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What the Iranian Nuke Deal Means for the Oil Markets

by | published November 26th, 2013

The big news over the weekend was the apparent “breakthrough” with Iran.

I say “apparent” because we don’t know much about the substance of the deal. The reason is because the substance doesn’t exist yet.

The real devil, I suspect, is coming in the details.

Nonetheless, this apparent step forward is creating its fair share of investor angst right now about oil prices – even though the initial conclusions have been largely baseless.

In fact, the news of the breakthrough has already revised my scheduled meetings in Moscow.  And even the Nigerians, with whom I met last week, are now concerned and would like another session.

Across the globe, the concern among the major crude producers I am talking to is all the same: If this really constitutes a major initiative, what will it do to the price of oil?

Meanwhile, investors have worries of their own – specifically how it will affect their investments.

Here’s the answer to both questions…

Oil Prices and the Iranian Nuke Deal

First, everybody should calm down. Nothing has (or may) yet happen. The heavy lifting is still ahead.   And it is far too early to make any definitive conclusions.

The truth is most of the decline in oil prices since yesterday has been very knee-jerk and over-reactive. But the concern is certainly high profile nonetheless.  

Iran has, on paper at least, one of the largest conventional oil reserve totals in the world. Much of it comes from very mature wells – in fact the oldest producing wells in the entire Middle East are located in Iran.

But the stringent Western sanctions introduced over the past two years have exacerbated the problem (and expense) of offsetting significant extraction declines in these wells. Those sanctions have cut off Iranian access to the essential technology from abroad necessary to keep these fields operating and has prevented oil exports to much of the world.

That combined double whammy has created an economic nightmare in Tehran.

With its access to international banking significantly blocked by the sanctions, Iran can only exchange currency in ad hoc, shadowy, and inefficient ways.  In the oil business, an ability to tap banks is decisive since all trade is denominated in U.S. dollars regardless of the local currencies involved.

The result has been a collapse in oil production and exports with both figures at or below multi-decade lows.

Since oil comprises almost 75% of Iran’s budgetary revenues, domestic inflation has skyrocketed and severely challenged Iran’s ability to provide basic services.

The election of Hassan Rouhani as the new Iranian President has created the potential for possible reforms. None of this, however, will mean a rapid end to the nation’s nuclear ambitions (energy only or otherwise) or regional tension.

Reform leaders in Iran (assuming Rouhani is one) only have limited leverage with the real power held by the Supreme Religious Leader (Ali Hosseini Khamenei), while the clerics still wield veto power over legislative and executive decisions and also control the courts. Mohammad Khatami, the reformer who held the presidency from 1997 through 2005, had major problems in these areas.

Still, Rouhani and Khatami are ayatollahs.

In fact, six of the seven presidents since the 1979 Revolution have been clerics. The exception (that may prove the rule) was the eight tumultuous years of Mahmoud Ahmadinejad, the leader between Khatami and Rouhani.

So it is far too early to estimate how far any real reforms may move this time around.

But the window of opportunity apparently was there for the “five plus one” (the permanent members of the UN Security Council – the U.S., U.K., China, Russia, and France – plus Germany, with the European Union looking over everybody’s shoulder) to take a chance.

But nothing has changed yet.

First, the verification process needs to begin. Iran must be prepared to open up all of its enrichment programs to international monitoring, while agreeing to close down new facilities (especially the Arak plant where plutonium could be produced) and cease enrichment beyond 5% purity (the level for energy production; anything beyond this may have specialized medicinal isotope applications but levels approaching weapons grade have no other non-military purposes).

And while the six-month initial period will release about $7 billion in sanctions relief, it will also leave in place most of the major roadblocks to ramping up Iranian oil exports.

What the New Accord Means for Investors

And that brings us back to how the new accord will affect investors.  

Will an opening of international markets to Iranian oil – which must be emphasized, cannot happen in a major way for at least six months – lead to a contraction in oil investment profits?

Based on the downward fluctuations in crude oil futures contract pricing over the past two days, the expectations are that the accord will lower prices.

But that doesn’t automatically mean lower profits for investors.

In fact, the days are gone when investment gains in oil producers, refineries, field service companies, and pipeline partnerships required high prices for the raw material.  

The truth is significant investment benefits are no longer pegged to just the price of oil. It’s just not that simple anymore.

As I noted earlier this month, it depends more on where a company is positioned in the upstream-midstream-downstream process, what basins the company is focused on, and who controls the essential assets necessary for the company’s activities.   Those are greater profits triggers than high oil prices these days.

