The Trump administration adds a new political risk premium to international oil markets, with a more hawkish and capricious U.S. president, an unprecedented oil-centric Cabinet, and an empowered Republican-led Congress poised to reset the country’s foreign policy agenda as well as the outlook for the domestic energy sector. Vows to upend the controversial Iran nuclear agreement, renewed debate over legislation fraying the U.S.-Saudi relationship, a pivot toward an increasingly interventionist Russia, and plans to rollback regulations impeding the expansion of domestic oil production are expected to have wide-ranging and destabilizing implications for the geopolitics of the oil-producing Gulf region and, with them, a steady stream of news headlines that will rattle oil markets and increase price volatility.

Moreover, the political risk premium over the past several years has largely been tempered by the unprecedented overhang of global inventories weighing on oil prices. The rebalancing of excess supplies now underway, aided and abetted by the OPEC and non-OPEC pact to rein in production, will lead to tighter markets in 2017. As a result, oil price direction will be increasingly vulnerable to geopolitical turbulence, especially that associated with the new political landscape unfolding in the United States.

U.S. President-elect Donald Trump’s statements on foreign policy and energy issues during the most incendiary election in history, however, are a cauldron of contradictions. Discerning what was campaign rhetoric from serious policy positions will only become possible after Trump assumes office on January 20. Even then, Trump’s inexperience as a publicly elected official and policymaker make it near impossible to judge how he will manage the reality and complexity of energy policies and international affairs. Trump’s anti-OPEC comments such as claims of “price fixing” and threats to ban imports from Middle East oil producers perceived to have unfriendly policies toward the United States, including Saudi Arabia, have been roundly dismissed as electioneering bombast, however many other provocative statements on foreign policy are less easily characterized. Indeed, apparent contradictions in Trump’s shifting foreign policy agenda are expected to have a far greater impact on international oil markets than his pro-oil domestic policies.

Perhaps less by design than happenstance, Trump’s proposed Cabinet will have four leaders steeped in the oil industry, none more so than his nominee for secretary of state, ExxonMobil CEO Rex Tillerson, whose close working relationship with Russian President Vladimir Putin has set the stage for a grueling confirmation process. The former governor of oil-rich Texas, Rick Perry, was selected to head the Department of Energy, which he threatened to shut down when he was campaigning in the 2012 Republican presidential primaries. Scott Pruitt, attorney general and a former state senator of shale oil-rich Oklahoma, was named to take over the Environmental Protection Agency. Pruitt is a climate change skeptic and is expected to seek to rollback many of the Obama administration’s policies and regulations on the environment. U.S. Representative Ryan Zinke of Montana, a former CEO of an oil and gas consulting firm, has been nominated to lead the Department of the Interior, which has oversight of oil and gas resources on federal lands.

With its global reach, no appointment is more important to international oil markets than Tillerson to lead the State Department. The nomination has sparked fierce criticism, not least because of his ties to Russia, especially amid the fury over Moscow’s interference in the 2016 presidential election campaign. Tillerson, nonetheless, brings extensive knowledge of international affairs as head of the world’s largest publicly-traded oil company and experience in negotiating complex contracts in high-risk and politically-challenging countries around the world. His controversial business transactions with Russia have garnered the most attention but many in the oil industry see his experience as “equal parts diplomat and executive.” And, according to OPEC Secretary General Mohammad Sanusi Barkindo, “There is a very thin line between oil, geopolitics and diplomacy,”

For the Gulf Arab states and OPEC, Tillerson’s long experience in the Middle East is seen as an advantage. Tillerson played a pivotal role in expanding ExxonMobil’s activities in the region, including its world-class liquefied natural gas business in Qatar and its joint venture partnership at the giant West Qurna oil field in Iraq. ExxonMobil has an eight-decade history of working with Saudi Arabia, which most recently includes a major upgrade at its refining joint venture. Under Tillerson’s watch, ExxonMobil renewed its concession at Abu Dhabi’s massive offshore Upper Zakum development but the company bowed out of bidding for the costly onshore contracts. More controversial, ExxonMobil has signed a contract for six exploration and production concessions with the Kurdistan Regional Government, much to the chagrin of Baghdad and Washington, although the company just relinquished half of the blocks in early December.

