Economy Will Struggle with Oil Prices if Trump Cancels Iran Nuclear Deal
By May 12, we will have found out just how interesting our times are, as the oil price could trigger another economic crisis.
A saying of dubious Chinese origin states: “May you live in interesting times.” And 2018 could be a pivotal year. President Donald Trump will have decided whether to renew or scrap the Iran “5+1” nuclear deal. It’s the one that policy wonks call the Joint Comprehensive Plan of Action (JCPOA).
Apart from revealing how influential Trump’s new foreign policy, defense, and security advisors are, ditching the Iran nuclear deal would have important and direct consequences for all Americans.
This will not be one of those decisions in which the risks are limited to one country at the center of an international dispute. What happens between the United States and Iran will affect worldwide oil prices.
It will affect how much you pay when you fill up at the pump for your daily commute. And if that cost is too high, it will make everything more expensive. At the same time, production problems in Venezuela have caused a reduction in the oil supply.
Everything Is Conspiring to Boost the Oil Price
What happens with the Iran deal will determine how far inflation will reach and how the Federal Reserve reacts.
All this is because President Trump seems ready to cancel the nuclear deal that his predecessor signed in 2015. Even if Trump were to choose the terminology of “renegotiating” the deal, it would still imply a withdrawal.
Renegotiation would imply that Iran had somehow violated the terms of the agreement. But Trump himself has recognized that Iran has acted in full compliance with the JCPOA. After all, he did sign the quarterly waiver of sanctions against Iran until last January 12.
Trump Administration Has Violated the Terms of the Iran Deal
If anyone has not honored its end of the bargain, it has been Washington. Congress has imposed secondary sanctions against European banks that lend money to Iran—something that the banks are legally entitled to do under the JCPOA and European laws.
Moreover, Iran has billions of dollars in deals with European companies, which are now left in limbo because of the U.S. insistence on continuing to isolate Iran.
Yet, the effects of the isolation will have a boomerang effect. The oil price will wind up as the target of that boomerang. And it would leave the U.S. in a difficult position.
Pulling out of the Iran deal might please the Saudis and Israelis, but it would leave Russia as the undisputed master of diplomacy in the Middle East.
In addition, if Donald Trump thinks he can get more concessions from Iran in the nuclear deal, it will raise many questions about U.S. credibility in the forthcoming North Korea talks.
Moscow enjoys relations with states on both sides of the Iran spectrum. Washington does not. And such power translates to currency as the Syrian conflict could be about to enter a more pernicious phase.
Russia and Iran have managed to maintain Bashar al-Assad in power. But now, the United States and Israel (and a handful of reluctant allies in the West) appear ready to adopt punitive measures against Iran.
These will include more sanctions, of course. But there will also be more action against Iranian interests in Syria.
Lebanon, where Iranian ally Hezbollah won a decisive victory in the May 6 elections, will not be spared.
Oil Price Could Hit $80/Barrel Before Summer
Such is the context that has pushed oil prices to their highest levels since 2014. On the eve of Trump’s decision about the Iran nuclear deal, the price of oil reached higher than $70.00/barrel.
By the summer, the West Texas Intermediate (WTI) price could hit $80.00 per barrel. Yet, it could go even higher, because Trump’s Iran decision carries risks, the consequences of which are unknown.
Of course, the current oil prices solely reflect geopolitical risk. The Iranians could retaliate by contributing to that risk, blocking Saudi and other Organization of the Petroleum Exporting Countries (OPEC) oil shipments in the Hormuz Strait, as it did in the 1980s during the Iran-Iraq War.
The OPEC production quotas have little to do with the recent and dramatic escalation of the price of oil. Of course, if Trump’s Iran policy is a geopolitical boomerang, its effects on the oil price could ricochet against the Saudis.
Does Trump Have a Plan or Is He Playing Poker?
As for Iran, Trump’s calculus, if he has one, is that European companies will pull out of Iran. That will reduce Iran’s ability to develop new wells and invest in upgrading its outdated and insufficient refining capacity.
U.S. shale producers will find it ever more cost-efficient to produce at levels above $53.00 per barrel, the estimated break-even price. At $70.00–$80.00/barrel, shale becomes downright profitable. The Saudis have reason to worry about being priced out of their own market.
Moreover, there are also hedge funds, which could be contributing to driving the oil price higher and faster than the world can absorb, as “long” bets lurk.
The fund managers will be watching Syria and Iran closely to make sure they don’t get caught in a false-alarm situation.
Downsides Outweigh Any Advantages Trump Hopes to Secure
In relative terms, the oil industry does not employ many people. Outside of those few people—and the investors who have held on to their shale stocks—few will appreciate spending some $3.00 for a gallon of gasoline.
Trump has pleaded the equivalent of “the fifth” to his voters. Instead of considering the effect of his diplomatic belligerence with Iran, he has been blaming the growing oil price on OPEC.
Trump’s claim is that OPEC is keeping the price of oil “artificially very high.” (Source: “Trump blasts OPEC, says cartel is keeping oil prices ‘artificially very high’ and that ‘will not be accepted’,” CNBC, April 20, 2018.)
And then there’s inflation, which will be rearing its ugly head. The price of oil at the pump is merely the most direct way that Trump’s Iran policy will hit Americans in their pocketbooks. Higher oil prices will drive up prices for all goods and commodities.
The oil-related inflation dynamic will compel the Federal Reserve to raise interest rates much further than its chair, Jerome Powell, envisaged at the start of 2018.
Higher Interest Rates Hit Working Americans
Higher interest rates, in a financial environment dominated by debt at both the private and government levels, represent a major downside risk for the U.S. economy.
The higher inflation and higher interest rates will hit lower- and middle-class Americans hard.
Whatever gains—minimal at best—that most Americans received from the tax cuts announced last December will pale in comparison to the financial pressure they will face.
Consumption from housing to food will drop, suffocating any recovery that economists were celebrating. Simply put, rescinding the Iran nuclear deal comports a real risk of a recession for the United States.
There are additional, if less immediate, costs to the country. These costs might be classified as a massive loss of international credibility.
America’s European allies will be forced to go along with the U.S. sanctions, but there’s little chance that Trump will then be able to secure a more favorable tariff regime.
Trump’s decision to scrap the Iran deal, should it have come to that, will represent a clear position. The United States will have pleased their Israeli and Saudi allies at the expense not only of Iran, but of Europe.
China, a major importer of Iranian oil, will seek ways to put pressure on the United States the best way it knows how: the U.S. dollar. Together with Russia and Iran, China has already tried to reduce the strength of the petrodollar.
War with Iran Is the Ultimate and Very Real Risk
Since 2016, Iran has resumed its traditional role as one of the world’s top oil suppliers. The end of international sanctions, which the nuclear deal made possible, allowed Iran to become OPEC’s third-strongest producer.
China, India, and South Korea are its top customers.
Iran could try to rally some OPEC producers (Qatar could be one) to exceed quotas and put pressure on oil prices, which would reduce the incentives for U.S. shale producers.
The oil game has become far more complicated since both sides need to find an optimal equilibrium. But the United States has the most to lose.
The diplomatic fallout from the U.S. decision on the Iran nuclear deal could, apart from raising the risk of war, erode the United States’ global influence. And with it, the influence of the dollar.
Of course, repealing the Iran nuclear deal will also increase the risk of war with Iran. And such a war would probably involve Israel. Trump could find himself forced to order a large-scale deployment of troops to the Middle East.
That’s not what Trump promised his voters. Is trashing the Iran deal worth all that?