Iranian Nuclear Impasse

Jim Brown
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The president pulled out of the Iranian nuclear agreement and threatened them if they resume enrichment.

Twenty-five percent the world complained and twenty five percent cheered while the rest ignored the headlines. The Europeans were upset because it could mean they will have to stop trading with Iran once again and the peace and security of the Middle East was being threatened. Excuse me; have you actually seen any peace in the Middle East recently?

The Arab countries cheered because the bully on the block got knocked down a few levels and there is a good possibility there is a decent beating ahead.

Iran took the opportunity to attack Israel because they could not attack the U.S. and Israel was the next best target. Fortunately, Israel can take care of itself and they flattened most of the Iranian positions and facilities in Syria. The Israeli spokesman said "if you rain on Israel we will flood on you." They have such a way with words.

Oil prices were volatile both before and after the president's speech. Crude rallied almost to $72 on Thursday before calmer heads began to prevail.

Prices rose on the potential for Iran to take another shot at Saudi Arabian facilities as a form of retribution against the USA. They have been unsuccessful so far but it only takes one direct hit to send prices soaring.

There is a 90-180 day wind down period before sanctions will take effect. This is to protect anyone with existing orders and scheduled shipments from being caught in the sanctions. What it means is that any European nations will refrain from booking cargoes for delivery after the wind down period.

Unfortunately, China, India and South Korea will continue to buy oil from Iran and probably at a decent discount.

Different analysts have different opinions about the impact of partial sanctions. Iran exports 2.5 million bpd. Impact estimates range from 300,000 bpd to 1.0 million bpd. The consensus is around 500,000 bpd since many countries will ignore the sanctions. That is a $35 million hit every day for Iran. The offset is that a decline in exports of 500,000 bpd will raise crude prices by $3-$5 per barrel. The 2.0 million barrels they are still selling will be worth an extra $8 million per day at a $4 rise.

The sanctions are not going to have the same impact as last time because the other four nations in the pact, Germany, Britain, France and China are having talks to determine how they can keep the agreement in force. The flash point will come when the European countries hold meetings with the U.S. to determine how their companies can continue working with Iran. This is not going to go over well with president Trump and Theresa May said the talks need to be held quickly so that all parties understand how things will work in the future. The president said several days earlier that the U.S. has a $45 trillion GDP and Iran has a $500 billion GDP. Guess who the agreement participants will decide to work with.

Another wild card in the equation is Saudi Arabia and OPEC. They are not showing any willingness to make up any shortfall brought about by the sanctions. With oil inventories still high, this is another opportunity to reduce inventories at a faster pace. In the case of Saudi Arabia it is an opportunity to push oil prices higher to support a high valuation when they IPO Saudi Aramco later this year. Higher oil prices are taking the pain out of the voluntary production cuts that have been in effect for the last year. They would like to see $80 oil again so they are being quiet about making up any shortfalls.

US production rose to another new high at 10.7 million bpd last week. This is a 26% increase in production over the last 12 months. The high oil prices have caused a surge in rig activations. Over the last six weeks along there have been 52 rigs reactivated. Companies are also bringing the drilled but uncompleted (DUC) wells onto production. The high prices are a strong incentive for producers to ramp up production. Not only are they increasing current production but they are selling into the futures market for production over the next 12 months. They want to be sure and lock in these prices just in case the Iranian headlines fade and WTI drops back to $60.

Despite the rapidly rising shale production a well-known geologist, Arthur Berman, a man I have spoken with and have a great respect for, is calling an end to Permian production. He believes there are only seven years of proven oil reserves left in the Permian. "The best years are behind us."

He has analyzed reserves and production data from more than a dozen major shale producers. He said those who believe the Permian will continue producing for decades ahead are in for a big disappointment. "The reserves are respectable but they are not going to save the world." The EIA expects Permian production to rise by about 73,000 bpd per month from a 3.11 million bpd rate in April.

Last week the EIA raised their forecast for US production to average 10.7 mmbpd for 2018, it is currently 10.7, and then rise to average 11.9 in 2019. That is 400,000 bpd more than their forecast just last month. They expect production to end 2019 at 12.0 mmbpd.

Wood Mackenzie has warned that producers are likely to test the geological limits of the Permian soon. They believe production will peak in 2021 and cause a shock to future production forecasts. They said the lack of pipeline capacity is critical to increasing short term production. The lack of pipeline capacity from the Permian has caused oil prices to be discounted by as much as $17.69 off the benchmark on May 3rd. That means producers are only getting $55 if WTI is at $72. This is a major widening of the discount which was $10 at the beginning of April.

Apache and Noble Energy just joined a partnership with EPIC Midstream for a 590,000 bpd pipeline from the Permian and Eagle Ford. The 730-mile pipeline will run from southeastern New Mexico to Corpus Christi and is expected to be in service in the second half of 2019. It will transport 440,000 bpd from the Permian and 150,000 bpd from the Eagle Ford. This is just one of several pipelines under construction from the Permian.

Oil is a finite resource and they are not making any more. Every barrel we pump out of the ground is a barrel that no longer exists. Technology has allowed us to nearly double production in the US since 2012 but there is a limit to how much we can extract. There are only X barrels under every well. The faster technology allows us to extract them the faster that well depletes and the sooner it is shutdown. Shale wells deplete rapidly. The normal decline rate is 65% per year for the first three years. That means a well that produces 1,000 bpd on day one may only produce 75 bpd at the end of year three. That is a significant difference.

There are more than one million operational wells in the U.S. and we produce 10.7 million bpd. That means the average per well is slightly more than 10 bpd. Peak oil still exists but technology has pushed it several more years into the future. There are quite a few analysts who believe the current rapid extraction rates will cause the post peak decline to be even sharper than was thought just five years ago. Consider that factoid as food for thought as you enjoy $2.75 gasoline this Memorial Day. By 2025 that could be $5.75 per gallon.

Jim Brown

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