Was Iran’s Claim About Ramping Up Oil Production Just Hype?

Lost in the financial market turmoil in the first weeks of 2016 has been the abrupt change in Iran’s public posture on its post-sanctions oil export strategy. Several times in the past week, an authoritative Iranian petroleum industry official stated that Iran would shape its export strategy to avoid exacerbating pressure on crude prices. January 2, Bloomberg quoted Seyyid Mohsen Ghamsari, the head of international affairs at National Iranian Oil Company as saying that Iran:

“…will try to enter the market in a way to make sure the boosted production will not cause a further drop in prices. Production potential does not mean we will be entering the boosted production into the market or stockpile it. We will be producing as much as the market can absorb.”

January 6, according to Reuters, Ghamsari underscored Iran’s aversion to adding downward pressure to crude prices:

“We don’t want to start a sort of a price war. We will be more subtle in our approach and may gradually increase output. I have to say that there is no room to push prices down any further, given the level where they are.”

Ghamsari’s measured approach stands in sharp contrast Iran’s public posture in 2015’s second half, during which Iranian officials promised to push crude exports energetically as soon as the international community lifted sanctions. In September, soon after the P5+1 countries reached agreement with Iran on its nuclear program, Iranian Oil Minister Bijan Zanganeh stated that “Production will rise immediately by a half-million barrels per day, and after four to five months, by an additional half-million barrels”. As the December 4 OPEC meeting in Vienna approached, Zanganeh asserted that Iran would not seek OPEC’s permission to export an additional 500,000 barrels daily and was not concerned about the impact on crude prices:

“The drop in prices won’t be a concern for us. It should be a concern for those who have replaced Iran.”

Why the Shift?

Several explanations for the shift in public posture are possible. One is that Iran’s immediate post-sanction aggressive public posture was a bluff—that Iran currently does not have the physical capacity to produce and export an additional one million barrels and cannot do so without substantial foreign investment. International sanctions on Iran over the years have eroded Iran’s oil production, transportation, and export infrastructure. The conditions of its oil wells likely deteriorated and require extensive maintenance, while many pipelines are in poor condition and potentially unfit to handle increased volumes.

Another (and not necessarily contradictory) explanation is that Iran recognizes its aggressive public posture is proving counterproductive—that it contributed substantially to the decline in crude prices in 2015. The following table provides the monthly OPEC basket crude price for 2015. In the first quarter, as global markets absorbed the shock from the shift in OPEC production policy at its November 27 meeting in Vienna, crude prices began to stabilize.

In the second quarter, prices increased as markets anticipated supply and demand soon would balance. In the third quarter, however, as an agreement between the P5+1 countries and Iran grew increasingly likely, markets anticipated that the end to limits on Iran’s oil exports would delay rebalancing and prices resumed their decline. In the fourth quarter, Iran’s assertion that it would increase exports by one million barrels per day in the course of 2016 exacerbated the downward pressure and the OPEC basket price reached its 2015 nadir at $33.6. In January, the OPEC basket price reached ~$30 per barrel.

The decrease in crude prices means that the incremental 500,000 barrels per day will now generate less net export revenue for Iran than exporting only one million barrels at $45 per barrel. Assuming that increasing the total incremental export volume to one million barrels per day would cause the OPEC basket price to drop an additional $5, to $25 per barrel, net revenues would fall further (annual revenues net of the $15 production cost).

Of course, Iran will generate more net revenue exporting 1.5-2.0 million barrels daily than it will exporting only one million barrels at $30 per barrel. However, Iran desperately needs foreign investment in its oil industry. Due to low crude prices, Iran’s investment in its oil industry has dropped to a trickle.

http://time.com/4175139/iran-oil-production/