Iran deal could lead to scuttling of the great U.S. oil boom

In the short term, the Iran deal will ease the political risk premium baked into oil prices. In the medium term a comprehensive deal could add 1 million or more barrels per day to the market. In the long-term a gush of Iranian oil could soften oil prices enough to kill the economics of America’s tight oil boom. 

In Monday trades, after the weekend signing of an interim resolution between the U.S. and Iran, the price of benchmark Brent crude slid about 1.5% to $109 per barrel. West Texas Intermediate crude was down about 1% to $94 per barrel in mid-morning trades.

These modest declines are a reasonable reaction to the deal signed over the weekend. No one is expecting any flood of Iranian crude back to the market. The White House insists that sanctions on Iran’s oil and banking sectors remain in place and that the international community will “continue to enforce these sanctions vigorously.”

But successful diplomacy reduces geopolitical risk. Although any military strike on Iran’s nuclear facilities was exceedingly remote before the deal (President Obama was not about to start another war in the Middle East), it is now virtually inconceivable for at least the six months during which the U.S. and the rest of the P5+1 group of nations will negotiate what the White House refers to as a “long-term, comprehensive solution that addresses all of the international community’s concerns.” Israel, despite Prime Minister Benjamin Netanyahu’s condemnation of the deal as “an historic mistake,” is unlikely to attack Iran unilaterally during this time.

How much geopolitical risk is baked into the price of a barrel of oil? At the height of former President Ahmadinajad’s bellicose anti-Israel rhetoric and threats to blockade the Straits of Hormuz, it was understood that as much as $20 per barrel represented a risk premium. About that much could quickly melt off of benchmark prices in the days and weeks to come, bring crude oil down from about $100 a barrel in the U.S. into the $80 range.

But what about the price impact of an uptick in longer-term supplies? This interim deal naturally makes the chances of a long-term deal more likely, so traders will naturally price in marginally higher exports from Iran starting in six months or so. That could soften prices even more.

Since the toughest sanctions were imposed in 2012, Iran’s oil production has declined 900,000 barrels per day, according to analysts at Tudor, Pickering & Holt. Much of that production is heavy oil. Saudi Arabia has adeptly replaced those Iranian barrels in the market by boosting their own production by roughly 1 million bpd. But when it comes time for Iranian oil to come back onto the market, the Saudis (though no friends of Iran), would likely dial back their exports to make room.

But how much room will the Saudis be willing to make in the years ahead? Iran has the reserves to add millions more in supplies. It would take awhile. As Bill Herbert, analyst at Simmons & Company, points out in his morning note, “sustainably increasing production levels well above 3 million bpd for a consistent period of time will most likely require substantial foreign investment from global IOCs and western service companies.”

Some of those IOCs — like Exxon Mobil XOM +1.61%, Chevron CVX +0.98% and Total TOT +1.21% — have jumped at the opportunity to invest in untapped oil fields just over the border from Iran in the Kurdish region of Iraq. The fields there have proven to be enormous, the flow rates prodigous, the ease of recovery unmatched anywhere else in the world. Iran’s potential is even greater.

Given sufficient investment in drilling and infrastructure, there are ample oil reserves in Iraq and Iran to add another 5 million bpd to global oil supplies within 10 years. In addition to those two, there remains roughly 1 million bpd of Libyan production offline due to continued unrest there.  Nigeria too has at least 250,000 bpd shut in. Solve political and security problems in those countries and the world could suddenly be awash in excess oil supply.

Over the long run the easing of sanctions against Iran spells trouble for the economics of the tight oil plays that have sprung up across the United States in recent years. The Eagle Ford and Permian Basin and Bakken need sustained high oil prices to make the economics of expensive drilling and steep decline rates pay off. It’s no coincidence that America’s great oil and gas renaissance has coincided with sanctions on Iran and unrest in Libya. The concern for U.S. drillers is that successful Middle Eastern diplomacy could end up being the worst thing for their business. If crude oil benchmarks were to fall to $75 a barrel and stay there for a couple months you’d see drilling rigs across Texas and North Dakota fall silent.

The U.S. onshore oil industry has been perhaps the brightest spot in what passes for America’s economic recovery. How ironic that it could end up being a casualty of the Middle Eastern peace process.

http://www.forbes.com/sites/christopherhelman/2013/11/25/iran-deal-could-lead-to-scuttling-of-the-great-u-s-oil-boom/?ss=business%3Aenergy