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Macro Macchiato 29/04/19: Forget the Ides of March, What about the First of May?

I received several calls on Friday and over the weekend asking for my view on the US announcement that it intends to stand by its decision not to renew the eight-country waiver on sanctions for buying Iranian oil. Flattered as I am by these calls, my guess is as good as yours as to how the US will police the sanctions and whether any of the waiver nations will take any notice. But it’s worthwhile thinking through the situation.

First of all, what are the US motivations for rescinding the waiver? The Trump administration has a bee in its bonnet about Iran. It has ignored all the evidence presented to it suggesting that Iran has kept the terms of its agreement with the Western powers. It has not presented any evidence that Iran is not keeping to the terms of the agreement. The US beef with Iran is not legal but political. It is founded on current American policy for dealing with the Middle East, which is to support Israel and to undermine Israel’s enemies. The original purpose of the sanctions was to curtail Iran’s nuclear weapons program. The current US regime has expanded their purpose to reduce Iran’s regional influence and activities in particular in Yemen, Syria and Iraq.

Sanctions on Iran, like those on Venezuela, also help to prop up oil prices. This which supports Israel’s friend and America’s ally, Saudi Arabia, itself fighting proxy wars with Iran. Higher oil prices also benefit US oil producers and exporters. But this is not uppermost in the mind for the Trump administration.

Secondly, can the US enforce the deal? It can make life difficult for sanctions busters trading in dollars. Buyers of Iranian oil might then consider that Iran’s exports have fallen to an uncertain quantity thought to be around 1 to 2 million barrels per day (Mn bpd) of which half probably goes to China on contracts rather than spot shipments. The lost 1 Mn bpd or so can be found from other suppliers with Saudi Arabia standing by to make up the shortfall of the kind of heavy sour oil Iran exports. Some oil will always find its way out but mainstream buyers in the West in particular will probably fall into line in order to protect their other business.

The US administration’s Middle East policy and its overall credibility now rely on its ability to enforce the 1st May deadline. This means bringing China on board. There has to my knowledge been no official statement about how the US would deal with continuing Chinese purchases of Iranian oil. But the implication is clear: if China still buys Iran’s oil, the Trump administration might only be able to save face by blocking Chinese access to the US banking system. The dangers are apparent, with China being the largest overseas holder of US debt and in the middle of trade negotiations with the US.

Will Trump really put hundreds of billions of dollars of trade with China in jeopardy for the sake of hundreds of millions of dollars of China-Iran trade? That seems to be his policy. “We understand they don’t like this,” one US official told Reuters about China’s aversion to sanctions on Iran from the United States alone. “But at same time they tend to act pragmatically and they are going to take what the best most reliable deal is.”

The best, most reliable deal for China is the third and most important point to consider. China can choose to circumvent the sanctions in a number of ways. Firstly, it could effectively ignore the sanctions. It can buy Iranian oil with its own currency, ship it on its own tankers and protect its seaways with its expanding blue water navy. President Xi notably inspected China’s navy last week. Secondly, China can face the US head on. Its policy of non-interference in the pollical affairs of other nations is tested by unilateral US activity. This is a chance to use legal and diplomatic means to show the US that China is now its equal in world affairs. China has already argued that the US is bursting the boundaries of the original deal to support its own political aims in the Middle East. It has already lodged a formal protest with the US. China can use its global soft power here: for instance, America’s disaffected European partners in the Iran nuclear deal are now China’s Belt and Road Initiative partners. Maybe they can be held in check and prevented from fully supporting America’s hegemony.

Finally, China could keep its powder dry and fall into line for now as larger prizes are at stake including its trade deal with the US and more expected BRI deals as the BRI convention in Beijing wraps up. The People’s Daily mouthpiece for the Chinese government opined in an editorial on Friday that “China should oppose the hegemonic approach of the US, but it can’t take the lead in confronting the US on issues involving Iran.”

The Take Away

A day may come when China stands up to what it sees as the US hegemon. But 1st May 2019 is probably not that day. Iran makes a good show of standing up to the US, but it has to acknowledge its weak hand. Iran may leave the deal itself, it may as it has threatened block the Straits of Hormuz and plunge the world into crisis. It may accept its weak hand for now and bide its time. If this last option is the most likely, the effect on shipping should be limited. There may be a small positive tonne mile effect if Atlantic oil exports to the Far East are supported by rising prices and a thinner Dubai/WTI arbitrage. There would also be higher fuel costs to consider just as the IMO regulations loom large on the radar. But 1st May 2019 is just one more day with one more move in the Great Game of the 21st Century: who controls energy, and who controls the money that pays for it?

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