Trump administration backs out of Iran nuclear deal

What has happened?

President Donald Trump has withdrawn from the 2015 Iran nuclear agreement and re-imposed oil-related sanctions. Market reaction to the May 8 announcement was mixed. The price of Brent crude recovered after a 4.3% drop and finished the US trading day mostly unchanged at USD 75.6 a barrel. The S&P 500 also ended the day unchanged after early losses, while the 10-year Treasury yield rose 2 basis points to 2.97% and the US dollar gained 0.3%.

Thoughts on the Iran nuclear deal

President Trump has announced that the US will exit the Iran nuclear deal and reinstate financial sanctions. Learn key takeaways, how global partners have responded and what the implications are for the oil markets.

What does this mean?

The decision is likely to curb global oil supplies and put upward pressure on oil prices. Iran is OPEC's third largest producer, with production fluctuating around 3.8 million barrels per day (mbpd) in recent months and exports of between 2 mbpd and 2.5 mbpd. While the US does not import any Iranian oil, the return of US sanctions will penalize countries that have not significantly reduced their crude purchases from Iran. As a result, the UBS Chief Investment Office (CIO) expects Trump's move to push Brent higher and lead to increased volatility over coming months.

Actions by other nations have the potential to cushion, but not eliminate, the oil price boost from the US decision. Some efforts to offset the US decision look likely given that other parties to the 2015 deal – including China, France, Germany, the UK and Russia – have continued to back the pact. On the demand side, China could increase purchases of Iranian oil in return for discounted prices, as could other large importers, such as India or Turkey. European leaders, who followed the US in banning Iranian crude imports in 2012, could refuse to introduce curbs this time. Still, Iranian exports may drop by around 0.2 mbpd–0.5 mbpd over the next six months, which would further tighten the oil market, even though it is a fraction of current global production of 98 mbpd.

And on the supply side, OPEC, which meets on 22 June, could raise production. The group's largest producer, Saudi Arabia, is estimated to have around 2.2 million barrels a day of spare capacity. Meanwhile, the International Energy Agency, which represents consuming nations, could request its members to release oil from their strategic reserves to offset market tightness.

Despite these offsets, CIO would still expect some upward pressure on prices reflecting higher uncertainty. And any increase in Saudi production reduces OPEC surplus capacity and thus the group's ability to cope with future oil supply shocks.

What next?

The Administration stated its intention to take immediate action on re-imposing sanctions subject to 90- and 180-day wind-down periods. It is still possible that the White House will dilute or delay sanctions on Iran. Keep in mind that President Trump has a record of making strong statements and then giving ground on implementation, such as earlier this year when higher tariffs on steel were followed by exemptions for allies. However, the harsh tone of Trump's remarks likely complicates diplomatic efforts to renegotiate a deal. A strong line from the US could also be taken as a signal of their negotiating stance on other market-sensitive issues, including trade talks with NAFTA partners and China, as well as the upcoming conference with North Korea. Such geopolitical risks have the potential to divert investor attention away from strong fundamentals.

Overall, CIO believes equity markets can withstand modestly higher oil prices. A boost to oil firms, which account for 7% of the MSCI All Country Index, should help offset the downside for other companies from higher input costs and the negative effects on consumer disposable incomes from higher fuel bills.

Disclosures: