The Fuse

Iran’s Oil and the Nuclear Deal: What a Breakthrough Means for the Market

by Gregory Brew | April 05, 2021

This week, representatives from Germany, Russia, China, the European Union, France, and the United Kingdom will meet with counterparts from Iran and the United States in Vienna to discuss plans to bring the two countries back into full compliance with the Joint Comprehensive Plan of Action (JCPOA, otherwise known as the Iran nuclear deal).

The talks constitute the first progress on U.S.-Iranian dialogue since the Trump administration withdrew from the agreement in May 2018 and reimposed sanctions on the Islamic Republic of Iran, causing the latter’s oil exports to fall to nearly nothing.

Should the talks succeed in starting a dialogue between the United States and Iran, the outcome may be an agreement whereby the United States reenters the JCPOA and drops sanctions on Iran’s oil exports, in exchange for Iran drawing back its enrichment of uranium and reopening its nuclear facilities to international inspectors.

Such an agreement could have a profound impact on the global energy market.

Before the signing of the JCPOA in July 2015, the United States imposed heavy economic sanctions on Iran, in an effort to compel its cooperation with nuclear negotiations. Iran’s oil exports fell from 2.6 million barrels per day (Mbd) to 1.4 Mbd between 2011 and 2014. As per the nuclear agreement, the United States ended its sanctions related to Iran’s nuclear activities (other sanctions were kept in place), allowing Iran to increase its exports in 2016.

While the oil market was still recovering from the collapse of 2014-2015, Iran successfully regained much of its original market share, thanks in part to aggressive diplomacy by energy minister Bijan Zanganeh. As most OPEC members cut production to raise prices, Iran was permitted to increase exports to 2.6 Mbd, roughly the level before the previous wave of U.S. sanctions.

When the Trump administration withdrew from the JCPOA in May 2018, President Donald Trump and Secretary of State Mike Pompeo instituted a new round of heavy sanctions, including measures designed to reduce Iran’s oil exports to “zero.” The measures were initially very successful: after sanctions went into effect, Iran’s exports fell sharply, cratering below 500,000 bpd in 2019 according to official statistics.

Since May 2018, Tehran has adopted a posture of strategic patience.

Since May 2018, Tehran has adopted a posture of strategic patience. As its economy suffers from the weight of American sanctions, Iran’s government has gradually moved away from the JCPOA’s conditions on uranium enrichment, centrifuges, and inspections. At the same time, Tehran has not fully repudiated the JCPOA, insisting it remains in compliance and that its expanded enrichment is temporary and reversible. The conventional wisdom was that Iran was trying to wait out the Trump administration, in the hope that a successor administration would return to the JCPOA.

Stronger and Longer

Joe Biden promised to return the United States to the JCPOA while running as President in 2020. Upon assuming office, however, the president and his advisors struck a firmer line, insisting that Iran end its enrichment and return to “full compliance.” There were also repeated mentions of a “stronger and longer” deal that the United States would negotiate with Iran over its ballistic missile program and support for militia groups in Syria and Iraq, which are seen to pose a security threat to the United States and its partners in the region. Tehran objected to these conditions and instead insisted that the United States drop sanctions before agreeing to any talks.

As a result, talks between the United States and Iran over a return to the JCPOA have been delayed, with this week’s Vienna meeting the first real breakthrough. The two sides will not speak directly, but instead discuss relevant issues through intermediaries.

Should an agreement result from the talks, it is more than likely that Iran will once again be free to export oil. There is some debate over how much oil Iran is currently exporting. While it has been cut off from major customers like South Korea, Taiwan, and Japan, it continues to sell large amounts of oil to China.

This oil is moved by various clandestine means, including ship-to-ship transfers and through Malaysia. Those watching the movement of Iranian tankers suggest it is exporting 1 Mbd to China.

The price of oil is currently enjoying a rally, having risen from $49/barrel to $60/barrel since January, thanks to OPEC supply cuts and signs that demand is set to rise as COVID conditions subside. The rally stalled in March and prices have hovered around $60/barrel for much of 2021.

The rally obscures the degree to which geopolitical shocks have contributed by removing capacity from the market. In Iran, this was due to sanctions. In Libya, production fell sharply from 1.16 Mbd to nearly nothing after the civil war in 2011. Ongoing violence kept production suppressed. In late 2020, output began to recover and the Libyan National Oil Company hopes to increase output to 1.45 Mbd by the end of 2021. Venezuela’s post-2015 economic collapse has caused output to fall off a cliff, but has recovered to around 500,000 bpd.

What this means is that oil that was kept off the market for years is slowly coming back on, at a time when the demand future looks uncertain and OPEC continues to buttress prices through coordinated production cuts.

Clandestine purchases by China mean that a great deal of Iranian oil is already flowing through the market.

Clandestine purchases by China mean that a great deal of Iranian oil is already flowing through the market. This suggests a deal over U.S. sanctions may have a smaller impact on the oil market. However, the best estimates suggest there is at least 1.5 Mbd in Iranian crude and condensate waiting for a market. Iran will seize the opportunity to export more once sanctions are lifted. That will place more pressure on OPEC to cut production yet again.

Greater Chinese Dependence

Alternatively, Iran could find a less hospitable environment than it faced in 2016. It may find its former customers have moved on, or that OPEC is less comfortable with permitting more Iranian crude on the market (thought the group’s abilities to prevent producers from pumping what they want are fairly limited).

This may encourage further dependence on Chinese demand, coming on the heels of a general Iran-China accord to improve economic and political ties. China, which imports heavily from Iran’s competitor Saudi Arabia, has taken on Iranian crude for a variety of economic and political reasons, some of which are tied to its competition with the United States. The fact that Iran is offering crude at a steep discount is also attracting Chinese attention. It may choose to grow closer to Tehran even if the United States agrees to return to the JCPOA, an agreement to which China is also a party.

It’s still possible talks in Vienna this week will fail, further prolonging the U.S.-Iranian rupture over the nuclear deal. Iran holds a presidential election in June. Yet decisions over nuclear policy are made by the Supreme Leader, Ayatollah Ali Khamenei. Though his position appears rigid, Khamenei clearly supports a return to the JCPOA by all parties, provided it does not require further concessions from Iran. There is considerable opposition to dropping sanctions on Iran among American conservatives, with members of Biden’s own Democratic Party wary of losing what they see as leverage over Tehran.

Nevertheless, provided some flexibility is shown by both sides, a return to the JCPOA appears likely at some point in the future. Oil markets will have to be ready for a potential flood of Iranian crude, putting more pressure on prices and squashing efforts by OPEC to boost prices as the global economy gradually recovers from the COVID shock of 2020.

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