There are two main opinions regarding the impact of Iranian oil on the global oil market. On one side, the International Energy Agency (IEA) estimates that Iran currently has a sustainable spare oil production capacity of around 800,000 barrels per day (b/d), second only to Saudi Arabia.
On the other side, the U.S. Energy Information Administration (EIA) estimates, assuming sanctions end in early 2016, an annual average increase in Iranian crude oil production of 300,000 b/d from 2015 to 2016, with most of the increase coming in the second half of the year. The main reason for such disparate estimates is that the EIA gives more weight to the impact several years of sanctions have had on the deterioration of Iran’s upstream infrastructure, which might now need some time to ramp up. Since mid-2012, Iran has consistently missed between 600,000 and 800,000 b/d of crude oil production due to unplanned shutdowns.
Yet, how relevant are these production estimates in today’s global oil market where a production increase of 800,000 b/d represents 1 percent of today’s total global oil supply? This may suffice to drive dramatic price changes in a tight market, but not necessarily in an oversupplied one. More specifically, in the medium to long run, oil prices tend to align to marginal upstream costs (that is, the cost of extracting the last barrel of oil to fulfill demand). A prolonged low oil price stifles investment in developing higher cost fields; eventually wells shut down and supply shrinks. If prices stray above marginal upstream costs, new investments bring in additional, more expensive oil sources. In this context, relative to the oil price shift in 2014, the market today has a less-sensitive cost curve (as the most expensive developments are already profitable). So a small additional source of lower-cost supply will have much less impact on price than in the tight market mid-2014.
As a result, A.T. Kearney oil market models suggest that should Iran be in the position to ramp up its crude oil production by an extra 800,000 barrels per day in 2016, Brent crude prices in 2016 will most likely continue to be in the $45-$65 per barrel range, which is consistent with the price band already observed throughout 2015In the longer run, however, the impact of Iran’s comeback could be more substantial. The past few years have witnessed a wave of new reserve findings in Iran, which is significantly above the Middle East average. The country has not been in a position to fully exploit these reserves due to limited access to external upstream technology and expertise. As a result, not only is Iran’s crude oil production tracking behind its historical record, but its proven reserves level is the highest in its history. At the same time, current production levels are nowhere near where they need to be to cover government expenditures.
This, combined with the fact that Iran (unlike Kuwait, Saudi Arabia, and the UAE) does not have a well-stocked investment fund to make up for fiscal shortfalls, means that Iran faces a fiscal deficit whose most obvious solution, should the sanctions be lifted, is to increase oil (and gas) exports.
Sanctions relief for Iran, and the resulting increase in hydrocarbon supply, reinforces the conclusion that we are—as in the 1980s—at the beginning of a potentially long stretch of cheap oil years.