Economics is a constant battle between logic and contradictory evidence. The US and Iran have agreed upon a historic deal that, unless contested, will see the US and other nations lift many of the sanctions currently placed on Iran – including those on oil exports. Due to Iran’s large oil producing capacity, the markets are abuzz with speculation about what effect this will have on the price of oil – already at depressed levels due to Opec’s commitment to maintaining a high level of supply and the US shale boom.
The camps are split. Many resting upon the logic of economic dynamics and faced with unreliable information to the contrary believe that the oil price will drop even further and that Iran’s increased production will decrease the price of Brent crude by between $5 (R62) and $10 per barrel. Brent crude is currently trading at about $57 per barrel, down from $105 from July last year.
The feeling is that the market for oil is already oversupplied and that buyers have been hoarding oil wherever they can store it to take advantage of the low prices. With storage approaching full capacity and no sign of significant growth in the global economy, this oversupply – heightened by Iran’s new access to the international market – will drive prices down even further.
Sanctions have cut Iran’s oil production by about 800 000 barrels a day and energy analysts expect them to take between one and two years to bring this capacity back to the normal levels of roughly 3.8 million barrels per day. Iran also sits on $150 billion of frozen assets that could be released when sanctions are lifted – providing further stimulus for Iran’s recovery.
Iran also reportedly has between 30 and 50 million barrels of oil sitting idle in floating storage that they will release to the market when conditions are favourable to them.
Not significant
The arguments make good, logical sense but digging deeper into the situation reveals that the market may be panicking a little. In its best case scenario, Iran will increase its total production by about 1 million barrels per day within the next year. Global oil production, however, averaged 93 million barrels per day in 2014, meaning, that Iran’s contribution will not significantly affect the price in the global market.
In an interview with Bloomberg, Gary Ross, the managing director of Pira Global Oil Group, was less pessimistic about the plunge in oil prices. Prices have already reached the low end of the range and pointed out that global oil demand has been growing by between 1.5 and 2 million barrels per day, year on year. Combine this with a 20 percent decrease in drilling activity outside of North America, Russia, and China, Ross says that the raised contribution from Iran will be quickly absorbed by the existing market.
According to Ross, two-thirds of Iran’s floating oil stock are of such poor quality that refineries will be reluctant to accept it. There may be a slight drop in prices as this stock feeds through the market but it will be short lived As with so many economic predictions, it depends on whether you believe the overarching logic or the anecdotal facts.
Due to the competitive nature of oil producers, the truth is that nobody knows how much oil is being produced or where. Drilling rigs are being shut down and projects are being cancelled but it takes a while for these production changes to feed through to total supply changes, by which time the major players in the market have altered strategies and global demand has changed.
* Pierre Heistein is the convener of UCT’s Applied Economics for Smart Decision Making course. Follow him on Twitter @PierreHeistein.
** The views expressed here are not necessarily those of Independent Media.
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