How Would The Iran Nuclear Deal Impact Oil Prices?
Iran was the first Middle East nation to report an oil discovery. In 1908, the Anglo-Persian Oil Company, known as BP (NYSE:BP) today, struck first oil in the country. Since then, the country’s crude oil industry has seen many ups and downs, including the nationalization of oil fields in the 1950s and the formation of OPEC in the 1970s. Today, it holds the second-largest proved crude oil reserves base in the Middle East. However, the country’s ability to market these reserves internationally has been severely restricted since 2012 because of the tighter sanctions imposed by the European Union (EU) and the U.S. to curtail its nuclear program. Iran’s crude oil exports, which contribute around 80% to its total exports income, and almost 50-60% of all government revenue, have almost halved in volume since 2011, and the recent slump in oil prices means that the decline in revenue could be much worse. The chart below shows how Iran’s crude oil production has trended over the past few years. ((Sanctions Cut Iran’s Oil Exports, wsj.com))
Source: BP’s Statistical Review of World Energy
However, things could start to look up for ancient Persia if it is able to strike a deal with the U.S. and its negotiating partners that include Russia, China, Britain, France, and Germany. Negotiations for the deal have been ongoing for over 18 months now and a framework agreement was signed in April this year. The parties involved are looking at a June 30 deadline to work out the details including the pace and the manner in which sanctions over Iran would be lifted, and the level of access that would be given to the Nuclear watchdog, IAEA (International Atomic Energy Agency), to monitor the country’s nuclear facilities and scrutinize the broader program. Based on the final form of the deal, it could have huge implications for both Iran’s economy, as well as the global crude oil market. Let’s focus on the latter for now. ((Iran’s Rohani: Final Nuclear Deal ‘Within Reach’, haaretz.com))
The global crude oil market is already oversupplied currently, which is also evident from the recent weakness in benchmark prices. The front-month Brent crude oil futures contract on the ICE has fallen by more than 45% over the past 12 months. A lot of this could be attributed to a combination of the slowest growth in demand for oil products last year, since the 2008-2009 recession, and a robust growth in supply from Non-OPEC sources, primarily the U.S. In the U.S., increased horizontal drilling of relatively impervious shale rocks has led to a significant jump in crude oil production over the last few years. According to the latest statistical review of world energy by BP, the country’s oil production increased by almost 1.6 million barrels per day or 15.9% year-on-year in 2014. This made up for more than 75% of the total net growth in global crude oil production last year. Global demand on the other hand, increased by just around 0.7 million barrels per day. [1] Although the slump in oil prices has resulted in a significant decline in drilling activity in the U.S. over the past several months, crude oil production from the country is still expected to increase by around 0.6 million barrels per day this year. And despite weaker prices, the OPEC, led by Saudi Arabia, has also been adding supplies to the market, to increase its market share. All of this additional supply means that global crude oil prices are not expected to recover significantly from current levels anytime soon, despite a much faster growth in global demand, expected at 1.5 million barrels per day this year. ((Latest Oil Market Report, iea.org))
In such a scenario, the Iran nuclear deal could mean even more oil in the market, further widening the gap between the demand and supply. In terms of how much and how soon, based on the market reports regarding the country’s floating oil storage capacity, we believe that Iran could introduce as much as 30 million barrels of crude oil into the market almost immediately as soon as the sanctions are lifted. [2] This will not have a sustained impact on benchmark crude oil prices, as it represents just about one-third of the daily consumption of oil products and other liquid fuels globally. However, the impact of the actual increase in Iranian crude oil production could be far more significant. We expect the country to easily be able to ramp up its production by around 1 million barrels per day over a period of 8-12 months after the sanctions are lifted, as it would be just about starting up shut down wells. To give some perspective, that is more than one-fourth the daily consumption of oil products in India, an emerging market that has been a key customer of Iran’s crude oil in the past. [3] Since the Iranian exports will be entering an already oversupplied market, it will have to offer some discounts to buyers in order to lure them into long-term contracts. This will further increase the competition for market share in the global crude oil market and might even lead to Saudi Arabia following an even more aggressive approach on pricing, as it is not in favor of the U.S. and other world powers to ease sanctions on Iran. We have therefore reduced our short to medium term price estimate for crude oil on growing signs of a final deal between Iran and the world powers by the end of this year. We currently forecast spot crude oil prices (Brent) to average around $63 per barrel this year and increase gradually to around $93 per barrel by 2021.
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Notes:- BP Statistical Review of World Energy 2015, bp.com [↩]
- Iran Storing 30 Million Barrels of Oil at Sea, reuters.com [↩]
- ref:3 [↩]