Iranian Nuclear Negotiations: As Talks Extend, Oil Markets Tilt in the Balance in Favor of the P5+1

Last week, Iran and the P5+1 negotiators announced that they would again extend talks aimed at halting Iran’s nuclear program, with a proposed final framework due by March 1, 2015, and a final deal due by July 1.

Since the previous 2014 extension, oil markets have experienced a significant shift. With global oil demand growth proceeding at a manageable pace, non-OPEC oil production surging, and Libyan output back online, the market is extremely well supplsed. Prices have dropped by $40/bbl since June as a result

These developments could play an important role in the negotiations going forward. If current market dynamics persist, Iranian oil exports revenue will decline by 25 percent year-over-year in 2015 to roughly $40 billion—the lowest level since 2004 and well short of a projected budget requirement in excess of $60 billion. While most of Iran’s oil revenues are captured in escrow accounts abroad, this drop in earnings should increase Iran’s desire for a deal.

Yet, Iran is in a catch-22: Revenues are falling and sanctions are stressing its economy, but any incremental barrels it brings to the market will simply add to the glut, further depressing prices and offsetting any revenue gains.

Meanwhile, a more flexible global oil market should make the P5+1 more willing to maintain current sanctions levels, which are now essentially cost-free. Moreover, our analysis suggests that oil market conditions throughout 2015 will make it possible for the P5+1 to credibly threaten to strengthen sanctions if needed without risking economically-destructive oil price volatility.