Soaring regional tensions boost Gulf budgets, threaten long-term goals

DUBAI — Over the weekend, Iran launched for the first time from its territory a direct attack on Israel in retaliation for the April 1 strike on its consulate in Damascus that killed seven Islamic Revolutionary Guard Corps members. The weekend attack was to an extent expected and most of the missiles and drones were intercepted. Still, tensions are at an all-time high over fear that the violence could escalate into a wider Middle East conflict.

Many projectiles were intercepted by Israel's multilayered air defense system with strong support from the United States and other European and Arab allies. Amid the attack, Iran’s mission to the United Nations posted on X that “the matter can be deemed concluded,” but warned that a “considerably more severe” response should be expected if Israel retaliates against the Islamic Republic. “US must stay away!” the post added as American military forces stationed in the region received additional F-15 fighter jets this past week.

In this fog of war, and on the back of OPEC+ oil output cuts extended until mid-2024, Brent crude rose above $90 a barrel this month for the first time since November 2023. Some analysts predict that further escalation between Iran and Israel could send oil prices above $100 per barrel. At the time of writing, Brent crude hovered around $90 a barrel. Rating agency S&P Global previously expected prices to average $83 per barrel in 2024 and $76 in 2025. 

Funding diversification plans

Higher oil prices are a short-term boon to Gulf governments that rely heavily on hydrocarbon revenues and the taxation of petrodollar-fuelled non-oil sectors to balance their budgets. In the largest Gulf economy, Saudi Arabia, oil receipts still made up 62% of government revenues in 2023. The kingdom has been in a deficit since 2013, except for 2022, when Brent crude averaged $101 per barrel as Russia’s invasion of Ukraine shocked energy markets, and it expects to be $21 billion in the red in 2024, $19 billion in 2025 and $29 billion in 2026.

A hypothetical return to surplus would provide Gulf governments with the influx of capital required to get a flurry of economic diversification projects off the ground. Many have failed to entice foreign investors, forcing the region to risk its own capital on ventures whose viability have yet to be proven, opt for debt financing or abandon them altogether.

Not all Gulf countries have equally struggled to attract foreign capital, though. Between 2012 and 2022, foreign direct investment into the United Arab Emirates and Oman roughly doubled compared to the 2001-2011 period. But inflows halved over the same period in Saudi Arabia, dropping from a total of $179.9 billion between 2001 and 2011 to $87.4 billion between 2011 and 2022, according to data from the United Nations Conference on Trade and Development.

As it lags far behind its goal of attracting $100 billion in annual FDI by 2030, Saudi Arabia has started to scale back parts of its economic diversification plans. Only 2.4 kilometers (1.5 miles) of the Neom mega project, two parallel 170-kilometer (1.05-mile) skyscrapers, will be completed by 2030, and analysts expect more downsizing. The Line was first intended to house 1.5 million residents, but this figure has now been revised to 300,000. Kristian Coates Ulrichsen, fellow for the Middle East at the Baker Institute, told Al-Monitor that “a dose of realism has been injected into the plans.”

Although an oil bonanza fueled by a Middle East war would boost Gulf countries’ economic firepower, the region is notorious for launching overambitious plans that are scaled back a few years later.

Gulf-Iran dialogue

The escalation of Iran-Israel tensions, albeit indirectly beneficial to diversification plans via a rise in oil prices, conflicts with Gulf countries’ long-term interests, which include embracing new alliances.

A key driver of increased Gulf-Iran dialogue is the former's focus on regional stability, crucial to growth in the travel and tourism sector and to attracting foreign investment. The tourism industry features prominently in most Gulf countries’ economic diversification plans and already accounted in 2022 for 9% of gross domestic product in the UAE. The country’s leisure hub, Dubai, welcomed a record 17.15 million international overnight tourists in 2023.

Following Iran’s missile and drone attack on Israel on Saturday night, the UAE’s Ministry of Foreign Affairs called for restraint to avoid pulling the region into “new levels of instability.” A regional conflict would upend efforts to brand the Gulf as a global tourism and investment hub, throwing a wrench into economic diversification plans and further entrenching the region’s reliance on hydrocarbons.