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The United States’ unilateral withdrawal from the Vienna Agreement, announced by Mr Trump in May 2018, marks the return of US sanctions against Iran. Such sanctions are based on the extraterritoriality of US law, and raise the question of the independence of the European Union's foreign and trade policy from Washington. Eric Chaney, Economic Advisor to Institut Montaigne, answers our questions on the economic consequences of this withdrawal for the European Union and the oil market.
The European Union and its UN Security Council permanent members, along with Russia and China, have decided to continue to implement the JCPOA with Iran. The imposition of trade sanctions against Iran and the threat of retaliation against any company doing business with an Iranian entity strengthen the American position, and pushed the EU to find a solution. In fact, Iran turned this into a necessary condition for its own compliance with the agreement: among the seven conditions put forward by the country's political and religious leader are the maintenance of business relations with Iranian banks and the purchase of Iranian oil.
In reality, the EU has not yet implemented a plan to circumvent US sanctions. The first step is to pursue trade relations with Iran for unsanctioned goods (food, medicine), which necessarily go through Iranian and European banks, without risking them being targeted by the United States. Since most of the information exchanges associated with interbank netting schemes are carried out through the SWIFT system (a cooperative company registered under Belgian law and counting the world's largest banks as members), the first goal is to secure SWIFT. Already in 2012, upon the request of the European Council, SWIFT had to disconnect from its network several Iranian banks that used the system to circumvent the sanctions of the time. Since the JCPOA agreement, these banks were allowed back in, but it is hard to see how the EU could prevent the United States, whose banks participate in SWIFT and have access to its information, from acting against European banks through this inherently cooperative channel.
In reality, the EU has not yet implemented a plan to circumvent US sanctions
Hence the more ambitious project to establish a payment system dedicated to transactions with countries targeted by sanctions initiated outside the Union. This system would be a "special purpose vehicle" (SPV) owned by Member States (or at least some of them) and allowing for transactions in euros with Iranian entities, intermediated by EU banks.
An even more ambitious version of this SPV would have a banking licence, and would thus have access to the ECB and its TARGET interbank settlement system. The explicit purpose of such a vehicle would be to completely bypass the dollar channel, to allow Iran to denominate its oil exports in euros, and thus to be able to purchase goods and services invoiced in euros.
The political willingness underlying this project - at this stage, it is only a project - is both necessary and commendable, but its effectiveness is questionable. The United States’ main argument aims to have a deterrent effect: "if you do business with Iran, expect great difficulty in doing business in the United States". The shocking brutality of the wording of this law of the strongest makes it no less effective, and it is hard to see how European companies could ignore it - except, perhaps, for certain companies specializing in the Iranian market.
France has long denounced the "exorbitant privilege" that the US dollar, as the world currency, confers to the United States. Yet this denunciation has rarely complemented by realistic proposals to reduce the dollar’s role. The euro’s launch resurrected this goal, which has now been taken up by federalists such as Jean-Claude Juncker, but also mentioned by some German politicians, who are sensitive to the trade opportunities offered by the Iranian market. Yet this goal is still a long way from being achieved. It is true that the US dollar is THE international reserve currency, in a sense that goes beyond the mere holding of foreign exchange reserves by various countries’ central banks. The US Federal Reserve (Fed) is, de facto rather than de jure, the ultimate provider of the liquidity required for the functioning of global financial markets. This was very clear at the end of the year 2008. Indeed, in order to avoid the international financial collapse that would have occurred had the intense global demand for dollars not been met, the Fed established unlimited swap lines with many central banks, including the ECB and the Swiss National Bank. The ECB, which used these swap lines to respond to European banks’ needs, was very cautious when it came to demands for euros, as demonstrated by its reluctance towards Hungary, Poland and Latvia during the same period. The ECB is however not to blame, because, unlike the Fed or the PBC (China’s central bank), it is not supported by a state, and must constantly consider the risks posed by its decisions to grant liquidity or to acquire assets.
In order to overcome the dollar’s dominance and the risk of extraterritorial sanctions, China followed the American example to internationalize the renminbi (Chinese currency), by establishing swap lines between the PBC and many of its trading partners’ central banks.
Wanting to emancipate from the dollar today seems to me to be more of a political posturing than a practical possibility
"If the PBC does so, why not the ECB?" one might be tempted to ask. Again, the difference is that the PBC is the instrument of the Chinese government, which itself produces the reference asset for the Chinese market, i.e. government bonds. This is obviously not the case for the ECB. This, however, does not stop the euro from having a much more important international role than the renminbi. The former indeed offers quite fundamental advantages: a flexible exchange rate, free movement of capital, and respect for the rule of law. China is still far from meeting such conditions.
In conclusion, wanting to emancipate from the dollar today seems to me to be more of a political posturing than a practical possibility. If the euro were one day to become a competing source of international liquidity, it would mean that the monetary union would have made great progress towards a political union, which today seems quite unlikely.
Let us temporarily put aside the political dimension of the reimposition of sanctions by the United States, scheduled on 4 November. On that date, and if no unforeseen development occurs by then, any trade related to Iranian oil exports should be subject to US sanctions. In an attempt to limit the short-term effects of this boycott, Iran significantly accelerated its crude oil exports and loaded around 10 super tankers (Very Large Crude Carriers, VLCC). The latter’s destination, which is difficult to track since some of them sometimes disconnect their transponders, seems to be China and/or India. China also made it clear that it intends to buy Iranian oil, by denominating transactions in renminbi. While it is difficult for the United States to completely block Iranian exports, I believe most of them will be stopped, which will drastically reduce the Islamic Republic's foreign exchange resources. The question we are all asking ourselves is thus how the balance between supply and demand on the world crude oil market will be achieved, knowing that it could ‘run out' of about 2 mb/d (millions of barrels per day), i.e. approximately 10% of the internationally traded crude oil.
Saudi Arabia, which obviously supports US sanctions, certified that it could increase its oil production
Saudi Arabia, which obviously supports US sanctions, certified that it could increase its production from 10.5 to 12 mb/d, which is not entirely convincing, given the secrecy surrounding Saudi production sites. Moreover, the Kingdom could try to use its buffer role in the market to block possible sanctions after the assassination of editorialist Jamal Khashoggi. However, the market is not overly alarmed, since, for example, the price of a barrel of Brent oil fell back to $80, after having risen to $86 in early October.
In fact, the main effect of the rise in oil prices is to stimulate the production of so-called "technological" or "non-conventional" oil, particularly in the United States. This is exactly what happened after each oil crisis (1973 and 1979), with one important difference: technological advances allowing for shale oil exploitation have been massive and have considerably reduced the investment required to bring new sites into service. In a way, the United States have become the new 'marginal producer', i.e. one who can balance the market - a role hitherto played by Saudi Arabia.
The risk of a sharp rise in oil prices can however not be entirely ruled out, given the political circumstances. It is worth remembering that in 2007-2008, the price of a barrel of crude oil had risen to $145 due to possible Israeli military action against Iranian uranium enrichment sites - an action the Bush administration finally decided not to support logistically. Today, the position of the US President's new Security Advisor, John Bolton, is known to be very hawkish towards Iran, as was that of Vice President Dick Cheney in 2007. The resignation of Nikki Haley, former US ambassador to the UN, who was generally considered to have a moderating influence on the American President, opens new opportunities for ultras, who could be tempted by a military option, were Iran to adopt a provocative attitude. While this scenario might still seem improbable today, it would be a mistake to dismiss it completely in the next two years.
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