Only fools rush in: Remaining sanctions, structural issues still hamper investment in Iran
US trade embargo and sanctions on certain people and entities remain in place, creating legal delays for some investors. (File photo)
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The International Atomic Energy Agency (IAEA) confirmed on Saturday, that Iran had fulfilled its nuclear related obligations under the Joint Comprehensive Plan of Action (JCPOA) enabling “Implementation Day” to occur and the lifting of international sanctions much earlier than experts and markets expected.
The lifting of key economic and financial sanctions should allow Iran to increase its crude exports this year by at least 500,000 barrels per day on average, putting further downward pressure on oil prices in the near term, said the latest geopolitical update from British multinational banking and financial services company Barclays.
“We expect many memoranda of understanding with Western oil firms, especially in February, but in this price environment, we think that energy investment is likely to proceed slowly,” the report said.
A number of nuclear-related economic and financial sanctions were lifted on Saturday following the IAEA statement, in line with the JCPOA. A number of UN Security Council (UNSC) resolutions provisions governing Iran’s nuclear activities have been terminated. The EU and US have lifted nuclear-related sanctions on Iran in accordance with the JCPOA.
However, some proliferation and non-proliferation sanctions remain in place. These concern the arms embargo, sanctions related to missile technology, restrictions on certain nuclear-related transfers and activities, and provisions concerning certain metals and software, which are subject to an authorisation regime.
Sanctions imposed in view of the human rights situation in Iran, support for terrorism and for other reasons are not part of the JCPOA, and will remain in place. These include an asset freeze and visa ban on a number of persons and one entity responsible for grave human rights violations, as well as a ban on exports to Iran of equipment that could be used for internal repression and of equipment for monitoring telecommunications. Also, snap-back provisions could be imposed should Iran fail to comply with the JCPOA in the future.
Though “secondary” sanctions have been mostly removed, the US trade embargo and sanctions on certain people and entities remain in place, creating legal delays for investors. The primary sanctions remain in place and limit the trade of certain goods that contain US content, including for the oil and gas industry. Upstream and downstream technologies will have to be in compliance with US export controls.
Many of the deals being considered at this time are going to be engineering based, so investors must be aware of how much of that content is from the US and subject to special restrictions. Also, it will limit direct investment by US companies in Iran, and it prohibits dollar trade with Iran.
Non-US financial institutions that engage in a significant transaction with Iranian individuals and entities that remain on the US Department of Treasury’s SDN list, risk losing access to dollar clearing through US financial institutions.
Implications for oil markets
Iranian exports come at a very bad time - further downside pressure as ramp-up begins. The oil market has remained under extreme pressure since December due to macroeconomic concerns, rising Opec supply, and warm weather.
According to Barclays, it is too early to say what kind of market impact Iran’s return will have or how much of Iran’s return is already priced in. Moreover, it is not clear how much of the decline in oil prices since July is demand related and how much is related specifically to the impending removal of sanctions against Iran.
It is clear that while oil has dropped 50 per cent since early July, copper has fallen 29 per cent, so at least some of oil’s decline may have been attributed to solely to supply side and oil-specific issues since then, the update said.
“Our view is that Iranian wellhead production and sales from existing onshore and offshore storage will surprise the market initially, as the country shows its muscle, leading to downward price pressure, more so on Brent than on WTI. Our balances peg Iranian crude and condensate output at 3.6 millions of barrels per day in Q4 2015, and we expect it to reach 4.4 millions of barrels per day by Q4 2016,” Barclays said.
Initial export levels to increase by 500,000 barrels per day according to Iranian government sources, although this may include oil in storage.
On Sunday, Iranian Deputy Oil Minister Zamaninia was quoted in official Iranian news sources as saying that “the oil ministry, by ordering companies to boost production and oil terminals to be ready, kicked off today the plan to increase Iran’s crude exports by 500,000 barrels.”
One thing that remains uncertain is how willing Iran will be to discount its oil further to gain footholds in new markets in the next several months. Iran exported around 980,000 barrels per day of crude and condensate in Q4 2015, one of the lowest export levels in recent years.
“We believe Iran will almost immediately move to reclaim its lost market share in Europe, where it exported 800 kb/d of its crude in 2011, but further market share gains in India and China will be more difficult,” Barclays said.
Implications for Iran’s economy and domestic politics
The lifting of sanctions should provide a big relief to Iran’s ailing economy and support President Rouhani’s camp ahead of important elections in Iran. Sanctions have crippled its economy and exacerbated long-standing structural problems.
The partial relief of sanctions since November 2013 has eased pressure on growth and inflation, and the prospect of a full lifting of sanctions should help to accelerate Iran’s growth recovery, despite lower oil prices.
The expected increase in oil production and exports, the prospective access to at least $26-30 billion of frozen Iranian assets, and the reduction in the financial and trade transactions costs all should allow GDP growth to accelerate from an estimated 0 per cent in FY15/16 to around 4-5 per cent y/y in FY16/17, according to Barclays.
Iran’s growth should rebound after sanctions relief
Iran’s economic potential, though encouraging, is handicapped by structural issues, state dominance and a weak business environment. Iran is the second-largest economy and most populous state in the Middle East.
Its sheer market size, large young and skilled labour force, diversified economic fabric, and abundant mineral riches are all supportive factors, but structural factors have long been barriers to private investment and, consequently, a major drag on competitiveness, and have meant that Iran’s business environment scores lag behind many of its regional and other EM peers.
While improvements have been registered, accessing credit remains a major concern for businesses. Moreover, government ineffectiveness and poor regulatory quality is another major impediment as a result of the large size of government and the dominance of parastatal institutions closely connected with higher political spheres.
Implications for geopolitical risk
The lifting of sanctions on Iran – amid extreme turbulence in the Middle East and tensions with its neighbours – is unlikely to see a major de-escalation of risks in the short to medium term. The region is plagued by conflict, wherein growing insecurity and sectarian divides are weakening traditional nation states and giving rise to unruly non-state actors – be it in Syria, Iraq, Yemen, Libya or Lebanon.
Iran, as a key regional power, is party to several of these ongoing conflicts, whether directly or through proxies. Most recent events over the past couple of weeks have exacerbated the tension between Iran and Saudi Arabia to its highest level.
“Against this backdrop, the hope that an agreement with Iran will pave the way to a regional entente, which could open channels to an eventual resolution of a whole host of conflicts in the region, in our view, will at worst be repeatedly shattered and, at best, be postponed for many months to come,” said the Barclays update.
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