After a sharp plunge that saw oil prices collapse below $70/bbl for the first time in months, the oil bulls appear to be back in control. Crude oil has climbed nearly 5% on Monday after Saudi Arabia hiked prices for buyers in the U.S. and Asia, a clear signal that the oil giant sees demand remaining strong despite the emergence of the COVID-19 omicron variant. WTI crude was quoted at $71.53/bbl on Tuesday intraday trading while Brent traded at $74.92/bbl, with both benchmarks coming off six straight weekly declines.
Oil prices have also been rising on reports from South Africa that omicron cases have so far been mild with Dr. Anthony Fauci saying the variant has not appeared to produce a "great deal of severity" in cases so far.
But more importantly, actions by OPEC+ ministers at the latest virtual meeting have also injected much-needed enthusiasm and bullishness in a market that has been dour for weeks.
Physical Floor
When OPEC+ held its latest ministerial meeting on December 2, majority of experts expected the cartel to announce a pause in the sequence of 400 thousand barrels per day (kb/d) m/m increases in the output target on the basis that Omicron variant represents further source of downside demand risk while Q1 balances appear weak.
However, the ministers surprised the markets when they agreed to increase the target by 400kb/d in January, bringing the total increase under the July 2021 agreement to 2.4 million barrels per day (mb/d).
The ministers, however, made the increase conditional by the use of an elegant device: the December meeting is formally still in progress; and the press release states (in underlined text), “The Meeting remains in session”.
According to Standard Chartered analysts, the implication of this move is that OPEC+ could choose to withdraw the latest increase on the fly at the first signs of negative developments in the short-term. The idea of keeping the meeting in session suggests that there need not be much warning before OPEC+ implements a policy change, which obviously puts the shorts on notice.
Thankfully, that move appears to have calmed the markets. Brent prices initially fell to USD 65.70 per barrel on news of the production increase but rebounded back above USD 70/bbl when the significance of the continuing virtual meeting was priced in.
But Stanchart has warned that whereas the empty virtual room created a short-term floor for prices, oil market fundamentals remain uncertain. For instance, while OPEC+ delayed consideration of Omicron variant effects, there are still significant Delta variant effects that have not been priced in or reflected in OPEC+ policy, for example recent declines in mobility in Europe. This is reaffirmed by the latest Energy Information Administration (EIA) report, which was highly bearish.
Iran wildcard
Another big reason why oil prices have been rallying: Iran nuclear talks have lately stalled, delaying a return of Iranian crude.
After a three-year layoff, Iran appeared poised to officially rejoin the ranks of oil exporters--maybe as early as 2022--if Tehran and Washington are able to strike a new nuclear deal and Iran returns to the Joint Comprehensive Plan of Action (JCPOA).
But so far, indirect nuclear talks between the United States and Iran have hit stumbling blocks after Iran walked back on earlier concessions.
The Biden administration is still seeking a return to mutual compliance to the 2015 nuclear deal with Iran but also says it’s "preparing for a world in which there is no return."
"It is not our preference. Every day that goes by is a day where we come closer to the conclusion that they don't have in mind a return to the JCPOA in short order," said an official, who briefed CNN reporters by phone, referring to a lack of compliance.
But how much could a new nuclear deal boost Iran’s oil production? More importantly, will investors start flocking to a post-sanctions Iran?
After all, Iran’s former oil minister Bijan Namdar Zanganeh is on record 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.
Obviously, such a level of production would cause considerable jitters in the delicately balanced oil markets.
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?
Last year, Biden rejected former president Donald Trump’s decision to withdraw from JCPOA or the 2015 nuclear deal which critics say is inadequate in stopping Iran from eventually acquiring nuclear weapons. Negotiations kicked off in early April, but that did not stop Tehran from increasing its uranium enrichment program and passing a new law to limit International Atomic Energy Agency (IAEA) inspections. The Islamic Republic initially allowed limited monitoring to go on for another three months until May 24 but rejected a new agreement with the IAEA to continue monitoring its activities related to JCPOA.
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But as OilPrice.com contributor Simon Watkins predicted back in June, Iran’s dire economic situation was likely to force its hand into eventually accepting monitoring and signing a new nuclear deal, noting that Iran’s foreign currency reserves had greatly dwindled and stood at ~$10 billion, down from $114 billion just before the U.S. withdrew from the JCPOA in May 2018, while the country’s gold reserves are now insignificant. Watkins reckoned that the rate of foreign currency-denominated capital flight out of Iran was running at ~US$4-4.5 billion per month, meaning the reserve could run out in under three months.
And it appears he was right on the money: In September, Iran gave consent to the U.N. nuclear watchdog to service monitoring cameras at Iranian nuclear sites after talks.
Assuming the Vienna talks resume at some point in the future and the U.S. lifts Iran’s sanctions, how much oil can we expect?
It’s an open secret that Iran has been flouting U.S. sanctions by applying several cloaking methods to evade detection and sell its crude oil to China.
According to Stanchart, Iran has increased output 0.6mb/d y/y, and a further 1.4mb/d could return during 2022 if the Vienna talks succeed.
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Source: Standard Chartered
Iran’s current production of ~2.5M b/d is nearly a million b/d less than the 3.48 million b/d the country pumped in 2016 and 1.3 m b/d less than the 3.79 million b/d it managed in 2017. So Stanchart’s figures appear to be within the ballpark of what Iran can manage over the next year or so.
But boosting production from the current 2.5mb/d to 6mb/d could take several years at the very least.
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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