20 Jul 2015 20:21 IST

Iran: Oil’s X factor

The price of benchmark Brent crude has dropped from the mid-sixties to around $58 to a barrel now. Investment banker Goldman Sachs which predicted an average price of $62 a barrel for 2016 now says that the Iran deal poses a downside risk to its forecast.

If all goes well, Iranian oil might start flowing into the global markets by the end of this year

The global oil industry is in a flap over the nuclear deal sealed last week between Iran and the West and it is not without reason. After the advent of shale oil and gas, the return of Iran — once the third-largest exporter — to the oil market, is the most significant development in recent times for the industry.

If all goes well, Iranian oil might start flowing into the global markets by the end of this year. Experts conservatively estimate that as much as 3,00,000 - 5,00,000 barrels of oil a day might hit the market by early-2016; while Iran’s Oil Minister Bijan Zanganeh is quoted as saying that exports could increase as much as by a million barrels a day.

Now, that is a significant number indeed, especially in a market that is already oversupplied (OPEC estimates oversupply of a million barrels in 2016) even without including the oil that will flow out of Iran. The Islamic Republic has also got about 40-million barrels of oil in floating storage (tankers) which can be immediately released into the market once the procedural formalities over lifting of sanctions are done with.

Big Oil companies are salivating at the prospect of laying their hands on the oil (and gas) riches of Iran. European majors, such as Royal Dutch Shell, Total and Italy’s Eni, are the first off the block; executives from these companies are understood to have visited Iran in recent weeks to start preliminary contacts with government officials for development of the country’s oil and gas fields.

Candy store

Iranian oilfields are in desperate need for investment and new technologies; they’ve been deprived of both for several years thanks to the sanctions imposed by the West. The reserves are proven and the risks are minimal for the Big Oil majors compared to exploring in frontier basins with unknown reserves potential. And Iran is designing friendlier terms of contracts and engagement with the oil companies compared to the past. The Financial Times, in an apt comment, called Iran a “candy store” for Big Oil companies with a “multibillion-dollar shop window of oil and gas projects”.

If the oil is attractive even more so are the prospects of gas. Iran has the second-largest gas reserves in the world, after Russia, but it has been unable to ride the boom in gas over the last decade due to sanctions. Its next door neighbour, Qatar, with whom it shares a major offshore gas field, has capitalised on Iran’s absence and quickly built up large infrastructure for liquefaction of natural gas into LNG (liquefied natural gas) and also signed long-term contracts with buyers. India is one of them.

He who drills

According to Iran’s Oil Minister, quoted in Financial Times, much of its gas that should have flowed out of its own wells is now flowing out of Qatari taps! The comment may not be too off the mark because oil and gas reserves are contiguous and extend beyond national geographical boundaries. Whoever drills the well gets the prize.

Iran is strategically located to large gas markets such as India and China, which are the growth areas of the future. A gas pipeline was planned from Iran to India through Pakistan many years ago but had to be shelved for various reasons. A deal for LNG was also discussed between Iran and India but it never progressed due to sanctions.

For Big Oil companies, such as Shell, which has deep expertise in the LNG market, Iran is indeed a “candy store”, which explains the fact that it was one of the first to establish contact with the Iranian government even before the ink on the nuclear deal dried. Just imagine the potential for setting up an LNG chain from Iran to India or China — on one side is massive reserves of gas waiting to be tapped and on the other a market with an ever-growing hunger for energy. This should explain why the oil industry is now all aflutter over the nuclear deal.

On a retreat

Meanwhile, oil prices appear headed for a prolonged period of softness unless if growth revives miraculously in the US, Europe and China. An already over-supplied market will be awash with Iranian oil in the next few months and that can have only one effect on the price — push it downwards. The only way to support prices in the absence of demand growth is by cutting output but geopolitics is likely to ensure that this will not happen.

Saudi Arabia, which sees Iran as a regional rival, is a Sunni country while Iranians are Shias. The last thing that Saudi Arabia would want to do is push up prices by cutting output as that will help Iran realise more for its oil. To the contrary, the Saudis will want prices to drop further if only to ensure Iran does not benefit. Saudi Arabia has shown in the last one year that it has the required stamina to bear a prolonged period of low oil prices when it took on the shale oil producers in the US. There is nothing to suggest that the stamina has now decreased.

It is not surprising therefore that oil prices have been on the retreat in the last couple of weeks. The price of benchmark Brent crude has dropped from the mid-sixties to around $58 to a barrel now. Investment banker Goldman Sachs which predicted an average price of $62 a barrel for 2016 now says that the Iran deal poses a downside risk to its forecast. The oil market cycle is now firmly on the side of buyers and is likely to remain so for the near future.