Remember, the ability to replace arms-length (market)  transactions with transfer cost/price relationships will have a bigger impact on bottom lines than the nominal price commanded for the product.

Here, we plan to make some nice returns… regardless of how fast (or if) Iranian oil flows into the market again.

PS. Iran may have grabbed the headlines, but the real story is happening much farther north. Thanks to the discovery of $43 trillion worth of oil and gas, all hell is about to break loose in the Arctic Circle.  And guess what…one small western company is the key to nearly every single barrel. I have the details right here.

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  1. NEIL MEHTA
    November 26th, 2013 at 14:29 | #1

    Wait and see
    Undercurrent of Mistrusts -both sides
    Trust but Verify -probably for both sides
    Not much to depend on anyway –
    Time will tell

    Give Peace a Chance-but Verify

  2. Wyatt lee Johnson
    November 26th, 2013 at 14:44 | #2

    Iran has every right to make nuclear power in Iran. Iran has signed the nuclear proliferation agreement. The us has not. Why should Israel have hundreds of nuclear weapons? They have much less right to make nuclear anything. But of course, the us provided them with their weapons. These bank sanctions are wrong. Everything you know, is a lie. Wake up folks. Before it’s to late.

  3. Dom
    November 26th, 2013 at 14:53 | #3

    Interesting commentary. I realize this is a mainly investment and money driven newsletter.

    At the same time, I’m curious to hear the political implications of this deal, especially since over time politics can be a driver of investment returns.

    So what say you Kent? Do you think this deal will lead to better prospects of Middle East peace? Can US and Israel now sleep soundly knowing Iran will not get the bomb in the foreseeable future? Or is this instead just another way for Iran to make everyone think they’ve abandoned their nuclear efforts?

    Curious to hear your thoughts, perhaps could be a follow-up piece or answered in the Q&A.

    Dom

  4. Allen Novotny
    November 27th, 2013 at 12:18 | #4

    @Wyatt lee Johnson
    Wyatt, you are the one that needs to wake up. Israel isn’t threatening to wipe them out like Iran is doing. I would never trust Iran.

  5. yngso
    November 28th, 2013 at 11:18 | #5

    Israel is the most secret nuclear nation on Earth, the biggest of all rule breakers. They are not qualified to speak.

  6. Alrightythen
    November 28th, 2013 at 11:31 | #6

    This is not about preventing Iran from getting the Bomb. They already have the Bomb. The real game worldwide is currency. Its the petro Dollar vs an alternative currency (whatever that might shake out to be). Iran has a lot of oil and appears willing to throw it behind the an alternative to the petro dollar.

  7. yngso
    December 3rd, 2013 at 08:01 | #7

    The world needs Iranian oil, and intl oil, gas and even nuclear companies need to work in Iran, and we can make money on that.
    War is a better option, seriously?
    -And by the way, Iran is a big country with a big population that needs a decent economy. There are big opportunities also in the non-energy sectors. Iran needs everything!

  8. Ann
    December 3rd, 2013 at 16:17 | #8

    Yngso Iran threatens to destroy Israel and Israel don’t have a right to speak looks like you been a bully in the kindergarten .israel have enough energy now .its going to be one of the best countries with its brain power and energy resources . Iran should first feed it’s citizens before starting on military adventures.you are dreaming about opportunities in totalitarian regime.there can be only limited opportunities and only people close to the regime wii benefit.good luck with your fantasy

  9. yngso
    December 6th, 2013 at 07:36 | #9

    Yes, history is interesting in this context, especially USA involvement in Iran in the 1950s.
    However, the past is the past. Mandelas approach to “mending fences” should be considered very carefully by anyone involved in peace negotiations anywhere.

  10. Sue
    December 14th, 2013 at 21:25 | #10

    @yngso
    Yngso, Ann is right U sound as if U hate Israel and Israel has said nor done anything to suggest they would hurt anyone they pray daily for the world and Iran on the other hand hates Israel and any christians Israel is a power to recon with but they will protect them selves with that power only They have knowledge that most country could just dream to have and energy resources and what they don’t have now God will give them no one should come against Israel!!!

  11. yngso
    December 20th, 2013 at 15:17 | #11

    Dear Sue,
    I never said anything about hating anybody. Au contraire! I´m all for pragmatic solutions that are win-win for all.
    I´m not saying that it´s easy, but that there´s no other way. Nelson Mandela showed us that.
    This isn´t a zero-sum game where you take from enemies and give to friends. The solutions found must be good for everyone in order to eliminate enmity, distrust, wars, terrorism, corruption and so on.
    Iran – a very major oil producer – imports gasoline, believe it or not!

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