Tensions between West and Iran not the main factor in future oil prices

Iran's confrontation with the West has been a worthy headline-grabber for months, but it is mundane economic realities that will set the tone for oil markets in the months ahead.

Market concerns about the loss of Iranian oil exports because of sanctions and the potential for a Gulf-wide conflict that would hit exports from the region's major producers became the standard explanation for rising oil prices in the first quarter of the year. Increased tensions have fed a political risk premium that has tended to drown out more sober assessments of the shape of the oil market heading into the season when demand rises thanks to the summer holidays in the United States, when more Americans get behind the wheel.

No one can sensibly predict the endgame in Iran's standoff with the West over the country's nuclear programme, but there are good reasons to look through the fog of Iran's political risk premium as weak oil market fundamentals increase the risk of a significant move lower for oil. Fresh evidence is emerging that oil prices above US$120 a barrel undermine prospects for a sustainable economic recovery in Western Europe and the US; that they are encouraging investment in a new wall of oil supply outside Opec; and, crucially, are likely to increase risks to economic growth and therefore oil demand from the developing countries outside the Gulf.

The disconnection between Brent futures - widely used as a global hedge against supply disruption - and weakening prices for spot crude oil point to a market on the cusp of a slide. Even as Brent futures have tested three-year highs in recent weeks, trading in Russian crude oil in the Mediterranean has hit year lows, and North Sea crudes are also off their peaks.

A well-flagged initiative by the US, likely to be backed by the United Kingdom and France, to deploy oil from its Strategic Petroleum Reserve will also help to keep any fresh price rallies in check. While a release of oil from storage tanks is unlikely to win the support of the International Energy Agency and its other member countries, the US has made it clear it is ready and willing to pull the trigger on releasing back-up barrels if prices remain high.

Early evidence on the impact of new US and European sanctions against Iran suggests that Iran's oil exports have dipped by 250,000 barrels per day (bpd). Some Wall Street analysts believe that number may rise as high as 1 million bpd over the next few months. But those familiar with Iran's oil marketing point to the National Iranian Oil Company's readiness under pressure to sweeten credit terms and establish new intermediaries and financial settlement arrangements that will over time limit the impact of the sanctions.

Recent reassurances from Saudi Arabia - the largest global oil exporter - on oil supply indicate a fresh determination to drive the froth out of the oil price. The kingdom's commitment to meeting any additional call on its crude has been underlined by senior officials on multiple occasions and should not be doubted. But it is Saudi Arabia's view that Asian markets are softening that is most telling.

China, the world's fastest-growing major oil consumer, is grappling with slowing economic growth, most recently reflected by slowing imports, even though data suggests that oil imports are holding close to record highs. Whether this is driven by consumption or strategic stock-buying is difficult to discern, but the risk is that any tangible reduction in Iranian-related risks will diminish strategic buying.

Finally, high oil prices are encouraging investment in new oil developments, particularly in the US and Canada, where insufficient export routes are now the main constraint to higher oil production. With rising oil supply from countries outside Opec set to push its way into the market in the next five years, even explosive headlines on Iran may struggle to keep oil prices near present highs.

Bill Farren-Price is the founder and chief executive of Petroleum Policy Intelligence, a consultancy