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Ready to deal, Saudi Arabia waits on Iran

The kingdom is ready to ditch its laissez-fair market strategy and cut production. Iran needs to come on board, but an agreement is close

The guts of an Opec deal to remove up to 1m barrels a day of oil from the market are in place. It may take several weeks for the terms to be ironed out but Saudi Arabia has signalled that the period of Opec passivity is over.

Russia is on board with the deal and its energy minister Alexander Novak says it will freeze its output, “once Opec agrees”. Iran remains the final obstacle and is sticking to its wish to recover pre-sanctions production levels. But it is understood to be flexible and the mood within Opec is upbeat. Secretary-general Mohammed Barkindo is said to be “cautiously optimistic”. Khalid al-Falih, the Saudi oil minister, says the agreement “will give clarity to the market”.

The timing is not yet clear. In a closed briefing in Algiers on 27 September, Falih and Novak – who sat shoulder-to-shoulder – suggested it would be agreed by the Opec meeting on 30 November. It could come much sooner.

Although Falih said there “won’t be an agreement tomorrow”, meaning at another Opec meeting in Algiers on 28 September, several sources suggested this remained possible. Novak, who briefed the gathering alongside Falih in a show of unity, said Russia was waiting for Opec to agree, but Russia “will help make a swifter rebalancing of the oil market”. Senior Russian officials later told Petroleum Economist this was “open to interpretation” but Russia “will not put additional oil on the market in the short term”.

The significance of events in Algiers for oil cannot be underestimated. After almost two years of letting the market drift, Saudi Arabia is ready to ditch the policy. Domestic pressures – including a slumping stock market, the urge for higher oil prices ahead of an Aramco IPO, cuts to state salaries – are all in the background. The kingdom is also increasingly worried that the collapse in upstream investment risks damaging price spikes in the coming years.

Falih says the deal will involve “gentle adjustments and reassurances to the market” but added: “it will be called a freeze but involve individual cuts”.

It is understood that the terms of the deal are the following: Saudi Arabia and other Opec members, excluding Iran, Libya and Nigeria, would reduce production back to levels earlier in the year. January 2016 is the month that has been mentioned most. The three countries under special measures would be allowed to produce at “maximum levels that make sense”, says Falih.

In other words, the deal in its essence is the one that had been agreed in Doha in April, before being rejected at the last minute by Saudi deputy crown prince Mohammed bin Salman.

But those are hazy terms and the market, sceptical of Opec promises, will need much more detail. The month chosen for a baseline will be critical. January 2016 would bring a big cut from Saudi Arabia, but actually allow Iraq and Venezuela, on paper at least, to produce more compared with August. A different formula may be necessary.

Thus, excluding Libya, Iran, Nigeria (and Gabon), if the rest of the group returned to January production levels the combined cuts would amount to just 334,000 b/d. In that context, the “maximum that makes sense” from Libya, Nigeria and of course Iran is a fraught notion. Libya hopes to add up to 0.5m b/d more oil this year alone. Nigeria, the same. Either of them could more than wipe out the cuts made by others.

Iran’s ambitions remain the biggest problem. Its maximalist negotiating position has been that it wants to regain the 12.7% of Opec’s market share that it held in November 2011, before sanctions were imposed. At current Opec production, this would imply 4.173m b/d, it says.

Those are unacceptable terms for Saudi Arabia, because the kingdom would be left, as usual, shouldering the bulk of the cuts while its geopolitical rival gets a pass. So Iran will need to rein in its production target too. Word among several Opec watchers is that a plausible compromise could see Iran postpone the longer-term target and accept a freeze around 3.6m-3.8m b/d, while a formula be found that restores Saudi output to 10.2m b/d, implying a cut of 400,000-500,000 b/d, and involves others trimming output too, for a total of 0.8m b/d. Against August’s group-wide production of 33.237m b/d, this would imply production of around 32.5m b/d.

None of those numbers has yet been finalised. But the political will in Saudi Arabia is now clear – it wants a deal. This is the main difference from Doha in April. Having put aside its anger at the Doha debacle, Russia remains on board. Persistent weakness in the oil price – Brent fell by 3% on 27 September while Opec members were in Algiers, to under $46 a barrel – is adding pressure.

The joint briefing from Saudi Arabia’s and Russia’s oil ministers was designed to convey unity and isolate Iran, which will now be blamed if a deal is not secured. Expect negotiations to continue over the coming weeks, but unless relations now deteriorate again a deal is coming. The meeting in Algeria confirms that Opec and its kingpin are fed up with the oil price and ready at last to intervene.

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