Iran/Saudi Arabia: Worsening Riyadh-Tehran rift exacerbates regional tensions

08 Jan 2016

Iran/Saudi Arabia: Worsening Riyadh-Tehran rift ex...
  •   The execution of prominent Shi’a cleric Sheikh Nimr al-Nimr by Saudi authorities on 2 January for terror-related offences has inflamed sectarian divisions and geopolitical tensions across the Middle East.  
  •   Violent protests against Saudi diplomatic facilities in Iran have led Riyadh and several of its allies to downgrade their ties with Tehran in what appears to be an effort to rally Sunni-led governments against Iran. 
  •   Deteriorating relations with Sunni powers come as Washington is reportedly preparing new sanctions on Iran over its ballistic missile programme. Although this and current regional hostilities are unlikely to affect the implementation of the nuclear deal between Tehran and world powers, recent developments highlight how external crises will remain important political and operational considerations for investors in Iran.  


Growing regional tensions 

Divisions between Saudi Arabia and Iran have grown since the landmark nuclear deal between Tehran and world powers in July 2014. Although the deal paved the way for the West’s re-engagement with Iran, it has fuelled fears in Riyadh that an easing of US pressure on Tehran could lead to a shift in the regional balance of power. Saudi Arabia has taken an increasingly aggressive stance on Iran over the past 18 months by boosting support for rival factions in proxy conflicts in both Syria and Yemen. Economic rivalries have also increased as the two countries prepare for Iran’s return to world oil markets once the sanctions are lifted, which could take place in the first quarter of 2016 under the nuclear deal. Tehran has accused Riyadh of maintaining surplus crude production in an attempt to weaken prices and undercut its attempts to regain oil revenues from oil exports. 

In the context of these escalating tensions, the execution of Sheikh Nimr was undoubtedly going to be viewed as provocation by Iran, and the subsequent storming of Saudi diplomatic missions is of little surprise. Nimr was a highly regarded Shi’a cleric from Saudi Arabia’s restive Eastern Province, where the predominant Shi’a population has long complained of marginalisation by the Sunni authorities. Riyadh had accused Nimr of receiving support from Iran to destabilise the region, and although the full extent of the Sheikh’s ties to Iran is uncertain, his vocal support for Shi’a protests in the Sunni monarchies had made him a revered figure in Iran.

Bahrain, Sudan and Djibouti have all severed diplomatic ties with Iran, while Kuwait, Qatar and the UAE have downgraded their relationship with Tehran by withdrawing diplomats. In keeping with its more neutral stance in regional conflicts, Oman is the sole member of the Gulf Cooperation Council to have criticised Riyadh’s decision to break off relations with Tehran, though it has also expressed regret over the attacks on Saudi diplomatic posts in Iran.

The potential for a further escalation of the crisis was reinforced by Iranian claims on 7 January that Saudi-led coalition forces had deliberately targeted Tehran’s embassy in an air strike on Sana’a. Coalition forces said an investigation had proved that the claims were unfounded, and unconfirmed press reports from the AP and Reuters also indicated that the complex itself was not struck and gave no indication that an Iranian guard had been injured as Tehran claimed. The dispute illustrates the volatility of the situation and the potential for an unintended deterioration of bilateral relations as the two countries vie for influence in regional conflicts. 


Iran’s commercial ties with Gulf powers will undoubtedly suffer as a result of the breakdown in regional relations. Saudi Arabia suspended all flights with Iran, affecting around 150 direct flights per month, and halted all bilateral trade, though the overall volume is modest, at around USD 172.5 mn since March 2015. In response to claims of a deliberate Saudi attack on Tehran’s embassy in Yemen, the hostility of rhetoric on both sides is likely to escalate even further. Iran could also attempt to challenge the Saudi military presence in Yemen as it did in May 2015, when Iranian warships threatened to escort a cargo ship to Houthi-controlled territory in Yemen in violation of a coalition blockade.

Of greater consequence for Tehran may be any long-term disruption of trade and investment ties with the UAE. Dubai, with around 10,000 Iranian businesses, is considered among the best positioned in the region to benefit from the lifting of international sanctions on Iran. The UAE has pursued an increasingly assertive foreign policy over recent years and Dubai could come under pressure to limit Iran’s access to its lucrative capital markets and logistic networks. Dubai’s Jebal Ali free zone is a major hub for oilfield services, and includes Western companies such as Amec and Petrofac with the requisite technology and capability to support a recovery of Iran’s oil sector. The crisis could also affect Iran’s access to financial institutions in Dubai, which Iranian officials are targeting to support the country’s post-sanctions recovery.

