The Fuse

Expert: No Price Impact from Higher Iranian Exports

by Matt Piotrowski | September 29, 2015

There will be “no dramatic price impact” from a ramp-up of Iranian exports next year as volumes from the OPEC producer will be accommodated by other market developments.

There will be “no dramatic price impact” from a ramp-up of Iranian exports next year as volumes from the OPEC producer will be accommodated by other market developments, such as lower U.S. shale output, other non-OPEC losses, and a cutback by Saudi Arabia.

This view comes from Bijan Khajehpour, a leading expert on Iran’s oil sector and a managing partner at Atieh International, the Vienna-based international arm of the Atieh Group of Companies, who says that Tehran will “grow exports gradually and recapture market share slowly,” adding about .5 mbd over the course of 2016.

Speaking at the New York Energy Forum at Columbia University on Monday, he stated that the “psychological impact of the nuclear deal has already been accounted for” and that recent talk of Iran boosting exports as much as 1 million barrels per day (mbd) as soon as sanctions are lifted is “exaggerated.”

Following the announcement of the nuclear deal between Tehran and world powers during the second week of July, oil prices collapsed by about $10 despite no new supply hitting the market. As a result, Khajehpour believes that the market impact of Iran’s return has already been factored in.

The comeback of Iran to the oil market has been a major wild card for price direction since Tehran and world powers struck a landmark nuclear deal in July. A top Iranian official said last week that he expects the country to be ready to boost exports by .5 mbd by late November, even before the sanctions are lifted. Some analysts have suggested these comments were simply posturing ahead of the OPEC meeting the first week of December.

According to Khajehpour, OPEC (led be Saudi Arabia) will accommodate the increased barrels from Iran, but the members will not admit any action publicly. They’ll need to tweak levels quietly to keep a floor under prices. Attendees at the event The Fuse spoke with said they believe differently, saying that the Saudis will not adjust volumes to allow Iran to regain market share. The main motivation behind the Saudi strategy since OPEC’s meeting last November is to keep output high and sacrifice price for hold onto customers. Although the Saudi economy is hurting, the kingdom is able to ride out the low price environment better than other producers, including its OPEC counterparts and U.S. shale firms.

Speaking after the event to reporters and members of the audience, Khajehpour said that “the Saudis will have to do something so the market isn’t upset.” He added: “There is room for maneuvering.”

“The Saudis will have to do something so the market isn’t upset. There is room for maneuvering.”

OPEC production is 1.2 mbd higher than a year ago, as the Saudis and Iraq have boosted output significantly. Saudi Arabia has produced above 10 mbd for six months straight. Pipeline disruptions in northern Iraq have limited flows in that country, but Baghdad is poised to see a .56 mbd rise this year.

Many commentators have stated that the kingdom has primarily been motivated to keep levels high in order to thwart U.S. supply, but positioning for market share ahead Iran’s return could be the bigger reason.

So far this year, OPEC supply has averaged about 31.17 mbd. The call on OPEC crude for next year is 31.3 mbd, up 1.6 mbd from 2015, but only slightly above this year’s average output. In other words, even with declines in U.S. supply, there might not be much room for Iran’s volumes. Iran’s market share has dropped significantly since 2011—more than any other OPEC member (see graphic below from IEA).

opecmarketshare

Iran’s production capacity is currently 3.6 mbd (but output is about 2.8 mbd), and it is exporting about 1.21 mbd, according to Khajehpour, who sees Iran returning to pre-sanctions levels of around 4.3 mbd by the end of 2017. The country currently has 50 million barrels of fuel in floating storage, 30 million barrels of which is crude oil. These volumes can be released to the market relatively quickly, but Iran has always held volumes at sea, meaning any sales from storage, while bearish for oil, are not a huge abnormality.

Khajehpour, along with another speaker at the event, Richard Nephew, former Principal Deputy Coordinator for Sanctions Policy at the State Department, says sanctions relief should occur in the first half of the year, perhaps even as early as the first quarter. Iran’s timetable of the end of the year is too optimistic. There is the possibility of “snapback” sanctions if Iran cheats on its obligations, or political hardliners in the U.S. or Iran derailing the deal, but the chances of these outcomes coming to fruition are remote

Snapback, however, will remain a risk for any companies doing business in the country going forward.

Companies should be “very careful to wait until sanctions relief has been fully granted,” Nephew said. “Anyone planning to deal with Iran should be wary of snapback.”

Challenges in reclaiming market share

Before sanctions were put into place, exports were about 1 mbd higher than current levels. The market adjusted in 2012, when prices were north of $100 per barrel, as growing output in the U.S. and increases from the Saudis offset the lost Iranian barrels. The situation is much different now, as supply exceeds demand by almost 3 mbd and prices are below $50/bbl.

While the Iranians will have difficulty muscling back into the market, they do have some distinct advantages.

While the Iranians will have difficulty muscling back into the market, they do have some distinct advantages.

First of all, former EU customers of Iran will want to return to buying volumes from the OPEC country in order to diversify away from Russia, given the turmoil European countries have had with Russia concerning Ukraine. Before sanctions, Europe bought roughly .5 mbd from Iran, or about 20 percent of the country’s exports.

Secondly, Iran produces mostly heavy crude, which is in high demand in Asia. “Iran has what customers, especially Asian customers, want,” according to Khajehpour. The share of exports to China, in fact, has risen from 20 percent to 40 percent during the period that Tehran has been under sanctions, while Iran can revive relationships with South Korean and Japanese refiners with whom it has a long history.

Iran is also becoming a much larger exporter of petroleum products. While under international sanctions, Tehran boosted its refining capacity so it could sell refined fuels to make up for lost crude exports.

Longer-Term Iranian outlook

The long-term outlook for Iran is full of potential, but also full of risks. Iran is eyeing production of 6 mbd by 2020, but Khajehpour says 5 mbd is more realistic given challenges with investment, technology, and possible domestic mismanagement. In 2011, before sanctions, Iran had production capacity of 4.3 mbd, and it should hit 4.5 mbd by the end of 2017. But beyond that? It needs foreign investment, and it is unclear how the new contractual framework will work. The Iran Petroleum Contract (IPC), which will be unveiled in late October-November in Iran, was originally expected to be shown to potential investors in December in London, but the conference has been delayed until February, and could even be pushed back even later depending on when sanctions relief occurs.

Iran

Besides finding outside investors, Iran also has to contend with steep declines at mature fields, which are about .25 mbd per year.

International oil companies are “very interested” in Iran, says Khajehpour, as they want access to low-cost production. However, a contract will not likely be signed until 2017, which means the first new production will not likely occur until 2020. He even doubts whether the 6 mbd target can be reached by 2025. Besides finding outside investors, Iran also has to contend with steep declines at mature fields, which are about .25 mbd per year. Against this backdrop, a good portion of the new production coming online will simply be compensating for the declines.

Economic boon to Iran

The relief of sanctions will bring a good bit of economic positive developments for Iran, although certain key indicators are still worrisome.

The relief of sanctions will bring a good bit of economic positive developments for Iran, although certain key indicators are still worrisome. GDP growth is expected to rise from 3 percent this year to 4.5 percent in 2017. With the growth in oil and gas exports, the trade surplus will grow from $55.3 billion in 2015 to $78.1 billion in 2017. Khajehpour agrees with other experts that the big story in Iran over the next decades will be its potential in its gas sector, which holds some of the highest reserves in the world.

The economy still has to deal with higher inflation and structural underemployment, however. While the rise of oil and gas exports will no doubt bring an economic boon to Iran, providing sanctions relief goes according to plan, the country still has a far way to go after decades of war, underinvestment, and sanctions.