OPEC Deal: Riyadh and Tehran Reached a Pact on Reducing Crude Oil Production

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Khalid Al-Falih, Saudi Arabia’s minister of energy and industry, center, speaks to journalists ahead of the OPEC meeting in Vienna
Source: Bloomberg
By Sophie Nguebana

As producing countries gathered in Algiers for talks on September 28, Riyadh and Tehran unexpectedly reached a pact on modestly reducing crude oil production. The exact numbers will be determined on November 30, but the September deal is still significant. It is the first time that the cartel members agreed on reducing their oil outputs since the 2008 crisis. The goal is to drop crude oil production to 32.5 million bbl/d (which has reached 33.47 million bbl/d in August). Should the parties fail in reaching an agreement on November 30, it will be a disaster according to some OPEC sources.

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Figure 1: Oil production by OPEC, Saudi Arabia and Iran
Source: BP

For two years, crude oil prices have been tumbling. In June 2014, the crude oil Brent price was US $110 per barrel and fell to $30 per barrel at the beginning of 2016. Currently, the Brent price is just under $50 per barrel. Apart from the US shale revolution, another significant reason for the oil price drop is the recovery of Iran. As the sanctions on Iran were lifted, it set a target output of 4 million bbl/d – roughly the level it pumped before oil sanctions were imposed in 2012 – and above the country’s current level of around $3.6 million bbl/d. Moreover, the recovery of Libya and Nigeria has also played an important role in the oil price drop. Since Libya has reopened its oil terminals it produces today more than 0.4 million bbl/d. Nigeria produced 1.92 million bbl/d in 2015.
The spark that has led to the immediate turnaround was Saudi Arabia’s gargantuan financial crisis. If the price decreases continue, Riyadh will suffer a fiscal deficit equal to 13.5% of GDP this year. Indeed, almost two-thirds of Saudi revenues are based on oil. The IMF reports that in order for Saudi Arabia to recover, an increase in the per barrel price to $67 per barrel will be necessary. “There is a lot going on domestically in Saudi Arabia and a price less than $50-60 a barrel was not desirable,” one Gulf OPEC delegate observed.

The agreement to reduce crude oil production is a short-term positive for oil markets. However, reductions in OPEC production probably won’t be fully in place until 2017 analysts say. The freeze agreement will only be really effective if non OPEC members will also agree on reducing their oil production i.e. Russia. However, according to some Russian sources, it is unlikely to happen in the short run. Eventually, OPEC members should truly respect their cuts otherwise this agreement will not result in any significant reduction of supplies and that is to say no change in oil prices.

David Sheppard and Anjli Raval, 2016 Opec deal: How Riyadh and Tehran poured oil on troubled waters. Financial Times. 30 September, 2016. https://www.ft.com/content/1ee0aeb2-870d-11e6-bbbe-2a4dcea95797

 

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