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Trading  | September 3, 2018

Authored by Scott Belinski via,

As Iran is turning to the UN’s International Court of Justice to have the US-imposed sanctions against its oil suspended, the EU is preparing for the hit its economies will have to absorb once the full weight of Washington’s punitive measures comes into effect in the fourth quarter of this year.

With these latest moves, American intentions are clear: cut off Iranian oil from the market entirely and reduce Tehran’s financial power.

As oil prices rise, however, the White House’s policy looks set to hurt more countries than just Iran. Will Europe’s economies take the hit – or will they fight back?

Iran is the world’s third largest oil producer within OPEC (after Saudi Arabia and Iraq) with a daily production of 4 million barrels. Currently, major economic regions from North America to Europe and East Asia are witnessing growing economic activity, causing global oil consumption in 2017 to rise by 1.5 million barrels per day, further tightening the market. As Tehran has already warned, OPEC capacity will be unable to meet shortfalls if the US pursues its policy of reducing Iranian oil exports to zero.

The risk is that any constraints on Iran’s exports will only further drive up prices and create major headwinds for the economy of major oil consumers. By law, the US must ensure the global oil market is well-supplied before issuing sanctions on Iranian oil exports. But in light of current demand, this might be a tough argument to land – especially since more oil supply shocks can be expected: Venezuela is struggling, and an agreement between OPEC and Russia is curbing daily oil production by 1.8 million barrels, compared to 2017 levels.

As foreign firms are closing down their operations in Iran, the sanctions-induced oil price surge is already hurting America’s allies, particularly the EU. The bloc is reliant on oil imports for 98 percent of demand, and with the Euro continuing to perform poorly against the Dollar, the impact of rising prices will only be magnified. Higher oil prices are hitting Germany, the continent’s economic powerhouse, especially hard. Its export-based economy is highly vulnerable to commodity shocks, which lead to higher unemployment because they drag down industrial productivity. The country’s factory orders have been falling since January – and now, business surveys indicate that the knock-on impact of higher oil prices are beginning to kick in.

However, if oil prices are already one negative side effect of Iran sanctions, then the EU should also fear their extraterritorial reach. This clause imparts Washington with the right to sanction any entity doing business with Iran. Forced to pull out of Iran or risk losing access to the US markets, many are looking at losses numbering in the billions, as long-term invest deals concluded at the singing of the nuclear deal are rendered void.

Case in point is the experience of French giant Total SA. The oil major signed in 2017 a $5 billion, 20-year agreement with Iran to develop the vast South Pars offshore natural gas field. Now, the firm is scrambling to divest from its Iranian assets before the US-imposed November 4 deadline, after it became clear that no exemption would be granted for its operations. Along with Royal Dutch Shell, Total was among the first energy companies to halt crude oil purchases from the Islamic Republic, fearing repercussions if they failed to do so.

European refiners too began winding down Iranian oil purchases upon the sanctions announcement, but EU governments are pushing back. They hope to neutralize the effects of US sanctions via a “blocking statute” intended to shield businesses working in Iran from US actions. In a show of defiance, European Commission president Jean-Claude Juncker remarked that “It is the duty of the EU… to protect European business and that applies particularly to smaller and medium-size businesses.” The statute entered into force on August 7, but its effectiveness remains unclear, considering that Brussels continues to negotiate exemptions for SMEs operating in Iran.

The EU’s staunch resistance to Washington is not based just on principle, but on economic necessity. Indeed, Europe is facing a double onslaught by the end of the year: not only are Iran sanctions coming into effect in November; in late October, biting sanctions on Russian aluminium giant Rusal will go live. The world’s second biggest producer, Rusal supplies 20% of the Union’s consumption of the metal. As such, member states could be exposed to the twin shocks of oil and aluminium shortages – a gale-force headwind on economic indicators.

Much like in the case of the Iran sanctions, America’s blacklisting of Rusal in April was done without consulting allies. Global aluminium and bauxite supply chains were immediately thrown into unprecedented chaos, raising costs for both EU and US consumers. Metal prices soared as aluminium traders on both sides of the Atlantic scrambled to find other suppliers. However, replacing Rusal’s input proved to be expensive, with consumers left holding the bag. One trader remarked that it was forced to accept 20% higher prices – which will affect consumers and end-users alike.

Still, WirtschaftsVereinigung Metalle, representing 655 metals companies, warns aluminium plants might have to shut down, causing supply shortages to major downstream industries. The automotive sector, with its numerous specialized SMEs providing parts to global companies like Daimler AG and Volkswagen, accounts for 13 percent of European jobs alone. In Germany, they even provide as much as 60 percent. Were aluminum shortages to become a reality, the market would plunge into “complete shock” that together with surging oil prices will have catastrophic consequences on employment levels.

Washington’s foreign policy is clearly increasingly at odds with Europe’s core interests: oil and aluminium are crucial to keeping the economic engines running. Donald Trump’s flurry of sanctions should be seen for what they are: an existential threat to the EU and to the countless firms that hold up the struggling Eurozone. One can only hope the Europeans will not waver in their determination to stand up to the White House.

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