Despite Tillerson’s long history with the Middle East, devising a new strategy for the multitude of competing issues in the region will be challenging, made more so by Trump’s aggressive and contrary posturing during the election campaign. Oil analysts, in particular, will focus on the already fragile relationship between Riyadh and Washington amid fears a further breakdown will destabilize markets. Saudi Arabia’s growing disenchantment with Washington during the Obama administration is well-documented but the relationship will continue to confront challenges in the new year. Tillerson will likely have an ally in the nominee for secretary of defense, retired Gen. James Mattis, who is a strong supporter of a more constructive and engaging U.S. foreign policy in the Middle East, and especially with the Gulf Arab states. At the same time, Mattis is more hawkish toward traditional U.S. adversaries such as Iran and, unlike Trump, Russia.

In the wake of uncertainty surrounding the Trump administration, Saudi Arabia is reportedly reassessing whether to move forward with plans to launch its massive Aramco initial public offering (IPO) in New York in 2018, which could reap as much as $100 billion for the kingdom and generate fees of a staggering $1 billion for the banks handling the deal. The reassessment follows congressional legislation passed in September that allows U.S. citizens to sue foreign governments or officials for legal liability in the deaths of Americans killed in terrorist actions on U.S. soil, permitting families of 9/11 victims to sue Saudi Arabia. Known as the Justice Against Sponsors of Terrorism Act, President Barack Obama vetoed the legislation, but Congress overrode him. As expected, Saudi Arabia is considering divesting itself of U.S. assets to protect them from being seized to pay damages imposed in the event of a plaintiff’s victory in a JASTA-related case. Earlier expectations that the legislation would be softened during the lame duck session of Congress failed to materialize, and amending it may become even less likely under Trump, who strongly supported JASTA.

Iran Conundrum

No issue, however, is more important for international oil markets than the future of the Iran nuclear deal. Trump repeatedly vowed during the campaign to revoke the Iran nuclear agreement, formally known as the Joint Comprehensive Plan of Action (JCPOA), on his first day in office and reimpose sanctions on Tehran. After his election, Trump marginally toned down his more extreme rhetoric on Iran, in part due to considerable pressure from veteran politicians from all quarters. Even hardcore opponents of the deal have urged Trump to temper his most provocative statements, recognizing that a more measured response is required given the complex agreement and the international support behind it. Trump has argued both for a renegotiation that permits greater U.S. economic access to Iran and for more stringent monitoring of Tehran’s nuclear program.

That said, the deal has been hugely unpopular with Congress and Trump will be under enormous pressure from its elected leaders to follow through on his hard-line stance against Iran, especially now that Republicans control both the Senate and House. The deal, negotiated with Iran by the permanent five members of the U.N. Security Council – the United States, France, the United Kingdom, Russia, and China – plus Germany, was only made possible because Obama used his executive powers to meet U.S. obligations under the agreement by implementing waivers that enabled U.S. sanctions relief required by the accord. Indeed, U.S. compliance with the deal was entirely done with presidential powers. Theoretically, Trump could use the same executive powers to overturn the agreement, but such an action would come with an enormous reputational cost to the United States. Even if Washington were to adopt the radical decision to revoke the agreement and reimpose sanctions on Iran, it is highly unlikely that the European signatories to the deal would follow suit, which would create pandemonium for oil companies trying to navigate a complex web of different legal requirements.

For all its perceived flaws, the agreement has put in place restraints on Iran’s worrying nuclear program and at the same time the lifting of international sanctions has allowed the almost full resumption of the country’s oil production and exports. Since the formal lifting of sanctions in January, production has rebounded by 800,000 barrels per day (kb/d) to just over 3.7 million barrels per day (mb/d). At the same time, exports have recovered after falling from 2.4 mb/d in 2011 to just 1 mb/d by 2013. Despite Trump’s campaign statements and the hard line taken by many members of Congress, a growing number of political and financial market observers believe the new administration will not follow through on threats to outright revoke the agreement, but instead will tread carefully, at least in the early days.

That said, even if the JCPOA remains intact, Congress holds the potential to strengthen unilateral sanctions, which would trigger further strains with Iran. In November, the House approved the renewal of the Iran Sanctions Act and it now goes to the White House for approval. Obama is expected to sign the act into law, which will be in effect for the next 10 years. It was enacted in 1996 and essentially forms the basis for energy, banking, and defense sanctions against Iran’s nuclear and missile activities, and was set to expire at the end of 2016. The renewal does not change existing U.S. sanctions policy but it does send a strong message to Iran that there will be no easing of U.S. sanctions, for which Tehran had been arguing.

