Iran Deal Done - "Stunning, Historic
Mistake" Or "Profoundly Positive Change"
Submitted by Tyler Durden on 07/14/2015 11:30 -0400
While slightly later than expected, a comprehensive
deal on Iran’s nuclear weapons program has now been reached.As Reuters reports, the agreement will be greeted with alarm in
several quarters, both in Washington and Tehran and internationally too, and
could yet unravel.
Internationally, the deal will accelerate unease in
some Arab states, including Saudi Arabia, but it is Israeli Prime Minister
Benjamin Netanyahu who remains the fiercest public critic and has issued a
warning that the accord will "inevitably lead to a nuclear
war."
The deal profoundly changes the balance of power in the
region, but averts the conflict that was likely otherwise, but as ECStrat
notes, Iran offers exceptional investment opportunities, but the near
term impact will be to continue oil’s decline back to its lows, potentially
taking energy stocks with it.
The agreement will be greeted with alarm in several
quarters, both in Washington and Tehran and internationally too, and could yet
unravel. Internationally,
the deal will accelerate unease in some Arab states, including Saudi Arabia,
but it is Israeli Prime Minister Benjamin Netanyahu who remains the fiercest
public critic and has issued a warning that the accord will “inevitably lead to
a nuclear war.”
To be sure, no lasting settlement that Iran would ever
be likely to agree to will completely eliminate its ability to build a nuclear
bomb. In
testimony last year, Kerry told Congress that it would, in theory, currently
take Tehran around “two months” to produce sufficient nuclear material for such
a weapon.
However, buttressed by greater international
monitoring and oversight of Iran’s program, the P5+1 believe that they have
significantly lengthened this so-called ‘break-out period’ to at least 12
months. This is a very sensitive issue with many conservatives in Tehran,
including Supreme Leader Ayatollah Ali Khamenei.
This underlines the fact that, within Iran and the
United States, opposition to a final deal is concentrated largely (but by no
means exclusively rests) amongst conservatives, including the Republican Party
which controls Congress. And, it is the American federal legislature where the
deal faces the most obvious and immediate challenge, with a 60 day review
period soon underway with final votes probably not until the autumn.
And John Boehner came out firing this morning...
- *PRESIDENT
OBAMA 'ABANDONED HIS OWN GOALS' WITH IRAN: BOEHNER
- *OBAMA'S
'DEAL' WILL 'ONLY EMBOLDEN' IRAN: BOEHNER
However, as ECStrat's Emad Mostique notes, there are positives (and opportunities)
from the deal...
While slightly later than expected, a comprehensive
deal on Iran’s nuclear weapons program has now been reached. We think this is a
good deal that stops nuclear breakout, the primary aim.
The deal profoundly changes the balance of power in
the region, but averts the conflict that was likely otherwise.
We have been of the opinion that Iran’s nuclear
program was primarily a defensive deterrent for a pariah, autarchic state, with
any offensive function circumscribed by the jurisprudential foundations of
Twelver Shia Islam (see
page 6 onwards here).
Iran offers exceptional investment opportunities, but
the near term impact will be to continue oil’s decline back to its lows,
potentially taking energy stocks with it.
Pariah no longer?
The mutual distrust between Iran and the rest of the
world stemmed from their outcast status that started after the Iranian
revolution in 1979, when Iran had its own “Arab Spring”, overthrowing the
monarchy for a democratic system that was then handed over to the control of
Ayatollah Khomenei, who pushed a new concept of velayat-e-faqih, “guardianship
of the jurists”. The unpredictable nature of the new, non-autocratic Iran led
to most of the world uniting behind Arab leader Saddam Hussein in the horrible
Iran-Iraq war that ensued, with only Israel providing substantive support to
Iran as they were unsure Saddam was quite all there.
In the decades since there has been some degree of
hesistance and debate in the West and Israel as to whether Iran was a state or
an ideology (with the pejorative use of “mullahs” to refer to its leadership).
As the former, one could treat it as a rational actor with various power blocs
within it, as the latter the tendency was, to quote Benjamin Netanyahu who used
a nuclear Iran as a key political canard, to view it as an “messianic
apocalyptic cult”, particularly given Ahmadinejad’s tendency to make
millenarian declarations of the return of the Mahdi.
