- Saudi Arabia and Iran's diplomatic engagement signals closer ties.
- Iran's rising oil production challenges Saudi efforts to stabilize prices.
- Uncertainty looms as Iran's growing production and release of stored oil in China could impact crude prices.
A week ago, Saudi Crown Prince Mohammed bin Salman sat with Iranian Foreign Minister Hossein Amir-Abdollahian in Jeddah for a meeting — or more importantly photo opportunity — he intended the world to see.
This week, the Saudis and five others, including notably Iran, joined BRICS, the economic alliance led by Brazil, Russia, India, China, and South Africa, where Riyadh announced a $16 billion investment.
Once the bitterest enemies of the Arab world, the Saudis and Iranians seem closer than ever.
Yet, something else is brewing that could test their fledgling diplomacy: More-than-expected Iranian barrels coming onto the oil market.
That second phenomenon became evident this week after Reuters, citing influential secondary sources on oil production, reported that August oil output from OPEC, which stands for the Saudi-led 13-member Organization of the Petroleum Exporting, climbed by 220,000 barrels per day. That was largely due to a jump in Iranian supply, the report said.
Iran is a founding member of OPEC, which was established in 1960. But since 2018, it has existed as more of an outcast within OPEC due to sanctions on its oil exports imposed by former US President Donald Trump, who accused the Islamic Republic of trying to develop nuclear weapons.
The sanctions were once a major burden to the Iranian economy. These days, they cause little hurt to Tehran, thanks to little enforcement of them by the administration of Joe Biden, the Democrat president who succeeded Republican Trump.
Into their sixth year now, the sanctions also allow Iran the privilege of being excluded from every production cut carried out by OPEC. Lack of enforcement over the sanctions means Tehran can export as much oil as it wants without telling anyone. But like Russia, which is under US sanctions for its invasion of Ukraine, Iran chooses to brag at times about its oil production and exports, to convey the message that it’s above the imperial powers trying to contain it.
The Saudis, of course, have an idea of how much oil Iran is producing and exporting via OPEC’s own monitoring. But even without that, the Reuters report suggests the Islamic Republic is putting out 3.1 million barrels per day now versus the 2.9 million averaged in July. Iran aside, Nigeria added 20,000 barrels daily in August, the report said.
Cumulatively, last month’s supply gain within OPEC is “erasing nearly half of the 'lollypop' cut from Saudi Arabia”, Adam Button, an economist who follows oil, noted on the ForexLive platform.
Shifting Geopolitical Landscape
The world first heard of the so-called lollypop cut in June when Saudi Energy Minister Abdul Aziz Salman — who’s half-brother to crown prince and future king Mohammed — used it to describe a voluntary reduction of one million barrels per day by the kingdom in July. Since then, it's become part of the oil market lexicon as the Salman brothers, in their obsession to get oil back to $100 or more a barrel, have made the cut a near permanent feature month after month. What’s more, they’ve threatened steeper reductions should crude prices tumble instead.
Aiding the Saudi mission are the Russians, who since 2015 have been part of the broader OPEC+ alliance anyway. The Kremlin, which theoretically needs to sell as much oil as possible to sustain its war machinery against Ukraine, has decided to try the Saudi way of cuts to get more dollars per barrel.
The results to the Saudi-Russian initiative have been mixed and volatile: After a near 20% gain between July and mid-August, crude prices hit a one-month low before climbing 6% again in the latest week. September onwards is also the period for seasonally lower oil demand. But the Saudis are hoping to challenge that with significantly lower global supplies and stockpiles, effected through their cuts.
Here’s where the Iranian development becomes more important.
Under Trump, the 'House of Saud' did not have to worry at all about containing its one-time rival because the Republican president was doing a marvelous job of it, so much so that Tehran struck back in 2019 with an attack on Saudi oil facilities and infrastructure via its Houthi allies that momentarily stunned Riyadh.
Under Biden, who has kept the Trump-era sanctions on Iran but barely enforced them, the Islamic Republic could be a problem for the Saudis, in the same way Russia was for years: an OPEC ally that wasn’t an ally at all.
