By Eric R. Eissler*
The oil industry has seen a major paradigm shift over the past five years, with the United States emerging as the world’s foremost oil producers, dethroning Saudi Arabia. While the U.S. still consumes more oil than it produces— with 18.8 million barrels of oil (bopd) consumed per day in 2013 and only 10 million produced—the increased supply means there is more on the world market. With Europe and Asia’s weakened demand and with Saudi Arabia unwilling to cut production, oil prices fell hard through the final quarter of 2014. Falling from a high of $100 per barrel in mid-2014 down to the current price of $56 for a barrel of Brent crude, the quick drop badly hurt producers around the world. Saudi Arabia is brandishing its power with continued unthrottled production in hopes to dry up producers working in tight oil (shale oil) in the U.S.
Furthermore, it has the power to do so with a vast strategic cash reserve, created to weather sustained low oil prices. However, if a deal on nuclear weapons is reached between the U.S. and Iran, sanctions will dropped and a potential million bopd could be unleashed on top of an existing 2-million-barrel supply glut. This could force more downward pressure on prices and have even more severe global consequences on the already debilitated industry.
A nuclear deal could crash the market
The unintended effects of an Iran-U.S. deal could add more oil to the global market, as sanctions would be lifted and the country would be able to export its oil to the world market. Iran already produces some 3.5 million bopd and with the crippling effects of the long imposed sanctions on its economy, it will want to bring in some much needed income and relief—fast! Selling oil will help offset years of a disabled hydrocarbon industry. In 2013, Iran produced 3.5 million bopd which is lower than its peak of 4.3 million bopd in 2008. Furthermore, the sanctions imposed by the US and EU have impeded Iran’s ability to sell oil to major markets, resulting in a 1 million bopd drop in crude oil and condensate exports in 2012 compared with the previous year.
Once sanctions have been lifted—if a deal should come to pass—then Iran will have access to major markets and then will have income to reinvest into its oil and gas industry, resulting in an increase in its output.
This could be done “within a few months” according to Iran’s Oil Minister Bijan Zanganeh in a statement made on 16 March 2015. However, given the current infrastructure, it may take longer than three months, and may require a $50-billion investment, according to one observer, Leonardo Maugeri, an associate at Harvard University’s Kennedy School, who was head of strategy at Italy’s Eni until 2011 and has worked on hydrocarbon projects in Iran.
An opening of Iran will also have many super-majors and other major oil and gas companies vying to get a piece of the action. This will certainly be the case for exploration and production companies, which would be keen to develop and open up new gasfields: Iran holds 18.2 percent of the world’s proven gas reserves. However, this venture would only be profitable if these international oil companies (IOCs) could obtain proper production-sharing agreements in place of the current “buybacks,” whereby the IOCs only make a fixed return on successful projects and do not own the assets. The new contracts that Iran is touting are long-term agreements (up to 25 years), an effort to attract Western IOCs.
$40 Per Barrel: Good For Consumers, Bad For State Budgeters
The world markets haven’t seen prices of $40 for a barrel of oil since February 2008. Current prices are close to that point now, but if the deal goes though and Iran is able to export and redevelop its oil and gas industry, then the price will fall again. In a precursory move, the Islamic Republic adjusted its state budget to reflect an oil price at $40 per barrel of oil.
Could this preemptive move come along with Iran already knowing what lifted sanctions could do to the market? If this is the case, many countries which rely on hydrocarbons to run the state budget and economy will continue to struggle with gaps left by the low prices and high price expectations. Azerbaijan is one of those countries that has been hit hard.
The national currency of Azerbaijan, the Manat, lost 33.5 percent of its value against the dollar and 30 percent against the Euro when it was devalued on 21 February 2015 . This came as a shock to the country as it was believed the currency was not susceptible to such fluctuations. However, in reality, Azerbaijan’s economy is not sufficiently diversified to protect it from such market changes. Other major oil and gas producers, such as the US, will be less affected by lower oil prices because oil and gas make up only a part of the entire economy. By contrast, Azerbaijan’s hydrocarbon revenues in 2014 made up more than 52 percent of the state budget, which are transferred from the State Oil Fund of Azerbaijan.
Comparing Texas Tea With Azercay
To compare the U.S. with Azerbaijan by ways of state budgets is not so straightforward, due to the federalist system in the U.S. and the way state governments collect taxes and prepare budgets as compared to the Federal Government. For the sake of simplicity, tax collections for the state of Texas are analyzed here, because it is the country’s largest oil producing state. In 2014, Texas collected $104,942,293,918 of which only $3,874,070,862 or only 3.7 percent of the total tax revenue was collected though an oil production tax. While hydrocarbons are a big part of the Texan economy, the revenue source is barely 4 percent of state income and, furthermore, the state does not own the industry, it is privately held. This demonstrates just how diversified the U.S. economy is compared to Azerbaijan at only the state level.
If Iran gets the deal, the oil glut will grow, prices will fall, and there will be major consequences for state budgeters of oil-heavy reliant nations. Furthermore, the private producers and the small companies working with unconventional oil – already struggling in this time of low oil prices – will suffer the most.
Iran has the potential to shake up the Middle East political paradigm, if sanctions are lifted and assets unfrozen. Its energy industry can heat up within a short time period and would be second to Saudi Arabia and the second largest OPEC producer. This new reality would make Saudi Arabia uneasy, as it has been the hegemon for decades in the region. A major upset from Iran has could bring more chaos to an already very troubled region by means of a power struggle between the two nations. If 2014 was the year that turned the world on its head, then 2015 will be an extension of the table-turning game.
About the author:
*Eric R. Eissler is the editor-in-chief of Oil & Gas Engineering