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Impending Iran Deal Could Crush Current Rally

Impending Iran Deal Could Crush Current Rally

The headline for the week was Saudi Arabia’s attack on rebels in Yemen, which threatens to ignite tensions between regional rivalries in the Middle East. The proximate cause was the advance by Houthi rebels on Aden where the Yemeni President is located. Saudi Arabia spent several weeks secretly reaching out to its regional allies to build support for an attack on the Houthis, signing up support from Turkey, Egypt, and an array of Gulf States. The advanced knowledge of the United States government appears to be a matter of dispute, with some top level Pentagon officials saying they were only given one hour’s notice before the attack. Nevertheless, the U.S. is providing logistical support – refueling and satellite imagery.

This attack comes at an awful time which may not be a coincidence. The negotiations between the P5+1 nations and Iran are coming down to the wire. The outlines of a deal are visible, but the sides are hoping to use the next few days to seal the deal. Saudi Arabia’s attack on Houthi rebels is not just about Yemeni stability. It is a proxy war between Saudi Arabia and its Gulf allies on one side, and Iran on the other. The U.S. finds itself confronting Iranian-backed rebels in Yemen at the same time that it is attacking ISIS in Iraq alongside Iran. How this affects nuclear negotiations is anybody’s guess. Related: Forget Rig Counts And OPEC, Media Bias Is Driving Oil Down

In the meantime, the price of oil spiked by about 5% after the surprise attack by Saudi Arabia. On this at least, the reaction is overblown. Yemen’s oil production is next to nothing, and has been declining for more than a decade. It produces less than 150,000 barrels per day, an amount that would go almost completely unnoticed in the global market place if it was taken offline. There is little threat of a supply disruption through the straits of Bab el Mandeb – the Egyptian Navy moved in to secure the narrow passageway on the same day as the Saudi attack. Also, the U.S. Navy routinely patrols the waterway, and just across the strait in Djibouti, the U.S. has a major military base. There is little to no chance that these military powers will allow oil supplies to be disrupted.

In that context, the price spike could be temporary. After the shock of the Saudi attack wears off, prices could tick downwards again. Indeed, early on Friday March 27, oil prices pared back some of their previous gains. There are still some fundamental reasons to think that oil prices will remain weak over the next few months. We have discussed in detail the shrinking capacity of the U.S. to divert oil into storage. In Edmonton, Canada as well – another critical oil storage hub – oil storage is at a record high. Also, Saudi Arabia last week reiterated its position to maintain production at elevated levels, and even appeared to ramp up production in February. The supply picture still looks pretty grim. Related: The Most Challenging Oil And Gas Projects In The World

But the big market mover in the coming days will be the outcome of the aforementioned negotiations with Iran over its nuclear program. If a deal is reached, oil prices will most likely tank immediately, on the expectation that Iran could soon bring an additional 1 million barrels per day back online with the removal of western sanctions. A real, comprehensive agreement still looks like a heavy lift, given the outstanding differences between the two sides and the opposition from hardliners in both the United States and Iran. Next week will go a long way in determining the trajectory of oil prices for the next few months.

Despite all that is going on, there was some actual news outside of the Middle East. Mexican state-owned oil company Pemex received its first significant investment since the government swept through dramatic reforms that opened up the energy sector. BlackRock invested $900 million in natural gas pipeline that will connect gas fields in the U.S. to central Mexico. There has been a lot of excitement surrounding Mexico’s historic pivot away from state control of oil and gas. BlackRock’s move marks a major milestone for Mexico as it seeks international investment. But the deal will also serve several purposes for Mexico. First, it will open up a new source of low-cost energy, allowing natural gas to reach Mexico’s manufacturing heartland. And it will also provide an injection of cash that will provide much needed financial assistance to Pemex, struggling under the weight of low oil prices. No doubt drillers in South Texas are enthusiastic about a project that could provide a boost in demand for their product. Related: T. Boone Pickens Points The Finger At U.S Shale

Farther north, the U.S. government published a report on March 27 that calls for quicker development of oil and gas in the Arctic. The study from the Department of Energy concludes that the U.S. has made impressive strides in reducing its dependence on oil imports, largely the result of several years of frenzied drilling in shale formations. However, the shale revolution may begin to fizzle by the end of the decade, opening up the possibility that the U.S. will find itself much more reliant on imported energy. That is, unless the U.S. goes full speed ahead with drilling in the Arctic, which potentially holds billions of barrels of recoverable oil. The problem is that drilling offshore in the Arctic will likely take at least a decade or more before oil begins to flow in earnest, meaning drilling needs to start today if Arctic oil is going to smoothly replace shale. “To remain globally competitive and to be positioned to provide global leadership and influence in the Arctic, the U.S. should facilitate exploration in the offshore Alaskan Arctic now,” the National Petroleum Council stated in a report that was requested by the Energy Department.

To that end, Royal Dutch Shell (NYSE: RDS.A), the only company with a viable plan to explore the U.S. Arctic, is currently running drills in Washington State for federal regulators. It is also moving oil rigs to Alaska, preparing for summer drilling. Shell hopes to return to the Arctic in the coming months once it has received all the necessary permits from the Department of Interior. After several years of bungled operations, Shell needs to right the ship if it hopes to drill in the Arctic over the long haul. Another slip up could doom Arctic development for years.

By James Stafford of Oilprice.com

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