It finally happened: Donald Trump will be reimposing sanctions on Iran, violating the JCPOA deal designed to impede Iran’s ability to develop nuclear weapons. Long telegraphed as part of his presidential campaign, the President had to sack a Secretary of State to get his way, but get his way he has. Now the decision has been made, what are the consequences for the production management deals which have underpinned Brent’s rally to $77/bbl?
Some, like Energy Intelligence, are already suggesting fresh sanctions threaten the deal between OPEC and its allies. Their sources in OPEC suggest both that the deal is highly important to Saudi Arabia, but also that a relaxation of targets is possible to cope with any Iranian outages. They see Iran’s loss of production as 200,000 – 700,000 b/d by mid-2019.
In our view, there is no real need for OPEC or its allies to relax targets, given the way that compliance is measured. OPEC adds together all deal participants’ targets, then all their production, and divides total production by total targets to get a compliance percentage. This means any Iranian production lost due to sanctions will actually improve OPEC’s compliance with the deal, and allow other OPEC states to increase production to compensate even if this means exceeding their own personal target.
Because the deal is split into two groups, however, non-OPEC states could not compensate for Iran’s outages. But as long as there is good communication between members – particularly key players like Saudi Arabia and Russia – rather than a free-for-all grab for market share, the deal will not collapse. Ironically, Iran’s target is actually for 90,000 b/d of growth against baseline production – which it is currently exceeding by ~17,000 b/d.
We have long argued in our Oil Market Snapshot series that this way of measuring of compliance is flawed – it monitors collective, rather than individual compliance and excludes Libya and Nigeria, who have swiftly grown production. For an extended period, compliance was reliant on overcutting by three states to compensate for other members’ overproduction. Even now, when every member except Iraq is indeed complying, Venezuela’s involuntary production collapse aids the OPEC compliance figure. Nevertheless, this is how compliance is currently measured under the Vienna agreement and, crucially, this measure is widely used in the oil media and thus affects prices.
What is important for supply/demand fundamentals, however, is how much oil finds its way to market, which is why we also track compliance against the total OPEC production ceiling. This traditional measure of OPEC compliance includes growth from Libya and Nigeria, and was also agreed in the same deal document that set OPEC member targets – though this is mostly forgotten as the deal members set the narrative of what compliance means. Compliance with OPEC’s ceiling stands at a record 95%, but if Venezuela is excluded it is only 56%. This indicates how important to the current rally Venezuela’s outages are – and also how much headroom other OPEC members have to grow and still be in compliance collectively.
As long as sanctions have only a minor effect on oil demand and members continue to communicate, this is a test the Vienna agreement should pass quite easily – less production is always good for compliance, even if it is not for the country that produces less.