Classic game theory
If both countries remain destined to act in their own best interest, like the two prisoners in classic game theory, they’ll both be losers for the time being. The clear implications will be an oil glut that takes longer to work through and more downside for oil prices this year.
At first glance, the Saudis seem better positioned economically to play this game, but the more Iran remains first runner up, the more volatile the situation can become. In the words of John D. Rockefeller, we will have to see who can endure this “good sweating” battle.
Market Realist – Survival of the fittest
On the Middle East’s geopolitical canvas, both countries are playing a very dangerous game that affects every other country in the region. To undermine Iran, Saudi is determined to keep its current oil supply intact. All efforts by other OPEC members to curtail oil (USO) production are in vain. On the other hand, Iran recently announced its plans to produce 500,000 barrels a day. This move should add significant pressure to an already oversupplied market. Everybody in the Middle East seems to be on the losing side. If Saudi persists with its current strategy, the oil glut will ensure a further drop in prices this year, which will benefit oil consumers like the United States (IVV), China (FXI), Japan (EWJ), and India (INDA).
The new Saudi regime seems very assertive at home and in the wider Middle East. However, this assertiveness isn’t helping the economy. Nevertheless, you should note that the Saudis are playing the long geopolitical game in the oil market. They know they’re in a better position to withstand lower oil prices in the near term compared to Iran. Saudi has more financial muscle in terms of higher foreign exchange reserves, and it has more than four times Iran’s GDP per capita. Plus, the break-even price for oil production is one of the world’s lowest for Saudi Arabia. As Saudi Arabia is so well positioned to weather the sharp fall in oil prices, the situation looks increasingly difficult for Iran. This is why Iran could eventually negotiate on oil prices with Saudi Arabia.