Countdown To OPEC’s Nov 30 Meeting – Part 3
Nov 14, 2016
Part 3: Better To Deal With Iran Now Before They Get Even Stronger
Oil prices have been weak on increasing sentiment that OPEC will not be successful at its Nov 30 meeting to reach a quota agreement to get down to the Algiers target of 32.5 to 33.0 million b/d. [LINK] A deal was made harder with OPEC Oct oil production at 34.6 million b/d, compared to 33.175 million b/d assumed at Algiers. Q4 production increases for Iran, Libya and Nigeria were expected and are in line with our Nov 7 blog “Countdown To OPEC’s Nov 30 Meeting. Part 2: Increasing Challenge To Get Down To 32.5 Mmb/d”.
Libya, Nigeria and Iraq all need to be dealt with to get to the Nov 30 deal. The reality is that Iran has been the major challenge for Saudi Arabia and OPEC to get to a Nov 30 deal. Iran has been firm to want to get back to pre-sanctions levels, which at least are now is in sight, and not much higher than current Oct oil production.
- Iran’s production is 0.273 million b/d higher than it was at the time of the Algiers deal. This should not be a surprise. Iran says its Oct production was 3.92 million b/d compared to the 3.647 million b/d assumed in the Algiers deal.
- Iran’s target isn’t 4 million b/d, but 4.1 to 4.2 million b/d. In the lead up to Algiers, Iran’s number was mostly talked at 4 million b/d. But this number seems to have shifted to its pre-sanction levels of either 4.1 or 4.2 million b/d.
- Iran also wants to regain a 13% share of OPEC. This was another moving target that came out in the lead up to Algiers. A 13% of 32.5 million b/d would be 4.225 million b/d.
No question it looks even tougher to get to a deal that sees OPEC get to 32.5 to 33.0 million b/d while getting Iran to “agree”. We recognize that any “agreement” on Nov 30 will be discounted to some degree to its strength, but an “agreement” will at least provide support that OPEC can work as a cartel in crunch times. We believe Iran has negotiating leverage and, with the sanctions removal, a stronger economic position. But it is likely easier to get Iran to agree to a deal today with relatively limited near term oil production adds in 2017 and, at the same time, it is a timely strategic move for Saudi Arabia and others as Iran’s economic strength and negotiating leverage will continue to increase in future years.
- Iran’s has relatively limited near term oil production adds in 2017. We saw what happened in early 2016, there was no way Iran was going to agree to a deal as it had ~1 million b/d of near term production to adds post the removal of sanctions. Iran’s oil production is up ~0.8 million b/d in the last year to 3.92 million b/d in Oct. Its near term oil production adds can reportedly take Iran back to 4 million b/d by March 2017 (end of the Iranian calendar year), and to 4.2 million b/d next summer. Iran “agreeing” to a cap of 4 to 4.2 million b/d will not hurt Iran.
- The lifting of sanctions was a game changer and gives Iran negotiating leverage over everyone else in OPEC. It provided a return of capital of ~$50 to $100 billion. The $50 to $100 billion wide range represents the US vs Iran view of how much capital was freed up. Iran is negotiating from a positon of huge economic strength and superiority. Iran is in Saudi Arabia’s former position, it can withstand low oil prices, whereas all the other key OPEC players cannot do so much longer. Iran is on its way to become the economic power in OPEC, whereas the others are all facing slowing economic growth and increasing deficits. Iran has ramped up oil and natural gas exports. Yet it is just now starting to get its major capital investment deals signed up (ie. Total’s natural gas deal last week). All OPEC oil producers want higher oil prices, the others just can’t withstand lower oil prices much longer.
- Iran is just starting to get stronger economically. The return of $50 to $100 billion of capital was a huge boost to Iran. Iran is at the beginning of its multi year strong economic growth period. The increasing oil exports and return of foreign capital is a big boost to the economy. All of this means Iran is in a period of stronger economic growth than its OPEC rivals. Wood Mackenzie forecasts Iran’s GDP growth to increase to 4% to 2020. Whereas they forecast declining GDP growth for Saudi Arabia (5% to 2015 down to 1.9% by 2020), Kuwait (3.1% down to 2.8% in the same period), Iraq (5.6% in 2011-2015 down to 2.8% in 2016 to 2020), and UAE (4.8% down to 3.1%). Iran reminds us of China in the early 2000’s and how China’s multi year strong economic growth translated into economic dominance in the mid 2000’s for a decade. Iran won’t become a global economic dominant player, but is on the early stages to become a Middle East dominant economic player.
- Long term demand for OPEC crude is expected to decline. Last week, OPEC issued its 2016 World Oil Outlook [LINK] and it estimates very little change in the demand for OPEC crude oil. OPEC estimates that demand for OPEC crude “rises from 32 mb/d in 2015 to 33.4 mb/d in 2018. It then stays approximately constant for several years – hovering in the range of 33.6–33.8 mb/d between 2019 and 2025”. There will be an increasing fight for OPEC market share in future years for any OPEC members that can grow.
- Iran likely has the strongest near term oil growth potential and could likely add 2 million b/d or more over the next 4 to 7 years years, certainly by 2025. Iran’s production is up 0.8 million b/d in the past year, and expected to grow to 4.2 million b/d in H1/17. This is before any significant foreign capital. In the early 70’s, Iran was at 6 million b/d, Saudi Arabia was at 8.6 million b/d and Iraq at 2.0 million b/d. Iraq reminds us After 40 years of essentially zero major foreign capital in the oil and gas sector, the removal of sanctions is allowing Iran to attract foreign capital. Iraq is a perfect example of how the return of foreign capital (Iraq had about 20 years of no foreign capital) has driven oil production to 4.8 million b/d, or more than double the early 70’s level. We expect that Iran has the potential to go well above the 6 million b/d seen 40 years ago.
Post Donald Trump’s win, the US is now a big wildcard in the Middle East. Our Nov 9 blog “Piercing Together Trump’s Oil And Gas Impact” highlighted how Trump’s election makes Iran and the Middle East a big wildcard. It will no longer be the immediate expectation that the US will step in everywhere in the Middle East. We wrote “but what he does with Iran, how big a role he plays in the Middle East, how he deals with the range of hotspots, how his target to eliminate imports from OPEC, and the added dynamic of Russia’s growing relationship with Iran should all add up to more uncertainty and more risk to the Middle East”. However, with respect to Iran’s negotiating strength to OPEC, to a great degree the genie is out of the bottle as the removal of the sanctions and return of capital has put Iran in a position of strength for OPEC negotiations today.
There is no question that a Nov 30 quota agreement will be tough to get done and that a deal will fall mostly on the shoulders of Saudi Arabia. We believe Saudi Arabia has run out of time and needs oil prices to return to $50 and not $40. Saudi Arabia’s financial position is getting worse and it publicly committed to an early 2018 Saudi Aramco IPO whose valuation will depend on 2017 and 2018 oil prices. Iran doesn’t really lose much by “agreeing” to a cap as the oil production growth post removal of sanctions is almost done. But perhaps most important of all, the removal of the sanctions has put Iran into a period of strong economic growth (when others are getting financially weaker) and this should only increase Iran’s negotiating leverage in future. Even with the negatives, it may well be the best possible time for Saudi Arabia to grit their teeth and accommodate Iran. Iran is expected to only get stronger economically.
Part 4 will show how US oil production is “predictably” back to growth