What the Iran nuclear deal means for oil prices

From an economic standpoint, one of the most significant aspects of today's US-Iran nuclear deal is that it could open up Iran's vast crude oil reserves to the rest of the world. Once Europe and the US ease their sanctions, Iran can ramp up crude production and exports, locking in this new era of low oil prices.

But here's the catch — this won't all happen immediately. It will likely take at least six months before we see any significant oil impact from the deal, and possibly even longer than that.

Even if all goes according to plan, the US and EU won't lift sanctions on Iran until 2016 at the earliest. Once that happens, Iran can finally start selling some of the roughly 30 to 40 million barrels of oil it currently has stored in vast floating tankers off its coast. That could help push oil prices down moderately.

But after that, it might take years for Iran to get production in its crippled oil fields back to pre-sanctions levels. The country does possess vast crude reserves — but that doesn't mean it's all coming online tomorrow.

Iran has the world's fourth-largest oil reserves — but sanctions have crippled output

(Sara Vakshouri)

Iran is sitting on some 158 billion barrels of crude oil, the fourth-largest proved reserves in the world. But thanks to a slew of sanctions by the United States and Europe in recent years — meant to pressure Iran over its nuclear program — the nation's oil fields have fallen into serious decline, driven by a lack of investment.

Back in 2008, Iran produced some 4 million barrels of oil per day. By May 2015, that had fallen to just 2.8 million barrels per day. (To put that in perspective, the entire world uses about 90 million barrels of oil per day, so this is a significant amount.)

Iran currently has 30 to 40 million barrels of oil stored at sea

On top of that, Iran has been having trouble selling the oil that it can still pump out — particularly after the EU imposed sanctions in 2012 that barred insurers from covering ships that carry Iranian oil.

Iran's exports plummeted from 2.6 million barrels per day in 2011 down to 1.4 million barrels per day in 2014 — with sales going mainly to China, India, Japan, South Korea, and Turkey:

(US Energy Information Administration)

The rest is just ... sitting there. Iran has been storing much of the oil that it can't export on massive floating tankers off its coast. Most estimates suggest they have around 30 to 40 million barrels in storage, with about half of that crude oil and the other half condensates.

This, in theory, should be the first effect of the Iran deal. Once sanctions are lifted, this stored oil can get sold off. The key question is how quickly this will all happen.

Sanctions won't be lifted for at least six months

So now comes the US-Iran nuclear deal, in which Iran gives up the bulk of its nuclear program in exchange for sanctions relief. In theory, that  will allow Iran to boost oil exports and production.

But it will be at least six months before sanctions start getting lifted — and even that might be optimistic. Richard Nephew, a former State Department official who served as lead sanctions expert for the US team negotiating with Iran, explains the timeline here:

First, the agreement involves an extensive procedure for ascertaining the support of home legislative and other legal bodies for it. In the US system, this will take at least 30-60 days as Congress will need to receive the text of the deal, hold hearings on it, and decide what to do. ....

Second, the implementation will itself take months. Iran’s list of nuclear steps is long, as is appropriate considering they are the party in need of building the most confidence. I’ve noted for a long time that removal and storage of centrifuges will be the long-pole in the timing tent, and nothing in the text contradicts this. Based on the schedule in the document, all of this work will not even start until after 90 days from today (the end of October) and it will take months from that point to fully execute the remaining changes to Iran’s nuclear program.

Third, sanctions relief itself will not flow until these nuclear steps are completed. There will be meetings and business trips by trading companies, investment firms, and by oil companies and potentially even concluded contracts (if not signed until the deal comes into force). But, if these steps cross the sanctions line, the Obama Administration has made clear that it will be forced to act. Iran will not and cannot obtain relief without having completed its part of the bargain.

So Iran shouldn't expect sanctions relief until the first half of 2016 — and possibly even later than that, if implementation ends up getting bogged down in mistrust or other disputes.

Even after sanctions are lifted, Iran could struggle to boost production

(Shutterstock)

Once sanctions are lifted, Iran has several options. First, it can start selling all that oil it has sitting in offshore tankers. Iran probably won't want to unload this all at once (since that could cause prices to crash), but the International Energy Agency estimates that it could sell some 180,000 barrels per day for six months.

Those sales would bump up global crude supplies modestly, although they're unlikely to upend oil markets on their own. (That said, we might see other countries increase their own production in response to these sales, as they fight to maintain market share. That would push prices down further.)

After that, Iran will likely try to bolster production in some of its existing fields, although it's unclear how much is actually possible. The IEA estimates that Iran will be able to increase oil production from its current level of 2.8 million barrels per day to around 3.5 million barrels per day "within months of sanctions being lifted."

But Nephew, for his part, is skeptical that Iran can ratchet up production that quickly. For one, he says, Iran is facing "fatigued fields and antiquated equipment." Once pumping ceases in a field, it's not so simple to just flip a switch and turn it back on. By some estimates, Iran will need $50 billion to $100 billion in foreign investment to get production back up to pre-sanctions levels. That could take years.

What's more, Nephew points out, foreign investors are likely to be wary about rushing into Iran. "Iran itself is a difficult environment in which to work," he writes. "The Iranian bureaucracy is formidable and it will be a real achievement if the Iranian government is able to deliver on its bait to international oil companies and others to make the process less painful."

Plus, there's always the risk that the nuclear deal falls through and the United States and Europe reimpose sanctions: "Sanctions snap-back is a real threat and businesses would be well-advised to design their contracts with Iran accordingly. Companies and banks that develop business ties in Iran will need to be prepared to have them vacated immediately if Iranian cheating is detected."

Bottom line: The IEA thinks Iran can get back to producing 4 million barrels of oil per day — the level it was at in 2008 — by the end of this decade. Oil Minister Bijan Namdar Zangeneh wants Iran to resume its spot as the world's No. 2 oil exporter behind Saudi Arabia (a spot currently occupied by Russia). But that's far from assured, and there could easily be hiccups on the way.

What would more Iranian oil mean for the US? Lower gas prices, for one.

Lower gas prices? Maybe. (Cheryl A. Guerrero/Los Angeles Times via Getty Images)

If Iran can ramp up oil production in the coming years, that would put downward pressure on global oil prices, which in turn could be a big deal for the United States.

Global crude oil prices have already fallen from $115 per barrel last June to around $58 per barrel today — a major storyline for the global economy. That price crash, in turn, has pushed down gasoline prices and made driving cheaper for Americans, freeing up money to spend on other things.

On the flip side, low prices have also squeezed US oil companies working in costly shale regions like North Dakota and Texas. Over the past year, drillers have responded to lower prices by slashing costs and steadily improving efficiency — and US oil production has held surprisingly steady. But fresh competition from Iran will make this task even tougher.

That said, the Iran story is likely to unfold over several years — it won't happen right away. It's telling that oil prices didn't drop in the day after the US-Iran nuclear agreement was announced. One explanation is that traders had been expecting a deal for months and they'd already priced in its effects. But another explanation is that it will take time for Iranian oil to reach the market, and nothing's guaranteed just yet.

Further reading

-- The Iran nuclear deal, translated into plain English

-- For more on the Iran deal and oil prices, I'd recommend analyses by Sara Vakhshouri, Richard Nephew, and the International Energy Agency.

-- Here's a big-picture look at why global oil prices have been tumbling since June 2014.

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