The West Lifts Sanctions Against Iran: Now What?

6 MINS READJan 16, 2016 | 21:08 GMT
The West Lifts Sanctions Against Iran: Now What?
(ATTA KENARE/AFP/Getty Images)
Iranian Oil Minister Bijan Zanganeh speaks in Tehran in 2014, outlining his vision for a post-sanctions Iran.

The International Atomic Energy Agency released a report Jan. 16 confirming that Iran has honored its commitments to the nuclear deal it reached with international powers in July. With the announcement comes the prospect of Iran's return to the international community and, more important for its government, the end of most EU sanctions and several important U.S. sanctions. With the legal frameworks already in place, the European Union and United States announced the formal repeal of their respective sanctions shortly after the release of the report.

Iran's oil sector will be the first beneficiary of the agreement, which will remove most of the sanctions that cap export volumes. The European Union is removing its embargo on Iranian crude oil imports, and the United States is suspending its so-called secondary sanctions on foreign firms doing business in Iran. This means that Washington will no longer sanction a foreign company that imports Iran's oil or invests in its oil sector. However, the U.S. embargo remains largely intact, so while other Iranian industries will also see the benefits of the agreement, those benefits will mostly derive from trade with — and investment from — Europe. 

Tehran has been preparing for this moment for some time. Iranian Oil Minister Bijan Zanganeh has said his country will raise oil production in two phases. In the first phase, Iran will increase oil production by 500,000 barrels per day within a week of the sanctions' removal. In the next phase, it will raise production by an additional 500,000 bpd within six months.

But there are questions as to whether Iran can do all it aspires to. The government has insisted that it has the capability to reach its goals, but it is unclear whether Tehran can bring as much oil to market so quickly. Iran's most recent annual production tests suggest it can increase production to 500,000 bpd relatively quickly, according to Stratfor sources. Despite this, Tehran's six-month outlook is much grimmer.

This is because Iran cannot flip a switch and expect to pump as much oil as it once did. Much of the country's installed capacity is in older fields that decline by 8-10 percent annually. And even if shutting down the fields has the added benefit of raising reservoir pressure — which could expedite the process by which oil is extracted — Iran cannot really increase its production without new upstream activity, either at existing or new fields. Simply put, Iran needs a substantial amount of investment to bring its new fields online — investment that will not materialize for several years.

In the meantime, Iran will sell the oil it has in storage, the amount of which ranges from 7 million barrels to 50 million barrels of crude oil and condensate, depending on which estimates you go by. Stratfor believes Iran has at least 25 million barrels in floating storage depots in the Strait of Hormuz. If Iran has 50 million barrels in storage, that alone could increase exports by 500,000 barrels per day for more than three months.

The exports will go to Iran's traditional destination markets. Some 200,000-220,000 bpd will be exported to customers in France, the United Kingdom, Italy, Spain and Germany, according to the National Iranian Tanker Co. Iran also plans to increase exports to India, a huge consumer of energy, by 200,000 bpd.

Telling Statements

But while Iran's return to market bodes well for its own economy, it bodes ill for oil prices, which are already in a state of decline. After dipping to $36.61 at the end of 2015, Brent touched $29.00 per barrel on Jan. 15 — a 20 percent drop in just two weeks.

Current prices have factored in Iran's return to market, but it is not clear how accurate the prices are. Prices could fall to the $20 per barrel range, which would be extremely detrimental to oil producers such as Venezuela and Russia. For its part, OPEC failed to reach a consensus at its meeting in December on how to scale back production to stabilize prices. And now that prices are 30 percent lower than they were when the meeting was held, two OPEC members (one of which is probably Venezuela) are calling for an emergency meeting sometime before June.

But convening an emergency meeting is unlikely to change the policy of OPEC's core members: Saudi Arabia, Kuwait, Qatar and the United Arab Emirates. These four countries have formed a common policy on managing production, and they are prepared to withstand a lengthy period of cheap oil. Over the past two weeks, Saudi Arabia and Qatar have raised the price of domestic fuel prices; the United Arab Emirates did so in 2015. All four have curbed public spending and can withdraw from their extensive sovereign wealth funds and foreign currency reserves. Furthermore, they can issue debt to plug the gaps in their budgets, and they have even discussed implementing further economic reform. Saudi Arabia, for example, will hold initial public offerings on stakes in certain units of national oil company Saudi Arabian Oil Co.

Even more telling are the statements made by the Emirati energy minister, who as recently as Jan. 12 insisted that OPEC's strategy was working. He also said the plan would need an additional 12-18 months to run its course. Perhaps he is right. Currently, global production growth has not fallen far enough for prices to recover.

But there is also a political component to OPEC's refusal to cut production. Gulf states are fighting several proxy wars with Iran, their regional rival. Cutting production without Iran's doing the same would be tantamount to subsidizing Tehran, which is politically untenable.

Sanctions relief will be a welcome reprieve for the Iranian economy, but for President Hassan Rouhani and his supporters, the reprieve may have come too late.

Too Late a Reprieve?

Sanctions relief will be a welcome reprieve for the Iranian economy, but for President Hassan Rouhani and his supporters, the reprieve may have come too late. The country is gearing up for elections in February, when Iran will elect a new national parliament and assembly of experts, which can choose and remove the supreme leader. Hard-liners have strongly criticized Rouhani's more moderate and traditional conservative supporters by downplaying the significance of the nuclear deal. With sanctions removed, Rouhani's supporters may be able to capitalize on the momentum in election polls.

More important for Rouhani, the country will hold its presidential election in early 2017. Low oil prices present Rouhani with a difficult challenge. He originally campaigned on a platform of improving Iran's relations with the West to improve Iran's economy, weighed down as it was by sanctions. But with oil prices so low, Rouhani will have a difficult time showing how sanctions relief actually improved the lives of his constituents. Even if Iran does achieve its goals of increasing oil production by 1 million bpd, the president needs oil prices to reach at least $60. Absent that, oil revenue will be lower than it was when oil was $110 per barrel — in other words, lower than when he was elected. 

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