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Middle East Energy Focus

A News Feature

How will Iran's nuclear deal affect oil markets?

August 28, 2015 -- By Margaret McQuaile in London

* More barrels onto oversupplied market
* Future additional production capacity
* Possible shift in OPEC power balance

On July 14, Iran and six world powers concluded nearly two years of negotiations with a landmark nuclear deal that will, if finalized later this year, see the removal of sanctions that have drastically cut Tehran's oil earnings and deprived the country of the investment it needs to develop its vast oil and gas reserves.

December 15 is the date by which the UN's International Atomic Energy Agency hopes to issue its final report on Iran's compliance with the deal, a key milestone in the verification process.

Analysis continues below...

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December 7-9, 2015: Dubai, UAE

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Platts Middle East Crude Oil Summit Join 150+ influential upstream leaders and experts from the international oil community as they evaluate and debate the new regional oil landscape. Explore the race for internal and external Asia market share, Iraq and its unstable crude production, Iran and the possible removal of sanctions, and the Middle East's increasing role as a global oil trading hub and what it means for crude flows, pricing and benchmarks moving forward.

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Iran says that, once free of sanctions, it will be able to double its current 1 million b/d of crude exports within six months.

It goes without saying that Iran will benefit enormously from the removal of sanctions: the country will have full access to its frozen petrodollars; it will be able to export as much oil as it wishes; and international oil companies will be able to work in the country's upstream.

Internationally, the biggest impact is likely to be on oil prices, depending on whether or not other producers -- and particularly Iran's fellow members of OPEC -- make room for its additional barrels.

There is no indication at this point that key OPEC producers such as Saudi Arabia and its Gulf allies will voluntarily rein in output to accommodate Iran's increased flows.

In the meantime, deepening concerns about the Chinese economy have spread across equity and commodity markets, pushing crude prices to their lowest levels since early 2009, with Brent having traded as low as $42.23/barrel earlier this week and US light crude WTI at $37.75/b.

Barring supply outages, OPEC action to reduce production -- either unilaterally or in concert with major non-OPEC producers -- or a big increase in demand over the next few months, there's a strong possibility that Iran's additional barrels will flow onto a volatile and oversupplied market.

The fight for market share that kicked off late last year when Saudi Arabia persuaded OPEC not to reduce production despite plummeting oil prices seemed to be primarily focused on the relentless rise in non-OPEC supply in general and the US shale oil boom in particular.

This latter phenomenon has reduced US reliance on imported crude and sent former crude suppliers seeking new customers elsewhere and especially in Asia, the region driving growth in demand for oil and the key market for the oil producers of the Persian Gulf.

Asia has also seen increased volumes of Russia's ESPO crude and has been a magnet for additional barrels from Iraq, which is now exporting record volumes of crude as a result of its work on a range of infrastructural constraints in the south of the country.

But this is no longer simply an OPEC-versus-non-OPEC story. Within OPEC itself, there is an equally intense fight for market share under way ahead of Iran's full return to the market.

OPEC kingpin Saudi Arabia, according to its own official figures, increased production by 940,000 b/d between November and June, when, it told OPEC, it pumped a record 10.56 million b/d before cutting back by 200,000 b/d in July. The kingdom has been pumping more than 10 million b/d since March.

One of the big question marks lies over the pace at which Iran can boost production and exports.

The International Energy Agency earlier this month said that Iran's oil fields, having pumped around 2.87 million b/d in July, were estimated to be capable of ramping up production to 3.4-3.6 million b/d within months of sanctions being removed.

Iran has, however, been building up its stocks of oil on tankers in the Persian Gulf and the IEA estimated the end-July volume at 46 million barrels, some 60% of which was crude.

So, the agency said, "while significantly higher production is unlikely before next year, oil held in floating storage -- at the highest level since sanctions were tightened in mid-2012 -- could start to reach international markets before then."

Platts' own estimates put Iranian floating storage currently at 51-53 million barrels.

The US Energy Information Administration in its monthly Short-Term Energy Outlook came up with a much lower estimate of Iran's floating stocks -- 30 million barrels, with condensate accounting for more than half of the total volume and the rest mainly medium, sour crude.

