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Saudi Arabia, a Diminishing OPEC and an Ascending Iran

Monday, February 1, 2016

Lindsay Hughes, Research Analyst, Indian Ocean Research Programme

Key Points

*Saudi Arabia faces a raft of internal and external challenges that could collectively bring down the House of Saud.

*External challenges include falling oil prices, being bogged down in proxy wars in Syria and Yemen, increased competition for energy markets from non-OPEC countries such as Russia, the return of post-sanctions Iran, its competitor for regional influence and, arguably most importantly, its fading relevance to a West that has its own newly-developed energy resources.

*Internally, Saudi Arabia faces reduced water availability, problems over the succession to the throne and a lack of employment opportunities for its growing youth population.

*It could, therefore, adopt the Iranian stratagem of initiating a nuclear programme in order to force the West to pay more attention to its needs, to retain its leadership in OPEC and regionally, and to once again regain its standing internationally.

Summary

Saudi Arabia faces a raft of internal and external challenges. These include falling oil prices, its inability to gain traction in its proxy wars in Yemen and Syria, its adoption of energy policies that have tended to alienate other Organisation of Petrol Exporting Countries (OPEC) members, the return of Iran to the international community after the lifting of sanctions against it and internal issues such as dwindling water resources, a lack of employment for its youth and growing strife within the House of Saud regarding a successor to King Salman.

These challenges could cause Riyadh to adopt a nuclear policy that seeks to emulate that of Tehran: adopting an aggressive stance that will force the West to negotiate with it in order to stave off a nuclear race and keep nuclear weapons at a minimum – if not at a standstill – in the region and thus regain its standing in OPEC, regionally and with the West. This reasoning could, however, prove very dangerous for the region and for Saudi Arabia itself.

Analysis

Saudi Arabia has previously been likened to a wealthy passenger in the back seat of a limousine; it does not actually steer the vehicle but, nevertheless, commands it. Riyadh has made it a point over the last few decades to increase its regional and extra-regional influence very quietly and with the knowledge that it possessed sufficient wealth to achieve its goals. That wealth stemmed from its oil resources. Saudi Arabia was, until fairly recently, the world’s largest exporter of oil. It more or less determined oil prices internationally through its de facto mouthpiece, OPEC, and brooked little dissent. It is estimated that the kingdom holds around 25 per cent or 261 billion barrels of proven reserves. It is, however, totally dependent upon its oil exports and is, therefore, not above ensuring that countries around the world remain dependent upon oil to fuel their economies for as long as possible.

Since the early 2000s, however, non-OPEC Russia has increased its oil production annually and encroached on Saudi market share. If that was not annoying enough, Russia remained a non-OPEC member and refused to be dictated to by Riyadh. Little wonder, then, that when Russia entered the war in Syria, it was speculated that while it did so to retain its presence in the Eastern Mediterranean, it also aimed to further prosecute its undeclared oil price war against the Saudis.

Russia is not the only problem that the Saudis face. Their greatest dangers stem from within. In 2014, when oil prices were around US$100 a barrel, Riyadh decided to block OPEC’s suggested oil cuts and increased its production of oil so as to engineer a fall in the price to around US$80. It reasoned that because of its foreign exchange reserves of more than US$750 billion, it could withstand the lower price for a few months, during which time its competitors (read Russia, the US with its new fracking technology, Canada with its oil sands, Iran and sundry others) would have to toe the Saudi line.

The gambit worked – but unexpectedly so. Oil fell from around US$115 in June 2014 to around US$30 today. The Saudis had failed to recognise the signs of the economic slowdown in China, one of their largest customers. According to the International Monetary Fund’s September 2015 report, Saudi Arabia needs oil to remain at US$106 per barrel in order to break even. Its foreign exchange holdings, consequently, have reduced by around US$10 billion a month in order to meet its expenditures, leading the IMF to warn that the country could go broke in five years unless it cut its costs.

King Salman, however, cannot acquiesce to that requirement. The House of Saud buys the compliance of its citizens. Thus, when a fruit vendor in Tunisia, Tarek el-Tayeb Mohamed Bouazizi, immolated himself and unwittingly set off the Arab Spring in 2011 that eventually overthrew the Tunisian and Egyptian regimes, the Saudis spent an estimated US$130 billon in raising wages, enhancing services and providing jobs. These initiatives, however, have further reduced the country’s foreign exchange reserves.

Again, hoping to stabilise Yemen and retain a Sunni leader in power, Saudi Arabia entered the hostilities there with air strikes and a naval blockade. It believed that with the backing of the US and Pakistan, its close ally, the fighting in Yemen could be ended in short order. In January, there is no sign of achieving this outcome; in fact, there is every indication that Riyadh has become bogged down in Yemen and is accused of war crimes, while at least 5,600 people have been killed and the conflict has allowed Islamic State (IS) and al Qaeda to establish footholds there.

