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OPEC's Output Deal Will Shrug Off Iran Sanctions

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(Bloomberg) -- President Donald Trump’s decision to tear up the Iran nuclear deal and reimpose sanctions on buyers of its oil will have a big impact on Iran’s crude exports, but don’t expect it to imperil the output deal among OPEC and its friends.

There is no pressure from within the group to bring their cooperation to an end. Far from it. The deal will run until the end of 2018 and could be extended again if participants don’t believe that the market has been rebalanced.

Last month I suggested that OPEC+ was in the process of dropping the five-year average level of inventories as a target. Last week Saudi oil minister Khalid Al-Falih did just that, denying that it had ever been the group’s goal. 

All the parties to the cuts are enjoying the benefits of higher prices, and for many of them it is effectively cost-free — they are already producing as much as they can.

The only significant, immediately available spare production capacity within the group lies in Saudi Arabia, Russia and the United Arab Emirates. These countries have chosen not to boost their production in response to Venezuela’s collapsing output, not because they lack a mandate to do so, but because they prefer the higher price that results from the loss to higher volumes for themselves. That calculation could quickly change in the event of a big drop in Iran’s exports as a result of sanctions.

If Saudi Arabia and Russia decide that that they want to supply the world with more oil, they can. There is plenty of historical precedent. Just look back at 2011, when Saudi Arabia boosted production in response to the loss of Libyan supply. Or look at 2015, when it refused to subsidize high-cost producers and embarked on the market-share strategy that was eventually brought to an end by the current output deal. It didn’t seek the approval of other OPEC members in either case.

Iran would certainly view this as a blatant attempt to “steal” the customers of a fellow OPEC member. But it shouldn’t be surprised. OPEC has a long history of operating when one or more of its members suffers international sanctions. When Iraq fell under United Nations sanctions for more than a decade after it invaded fellow OPEC member Kuwait in 1990, that didn’t stop the rest of the group from functioning, or prevent Saudi Arabia, Iran and Venezuela from stepping in quickly to make up the loss.

The holders of spare capacity won’t need to actively chase Iran’s buyers. They will come calling as soon as their access to Iranian barrels is cut off. The exporters will simply respond to customer demand for their crude.

How much crude supply might the world lose as a result of Trump’s actions? Probably at least as much as was lost under President Barack Obama’s sanctions. The current president will undoubtedly want his curbs to be “the biggest,” and he certainly won’t want them to be less punitive than his predecessor’s.

The U.S. Treasury department is allowing buyers of Iranian crude to apply for exceptions from sanctions if they “demonstrate a commitment to decrease substantially such purchases.” What constitutes a substantial decrease is not clear. It is likely to be a volume reduction of at least 20 percent, which appears to have been the Obama administration’s threshold, in addition to terminating contracts for future delivery of Iranian crude.

It also isn’t clear if the sanctions may also be applied to Iran’s condensate exports, which the Obama administration had exempted, but not specifically excluded, from trade restrictions. The nation’s sales abroad are currently running at around 400,000 barrels a day. If the definition of crude is extended to include condensate, then purchases of this light form of crude oil would also have to be cut.

Applying the 20 percent rule to the 2.82 million barrels a day of crude and condensate Iran exported in April suggests that we could see more than 560,000 barrels a day removed from the market by November, if all buyers seek to comply with U.S. demands.

If that happens, expect Al-Falih and his Russian counterpart to be on the phone agreeing by how much each will raise production. Meanwhile, the group’s overall compliance with its output cuts target will remain well above 100 percent and the deal will roll serenely on.

©2018 Bloomberg L.P.

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