Now that the U.S. and other world powers have reached an agreement with Iran, limiting its nuclear program and eventually lifting sanctions, investors are faced with several questions. Key among them: the terms of production agreements that Iran strikes with Western, Russian and Chinese oil firms and how this may affect longer-term investments in one of the world’s largest reserve basins.
The nuclear accord, of course, is far from implementation. Among other steps, the U.S. Congress has 60 days to approve the deal; should it disapprove, Congress may struggle to overcome a White House veto. The International Atomic Energy Agency (IAEA) also must verify that Iran has completed its commitments. In short, a lot can still go wrong.
Should all work out, though, over the next 12 months Iran could provide an additional 500,000 barrels per day (b/d) – a not-immaterial volume but only one-third of what the U.S. added to global supplies in 2014. Moreover, we view this increase as more than discounted at current prices.
The more meaningful impact would be on long-term investment. Iran has a sizable reserve base, much of which is already known to Western oil companies that once operated there. Much will depend on contract terms with Western, Russian and Chinese oil companies. Should Iran choose to use production-sharing agreements and create agreeable terms for investment, it could simply move the needle on what Iraq and other countries would need to do to match. One caveat, though: Western oil companies in particular may be concerned about “snap-back” provisions, which would reimpose sanctions for Iranian non-compliance, limiting investment.
Another wrinkle is whether Saudi Arabia will respond by increasing output and hence lowering prices. The latest production data from Saudi Arabia – an increase to 10.55 million b/d – is telling. The Kingdom appears unwilling to cede market share to Iran or other producers; if anything, it seems to be increasing output to make up for lost revenues. If Saudi Arabia goes to 11 million b/d, then a market equilibrium price of around $60 per barrel for Brent crude is more reasonable than $65–$70.
Overall, we view this as a bearish event, but less because of incremental oil supplies in the next year and more because of the impact Iran could have on other suppliers over the long term. In our view, though, much of this Iran risk has been priced in already.