Saudi Arabia announced on Sunday that it has broken off diplomatic ties with Iran. This comes amid a row over the execution by Saudi Arabia of a prominent Shia Muslim cleric.
To be clear, tension between the two nations is nothing new, they have been in a de-facto Islamic Cold War since 1979. However, the pseudo war between Islam’s largest sects – the Shia’s and Sunni’s – in the Middle East, centred on Syria has heightened tension between the two nations. Iran’s return to the international community following successful talks to end its nuclear program have only served to stir the pot even further.
The reaction on the Saudi equity market was sanguine today (Sunday) with the overall index up 0.59% and energy and utilities down 0.69%. At the time of writing Brent crude opened up 2% higher at $38.35 per barrel.
Any knee jerk reaction in the price of crude is likely to be transitory. Geopolitical shocks tend to result in sharp price rises only to gradually settle back once it appears that no actual oil production has been affected. For Saudi Arabia that risk would appear to increase if protests start to appear in the Eastern Province of the country, the location of most of the richest oilfields and home to most of the Shia minority.
Based on previous bouts of tension between the two nations things are likely to get worse (a war of words at least) before they get better. The last time diplomatic relations were cut was in 1988, they weren’t restored until 1991.
Indeed the oil market may start to realise that there is now even less chance that the Saudi’s will accommodate the return of Iranian crude exports – scheduled to take place sometime before mid-2016. According to the Iranian oil minister Iran will raise exports by 0.5 million b/d within a week of sanctions being lifted and by another 0.5 million b/d within six months.
Any actual disruption to production needs to be seen in the context of a market that is already oversupplied by 2.5-3 million b/d and one where the new ‘swing’ producer, the US shale producers can rapidly bring new and existing (unfinished wells) to market.
The escalation in tensions between the two nations brings back in focus the risk tat geopolitical events can have on the oil market, even one which is currently facing massive oversupply. Indeed, its worth remembering that the Iraqi invasion of Kuwait in 1991 was at least partly triggered by the conditions in the oil market at the time – oversupply and low oil prices.