U.S. has recently claimed that it wants to wipe all the Iranian oil from the global market to reduce the Islamic country’s oil revenues to zero, a plan which seems rather like a ‘Trump fantasy’ than a well-thought government-level program.

When the U.S. President Donald Trump abandoned Iran’s nuclear deal on May 8, he offered a 180-day window to non-U.S. persons to quit activities involving Iran before a new round of sanctions on Iran starts.
Since Trump’s announcement the oil market has been through so many ups and downs with the worried traders constantly exposed to a ‘war of words’ between the involved parties.
These days, the most important issue among the oil traders is estimating the magnitude of the effect of U.S. sanctions on Iranian oil exports. Will the U.S. ‘really’ succeed in eliminating all the Iranian oil exports?

‘Zero Iranian oil’

In a nutshell, The United States is aiming to cut all Iran’s crude oil exports, starting from November. In doing so, the U.S. expects its allies like Saudi Arabia and other OPEC and non-OPEC members to use their spare capacity to fill the supply gap.

“We are working to minimize disruptions to the global market, but we are confident that there is sufficient global spare oil production capacity,” Reuters quoted Brian Hook, the U.S. director of policy planning as saying on July 2.

But to what extent this goal is reachable in reality and how practical this strategy is? There are two main aspects to be considered for a clear understanding of the extent of ‘practicality’ for this plan. The first aspect concerns the export destinations of the Iranian crude oil, will they all comply with the U.S. imposition, despite their own national interests?

Case of Iranian oil buyers

Iran is currently exporting oil to several Asian and European countries, with more than 60 percent of the shipments heading to Asian buyers like China, India, Japan and South Korea and the rest going to European countries including Turkey, Italy, Greece, France and Spain.

First of all, as Iran’s top oil importer, China plays a very significant role in the whole situation, the country is in the midst of a trade war with the U.S. and has threatened to increase tariffs on U.S. oil shipment to the Asian country, a move, which according to many energy analysts, could push Chinese refineries further toward Iran for securing their feedstock.
Considering the situation with the U.S., it is safe to say that the country will most certainly oppose the U.S. decision and not only continue taking in the current levels of Iranian crude but also there is chance that under a yuan-rial payment agreement, more Chinese refineries lean toward Iran amid the trade war with the U.S.

Among other Asian customers, Japan has already plead for a waiver to continue imports of Iranian crude.  On the other hand, worried about losing the convenience of Iranian crude imports, India is also not happy about the U.S. actions. Indian Energy Minister Dharmendra Pradhan said India sees the U.S. sanctions on Iran as a ‘challenge’ and will take a ‘considered and comprehensive’ view based on ‘national interest’, Hindustan times reported. According to Indian news agencies, India is also considering a rupee-rial payment strategy to withstand the U.S. sanctions.

Overall, considering all the aspects, the most likely outcome would be that Asians, as Iran’s main oil importers, will seek ways to keep Iranian oil flowing.
“Asian buyers could resort to using currencies other than the dollar to pay Iran for their oil purchases. Payments may be routed through either local or foreign banks that don’t have close ties to America,” Goldman wrote in a report on the matter.

Following Trump’s announcement, the EU has vowed to uphold the Iran nuclear accord and since then the three European signatories namely France, Germany and UK have been trying to find the best solution to persuade Iran for staying in the nuclear accord (known as JCPOA). Iran has also announced that it will remain in the deal provided that the country’s interests are guaranteed.

So considering the support of the deal signatories in place, it seems obvious that European customers of Iranian crude will most likely continue to do so in the future, but of course if they are granted waivers.

Case of supply and demand

So far we discussed how much the U.S. plan for zeroing Iranian crude oil revenues is close to reality considering the position of Iranian oil buyers, now the second and more important aspect to take into account is the global oil market’s supply and demand situation.

With all the OPEC efforts for pushing the prices up, the oil market is already going through a tight state and if U.S. succeeds in removing the whole 2.4 million barrels of Iranian oil from the market, this would, in Reuters words, “leave the global market tighter than at any time since the oil shocks of 1973/74 and 1979/80”.

Although quite unlikely, but the situation also begs the question of “where all this oil is going to be supplied from?”

According to a report by the International Energy Agency (IEA) published in June, OPEC and non-member nations all together had about 3.7 million barrels per day (bpd) of spare capacity at the end of May.

The OPEC’s spare capacity is mostly accounted by Saudi Arabia followed by Iraq, United Arab Emirates and Kuwait while Russia accounted for almost all of the non-OPEC spare capacity.

However, it should be noted that despite IEA report, the real spare capacity that OPEC and non-OPEC nations hold is much less than what comes on paper.

For instance, in Iraq thousands of people are currently protesting for their right for being employed by oil companies. As reported by several news agencies the protesters have threatened to ‘paralyze’ oil production if the hundreds of companies running the oil fields fail to employ them.

UAE and Kuwait, too, hold quite a small amount of spare capacity [if any in reality] compared to what is needed to offset Iranian oil in the market.

The IEA data implies that most of the Iranian oil [which is going to be cut!] is expected to be offset by Saudi oil. That means the Arab nation is required to ramp up its current 10.5 million bpd output to over 12.5 million bpd to completely offset Iranian crude shipments to the market.

It is interesting to note that, as reported by Reuters, according to the U.S. Energy Information Administration, “Saudi Arabia has not produced more than 10.42 million bpd on an annual basis (2016) or 10.63 million bpd in a single month (July 2016) in the last 20 years.”

Furthermore, the kingdom has already increased output to compensate the losses in Libya, Angola and Venezuela, which means the nation has already used some of its spare capacity.

It should also be noted that maximizing production is not a simple affair which can be quickly achieved, and even if Saudi Arabia hypothetically does so, maintaining that maximum for a long period of time won’t be an easy task for them.

The inevitable increase in domestic consumption in a country which is seeking a separation from an oil-dependent economy in long-term is yet another factor which teases the illusion of “Saudi is going to offset Iranian oil”!

Considering the geopolitical and economic factors which are entangled to shape the current global oil market, the U.S. will most probably have to back down on its “zero tolerance” policy towards Iran.

The supply gap in the oil market would be too large for any country to be able to fill and eliminating Iran exports in this tight market would push prices to unimaginable highs, creating a mess which Trump administration will be the first to cry from.