[For Turkish magazine Derinekonomi]

Tensions between Saudi Arabia and Iran are ringing alarm bells, not only because of the increased risk of sectarian war in the Middle East but because of the wider political and financial ramifications.

The Saudi economy is already struggling under the unprecedented drop in the price of oil, the proxy war it is waging in Syria, and the actual military intervention it launched in Yemen ten months ago under the moniker ‘Operation Decisive Storm’.

All of the above have their roots in the Sunni kingdom’s rivalry with Shiite Iran which is essentially sectarian and has its roots (in modern times at least) in the 1979 Islamic revolution which deposed the Shah and struck dread into the hearts of the Saudi royal family, which feared it may suffer a similar fate.

The drop in oil prices to a record $30 per barrel (it peaked at $145 in 2008) is largely due to Saudi pressure on Opec members not to apply the agreed ceiling on oil production. Riyadh’s intentions were, apparently, political and designed to damage the Iranian and Russian economies; both are oil-rich enemies (Russia backs Iran and Syrian President Assad, also Shiite, from the Alawite branch) and both under sanctions. Many Opec members (including KSA) are suffering as a result – 2016 budgets were conceived with a projected oil price in mind: for Libya this was a wildly off the mark $208 per barrel, KSA $96, Ian $70.

Saudi planners clearly did not expect its ‘oil war’ to last as long as it has. Nor did it factor in the rapprochement between the US and Iran which saw the Joint Comprehensive Plan of Action agreed in July 2015. To date, Tehran has been complying with the nuclear limitation terms and all UN, US and EU sanctions are due to be lifted in early 2016 at which point, Tehran has signalled, it will immediately boost oil production which has been running at half its capacity for nine years.

Behind the West’s new deal with Iran is the search for a political solution to the Syrian crisis. Russian President Putin has taken the diplomatic lead here and convinced the major powers that without Iran (which supports the Assad regime, whereas the Saudis insist he is removed) negotiations will have no chance of success.

Diminished oil revenues are by no means the only drain on the Saudi economy. The kingdom has been leading the coalition bombarding southern neighbour, Yemen, for the past ten months at a cost of at least $60 billion. The ongoing offensive is the initiative of the recently appointed Defence Minister, Prince Mohammad bin Sultan, 30, the son of King Salman whom many believe to be the power behind the throne. Prince Mohammad believed the war – designed to destroy the Iran-backed Houthi rebel brigades who have unseated the legitimate (Sunni/Riyadh friendly) President Hadi – would last no more than ten days and does not appear to have a Plan B or an exit strategy. Meanwhile, an estimated 3000 Yemeni non-combatants have been killed, half of them children.

The oil-dependent kingdom is running out of funds and has started dipping into its savings to meet ongoing costs – it has already sold most of its European currency reserves.

At the end of 2015, the IMF warned that Saudi Arabia would go bankrupt within five years if it does not change its economic policy.

Meanwhile, Iran can see the light at the end of the austerity tunnel and its economy is growing again after a 6.6% contraction in 2012. Post-sanctions it will expand existing oil contracts and has been courting new business, worth $30 billion, from global players such as BP, Shell, Total, Statoil and Sinopec.

Unlike Saudi Arabia, the Iranian economy is relatively diversified, and with 80 million people it is the 17^th largest market in the world. Tehran is currently awash with high profile Western business people seeking new opportunities in a variety of fields from technology to education; former German Chancellor Gerhard Schroeder led a German delegation at the beginning of January.

Tehran’s five year plan projects 8% growth and, so long as Tehran does not renege on its nuclear commitments, the World Bank agrees, forecasting 5.8% growth in 2016 and 6.75% in 2017. Several commentators compare Iran’s potential to Turkey’s economic miracle at the last part of 1990s.

The region’s main financial worry remains Saudi intransigence with the financial press suggesting that prices could tumble to just $10 per barrel.

The Kingdom appears to be standing firm despite its alarming 15% deficit in 2015. The budget for 2016 includes cuts in public subsidies for fuel, electricity and water. Prince Salman outlined drastic ideas for a short-term solution to his country’s fiscal woes in an interview with The Economist in early January. These include floating the state-owned Saudi Aramco, the world’s most expensive company valued between $1-$3 trillion.

The Western corporate press has embraced this Thatcherite project with Forbes magazine calling it a ‘mini revolution’ which will see Saudi Arabia ‘emerge as the leader of the Middle East’. Others foresee civil unrest: the region’s autocratic regimes are largely tolerated because of an unspoken contract between government and people that the nation’s resources belong to everyone and are shared (however unequally).

There are ramifications abroad too. Saudi Arabia’s influence regionally, as well as internationally, has largely depended on its oil wealth. Egypt, in particular, will be hard hit by any Saudi belt-tightening – the military regime has benefitted from $ billions to keep it afloat after years of war and instability.

Nevertheless, Saudi Arabia ramped up the stakes in early January when it decided to behead controversial Shiite cleric Nimr al-Nimr. The riots in Tehran that followed saw the Saudi Embassy set ablaze and Riyadh severing all diplomatic ties. The headstrong Prince Mohammad is now adopting George W. Bush’s stance that ‘who is not with us is against us’, apparently challenging the West to choose between KSA and Iran.

The West would do well to avoid siding with either rival, seeking, instead, to broker peace… preferably via the mediation of a regional, neutral player, such as Oman.

Anything else risks a region-wide meltdown in the flames of sectarian hatred.