Iranian oil goes back on the market

After years of sanctions, the country is boosting production and aiming to win customers back from the Saudis and Russians.

The fate of the oil market in 2016 depends in large part on a series of oil fields with names such as Ahwaz, Gachsaran, Bibi Hakimeh, and Darkhovin. All of them are pumping crude buried thousands of feet under the hills of the Zagros mountain range in western Iran.

Since mid-2012 the fields have been producing far below their capacity because of U.S. and European sanctions limiting Iranian oil exports. Now that Tehran has reached a deal with the Western powers to resolve the dispute over the country’s nuclear program, Iranian engineers are working to bring the fields back to full production.

“Immediately after lifting sanctions, it’s our right to return to the level of production we historically had,” Iran Oil Minister Bijan Namdar Zanganeh said in September, weeks before the first international oil conference held in years in Tehran.

The country’s return to the oil market comes as the world is producing much more oil than it needs. According to the International Energy Agency (IEA), global oil production in the first half of 2015 averaged 95.7 million barrels a day, while average daily consumption came in at only 93.8 million barrels.

The difference of almost 2 million barrels a day—equal to the daily consumption of France—has forced traders to turn supertankers into floating storage facilities. The Iranians had to make a similar move when sanctions hit in 2012, converting their extensive fleet of crude tankers into giant storage bins that have spent much of the past three years anchored in the Persian Gulf.

More Iranian oil on the market in 2016 will extend the oversupply. The impact will reverberate across the world, hurting oil-producing countries such as Russia, Saudi Arabia, and Venezuela, as well as entrepreneurial shale companies in North Dakota and Texas, and major oil companies including ExxonMobil and Royal Dutch Shell.

As traders anticipate the return of Iranian oil, the futures market is already lowering its expectations for prices next year, with contracts for December 2016 trading at less than $60 a barrel.

Zanganeh has repeatedly said Tehran would increase its production by 1 million barrels a day within weeks of the end of the sanctions, expected to be lifted sometime during the first half of 2016. The IEA estimates that within six months of sanctions ending, Tehran could bring daily production to 3.6 million barrels—or about 800,000 barrels a day above current production. That would mark Iran’s highest level of crude output since 2011.

Oil traders and analysts are far more conservative about the country’s ability to quickly increase production. “We believe the potential removal of Iranian sanctions could provide strong conditions for a recovery in oil production, but we do not share the optimism expressed by some market commentators on the speed of the production turnaround,” says Ildar Davletshin, an analyst at Renaissance Capital in London.

Iran could surprise the pessimists. Oil-dependent countries have a history of recovering production faster than anticipated after disruptions.

In 2003, Venezuela’s state-owned Petróleos de Venezuela was able to lift output by 2 million barrels a day in only four months despite widespread damage to equipment resulting from an attempted coup against President Hugo Chávez. In 2011, after civil war broke out in Libya and the country’s oil production fell to zero, the market widely expected it to take 18 months to raise output by 1 million barrels a day. Production surpassed that level in less than six months.

Whatever Iran is able to produce next year, much of its crude could end up in Southern Europe, as Iran aims to regain customers it lost in France, Italy, and Greece. After sanctions forced European countries to stop buying from Iran, Southern Europe turned to Saudi Arabia, Russia, and Iraq as its main suppliers. Analysts say that to take back market share, Iran will have to offer customers cheaper crude than the Saudis and Russians.

Another unknown is the amount of oil Iran has in storage, both inland and in supertankers in the Persian Gulf. Estimates range from about 12 million barrels to 60 million barrels. The exact composition of what’s in storage is also unknown: Crude oil, fuel oil, and so-called condensate (a form of high-quality crude) are all possible.

Regardless of the final increase, Zanganeh, Iran’s oil minister, has a message to the rest of the energy world: “Our only responsibility here is attaining our lost share of the market, not protecting prices.”

This article was written by Javier Blas for Bloomberg Business on Nov. 5, 2015.