Saudi Kingdom’s role in the abolishment of Iran Nuclear Deal
George Z. Heliopoulos – Μarket Analyst
While Israel is trying its best to dominate the news coverage by the international media, escalating hostilities against Iran, the world is already preparing for the next steps. Since the beginning of April, the raids of 4/9, 4/30 and 5/9, in conjunction with the recent violent clashes at the borders with Gaza, have caused growing concerns around the world and fears for an upcoming conflict, which might cause severe complications on a much larger scale than Syria and the Middle East. Though Israel didn’t assume the responsibility for the raids against a Syrian military base on 4/30, which killed at least 11 Iranians and dozens of others and nobody has yet “claimed responsibility” for the attack, US officials told NBC News that it was indeed Israeli F-15 fighter jets that struck the base, and quite ominously, the same officials admitted that Israel appears to be preparing for open warfare with Iran and is seeking U.S. help and support. Another senior U.S. official revealed that on the list of the potentials for most likely live hostilities around the world, the battle between Israel and Iran in Syria is at the top of the list right now.
The Picture inside the Picture
Though Israel has managed to become one of the main topics for daily news with its risky behaviour, it is the Saudis that represent as much, if not a bigger, agitator for tearing up the Iran Nuclear Deal and promoting indirectly further hostilities in the Middle East, pressing an unstable equilibrium to devolve into a lethal escalation, since it is them that are truly most threatened by Iran’s return to the global economy.
Crown Prince Mohammed bin Salman’s “Vision 2030” plan will require a complete make-over of Saudi society and it will likely cost trillions. Unfortunately, the Saudis still have a big budget deficit, which it is set to shrink to a more manageable 7% of GDP this year while allowing government spending to expand by more than 5%. The only thing keeping this budget deficit moving lower is, of course, higher oil prices and last year’s breakeven point for Saudi Arabia was just $70 per barrel. But if that rises this year to $88, according to IMF analysts, this rather unexpected increase in price, is undoubtedly related with Bin Salman’s spending associated with “Vision 2030”. Now, since the implementation of the Iran Nuclear Deal (JCPOA) Iran’s oil output has risen back to its pre-sanctions level of around 3.8 million barrels per day, with new exploration and production deals signed by European, Chinese and Russian oil majors, Iranian output over the next two or three years could easily push over 4 million barrels if not closer to 5 million per day.
At the same time Saudi Arabia wants to both cut back on production and its exports to raise the price per barrel to the level it needs. So, it shouldn’t take a genius to see the incentive here to try and bribe U.S. with hundreds of billions in arms sales and promises of fighting Iran in Syria, in order to get President Trump to de-certify the JCPOA and have the deal fall apart.
It is more than obvious that the unilateral annulment of the JCPOA, the Israeli hostile actions in Syria, or even the new American embassy in Jerusalem have to do with oil. Saudi Arabia wants Iran back to less than 3 million barrels a day to support higher prices, while Israel and the U.S. want to starve the Iranian government of money, so pulling out of the deal will allow the U.S. to re-impose sanctions on Iran, cutting it out of the global banking system again. But Iran being back to pre-2012 production levels and removing the U.S. dollarfrom its oil trade, officially means that China has a different partner to buy its oil from and that supports the fledgling petroyuan system developing in Shanghai financial markets.
The China Syndrome
Unfortunately the planners of this grandiose scheme will have to face extensive loopholes as the variables could multiply. The giant Chinese petrochemical conglomerate SINOPEC is set to curb imports of Saudi Oil another 40% this month, citing inexplicable high prices from the Saudis during a time when a significant portion of SINOPEC’s refineries are down for annual maintenance and other producers are happy to offer more for less to grab market share. Last month, a UNIPEC official in Hong-Kong told Reuters, “Our refineries think these are unreasonable prices as the Saudis do not follow the pricing methodology.” Besides SINOPEC and UNIPEC, a source from two big refineries in northern Asia said they will be cutting their imports from Saudi Arabia by 10%, as oil buyers have a hard time grasping how the Kingdom is calculating the price for its most popular grade.
