Monthly Article

July 2015 Monthly Article – Iran and Oil

By Jerry Pacheco

On July 14, international negotiators and Iran reached a historic accord to limit its nuclear capabilities in an attempt to provide stability to the Middle East. Per the accord, Iran has agreed to transform its major nuclear reactor in such a way that it cannot produce weapons-grade plutonium, and to send its fuel to other countries. Per the terms, it agrees to change some plants from enriching uranium to research and to cut back at others. It also has agreed not to build other nuclear reactors for 15 years. To ease western fears that Iran will not adhere to the agreement, the country has agreed to periodic inspections, some for up to 25 years. In exchange for agreeing to the deal, sanctions will be lifted by western allies that have restricted the country’s exports and limited the ability of many western companies from doing business with this country.

The packaged deal now goes to the U.S. Senate where it will need to be approved, amid a lot of controversy. Many senators are afraid that Iran cannot be trusted and that it will cheat during the accord period, and/or revert to a military nuclear program once the deal is complete. Israel, believing that the U.S. is making a huge mistake that will endanger the Jewish state, is strongly lobbying individual senators to vote against the agreement. Meanwhile, Iranian leaders are counting on passage of the accord in order to jump-start their nation’s economy and to fortify its role as a regional leader. Initially, the deal could free up $150 billion for Iran in assets that have been frozen for a long time.

Iran has been less dependent on oil exports over the past few years to prop up its economy, as long-standing sanctions have forced this nation to diversify its economy. Today, the country manufactures a myriad of products, including automobiles (Iran Khodro and Saipa) that it exports. However, sanctions that have restricted foreign oil sales have cut the country’s exports by one-third. The country has huge oil reserves and an educated population that if unleashed, could rapidly expand the country’s economy.

As the Senate ponders the deal, economics will undoubtedly come into play, apart from world security. A major element will be Iran’s capability to ramp up its oil production for export. Bloomberg recently reported that Iran produced 2.85 million barrels per day in March. It predicts that by 2016, the country can add another 700,000 barrels per day, thus adding to the current oil glut. In addition to increased production, Iran holds in storage more than 30 million barrels that can quickly be released on the world market.

The Energy Information Administration estimates that worldwide oil prices could drop up to $15 per barrel within a year if the deal is approved and sanctions against Iran are lifted. A current oversupply of oil has decreased the price per barrel by nearly half within the last year. The Iran nuclear deal could have the effect of increasing the oversupply.

In U.S. oil states such as Texas, New Mexico, Oklahoma and California, hundreds of thousands of jobs, either directly or indirectly, depend on the oil industry. When oil prices are strong, the industry expands, more employees are hired and companies that service the oil industry also expand. When prices fall, as they have during the last year, oil communities start shedding jobs and investments are put on hold. Recently, I was talking to an investor who had everything lined up to construct a new hotel in the Permian Basin. The fall in oil prices caused him to shelf the project with no anticipated date for implementation.

If the Iran deal has the predicted effect of decreasing worldwide oil prices, we can expect a direct effect on the oil-producing industry in the U.S. State budgets will contract due to diminishing tax bases, affecting critical areas such as capital outlay for infrastructure projects and funding for education.

Stabilization of the Middle East and the larger objective of global security are the major drivers behind the Iran nuclear accord. Most news reports focus on these objectives. However, the effects that it will have on the U.S. economy and on oil-producing states must also be seriously considered. The livelihood and welfare of millions of Americans could be affected. This is not to say that Iran should be permanently ostracized, especially if it is willing to become a responsible country that does not threaten its neighbors or world security. However, any deal with Iran must be implemented with as little negative economic impact as possible.