The initial response by markets to last weekend’s breakthrough in negotiations between Iran and the West was relatively modest, with oil prices easing around 1% on Monday, says Christopher Helman on Forbes.com.
In practice, that looks a sensible reaction, given that what was announced was purely an interim deal of limited scope. “No one is expecting any flood of Iranian crude back to the market [and] the White House insists that sanctions on Iran’s oil and banking sectors remain in place.” But if these first steps lead to a long-term solution, the effects will quickly be seen.
How much risk is in the price?
The most immediate consequence would be a reduction in the geopolitical risk premium currently priced into oil. Estimates of how much this is are necessarily highly inexact, but “at the height of former President Ahmadinejad’s bellicose anti-Israel rhetoric and threats to blockade the Strait of Hormuz, it was understood that as much as $20 per barrel represented a risk premium”, says Helman.
“About that much could quickly melt off of benchmark prices in the days and weeks to come, bring crude oil down from about $100 a barrel in the US into the $80 range.”
But reduced risk would only be part of the picture, with the potential boost to supply proving equally important. “The accord should unlock 800,000 barrels a day of global supply by next year [compared to global demand of] 89 million, rising over time as foreign firms return and the country’s ruined oil industry comes back to life,” says Ambrose Evans-Pritchard in The Daily Telegraph.
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That would help to “unleash a flood of oil onto world markets by next year just as crude output picks up in Libya, Iraq, and North America, triggering a slide in prices and a major shake-up of the energy landscape”. The increased contribution from the Iran deal alone could take $13 per barrel off prices, he says, citing estimates by Citigroup.
In the medium term, the end of sanctions and increased foreign investment in Iranian oil fields could lift global supply by at least a further one million barrels per day, says Tom Pugh at Capital Economics; the fact that the country’s output today is just half of the six million barrels per day it was producing at the time of the 1979 revolution gives some indication of how much ground it might be able to make up.
Factor this into a picture of steadily increasingly supplies from other sources, plus greater energy efficiency, and it seems likely that oil prices could fall to around $70 by the end of the decade.
Will the deal go through?
The caveat to all this is that it requires the deal so far – which simply amounts to Iran suspending its nuclear programme in return for some limited relief on sanctions – to turn into something more substantial and permanent.
This is likely to be challenging, say analysts at Barclays; many US lawmakers are already expressing concerns that the Obama administration is being too conciliatory and may try to scuttle the agreement.
The reaction of Israel and Saudi Arabia – who have already made plain their displeasure at any concessions being made to their principal enemy – won’t help.
Nonetheless, a successful outcome is more likely than not, although it will be a close call, says political risk consultancy Eurasia Group. The “dire state of Iran’s economy” means that Iranian leaders have every reason to try to secure a deal, while the Obama administration has one “very strong, even trump argument” at its disposal.
“If this deal fails, the only way to prevent Iran from becoming nuclear-weapons capable is a war. That line will resonate with Congress.” Overall, the outlook for oil has just become significantly more bearish.