutions of countries that continue to purchase Iranian crude or to back down from the hard line it has taken publicly.
I. The Sanctions
The sanctions in question grew out of legislation passed at the end of 2011. The United States was expanding so-called “secondary sanctions” on Iran, meaning the threat of sanctions against third-country companies for engaging in certain transactions involving Iran, particularly its oil sector. The 2012 National Defense Authorization Act (NDAA), signed into law on December 31, 2011, included a provision requiring the president to restrict the opening of correspondent or payable-through accounts by a foreign financial institution (FFI) determined to have knowingly conducted or facilitated any significant financial transaction with the Central Bank of Iran or another designated Iranian financial institution. While ostensibly a banking sanction, in practice the provision in Section 1245 of the NDAA targeted Iran’s crude oil sales. The statute included a key exception that the sanctions would not apply with respect to a foreign financial institution, if the president determined that the country with primary jurisdiction over the institution had significantly reduced its volume of crude oil purchased from Iran in the previous 180 days.
The administration and Congress adopted the same “significant reduction” exception into numerous subsequent sanctions, including the threat of sanctions on any person engaged in a significant transaction for the acquisition of Iranian petroleum products. Bowing to the combination of the threat of sanctions and intense economic engagement from the Obama administration, every major purchaser of Iranian crude received an exception for significantly reducing their purchases of Iranian crude. The European Union eliminated purchases of Iranian oil entirely, while other countries reduced at various rates, resulting in the removal of approximately 1.5 million barrels per day of Iranian crude from the market. Iran went from selling 2.5 million barrels per day in 2011 to only 1 million in 2014.
The Trump Administration has indicated it will seek immediate elimination of oil purchase from Iran, a less gradual approach than the Obama administration. Thus, if importers do not receive an exception under Section 1245 of the NDAA and other provisions, various activities necessary for the purchase of Iranian crude will become sanctionable, and central banks from purchasing countries could be sanctioned for payment for any Iranian crude, as Iran processes all oil payments for its oil through the Central Bank of Iran.
II. The Oil Market
The market reaction to the Obama-era sanctions on Iranian oil was clear. Oil prices remained consistently high. The average price of the US benchmark (WTI) during these three years was $96 per barrel, though prices spiked as high as $113 per barrel at times. It is possible that the removal of Iranian oil from the global market added as much as $10 per barrel to the price of oil during these years.
When Iranian crude returned to the global market in January 2016, oil prices were already significantly lower than they were in 2011, hitting new lows as Iran ramped up exports to pre-sanctions levels. It took markets over a year and a half to recover from the crude oil glut that ensued. However, current global crude oil inventories have decreased, in part due to a multi-year production curtailment agreement between OPEC and non-OPEC producers, reflected by rising prices.
Removing all of Iran’s 2.5 million barrels per day from the global oil market by November 2018 would exacerbate the tightening oil market and drive oil prices up significantly. In fact, the market is already feeling the impact of the administration’s policy. Initially, analysts anticipated that the Trump Administration’s sanctions would remove only 300,000 to 500,000 barrels per day of Iranian oil from the market. However, after seeing the administration’s new policies and the positive response from crude oil purchasers in Europe and India, analysts now anticipate that as much as 1 million barrels per day of Iranian oil will come off the market. Oil prices shot up between 1 and 2.5 percent the day the State Department announced plans to pressure importers of Iranian oil to zero out their purchases. These gains came despite Saudi Arabia’s plans to increase production in the next month.
The issue is compounded by involuntary declines in oil production from other producers. Venezuela, which has the largest crude oil reserves in the world, has been hit with such severe economic and financial problems that it can barely produce over 1 million barrels per day. Unrest in Libya has thrown at least 600,000 barrels per day in exports into jeopardy. Canadian oil producer Syncrude, which sends a significant amount of oil to the United States, is experiencing technical problems that will likely remove at least 360,000 barrels per day through the end of July. Some American oil producers in the Permian are planning to shut in wells because the pipeline infrastructure for oil and gas is at capacity. It is unclear how much oil will be impacted, but this news, when combined with known outages, has pushed oil prices significantly higher in recent days.
American businesses and consumers will feel the financial impact of this unexpected increase in oil prices in the near term. At the same time, the US oil and gas industry will benefit from rising prices. Additional infrastructure is in the process of being built and transportation capacity in the Permian region is expected to increase significantly in 2019. Oil export facilities in the United States are also growing to accommodate higher exports and it is anticipated that some US oil will be able to take the place of Iranian oil on the global market. While the short-term economic effects of the new Iran sanctions policy will increase costs for consumers and businesses that could have political consequences in November, the US economy will reap some rewards in the long-term.
III. The Risks
It is possible that importers could try to game the system and route Iranian oil purchases through “sacrificial lambs” with no US ties. The Chinese tried such a tactic in the early days of the Iran secondary sanctions by routing transactions with designated Iranian banks through Bank of Kunlun, which the United States sanctioned with little practical effect. In the long-term, the aggressive use of sanctions authorities could encourage countries to establish isolated channels to Iran using entities with no need for access to the US market and are willing to be sanctioned, potentially decreasing the effectiveness of US sanctions over time, making it harder for the United States to use sanctions to affect the behavior of our adversaries in the future. The United States could counter these efforts by sanctioning the central banks and other key entities at the end of the financial chain, but the prospect of imposing sanctions on the People’s Bank of China and other state-owned institutions could have grave political and economic consequences when they are severed from the US financial system.
In the short-term, even if importers do find ways to skirt these sanctions, they will not be able to continue to purchase Iranian oil at current quantities, suggesting that at least 500,000 to 1 million barrels per day of Iranian oil will come off the market. Even with planned increases in oil production from Saudi Arabia and Russia, the administration’s Iran policy will push oil prices higher in coming months, which consumers will feel on their wallets, and politicians could feel at the polls.
It appears that the Trump administration is aware of the impact its Iran policy will have on oil markets and is taking steps to encourage oil producers like Saudi Arabia to put more crude oil on the market. Even with assurances from the king of Saudi Arabia and other OPEC countries that they will increase oil production, these efforts may not be enough to counteract higher energy prices.
This Administration’s approach to the sanctions is undoubtedly more severe in its implementation than its predecessor's approach. These tactics could backfire by encouraging countries to create sustainable workarounds and are almost certain to increase the price of oil, at least in the short-term. The administration could have softened the immediate economic impacts by seeking a coordinated multilateral approach to the sanctions and blocking alternative channels for the business with Iran. That approach—pursued by the last administration—does not seem in the cards for the current one.
David Mortlock and Ellen Wald are senior fellows at the Atlantic Council Global Energy Center. You can follow Ellen Wald @EnergzdEconomy and David Mortlock @yotus44 on Twitter