This morning, the P5+1 and Iran announced that they have established a Joint Plan of Action (full text) regarding the future of Iran’s nuclear program. The agreement will lift sanctions on Iran’s oil exports that have been in place since 2011, pending final authentication from the International Atomic Energy Agency (IAEA) that Iran has complied with the terms of the agreement. This authentication is expected to occur before the end of the year.
From an oil market perspective, the agreement has massive implications. Although there will be a delay before Iran unleashes a flood of fresh crude supplies, the ultimate lifting of sanctions will reignite tensions within OPEC, and increases the likelihood of global upstream underinvestment. Geopolitically, the deal has angered Saudi Arabia, which has responded with saber rattling and threats from certain officials that Saudi Arabia will seek to pursue a weapon of its own. While such statements must be taken with a grain of salt, Saudi Arabia’s reaction will undoubtedly contribute to tensions in the region and could hike the global “risk premium” factored into oil prices.
Tensions within OPEC
In recent months, Iranian officials have issued plenty of bellicose rhetoric, stating that its exports will “double” to 2.3 million barrels per day (mbd) almost immediately after sanctions are lifted, with the country’s Deputy Oil Minister describing the oil sector as “a pilot on the runway ready to take off.” Meanwhile, Iranian Oil Minister Bijan Zanganeh has repeatedly told OPEC to “make room” for Iran’s production, and argued that it will sell its oil “at any price.”
Despite the current global supply glut, making room is the last thing on Saudi Arabia’s mind.
Despite the current global supply glut, making room is the last thing on Saudi Arabia’s mind—OPEC’s latest oil market report shows that the oil kingdom pumped 10.6 million barrels per day in June, up a whopping .2 mbd over May. At this rate, Saudi Arabia could be producing 11 mbd in no time, making it the first country to reach such production levels since the former Soviet Union.
Independent analysts are less confident that Iran’s output will surge anytime soon. At present, the Rapidan Group projects that Iran’s production will grow by .5-.7 mbd by mid-2016, although some .2 mbd could leak out in Q4 2015.
Downward price risks and oversupply
Production is expected to lag given the various challenges and complexities facing Iran’s oil sector both above and below ground. International oil companies have faced setbacks and losses in Iran’s oilfields in the past—they are still waiting for the final contract terms that Iran will offer foreign companies, and extensive negations are likely to follow. However, the country’s low-cost, conventional oil reserves are appealing for international companies during the low oil price environment, when development of expensive frontier oil reserves (Arctic, deepwater, etc.) becomes an uninviting and risky prospect.
In the nearer term, big questions remain regarding Iran’s floating storage: Oil that is currently stored in offshore oil tankers, ready to be sold to buyers at a moment’s notice and probably at a steep discount. Even if a sustained increase in Iran’s production will face delays, barrel counters have been eyeing these volumes for some time.
Matthew M. Reed, Vice President of Foreign Reports, tells The Fuse that there is still some time before Iran’s oil floods markets. Reed says, “The most severe oil sanctions, those imposed by the EU and U.S., will remain in force until the IAEA verifies Iran’s compliance. That means Iran can’t jump into the European market for some time. Beyond that, Iran might have better luck in Asia, where customers could technically cheat while betting that sanctions will be lifted soon enough that it won’t matter. Ramping up Iranian exports will be tricky if the EU is off-limits and the United States is warning customers not to jump the gun.”
According to Cornelia Meyer, Analyst and CEO of MRL Corporation, Iran has between 30 and 40 million barrels currently in floating storage, a bit more than OPEC’s daily production. It’s a significant amount of oil, and although these barrels can be sold quickly, if released gradually over six months the price impacts are unlikely to be dramatic.
Prices could go sky-high again.
However, Meyer told The Fuse at the June OPEC meeting that “another risk in the medium term is that because of the low prices, we’re pretty much underinvested. The IOCs and big oil companies have cut more than $50 billion in capital expenditures over the past year or so, and three to four years down the road that underinvestment will work its way into the system. If the economy is doing well, prices could go sky-high again.” Adding Iranian barrels to the current market only increase the likelihood of this outcome.
Worst case scenario: An arms race
Senior U.S. government officials have been clear that “This arrangement will not prevent Iran from having a nuclear weapons capability.”
As noted by Columbia University’s Center on Global Energy Policy, senior U.S. government officials have been clear that “This arrangement will not prevent Iran from having a nuclear weapons capability.” As widely reported a few months ago, some of Iran’s regional rivals have made statements that they see the ten year delay on the country’s nuclear program as their window of opportunity to catch up with their own weapons programs. Saudi Arabia, likely the strongest opponent of a nuclearized Iran alongside Israel, is first on the list according to the Wall Street Journal.
“We prefer a region without nuclear weapons. But if Iran does it, nothing can prevent us from doing it too, not even the international community,” said Abdullah al Askar, a member and former chairman of the foreign affairs committee of Saudi Arabia’s advisory legislature.
“Our leaders will never allow Iran to have a nuclear weapon while we don’t,” added Ibrahim al-Marie, a retired Saudi colonel and a security analyst in Riyadh. “If Iran declares a nuclear weapon, we can’t afford to wait 30 years more for our own—we should be able to declare ours within a week.”
Striking a similar note, scholar Prince Faisal bin Saud bin Abdulmohsen has stated, “Should Iran gain the ability to produce weapons-grade uranium and ability to deploy such weapons, developing a Saudi capability in response would be considered as part of our homeland security.”
Of course, such statements are largely bluster, but they reflect the Kingdom’s displeasure with the current framework. Furthermore, if the KSA is ultimately convinced it needs to counter Iran by pursuing nuclear weapons, developing a program is no small feat. The Wall Street Journal reports that Saudi Arabia’s neighbor and close ally Jordan holds the region’s largest uranium reserves but lacks the resources to extract them, creating a potential partnership. The viability of starting a nuclear weapons program from scratch would likely hinge on where oil prices go in the medium term, but Saudi Arabia has other options. The country has been financing up to 60 percent of Pakistan’s weapons program, with the understanding that it can purchase a warhead on short order should the need arise. As reported by the New York Times earlier this year, the Saudis have a “natural if unacknowledged claim on the technology: They financed much of the work done by A. Q. Kahn, a Pakistani nuclear scientist who ended up peddling his nuclear wares abroad. It is widely presumed that Pakistan would provide Saudi Arabia with the technology, if not a weapon itself.”
A nuclearized Middle East will presumably tighten tensions in the world’s most politically charged region, with unknown impacts for oil price volatility and the global risk premium.