Oil: Swing producers’ decision key to mitigating risks of Iran sanctions

The US decision to back out of the Iran nuclear agreement and to re-impose sanctions against Iran has put additional upward pressure on the price of oil. This decision was made in a context where crude oil prices have risen by 20% since the beginning of the year and where OPEC production is already below target due to problems in Venezuela.

Restoring the oil market balance will take more time. OPEC countries have managed, in coordination with Russia, to reduce oil inventories to more “normal” levels thanks to their production-cut agreement, extended in November 2017 until the end of 2018. Since Q4 2017, Venezuelan production has been in freefall due to a severe political and economic crisis (-0.5mb/d ytd), not offset by the other OPEC countries and leading to an increased supply deficit for this year. The threat of new sanctions on Iran is now coming on top of that and could represent a more-than-0.5mb/d production loss in the coming months. This has already supported the 80% increase in Brent prices from 45USD in June last to almost 80USD today.

At this stage, Russian and Saudi Arabian production levels will be key to the evolution of oil prices. US shale production has a shorter cycle and is more reactive to oil price increases. Incentivised by higher oil prices, it has already been increasing since H2 2017. But the number of additional active oil rigs won’t be sufficient to offset Venezuelan and Iranian production losses. All eyes will now turn to the next OPEC meeting on 22 June, at which production cuts will be re-evaluated in coordination with non-OPEC countries like Russia. Saudi Arabia may be happy with oil prices above 80USD (IPO of Saudi Aramco, budget constraints) and unwilling to significantly increase its production. This may be not the case for Russia, the world’s biggest oil producer, which could take into account the negative impact on demand of higher oil prices and a consequent stronger increase in US production. Excessively high oil prices would ruin recent years’ efforts to rebalance the market.

Overall, we do not exclude an overshooting of oil prices in the coming weeks but there are short-term and medium-term downside risks to this scenario. Over the short term, less cooperation between OPEC and Russia could lead to higher global production. The evolution of Iran production will also depend on US sanctions. Over the medium term, lower demand and higher US production could also put some downward pressure on oil prices.