How will Iran’s return to oil markets impact prices

Oil Price
How will Iran’s return to oil markets impact prices

The United States and Iran are in the final stages of agreeing on a new nuclear deal that could see the return of Iranian crude on international markets, which some analysts say would result in downward pressure on oil prices–an eventuality Saudi Arabia is trying to avoid. Still, other analysts suggest that the return of Iran to oil markets could be completely irrelevant for prices, Oil Price writes.

Earlier this month, Saudi Arabia’s energy minister Abdulaziz bin Salman hinted that OPEC+ could decide to reverse its production growth strategy in response to what he called "a self-perpetuating vicious circle of very thin liquidity and extreme volatility" on oil markets. The news sent Brent over $100 per barrel after the international benchmark slipped below that threshold amid deepening fears of a global recession. It was this fear that led to the divorce between paper and physical markets that bin Salman referenced in an interview with Bloomberg last week, when he noted that traders are ignoring the tightness on physical oil markets.

However, some analysts have suggested that the Saudis are getting nervous about a potential Iran deal that would see their arch-rival in the Middle East join international oil markets legally. The Financial Times reported last week, citing several analysts, that bin Salman’s hint about a production cut was, among other things, aimed at the White House as a warning of what would happen if the United States does end up sealing a deal with Iran.

 “Earlier this year I think it’s fair to say Saudi Arabia and other regional actors were reasonably confident the Iran deal wasn’t going to happen in the near future,” RBC Capital Markets’ Helima Croft said. “Now that the negotiations have been revived I think they will be focused on both the oil market and the wider security implications of this deal,” she added. 

Yet in the context of security implications, it is worth noting that there has been a thaw between Iran and Saudi allies. Just this month, Iran restored diplomatic relations with the United Arab Emirates—the closest Saudi ally in the Middle East—and Kuwait. Next on the agenda is Saudi Arabia itself and the Iranian side has signaled optimism about this development.

In other words, Saudi Arabia and Iran are taking steps to restore bilateral relations after these were severed in 2016 after the execution of a Shiite Saudi cleric in the Kingdom. This, if it happens, could have huge implications for the security situation in the Middle East and it will also consolidate OPEC. Such a consolidation would arguably render a new nuclear deal with Iran irrelevant for oil prices.

OPEC+ has demonstrated that it can control the supply of crude oil whenever necessary.

Warnings from analysts that a nuclear deal could see oil falling to below $70 and even to $60 per barrel have a sound basis but there is one little detail that the FT analysis did not mention: prices won’t stay low for long. Not if OPEC+ does not want them to stay low.

A couple of months ago, the spare capacity of OPEC+ came to the fore as at the time the market fretted about supply security in the face of strong demand and production constraints. Saudi Arabia admitted it could not boost production much more from current levels at short notice. The result was greater fear about supply security that only subsided as an even greater fear overwhelmed markets: recession.

Recession will indeed hurt oil demand although in some parts of the world such as Europe it might actually help it grow: gas prices are so high that utilities are switching from gas to oil in parts of Europe, such as Germany.

Yet OPEC+ has demonstrated that it can be flexible not only with regard to production control but with regard to prices. Few remember that far back but it was less than two years ago that various OPEC officials signaled a range of $60 to $70 per barrel of Brent crude was a good one for the cartel. Now, some analysts are arguing that OPEC wants to put a floor on oil and this floor is $100. A return of Iranian crude to international markets would certainly compromise this floor, for a while, at least.

But if the return of Iran coincides with a continued thawing with Riyadh, one could safely bet that the two would coordinate on oil production, them and Russia, too. Whether or not Iran exports oil legally or skirts U.S. sanctions is not all that relevant for oil prices in the longer run.

With a deal, Iran would certainly be eager to boost exports. At the same time, the Saudis and the Emiratis stand ready to reduce their own production to keep prices comfortably high. Iran, by the way, would certainly not mind higher prices, either, after years of sanctions that must have affected its coffers. It would really be a win-win.

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