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How Will The Saudi-Iranian Conflict Affect Oil Markets?

The recent Saudi-Iranian clash is unlikely to affect oil markets for now, but the redistribution of political power between Saudi Arabia and Iran, along with the US disengagement from the Middle East might have long-term consequences for the region’s stability and global oil supply trends.

The recent outburst of hostility between Saudi Arabia and Iran only confirmed the true extent of animosities between the two most powerful political and religious players in the Middle East.

The conflict is not new, and in its modern form has lasted ever since the Shia clerics won power in Tehran in the 1979 Iranian revolution. But the context has changed since the days of Khomeini. The Middle East is a much more fractured place today, and the sectarian division between the Shia and the Sunnis is currently ripping apart Syria, Iraq and Yemen. This is partly a consequence of the US-led intervention in Iraq in 2003 that toppled the secular regime of Saddam Hussein, but also of the Arab Spring, which brought new dynamics to the Middle East.

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Distribution of Shia and Sunni communities in the Middle East. Source: FT.

In terms of oil geopolitics, Iran and Saudi Arabia have immense geological and geographical importance. Saudi Arabia has the second, and Iran the fourth, largest global reserves of oil. Combined, they hold around a third of the world’s proven reserves of conventional oil. In addition, both Saudi Arabia and Iran share the coasts of the Persian Gulf, with Iran controlling the strategically important Strait of Hormuz with its daily oil flow of 17 million barrels, which makes up around 20% of oil traded worldwide.

Daily transit volumes through world maritime oil chokepoints

Daily transit volumes through world maritime oil chokepoints

The recent clash over the execution of Sheik Nimr al Nimr did not have a tremendous effect on oil prices. Despite an immediate 4% increase, oil prices soon returned to below $36 levels. Unless the conflict spirals out of control and directly affects the oil production and infrastructure in the area, it is unlikely that the discord will have a major effect on oil prices in the short term. But there might be long-term consequences. Saudi Arabia is traditionally wary of its Shia minority in the Eastern parts of the country where, coincidentally, lie the country’s largest oil fields. Iran will most certainly try to take advantage of the grievances within the Kingdom’s Shia community. 

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Direct conflict would undoubtedly disrupt both the oil markets and global economy, with oil prices rocketing to new heights. However, the immediate victims of the potential halt of oil exports from the Middle East would be China and other Asian countries. At the moment, 66% of Asia’s total oil imports come from the Middle East, making Asian economies extremely vulnerable to any disruptions in the region.

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Source: IEA

Another important geopolitical shift is related to the US shale revolution. At the moment, the US imports 20% of its oil requirements from the Persian Gulf, and almost all of it comes from Saudi Arabia and Iraq. Despite the significant overall decline, imports from the Gulf remained steady at around 20% and haven’t changed much over the past decade. But with the rise of shale, the dynamics has changed: America now has a choice, and it is less susceptible to the volatilities of Middle Eastern politics.

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Paradoxically, the conflict and its effect on prices, together with the recent decision to allow unrestricted exports of crude oil from the US, would be a life-saver for the US shale sector. This sector is on the verge of bankruptcy due to the global oil glut caused by Opec’s decision to pursue unrestricted production.

Although it is unlikely that the White House will make a dramatic and sudden shift in its Middle Eastern policy, energy independence gives Washington more freedom to pursue its interests in the region, which include the potential reassessment of its relations with Riyadh. The Saudis reluctantly acknowledged the Iranian nuclear deal as a sign of a potential US détente with Tehran. Washington is also not happy with the Kingdom’s continual promotion and export of the ultra-conservative Wahhabi brand of political Islam.

The United States will remain heavily present in the region, but we will not see anything similar to 1991 and 2003 military interventions any time soon. US disengagement will force the Middle Eastern players to reassess their current roles and strategies, both in terms of military and political engagement. In this context, the Saudi-Iranian relationship will continue to play a crucial role in preserving or destroying the already fragile political stability in the region.

 This article was originally published by Global Risk Insights and written by GRI analyst Ante Batovic