Abu Dhabi, UAESunday 22 September 2019

How the US war of attrition with Iran is playing out on the oil market

Refiners and financial institutions are too entwined with the US to ignore or work round American sanctions

President Donald Trump and America wield significant power in the global oil market. Bloomberg
President Donald Trump and America wield significant power in the global oil market. Bloomberg

“The best strategy is always to be very strong, first generally, then at the decisive point,” as the 19th Century Prussian military thinker Carl von Clausewitz observed.

In the US-Iran oil confrontation, four powers really matter. Each have their strengths and weaknesses, but is any strong enough for a decisive victory?

The struggle between the US and its oil-exporting Gulf Arab allies on one side, Iran on the other, its key customer China and various other concerned players is waged on numerous battlegrounds: diplomatic; cyber; covert; and (albeit not head-on) military. The oil economy has emerged for now as the American arena of choice.

The US is, of course, the strongest in this contest and it has devoted an unusual amount of attention to it. Even a decade ago, waging the fight in the oil market, an American Achilles’ heel, would have been a strange and losing strategy. But under president Barack Obama and now Donald Trump, swelling domestic production has given the confidence to target directly the oil industries of opponents: Iran; Venezuela; and Russia.

This approach has its limitations. Despite an astonishing economic collapse in Venezuela, mostly self-inflicted but worsened by American sanctions, Washington’s favoured presidential contender Juan Guaido has not secured power and his attempted coup last week seems to have fizzled out. Sanctions can inflict pain and economic damage, perhaps change behaviour, but not overthrow regimes.

Trying to take out Venezuela and Iran simultaneously tightens the oil market. Additional upsets in Libya or a less expected area such as Algeria or Nigeria could exceed available spare capacity. The US production will expand with higher prices but cannot switch on and off at command like a true strategic producer.

Its predominantly very light crude is not a good replacement for diesel-rich medium-heavy barrels, like those from these two countries. This issue may become more acute at the end of this year when as much as 1 million barrels of diesel may be required worldwide to meet new shipping fuel regulations.

Most seriously, for the US and Mr Trump, domestic politics comes first. Reliably Republican Texas, Oklahoma, North Dakota and Alaska like higher oil prices, but motorists in mid-western swing states do not. The policy of “maximum pressure” needs a safety valve.

So the US has relied on the major Gulf oil producers, Saudi Arabia, the UAE and Kuwait, to make up any deficit. Riyadh could add 1.2 million barrels per day by returning to late 2018 levels of output, the UAE 0.25 million bpd, and the Saudi-Kuwait neutral zone would contribute about 0.5 million bpd once differences which have closed down output are resolved.

These countries have continued to build on their key strength. Saudi Arabia’s plans for gas and renewable energy would free up more crude for export. Adnoc plans to increase its official output capacity from 3.5 million bpd to 4 million bpd next year.

They are also solidifying their ability to serve customers in the event of Iran’s threatened action against the Strait of Hormuz. Adnoc is building 42 million barrels of strategic storage at Fujairah, outside the Strait, and Aramco is expanding its bypass pipeline to the Red Sea.

Agreements on oil exploration and development concessions, overseas refineries and strategic storage bind in important countries, including China, India, France and Italy, and reassure them of continued supplies.

But Riyadh and Abu Dhabi will consult their own interests. Although supportive of the campaign against Iran, they will want to see tangible evidence of shortage before filling the gap, even at the risk of a spike in prices.

Iran, meanwhile, strengthened its oil industry in some ways before the US abandoned the nuclear deal, but it failed to seize the opportunity of tying in important partners with development contracts or gas exports. Its budget is much less dependent on oil than that of other petro-states but most of its exports are still petroleum, along with petrochemicals which the US now seeks to limit.

Disguised oil sales help keep the economy afloat but the US has largely won the first sanctions battle. Withdrawing from Opec or exploiting trouble in Iraq could shift the focus.

Tehran will have to lean heavily on Beijing as its remaining reliable buyer, while concerned that it might be sacrificed to a trade pact with Washington. China, meanwhile, must weigh a perhaps ephemeral deal with the Trump administration against a reliable supply of discounted oil.

Three other players should not be neglected but are not capable of playing a decisive role in oil. Europe is diplomatically vital for the future of the nuclear deal. But its refiners and financial institutions are too entwined with the US to ignore or work round American sanctions. India has faced practical problems in continuing to buy Iranian oil and has not leveraged its role as a potential Asian counterweight to China.

Russia has numerous cards to play outside the oil sector but, within it, Moscow has to weigh blunting US sanctions that are applied against it, keeping competing oil off the market, maintaining ground-breaking cooperation with Opec, and sustaining its important ally in Tehran.

The Trump administration has chosen a war of attrition, but its impatience and perhaps limited tenure may undercut it. The Islamic Republic will regard mere survival as a form of victory, and if it strikes back, it will be on another front. This struggle can be waged on the oilfields, but not won there.

Robin M Mills is CEO of Qamar Energy, and author of The Myth of the Oil Crisis

Updated: May 5, 2019 01:16 PM

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