Brent crude prices have been on an upswing in recent months, and most people assume this is because of rising tensions in Libya and continuing problems in Nigeria. However, Saudi Arabia has increased production to keep supply stable, so the supply risk premium seems to largely be a product of investors speculating on oil futures.
“We believe that current oil prices are not supported by market fundamentals, but driven by speculation about potential disruption in Middle East oil exports,” write Oppenheimer analysts Fadel Gheit and Robert Du Boff. “As a result, we expect oil prices to remain inflated until Iran's nuclear issue is resolved, one way or another. This should remove the current supply risk premium, which we estimate to be as much as 20%-30%.”
Iran has among the largest oil reserves in the world
The recent deal between Iran and the P-5+1 (the UN Security Council permanent members plus Germany) has paved the way for a possible permanent normalization of relations. There’s still a lot that has to be worked out, and the current deal expires after six months, but this is one of the most significant thaws in Iran's relations with the West since the 1979 revolution. Iran has among the largest oil reserves in the world, but a lack of investment has prevented it from reaching or surpassing the level of production it emjoyed in the early 70s. If the deal turns into a solid treaty, capital projects backed by Western investment could become feasible and put downward pressure on oil prices.
In addition to the developments with Iran, the US and Canada continue to increase oil production through the development of shale oil, and Gheit and Du Boff argue that technology gains will continue this trend. “New pipeline capacity should narrow the crude differentials without significantly reducing US refineries inherent cost advantages, which should enable them to continue to grow product exports,” they write.
Oil sector could benefit from new projects in Iran
If oil drops to $75 - $85 per barrel as Gheit and Du Boff expect (they don’t give a specific timetable), it could hasten the global recovery and increase consumer confidence as lower costs echo throughout the economy. Even the oil sector could benefit from new projects in Iran offsetting profits lost to falling prices.