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Irina Slav

Irina Slav

Irina is a writer for Oilprice.com with over a decade of experience writing on the oil and gas industry.

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Saudi-Iran Proxy War Threatens OPEC Deal

Tensions between Iran and Saudi Arabia triggered doubts about the success of the OPEC+ oil production cut deal two years ago when it was first being hatched. Now, with the deal in its second year, these doubts have been rekindled by the escalation between the two regional rivals. There is no end in sight for the proxy war that Saudi Arabia and Iran are fighting in Yemen, and it could spell the end of the deal.

There are already doubters that the deal will survive beyond the June 2018 meeting of the partners. Earlier this year, commodity analysts from leading investment banks warned that for some of the partners in the deal, oil prices are getting too high for comfort. Russia was a notable example in this respect: with its economy mainly export-oriented, it could use lower oil prices to keep the ruble low and maintain demand for its export goods.

Iran seems to also be on the side that is fine with sub-$70 Brent. Last month, Energy Minister Bijan Zanganeh told the Wall Street Journal in an interview that Iran was uncomfortable with oil at US$70, as this price level would stimulate more U.S. shale production. Indeed, U.S. production has been growing inexorably, last week hitting 10.43 million bpd.

Now the growing hostility between Riyadh and Tehran could become the last straw. ETF Securities commodities strategist Nitesh Shah this week told CNBC that these bilateral relations that have so far had only a fleeting effect on oil markets could now lead to an earlier end to the deal. Related: Bahrain Says Giant Discovery Holds 80 Billion Barrels Of Oil

"Saudi Arabia-Iran tensions appear to be intensifying. While this provides a geopolitical premium in oil for now, it could develop cracks in OPEC's unity, which could end the pact prematurely," Shah said.

But this unity has been questionable since the inception of the deal, and not jut because of Iran and Saudi Arabia’s troubled relationship. Not everyone in OPEC was on board with the cuts, most notably Iraq.

OPEC’s second-largest producer is still behind on compliance, and if it weren’t for Saudi Arabia’s cutting more than it had vowed to and—more significantly—Venezuela’s fast-falling production, the cartel would not have achieved the over-100-percent compliance rates it is so proud of.

OPEC is meeting next month to review the deal before the wider OPEC+ meeting in June. Most members have signaled their unwavering support for the deal, even Iraq. Yet meanwhile, Baghdad has announced plans to increase its oil production capacity substantially and has announced that its reserves of crude could turn out to be much higher than previously estimated. The implications of these two pieces of news from Iraq are not too positive for the prospects of the cut deal.

Related: Houthi Missile Hits Saudi Oil Tanker

There is also the question of how much longer Saudi Arabia will continue to shoulder more of the cut than it had agreed to. Until now, its patience has been bordering on martyrdom: the “Whatever it takes” refrain has been applied literally to production. But Saudi Arabia needs money for its ambitious economic reform plans, and it can’t—or at least shouldn’t—pin all its hopes on the Aramco IPO. Calculations that lower oil prices actually lead to higher revenues are bound to have reached Riyadh as well.

A further escalation in the proxy war would push prices higher, that’s more or less certain. But can Iran and Saudi Arabia afford this further escalation? It could lead to the breakup of the cartel and the cancellation of the production cut deal, which would weigh on prices, offsetting the positive price effect of the political escalation. In other words, Iran and Saudi Arabia may be playing a zero-sum game when it comes to oil. That’s hardly something either Tehran or Riyadh is happy about, so they might have to choose at some point between aggressively advancing their regional influence and maintaining higher oil prices for longer.

By Irina Slav for Oilprice.com

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Leave a comment
  • Kr55 on April 04 2018 said:
    Iran has never lifted a single finger in the deal. They have sold every bit of oil they could possibly produce and had stored while desperately seeking investment to be able to produce more (and failing for the most part).
  • Mickey M. on April 05 2018 said:
    "Calculations that lower oil prices actually lead to higher revenues are bound to have reached Riyadh as well" ??

    On this planet?

    At $50 Brent, SA would have to ship 13 Mbpd or so to equal 9Mbpd at $70.
    Can't do it.

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