The implementation of the historic agreement over Iran’s nuclear program on January 16 has paved the way for the removal of western sanctions. Immediately after the lifting of sanctions, Iran’s oil ministry ordered oil production to be increased by 500,000 barrels per day.
The wave of new Iranian oil should not have come as a surprise to the markets since the nuclear deal was reached more than six months ago. As such, the new supply should already be factored into the price of crude oil. However, there is a large degree of uncertainty surrounding how quickly and to what magnitude Iran’s oil production can be increased.
Iranian oil weighs on markets
The prospect of Iranian crude flooding an already oversupplied market helped to push oil prices below $30 per barrel in mid-January.
The threat to oil prices stems from the fact that the expected declines in production from around the world could be partially or wholly offset by rising output from Iran. For example, in the International Energy Agency’s (IEA) January Oil Market Report, the Paris-based energy agency predicted that oil production from OPEC would fall by 600,000 barrels per day this year. Iran could easily compensate for that lost output, leaving the world in a state of oversupply through 2016. As a result, the IEA raises the possibility that the world could see a “third successive year when supply will exceed demand by 1.0 mb/d and there will be enormous strain on the ability of the oil system to absorb it efficiently.”
But estimates vary on how quickly Iran will be able to bring production online. Goldman Sachs only sees Iran bringing back 285,000 barrels per day this year. Morgan Stanley predicts a stronger increase of 600,000 barrels per day. The EIA estimates 500,000 barrels per day by the end of 2016 plus another 400,000 barrels per day next year. That would bring Iran’s output to 3.7 million barrels per day (mbd) by the end of 2017, up from the 2015 total of just 2.8 mbd.
Adding to the short-term woes are around two dozen tankers sitting offshore in the Persian Gulf, which Iran has used as floating storage while sanctions prevented exports. Those tankers could be holding 30 to 50 million barrels of oil and condensate, and can now be sold abroad.
“It will take time for this increase in production to be transported on the commercial tanker fleet given the financial sanctions still in place and reluctance of insurance providers to cover given the snapback provisions in the P5+1 agreement.”
One potential near-term stumbling block for Iran is the ability to obtain shipping insurance. The U.S. still has some sanctions in place, which will give insurers and international shipping companies pause. “It will take time for this increase in production to be transported on the commercial tanker fleet given the financial sanctions still in place and reluctance of insurance providers to cover given the snapback provisions in the P5+1 agreement,” Paddy Rodgers, CEO of oil tanker company Euronav, told Reuters, referring to the potential for sanctions to “snap back” into place if Iran violates the agreed upon terms of the nuclear accord. For a while at least, shipments of Iranian crude might have to travel exclusively on Iranian tankers.
But Iran reportedly has one of the largest shipping fleets of supertankers in the world, so this might not be a major hurdle. Also, the National Iranian Tanker Company says that it has been in negotiations with foreign organizations since the nuclear deal was sealed in mid-2015, and that it is very close to obtaining the necessary insurance against oil spills, as well as registering their vessels. To the extent that shipping insurance is a problem, it will likely be a short-term one.
Another issue for Iran will be its ability to market and find buyers for its oil.
IEA says that Iran has spent months preparing for this moment, finding purchasers and readying its oil infrastructure. That progress will permit Iran to add 300,000 barrels per day in the first quarter of 2016, IEA estimates.
Iran will target its customers in Asia where oil exports were not interrupted by sanctions over the past few years because several large buyers—China, India, South Korea, and Japan—were exempt from sanctions. An additional 200,000 barrels per day could flow east from Iran.
But Europe is where much of the new action will be. Prior to the strict international sanctions that Europe and the U.S. slapped on Iran in 2012, Iran exported more than 1 mbd to Europe. Iran is eager to regain that lost market share, which was largely taken up by Saudi Arabia, Iraq, and Russia in the intervening years.
In a sign that Iran intends to move quickly to regain lost ground, the National Iranian Oil Company slashed its selling price for light oil shipped to Europe for February by $0.55 per barrel. The move is likely intended to compete with Saudi Arabia for European customers, which discounted its shipments in early January by $0.60 per barrel.
New sources of oil
The initial production gains could be relatively straightforward. In fact, several key oil fields may have even seen their well pressure increase over the past several years after they were throttled back because of sanctions, allowing for “a swift production boost” now, as the IEA put it.
But beyond the low-hanging fruit of selling off the oil sitting in storage and reviving dormant oil fields, Iran’s future production gains will need to come from fresh investment in greenfields. For example, the EIA says that China has worked with Iran on new oil fields, and these projects have the potential to add 100,000 to 200,000 barrels per day of additional output this year. But the likelihood that Iran is able to add 1 mbd by 2017 is “dependent on Iran’s ability to mitigate production decline rates, deal with technical challenges, and bring new oil fields into production.”
IEA also sees some “surface-related” hurdles in Iran, with the need to upgrade flow lines, compressor stations, pipelines, and production units. But for Iran to reach 4 mbd, which probably won’t happen before the end of the decade, it will require foreign investment and cutting edge technology.
Iran is hoping to attract at least $30 billion in investment and released details at the November conference relating to 70 oil and gas projects on offer.
The Iranian government unveiled a new contract model in November 2015 at a two-day conference in Iran, with several large oil companies including BP, Royal Dutch Shell, Total, Repsol, Statoil and Sinopec all in attendance. The sweetened contract terms could allow foreign oil companies to book reserves in certain circumstances, although the National Iranian Oil Company will retain ownership. Contracts would be offered for 25 years and companies would be compensated for investing in riskier oil fields. Iran is hoping to attract at least $30 billion in investment and released details at the November conference relating to 70 oil and gas projects on offer. More details will be released by Iranian officials at a summit in the UK in February, which could go a long way to determining the level of interest from private companies.
Still, the lingering sanctions from the United States could deter some investment, and the possibility of “snap back” provisions in the nuclear deal could prevent companies from plunging back in.