September 29, 2016
TSG IntelBrief: OPEC Reaches an Unexpected Agreement
• At a meeting of world oil producers in Algeria, OPEC unexpectedly agreed to slightly reduce oil production as of November, overcoming deep disputes between Iran and Saudi Arabia.
• Under the pact, Iran will likely increase its production in order to compensate for years of sanctions on its energy sector, while Saudi Arabia will apparently reduce its output.
• Two years of low oil prices have compelled Gulf oil producers to cut subsidies and salaries, reduce sovereign wealth holdings, and even tap international capital markets.
• The agreement might adversely affect Western consumers, but a failure to raise oil prices could have substantial consequences for the Middle East region.
Following a meeting of the Organization of Petroleum Exporting Countries (OPEC) in Algeria on September 28, the 14-country organization announced that as of November it would reduce its total oil production by over 2%. The OPEC countries also agreed to attempt to reach a broader production restraint agreement with non-OPEC producers, particularly Russia. The stage for the agreement was set by a September 5 meeting in which Russia and Saudi Arabia—OPEC’s largest producer—pledged to form a working group to assess measures to stabilize the global oil market. Exact country production targets are to be set at OPEC’s November 30 meeting, but Saudi Arabia apparently agreed to allow Iran, Libya, and Nigeria to increase their production, and to cut its own production by around 500,000 barrels per day. The urgency to reach an agreement was injected into the talks by the realization that oil production in the U.S.—which has not been involved in the production restraint talks—remains at record levels. Other factors affecting oil prices, such as global demand, are beyond producers’ control and there is no guarantee that the tentative pact would result in a rise in oil prices.
The serious rift between Iran and Saudi Arabia prevented an agreement in similar talks in April and June, and nearly derailed the Algeria negotiations as well. The two powers, who represent the Shi’a and Sunni poles of the Islamic world, respectively, are at odds on several fronts in the region. In Syria and Yemen, in particular, the two are backing warring sides. In Iraq and Lebanon, the two countries also back rival factions in a competition for influence. More broadly, Saudi Arabia highlights aggressive behavior by Iran—such as continuing ballistic missile tests and challenges to U.S. naval vessels in the Gulf—to argue that Iran does not deserve a voice in regional security arrangements. Iran and Saudi Arabia have a common interest in raising world oil prices, but Iran is emerging from five years of crippling economic sanctions and has insisted on being allowed to increase production to pre-sanctions levels. Saudi Arabia, by contrast, sought to freeze total OPEC production without having to cut its own production, in an effort to raise prices closer to the $100+ per barrel seen in 2014. These basic differences on oil issues—as well as their broader regional competition—nearly prevented agreement in Algeria. In addition, Russia’s alliance with Iran in supporting Syrian President Bashar al-Assad reinforced Saudi suspicions that Russia and Iran might not comply with any production restraint agreement, even if one were reached.
Compounding the urgency to reach an agreement was the daunting economic challenges facing Saudi Arabia and its allies in the Gulf Cooperation Council (GCC), which remain highly dependent on oil exports. Saudi Arabia has cut subsidies and government salaries, postponed some major investment projects, and been forced to consider selling equity in its crown jewel asset, Saudi Aramco. Kuwait will run its first budget deficit in 2016 in its 55 year history. For the first time ever, Qatar has borrowed funds on international capital markets. All of the GCC countries have had to sell some of their assets held by sovereign wealth funds, which—in the case of Saudi Arabia and UAE—had balances in 2015 of nearly $700 billion. Unless oil prices rise or it slows its rate of drawdown, Saudi Arabia’s sovereign wealth fund will be exhausted in approximately five years. By contrast, Iran could afford to hold firm in Algeria because it had diversified its economy substantially, partly because of sanctions on its energy sector. Iran has a growing light manufacturing sector, and automobile production is its largest industry aside from energy.
Should the Algeria agreement—if finalized—fail to translate into a rise in oil prices, the consequences for the Middle East region could be substantial. Continued economic difficulties are likely to cause the GCC countries to reduce their aid to those affected by the region’s many conflicts. Since the 2011 fall of President Hosni Mubarak in Egypt, the Gulf states have donated billions of dollars to Egypt to stabilize its cash reserves. The Gulf states, particularly Kuwait, have contributed large amounts of aid for Syria’s millions of refugees and internally displaced persons, and have helped Jordan handle its influx of Syrian refugees. The GCC countries are funding the rebuilding of areas of Iraq liberated from the so-called Islamic State. Qatar has been a large donor to the Hamas-run Gaza Strip, which has been economically depressed by isolation and conflict with Israel. Absent GCC donations, such aid would most likely have to be compensated by the Western countries that benefit from low oil prices.
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