Another week another crisis
15 May 2018
How might Trump’s decision to pull the US out of the Iran nuclear deal (JCPOA) impact oil prices, and if prices go higher how could emerging markets (EM) be impacted? In terms of Iranian crude supply, it’s unclear how much crude exports will be reduced by unilateral US sanctions. Pre-JCPOA sanctions removed approximately 1 -1.5 million barrels from the daily market (see Chart 10), but at the time sanctions were a unanimously agreed multilateral effort (see chart 11). In current conditions, countries such as China might not comply or will circumvent sanctions, and other countries will vigorously seek exemptions. Without global cooperation (which is unlikely) the return of US sanctions will be less harmful than the sanctions regime that existed prior to the agreement being struck. It took the combined efforts of Congress and two US presidents over nearly a decade to cripple Iran’s economy. Rebuilding economic pressure will now be an even greater challenge, given international opposition to the US withdrawal and scant international support for renewed sanctions. With an unclear compliance and enforcement outlook, most estimates show that the decline in Iranian crude exports will be modest.
While the range of political outcomes is wide and there are innumerable uncertainties around the Iranian response and Trump administration policies, we think four broad factors will be important to determine how oil prices are impacted. First, the response from US shale − US crude output continues to hit new highs as rig counts continue to rise, although this may be a slow process. If Iranian exports decline modestly (200-500,000 barrels per day), US production could potentially offset the loss. Second, the Saudi/OPEC/Russia reaction -- Saudi Arabia could increase production to offset without impacting prices. This could be done both to increase market share but also due to potential pressure from the Trump administration to prevent prices from rising. Third, the China response − China is Iran’s largest customer and its refineries are particularly geared towards Iran’s heavy crude. China had exemptions during the pre-JCPOA sanctions that allowed it to continue importing Iranian crude albeit at slightly lower levels. This time around, it is less likely to comply and may continue importing higher levels of Iranian crude, especially now that it will probably receive discounted prices. Fourth, risk premium − the impact on oil prices may be less a factor of lower Iranian production and more a factor of higher risk premium as stability in the region is further undermined. Iran’s response is an open question, and the Middle East could be further destabilised. Oil markets were positioned very long prior to the announcement, suggesting the decision was already priced in; nonetheless, higher volatility will likely result.
If prices do rise on the back of reduced Iranian supply, greater economic differentiation is expected across EM. The macro impact of higher oil prices differs depending on the supply and/or demand driver. A demand-driven rise in oil prices can be cushioned by a strong pick up in exports. On the other hand, a supply-side driven rise in oil prices is more damaging to oil importers because, in the absence of a strong pick up in exports, the higher import cost of oil would worsen current accounts, compress margins and raise inflation. In this situation, Turkey, India, and the Philippines look exposed.