Iran Deal Reduces Risk Premium But Don't Expect More Oil — Yet

The announcement over the weekend that Iran and the P5+1 group of nations (US, Russia, China, France, UK and Germany) had reached a preliminary agreement on the country's nuclear program has sent the price of Brent Crude lower by almost 3 dollars in early Monday trading. This is the biggest drop in three weeks and it comes primarily as a relief sell-off as extra oil is not going to be flowing anytime soon.

The agreement will loosen some of the economic sanctions which has been imposed over the past year and this should bring an immediate relief to the Iranian economy which has been reeling. But relief measures are all at this stage being regarded as temporary and targeted towards non-oil related areas. During the six-month interim time frame on the current deal, further negotiations are planned to take place.

A statement from the US White House following the agreement said that Iranian exports of oil cannot be increased over the next six months and it should remain limited to around 1 million barrels per day. Since sanctions were introduced at the beginning of 2012, Iranian exports have sunk by 60 percent and have cost the country more than USD 80 billion in revenue.

The IEA in its latest report estimated that Iran's export dropped to 715,000 barrels in October from around 1.26 million the previous month, so a small pick-up in oil supplies can be expected but overall the impact seems to be limited, at least for the next six months. Beyond that we have the potential for both Iranian and also Libyan oil beginning to flow more freely, which eventually could add more than 2 million barrels/day of extra supply. This would exceed the expected demand growth over the coming year and if not checked by Saudi Arabia in terms of reducing its own supplies, global oil prices could end up at considerably lower levels than those seen currently.

So is the near three percent drop overnight justified? The answer to that is a resounding "Yes" as supplies near term will rise a bit, but more importantly it should reduce some of the geopolitical-risk premium which has and will continue to support prices in the near term. The impact on Brent crude has been the greatest with the premium over WTI falling to USD 15/barrel after reaching an eight-month high on Friday.

Brent crude remains stuck within an overall trading range of USD106.50-111.50/barrel. So far today, the January future has found some initial support towards USD 108.24/barrel, the 38.2 percent retracement of the rally seen over the past two weeks with the next level at USD 107.26/barrel. So while hedge funds trim their net-long positions, some further losses can be seen. Nevertheless, those selling in anticipation of the market being flooded with oil may end up disappointed.