The Risk to Saudi Arabia

From Ambrose Evans-Pritchard:

At least four protesters were killed in a bloody crack-down in Bahrain after tanks entered the capital and security forces smashed a tent city in the main square, opening fire with grapeshot. The situation is fraught with risk since a Sunni monarchy rules a Shia majority with mixed Iranian ancestry and sympathetic ties to Tehran.

"Bahrain is the main danger, not because it is intrinsically important, but because it could trigger intervention by Saudi Arabia," said Faysal Itani, a Mid-East expert at consultants Exclusive Analysis. "We have heard reports that the Saudis have already dispatched troops and equipment to put down the uprising". . . .

BNP Paribas said events in the Gulf were setting off a scramble for scarce energy supplies. "Rising oil prices are becoming an increasing threat to the global economy, hitting the net oil consumers of China, Europe, and Japan the most."

Credit default swaps (CDS) measuring bond risk in Bahrain have been rising all week, surging another 24 basis points yesterday to 285. The CDS on Saudi Arabia rose 3 to 127, and Egypt pushed back 9 to 360 as the political euphoria gives way to industrial strikes. The Mid-East holds 60pc of the world's proven oil reserves, and makes up 36pc of current supply.

"The real issue is whether this will spread to Saudi Arabia," said Mr Itani. "The Kingdom's Eastern Province is also mostly Shi'ite and contains the vast majority of its oil reserves. When markets start to make the connection between the region's political geography and the location of the oil, that is when they might react."

The province is the headquarters of the Saudi oil giant Aramco and holds the huge Safaniya, Shaybah and Ghawar oilfields. The area rose up in 1979 in sympathy with the Iranian revolution, leading to 21 deaths. The Saudis have since made efforts to address grievances.

Mr Itani said Western observers are complacent about Saudi Arabia. "We do not believe things are as docile as presented. There is very high unemployment, deeply-aggrieved minorities, and the army has been kept weak and divided for political reasons," he said.

Mr Itani said the Shia majority in Bahrain were kept out of sensitive jobs and denied a real voice in the island's parliament, where an appointed upper house calls the shots. "This uprising has been brewing for two years but the authorities were able to confine protests to the villages until now. This time it reached Manama," he said.

Oil analysts say crude prices would become a major drag on growth if they punch above $120 a barrel and stay there for long. It was this sort of level that sapped the foundations of the global economy in mid 2008, though prices did briefly spike to $147.

Rising oil costs are a major headache for China and other emerging powers in Asia that have a much higher dependence on energy for each unit of output than the the West. They rely on cheap shipping cost to transport exports with wafer-thin profit margins.

Lighter US crude has not risen as much, though it jumped $2 yesterday to $86.5. However, US crude and Brent prices rarely diverge for long. A major disruption in the Gulf would ultimately cause oil to rise acoss the global system.

Most analysts expect Brent to drop back to US crude levels once the Mid-East jitters subside. "Prices are expected to severely correct downward as current prices are too high for fundamentals," said Christophe Barret from Credit Agricole CIB

However, OPEC is already overshooting its output target by some 2m barrels-a-day (b/d). It is not clear whether the cartel has the spare capacity to meet fast-growing demand in Asia for much longer, leaving a thinner margin of security in the energy markets.

The International Energy Agency (IEA) expects consumption to jump by over 2m b/d to 89.3m this year, the fifth upgrade since August. The global "oil burden" will rise sharply to 4.7, "close to levels that have coincided in the past with a marked economic slowdown."

"The combination of higher prices, emerging inflationary pressures and instability in the Middle East is not a healthy one," said the IEA's monthly report.

Two additional data points underline the potential for disruption from the Persian Gulf:

Seventeen million barrels of oil passes through the Persian Gulf and the Strait of Hormuz every day, according to an IEA official. The IEA's chief economist, Fatih Birol, estimates that "90 percent of growth in oil production" will have to be met by Middle East and North African countries.