–Clyde Russell is a Reuters columnist. The views expressed are his own.–
LAUNCESTON, Australia – Have oil markets done enough, or too much, to price in the expected return of millions of barrels of Iranian crude?
Global benchmark Brent crude gained 1.1 percent on Tuesday after news of the deal between Iran and six major powers to monitor the Islamic republic’s nuclear program in exchange for a relaxation of sanctions, including those on oil exports and investment.
The rise in Brent was ascribed to the view that even if the deal gets final approval from all parties, it will still take several months to start being implemented, meaning that increased Iranian oil shipments are unlikely to hit the market until sometime in 2016.
While movements in the front-month futures contract tend to be the focus of market reports, as far as Iran is concerned, the back end of the curve is more relevant.
The Brent futures curve <0#LCO:> has flattened in recent months, as the Iranian deal inched towards conclusion.
The 12-month contract was at a 7.2-percent premium to the front-month in early Asian trade on Wednesday, narrowing from a premium of 21 percent six months ago.
However, a year ago the curve was mildly backwardated, suggesting that there is still sufficient scope for further flattening, especially if you subscribed to the view that fairly substantial amounts of Iran crude will flow to global markets next year.
The flattening of the curve has also happened in Oman futures <0#OQ:>, with the premium of the 12-month contract over the front-month standing at 2.3 percent early Wednesday, down from almost 25 percent six months ago.
While not as liquid as Brent futures, Oman contracts traded on the Dubai Mercantile Exchange are a good proxy for Iranian oil, given the similarities between Oman and Iranian grades, which are heavier and more sour than light crudes such as Brent.
What the futures curves are most likely showing is that they have priced in the return of Iranian oil from next year, but are treading a middle path between the optimistic and pessimistic scenarios.
BALANCE OF RISKS POINT TO CAUTION
The most optimistic scenario, put forward by the Iranians themselves, sees a rapid ramp-up in output to about 4 million barrels per day (bpd), which in turn would lead to at least an additional 1 million bpd being available for export.
Most analysts see this as unrealistic, at least in the short term, with a figure of about 500,000 bpd in additional exports being slated as more likely.
Even 500,000 bpd extra on the world market would most likely depress prices considerably, especially if other producers kept output at current levels.
There’s no reason to believe that Saudi Arabia, the top producer in the Organization of the Petroleum Exporting Countries (OPEC), would be willing to cede market share to Iran, especially in key Asian exports markets China and India.
The cool relations between the two Middle East powers will also make it hard for OPEC to agree to, and effectively implement, production cuts to accommodate extra Iranian barrels in the market.
But the balance of risks appears more tilted toward the cautious view of the return of Iranian oil, given that the agreement with the six powers contains numerous steps, and any time the complexity of implementation is high, the likelihood of delays increases.
If Iranian oil is slow to return to the global market and volumes disappoint, then the flattening in the futures curve of recent months looks overdone.
Another question worth posing is whether the outlook for demand is going to be more of a factor in determining oil prices.
Given that the market is known to be oversupplied, it’s more likely that changes in demand will play a bigger part, especially if China and India, Asia’s two biggest importers, continue to take advantage of low prices and fill strategic storages.
A recovery in the second half in the Chinese economy, extending into 2016, may also boost demand for oil, but this isn’t a certainty given the poor response of the economy to stimulus measures so far this year.
Overall, the oil futures curve is probably correct in treading a middle path on the likely influence of Iran until just how quickly the deal can be implemented becomes clearer.
(Editing by Joseph Radford)
This article was from Reuters and was legally licensed through the NewsCred publisher network.