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Drop in Oil Prices Fuels Iran-Saudi Arabia Rivalry

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Saudi Arabia and Iran are currently locked in a regional proxy war, buttressed by their respective oil reserves. Relations between the two Mideast heavyweights took a hit in January following Riyadh’s execution of a prominent Shiite cleric, though tensions had been brewing long before then. Ties are likely to further deteriorate as global oil prices bottom out, Iran opens itself to the West and sectarian conflicts rage from Syria to Yemen.

Saudi Arabia prides itself as the custodian of Sunni Islam, while Iran is the standard-bearer of Shiism, but their rivalry extends far beyond ancient rifts in religion. The energy-rich nations, both of which rely heavily on crude oil exports, compete for market share, influence, allies and Islamic legitimacy.

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Photo: By Ninara - Flickr: IMG_7901-2, CC BY 2.0
Abrisham Bridge, or Silk Bridge, is a cable pedestrian bridge in Tehran, Iran.

The successful nuclear deal with Iran has put the Gulf monarchy on edge that Washington’s rapprochement with Tehran will threaten its longstanding alliance with the U.S. and Saudi hegemony in the region.

Riyadh backs a variety of opposition groups in Syria, leads a coalition to bomb rebels in Yemen and props up the Sunni monarchy in Bahrain. In contrast, Iran’s support of Syria’s regime has been crucial in keeping President Bashar al-Assad in power. Iran has also been accused of meddling in its neighbors’ affairs by at least marginally supporting the Houthi rebels in Yemen and the disgruntled Shiite majority in Bahrain. Both countries also are extremely influential in Lebanon, where they financially support opposing political parties. As of late though, the two nations have traded barbs directly.

In a provocative move, Saudi Arabia executed Nimr al-Nimr, a revered Shiite cleric, shortly after the New Year. Nimr had participated in demonstrations in Saudi Arabia’s eastern region — home to a large, restive Shiite population (and most of the country’s oil) — and he was later tried on terror charges, despite human rights groups calling for his release. The execution ignited protests in key spots around the world, including Baghdad and Tehran, where a mob ransacked the Saudi Embassy. The row led Saudi Arabia, Kuwait, Sudan and Bahrain to sever diplomatic relations with Iran. As this cold war heats up, oil could play an exacerbating role in economic relations as well as any potential conflicts.

Global markets, already awash in cheap oil, have largely shrugged off the Iran-Saudi feud, as prices continue to hover at record lows. In mid-March, the Brent crude benchmark crashed to $27 a barrel in early 2016, compared to over $100 a barrel less than two years earlier.

Despite the dramatic drop in oil prices, along with slowing demand from places like China and a global supply glut, the Saudis have steadfastly refused to tighten the spigot in order to stabilize prices. While Saudi Arabia — cushioned by over $600 billion in financial reserves — can keep pumping at full capacity, it is banking on the fact that other oil-dependent economies do not have that luxury.

Some energy analysts say Saudi Arabia is reluctant to curtail production because other nations may not follow suit, causing the Saudis to lose market share. Others say the monarchy’s strategy is to corner the market and squeeze out the competition, including the burgeoning shale industry in the United States, where it is far more expensive to drill for shale oil than traditional crude. Experts speculate that Riyadh is also willing to sacrifice profits in order to sabotage Iran as it seeks to boost production in the wake of the nuclear accord and partial lifting of Western sanctions.

While Saudi Arabia, the Middle East’s largest economy, keeps prices low to gain market share, Iran’s flagging economy forces it to boost prices. Both nations have had to make serious changes in recent years — either regionally or domestically — to avoid implosions from within.

“Iran’s resources are [less], but its costs are lower too, while the Saudis have more resources and higher costs,” Saeed Ghasseminejad, an associate fellow at the Foundation for Defense of Democracies who specializes in Iran’s economy and politics, told The Washington Diplomat by email. “So the question is which one is exhausting its resources at a higher rate and which one can tolerate a lower level of resources without imploding.”