Even before the Ukraine war, Russia often exported more oil every month than what it promised the Saudis. Once the war broke out and sanctions were applied on Russian oil, along with a G7 price cap of $70 per barrel, the Kremlin began shipping crude like there was no tomorrow, using every stealth method already shown by the Iranians over the past five years. Price discounting also became the order of the day as a barrel of Russian urals went for $20 below global benchmark Brent, which itself went from nearly $140 a barrel in March 2022 to below $72 in June this year.
Uncertainty Ahead for Oil Prices?
The Iranians, given the opportunity, could upset the Salmans’ applecart on oil pricing. From a Trump-era low of 2.1 million barrels per day, the Iranians have steadily added another 1.1 million now. There’s more they could do. Iran’s all-time high was 4.8 million barrels per day in 2017, a year before Trump’s sanctions came on. There’s no certainty, of course, that they will get there. To produce more oil, the Iranians have to invest more in drilling and infrastructure, and Tehran’s finances are still recovering from the extensive damage done by years of sanctions.
But $80 and above for Brent, compared with pandemic-era lows of $40 and under, are a bonanza for Iran and could help it quickly scale its production. Also at $90 or closer to $100 a barrel, Tehran could do what Russia until recently did: Discount its own barrels by $20 or more. And waiting to grab that off them will be the same Chinese and Indian buyers who have stockpiled enough cheap Russian oil over the past year that they are slowly working off their inventory despite the tight global supply situation.
The Saudi engagement of Iran, on the surface of it, goes way beyond oil. Peace with its one-time bitter economy, brokered interestingly by its new ally China, is part of a larger foreign policy focus on Mohammed bin Salman’s multi-trillion dollar socioeconomic development plan, known as Vision 2030.
The Saudi crown prince needs an escalation with Iran in order not to threaten the project’s funding, deter much needed foreign investment, and dash Saudi dreams of becoming a regional and global hub especially for cloud computing, logistics, trade, and industry. Think the 2019 attack on its oil facilities — the Saudis certainly don’t want a repeat of that. More than all these, the crown prince wants to show the world he’s a dealmaker and statesman who doesn’t take orders from anyone, especially America. The shift from decades of dependence on the United States for Arab security — and US reliance on stable, affordable Saudi oil, is all but over, except maybe in official speak.
The United States, having seen the writing on the wall, is countering the Saudi move with a charm offensive of its own by offering a Saudi-Israel deal as well — one that could certainly anger the Iranians, who regard Jerusalem as an unforgivable enemy compared to the Saudis. Riyadh hasn’t completely batted away the deal, which would help Washington regain some influence over the House of Saud, but more importantly than anything, check the rise of China’s growing clout there and the world.
In between all that, is the future of Iranian oil supply as well as previous barrels from the Islamic Republic sitting in storage. Some 12 million to 14 million barrels of Iranian crude is also estimated to be held as “bonded storage” in Chinese ports, awaiting the US go-ahead for them to be put to commercial use. The oil made its way to China before the reimposition of sanctions on Iran by Trump. China keeps the crude in “bonded storage,” which means the oil has not been cleared through Chinese customs and is not being used, therefore not yet violating the sanctions. The release of these barrels seem contingent on an Iran-US prisoner swap deal that both countries insist is not tied to oil.
If all these barrels hit the market, they could put commensurate weight on crude prices over the coming months.
Bottom Line
Biden can only lift sanctions on Iran by reenacting his ex-boss Barack Obama’s 2015 nuclear deal with Iran and Israel is dead set against that. The US congress, now controlled by Republicans, would also vehemently oppose that. Thus, Biden’s best chance of advancing US interests would be to get a Saudi-Israel peace deal going while allowing the Iranians to export crude with little worry of sanctions enforcement. Washington is also working on getting Venezuela, sanctioned along with Iran by Trump, to produce more.
Interesting months ahead wait for the oil market as the global titans for the commodity plays for the highest stakes of all.
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Disclaimer: The content of this article is purely to inform and does not in any way represent an inducement or recommendation to buy or sell any commodity or its related securities. The author Barani Krishnan does not hold a position in the commodities and securities he writes about. He typically uses a range of views outside his own to bring diversity to his analysis of any market. For neutrality, he sometimes presents contrarian views and market variables.