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Saudi-Iranian Tensions — Economic Effects and Political Consequences

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Iranian oil workers on Kharg Island in the Persian Gulf, February 2016. Kharg Island provides a sea port for the export of oil and extends Iranian territorial sea claims into the Persian Gulf oil fields. Photo Xinhua/Ahmad Halabisaz.

Historically, Saudi Arabia and Iran have not stood head-to-head; both countries were highly valued allies of the United States in the 1970s, under the US Twin Pillar Policy, and both were amongst the five founding members of the Organization of Petroleum Exporting Countries (OPEC), established in 1960.

Disagreement about whether to increase oil prices in 1979 started the rift between the two nations. The Iranian Revolution, Saudi Arabian support for Saddam Hussein during the Iraq-Iran war, and accusations of Iranian involvement in the Khobar Tower bombings did nothing to reduce hostilities. Recently, the execution of Shiite preacher Nimr al-Nimr in January 2016 sparked tensions, which some believe to have been intentional and which led Saudi Arabia to break off diplomatic relations with Iran.

Friction between the two countries had already resurfaced in July 2015, when the P5+1 reached a nuclear deal with Iran, and sanctions relief was forecast. Saudi Arabia’s response to the signing of the deal, while not as loudly oppositional as Israel’s, was not positive. US-Iranian rapprochement, one of the possible outcomes of the nuclear deal, feared by the Saudis to affect US-Saudi relations, is an unwelcome development and a strategic threat.

The main reason, however, was related to the economic consequences for Saudi Arabia and other Gulf nations of Iran’s full reentry into the oil market. Saudi Arabia has been OPEC’s top producer since its establishment, and Iran was the second largest producer until the 2012 sanctions were imposed. The effects of the lifting of sanctions on Iran’s oil output were feared to have a critical impact on the Saudi position in OPEC.

Thus, while several factors played into the historical deterioration of relations between the two regional powers, oil was the main cause.

On 16 January 2016 the International Atomic Energy Agency confirmed Iran’s completion of the preparatory steps of the nuclear deal. This so-called Implementation Day was followed by the lifting of EU, US, and UN sanctions, specifically those banning private investments and restricting oil exports. Iran announced its intention to “hike sales by 500,000 barrels the day after sanctions are lifted and increase total exports to around 2.5 million barrels [per day] within 2016.” Subsequently, as Saudi Arabia had feared, oil prices fell to $28 a barrel. While oil prices had already been low due to flooded markets and Chinese economic problems, this nadir has not been seen since 2003.

Analysts say that it could take more time to feel the full effects of Iran’s return to the oil market. Meanwhile, Saudi Arabia —especially its people— is already afflicted by the price drop. As the government faces budget deficits, social programmes and perks, such as scholarships, are being (pre-emptively) downsized or eliminated.

Oil prices have been hovering around $31-33 a barrel since 1 March 2016. While still far from the 2015 highest selling price of $62 a barrel in May, the dramatic consequences to the nuclear deal as expected by Saudi Arabia have not yet materialized, months after Iran reestablished a full presence in the market. Iran has not “flooded the market,” selling only about 4 million barrels to Europe from mid-January to mid-March 2016. Though there seem to be legal complications, the lack of buyers flocking to Iran to buy oil is due mainly to its inflexibility in terms and pricing.

Even so, Saudi Arabia felt it necessary to take steps to further slow Iran’s oil exports. Iranian oil vessels are reportedly not allowed to enter ports through Saudi Arabia or Bahrain. Saudi Arabia has not officially given notice of this ban, but Iran has blamed part of its difficulty selling oil on this message being spread by ship brokers and traders. As a result, the tensions reach further than the oil or economic sphere, and become geographical.

More importantly, the friction between the two countries influences their foreign policies. Religion alone is not to blame for the troubled relationship between the two regional powers, but Shiite Iran and Sunni (Wahhabi) Saudi Arabia do have fundamental differences on religion, which trickle down to their regional policies and choice of allies. This does not mean that religion plays no role in the countries’ relationship and actions, as demonstrated by the execution of Nimr al-Nimr in January 2016.

Iran’s support for the Sunni Palestinian organization Hamas proves that the main driver behind Iran’s choice of allies is not religion alone. Intensified involvements in conflicts such as Syria have been increasingly strategic. In Saudi Arabia’s case, support for Syrian rebels is driven by its wish to rob Iran of one of its few Arab allies.

While Yemen is also viewed by some analysts as the site of a proxy war between the two powers, Iran’s involvement in the Yemeni war is highly overrated. Though it is obvious whose side Iran is on—that of the Houthi rebellion—its support has been limited, being described as opportunistic and extending, at most, to arming the Houthis. Saudi Arabia, on the other hand, has launched a full-fledged offensive against these so-called “agents of Iran,” with the support of the United Arab Emirates, Bahrain, and other Sunni states.

Over the years, these proxy conflicts had been the main arena in which Iran and Saudi Arabia confronted each other (indirectly), and the negative impact barely affected the two countries themselves. Following the lifting of sanctions on Iran, the consequences of the economic face off are felt by both nations, and, most importantly, their populations. Compromise seems to be the only solution. The only way to prevent a further drop in oil prices would be for OPEC to intervene, pushing through the “output freeze,” with Saudi Arabia and Iran seeing eye to eye. This would not only be economically beneficial to the antagonists but would also assist in reaching a long-term solution to the Syrian and Yemeni conflicts.