Interim Nuclear Deal: Key Implications

BMI View: Iran and the 5+1 powers clinched a landmark interim deal on the Islamic Republic's nuclear programme on November 24, paving the way for a partial easing of sanctions. However, we caution that progress towards a more permanent agreement will face substantial difficulties. Our below consensus forecasts for oil prices have largely priced in the impact of continued negotiations, and we note that a return of significant volumes of Iranian crude to the market remains off the cards for now.

Iran and the 5+1 powers (the United States, Russia, China, France, Britain and Germany) clinched an interim deal on the Islamic Republic's nuclear programme on November 24, following four days of negotiations in Geneva. Under the agreement, which will last for six months while a more permanent and comprehensive settlement is found, Iran will curb some of its nuclear activities in return for an immediate gain of approximately US$7bn in sanctions relief (see table below). US President Barack Obama called the deal "an important first step toward a comprehensive solution that addresses our concerns".

A More Substantive Deal Faces Significant Challenges

A Modest Price Drop
Brent Oil Prices, US$/bbl

BMI View: Iran and the 5+1 powers clinched a landmark interim deal on the Islamic Republic's nuclear programme on November 24, paving the way for a partial easing of sanctions. However, we caution that progress towards a more permanent agreement will face substantial difficulties. Our below consensus forecasts for oil prices have largely priced in the impact of continued negotiations, and we note that a return of significant volumes of Iranian crude to the market remains off the cards for now.

Iran and the 5+1 powers (the United States, Russia, China, France, Britain and Germany) clinched an interim deal on the Islamic Republic's nuclear programme on November 24, following four days of negotiations in Geneva. Under the agreement, which will last for six months while a more permanent and comprehensive settlement is found, Iran will curb some of its nuclear activities in return for an immediate gain of approximately US$7bn in sanctions relief (see table below). US President Barack Obama called the deal "an important first step toward a comprehensive solution that addresses our concerns".

KEY TERMS OF THE NOVEMBER 24 DEAL:
Iran will stop enriching uranium above 5%, and neutralise its stockpile of 20% uranium
Iran will limit the number and capability of its centrifuges, and will not construct additional enrichment facilities
Iran will halt work at the Arak heavy-water reactor, which could in theory produce plutonium for a nuclear weapon if it became operational
Iran will allow more intrusive inspections by the International Atomic Energy Agency, including daily access to the Natanz and Fordow sites
In return, Iran will receive as much as US$7bn in sanctions relief over six months, including the release of US$4.2bn in frozen oil assets and the suspension of some sanctions on sales of gold and precious metals, autos, and petrochemicals
The P5+1 will not impose new nuclear-related sanctions for six months if Iran abides by the terms of the accord, "to the extent permissible within their political systems"
Iran will retain the right to enrich uranium up to 5% in the interim period - the required level for a civilian power reactor
Source: BMI, BBC, Bloomberg
Work At Arak To Be Halted
Iran - Main Nuclear Facilities

A More Substantive Deal Faces Significant Challenges

The interim Geneva agreement has rightly been hailed as a significant development in the negotiations between Iran and the West, and marks a further improvement in the Islamic Republic's international position since the election of Iranian President Hassan Rouhani in June 2013. The deal will help to bolster Rouhani's domestic popularity, strengthening his government's hand against hardliners at home. Iranian negotiators were greeted by large cheering crowds on their return home, while Supreme Leader Ali Khamenei - who retains the final say in foreign policy and nuclear matters - expressed his support for the accord. The Iranian rial strengthened against the US dollar by 2.3% once the agreement was announced.

That said, we note the clear risk that the November 24 agreement could turn out to be the apex of the negotiations, with the next phase of talks - aimed at reaching a long-term deal on Iran's nuclear programme - likely to face significant opposition by hardline policymakers from all sides. Israel remains loath to endorse any agreement falling short of a full dismantling of Iran's nuclear enrichment capabilities - an outcome that would in our view never be accepted voluntarily by Tehran. Israeli Prime Minister Benjamin Netanyahu denounced the interim agreement as "an historic mistake" characterised by "cosmetic Iranian concessions that can be cancelled in weeks". Israeli officials have warned that all options remain on the table, including a unilateral military strike on Iranian nuclear facilities - although we consider such a scenario unlikely. At the same time, the US' Arab Gulf allies, most notably Saudi Arabia, fear that a more substantive US-Iran détente would come at the expense of their own interests (see 'Rising Strains In US - Saudi Relationship', October 17).

These views will continue to influence lawmakers in the US Congress, who have the power to pass further sanctions bills or even restrict Obama's waiver authority (the executive power to pause the implementation of existing sanctions). While the interim agreement pledges for the P5+1 to impose no new nuclear-related sanctions for six months if Iran abides by its commitments, the phrase "to the extent permissible within their political systems" stands as an important caveat . Both houses of Congress have introduced legislation in favour of expanding the sanctions regime (with a motion passed in the House of Representatives in July 2013), and Iran 'hawks' are present amongst both the Republican and Democrat parties. Were a bipartisan sanctions bill to pass through the Senate over the coming months, Obama's authority and the general climate for negotiations would be significantly worsened, diminishing the prospects for further rapprochement with Iran.

