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Iran abandons production freeze oil won't be going up any time soon
The price of oil declines slightly after a three-month high of $41 a barrel as Iran refuses a deal to freeze oil prices, but some analysts say the price freeze wasn't in oil companies' best interests anyway. - photo by Sam Turner
Chances are American consumers will enjoy low gasoline prices for a little longer.

On Sunday, Iran bowed out of a deal with Russia, Saudi Arabia, and other countries to freeze its oil production.

The intent of the deal was to slow oil production and narrow the gap between oil's large supply and relatively low demand, subsequently increasing the price.

According to Fortune, Iran oil minister Bijan Zanganeh said that Iran would not consider talks of freezing oil production until Iran's own production reaches 4 million barrels per day and that could be a while.

Even with U.S. and E.U. economic sanctions against Iran being lifted this year, the country's current production is only at 3.3 million barrels per day. Fortune reports that Iran's goal to increase that rate by 500,000 barrels per day by the end of the year is unlikely.

Iran's lack of cooperation led to a 2 percent drop in oil prices on Monday morning from a three-month high of around $41 a barrel on Friday. Still, some believe that freezing production is not the way for oil to recover.

When the production freeze was initially announced in February, University of Michigan Energy Institute director Mark Barteau wrote for Fortune that slowing production will not close the gap between supply and demand.

Barteau notes that if Russia, Saudi Arabia, and other countries were to freeze production rates now, they would still be producing more oil than ever before. Combined with the fact that the supply restricted by one producer can be replaced by another, freezing production is unlikely to limit supply enough to make a significant impact.

"There is ample evidence that we have arrived upon a new normal," writes Barteau. "We have likely entered an era of abundant and relatively cheap oil."

Barteau's view of a future with a surplus of inexpensive oil is not shared by all analysts, though.

Adam Longson of international bank Morgan Stanley says oil companies have ruined the chance of oil price recovery by hedging against volatility, reports Business Insider.

To secure themselves against uncertain oil prices, oil producers are selling futures contracts to distributors. This means they are agreeing to sell oil in the future at the current oil price.

According to Longson, the gains in the price of oil since it hit rock bottom in January are a result of producers being forced to hedge, or sell futures. By hedging near the $40-a-barrell range, however, producers are also insuring that oil prices don't rebound to the high prices of $80-$100 a barrel.

By selling so much oil at the lower rate, producers are almost betting against the price of oil going up, as increases in price would force producers to buy back futures contracts at a loss, Business Insider explains.

Hedging also forces companies to ramp up production, perpetuating the broad gap between supply and demand and therefore keeping prices low.

In some ways, the opposite approach to hedging has been taken by industries which are dependent on the oil and gas industry namely airlines. Like oil producers, airlines are betting the price of oil stays low. But rather than hedging, airlines are eliminating their derivatives and security funds.

According to the Wall Street Journal, the move away from derivatives started as early as 2014 with American Airlines. Last week, Delta announced it had closed its hedges altogether. United and Southwest have also decreased their holdings significantly.

The idea is that with the financial windfall from lower fuel costs, airlines can avoid the financial safeguards of derivatives and instead focus on improving their bottom line earnings.

With fuel costs down from 33 percent of revenues in 2011 to 18.7 percent in 2015, airlines have some room to breathe, especially since ticket prices remain high.

But airlines should be careful, says the Wall Street Journal. Energy costs are volatile and removing all hedges is high-risk.
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