I’m happy to say my 2012 Iranian Oil Survey is getting attention. I’ve received great comments online and in person, but I’ll be the first to admit the survey was incomplete. I wrote for the broadest possible audience and wanted to break down Iran’s predicament in a readable way that left little doubt about the conclusion. Some nuance was sacrificed as a result. So here at Al Ajnabee I want to review a few statements and questions I’ve heard in the past week.
Sanctions are really hurting Iran today. Yes and no. The rial has stabilized since January, when it lost about half its value. It hovers around 16,500 to the dollar now as opposed to early this year when it traded at the unofficial rate of about 20,000 to the dollar. Inflation, unemployment, and a lack of foreign investment are hurting the economy. However, the West should not take credit for all of Iran’s economic troubles. Mismanagement by Iranian officials contributes to and worsens the country’s economic standing. We should also remember that new EU and U.S. sanctions will not be locked in until mid-summer even though some countries are severing ties with Tehran early. After July 1, we should be able to measure the damage.
Iran also made up for lost exports to China in Q1 with increased sales to Turkey and India this year.
Can’t Iran avoid sanctions with trickery? Iran may lose 1 million b/d in exports in the second half of this year. The Revolutionary Guards are good at smuggling cigarettes. But moving 1 million barrels of oil—every day, for a sustained period—is a huge undertaking with limited chances of success. It’s also very hard to hide 1,000-foot tankers that carry two million barrels each. The U.S. can certainly track these shipments with satellite surveillance.
Other schemes are now under consideration. Authorities may introduce private middle men to oil transactions in order to distance customers from the sanctioned Central Bank of Iran. On May 10, David Cohen, Undersecretary for Terrorism and Financial Intelligence at the U.S. Treasury, told a think tank crowd that, “Our presumption going in is anyone buying oil from Iran is ultimately paying the central bank of Iran, even if there is some intermediary step.”
Global demand is set to rise by about 1 million b/d this year. Cutting Iranian exports will only tighten the market more. The end result will be higher prices that help Iran and hurt Western economies—right? Not necessarily. Oil prices could rise again to the highs seen in March, when Brent, the most widely traded oil contract, traded around $128. If negotiations between Iran and the IAEA and P5+1 break down, anxiety could prompt traders to bid up the price of oil; open conflict would send prices soaring. Economic indicators from the European Union and China are flagging. Should these recover, demand would rise along with prices. The U.S. recovery will also partially dictate price. But we shouldn’t forget that supply is expected to rise in 2012—not just demand.
On May 11, Reuters referenced the newest International Energy Agency report, saying “global oil supply rose 600,000 [b/d in the first quarter of 2012]… to 91 million bpd in April.” The same report low-balled demand growth at 790,000 b/d for this year. In my Tehran Bureau article, my closing comments also noted the increase in global stocks. Refiners and governments around the world are sitting on millions of barrels of oil today. Some speculate that Saudi Arabia is selling its oil at a discount in order to undercut Iran and make further purchases more appealing to those with inventory space. U.S., Canadian, and Russian production is expected to increase this year. Nigerian exports contributed to this year’s early increase along with Iraq.
Market fundamentals, as the IEA report noted this month, will probably remain tight. But a tight market does not favor the regime in Tehran by default. Today’s supply-demand picture is tight but oil prices have declined for seven weeks in a row. If Iran sells discounted crude later this year it could very well change the market outlook too (more on that below).
Who will replace Iranian oil? Iraq is a prime candidate for assuming Iran’s market share. Iraqi exports will grow this year and next. In the first quarter of 2012, Iraq introduced two new single-point mooring units in the Gulf, each with a nameplate capacity of 900,000 b/d. They aren’t operating at maximum capacity yet but they’re already making a big difference. Last month, Iraq exported more oil than at any time since 1990, before Saddam Hussein’s armies invaded Kuwait and invited international pressure and intervention that further handicapped the industry after the Iran-Iraq War. It’s worth noting that Iraq will sell more oil in the near-term with or without Kurdish crude from the north, which was shut in on April 1 due to a payments dispute and outstanding revenue-sharing issues. By the end of 2013, Iraq plans to pump 4 million b/d.
In January, I said Libyan exports would help make up for Iranian supplies. But Libya’s production returned faster than anyone expected and they are now just 100,000 b/d short of their pre-war output levels. So we can say with confidence that they have already made up for lost Iranian supplies—but they cannot offer much more in the short-term, as Iranian exports face the worst cuts in the coming months. Libya has already done its part to stabilize the market by pumping 1.5 million b/d. It can’t export more until international oil companies have a chance to explore Libya and expand production without Qaddafi’s heavy hand. That could take years.
But this brings us to our next and perhaps most important point: Iran might actually make up for the loss of its own exports by selling cargoes at a severe discount later this year.
Where is Iran’s oil going if they aren’t shutting in production and exports are shrinking? On April 25, Platts, an industry reporting service, released data indicating that Iran’s national tanker fleet (NITC) was holding 22 million barrels of crude and condensates off-shore while it sought new customers. Iran’s 23-million barrel Kharg Island facility is presumably near max capacity. Otherwise there is no reason to dedicate so much of Iran’s fleet to storage. Reuters reported a significantly higher number on April 23—saying Iran held 56 million barrels total—but this seems too high, especially since no sources have confirmed the number since.
This is not a new practice for Iran: in the past few years, the country has used its own tanker fleet to store oil in the Gulf. From September 2010 through March 2011, for example, Iran stored anywhere from 10-18 million barrels on its tankers. If the Platts report is anywhere near the mark, however, it would be a significant development because the amount and duration of storage would be unprecedented.
What do you do with all that oil? Discount it and sell it. But here’s the problem: if they discount it significantly, those already contracted to buy Iranian crude may want matching discounts. Revenues would suffer accordingly. And let’s look at the big picture: if Iran starts selling discounted cargoes, the market’s “tight fundamentals” may gain slack, as millions of barrels flood the market in a relatively short period. It is entirely possible that a future Iranian discount scheme could slash revenues and destroy the price structure.
So Iranian oil exports may only disappear temporarily. I’m not saying this is the likeliest outcome but it’s possible. Whether or not the country’s unenviable position changes Iran’s negotiating posture is still harder to forecast.