In oil price battle with Saudi Arabia, it’s advantage Iran

By Javier Blas on 9/27/2016

LONDON (Bloomberg) -- Suddenly the tables have been turned on Saudi Arabia.

The biggest oil exporter has swapped its traditional role as price dove with regional foe Iran, for years OPEC price hawk. The government in Riyadh is now offering a deal -- including its first output cut in eight years -- to boost prices; Tehran is dragging its feet. At the center of the reversal is their contrasting thresholds for enduring economic pain.

"Both countries are coming from different positions," said Jason Tuvey, Middle East economist at consulting firm Capital Economics. "Iran has been under sanctions until recently, so it’s getting an economic boost as investment returns and oil output rises. Meanwhile, Saudi Arabia is facing steep fiscal cuts."

The contrast between the two countries is stark. Iran, never as dependent on oil revenue as its neighbor, has seen prospects boosted by rapprochement with the west. In Saudi Arabia, tentative moves toward economic reform haven’t prevented two years of weak prices causing financial havoc: it’s burning through foreign exchange reserves, government contractors have gone unpaid and civil servants will get no bonus this year.

Diverging economies

Saudi Arabia will suffer a fiscal deficit equal to 13.5% of gross domestic product this year, compared with one of less than 2.5% of GDP for Iran, the International Monetary Fund estimates. The IMF says the Saudis need oil close to $67/bbl to square the books. For Iran, it’s lower, at $61.50. Brent crude, the global benchmark, fell to $46.50/bbl in early trading in London on Tuesday.

When it comes to economic growth, Saudi Arabia is slowing sharply to 1% while Iran is accelerating toward 4%. The current account -- a broad measure of a country’s economic relationship with the world -- tells the same story. Saudi Arabia faces a double-digit deficit this year; Iran’s is nearly balanced following economic reforms in 2012 and 2013 to weather the impact of international sanctions over its nuclear program.

While Iranian President Hassan Rouhani faces elections next May and is under pressure over the country’s economic performance since sanctions were lifted, it’s already been through the austerity that’s only starting in Saudi Arabia, according to Amrita Sen, chief oil analyst at consultant Energy Aspects Ltd. "Iran has already been through so much pain, incrementally they aren’t really worse off," she said.

U-Turn

Saudi Arabia led OPEC in November 2014 to defend market share, notably against U.S. shale oil producers, at the expense of high oil prices. A month after the policy shift, Ali Al-Naimi, then Saudi oil minister, told the trade journal Middle East Economic Survey that "sooner or later" rivals would run into financial difficulties. The kingdom had "the ability to hold out" for a long time, he said.

Nearly two years later -- and under different oil minister -- Riyadh is now signaling it may be ready for a U-turn.

Saudi Arabia has told other OPEC members it’s willing to reduce production to January levels, according to Algerian Energy Minister Noureddine Boutarfa. That effectively would mean a cut of 500,000 bpd. Iran, meanwhile, is refusing to freeze its production at the current level of 3.6 MMbpd, aiming instead to lift output above 4 MMbpd, the level before sanctions halved exports.

It’s "not on our agenda" to reach an agreement over the next two days, Bijan Namdar Zanganeh, the Iranian oil minister, said in an interview, adding that he was in Algiers "to have a consultative informal meeting with OPEC to exchange views, not more."

When the oil slump started, few would have anticipated that Saudi Arabia would be seeking a deal to boost prices and Iran would resist it. Beyond the economy, other factors are at play, including regional politics. Both countries are on opposite sides of the Syrian and Yemeni civil wars. Then there’s pride -- Iran wants to return to pre-sanctions production.

Spending Petrodollars

For the last two years, as oil prices plunged from more than $100/bbl to a 12-year low of less than $30/bbl in January, the Saudis have drawn on their huge currency reserves to cushion the impact. It spent $115 billion last year and between January and July this year it used up another $52 billion.

Khalid al-Falih, the Saudi oil minister, on Tuesday warned that many energy-rich countries were "facing financial distress" from the slump in prices. Worried about a looming insolvency if the kingdom continued to spend way above its oil income, Riyadh sought to staunch the financial bleeding.

Subsidies, long a political taboo, are being cut, as are the salaries of government ministers by 20%. Infrastructure projects have been delayed, and a value-added tax is mooted for 2018. If Saudis have continued spending as they did last year, Mohammed Al-Sheikh, a financial adviser to the crown, told Bloomberg in April the country would have gone “completely broke” by early 2017.

On the other side of the Persian Gulf, there isn’t the same sense of crisis.

"Tehran would love to have higher oil prices, but Iran is the OPEC country that had to do fewer budget sacrifices due to cheap oil," said Olivier Jakob, an analyst at Petromatrix GmbH in Zug, Switzerland. "They feel they have a strong hand.”

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