Iran has been in trouble with the West since the Islamic Revolution in
1979. Following the American hostage crisis, the first sanctions were
levied at an early stage of the then newly formed Islamic Republic of
Iran, and then more sanctions were levied in 1984 when the Lebanon-based
Hizbullah group, tied to Iran, was implicated in the bombing of the US
military base in Beirut.
Such historical tensions remained in
place over the following decades, even getting worse after the
International Atomic Energy Agency (IAEA) discovered in 2005 that Iran
was not compliant with its international obligations and highlighted the
fact that the country was moving ahead with its nuclear programme. This
led to more sanctions in 2012, isolating the Iranian economy from the
rest of the world and slowing down its growth potential.
With the
election of Hassan Rouhani as the new Iranian president in June 2013, a
deal with the West was looming on the horizon. Negotiations were
intensified, and an initial deal was reached by the end of 2013 leading
to a final deal in spring 2015. This was a historic moment, not just for
Iran or even for the Middle East region, but also for the world as a
whole.
Iran today is the sixth-largest oil producer in the world
and has the second-largest gas reserves. Accordingly, the deal will have
implications for the oil market, which has already been turbulent over
the last year. Standing at $110 per barrel l in early 2014, a
combination of low European demand post the global financial crisis, an
increased supply from Iraq and Libya together with a surge in shale gas
production in the US has pushed the prices to below $50 a barrel by the
end of 2014.
As is typical in such circumstances, the
Organisation of Petroleum Exporting Countries (OPEC) cut back on supply
in order to balance the market. But what then happened was the opposite
of the usual strategy, since OPEC decided to keep its level of
production steady to avoid losing market share, pushing prices downwards
even faster, reaching below $50 per barrel.
A short pause for
breath was seen in early 2015 when prices started to edge up on higher
demand due to slower production rates of shale gas and the shelving of
global oil and gas projects worth $200 billion due to low prices.
The
prices resumed its downward trend in May again going below $50 per
barrel and causing huge frustration for oil producers, especially the
oil-dependent Gulf countries. The recent news about the slowdown in
economic activity in China definitely played a role, but the deal with
Iran and its near return to the global oil market has undoubtedly helped
to push prices downwards.
Looking at Iran, it supposedly has
around 40 million barrels of oil stored in floating tanks and currently
produces 2.8 million barrels per day (bpd) and could return to its
pre-sanctions level in 6-12 months to reach 3.8 million bpd. Some
analysts believe the return of Iran to the oil market will increase
supply, pushing prices downwards, while others believe that since Iran
is a member of OPEC, which has a production ceiling of 30 million bpd,
total production will stay the same with no effect on the market.
However, for this to happen other OPEC members would have to reduce
their output.
As the decrease in Iran’s production that took
place some years ago due to the sanctions was covered by increased
production from Kuwait, Saudi Arabia, the UAE and Iraq, questions
naturally arise about how these Gulf countries may be affected by the
pumping of Iranian oil to the market.
Despite the claims by the
US that the Iran deal will not affect the Gulf countries, the deal will
probably have four major impacts on the region. The first relates to oil
prices and Gulf country deficits. Iran is a member of OPEC, and its
return to the international oil market would ordinarily force other
members to cut their production, thus affecting their revenues. It is
worth noting that the Gulf countries have budget break-even levels at an
oil price of around 0$80-90 per barrel. At the currently prevailing
prices, they are mostly in deficit, especially Saudi Arabia which is
expected to run a double-digit budget deficit this year of over $100
billion.
The Gulf countries have accumulated huge foreign
reserves over several decades, but these are being eroded very quickly
due to the low oil prices, and Saudi official reserves decreased from
$900 billion in September 2014 to $650 billion in August 2015. The case
is same in the other Gulf countries, slowing their investments in Egypt
after their direct aid stopped a while ago.
The second impact
relates to trade and exploration. Iran shares a major gas well with
Qatar, which has the right to two-thirds of the well’s production. Qatar
has been thought to have used advanced technologies to extract more
than its fair share from this well, but with the new deal Iran will be
at par with it technologically. Moreover, while Dubai in the UAE was
Tehran’s main trade gateway during the years of sanctions, Iran now
plans to construct free-trade zones which will affect Dubai.
The
third impact relates to oil and infrastructure investment. Around
$100-150 billion of frozen Iranian assets will be released as a result
of the deal, giving Tehran the opportunity to upgrade its public
infrastructure. In addition, Iran’s oil industry needs a massive
upgrade, which it plans to do by partnering with the major oil companies
in 50 projects worth $185 billion by 2020.
An aggressive
investment plan of this sort will turn Iran into a centre for global oil
and infrastructure companies, making the rest of the region
unattractive for the time being. This shift will also hit countries like
Egypt that are looking for investment, especially in oil and gas. At
low oil prices, the oil majors will have to prioritise their
investments, and logically Iran will come at the top of their list.
The
fourth and last main impact of the deal relates to regional political
stability. It is very hard to miss the huge regional influence of Iran
and its involvement in Syria, Iraq, Yemen and Lebanon which has helped
to exacerbate the Sunni-Shia conflict in these countries. With the new
deal, Iran’s political power will get stronger, translating into
increased military spending by the Gulf countries and affecting their
growth potential and capability to invest in other countries such as
Egypt.
The bottom line is that the Iran nuclear deal looks like
great news to many, but not for the Gulf countries and their allies,
where the return of Iran to the global oil market will most likely
result in more deficits. In addition, Iran will probably become the
centre of western investments, limiting the potential to attract
investments of other regional countries, including Egypt. More
importantly, the deal will also strengthen the regional influence of
Iran, pushing the Sunni-Shia conflict in the region to the edge.
Omar El-Shenety
27 August 2015
This article was published in "Al Ahram Weekly"