Global Oil Flows and the Fragility of the Saudi Monarchy

Colleagues: Two very thoughtful and important op-eds on the fragility of the Saudi political structure, the prospect of the revolutions in the Arab world sweeping away all remnants of the old order, and the likelihood of a serious disruption of global oil markets.

We have been striving for “Energy Independence” for decades, yet we have gone from importing 36% of our petroleum requirements in the Reagan days to almost double that today–about 66%. We have had little success in substituting for oil, particularly in the transportation sector, and in exploiting domestic oil reserves (and not just for political reasons). We have had a schizophrenic policy on the protests that are exploding in the Arab world, but as the two authors warn, we need to be very careful in not assisting the overthrow of monarchies/stable, autocratic governments lest the turmoil and anarchy lead to serious disruptions in the flow of oil and a likely collapse of the global economic order.

Difficult to thread the needle between our moral imperatives and our need for stability in this region, but both authors worry that the current administration is not handling that balance very well. Read on! Ty

The new geopolitics of oil

By Ed Morse

Published: April 6 2011 in the Financial Times

A new dynamic has emerged in oil markets that is likely to push prices on to a higher path in the years ahead than almost anyone had forecast a year ago. It relates to the now unfolding critical dimensions of what can be called the “new geopolitics” of oil.

Although the disruption of Libyan supplies has had a tangible impact both in the Mediterranean market and in the global balance between light sweet and heavy sour crude streams, the 30 per cent increase in oil prices since the start of the year has had far more to do with changed expectations than market fundamentals. And while there may be good reasons to believe that oil prices could fall later this year, there are many more to fear rising prices.

Three elements of the new geopolitics are becoming clear.

First, the profile of many oil producing countries has long been seen as precarious. The profile includes a combination of rapidly growing, young populations, high unemployment, skewed distribution of income, geriatric and kleptomaniac leaders with diminishing political legitimacy, and rising public expectations.

This is not new news. What is new is the explosive way popular discontent can lead to civil disorder and regime change and spark contagion. The prospect of the largest oil producing countries confronting challenges, such as those seen largely in north Africa so far, is more probable now than a year ago, telescoping the potential day of reckoning and raising the probability of an apocalyptic oil supply disruption.

The oil risk premium is likely to remain high for a long period as any review of potential additional instability and supply disruptions makes clear. This month’s set of three weekends of Nigeria elections is likely to bring violence and potential oil disruption. Civil disorder and political fragmentation in Yemen could interrupt 300,000 barrels a day of oil exports and cargoes of liquefied natural gas and could further jeopardize shipping through the 18-mile wide Bab El-Mandab through which 4m b/d of oil flows to the Suez Canal and the Sumed pipeline.

Then there’s the ever present dangers from terrorist attacks on Saudi oil facilities, political upheaval in Iran, or an awkward combination of simultaneous disruptions in Algeria, Nigeria, Syria and Libya. Or civil disorder could erupt in Venezuela where the socioeconomic political profile doesn’t differ much from oil producers in the Middle East.

Particularly dangerous in the short term is a real disruption of light, low-sulphur crude oil from Algeria or Nigeria or both. As has been learnt from the Libyan shortfall, light sweet crude is needed to make low sulphur transportation fuels and there is no capacity to replace that anywhere, whatever the level of Saudi spare production capacity.

Second, in order to ward off popular discontent, oil producing countries are dramatically increasing public expenditures. In Saudi Arabia, King Abdullah has announced two packages of spending equivalent to $125bn, about 27 per cent of last year’s gross domestic product, where the important impact is on what Saudi Arabia needs to earn from oil exports. The budgetary break-even price for Saudi Arabia seems to have escalated by 30 per cent to $88 per barrel, with similar impacts elsewhere, according to a recent report from the Institute of International Finance. These spending commitments cannot easily be wound down, and looking at Opec as a whole, pressure for ever higher prices is likely to become a more permanent part of the petroleum landscape.

Third, as part of the pressure to deliver more material goods at home, oil producers are likely to continue domestic subsidies, including for energy, accelerating domestic oil demand and decreasing oil production available for exports. Middle East producers are set to consume 1m b/d more in 2015 than in 2010 with another 1.5m b/d by 2020. That could tighten markets considerably.

There are reactions to future supply disruptions already. Just last week, President Barack Obama appeared to eat a lot of past words on the balance between environmental protection and development of fossil fuels at home, tilting the balance toward oil and gas less than one year after the Macondo disaster. Mr Obama’s target to decrease US oil imports by a third by 2022 may well be doubled, given the pace of US discoveries in the Gulf of Mexico and onshore.

Notwithstanding all of the dangers ahead, the price of oil could well fall by summer or year-end, as some of the risk froth comes out of the market. Investors have dramatically increased purchases in high-priced call options for expiry at the end of 2011 and 2012, reflecting a higher probability of increased prices. If short-term stability prevails, their bets will come off the table. But it remains the case that while oil markets are unlikely to face Armageddon this year, it looks like it’s coming a lot sooner than it appeared a year ago.

