Opec divided: Iran's risky battle with Saudi Arabia
Opec’s Gulf states hold the aces – spare oil-production capacity – in a high-risk, high-profile spat between its members. Derek Brower reports from Vienna
AN INTERNAL conflict that has simmered for years is now in plain view. Iran, holding Opec’s rotating presidency, used its temporary institutional clout to humiliate Saudi Arabia, the group’s most important member and true leader. Describing Iran’s strategy as a risk doesn’t do justice to it; it has started a battle that it cannot win.
Don’t underestimate the fallout from yesterday’s meeting in Vienna, which Saudi oil minister Ali Naimi, a paragon of fine manners and restraint, said was the “worst ever”. No wonder Abdalla El-Badri, Opec’s secretary general and a sublime diplomat, looked uncharacteristically peeved when he was left to explain in public why the meeting had descended into internecine conflict.
He blamed differences in the data. No doubt they exist. Opec’s own forecasts for demand predict a 2 million barrels a day (b/d) jump in the call on its crude during the third quarter of the year. The logical response, unless Opec wishes for another oil-price spike and damaging bout of demand destruction, was to release more crude. That’s what Naimi sought, demanding the group agree to increase output by 1.5 million b/d to 30.3 million b/d.
Such a surge in demand assumes continued economic recovery in the rich west and yet more rapid consumption growth in Asia. Neither is out of the question. BP’s annual statistical review, released yesterday, showed that total global energy consumption last year grew by almost 6% – its highest rate since the early 1970s (see Figure 1).
Yet to pretend this will continue while the oil price keeps surging is risky. In euros, a barrel of oil has already this year breached its all-time high. Only the dollar’s weakness has kept this reality from the front pages of newspapers.
Seeds of destruction
Saudi Arabia knows that, as the International Energy Agency (IEA) put it recently, persistently high prices now will “ultimately sow the seeds of their own destruction”. Letting an inflated oil market force consumer economies away from pricey oil isn’t in producers’ interests.
With the world’s largest endowment of oil, Saudi Arabia doesn’t wish to see its clients develop other energy sources. As Prince Alwaleed bin Talal, the king’s nephew, said last month: “we don’t want the West to go and find alternatives”. Oil prices of $70-80 a barrel would fend off conservation and alternative-energy drives, he suggested.
That’s clever. It also ignores China and the other fast-growing economies of Asia. For all the dynamism in those markets, the rich countries of the West still consume the bulk of the world’s oil (see Figure 2). A long-term strategic shift away from oil in the OECD could also yield a similar strategy in China.
A $40-50/b unwinding of Brent oil prices, however, would look like a short-term disaster to Saudi Arabia’s rivals in Opec. The group of hawks that faced down Naimi in Vienna yesterday – Iran, Algeria, Angola, Venezuela, Ecuador and Libya – have a desperately different outlook on the market. Algeria is said to have raised as much opposition yesterday as Iran and, without any data of its own, questioned Opec's bullish forecast for the third quarter.
For these countries, signs of demand erosion mean Opec should constrain output, for fear of triggering a collapse in oil prices. Such a strategy is also loaded with risk, because if the intransigence they showed yesterday helps sustain strong oil prices or, worse, underpins a new price spike, demand will come under even more pressure.
It also ignores an oil-demand fundamental: when it’s gone, it’s usually gone for good. Consumer governments don’t tend to relax conservation measures when the crude price drops. And car drivers who buy a hybrid during an oil bull run don’t trade it in for an SUV when the market turns. Americans are driving fewer miles because of soaring fuel prices. Britons are also buying less gasoline and diesel.
Meanwhile, global oil and fuel prices are back where they were in 2008 – but does anyone think the US, EU, or global economy are as healthy as they were three years ago?
They fear the worst, and they may still get it
The legacy of the Jakarta Opec meeting in 1997 hangs like a spectre over Opec’s price hawks. Back then, seeing signs of a jump in consumption from China – ring any bells? – the group agreed to lift production quotas by 10%. Oil prices, then around $20/b, plummeted, losing almost half of their value. The collapse of 2008 is an even more recent bad memory.
With those disasters in mind, the hawks also know that they have most to lose from another price drop now – even one that takes crude to Saudi Arabia’s preferred price range. Thanks to a combination of mismanagement and generous social-welfare programmes in their petro-dependent economies, their budgets all rely on an oil price that a decade ago was unimaginable (see Table 1).
The legacy of the Jakarta Opec meeting in 1997 hangs like a spectre over Opec’s price hawks
Deficiencies in the upstream of some of these countries, however, also mean that their clout as producers within Opec has diminished. Between them, the hawks can muster less than 500,000 b/d of spare production capacity, according to the IEA. Many analysts are sceptical about even that number, saying Iranian and Venezuelan capacity – which the IEA puts 200,000 b/d – is far less.
By comparison, Saudi Arabia alone has 3.2 million b/d of spare capacity and the other Mideast Gulf countries that supported Naimi in calling for an extra slug of oil production – Kuwait, the UAE and Qatar – hold about a combined 410,000 b/d. Saudi Arabia will shoulder the vast bulk of the 1.5 million b/d rise in output now, but it will be supported with as much as 300,000 b/d from elsewhere in the Gulf, sources said.
Short-term self preservation
So for the hawks, refusing a rise in output yesterday was as much about their inability to pump more oil as it was about a strategic view of the market. More Opec oil means greater market share for the Gulf countries – a galling prospect especially for Iran, whose own upstream remains stunted by sanctions and chronic underinvestment. The hawks' capacity deficiencies will soon be brutally obvious to the market.
The tail is not going to wag Opec’s dog. Humiliating Naimi yesterday was a useless strategy that would succeed only if Saudi Arabia put Opec’s unity ahead of its own strategic view of the oil market. It didn’t work. Naimi left the meeting in anger and Saudi Arabia, alongside its Gulf neighbours, will pump more oil. Naimi was adamant about that.
It leaves the increasingly defunct production-quota system in tatters; sours relations between group president Iran and lynchpin Saudi Arabia; and demolishes notions that, in the face of turmoil in the Middle East and North Africa, Opec would mount a united front and provide guidance to a jittery oil market.
Opec’s next scheduled meeting is in December, although Iran’s acting oil minister, Mohammed Aliabadi, suggested there may be an extraordinary gathering three months from now. Saudi Arabia’s output surge may have changed the market by then. The kingdom’s oil minister looked yesterday like he was in a mood to teach Iran a lesson. It could make for a turbulent few months.