Iran's resistance stiffens as US pressure grows
Minor incidents in and around the Gulf have failed to trigger a major conflict, but diplomats are struggling to ease tensions
An "evil maturity" of US sanctions has tightened around Iran, according to oil minister Bijan Zanganeh, making conditions worse than during the Iran-Iraq War. The government has limited options on the economic front, but the means to strike back diplomatically and militarily.
Prior to the re-imposition of sanctions in November 2018, oil exports were running at about 2.7mn bl/d. April was the last month before the expiry of all US waivers, and Iran exported almost 1.2mn bl of crude and condensate, though some of this was delivered to storage. China took almost half of the total, India another quarter, and Japan, South Korea and Turkey the rest.
In May, this was slashed to barely 0.5mn bl/d, virtually all of which seemed destined for China. Chinese imports form part of its diplomatic and economic sparring with the US over trade and tariffs. Reuters put total June exports at 300,000bl/d, but another 300,000bl/d or so may be going into floating storage.
Local efforts continue on the new fields of the West Karoun area, including Yadavaran, Azadegan and north and south Yaran, after some winter interruption by flooding. Apart from limited work by Sinopec on Yadavaran, foreign investment in the oil and gas sector has virtually dried up. But a likely further slump in crude oil output to about 2.5mn bl/d, from a Joint Comprehensive Plan of Action (JCPOA) high of 3.8mn bl/d, has lessened the urgency to develop new fields to stem declines in the mature giants such as Ahwaz, Gachsaran and Marun. With the limit in exports, more oil will have to go to onshore and floating storage, while Iran is also trying to boost refining capacity to about 2.4mn bl/d by next March.
The overall state of affairs is far from clear. Eni recently rejected a cargo of "Iraqi" crude which it suspected to be Iranian. Analysis from Tanker Trackers and others indicates Iran using smaller vessels such as Aframaxes, switching off transponders to allow vessels to appear to be calling at Iraqi terminals instead of Iran's Kharg Island loading point, and performing ship-to-ship transfers. Some fuel oil from the Kurdish region of Iraq is transited via Iran, again clouding its actual origin.
The economy has suffered severely from the sanctions
Iraq continues to be granted short-term waivers for gas and electricity imports from Iran, which at 2018 volumes and prices earn about $1.1bn/yr for gas, though volumes are expected to more than double this year, and $0.7bn of electricity. Of course, this depends on Iraq paying its bills—power was cut off last summer over unpaid bills of $1bn—and Iran being able to access the cash, which is set to be paid in euros and Iraqi dinars. Meanwhile, oil exports to Turkey have dried up, but gas exports continue, earning another $2bn or so.
In 2017, from $53.7bn of declared exports, oil and gas accounted for $40.4bn, metals for $4.3bn and chemicals $6.1bn. In addition to the attempt to drive Iran's oil exports to zero, the US imposed sanctions on metals in May, and on Persian Gulf Petrochemical Industry Company, the country's largest petrochemicals firm, in early June.
The economy has certainly suffered severely from the sanctions. After a burst of growth above 10pc in 2016, following the implementation of JCPOA, it shrank by 5pc in the Iranian year ending in March 2019, according to economist Djavad Salehi-Isfahani, mostly because of a decline in oil output and export-linked manufacturing. The IMF sees a 6pc decline this year, but this may be overly pessimistic.
Iranians are suffering from growing unemployment, high—though easing—inflation, and shortages of imported medicine and other products. Anecdotally half of prescriptions are unable to be filled, prices are doubling or tripling in dollar terms, and concerns are growing over the poor quality of domestically-produced medication.
Yet Iran is not 1990s Iraq. It is domestically far more self-sufficient, with a sizeable industrial sector, ironically itself an autarkic response to earlier rounds of sanctions. It has attempted to improve relations with its Caspian neighbours and broaden its trade links into Central Asia. After a troubled 2018, the incidence of protests has dropped off significantly—whether because of a "rally-round-the-flag" effect, intensified repression or people's attention turning to the daily grind of survival.
