Cart before the horse

Published at 13:43 13 Sep 2019 by . Last edited 15:55 13 Sep 2019.

There was sense a of panic emanating from the White House this week. First, Trump suddenly (perhaps even impulsively) fired his national security advisor John Bolton, triggering frantic speculation in the oil market that the US was about to ease sanctions on Iran. This was followed within a day by leaks to the press from a ‘senior administration official’ that the Trump administration was considering an ‘interim China deal’ that would delay and even roll back some US tariffs in exchange for Chinese commitments on agricultural purchases. Predictably, less than 10 minutes later, there was another press report quoting a ‘senior administration official’—and we would hope that it was a different official—categorically denying that the White House was considering any such deal. Risk assets reacted about as one would expect: badly.

We do feel, however, that it is premature to price in a policy shift on either Iran or China. There is no doubt that any easing of the sanctions on Iran by the US would be bearish for the crude market, and likewise we also understand that even a temporary deal between the US and China that serves to de-escalate the trade war would be bullish for the equity market, especially given the reversal seen in markets since 1 September (see E-mail alert: Risk off, risk on, 11 September 2019). But the market is putting the cart before the horse on both issues.

Keeping the diplomacy to bite-sized pieces
President Trump announced two weeks ago that the US and China would meet again in early October to resume attempts to forge a trade deal. The aim of discussions this month would be to work out an agenda for the October talks in Washington DC, setting the stage for a more modest and more manageable agreement. We have confirmed that the US and China are exploring whether they can put together a confidence-building package that will include commitments from the Chinese on agricultural purchases and will allow for the granting of some limited licenses from the US on Huawei. Nothing has been agreed yet, but this is the crux of the current discussions. Trump agreed to delay the next set of tariffs from 1 to 15 Octoberto allow these negotiations to continue. The goal is not to find a comprehensive deal that will address all the areas of concern, as that is impossible at the moment. The focus will instead be to reduce the current tensions and stop the escalation. Ultimately, if all goes well, this would culminate in a Trump-Xi meeting (again) at the Asia-Pacific Economic Cooperation (APEC) summit in Chile in mid-November. Of course, we have seen this movie before, many times.

Clearly, it is in China’s interest to have a limited agreement that skirts the thorniest issues involved, and the concept of a mini confidence-building package appeals to the Chinese leadership as it would allow the government to defer difficult choices until later this year. Clearly getting to the 70th anniversary celebrations of the founding of the People’s Republic of China in early October without a total breakdown in the economy is a high priority for the party.

We would caution that a lot of differences between China and the US still need to be overcome. In short, there is as yet very little visibility on whether the talks will succeed. Beijing’s attempt to separate trade from broader concerns around intellectual property rights and geopolitics will be a hard sell for many in the Trump administration, as evidenced by the competing headlines on this process this week. But with the lack of a clear process inside the White House, Kudlow and Navarro seem to be doing their lobbying publicly. Trump has demonstrated that he can be rather petulant when things do not go his way. There is still plenty of time for him to fire off a tweet in the coming weeks and undermine the entire process. There is no such thing as a slam dunk with this administration.

Move the pawn
In chess, the advice generally is that when you are uncertain, be cautious and ‘move the pawn’. It would seem that Trump decided to move his pawn when he fired his National Security Advisor John Bolton. Trump’s decision to fire Bolton has been a long time in the making, with the only real surprise being that it was over a disagreement on Iran that finally tipped the balance. Trump has publicly voiced his disagreements with Bolton over Venezuela, Cuba and North Korea. But ultimately it was Bolton’s obsession with regime change in, and confrontation with, Iran that led to his sacking.

Crude oil prices sold off by 2.5% on the news that Bolton had been fired, even after a very bullish set of EIA US inventory numbers. But it was ultimately a news report on 11 September that stated Trump was preparing to meet with Iranian President Rouhani at the UN General Assembly later this month that made crude sell off by another 4.5%. For many, this was the final proof that the Trump administration was getting ready to relax sanctions on Iran.

But again here, the market may be getting ahead of itself. First, it is important to keep in mind exactly why Bolton was fired and where the disagreements within the Trump administration lie. Trump is rejecting the most hawkish advice from within his administration on Iran and he understands that there is little upside to further escalation at this point. Trump not only does not want a war with Iran, but he is also very interested in a diplomatic resolution (see E-mail alert: Searching for the diplomatic off-ramp for US-Iran conflict, 11 July 2019).

Unfortunately, the price the Iranians are asking for (sanctions relief) in return for a bilateral meeting is too high. The Iranians have made it very clear that they would only agree to direct negotiations with the US if the US first commits to fully lifting sanctions. It is no secret that Trump loves a good photo op and will go to great lengths to get one. Just ask the North Koreans. However, while Bolton may be gone, other Iran hawks like Vice President Mike Pence and Secretary of State Mike Pompeo remain in the administration. Sanctions relief remains too high a price to pay for a photo op. Both Pompeo and Treasury Secretary Steven Mnuchin have stated categorically that the president is willing to meet without preconditions, a caveat that means the US will not agree to lift sanctions to facilitate a meeting.

Two roads converge
Meanwhile, the French have been trying to facilitate a meeting between the US and Iran and came close at the G7 summit last month. Trump was prepared to meet with the Iranians, but the Iranians insisted that the US remove the sanctions first. Moreover, the Iranians are refusing any bilateral discussions with the US and are demanding that any discussions with the US be on a multilateral basis and preferably within the context of the JCPOA. The market is assuming that the only obstacle to a US-Iran meeting is from the US side, but in fact Iran has its own conditions too.

