John Kemp, Reuters
The White House can drive Iran’s oil exports to zero, or it can have moderate U.S. gasoline prices, but it probably cannot have both.
The awkward tension between the administration’s foreign policy priority (tough Iran sanctions) and its electoral calculation (to keep gasoline prices low) explains its increasingly frequent comments about oil prices.
President Donald Trump has already blamed OPEC for the sharp rise in prices that has pushed the average cost of U.S. gasoline close to $3 per gallon. “Looks like OPEC is at it again,” the president wrote in a message on Twitter on April 20. “Oil prices are artificially Very High! No good and will not be accepted!”
Under pressure from the U.S., OPEC and its allies agreed on June 23 to boost production by an implied 1 million barrels per day (MMbbl/d) from the start of July. Saudi Arabia is expected to provide most of the increase, with smaller contributions from the United Arab Emirates, Kuwait and Russia, though specific country allocations were not included in the accord.
But the agreement failed to bring prices down and senior U.S. officials have since indicated they want an even larger increase to dampen the market.
The president has now weighed in by pressing Saudi Arabia for a much bigger increase in oil production, with another message on Twitter on June 30:
“Just spoke to King Salman of Saudi Arabia and explained to him that, because of the turmoil & disfunction in Iran and Venezuela, I am asking that Saudi Arabia increase oil production, maybe up to 2,000,000 barrels, to make up the difference,” the president wrote. “Prices to high! He has agreed!”
Saudi Arabia’s official news agency confirmed the telephone call though it made no mention about volumes of extra oil.
According to the Saudi Press Agency: “The two leaders stressed the need to make efforts to maintain the stability of oil markets, the growth of the global economy, and the efforts of producing countries to compensate for any potential shortage of supplies.”
The White House also softened its position on extra barrels. “The two leaders agreed that balancing the energy market is essential,” it said in an official statement.
“In response to the President’s assessment of a deficit in the oil market, King Salman affirmed that the Kingdom maintains a two million barrel per day spare capacity, which it will prudently use if and when necessary to ensure market balance and stability, and in coordination with its producer partners, to respond to any eventuality.”
However, the president later made much more explicit the link between Iran sanctions and OPEC/Saudi Arabia’s production, in a television interview with Fox News on July 1.
Asked whether OPEC was manipulating the oil market, the president replied affirmatively: “100 percent, OPEC is, and they better stop it, because we are protecting those countries, many of those countries.
“OPEC is manipulating, and you know they allowed [a production increase] less than we thought last week. They have to put out another 2 million barrels in my opinion, because we don’t want that happening.
“Don’t forget the one negative to the Iran deal is that you lose a lot of oil, and they got to make up for it. And who is their big enemy? Iran.
“Iran is their big enemy, so they are going to have to do it. And I have a very good relationship with the king and with the crown prince of Saudi Arabia and with the others around, and they are going to have to put out more oil.”
In contrast to the Obama administration, which employed sanctions to reduce Iran’s oil exports gradually, the Trump administration has made clear it wants to see Iran’s oil exports fall to zero from November.
In a media briefing on June 26, a senior State Department official repeatedly stated the administration wants U.S. allies as well as India and China to cut imports from Iran to zero and does not plan to issue waivers.
So far in 2018, Iran has been exporting well over 2 MMbbl/d of crude and condensates, according to the Joint Organizations Data Initiative. The problem is that the total amount of unused and available spare capacity held by OPEC members was just 3 MMbbl/d at the end of May, International Energy Agency data shows.
Most of the remaining spare capacity is in Saudi Arabia (2 MMbbl/d) with smaller volumes in Iraq (330,000 bbl/d), the United Arab Emirates (330,000 bbl/d) and Kuwait (220,000 bbl/d).
Other analysts put the level of spare capacity much lower.
Russia also has the capacity to increase output by several hundred thousand barrels per day over the next six months, but unused capacity elsewhere is negligible.
Saudi Arabia, the UAE, Kuwait and Russia have already pledged to boost their combined output by 1 MMbbl/d from July.
If Iran’s exports are pushed close to zero from November, and Saudi Arabia and its allies step up production to fill the gap, remaining spare capacity will fall to 1 MMbbl/d or less by the end of 2018.
The volume of spare capacity has not fallen that low since 2004, and before that, the first U.S.-Iraq Gulf War in 1991. But if spare capacity is adjusted for increases in consumption, it will be at the lowest level since the oil shocks of 1973-1974 and 1980-1981.
The oil market relies on a set of shock absorbers to help manage variations in production and consumption and ensure the smooth flow of oil from wellhead to consumer. In rough order of availability, these shock absorbers are:
- Commercial inventories (including floating storage);
- OPEC spare capacity;
- OECD strategic stocks and
- Short-cycle oil production (shale and development within existing oilfields).
Most of these shock absorbers have become seriously depleted as a result of the recent tightening of the oil market.
Commercial inventories have fallen below the average of the last five years and are much tighter if adjusted for the increase in consumption since 2013.
If Iran’s exports are eliminated entirely, and Saudi Arabia and its allies step up their own production to compensate, the OPEC spare capacity shock absorber will also disappear. The market will then rely on strategic stocks and an increase in short-cycle oil production to meet any further disruptions of supply or unexpectedly fast growth in consumption.
Stock releases from the U.S. Strategic Petroleum Reserve and other IEA members could help ease future shortages and calm prices but only as a temporary measure. Inventory releases (a one-time adjustment in stock levels) cannot offset an ongoing disruption in production (a flow problem).
In the medium term, the market would have to rely on an increase in short-cycle production to cover any remaining production-consumption gap.
Short-cycle producers, especially U.S. shale firms, could raise their output but their response will be limited by the lack of available pipeline capacity.
The oil market is already at a relatively late stage in the cycle, when prices tend to rise to stimulate faster production growth and moderate consumption growth.
Other things being equal, prices are more likely to rise than fall over the next two years, assuming the global economic expansion remains on track.
If the Trump administration takes a tough line on sanctions and attempts to push Iran’s oil exports close to zero, it will be removing a further 2 MMbbl/d of production from a market that is already likely to be very tight.
The most likely outcome is that prices will rise to cut consumption growth and rebuild the spare capacity and inventory shock absorbers to a more comfortable level.
The almost inevitable consequence is a further increase in gasoline and diesel costs and/or a slowdown in the global economy to curb consumption growth—perhaps as a result of the oil price increase or rising trade tensions.
Markets have fundamental constraints of their own quite distinct from politics. No matter how much it presses Saudi Arabia to boost oil supplies, the White House cannot escape this logic.