Saudi Arabia supports many of the various groups that seek to rid Syria of Bashar al Assad. When the 2011 anti-Assad demonstrations occurred, Riyadh believed Assad’s downfall could happen in a few months and, along with him, Iran’s hopes of escalating its influence in the region. That reasoning, too, was flawed. Internally, many of Syria’s minorities like the Christians, Shi’ites and Druze, preferred the devil they knew to the worse evil of IS. The civil war in Syria has now dragged on for four years. Worse, the unwavering Saudi demand that Assad must go only brought Iran and Riyadh’s energy nemesis, Moscow, into the picture. President Putin has virtually taken over the situation from his US counterpart, launching air and missile strikes against Islamic State fighters and making himself a hero to the Syrians who are fighting IS.

Just as in Yemen, Riyadh finds itself bogged down in Syria. To turn away now would be to concede defeat to its arch-enemy, Iran. Post-sanctions Iran is champing at the bit to get its own energy production up and fully running. Its officials have already made overtures to Beijing to purchase more energy in addition to the natural gas being piped to China via Pakistan. This is especially galling for Riyadh. Enmeshed in Syria, it is now in danger of losing a major purchaser of its oil to Iran.

Just when it seemed things could not possibly get any worse, Riyadh is reported to be planning a war of attrition against Russian oil, it is fast running out of water, its agriculture is jeopardised, youth unemployment is close to 30 per cent and, just to complicate an already complex situation, IS has called for the liberation of Mecca, thus throwing into further question the legitimacy of the House of Saud.

Given these factors, it is hardly surprising that eight of King Salman’s eleven brothers wish to oust him. Salman’s reported battle with Alzheimer’s disease (some sources say he is battling cancer) only adds to their urgency. It is perhaps in recognition of this that Salman is reported to want his son, Prince Mohammed, who is the deputy crown prince, to be his successor. To achieve this, however, would entail deposing the current crown prince, Prince Mohammed bin Nayef. This has led to a great deal of strain within the palace.

The House of Saud is now a house divided and a house divided is one weakened. No matter who its future ruler may be, Saudi Arabia faces a host of crises, internal and external, and is in every danger of becoming a failed state. Oil, the mainstay of its economy, is believed to rise to US$65 a barrel but not much, if any, beyond that. Riyadh cannot sustain this.

It is unlikely that Riyadh will, however, go down alone if it does. If Saudi Arabia fails, or if prices rise to US$65, the US shale industry will likely keep the US economy moving along. Canada’s oil sands will, similarly, enable that country to become self-sufficient in energy products. Added to this situation is the looming presence of Russia, which has signed a gas deal with China worth a reported US$400 billion. Israel has its huge Leviathan and Tamar gas fields. Egypt, long a basket case, has a major gas find on its doorstep. This will put an unheard of degree of pressure on the other OPEC members, including the likes of Qatar and Bahrain. It would take just one of the other OPEC states to panic and, minus the authoritarian Saudi hand, work for what it believes to be its own interest for the entire OPEC edifice to collapse.

Essentially, then, Saudi Arabia is losing its leadership in OPEC. Its failure to acknowledge (at least publicly) the threats posed by US shale oil, increasing Russian energy production, its lack of progress in prosecuting its proxy wars in Syria and Yemen, its failure (at least for now) to persuade the West (read the US, its former friend and ally) to forego any interest in bringing Iran back into the international community and the threat Iran poses in terms of energy exports and geostrategically, the internal problems such as who will succeed King Salman, rapidly dwindling water and agricultural output and the need to cut spending have all combined to pose economic, political and geostrategic problems for the House of Saud. If Saudi Arabia does survive those problems, it will likely emerge in a different form – either economically constrained or worse. If Saudi Arabia does survive those problems, it will likely emerge in a different form – either economically constrained or worse. If that happens or if Saudi Arabia collapses altogether, OPEC will lose its relevance or will likely collapse too.

Will Saudi Arabia Play The Nuclear Card?

The crises that Saudi Arabia faces are coming together in a perfect storm. This could be a body blow to its hopes of becoming the regional hegemon and the leader of the Muslim world. Riyadh would be forced to adopt desperate measures to ensure the continued rule of the House of Saud and the security of Saudi Arabia in the face of its rising arch-enemy, Iran.

In addition to the challenges listed above, Saudi Arabia faces environmental risks, fiscal mismanagement that has resulted in depleted foreign exchange reserves and a growing youth population that demands better education and job opportunities but which remains tied down by an archaic educational system and few employment openings once they have graduated. Riyadh has learned that throwing money at these problems can buy time but does not get to the root of the problem. It needs a more viable solution to these issues and the West to once again support it while treating Iran as a threat to international peace. Iran remains the most pressing existential threat in the Saudi perception.

