Iran deal opens taps on cheap(er) oil

Lifting sanctions could flood the market with Iranian crude, but will Saudi Arabia take it lying down?

by Adam Gale
Last Updated: 18 Aug 2015

Iran finally clinched a deal with the international community today to scale down the UN’s suffocating sanctions in exchange for inspections to keep its nuclear programme firmly civilian. Yet while nuclear energy was at the heart of the talks, their greater impact could be on the oil markets.

Iran is the Middle East’s sleeping oil giant. It exported a mere 1.4 million barrels a day in 2014 according to the US Energy Department, compared to 2.6 million in 2011, before the sanctions were imposed, and up to 6 million in the 1970s.

Sanctions on exports and chronic underinvestment have kept it down, but now there’s the prospect that Iran could get pumping again. It could flood the market with its reserves within a few months and become a production powerhouse again within a few years.

That’s great if you’re Iranian or own a Hummer, but the problem for anyone in the oil industry is there’s already an oversupply in the market. Over the last year, Saudi Arabia has led OPEC into a price war with American shale frackers, whose unorthodox methods have doubled US production since 2008.

The price fell from $100 (£71) a barrel to less than $50, as the sheikhs kept production high to squeeze the returns on the frackers’ pricey wells, starving the Americans of investment. How successfully remains to be seen.

While there was a rebound in April, probably as a result of speculation, it’s fallen again in the last month on soaring Saudi production (self-reported today at a record 10.6 million barrels  a day) and the prospect of Iran’s return to the market. Today, West Texas Intermediate fell 2.3% to $51, while Brent crude fell 2.1% to $56.7.

Does this news mean the recent era of cheap oil will be prolonged? The Saudis price-slashing strategy may well deter the necessary investment in Iranian wells for a time, but that would only delay the inevitable.

So long as the Iranian and US legislatures approve the deal, Iran will reassume its position, and this means oil will be cheaper than it otherwise would have been. In the long run, however, the ever rising tide of global demand will overpower even the Saudis and the Iranians combined.

With economic growth still at 7%, China alone could probably absorb most of the increase, so long as its economy doesn’t stall. The price will eventually rise again, which means the frackers - and the renewable energy industry – will still have their day.

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