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What the Iran deal will do to global crude supply and prices

Given the state of the global economy, demand picking up is more unlikely than supply side disturbance

Shishir Asthana  |  Mumbai 

It’s deal-making season, only at a country level. A day after the European Union agreed to sign a deal to bail out Greece, six nations led by the US on Tuesday agreed to sign a deal with Iran and relax sanctions on the country in return for restrictions on its nuclear weapons programme. The marathon ministerial level negotiations went on for two weeks in Vienna before a decision was reached.

No doubt, the deal is good for the Iranian economy which has been severely hit after a decade of sanctions restricted the amount of oil the country could sell. Iran surely will be happy with the deal but the same cannot be said about other oil-producing nations.

All oil producers have been affected by the fall in crude oil prices after the US increased shale oil production. From being one of the biggest importers of oil, the North American superpower turned a net exporter for the first time. Meanwhile, other oil producing countries kept on pumping more oil in a fight for market share.

To add to this, a global slowdown, especially by China – the biggest importer of oil in the world – has affected demand of crude oil. Europe too is reeling under deflation and Russian currency devaluation has made its oil cheaper. All these factors have contributed to oil prices and the net result is that the global oil market is now a buyer’s market, with supply exceeding demand.

Iran, once the sanction is formally lifted, will only add to the supply problem of the oil market. Iran’s oil minister has said that his country can add an extra 500,000 barrels per day within a month and around 1 million barrels per day within six months of the sanctions being removed. Iran currently exports about 1.3 million barrels per day (bpd) of oil, down from its 2.2 million bpd level ten years ago, before sanctions were imposed.

The extra crude will obviously have an adverse impact on oil prices; however, there are two points to be taken into consideration. One, with Iran increasing production, will the other OPEC (Organisation of Oil Exporting Countries) countries consider reducing their production?

This seems to be unlikely as even during the worst period of the oil slide when it nearly touched $40 a barrel none of the OPEC nations cut production. The fall in oil prices, however, resulted in many shale oil rigs closing down. OPEC countries maintained their production levels, and sometimes even exceeded them. Saudi Arabia, the largest oil producer in the world, increased oil production to its highest mark of 10.56 million barrel per day last month. Now Iran will have to join the fight for market share in order to bring its increased production to market, which can only be possible by pushing prices even lower.

Iran has the fourth largest oil reserve in the world. Though it produces only 1.3 million barrels per day, it is sitting on an inventory of around 40 million barrels stacked in its onshore tanks and over a dozen oil tankers floating on its shores. This oil can immediately hit the market.

Two, most of Iran’s oil wells have been mothballed for the last ten years. They will need some investments and refurbishment to start. Oil experts feel that these wells along with new ones will be ready to produce within a year. This will give the physical oil market sometime to adjust, but the futures oil market will discount this event immediately. Crude oil is already trading 2% lower despite not an extra barrel of oil leaving Iran’s shores.

The Iran-US deal will surely increase supply and keep prices low unless demand picks up. But demand picking up is a more unlikely prospect than supply side disturbance.

First Published: Tue, July 14 2015. 16:09 IST