The latest hostilities will reinforce investor perceptions of elevated risks in Iran that stem in part from its volatile foreign relations. Despite the significant business opportunities presented by a large population and significant natural resource endowment, Iran is ranked 118 out of 189 economies in the World Bank’s 2016 Ease of Doing Business Report, underscoring the extent of challenges presented by corruption, bureaucracy and poor infrastructure. These existing barriers to investment are exacerbated by continued external tensions, which taken together will encourage further caution among potential investors who already face significant legal and reputational considerations in Iran.

Risks to businesses  

Elevated hostilities and continued diplomatic breaches could increase the risk of unrest targeting foreign interests, while providing a useful narrative for selective discrimination against investors by Iranian hardliners who oppose the nuclear deal and greater foreign engagement. Protracted tensions between Iran and foreign powers could damage the prospects for reforms by empowering conservative elites who already seek to undermine reformist President Hassan Rouhani’s effort to improve his country’s ties with the outside world. The October 2015 detention of a Dubai-based US-Iranian businessmen by the Iranian security services was one in a series of arrests since the nuclear deal was announced targeting dual nationals, as well as Iranian businessmen and journalists with foreign ties. As evidenced by the crackdown, hardliners may use their positions in the judiciary, security services and other institutions to target foreign interests.

External events could provoke an escalation of Iranian efforts to limit the opportunities to individuals or entities associated with regimes deemed unfriendly to the country. Parliamentary scrutiny of oil contracts signed with Western companies in the 2000s was motivated in part by conservative opposition. Although the Rouhani administration has prioritised efforts to attract Western capital, potential investors will remain vulnerable to formal or informal obstacles that may be erected by hardliners. As foreign brands become increasingly prominent in Iran, they are also likely to emerge as potential targets for demonstrations – some of which are said to be mobilised by elements close to the regime – in the event of future diplomatic crises.

Competing agendas between Saudi Arabia and Iran will sustain challenges in Tehran’s relations with foreign powers indefinitely. Unresolved proxy conflicts in Yemen, Lebanon and Syria will see tensions between Iran and Sunni powers maintained at high levels, while the return of Iranian oil volumes to market will increase competition and economic anxiety among Iran’s fellow OPEC members. The competition for regional influence between Iran and Saudi Arabia will exacerbate regional sectarian divisions, fuelling continued unrest and potential violence among Shi’a communities in Bahrain, Iraq and Saudi Arabia. This has already manifested in unrest in Saudi Arabia’s Eastern Province since Nimr’s execution, where daily protests have been reported, and on 5 January unknown gunmen attacked a Saudi Aramco bus in an incident with unclear motivations. A hardening of divisions will also damage the prospects for collective action on resolving regional conflicts and reducing the surplus of crude on world markets that has suppressed global prices.

Iran-US relations set to remain tense 

As yet, the crisis is unlikely to affect the 2015 nuclear agreement or lead to a re-imposition of Western economic sanctions on Iran. The US has responded cautiously to the stand-off and has appealed to both sides to de-escalate the situation, fearing broader instability across the Middle East. Relations between the West and Iran are likely to remain fraught, and earlier in January the prospect of fresh sanctions was widely reported in response to Iranian ballistic missile tests since October 2015. Under a 2010 UN resolution, Iran is banned from developing or testing nuclear-capable ballistic missiles, and once the nuclear deal goes into effect, Iran’s missile programme will be restricted for a further eight years. In response to the threat of sanctions, Rouhani ordered an acceleration of Iran’s missile programme, highlighting the potential for repeat bilateral tensions despite the détente over the nuclear programme.

Although any punitive sanctions by the West would be carefully crafted and targeted not to disturb the implementation of the nuclear deal, the potential for a miscalculation remains high. In late December, Washington reassured Iran that it would honour its obligations under the nuclear deal, after Tehran complained that a recently adopted US law increasing scrutiny of US visitors who have recently travelled to Iran amounted to a violation of the July 2015 agreement. Further sanctions and continued tensions may weaken interest among investors, while making it more difficult for moderates in Iran to engage with Western firms, thereby damaging the prospects for Iran’s economy and undermining any potential rapprochement between Iran and some Western states.   



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