Next Up Iran

Jim Brown
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With Libya returning to exporting oil and Iraq finally making gains against the ISIS insurgents the next topic for energy investors is Iran.

Negotiators from the P5+1 nations return to Vienna this weekend in a last ditch attempt to work out a deal with Iran over its nuclear program. Six months ago Iran agreed to an interim proposal where $6 billion in hostage funds were released and they were allowed to sell oil and buy parts and equipment for their declining economy. In theory Iran and the six nations were supposed to sign a permanent agreement by July 20th and all the rest of the sanctions would end.

Fast forward to today and Iran is not in a negotiating mode and they are playing the Iranian rope-a-dope perfectly. This is where they show up at the meetings, talk about nothing and then complain after the meetings that the West does not want to negotiate in good faith.

The clock is ticking down on the interim agreement and unless a new agreement can be hammered out soon the sanctions are going back in place and the Iranian economy is going to take another hit.

This time Iran believes the fighting in Iraq and the potential loss of oil exports is working in their favor. By allowing Iran to continue exporting oil the global price for crude would be restrained. Cutting off Iranian exports again would push prices higher.

However, with U.S. production growing and Libyan production coming back online they are losing their bargaining chip. Libya could be exporting an extra 560,000 bpd within a couple weeks and Iraqi oil fields are not in danger at the present time. The new Kurdish pipeline into Turkey will double exports to 250,000 bpd and up to 400,000 bpd by year-end.

This sudden surge of oil coming back onto the market will offset any sanction related decline in Iranian exports. Until July 20th they are allowed to export 1.1 mbpd.

SOS John Kerry wrote in the Washington Post last week there are significant gaps between what Iran is willing to do and what it must do to avoid the return of sanctions. He said the 6 nations are determined to reach a comprehensive agreement by July 20th but it will be impossible unless Iran capitulates and agrees to reduce its uranium enrichment capacity. The Supreme Leader in Iran has said the country would never give in to nuclear blackmail. He claims the West does not want to negotiate and no deal will ever be reached. With him holding firm to his demands and the 6 nations holding to theirs the outlook is dim.

What is likely to happen is another six month interim agreement while the parties lobby in the press in support of their positions. For Iran this would be a win. They get six more months of oil exports and six more months of uranium enrichment. Then they get to play the game all over again.

The current Iranian President Hassan Rouhani was previously the nuclear negotiator. He bragged in a speech before he was elected president that he dragged out negotiations for five years and gave Iranian nuclear scientists the time they needed to bring their operations up to scale. Iran is very good at the tactic of delaying meaningful negotiations. Another six month delay would be a victory and bring Iran closer to a bomb.

In a video posted online last week the Iranian Foreign Minister said the nuclear issue was just a distraction by the West that was preventing world powers from working with Iran to solve "common challenges" in the region. He was referring to the ISIS insurgence in Iraq and the civil war in Syria. Iran wants to be the major power in the region and having a nuclear weapon would give them that power.

Zarif said "The decisive time approaches when the temporary nuclear deal could be turned into a global solution. I press them to not allow illusions to derail a process that will allow an end to a pointless crisis and an opening to new horizons." Is it me or does that sound like they have no interest in talking about the nuclear problem and hope it can be swept under the rug because of bigger issues in the region?

The problem is that Iran wants the capacity to quickly enrich more uranium to higher stages than is required for fueling a nuclear reactor. The 6 nations have said they would give Iran the fuel it needed for its reactors and Iran has refused. Considering how expensive and how dangerous uranium enrichment is the fact they would turn down free fuel is a key piece of the puzzle.

Today Iran has 19,000 enrichment centrifuges compared to only 3,000 in 2005. The delaying tactics have worked perfectly. Zarif said "No one can go back in time, sacrifices were made, and our capacities are considerably different today. No one can make them disappear with a magic wand."

Part of the interim agreement was a deal to allow inspectors into sensitive areas and to clear up past deceptions about work on nuclear triggers. Over the six months Iran has failed to let inspectors into sensitive areas and they have failed to provide any of the documents and evidence requested on the nuclear weapons research. Through January Iran had enriched 200 Kg of uranium to a level of 20% purity. That is four times the enrichment level needed to fuel a power plant. Once at 20% it can be quickly improved to the 90% level needed for a bomb. Under the interim agreement Iran was to eliminate its 20% enriched uranium. That has not happened. They did downgrade about 25% but they still retain 150 Kg of highly enriched uranium.

