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The Saudi Arabia-Iran Hurt Locker – A War Fought with Oil Prices

Gulp. Just when you thought you’d seen every possible thing happen in the world of oil, it goes and does something it’s never done before. Last week amid the growing tension between Saudi Arabia and Iran, oil prices hit a 14-year low – dropping to $34.27.

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Traditionally any sort of crisis in the Middle East would have sent prices skyrocketing, but not now. Some say relations are as poor as they were during the 1980s war, and certainly it’s generally accepted that people have never seen OPEC in such disarray. That’s why the lack of traditional market reaction is so surprising. The Strait of Hormuz, described by CNN recently as the world’s most important oil chokepoint, lies close to the warring parties and Oppenheimer’s Fidel Gheit didn’t mince any words when warning that, “You cannot afford to disrupt oil supply from this part of the world – not at any time.”

There were difficult relations between the two countries in 2015 as Washington and Tehran appeared to be warming towards each other during the talks process. Saudi did not watch with joy as the West appeared to find a path to better relations with Iran with the historic nuclear deal. It will eventually see the lifting of sanctions and enable Iran to do what it does best – produce oil. Tehran has long stated that it intends on working towards pumping as much oil as it can manage, which would cause further problems for Saudi’s rulers who are facing considerable strife at home as a result of the ongoing price war. The Kingdom has been forced to consider some particularly unpopular revenue growing initiatives.

While Saudi certainly does not want to see low prices continue indefinitely, it enjoys other benefits by perpetuating the situation for now. James Schumm from Oppenheimer recently sent a note to clients in which he outlined one significant impact of low prices: “Though low oil prices hurt Saudi Arabia, they negatively impact Iran in a much greater way and it crimps Iran’s ability to fund sectarian uprisings in Saudi Arabia’s backyard. Essentially, they are forcing Iran to choose between higher oil prices and the economic prosperity that comes with it, and the desire to foment Shia uprisings in the Middle East. In essence we believe Saudi Arabia and Iran are fighting a war without tanks and jets but one with oil prices.”

The war in Syria and internal wranglings in OPEC played their part but it was the beheading of a Shia cleric by Riyadh that “unleashed a torrent of anger” from Tehran and brought us to the edge of what could erupt into an all-out conflict.

Iran’s reaction to the killing of Nimr al-Nimr (along with 45 other people in one fell swoop) – within hours protesters had sacked and set fire to the Saudi embassy in Tehran – is not doing it any favours and has led to questions about how strategic this entire situation is. The Guardian says, “Some analysts think the move was intended to reinforce Saudi Arabia’s alliances by reminding western nations where their core interests lie in times of turmoil.” It seemed to work – a number of countries – Bahrain and UAE as well as Sudan – followed Saudi’s lead and downgraded (note did not cut absolutely) ties with Iran.

Saudi is fighting on almost every front – domestically with the new ‘austerity’ measures (though when you consider it will remove subsidies for things like motor fuel and other domestic energy products it’s not quite the austerity we’re intimately acquainted with!), in the region with Iran, within the OPEC group of oil producers as it aims to continue with the price war and internationally with US producers. Looks like RBC Capital Markets’ Helima Croft hit the nail on the head when she said, “2016 could prove to be the year of living dangerously for Saudi Arabia.” But what it means for the price of oil is anyone’s guess..