Saudi No Longer a Decision-Maker
International media and market analysts maintained that any agreement would hinge on Iran’s decision. Market symptoms also indicated that the conditions have changed in favor of Iran and unlike in the past, Saudi Arabia does no longer have final say on oil affairs.
Speculation about Saudi Arabia’s weakening position gathered steam after reports emerged of economic woes in the Arab kingdom.
“Suddenly the tables have been turned on Saudi Arabia,” wrote Bloomberg.
The biggest oil exporter has swapped its traditional role as price dove with regional foe Iran, for years OPEC price hawk, it said.
The government in Riyadh is now offering a deal -- including its first output cut in eight years -- to boost prices; Tehran is dragging its feet. At the center of the reversal is their contrasting threshold for enduring economic pain.
"Both countries are coming from different positions," said Jason Tuvey, Middle East economist at consulting firm Capital Economics. "Iran has been under sanctions until recently, so it’s getting an economic boost as investment returns and oil output rises. Meanwhile, Saudi Arabia is facing steep fiscal cuts."
The contrast between the two countries is stark. Iran, never as dependent on oil revenue as its neighbor, has seen prospects boosted by rapprochement with the west. In Saudi Arabia, tentative moves toward economic reform haven’t prevented two years of weak prices causing financial havoc: it’s burning through foreign exchange reserves, government contractors have gone unpaid and civil servants will get no bonus this year.
Saudi Arabia will suffer a budget deficit equal to 13.5% of gross domestic product this year, compared with one of less than 2.5% of GDP for Iran, the International Monetary Fund estimates. The IMF says the Saudis need oil close to $67/bbl to square the books. For Iran, it’s lower, at $61.50. Brent crude, the global benchmark, fell to $46.50/bbl in early trading in London.
When it comes to economic growth, Saudi Arabia is slowing sharply to 1%, while Iran is accelerating toward 4%. The current account -- a broad measure of a country’s economic relationship with the world -- tells the same story. Saudi Arabia faces a double-digit deficit this year; Iran’s is nearly balanced following economic reforms in 2012 and 2013 to weather the impact of international sanctions over its nuclear program.
Saudi Offer Turned Down
Saudi Arabia had offered to reduce its oil output from 10.6 mb/d to 10.2 mb/d in exchange for Iran freezing its output at 36 million tons.
But Iran turned down the offer with Zangeneh reiterating that the country would continue to raise its output to 4 mb/d.
Under normal conditions, such views would have driven the market further into degradation because Saudi Arabia was sticking to its positions.
However, Saudi’s Falih adopted a more flexible position, saying Iran, Libya and Nigeria must be able to produce oil at their maximum reasonable capacity.
Although Falih said no agreement was expected to be signed in the Algeria meeting, tough economic conditions forced Saudi Arabia to bow to Iran’s proposal.
“Saudi Arabia and Iran are sworn enemies on opposite sides of proxy wars tearing through the Middle East. But at a marble-paved conference centre on the outskirts of Algiers that is a legacy of the $100 a barrel oil era, there was an unexpected sign of conviviality this week: Iran’s OPEC governor was chatting warmly with a member of the Saudi delegation, even posing for a photograph together,” wrote the Financial Times.
It was the prelude to an agreement five hours later that should result in the OPEC-14 cutting production for the first time since 2008.
Iran’s Zangeneh, called it “a very good day for OPEC” as his Saudi counterpart headed straight for a waiting car.
The pact wrongfooted oil traders. It also signaled the end of a two-year Saudi experiment to surrender the oil price to market forces. More broadly, it has forced the industry to rethink its assumptions about the supposedly unbridgeable chasm between Riyadh and Tehran.
“It is a massive deal for the oil market that Saudi Arabia and Iran can set aside the poisonous regional rivalry that has dominated the relationship in recent years,” said Bill Farren-Price, an energy industry consultant. “It shows the extent both sides wanted and needed to get a deal done.”
Oil Edges Up
The 15th IEF ministerial meeting turned into OPEC ministerial meeting. Saudi Arabia agreed to exemption of Iran, Libya and Nigeria from an oil production ceiling cut. Immediately after the decision was revealed, the West Texas Intermediate (WTI) oil jumped to $47, gaining 5.3%.
“OPEC made an exceptional decision and reached consensus on market management after two and a half years,” Zangeneh said.
He and other ministers said the Organization of the Petroleum Exporting Countries would reduce output to a range of 32.5-33.0 mb/d. OPEC estimates its current output at 33.24 mb/d.
"We have decided to decrease the production around 700,000 bpd," Zangeneh said.
The move would effectively re-establish OPEC production ceilings abandoned a year ago.
Many traders said they were impressed OPEC had managed to reach a compromise after years of wrangling, but others said they wanted to get to know about the details.
"This is the first OPEC deal in eight years! OPEC proved that it still matters even in the age of shale! This is the end of the ‘production war' and OPEC claims victory," said Phil Flynn, senior energy analyst at Price Futures Group.
Goldman Sachs Group Inc. said OPEC’s deal to cut output could add as much as $10 a barrel to oil prices, though it remains skeptical along with other banks on how the accord will be implemented.
“Strictly implemented in the first half of 2017 and all else constant, the production quotas announced today should be worth $7 a barrel to $10 a barrel to the oil price,” Goldman analysts including Damien Courvalin and Jeffrey Currie wrote in the report. “It has historically taken a fall in oil demand to ensure quota compliance, as in that case, production is forced lower by a decline in refinery intake around the world. This is not the case today with resilient demand growth.”
If OPEC cuts its production by 200 tb/d, to 33 mb/d, that wouldn’t be enough to bring production back in line with demand until the second half of 2017, according to estimates by the International Energy Agency (IEA).
That timing is roughly in line with what analysts already believed would happen if OPEC took no action.
If OPEC cut output by up to 700 tb/d, the production glut would disappear as soon as the end of this year, according to IEA estimates. The world’s inventories could then be drawn down and prices could rise.