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Trump lays down Iran gauntlet

The US administration must win over sceptical European and Asian allies to make oil sanctions bite as hard as last time

President Donald Trump pulled the US out of the Iran nuclear agreement on Tuesday, in a widely expected move that threatens to knock hundreds of thousands of barrels a day out of the oil market and ratchet up tensions across the Middle East.

Brent oil prices have surged around 10% over the past month, to over $76 as of 9 May, amid overt signals from Trump that he'd be pulling out of the Joint Comprehensive Plan of Action—as the Iranian nuclear deal is known—ahead of the 12 May deadline to waive sanctions relief.

Trump called for the "highest level" of sanctions on Iran in his White House address, including sanctions on crude purchases and investments in the country's energy sector. While Trump administration officials have repeatedly acknowledged that Iran has been compliant with the JCPOA terms, Trump himself has been harshly critical of the deal because of its narrow focus on Tehran's nuclear programme.

The US president wants a future deal to address broader security issues, including Iran's missile programme and involvement in conflicts around the region—though there seems to be little prospect of actually reaching such an agreement on this.

The Iranian response has sought to cast itself as the responsible alternative to a reckless Trump administration, with the aim of splitting the American and European alliance. Iranian President Hassan Rouhani said his government would continue with the agreement and hold talks on its future with the remaining parties: France, Germany, the UK, China and Russia.

However, it's not clear how sustainable that will be. Conservative forces in Iran, long critical of the agreement, will feel emboldened and push for a more adversarial approach to the US, which may include restarting the nuclear programme. Rouhani himself said that if talks break down, Iran could move within weeks to restart its programme of enriching uranium.

Muscular stance

The key question hanging over the oil market is how much oil will be knocked off global markets as sanctions are put back in place. The original oil sanctions regime against Iran was remarkably effective, reducing exports from around 2.5m barrels a day in 2011 to less than 1m b/d by early 2013. However, this was largely because painstaking diplomacy stitched together a global patchwork of sanctions that reduced leakages.

European leaders have made no secret of the fact that they think Trump is making a major strategic blunder

While US sanctions are a powerful tool given how deeply enmeshed American financial institutions are with global markets, it is unlikely the Trump administration's unilateral approach will be this effective. Estimates range from anywhere from just 250,000 b/d or so on the low end to more than 1m b/d on the high end of Iranian oil exports that could be affected.

The scale of exports knocked off the market will largely depend on both how Europe, and China and other Asian buyers of Iranian crude react.

Another front

European leaders have made no secret of the fact that they think Trump is making a major strategic blunder in unilaterally pulling out of the JCPOA. If they respond with only tepid support for renewed sanctions on Iran it could blunt their impact.

European Union sanctions that, for instance, prohibited insuring shipments of Iranian crude were key to the success of the first wave of sanctions. If the EU takes more limited measures against Iranian oil this time around, it would be easier for Tehran to skirt the measures.

Also important to the success of the first round was cooperation from China, India, South Korea and Japan, all of which are important buyers of Iranian oil. The US granted waivers for these countries to continue buying Iranian oil, but were largely able to persuade them to cooperate.

China, in particular, will be important as financing and other support for Iranian oil exports and production would help keep Iranian oil flowing. With the Trump administration ratcheting up a trade war with Beijing, it is doubtful China's leadership will be in the mood to do the administration any favours - and could use the issue as leverage in negotiations.

Trump's gamble

While there will be a six-month wind-down period for countries to curtail their purchases of Iranian oil and pull out of their investments in the country, the Trump administration is looking to tighten the screws on Tehran as quickly as possible. In its guidelines for the re-imposition of oil sanctions, the Treasury Department said that countries hoping to get a waiver to continue purchasing Iranian oil "are advised to reduce their volume of crude oil purchases from Iran during this wind-down period". 

The move to sanction Iranian oil is clearly bullish for prices, but exactly how supportive it is for prices will depend on how effective the Trump administration is at restricting Iranian oil exports.

Trump's move this week also sets the stage for a period of heightened risk of broader military conflict in the Middle East. Whereas the Obama administration's imposition of sanctions was an effort to avoid war with Iran, the Trump strategy looks to be moving more in that direction. On top of the sanctions, and harsh rhetoric against Iran, Trump has thrown his full support in the region behind Iranian foes Saudi Arabia and Israel and stocked his cabinet with Iran hawks that have agitated for a more muscular stance against Tehran.

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