Oil Freeze Talks Hit Impasse As Iran Seeks Production Carve-Out

Russian Energy Minister Alexander Novak traveled to Tehran on March 14 on a trade mission where he met with Iranian Petroleum Minister Bijan Zanganeh and Iranian Energy Minister Hamid Chitchian. On the agenda were discussions about the proposed “production freeze”, which Iran has consistently and unequivocally stated it will not consider joining until after its oil production reaches the pre-sanctions level of 4 million barrels per day.

Setting the stage for bilateral talks the day before Novak’s scheduled arrival, Iran’s Petroleum Minister reiterated Tehran’s resolute position that the country aims to recover its shut-in production and lost market share. Following the meeting, Novak expressed acceptance and support for Iran’s position, raising the possibility of a special carve-out for Iranian crude production.

Despite the impasse, Moscow will likely work to keep talk of the initiative afloat with a constructive appearance, at least until the next OPEC meeting scheduled for June. The overt collapse of talks would add bearish sentiment to the market, further erode recent gains and weaken support for a new price floor.

Since February 16, market sentiment has been partially shaped by reports of the proposal by Russia, Saudi Arabia, Venezuela, and Qatar to “freeze production" at January levels. The proposal has been interpreted optimistically as a sign of growing cooperation among major producers and generated expectations that with Russia’s help, OPEC could stabilize the oil market.

Saudi Arabia’s Petroleum Minister Ali Ibrahim al-Naimi declared at the annual IHS CERAWeek conference in Houston on February 23, that the proposed freeze was “the beginning of a process” and that further discussion were expected to take place in March. This framing helped shape market expectations that, with time and effort, other major producers such as Iraq and Iran could be brought on board.  Talk of the "production freeze" added tenuous support to claims of a new price floor, with Brent crude oil hitting the $40 mark after a 12-year low reached in mid-January.

Disagreements and confusion have emerged on when and where the meeting would take place, raising doubts about whether the meeting would be postponed or scuttled altogether. On March 4, Russia’s Energy Minister clarified that the planned meeting would occur sometime between March 20 and April 1 in Russia, Doha, or Vienna. Now, in the aftermath of the meeting in Tehran, the meeting may not take place until sometime in April.

As a result, the proposed production freeze remains more highly tentative than ever and still conditioned on the buy-in from other major producers such as Iraq and Iran. Simply locking-in relatively high production levels will do little to balance the physical market by reducing oversupply and drawing down record level crude inventories.

Neither Russia nor Saudi Arabia had planned significant production increases in 2016. Russia’s January production of 10.88 million barrels per day was already at a post-Soviet record high. Russia could freeze production but still increase exports of crude oil relative to oil products by manipulating its tax regime. Saudi Arabia’s output was relatively stable in January at near record levels of 10.23 million barrels per day.

Iraq has signaled that it will consider participating in the proposal, but only if all other major OPEC and no-OPEC producers were in agreement. By declaring that its January production was 4.775 million barrels per day, Iraq has put forth an inflated production ceiling that doesn’t reflect actual production but would lock-in a targeted production increase. Iraq’s January oil production was closer to 4.35 million barrels per day.

Getting Iran on board will require finding a mutually acceptable production ceiling.  Yet, Iran has refused to cap its production at January levels, which OPEC secondary sources estimate to be 2.93 million barrels per day. In Tehran’s perspective, this would leave an unacceptable amount of money on the table considering that pre-sanctions production was around 3.8 million barrels per day. Iran produced an estimated 3.22 million barrels per day in February.

Although the so-called production freeze is unlikely to result in anything beyond more talk, Russia’s implied strategy is to broker an “individual solution” with a special carve-out for Iranian crude production accompanied by guarantees that Iran will smooth the flow of its additional oil allotment to the market.

A brokered solution may be palatable given the fact that the return of previously shut-in Iranian oil has been slower than expected and less robust than Tehran had planned since sanctions were lifted on January 16. Last month, Iran only added about 220,000 barrels a day to the market and is likely to fall short of its goal of ramping up production to 500,000 barrels per day by March 20. Commercial and technical limits to how much additional oil Iran can bring to the market in 2016 could provide the negotiating space for a brokered deal.