There is a possibility of a nuclear deal being agreed between the P5 + 1 nations and Iran next Friday, 20th March. This may be the precursor for energy stocks to recouple to downside and for spending cuts to spread from capex to dividends for majors.
The Iranian nuclear program and its ultimate intent is something that periodically hits the headlines, with views ranging from it being for peaceful use only to the Iranians being a "messianic, apocalyptic cult of zealots" who would try to annihilate Israel even if they were nearly annihilated in return to accelerate the advent of the Day of Judgement.
Our view, based on studying and translating internal Iranian legal judgments and discussions with a range of informed parties, is that Iran wishes to have a nuclear program as a matter of national pride and having nuclear weapons breakout capability as a deterrent against potential externally-catalyzed regime change.
Negotiations have dragged on for years, from Iran's offer to Bush to freeze the number of centrifuges they had at 164 in 2003 to today's position of Iran having almost 20,000, more efficient centrifuges and full nuclear weapons capability.
A confluence of political factors makes a deal highly likely at this point however.
Firstly, the USA has a stated policy of pivoting from the Middle East and Europe toward Asia. There are a number of reasons for this, but the major one is that the rebalancing of China is likely to be a fraught affair and nobody can forsee the outcome. As such, the USA would prefer a balance of power stabilising the Middle East, of which Iran and Iraq form an important part.
Second, a number of traditional Middle Eastern alliances such as have been frayed in recent years due to certain conflicts and clashes on a leadership basis. This is not to say that Iran, who are leading the fight against ISIS, are a prospective ally, but they may no longer be part of a defined Axis of Terror.
Third, President Obama is a final term President looking for some final wins. The recent letter from 47 letters in which they claimed to have the power to rewind any Iran deal ironically highlighted his ability to push through a deal if he chose on the response, with a range of parties, from Iranian lead negotiator Zarif to US government officials pointing out that any agreement would be bilateral and binding and that Obama has the power to put this in place. This has been our view for some time as the persistence of multilateral agreements, particularly those likely endorsed by the UN security council is huge, with sanctions also only working if one has assistance from a wide range of parties. Any future US leader could theoretically renege on the agreement, but this is something almost unprecedented and with minimal upside given the agreement will have clauses in case Iran steps out of line.
Fourth, the interim deal extensions which have rolled back Iran's nuclear breakout capability (they had lots of 20% enriched Uranium, which has now been converted to 5%, which takes longer to build a bomb from) have an initial end point at the 28th March for a preliminary deal (to be finalized end of June), with, from our sources, the technical details having already been worked out last year of how monitoring etc would work, but the political side not quite there. The Iranian new year celebrations of Nowruz start on the 21st March, putting pressure on the Iranian side to get a deal done by the 20th as the period after this is one where reaction locally will be minimal and it is generally difficult to get anything done for a while. The P5 + 1 parties are scheduled to start their latest talks on the 15th.
Fifth, the Iranian government has changed to a more moderate Rouhani from the more populist Ahmedinejad and the Iranian economy has stabilised dramatically, something likely to continue as they increase their influence in Iraq. It is notable that there are more American educated PhDs in the Iranian cabinet than the whole of Senate and Congress.
Finally, sanctions are already breaking apart on Iran as Russia has been pushed out in the cold due to what I believe is the true Clash of Civilizations. There have been numerous moves for increased co-operation between the two countries as part of Russia's push to increase its soft power in the Middle East as it fills the gap left by the departing USA and Russia is also set to sell Iran Antey-2500 anti-aircraft missiles, an upgrade on the already agreed S300 system. This is an interesting system as it offers anti-ballistic missile protection as well as anti-aircraft protection, effectively hardening Iranian nuclear sites against Israeli attack (the US could still overwhelm it)
So, with these factors it seems we are heading to a deal perhaps next week, or if not in June of this year when the interim deal officially subsides. After June given the political environment in the US and likely developments in Iran, it will become considerably more difficult.
This deal will likely involve export of Iranian uranium hexaflouride gas to a third party, perhaps Russia, for conversion into fuel plates, which are difficult to turn back into nuclear weapons grade uranium. Other nuclear activities will be frozen and European and SWIFT sanctions removed, as well as oil export sanctions. US sanctions will remain, subject to a 2-3 year monitoring period, but US-Iranian trade is likely to remain minimal and the SWIFT sanction removal will allow Iran to trade actively once more. There will be a 10 year "sunset" provision at which point the deal will have to be renegotiated, but the Nuclear Non-proliferation Treaty will stay in place past that, along with the Additional Protocol of increased inspections Iran is likely to agree to.
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The market impact of an Iranian nuclear deal would be most immediately anticipating the return of 1mbpd of Iranian exports that disappeared a few years ago to be priced back into the market, along with expectations of rising Iranian production given they can access the market for much needed infrastructure investment (Iran still imports gasoline!).
This is likely to put pressure on a fragile oil price and set the stage for a second bottom before the much higher levels of oil price we have predicted in the coming years (my two year target remains $130 spot Brent, JP is considerably more bearish), particularly as Cushing inventories fill to the max in the next few months thanks to the contango still in place as we noted in January when predicting a sharp spike following the ascension of King Salman before the oil price subsided once more.
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This presents an interesting short-term play as the likelihood of a spike on no deal is minimal as the market is not expecting one as this point in time, but the downside risk could be substantial as classical data like inventory build continues to mount and we are still a few months away from meaningful shale production slowdown.
Oil stocks have disassociated from oil prices given the steep oil contango, but as consensus expectations continue to drop and US companies in particular are forced to revalue reserves due to accounting rollover next quarter at $50 versus $90/barrel, we should expect to see increased pressure on dividends, with majors like ENI perhaps the first to go, destroying a key support for these stocks.
Gulf stock markets are likely to be relatively unaffected, although we could see some move in Dubai property as capital is repatriated to Iran. The Iranian stock exchange is a massive beneficiary at 10x the size of Nigeria and once SWIFT sanctions are removed, there are paths to invest in this at mid-single digit PEs and dividends in the teens, offering huge potential upside..
The markets that will be hit are likely Russia, which is one of the top performers year to date but has a currency that is basically pegged to oil now and Nigeria, where crunch elections are coming at the end of March and the central bank has simply run out of resources to stabilize the currency, which I still see going to 240 or so. The new budget in Nigeria is meant to balance at $50-60, but the leakage in the system still remains immense. There is some danger of political fracas during the elections and even worse if they are delayed once more.