Opec deal: How Riyadh and Tehran poured oil on troubled waters

Posted on September 30, 2016

Saudi Arabia and Iran are sworn enemies on opposite sides of proxy wars tearing through the Middle East.

But at a marble-halled 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.

It was the prelude to an agreement five hours later that should result in the 14-member bloc cutting production for the first time since 2008.

Iran’s oil minister, Bijan Zanganeh, called it “a very good day for Opec” as his Saudi counterpart, Khalid al Falih, headed straight for a waiting car.

The pact wrongfooted oil traders. It also signalled 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.”

The deal was preceded by months of shuttle diplomacy by Opec members Qatar, Venezuela and Algeria — together with Russia. But what ultimately brought the two sides together, say analysts, was a two-year price slump that has placed particular strain on Saudi Arabia and its finances.

“The move marks a major turnround for Saudi Arabia,” said Helima Croft at RBC Capital Markets. “[It] reflects the mounting economic challenges facing the Kingdom.”

The price slide began in late 2014 as the US shale oil revolution soaked the world market. Riyadh responded by opening the taps to try to squeeze out the higher-cost upstarts, convinced they had the financial firepower to weather lower prices. But the price has fallen further — and for longer — than many in Riyadh ever imagined.


Khalid Al-Falih, Saudi Arabia’s minister of energy and industry, center, speaks to journalists ahead of the Opec meeting in Vienna © Bloomberg

Making matters worse was Iran’s return in January from years of western sanctions against its oil industry, and its determination to make up for lost sales by boosting production and regaining market share.

Opec was strained, with many members frustrated at the Saudi-led policy. In June, shortly after his appointment, Mr Falih set about repairing relations with those who had been alienated by his dogmatic predecessor, Ali al Naimi, who often talked down to members he believed wanted a free ride from the kingdom.

Ministers emerged from Opec’s June meeting with a rare show of unity. Even price hawk Venezuela smiled broadly for the cameras, despite the cartel making no effort to rein in production.

High-level diplomatic moves were also under way. At the G20 summit in China in early September Saudi Arabia’s influential deputy crown price Mohammed bin Salman met with Russia’s President Vladimir Putin. The countries’ oil ministers announced they had a pact to work together.

But as this week’s meeting in Algiers neared, both Saudi Arabia and Iran played down the likelihood of a deal. Their delegations were the last to arrive in Algiers, leaving little time for a rapprochement.

Iranian delegates quietly mocked the Saudis, arguing that — unlike sanction-toughened Iran — they had little experience of austerity. Saudi Arabia’s foreign reserves have dropped by almost a quarter in two years.

On the eve of the meeting Mr Falih told a joint press conference with Alexander Novak of Russia — the largest exporter outside Opec — that an agreement was unlikely.

But Mr Falih did offer a tantalising hint: Price again mattered to Saudi Arabia, he told the audience, a stark turnround from his predecessor Mr Naimi.

He had flown to Algiers straight from a cabinet decision in Riyadh where public sector salaries — including his own — were cut by 20 per cent due to the impact of $40 oil. Almost two-thirds of Saudis work for the state.

“There is a lot going on domestically in Saudi Arabia and a price less than $50-60 a barrel was not desirable,” one Gulf Opec delegate observed. “All producers are hurting from this price.”

As the meeting started on Thursday Iranian delegates acknowledged there had been dialogue with the Saudis since May, including meetings at the Opec secretariat in Vienna last week.

The stumbling block was Iran’s determination to rev up production. Tehran had set a target output of 4m barrels a day — roughly the level it pumped before oil sanctions were imposed in 2012 — and above the country’s current level of around 3.6m b/d.

Far from softening, Iranian delegates upped their demands in Algiers, seeking an output target of 4.2m b/d, a level few believe they are even capable of producing.

The hardball tactics paid off. Before the meeting Mr Falih first said that Iran’s history of sanctions meant it should “produce at the maximum levels that make sense”, alongside violence-hit members Nigeria and Libya.

The Iranians believe they have secured a target of 3.9m-4m b/d. Meanwhile, Saudi won a commitment from other members to pursue cuts, even though some are bristling.

“These countries need to understand there is a greater reward for them to freeze at these levels,” said one Opec source. “It is all about the distribution of the misery.”

The hope in Riyadh is that the group’s production can be dialled back towards 32.5m b/d from around 33.2m b/d in August — enough, they believe, to start draining oil inventories next year.

Saudi Arabia could end up shouldering a larger proportion of cuts than initially proposed, analysts believe. But that was the cost of bringing Iran on side and sending an unmistakable message.

“We believe the meeting represents a ‘read my lips’ moment,” said Standard Chartered analyst Paul Horsnell. “The statement of intent being put forward is effectively: ‘Prices are too low … Read our lips, prices will rise’.”

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