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.