The last few years of negotiation following the
freezing of Iran from the global system in 2012, co-ordinated with several
regional allies to try to prevent the inexorable shift in the regional balance
of power and baking of the Shia croissant, has shown that Iran is
indeed a rational state, albeit one with irrational actors within it.
These irrational actors were, as in many countries,
primarily driven not by religious fervour, but rather by political ideology
(rather conservative) and the desire to maintain their privileged status in
society – Iran’s elite controlled the reins to the sanctions economy and thus
became inordinately wealthy from it, even as the middle classes suffered.
The role of religion in the purported Sunni-Shia Cold
War in the region has been overplayed and is primarily only a small
contributory factor on the basis of cultural prejudices. This can be seen by historically well-integrated
societies such as Iraq pre-war and Kuwait today, but external actors such as
ISIS are adept at driving and widening sectarian wedges, building on some of
the more aggressive interpretations of religion (an interesting exercise is to
see how references to Shia shift from rafidi (rejectors of faith) to ajam
(persian) in Gulf media).
Economic factors to political sanctions
Indeed, the erosion of the middle class and “bazaaris”
was one of the most interesting elements of the recent sanctions regime, as this
group had benefited dramatically from the easy monetary policy in Iran under
President Ahmadinejad, who set real interest rates to -10% in a populist binge,
causing a huge boom in the monetary supply base (almost four-fold pop) even as
the currency was pegged to the dollar, resulting in a hugely overvalued rial
and Iranian cash flooding the region and doubling imports into the Arab Spring
to nearly $80bn.
This, combined with Iran undergoing subsidy reform
(moving from $100bn a year on a $350bn economy to a basic income model) and GDP
approaching $400bn made Iran a real threat from a soft-power basis in the
region, particularly given its traditional “role” as supporting self-declared
revolutionary groups such as Hamas and Hezbollah.
When sanctions kicked in in 2012, the Iranian rial
simply corrected back to its real effective exchange rate, not a hyper
inflationary collapse that some were warning of at the time. The currency has remained relatively stable in
an EM context at around 30,000 with interest rates at 20% and the Rouhani
government steadily reducing inflation down to 15% from over 40% (be careful
when analysing Iranian economic stats as the years are a bit funny, as are some
of the official calculations).
This move in the currency, which the elite could
circumvent, halved imports and ironically crushed the increasingly influential
middle class, who were effectively frozen out of the international market by
SWIFT/banking sanctions. Indeed, the banking sanctions were the main spanner in
the works for Iranian industry, as many industries were untouched by other
sanctions but business just became too difficult to do for many others,
particularly if focused on trade.
Recent sanctions and government action has led to some
oddities in the Iranian economy in recent years, such as the savings rate
dropping from 45% to 33% in the last few years with investment being squeezed,
even as household consumption increased almost 10% to 52%. Real estate and
luxury cars (particularly Porsches, which are oddly prevalent in Tehran)
benefitted with imports at a quarter of consumption, but there is a significant
gap in SME financing in particular.
While Iran will likely have access to over $100bn in
frozen offshore reserves and assets, as well as 30m barrels of floating oil and
increased oil flows, it faces a delicate balancing act if it is to avoid
stoking inflation ahead of next year’s elections.
The economy is moderately well diversified
versus regional peers, with oil receipts under a third of GDP (with most of the
receipts going on remaining energy subsidies and new social payments), but
there is an increasing focus on economic diversification, with startup growth
and accelerators actively encouraged and FDI, which currently stands at 2% of
GDP, a key target. The opening of Iran should also change the political balance
of power profoundly as the middle classes, who actually (mostly) pay tax,
become the primary beneficiaries of increased trade and a reversal in declining
investment.
