Iran's Oil Production: Fallacy Or Fallowed

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Includes: BNO, CR, CRAK, DBO, DDG, DIG, DNO, DRIP, DTO, DUG, ERX, ERY, FENY, FIF, FXN, GUSH, IEO, IEZ, IYE, NANR, NDP, OIH, PXE, PXJ, RYE, SOP, UOP, USO, UWT, VDE, XES, XLE, XOP
by: Open Square Capital

Summary

Iran's increased production in 2016 has been dramatic after international sanctions were lifted.

Large scale offshore inventory destocking may have played a large part in this increase.

We believe Iranian destocking is being misinterpreted as production, and actual production will decline as the year moves forward.

When investing in oil, it helps to have a healthy dose of skepticism when it comes to looking at the data. Take Iran for instance. After freeing itself of onerous international sanctions, Iran has returned fully to the oil market.

Iranian oil production increased from an average of 2.8M bpd to 3.5M bpd, an increase of over 25% from 2015 to 2016. Once freed of international sanctions, 2016 output showed a healthy ramp in "oil production" from Q1 to Q4, with sequential quarterly increases (OPEC Monthly Oil Market Report 03/2017)

Iran (tb/d)

2015

2016

Q1 2016

Q2 2016

Q3 2016

Q4 2016

Production

2,838

3,502

3,096

3,539

3,646

3,725

The robustness of Iran's production was such that as OPEC settled into negotiating production cuts in Vienna last year, Iran was adamant that it be granted a higher production quota after emerging from years of sanctions. OPEC subsequently relented, and allowed Iran to increase production to 3.8M barrels per day. Iran had originally argued for a 4M bpd cap, but the compromise was politically palatable for Iran's leaders and OPEC.

As we're now receiving full year data, a clearer picture is emerging of Iran's actual production capability. We're often bemused when reality pulls back the curtain and what you thought may have been happening was actually happening. Given the years of underinvestment in Iranian oil fields, we believed it was unlikely Iran was able to increase and sustain production at the Q3/Q4 levels of over +3.7M bpd. Even secondary sources in OPEC's March MOMR reported that Iran produced 3.778M bpd in January and 3.814M bpd in February in Q1 of 2017. Although some increase was inevitable given the lifting of economic sanctions, it was much more likely that part of Iran's oil "production" was really oil exports coming from offshore/onshore storage.

In a recent report by Energy Aspects, the firm included a chart that shows Iranian floating condensate levels. Notice anything?

Coinciding with the rise in Q3/Q4 "production", offshore inventories fell considerably. Today Reuters reported the following

"Prior to the lifting of sanctions, Iran stored unsold oil on ships, which peaked in 2015 at 40 million barrels on around 25 tankers. The country has up to 60 oil tankers in its fleet.

Iran's drawdown of floating storage gathered pace in September. By the start of 2017, Iran still held an estimated 16 million barrels of oil on ships. Since then, they have emptied."

We believe this explains in part Iran's statement last month that if OPEC agreed to extend the cuts in its May meeting, then Iran would agree to hold production at 3.8M bpd. This is essentially a "free" concession as Iran has little ability to actually increase production even if it wanted to. The most likely explanation for the recent increase in "production" is that offshore destocking is being misinterpreted as oil coming from incremental production.

As we've been wrapping up our quarter and reexaming the underlying data, it's also becoming clear that much of what the world attributes to production has really been inventory destocking by national oil companies and traders. In fact, the dearth of investments these past few years will likely lead to a reduction of overall Non-US/Non-OPEC production. We'll be following-up the next few weeks with additional articles addressing and updating our larger oil thesis, but for now, all signs continue pointing to an eventual oil shortage by 2018 and much higher oil prices than today.

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Disclosure: I/we have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours.

I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.