Oil Market Report November, 2013

The geo-political implications of lifting certain sanctions against Iran rightly dominated world headlines in November. But when it comes to Iran, the world of oil is never far away and the possibility that significant Iranian product may soon be flowing onto world markets is also big news.

Even though sanctions against Iran’s “uranium enriching programme” were first applied back in 2006, it was only at the beginning of 2012 that oil exports were included – such was the fear in the West that a shortage of oil (and consequent price rises) would detrimentally affect the feeble world economy. And the facts surrounding Iranian oil production would suggest such fears were well founded. With 151 billion barrels of oil under the ground, Iranian oil makes up almost 10% of the world’s reserves. Up until 2011, the country was the second largest oil producer in OPEC with 3m barrels per day (bpd) and at the time, memories of the 2011 Libyan crisis were fresh in people’s minds (where a reduction of 1.4m bpd caused a $15 per barrel price increase). In fact, many in the West were convinced that any reductions to Iranian oil supply would be nothing short of economic armageddon.

Therefore it was a courageous move to introduce the draconian sanctions of 2012, although by then, most western politicians knew that only sanctions on “black gold” (making up 80% of Iran’s GDP) would have the desired effect on Iran’s leaders. Plus the decision was made significantly easier by a Saudi Arabian announcement at the time, which made assurances that their spare production capacity (almost 4m bpd – more than total Iranian production) would be made available to help ease market fears. Consequently, there was no economic armageddon and in fact the cushion of oil provided by Saudi Arabia ensured that prices in 2013 have actually been lower than 2012. The Saudi’s involvement has also ensured one further thing: undying enmity from Iran, who have correctly concluded that the offering of spare capacity was the single decisive factor that emboldened the western leaders to apply the sanctions.

But with sanctions now easing off and Iranian oil making its way back to the market, the logical question is whether the new supply will lead to a drop in fuel prices anytime soon. Certainly, the extra supply must ease price pressure (there can be no doubt of this), but punters waiting on a large-scale and immediate drop in prices will be disappointed. Firstly, there is the obvious fact that Iran is a long-way from normal acceptance into the international community and any misdemeanors on the way to redemption will be heavily punished. Secondly, the 2012 embargoes – although more successful than previous sanction programmes – were far from universally applied, as is often the case with western backed sanctions. Countries like India, whilst condemning the Iranian regime and agreeing to sanction non-essential goods, have simply not been in a position to cut off oil supply from a country which provides 15% of Indian energy. Likewise, Chinese economic policy will always take precedence over world politics (and opinion), so Iran has been able to continue exporting up to 70% of its oil (almost 2m bpd) eastwards*.

So we should not expect Iranian oil to flood the markets, as much of it is already on the market. Plus political expedience in the West will mean that those wanting to buy Iranian oil must proceed with supreme caution and this means that product will return only in dribs and drabs rather than all at once. We also have the classic price versus volume conundrum for the Iranians to consider. Of course they will want to see greater volumes coming out of Iran, but not at the expense of falling prices affecting income from existing sales. In fact, a significant drop in crude price would be ruinous for Iran, particularly in the early stages of 2014, when production and volumes will not have recovered to pre-2012 levels.

Finally, there are many commentators and politicians from countries as diverse as Canada, Israel and Saudi Arabia, who say that this latest gesture from Iran is merely a stunt to buy some time. According to Stephen of Ottawa, Benjamin of Tel Aviv and Abdullah of Riyadh, the rules around Iran’s uranium enrichment will (once again) very soon be broken and inevitably, supply constraints will have to be re-applied. At that point, we should expect any short-term benefits since the easing of sanctions to rapidly vaporise and prices to head northwards once again.

* Of course, with the world economy in such a perilous condition, at no point has it been suggested that on account of breaking the embargo, tit-for-tat sanctions against China (or India) should be implemented!