Iran-Saudi Arabia tensions and impact on oil price

The following is commentary from Douglas-Westwood researcher, Katy Smith, on the recent developments in the Middle East between Iran and Saudi Arabia, and the potential fallout for oil price.  

Following recent attacks on the Saudi Arabian Embassy in Tehran in response to the execution of a prominent cleric, the Kingdom has announced that it will be severing diplomatic ties with Iran. This soaring political tension between the two most influential members of the Organization of the Petroleum Exporting Countries (OPEC) has led to fluctuating oil prices, with the price of Brent crude briefly having risen to $38.50/bbl, its highest level for three weeks, then being followed by a drop to below $33/bbl, due to concerns over rising product inventories and weakening Chinese demand growth. These developments have potentially significant repercussions for the oil & gas industry.

Douglas-Westwood (DW) expects total oil production in Saudi Arabia to increase steadily over the next six years, reaching just over 12.1 MMbbl/d in 2021, with the Kingdom keen to maintain its market share. Following the signature of the Joint Comprehensive Plan of Action (JCPOA) agreement in July 2015, and anticipated removal of international sanctions, Iran is eager to re-enter the market and increase its oil export volumes. Though the Iranian government has an ambitious target to raise its oil production to 5.7 MMbbl/d by 2018, DW takes a conservative view, expecting total Iranian oil production to rise at a 4% CAGR through to 2021. This could add further pressure on a market which is already oversupplied and pose an obstacle for other key producers within the Middle East, such as Saudi Arabia. In October 2015, the World Bank lowered its 2015 forecast for crude oil prices from $57/bbl to $52/bbl, due in part to expectations that Iranian oil exports would rise once international sanctions were lifted.

Regardless of the initial spike in oil prices, as the market reacted to political developments between the countries, continued tension between Iran and Saudi Arabia could potentially place further downward pressure on the oil price in the short-to-medium term, should it impact cooperation within OPEC. Notably, any future decisions to constrain output in order to support the oil price would likely require the agreement of both Saudi Arabia and Iran.

Conversely, further deterioration of political relations between the two countries could impact supply along the Strait of Hormuz, which accounts for approximately 30% or 17 MMbbl/d of oil transported via maritime routes. Concerns for supply via this route have already grown, following airstrikes initiated by Saudi Arabia against rebels in Yemen. The current government in Yemen is supported by Saudi Arabia, whereas the rebels have been linked with the Iranian government. The recent severing of diplomatic ties between Iran and Saudi Arabia could therefore exacerbate pre-existing tensions between the two countries in the region. Any disruption to transit along the Strait of Hormuz could potentially reduce the current oversupply in the market, thereby increasing commodity prices. This could be compounded by lower output from non-OPEC producers, with DW forecasting declining production for both the USA and Russia in 2016.

Despite this recent volatility in the oil price, analysts have maintained a negative outlook regarding the recovery of commodity prices in the short-to-medium term. In its Short-term Energy Outlook, published in December 2015, the Energy Information Administration (EIA) expects average Brent spot prices to recover only marginally from $53/bbl in 2015 to $55.78/bbl in 2016. RBC also forecast a slow recovery in average Brent prices from $53/bbl in 2015 to $80/bbl by 2019.




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