What does the Iran-Saudi normalisation mean for oil?
The normalisation of diplomatic relations between the two Middle Eastern powerhouses is a bearish event for flat prices. The main impact is going to be seen in the Yemen war, removing some risk premium due to higher costs of insuring Saudi oil cargoes and its onshore infrastructure’s exposition to attacks. In the long run, the deal could also result in more production from Iran and Yemen. Finally, it is an essential foreign policy success for China but is yet to mark the beginning of a new era.
The latest crisis around US and European banks has overshadowed other key events lately. On 10th March, Iran and Saudi Arabia announced they will resume their diplomatic ties after a 7-year hiatus. The agreement to resume diplomatic relations comes as both countries have faced failures in their foreign and domestic policies, respectively.
Regime change in Syria, one of Saudi’s goals, never happened, whilst the kingdom’s lengthy war with the Houthis has also not yielded any success, the Houthis still controlling much of the country and the UAE’s increasing assertiveness having partly started as they parted ways with the Saudis on Yemen. On the other side, while Iran has increased its sway over parts of the region, the Islamic Republic’s internal legitimacy is in shambles as it is shaken by an ongoing wave of protests at home.
Therefore, the agreement to resume diplomatic ties almost sounds like a cease-fire rather than a genuine rapprochement. Both Tehran and Riyadh have concluded that their never-ending dispute was not going to end well for either side. In addition, the people who are pulling the strings in both countries, Mohammed Bin Salman (MBS), the Saudi crown prince, and Mojtaba Khamenei, the Supreme Leader’s son, are both relatively young (MBS is 37, Mojtaba Khamenei is 53) and are therefore interested in a long-term détente. The fact that Iran sent Ali Shamkhani, the head of the Supreme National Security Council, instead of the foreign minister is a sign that the Supreme Leader’s office directly coordinated the deal rather than the government.
The deal's main impact will likely be seen in Yemen. Only days after the agreement was announced, Iran reportedly agreed to halt weapon supplies to the Houthis. In the coming weeks, Tehran could pressure the group to accept a deal that would see them remain in power but stop missile and drone attacks on Saudi infrastructure. Ending the Yemen conflict is truly key for Riyadh. Its cargoes and onshore infrastructure would face fewer risks, reducing the risk premium and associated costs. The new Jizan refinery, which has been exporting about 150 kbd of products ytd, is located only about 100km from the Yemeni border and has been the subject of multiple drone attacks. The deal increases security for an even more important Saudi project: Neom. The $500bn futurist city will be built near the Red Sea in the northwestern Saudi desert. However, its value wouldn’t be much if it were at risk of missile or drone attacks such as those at Abqaiq in September 2019.
An agreement between the Houthis and Riyadh could also lead to a resumption of Yemeni oil exports. However, these will not be a game changer for the market given the state of the Yemeni oil infrastructure, its relatively low level of oil reserves, and the fact that the civil war is unlikely to end even after a deal with the Saudis. Austria’s OMV, the last remaining IOC in the country, sold its upstream assets to Zenith Energy in January. We expect Chinese companies to be the most willing to enter the country, solidifying their influence on Yemeni supply, which mainly used to be headed to China. The last cargoes of Masila and Shabwah crude were shipped in Q3 2022 and were shipped to China. Before the war, Yemen exported as much as 60 kbd of oil, mainly to China and Southeast Asia.
Yemeni oil exports by destination country (kbd)
China, which helped broker the deal, is the other winner of the Saudi-Iranian rapprochement. The country can claim a substantial diplomatic victory against Washington in a region with uncontested US influence for decades. Indeed, negotiations may have gotten their final push following the visit of Xi Jinping to Saudi Arabia in December and Ebrahim Raisi’s 2-day tour in Beijing in February. Above all, it makes the Strait of Hormuz and the Gulf of Aden safer, a critical point to Beijing, as 37% of global seaborne oil passes through the first chokepoint daily. China is the largest trading partner for both countries, taking about 90% of Iranian oil exports and enjoying deep oil ties with Aramco, its second-largest oil supplier after Russia, with volumes of 1.65 Mbd ytd. This year, Iranian and Saudi oil represent 22% of China’s seaborne oil supply.
However, China’s role needs not to be exaggerated, just as the extent of the Saudi-Iran deal shouldn’t. For the Saudis, this may be another way to show their independent decision-making to Washington and remind the US that the kingdom has other levers it can count on. Despite this, we believe the Saudi leadership is likely to return to the bosom of the US if Republicans win the White House again in 2024. Key issues and rivalry in the region remain unsolved, and talks of potential Saudi investment into Iran are all but improbable, despite the Saudi Finance Minister saying it could happen quickly. As long as US secondary sanctions remain in place, even China wouldn’t invest in Iran’s oil sector, which deeply needs capital and technology.