Seeking Alpha
Recommended for you:
, Alex's Twitter (361 clicks)
Long/short equity, research analyst, tech, growth
Profile| Send Message|
( followers)  

If you want to bet against oil markets, now is the best time. Oil imports are falling in the United States, and we have further sources of supply if political sanctions against Iran come to an end. If the Iranian embargo ends, you can expect a pretty steep drop in the price of crude oil (NYSEARCA:USO)(NYSEARCA:SCO)(NYSE:DCO)(NYSEARCA:OIL)(NYSEARCA:UCO)(NYSEARCA:DTO).

Could things get any worse for the price of oil?

(click to enlarge)

Source: CME Group

The price of crude oil has been on a consistent down-trend. This is consistent with the poor earnings results generated by Exxon Mobil (NYSE:XOM), Chevron (NYSE:CVX), Ecopetrol S.A. (EC) and others. The three companies reported year-over-year earnings declines. The falling volumes in the downstream business paired with falling crude oil prices had a negative impact on oil companies in the most recent quarter.

There's speculation that Iran will strike a nuclear deal with the west, and this will alleviate the oil embargo that has been put on the country. The United States speculates that opening Iran's oil to global markets could potentially reduce the price of crude oil by 10%. This depends on whether they can strike a deal that will reduce Iran's potential of being a nuclear threat, and prove that nuclear research is done with the intent of generating nuclear energy.

The biggest issue here is the enrichment of uranium for the purpose of nuclear armament. The Iranian government strongly denies having any intention of developing nuclear weaponry. However, the United States, U.K., Canada, France, Germany, Italy and Japan have their doubts on whether the uranium is being purposed for power generation or nuclear research. This has been a decade long stand-off, and honestly, at this point I'm not sure who's telling the truth. But, if political negotiations work out so that the G6 feels comfortable with Iran not being a "nuclear threat", Iran may be able to export a significant amount of crude oil to the world.

Iranian impact on crude oil prices

Currently, Iran is sitting on 150 billion barrels in oil reserves, which represents 10% of global proven crude oil reserves. Iran has plenty of oil, and if oil production rates were to increase due to an increase in the total number of oil drilling rigs, the amount of exports could be substantially higher than the conservative estimate of an extra one million barrels of oil per day.

According to 2012 EIA estimates, the world consumes about 89.27 million barrels per day. In the same year, oil production was 89.34 million barrels per day. In 2012, Iran's oil production fell by about 700 million barrels per day, according to EIA. The Iranian Central Bank estimates that Iran was exporting 1 million to 1.5 million barrels per day towards the end of 2011. However, speculation also indicates that Iran sold most of its oil to China. So, without demand from Europe, and United States, the real net impact is harder to estimate. But it seems that China, South Korea, India and Japan have been cutting back on their Iranian oil imports. After all, angering the United States isn't a part of the agenda.

That being the case if speculation of Asians pulling out of Mid East oil is accurate, Iran may have to consider signing treaties on nuclear disarmament. Starving an economy of its most prized resource is an effective way to gain compliance. Currently, the United States is hoping to reduce Iranian exports of crude oil to 500,000 barrels per day. The Energy Information Administration estimates that in 2008 Iran's production was 4.17 million barrels per day, with 2012 production at 3.5 million barrels per day. There's an enormous difference between oil production and oil exports. This indicates that Iran has been stockpiling a gargantuan amount of crude oil.

The massive stockpile could be calculated to be the difference between the production figures reported by the EIA and the actual sales figure that's been reported to be around 1 to 2 million bpd (barrels per day) since 2012. In other words, I'm willing to assume that if I took 365 days in the year, and multiplied by 3 million barrels for two years, that would give us an idea on total Iranian oil in storage. After making that quick calculation, I estimate that Iran may have more than 2.19 billion barrels of oil stocked up to flood the market once the oil embargo ends. In other words, the world could live off of Iranian oil without drilling for 30 days if they have stockpilled as much oil as I have estimated. The 10% drop in crude oil price that was estimated by the U.S. government may not have an exaggeration after all.

Downside and upside considerations

While I'm very confident that Iran will store the oil that it drills from the ground and unload it onto the oil market once the embargo ends, there's always the risk that Iran holds back supply for an extended period, dampening our short thesis on oil. Following sanctions to reduce Iran's oil exports there was a significant contraction in its GDP. The contraction in GDP was -1.9% in 2012. This implies that Iran will want to boost its net GDP figure at all costs. Even if it means reducing the maximum profit that can be earned from crude oil.

The country has low debt however. The debt to GDP is around 19.9%. Which is laughable in comparison to the debt to GDP ratio of the United States, which is 73% of GDP. However, the low level of debt in Iran is driven by the low credit rating offered by the debt rating agencies. Sovereign risk is rated at a B. This is a terrible rating when compared to the AA+ rating for the United States. The high cost of debt reduces Iran's incentive to borrow. In 2012, the CPI inflation rate was 27.1%. The high rate of inflation may be stabilized with liquidity in the foreign exchange pair. Plus, for the IRR/USD to stabilize there has to be legitimate demand for the Iranian Real, which will only occur if it can import goods from the developed markets.

Inflation also comes from Iran's attempt to stabilize GDP growth. In other words, the falling purchasing power of the economy is driven by a government constantly increasing currency supply in order to induce economic growth. Plus, if you can sustain a wealth effect, you can continue nuclear policy.

But, at some point all rapid inflation policies come to an end. History points to this fact time, and time again. Even if an agreement isn't arrived upon by the end of the week. The political willpower of constantly printing money and stockpiling oil will only go on for so long. Iran will have no choice but to fold its deck of cards, and that's what the market is waiting for.

A quick look at the Iranian Reel to US dollar chart. The IRR/USD skyrocketed recently (hyper inflation).

(click to enlarge)

Source: XE

Maybe the Iranian Real will no longer exist, and the country may have to issue a different currency. Once the slate turns clean, the government will probably try its best to boost its credit rating, gain foreign investment through debt and stimulate the economy though excessive spending. Of course, to generate excessive spending, the government would need to import goods and services from the rest of the developed world. Plus, to pay for the monetary stimulus, the Iranian government would have to sell that huge stockpile of oil I calculated.

Iran needs to end whatever nuclear agenda it may or may not have. The timeframe for when it will end its political stance on nuclear is uncertain. It could happen this week, next 6 months, or perhaps a couple years. But given enough time, I'm sure Iran will ultimately cut the cord on higher uranium enrichment levels.

Conclusion

This is just one of many reasons to be a bear on crude oil. Once the embargo ends, Iran will have no choice but to flood the global oil market to free up storage capacity. Plus, the government will be busy trying to stimulate the economy with the money generated from the oil.

So for all you oil bears out there, this just adds one more reason to bet against hydrocarbons. I'm not a full-blown environmentalist and I'm not a pure-bred Alaskan screaming drill baby, drill baby! I'm just a guy who wants to make money from price volatility. In other words, I'm willing to bet against crude oil, and I hope you will too.

Source: Iranian Oil Outlook: Due For A Crude Oil Crash