The Iranian endorsement of a plan by its arch regional rival, Saudi Arabia, to stabilize global oil prices could be seen as a diplomatic coup for Riyadh.
However, Tehran’s support for a production freeze has not been driven by a new desire for political rapprochement as much as acceptance of a greater enemy: collapsed commodity prices. The markets are flooded in crude at a time when demand is faltering due to a slowdown in expected growth from key importers such as China. Desperate times require desperate measures.
Iran and Saudi Arabia are rival oil producers, but also bitter adversaries in regional politics. Short of a shooting war, tensions could hardly get any worse at this particular moment.
Illustration: Mountain people
The Saudis severed diplomatic relations with Iran last month following a mob attack on their embassy in Tehran — a protest at the execution of a leading Shiite cleric, Nimr al-Nimr, in Saudi Arabia’s eastern province.
The two nations stand on opposite sides in the wars in Syria and Yemen — their strategic competition is interlaced with vicious sectarian hostility — adding a proxy element to an already toxic mix.
Despite this unpromising geopolitical backdrop, last week there were positive moves toward an oil production deal. The price of Brent blend crude soared 7.5 percent on Wednesday last week after Iranian Oil Minister Bijan Zanganeh came out of a two-hour meeting with some of his OPEC counterparts to approve a deal hatched by Saudi with non-OPEC member Russia the day before.
“Iran backs any measures which help stabilize the market and improve the price of crude oil,” Zanganeh said, although, crucially, he gave no indication as to whether Iran would curtail its own production.
Iran, which has the fourth-biggest oil reserves in the world, had previously trumpeted its desire to vastly expand its output following the lifting last month of Western sanctions imposed over its nuclear program.
It still remains unclear exactly what is to happen now: The Saudis and Russians said they would hold their output at the same levels as last month, but only if other key players — including Iran — joined in.
Deals of this kind were brokered by Saudi Arabia in the 1980s only to see Russia and others renege on their commitments, forcing Riyadh to cut its output from 10 million barrels per day (bpd) to 2.5 million with little impact on prices.
Last week, the price of Brent blend continued to rise toward US$36 per barrel following Iran’s statement, although it fell back on Friday in the face of new US data showing stockpiles of oil were bigger than ever. This is still well ahead of the sub-US$28 price seen last month, but a long way off the US$115 highs in June 2014.
Oil traders and investors see last week’s developments as an increasingly hopeful sign that producers have reached their pain threshold and are to do what it takes to try to force prices upward again.
However, the wider political and religious rivalry between Saudi Arabia and Iran is unlikely to go away any time soon. Saudi control of Mecca and the hajj pilgrimage gives it legitimacy in the Sunni Muslim world, while Iran is a beacon for Shiites everywhere. Arabs and Persians have long memories of prejudice, though in modern times their animosity began with the 1979 revolution and grew after the Iraq War in 2003.
More recently, Iran has deployed its own Revolutionary Guards and Lebanon’s Hezbollah, as well as Shiite militiamen from Iraq, Afghanistan and Pakistan, to help keep Syrian President Bashar al-Assad in power in Damascus, while the Saudis see Tehran’s covert hand behind the Houthi rebels it is bombing in impoverished Yemen.
Tehran routinely lambasts Riyadh as a US stooge and a sponsor or incubator of fanatical terror.
However, it was last year’s Iranian nuclear deal that really set nerves jangling in Riyadh, fueling fears that the decades-long US-Saudi bargain of oil for security was ending as US President Barack Obama leaned toward Tehran.
Meanwhile, the Saudi strategy over the past 18 months to pump in excess of 10 million bpd and discount its crude prices on key markets has backfired.
The kingdom, OPEC’s biggest oil exporter, is said to need US$100 per barrel of oil to cover its enormous public spending commitments. The IMF recently said that Riyadh would burn through all its financial reserves within five years under a US$50 oil price unless it took steps to raise taxes or cut spending, which it has since started to do.
In recent months the Saudis have introduced tax increases, removed fuel subsidies and even suggested they are willing to privatize at least part of its state oil company, Saudi Aramco, in clear signals of their need for cash.
So far, the OPEC powerbroker has refused to return to its traditional role of market balancer by organizing a cartel cutback in production, but the proposed deal with Russia last week shows it is keen to try to break the impasse.
Iran wants better prices to help power its post-sanctions economy out of recession. As recently as 2011. it was producing 3.6 million barrels per day, but is now down to 2.8 million, while exports are down to 1.1 million, half the level seen before sanctions. It has also promised more, rather than less, output. Following the historic sanctions-lifting deal with the US on Jan. 16, Tehran said it would pump an extra half-million barrels as soon as possible.
There is no doubting the scale of the oil price problem for producers, which started 18 months ago when traders woke up to the dual realization that US shale production was going to continue rising and that OPEC was no longer willing to reduce its output.
The standoff was interpreted as an unspoken determination by Saudi and other oil cartel members to keep on pumping in an attempt to drive higher-cost US drillers out of business.
The strategy is certainly working — but much too slowly to avoid enormous problems building up inside the Saudi economy and in other countries almost completely dependent on oil revenues.
US shale production is now almost 500,000bpd lower than in April last year, according to the US Department of Energy, and is forecast to fall another 500,000 this year.
US production had been growing at 15 percent per annum when crude prices were racing along at over US$100 per barrel, but that growth has now stalled, despite attempts by US producers to keep going by cutting costs.
Latest figures from industry specialist Baker Hughes show there are now about 540 US rigs operating — 800 fewer than a year ago — while bankruptcies have risen to above numbers seen at the height of the 2008-2009 banking crisis.
The shale drillers need oil prices of US$70 a barrel to really thrive, Oppenheimer & Co analyst Fadel Ghei said, compared with about US$50 for the UK North Sea and less than US$6 for the likes of Saudi Arabia.
The big question now is will a production freeze take hold — and, if it does, will it not just provide a fillip for the shale drillers? Traders are nervous, but hopeful.
Investec Asset Management head of commodities Tom Nelson believes oil prices might reach US$60 a barrel by the end of this year.
However, opinion is polarized. Paul Stevens, an energy expert at Chatham House, insists of the latest Saudi deal that “nothing will come of it” and predicts Brent could be anywhere between US$25 and US$50 by the end of this year.
“The huge ‘fracklog’ of US shale wells that have already drilled, but not completed, and which can quickly be brought back into operation as prices rise mean there is a ceiling of around US$55 on prices for some time to come,” he said.
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