THE BLOG
05/28/2016 09:46 am ET Updated May 29, 2017

Will OPEC's June 2 Meeting Mark the Death of OPEC?

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New developments in Saudi Arabia and Iran, related to the oil market, may precipitate the emergence of a new battleground in the rivalry between the two countries. This article seeks to investigate where the Saudi-Iran confrontation may lead and whether it could result in the death of OPEC (Organization of Petroleum Exporting Countries).

Iran surprised the oil markets

After the imposition of nuclear sanctions by the United States and Europe in 2012 on Iran, the country's oil production decreased by a million barrels per day (bpd). This abatement was the result of a decrease in Iran's oil exports because domestic consumption had not changed.

In January 2016, the sanctions were removed as a result of an agreement between Iran and the six world powers followed by the endorsement of the UN Security Council. Analysts asserted that it would take a year before Iran can reach pre-sanctions production levels and some expressed suspicion as to whether it could be achieved at all. As an example, the US Energy Information Administration had predicted Iran can produce 3.6 bpd in 2017. The official OPEC-supplied production numbers provided by Iran prior to the 2012 sanctions showed its daily output to be between 3.7 million and 3.8 million bpd.

A Bloomberg report in April, however, revealed that, miraculously, Iran had been able to increase the volume of oil it exports to two million bpd in the first half of April. By adding the oil refined in Iran, which is estimated at about 1.6 million bpd, to the exports, the total crude daily supply would be 3.6 million barrels (these figure do not include the exports of light oil recovered from gas fields). This means that Iran's oil production has almost rebounded to its pre-sanctions level, resulting in Iran regaining its position in OPEC.

Saudi Arabia's oil policies openly reflect rivalry with Iran

Saudi Arabia's decision in 2014 to not reduce its oil production when oil prices began to plunge was primarily an economic one aimed at choking the US shale industry. However, as many experts concluded, exerting pressure on Iran and Russia, with whom the Saudis were in a proxy war in Syria, was their secondary objective.

As a result of the Saudi onslaught against American shale producers, "some 77 North American energy companies have now declared bankruptcy since the start of 2015." Most of them have been "small and midsize US shale producers and the service companies that help them drill" according to a May Wall Street Journal report.

However, Saudis reaction to an April meeting in Doha, where OPEC and, unusually, non-OPEC countries gathered to negotiate a production freeze intended to strengthen prices was completely geopolitical in nature. The talks collapsed after Saudi Arabia surprised the participants at the last moment by demanding that Iran should also agree to cap its oil production at its January level. This would leave Iranian production levels at a rate similar to when sanctions were in effect.

Iran had refused to send a delegation to the meeting, arguing that it would not accept a cap on its production to the January level. Iran wanted its market share to return to the level it held before the sanctions were imposed.

The upcoming OPEC meeting could be at a critical juncture

The more than halving of oil prices in the last eighteen months was a serious blow for Saudi Arabia where oil revenues account for around 90 percent of central government fiscal revenues. The staggering $98 billion budget deficit in 2015 portendeds the trouble facing the oil-dependent kingdom.

With a looming dire financial situation, the American consulting firm McKinsey & Co planned an ambitious blueprint for the kingdom's economic transformation and diversification away from oil by the year 2030.

Some experts applauded the plan and some criticized it at both macro and micro level. One critique which stands out among the others is that the plan ignores the fact that the suggested reforms will not simply revolutionize the direction of the kingdom's economy. Rather it forces a monumental social transformation--the outcome of which is open to anyone's guess--by eliminating all kind of subsidies in a country where its citizens have long been accustomed to state largesse.

Saudi Arabia can achieve "our national vision" even if the price of oil falls to less than $30 a barrel, says Prince Mohammed bin Salman, the deputy crown prince, the King's favorite and de facto ruler of the country.

Against this backdrop, if nothing unexpected happens, Iran will most likely participate in OPEC's June 2nd meeting in Vienna.

Iran will likely accept a freeze on its production at 3.8 to 4 bpd, which it is likely to meet by June 2. In other words, Saudi Arabia would face a fait accompli at the June 2 meeting. "Iran would support any move toward market restoration and stability of the market as well as cooperate with OPEC and non-OPEC" an Iranian source told Reuters.

Russia, a non-OPEC member and the second largest producer of crude oil, will also attend the meeting and is ready to freeze its production at the January level as it had agreed prior to the Doha summit.

Now, if Russia and Iran are on the same page, given the current fiscal difficulties of all OPEC and non-OPEC members, everyone else, including Saudi Arabia's allies will, in all likelihood, back the production freeze. Let us not forget that it was Saudi Arabia that killed Doha.

Two scenarios are likely to result from this.

First, if the Saudis acquiesce to a Russo-Iranian deal, for the first time since the inception of the Islamic Republic, the Saudis has conceded the strategic leadership of OPEC--the consequence of which, in the long-term, remains to be seen.

Second, if the Saudis decide to scuttle the meeting again, the move will bring the future of OPEC into sharp question. Because the current trend "which allows members to produce as much as they choose with no need for coordination, calls the organization's basic purpose into question, said Eugen Weinberg, head of commodities research at Commerzbank AG in Frankfurt" according to Bloomberg. In such an eventuality, as Weinberg suggests, the question becomes "is OPEC dead or just in a coma?"