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Photo: Eugene Sergeev / Fotolia
A group of large fuel tanks sits at the Ras Tanura oil terminal in Saudi Arabia, which maintains the world's largest crude oil capacity and is its largest exporter of total petroleum liquids.

Saudi Arabia is believed to have 266 million barrels of proved crude oil reserves alone. Iran, meanwhile, is estimated to have 157 billion barrels of crude oil reserves, according to the Organization of the Petroleum Exporting Countries. The U.S. Energy Information Administration says Iran holds the world’s fourth-largest proven crude oil reserves and its second-largest natural gas reserves. Saudi Arabia maintains the world’s largest crude oil capacity, is the largest exporter of total petroleum liquids in the world and holds its fifth-largest natural gas reserves.

For years, Saudi Arabia was the greater power in the Middle East out of the two nations, while Iran’s economy staggered along for the last decade. Despite having an educated and diverse population, economic sanctions hit Tehran hard. Saudi Arabia, on the other hand, was buoyed by high oil prices. But that status quo threatens to be upset in the near future as oil prices continue to tumble.

Low oil prices have affected Saudi Arabia, though it is better positioned to weather the storm. The country is the world leader in oil production, currently manufacturing nearly 12 million barrels per day. Oil reserves are estimated to be anywhere from 260 billion to 712 billion barrels, depending on who you believe. Riyadh also enjoys a sizable sovereign wealth fund.

“The Saudis have a full coffer of money, which Iran does not,” Ghasseminejad pointed out. “As a result, the Saudis may be able to tolerate the low oil prices for a longer period of time, relying on their reserve money.”

Plummeting oil prices have taken their toll, however, blowing a hole through the monarchy’s finances. A growing budget deficit is forcing the kingdom to dip into its reserves and cut back on the generous subsidies that Saudis have come to expect — which some fear could spark social unrest.

The Saudis have also struggled to diversify their economy, with oil funding the bulk of the country’s revenue. In addition, unlike Iran, Saudi Arabia’s alliances are often less ideological and more financially driven. If oil reserves run dry, so too will much of Riyadh’s regional support and clout.

Iran is also in a precarious state, suffering heavily from nuclear-related sanctions on its oil exports since 2012. Iranians, however, are used to high inflation rates and international condemnation. The Islamic Republic’s leaders have propagated the term “resistance economy” to rally local support and insulate the country from external pressures.

“This helps Iran to feel less pain, compared with Saudi Arabia, which had to expand its social welfare program significantly following the Arab Spring and is not used to low oil income,” Ghasseminejad said. “Another factor in favor of Iran, in its regional war against the Saudis, is the low operating cost of Iran’s military forces. Iran is using the Shiite population of Afghanistan, Iraq and Lebanon. In general, Iran’s model is a low-cost one as it is based on ideology.”

Iran, however, does face a number of challenges. The energy industry there is aging and doesn’t have the proper infrastructure to maintain it. Despite holding the largest gas reserves in the world, Iran still imports gas from abroad, Ghasseminejad noted.

Going forward, the situation may start to look up for the Iranians though. The economic boost from the recent nuclear deal could potentially inject Tehran with a major infusion of cash, both from the release of frozen assets (anywhere from $50 billion to $100 billion) and the lifting of sanctions. Those sanctions have cut Iran’s output from 2.5 million barrels of oil a day to 1 million barrels since 2012.

According to the International Monetary Fund, suspending sanctions will see Iran increase its oil production from 500,000 to 800,000 barrels a day in just two years — a dramatic rise that could replenish Iran’s depleted coffers. Iranian officials have offered even more optimistic forecasts, saying they hope to boost production by 1 million barrels a day within six months.

“If the international sanctions on Iran [are] lifted, Iran can both increase its oil export and absorb international investment, which both would help its economy at the time of low oil prices,” Sara Vakhshouri, a nonresident senior fellow with the Atlantic Council who specializes in energy security and geopolitical risk with a special focus on Iran, told The Diplomat.

