What Iran's Nuclear Deal Means For Oil

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Reach back a decade into your memory banks and pull out the file folder marked "Axis of Evil." Remember all the participants? Iraq, Iran, and North Korea constituted the three great threats to the United States during the second Bush Administration, each one a sponsor of terrorism and dastardly deeds. We've invaded Iraq to stop the first threat. We've brought North Korea to the bargaining table without much to show for it (fun fact: North Korea's main export is counterfeit $100 bills). The news today features the third member of the Axis, Iran, a nation wracked with a variety of sanctions over their nuclear energy program. The United States fears Iran could enrich uranium to weapons-grade; Iran fears for its safety when Israeli A4 Vultures can can be in Iranian airspace within two hours. Iran produces more oil than all but six other nations in the world, however, and their ability to develop fossil fuels can hinge upon nuclear power. What's the long-term outlook for oil if Iran gets the nuclear fuel they're looking for?

Up and Atom

Iran's nuclear program represents one of the greatest stories of the 20th century, a true-to-life James Bond saga built in the hands of a Pakistani atomic technician named A.Q. Khan. Khan stole nuclear core blueprints from a Dutch engineering company during the 1980s and started up his own laboratory to sell the designs. Iran purchased the centrifuges needed to enrich uranium from Khan during the 1990s, along with Libya and North Korea. Unlike North Korea's program, which almost certainly churned out at least one nuclear bomb, the Iranian centrifuges turned out to be duds: old, rusted, faulty. Iran spent about a billion dollars on the project (Khan didn't issue a refund) and earned massive sanctions for the effort, resulting in major economic collapse in a nation already left fragile by the brutal Iran-Iraq war of the 1980s. By 9/11, Iran's economy had showed signs of recovery and moderate secularists had began to openly call for democratic elections in the country. Their inclusion on the Axis of Evil proved to be ample ammunition for hardliners, however, resulting in yet another backfiring for U.S. foreign policy. Iran relies almost exclusively on oil today -- a full 90% of their exports are petroleum and petroleum by-products, a larger figure than Saudi Arabia. The Iranian government looks to nuclear power as a means of advancing their one-trick-pony economy and alleviating the horrible pollution problems caused by abundant supplies of oil, with four of the ten-worst cities for air quality located in Iranian borders.

Deal Options

The current deal on the table of Iran reads fairly simply. The ayatollahs must agree to cease the enrichment of uranium past the point where it approaches weapons-grade and dismantle the centrifuges capable of plutonium enrichment. They cannot build new centrifuges except to repair existing equipment. Iran must halt almost all progress at the Arak reactor, the spot where intelligence agents believe their heavy water reprocessing can separate plutonium from nuclear fuel. Do that, says the US State Department, and the world will ease sanctions and transfer about four billion dollars of oil revenue to the Iranian government. Since Iran has by and large just one economic pulse, the sanctions in question threaten the nation's ability to pump, distribute, and sell oil. The push to approve the deal isn't just coming from the US and our EU allies. Iran sells almost all of its oil to just four nations: India, China, Japan, and South Korea. Since China holds a seat on the UN Security Council and purchases about 50% of Iranian oil, furthermore, they're putting pressure on western nations that Iran couldn't hope to leverage themselves.

Market Reactions

Taking the deal or not taking the deal will likely not push the cost of oil up or down more than a fraction. Where the value rises comes in the scenarios for the Iranian economy once they've either taken or rejected the deal on the table. If Iran rejects the nuclear deal, they can expect a bevy of sanctions slapped on their oil exports that will further choke the government's main source of revenue. Iran can't afford to follow in the footsteps of fellow OPEC founding member Saudi Arabia, who will happily sit on their oil stockpiles rather than sell at depressed prices. The decision to ratify the deal could mean the Iranians flood oil on the market in order to make up for the economic penalties, sending what little value gains crude petroleum has enjoyed in the past month into the toilet. Indeed, the price of oil has climbed in the past week largely thanks to uncertainty over the deal. If Iran chooses to walk away from the bargaining table, they'll be put in a particular pickle. Iran can't squeeze valuable profit from oil if fresh sanctions mitigate their trade partners, while China will likely choose to buy cheaper oil from Indonesia and Russia rather than adhere to the draconian standards placed on the price tag. That won't depress prices, but likely won't drive oil up either.

Between Iraq and a Hard Place

The odds of a refusal are most likely fairly low. The Iranian rial has lost 75% of its value in the last year alone and unemployment has risen to about 13%. What's more, Iran has a host of other problems, including but not limited to the world's largest heroin addiction rate and 200 separate political parties squabbling for votes and control. Iran has refused to come to the bargaining table before, however. At present, the nuclear deal is a likelyhood, which means downward pressure on oil is a likelihood as well; London's Capital Economics expects the deal to depress oil prices to about $40 per barrel. With crude futures currently standing at $50.35 per barrel, there's great potential for investors to short oil and capitalize on the Iranian deal. What's more there's little risk in the event that the deal falls short, since Iran will have to continue pumping oil either way.

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