The Fuse

U.S. Policy On Iran Constrained By Venezuela

by Nick Cunningham | February 21, 2019

The waivers that the U.S. government granted to eight countries allowing them to continue to buy oil from Iran expire in May. The Trump administration has struck a determined tone, repeatedly suggesting that the leniency it showed last November will not be extended.

The goal is to knock Iran’s oil exports down to zero. Trump officials appear confident that they can pull off such a feat, despite the opposition from close U.S. allies in Europe. However, the U.S. government may be boxed in by its own policy towards Venezuela.

Iran waivers
After withdrawing from the Iran nuclear deal in May 2018, the Trump administration announced new sanctions on Iran and compelled other countries to follow along. In the ensuing months, top U.S. officials repeatedly spelled out a rigid position on sanctions and what it was aiming to achieve. “Our focus is to work with countries importing Iranian crude oil to get imports as close to zero as possible by November 4th,” U.S. Secretary of State Mike Pompeo said in July, before repeating “zero” for emphasis.

Ultimately, the Trump administration backed down as oil prices climbed to multi-year highs just ahead of the November deadline for sanctions to take effect. The oil market had tightened dramatically since the start of the year, in part because of the U.S. policy change on Iran.

However, after raising market expectations about the oil supply losses coming from Iran, the issuance of waivers to eight countries, granting them the ability to maintain imports from Iran for six months, caught the market off guard. Saudi Arabia had ramped up production in anticipation of needing to plug supply gaps. The combination resulted in a price crash.

This time around, the U.S. has once again struck a hard line. “We are going to continue our path to get to zero,” Brian Hook, the State Department’s special representative for Iran, said in a Bloomberg interview in January. “We are not looking to grant any new waivers. That’s been our policy from the beginning.” Hook boasted that the U.S. was able to knock Iran’s oil exports down to 1 million barrels per day (Mb/d) after the sanctions took effect, down from around 2.7 Mb/d in the spring of 2018.

The sudden surplus of supply in the fourth quarter of 2018 and the corresponding price crash seemingly gives the U.S. much more room to tighten the screws on Iran this time around. OPEC+ sprang into action in December to take supply offline in response to the price collapse. Since then, crude prices have rebounded by more than 30 percent, but they are still down from the highs of last October.

Nevertheless, the leeway granted to the Trump administration by the oil market downturn may quickly disappear, owing in no small part to another Trump policy: the U.S. campaign to topple the government of Venezuelan President Nicolas Maduro. The U.S. has sought quick regime change, recognizing opposition leader Juan Guaidó as the legitimate president of the country while also trying to shift Venezuelan assets abroad, including Citgo, under his control. Dozens of other countries followed the U.S. in supporting Guaidó.

The effort has arguably not been as quick or as clean as the administration may have hoped and the longer it drags out the more likely that the oil supply losses from Venezuela will mount. Sanctions on PDVSA amount to an embargo on Venezuelan oil, blocking imports into the United States. Venezuela’s shipments to the U.S. were the only major source of hard currency – Venezuelan oil exports to Russia and China are sent as repayment for past loans. To make matters worse, the U.S. government blocked the export of diluents to Venezuela, which has complicated PDVSA’s task of blending its heavy oil into an exportable product. Maduro’s government is scrambling to find buyers, but will have to heavily discount shipments. In the meantime, satellite data suggests that oil is being diverted into storage. “If none of the Venezuelan barrels that normally sail to the US could quickly find a home, Caracas would have one month of storage capacity left before having to shut in production,” data firm Kayrros wrote in a February 13 report.

Oil market tightening again
The crisis in Venezuela is very fluid and changing by the day. The impasse over the U.S.-backed aid shipments to Venezuela, and Maduro’s attempts to block entry, could provide the catalyst for the next phase of escalation.

“Without a solution to this impasse within days, we believe the country could be on a path to a fully anarchic situation that, if not rapidly tackled, could compromise the country’s economic capacity to recover,” Barclays wrote in a February 12 note. The bank’s analysts warned “the actors involved in the crisis” could “accelerate the transition process in the upcoming weeks.”

For now, data on Venezuela’s oil exports are opaque, but steep losses are highly likely. Against the backdrop of the OPEC+ cuts that have already taken effect, the oil market is now tightening up significantly. Moreover, Saudi Arabia has pledged to cut 0.5 Mb/d more than required by March. Combined, these factors could erase the market surplus entirely.

“We forecast that the oil market will move into a deficit of over 500kb/d in February and March, with the call on OPEC crude rising while output falls,” Standard Chartered analysts led by Paul Horsnell wrote in a February 19 note. “With market fears of a supply glut abating rapidly, we see the balances as supportive of Brent prices moving back above USD 70 per barrel (bbl).”

If the market shifts into a supply deficit and Brent rebounds above $70 per barrel, there would once again be very little room for the U.S. government to try to zero out Iran’s oil exports. Taking 1 Mb/d of supply offline at a time when supply is already in a deficit could send shockwaves through the market. The Trump administration has already gone after Venezuela, but that may mean it needs to punt – once again – on its “zero export” campaign in Iran.