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Why oil prices could touch $200 a barrel

Barack Obama, the President of the United States, has been making the right noises when it comes to supporting the pro-democracy movement in northern Africa and parts of the Middle East.

He came out in full support of democracy when protests were on in Egypt and so has been the case with the current protests in Libya.

But the interesting question is whether Obama will come out in support of democracy or some basic reform in Saudi Arabia, as protests for reform hit the country.

March 11 and March 20 had been planned as “day of rage” by Saudi protestors. The Washington Post reports some activists as saying that “uprisings that have toppled Arab leaders in Egypt and Tunisia...will show ordinary Saudis that their royal family must also be held accountable.”

Before we dwell on the kind of impact any protests will have on the price of oil, a little bit of history is in order.

The secret meeting
The story goes that towards the end of World War II, Franklin Delano Roosevelt, the then US president attended a summit.

As Iain Carson and Vijay V Vaitheeswaran recount in their book Zoom — The Global Race to Fuel the Car of the Future “Roosevelt travelled quietly to the USS Quincy, anchored in the Red Sea. The man he met there had rarely set foot outside his home country and insisted on bringing an entourage of dozens, which included his household slaves and a royal astrologer. He did not preside over a vast nation, he was not a significant world ruler, but he was in command of the greatest store of the one commodity the modern world needed more than anything else: oil. He was King Ibn Sa’ud, father of the new country of Saudi Arabia, home to the biggest reserves of oil on the planet.”

Of course what followed was an “oil-for-security” pact. “In return for guaranteed access to Saudi Arabia’s vast quantities of oil, Roosevelt promised the tribal chieftain America’s full military support. Revealingly, the oil-for-security guarantee was extended not to the people or the government of Saudi Arabia but to the Al Sa’ud ruling clan itself,” write the authors.

What this guarantee did was it helped US consume oil way more than it required. In fact, currently the way things stand, the US consumes a quarter of the world’s daily production of oil and half of its petrol production.

The first law of petropolitics
Interestingly, due to this guarantee, Saudi Arabia became the first country to follow what Thomas Friedman, the New York Times columnist and a well known mouthpiece for the American establishment, called the First Law of Petropolitics.

The law, Friedman wrote in an article in the Foreign Policy magazine five years ago, states: “The price of oil and the pace of freedom always move in opposite directions in oil-rich petrolist states.”

There are various ways in which the discovery of oil stifles the idea of a democratic state. Oil generates a huge amount of cash for the government in power and that in turn allows them to buy off the citizens through greater patronage spending.

As David Strahan writes in The Last Oil Shock, “With the arrival of the oil boom of the 1970s Saudi Arabia’s royal family was able to buy domestic political legitimacy, or at least acquiescence, by providing one of the most lavish welfare systems anywhere in the world. For years, Saudis effectively paid no tax, and received not just free healthcare and education but also subsidised housing, electricity, fuel and food, and interest-free loans - often not repaid.”

Over and above this, the large amount of cash that oil generates allows the government or the ruler in power to build a large secret police force which can be used to choke any democratic movements.

These things have happened in Saudi Arabia as well and the power remains largely with the Al Sa’ud family.

But at the ground level things haven’t been as good as they were in the past. As can be seen from the accompanying table sourced from the International Monetary Fund, the per capita income in Saudi Arabia has been going down over the years. Unemployment among youth currently stands at 30%. As Strahan writes, “Since their heydays in the early1980s, Saudi finances have deteriorated badly, and social benefits have been cut back.”

All this sets the stage for some form of protest clearly. The bigger question though is whether the Saudi citizens want to continue to be governed by a monarchy like in the Middle Ages. “For decades the fundamental contradiction of Saudi Arabian society has been that a population that largely adheres to Wahabism, the most puritanical, fundamentalist and xenophobic sect of Islam, is ruled by royal family that is venal, bloated and Westward-leaning. The absolute monarchy has only managed to survive because its control of oil has allowed to buy American protection, and to bribe its own people. But now the entire arrangement is teetering,” writes Strahan.

The price of oil
The latest issue of the Economist states: “Two factors determine the price of a barrel of oil — the fundamental laws of supply and demand and naked fear”.

The supply of oil will remain a huge issue in the years to come, but in the near term it is “naked fear” that will drive prices up. Currently, analysts and experts are not convinced about a democratic revolution hitting Saudi Arabia. But what they are convinced about is the fact that even a significant threat of protests in Saudi Arabia will send prices soaring through the roof.

In fact the “day of rage” planned on March 11 and March 20, has led to investors buying $200 call options on crude oil. As Bloomberg reports, “The number of outstanding contracts for “call” options to buy New York crude for June delivery at $200 a barrel...has escalated, along with crude futures, to the highest since the options started trading in July 2009 amid worsening civil unrest in Libya and rare demonstrations in Saudi Arabia.”

Call options are essentially derivatives which give the holder of the option the right but not the obligation, to buy a particular security at a particular price before a certain date.

As David Rosenberg, a well respected Canadian economist wrote in a recent report, “But what if this social unrest spreads to Saudi Arabia, which holds 20% of the world’s oil? If Libya can spark a $10/bbl response, imagine what a similar uprising in Saudi Arabia could unleash. Do the math: we’d be talking about $200 oil.”

The Shia factor
The ruling majority in Saudi Arabia is Sunni. Shias form around 10-15% of the population. But interestingly most of Saudi Arabia’s bigger oil fields are located in areas around which Shias have a significant presence. Some analysts are of the view that protests by Shias in Bahrain could motivate Shias in Saudi Arabia to also protest against the ruling order.

Of course all this leads to the question whether the US will intervene in Saudi Arabia to stop any large democratic demonstrations? If they do, they will go against a famous phrase in their Declaration of Independence: “We hold these truths to be self-evident, that all men are created equal, that they are endowed by their creator with certain unalienable rights, that among these are life, liberty and the pursuit of happiness.”

If they don’t, there will be a new world order. But either way, the price of oil will go through the roof.

The writer works in the financial services industry in India and can be reached at Views are personal