What the Iranian Nuke Deal Means for the Oil Markets
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?
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.