Step by step, month by month, the agreement between Iran and the international powers to control nuclear development in the country is moving forward. Beyond the rhetoric about whether the deal will be effective or not — a debate that will surely continue — the prospect of an end to some of the sanctions on Iran comes closer. What could that mean for the oil market?
The question has to be answered in two parts. First, the short term up to the end of 2016. Second, the longer term stretching to 2020 and beyond. On the first there is a clear consensus across the industry. Iran can produce and export perhaps another 400,000 barrels a day by the end of next year. The limit is set by the condition of existing fields and infrastructure. In the latest of a series of excellent and detailed papers, the US Energy Information Administration suggests the number could be a little higher but also cautions that the amount of condensate available may not be exportable because the market is saturated. That number of barrels a day would add a further dampener to the world price and might force producers in the US to shut in some more tight oil. It is not enough to change the game.
The longer term is much more interesting and open. The conventional wisdom is that the remaining US sanctions on Iran — in respect of terrorist links and human rights — will continue to prevent any of the international companies that have the technical ability and the cash investing in major new developments for the foreseeable future. The legal advice, summed up neatly in a paper from the law firm Shearman and Sterling, sets out the obstacles in detail and explains why companies that want to do future business in the US will stay away. The absence of clear arrangements for the financial sector to process transactions reinforces the direct sanctions. That view could be right, but there are numbers of factors which suggest otherwise.
First, in Iran itself, President Hassan Rouhani and many others have an interest in demonstrating that the nuclear deal was worthwhile and can bring material, economic benefits to the Iranian people before the next election. That, after all was why the deal was done.
There are many factions in and around the Iranian government but it would be wrong to assume that there is a simple binary split between the so-called modernisers and the hard-line clerics and their core supporters. It is intriguing that the deal includes a clause, reported in the FT a few weeks ago which lifts sanctions on Khatam al-Anbia — the major construction arm of the Revolutionary Guards and a powerful organisation that combines physical power with a very substantial and growing business. The clause in the agreement suggest that some of the Revolutionary Guards at least see an opportunity to make money as sanctions are progressively lifted.
Then there is Iran’s behaviour since the deal was signed. For the first time Iran has become an active participant in the international dialogue on the future of Syria. That seems to me a big step, and a further indication that the Iranians have taken a strategic decision to abandon isolation and to assert their role in the region. Many of their neighbours will find this an uncomfortable thought but the US and Europe might welcome the engagement if it continues because it implies that there is another power able and willing to impose a settlement and some sort of order on the current chaos. Germany, in particular, seems ready to involve anyone able to stem the flow of refugees. A co-operative Iran is not inconceivable and the leadership would no doubt extract a price for their help in the form of further relaxation of sanctions.
The desire for an opening is not limited to Tehran. The international oil companies see Iran as their last great hope of getting access to large-scale reserves of oil and gas. The country has a resource base matched by very few others and it has local skills. The fields that could be developed are well known and the costs are low. Seventy per cent of the remaining reserves are onshore and within reach of existing infrastructure, which could easily be upgraded. The terms of the Iranian contract agreement with the companies are comparable to the standard production-sharing model and far better than those available in many other Opec member states, including Iraq. By comparison with many oil-producing countries, the Islamic Republic is orderly and secure. That means that Iran is almost a dream destination for the companies, especially for the majors which have been finding it so difficult lately to replace their production with new reserves.
Many of the companies are indeed constrained by US sanctions because they work in America, but US companies also want access and would not wish to see others taking all the prizes. In a quiet way, one would expect them to be lobbying for a managed removal of the sanctions.
None of this means that the Islamic Revolution which began in 1979 is over. Quite the reverse. Those who want the revolution to survive see the need to provide jobs and wealth to the country’s 80m people. Revolutionaries do not have to be unrealistic dreamers.
If this view is right, things could move much more quickly than the conventional wisdom suggests. Investment in new fields could begin next year, lifting production within a year or two. Looking at the list of prospective developments it is easy to envisage Iran output rising to 4.5m or even 5m barrels a day by 2018. Then the next game would begin — a contest for quotas within what remains of Opec and a direct battle for market share and revenue between Saudi Arabia, Iraq (which could also be producing more) and Iran. Nothing in this analysis suggests a return to high prices anytime soon.
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