The Iran Nuclear Deal And Oil Markets

By Professor Paul Stevens

The 14 July deal with Iran over its nuclear program has generated much speculation over the potential impact on oil markets. There are three issues to consider: sentiment in the paper markets; short-term physical supply impacts; and medium to longer-term supply impacts if and when Iranian oil production ramps up.

As soon as the deal was confirmed, oil prices immediately fell a couple of dollars as the paper markets anticipated a flood of Iranian exports. However, the fall was smaller than might have been expected. This reflected the reality that the market had already factored in the likely impact of a deal. Over the preceeding three weeks as the direction of travel of the negotiations became clearer, the price of WTI fell by around $8/B, though this also reflected underlying over-supply in the market.

The next issue concerns the immediate impact of Iranian barrels entering an already weakening market. Iran has a great deal of floating storage in large tankers, mostly around Kharg Island, but with some close to markets in the Far East. Estimates suggest these amount to between 30 to 40mn barrels. Over a three month period, this is equivalent to 0.33 to 0.44mn b/d which is a significant amount in an already over-supplied market. It is expected that these will be sold as quickly as possible.

Iran needs the cash. It also needs to emphasise its return to oil markets and its importance in those markets. However, things are unlikely to happen quickly. It will take time to unravel the sanctions regime. In any case, this will not start to happen until Iran begins to meet some of its agreed obligations under the deal. Little is likely to change before six months at the earliest, and even then some institutions such as those linked to the Islamic Revolutionary Guard Corps (IRGC) may still continue to face sanctions. There are also some queries over the quality of the oil in storage: Iran appears to have had trouble selling it irrespective of sanctions. Much is condensate (not subject to sanctions), and a crude/condensate mix which is not attractive to refiners.

PROSPECTS FOR A RAMP-UP

More interesting are the prospects for Iranian production from existing and newly developed fields in a post-sanctions world. There are questions over how much damage has been done to fields closed because of sanctions. It appears some Iranian fields may have trouble restarting. Furthermore, the fields are aged and for a number of years have struggled to maintain production. A major reinjection program planned by the now defunct Iranian Consortium in the late 1970s was never fully implemented following the revolution and the Iran-Iraq war. The ‘Consortium for Iran’ was a group of majors tasked with bringing Iranian oil back to international markets post-1951 nationalization.

A key problem for the upstream has been a lack of capital; another growing problem has been a lack of technical expertise. The National Iranian Oil Company (NIOC) during the regime of Ahmadinejad saw many of its technical experts retire, despairing of the constant political interference in the sector. The implication is that Iran will need significant inputs from international oil companies (IOCs) before production can be increased to any great extent. Recent claims from the oil ministry that Iran could within three months increase its production (currently estimated at around 2.8mn b/d) to 4mn b/d appear extremely unrealistic.

Securing IOC investment will not be as easy as many assume, despite the fact that many IOCs are clearly interested in gaining access to Iran’s (relatively) low cost reserves. A number of other producing governments from Mexico to East Africa are also trying to attract IOC investment into their upstream. This is in a world where the investment pot is shrinking.

Even before the price collapse since June 2014, the IOCs, in an effort to satisfy investor expectations, were cutting back on capital investments in exploration, development and production. In a world of now much lower oil prices these cuts have accelerated.

NEW, MORE ATTRACTIVE TERMS

Thus to compete for shrinking IOC investment, Iran must be able to offer very attractive terms. Almost immediately after the Geneva accord of November 2013 which triggered the nuclear negotiations, the ministry in Tehran set up a small working group to propose new terms for upstream access. The old ‘buyback’ contracts introduced in 1990 had not been successful (despite attempts at variations) even before sanctions began to force the IOCs to lose interest. They gave the IOCs no access to benefits in a world where production and prices might exceed expectations; their reward was too dependent on NIOC performing; and they were not allowed to book the reserves.

As yet there are no concrete details on what the new terms might be since various proposed ‘launches’ of the new contract have been postponed awaiting the formal lifting of oil sanctions. There is a fundamental problem in that the Iranian Constitution forbids foreign ‘ownership’ of Iranian oil. However, it is largely a question of language. If IOC investment is to be secured, as it must be if Iranian production is to grow strongly in the years ahead, some form of production sharing agreement will be required even if it goes by another name. Finally, the terms of the nuclear deal make it possible that sanctions could be re-imposed very quickly in the event of non-compliance by Iran. The IOCs will certainly take this into account in their deliberations.