A flood of Iranian oil into an already-saturated market could exacerbate the geopolitical tug of war with Saudi Arabia. But the clerical regime in Tehran is keen to show its people tangible benefits from the landmark diplomatic accord that curbed Iran’s nuclear program in exchange for sanctions relief. Proponents of the deal say it will help Iran come in from the cold after years of isolation, rebuilding its tattered economy and potentially sidelining hard-liners who opposed the deal.

Critics say it will help finance Iran-backed terrorist groups such as Hezbollah, allow Iran to go on an arms-buying spree and possibly jeopardize efforts to hold peace talks to end Syria’s civil war by emboldening its embattled president.

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Photo: By Nora.alsh2 - Own work, CC BY-SA 4.0
Riyadh's Kingdom Centre skyscraper is seen against the Saudi capital skyline.

Either scenario — a resurgent, responsible Iran or a trouble-making one — rankles the Saudis, who fear Iran’s rise will come at their expense. In response, a new generation of Saudi leaders is adopting a more aggressive, muscular approach, beefing up the military and ramping up support to proxies in Syria and elsewhere.

“To fill what the Saudis see as a power vacuum that the Obama administration left in the region, they went to war in Yemen against Houthi rebels, whom they accuse of receiving Iranian backing,” wrote Kim Ghattas in a Jan. 13 Foreign Policy article. “Although the war has proved disastrous and never-ending, Riyadh has refused to relent — recently announcing another counterterrorism coalition of Muslim countries that excludes Iran. The kingdom has also hired Western consultants to help revamp and modernize its armed forces and develop the Sunni coalition.”

In addition to Shiite expansion, Saudi Arabia is grappling with a number of other pressures — among them, uncertainty over the handover of power in the House of Saud and fears that the United States is abandoning its traditional allies in the region.

“Things are not going particularly well in the kingdom when you’ve got falling oil prices and budget deficits and a very difficult conflict in Yemen and lack of success in Syria and a potential transition coming up,” said Philip Gordon, a senior fellow at the Council on Foreign Relations (CFR), in a recent media conference call. “Saudi Arabia has an interest in reviving sectarianism and showing that they’re going to be the stalwarts in standing up to it.”

CFR Senior Fellow Ray Takeyh added that the potential for the conflict to escalate is very real.

“I don’t know how it ends, but the tension between the two states is likely to continue,” he told reporters. “And I think you’ll see it not so much in direct confrontation between them, but you’ll see it as they’ve tried to empower their surrogates, they’ve tried to empower their proxies. It will contribute to further radicalization of the region’s political culture and further polarization of the sectarian sides in the region.”

Other experts say fears of a full-blown sectarian clash have been inflated. They cite the fact that Iran has more to lose in any confrontation, as well as the fact that the two countries have a long history of squabbles and détente.

“A sectarian strategy doesn’t make sense for Iran,” said Karim Sadjadpour of the Carnegie Endowment for International Peace, noting that over 80 percent of the region’s Muslims are Sunni. “If you are trying to be the dominant power in the region by waving a Shiite flag, you’re not going to get a lot of people.”

Sadjadpour spoke with his Carnegie colleague Frederic Wehrey in a January conference call in which Wehrey agreed that the adversarial relationship has experienced its share of ups and downs but always managed to pull itself back from the brink.

Wehrey said “we’ve seen this sort of spat before,” adding that Iran and Saudi Arabia are “not inherently historical antagonistic sectarian rivals but rather strategic competitors.”

“If you look at the entire span of Saudi-Iranian relations, there’s always been a degree of coordination and perhaps back-channel dialogue even when they’ve been at each other’s throats on a number of regional issues,” he said. “So my conclusion is that this spat will eventually if not settle down, reach some sort of equilibrium.”


About the Author

Justin Salhani (@JustinSalhani) is a contributing writer for The Washington Diplomat. Anna Gawel (@diplomatnews) is the managing editor.

Last Edited on March 8, 2016