Economic consequences of the peace with Iran

A final deal with Iran could depress oil prices by around $9.

On 2 April, the world’s major powers (the so-called P5+1) and Iran announced a framework for a final agreement on Iran’s nuclear programme. The P5+1 are demanding limits on Iran’s nuclear programme in exchange for lifting the sanctions which have crippled the country and its economy. The impact that this announcement will have on the oil market depends on three related questions: Will the announcement lead to a lifting of the sanctions on Iran? How much will Iran produce once the sanctions are lifted? And how will the extra Iranian production affect oil prices?

Will the announcement lead to a lifting of the sanctions on Iran?

The announcement was far from being a final deal. It merely represented a set of parameters which will form the foundation of the final agreement. Long and hard negotiations are expected before the 30 June deadline, and “nothing is agreed until everything is agreed”.  But, a deal looks now more likely than it before the announcement, if only because the framework was more detailed than expected.

Sanctions, in particular, remain a thorny issue. The framework suggests that sanctions will be lifted only after “after the IAEA has verified that Iran has taken all of its key nuclear-related steps”. This could take six months to a year after reaching a final agreement, according to John Kerry, the US secretary of state. So sanctions are unlikely to be lifted until the first half of 2016, which runs contrary to the Iranians’ desire for their removal on the day of the agreement.

How much will Iran produce once the sanctions are lifted?

According to the latest estimates by the International Energy Agency, Iran has a spare oil capacity of 0.76m barrels per day (b/d) which can be reached within 30 days. It is fair to assume that Iran will try to produce and export the bulk of this spare capacity once the sanctions are lifted.

How will the extra Iranian production affect oil prices?

Useful lessons can be drawn from the Libyan supply shock in 2011. In that episode, Libya’s production declined from around 1.7m b/d to only 0.5m b/d resulting in a 25% increase in oil price from mid-February to end-April 2011. Assuming that Iran will impact the market proportionally but in the opposite direction, the additional expected Iranian production will probably lower oil prices by 16% (=25%*0.76/1.2). This means that the lifting of sanctions on Iran could depress oil prices by around $9. This assessment is similar to that of the US Energy Information Administration, which expects that additional Iranian production would lower oil prices by $5-$15.

Conclusion. While there is still a long way before a final deal with Iran is reached, the recent agreement on a framework is an important step in that direction. Once a final deal is reached, it could result in a lifting of the sanctions in the first half of 2016. This would add 0.76m b/d of extra Iranian oil into the market, which could depress oil prices by around $9.