Thursday, August 27, 2015

Changes in Iran

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"

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