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A perfect storm in the Middle East as protests continue

Backing dictatorships is a cynical strategy, but a policy designed to preserve the steady flow of oil from a volatile region may end up doing the opposite

THE MIDDLE East is in turmoil. A protest movement that began in Tunisia, after Mohamad Bouazizi set himself alight in protest at petty local bureaucracy, has claimed two despots, could soon topple Muammar Qadhafi, threatens the regime of Bahrain and may yet strike at the foundations of autocracies across the region.

The old order is collapsing. Decades-long Western diplomacy in the Middle East – Realpolitik designed to preserve stability, however brutal – is unravelling. As Petroleum Economist went to press, an Iranian gunboat was sailing up the Suez Canal. Long-simmering hatreds between Israel and the nations that surround it threaten to come boiling to the surface. Egypt's uprising, spurred by events in Tunisia, promised freedom. But a regional war could be as likely an outcome.

The immediate threats are obvious. Israeli foreign minister Avigdor Lieberman says the world cannot expect his country to ignore Iran's "provocations" indefinitely. In the past, it has acted swiftly when it sees a threat. A warship in the Suez is not a peace overture and Israel is nervous.

Meanwhile, a fifth of global oil supplies flow through the Strait of Hormuz. The motives of Iran, which has threatened to shut the shipping lanes before, are scarcely to be trusted there, either. A conflict between Israel and Iran could draw in the US and possibly other countries in the Mideast Gulf.

Luckily, we aren't there yet. But these are Armageddon scenarios for the global economy. If the great recession is over, as Opec's secretary general told Petroleum Economist last month, another price spike would change the outlook. Indeed, the International Energy Agency (IEA) already sees $100 a barrel oil as a threat to the economic recovery. That barrier was breached during the uprising against Egypt's Hosni Mubarak. At press time, the front-month Brent contract was well above $107/b. A retreat into double digits looks some way off.

Rising prices will make Opec nervous, too. The IEA has said it may release crude from OECD stocks to soften the price – but the agreed order of such a move is to let Opec pump the necessary volumes first. The group has no plans to ratify such a step, yet, but if the bull-run keeps gathering momentum it may need to, sooner rather than later. There has been talk of an emergency meeting, but that appears to be nothing more than wishful thinking by harassed crude traders. Opec's next meeting isn't scheduled until the summer. Given the speed of events in the Middle East right now, that feels like an age away.

Not surprisingly, the market's bears have disappeared. Libya, wobbling on the precipice of its own upheaval, has already shut in some of its output as foreign operators withdraw. Loadings of crude from its ports on the Mediterranean have been patchy. Banks have closed, so no letters of credit were being issued as recently as 22 February. The country exports 1.2m b/d.

On its own, the loss of those volumes from the world market wouldn't be sufficient to rock the boat. Opec claims spare production capacity of more than 6m b/d. But a supply hit now would add to fundamentals that have tightened markedly since the third quarter of 2010.

With an eye on China's seemingly insatiable appetite for more oil, Opec and the IEA both last month revised up their estimates for how much the world consumed last year and how much it will in 2011 (see Figure 1). Opec reckons demand will hit 87.3m b/d this year and the IEA, far more bullish, predicts 89.1m b/d. This will help lift the call on Opec's crude to almost 29.8m b/d, 0.5m b/d above the average last year. The vast bulk of this demand growth, both agree, will come from China – Opec says its consumption will rise by 5% next year, to 9.3m b/d.

That's the backdrop against which unrest in the Middle East will hit the oil market and, by extension, the global economy. Indeed, says Fateh Al-Khayat, a former director in Iraq's oil ministry, add together the output from oil producers caught up in the maelstrom – Libya, Yemen, Algeria, Egypt – and as much as 4m b/d could be lost from supplies. Opec would struggle to replace that, even if it has the barrels theoretically in store.

It all adds up to the perfect storm that foreign oil-consuming countries have long sought to avoid. For Western countries, the outlook may be particularly bleak. China now buys more oil from Saudi Arabia than any other country, including the US, long the stalwart client of the kingdom. Indeed, Asian consumers account for almost 60% of Saudi exports. So prices for crude out of the Middle East are likely to reflect not what developed countries can afford to pay, but what China and its fast-growing neighbours can.

The spread of unrest

Nor does that factor in the spread of unrest in Bahrain to its fellow Gulf states. Iran's opposition was quelled in 2009 and the regime has acted quickly to stifle renewed rebellion. But rumours already abound about protests planned for Riyadh. Kuwait and the United Arab Emirates will watch developments closely.

That stability in the Middle East has for so long depended on despotic regimes and their ability to crush dissent is a regional tragedy. But shame also lies with democratic Western nations – chiefly the US, UK and France – which have supported these corrupt and repressive governments. Weapons supplied by the UK have been used to quell protests in recent weeks. Indeed, the country sold almost £215m ($347m) worth of weapons and "crowd-control ammunition" to Libya in the 12 months to October 2010. The country's prime minister, David Cameron, was last month in Cairo to promote a democratic transition – and took several British arms peddlers along for the trip, too.

If the regimes are wise, they will avoid using these arsenals on their own people – and bring the region back from the brink. Gulf governments have begun buying food, say local sources, in an effort to stop hunger turning to anger. But man doesn't live by bread alone. Genuine political and economic reforms are also necessary.

The world needs a stable Middle East, but the price should no longer be repression. Backing dictatorships was always a cynical strategy, but a policy designed to preserve the steady flow of oil from a volatile region may now end up doing the opposite. A fire that started in Tunisia could soon burn the global economy, too.

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