A Modest Price Drop
Brent Oil Prices, US$/bbl

Outlook For The Oil Market: Near-Term Impact To Be Limited...

The initial impact the agreement reached between the P5+1 and Iran is in line with our view. At the time of writing, prices for Brent had fallen by nearly 2% in early trading on the back of the deal reached in Geneva, standing at US$108/bbl. Yet as we have outlined in the past, the fall in prices is based on a change in sentiment, with a further reduction in the risk of military action as diplomatic efforts intensify, rather than a more tangible change in the fundamentals of supply and demand.

POSSIBLE SCENARIOS & POTENTIAL IMPACTS AS DIPLOMACY ADVANCES
Event Summary Timeline Impact On Oil Market
Scenario 1 Gradual Improvement 12- 24 months Change in Sentiment: Lower Risk Premium; Prices Drop US$5 -US$8/bbl
Scenario 2 Breakthrough 6 - 12 months Change To Market Fundamentals & Sentiment: Prices Could Fall To US$80/bbl Range
Scenario 3 Tactical Move - Breakdown 6 -12 months Change in Sentiment: Prices Rise As Optimism Fades And Risk Premium Rebounds
Note: Broad impact of potential outcomes, discounting other exogenous events to negotiations such as volatile Libyan production.

We hold onto our view that all other things being equal, the continuation of diplomatic efforts will support further weakness in global oil prices. Although we cannot discount the impact of unforeseen events or continued unplanned supply outages in key markets such as Libya, we believe the market remains well supplied overall. This leaves political developments in the Middle East as the greatest source of upside risk to our forecasts.

BMI AND BLMBERG CONSENSUS FORECASTS, US$/bbl
2014f 2015f 2016f
Brent Forecast - Bloomberg Consensus* 105 103.5 102
Brent BMI Forecast 102.75 102 101
*BMI is a contributor to Bloomberg Consensus; Accurate as of 20/11/13; Source: Bloomberg, BMI

However, our below consensus forecasts have Brent have largely priced in the impact of continued negotiations in reducing the risk premium, moderate growth in demand, and a well supplied market (with increased production from North America and elevated output from Saudi Arabia largely offsetting the loss of supplies from elsewhere). This view was reinforced by the recent deal reached among negotiators, and by a gradual downward move in consensus prices toward our forecasts.

BMI AND BLMBERG CONSENSUS FORECASTS, US$/bbl
2014f 2015f 2016f
Brent Forecast - Bloomberg Consensus, As Of 3/10/13 107 106.5 104
Brent Forecast - Bloomberg Consensus, As Of 22/11/13 105 103.5 102
Brent BMI Forecast 102.75 102 101
*BMI is a contributor to Bloomberg Consensus; Accurate as of 20/11/13; Source: Bloomberg, BMI

However, we have not yet reached the point at which we can factor in a return of significant volumes of Iranian crude to the market - a development that would have a more dramatic impact on global prices. As US Secretary of State John Kerry warned after news of the agreement broke, "the next phase...will be even more difficult...but it will also be even more consequential". Given the challenges outlined above, we share this view and thus remain convinced that achieving the breakthrough scenario we outlined, whereby Iranian oil could return to markets and send prices to the US$80/bbl range, is both uncertain and at least 6 - 12 months away ( see, 'US - Iran Talks: Three Scenarios,' October 1). With existing restrictions on Iran's oil sector forming the greatest source of leverage for the West (along with sanctions on the banking system), any easing is likely to only come as part of a broader, final settlement. In the interim, while we anticipate lower prices as negotiations progress, we see only moderate downside risks to prices for now.

Bottoming Out, But No Shortage Of Downside Risks
Iran - Oil Production & Net Exports

... But A Successful Resolution Would Be Game-Changing

Unrolling the sanctions on Iran's oil sector will be challenging, complex, and time consuming, but we continue to believe that a reversal would be game-changing. Iran would quickly be able to put additional volumes on the market, with an estimated 25- 30mn barrels of oil estimated to be in floating storage alone. Moreover, with new investment Iran could eventually recover to pre-sanctions production capacity, which was in the area of 4.0mn bbl/d, compared to current output of 2.79mn b/d in September 2013 (according to International Energy Agency data).

Iran has already begun engaging with western international oil companies and discussing the introduction of new and more attractive contract terms in the hopes of filling what the Rouhani administration admits are substantial investment needs in light of the deterioration of hydrocarbons sector over recent years. Given Iran's below ground potential, the country would attract serious consideration were political and legal obstacles removed. That said, given the history and complexity of restrictions, firms are likely to move cautiously in light of the risks that any progress be reversed.

While we note that such investment would pose sizable upside risk to our production forecasts for Iran, we caution that impact on global prices could be short-lived. Signs that Iranian oil would return to market in a more material fashion may initially lead to price war among OPEC members competing for a share of the Asian market. Yet as greater volumes of Iranian oil came online or were expected to be available, we anticipate that OPEC members eager to keep prices in the US$100/bbl range to support their own fiscal positions would respond by curtailing production ( see, 'Discounts May Be On Offer To Regain Customers,' October 23). Thus, any dramatic fall in prices stemming from an uncertain breakthrough could be short-lived.

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This article is tagged to:
Sector: Country Risk, Oil & Gas
Geography: Iran
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