The bitter rivalry between Saudi Arabia and Iran escalated to a new stage over the weekend, on the Saudi execution of a popular Shiite cleric. The resulting riots throughout the region led to Saudi Arabia's embassy in Iran being burned down, and Saudi Arabia severing diplomatic and commercial ties with Iran.
Recent developments hint that, while the Saudis do not want to get into a shooting war with Iran that would likely spark rebellion among the Shiites in eastern Saudi Arabia, they preparing a "nuclear option" to choke off any hope Iran has of reentering the global oil market in a meaningful way.
What's Causing the Riots?
The Shiite cleric who was beheaded along with 46 others was Nimr Baqr al-Nimr. He called for better treatment of the kingdom's Shiite minority, and was a leader in the failed Arab Spring movement in Saudi Arabia. His belief that persecuted Shiites in the oil-rich eastern province of Saudi Arabia had the right to secede is what landed him on death row. He was very popular with Shiites throughout the Persian Gulf region and beyond, with protests upon the news of his death reaching as far as India.
Over The Tipping Point
Nimr's execution was the straw that broke the camel's back, in a region where Saudi Arabia was fighting proxy wars with Iran in Syria and Yemen. The Sunni - Shiia divide has burst wide open, a very real threat to the Sunni-owned Persian Gulf monarchies. Each has a sizable Shiite minority, with Shiites forming the majority population of Bahrain.
An Iran that has international sanctions lifted, is an Iran once again flush with oil money. It will have plenty to spare to foment Shiia unrest against these hereditary rulers, hoping to trigger a second "Arab Spring."
Nuking Them With Oil
The Saudi plan is to flood the market with even more oil, before international sanctions against Iran are lifted. The Saudis have already declared that they will no longer set production limits on crude production. The Saudi oil minister told reporters last week "We no longer limit production. If there is demand, we will respond. We have the capacity to respond to demand." Similarly, the CEO of Saudi Aramco, the state-run oil company, said "Saudi Arabia more than anyone else has the capacity to wait out the market [of low oil prices]"
This was initially done to deliver the finishing blow to high-cost US shale drillers and North Sea oil, but will certainly be expanded to take Iran's share of the market as well. Iran is expecting to have international sanctions against it lifted as early as next month, allowing it to once again export oil to global markets.
To head this off, Riyadh cut the price of Saudi oil to European customers this week, as Iranian oil officials were touring EU countries attempting to land new contracts with old customers.
Holy Collateral Damage, Batman!
News of the price cuts for Saudi oil in Europe contributed to a sharp decline of over 5% in oil futures Wednesday. Both West Texas Intermediate and Brent crude fell to 11-year lows near $34 a barrel. The moves by Saudi Arabia aren't just affecting Iran and US shale companies.
This could bring about a showdown at a rumored emergency meeting of OPEC in February. The small oil exporters, who were already forced to drastically cut public services with an oil price of $50 a barrel, may find an ally in Iran. Falling oil prices have put the existence of governments from Venezuela to Nigeria in doubt, as catastrophic declines in oil revenue has meant vital social services have been cut.
On the other hand, the Gulf oil monarchies have fallen into line behind Saudi Arabia's decision to drown all competitors in cheap oil. They believe (probably correctly) that Iran is supporting Shiite agitators in their Sunni kingdoms. They will be more than happy to cripple Iran, even if it means throwing their smaller "allies" under the bus. The recent decision by Saudi Arabia to remove all caps on production only reinforces the belief of the smaller exporters that the Gulf Arabs are cheerfully willing to watch their governments collapse, as long as they survive to reap the profits.
What Could Go Wrong? Plenty.
While it may seem that Saudi Arabia is sitting in the catbird seat , even the kingdoms of billionaire oil sheikhs can go bust. Saudi oil not only fuels one of the most pervasive welfare states in the world, but it funds a worldwide network of Wahhabist religious schools and mosques, and props up the governments of Egypt and Yemen. The Saudis are also the world's largest spending on military defense, proportionately, spending 11% of GDP on its military. This doesn't count the money flowing to Sunni militias in Syria and Yemen. That's one huge pile of obligations.
The IMF says that Saudi Arabia will completely drain its cash reserves in five years at the current pace of deficit spending. It wasn't supposed to be this way. The US shale producers , offshore oilfields and Russia were supposed to have knuckled under by now. Instead, they are still hanging tough, and the Saudis have run up the largest deficit in the kingdom's history -- $98 billion, 15% of GDP. The budget deficit for 2016 is calculated to not be much less.
The war machine must remain funded, so for the first time in modern history, domestic subsidies and benefits are being cut. One that particularly shocked the Saudi consciousness was gasoline prices rising by 50%. That's not as bad as it sounds. Gas went from 16¢ a liter to 24¢ a liter (61¢ a gallon to 91¢ a gallon.) Water and electricity subsidies will be cut next. Spending on roads and other infrastructure have also been cut. With 90% of all Saudis working for the government (and making good salaries,) these cuts will mean more people out of a job during an economic slowdown.
Playing With Fire In The Oilfields
Saudi oil has bought off dissent and calls for democracy for many decades. Some of the benefits Saudis enjoy are free health care, free education, no income tax, no sales tax, and interest-free loans for homebuyers and entrepreneurs. A recent addition has been unemployment benefits (added after quelling the "Arab Spring" movement in the kingdom.)
Cutting these benefits are a breach of the unspoken social contract between the people and their rulers: "We live under Sharia law with no representation, and the kingdom provides for us." With unemployment now running above 12%, this is the worst time to be taking away the largess that ordinary citizens believe is their right.
On the other side of the Persian Gulf, Iranians have lived with hardship for years. This time, the ayatollahs can point at the "decadent" Saudis as the reason.
What's the Endgame?
While cheap Saudi oil may keep the Iranians from recovering quickly from years of sanctions, Tehran will once again (with the help of the Russians) be a force in the global oil market, and an even larger force in the ancient Shiite - Sunni conflict (expect increased funding for Hamas and Hezbollah.) The Arab oil sultans better hope for a rebound in prices soon, to keep unrest contained at home.
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