Today, the U.S. provided more details on the reimposition of selected financial sanctions, clarifying decisions taken by virtue its repudiation of the JCPOA some months ago. Formally the sanctions, which come into effect today, include measures limiting Iranian access to USD, precious metals including gold, restriction on the auto trade, industry and shipping. The updated OFAC guidance also provided some updates on the energy related sanctions which are set to kick in as of November 3 which are likely to loom over the energy markets for the coming markets.
Bottom-line: The August re-imposition of sanctions was little surprise, providing only a little additional guidance about the enforcement of the upcoming energy sanctions. The implementation is likely to further stress the transatlantic relationship, especially as the EU blocking mechanisms are implemented. Iran will likely emerge more reliant on trade and investment involving China and Russia with whom it will increasingly be a price taker.
Market implications: The pre-announced nature of the decision limited the market impact, and indeed, the IRR rallied slightly and oil price was little change. A range of policy decisions including U.S. enforcement, EU blocking legislation, Iranian political and economic efforts, as well as Iran’s OPEC+ competitors will frame the outlook for energy prices. With an additional 500K/day or more of oil likely to come offline in the coming months, and OPEC+ stuck in data-dependent mode, greater price swings are likely as investors struggle to assess demand.
The formal reimposition is somewhat anti-climactic, as many businesses including those in Europe already began winding down operations some months ago, freezing or planning to exit, rather than facing additional sanctions. In some cases, the looming reimposition of sanctions was a last straw, coupled with considerable counterparty risk in the banking system and financial transactions, local policy decisions and tight financing. The sanctions pressure, along with some domestic missteps has already priced in a major hit via the currency, which is adding to inflationary pressures, adding to asset bubbles (Tehran property, gold), which are hitting real per capita income and reinforcing a weakening of domestic demand. The development of these trends will depend not only on sanctions, but also on Iranian government response to the symptoms and cause of the pressures. In particular, the monetary policy, housing market measures, and fiscal trends will remain key.
How much can the EU help? European authorities are on the verge of announcing their updated blocking mechanism, which looks to compensate businesses that suffer from the U.S. sanctions and theoretically to punish European companies that comply. These measures, updated and adapted from the blocking mechanism first introduced in the mid-1990s when the U.S. imposed sanctions on third parties operating in Cuba, would involve significant implementation at the nation state level which would be responsible for much of the punitive measures and many companies may be relunctant to be a test case.
EU officials are serious about maintaining some version of the JCPOA, seeing it as key to regional and international security, but it remains to be seen how much the blocking mechanism will work in practice. My worry, expressed back in May was that European companies (and many in developed Asia) would pare exposure as the risk-reward looked less attractive, and might wait to see how local conditions evolved. The blocking mechanism, critical for political reasons, might not salvage much long-term investment, but might provide a mechanism to facilitate some continued flows of non-sanctioned goods including humanitarian goods.
Even if the decision is more political, setting in motion a blocking statute, only reinforces the transatlantic divides on this issue and other economic sanctions policies and may undermine future implementation. It might also prompt a serious question regarding key global payments systems including SWIFT, or encourage a greater segmentation of such systems. This could create loopholes and undermine the system for future coordination. Its also likely to undermine the recent EU-US “truce” on trade policy issues, which seemed a bit flimsy on its own. All around, there seem to be significant room for uncertainty for business and consumers who may choose to limit their investment.
What about the oil sanctions?
The OFAC guidance suggests that countries will be subject to financial sanctions, unless they significantly reduce their fuel imports. That contrasts with the guidance from the state department in its briefings as recently as today, in which the administration re-iterated its goal of reducing Iran’s oil exports to zero – a level which colleagues and I have argued is unrealistic and challenged by lack of coordination with potential buyers and sellers. This coordination will be key to managing the market for the rest of the year and 2019.
OPEC (and its producing partners in the Vienna group) policy raises an additional concern. The countries agreed to reduce overcompliance to cuts earlier in the summer, but the uncertainty of sanctions implementation regarding Iran makes it harder to know how much new supply to provide. OPEC+ members, worried about providing too much supply, seem now to have shifted into a data dependent mode, with Saudi Arabia and some GCC countries actually trimming exports back to spring levels, citing limited demand. This shift to a data-dependent mode, may exacerbate swings in local oil prices as producers struggle to calibrate price.
Gold and precious metals:
The impact of the reimposition of the gold measures is hard to predict – but could be more meaningful as Iranian final demand for gold has been rising during the devaluation and increase in inflation. The World Gold council recently highlighted this increased demand, which may understate demand given the unofficial trade. While the looming imposition of sanctions may have prompted stockpiling, its likely the main driver was the desire for a store of value, suggesting that some of this trade might continue, less officially.
Economic and policy impact.
Its harder to assess the “effectiveness of the measures” from a political perspective in terms of policy change than economic assessment, Its much easier to generate economic strain or financial pain on an individual, company or entity, than to necessary trigger a policy change if the entity is uninterested in making the choice. Greater divides between erstwhile allies and stress to global payments system may store up challenges for the future.
The economic impact of the measures will remain negative, with some impacts reinforced by local policy choices including banking issues, monetary policy and FX policy. The blunt tool of sanctions coupled with measures that are a symptom of sanctions including restrictive fiscal and monetary policy, are likely to be negative for domestic demand. Iran’s reliance on investment from China, and trade with Turkey, Russia and others officially or through middlemen is likely to increase. Iran will likely become again more price taker on quality of goods. However, its not clear that this pressure will lead to the sort of regime change that some in the U.S. administration are looking for.