The Arab Spring

The Arab Spring, a term given to the Arab Revolution, is a revolutionary wave of demonstrations, protests, and wars occurring in the Arab world that began on 18 December 2010. To date, rulers have been forced from power in Tunisia, Egypt, Libya,and Yemen; civil uprisings have erupted in Bahrain and Syria; major protests have broken out in Algeria, Iraq, Jordan, Kuwait, Morocco, and Sudan; and minor protests have occurred in Lebanon, Mauritania, Oman, Saudi Arabia, Djibouti,and Western Sahara. The major oil rich nations (Saudi Arabia, UAE, Qatar, Kuwait and Oman) have been able to keep their ruling families in power. Clashes at the borders of Israel in May 2011, and the protests by the Arab minority in Iranian Khuzestan erupted in 2011 as well. Weapons and Tuareg fighters returning from the Libyan civil war stoked a simmering rebellion in Mali, and the consequent Malian coup d'tat has been described as "fallout" from the Arab Spring in North Africa. The sectarian clashes in Lebanon were described as a spillover violence of the Syrian uprising and hence the regional Arab Spring. Most recently, in September 2012 a wave of social protests swept Palestinian Authority, demanding lower consumer prices and resignation of the Palestinian Prime Minister Fayyad. The protests have shared techniques of mostly civil resistance in sustained campaigns involving strikes, demonstrations, marches, and rallies, as well as the effective use of social media to organize, communicate, and raise awareness in the face of state attempts at repression and Internet censorship. Many Arab Spring demonstrations have met violent responses from authorities, as well as from pro-government militias and counterdemonstrators. These attacks have been answered with violence from protestors in some cases. A major slogan of the demonstrators in the Arab world has been Ash-sha b yurd isq an-nim ("the people want to bring down the regime").

Global Impact of Instability

The concern here is more with the impact of these changes. In the long run, 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. Instability in the Middle East is obviously nothing new, and while turmoil in nations such as Egypt, Bahrain, Iran, Libya, Algeria, and Yemen may set back those economies, a slowdown in regional growth is unlikely to spread elsewhere. The roughly two dozen countries that make up the Middle East and North Africa regionMENA, to economistsaccount for only about $2.5 trillion in GDP, combined. That's one-fifth the size of the U.S. economy and barely 3 percent of world output. Furthermore, 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.

The Oil Issue

Oil, however, is a different story, since it can rapidly transmit Middle East turmoil to many other nations. The Middle East accounts for 30 percent of the world's oil production and a bigger portion of proven reserves, and even small changes in the supply of petroleum can have an outsized impact on the oil-thirsty economies of the United States, Europe, and Asia. Research firm Roubini Global Economics points out that three of the last five global recessions have followed some kind of shock in the Middle East that drove oil prices up. So far, regime change in Tunisia and Egypt and the increasingly violent protests in Bahrain and Yemen have left the oil markets unscathed. But the same types of socioeconomic problems exist in Libya, Algeria, Iran, Saudi Arabia, and other major oil producers, and if Egyptian-style revolution hit any of those countries, it could be a game-changer. The most representative benchmark Brent crude hit a two-and-a-halfyear high last year. Goldman Sachs said the Mid-East holds 61 percent of the worlds proven oil reserves and 36 percent of current supply. Paul Horsnell, head of oil research at Barclays Capital, is quoted 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. 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 worlds 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.

Risk in Saudi Arabia

The greatest risk lies in Saudi Arabia: most of the kingdoms 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 Arabias 25 million residents are foreigners and unemployment is at 42 percent among the most volatile 20 to 24 year age group. 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. For now, the overthrow of any Persian Gulf oil monarchies seems unlikely, partly because oil-rich nations are somewhat insulated by their own wealth. When the natives get restless in Saudi Arabia or Kuwait, for instance, the government typically boosts the lavish subsidies paid to ordinary citizens, essentially buying their quiescence. Plus, living standards are already much higher in the oil-rich nations than in struggling economies like Egypt or Yemen, where poverty and high unemployment drove protesters into the streets. Still, there's no guarantee that what has worked in the past will keep working. In Bahrain, for instance, the king tried recently to lull protesters by offering every family $2,500 in cash. The protesters only seemed to get angrier. Water-cooler worst-case scenarios focus on a militant takeover of Saudi Arabia or another big oil nation, similar to the 1979 Iranian revolution. But far lesser shocks could also send oil prices skyrocketing, which in turn could be enough to torpedo the fragile economic recovery that's underway in many countries. Libya and Algeria, for instance, control about 4.5 percent of the world's oil production, and rulers in both countries are battling pro-democracy uprisings. If either nation underwent a full-fledged revolution, that wouldn't necessarily mean the oil fields would stop pumping. But there could be

sabotage, strikes, or other measures meant to disrupt the flow of oil, and that could be enough to send prices upward. Iran, with about 4.8 percent of the world's oil production, is another obvious wild card. The theocratic, hard-line regime there has been able to squash pro-democracy movements in the past, but its grip on control seems to be under stress once again. One common assumption is that if political developments impeded the flow of oil in one or two nations, other producersSaudi Arabia, mostlywould pump more, to make up for it. Roubini estimates that the Saudis have up to four million barrels per day of excess capacityroughly equivalent to Iran's total productionwhich seems like a lot of slack in the system. But that doesn't account for the jittery psychology of the oil markets, which at times can be more powerful than the underlying fundamentals.

