Baltimore, MD-A showdown within OPEC may soon erupt. Iran and Saudi Arabia are at odds over oil cuts. Could this fissure lead to OPEC's dissolution?

In This Corner

Iran and Venezuela have a few things in common. And, although both share a hatred for the U.S., the bond I'm referring to is their desperate need for higher oil prices.

Both have smaller production capacities than Saudi Arabia, so they would benefit from selling less oil at greater prices.

Oil and natural gas revenues are crucial to Iran's economy. They constitute almost half of the country's income. And the price of oil can have a drastic effect. A low price can slow economic growth and hurt government spending. Prices peaked at $77 per barrel back in July. As a result, revenue soared, allowing the government to increase spending. Recent price levels hovering in the mid 50s have led Iranian President Mahmoud Ahmadinejad to unveil a new budget. The plan includes a spending increase of 20% and assumes that oil prices stay over $33 per barrel.

This budget suggests Iran is preparing to defend itself from economic pressures by the U.S. and other countries. Their controversial nuclear program has come under the global spotlight.

Another factor is Iran's inability to keep up production. They have been unable to fill OPEC's quotas for the last few years. The 2.5 million bbl/day that Iran exports is less than the Saudis' spare capacity.

Venezuela would suffer more from low oil prices. President Hugo Chavez has been even more careless with his spending than Iran. It grew by 43% last year.

Venezuela's need for oil revenues is staggering. Approximately 90% of export earnings come from oil. These revenues fund half of the federal budget and 30% of GDP.

Venezuela's source of non-oil revenue is tax collection. And taxes exceeded the 2006 year-end goal by 20%. At the rates of spending and GDP growth, dropping oil prices could be devastating.

Saudi Arabia is another founding member of OPEC. But its situation is the opposite of Iran's and Venezuela's.

It owns 25% of the world's proven petroleum reserves. Oil exports account for three quarters of the budget and 90% of total export earnings. The Ghawar oilfield is the largest in the world and provides half of Saudi oil production.

But unlike Iran and Venezuela, Saudi Arabia benefits the most from lower oil prices.

Consumers buy less oil when prices are too high. Saudi Arabia learned that painful lesson during that July price spike. For Saudi Arabia, prices are optimal around $50. That's the level at which they can sell the most oil.

To Cut or to Not Cut, That Is the Question

The real showdown is between Iran and Saudi Arabia. Venezuela exports nearly the same amount of oil that Iran does. But its known oil reserves are a different story. Iran holds 132 billion barrels of oil while Venezuela only has 75 billion.

This gives Iran a considerable edge in OPEC decisions. And they have repeatedly called for cuts in production to boost prices. Yet resistance is met from countries with higher production, like Saudi Arabia.

The Saudis have been accused of waging war on the Iranian economy by consistently refusing to call for a special OPEC meeting to cut production.

The Sunni-led Saudis are blamed for intentionally attempting to break the Shiite government in Iran, a claim the Saudis have repeatedly denied.

Iranian reserves are declining at a faster rate. Iranian oil exports have been shrinking annually by ten to twelve percent. Oil production costs the Saudis roughly two to three dollars per barrel. Costs for Iran are over five times more at $15-18 per barrel.

But Iran also uses more of its oil production domestically than do the Saudis. This is because of the smaller population and milder climate of Saudi Arabia.

And the Winner Is . . .

Unfortunately, we can't declare a definite winner yet.

OPEC's demise is unlikely in any event. Both parties would lose too much money if that were to happen. But tensions within the organization will grow as this battle over production cuts rages.

The price of crude oil closed yesterday at $57.30 per barrel.

The Saudis will call it a victory if oil prices drop closer to $50 for a sustained period of time. If OPEC drives the price up by cutting production, then you can award the prize to Iran, with Venezuela benefiting as well.

Until next time,