Editor's Note: This is Part 1 of a two-part analysis on energy implications of the July 14 nuclear agreement between and Iran and six world powers. Part 1 will focus on the short-term effects of Iran's return to the global oil market while Part 2 will focus on the longer term.
The nuclear agreement between Iran and six world powers will naturally have consequences for global oil markets as Iran, the world's third-largest oil producer before the Iranian Revolution, eventually exports more oil. Prior to the implementation of sanctions in 2012, Iran was a major crude oil and condensate exporter to Asia, Europe and others — in fact, exports totaled 2.6 million barrels per day in 2011. Today, that figure has fallen by almost 600,000 bpd to Europe and another 600,000 bpd to Asia. Iranian exports now hover closer to 1.4 million bpd, 1 million bpd of which is crude oil.
The July 14 deal paves the way for sanctions to be relaxed by early 2016, enabling anyone to buy oil from Iran. While Iran maintains that it can increase oil production by 500,000 to 600,000 bpd within one month of the removal of sanctions and increase exports to 2.5 million bpd within three months, Stratfor sees these figures as overly optimistic. Iran does, however, have at least 35 million barrels of crude oil and condensate in storage that it could use to increase exports in the interim before its oil production rises again. 2016, consequently, will likely be another year where a healthy oil supply tamps down any oil price recovery.
Potential Obstacles in Washington and Tehran
There are, of course, potential obstacles to passing the deal, both in the United States and Iran. In the United States, President Barack Obama is preparing for a fight with the Republican-controlled Congress, which could reject the deal. Congress has a 60-day review period to approve, disapprove or do nothing with the deal, in which case the agreement would go into effect. Obama has said he will veto any rejection of the deal, and Congress would find it quite difficult to assemble the two-thirds vote in the House and Senate needed to override the presidential veto.
Obama cannot lift sanctions or issue presidential waivers allowing countries and companies to skirt the sanctions during the 60-day review period, only after. The European Union, Japan and South Korea, meanwhile, can remove sanctions more quickly, most likely giving companies from these countries an advantage in investing in Iran.
In Iran, the parliament is interjecting by demanding a full removal of sanctions upon the deal's signing. Supreme Leader Ali Khamenei and his security council, however, probably have the authority to block the deal. But President Hassan Rouhani and Foreign Minister Javad Zarif likely would not have reached this stage of the process without Khamenei's blessing. Once the supreme leader has backed the deal, or at least failed to block it, most of the rest of Iran's politicians should fall in line and stop seeking to halt its implementation.
Sanctions Relief Meets Maintenance Issues
Assuming Washington and Tehran avoid their respective obstacles, sanctions relief could happen by the first quarter of 2016, if not the end of 2015. EU and U.S. sanctions are to be simultaneously suspended once the International Atomic Energy Agency (IAEA) issues a final report that Iran has implemented the terms agreed to under the nuclear deal. The IAEA draft report could come by Dec. 15. The IAEA Board of Governors, which has meetings scheduled for Nov. 26-27, 2015, and March 7-11, 2016, will then vote on whether to adopt it. If the board adopts the report, sanctions would be suspended.
Markets could have indications as to how the IAEA inspections went as early as mid-December. We expect sanctions relief by the first quarter of 2016 (again, assuming domestic opposition in the United States and Iran is overcome), allowing Iran to renew exports.
Iran will begin preparations to bring mothballed fields back online prior to sanctions relief so it can resume exports immediately. But once fields are taken offline — especially for an extended period — they cannot all be brought back online at maximum capacity without new investment. It is unclear how well maintained these fields are and what, if any, damage to infrastructure, equipment and reservoirs occurred during the shutdown process. While not nearly as technologically proficient as its Western counterparts, the National Iranian Oil Co. is not inept, and it likely shut down its most mature fields with lower levels of production and higher operating costs first.
It is difficult to ascertain how much production capacity Iran actually has, and how expensive or difficult it will be to bring mature, largely inefficient fields back online. All of this uncertainty has created wide-ranging expectations of how quickly production will increase.
Dealing with aging oil fields is not a new problem for Iran either. Even prior to sanctions and the exodus of Western companies, Iran had been in the process of injecting gas (along with other methods of enhanced oil recovery techniques) to maintain pressure in the reservoirs to slow the natural decline rate of these fields, often rising as high as 10 percent annually, helping to maintain production levels. But even when Western companies were still there, Iran failed to meet its targeted injection rates. How quickly Iran can drill new wells and build new injection facilities before sanctions relief occurs, then, is unclear. It is one reason Stratfor is suspicious of short-term optimism regarding Iranian production.
New Oil Fields and Stored Petroleum
Yet while sanctions were in force, Iran did not totally abandon the development of new oil and natural gas fields. At times with Chinese assistance, Iran has been developing the massive South Pars natural gas and condensate field. (Condensate is a low-density mixture of hydrocarbon liquids that coexist with raw natural gas deposits in many natural gas and oil fields.) Over the past few years alone, 120,000 bpd of condensate production has come online, a figure projected to increase in 2016.
Condensate production is becoming a more substantial percentage of Iranian petroleum production. All told, new condensate production could easily add 100,000 to 200,000 bpd to Iranian oil production in 2016 with Iranian crude oil production separately increasing by as much as 300,000 bpd by the middle of next year depending on when the IAEA actually adopts its report. Whether crude production in fact reaches that level depends on how much Iran prepares before sanctions end, and we fully expect lower production figures. As more injection wells are put into operation and new wells are drilled, Iran's oil production capacity could increase even more by the latter half of 2016 — perhaps even returning close to pre-sanction levels (an increase of about 750,000 bpd over current levels) sometime in 2017.
However, oil exports may well exceed oil production capacity. Iran has stockpiled substantial volumes of petroleum, a little more than half of it condensate, in tankers offshore and onshore storage tanks for the last few years. Stored Iranian crude oil, which totals 35 million barrels, could quickly be sold. Iran, though, is unlikely to flood the market with this oil storage right away, opting instead for sustained exports as production capacity comes back online over the course of 2016.
Finally, Iran's oil exports will affect global energy markets and the countries in them. Renewed oil exports in 2016 will continue to keep global oil prices down, ensuring less risk to prices. Subsequently, countries suffering from low oil prices, such as Venezuela, will continue to be battered. North America will be affected as well. Expensive producers will continue concentrating on their most efficient operations, hampering supply growth and cementing previous production declines in the United States.