But it also sees the first impact on markets coming from the release of these inventories. Stored volumes could boost total world supply by about 100,000 b/d by the end of 2015, the EIA said.

"Iran may find it challenging to find buyers for the condensate, as current condensate prices indicate that consuming markets, particularly in Asia, are well supplied.

By contrast, the crude oil held in storage could be sold more quickly, as price differences currently indicate more demand for medium, sour crude compared to lighter, sweeter crude.

There is evidence that initial volumes are already moving out of floating storage," the EIA said.

So what does the EIA expect to happen to the oil market next year once the extra Iranian oil is flowing?

The agency, which is the statistics arm of the US Department of Energy, reckons that Iran has the technical capability to increase crude production by about 600,000 b/d by the end of 2016, with most of this increase occurring in the second half of 2016.

"These additional Iranian volumes are expected to put downward pressure on global oil prices in 2016, as Saudi Arabia and the rest of producers in [OPEC] are not expected to make production cuts to accommodate additional Iranian volumes in a well-supplied global oil market," it said.

On August 23, Iranian oil minister Bijan Zanganeh said he supported the idea of an emergency OPEC meeting to discuss how the oil producer group might respond to the latest oil price rout that has seen crude prices fall to six-year lows.

But he also said an emergency OPEC meeting was unlikely to take place because the political atmosphere within the group was not conducive to such a meeting.

There is no doubt that the price collapse is causing deep pain in those member countries that do not have the financial reserves of the Gulf countries.

Venezuelan President Nicolas Maduro said in mid-August that he was urging OPEC to call an emergency meeting and invite Russian President Vladimir Putin to discuss how to stop the oil price slump. Algerian oil minister Salah Khebri has also voiced deep concern about plummeting prices.

And earlier this week Ecuador's President Rafael Correa said his country was pumping crude at a loss -- producing it at an average cost of $39/b and selling it at around $30/b.

It wasn't clear, though, whether he was referring strictly to the actual costs of production or whether the $39/b included the fees the country pays to private and foreign oil companies. Ecuador is "confronting a tough emergency," Correa said.

An extraordinary meeting of OPEC before December would require the backing of Saudi Arabia and there has been no sign that Riyadh, which argued last November that cutting oil output would not halt the oil price fall but would further reduce OPEC's share of world markets, may be willing to back an emergency meeting.

Indeed, Saudi Arabian oil minister Ali Naimi has not spoken publicly about oil prices since June, when, with prices some $20/b higher than they are now, he said the market was moving in the right direction.

The US EIA, meanwhile, expects the biggest non-OPEC declines to occur beyond 2016 as capital spending cuts hit conventional projects with longer investment horizons.

Capex cuts are most likely to affect producers in areas outside the shale plays in the US, it said in its August Outlook.

Which leads us on to the investment Iran hopes to attract into its upstream.

Iran will unveil its new Integrated Petroleum Contract at a December 14-16 roadshow in London. This will replace the current contract, known as the buyback because investors were paid from project revenues and which has long been criticized as providing little incentive for international oil companies to invest.

Indeed, the buyback was often cited as having had as much of a role in dampening oil company enthusiasm for Iranian projects over the years as the growing political pressure from the United States.

The new model has yet to be revealed in its entirety but Iranian officials say its provisions will include longer-term involvement of contractors and adjusted interest rates in accordance with risks as well as financial transparency.

At a Vienna trade conference shortly after the nuclear deal was signed in the Austrian capital, Iran's deputy oil minister for international and commercial affairs, Amir Hossein Zamaninia, said Tehran had identified nearly 50 projects worth some $185 billion that would be up for grabs between now and 2020.

But will the new IPC be attractive enough at a time when even the international majors are slashing spending?

Iran has been talking to international oil firms for some time. And since mid-July, several high-ranking political and trade delegations -- including from Britain, France, Germany, Italy, Japan and South Korea -- have visited Iran for talks with government officials and the private sector on possible future cooperation.

Nevertheless, the message coming from the companies is that -- apart from the actual lifting of sanctions -- the key to their future participation in Iranian upstream projects will be the terms of the new contract.

Next article: Iraqi Kurdish crude oil exports win favor in Europe

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