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How an Opec deal could work

Iran’s demands can be accommodated with some adjustments of the numbers

Getting Opec’s fractious members to agree on cuts has always been difficult: herding cats is easier. But the geopolitical rivalry between Saudi Arabia and Iran, enemies in proxy conflicts from Yemen to Syria, makes the negotiations underway now even harder.

Iran is under less pressure than Saudi Arabia. The kingdom’s economy is suffering, while its rival enjoys a post-sanctions recovery. One equation sums up their different stances in negotiations about whether to cut output to support prices. Say Saudi Arabia slashes 0.5m barrels a day from its output – the idea it has floated – to 10.1m b/d, and gains a $5-a-barrel lift in the oil price, from $46 to $51/b. Its daily income rises by about $30m, or $11bn a year. It makes sense.

Say Iran succeeds in lifting its output from 3.6m b/d to 4.1m b/d – its stated target – softening oil prices from $46 to $41/b in the process. Its income rises by about $2.5m a day, or almost $1bn a year. It also wins a political victory, fulfilling its pledge to restore production to pre-sanctions levels and regain much of the market share it lost to its Gulf Arab rivals. It also makes sense.

Oil accounts for almost all of the Saudi budget. But it makes up less than half of Iran’s and has a far smaller share in the country’s more diverse economy – oil rents account for 23.6% of Iran’s economy, says the World Bank, but 38.7% of Saudi Arabia’s. The oil-price stakes are higher for Riyadh.

Saudi Arabia has conceded that Iran will be a special case in the forthcoming supply deal. That’s already a political concession, though the details have yet to be worked out. Iran, though, has not yet abandoned its maximalist negotiating position: it wants to recover the 12.7% of Opec market share it held before sanctions were put in place.

Based on August’s output of 33.237m b/d, that would entitle Iran to produce 4.173m b/d, or growth in production of another 0.52m b/d. In short, Iran’s terms mean it would add to its output more than Saudi Arabia has offered to cut. Clearly, it’s a deal-breaker for Riyadh.

But there’s a way out of this impasse that gives both sides a victory. It depends on some trickery with the numbers.

Iran’s 12.7% claim is based on its output from November 2011 (3.55m b/d) against group output then of 27.97m b/d. But that second number excluded Iraq, then still recovering from years of war and sanctions. Including Iraq, Iran’s November 2011 of Opec output share was 11.6%.

Apply that 11.6% to August 2016’s group-wide production from Opec (including Iraq) and Iran would be entitled to 3.85m b/d, or growth of another 200,000 b/d.

Alternatively, Saudi Arabia might recognise Iran’s 12.7% demand, but insist it follows the same methodology used by Iran for its November 2011 number. That is, exclude Iraq from the August 2016 total. This would entitle Iran to 3.67m b/d.

That is within a whisker or two of Iran’s actual output number in August of 3.65m b/d – or the equivalent of an extra VLCC every three months or so.

In other words, the two sides aren’t that far apart on oil demands, though the geopolitics shroud the negotiations. Saudi Arabia could concede Iran’s right to reclaim its old market share, but insist it is measuring like for like in terms of group-wide output. Bijan Namdar Zangeneh, Iran’s oil minister, while maintaining a hard line in negotiations, has apparently said in private that he won’t miss a deal “for the sake of 200,000 b/d”.

It would, though, involve Iran conceding its urge to reach 4m b/d. The way to secure that is to put a time stamp on any Opec-wide deal, saying the cuts – and Iran’s limit – would last for a year, or until market conditions approve.

Khalid al-Falih, Saudi oil minister, and his counterpart Alexander Novak both said in a briefing on 27 September that the market was rebalancing anyway. So if they believe that, why not offer Iran a term limit on its production freeze? Sure, they might say, get your 11.6% now, but hold the 4m b/d target until the market can absorb the extra oil in late 2017.

Assuming Iran could be persuaded to accept these terms – a victory in its market-share quest – Saudi Arabia’s offer to cut 0.5m b/d could then be matched by an equivalent 5% cut from other Gulf members. In total, this would strip more than 0.8m b/d from supply.

Alongside Russia’s freeze – conditional on an Opec agreement – and similar pledges from other Opec members, a deal on these terms begins to look plausible. It would also look significant for the market. Crucially, both sides would win something. Saudi Arabia could claim it had restored some Opec unity, stopped the surge in production from Iran, and cajoled Russia into a deal. Iran would be able to claim victory in having its market-share needs respected, while leaving the longer-term goal of 4m b/d in place for later.

Libya and Nigeria would be wildcards, capable between them of adding enough to supply to wipe out the cuts elsewhere in the group. But that is unavoidable. For now, a deal satisfactory to all parties is within Opec’s grasp.

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