ARAMCO is pressing China at a time when it is clear it has other options in the oil market and no longer wants to pay for oil in dollars. Brazil’s exports to China have risen sharply and Iran’s exports to India, tangentially related, are set to double this year to nearly 400,000 barrels per day. The Saudis hope that the new American sanctions against Iran and the looming trade war between U.S. and China will support their exports, even at higher prices.
However, in addressing the underlying futility of the U.S. sanctions, the head of MENA research at MUFG Bank, Ehsan Khoman, said that China, India, Russia and Turkey will likely oppose U.S. sanctions and keep current levels of Iranian crude purchases, even if the occasional U.S. allies – including Japan and South Korea – may comply with U.S. sanctions because of concerns they could lose U.S. security umbrella against North Korea.
Meanwhile, the EU could also escape Trump’s retribution and protect its entities operating in Iran by offering non-USD denominated currencies, through institutions including European Investment Bank, or even imposing blocking regulations, which were accepted by the European Parliament but never imposed until now. “It is unclear whether the potential use of non-USD denominated finance lines will offer much protection to European entities, and thus such a move could be largely symbolic in nature”. Finally, Khoman notes that in a sign of de-escalation, the EU may not reinstate sanctions on shipping insurance, which were “critical in disrupting Iranian crude exports between 2012 and 2016”.
The Benchmark Puzzle
There are many benchmarks used in pricing oil, though the most common are BRENT, DUBAI, OPEC Reference Basket of Crudes (ORB) and West Texas Intermediate Crude Oil price (WTI). The OPEC Reference Basket of Crudes (ORB) is made up of Saharan Blend (Algeria), Girassol (Angola), Oriente (Ecuador), Zafiro (Equatorial Guinea), Rabi Light (Gabon), Iran Heavy (Islamic Republic of Iran), Basra Light (Iraq), Kuwait Export (Kuwait), Es Sider (Libya), Bonny Light (Nigeria), Qatar Marine (Qatar), Arab Light (Saudi Arabia), Murban (UAE) and Merey (Venezuela).
West Texas Intermediate Crude Oil price (WTI) has been a famous benchmark in the world. It’s largest trade volume in the paper trade market help it to be the leading benchmark in the world oil market and many commercial traders use WTI to hedge the oil price risk. However, WTI lost its world leading pricing role beginning in 2012 due to the apparent price deviation from the other two main benchmarks, i.e. BRENT and DUBAI. Although BRENT replaced WTI as the new leading benchmark since then, many market players still prefer to hedge by trading the WTI futures, though this kind of trade may incur some risk. First of all, the hedgers may not avoid their risk if the gap between BRENT and WTI becomes more volatile and secondly, hedgers may even lose more money in some severe cases of unexpected fluctuations.
On the other hand, this gap might boost American exports if it widens steadily and president Trump seems to understand its significance in reducing the huge U.S. deficit. His staunch support of the Saudis, combined with his new sanctions against Iran, is undoubtedly having a significant impact in keeping the oil price moving up and at the same time widening the spreads between the main benchmarks, especially the BRENT/WTI spread. Since this particular spread continues to widen, now over $6.40, with options rising to $7.25 for December 20th 2018, it is obvious that there is a good opportunity to combat the U.S. trade deficit with China, by offering American oil at a significantly lower price.
U.S. production keeps surging and will continue for likely the rest of 2018 and beyond, as new fracking techniques lengthen the production time of new wells, albeit at lower daily output. So, even if rig counts fall, which they show no signs of doing, U.S. shale oil output will keep rising and at a time when Brent crude output is falling. So, the BRENT/WTI spread will continue to widen if new markets aren’t opened up for U.S. shale producers.
WTI and BRENT remain two important benchmark prices for both the oil spot market, futures market and the derivative market, since in order to reduce the holding risk, many people use different kinds of financial tools to hedge. In recent years, the option of BRENT/WTI Spread is also very popular especially in the period from 2011 to 2013 due to the shale production boom in US. It is reasonable to estimate that the shale production boom is very likely to continue because of the claim of the new U.S. president Trump. This again, brings us back to the Iran Nuclear Deal being all about oil and not about bombs.