A busy week for global news mid-July sent crude prices plummeting. The agreement between the Greek government and European financial ministers left a lingering uncertainty hanging over the Eurozone, with several high profile organizations remaining openly critical of it. Elsewhere in the news, erratic Chinese equity markets and a landmark Iranian nuclear deal all served to dampen crude prices. The concern for oil markets centers around several factors: the consequences for economic stability and growth in Europe and China, the prospect for additional crude volumes into an already over-supplied market and the strengthening of the US dollar.
Greece itself consumes less than 0.4% of global crude, produces fewer than 9000 b/d and had an economy of US$240 billion last year – around 0.3% of the global total. An exit from the Euro, which now seems less-likely, threatens the breakup of the Eurozone itself, a major global economy and consumer of 9.7 MMb/d. Should Greece “walk away” from her debts, exposure to the debt in other member states, coupled with premiums for borrowing (particularly in southern Europe) could be expected to usher in another period of recession. Estimates from the International Monetary Fund suggest a contraction of between 2% and 5% is possible. While this picture remains uncertain, historical linkage of oil consumption and gross domestic product growth would imply a potential reduction of 360,000 boe/d per year in consumption. Tiny indeed, but in an over-supplied market, every portion of demand is important.
Ever-deeper uncertainty within Eurozone economies, however, is likely to increase the flight of capital to dollar-based equities. The Euro has already fallen 18% against the dollar in the past 12 months and a Greek exit would likely dampen this significantly as investors look nervously at other debt-laden Euro members. A strong dollar weakens international oil demand as the commodity, traded in US dollars, is more expensive on a relative basis.
After 10 years of diplomatic negotiation, the UN P5+1 countries (the US, the UK, France, China, Russia and Germany) at last reached an agreement to unwind economic sanctions on Iran in return for significant international control and surveillance over its nuclear activities. The long-awaited deal will revive foreign investment in Iran, as Western international oil companies (IOCs) renew pre-sanction projects. Brent dropped $1.15 to $56.70/bbl on the back of the announcement, with markets fearing a worsening of the global supply glut.
Iran holds the world’s fourth-largest oil reserves and second-largest gas reserves, while being the second largest OPEC producer after Saudi Arabia. In 2014 total Iranian production, heavily driven by gas and condensate production from the giant South Pars offshore field, amounted to 6.7 MMboe/d. During the sanction period, however, Iran had limited access to technology from the West and complex LNG export terminal projects stalled. Vast capital inflows will now be required to develop under-invested Iranian fields, however, due to the large reserves base, Douglas Westwood believes appetite to invest in Iran will be strong amongst major operators.
While no sanctions will be lifted before December, Douglas Westwood believes that Iranian liquids production will rise to a 2015 average of 3.5 MMb/d, based on pre-sanction production levels and available oil currently stored in storage tankers off Iran. Further production gains are expected as additional development phases of South Pars come onstream, while the removal of sanctions will clear supply bottle necks out of the Persian Gulf. IOC investment in the country’s huge potential will further boost production as sanctions are rolled back, though any new projects will see a lag of several years from lease acquisition to production phases.
Global oil prices have been weighed down in recent months by resilient US production, record Saudi output, continued weakness on the demand side, and the Grexit prospect. While commodity prices are unlikely to be aided by an opening of Iranian taps, the true tidal wave of Persian crude could be later rather than sooner.
Matt Loffman, manager, Houston, and Marina Ivanova, researcher, Douglas Westwood.