Is The New Iranian Oil Contract Another Nail in the OPEC Coffin?

Since OPEC’s historic decision in November of 2014 to leave crude output targets unchanged for member countries, thereby causing the price of oil to slide, many commentators have discussed the future role of OPEC on the world stage and as the price regulator and swing producer for the world.

Every whimper that comes from OPEC is met with a market reaction. On Monday, August 08, 2016, oil closed up 3% on mere speculation that OPEC might make another attempt to cooperate in reigning in supply after their last failed attempt. It is interesting to note that this story was first reported by the Wall Street Journal and relied on comments from Venezuela, Ecuador and Kuwait rather than powerhouse Saudi Arabia.

Whatever the reason OPEC made its decision to leave supply unrestrained, and many commentators have had many different opinions as to what was truly driving the decision, OPEC essentially abandoned its role as the de facto insurer of price stability. And for the most part, that decision rested solely in the hands of Saudi Arabia who, by announcing they would not agree to production cuts, forced other OPEC members into pumping as much crude as possible to keep State revenues up. Hardest hit, of course, were the marginal producers such as Venezuela and Nigeria who rely heavily on oil to fund their governments and economies. But Saudi has been hit itself. Since the price of oil plummeted, as of March 30, Saudi foreign currency reserves stood at $593 billion, down over $150 billion from its peak in late 2014. In fighting an expensive proxy war, and the social gifts that come with a new king, Saudi is facing challenges as they have not been able to reduce spending to offset their loses.

OPEC has always been a bit of a loose coalition. Member States, have always been questionably loyal and frequently ignore production quotas. But there was at least some semblance of unity. And, for the most part, certain member States were willing to be a little more sacrificial than others if necessary.

Last week, Iran’s cabinet approved the general terms of a contract model that will allow foreign O&G investments. While the outline of terms must still be approved by parliament, where it faces opposition, one interesting note is that the contracts, which will last for 20 years, protects those winning them from any future OPEC output reductions, effectively shielding investors from having to comply with any new production quotas and allowing foreign investors the opportunity to produce at will.

While production quotas for the country could theoretically come from existing Iranian fields with no external partners, one has to wonder, would Iran actually cut production? Are they signaling to the world as they come back into the free market world economy that they are not willing to abide by production quotas? There is certainly an argument that Iran is not going to let their archrival Saudi Arabia control their income. Taken to an extreme – if these contracts go into place, and if OPEC were to suddenly reverse course and implement substantial production quota reductions, would Iran really bear all of that through existing fields? I am skeptical.

Last week, we saw Mohammad Sanusi Barkindo of Nigeria assume the helm of OPEC as secretary-general. He is largely seen as a compromise candidate and technocrat who will have little real power or influence. Some view him effectively as a place holder in a world where Saudi Arabia is going to dictate OPEC’s stance regardless of who is technically in a leadership position.

We have seen the cobbled together coalition that is OPEC engage in bitter internal fights, frequently breaking out into public disagreement as the downturn worsened and member State’s saw their economies reduced to shambles. Add into that the regional rivalries and one has to wonder, is Iran telecasting its intent to not be bound anymore by production quotas? Do they view the current state of OPEC and its place in the world as becoming increasingly irrelevant? Again, only time will tell. Right now, markets still react to every word any member of OPEC says. But given their inability to reach agreement, increasing hostility amongst themselves, and the U.S.’s ability to bring production online quickly and cheaply (see our article on Big Oil Earnings to find out how cheaply), OPEC may be slowly but surely becoming irrelevant.