Bloomberg Businessweek (Europe)

Iran. Islamic State. Cheap oil. Saudi Arabia’s King Salman has his hands full

▶▶The setback in relations with Iran is just one of Saudi Arabia’s many problems ▶▶“They’re surprised when people have a negative reaction”

- Matthew Philips, with Vivian Nereim

The collapse in Saudi relations with Iran after the execution of a prominent Shiite cleric marks a grim start to the new year for Saudi Arabia’s King Salman. Since succeeding his half-brother, Abdullah, who died in January 2015, the 80-year-old Salman has gone to war in Yemen, faced Islamic State-backed suicide bomb attacks inside his borders, and watched rival Iran sign an historic nuclear accord brokered by the U.S., the kingdom’s strongest ally for the past 50 years. Crude oil, the lifeblood of the Saudi economy, has remained cheap, depriving the country of billions in revenue.

On Dec. 28 the Saudi finance ministry announced big spending cuts for 2016. According to Luay al-Kahtteeb, a visiting fellow at the Brookings Institutio­n’s Doha Center in Qatar, one item that did increase was military spending, rising to 25 percent of the budget (vs. 18 percent in the U.S.). A week later, the kingdom executed 47 prisoners it labeled terrorists, including the Saudi Shiite cleric Nimr al-Nimr. Days later, Saudi Arabia’s already strained relations with predominan­tly Shiite Iran were in tatters. After protesters set fire to the Saudi embassy in Tehran, the kingdom cut relations with the Islamic Republic.

Some analysts say al-Nimr’s execution was a way to bait Iran into overreacti­ng. That would help the Saudis isolate the rival nation, as well as give them an excuse to slow down peace talks on Syria, which the United Nations has tentativel­y scheduled for Jan. 25 in Geneva. Now that Russia is at the table, the Saudis are concerned that any deal will leave the Iran- and Russia-backed Syrian President Bashar al-Assad in power, as forces coalesce around the goal of defeating Islamic State. The Saudis see Assad as a puppet of Shia Iran who rules over a Sunni-majority country. Since the embassy was attacked, Saudi Arabia has expressed continued support for the peace talks.

Those who know the Saudis best think it’s unlikely they planned very far ahead. “I actually don’t think the Saudis calculated what the impact would be on the region,” says James Smith, who served as U.S. ambassador to Saudi Arabia from 2009 to 2013. The Saudis lack a certain self-awareness,

Smith says. “They don’t stop and think, and then they’re surprised when people have a negative reaction.”

Saudi officials say the executions were meant to convince ordinary citizens of the government’s resolve to fight terrorism. They’re “annoyed at the level of internatio­nal interest in the matter,” says Faisal bin Farhan Al Saud, chairman of Shamal Investment and a member of the royal family. “They expected a reaction from Iran, probably in the sense of blustery speeches as usual, but I don’t think they were intentiona­lly sending a message to Iran. I don’t think they necessaril­y expected a move such as the storming of the embassy.”

The attack raises questions as to whether Iran is ready to rejoin the global economy after years of sanctions; it also strengthen­s the feeling among the Saudis that they’re under siege. “Salman views himself as a wartime king,” says Robert Jordan, U.S. ambassador to the country from 2001 to 2003. The Saudis also feel abandoned by the Obama administra­tion. “There is a real sense of encircleme­nt they’re feeling,” he says. “They are bitter and frustrated at the U.S. for walking away and seem to be lashing out.”

Saudi anxiety about the U.S. began when American foreign policy attempted its pivot to Asia; that was aggravated by the 2011 fall of Egyptian President Hosni Mubarak, whom the U.S. had supported for decades. Consternat­ion grew after Obama drew a red line over Assad’s alleged use of chemical weapons, then failed to follow through on the threat. “It was perceived as proof that the word of the United States is no longer of value,” Smith says.

For all the talk of abandonmen­t, Saudi Arabia remains by far the U.S.’s top weapons customer. Sales have ramped up significan­tly under Obama, says William Hartung, director of the Arms & Security Project at the Center for Internatio­nal Policy. From October 2010 through 2015, the U.S. has approved sales of $111.3 billion of arms to Saudi Arabia, including $29 billion for 84 F-15 warplanes—more than three times the arms sales approved to the U.S.’s second-biggest customer, South Korea.

A lot of that firepower is being used in Yemen. The 10-month bombing campaign against the Iran-backed Shia rebels, the Houthis, has been sloppy. The UN estimates that 2,600 Yemen civilians were killed from March to October, including 1,600 in Saudiled airstrikes. To pay for the war, the Saudis have been dipping into shrinking foreign currency reserves. “The only thing it accomplish­ed is to create a major humanitari­an crisis,” Hartung says. The air campaign has been led by the king’s 30-year-old son, Mohammad bin Salman, the youngest defense minister in the world. “They should be worried about ISIS, but instead they’re spending all their blood and treasure in Yemen as some kind of anti-Iranian measure,” Hartung says. “And it’s a disaster.”

The Saudis are also engaged in an oil war—one in which they’re struggling to balance continued production and falling prices. Iran says it will sell an extra million barrels of oil a day by midyear, increasing current output by more than a third. There’s so much crude for sale that even rash actions by two of the world’s biggest suppliers don’t translate into higher prices— which isn’t good for the treasuries of Tehran and Riyadh. As Iran prepares to reenter the market, the Saudis are offering huge discounts to customers in Europe and Asia in hopes of keeping them from buying Iranian oil.

Although Saudi Arabia remains the world’s largest oil producer and can get oil out of the ground more cheaply than Iran can, in some ways Iran is better positioned to weather low prices. Sanctions, which may end in March, have forced the Iranians to live without oil and diversify their economy, whereas oil accounts for 80 percent of Saudi Arabia’s revenue. According to Internatio­nal Monetary Fund estimates, Iran can balance its budget with crude at $70 a barrel, while the Saudis need $95. Ominously, the IMF predicts that if the Saudis don’t lower spending, and if oil stays at $50 a barrel, they’ll burn through their foreign currency reserves by 2020. Being a wartime king is expensive.

The bottom line Saudi Arabia is battling rebels in Yemen, sparring with the Iranians, and trying to fix its budget deficit.

“They should be worried about ISIS, but instead they’re spending all their blood and treasure in Yemen as some kind of anti-Iranian measure.” —William Hartung, Center for Internatio­nal Policy

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