Iran Deal in the Balance

Talks on Iran’s nuclear deal have raised Western hopes. We believe the odds are marginally in favor of an agreement, but that real sticking points would need to be resolved in coming weeks for a breakthrough.  The outcome will have fundamental implications for oil markets and Gulf stability. 

• US-Iran negotiations have taken a positive turn. After talks resumed Dec. 27, there is a strong sense on both sides that the time is now or never, with high risks from a no-deal path. After several rounds with little or no progress, delegations have made it to the drafting stage. Iran is showing greater flexibility, has backed off from more rigid demands on the timeline and easing of sanctions, and has pledged not to enrich uranium beyond 60% — an unprecedented level for a country with no nuclear weapons program, but not yet weapons-grade. Western policymakers are acutely aware of the nuclear knowledge gained by Tehran during the deal’s lapse. The estimated timeline for Iran to get enough fissile material for a nuclear weapon — but not a weapon itself — has shortened to weeks. 
  
• Deal prospects remain uncertain, with tensions on key sticking points. A deal will require creative diplomacy and real progress on points of contention over the next month. Key sticking points include remaining Iranian demands for verification that sanctions relief will give sustainable economic benefits, and the pace and shape of implementation. Iran has also pushed hard for guarantees that the deal would stick even under a new US president, but US negotiators have been clear that they cannot deliver this. Still, there is a growing sense Iran may treat the situation opportunistically, seeing benefits from freeing oil exports at current high prices even through the end of US President Joe Biden’s term. Any agreement remains vulnerable to criticism from hard-liners on both sides. 
  
• Iran’s President Ebrahim Raisi is prepared for a no-deal scenario. Despite severe economic pressures, Raisi’s position is stronger than it appears. Iran has proved surprisingly resilient to US sanctions given support from clandestine oil exports. Raisi insists economic performance is not inextricably linked to the fate of the deal, and his government’s 2022-23 budget does not anticipate any increase in oil revenue. Absent a new agreement, we see Raisi doubling down on strengthening Iran’s “resistance economy,” with greater self-reliance and more focus on trade projects in the region and with Moscow and Beijing. That said, a deal would allow Raisi to claim a victory for Iran’s conservatives. Supreme Leader Ayatollah Ali Khamenei has also softened his language somewhat in recent weeks. But with hard-liners in firm control in Iran, we do not see any agreement bringing broader détente with the West. 
  
• A deal could quickly add spare capacity to a tight oil market. Iran has exported an estimated 550,000-650,000 b/d of crude under US sanctions in recent months, mainly to independent Chinese teapot refiners. A deal in the next couple of months could boost production by 1.5 million b/d this year, according to our estimates, from about 2.5 million b/d now to 3.8 million b/d by Q3 and 4 million b/d by Q4. Some insiders see a quicker rebound. We see skepticism about a deal already priced into today’s tight market. An agreement would introduce some downside, potentially deflating prices back to the lower $80s. 
  
• The outcome will be pivotal for Gulf stability. Successful negotiations could be transformational for the region, while failure would produce a tense stand-off at best, with escalation into serious conflict a real prospect. We believe a deal would reduce the risk of flare-ups, encourage more regional dialogue (as states seek a new balance) and generally improve Gulf stability. It could also de-escalate flash points including Yemen, Syria and Iraq, and maritime tensions in the Gulf and Red Sea. Iranian ties with Russia and China would develop further, encouraging stability. In a no-deal scenario, recent improvement in regional relations could help limit a return to frequent attacks on Gulf oil infrastructure and tankers. However, escalation could instead play out via proxy forces in other countries. But the situation would be highly unpredictable and inflammatory. Any major unilateral military action by Israel in response to continued Iranian nuclear development could tip the region into conflict.