Why Iran is a problem for the oil market

An Iranian oil tanker, moored at the port of Assaluyeh for more than a year, set sail for South Korea last week, heralding a new period of uncertainty for world crude prices.

The global oil market, already suffering a supply glut, has been anticipating the arrival of Iranian crude for months, and now that sanctions against its nuclear program have been lifted, Iran is free to sell more of its oil into a market already oversupplied by 1.5 million barrels or more a day.

At the same time, neighboring Iraq promises to produce even more than its current 3.7 million to 3.8 million barrels a day, a recent record. Reports that Iraq could produce more than 4 million barrels a day weighed on energy prices Monday. West Texas Intermediate crude fell 5.8 percent to $30.34 per barrel.
An Iranian oil tanker is seen floating on the Caspian Sea.
Henghameh Fahimi | Getty Images
An Iranian oil tanker is seen floating on the Caspian Sea.

Saudi Arabia, the world's biggest exporter, has pledged to keep its approximately 10.2 million barrels a day of output steady — or even raise it — unless other producers agree to cut back, an unlikely outcome.

Other OPEC members in the Gulf, like Kuwait and the United Arab Emirates, have stood behind Saudi Arabia, which drove the more-than-year-old policy of letting the market set prices, rather than the cartel's traditional tactic of attempting to control them with production levels.

But it's Iran and Iraq as well as Saudi Arabia that are most capable of adding to OPEC supply, about a third of the world's daily oil output. While Iraq may be close to its limit, officials have said they could add several hundred thousand more barrels a day.

"Those three have to find a way to come together. They have to find a way to sort this out. The Iranians have become more reticent. I think the Iraqis are going to get every last barrel out because of their financial situation. There's nothing that gives them a better outlook than oil," said Helima Croft, global head of commodities strategy at RBC Capital Markets.

Croft said it is difficult to separate the geopolitics from oil when discussing Iran and Saudi Arabia, facing the worst relations in decades. Iran blames Saudi Arabia for executing a Shiite cleric, who was hostile to the Saudi royal family.

Former U.S. Energy Secretary and New Mexico Gov. Bill Richardson said Saudi Arabia is key to the oil price, and if it agrees to an emergency OPEC meeting and production cuts that would change the dynamic. But that is unlikely. "The Saudis hate Iran. They are geopolitical rivals. They don't want to see Iran's economy get any better and oil prices are big factors in the Iranian economy," he said Monday on CNBC's "Squawk Box."

Iran has said it can quickly bring back 500,000 barrels a day within weeks, but that it plans to do so in a way that will not hurt oil prices. While 500,000 is not huge when compared to the 94 million barrels a day the world consumes each day, Wells Fargo analysts in a new report say the arrival of Iranian crude will cap any oil rally for now.

"One big question has been answered. Iran is now back in the oil market, but the question still to be answered in the next couple of weeks which will have a big impact on price is what kind of volumes they can put back on the market once they sell off their floating storage," said Daniel Yergin, vice chairman of IHS.

"Iranians will try to win back markets by price. They'll go back to their traditional customers in Asia who simply had reduced their share of Iranian oil. It's not like Iran has been out of the market. Iran's only been half out of the market," said Yergin.

The world's other large producers, Russia and the U.S. have not slowed down their output, even though U.S. production is expected to take a hit as oil companies feel the pinch of extended low prices. But if OPEC, responsible for about a third of the world's oil, wants to stop prices from falling, it would be imperative for the Shiite nations of Iran and Iraq to cooperate with Sunni-run Saudi Arabia.

"It's this whole idea that nobody is blinking. You have Russian and U.S. production. The newest U.S. exports are going to Europe, where they're all battling it out," said John Kilduff, partner at Again Capital. "It will take weeks to months to see the real impact of Iran's oil on the markets. We've all anticipated it. We've all handicapped it, and now we'll see what the reality is. Plus we're going to have the U.S. refining maintenance season coming up. That's going to add to the glut for a while."

The movement of the tanker Serena was significant, since Iran has an estimated 40 million to 50 million barrels of crude and condensates in floating storage, in addition to the increased production it plans. Iran has said it would immediately return 500,000 barrels, then another 500,000 barrels months later.

"It was the first of that fleet of floating storage that was to leave," said Paulo Nery, head of EMEA oil at Genscape. Nery said the Iranian tanker was the first his firm was able to track, and so far the only one that it reports has moved.

"There are 17 cargoes we know are sitting there for sure that haven't moved," said Nery, adding there are also a couple of others.

Goldman Sachs commodities strategist Jeff Currie said the arrival of Iranian oil will make for a volatile market. "A lot of it was already priced into the market. In terms of the implications ... it means you're going to have to squeeze out more of that non-OPEC oil than you would have if it had not come on line."

Croft said Iran and Iraq seemed to act as a bloc at the OPEC meeting last month, with both emphasizing they would not be limited in output. Iran has since modified its comments, saying it would not harm the market as it brings back oil but it is still expected to be aggressive to regain share.

"They're not going to balance the market for their biggest regional rivals to prosper," said Croft. "In the case of those three fighting, that's the big problem within OPEC. ... Those are the only three that can really do it. Those three have to come together. They have to find a way to sort this out."

Croft said Iran could move to sell what it has in floating storage while it ramps up production. But because of parliamentary elections next month, it may move more slowly to dump oil into the market so its officials escape domestic criticism for dampening oil prices.

On the other hand, if Iran expedites its exports, the world market will take a hit. "Iran came back faster (than expected to market). What if it comes back bigger?" said Croft.

There is little impetus for any of these producers to slow down, a factor that could continue to pound the oil market.

Iraq, for instance, gets most of its revenue from oil. Saudi Arabia is clearly feeling the pain of lower prices, and is now running a deficit, issuing debt and cutting back on social programs. Iran, desperate to return to more normal times, wants to generate as much revenue as possible.

"They're definitely feeling it. But I guess they figure it's worth it in the long run," said Kilduff.

http://www.cnbc.com/2016/01/25/why-iran-is-a-problem-for-the-oil-market.html