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How New Saudi-Iran Relations Could Shape the Oil Market

Published 2023-06-15, 03:28 a/m
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  • Tehran's embassy opening in Riyadh is unlikely to impact Saudi Arabia, OPEC, or oil policies.
  • Still, rapprochement between the two countries could facilitate U.S. negotiations, potentially affecting Iranian oil sanctions.
  • Increased Iranian oil production under sanctions challenges the traditional incentive for nuclear negotiations.
  • Tehran recently opened an embassy in Riyadh, Saudi Arabia. Many market watchers are wondering if this is meaningful for the oil prices. The short answer is no… but maybe a little yes.

    First, this will not impact how Saudi Arabia or OPEC deals with Iran or the oil market. There is no indication that the Saudi-Iran rift interfered with oil policy.

    In fact, OPEC, which is in many ways dominated by Saudi Arabia, has consistently given Iran exemptions from production quotas in recent years despite the apparent animosity between Riyadh and Tehran. Therefore, there is no indication that better relations are going to change anything between these countries in the oil world or have market implications.

    Where this may have some relevance in the oil market is that a rapprochement between Saudi Arabia and Iran might make it easier for Washington DC to renew negotiations with Iran and thus weaken or end the current sanctions on Iranian oil.

    If DC does halt or minimize its sanctions on Iranian oil, look for at least a short-term drop in oil prices as the market would expect more open trading of Iranian oil at market prices that are not discounted. However, traders should not anticipate that improved U.S.—Iran relations will result in an increase in Iranian oil production. According to the latest survey by S&P Platts, Iran produced 2.66 million bpd in May 2023.

    This reflects a small increase from Iran’s average production rate of 2.4 million bpd in 2021. At the beginning of May, Iran claimed its production had hit 3 million bpd, but independent sources, like Platts, could not confirm this.

    Even if Iran is not producing quite at the 3 million bpd level, its production rates have risen despite the strict oil sanctions the United States imposed on Iran. If Iran can increase production and exports while under sanctions, then the incentive to negotiate with the United States over its nuclear program could come under threat.

    There are signs that the U.S. and Iran might be considering re-opening negotiations with each other, as according to recent reports, representatives from both countries traveled to Oman for indirect talks with each other through Omani intermediaries.

    The discussions concerned the release of American prisoners held by Tehran in exchange for Iranian oil and gas revenue frozen in overseas accounts.

    Even though talks are very far from any agreement that would end sanctions, given how well-developed Iran’s illicit oil trade has become, the incentive to give up nuclear ambitions in order to end the sanctions is not as great a motivator as it used to be. Oil traders should be aware that talks and negotiations between the U.S. and Iran are not necessarily a bearish signal for the market.

    ***

    Disclosure: The author doesn’t own any of the instruments mentioned in this report.

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