4 May 2019

What Effects Will Tighter U.S. Sanctions on Iran’s Oil Have?

by Amy M. Jaffe

The United States announced it will no longer exempt a small set of countries, including China, from its oil sanctions regime against Iran. CFR’s Amy Myers Jaffe, an expert on global energy policy, assesses the impact on the oil market and the potential reactions from both Tehran and Beijing. Oil prices ticked up a few percentage points after the announcement. Do you expect prices to remain higher, or is there enough supply in the market to cover a drop in Iranian exports?

U.S. sanctions had already curbed Iran’s oil production substantially earlier this year. The Trump administration’s tough stand on waivers could remove an additional five hundred thousand barrels per day or more from the market in the coming weeks. This would come on top of production cuts planned by the Organization of the Petroleum Exporting Countries (OPEC) and ongoing production and export problems in Libya and Venezuela.

Oil prices will continue to be sensitive to any supply disruptions, despite expectations of rising U.S. oil production and possible production increases from Saudi Arabia. Should prices begin to rise precipitously, the Trump administration could make sales from the United States’ strategic petroleum reserve.

How has the United States’ growing role as a major crude oil exporter changed its attitudes when it comes to sanctions? 

There is no question that rising U.S. oil production has emboldened U.S. policy regarding oil sanctions. U.S. crude oil exports reached record levels, above 2.5 million barrels per day, in recent weeks and are expected to rise further this year. However, the administration should take care not to impose too many complex sanctions in the oil market at once because surprise events such as hurricanes, accidents at major oil fields, or geopolitical strife can create sudden disruptions in oil supplies and leave markets more vulnerable to price spikes. U.S. crude oil production is still less than 12 percent of the total global crude oil supply. It can only go so far in hedging against the multiple risks now looming in the market.

Iran has threatened to stop the flow of oil from other big suppliers via the Strait of Hormuz. Could it do that? How exposed is the U.S. economy to oil disruptions in the Middle East?

The Strait of Hormuz is more than twenty miles wide. It would be extremely difficult for Iran to close it completely for an extended period of time. There is the question of whether Iran could use asymmetric warfare tactics, such as swarming speedboats and missile attacks, but the possibility of a decisive international military response led by the United States makes such an endeavor extremely risky for Iran and its military.

Iran would likely use more clandestine approaches, such as cyberattacks on neighboring state oil facilities. Saudi Arabia and the United Arab Emirates have alternative pipeline routes that can bypass the Strait of Hormuz. In the case of Saudi Arabia, upward of 6.5 million barrels per day in exports could bypass the Persian Gulf. The U.S. economy is less exposed now to oil price shocks than in past decades due to the lower oil intensity of the U.S. economy. Still, high gasoline prices can derail consumer spending, especially on durable goods such as cars. At the same time, an oil price shock in the developing world could cut into countries’ appetites for U.S. goods and services.

China is the largest purchaser of Iranian crude. How do you expect it to respond to the Trump administration’s decision?

China said that Iran’s discounted oil was too cheap to pass up, and it has been increasing its purchases of Iranian crude in 2019, reaching over seven hundred thousand barrels per day this month. In the past, China attempted to circumvent these sanctions by purchasing Iranian crude on a barter basis or by promising to pay Tehran once sanctions are lifted. In the end, the United States and China have many bilateral issues of greater salience, so both sides will be reluctant to fight over Iran policy.
What will this additional pressure on Iran achieve?

Iran has little incentive at this point to negotiate with the Trump administration so close to the U.S. presidential election cycle. Iran has a policy it calls strategic patience, which is simply waiting to see if a new administration might reinstate the Iran nuclear agreement or take a less aggressive posture. The International Atomic Energy Agency maintains that Iran has continued to comply with nuclear inspections set up by the deal, which is still being honored by European signatories.

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