Possibly the most interesting stock market in the
world
The Tehran Stock Exchange has a market cap of $100bn
and trades up to $200m a day, high in a frontier market context with a PE of
around 6x and double digit dividends. Access should SWIFT sanctions be removed
is surprisingly easy, but navigating the market is a bit harder as local
knowledge is needed to separate the privately owned and controlled companies
from those controlled by groups such as the Setad under Ayatollah Khamenei or
under one of the myriad companies controlled by the praetorian guard of Iran,
the IRGC. The bond market is nascent, but Shariah-compliant and growing
The stock market will be an essential means for Iran
to encourage foreign investment and increase its profile, particularly as there
are another potential $100bn of privatisations in the pipeline if current plans
are kept to, ideally for the government at a higher valuation to the ones we’ve
seen. We would expect inflows to be slower than one might think as foreign
companies will be cautious of the web of sanctions that needs to be unravelled
and many lack expertise in the region sufficient to navigate the opaque on the
ground environment where corporate governance can be variable to say the least.
The banking sector also doesn’t appear to be very healthy after years of
economic mismanagement, but capital may suddenly become considerably cheaper to
paper over the cracks
Gradual sanctions removal
Back to the Iran deal, per the proposed text
sanctions removal looks to be gradated but reasonably comprehensive, with the
key banking sanctions being removed with IAEA verification, the major fillip to
the economy that will allow it to resume its growth.
Certain sanctions focused on human rights abuses and
related to Iran as a state sponsor of terror will stay in place, but the
initial range of removed sanctions seems surprisingly broad. Iran has much more
work to do to become a valued member of the global community, but trade goes a
long way toward that.
The most aggressive US sanctions have been codified by
Congress and thus can only be waived by Congressional vote or waived on a
short-term basis by presidential waiver. We don’t see this as being
rolled back by future administrations, particularly as the likelihood of Iran
adhering to the deal under our model is very high
Oil cracking
We have been firmly negative on oil for the last few
months and continue to see a double bottom in the oil price as the near term
impact of floating Iranian barrels and medium term impact of increased Iranian
production (we would venture 700kbpd in 6-12 months and potential output of
4.5-5mbpd in a few years vs a prior peak of 6mbpd) is absorbed by the market,
pushing down the curve over the next year out even as inventory build continues
and we are a month or two away from US production falling.
It is worth noting that Iranian oil is fairly low cost and the current outline of new production
sharing agreements looks attractive, so this is oil that is highly likely to
come to the market versus higher cost fields elsewhere. Iran has proved oil
reserves of 160n barrels, 10% of the global total and the worlds largest proved
gas reserves at 34 tr cubic metres (18% of global total). Not all Iranian crude
will be exported however as it already consumes 2mbpd a day and sanctions
removal will allow it to diversify downstream, with the bulk of production
increase occurring in 2018-2020.
We also note that, unlikely the end of last year when
Saudi was actually cutting exports and not really being that aggressive on
pricing differentials, they have, as expected, ramped up oil production to
record levels and actually reduced internal consumption on a seasonally
adjusted basis, as well as slashed prices going into this summer, trying to
drive down prices at a critical time. This has been a key driver of recent
weakness in the price, as well as the market factoring in returning Iranian
oil.
OPEC won’t cut in line and our view on China remains
firmly bearish (note they’ve also filled their strategic reserves, removing up
to 200kbpd of “demand”), with all signs pointing to a double bottom in the oil
price.
After that our viewpoints diverge, with my view being
that we work through the inventory overhang to the end of this year as oil sold
forward comes back to the market and geopolitics looks somewhat troubling into
2016, even as production peaks and falls due to lack of exploration spending
and cash run off, pushing up the back end of the oil curve and seeing a return
to backwardation taking us back up above $100 into 2017.
JP thinks we are in a new normal and the end of the
Chinese boom and increased fuel efficiency means we could go even lower than
the lows.
Market impact
Shall be interesting to find out, but a double dip
will put real pressure on energy equities, maybe even on the magical CNOOC and
Sinopec (!) which have divorced from reality on the China equity boom. Global
energy stocks have largely been tracking 12m oil and this is the key gauge to
look at as the market prices forward Iranian crude.
Elsewhere, this is terrible news for Nigeria,
where the Buhari government has been slow out of the blocks in getting the new
cabinet and leadership team in place. A devaluation to 240-250 over the summer
is highly likely, even as subsidies are removed, placing a lot of pain on the
locals. The only reason it seems to feel bullish is because suddenly everyone
is so bearish on Nigeria, but valuations still don’t quite give the comfort one
would require here as the post-Buhari pop has slowly punctured.
