OPEC Iran Discussion A Farce? Deal already in the making

The world again is watching for some white smoke out of the chimneys at the GECF meeting in Doha, as OPEC oil ministers have been talking behind closed doors on reaching a production freeze or cut deal. Even that Iran has not sent the Minister of Oil, as geopolitics are playing a role, and tension between Tehran and Riyadh is still extremely high, a deal seems to be in the making. Reading between the lines of the long list of statements made by the different Arab oil producing countries, supported by Russia, a production freeze is on the table and almost ready to be signed. The Iranians seem already to be heading for a position that they can play to be the winner but still complying to the Saudi instigated OPEC production deal. Iranian officials already have stated that a production freeze could be agreed upon if Iran would be allowed to produce between 4.0 and 4.2 million bpd. Arab countries have always said that Iran should cap output at around 3.6-3.7 million bpd, which is the volume the Islamic Republic is currently producing, according to OPEC estimates.

The overwhelming majority of OPEC has again committed itself openly to an oil output deal at the end of this month in Vienna. It will be a watershed decision if implemented, as it will mean a first deal of this kind since 2008. The last 8 years market forces have been given total freedom to shape the market, after that the US shale revolution shook the market. The last couple of months, a possible change in the OPEC strategy has been hitting a brick wall, as Saudi Arabia and Iran were not able or willing to find a solution to reach a hard needed deal. Iran’s political strategy to block any Saudi proposal by demanding full freedom to reach a post-sanctions production level has increased instability within the oil cartel significantly. Some analysts, especially Western observers, already have been writing long essays about the end of OPEC, writing off the oil cartel as a power broker in the market. Others were expecting that OPEC would be heading towards a stalemate, in which a market share war between Saudi Arabia and Iran could become very bloody. Both future scenarios have not yet materialized. The oil cartel has been hurt, but seems now to be rising again out of the geopolitical-religious fire that has threatened to consume the cartel from within. 

The statements at present in Doha show that OPEC is moving towards a new equilibrium, in which Iran is given the opportunity to increase its overall production volumes to around 4 million bpd, while officially committing to a 32.5 million bpd OPEC production ceiling. The growing flexibility shown by Saudi Arabia, and several of its Arab fellow members, such as UAE, Qatar and Algeria, is not surprising. All OPEC producers want to stabilize the market, to gain an upward momentum in which oil prices will increase to levels that government budgets again on par with oil revenues. At the same time, the Arab countries want to have a say in the future export volumes of OPEC stalwart Iran, and its ally Iraq. Giving these two major oil producers the opportunity to go their own ways could lead not only to a new price war within OPEC but also lead to a clear Arab Sunni-Shia division in which Iran and Iraq could be totally hooking up in all aspects.

The creeping encroachment of the Middle East by Iran, as is currently being shown in Yemen (Iran supporting Houthis), Lebanon (Hezbollah supported president Aoun), Syria (supporting Bashir Assad and Hezbollah) and open military operations of several Iranian brigades in the operations against IS/Daesh, is not taken lightly by the Arab oil and gas producers. Security and oil are in the region interconnected and strategically important. The continuing conflict between Sunni led Arab regimes and Shia-led regimes and non-state actors will have its impact on all current and future deliberations inside OPEC. Some analysts subscribe to the view that the current flexibility shown by Saudi Arabia and others is partly caused by the idea that by keeping the OPEC cartel together, while giving some leeway to Iran and Iraq, could also drive a possible wedge between Baghdad and Tehran in future. Flexibility shown to Iran is however not being given to others, especially not to Iraq. As OPEC and Saudi officials have reiterated, Iraq will have to comply to the normal OPEC freeze proposals, which due to some extra volumes offered to Iran and Nigeria, others will have to cut production in reality.  Iraq will be confronted by a harsher reality. Baghdad always indicated that its official production stands at present at 4.8 million bpd, but OPEC has put this at 4.6 million bpd. A production cut proposal as indicated by OPEC leaders will be linked to the 4.6 million bpd level, so will have Baghdad to take out more than expected.  Baghdad is still trying to get some room from OPEC, indicating that it needs more oil production to counter the costs of the ongoing war with Daesh. At present, the majority of OPEC, especially Saudi Arabia and other GCC countries, don’t feel like this at all.

