What Does Middle East Unrest Hold in Store for the Global Economy?

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Many of us have been glued to our TV screens or the front pages of our papers over the last few weeks watching history in the making in the Middle East. To begin with, the protests were largely non-violent and freedom from authoritarian rule in Tunisia and Egypt was achieved with minimal loss of life. Even the protests in Bahrain, while initially met with violence, have so far not resulted in mass killings and international pressure appears to have had the effect of calming authoritarian reactions in recent days with the cancellation of the first round of the world Formula One Grand Prix in Bahrain — the most notable casualty.

Libya, however, is proving to be a different case. As a Telegraph article reported, so violent has the regime’s response been to riots in Benghazi that even some of Col. Gaddafi’s closest supporters have abandoned him. His public security minister, the justice minister and seven ambassadors around the world have openly come out against him while Libya’s deputy ambassador to the UN, Ibrahim Omar al-Dabashi described Gaddafi’s actions as “genocide. The loss of life in events at the weekend is reported by EuroNews/ to be at 84, with hundreds injured from gunshot wounds. Although the capital Tripoli appeared largely calm with the Internet down and foreign journalists banned, reports are patchy at best.

We are not going to catalogue the growing unrest sweeping across much of the Middle East, fascinating as such sudden developments are after decades of authoritarian rule. Our concern here is more with the impact of these changes. In the long run we firmly believe freedom for millions across the Middle East will lead to greater democracy and prosperity, but in the short term it is creating significant volatility in the markets. Disappointingly for the gold bulls, the price has risen only modestly and indeed after an initial run up has fallen back to below $1400 per ounce. But the oil price is a different matter, with the most representative benchmark — Brent crude — hitting a two-and-a-half-year high. As a separate Telegraph article points out, while Libya’s eastern Sirte Basin holds Africa’s largest reserves and supplies 1.4 million bpd of exports, it still only makes up 2.7 percent of global consumption; the rate at which unrest is spreading in Middle Eastern countries is causing the world to say, who next? Goldman Sachs said the Mid-East holds 61 percent of the world’s proven oil reserves and 36 percent of current supply. Paul Horsnell, head of oil research at Barclays Capital, is quoted in a Telegraph article as saying, “This is potentially worse for oil than the Iran crisis in 1979,” adding, “The world has only 4.5 million barrels-per-day (bpd) of spare capacity, which is not comfortable.” While it is unlikely a revolution in any oil producer would completely curtail extraction and exports, it will have two effects if it occurs in a major producer like Saudi Arabia.

The first is make further investment in extraction, refining or process industries more expensive as investors add a risk premium to doing business there in the future. If a new regime develops that appears stable, then that risk premium may reduce over time, but the impact could be to delay much needed development and leave a gap in future supply curves.

The second is a rising oil price could drive both inflation and retard growth in the world’s struggling economies before many of them are robust enough to withstand such sudden changes. Michael Lewis, commodities chief at Deutsche Bank, said oil prices tend to cause economic damage at $95 to $100 per barrel for US crude. As a rule of thumb, a sustained $10 rise in price lops 0.5 percent off US growth over two years. “It’s like a $50bn tax,” he said.

The greatest risk lies in Saudi Arabia: most of the kingdom’s oil wealth lies in the eastern provinces, home not only to the vast Safaniya, Shaybah and Ghawar oilfields, but also the underprivileged Shia minority. The Shias are more naturally aligned with Iran and have been accused before of stoking unrest. On a wider note, a third of Saudi Arabia’s 25 million residents are foreigners and unemployment is at 42 percent among the most volatile 20 to 24 year age group. So far, Saudi Arabia has been watching events from the sidelines, so let’s hope that if change comes, it comes peacefully. It is not at all clear how well the gradually recovering but still fragile economies of Europe, Japan and the US would handle another prolonged period of high oil prices.

–Stuart Burns

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