Clear thinking required as sanctions loom for Iran
All leading oil exporters ought to be concerned by a leap in oil prices
The high oil price predictions have started re-emerging in response to the US’s abandonment of the Iran nuclear deal.
Saudi Arabia has quietly sounded out $80 or $100 per barrel, Bank of America has put forward $100 for 2019, and hedge fund manager Pierre Andurand suggested $300. Opec needs a strategy to prevent the market running away.
Iran exports about 2.5 million barrels per day (bpd) of crude oil and condensate (derived from natural gas), although April sales were higher as it sought to drain storage ahead of the sanctions announcement. The Obama-era sanctions, which did not include condensate, reduced its exports by about 1 million bpd. The current unilateral measures, not supported by the EU, China or Russia, should have less impact.
The market has already been going through a supply shock more consequential, so far, than the constraints on Iran. Venezuela, producing 2.1 million bpd in January 2017, was down to 1.5 million bpd in April and is now pegged at 1.41 million bpd as its economy collapses and oil workers go hungry or walk off the job. In pursuit of a $2 billion arbitration award, ConocoPhillips has begun seizing Venezuelan oil storage and terminals in the Caribbean, further hampering its exports.
The combination of Venezuela’s travails with a so-far strong global economy, Saudi Arabia’s voluntarily under-producing its allocation and Angola’s falling below target as its fields mature has pushed up prices sharply.
Now, the American abandonment of the Joint Comprehensive Plan of Action nuclear deal clouds the current accord between the “Vienna Group” of Opec, Russia and some other leading non-Opec producers. Political opinion in the amalgamation is divided between Tehran allies, notably Russia; those without a dog in the fight, such as Nigeria; those that have sought to steer a middle course, including Iraq, Oman and Kuwait; and those, led by Saudi Arabia and the UAE, that have been pushing the US for tougher action against Tehran. Iran will probably consider itself no longer bound by the deal if sanctions begin to bite, although that doesn’t matter practically if its exports are hampered below its allocated level of production.
To avoid collapsing the Opec pact, Riyadh has suggested that any increase in production would be coordinated with the other adherents. But that would mean a difficult re-allocation of the burden, since the Arabian Gulf members and Russia would benefit at the expense of most of the others.
Saudi Arabia and its political allies will wish to maintain pressure on Tehran. And that requires lower, not higher prices. High oil prices mean that Iran will not lose in revenues even if exports are curbed. Customers for Iranian crude will have an incentive to find ways round the measures. Political pressure on the US Trump administration, both at home and around the world, will mount if its actions are seen to have led to soaring petrol prices.
Quite apart from political factors, all leading oil exporters ought to be concerned by a leap in oil prices. This is often a harbinger of a recession and subsequent slump in demand. Even if not, it will further encourage electric vehicles and other non-oil competitors.
The US’ agenda of “energy dominance” ought to be able to meet shortfalls. But in such a situation, the giant has three weaknesses. Firstly, the US does not maintain spare capacity nor does the government direct production and export levels.
Secondly, US production growth is constrained, mainly by a lack of pipeline capacity, which will likely only be alleviated late in 2019.
Thirdly, shale oil is mostly very light, good for making petrol and petrochemicals, not good for the diesel and kerosene that heavy goods transport, ships, aeroplanes and industry depend on. Venezuela, Russia, Iran and the rest of Middle East Opec produce medium and heavy grades that yield more of these vital “middle distillates”.
Spare capacity in Opec and allies to meet a possible Iranian shortfall is available, but not infinite. Saudi Arabia, as usual, is the keystone, with about 2 million bpd available. The UAE and Iraq have about 300,000 bpd spare each, Kuwait 240,000 bpd, and Russia perhaps 100,000 to 150,000 bpd. Iraq’s extra capacity is around Kirkuk, locked in until there is agreement between Baghdad and the Kurdish authorities to use their pipeline. Kuwait’s and some of Saudi Arabia’s spare is in the Neutral Zone, closed down by an environmental dispute, although that could probably be resolved in an emergency.
If Iran’s production is severely restricted over a longer period, as it was during 2012-15 and as Iraq’s was in the 1990s, the other Opec members will have to increase their overall production capacity to make up. Iraq and the UAE are doing this, Kuwait wishes to if it can overcome domestic politics, but the most important producer, Saudi Arabia, has been studiedly ambiguous on its future plans.
The reimposition of sanctions on Iran and the implosion of Venezuela are hardly unforeseen events. So the key Opec players and their allies need to give clear guidance to the market: how will they react to a production shortfall or too-steep rise in prices?
Robin M Mills is CEO of Qamar Energy, and author of The Myth of the Oil Crisis
Updated: May 13, 2018 02:59 PM