After the Iran Deal, What's Next for the Oil Market?

On May 8th, Trump withdrew the US from the Joint Comprehensive Plan of Action, also known as the Iran nuclear deal. Even if the other signatories don't follow the US and refrain from reimposing sanctions, this decision has major political and economic consequences. This is particularly true for the oil market. Iran's oil production accounts for around 5% of total global oil output, and any trade restrictions will undoubtedly leave an imprint on the global oil market.

The Iran deal came into effect in October 2015 as a joint effort of the US, Iran, France, Germany, Britain, Russia, and China. The Iran deal essentially lifted sanctions against Iran in exchange for imposing limits on Iran's nuclear development. Previous sanctions on oil exports from 2012 to 2016 cost Iran up to 160 bn USD. The deal lifted the trade restrictions, enabling Iran to profit from the bullish oil market. Once exempted from oil production cuts, Iran supplied mainly Asian and European markets, with Eni (ENI.MI), Repsol (REP.MC), Royal Dutch Shell (NYSE: RDS) and Total (NYSE: TOT) among recipients.

On Monday, May 7th, Trump tweeted that he would announce his decision on Iran deal next day. Almost simultaneously, prices rose above 70 USD/barrel for WTI, breaking through the resistance level. On Tuesday morning, prices dropped again below 69 USD/barrel, suggesting that the withdrawal from Iran deal might have been already priced in. The remaining trading sessions last week were mostly bullish, with the max price on the level of 71.89 USD/barrel for WTI. On Friday, the price dropped by over 1.25% to 70.51 USD/barrel, mainly due to the news that the rig count hit its highest level in the US since 2015.

According to a Goldman Sachs (NYSE: GS) note, published on Wednesday, current Iranian oil output is 3.8 million barrels a day (bpd). The reimposed sanctions could cut production by 0.5 million bpd and threaten recently kicked-off investment projects in Iranian oil and gas sector. One of the most impacted might be French Total, which may be forced to downsize its activity in the South Pars field. With current geopolitical risks in the Middle East and crushing oil production in Venezuela, the bullish sentiment is reasonable.

Other major oil producers have also reacted to Trump's decision. The shortage of oil supply caused by sanctions imposed on Iran can be easily offset by increased production by US shale producers, who constantly add new rigs. This scenario resembles the situation from 2009, when oil prices remained low because of the introduction of shale technology, despite heavy sanctions on Tehran. The impact of Trump's decision depends also on the reaction of other signatories, who called on Iran to remain committed to the deal and who may find avenues to circumvent US sanctions. Europe has a particular interest in maintaining a relationship with Iran, as they have become a major recipient of Iranian oil in recent years.

The trade restrictions reimposed on Iran might not have an immediate impact on the oil prices, but they are a sign of geopolitical tensions in the region. The risks associated with possible conflicts in the Middle East and the development of Iranian nuclear program will stimulate bullish sentiment in the long term. The US production can offset it for now, but the geopolitical uncertainty can become a major force on the market.