It's not been a great start to 2016. Saudi Arabia has cut diplomatic ties with Iran after its embassy in Tehran was torched by protesters over the weekend. Iran's Supreme Leader, Ayatollah Ali Khamenei, has promised "divine vengeance" on the Desert Kingdom, prompting fears that a decade-long Cold War may suddenly get a lot hotter. Here's a quick explainer of what's happened so far, and what could still happen.
Q. What happened while I was still celebrating New Year's?
A. Saudi Arabia executed 47 people for either committing or conspiring to commit terrorist attacks. According to various reports, most of the victims were loyal, or sympathetic, to Al Qaeda. But they also included Sheikh Nimr al-Nimr, a prominent cleric from Saudi Arabia's Shia minority. That caused a wave of protests, both in Iran and among Shia communities in Arab countries, culminating in the attack on the Saudi embassy.
Q. But it didn't come out of nowhere, did it?
A. Far from it. Saudi and Iran are the two biggest powers in the Middle East, facing off against each other through proxies in at least three conflicts right now: in civil wars in Yemen, Syria, and Iraq, Saudi is backing (mainly Sunni) rebels against non-Sunni governments (Shia in Iraq and Yemen, Alawite in Syria), which are supported to various degrees by Iran. It's an indication of Saudi's priorities that it stopped bombing Islamic State positions in Iraq three months ago to concentrate on bombing Yemeni rebels (with substantial civilian casualties).
Q. So, is this about religion or politics, and who's winning?
A. As Fawaz Gerges, a professor of international relations and Middle Eastern policy at the London School of Economics, puts it, it is "a fight for political supremacy," of which the traditional rivalry between the Sunni and Shia branches of Islam are only one element. Gerges says Iran has had the upper hand in recent years, ending its international isolation over its nuclear program, buttressing its long-time government allies in Syria, and generally exploiting the grievances of Shia Arabs in places such as Yemen and Bahrain to chip away at Saudi power.
The rivalry has turned increasingly hostile since Saddam Hussein was toppled from power in Iraq (which borders both countries), paving the way for that country's Shia majority to take power there. It got a lot more hostile in the last 12 months under the influence of Saudi Arabia's new king, Salman, who has been much more aggressive in trying to stop Iranian influence from spreading.
Q. Is Saudi's oil price war part of its strategy?
A. When Saudi Arabia stopped cooperating with the rest of OPEC in 2014 to support oil prices, it had other targets in mind, notably higher-cost producers in the U.S. But low oil prices has the bonus effect of punishing both Iran and (non-OPEC) Russia for thwarting its efforts to topple President Bashar al-Assad in Syria. For the moment, Saudi has deep enough pockets to survive the hit to its own finances. But as Emad Mostaque, a strategist with the London-based research consultancy Ecstrat, says, Iran is better equipped to cope with the long-term upheaval because it is less dependent on oil than Saudi Arabia, having raised more through general taxation than through oil duties last year.
Q. Will oil prices spike if the tensions worsen?
A. Maybe. It's important to distinguish between the actual balance of supply and demand in the oil market, and the geopolitical risk premium that traders build in to oil prices. The first impact on prices is likely to come through the latter channel. Everyone is so bearish about oil in general at the moment, says Mostaque, that there's no geopolitical risk component in the price at all (crude prices have already given up three-quarters of their gains since the Saudi embassy went up in flames).
Q. Is that it? Just an abstract "risk premium"?
A. In the short term, yes, although it would be unwise to underestimate that. Oil traders are a jumpy lot (especially if they work for strategically important trading houses in big oil importer countries like China or Japan), and things could change quickly if there's further escalation in the tensions between Saudi Arabia and Iran.
But fundamentally, the oil market is badly oversupplied. While such imbalances invariably correct themselves as demand responds and expensive production is curtailed, the process takes time. To achieve a real, sustained lift to oil prices, you need a real, sustained disruption to supply (preferably in conjunction with a revival in demand). That could happen in the form of a stand-off in the Persian Gulf, through which around 20% of the world's oil supplies flow.
But an outright interstate conflict isn't the most likely course of events, experts say. Jane Kinninmont, deputy head of the Middle East and North Africa program at the Royal Institute for International Affairs in London, reckons that an extension of the proxy conflicts between Saudi Arabia and Iran is more likely. If Saudi's focus falls on Yemen, or Lebanon, as some fear, then there'll still be no big hit to output. Destabilizing Iraq, which raised oil production more than any other single country last year, would have a much bigger impact on oil prices (albeit at the price of angering the U.S., the Kingdom's most important ally).