The world still needs Iran’s oil, even if the price isn’t right

At some point production cutbacks are going to bring the price back into balance – and maybe create the next oil crisis when we are back to shortages again, writes Ivan Fallon.

The breaching of the $50 per barrel mark late last year was a landmark that has fundamentally altered the supply/demand curve. Above, oilfield workers at Azadegan southwest of Tehran. Vahid Salemi / AP PhotoShow less

Iran's re-entry on to the international stage could hardly have come at a worse time, not just for Iran itself but for oil-producing countries in general. By adding an extra 500,000 barrels per day to the glut, which has already forced oil prices to a 12-year low of under $30 per barrel, it can only make things worse, at least in the short term.

Iranian officials say they intend to increase production by 1 million bpd within six months and to return to their pre-sanctions level of 3.4 million bpd by the end of the year. Although international oil analysts last week dismissed that target as “ambitious”, there is still going to be an awful lot of extra oil around to keep the pressure on prices.

There are some misconceptions about Iran’s existing capacity. Despite sanctions, it has never been out of the market altogether and last year shipped 1 million bpd to some of its more friendly countries, including India and South Africa, which it supplied all through the apartheid years in the face of sanctions.

Up to now, however, it has mostly bartered oil for goods and has therefore been insulated from the collapse in the oil price. The point about the removal of sanctions following the agreement with the US over its nuclear power programme is that, as one White House offices pointed out last week, “free to sell as much oil as it wants to whomever it likes (and) at whatever price it can get”.

What price will that be? No one has a clue. I watched last week an eminent oil analyst quizzed on Bloomberg about his prediction that oil could reach US$15 per barrel and maybe even $10. “Ah”, said the interviewer, “aren’t you the same man who a year ago was predicting $200 a barrel?”

He wasn’t the only one, just as he is not the only one forecasting Armageddon today. One thing is for sure: we are not going to see $200 a barrel any time soon, if ever. But I doubt we will see $15 either, or if we do, it won’t be for long.

The breaching of the $50 per barrel mark late last year was a landmark that has fundamentally altered the supply/demand curve and $30 oil has reinforced that.

In an authoritative report published on Thursday, the international energy consultants Wood McKenzie estimated that oil companies around the world have shelved more than $400 billion of new gas and oil projects since the price collapsed. Million of barrels of production have already been pushed back in the Gulf of Mexico, Africa and Kazakhstan. According to WoodMac, development of 68 projects totalling 27 billion barrels equivalent of reserves have been postponed or abandoned as companies desperately try to contain costs and maintain their precious dividends.

“Company budgets have shrunk drastically and investors are favouring those delivering severe capex cuts,” says the report. “As a result, there is a growing backlog of deferred greenfield and incremental developments that require significant investment.”

Roughly, the postponed projects equate to 2.9 million bpd, which is about the production of Kuwait. None of this will now be on stream until early in the next decade, by which stage the world will be a different place. More projects, some of them costly deepwater projects, are expected to be delayed over the next six months and, if oil does drop to $15, oil companies will basically go into hibernation. The WoodMac report estimates that the average production cost of these projects is $62 per barrel, which is around the cost of fracking in the US.

“It’s a bunker mentality,” says WoodMac. “We will see more projects postponed over the next six months. This trend is going to continue.” At some point production cutbacks are going to bring the price back into balance – and maybe create the next oil crisis when we are back to shortages again.

The chief executive of Royal Dutch Shell, Ben van Beurden, in the middle of a controversial £34bn (Dh178.61bn) takeover of BG, has this to say about the price: “Some people will forecast oil to be $20, others $120, and they will both be right eventually. But if you come back to the fundamentals, there is going to be an increase in demand – this year it will be 1.2 million extra barrels a day.” Opec, he points out, has done a lot to increase supply but is running out of room. “Saudi Arabia can’t do much more, nor can Iraq, there’s just Iran left.”

So, he argues: “The market is going to balance. I don’t know when, and then we will have a normal market where the cost is set by the cost of the marginal producer. And that will be a lot higher than $30 a barrel, and it’s safe to say it will be above the low 60s.”

If he is wrong, Mr van Beurden will have vastly overpaid for BG and will lose his job. Shell shares have halved in the past 18 months (as has the Saudi Arabian stock market) and BG is a big mouthful, even for a group that is still valued at about £100bn.

But what he says makes sense. The current price is insane, driven by short-term political and strategic factors, notably Saudi Arabia’s obsession with killing the American fracking industry. And huge stocks. A return to common sense would certainly see it back at $50, which is still historically low; $60 sounds about right. The burning question, for Iran as well as for the rest of the world is, when?

Ivan Fallon is a former business editor of The Sunday Times and the author of Black Horse Ride: The Inside Story of Lloyds and the Financial Crisis