The French have been working feverishly to try and keep Iran from resuming enrichment of uranium to 20% purity, which would effectively represent a complete withdrawal from the JCPOA. France’s primary objective is to keep Iran in the JCPOA. France is currently trying to negotiate an economic package involving offering Iran a line of credit facility through the end of the year, in exchange for Iran returning to full compliance with the JCPOA. The terms of this agreement have not been disclosed, but our understanding is that the credit facility would be secured against future Iranian oil revenues.

The problem for Macron is that even this credit facility would require approval from the US. Operationally, the facility would still require waivers for banking, insurance and possibly even shipping depending on how Iran intends to repay the loans. Moreover, even if the loan is secured by a country (France, for example), a private bank would still be needed to facilitate the transactions, which again would require a waiver from the US. The irony is not lost on us that while the US is trying to ‘rip up’ the JCPOA, France is presenting the credit facility in order to try and save the nuclear deal.

Somehow, these two issues—easing of sanctions in exchange for a meeting and a credit facility to keep Iran in the JCPOA—are being conflated by the market though they are separate. Iran’s escalation on the enrichment front is designed specifically to persuade the other participants in the JCPOA to convince the US to stick to the agreement, or to find suitable alternatives to the US sanctions, as the main reason Iran agreed to sign the JCPOA was to secure relief from those sanctions. And while Iran clearly understands that further enrichment could lead to even tougher economic and even military responses, it also understands that stopping its breaches of the JCPOA now without any tangible gains in return means ceding the only leverage it currently has.

But, while the US does not want war with Iran, it does not necessarily want normalisation of relations either, and Iran is not in any hurry to renegotiate the JCPOA. The market seems to be assuming that the Iranians would jump to take whatever deal is offered by the US in order to get the sanctions removed, but we do not think that would be the case. Iran clearly would like to make the pain of sanctions go away but it is not yet suffering horribly. More than anything, Iran would like to be able to run the clock out on the Trump administration and wait and see who is elected in 2020.

And for those who say that Trump is desperate for a win ahead of the elections, it is not clear to us how capitulation on sanctions could be considered a win. Trump is currently trapped in a policy of maximum pressure that he himself created. Any retreat from sanctions without reciprocal moves from Iran would be interpreted as weakness. While it is possible that Trump would be willing to simply rebrand the existing JCPOA with one or two additional commitments from the Iranians and declare victory, it is unclear how the Iran hawks in the administration or in Congress would get behind such an initiative.

Win, lose or draw
What is notable about both these tracks (Iran and China) is that policy decisions are being made clearly with an eye towards the election timetable over the next year. For Trump, a photo op with the Iranians ahead of the elections is about trying to have something to show on the foreign policy front ahead of the elections. He would like nothing more than to fulfil a campaign promise—any promise—and deliver a renegotiated Iran deal on the campaign trail. Clearly Trump doesn’t want a war ahead of the elections, but are those left in his administration deft enough to start a diplomatic process with Iran ahead of the elections? We remain skeptical. In fact, as things stand, there could very well be more scope for movement on the China front than on Iran in the coming weeks.

The Outlook
Brent: Crude structure continues to tighten as benchmark spreads Brent and Dubai hover on either side of $1 per barrel backwardation and, in the case of Brent, despite continued strong US crude exports. Brent-Dubai remains well supported too. The OPEC Joint Ministerial Monitoring Committee met this week and agreed no new cuts in production were needed and that what is required is simply a renewed emphasis on compliance as Nigeria, Iraq and Russia continued to produce above their quotas. The new Saudi energy minister Prince Abdulaziz bin Salman (AbS) pegged October Saudi production at 9.89 mb/d and expects that level to be maintained through the end of the year and until the group meets in December in Vienna to discuss output plans for 2020. He also noted that Saudi crude exports should hover around 7 mb/d for the balance of 2019. The commitment to 7 mb/d exports for November would be very meaningful indeed. First, in H1 19, Saudi total exports more or less matched H1 18, averaging only 0.15 mb/d lower on average. However, if Saudi exports average only 7 mb/d in H2 19, that would represent a 1.24 mb/d y/y decline in November. On average, H2 19 volumes we expect to average 0.6 mb/d lower than H2 18.

Fig 1: Saudi crude exports, y/y mb/d Fig 2: US crude exports, mb/d
Note: H2 19 based on 7 mb/d export estimate
Source: Kpler, Jodi, Energy Aspects

Source: EIA, Energy Aspects

: US crude and principal product inventories continue to draw at faster rates than the five-year average. The crude surplus to last year stood at close to 55 mb in early June and is now just under 20 mb, with more draws expected this year. A combination of higher exports (3.3 mb/d) and a w/w increase in runs of roughly 0.11 mb/d helped push crude stocks lower. Crude, gasoline and distillate stocks combined are just slightly above last year’s levels. Notably, imports from Saudi Arabia remain at historical lows, and with the Kingdom set to maintain current exports levels through the end of the year, exports to the US are unlikely to go up from here. Currently, Saudi exports to the US are 0.57 mb/d lower y/y. US crude stocks surged in Q4 18, which also coincided with an increase in Saudi exports to the US. With runs expected to continue moving higher (hurricanes not withstanding), crude exports also expected to rise, and US crude production growing but more stably, we do not expect to see in Q4 19 a repeat of the stock surge seen in Q4 18.

Fig 3: Crude+gasoline+distillate inventory, mb Fig 4: US crude runs, four-week avg, mb/d
Source: EIA, Energy Aspects Source: EIA, Energy Aspects


Yasser Elguindi, Market Strategist
+1 646 760 8100 (direct)

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