As he emerged from nearly five hours of talks in Algiers on Wednesday evening, Iran’s oil minister Bijan Zanganeh stopped to speak to reporters.
“Opec made an exceptional decision,” he said, as the Saudi energy minister left the meeting without taking questions.
After two years of squabbling, the cartel had finally crafted a provisional deal to cut production and tackle the global supply glut in crude oil.
Agreeing, in principle, a target to cut production to 32.5m-33m barrels a day* was enough to send oil prices shooting higher. Opec, it seems, is back, delivering a rebuke to those who have penned the cartel’s obituary. But hurdles remain before a deal is finally signed off.
Central to this week’s agreement in Algiers were Opec’s most powerful and influential members, Saudi Arabia and Iran.
Riyadh softening its stance towards Tehran provided the backdrop for the pledge by Opec to reduce its output. The kingdom privately agreed to take the bulk of any cuts with Iran given special consideration as its oil production recovers after years under western sanctions.
During the meeting, held at north Africa’s newest and largest conference centre, oil ministers were seated around a huge circular table. Iran and Saudi Arabia were placed five or six places apart, but not directly opposite each other.
The development marks the first action to bolster crude prices that have battered the finances of producer economies and many energy companies, notably US shale drillers, since the oil collapse began two years ago. The last time a push was made to limit production occurred in 2008.
It also signifies a change in the Saudi-led Opec strategy of pumping flat out to maintain market share and put pressure on high-cost producers — from US shale drillers to those pumping oil from Brazil’s deepwater fields.
“Saudi Arabia and Opec have returned to active market management,” says Michael Wittner, head of oil research at Société Générale.
But stiff challenges remain in order to turn the agreement into a binding deal in time for the cartel’s next formal meeting in Vienna on November 30.
The Saudi shift comes as the country faces severe fiscal headwinds, cancelling bonuses and allowances for public sector workers earlier this week. The kingdom’s energy minister Khalid Al Falih sent a firm signal to Opec peers and rivals, that price does indeed matter.
Weeks of back-channel talks between Opec producers in France, Austria and China and bilateral meetings in Algeria resulted in several proposals for production cuts that went back and forth between Saudi and Iranian camps. Even as disagreements over production targets continued late into Tuesday their position was seen to be narrowing.
After the failure of talks in Doha earlier this year, both sides recognised the need to show unity even if their positions were not yet fully aligned. Fereidun Fesharaki, head of consultancy FGE, said: “Opec could not afford to come up with no agreement.”
Opec’s ability to reach at least a consensus for a new production range was seen as a positive development, with oil rising to a level just shy of $50 a barrel on Thursday. But obstacles remain.
First, no official cut will take place until Opec’s November meeting, with the group pushing down the road the most contentious part of any agreement — who should curb output and by how much. “Opec saves face and kicks the can to November,” was how analysts at Barclays summarised the meeting.
While it was no small feat for Saudi Arabia and Iran to come to an understanding of any sort, much work remains.
Saudi Arabia had initially said in closed-door meetings that it was prepared to join a co-ordinated cut of up to 1m b/d should Iran cap its output at current levels, estimated at 3.6m b/d by analysts.
It later gave ground to a slightly higher level of 3.7m b/d for Iran, according to one person briefed by Gulf Opec delegates. The kingdom does not believe Tehran can ramp up any higher, but allowing Iran to openly increase even on paper is politically problematic, a person familiar with Saudi policymaking said.
Although Iran supported the freeze, in the days leading up to the meeting it played hardball over the level at which it would cap its output and initially signalled it would only accept around 4.2m b/d.
Iranian delegates said years of sanctions had left the country less reliant on oil revenues. Saudi, they argued, could not fund military action in Yemen or help the government in Bahrain with the current price.
“We won a war with $6 a barrel in the 1980s,” one Iranian delegate said, referring to the Iran-Iraq war. “They are struggling to win their battles with $45,” said one.
Delegates later said they had secured a production number close to 4m b/d — Iran’s stated post-sanctions target — deemed to be around 3.9m b/d. Although analysts say Iran is struggling to increase its production, an output cut is unpalatable domestically as it emerges from the cold after the lifting of sanctions against its oil industry.
Still, negotiations will continue at a technical analyst level next month, one senior Gulf Opec delegate said. The aim is to bridge the 200,000 b/d gap. Separately, with Saudi and Iran still fighting proxy battles from Yemen to Syria, renewed disagreement before Vienna cannot be ruled out.
Another threat is Iraq, with the country being asked to join cuts for the first time since the first Gulf war in 1991. While in principle Baghdad backs output curbs, its reaction in the immediate aftermath of the meeting may be a taster of what Opec now faces.
“In the end, Iraq proved far more rigid in discussions than Iran,” says the senior Gulf Opec delegate.
Iraq’s oil minister furiously argued that its oil production was being underestimated by the so-called secondary sources Opec will use to form the basis of any target, with Ali Hussein Al-Luiebi publicly berating a journalist from a pricing agency that assesses the members’ oil flows.
“The Iraq minister commented that secondary sources for oil production are too low, with his country’s output potentially 300,000 higher …a gap of nearly half of the proposed production cut,” note analysts at Goldman Sachs, the investment bank with the most clout in the commodities space.
The cartel will also have to contend with a sceptical oil market. Although a consensus was reached for a new production range, after Opec abandoned its output ceiling last year, a level between 32.5m and 33m b/d may not be enough to placate traders.
The lower target would entail a substantial 740,000 b/d cut that should help halt oil inventories from climbing next year. Any agreement from big producers outside the cartel in the next few months to join in any deal will only add to its credibility. Russia has privately said it is willing to curb its output, but only after Opec has its house in order.
Another risk is that a final production-cut agreement closer to the higher figure — which Opec delegates say is there to allow Libya and Nigeria’s violence-hit output to recover — will be viewed as an almost imperceptible adjustment to current supply. The cartel pumped 33.23m b/d in August, according to secondary sources.
Nonetheless, hedge funds and speculators will probably be much more wary about making large bearish bets against the oil price in the wake of Wednesday’s agreement.
Longer-term challenges also remain. The US shale industry is still standing and set to prosper from any pick-up in the price of oil.
US production has dropped by about 10 per cent since late 2014 but the companies that have survived are now leaner and more efficient. Many already believe they can turn a profit with oil at $50 a barrel. It remains to be seen what price will flip the industry from survival mode to expansion again.
Opec, for its part, believes it has done enough to slow shale’s growth and is now concerned about the long-term impact of a near-trillion-dollar reduction in capital expenditure globally.
But the lesson of letting crude trade above $100 a barrel for too long is likely to have been learnt — $60 is a more likely target.
While that could provide a welcome fillip to members’ revenues and shows the cartel is not dead, Opec is hardly thriving.
“Those who think that this is a return to the old Opec should take more seriously the new circumstances of a world with shale and lower demand growth,” says veteran Citi oil analyst Edward Morse.
* This article has been amended to specify accurately Opec’s new production target
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