What the Iranian Geneva Accord Means for Oil

What the Iranian Geneva Accord Means for Oil

On Nov. 23, the United States and five world powers reached an accord with Iran to temporarily freeze Iran's nuclear program and lay the groundwork to reach a more comprehensive agreement later on.

As part of the agreement, Iran agreed to stop enriching uranium past 5%, to dismantle links between centrifuges, and to allow international inspectors to inspect Iran's nuclear facilities. Experts estimate that those steps will delay Iran's ability to produce weapons-grade uranium by several weeks. In return, the U.S. agreed to provide Iran with around $7 billion in sanctions relief, of which $4.2 billion is oil revenue frozen in foreign banks. The sanctions that limit Iran's oil exports to less than 1 million barrels a day will still be in place.

Iran used to argue that it needed a nuclear reactor to save oil and gas. According to the IEA, in 2010, 59% of Iranian energy consumption came from natural gas and 39% from oil. Building a nuclear reactor would help Iran save oil and gas for export. Iran, however, enriched uranium past the 5% necessary to make nuclear fuel and led the world to believe it wanted to make highly enriched uranium for nuclear weapons. That led to international sanctions.

Due to the recent agreement, those sanctions and the Iranian nuclear program could both end as negotiations progress.

The implications
The possibility of Iran blocking the Strait of Hormuz in retaliation for an Israeli airstrike is something that greatly concerns oil markets. 20% of the world's oil passes through the Strait every day. It is one of the premier choke points for oil, and Iran has the ability to block it. With the recent accord, that black swan scenario and the contagion that follows is now a lot less likely.

The accord also means a tighter WTI-Brent spread. Since WTI is chiefly determined by supply and demand of U.S. oil and Brent is determined by supply and demand of global oil, more Iranian oil will weaken Brent more than WTI. A tighter WTI-Brent spread will likely lead to tighter crack spread for U.S. refiners that have been buying WTI oil but have their end products priced globally. This means tighter margins for refiners such as Phillips 66 .

The accord also means big opportunities for Western oil giants such as the French Total and Royal Dutch Shell . Iran has the world's second-largest natural gas reserves at 1,187 trillion cubic feet. Its natural gas sector is undeveloped due to a lack of foreign investment and technology. Technology and development from Total and Royal Dutch Shell could solve Iran's natural gas infrastructure problem and lead to more LNG terminals to export to China and Japan.

Both Total and Royal Dutch Shell have also done business with Iran before, sometimes in defiance of U.S. sanction threats. Royal Dutch Shell helped Iran develop its offshore oil fields of Soroosh and Nowrooz, while Total helped Iran develop the South Pars natural gas field.

The two companies are consequently the most likely super-majors to benefit if Iran continues to open up.

The bottom line
The November Geneva accord is likely the first of many negotiations down the road. The initial agreement could still be derailed by hardliners from both United States and Iran. Needless to say, Israel and Saudi Arabia are not happy with the agreement and will try to influence negotiations.

It is speculated that many long oil contracts have been placed in part due to anticipation of a geopolitical event with Iran. The Geneva accord is a meaningful first step that could unravel those contracts and send the price of Brent below $100. Long term, this is very good news that for the global economy as it removes a very destabilizing black swan scenario and increases the supply of oil.

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The article What the Iranian Geneva Accord Means for Oil originally appeared on Fool.com.

Jay Yao has no position in any stocks mentioned. The Motley Fool recommends Total SA. (ADR). Try any of our Foolish newsletter services free for 30 days. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy.

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