OPEC Hopes Iran Won’t Spoil the Party

A potential revival of the Iran nuclear deal could lift the sanctions that have crippled the country’s oil exports since 2018. The timing of such an agreement is uncertain, as is the nature of potential sanctions relief. But if a deal is reached in the next month, Iran could raise its oil exports in the second half of the year and into 2022. Iran’s return to the market could spoil the party for Organization of the Petroleum Exporting Countries (OPEC) states hoping to reap the benefits of an improving demand environment, but for now the producers’ club seems unconcerned.

A fifth round of talks over reviving the Iran nuclear deal, or the Joint Comprehensive Plan of Action (JCPOA), began on May 24 in Vienna. Iranian president Hassan Rouhani said on May 20 that the outlines of a deal have already been reached, including the lifting of U.S. sanctions on the oil, banking, petrochemicals, and shipping sectors, as well as the insurance industry. But the two sides are still negotiating over the complicated steps required for Iran to roll back the advances it has made in its nuclear program, as well as the U.S. moves toward unwinding sanctions. Key concerns for Washington and its allies include Iran’s stockpile of enriched uranium and the fate of its advanced centrifuges.

The ultimate timing of a deal is difficult to predict. One obstacle was overcome on May 24, when Iran extended for one month a technical agreement with the International Atomic Energy Agency (IAEA) that allows camera monitoring of important nuclear activities in Iran. The all-important signpost is Iran’s June 18 presidential election, and time is running short for a deal to be finalized before the elections. The recent exclusion of reformist and moderate candidates by the country’s Guardian Council means there is very little risk of an upset, but the government may prefer to seal an agreement after the polls.

Iran Already Exporting More Barrels

When the Trump administration withdrew from the JCPOA in May 2018 and reimposed sanctions on Iran six months later, Iran’s production and exports to Europe and Asia fell precipitously. Iran’s crude output dropped from 3.81 million barrels per day (b/d) in May 2018 to 2 million b/d by late 2019. Yet Iran has extensive experience in evading sanctions, and its output in recent months has been a subject of debate. Tankers carrying Iranian crude frequently turn off their transponders at sea, facilitating blending and ship-to-ship transfers that obfuscate the crude’s origin. Iranian barrels often show up in customs reports as imports from Malaysia, Indonesia, Oman, or other countries. Tanker trackers and firms using satellite imagery estimate that Iran has raised production and exports substantially this year. Kpler estimates that Iran’s crude and condensate exports in the first four months of this year averaged 727,000 b/d, compared with a trough of around 250,000 b/d after sanctions were reimposed in 2018 (see chart below). S&P Global Platts pegs Iran’s current crude and condensate exports at around 800,000 b/d. Iran also may have 65 million barrels of crude in floating storage, according to Citigroup estimates, in the expectation that it can quickly find a market for those barrels if sanctions are lifted.

Past experience suggests that Iran will be able to quickly ramp up both production and exports if sanctions are rolled back. When the JCPOA was implemented, Iran raised crude production from 2.8 million b/d in December 2015 to 3.7 million b/d within eight months. A similar pattern could hold this year, with exports increasing as soon as July if a deal is struck next month. Citigroup estimates that Iran’s exports could increase by 500,000 b/d as soon as July and August, although the pace would depend on the exact terms of a deal. A crude output increase of 1 million b/d by the first quarter of 2022 seems feasible.

In advance of a new deal with Iran, there are reports that European and Asian refiners are preparing to ramp up their imports of Iranian crude. Indian state refiners such as Bharat Petroleum, Indian Oil Corp., and Hindustan Petroleum have expressed interest in crude purchases. Japan, which suspended imports from Iran in May 2019, could begin imports within three months if a deal is struck. And already there are indications that Iran is adjusting its crude grades to meet specific demands of Chinese refiners, especially demand for lighter grades.

Iran exports a variety of crudes that compete with barrels from the OPEC states, Russia, and the United States. A ramp-up would add large volumes of heavy sour and medium sour barrels, as well as some light crude. Growing exports of South Pars condensate would also compete with supplies from the United States, Qatar, and Australia.

Iran Presents Wildcard for OPEC-Plus

For the OPEC countries and allied producers in the OPEC-plus framework, the return of Iranian barrels presents a challenge but has not created a shift in market management. Following the largest-ever production cuts last year, OPEC-plus is gradually adding more barrels to the market. In its June 1 meeting, OPEC-plus decided to stick with its current plan to add 350,000 b/d in June and another 441,000 b/d in July (see table). Saudi Arabia also plans to unwind its additional cut of 1 million b/d within the next few months. Increasing air and road travel in the United States and Europe have given OPEC-plus more confidence that the market can absorb these barrels.

OPEC-plus ministers are probably wary of a big output increase from Iran but see no need to take action until there is evidence of a material impact. Indeed, the market has been strong enough to absorb more Iranian barrels without much trouble over the past few months. Slowing the planned output increases would have deprived producing states of revenue, at a time when crude prices have firmed up and countries are anxious to take advantage of stronger demand.

Still, sanctions relief for Iran could create challenges for OPEC heading into 2022, shaping future deliberations over whether to hold production steady in the second half of the year. Production increases from Iran could slow inventory draws and potentially create a looser market (Iran is exempt from the current OPEC-plus cuts).

The remarkably strong production discipline of OPEC-plus over the past year has been essential to the rebound in oil prices. Yet even after the planned increases through July, OPEC will have about 6 million b/d in spare capacity. Saudi Arabia has been especially keen to avoid adding barrels too quickly, preferring a cautious approach given the uncertainties over the pace of demand recovery. An Iranian ramp-up would potentially create more pressure to keep OPEC-plus output steady after July rather than add capacity, which would frustrate members who are weary of supply restraint. This course of action could also raise concerns that OPEC-plus will allow the market to overheat.

Ultimately, the best medicine for the OPEC-plus states would be a continued demand recovery—one strong enough to absorb Iran’s output increases as well as those of the rest of the group. For now, OPEC seems comfortable with the market trajectory and confident that it can manage a potential return of Iranian barrels.

Ben Cahill is a senior fellow with the Energy Security and Climate Change Program at the Center for Strategic and International Studies in Washington, D.C.

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