On a single stock level, concerns over Nigeria
may be outweighing the positive impact of potential repatriation of Iranian
profits for MTN, which has had a subdued reaction today. In contrast,
Gubre, a Turkish fertilizer stock we have highlighted in the past as having a
substantial portion of its EBITDA from Iran, is up 10% (looking expensive) and
Savola, which has a solid portion of its edible oils business in Iran is also
up a couple of percent.
Russia should also suffer from the Iranian deal
short-term as can be seen by the Ruble reaction, but this is predictable given
the high correlation one should expect between the currency and the oil
price. Please see our latest governments and markets piece for our latest
views on the overall market.
The Gulf nations face somewhat of a mixed bag as there
are undeniably proxy conflicts in certain areas, such as Yemen (where the Shia
influence is overstated), yet alliances in others such as the fight against
ISIS. The Gulf stock markets will likely remain secure as the governments have
shown they will continue spending, although the question now is whether and in
what form they will finance potential deficits. Certain regional companies such
as Savola may well benefit from their Iranian ties and as Iran opens it
provides an attractive new market to cash rich Gulf companies in need of a
population to sell to, particularly as North Africa looks increasingly dicey.
Geopolitical fallout
On a military basis fears of a regional Iranian
hegemon are overblown, with
the Iranian army likely continuing a defensive posture, even as it supports
regional allies.
The support of regional allies is not a case of Iran
being “evil” and supporting “evil”, but rather the quite rational policy of
supporting those who share commonalities in political position and goals. The
level of support also varies dramatically, from heavy support for Assad and the
Iraqi government (where a delicate dance is playing out) to minimal support for
the Houthis in Yemen, which looks like it is headed toward becoming Al
Qaedastan as the death toll rises above that of the Gaza offensive last year
and the sheer scale of emergency aid requirements is mind boggling but largely
ignored.
None of these pose a threat to regional governments
territorially, certainly compared to the threat of ISIS and Iranian military
spending is unlikely to ramp considerably as the IRGC concentrate on
maintaining internal power under a new political and economic reality.
To put this in context, Iran spends just slightly more
on its army than Oman
This is not particularly good for President Netanyahu
in Israel and may drive further wedges in the political process there as a key
“immediate” threat has been largely neutralised. Long-term there is the
possibility that this is a bad deal for Israel as he says, but it is difficult
to get people to rally around long-term, with short-term domestic issues now
likely to dominate. We think this is good for Israel’s safety.
Geopolitically this deal is great for Russia as it
fits in with their theme of moving in to occupy the space left by the USA as it
pivots from the Middle East to Asia.
We should expect a significant pickup in trade between
Russia and Iran, with Turkey and China being the other major beneficiaries in
this regard as the petrodollar nexus moves further East.
This also marks a massive success for President Obama
and paves the way for an increased focus on Asia, where the rebalancing of
China and Japan pose an uncomfortable problem with no clear solution.
It is unlikely that the next President will roll back
a nuclear deal or stop extending waivers regardless of the current rhetoric.
The exception would be if Donald Trump wins, but that opens up a whole new
barrel of worms.
Congress will have 60 days to look at the deal but
ultimately can’t block it. Big Oil will also lobby aggressively for the deal to
be put in place.
The ultimate upshot of the deal however is peace as we
avoid a distrous regional conflict.
* * *
This political discontent in the United States may
only embolden Netanyahu...
- *NETANYAHU
CALLS IRAN NUCLEAR DEAL `STUNNING, HISTORIC MISTAKE'
- *ISRAEL
NOT BOUND BY IRAN DEAL, ISRAELI PRIME MINISTER SAYS
Especially with the latter’s new electoral mandate,
Israel will probably reserve the right to take unilateral military action
against Iran’s nuclear facilities.
Taken overall, the final, comprehensive nuclear deal
is a historic landmark that opens a new chapter in Iran’s relations with the
United States, and wider West. However, domestic and international critics will
now rally against the agreement, and it will face an early and significant
hurdle this autumn in Congress.
No comments:
Post a Comment