The oil market faces a precarious few months. The imposition of US secondary sanctions on Iranian exports on November 5 is the critical factor behind Brent’s rally to over $80 a barrel in October. There is enough supply to meet demand this winter, but the margin for error is worryingly narrow.

After the the implementation of the nuclear deal in January 2016, Iranian production and exports recovered to pre-sanctions levels within six months. Exports reached a peak of 2.8 million barrels per day (b/d) in April 2018, including 300,000 b/d of condensate. Buyers have come from numerous countries, with the bulk sold into Asia, the Mediterranean, and Northwest Europe.

Since the US withdrew from the nuclear deal in May 2018, Iranian crude and condensate exports fell to around 1.8 million in September on our estimates. South Korea, a big customer, has cut all imports since August. European buyers are winding down – France stopped in July; Italy, Spain, and Greece follow this month. Beyond November 5, we expect crude exports to fall to 1 million b/d, though it could vary month to month; and condensate to 100,000 b/d. Crude sales will be concentrated around a core of supportive state buyers: China, India, and Turkey.

It will be difficult for Iran to maximize exports when virtually all trade in oil is cleared in US dollars, putting international oil companies, many national oil companies, traders, and banks off limits. Crude exports contribute one-third of government revenues, so there is a huge incentive for Iran to use every conceivable lever.

We have seen Iranian crudes discounted by $1 per barrel compared with similar Middle East grades, the biggest for a decade.  Iran is hoping the European Union’s (EU) barter proposal – goods as indirect payment for oil – opens doors, though we doubt any big oil traders will leap at the opportunity. Access to shipping insurance is also a problem, though Iran has its own fleet of 60 tankers and has offered cargoes CIF (cost, insurance and freight) to buyers. Specialized tanker trackers suggest Iranian tankers are operating ghost with disabled ID systems to avoid detection.

As for condensate, Iran’s production is around 750,000 b/d; big in global terms, with about half exported. The condensate is produced in association with gas needed for the domestic market, so it cannot be shut-in like oil. During the 2012-2015 sanctions, Iran increased condensate sales to cushion the impact of lost oil exports. It is not clear if they will have the same flexibility under the new sanctions. South Korea, the biggest buyer, and the UAE, have now stopped condensate imports.

What Does this Mean for the Oil Market?

The biggest risk is this winter. Losing another 1 million b/d or more from Iran comes on top of a similar loss in supply from Venezuela over the last couple of years. Saudi Arabia, the UAE, and Kuwait have stepped up production since July to minimize the increase in price as the market tightens. We think there is just enough growth in supply from elsewhere to muddle through the next few months, meet winter demand and avert a price spike. Brent should hold around $78 a barrel, but it is a very fine line. The Organization of Petroleum Exporting Countries’ (OPEC) spare capacity was an ample 4 million to 5 million b/d two years ago. There is only 700,000 b/d of additional available within 30 days right now.

That means the market is vulnerable to strong demand in a cold winter or any new supply outage.

Do Things Look Better Once Winter Is Over?

The situation may look better once the northern winter is over, but only up to a point. We forecast that Brent will ease and average $74 a barrel in 2019. We expect supply to grow 1.6 million b/d in 2019, with US tight oil driving this. That is well ahead of 1.2 million b/d of demand growth and should lead to a healthy inventory build during the year. But with Iran in the full grip of sanctions and Venezuela continuing to decline, that limited OPEC spare capacity will cast a shadow over the market for some time.