Oil price rise poses challenge for sanctions policy

The United States and Saudi Arabia seem to have an understanding to keep the oil market well supplied and avoid a significant price rise after the US re-imposition of sanctions on Iran.

But exactly what this involves is not clear to the market, and may not even be clear to the two governments themselves, sowing uncertainty in the weeks ahead.

“We have had various conversations with various parties about different parties that would be willing to increase oil supply to offset [the impact of sanctions]” US Treasury Secretary Steven Mnuchin told reporters on May 8.

My expectation is not that oil prices go higher. To a certain extent some of this was already in the market, on oil prices

Mnuchin added.

He declined to name the countries or companies involved but since Saudi Arabia holds most of the world’s spare production capacity it is likely to have been included.

In retrospect, the US president’s April 20 tweet blaming OPEC for high oil prices can be seen as part of the negotiating.

The basic bargain appears to be that the United States will impose tough sanctions that curb Iran’s oil exports and in return Saudi Arabia will avoid a damaging and politically controversial spike in prices.

Read: US president slams cartel OPEC over high oil prices

Saudi Arabia appeared to confirm the existence of an understanding by committing to maintain “the stability of oil markets” and more specifically to “mitigate the impact of any potential supply shortages”.

The kingdom committed to “work with major producers within and outside OPEC as well as major consumers” to limit the impact from possible supply disruptions.

The comments were made in an unusual statement issued by the kingdom’s ministry of energy and carried by the official news agency shortly after the sanctions were announced.

They were subsequently confirmed by the energy minister in a statement on Twitter and in briefings with news organisations.

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While the existence of an understanding seems fairly well confirmed, its content remains a mystery.

Neither Saudi Arabia nor the United States have indicated a specific price level that would trigger a production increase, and the kingdom has declined to give a specific commitment to replace any fall in Iranian oil exports now or in the future.

Instead, Saudi sources have briefed the media to say the kingdom would not act alone to increase production and intends to consult with other OPEC and non-OPEC members.

OPEC sources have indicated the organisation has up to 180 days, until the end of the sanctions phase-in period, before needing to decide whether to increase output elsewhere to compensate for Iran.

The safest thing for OPEC may be to leave output unchanged in the near term and monitor the situation.

In the past, Saudi Arabia has usually been slow to raise production in response to rising prices, preferring the extra revenue to using spare capacity to put a lid on prices.

But in a market like oil, traders will respond to the prospect of supply curbs in future by driving up the price now.

So if Saudi Arabia and its allies stall, the market will reach its own judgement about the impact on the supply-demand balance.

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The United States and Saudi Arabia may have reached a detailed agreement on how to handle the prospective reduction of Iranian oil exports and its impact on oil prices.

But it is also possible that they have reached nothing more than a vague high-level political consensus or “gentleman’s agreement” and plan to improvise. If so, that leaves plenty of room for misunderstandings and uncertainty.

The recent rise in crude oil prices will very likely push average US gasoline prices above the psychologically important threshold of $3 per gallon next week, for the first time since 2014.

And if prices continue to escalate, they could become a political issue in the United States ahead of congressional elections in November.

Neither the Trump administration nor Saudi Arabia will want to be blamed for driving oil prices significantly higher.

The US president has already said that oil prices are “artificially very high” and this “will not be accepted”, while Saudi Arabia has been trying to push prices higher, and resisting calls for it to ease production curbs.

Saudi officials have said that the market can absorb higher prices, though they do not want them to rise too much. But there is a lot of uncertainty about how much is “too much”.

In the end, Saudi Arabia and the United States may have differing views about what would constitute an unacceptable spike in prices in response to sanctions.

Whatever they may want, benchmark Brent futures prices have risen by almost $4 per barrel or 5 percent over the last week, and more than $6 or 9 percent higher over the last month, and are still trending higher.

The views expressed in this article belong to the author and do not necessarily reflect the editorial policy of Middle East Monitor.