Oiling the wheels of conflict

The expiry of the six-month waiver granted by the US to eight countries for importing oil from Iran has thrown into flux the output, trade and pricing of arguably the world’s most valuable commodity. Geo-strategic tensions are also escalating, as Washington has deployed an aircraft carrier to the Gulf region, and Tehran has put on hold parts of the July 2015 Joint Comprehensive Plan of Action (JCPOA), which is commonly known as the Iran nuclear deal.

The US sanctions on Iran are categorized into primary and secondary. The primary sanctions apply to American citizens as well as entities, while the secondary sanctions cover persons and entities outside the US. In both cases, carrying out transactions with the public and private sector entities of Iran is declared illegal and thus subject to punitive action by Washington. The sanctions are wide ranging and include Iran’s energy, petro-chemical, banking, insurance and shipping sectors.

After the nuclear deal, Washington withdrew the secondary sanctions with effect from January 26, 2016, thus allowing non-US businesses to do business with Iran. Following Donald Trump’s decision to withdraw from the JCPOA in May 2018, the secondary sanctions were re-introduced in phases. However, starting November 5, 2018, eight major buyers of Iranian oil – China, India, Japan, South Korea, Taiwan, Turkey, Italy, and Greece – were allowed to continue to procure the commodity from Tehran for six months subject to the condition that they would cut back on their dependence on Iranian oil. The waivers were granted because these countries were considerably dependent on oil imports from Iran and cutting purchases to zero would affect their industry and ratchet up fuel costs.

In the wake of the end of the waivers, there are two possible scenarios: In the first scenario, all or some of the countries would cease to buy oil from Iran thus forcing the latter to scale down its output. At present, Iran is the globe’s fourth largest producer of oil and accounts for 4 percent of the world output. After the conclusion of the JCPOA, Iran’s average crude oil output scaled up from 3.49 million barrels per day (bpd) in 2015 to 4.37 million bpd in 2016 and further to 4.70 million bpd in 2017. In 2018, however, the oil production slightly came down to 4.47 million bpd, as Washington re-imposed the secondary sanctions.

Iran’s average oil consumption is 1.8 million bpd, which means that nearly 60 percent of its oil is exported. It’s the sixth largest oil exporter and makes up nearly 5 percent of the commodity’s global sales. In 2017, Iran’s oil exports were 2.7 million bpd. In value terms, Iran’s crude oil exports rose from $19.2 billion in 2015 to $48.3 billion in 2017 before falling to $45.6 billion in 2018.

A slump in oil revenue may throw an already fragile economy into a tailspin and force Iran into taking some tough actions. Tehran has already threatened to close the Strait of Hormuz, a key conduit for oil trade, in case it was stopped from selling oil. Many believe this threat is mere saber-rattling. In any event, that was enough for the US to deploy an aircraft carrier to the region.

China and India are the two largest buyers of Iranian oil and together account for $28 billion ($15 billion and $13 billion respectively) or 62 percent of its global exports. They are the world’s two largest countries and among the fastest growing economies in the world and thus need energy security to maintain the growth momentum. However, China and India are only partly dependent on Iran for their energy needs. The share of Iran in total oil imports of China and India is 6 percent and 11 percent respectively. China’s top oil suppliers are Russia and Saudi Arabia, while in case of India, the major oil exporters are Iraq and Saudi Arabia. Hence, over the long run, both these countries can afford to cease buying oil from Iran.

For Tehran, however, it will be crucial how Beijing and New Delhi respond to the end of the waiver. If they both cave in to Washington’s pressure, Iranian oil exports and output will come down with a thud, which would bid up international oil prices. The important question is whether other major oil exporting countries are capable as well as willing to fill the gap in world oil supplies.

The world’s top five oil suppliers are Saudi Arabia, Russia, Iraq, Canada and the UAE. Together they account for 37 percent of world oil production and 47 percent of exports. Despite being the top oil producer, the US has to import the commodity due to higher domestic consumption. Of the five principal oil suppliers, Saudi Arabia, Iraq, and the UAE are members of the OPEC – the international cartel – which fixes oil output with a view to manipulating its prices. In December 2018, OPEC and its allies led by Russia agreed to cut oil output by 1.2 million bpd for six months with a view to raising prices to $70 barrel a day. So from the economic viewpoint, the major oil exporters don’t seem to be too willing to raise oil production.

This brings us to the politics of oil trade. All said, political rather than economic considerations prompted Washington to clamp sanctions on Tehran. At the same time, being the world’s largest oil consumer, the US will be hit seriously by a possible hike in the commodity’s price, which will push Trump’s ratings down at a time when he is under fire for alleged collusion with Russia during the 2016 race for the White House. That’s why he’s pinning high hopes on Saudi Arabia, and the UAE, both of which are believed to be under Washington’s infulence, to step up oil production. Tehran and Riyadh being the two perennial antagonists in the Middle East, Saudi Arabia has been a staunch critic of the JCPOA. The case of Iraq is curious, as it’s in the sphere of influence of both Iran and the US.

Assuming that Saudi Arabia and the UAE are willing to oblige the US on enhancing oil output, do they have the capacity to do so? Saudi Arabia is said to have a maximum sustainable capacity of 12 million bpd, while its average oil production in recent months has been 11.1 million bpd. The UAE, which produced 3.8 million bpd in 2018 and 3.1 million bpd in the first four months of 2019, is also producing oil close to capacity. Therefore, in the foreseeable future, neither Saudi Arabia nor the UAE seems to be in a position to fill the oil supply gap. The oil output outlook is further vitiated by the fact that Libya and Venezuela, another two big oil suppliers, are in turmoil. Does that mean oil prices would shoot up?

Not necessarily. The price of a commodity is determined by both demand and supply. If oil demand also goes down, for example due to deceleration in growth of major oil consumers such as the US and China, prices will remain stable. However, if demand increases or even remains stable, prices will rack up. So it’s a toss-up where the prices will settle.

In the alternative scenario, China and India, as well as some other countries like Turkey, defy the US and continue to procure oil from Iran. In that event, Iran will not be forced to cut back on its oil production and, save for some contrived oil shortage, the supplies will remain fairly stable. The defiance will leave the Trump administration with two courses: either to punish the ‘offenders’ through sanctions or making a virtue of necessity grant them another waiver.

For Pakistan, a spike in oil prices will turn out to be a triple whammy: it will inflate the import bill and thus external deficit, stoke inflation, and put further brakes on economic growth by driving up manufacturing cost. Let’s hope such a situation doesn’t come about.

The writer is an Islamabad-based columnist.

Email: hussainhzaidi@gmail.com

Twitter: @hussainhzaidi