The Fuse

OPEC Rivals Saudi Arabia and Iran Plan to Quit Oil Addictions

June 28, 2016

Guest Post by Matthew M. Reed | @matthewmreed

Matthew Reed is Vice President of Foreign Reports, Inc. and a non-resident fellow at New America and the Payne Institute at the Colorado School of Mines.

Not since the 1980s have Saudi-Iranian relations been so bad. In January, Riyadh broke ties with Tehran, after Saudi authorities executed a Shiite cleric and Iranian mobs protested by sacking the Saudi embassy in Tehran plus a consulate. Three decades ago, the last time relations were this tortured, Saudi Arabia and its Gulf allies backed Iraq in a brutal eight-year war against Iran. Today the two sides are fighting a cold war across the Middle East.

Tensions have spilled over into oil markets as Iran has raised production following the lifting of sanctions and Saudi Arabia has resisted pressure to cut production since late 2014. OPEC has rarely been so ineffectual, in large part because Riyadh and Tehran don’t see eye-to-eye. An emergency meeting held by OPEC and non-OPEC producers in April collapsed because the two could not be reconciled. They’re now fighting for market share.

Outwardly, the two countries are fierce rivals. But internally, both countries are having very similar debates about oil and the wisdom of being so economically dependent on its revenues. In the foreword to his hugely ambitious economic overhaul plan, dubbed Saudi Vision 2030, Deputy Crown Prince Mohammed bin Salman wrote in April: “We will not allow our country ever to be at the mercy of… commodity price volatility or external markets.” Meanwhile, Iran’s Supreme Leader Ali Khamenei has called for a more self-sufficient economy. “Instead of relying on the oil revenues, Iran should… rely on the domestic forces [of industry etc.] and the sources above the ground, namely the intelligence and talent of young people and the generation of science and knowledge,” he argued two years ago.*

Saudi’s Vision 2030 seeks to insulate economy from oil price volatility

In Saudi Arabia, this debate is settled for now. Saudi Vision 2030 lays out the general strategy and benchmarks for a comprehensive reform agenda. It (and a more detailed five-year plan) foresees subsidy cuts, widespread privatization, increased foreign investment, more efficient public services, and the partial listing of the national oil company—Saudi Aramco. Ownership of Aramco is to be handed over to the Public Investment Fund or PIF (i.e. the sovereign wealth fund) which will in turn invest in companies at home (to spur private sector employment) and abroad (for value and profit).

This combination of fixes in Saudi Vision 2030 is sound in theory. But practically speaking, it remains to be seen whether Saudi institutions and bureaucrats are up to the task.

Saudi Arabia previously relied on corporate taxes and royalties from hydrocarbons, but new consumption, luxury and land taxes will be imposed and the government will collect dividends on investments made by the PIF. Saudi Arabia aims to escape the oil price cycle trap so that, when prices plummet, other sources of revenue can sustain a more rational spending program. In boom years, oil will still lift the economy and stuff state coffers. The plan is to keep oil production capacity at 12.5 million b/d, double natural gas production over 10 years, burn less crude for electricity generation, and increase efficiency overall.

Previous programs, issued every five years going back to 1970, paid lip service to “diversification” but the sense of urgency tracked the trajectory of oil prices. Whenever oil prices rebounded, reforms were shelved. The state could afford to be generous. Reform advanced in the pursuit of certain narrow causes such as WTO accession (achieved in 2005), but a decade later, non-hydrocarbon sectors are lagging. Saudi Vision 2030 aims to remedy this through both direct, government-sanctioned intervention, and a more organic process whereby foreign investors find worthy companies and causes. This combination of fixes is sound in theory. But practically speaking, it remains to be seen whether Saudi institutions and bureaucrats are up to the task. The real-world results will not become apparent for years.

Iran’s leaders have different visions of Resistance Economy

In Iran, the debate has caused tension between the elected government, led by President Hassan Rouhani, and the Supreme Leader Ali Khamenei. President Rouhani was elected in 2013 arguing for “constructive engagement” with the world. He promised to resolve the nuclear dispute, lift sanctions, and address runaway inflation. He blamed his predecessor for both enabling the international consensus that imposed oil export sanctions and mismanaging Iran’s economy, including its oil industry, which needs foreign capital and know-how. President Rouhani has not rolled out a detailed economic recovery program—he trusts that the economy will gain steam and attract foreign investors if the government generally gets out of the way.

President Rouhani has not rolled out a detailed economic recovery program—he trusts that the economy will gain steam and attract foreign investors if the government generally gets out of the way.

Rouhani made his case crystal clear in a January 2015 speech delivered in Tehran: “The more powerful we become in the field of trade and ties with the world, it will take longer for us to be damaged, this is the exact definition of Resistance Economy,” he argued. “The times have passed when they said if a foreign investor comes to Iran, Iran’s independence will be endangered. Today it is the opposite of this.”* Iran’s Oil Ministry is intent on tendering new deals this summer as a sign of progress. These will be essential in the years ahead, as Iran aims to raise its oil production to 4.8 million b/d.

Khamenei is more skeptical. The Resistance Economy referred to by Rouhani is the invention of the Supreme Leader who announced it in February 2014, at a time when talks were underway but sanctions were locked in. For Khamenei the Resistance Economy is the ideal model that should be aspired to no matter what. It is a short list of 24 principles to be followed forever. It emphasizes self-sufficiency, subsidizing manufacturing, simplifying regulations, restructuring public wages and making Iran indispensable to friendly countries that will never compromise trade or adopt sanctions.

As for oil and gas, Khamenei’s decree holds that these are essential and that exports would increase if only officials chose “strategic customers,” diversified “methods of sale” and leveraged private sector partnerships. In sum, it is a vague plan to limit exposure. The Supreme Leader has tolerated Rouhani’s efforts thus far; he isn’t inclined to micro-manage the economy. But Khamenei views foreign trade and investment as a necessary evil at best.

Saudi Arabia and Iran want to quit their addiction to oil revenues while maintaining robust oil and gas sectors. Both recognize the dangers of runaway subsidies and wasteful consumption. In fact the Saudi plan for dialing back subsidies and offsetting these costs is remarkably similar to Iran’s program. Saudi Aramco doesn’t need foreign capital or technology to continue thriving and Riyadh sees foreign investment as absolutely necessary for diversifying away from oil. Tehran, by contrast, needs foreign investors to increase production and introduce enhanced oil recovery techniques.

*Quoted by BBC Monitoring service.