Trump move to benefit Riyadh most

Saudi Arabia seems to be the biggest beneficiary after US President Trump decided to walk away from Iranian nuclear deal and to re-impose sanctions on Iran. The quick embrace of Trump's announcement reflects a sense of vindication by Saudi Arabia and UAE, which have pushed President Trump to take seriously Tehran's ballistic missile programme and support for militant groups. Saudi Arabia has been condemning that Iran used economic gains from the lifting of sanctions to continue its activities to destabilise the region, particularly by developing ballistic missiles and supporting terrorist groups in the region.

Saudi Arabia now enjoys a double-whammy windfall as crude oil prices may remain strong and state producer Saudi Aramco will also likely to be able to pump more oil to replace any Iranian barrels lost because of the re-imposed sanctions. Moreover, the customers who shifted to Iran for their crude purchase, such as world’s top importer China will be forced to buy from the kingdom at higher prices. This would allow the Saudis to regain market share lost since the 2016 deal between OPEC and allies, such as Russia, to reduce output in order to tighten global oil markets.

Meanwhile, Saudi Arabia’s financial position has stabilised as a result of the increase in oil prices as well as efforts to raise non-oil revenues and trim government spending. The kingdom’s foreign reserves stood at $493 billion at the end of March 2018 and have been basically stable for eight months after declining steadily for nearly three years. The rise in oil revenues has provided much-needed fiscal breathing room and the IMF has encouraged the government to slow the pace of tax increases and spending cuts. IMF in its report argued that Saudi Arabia still needs oil trading at $88 per barrel to balance its budget and pull off the structural reforms the country needs.

Saudi Arabia wants Iran back to less than 3 million barrels a day to support higher prices. Israel and the US want to starve the Iranian government of money, so pulling out of the deal will allow the US to reimpose sanctions on Iran, cutting it out of the global banking system again. Saudi Arabia has already indicated that it could raise its oil output to offset any potential supply shortage as a result of new sanctions on Tehran, after US President Donald Trump said Washington was withdrawing from the Iran nuclear deal.

However, despite all pugnacity, not much is likely to happen for several months. US Treasury Department has indicated that sanctions won't be re-imposed immediately, rather that it will take up to 180 days to allow Iranian oil customers and other companies involved in doing business with Tehran to make plans. It's also not clear what sanctions will be re-imposed and in what form, with the main risk being the so-called secondary sanctions that would target companies that do business with other entities involved with Iran. Investors are speculating the amount of crude that will be wiped out and it is estimated that approximately 2,00,000-5,00,000 bpd are currently at risk.

In addition, crude exports from US also have the capacity to increase as higher prices provide incentives to Shale producers to drill more wells. It also remains uncertain as to how buyers of Iranian crude will respond to the US decision. Virtually all of them, from Europe to Asia, vehemently disagree with Trump's move. We believe that Europe, Russia and China would continue the deal with Iran, leaving US isolated and weakened in handling challenges like North Korea.

Meanwhile, US government has boosted its forecast for domestic crude output both this year. Next year, crude production is seen averaging 11.86 MMbpd, up from a prior forecast of 11.44 MMbpd. Domestic output will average 10.72 MMbpd this year, still above the 1970 record of 9.6 MMbpd and raised from a 10.69-MMbpd forecast in an April report.

China's imports from Iran were 655,000 bpd in first quarter, up 17.4 per cent from same period in 2017 and enough to make Iran the sixth-biggest supplier. China imported 1.1 million bpd from Saudi Arabia in the first quarter, down 5.7 per cent, making Kingdom the second biggest supplier behind Russia. India, Asia's second-biggest crude importer, brought in 522,700 bpd of Iranian crude in first quarter, down 8.8 per cent from same period last year. The South Asian nation's imports from Saudi Arabia were up 1.9 per cent to about 811,000 bpd, but the big mover was imports from Iraq, up a massive 45 per cent to 1.13 million bpd.

While both India and China have scope to lower their imports from Iran, they will likely be reluctant, especially given the ongoing dispute over pricing between China's top refiner Sinopec and Saudi Arabia. Meanwhile, Sinopec, Asia's largest refiner, plans to cut volume of Saudi crude oil it loads in June by 40 per cent for a second month, after the price of the kingdom's key grade rose to a near four-year high. Sinopec has also cut crude imports from Angola and Russia in the first quarter, probably because they were also overpriced. In contrast, Sinopec increased crude imports from US, Brazil, Colombia and Iran.

The main risk for the Saudis is that the US decision inflames an already tense situation in the Middle East, resulting in increased conflict and even the possibility of outright war. Iranian Prime Minister Rouhani also ordered country's atomic industry organisation to be fully prepared for subsequent measures if needed in case of need to start their industrial enrichment without limitations.

Despite the US pulling out of the Iran deal and secondary sanctions getting reintroduced, the impact on the oil market may not be immediate and potentially not as large as the 1 mb/d of lost exports in 2012-2015, although there again, uncertainty remains high.

n First, a unilateral exit by the US would not lead to reintroduction of UN and European sanctions (with the former instead requiring evidence of violation by Iran be presented to the UN Security Council). As a result, some European refiners may decide not to stop importing Iranian crude if their exposure to the US is negligible (the EU accounts for 25 per cent of Iran’s 2.6 mb/d crude exports).

n Second, key to the global oil market will be whether displaced European exports end up simply redirected to India and China to replace declining Venezuela production, with India recently indicating its desire to increase imports from Iran.

n Third, secondary sanctions may not have immediate impact on the oil market as they historically offered exemptions and a phase-in period and only required that countries reduce Iranian crude imports by 20 per cent every 180 days.

Given the current environment, we could experience volatility in the oil market in the near term. We are in a situation where geopolitical premium is overshadowing the fundamentals of crude oil and driving prices higher. The extent to which US sanctions would impact Iranian oil exports remains to be seen. Although the markets were expecting such an action and had been factoring the same into oil prices, more upside from current levels cannot be ruled out. Over the medium term WTI crude oil could find support at $67-65 range and could extend the current rally towards 74-76 zone.

                        —Motilal Oswal