Price hike
The world got a primer on that in 2008, when oil prices rose from $95 per barrel to $145 in a mere six months. The causes still aren't completely clear, but it does seem evident that a bubble mentality led traders to bid up oil because they felt prices would go even higher in the future. The bubble burst as the global recession hit, and by the end of 2008, prices had collapsed by nearly 70 percent. On one hand, it's reassuring that oil prices fell back to levels more consistent with real economic activity. But the 2008 spike also revealed the extent to which psychology and fast computerized trading can dominate the market for volatile commodities like oil. Once there is movement in prices, momentum trading kicks in and people want to lock in future prices. That pushes prices higher and higher. The market can overshoot significantly.

The global economy can probably withstand a 10 or 15 percent rise in oil prices, but anything more than that could threaten the recovery. Roubini says that if prices crested $100 and stayed there for a while, it would cut into global consumption and GDP growth, which could lead to a double-dip recession in some countries. If political upheaval actually interrupted the flow of oil, the effect would be more abrupt. It would not have to be a permanent loss of oil. Even a temporary loss over six or 12 months would be enough for prices to rise very rapidly. The impact on the world economy would be significant. If oil prices could surge by 50 percent in 2008when the world was sliding

into recession and the Middle East seemed a bit calmer than it does now then another bubble is certainly possible if several Middle Eastern capitals are in a state of rebellion. And one clear lesson of the last few years is that despite the expertise of Ph.D.'s trying to predict every possible development, "externalities" able to shock the global economy can still catch everybody by surprise. So it might not be a challenge to the Saudi monarchy or the Iranian ayatollahs that sets off an oil shock, but a series of smaller triggers that nobody foresees right now. In addition to strikes or sabotage by oil workers, Khan says other indicators to watch for include the departure of foreign engineers or other technical experts who help keep the oil fields pumping in many Gulf states. Despite supply fears, some analysts contend that such price rallies are unjustified. According to MF Global, increased output from nations less affected by protests and slackening demand following Japans nuclear crisis imply that an oil surplus actually exists and that price increases have been driven by geopolitical news and not by actual data. While rational grounds for the rally exist due to ongoing growth in global demand and the gradual U.S. economic recovery, these factors may not be sufficient to support current price levels after initial panic over the Middle East subsides. Nevertheless, many institutions, including the IMF, have raised forecasts for oil prices. While the upward trend in oil prices is an important one to follow, the prevention of an oil supply shock would not prevent economic fallout from occurring. The effects of such a widespread series of disruptions in Middle Eastern economies will certainly extend beyond the price of a single commodity.

Natural Gas
The Middle East, home to 45% of the worlds natural gas reserves, has a prominent role as an exporter of natural gas. In sharp contrast to oil prices, natural gas prices have not spiked worldwide in response to regional unrest and actually declined on average as of the beginning of March. Because natural gas is a more segmented market, prices have been less volatile at a global level. Even so, some regions are more affected by natural gas supply fluctuations than others. While the United States can rely on domestic natural gas, Europe is vulnerable to supply disruptions. Libya, which has cut off exports,

triggered a 12% price increase in natural gas within the European market. Algeria, as Europes third-largest supplier, could have a severe impact on the European economy if its exports were also suspended. Thus far, though, in a move analogous to compensatory oil production in the Middle East, Russia has offset turmoil in this market by increasing natural gas exports to Europe.

Agricultural Goods
Consider one of the catalysts for the protests: food inflation. A number of inflationary pressures already applied to food prices independently of turmoil in the Middle East, including weather-based supply disruptions, demand growth in developing countries, increased utilization of bio-fuels, and a decline in farming productivity gains. Attempts by Middle Eastern nations to combat economic grievances by using wealth from oil and gas exports are considered a likely course of action and are generally favored over political reform by authoritarian regimes. Because food inflation has emerged as a major concern, unpopular governments may opt to stockpile and subsidize agricultural staples in order to make food more affordable. Some countries, including Algeria and Saudi Arabia, have already begun to stockpile commodities like wheat. If this trend continues, hoarding in the Middle East could apply additional upward pressure to global food prices. In addition to the excess demand that could be created by stockpiling, reduced supply is also a possibility. Exports from Morocco, Syria, Tunisia and Iran include considerable quantities of agricultural goods. Furthermore, export disruptions in Jordan, Tunisia, and Kuwait, major miners of potash and phosphates, could create a shortage of the materials needed to produce crop nutrients and fertilizer.

Industrial Metals
In the market for metals, there is the possibility of another supply interruption, the impact of which would be amplified by already-high price levels and rising global demand. Aluminum, the most-produced metal in the Middle East and a major export of Bahrain, was lifted by the commodities boom in 2010, appreciating 31% over that year. Widespread substitution of aluminum for copper, the prices of which have

appreciated five-fold since 2001 and surpassed $4.60/pound, is expected to augment aluminum demand in 2011. Switching from copper to aluminum becomes economical when copper reaches $3.50/pound, which is well below the current price. Because of this substitution effect, if unrest in the Middle East causes a decline in aluminum supply, the result could be a continued price rally for both aluminum and copper.

Shipping and Transportation

Shipping is another factor jeopardized while the Middle East remains in a volatile situation. The region serves as a transit hub for exports and imports. The usability of the Suez Canal has become cause for concern since the Egyptian revolution began in January. The Port of Djibouti is relied upon by multiple landlocked African countries to export goods and could be impacted if further unrest occurred.

To summarize, the potential impact of unrest in the Middle East cannot be treated as isolated to the prices and supply of petroleum products. While oil and oil-based products constitute an overwhelming majority of regional exports, most Middle Eastern countries have attempted to diversify their economies and reduce reliance upon a single commodity. As a result, when identifying the economic consequences that regional disruptions could cause, it has become necessary to consider a wider range of exported goods and services.