Saudi Arabia and Iran agreed to restore diplomatic ties on March 10, bringing an end to seven years of conflict between the two nations in a deal brokered by China that is expected to have wide ranging consequences.

“The restoration of diplomatic ties between Saudi Arabia and Iran adds to signs that geopolitical tensions in the Middle East are easing, which may help to reduce risk premia in financial assets in the region as well as the oil market. Tensions will not completely disappear, however, and China’s role in brokering the agreement highlights again that Saudi appears to be turning towards Beijing and away from the West,” Capital Economics said in a note.

The move came more than seven years after relations were severed following the execution in the Kingdom of Saudi Arabia (KSA) of prominent Shia cleric Nimr al-Nimr that prompted a storming of the Kingdom’s embassy in Tehran.

Two issues are in focus going forward: the possibility of restarting the Joint Comprehensive Plan of Action (JCPOA) nuclear sanctions deal; and the possibility of using the joint oil production to create an alternative yuan-priced oil market.

Relations between the KSA and the US have deteriorated since America’s shale revolution has made it an independent oil producer. The Saudis collapsed the oil price in a bid to kill off US investment into shale and limit its production, but the bid failed as production costs for US shale oil tumbled and kept the producers in business. Now that Russia has clashed with the US, Moscow has been moving closer to Riyadh and after resisting for decades, has joined the OPEC cartel to control prices, an alliance the US is not part of.

“We argued late last year how the decision by OPEC+ to cut its production quotas showed that, as the Saudi relationship with the US has deteriorated, the Kingdom has sought to build alliances with other powers. When it comes to China, that has fuelled talk of Saudi accepting renminbi for its sales of oil to China; the so-called “petroyuan” – although we’ve warned against the practical limitations of such a policy,” says Capital Economics.

The resumption of relations between KSA and Iran signifies a de-escalation of tensions in the region, which could reduce risk premia in financial assets in the area and the oil market, says Capital Economics. “However, it is unlikely that the animosity between the two nations will disappear completely.”

Crown Prince Mohammed bin Salman (MbS) has flipped from claiming the Iranian regime to be part of “contemporary triangle of evil” and comparing Iran’s Supreme Leader to Adolf Hitler, to calling for a “good and positive relationship” in 2021, although each country’s desire for regional dominance will remain in place, says Capital Economics.

“Proxy wars have played out, most notably in Yemen, and tensions between the two sides have also surfaced in the likes of Syria and Lebanon. Meanwhile, Saudi officials have blamed Iran-backed groups in Yemen for launching attacks on the Kingdom, particularly in 2019 when the Abqaiq oil facility was briefly taken offline,” Capital Economics said.

Riyadh appears to be keen to bring an end to the Yemen conflict. At the same time, the other powers in the region are also keen to improve relations with the Syrian regime, which is a key ally of Tehran. President al-Assad meeting with key Gulf officials over the past year as part of another attempt at reproachment.

The thawing of relations will also dampen expectations for a peace deal between Saudi Arabia and Israel.

“MbS has reportedly put forward demands to the US, including security guarantees and help with its civil nuclear programme, in return for signing up to peace with Israel under the Abraham Accords,” Capital Economics said. But his father, King Salman, has allegedly refused to follow Gulf allies, including the UAE, in agreeing to peace with Israel. Some have argued that restoring relations with Iran suggests that the Kingdom is unwilling to sign up to an effort by Israel’s Prime Minister Benjamin Netanyahu to establish a regional alliance aimed at taking a more combative line on Iran, and derailing any efforts to revive the country’s nuclear deal.”

The agreement was brokered by China, further evidence that Saudi Arabia is leaning towards a China-led camp. This could undermine the push by MbS to attract Western investment and technologies to diversify the Kingdom away from oil.

The remaking of relations in the Middle East is part of the wider fracturing of the world into regional blocks as bne IntelliNews reported in a cover story in October. The clash between Russia and the West has driven Western and Russian diplomats to travel the world recently, trying to shore up support. Russia and China are looking to build on ties in the Global South, which in turn are seeking to tighten regional alliances to improve their clout in relations with the two camps and maintain some autonomy.

KSA has turned towards China to help resolve its diplomatic disputes. As the biggest consumer of both Saudi and Iranian oil, there is a feeling that China now has greater sway than the US to make both sides fall into line, according to Capital Economics.

The revival of Iran’s JCPOA nuclear deal would be required to have a significant impact on the oil market. Efforts to restart the deal failed in the middle of last year, but recent signs suggest that the Iranian regime may have found renewed appetite to get the talks back on track.

“One possible reason why Saudi Arabia has sought to repair ties with Iran is to try to shore up the stability of the oil cartel, OPEC. After all, rumours earlier this month suggested that the UAE is, once again, considering leaving the group as it seeks to ramp up oil production. If the UAE were to depart, that could fuel talk about the group’s relevance and others may feel under little obligation to maintain their membership [of] a Saudi-dominated institution. Improved relations with Iran, particularly if the nuclear deal is revived and its oil production increases, may go some way to counter that,” says Capital Economics.