Time to bring Iranian oil back to the market
The obsession among oil analysts with the weekly rotary rig count in the US and what it might mean for marginal supply from North America has let a bigger, longer-term obstacle to price recovery emerge almost unseen.
Its name is Iran and as the summer deadline for a nuclear deal looms, the market should start paying attention. While an agreement would keep prices lower for longer, it would also provide rich opportunities for the world's oil industry.
The White House says the chances of an agreement are "50-50, at best". There are certainly many problems that could yet scupper the talks. Opposition to a deal from many US allies, including Gulf Arab states and Israel, remains immovable. Hardline politicians in both the US and Iran are doing their best to look tough and spoil a rapprochement.
But the omens look encouraging. Iran's fighting against Islamic State in Iraq is doing the US a favour. On Syria, US policy has shifted to include concessions sought by Tehran, including an acceptance that peace may involve talks with the Assad regime. None of this means a nuclear deal is a sure thing. But both sides have now invested plenty of diplomatic capital in securing an agreement. Returning to the status quo ante would be a failure.
As US President Barack Obama said in his Nowruz address to the Iranian people, this is an historic opportunity to end more than 35 years of rivalry - decades of 'twilight war', the term David Crist used in his book about the low-level conflict between the US and Iran since 1979. It would make the Middle East safer and return Iran from international exile.
For oil markets, the end of the embargo on Iranian oil would be just as momentous. A plausible rise in Iranian oil production and exports would take the following path. In the short term, as sanctions eased Iran would seek to sell oil it has stored offshore: the National Iranian Tanker Company now holds 30 million barrels in ships, says the International Energy Agency. After that, it would seek to increase output from 2.84m barrels a day (b/d) in February to its present sustainable capacity of 3.6m b/d. This would suggest another 600,000 b/d or so of extra production reaching the market over the coming months. Oil production that was taken offline in an orderly way as sanctions began to tighten four years ago would also begin to come back on stream, pushing capacity higher in the medium term.
As Iraq's output rises alongside Iran's, those two ever-closer allies could between them eventually be pumping more oil than Saudi Arabia. The kingdom would not like that
Iran's return to the international fold would also see its upstream open to foreign investors. Western oil executives are already applying for visas. Iran's need for investment and the weak oil price will mean the terms are attractive - far juicier than those offered in neighbouring Iraq, believe executives. Under oil minister Bijan Namdar Zangeneh the opening is expected to be comprehensive and targeted at the biggest companies. His previous record as oil minister suggests he knows how to get things done. Within a few years of sanctions ending, Iran may be pushing output beyond 5m b/d, or more.
This would be a big deal for Opec's Gulf members, because to recover its oil Iran would have to offer discounts on it. Saudi Arabia and other exporters that have increased market share at Iran's expense during the embargo would either have to hand it back or compete, through price, to keep it. Looking ahead, it is conceivable that the rush of post-sanctions Iranian oil would begin reaching the market just as supply growth in higher-cost North America began, at last, to wilt under the price pressure.
For Saudi Arabia, that would thwart the rationale for allowing the price decline in the first place. Riyadh is thought to want just a 300,000 b/d per year increase in Iranian oil production, should sanctions be lifted - an amount that might help keep markets in balance, assuming demand had begun to mop up some of the present stock overhang. But quite how the kingdom could enforce this is anyone's guess, especially since Iranian officials considered the Saudi-led decision at November's Opec meeting to be a deliberate attempt to weaken Iran's economy. Indeed, as Iraq's output rises alongside Iran's, those two ever-closer allies could between them eventually be pumping more oil than Saudi Arabia. The kingdom would not like that.
You might think the onset of more Iranian oil and with it prolonged softness in oil prices would be disastrous for international oil companies (IOCs). But it is not so simple. The opening of Iran's oil sector would give them long-term investment opportunities in one of the last great conventional oil plays. In a low-price environment, IOCs would rush to book low-cost reserves. When margins are everything, cheap-to-produce Iranian oil, with Asian buyers on the bill of lading, would look more enticing than land-locked, high-cost, tight oil destined for Cushing.
These dreams could all come to naught if the talks fail. Even if they don't, naysayers argue that whatever Obama and US Secretary of State John Kerry agree, Congress may nix it all. What the International Crisis Group called the 'spider web' of US sanctions on Iran could also take a painfully long time to unpick, even if Congress decided to suspend its penchant for obstruction.
The reality is that even if the latest round of talks end without progress, more Iranian oil is destined to begin reaching the market. In Europe, the reserves of diplomatic energy needed to keep punishing Iran are dwindling. In Asia, buyers are already lining up for the crude. Cracks in the sanctions regime would be inevitable and inevitably widen.
As for the US Congress, any efforts to kill a deal after the event will only hurt American interests. Iran understands the difficulties Obama faces on the Hill and probably doesn't expect the pulping of laws made over the past 35 years. What it needs is relief from UN and EU sanctions, which could be scrapped far more easily. If they go, more Iranian oil will flow to the market and European firms will stream into Tehran. American firms, stymied by their own politicians, would be left out. Like everyone else hoping Iran will forgo nuclear weaponisation in exchange for re-entry to the global economy, they should be backing a fair and comprehensive deal between Tehran and the West.