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6 October 2016, Gateway House

Saudi Arabia feels Iran’s pinch

OPEC’s announcement of a cut in oil production shows that Saudi Arabia is being affected by low oil prices even as Iran gains ground

Fellow, Energy & Environment Studies Programme

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The outcome of the latest meeting of the Organisation of Petroleum Exporting Countries (OPEC) highlights Saudi Arabia’s weakening position even as Iran gains influence. Any significant impact on oil prices is unlikely, so oil importing countries such as India needn’t worry just yet.

In its latest ‘extraordinary’ meeting at Algiers, OPEC agreed to a ‘production target’ of 32.5-33 million barrels per day (bpd) of oil, compared to the current production of 33.24 million bpd. This is the first time since 2008 that the cartel has agreed on production cuts.

Will oil prices go up?

Following the announcement, oil prices hit a three-month high of $50 a barrel on Monday, 3 October. This uptick does not indicate any fundamental reset of oil market dynamics: this is the fourth time in 2016 that the oil price has crossed the $50 mark. This is therefore random market noise, nothing out of the ordinary. In its oil market report of September 13, the International Energy Agency said that it expected world oil supply to outpace demand till mid-2017.

India needs to use this window of low oil prices to acquire oil reserves cheaply just as it has done with Russia. Indian government-owned oil companies have picked up a 49.9% stake in Vankorneft, a major Russian oil field. They have thus acquired production of 13.87 million tonnes of oil per annum (7.5% of India’s oil consumption) for $4.23 billion – a fraction of what similar assets would have cost some years ago. More such acquisitions will help India if and when oil prices go up.

In addition, India should also tie up natural gas supplies, available cheaply now, with suppliers such as Iran and Mozambique. Diversifying away from oil will reduce the impact of future price shocks.

New Saudi-Iran dynamic

Saudi Arabia has been the unchallenged leader of OPEC for almost three decades now, but the outcome of the latest meeting shows that this is no longer so.

The oil production cap is being touted as an ‘agreement’ between Saudi Arabia and Iran, rival states that don’t see eye to eye over Syria or much else. The issue of oil production cuts has had Saudi Arabia  insist so far that any production cap by the group should apply to all OPEC members while Iran’s view is that it should be allowed to match at least its pre-2011 sanction oil output: that is, there should be no cuts for Iran.

News reports indicate that Iran will be exempt from the latest production ‘cut’. Also on Monday, the managing director of the National Iranian Oil Company said that it had been able to reach a production of 4 million bpd of oil, and should eventually reach 5.2-5.7 million bpd. Clearly, Iran is not thinking of a production cut or even a cap at this point.

Iran is also less dependent on oil than Saudi Arabia is: in September 2015, the Iranian President said that the government was earning more from taxes than from oil for the first time in almost 50 years. Since then, Iran has concluded an agreement with P5+1 on its nuclear programme, resulting in a rollback of sanctions, allowing it to increase oil production and exports.

Meanwhile, Saudi Arabia is facing financial pressures. The Kingdom has just announced a shift from the lunar based Hijri calendar to the Gregorian one: this is a part of austerity measures which will save the government 11 days worth of salary payouts to its employees. The week before this, the government announced a 20% cut in the salaries of ministers and senior officials. The government, which gets the bulk of its revenues from oil sales, is expected to post a budget deficit of 13% of the GDP in 2016.

It seems that Saudi Arabia may have finally blinked and agreed to Iran’s position, forced by a worsening financial situation at home.

Amit Bhandari is Fellow, Energy & Environment Studies, Gateway House.

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