The downside oil market risks of a new Iran deal

After five rounds of negotiations to date, the United States and Iran have yet to reach a new agreement on the Iranian nuclear program, though reportedly the two sides have made some limited progress and plan to meet again. Most of the Middle East is looking at the prospects for a US-Iran deal with cautious optimism, viewing a bilateral modus vivendi as preferable to increased tensions and the possibility of military strikes on targets inside Iran. But while success in the talks promises to bring greater stability to a region too often beset by conflict, near-term progress in a renewed nuclear agreement may have negative collateral consequences in the energy sphere. Namely, a deal struck between Washington and Tehran could add further downward pressure to an already delicate oil market, potentially heralding more fiscal pain for Gulf oil producers and complicating US energy strategy.

While US diplomacy with Iran appears to be moving forward under sustained momentum for the time being, oil prices have been battered by dual threats of economic uncertainty. The first has been President Donald Trump’s “Liberation Day” tariffs. And the second was the surprise decision by OPEC+ — a grouping of the 12 members of the Organization of the Petroleum Exporting Countries (OPEC) and 10 non-OPEC petroleum producers (most notably Russia) — to add over 1.2 million barrels per day (bpd) in additional supply during May, June, and July. The price outlook may worsen if trade war uncertainty persists, or if US tariffs on major oil demand centers, particularly China, cause significant erosion in demand due to economic slowdowns.

The probability of a renewed nuclear agreement between Iran and the US is as difficult to predict as the result of Trump’s trade war. A more certain outcome, however, is that if a deal is indeed reached, US sanctions on Iranian oil exports will be lifted. Tehran will refuse a long-term, comprehensive deal containing anything less. In 2021, the last time a potential diplomatic opening between the US and Iran appeared possible, global oil demand was on an upward trajectory after recovering from the downturn of 2020, growing by over 5 million bpd that year — a ravenous pace that would have likely been able to absorb returning Iranian barrels much more easily. Conversely, a growing number of major forecasters now see demand growth in 2025 below 1 million bpd for the first time in a number of years and expect this year’s oil supply to exceed demand, typically a more bearish factor for prices. Oil prices may not necessarily retreat to a sustained “lower-for-longer” range; but at a time when volatility and uncertainty clearly remain the order of the day, a deal leading to a sudden influx of Iranian supply warrants a cautious approach.

Buyer beware

Should the US strike an updated nuclear agreement with Iran while these conditions persist, Iranian oil exports could surge. Estimates on the exact volume of such an increase vary, as do estimates of Iran’s current level of oil sold abroad, which is obfuscated by Tehran’s use of subterfuge to avoid sanctions. Depending on the nature of a deal and the timeline for its prospective implementation, Iranian oil exports could rise significantly in just a few short months. While this is doubtless the outcome Tehran seeks for itself, the result would expand the surplus that oil markets are already facing this year and further depress prices. The outlook for the global economy is likely to remain fluid while trade volatility persists, but with OPEC+ pressing ahead with its accelerated supply additions, markets will easily remain in surplus regardless of how Washington’s trade talks with much of the rest of the world progress.

To put things more simply, any measures containing sanctions relief for Iran are likely to result in an influx of oil that the market does not need. This added supply would push prices lower; and with crude mostly trading in the $60-$65 per barrel (bbl) range for much of May, the result would have negative implications for both the US energy industry and Washington’s oil-producing partners in the Gulf region. Prices at the aforementioned range or below will result in fiscal strain for Gulf states as well as prevent US supply growth, given that American firms have higher production costs than their Arab Gulf counterparts. According to one estimate from Bloomberg Intelligence, a rollback of sanctions on Iranian exports could bring West Texas Intermediate (WTI), a key US crude benchmark, as low as $40/bbl, a range that would be devastating for the US oil industry. Policymakers should be aware of the unintended impacts that a deal may bring, if only in the interest of exploring strategies to reduce these effects should there be a need to do so.

This outcome would be mitigated by the fact that Iranian production has already risen significantly during the last four years, mostly as a result of lax US sanctions enforcement during the administration of President Joe Biden. Iranian oil output has posted gains of around 1 million bpd over the last several years, averaging about 3.3 million bpd for most of 2025 thus far. Estimates of exactly how much Iran’s exports could rise above that level vary somewhat, but a total removal of sanctions could see up to 500,000 bpd worth of additional Iranian exports return to market.

What can be done to limit downside risks?

Assuming the US and Iran manage to reach a renewed nuclear accord — and do so at a time when oil prices remain suppressed due to macroeconomic uncertainty, an oil supply glut, or other factors — the US should give careful attention to the risks posed by low prices, both for its own benefit and the benefit of its partners in the Gulf region. First of all, the “energy dominance” agenda touted by the Trump administration ultimately requires energy prices sustained at a slightly elevated level in order to post further growth. And second of all, the billions in investment promised after the president’s latest visit to the Middle East will be slower to materialize if low prices constrain the Gulf states’ abilities to invest overseas. The toolkit for curbing a potential price collapse from a cascade of Iranian barrels returning to the open market is likely to be limited, but the US has some options it could implement to contain the risks and prevent oil market fallout from undermining what otherwise appears to be a broad appetite for diplomacy with Tehran.