In Riyadh’s view, the first threat was Tehran’s nuclear programme, which resulted in the West enforcing economic sanctions upon it including, importantly, on its sale of its energy products. According to the US Energy Information Administration, Iran’s oil exports fell to an average 1.4 million barrels a day last year from 2.6 million in 2011 due to the sanctions. This caused severe hardship to its people and a decrepit energy infrastructure. At the potential

end of the sanctions regime, however, Iran appears to be rising. Not only has it regained access to around US$56 billion in funds that were frozen but after a recent two-day conference in Tehran it announced that Total SA, Royal Dutch Shell and Lukoil PJSC are among the international companies that have been selected to develop in collaboration with Iranian firms some of its oil and natural gas deposits. These projects have an estimated value of US$30 billion to investors. Added to this, Russia has announced a lifting of the ban on nuclear co-operation with Iran and appears to be growing closer to the Iranian leadership. Seen in zero-sum terms, this amounts to a corresponding reduction of Riyadh’s influence.

The second threat that Iran now poses is economic. Riyadh requires oil to sell at US$105 a barrel to balance its budget but prices have dropped to below US$50, due mostly to its own doing. It cannot sustain prices at US$50 a barrel indefinitely or, worse, a further fall to around US$40 a barrel. It has already spent an estimated US$65bn of its fiscal reserves to maintain its level of spending since the oil price plunge began, leading the IMF to predict that it could go broke in five years. There remains, furthermore, the risk that this could be the undoing of OPEC. This appears to be the more immediate threat and one that Riyadh must tackle immediately. To do so, it has taken a leaf from the Iranian book on nuclear coercion.

Iran, as noted above, forced the West to negotiate with it by continuing with its nuclear programme; the sanctions had little effect on that. Even in the aftermath of the nuclear negotiations, there is every reason to believe that Iran will continue with its nuclear programme, albeit to a reduced extent. Riyadh has already announced that it wants to start its own nuclear programme to counter Iran’s which, it says, is a threat to it and the region. There is every reason to take this statement seriously.

Riyadh has funded Pakistan’s nuclear programme since the 1970s and now wants Islamabad to redeem that debt by giving it the technology it seeks. Saudi Arabia negotiated the release of Pakistani Prime Minister Nawaz Sharif when he was deposed by General Pervez Musharraf in a coup in 1999 and placed under arrest, and then provided him with sanctuary during his exile. Riyadh believed he would repay that favour. It came as a shock, therefore, when he refused to join the Saudi-led coalition against the Iran-backed Houthi insurgency in Yemen, opting to ‘play a mediating role and not get involved in the fighting in Yemen’. Sharif, nonetheless, said that Pakistan would not abandon its friends and strategic partners and added that Pakistan would defend the kingdom’s ‘territorial integrity’.

Pakistan’s reasons for this move are clear. It signed an agreement with China to pipe Iranian oil and gas to China through its territory. China will not jeopardise that deal under any circumstances and probably pressured Sharif to deny Riyadh’s request to join its anti-Houthi coalition. Riyadh’s hands are not exactly tied, however. Perhaps to persuade Pakistan and China to give it the technology it requires, King Salman made it a point earlier this year to reassert Saudi Arabia’s relationship with India, Pakistan’s arch-enemy. If Saudi Arabia were to offer New Delhi oil at a discounted rate, energy-starved India would take as much as it could possibly get. That would also help it to regain the market share it lost to Nigeria recently and help persuade Beijing that it, too could obtain oil at a low rate.

China, which wishes to increase its footprint in the Middle East and be seen as a peaceful power and not as a regional bully, will probably wish to obtain oil at a discounted price and take for itself the opportunity to be seen as a peacemaker in the Middle East. It is likely in this regard that Chinese President Xi Jinping has decided to visit Saudi Arabia, Egypt and Iran this week. While it is unlikely to be successful in this endeavour, the perception that it tried to act as one will be to its benefit and add a modicum of credibility to its claim that it seeks peace. It will be unable to stop Iran’s nuclear programme but could offer Saudi Arabia nuclear technology for peaceful purposes, just as it did to Iran and, moreover, stop similar overtures to the region from Moscow.

Riyadh has plans to construct sixteen nuclear reactors and has also reportedly signed agreements with Argentina, Russia, South Korea and Hungary, among others, for acquiring nuclear technology and waste management expertise. The reasoning is clear. First, a nuclear programme of its own will enable it to compete with Iran. Equally importantly, a nuclear programme would cause old allies such as the US to again pay heed to it. If it does not, Riyadh will reason, Washington runs the risk of Saudi Arabia turning increasingly to China or, worse, Russia, thus diminishing US standing in the region. Riyadh would, moreover, regain market share and a customer that is a member of the United Nations Security Council with the power to veto any actions that the US could bring against it.

Saudi Arabia, however, is playing a dangerous game, albeit one born of desperation, and must be careful that it does not become an expendable pawn in a much larger struggle for global influence.

Source: Future Directions International (FDI)
http://www.futuredirections.org.au/

*Photo Credit: Oil Online

*These views represent those of the author and are not necessarily Iran Review's viewpoints.

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