New York CNN Business  — 

The deepening trade war between the United States and China could deal a double shock to the fragile oil market.

The tit-for-tat tariffs have already sent crude prices plunging because of fears of a severe global economic slowdown or even recession in the United States that could dent already anemic demand for oil.

But there could also be a supply shock coming. Bank of America Merrill Lynch warned that China could retaliate against US tariffs by purchasing vast amounts of oil from Iran in defiance of Washington’s sanctions on the OPEC nation.

The one-two punch would cause Brent oil to crash from $60 a barrel today to just $40, Bank of America wrote in a note published on Friday.

“A Chinese decision to reinitiate Iran crude purchases could send oil prices into a tailspin,” Bank of America commodity strategists led by Francisco Blanch wrote in a note to clients.

US oil prices have tumbled by nearly 7% since July 31, the day before President Donald Trump vowed to impose a 10% tariff on $300 billion of US imports from China on September 1. Brent, the global benchmark, has plunged by 8%.

The latest round of US tariffs on China could wipe out 250,000 to 500,000 barrels per day of global oil demand, Bank of America said. The world’s appetite for oil has already been running at a sluggish pace because of the economic slowdown.

China has promised to retaliate, casting further doubt on the global economic outlook.

Beijing on Monday allowed its currency to drop sharply below a key psychological level. China’s central bank in part cited the looming US tariffs.

China is also taking further aim at American farmers by announcing Chinese companies have halted purchases of US agriculture goods.

Oil could be in the crosshairs next. Although Beijing has imposed a 10% tariff on US liquefied natural gas, oil has so far avoided tariffs.

Iran’s oil exports have crashed

China could retaliate indirectly by seeking to undermine Trump’s foreign policy.

Trump’s sanctions on Iran are aimed at starving Tehran of cash and creating economic pain that forces the country to abandon its nuclear ambitions.

The sanctions have successfully scared away most of Iran’s oil buyers and stressed the country’s economy. Iranian unemployment is expected to soar above 16% in 2020, according to the International Monetary Fund.

Iran’s oil exports plummeted to 530,000 barrels per day in June, according to the International Energy Agency. That’s down from 2.6 million barrels per day in May 2018.

In other words, the sanctions have wiped out about 2 million barrels of daily oil supply, helping to blunt the impact of blockbuster output from the United States.

Bank of America had been anticipating Iran’s oil exports would shrink to near-zero in 2020.

“If China ignores US sanctions, Iran oil could flood the market,” the firm wrote.

China may seek to avoid ‘open provocation’

However, it’s not like China has completely stopped purchasing oil from Iran.

China imported an average of 400,000 barrels per day from Iran during the first half of 2019, according to Matt Smith, director of commodity research at ClipperData.

“Iran could be a possible way for China to get back at the US, but to some extent they’re already doing that,” Smith said.

Smith said it’s difficult to say how many barrels were purchased in July because Iran has conducted “general subterfuge to try to disguise the origins of these flows.” He cited Iran turning off ship tracking signals and doing ship-to-ship transfers.

Some believe China would be unwilling to escalate the trade war dramatically by emphatically undermining Trump’s Iran crackdown.

“China will not phase out its imports from Iran by any means,” said Michael Hirson, Eurasia Group’s practice head of China and Northeast Asia. “But they are going to stop short of the kind of action that would be open provocation to the Trump administration.”

Hirson pointed out that China would have “a lot to lose” if the United States responded to vast purchases of Iranian oil by sanctioning a major Chinese company or financial institution.

“That would outweigh the benefit of importing more oil from Iran and thumbing Beijing’s nose at Washington,” he said.