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OPEC+ may build up oil production due to US sanctions against Iran

May 11, 2018/ 08:28

Moscow. The US decision to introduce sanctions against Iran, which restrict oil export, will make OPEC + soften the oil production restrictions but they will not abandon them completely, industry experts told TASS.

The volatility of prices will also grow - this year the price may exceed even $90 per barrel but it is most likely that the prices will be back to $50-60 per barrel.

Two sources in OPEC told TASS the technical committee of OPEC + agreement plans to discuss further implementation of the deal during a scheduled meeting in Jeddah (Saudi Arabia) on May 22.

Back to future

On May 8, US President Donald Trump announced his country’s withdrawal from the agreement on the Iranian nuclear program. The deal implied that the UN Security Council the US and the EU remove sanctions against Iran. In return, Tehran pledged to limit its nuclear activities, placing it under international control.

The US president promised not only to resume the old sanctions, but also to introduce new ones if Teheran decides to implement its nuclear ambitions. Market observers fear that, as in the past, new sanctions may impose restrictions on the export of Iranian oil.

Under the sanctions, Iran's oil production fell by 1 million barrels per day to 2.8 million barrels. Restrictions on exports turned Iran from the second largest oil producer of OPEC to the fourth.

However, after the removal of the sanctions in early 2016, Iran was able to gradually increase production to 3.8 million barrels per day and take the third place in the rating of OPEC producers. Of this daily volume Iran exports about 2 million barrels.

Iran and OPEC+ deal

Soon after Trump voiced the US intension to impose sanctions on Iran, Saudi Arabia, the largest member of OPEC, said it was ready to fill the likely shortage of oil on the market.

Also Iraqi Oil Minister Jabar al-Luaibi (Iraq is the second largest oil producer in OPEC), said that OPEC + is ready to discuss mitigation of the current oil production cut quotas.

According the experts questioned by TASS, gradual replacement of the volumes of Iranian oil may indeed become one of the strategies of OPEC +.

"Under the current plan for imposing sanctions, the consumers will have about half a year to replace the volumes," Maria Belova, research director at Vygon Consulting, recalls.

Judging by the experience of the previous sanctions, the ban on oil exports may not cover the whole volume of Iranian oil, Belova believes. Restrictions may affect about 40% of exports and nobody is talking about the instant withdrawal of these volumes from the market, she says.

Other members of OPEC + will have to occupy the share of Iran's sales on the market in order not to leave this opportunity to competitors, primarily the United States, Tatiana Mitrova, director of the Skolkovo business school energy center, says. To be able to do this, they will have to revise the terms of the oil production cut agreement and to soften them.

"Iraq has its main free production capacities in a politically unstable region, which casts doubt on the possibility of prompt replacement of the oil volume which is leaving the market, and Russian producers will also need time to increase production," Mitrova says.

The resumption of sanctions against Iran reduces the chance for further extension of the OPEC + deal on the current conditions in the future, otherwise the oil deficit will become more probable in 2019, Dmitry Marinchenko, Director of Fitch Corporation, says.

"Taking into account the sanctions, as well as high oil prices, it may be more difficult for the countries of the Vienna agreement to reach a consensus - the sense of extending the deal is not obvious."

Ultimately, this may loosen the discipline and even prompt the deal participants to abandon the quota policy, Marinchenko says. However, he does not rule out that now Iran may try to maximize production and export of oil, before the sanctions come into effect.

Market expectations

It remains unclear, if the sanctions will fully cut off Iran from the markets.

Belova from Vygon Consulting recalls that the main importers of Iranian oil are the countries of the Asia-Pacific region (up to 60%).

"This is primarily China and India and it is very doubtful that application of the US sanctions with regard to these countries will be effective," she said.

Mitrova also believes that Iran's exports will not decline to zero. However, she notes that Korea and Japan, for example, in April reduced Iranian oil imports by half compared to peak values of 2016-2017 - to 0.3 million barrels per day. China reduced imports by a third, from 0.9 million barrels per day in mid-2016 to 0.6 million barrels in 2018.

"Thus, consumers were preparing in advance for a possible break of the nuclear deal and reduced imports, but whether it will decline further - this will depend on the geopolitical situation," Mitrova said. In general, in her opinion, exports could fall to 1 million barrels per day.

What will happen to oil prices?

The market anticipated imposition of sanctions against Iran and amid these expectations oil prices exceeded $77 per barrel, analysts say. In the next three to four months, prices may continue to rise, Mitrova said.

The pace of growth will depend on how quickly consumers can replace Iranian supplies. The negative scenario does not rule out that the prices will reach $85 per barrel.

"However, in a longer period, additional volumes of oil from the countries of OPEC + and from the US will balance the price on the market at around $75 per barrel. In case OPEC + continues to comply with the terms of the deal, and the decline in Iranian oil exports will be maximum, prices may reach $90 per barrel, "she said.

Belova from Vygon Consulting agrees that the return of prices to the level of $100 per barrel is possible only in case of a serious deterioration of the geopolitical situation in the Middle East.

And according to Marinchenko of Fitch, the current price increase is more speculative. Most of the producing countries got adjusted to the level of about $60 per barrel, which is more reasonable from a fundamental point of view, given the significant reduction of cost of oil production and the growth in shale oil production. In general, Fitch believes that prices will return to the level of $50-60 per barrel.

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