Iran and impact of lifting sanctions04 september 2015, 15:40
“A drowning man is not troubled by rain” – Iranian proverb.
The proverb summons up why Iran and the US was and is almost desperate to strike a deal to lift Iranian sanctions.
For the part of Iran the harsh sanctions in place since 2012 are crippling the economy and making their presence less and less dominant in the region. For the part of the US it’s increasingly struggling to formulate a coherent Middle East strategy which caters for its ‘special’ relationship with Israel, Saudi Arabia, the Gulf States overall and Iran, hence they see a need to move Iran back online and, through the re-establishment of diplomatic and commercial ties, keep its role as a supplier of protection and stability.
There are so many levels of potential interpretations of this deal, but in terms of business prospects the oil supply story is the dominant:
Negative impact – Oil prices under pressure
Iran produced 2.87 million barrels/day of oil in July 2015 (source: IEA) this is expected to rise to 3.4-3.6 million b/d by Q2-2016 in the most optimistic forecast, an increase of 500K-700K barrels a day. The potential new supply from Iran has seen oil prices sink to below 40 US$ before the recent reaction higher.
What makes the oil market defensive is the new added potential Iranian oil, but also a US oil sector which continues to pump 700K-1 million b/d more than last year, and a floating storage of 222 million barrels of oil. To put this into context the daily global production of oil is 95 million b/d in 2015, but growing by 2 million b/d in the next two years according to the IEA.
The low oil prices will deflate activity in the region and put upward pressure on government to facilitate investment and jobs away from oil sector. A much needed change is now being forced on government through the extremely low prices of oil.
Saxo Bank expects that oil demand will rise in line with the IEA’s 2 million b/d estimate and maybe slightly more as we remain positive on global demand seeing its low between now and Q1-2016. The extra 2 million b/d should mean that by the time Iran is fully able to export more oil the market overall should have a bigger appetite. I see oil averaging 50$ for balance of this year and 55-60$ next year meaning the worst is now and the next three months.
Positive impact – Iran CAPEX spending and tourism
We have to understand that by the time Iran fully complies with all the conditions in the deal we will be into Q2 of 2016. Furthermore lifting the sanctions does not mean that Iran day one is able to float the world with oil, as their access to capital and hence investment in the oil sector obviously has been constrained. The Iran government estimate it needs 200 billion US$ of new oil and gas investment by 2020. More support for CAPEX will come through the release of 100 billion US$ worth of frozen assets which most likely will be used to invest in infrastructure and oil & gas investments meaning Iran will be net demand on oil service and equipment and the region. Iranians will also slowly start to travel, as we saw in China and Eastern Europe, facilitating a much need increase in tourism flow to the Gulf region. Add to this that economic theory states that free trade and open borders creates a net gain and one can see the bigger perspective for this event.
Geopolitical risk and Black Swans
However, it’s impossible and naïve not to analysis the geopolitical potential fall-out from the deal – call it the Black Swans risk.
Israel is fiercely fighting the deal and using its political leverage in Washington to get the deal scratched. It looks like the deal will be a close race President Obama is getting closer to getting the needed votes but is still short, leaving his veto as the potential second best way to ratify the deal.
The Gulf states have been positive diplomatically on the deal in public, but it seems in private the deal is raising concerns on security and its standing vis-à-vis the US. This comes at a time where the US is becoming energy independent and hence the fear is that the US increasingly will reduced its strategic and military involvement.
How the Iran deal ends up changing the business landscape in the Gulf Region over the next few years is path dependent: If Iran fully complies, moves towards normalization and opens borders the deal will strengthen the region strongly. More openness, more open borders, more influence and increased commercial ties will improve conditions not only for Iranians but for the whole region. History dictates that the more business is done over borders the richer the countries. Add to this the release of pent-up demand for foreign goods and services from 77 million Iranians and Iran could very well be the positive impact on growth for the whole region in 2016 and 2017.
On the other hand if this is one step forward and then two steps back then Iran but also the region will be worse off in economic terms and in stability terms. Having a plan, an agenda is better than the opposite – the plan is flawed indeed, but this move is in the right direction so that Iran but also the region can use its energy and resources to build on the massive positive changes that have happened to their economies and business since the 1960s.
In others word – the region is not drowning, but it’s getting more and heavy rain. Let’s hope the increased rain will fertilize the ground. I think it will.