Iran, the oil price, and the road ahead for oil

Mihir Kapadia, CEO and founder of Sun Global Investments, ponders the road ahead for black gold

Mihir Kapadia, CEO and founder, Sun Global Investments.
Mihir Kapadia, CEO and founder, Sun Global Investments.

Economic sanctions are always driven by political concerns, and this is especially likely to be the case where President Trump is concerned.  Any decision by him to impose sanctions is bound to be a big political statement. His announcement to withdraw from the Joint Comprehensive Plan of Action (JCPOA) was a major act of political showmanship and its impact has commenced with an economic clampdown on Iran.

The energy sector has been Iran’s engine for economic growth for decades, contributing the biggest chunk to the government’s purse due to the exports of about 1.5mn barrels per day of crude oil until the first half 2012.  When the West imposed sanctions midway in 2012, aimed at curbing Iran’s nuclear programme, the oil industry was directly affected, with an exponential fall in exports due to the uncertain trading environment. The Iranian oil industry’s decline came at a time when Iran was in fact the second largest crude exporter from the Organisation of the Petroleum Exporting Countries (OPEC) cartel, and when oil prices were at a rapid upward trajectory.

Missteps of 2014

As one of the largest producers within OPEC, the sudden demise of Iranian exports provided a perfect opportunity for the cartel to re-balance the markets through consolidation. However, as oil prices then were inching towards the $100 mark in 2013, OPEC and its leading producers (led by Saudi Arabia) were keen to monetise the rising prices and generate profits through further production. This contributed to the over-production and subsequent oil glut which brought the formerly high flying oil markets crashing down to $28 in 2016. 

The significant overproduction of oil during a period of weak demand led OPEC back to the drawing board to re-think production strategies, ultimately resulting in the historic production cutback deal in 2017 which is credited for the current higher oil prices.

New US sanctions have caused uncertainty as American allies in the EU and abroad firmly wish to remain committed to the JCPOA deal.

The united front initially presented by the original JCPOA signatories – UK, Russia, France, China, Germany and the EU, has complicated international diplomacy as it now creates a highly complex web for businesses that would seek engagement with Iran. As US financial institutions dominate the re-insurance and banking payments – reflecting the global role of the US dollar – international businesses will continue to remain hesitant to engage with Iran due to fears, and unambiguous threats courtesy of President Trump himself, of future US retribution down the line.

Some of Europe’s biggest firms who rushed quite enthusiastically to do business with Iran after the nuclear deal now find themselves reluctantly compelled to choose between persevering with their plans to invest there  - or trading with the US.

The US threat

Commodity markets often perform better during turbulent global geo-political times, and for oil, the past few months have been significant in terms of the support for prices due to the uncertainty in the Middle East. As President Trump carried the anti-Iran rhetoric, it created the expectation amongst some analysts of a market consolidation that would provide support for prices. While there is a great degree of uncertainty on the future of the JCPOA, the biggest deterrent to the oil markets currently has been the aggressive increase in oil production in the US, which is expected to be the single largest producer by the end of the year.

While the recovery of oil prices can only be credited to OPEC’s historic accord, along with occasional market support provided by geopolitical events, the commodity’s future will continue to be primarily dependent on OPEC’s internal stability. For OPEC, Iran had always been a difficult member nation, as it was quite vocal against extending the production cutback accord.

With oil markets having tightened in general though the first half of 2018 and with a forecast for a continued demand for the rest of the year, the heavyweight producers within OPEC have been seeking to capitalise. While Saudi Arabia and Russia were vocal proponents seeking to cash in on the higher prices, countries including Iran and Venezuela were resisting the moves citing a lack of preparedness to raise their production, fearing a loss in revenue and market share.

The biggest proponents for the production increase from OPEC are keen to make the most of the higher prices to cover their budget deficits. These are tricky waters to navigate. Should there be infighting within OPEC, the last year of hard work by the group may start to unravel.

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Oil & Gas Middle East - September 2019

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