Israel has escalated its bitter quarrel with Turkey, its erstwhile ally, by scrapping a $140 million deal for unmanned aerial vehicles and advanced intelligence-gathering systems the Israelis fear could end up in the hands of Iran.

The move by the Defense Ministry, which has the power to veto defense exports, could cost Israel Aerospace Industries and the military electronics manufacturer Elbit Systems an estimated $90 million if Ankara demands compensation.

The Jerusalem Post reported that IAI and Elbit were discussing the "expected economic implications" of the ministry's action with Director General Udi Shani and the possibility they will face Turkish lawsuits.

Under the 2005 deal, state-run IAI, flagship of Israel's defense industry, was contracted to supply Turkey with 10 Heron UAVs, with Elbit subsidiary El-Op producing the advanced infrared Lorop camera that the surveillance drones would carry.

The rift with Turkey has cost the Israeli defense industry potential contracts worth billions of dollars. There have been efforts to salvage the deals but the Israeli decision to halt exports of the Heron package is likely to dash any hopes of keeping them alive.

The ministry's refusal to renew the export license for the airborne surveillance system followed a declaration by Turkish Prime Minister Recep Tayyip Erdogan in September that his country and neighboring Iran were "firm in their stand" against Kurdish separatists based in northern Iraq.

Turkish commanders have claimed that Israel is aiding the Turkish rebels, who seek Kurdish autonomy in southeast Anatolia. Those allegations have never been verified but the Israelis are suspected to have long supported, armed and trained Iraqi Kurds, initially against the Baathist regime in Baghdad in the 1970s and '80s and more recently to destabilize Iran.

The Israeli Defense Ministry noted when it announced the cancellation of the contract that "we do not allow such advanced technology to fall into other hands as in this way the system can fall into enemy hands."

The ministry said Israel was seeking to improve ties with Erdogan's Islamist government in Ankara, although it didn't elaborate.

But it stressed that despite this, it couldn't permit the delivery of the Elbit system to Turkey because of security concerns.

Ties between Israel and Turkey have been deteriorating since Erdogan's Islamist Justice and Development Party took power in 2002 and gradually trimmed the power of the secular Turkish military, staunch backers of the military alliance with Israel.

The final break came in May 2010, when the Israeli navy intercepted a Turkish-organized flotilla of ships carrying humanitarian aid to the Israel-blockaded Gaza Strip, killing nine Turks. Israel refused Turkish demands for a formal apology.

Relations hit bottom earlier this year. Ankara expelled the Israeli ambassador after the United Nations published a report on the flotilla incident that justified Israel's blockade of Gaza.

The depth of the bitterness between the former allies can be gauged from a remark made by Israeli Defense Minister Ehud Barak in a speech in 2010 in which he described Hakan Fidan, newly appointed head of Turkey's powerful National Intelligence Organization as a "friend of Iran" who might betray Israel's secrets.

The Heron deal, under which Turkish companies headed by Turkish Aerospace Industries would provide subsystems and services, was plagued by delays.

In 2009, Turkey threatened lawsuits unless the Israeli package was delivered. Soon after, IANA and Elbit withdrew technical teams from Turkey.

After the 2010 flotilla encounter, Turkey reportedly froze 16 defense projects with Israel, including a $5 billion deal for hundreds of Merkava Mark 3 main battle tanks and the $800 million sale of two Israeli patrol aircraft and an early warning radar plane.

"We haven't seen big military deals since 2003, when Erdogan took office," Alon Liel, a former Israeli ambassador to Turkey lamented in June 2010, following the interception of the Gaza-bound Turkish convoy in the eastern Mediterranean.

"I don't think there will be further Turkish contracts for Israeli defense companies."

While the loss of the Turkish market was a hard blow for Israel's defense industry, it's increasingly looking to Asia and Latin America to develop new markets.

UAVs are a big seller. Tel Aviv's Globes business daily describes Israel as "a superpower in unmanned vehicles," sales of which made up a substantial portion of defense exports totaling $9.6 billion in 2010.