Published on July 11th, 2015 | by Henry Johnson3
The Future of Saudi-Iranian Relations Will Be Written in Oil
by Henry Johnson
Saudi Arabia’s cantankerous objections to nuclear talks with Iran have run counter to U.S. goals and have left some puzzled over the cause of its combative behavior. A deal with Iran, of course, means much more than a stride toward global non-proliferation. It will open new realms of possibility within both Iranian and American polities. It could, for example, lead to a shift in U.S. public opinion of Iran at the expense of the Gulf countries. Conservative elements in the U.S. cannot indefinitely call Iran the greatest threat since Nazi Germany while the administration relies on it to coordinate ground combat against the Islamic State.
In its worst nightmares, Saudi Arabia may find that it’s not only no longer the only sheriff in town but it has fallen in rank to that of deputy. If Western political attitudes regarding Iran indeed improve, the Kingdom will have lost a major supporter of its more contentious foreign policies, many of which have aimed at contesting Iranian influence. A tempering of U.S. vitriol toward Iran could even have prevented the U.S. from accepting the Saudi pretext for bombing Yemen, namely that the Houthis are Iranian-controlled proxies attempting to bring a Shia Islamic revolution to the Saudi backdoor.
What the Saudis do in the next year to their oil policy could determine the basic shape of their post-deal Iran strategy. Although the possibilities of how this deal could affect the future of the region are as endless as they are futile to predict, its impact on Iranian oil is nonetheless coming into view. Furthermore, the Saudi reaction to Iran’s energy aspirations will reveal the tenor of its strategy for coping with a post-sanctions Iran.
Post-Sanctions Iranian Petro
Iran will no doubt take advantage of sanctions relief to restore its diminished share of the oil market. Iran currently produces about 2.9 million barrels per day (b/d), down from the output of 3.6 million b/d it had reached in 2011, before the most onerous U.S. and EU sanctions took affect. Iranian exports of its crude oil stand at about 1.1 million b/d, or half its pre-2012 level. Iranian Oil Minister Bijan Namdar Zanganeh has outlined Iran’s short-term intention to use sanctions relief to boost overall production by 1 million b/d within “a few months.” He later announced a longer-term plan to produce an average of 5.7 million b/d by 2018.
Sara Vakhshouri, whose analyses of Iran’s energy sector have been featured on LobeLog, argues that the oil ministry has set its sights too high. She recently wrote, “Iran would probably be capable of adding up to 800,000 b/d of oil and liquids to its production in the next 6 to 12 months.” The decision to actually produce that amount will also depend on the timing of sanctions relief and the state of the market itself. Regardless, Iran will need access to international investment and technology in order to sustain and then expand this forecasted production capacity. Its aging oil fields are performing poorly in the absence of technically sophisticated injections of gas and water.
Vakhshouri estimates that since 2011, Iran has failed to meet more than 60% of its injection targets. She believes that Iran’s goal of reaching an output of 5.7 million b/d is overly ambitious. “It will take at least 3 to 4 years for Iran (from the time that it gets access to international investment and technology) to regain its pre-sanctions ‘crude oil’ production capacity,” said Vakhshouri. Since Iran’s production capacity hovered around 4 million b/d in the late 2000s, Iran could reasonably add a little over 1 million b/d in the first few years after an agreement.
The Saudi Response
Saudi Arabia will initially resist Iran’s production plans by continuing to flood the market with an oversupply of oil. This oversupply drives down prices and shaves off profits from all oil-producing countries. Yet it also advantages wealthier nations because they can outlast weaker ones and absorb greater shares of the market. Saudi Arabia will extend this policy for at least a few months after a deal. Perhaps, some Saudis hope, the deal will not stick and Iran’s economic and geopolitical position will not strengthen after all. But Saudi Arabia could change course and accommodate Iran’s reintegration to the market, as a panel of experts pointed out at the Woodrow Wilson Center last Thursday.
Jean-Francois Seznec, a fellow at the Atlantic Council, described a trend within Saudi Arabia that favors a transition to the refined oil products market, or, in industry jargon, downstream products. Such a transition would ease up the country’s crude output, thereby making space for supply from Iran and Iraq. “The civil service in Saudi Arabia,” he said, “has been trying to express the thought that they should not become so dependent on the production of crude oil. Their view is to take their energy and add value to it.” This added value would mean widening the country’s undersized sector of advanced jobs and skilled labor.
He added, “They have built a capacity today of 3.3 million b/d for their refined products, they’re using only 2.2 million b/d right now, but they’ll be producing 3.3 million b/d by the end of this year. They will now be exporting more gasoline and continuing their enormous development in chemicals.”
David Goldwyn, also a fellow at the Atlantic Council, agreed with Seznec’s analysis but questioned whether the country’s political leadership will pursue rational economic policy. “They have an enormous ability to sustain low prices for years, but it’s not really a long-term sustainable strategy,” Goldwyn pointed out. “How long do you drain those enormous reserves until you start affecting pension funds?” The country’s political leaders could overlook this calculus: “they have a very young leadership which has demonstrated potential for miscalculation, so I’m not predicting they will [change oil policy] but rationality suggests they should.”
Saudi princes face a choice between acting as if a deal never happened and accommodating an enlarged Iranian presence in both regional politics and world economics. Accepting Iran as an established regional power could yield benefits. In trade, for example, Iran has resources that Saudi Arabia needs. The former sits atop the world’s second largest deposits of natural gas while the latter spends exorbitant funds to avoid buying gas from it. In Syria, Iran holds the key to defeating the Islamic State, while Saudi Arabia holds the key to fostering an acceptable Islamist opposition. Cooperation in either field is probably many years away, if it’s even possible. But a Saudi shift in its oil policy will signify a first step toward constructing a better Middle East than the one both countries have suffered under since the 2011 sanctions started.
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