The US implementation of sanctions on Iran oil sales starts in 10 days on November 4, 2018. The Trump Administration is planning tough implementation of US sanctions on Iran oil sales with a goal to reduce exports to zero. At each step along the way, foreign policy and market experts have doubted Trump, but he has followed through on every promise to date. As a result, we expect zero or close to zero waivers (we explain below) and potentially an early enforcement of sanctions for a violation to send a message to markets. We maintain our forecast of at least 1 million b/d of Iran exports will be removed from oil markets (it could be more if India joins) and we see this as a catalyst for an upward Brent price swing of $5 a barrel. In our view Brent could even spike close to $90 but we see an average price of about $85 in the latter part of this year.
We have been following Iran oil sanctions from even before the nuclear deal handshake with Iran in the summer of 2015. We predicted the deal would get done because Obama wanted a foreign policy achievement to cap his second term. We also correctly forecast after sanctions were lifted that Iran would add 800,000 to 1 million b/d of crude to the market by spring 2016 while consensus had the number much lower around 300,000 b/d.
When Trump was elected in November 2016, we wrote a note that the Iran nuclear deal was on life support and later wrote that 2018 would mark the end of the Iran deal and the start of US oil sanctions. Consensus doubted Trump’s conviction to end the deal and then again about re-imposing oil sanctions. When we forecast in January 2018 that US sanctions would remove about 1 million b/d of Iranian crude from global markets, consensus put the number below 500,000 b/d. Our forecast of 1 million b/d that was scoffed at back in January now looks to be a conservative number as consensus now predicts even more barrels off the market.
Oil prices surged above $80 in September and early October on various media reports of reductions as much as 800,000 barrel per day (b/d) of Iran imports by current customers. But subsequently the price momentum has been reversed amid various reports of the US considering waiver requests, Iran turning off tanker transponders to hide exports on ghost ships, and some last minute buying of Iran oil ahead of sanctions. In our view, all of this just noise, and we provide a primer on Iran oil sanctions and the current state-of-play 10 days out.
Oil Waivers 101: Here is what to expect (or not to expect)
On November 6, the US will put the world on notice that it expects Iran’s oil customers to reduce imports to zero. But news coverage over the last three weeks has focused on possible US waivers to sanctions.
Goldman Sachs chief oil strategist Jeff Currie told Platts in an interview last week that he assumed waivers would be coming. After sanctions, he said “then you get waivers.” In our view, if you think there will be waivers, you are making a huge miscalculation.
The media report that gave oil bulls some pause was from Reuters that said the US was “actively considering waivers on sanctions.” Reuters quoted an unnamed administration official that said it was “in the midst of an internal process” of considering requests of waivers or exemptions from Iran sanctions.
In reality, this report is exactly the same as comments from other officials on the record about considering waiver requests on a case-by-case basis. We said at the time and still strongly believe that there is no change in administration policy. Anything else than zero waivers would undermine the administration’s objectives on Iran policy.
To provide an exclamation point, National Security Advisor John Bolton told reporters: “this is not the Obama Administration.” He continued to explain that the policy remains “maximum pressure” on Iran and “no waivers from the sanctions.” Bolton’s full quote is below:
“Our objective, as the second wave of sanctions come back onto Iran, is we want to put maximum pressure on the government in Tehran. It’s our objective that there be no waivers from the sanctions, that exports of Iranian oil and gas drops to zero. I’m not saying we’re necessarily going to achieve that, but nobody should be operating under any illusions, what the objective is. You can look at the possibility of reductions leading to zero. It doesn’t have to happen immediately, perhaps. But ‘this is not the Obama administration,’ would be my message not just to Iraq but to everybody else. And the frequency and the ease of getting waivers and exemptions is not going to be our policy.”
We think Bolton’s comments make clear there is no change in policy on waivers that the Reuters report suggests. Regardless, the oil market has given the Reuters report considerable weight.
India - India’s request for a US waiver is also spurring a great deal of speculation that the Trump Administration will grant waivers from Iran sanctions. India is telling everyone that will listen that it expects a waiver. The administration is politely listening to India and other requests for waivers. But we are told the discussions are going like this: India asks for a waiver because it says it needs the oil; the US tells India it will help them find alternative sources of oil.
Some of India’s refiners have already halted purchases of Iranian oil but others have deliveries scheduled for November after sanctions go into effect. If there are to be waivers, we expect them to be for a limited time of no more than a month or two in order to get imports to zero.
