Saudi Arabia Ready to `Mitigate' Impact of Iran Oil Sanctions

(Bloomberg) -- Saudi Arabia promised to work with other OPEC nations to "mitigate" the impact in the oil market of the U.S. exit from the Iran nuclear deal.

While the statement didn't say whether Riyadh would boost output, the new sanctions could disrupt as much as 1 million barrels a day of Iranian crude -- about a quarter of its total output -- opening room for Saudi Arabia to fill the gap. 

"The kingdom will work with major producers and consumers within and outside OPEC to mitigate the effects of any supply shortages," the state-run Saudi news agency reported Tuesday, citing a statement issued by an official in the energy ministry.

Treasury Secretary Steven Mnuchin downplayed the prospect of higher oil prices because of the sanctions, telling reporters that the U.S. has "had various conversations with various parties about different parties that would be willing to increase oil supply to offset this."

"The statement from the Saudi energy ministry was a general statement of intent. It was not meant to suggest a policy shift," said Yasser Elguindi, a strategist at Energy Aspects Ltd. in New York. "Saudi and its partners would only respond if it sees a major supply dislocation emerge, and current policy remains to reduce inventories to a more ‘normal' level," he wrote in a note to clients.

After the last round of sanctions were announced in 2011, Saudi Arabia boosted its production. Yet upping output now raises some risk for the OPEC and non-OPEC agreement that was put in place in 2016 and has helped to mop up a global glut, pushing prices higher. In particular, if Riyadh moves to fill any gap left by Iranian oil, it could upset relations with Moscow.

These are the most obvious options for Saudi Arabia:

1. Do Nothing

The Saudis could try and withstand political pressure from the U.S. and other consuming nations to pump more oil, letting the price rise even further (they have indicated $80 a barrel might be the best level). That would help refill government coffers strained by several years of lower prices, but it raises the risk of demand destruction. Valero Energy Corp. Senior Vice President Gary Simmons warned two weeks ago that oil prices at $80 to $100 would cause consumption to wane. It could also antagonize Trump, who has previously lashed out on Twitter, blaming OPEC for higher oil prices.

2. Fill the Gap

Saudi Arabia, which is pumping just under 10 million barrels a day, has the capacity to produce 12.5 million over time. It can almost immediately increase to 10.5 to 11 million barrels. Boosting output would please its U.S. ally, but would likely tear apart the carefully crafted alliance of OPEC and non-OPEC members who agreed to curb output through the end of the year. Riyadh could justify its decision invoking its traditional policy of fulfilling any extra demand from its customers -- even if effectively it's filling the gap left by Iran.

3. Do Both (But Quietly)

By being seen as doing nothing even as they quietly increase production, the Saudis could, in the short term, please its U.S. ally and take market share from rival Iran. But it couldn't do this for very long without being caught, and then you have the same problems as in option 2. Nowadays oil traders monitor Saudi oil exports in quasi real-time, using satellite tracking systems to count the number of oil tankers leaving the kingdom's ports. Riyadh could, nonetheless, tap its strategic oil storage facilities in the Netherlands, Japan and Egypt to mask the increase in exports, at least for a while before the market catches up.

--With assistance from Saleha Mohsin

To contact the reporter on this story: Javier Blas in London at jblas3@bloomberg.net.

To contact the editors responsible for this story: Will Kennedy at wkennedy3@bloomberg.net, Tina Davis, Will Wade

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