Hard-liners garner support
The government is widely and justly blamed by ordinary people for corruption and mismanagement, but there is no sympathy for Donald Trump and the US stance. This attitude is not new: it evoked not just resistance to Saddam Hussein, but also to the much earlier period of American and British oil sanctions under prime minister Mohammad Mossadeq, overthrown by a CIA-backed coup in 1953.
Following Donald Trump's exit from the JCPOA, Iran passively absorbed sanctions, hoping for assistance from the EU, China and Russia; but it has been disappointed by their inability to offer any real relief. It has now seemingly concluded that it needs to strike back, to encourage domestic defiance, boost morale, and raise the stakes versus Washington and its Gulf Arab adversaries.
The "reformist" and "moderate" faction of current politics have drawn closer to the hard-liners, and indeed the 12 demands made by US secretary of state Mike Pompeo are anathema to any Iranian nationalist, even those opposed to the Islamic Republic. The regime hopes unity and the strategic initiative can enable it to negotiate from a position of greater strength.
Retaliation has slowly ratcheted up. In July 2018, two Saudi tankers were fired on, apparently by the Houthi forces allied to Iran, in the Bab el-Mandeb, the southern entrance to the Red Sea, and Saudi Aramco briefly suspended shipments through that strait. In May, four ships off the UAE port of Fujairah suffered slight damage in mysterious attacks, and two drone attacks on the Saudi west-east pipeline were blamed on the Houthis.
Further escalation came on 13 June, with serious explosions on two tankers, carrying naphtha and methanol, in the Gulf of Oman. On 18 June, a rocket attack on an oil services area of Basra injured three Iraqi workers and caused ExxonMobil to withdraw its expatriate staff.
2.4mn bl/d — March 2020 target for domestic refining capacity
Iran, blamed by the US, has denied responsibility; but it seems highly likely that it was behind at least some of these incidents. Their locations are a reminder that the much-watched Strait of Hormuz is not the only vulnerable point for Gulf oil and LNG exports.
And on 20 June, Iran shot down a US drone which it claimed was in its airspace. Donald Trump then confirmed leaks that a planned American reprisal had been called off at the last moment. This may have been a genuine change of mind, but seems more likely to be down to a desire to warn Iran without moving into open conflict. Reported cyber-attacks on Iranian units are a less confrontational response.
Oil markets stay calm
A further escalation, even if desired by neither side, could happen after a miscalculation, with incalculable consequences for the region and its petroleum exports. This could include sabotage of more tankers or offshore oil installations, drone attacks on desalination plants and airports, cyber-warfare, or proxy damage or blockades of petroleum facilities in Iraq.
Yet oil markets have been oddly unworried by the turmoil. Insurance premia have risen, adding some 10 cents to the cost of shipping a barrel from the Gulf, and Brent crude jumped 4pc after the drone shooting. This is not insignificant, but a far cry from the $10 "risk premium" quoted during past tensions in 2008.
On the diplomatic front, attempted mediation by Japanese prime minister Shinzo Abe was torpedoed, literally, by the simultaneous attack on the Japanese-owned Kokuka Courageous oil tanker. Iran has begun gradually reducing its compliance with the JCPOA, without yet taking any irrevocable steps. Both Iran and the US have given mixed messages on their openness to diplomacy, but for now the temperature has cooled off a little.
The Iranians are betting on their resilience, their multiple options to retaliate and Trump's unwillingness to be sucked into another Middle East war. "Maximum pressure", however painful to ordinary Iranians, will not cause the regime in Tehran to crumble, nor to make unilateral concessions. What comes next, whether a Trump rebrand of the JCPOA, a stalemate punctuated by low-level hostilities or full-blown conflict will determine whether the oil market can stay so sanguine.
Robin M Mills is CEO of Qamar Energy, and author of The Myth of the Oil Crisis