China - China is expected to get a “wink waiver.” The State Department has requested China to go zero imports but in private no one believes the Chinese will comply. Instead, we think China will defy sanctions by keeping imports at current levels but will not increase purchases to take advantage of cheaper Iranian barrels with no where else to go. As long as the Chinese do not increase Iran imports substantially, we do not think the Administration will apply sanctions.
Iraq – After Iraq awarded a major multi-billion dollar power deal to GE over rival Siemens, we now think the Administration will approve a limited waiver to Iraq for electricity imports and possibly other products but definitely not oil sales. In addition, we believe that the US government will be watching Iraq closely for illegal exports of Iranian oil through Iits southern port.
Ghost Ships Confusing Market About Iran’s Current Exports
In August, Iran started to turn off tanker transponders to try to evade detection of export destinations. The practice really ramped up in September and October. The result has been media reports that relied on shipping data automated by transponder tracking that showed a substantial reduction of exports months ahead of US sanctions. A cynical person might say that Iran was intentionally trying to game the market to raise prices and maximize profits of real sales ahead of November 6.
The result of the practice has been widely different estimates of Iranian exports in September. Our friends at TankerTrackers.com, which tracks transponders as well as physically following satellite imagery, has Iran’s September exports at 2 million b/d while other media reports have it around 1.3 million b/d.
We think the real number is between both estimates. Let’s take a look at the TankerTrackers September estimate above. First, 200,000 b/d of the 2 million is on three unidentified VLCC’s or floating storage. So we reduce the 2 million b/d number down to 1.8 million b/d. In addition, we think about 100,000 b/d of exports to China are going to bonded storage rented by Iran and not to Chinese refineries. (Reuters reported recently that another 2 million barrels arrived in bonded storage at the Chinese port of Dalian. Three more tankers are due in the next week or so also for bonded storage.) As a result, the September TankerTrackers estimate can be further reduced to 1.7 million b/d. We also think a lot of September was elevated due to some trying to get last minute imports at favorable pricing ahead of sanctions.
Looking forward to November, exports to UAE, Italy, Spain, Japan, Greece and Croatia will go to zero and reduce the Tanker Trackers number of exports here to 1.2 million b/d. We also think we will see reductions in November from Turkey, India and possibly China that will remove a total of 1 million b/d from global markets. In addition, we see India getting close to zero imports in December or January that will raise the displaced Iran oil to close to the 1.5 million b/d range.
Look for early enforcement of sanctions to make an example.
We believe the Administration will be looking to impose sanctions for an early violation to make an example to the market. We want to make clear here that this is our analysis as a close watcher of Trump's Iran policy and not from any of our sources in the administration. However, we see more than a 50 percent chance of an early enforcement of Iran sanctions to send a message and incentivize others to get Iran imports to zero. We think this will come as a shock to oil markets that still seem to believe sanctions implementation are prescribed in the law as done in the past by the Obama Administration. We see a grace period in November but will be on red alert for a high-profile imposition of sanctions on an early violator. We think this will also be a catalyst for another price rise.
While the transponder trickery might confuse commercial markets, it will not evade US Government satellites. During the last oil sanctions on Iran, a lot of oil entered through the black market or illegal sales that were not followed or enforced by the Obama administration. Once again, some analysts point to the "black market" and cheating to make the case that sanctions will result in much less disruption of Iranian exports. We are not in this camp. The Trump administration already has a team and aggressive strategy in place to track and penalize efforts to evade sanctions.
Similarly, National Security Advisor John Bolton was in Moscow this week to warn Russia against attempts to launder and resell Iranian crude through some oil-for-goods trading program. So far US sanctions on Russia have largely been targeted and not affected oil production or the economy. But violating Iran oil sanctions would have major consequences, and we believe Russia will not think it will be worth it.
Implemented sanctions will give prices another leg up by year-end.
Saudi Arabia and other producers promised to make up for lost Iran barrels before the US mid-term election and have largely done so. Two weeks before the US election, Saudi energy minister al-Falih said OPEC was in a "produce as much as you can" mode. But on November 4, US sanctions on Iran oil become real, and we believe there will be little doubt that Iran exports will have been reduced in November by 1 million b/d. Moreover, this realization will come amid increasing low spare capacity.
While certainly some of reduced Iran barrels were already priced into markets, we think the market was also confused and underestimated the full impact of sanctions. We believe the Saudis will continue to keep production at elevated levels to mitigate the price impact but nevertheless we see another $5 swing higher from sanctions implementation by the end of the year.
