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Macroeconomics

26 April 2019

THE US AND THE OIL MARKET 

The US just threw another big stone in the ‘oil pond’ and it’s about to create serious ripples across the globe. Instead of prolonging the waivers for imports of Iranian oil, the US has decided to let them expire on 2 May. That would mean that countries like India, China, Turkey, Greece and Italy would all face sanctions if, beyond that date, they continued to buy Iranian oil. Sanctions entail blocking US-based assets or blocking money transfers through US banks when paying in dollars. In brief, it sends a message of ‘do business with them and lose business with us.’

The aim of course is to reduce the 1.14 million barrels per day of Iranian oil exports still remaining to zero. That is not without risk in an already tightly supplied oil market. The Saudis, together with the UAE, have promised to make up the shortfall. Experts estimate both could increase by 1.5 million bpd without too many problems. However, where would that leave the supply discipline within OPEC+ if two major producers open the valves and increase supply? And with oil prices rising further on the back of the news, US shale oil producers get another good reason to ramp up production.

Obviously, the US decision has major geopolitical consequences. Will countries like China and India abide by the rules imposed on them? And what about the EU? And how will Iran react? Is the Strait of Hormuz at risk of being closed? Tensions will rise without any doubt.

There are also clear economic consequences. Rising oil prices send inflation higher. Already, inflation swaps are rising. And more expensive oil is an immediate drag on emerging countries as it carries a bigger weight on domestic prices. Generally speaking, bond yields could also rise. The question therefore is whether President Trump is sufficiently aware of the risks he’s taking regarding a slowdown in the US. In the past, the President has often lashed out at OPEC, saying oil prices were too high. Today, he’s driving prices higher himself thereby also pushing up petrol prices at the pump for his electorate. The upcoming summer driving season in the US could turn out to be a bummer.