While Iran and the US make wary diplomatic overtures, a return to their lapsed nuclear agreement remains a distant prospect. But for world oil markets, a pact is already taking effect.

Months of secretive diplomacy between the two nations have yielded progress on prisoner exchanges, the unblocking of frozen assets and possibly even Iran’s enrichment of uranium. They also seem to have produced an informal arrangement on oil flows. 

US officials privately acknowledge they’ve gradually relaxed some enforcement of sanctions on Iranian oil sales. Tehran has restored production to the highest level since the ban kicked in five years ago and is shipping its most crude to China in a decade. Iranian officials are confident they’ll pump even more soon.

The supply flood is helping moderate oil prices, which eased below $85 a barrel in London this week, offering relief to consumers and central banks after years of rampant inflation. Keeping the cost of gasoline — now near $4 a gallon — in check may also aid President Joe Biden’s reelection campaign in 2024.

“It’s the traditional energy diplomacy game: cutting deals to get additional barrels,” said Helima Croft, head of global commodity strategy at RBC Capital Markets LLC in New York. “US and Iranian economic interests are aligned when it comes to more barrels on the market.”

A State Department spokesperson said the US continues to stringently enforce a robust framework of oil and other sanctions against Iran, and noted that export levels fluctuate regularly in response to prices and other factors.

Neither country expects to imminently resurrect the 2015 accord — abandoned by former President Donald Trump — that allowed the Islamic Republic to freely sell oil in return for limiting its nuclear program.

Yet in recent weeks they’ve reached an understanding on a possible prisoner exchange and the transfer of $6 billion in Iranian oil revenue stuck in South Korea — developments the Biden administration insists aren’t linked. There are even reports that Iran significantly slowed the buildup of near-weapons-grade enriched uranium.

The tentative detente is filtering through to the petroleum trade. Washington still won’t tolerate purchases by most of Iran’s pre-sanctions customers such as South Korea, Japan or European countries, but it’s relaxed about expanded sales to China. 

Shipments to the world’s biggest importer have reached 1.5 million barrels a day, the most in a decade, market intelligence firm Kpler Ltd. estimates. TankerTrackers.com Inc., another consultant, said exports are exceeding 2 million barrels a day.

Iran’s production climbed to 3 million barrels a day in July, the highest level since 2018, according to the International Energy Agency in Paris.

“Biden’s willing to look the other way in exchange for Iran capping those uranium stocks,” said Fernando Ferreira, director of geopolitical risk at Washington-based consultants Rapidan Energy Group. Besides, “the White House would be happy to see more barrels in the market to help keep prices in check,” he said.

Tehran expects to boost output to 3.4 million barrels in coming weeks, Oil Minister Javad Owji recently told the Iranian parliament’s energy committee, according to the state-run Shana news agency. That may increase to 3.6 million barrels by year’s end, according to people with direct knowledge of the matter.

If the country achieves that target — just a few hundred thousand barrels shy of pre-sanctions capacity of 3.8 million barrels — there won’t be much more oil to flow even if a formal agreement with the US is finalized.

“They’re getting close to pre-Trump levels; there’s a question of how much more can they do,” Croft said. “The question is: At what point does ‘de minimis sanctions enforcement’ really mean ‘de facto lifting of sanctions?’”

Rebounding sales are one of the most tangible signs yet that Iran — reeling financially from years of isolation — is reasserting itself on the global stage after starting to repair ties with regional rivals and foster relations with Asia’s leading power.

The supply surge comes at a fragile moment for global oil markets, with Chinese economic growth and fuel demand faltering, and undermines efforts by Iran’s counterparts in the OPEC+ coalition to shore up prices.

Saudi Arabia, leader of the Organization of Petroleum Exporting Countries, deepened oil output cutbacks over the summer by a hefty 1 million barrels a day. Yet Brent futures have retreated 5% since hitting a six-month high in early August.

For the Saudis, Iran’s comeback is “not a big problem at the moment but has the potential to become one,” said Christof Ruehl, senior analyst at Columbia University’s Center on Global Energy Policy.

Whether the Islamic Republic can sustain, or even increase, exports will depend initially on how much more oil it can pull from storage. The country has drawn down a combined 16 million barrels held onshore and aboard tankers this month, leaving it with another 80 million, according to Kpler.

But with most potential buyers still off-limits, Iran ultimately will rely on appetite from China.  

Beijing has been scooping up Iranian barrels to fill its strategic reserves, encouraged by the hefty discounts Tehran is offering to compete against Russian supplies spurned by Europe. Iran’s two main grades currently trade at discounts to Brent of more than $10 a barrel, traders say. 

But Chinese consumption is under pressure as the country contends with crises ranging from youth unemployment to turmoil in its property and shadow banking sectors. A top oil executive suggests the nation’s fuel use may have maxed out for the year.

“The amount of stockpiling China has been doing is going to tail off at some point,” said Ed Morse, head of commodities research at Citigroup Inc. “Demand growth out of China is close to being finished.”

Finally, there remain logistical obstacles. Restrictions on accessing the international banking system make it difficult for Iran to get paid, and without foreign investment it will struggle to boost production capacity.

Also, Tehran, frozen out of international shipping and insurance, needs to secure enough tankers from the “dark fleet” to haul its cargoes.

The vessels — often aging and uninsured carriers that deactivate transponders to avoid detection — also are essential for Russia, which has been shut out of conventional shipping following its invasion of Ukraine.

“Will there be enough tankers to move both?” Rapidan’s Ferreira said.