At the same time, reasonable flexibility towards Iran is being supported by Moscow. OPEC’s open flirt with non-OPEC producer Russia is not only caused by oil market fundamentals but also used as increasing the relationship between Arab producers (GCC) and Moscow, which could lead in the future to a reorientation by Moscow of its long-time Moscow-Iran-Syria axis. 

If Western oil analysts will keep on looking at only the financials of the oil market, mainly the short- or long-positions on the NYMEX, a major lack of intelligence is being displayed. Oil = Politics, and especially in the Middle East, North Africa and Russia. Regional politics have been partly causing the current oil volumes, not only pure technical issues but mainly politics. 

The coming weeks, the oil market could be heading towards a major reshuffle. If OPEC could reach even a tentative but feasible production freeze in Vienna, supported not only by Saudi Arabia, UAE, Algeria or Nigeria, but also Russia, the Iran-Iraq positions could be not of the utter importance anymore. An OPEC-Russia agreement would be a watershed, bringing enough stability in the market to cope with the still struggling Iranian Iraqi volume increases.

At the same time, an oil production shortage is looming. International agencies (IEA, EIA), but also several oil consultancies have been warning since long that current investment spending in the upstream will lead to a disastrous situation the coming years. The flexibility in production, especially in putting new volumes on the market, is highly overestimated. The optimism of most Western financial analysts about the flexibility of new production coming onstream is unreal. Yes, flexibility of shale oil in the US is exceptional and will react to even minor positive price adjustments. Still, these additional volumes will NOT be able to counter growing world demand for crude oil or be enough to even possible decreases in existing production. Future Iranian production is also again in doubt, as the coming US Administration already has stated that they will assess the options to block the lifting of sanctions on Iran, as agreed in the JCPOA. In a move to support a possible president Trump strategy to block Iran fully, the US House of Representatives has overwhelmingly passed a 10-Year extension of the American sanctions on Iran. The US Senate is now going to do the same, analysts expect.  With the sanctions, lawmakers would signal to President-elect Donald Trump that whatever his foreign policy, they intend to take a hard line against Tehran.  During his election campaign Trump has always criticized the Iran nuclear deal. Even that it will be hard to renegotiate the UN brokered deal, US sanctions will for sure hamper investments and operations in Iran to all companies and banks, with a listing or link to the US. The latter also is linked to developments in Iraq, as the US Senate and House is very wary of Iran’s leverage in Iraq and the other conflict areas.

To counter future growth in demand a high investment volume is needed. At present, based on current investment plans, the opposite is reality. Between 2015-2020 overall E&P investments will $740 billion lower than was expected in 2014. If prices are not going to increase substantially, it is expected that an additional $300 billion will be cut from new exploration, aka investments in new to be developed fields needed to counter ongoing decline in production fields and increased future demand. These investment cuts or project deferments will ultimately result in lower overall production. Keeping in mind that conventional oil and gas projects, from discovery to production, normally take 4-8 years to come onstream, the market is going to face very soon shortages. Some analysis even shows that current production could be decreased in the year(s) by 5 million bpd or more. WoodMackenzie even expected already shortages in 2016. The IEA, the energy watchdog of the OECD in Paris, also supports the general threat scenarios. Current investment levels, in combination with continuing low prices, will lead before 2020 to shortages. These scenarios are already taking into account an exponential growth of alternative energy supply, such as solar and wind. In even the most optimistic scenarios, overall demand for crude oil (and gas) will still grow. 

OPEC will be watched with intense scrutiny the coming weeks. The future of the cartel is still very rosy, but power players are looking for an end-game scenario. At present, a possible Battle of the Camel for OPEC main producers is looming, hopefully not with the same result. If parties can come together, a growing amount of signs is showing it, oil markets will stabilize and prices will jump. The coming years, prices will even go much higher, as whatever OPEC will decide, shortages are going to happen. The coming decade is not going to be “Peak Oil” as we know it, but a period of “Peak Oil 2.0” due to lack of investments.   Shortages and supply constraints will push up prices again above US$100 per barrel or even much higher. 

No solar, wind or TESLA that can prevent this, JR Ewing’s dream is not over yet, looking for a long and brighter future than most green party ideologists or alternative energy investors have been presenting in the media.