Iran-Saudi row unlikely to raise oil prices

Li Min/China Daily

The year 2016 for the Middle East began with the political crisis caused by the arrest and execution of Shiite cleric Sheikh Nimr al-Nimr in Saudi Arabia. Apart from intensifying tensions between Saudi Arabia and Iran, al-Nimr's execution and its aftermath also raised concerns in entire Persian Gulf region.

Even if Iran-Saudi Arabia confrontation continues, oil prices are unlikely to rise.

Economic and political fundamentals will determine oil prices this year, and the "bearish" oil market will continue for some more years, although prices in the international market are rising in the short term.

We must realize that though market players see the Iran-Saudi Arabia confrontation as a geopolitical risk, economic logic tells us that geopolitical risks alone do not lead to a rise in prices; after a short period, the situation will likely stabilize and oil production will return to normal.

Before the Iran-Iraq war (1980-1988), both countries were major oil producers and exporters. So oil prices should have skyrocketed after the war broke out. Instead, the opposite happened as oil prices plummeted by 50 percent between 1986 and 1987, signaling the beginning of more than 15 years of bearish oil market.

Theoretically speaking, oil prices have risen only when demand has surpassed supply or when geopolitical risks have significantly disrupted or threatened the transportation of oil.

The current international oil market is characterized by oversupply of millions of barrels a day and there is still huge overcapacity, and even during political turmoil, rival parties are not expected to undermine oil production or transportation. On the contrary, all sides make efforts to protect oil production to the best of their abilities because that will ensure more sales and increase their incomes.

The last round of the bullish oil market, from 2002 until the first half of 2014, gave way to falling oil prices largely due to financial speculation and weakening of the Organization of the Petroleum Exporting Countries' monopoly. In this case, although the Iran-Saudi Arabia row is seen by some market players as a "geopolitical risk", it will not lead to a reduction in oil output capacity or hinder oil transportation. Rather, it will prompt policymakers in oil producing countries to increase outputs and further weaken the OPEC "cartel", and accelerate the lifting of sanctions against Iran and raise its production capacity, which will lead to further fall in oil prices.

Moreover, contrary to popular belief, the hostility between Iran and Saudi Arabia could increase the investment in Iran's oil and gas sector, because Western powers don't want to see political forces in Iran and Saudi Arabia and other major Islamic countries coming together to form an alliance.

The Iran-Saudi Arabia confrontation will serve the United States' purpose of driving another wedge between the Shiite and Sunni majority countries. As a result, the US could expedite the implementation of its nuclear agreement with Iran, lift the sanctions on Teheran, increase investment in Iran which will boost its oil production capacity. All this will increase oil production not only in Iran; perhaps it will increase outputs of other countries as well.

Also, the Iran-Saudi Arabia row could spur Riyadh to also increase its oil production. This is not only because Saudi Arabia wants to prevent Iran from eating into its market share, but also because the deterioration in Riyadh-Teheran relations will force Saudi Arabia to greatly expand its military budget, which will be a drain on its finances.

The author is a researcher at the Ministry of Commerce's International Trade and Economic Cooperation Institute.