Mixed Data Keeping Oil Markets On Edge

Oil markets have become highly volatile in the current week as traders try to make sense of a mix of both bullish and bearish drivers. Oil prices rallied mid-week  after the latest EIA report showed crude refining has hit the highest level since August 2019 in anticipation of strong summer demand. However, the same report revealed that U.S. crude production has hit the highest levels since April 2020 while crude exports have declined.

Indeed, commodity analysts at Standard Chartered have termed the report neutral, saying 

Its proprietary U.S. oil data bull-bear index rose 34.1 w/w to +8.5 (Fig.  58). U.S. crude oil

inventories fell 2.72mb relative to the five-year average and are 10.54mb below it

However, crude oil inventories at the WTI pricing hub at Cushing, Oklahoma, rose for the seventh consecutive week and are currently close to the five-year average. The w/w crude oil balance shows unusually large swings in exports and imports.

But the most bearish piece of news came outside the U.S. market with reports that Iran might soon officially resume oil exports.

Source: Standard Chartered Research

Iran Wildcard

U.S. crude fell  nearly 5% on Thursday to briefly trade below $70/bbl after reports emerged that the U.S. and Iran are making progress after resuming talks on a nuclear deal, a move that could ease sanctions on Iran's oil exports. 

Israel's Haaretz newspaper has reported that the talks are moving forward more rapidly than expected, with the possibility of a deal being struck in a matter of weeks. Deal terms are likely to include Iran ceasing its 60% and higher uranium enrichment activities in return for permission to export as much as 1M bbl/day of oil. Related: Pentagon Papers Show Saudi Arabia, U.S. Traded Threats Over Oil

Prospects of reviving the Iran nuclear deal have swung dramatically, from near certain in March to almost nil by the end of 2022 and now this. Iran’s dire economic situation is likely to force its hand into eventually accepting monitoring and signing a new nuclear deal sooner rather than later, with the country’s foreign currency reserves having greatly dwindled from $122.5 billion in 2018 to a mere $20 billion in 2021 before recovering to $41.4 billion in 2022. With the rate of foreign currency-denominated capital flight out of Iran running at nearly $5billion per month, Iran is not in a very enviable situation. 

A successful nuclear deal could change the oil markets, with former Iran oil minister Bijan Namdar Zanganeh saying that his biggest dream has always been to increase Iran’s oil output to six million barrels per day; earn $2 trillion through oil exports over the next two decades and use the income to invest in the country’s development. 

Such a level of production would definitely cause considerable jitters especially with OPEC ready to take the country back to its fold once the sanctions are lifted. But how realistic are Iran’s oil ambitions and how much do the oil bulls need to worry about another large producer potentially muddying the waters for everybody?

Over the short-term, Iran rejoining the oil markets might not change anything much. After all, It’s an open secret that Tehran has been flouting U.S. sanctions by applying several cloaking methods to evade detection and sell its crude to China. 

Things could be different though over the long-term.

Iran’s current production of ~2.5M b/d is 1.2 million b/d less than the 2018 peak at 3.7 mb/d.

Boosting production from the current 2.5mb/d to 6mb/d could take several years at the very least. And even then it would be far from a certainty. Over the past four decades, Tehran has miserably failed to adequately re-invest its oil income into its production capacity or diversify its economy. In fact, since the 1979 revolution, the Islamic Republic has never at any point in time been able to produce more than 4 million bpd. To complicate matters further, foreign investors have mostly stayed away from Iran’s economy in the four decades since the Islamic Republic was established. In sharp contrast, foreign investments--mostly oil-related-- in its Arabian peers including Saudi Arabia totaled more than $170 billion from 2006-2012, and have continued to grow at an annual clip of 10 billion dollars since. 

Part of the problem here is that the state-controlled economic model wastes more than $50 billion a year on oil and gas subsidies to keep its citizens docile. The result is that Iranians enjoy the cheapest gasoline and electricity prices of anywhere on the globe, but have to contend with high unemployment and inflation due to an economy that relies too heavily on petrodollars. There’s little reason to believe that Raisi’s administration will do much to reform the economic model given the latest spate of populist promises of even more subsidies.

By Alex Kimani for Oilprice.com

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