Refilling the Strategic Petroleum Reserve

An initial option would be to take advantage of low oil prices to begin refilling the Strategic Petroleum Reserve (SPR), which Energy Secretary Chris Wright has already expressed his intent to do. Established by the Energy Policy and Conservation Act of 1975, the SPR is overseen by the Department of Energy (DOE) to shield the US from major oil supply disruptions. The Biden administration oversaw the largest SPR release in US history through an emergency sale of around 370 million barrels in 2022. While the move was intended to address high oil prices brought about by the Russo-Ukrainian war, it was viewed as a controversial policy at the time given the lack of an actual loss of supply. Whatever the debate surrounding the Biden administration’s policy, though, the end result of this decision was the SPR reaching its lowest level in 40 years.

Once these releases were completed, DOE gave a range of $67-72/bbl as its preferred price for purchasing crude with which to refill the SPR. Resurgent Iranian supply would likely push prices below this target, providing Washington with a budget-friendly price environment to support SPR refills. Any US government announcement of its intent to do so would also influence customer expectations and serve to mitigate downward price pressure, serving as somewhat of a soft backstop for the administration’s desire to see US energy production grow. Both the White House and Congress are more likely to view major crude purchases in a positive light, but budgetary constraints do represent a key obstacle for this policy. The Trump administration’s recent tax bill contained $1.32 billion earmarked for refilling the SPR, but funding for this type of measure will not be unlimited; it is far more likely that the funding to continue refilling the SPR will run out before the reserve facilities themselves run out of space to store crude from an oversupplied market.

Pushing Iran to limit its exports

Refilling the SPR, at least partially, represents what is likely the most effective unilateral action Washington might take to limit downside risks — that is, the potential for a sharp oil price drop — from an increase in Iranian output. However, there may be room, albeit limited, to coordinate other mitigation strategies with regional partners. For instance, Iran, although a founding member of OPEC, has been exempt from production quotas for nearly a decade, and so the Trump administration could in theory try to leverage its warm ties with the oil cartel’s de-facto leader, Saudi Arabia, to seek a renewed output quota for Iran if sanctions are lifted. Tehran would almost certainly reject any unilateral US efforts to restrict Iran’s ability to increase its oil production as part of a renewed nuclear agreement; but the Iranian government should presumably be more open to accepting such constraints if they were mandated by a multilateral organization of which it has been a longstanding member. Iranian compliance would, in turn, work in Riyadh’s interest by providing a greater degree of price support, while providing positive optics for OPEC+ group cohesion after it has struggled for months to contain overproduction from Kazakhstan and Iraq.

That said, major obstacles to such an undertaking would have to be overcome, at least in the near term. Tehran has resisted any discussion of an OPEC+ quota for years, and there is little reason to believe its position would change if it is finally able to boost output and sell its barrels for market prices instead of being forced to continue to offer steep discounts to a limited group of Chinese buyers. Mohsen Paknejad, Tehran’s current oil minister, reiterated this view as recently as November. While accepting a production quota alongside other OPEC+ members could be presented as the country returning to the fold of some of the most influential oil-producing countries in the world, it seems particularly far fetched that Iran would agree to limit its output at a time when most of the rest of the group is ramping up exports. Likewise, Riyadh may resist expending political capital on a likely doomed agenda item when its ties with Iran have largely been improving.

Limited room for maneuver versus strategic neglect

The risk of a price collapse stemming from a large-scale return of Iranian barrels to global oil markets is clear, and clearer still is how limited Washington’s options are for containing this risk. The aforementioned countervailing approaches could conceivably achieve some degree of success, if implemented. However, perhaps the deeper question is whether the White House actually has any interest in containing those negative externalities.

While candidate Donald Trump often repeated the mantra of “drill baby, drill” when attempting to articulate an energy policy, his preference for low oil prices has plainly overridden US production growth as a policy priority. It is distinctly possible that the White House views low oil prices — and how those translate for American consumers filling up their vehicles at the pump — as a hedge against the largely self-inflicted macroeconomic volatility stemming from its widespread use of tariffs. It may already be a base case scenario for many in the energy industry and in oil-producing countries, but for now, most signs point to the US taking a largely hands-off approach if a surge of Iranian supply significantly depresses prices.

 

Colby Connelly is a Senior Fellow at the Middle East Institute. He is also a senior analyst at Energy Intelligence, where he works with the firm’s research and advisory practices. His key areas of focus include oil and gas/LNG markets, aboveground risk, corporate strategy, and the impact of the energy transition on oil- and gas-producing states.

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