Also under the interim agreement Iran promised not to activate the Arak heavy water reactor, which if it became operational, could produce plutonium and give them an even faster route to nuclear weapons. At this point they have not activated the reactor but it is still available.

Iran claimed it was complying with long term UN restrictions until it was found out several years ago they had built two heavily fortified secret nuclear enrichment facilities deep underground at Natanz and Fordo. These facilities are thought to be bomb proof to anything but a nuclear weapon. If you are complying with UN regulations why build secret underground nuclear facilities?

Iran has a history of deception and a very evident history of successfully delaying any serious negotiations surrounding the nuclear issue. Anyone that has followed the progress of the negotiations over the last 11 years understands exactly where Iran is headed.

I only hope the P5+1 nations have the backbone to not renew the interim agreement and enforce even harder sanctions until Iran's nuclear program can be shutdown and monitored against an illegal restart. Unfortunately I have little faith this will happen. Iran has proven to be the better negotiator since time works for them. The P5+1 nations are tired of the battle and they just want to get something on paper and go home. Beating your head against an Iranian wall month after month is very frustrating.

I think everyone would be willing to pay a few cents more for gasoline and not have to worry about an Iranian nuclear missile streaking across the Middle East at some point in the future.

Oil Inventories

Inventories declined -3.2 million barrels last week as a result of a sharp increase in refinery usage. Utilization shot up +3% to 91.5% and the highest rate for the year. This is for the week ended on the 27th so this was clearly a surge to fill the distribution system with gasoline before the long holiday weekend.

The AAA predicts 34.8 million people will take to the roads this weekend and they will be paying the highest gasoline prices at $3.67 on average since 2008.

Refinery demand for crude rose +540,000 bpd for the week. Imports were 7.3 mbpd, down 72,000 bpd from the prior week. U.S. production was steady at 8.44 mbpd and basically flat for the last four weeks.

Cushing inventories fell to another multi-year low at 20.5 million barrels. With the 20.0 million barrel mark considered to be the minimum operational capacity it will be interesting to see what happens next week. I would expect them to hold the line on outgoing shipments but then we really don't know what the operating minimums really are.

Gasoline inventories declined -1.2 million barrels and gasoline demand rose 355,000 bpd to 9.17 mbpd. Gasoline production rose +382,000 bpd to offset the rise in demand. Demand was still lower than the Memorial Day surge at 9.31 mbpd but this current week, which will be reported next Wednesday, is where the real gasoline surge will show up.

There may be a blip in the expected demand because of Hurricane Arthur. The storm may keep millions of people home that would have traveled to the beach for the weekend.

Distillate inventories rose for the fifth week with a +1.0 million barrel gain. Distillate demand should increase this week as airline traffic will be heavy. Distillate demand rose +132,000 bpd and production rose +107,000 bpd.

In the graphic below green represents a recent high and yellow a recent low.

Natural gas inventory rose +100 Bcf last week to 1,929 Bcf. Since inventories are so low it will take record injections for the next 17 weeks to return inventory levels to normal at 3,750 Bcf by winter. This is not going to happen. As summer weather gets warmer the demand for electricity will rise and gas demand will increase. This will reduce the weekly injections into storage and we will miss the November target. With roughly 17 weeks before November 1st and the start of the winter heating season if we could continue to inject 100+ Bcf a week we could get to about 3750 Bcf before winter. However, summer injections average about 69 Bcf per week and that will leave us about 500 Bcf short for next winter.

With the fundamentals so strong for prices I am amazed by the decline over the last several weeks. Eventually investors will catch on to the expected shortage next winter.


Good news is good news for a change. The strong ADP and Nonfarm Payrolls energized what few traders were at work on Thursday and the markets moved to new highs.

This week is a light week for economics and the earnings calendar does not really accelerate until the following week when 30% of the S&P reports.

The market is free to pick its own direction this week and hopefully short covering will be the topic of the day for Monday. Volume will be low so any moves could be rapid.

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Jim Brown

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