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The Viability of Production Agreements – Shaky Frameworks and External Actors

The collapse in oil price has highlighted vulnerabilities within OPEC and ongoing talks have done little to address these inherent problems. Compounded by geopolitical tensions, other actors have sought to mediate a solution to supply concerns.

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There’s a Wall Street saying, “The main thing about money is that it makes you do things you don’t want to do.” The rapprochement between Tehran and Riyadh is a perfect example of this.

In a bid to counter the calamitous price fall in the market – in 18 months oil has lost more than 70% of its value –  Saudi Arabia agreed a plan with Russia to freeze production levels. Don’t break open the champagne just yet. There’s a condition – the involvement of other key players…..including Iran.

You’re right in thinking that relations between Saudi Arabia and Iran have been less than cordial recently. The beheading of a leading Shia cleric in Tehran in the first weekend of the New Year led to a mob attack on the Saudi embassy in Tehran. The Kingdom severed diplomatic relations as a result and the international community watched with bated breath, as prospects for the Middle East’s long-term stability seemed doomed. A sobering constant among the flashes of fury have been the wars in Syria and Yemen on which Iran and Saudi Arabia stand very much opposed.

But then this on Wednesday: ‘Iran backs any measures which help stabilise the market and improve the price of crude oil,’said Bijan Zanganeh the Iranian Oil Minister after a two hour meeting with some of his OPEC colleagues. The day before the legwork had been done with Russia. There was just one thing missing – an agreement to implement. Zanganeh had previously ruled out any deal to curb production before output was at pre-sanction levels.

Any commitment from Iran is not guaranteed. Fresh from the success at the negotiation table and President Hassan Rouhani’s ‘glorious victory’, Tehran wants to see a return to production levels of 6.6m bpd. It has already unveiled a set of new lucrative contracts worth tens of billions of dollars to attract international investment. However it no more wants a saturated and low price market than it wants to go back into political isolation.

There’s good reason for the Saudis to be cautious and insist on partners to the agreement. Previously in the 80s there were similar deals struck with Russia and others – but only the Saudis cut production, from 10m bpd to 2.5m. And that had little impact on prices. The last global deal involved Mexico, Russia and Norway. They agreed to contribute to a production cut – then Mexico reneged and increased exports instead.

While it is cheap as chips to produce oil in Saudi Arabia, The Guardian says, “The kingdom is said to need $100pb for oil to cover its enormous public spending commitments.” The IMF warned that in a world of $50pb Saudi Arabia will have used up every last cent in five years unless it makes big changes. There is talk of a radical austerity programme and percentages seem to back this up – gasoline went up by 40%. That meant $0.24c. The global average is $0.96c, In the UK it’s $1.47.  Saudis have known for a year and a half that prices couldn’t recover in a flooded market and yet along with Russia, continued to pump near record levels.

That we have now reached the stage where Russia and Saudi Arabia have agreed, at Venezuela’s urging, to the principle of a deal cannot be underestimated. In December the members were barely talking to each other. This is a fundamental problem. Yasser Elguindi of Medley Global Advisors told The National, “You cannot have a deal with non-OPEC, until you achieve a credible OPEC framework which at the moment is not possible because of Iraq and Iran. Until there can be some framework between Iran, Saudi and Iraq, all this non-OPEC talk is just noise.”

Insiders say they are sceptical about the prospects of a workable deal, and warn Russia cannot be trusted. But no-one is saying a deal doesn’t need to be done. An Iranian source told Reuters, “Iran is returning to the market and needs to be given a special chance but it also needs to make some calculations.” Watch this space for special terms and small print.

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