Years ago, Wanda Jablonski, the famous energy journalist and newsletter publisher, gave me an important piece of professional advice. Be careful how many conflicts you take on at one time.
Wanda’s admonition was intended to instruct me about how to be effective within the complex oil politics of the Middle East. But lately, I have been reminded of her wise counsel as I read the news. The Trump administration should heed her words in deliberating on the vast array of trade and oil sanctions issues that need to be considered by the White House. While it is true that chances are any individual policy that could affect oil and gas trade can be accommodated easily by markets, it could be a different calculation to impose multiple policies all at once. Oil markets are watching closely all of the various energy related trade and sanctions policies on the table. Right now, any tightening of oil sanctions against Iran are viewed as the most impactful upside market risk, with the U.S.-China trade war swinging sentiment in the opposite direction.
U.S. oil and gas exports are on the rise and that has been good for the United States geopolitically. U.S. energy exports help promote American influence while at the same time reducing the U.S. trade deficit. So far this year, U.S. energy exports have exceeded expectations and that is paving the way for some beneficial outcomes. Besides serving as a bulwark against Russian manipulation and Mideast supply disruptions, greater availability of U.S. oil and gas could make it easier to convince European countries they can afford to agree to renewed sanctions on Iran. They also up the pressure on Russia’s oligarchs by potentially shrinking the pie they have to split. One could even argue that rising U.S. shale production is playing a role in convincing Saudi Arabia’s new leaders to institute needed social and economic reforms by creating uncertainty about long run oil prices.
In another example, high U.S. oil refinery exports are replacing lost Venezuelan refined products. This could pave the way for United States regional diplomacy, should it make greater efforts, to gain more support within the Organization of American States (OAS) to isolate the Maduro government, which is no longer in a position to provide finance or free oil to Caribbean and Central American countries. Right now, OAS Secretary General Luis Almagro has expressed support for a case against Venezuela’s leader Nicolas Maduro for “crimes against humanity” before the international criminal court in the Hague. Perhaps in time, as the lingering effect of Venezuela’s defunct Petrocaribe oil aid program fades however, OAS could be able to reach a majority decision to declare foul on Venezuela’s actions to dismantle its democracy and thereby strengthen diplomatic pressure on Caracas.
The United States should add stronger diplomatic effort in this direction, before it resorts to unilateral oil sanctions on Venezuela. Banning sales of U.S. tight oil to Venezuela should be used as a last resort measure only. That’s because the whole concept of U.S. energy “dominance” is based on the diplomatic gain that comes from the U.S. reputation as a pivotal free market oil and gas supplier that would never cut off another nation. Albeit Venezuela could be considered a situation that is sui generis given the humanitarian suffering of the Venezuelan people, but some international backing from OAS or the United Nations would give the United States better standing with other buyers for imposing restrictions on U.S. tight oil exports to Caracas. The United States is well positioned to leverage that fact that U.S. exports of refined products are supplying Latin America and the Caribbean in the face of the decimation of the Venezuelan refining industry, which was rumored last month to be about to indefinitely shutter three of the country’s four largest refinery complexes.
In addition to mooting sanctions against Venezuela, the United States is due in May to decide whether to take steps that would effectively re-impose oil sanctions against Iran. During his visit to Washington, Saudi Crown Prince Mohammed bin Salman lobbied the Trump administration to reopen the Iranian nuclear deal and pressure Iran for better terms that would ensure Iran never obtains nuclear weapons, rather than the announced terms which reduces the number of Iran’s centrifuges and limit the level of uranium enrichment to 3.67 percent, far below weapons grade, for 15 years. Under the deal, Iran is tasked to remove the core of its heavy-water reactor at Arak, capable of producing spent fuel that can yield plutonium. The Saudi crown prince told the New York Times that “Delaying it and watching them getting that bomb, that means you are waiting for the bullet to reach your head.”
Last month, European leaders were sounding out the possibility that fresh sanctions be imposed on Iran aimed to moderate the country’s ballistic missile program and its role in regional conflicts in a manner they hope would maintain the Iran nuclear deal. Saudi Arabia is likely to oppose that approach and the Saudi diplomatic strategy regarding Iran could press the kingdom to offer to replace Iranian oil that would be lost to buyers during any re-imposition of oil sanctions against Iran. Iran has had increased difficulty marketing its oil in recent weeks, offering additional discounts to sway buyers who are worried about the effects of future sanctions policy. European companies are considering contingency plans, and Japan reportedly curtailed its oil imports from Iran in March.
Any U.S. moves on Iran will have to be taken in the context of the desire to take similar moves against Venezuela, which like Iran exports heavy crude oil (in contrast with rising U.S. production, which is of a different lighter quality). The U.S. strategic petroleum reserve has some heavy crude oil stored in its caverns. Worst comes to worst, a loan to a particular U.S. refiner hard hit by sanctions could be made.
The U.S.-China trade negotiations are yet another backdrop to U.S. energy issues to consider. As a recent Citi brief to clients notes on the latter, it is “clear that energy specific trade with China continues to improve in the U.S. favor.” The bank’s rough estimate is that the U.S.-China net oil export balance rose from +$2.8 billion in 2016 to +$8.2 billion last year and could reach $11 billion in 2018 if January trends can be sustained. This trade has implications for the direction of the U.S.-China trade balance that will need to be kept in mind by the Trump trade team.
But the complexities go beyond oil, U.S. exports of liquefied natural gas (LNG) are also finding a profitable opportunity window in the global market based on higher than anticipated demand from China, South Korea, and Taiwan, aided by economic growth and new policies aimed to reduce coal use and fight air pollution across Asia.
As it accelerated its policies to promote coal-to-gas switching, China’s LNG imports rose almost 50 percent in 2017 and have continued to be strong this winter, including purchases of six cargoes via the U.S. LNG export terminal at Sabine Pass. South Korea surpassed Mexico as the largest buyer of U.S. LNG in the first quarter of 2018, and a boost in the long run appetite from South Korea for LNG is expected, given President Moon Jae-in’s pledge to curb use of coal and nuclear in favor of cleaner, cheaper renewables and natural gas.
In other words, growing U.S. LNG exports intersect with several ongoing trade negotiations, namely with China, Mexico, and South Korea. S&P Global Platts is forecasting U.S. LNG exports to increase by 8.1 billion cubic feet per day (bcf/d) by 2020 and another 4.9 bcf/d by 2025, a factor that needs to be considered in trade negotiations. Sales to Mexico are particularly important for the Permian Basin, where excess natural gas is already being flared at high levels.
China’s threat to impose a 25 percent additional tariff on U.S. propane (which is an important component of the liquefied petroleum gas or LPG used in Asia as a residential heating and cooking fuel and as a feedstock to China’s growing petrochemical industry) won’t affect U.S. propane producers all that much. That’s because the largely fungible commodity will be sold elsewhere, with rising supply from Iran and Australia likely to replace the U.S. LPG in China, along with other Middle East supplies. As that shift takes place, U.S. sellers will shift to non-Chinese buyers.
The bottom line is that markets will likely still rebalance in the wake of turmoil created in the coming weeks from any disruptive new trade and sanctions policies, leaving it a little less clear whether prices are facing headwinds or tailwinds. For U.S. energy dominance, it could also be a mixed bag, with commercial availability of U.S. oil and gas only part of the equation. As the upcoming events could show, even fully free market oriented production can face a geopolitical context in a world in disarray.