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Oil Price Spike or Ignore Trump: China and India's Big Decision

How do you solve a problem like U.S. foreign policy? India and China would like to know.

Oil Price Spike or Ignore Trump: China and India's Big Decision
Men sit playing makruk, Thai chess, in the Chinatown area of Bangkok. (Photographer: Brent Lewin/Bloomberg)

(Bloomberg) -- How do you solve a problem like U.S. foreign policy? It’s a question two of the world’s largest oil consumers will have to wrestle with over the next four months -- and their answers will define the global trade in oil.

China and India, who together imported about 1.4 million barrels a day of Iranian crude over the past 3 months, will soon have to decide whether they want to snub the U.S. government’s desire to bring Iranian oil exports to zero, or run the risk of an ever-escalating crude import bill. It’s a story that’s complicated by the emergence of the U.S. as a major exporter of crude, in particular to China.

Down one path lie surging oil prices and less profitable refineries. Down the other, the wrath of the U.S. government and the risk of exclusion from America’s banking system.

“The question is: to what extent India and China can pick up the slack,” said Eugene Lindell, analyst at JBC Energy GmbH. “If you’re importing 10 million barrels a day and you manage to lower the price of all your imports by a buck or two by taking Iranian crude, it makes a big difference.”

The Iranian issue is just one of several U.S. foreign policy decisions that are reaching across the oil market with the potential to upend crude flows. Trade wars are looming with China and Europe. Venezuela’s output is crumbling under the weight of sanctions and economic collapse.

At the same time, the President has been pressuring OPEC, and in particular Saudi Arabia, to ramp up output by as much as 2 million barrels a day. If the Trump administration is serious about cutting Iranian exports to zero, prices could top $100 a barrel, consultants such as Energy Aspects Ltd. and JBC have argued.

Ripple Effect

The impact of curbs in Iranian output will ripple through the world’s refiners. Spain’s Repsol SA and Cia Espanola de Petroleos SAU have been active buyers in the past, while oil majors like Total SA and Royal Dutch Shell Plc have wound down their consumption, Iran’s oil minister said last month.

The U.S. has also put pressure on allies such as South Korea and Japan to end their purchases. India is also a heavy buyer under pressure to cut back. For those customers, Saudi Arabia’s barrels are the best replica for those lost from Iran as they are often similarly ‘heavy’ crudes -- a term used in the industry to denote the grade’s density.

“Saudi Arabia is the most obvious replacement for the Iranian barrels,” said Olivier Jakob, managing director at Petromatrix GmbH. “To fill the void it’s obviously Saudi Arabia, I think it’s quite clear that’s the plan.”

Urals Option?

Another possible outcome is Russia boosting its sales of Urals crude. Flows of Russian crude already shifted significantly this year as OPEC’s largest ally in oil cuts diverts more barrels to Asia, but outside of OPEC, Russia is one of the few nations with any spare production capacity.

It’s not just Iran where U.S. policy has been extending its reach. In Venezuela production has fallen from around 2 million barrels a day to 1.4 million barrels a day since OPEC begin cutting supply -- a move exacerbated more recently by U.S. sanctions. Venezuelan oil is “a special barrel” because it is one of the heaviest in the world, according to JBC’s Lindell. While that makes it harder to replace, Middle Eastern or Canadian grades may help fill the gap, Petromatrix’s Jakob said. Canadian supplies themselves are also currently restricted after an outage at an oil sands upgrader.

The reach of U.S. foreign policy into energy markets is also jumbled up with its own boom as an oil exporter. Weekly crude shipments topped 3 million barrels a day for the first time ever late last month, according to data from the Energy Information Administration.

Oil Price Spike or Ignore Trump: China and India's Big Decision

It may ultimately be Trump’s trade war with China that proves the biggest swing factor for flows. The U.S. has averaged 534,000 barrels a day of crude and products exports to China so far this year. Some U.S. crude grades have a similar density to lighter Iranian barrels, although not with the same sulfur content. As trade disputes between the two superpowers intensify, some analysts argue China may use its consumption of Iran’s crude as a political weapon in its dispute with the U.S.

“One option China’s got is to switch its imports from the U.S. to Iran, if it wants to escalate that situation a bit further,” says Tom Pugh, commodities economist at Capital Economics in London. “The big question mark is will China curtail.”

--With assistance from Jeremy Diamond.

To contact the reporters on this story: Alex Longley in London at alongley@bloomberg.net;Julian Lee in London at jlee1627@bloomberg.net

To contact the editors responsible for this story: Alaric Nightingale at anightingal1@bloomberg.net, Brian Wingfield

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