Amid Tensions With Saudi Arabia, Grim News for Iran’s Economy

The devolution in relations between Saudi Arabia and Iran could easily evolve into an economic war—with the advantage to Riyadh.

The Saudis and Iranians are longtime rivals for regional dominance. They are fighting proxy wars in Syria and Iraq, as well as in Yemen, with the Sunni kingdom leading the military campaign against the Iranian-backed Houthi rebels. Amid the conflicts outside its borders, Saudi Arabia has been cracking down on dissent from restive Shiite citizens. It executed a prominent Shiite cleric, Nemer al-Nemer, on Saturday, along with 46 others–mostly Sunnis–accused of participating in al-Qaeda terrorist attacks in the kingdom. 

After Iranians protesting the sheikh’s execution set fire to the Saudi embassy in Tehran, the Saudi government severed diplomatic and commercial relations with Iran and banned citizens from traveling there. Saudi allies Bahrain and Sudan have also cut diplomatic ties with Iran; the United Arab Emirates and Kuwait have withdrawn their ambassadors from Tehran. Tensions are high, and the Saudis have their own long-term financial concerns–the kingdom has been running deficits and cutting back on government subsidies–but still have strong advantages to deploy against Iran.  

As Congress targeted Iranian oil exports with sanctions between 2011 and 2013, Saudi Arabia increased its oil production to head off a spike in prices–a critical step. Iranian oil sales fell from 2.5 million barrels per day to about 1 million by the end of 2013, and its oil production plunged from 3.7 million barrels per day in 2011 to 2.8 million in November 2013. Oil prices have declined precipitously, which meant that sanctions hit Iran’s economy all the harder.

The crippling effect of the sanctions contributed to Iran’s willingness to make the deal with global powers last year over its nuclear program. Iranian officials are banking on sanctions relief facilitating a return to oil markets and massive foreign energy investment, both of which would help rescue its battered economy and soothe a frustrated population. 

That’s part of the reason Saudi Arabia opposed the nuclear deal. Together with increased U.S. shale production, the recent spike in Saudi oil production–from 9.6 million barrels per day in November 2014 to 10.2 million barrels per day one year later–has ensured that Iran will return to a depressed global oil market. Crude oil prices are around $37 a barrel, roughly a third of the rate when sanctions were imposed in January 2013. Tehran would have to sell about 7.5 million barrels a day to return to pre-sanctions revenue levels. That’s well beyond the 1.8 million barrels per day in sales and the 3.4 million to 3.6 million barrels per day in production that the International Energy Agency estimates that Tehran could reach within six months of sanctions being lifted.

And those projections may be optimistic if European and Asian energy companies slow-walk their investments in Iran’s energy infrastructure, which is badly damaged from the loss of capital and technology driven away by Western sanctions. So long as Riyadh is willing to run budget deficits to keep oil prices low, Tehran will get only about half of the oil price to which it pegged its budget last year.

Another economic weapon Saudi Arabia can deploy involves its hundreds of billions of dollars in overseas foreign holdings. The Saudis have significant influence at foreign banks and with foreign investors and could threaten to pull funds from entities doing business with Iran. Many institutions already worry that sanctions enforcement will become more aggressive after the Obama presidency ends. A Saudi threat could keep them further sidelined.

Through the nuclear deal, Iran found a way to free itself from U.S. and European economic pressures. But the Saudis have their own instruments of economic warfare. Whatever happens next, the fiscal picture for Iran could quickly become more grim.

Mark Dubowitz is executive director of the Foundation for Defense of Demorcracies and head of its Center on Sanctions and Illicit Finance. Follow Mark on Twitter, Facebook, and LinkedIn.