Ed Morse was US deputy assistant secretary of state for international energy policy from 1979-1981. He will join Citigroup in May as global head of commodities research

Copyright The Financial Times Limited 2011


Washington Post
April 8, 2011

A Hard Line In The Sand

President Obama’s Saudi dilemma

By Martin Indyk

There’s a crisis in U.S. policy in the Middle East — and it’s not about Libya. For weeks the Obama administration has been preoccupied with averting a humanitarian catastrophe in North Africa. But on the other side of the region, in the oil-rich Arabian Peninsula, a matter of vital, strategic importance awaits the urgent attention of policymakers.

Over there, the ailing 87-year-old king of Saudi Arabia probably isn’t getting much sleep. Abdullah, this Sunni monarch of monarchs, custodian of the holy mosques of Mecca and Medina, can see the flames of instability and turmoil licking at all his borders. In the south, Yemen is imploding, to the advantage of his al-Qaeda enemies. In the east, Bahrain’s Shiite majority has been in such a state of revolt that Abdullah has already sent armed forces to prevent Iran from establishing a “cat’s paw” on the Sunni Arab side of the Persian Gulf. In the north, Abdullah sees Iraq’s Shiite-dominated government as nothing more than a front for the hated Persians. In the west, a Palestinian majority is demanding that the Hashemite king of Jordan become a constitutional monarch. Meanwhile, Egypt’s Hosni Mubarak, that other Sunni pillar of regional stability, has already been overthrown.

Historically, in times of trouble, Saudi kings have depended on American presidents to guarantee their external security. But at this moment of crisis, Abdullah views President Obama as a threat to his internal security. He fears that in the event of a widespread revolt, Obama will demand that he leave office, just as he did to Mubarak, that other longtime friend of the United States. Consequently, Abdullah is reportedly making arrangements for Pakistani troops to enter his kingdom should the need to suppress popular demonstrations arise. (Did Marty really say “Pakistani troops?”)

This presents the Obama administration with a particularly thorny dilemma. Saudi Arabia is the world’s largest oil producer and the only one with sufficient excess production capacity to moderate rises in the price of oil. Instability in Saudi Arabia could produce panic in the oil markets and an oil shock that could put an end to America’s economic recovery (and the president’s hopes for reelection). This would argue for granting an “exception” to Saudi Arabia from the Obama administration’s trumpeting of universal rights. Indeed, the soft criticism of Bahrain’s Saudi-dictated suppression of its people suggests that this has already become U.S. policy.

Yet helping the Saudi king effectively erect a wall against the political tsunami sweeping across the Arab world is not a long-term solution. If there’s one thing that we can now predict with some confidence, it’s that no Arab authoritarian regime can remain immune from the demands of its people for political freedom and accountable government. To be sure, $100 billion in subventions from the palace and the promise of 60,000 jobs can help postpone, for a time, the demands of unemployed Saudi youths. But political freedom, transmitted across borders via cable TV and the Internet, has proved to be a seductive idea. In the end, it will not be assuaged by economic bribes or police-state suppression.

And the Saudi system is fragile. Power is concentrated in the hands of the king and his brothers, who are old and ailing. The Saud family’s legitimacy depends in significant part on its pact with a fundamentalist Wahhabi clergy that is deeply opposed to basic political reforms, such as equal rights for women. The deep structural tensions generated by a 21st-century Westernized elite existing within a 15th-century Saudi social structure have been papered over for decades by oil wealth. If this strange social contract begins to fray, it might tear completely. And over in the eastern quarter, adjacent to Bahrain, where most of Saudi Arabia’s oil reserves are located, sits a restive Shiite minority who have been treated as second-class citizens for decades.

Even if the Obama administration were understandably inclined to leave well enough alone, it cannot afford to do so for other reasons. The Saudis are attempting to erect the wall beyond their borders not only by suppressing the revolt in Bahrain but also by insisting that Jordan’s king not pursue the reform agenda he has promised his people. In effect, Abdullah intends to carve out an exception for all the kings and sheiks — Sunni to a man — in Saudi Arabia’s neighborhood. It might work for a time. But should this dam break, it could generate a sectarian Sunni-Shiite, Arab-Iranian conflict on one side and an Arab-Israeli conflict on the other. It could spell the end of Pax Americana in the Middle East.

For all of these reasons, President Obama urgently needs to negotiate a new compact with King Abdullah. He has to find a way to convince him that defining a road map that leads to constitutional monarchies in his neighborhood, and eventually in Saudi Arabia, is the only effective way to secure his kingdom and the interests of his subjects. Abdullah has been willing to undertake important reforms in the past. But if the king is to be persuaded to embark on this road again, he will need to know that the president will provide a secure safety net of support, rather than undermine him. And he will need to know that the United States will not make a deal with his Iranian enemies at Saudi expense.

Such a compact would be difficult to negotiate in the best of times. It cannot even be broached in current circumstances unless the basic trust between the president and the king can be reestablished. With a budget crisis at home and turmoil in the Middle East, it’s understandable that Obama has had little time for the personal engagement with potentates that does not come naturally to him. But it’s not just Abdullah’s survival that is at stake. A revolt in Saudi Arabia could sink his presidency.

The writer is vice president and director of the Brookings Institution’s foreign policy program and convener of the U.S.-Islamic World Forum, which meets in Washington next week.