The making of a perfect storm

About US sanctions, OPEC Plus policies and oil prices

Iran’s president Hassan Rouhani announced on May 8 that Iran would not perform some of its obligations under the nuclear deal or Joint Comprehensive Action Plan (JCPOA) for 60 days. This is not withdrawal from the agreement. It is a temporary measure within the scope of nuclear accord, and can be reversed if EU provides sanctions relief. As Rouhani said: "This surgery is for saving the deal, not destroying it". Rouhani’s speech came one year after US President Donald Trump’s decision to withdraw from the nuclear deal. The US administration has taken three measures recently to ratchet up pressure on Iran. It designated Iran's Islamic Revolutionary Guard Corps (IRGC) as a terrorist organisation, ended oil sanctions waiver and has deployed a naval task force led by USS Abraham Lincoln in the Middle East in response to perceived Iranian threat to US interests in the region. The attack on two Saudi tankers and a Norwegian ship near Fujairah on May 13 has further escalated tensions. 

The increase in geo-political tensions come at a time of supply disruption due to crisis in Venezuela and Libya. OPEC oil basket climbed to $72.38 per barrel following the Trump administration’s April 22 decision to withdraw the sanctions waiver. It has since come down to $70.45 per barrel. President Trump has exhorted Saudi Arabia and UAE to make up any shortfall in the market due to "zeroing down" of Iranian exports. 

Though Saudi Arabia has spare capacity, it is constrained by its budgetary requirements as well as agreement with non-OPEC oil exporters led by Russia. OPEC cannot set production or price level without the agreement of latter group of countries. OPEC Plus has followed a policy of restricting production to boost prices. It set a target in November 2016 to reduce output by 1.2 million barrel per day (mbd), so that production comes down to 32.5 mbd. By benchmarking production to 2016 level, this formula ignored subsequent two years of growth in world economy and oil demand. The agreement was set to expire in end of last year. Instead, in December 2018, OPEC Plus decided to extend the agreement further.

The fifth OPEC and non-OPEC ministerial meeting on December 7 adopted a new bench-mark of 1.2 million bpd “adjustment” in production from October 2018 level of 32.976 million barrels per day. OPEC’s share in this “adjustment” was 800,000 bpd. Thus the new target is 32.176 million bpd. This is below the 2016 benchmark. 

India stands to lose 3,00,000 bpd of crude oil supply from Iran, and 4,00,000 bpd from Venezuela

Since January 2019, political trouble in Venezuela resulted in loss of  5,00,000 bpd oil production in that country. Saudi Arabia and Russia have also reduced production. The OPEC output reached 30.022 million barrels per day by March 2019, the lowest level of OPEC production in  years. This is 2 mbd below the level set in December meeting of OPEC Plus. The March production includes Libyan (1 mbd) and Iranian (1.3 mbd) export , which could disappear precipitously given subsequent developments. 

It will be difficult for shale oil to bridge the gap of this scale in global supply-demand situation. Though America has been exporting crude oil in recent years, in March 2019 its net imports (crude oil and products) actually increased by 516,000 bpd according to OPEC monthly report for April.

Will the Venezuelan and Libyan situation get resolved in the short term to allow supply situation to normalise? Russia and China have sent "advisors" to Venezuela. In Libya, general Khalifa Haftar controls most of the oil export terminals, while the Tripoli-based government has the backing of the UN Security Council to declare any crude oil export without its consent illegal. This stalemate is likely to continue.

Saudi Arabia’s geo-political interests in containing Iran coincide with US policy. But will it risk a break with OPEC Plus, whose support it needs to maintain high prices to meet its budgetary demands? Russian president Vladimir Putin said in a media comments that his country has not received any message from Saudi Arabia to increase production. 

What if Iran accepts the US terms? This could help lift US sanctions and normalise supply-demand situation. Rouhani’s speech of May 8 suggests this is unlikely. The Iranian leadership suspects that the US is bent on a regime change. The moderates are weakened by US decision to pull out of JCPOA. The US decision to declare IRGC as a terrorist organisation means hard-liners have no interest in negotiating new accord. Neither US nor Iran may want a war, but increased tensions carry the risk of mis-calculation. 

India stands to lose 3,00,000 bpd of crude oil supply from Iran, and 4,00,000 bpd from Venezuela. This would amount to roughly a sixth of India’s current imports of 4.4 million bpd. The challenge is not simply to find alternate sources, but at prices we can afford. Apart from credit terms, Iranian crude is cheaper. The spread between Iranian Heavy and Arab Heavy has in fact widened from $1 to more than $5 per barrel in recent days. The US commerce secretary stated recently that the administration cannot intervene in pricing issue, as oil trade is in private sector.

The Indian crude oil basket averaged $47.6 per barrel in FY 2017. This went up in two years to $69.4 per barrel in FY 19. It stands at $70.59 per barrel. An increase of $10 per barrel translates into more than $16 billion or Rs 100,000 crore per annum in terms of import bill. The high US oil inventory and fear of tariff war between US and China may have dampened demand for the time being and moderated crude prices. The oil price is holding after the incident of attack on the tankers on May 13. But the combination of increased geo-political tensions and supply disruption could be the making of a perfect storm.

The author is a former ambassador to Iran