If This Happens, Oil Prices Will Go Lower Than $20

oilIran no longer has sanctions restraining its oil production and it is free to do business with Western countries. Iran also has the freedom to impose its conditions. Given that Europe has become its biggest trading partner, it comes as no surprise that it wants buyers to pay in euros rather than U.S. dollars for its oil. The decision adds to international tensions and has placed considerable additional pressure on oil prices. Iran is a Saudi Arabia and U.S. rival on the ground in the Syrian civil war and other geopolitical situations.

Iran’s goal is not only to increase production, but it’s also to slash its reliance on U.S. dollars, as reported by Reuters. Iranian government sources urge buyers to pay in euros, considering the exchange rate between the euro and dollar upon delivery. Iran simply wants to ease its own reliance on the U.S. currency. (Source: “Exclusive: Iran wants euro payment for new and outstanding oil sales,” Reuters, February 8, 2016.) The same source mentions Iranian authorities want to convert to euro frozen financial assets because of sanctions. In U.S. currency value, this is equivalent to about $100 billion.

Tehran has already discussed “billing” in euros in contracts with France’s Total SA, Spain’s CEPSA, and Litasco. Essentially, Iran wants to punish the United States for imposing years of economic tyranny by de-dollarizing the oil trade. This is happening while the petrodollar is under tremendous pressure. Russia and China are already defining oil sales in yuan and the petrodollar recycling system is in crisis.

Iran Wants to Trigger the End of the “Petrodollar”

If other manufacturers were to move away from the dollar as they did Russia and Iran, another instrument of U.S. hegemony would be lost. For decades, the use of the dollar to pay for oil and other raw materials has ensured a stable international demand for this currency. This has helped to support the exchange rate against rival currencies and against a negative balance of trade. In other words, the petrodollar mechanism has helped finance the United States’ external deficit. The demise of the petrodollar is a threat to the U.S. economy itself.

Oil, as Goldman Sachs recently agreed, could tumble as low as $20.00 a barrel. (Source: “Goldman Sachs and OPEC: Oil prices could crater to around $20 per barrel in 2016,” Business Insider, November 23, 2015.)

The market has already shown that oil prices are more than capable of dropping well below $26.00. Even at that level, current oil prices can crush the economies of Russia and even Saudi Arabia.

OPEC has predicted the price won’t go back above $100.00 until 2040. (Source: “World Oil Outlook,” OPEC, October 2015.)

Last December, Anatole Kaletsky, chief economist and co-chairman of Gavekal Dragonomics and a former columnist at such publications as the Times of London, the International New York Times, and the Financial Times, suggested Iran could produce oil at $1.00 a barrel. (Source: “Why Big Oil Should Kill Itself,” Project Syndicate, December 23, 2015.)

How Could Any of the Oil Majors Compete?

Exxon Mobil, Shell, and BP can no longer hope to compete with Iranian or even Saudi reserves. Rather than the complications of deep wells or fracking, Iran can exploit its reserves using 19th Century technology. Iran’s reserves are second only to Saudi Arabia’s. Even then, Iran can trounce the kingdom in production costs. Saudi Arabia is said to extract oil at anywhere from $10.00 to $20.00 a barrel. (Source: “The real reason Saudi Arabia can afford a price war against US shale,” Quartz, December 12, 2014.)

Iran has not hidden its absurdly low oil production costs. It brags that its pumps can extract oil at $1.00–$1.50 per barrel. (Source: “Iran Be Able to Produce Oil at $1,” NIOC, December 15, 2015.) Iran’s return to the markets represents the most significant threat to oil prices—and to the dollar’s pre-monetary pre-eminence.

Therefore, Iran plans to increase oil production by half a million barrels a day of exports to Asia and Europe. The goal is to export about a million barrels by the end of the year.

So far in February, Iran has increased its crude oil production. It is now pumping 200,000 barrels per day for export to Europe, according to the Fars news agency. The first shipments of this oil could be heading toward Greece. But that’s just the start.

Iran’s oil minister, Bijan Namdar Zanganeh, said that as part of a new contract, the French oil company Total plans to buy 160,000 barrels per day of crude oil from Iran. Total wants to develop oil and gas projects in the country.

The collapse in oil prices has devastated many oil-dependent economies. Venezuela is one, the Canadian province of Alberta is another, while Texas and Saudi Arabia are starting to feel the pressure. For example, Venezuela has set its budget according to $40.00-per-barrel oil. Yet it produces heavy oil at a cost of $25.27 a barrel. Government revenues, for this reason, have fallen by 70% and in 2015, the economy contracted by five percent.

Tehran’s plan shows how the traditional oil-producing countries, such as Iran and Saudi Arabia, can stave off competition from relative newcomers to the main export market, especially in Europe.

Market competition has affected oil prices, which have fallen to their lowest level in the past 12 years. Oil prices tried to rebound in recent days at around the $34.00 a barrel for Brent (WTI is trading at $30.80), but the floor is weak. Prices could drop much further.

Some have predicted a rebound in oil prices toward $40.00–$50.00 in the second half of 2016. Yet there is simply too much oil on offer with some major producers like Iran able to flood the market with ultra-cheap oil. As Iran comes back on tap, emerging markets—the drivers of commodity prices—are slowing. And OPEC is not going to change strategy, even as it confronts Iran. Perhaps international pressure on member states (i.e., Saudi Arabia, Qatar, and Kuwait) could achieve some changes. Still, these countries have solid reserves. Their ultimate goal is to squeeze out the most expensive producers, such as Russia and the United States. As shale oil production in the United States continues, even if at a lower level, OPEC will exercise more, rather than less, pressure.

Saudi Arabia, in particular, is driving OPEC policy. It has plunged OPEC into a crisis by refusing to reduce output and hit its competitors with higher costs. There is overproduction, which means that even if there may be doubts over how quickly Iran can reach full capacity, the risks of more and sharper drops in oil prices are higher.

In any case, the other OPEC countries had no chance of reducing overall production. They cannot help but respond to lower prices by continuing to produce. Their economies are not diversified enough to sustain an outright production cut until prices start climbing. Meanwhile, the hostility between Iran and Saudi Arabia will prevent the coordination of a production cut.

The fierce price competition between Russia, Iran, Iraq, and Saudi Arabia will not end now. None of these oil powers wants to risk losing market share or customers. This war will keep prices low for a long time.

As a result, U.S. shale oil producers might be the first to close. They have a much shorter investment production cycle compared to other manufacturers.

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