Last April, Iran exported about 2.5 million barrels of oil per day (mbpd) before President Donald Trump decided to withdraw from the nuclear deal with Tehran.
Sanctions were then placed on Iran, but following great opposition from Iran's key customers, namely China and India, the U.S. granted "waivers" to allow some exports of Iranian crude.
By this March, Iranian exports had already fallen to about 1 mbpd. The deadline for the waivers was May, 2018. This morning -- April 22 -- the U.S. declared it would not grant an extension of those waivers.
If the U.S. forges ahead and China and India both comply, it could potentially take about 700,000 to 1 million bpd of oil out of the market!
Brent Oil rose nearly $2.5/bbl. Monday morning on this news, with world markets rattled on the risk of an oil shortage given importance of Iran's role. Meanwhile the U.S., Saudi Arabia and UAE have promised to ramp up production to make up for any shortfall.
Let's reassess the situation. In December last year, OPEC/OPEC+ agreed to take about 1.2-1.5 mbpd of oil out of the market given the price collapse and glut in the market.
The main responsibility of the cuts was to fall on Saudi Arabia and Russia. Russia still has not met its quota and undercut so far. Saudi Arabia has cut much more than its quota and is mostly responsible for the majority of the cuts.
However, if Iran were to lose, say, 1 mbpd of oil, this amount can easily be met by Saudi Arabia. So, there is not shortage per se, it is just a matter of a redistributing who would be "allowed" to sell their oil.
If traders remember not too long ago, Trump accused OPEC (by default Saudi Arabia) of taking too much oil out of the market as Brent threatened $70/bbl. Going into re-election, Trump cannot afford to have angry voters staring at higher gasoline prices at the pump.
Similarly, Saudi Arabia could not pump more, even if they wanted to. The Saudis were losing out given higher prices, and they feared collapsing the oil price. Let's not forget the U.S. shale breakeven price is about $45-50/bbl., but Saudi Arabia's is closer to $75/bbl.+.
How else to appease their ally, keep the oil market balanced, and put pressure on their biggest nemesis, Iran? Seems like a zero-sum game.
Needless to say, there is no shortage of oil. Also, there is nothing to guarantee that all 1 mbpd of Iranian exports go to zero! Why? Well, three of the eight countries granted the 180-day waivers back in November -- Greece, Italy, and Taiwan -- have already reduced their imports to zero. And South Korea and Japan also are not as dependent on Iranian oil as they have found options.
That leaves China, India, and Turkey. We all know where these three countries fit on the U.S. foreign policy spectrum. China has been extremely vocal about the U.S. stepping outside of its jurisdiction to impose these sanctions in the first place. Anyone remember the trade talks that have been "progressing very well" and "close to reaching an agreement?" It is good to know the market is priced to perfection assuming all is hunky dory with U.S. and China as besties.
To summarize, we are exiting the peak winter heating oil season, when typically demand for crude drops in May just before gasoline season starts in June. Assuming worst-case scenario if Iran were to lose all 1 million bpd of oil, that shortfall can easily be met by the remaining members of OPEC+.
These waivers could potentially be in place for another year before being cancelled altogether. All in all, the oil market and its very temperamental traders have gotten a bit ahead of themselves.
The price of oil is more than fairly valued. If Iran were to close the strait of Hormuz, it could potentially cause a geopolitical crisis. One thing is certain: Equities in general are priced for perfection with no risks priced in, whether it is oil prices being toppy or demand falling off given the geopolitical and economic implications.
If there is any delay in U.S./Chinese trade deal, it goes without saying the S&P 500 could easily test its December lows.