Iranian comeback and its implications for short-term oil prices

August 2015 | Elif Kutsal

Now that Iran, the US and other members of the international community have reached a deal to end sanctions, Iran is one step closer to export oil as it sees fit.

Efforts are expected to focus on lifting production quickly to raise much needed crude export revenues, rather than any attempt to influence price by constraining output, and this has been indicated officially. Such an approach is unsurprising given Iran’s reduced market share compared to pre-sanction levels, and its inability to support prices without help from other OPEC members. Today’s Iranian oil production of 2.5-2.8 Mbd is almost 2 Mbd lower than the pre-sanction levels of 4.5 Mbd, and far below the country’s peak of 7 Mbd in 1970s.

The question now is how much and how quickly will fresh crude hit the international markets - something which is largely dependent on how fast Iran can rejuvenate both its upstream production capacity and downstream infrastructure and supply chain.

Iran has set itself a target of 4 Mbd by the end of 2016 and at least 5.7 Mbd by 2018, but this looks overly ambitious given the sector’s lack of technical attention over recent years. We expect Iran to reach the 4Mbd output target with a delay, most likely in 2017-18. However, Iran could ramp up exports quickly starting with the release of the approximately 30 Mbbl of crude currently in storage (estimates range between 10 to 40 Mbbl), followed by a material production increase beginning in 2016, which will keep a cap on global prices throughout the year. Even an additional 0.3 Mbd of exports in 1H 2016 and up to 0.5-0.8 Mbd by the end of 2016 could keep prices at USD 50-60/bbl in 2016, according to our Energy Insights forecasts.

Softening forward prices are an indication of the market already pricing in this fresh future Iranian exports. The premium of the Oman oil futures – a good proxy for Iranian grades - 12-month contract over the front-month stood at just over 2% on 15 July, down from almost 25% six months ago. The first sales of stored oil have already begun, with the Iranian super-tanker, Starla - which had been used for 2 Mbbl floating storage off the Iranian coast since December - reportedly now heading to East Asia.

The next question is how OPEC will react to additional Iranian volumes. Saudi Arabia has been defending its market share by pumping record volumes, and despite a growing budget deficit, there seems to be no sign of any change in direction. Indeed, on the morning after the Iran deal was announced, the Saudis made it clear that the Kingdom’s crude production is likely to remain near recent record levels for at least the next few months. In June, Saudi Arabia pumped 10.56 Mbd, according to OPEC figures; the highest since figures began in the early 1980s. Thanks to its huge foreign assets and ability to tap domestic savings, the Saudis can survive lower oil prices. This market share battle within OPEC could lead to a purely competitive oil market, like coal or iron ore and significantly delay the time in which OPEC is able to regain control of the oil markets.

Iran, in need to raise revenues, is likely to push for an increase in its OPEC output quota to bring it back towards its traditional position as the group’s second largest contributor. This may cause tensions within OPEC, as it conflicts directly with the Saudi-led policy of keeping OPEC’s overall quota at 30 Mbd. Such tensions over market share and quotas may cast a bearish influence over the markets for some time to come.


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About the authors

Elif Kutsal is a Senior Analyst in Energy Insights' London office