Moreover, under the Trump administration, Iran can expect further congressional sanctions in response to the country’s sponsorship of terrorist activities, violations of agreed upon limits to its ballistic missile program, and poor human rights record. Additional sanctions are under consideration and target cyberespionage and theft and the Islamic Revolutionary Guard Corps, among other issues. If implemented, such sanctions could further fuel claims by Tehran’s leadership that the United States is undermining the spirit, if not the letter, of the JCPOA.

Iran would certainly push back strongly in response to any new sanctions imposed by the Trump administration, escalating tensions that would inject upward pressure on oil prices. With Iran’s presidential elections taking place in May 2017, President Hassan Rouhani will want to carefully manage public comments on U.S. policy changes. The more hard-line Trump administration may discourage, or at least slow, already reluctant foreign oil companies from investing in joint venture oil projects, which are pivotal to Rouhani’s plans to spur economic activity. However, Royal Dutch Shell handed Rouhani a much-needed public success with its December 7 memorandum of understanding with the National Iran Oil Company to explore opportunities for oil and gas projects. Though the agreement is nonbinding it nonetheless sends a signal that European companies will not be deterred by Trump’s threats to unravel the deal.

In stark contrast to the Obama administration, which counted the Iran deal as a crowning diplomatic achievement, the new Trump era is set to usher in an unprecedented level of uncertainty around the agreement and heighten the potential for it to unravel, which will ultimately lead to increased price volatility in oil markets.

Trump’s Domestic Energy Policies

Trump’s campaign slogans such as “American energy first” and “energy independence” may have struck a chord with voters but overall his proposed policy changes will likely have a marginal impact on the domestic oil industry in the short and medium terms, and even less so on the international oil market. While U.S. shale is of paramount importance to global oil markets, especially after the lifting of the 40-year-old oil export ban in 2015, the country’s future production outlook will largely continue to be driven by market forces such as international oil price levels and development costs as well as supply and demand fundamentals rather than policy decisions.

In general, Trump’s energy policies are expected to favor increasing oil and gas usage and less regulation on industry, and will likely reverse some of Obama’s clean policy initiatives. But proposing new tax policies to benefit oil and gas producers, easing regulations, and opening up U.S. federal offshore oil and natural gas lease sales will actually have a limited impact on oil companies’ investment plans and strategies in the short to medium term given the outlook for a lower $50-60/bbl oil price range. In addition, U.S. energy policies and regulations are largely enshrined in law, difficult to reverse, and would take several years for final implementation.

Moreover, most oil company investments for oil and gas exploration projects, pipelines, and other infrastructure are measured in terms of decades, not just one presidential term. Trump’s proposal to unlock the United States’ “$50 trillion in untapped shale oil” and expand the use of federal lands for coal, oil, and gas exploration make for explosive headlines but the plans hinge on much stronger oil prices than currently forecast. The outlook for a lower oil price environment, high development costs, and the long planning and development times inherent to oil projects will continue to temper investments in the near term.

Economic Impact on Global Oil Demand Growth

Countering the potential for higher prices from escalating geopolitical issues, Trump’s economic policies may threaten global oil demand growth, which would add downward pressure on oil markets. A general unease about the outlook for the global economy has emerged since Trump’s election, with heightened fears of weaker economic growth in an already fragile global economy. Oil analysts are focused on Trump’s campaign platform of protectionism and unfriendly trade policies with their inherent risk of undermining economic activity and negative impact on the engines of global oil demand growth. Trump’s threats to renegotiate the North American Free Trade Agreement have caused particular concern for the region’s economic outlook. Trump stated on September 27 that “NAFTA is the worst trade deal maybe ever signed anywhere, but certainly ever signed in this country” but, like much of his pre-election statements, he may be forced to scale down his hard-line position, especially since it will surely face opposition in Congress.

While Trump has tempered his incendiary campaign rhetoric, a great deal of uncertainty and ambiguity remains over the new administration’s policy directions. Of paramount concern to the global oil market, including OPEC and Gulf Arab oil-producing countries, is Trump’s aggressive posturing on some key foreign policy issues, from threats to upend the controversial Iran nuclear deal to his embrace of Russia. The impact of the Trump presidency on international oil markets is not expected to become clear for at least six months, if not longer, as his new team is assembled and more coherent policies are developed. What is clear, however, is that oil markets should brace for a bumpy ride over the next four years.