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NEWS & COMMENTARY 2008 SPEAKERS 2007 2006 2005

Thursday, January 19, 2006

Iran oil premium

FROM THE ECONOMIST INTELLIGENCE UNIT

The price of crude oil is moving back up towards the US$70/b mark in response to the aggravated tensions over Iran's nuclear plans and to the latest outbreak of violence affecting the operations of oil companies in Nigeria.

The threat posed by the Iran factor is largely hypothetical, but it will nevertheless hang over the oil market for many months to come as the nuclear dispute evolves. In Nigeria, the activity of rebel groups has already resulted in the Royal Dutch/Shell Group shutting in some 200,000 barrels/day (b/d) of crude output--almost 10% of the country's total production--and other international oil companies have been obliged to take urgent security measures to protect their operations from possible attack. The effect of the Nigerian cut-off has been particularly marked because it involves light, sweet, crude that is not easy for buyers to replace from other sources.

The price of dated Brent crude last reach its current level of about US$65/b in the immediate aftermath of hurricane Katrina, before dipping to an average of US$56/b in the final two months of the year. Since the start of 2006 the price has edged steadily up in response to the seasonal increase in demand in the US and Europe and to the concerns raised by the gas dispute between Russia and Ukraine. Iran's decision to remove the seals from its Natanz uranium enrichment plant provided further reason for market jitters. The Nigerian events have added upward pressure through creating the first significant physical disruption to supply since the hurricanes in the Gulf of Mexico in August and September.

Adequate supply

The oil market nevertheless remains adequately supplied, despite the loss of Nigerian barrels. The Economist Intelligence Unit expects total oil demand to rise by 2.3% in 2006, following a relatively modest 1.4% increase in 2005. However, we envisage production rising by 3.4% to 87.1m b/d, which would lead to a build-up of stocks equivalent to 1.9m b/d. The prospect of a stockbuild of this magnitude has even prompted OPEC to consider production cuts so as to stave off a sharp fall in prices when seasonal factors depress demand in the second quarter of the year.

The impact of these market fundamentals has failed to trigger a drop in crude prices because of the continued lack of available surplus capacity, which could be called upon in the event of a sudden major interruption to supply. Another contributory factor which has underpinned high oil prices over the past three years has been the strains on the global refinery industry, which will not ease until investments in new refining capacity bear fruit towards the end of the current decade.

Iran premium

The dangers posed to the stability of the oil market by the dispute over Iran's nuclear ambitions have been evident ever since the scale of the Iranian programme came to the attention of the International Atomic Energy Agency at the end of 2002. However, the EU-led diplomatic initiative had the effect of taking the sting out of the issue for the past two years (while presumably also giving Iran the opportunity to bolster its defences against any possible military attack on its nuclear facilities). However, with the resumption of uranium conversion last August and the recent move to restart research into enrichment Iran made clear that it was not willing to have negotiations with the EU stretch on indefinitely.

Iran appears to have calculated that the risk of military attack is low, both because of the legacy of the Iraq war and because of Iran's numerous options to retaliate--targeting US military facilities in Gulf Arab states and Iraq, hitting Israel through the proxy of Lebanon's Hizbullah and inhibiting oil exports from the Gulf. Iran faces a greater risk of being subjected to UN sanctions, but any move of this sort will take time to materialise, and the scope of any such sanctions is likely to be limited.

However, if there is no diplomatic breakthrough in the next year or two, the risk of the crisis eventually having an impact on Iranian oil exports (currently about 2.6m b/d) and, conceivably, on the oil exports of the big Gulf Arab producers, will increase.

That suggests that the Iran premium on the oil price is here to stay.



SOURCE: ViewsWire Middle East
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