* Despite Saudi pressure, most haven't cut Iran ties
* Small states fear military confrontation, harm to business
* UAE has trade ties with Iran; Qatar shares gas field
By Tom Finn
DOHA, Jan 11 (Reuters) - Gulf Arab states rallied dutifully behind Saudi Arabia when it cut relations with Iran last week, recalling their ambassadors and cancelling flights to Tehran in solidarity with the oil-rich kingdom after its embassy in Iran was torched by protesters.
But all apart from Bahrain stopped short of severing ties, responses that suggest these small states - energy powers but military minnows - wish to safeguard strategic interests and avoid a full-blown conflict with Iran in which they would fare poorly.
The crisis erupted when Saudi Arabia executed a prominent Shi'ite cleric on Jan. 2 and Iranian protesters retaliated by storming and setting fire to the Saudi embassy in Tehran.
Tensions in the Gulf have reached levels unseen since the 1980s, when Iraq received Gulf Arab funding for its 1980-88 war against Iran in a pan-Arab effort to stem the influence of the Islamic revolution that had toppled the Shah.
Sunni Muslim power Saudi Arabia has warned it could take further steps against Shi'ite Iran, which it accuses of meddling in Arab affairs. That raises the prospect of renewed Saudi pressure on its Gulf Cooperation Council (GCC) allies to adopt more energetic responses.
"Gulf countries are under immense pressure from Riyadh. Most are trying to appease Saudi and maintain minimal relations with Iran to prevent further escalation," said Lina Khatib, former director of the Carnegie Middle East Center in Beirut.
"They fear they'll get caught in the middle".
In solidarity with Riyadh, Kuwait and Qatar last week pulled out their ambassadors from Tehran, and the United Arab Emirates downgraded its ties. Bahrain and two non-Gulf states, Djibouti and Sudan, severed relations completely.
But long-standing trade links, shared access to oil and gas fields and the presence of sizeable Shi'ite communities stopped many Gulf states from shutting the door on Iran, opting instead for positions of neutrality and diplomatic half-steps that could be quietly reversed if the furore were to die down.
BAD FOR BUSINESS
The Sunni-ruled Gulf states face a long-standing dilemma over Iran, whose regional clout gained an unintended boost from the 2003 U.S.-led war that toppled its Iraqi foe, Saddam Hussein.
Many of the smaller Gulf Arab states fret that deeper Saudi-Iranian tensions may only spur Iranian muscle-flexing.
"The Saudis are on the phone lobbying countries very hard to break off ties with Iran but most Gulf states are trying to find some common ground," said an Arab diplomat in Doha.
"The problem is, common ground between everyone in this region is shrinking."
Some officials calculate that cutting ties with Tehran would complicate efforts to end Syria's war, in which Iran is providing military support to President Bashar al-Assad.
It would also risk antagonizing an emerging regional power that is set to benefit from an easing of international sanctions after its landmark nuclear deal with world powers last July, and is already being courted by Western investors.
"Sudden escalations like this create a lot of anxiety in the region, a lot of fear. Oil prices are getting lower and lower and budgets are being restricted," said Shafeeq Ghabra, a professor of political science at Kuwait University.
"For business at least, it's a bad time to be making enemies."
Despite their similarities, the Gulf Arab monarchies have varying regional outlooks, economies and political systems.
Relations between Iran and Bahrain, a Sunni-ruled monarchy where Shi'ites are a majority, were already poor. Over the past four years, Bahrain has regularly accused Tehran of meddling in its internal affairs by backing various Shi'ite opposition groups since the start of the Arab Spring in 2011.
Elsewhere in the region, though, the calculus is less straightforward.
Oman stands apart from its Gulf Arab neighbours in keeping a cordial, even collaborative, relationship with Iran: much to the chagrin of its GCC partners, it played the role of intermediary in opening negotiations between the United States and Iran.
Then there is the UAE, Iran's most important regional trade partner. Despite a decades-old territorial dispute between the two countries over small Gulf islands near the Strait of Hormuz, the UAE in 2013 sent over $12 billion worth of goods to Iran according to IMF estimates. Most of this was exported from Dubai, which is home to a large population of Iranian nationals.
Trade between the other Gulf states and Iran is small, but goes back centuries. Much of that, too, is routed via Dubai.
"We, as Arabs, do not want a conflict, a confrontation or even a war with Iran. Instead we seek to drive development in our countries, our peoples and our region," UAE Foreign Minister Sheikh Abdullah bin Zayed al-Nahyan said in an interview on Sunday after an emergency Arab League meeting in Cairo.
'NO GREY AREAS'
Navigating the rift between Iran and Saudi Arabia is particularly tricky for Qatar.
The tiny, vastly wealthy monarchy shares access to the world's largest natural gas field beneath the Gulf waters with Iran which, following the nuclear deal, has sought to entice European and U.S. oil firms to invest in its energy infrastructure.
Qatar has drawn closer to Saudi Arabia since a spat in 2014 when Riyadh briefly withdrew its ambassador from Doha in a dispute over Qatar's alleged support for the Muslim Brotherhood.
Still, it took Doha more than three days after the attack on the Saudi embassy in the early hours of Jan. 3 to announce it was withdrawing its ambassador to Tehran. During that time, Saudi Arabia banned access for its citizens to a major Qatari-owned news site, signalling the potential for tensions between the neighbours to reignite.
Analysts see another possible reason for Qatar's cautious approach: Iran has declared its support for efforts to free 26 Qatari nationals kidnapped in December while on a hunting trip in southern Iraq.
"The Saudis need to know who supports them and who does not, because major, fateful battles have no grey areas," wrote Jamal Khashoggi, a Saudi commentator, in an article published in a Qatari newspaper on Sunday that compared Riyadh's conflict with Iran to the European fight against fascism in the 1930s.
Middle Eastern countries, Khashoggi wrote, faced a choice: "submit to the Guardianship of Islamic Jurists or defend freedom."
But the GCC has so far largely avoided the upheaval that has swept the region, and analysts say suggestions that the hardline Saudi position on Iran could cause splits within the economic bloc, or see states break away, are overstating the case.
"We can go on for ever talking about disunity within the GCC. Yes of course there are differences of opinions, but to make too much of that diversity is to neglect completely the unity that also prevails, especially over Iran," said Abdulkhaleq Abdulla, a political science professor in the United Arab Emirates.
"This is a time when the GCC are standing up to Iran and saying 'we've had enough of Iranian expansionism and we're going to be more determined to confront it.'" (Reporting by Tom Finn, editing by Sami Aboudi and Mark Trevelyan)