Trump's decision on May 8 to pull out of the Iran nuclear deal will have far reaching impacts. The decision has never been far from the realm of possibility but it is somewhat surprising he did not leave room for negotiating a "better deal".
Domestically Trump appears tough to his supporters and it seems the hardliners have gained the upper hand in the White House. Gasoline prices may spike short term because of deal being scuppered but his base should forgive him. If prices go too high too fast Trump might tap the Strategic Petroleum Reserve (SPR) as a gesture even though it will accomplish nothing.
With Venezuela's oil production plunging, a curtailment of 300Mb/d of Iranian oil is an additional tailwind for oil prices. Although America is acting unilaterally, U.S. extra-territorial sanctions will still cause multinationals, especially European ones, to comply because of their inability to bypass U.S. banks and U.S. dollar. However, with prolific U.S. shale production and plenty of OPEC production slack, this shortfall can be made up relatively easily. Therefore, we expect limited impact on the short term fundamentals, but a large second/third order effect from how various players respond.
1. How will Iran handle ongoing production?
Iran will likely resume its old trick during the Obama-era sanctions: storing oil in tankers and selling at a discount. China may step up its purchase from Iran because it has little to fear from the U.S.
2. How will Iran react politically?
President Rouhani, a moderate, having been an advocate for the nuclear deal, has been significantly weakened (they have politics too). Hardliners are not likely to take the new sanctions sitting down. We can expect increased regional conflicts and Iran following the North Korean path of securing nuclear weapons.
3. How will this affect the rest of Middle East?
While it is for Saudi Arabia, Turkey, and Israel, a clear political win to cripple Iran, they will also have to prepare for intensifying conflicts in Syria, Yemen, Lebanon. Increased risk of accidental miscalculations may lead to new conflicts. Russians got a boost in influence in the form of closer military coordination with Iran and economic cooperation with Saudi Arabia, at the expense of America.
4. How will North Korea react?
Actually, no big change. Kim Jung Un has already achieved their nuclear objectives for now. He also likely knows that by giving Trump good headlines he can stay out of trouble and wait him out. If anything, the unwinding of Iran deal reaffirms the importance of maintaining his nuclear options for him. Secretary of State Pompeo is heading to North Korea to sooth the tension and he is likely to succeed.
5. How will our European allies react?
High level French, German, and British lobby has failed. This is a big setback in America's traditional alliance with Europe, consistent with recent trade skirmishes, support of Brexit, and the undermining of NATO. We are signaling a return to the world order where the small fish survive at the mercy of great powers. China and Russia will seize on this to impose their world order; small countries will start to pick their protectors; Europe will lean further away from America. This is likely to negatively affect global commerce and stability in a meaningful way.
All in all, with still-robust oil demand growth forecast and heightened geopolitical risk, we see further rise in oil prices, albeit slowly. Through a few years of restraining production, OPEC and Russia have achieved sufficient inventory drawdown and held oil prices stable and provided a floor. The structural decline in oil volatility, however, owes itself to the U.S. shale plays. With their fast response time and export capabilities, shales have become a powerful swing producer that caps the world oil market. We expect oil prices to shrug off the Iran nuclear deal event and continue its march upward gradually.
Jeff Lee, CTA