Iran Launches Drills Near World’s Crucial Oil Chokepoint As U.S. Readies To Reimpose Sanctions

Farid Hajili Analysis 27 September 2018
Iran Launches Drills Near World’s Crucial Oil Chokepoint As U.S. Readies To Reimpose Sanctions

Sanctions will be re-imposed on Iran's oil industry on November 4. The move comes after U.S. President Donald Trump decided to withdraw his country from the 2015 nuclear deal in May. The U.S. has said that countries or companies that conduct transactions with Iran are also liable to face secondary sanctions.

When the oil sanctions are applied, Iran will be in a very difficult predicament as what to do with its oil industry and oil exports as Tehran will not receive funds in U.S. dollars from oil sales and the secondary sanctions against all companies and central banks from different countries that may try to bypass and circumvent the sanctions will deter them from doing business with Iran.

Iran will be facing a very difficult in selling oil externally, but also internally as their income will be drying up, which may cause internal problems, social unrests, demonstrations and so on.

For this and other reasons, the Iranian regime will have to make a strategic decision, whether to continue with its current policy in the Middle East, or change the policy and work with the international community and with the U.S. and the Trump administration in terms of lifting the sanctions.

"I do not believe that this change will come soon. I do not believe that this regime is about to change its course and therefore, the price that the Iranian people will pay is going to be very high, as was with the case of Iraq under Saddam Hossein during the sanctions," expert Cohen told Trend news agency.

Ariel Cohen said he thinks that there will be attempts to bypass the sanctions regime and sell oil either via Russia or via Turkey or even via some of the Gulf states such as Qatar. But in the long term, very few companies and countries will be interested in risking the repercussions and getting under the U.S. sanctions regime, he added.

OPEC does have a meeting in the coming days in Algiers to assess the state of the oil market, and decide on next steps. But one of the largest near-term challenges for OPEC is balancing the oil market in the wake of lost barrels from Iran – a key factor driving up prices and also a fact that seems to be lost on the American president. There are no clear solutions for OPEC+ that leaves the oil market satisfied while also maintaining group cohesion.

The obvious course of action is to allow for higher production levels. But there is no way to do this while also getting all parties on board. Iran’s oil minister said that any change to Tehran’s allotment would be blocked. “I will definitely veto any decision that threatens our national interest,” Bijan Zanganeh said in an interview with reporters from S&P Global Platts and Bloomberg News.

“Anyone who says they will compensate for the shortfall in the market is speaking against Iran. This is a 100% political statement, not economic.” Because any OPEC agreement requires unanimous consent, Iran could block any changes to the formal oil production cut deal.

Iran still holds a little bit of leverage because the specifics of the June agreement, which called for increased production on the order of 1m barrels per day (mb/d), were not hammered out. In all likelihood, Saudi Arabia and Russia would realistically take on a greater share of output, mostly because they are the only ones that have the ability to choose to produce substantially more.

But formalizing those increases is politically tricky. After all, Iran is taking tangible losses because of U.S. sanctions. Those missing barrels have to be made up elsewhere. Saudi Arabia, Russia and a few Gulf States are the only countries that can increase output on a large scale. But even if Riyadh can physically replace the gap left over by Iran, Iran would never vote in favor of such a scenario. “No consensus on this issue is likely,” Commerzbank wrote in a note.

Iran’s Air Force and the Islamic Revolution Guards Corps began on Friday fighter jet drills over the waters near the world’s most important oil chokepoint, the Strait of Hormuz, Iran’s IRNA news agency reported on Friday.

Aircraft including nine F-4, six Sukhoi, and four Mirage started the war games in the Persian Gulf and the Sea of Oman waters, IRNA said. The maneuver is a warning that Iran’s enemies will face a “stern response” if they show ill-will toward Tehran, the AP quoted the official Iranian news agency as saying. Earlier this year, Iran threatened to close the Strait of Hormuz for all tanker traffic if the U.S. drives Iranian oil exports to zero.

As the first round of U.S. sanctions on Iran kicked in last month and the second round of sanctions - including on Iranian oil exports - is set to snap back in early November, the Islamic Republic has recently stepped up rhetoric about controlling the most vital oil flow chokepoint in the world.

U.S. Secretary of State Mike Pompeo rebuffed Iran’s claims saying in a statement posted on Twitter: “The Islamic Republic of Iran does not control the Strait of Hormuz.”

The Strait of Hormuz is the world’s most important chokepoint, with an oil flow of 18.5 million bpd in 2016, the EIA estimates. The Strait connects the Persian Gulf with the Gulf of Oman and the Arabian Sea and is the key route through which Persian Gulf exporters - Saudi Arabia, Iran, Iraq, Kuwait, Qatar, the UAE, and Bahrain - ship their oil. Only Saudi Arabia and the UAE have pipelines that can ship crude oil outside of the Persian Gulf with additional pipeline capacity to bypass the Strait of Hormuz, which is a route of more than 30 percent of the daily global seaborne-traded crude oil and petroleum products and more than 30 percent of the liquefied natural gas (LNG) flows.

Some 80 percent of the crude oil shipped through the Strait of Hormuz goes to Asian markets, the EIA has estimated using data from Lloyd’s List Intelligence tanker tracking service. China, Japan, India, South Korea, and Singapore are the largest destinations for oil moving through the Strait of Hormuz.