April 7, 2011

If Saudi Arabia Is Overthrown, the Global Price for Oil Is Likely to Skyrocket

The Political-Unrest / Oil-Price / Food-Price Spiral

By Alfred Adask
March 11, 2011

The recent turmoil in the Middle East: 1) is likely to not only continue but get worse; and 2) could precipitate another global recession—or worse.

The fundamental problem is the relationship between political unrest in the Middle East, the price of crude oil, and the price of food. I.e., political unrest in the Middle East causes the price of oil to increase. A rise in the price of oil causes the price of food to increase. As the price of food increases in Arab countries (like Egypt) that are not significant producers of oil or food, political unrest within those countries will grow . . . causing the price of crude oil to go even higher . . . causing the price of food to go even higher . . . causing even more political unrest.

It’s hard to imagine an end to this spiral that doesn’t include catastrophe.


March 5th (AFP) “LONDON—The price of a barrel of crude could double if the unrest in the Arab world continues, oil trader turned British international development minister Alan Duncan warned Saturday. . . . the price of a barrel of crude could top $200, well above the record high of $147 reached in July 2008. If extremists used the instability in the Arab world to bomb oil tankers, pipelines or Saudi reserves, prices could even hit $250 a barrel . . . . Speaking of the turmoil in the Middle East, Mr. Duncan warned, ‘At the moment this is secular, economic and demographic but if it goes wrong you will see Islamic fundamentalism becoming the only vehicle for people’s grievances.’”

Note that the previous “record high” for crude oil helped precipitate the global “recession” in A.D. 2008. It follows that another “record high” for crude oil could precipitate another dose of “global recession”.

Note that crude oil is essential to modern agriculture. Tractors that pull plows run on diesel fuel or gasoline as do the trucks and ships that haul produce to markets. Crude oil is a primary component of most modern fertilizers. When the price of crude oil increases, the production costs for food must also increase.

When the Egyptian dissidents who recently fostered a new secular “democracy” are unable to feed the hungry, there will probably be more unrest and starving Egyptians may be drawn inevitably to support radical Muslims.

• The relationship between the price of crude oil and the price of food was implied in a March 4th report from News.com.au (out of Australia):

“Food prices hit highs as oil rises. World food prices have hit new records and oil price spikes could push them even higher, the UN food agency warned as unrest in the Middle East and North Africa hits markets. . . . The Food Price Index, which monitors average monthly price changes for a variety of key staples, rose to 236 points in February from 231 points in January, the UN’s Food and Agriculture Organization (FAO) said. It was the highest level since FAO began monitoring prices in 1990. . . . Unexpected oil price spikes could further exacerbate an already precarious situation in food markets, . . . rising food prices are driving unrest around the world, including recent uprisings in the Middle East and North Africa.”

Rising food prices can be an inconvenience for people in the Western World where, on average, food costs are a relatively small part of family budgets. But in the impoverished, third world, the cost of food can comprise over half of a family’s budget. Small increases in the price of food can be devastating to poor nations. Such price increases can easily exacerbate political unrest and precipitate revolution or social collapse.

Egypt, for example, does not produce much oil and therefore won’t profit significantly from any increase in the price of crude oil. Egypt is not self-sufficient for food. Therefore, if the price of crude oil increases, the price of imported food will increase, and the Egyptian people who overthrew Hosni Mubarak in February may be starving in June. In the midst of hunger, political unrest must increase.

Egypt sits on the Suez Canal—a significant means of transporting crude oil from the Middle East to Europe. If the Egyptian people become so frustrated that they restrict traffic on the Suez Canal, the price of oil will increase further, the price of food will increase further, and the Egyptian people will become even more frustrated.
• But growing political unrest is not limited to the Middle East and North Africa. On March 9th, NewsCore reported:

“A senior economist at the worldwide bank HSBC has warned of civil unrest in Britain if food prices continue to soar . . . . Karen Ward cautioned that ‘Even in the developed world I think we have very, very low wage growth, so people aren’t getting more in their pay packet to compensate them for food and energy price increases, and I think we could see social unrest certainly in parts of the developed world and the UK as well.’ . . . Food costs have gone up for eight months in a row, with the UK’s National Farmers Union forecasting the trend will continue for the rest of 2011.”

It’s unlikely that “the cost of food will continue to rise for the rest of 2011” in England and not also rise in the Middle East. If the cost of food continues to rise in the Middle East for the remainder of this year, how much more political unrest can we expect to see?

• The February 9th Wall Street Journal reports,

“Wheat prices rose to fresh highs yesterday as news that top buyer Egypt had entered the market after an absence of almost a month boosted dealers’ confidence following weeks of unrest. . . . Egypt’s state-owned wheat buyer, the General Authority for Supply Commodities, . . . . bought 170,000 tonnes of US, Argentine and Australian soft wheat. The news pushed wheat futures higher . . . . This upward pressure adds further stress to the carefully calibrated systems in place to bring enough food into countries to feed hungry populations, and provide the subsidies that ensure it is sold at prices that are accessible to the poor and the vulnerable.”

“Top buyer Egypt” implies that Egypt is incapable of growing sufficient food to feed its people and must therefore import lots of grain.

But, as Egypt bought more grain, the news “pushed wheat futures” (and prices) of grain higher. Egypt must buy grain. As it does, the price of grain rises . . . which makes it harder for Egypt to buy more grain . . . which tends to increase Egyptian political unrest.

Describing the global food distribution system as “carefully calibrated” means there’s not much room for error. Small increases in prices or small decreases in supplies may devastate impoverished countries and spawn more political instability.

• February 16th (AP) “Global food prices have hit ‘dangerous levels’ that could contribute to political instability, says World Bank President Robert Zoellick. The rising prices have hit people hardest in the developing world because they spend as much as half their income on food. . . . The World Bank estimates higher prices for corn, wheat and oil have pushed 44 million people into extreme poverty since last June. The bank report said global food prices have jumped 29 percent in the past year, and are just 3 percent below the all-time peak hit in 2008. The World Bank’s food price index rose by 15 percent between October and January alone.”

Annualized, a price increase of 15% in 4 months, is almost 50% in a year. If that rate of increase continued, a poor family that currently spends 50% of its income on food might soon be required to spend 75%. Chaos will ensue.

• “The U.S. Department of Agriculture predicted last week U.S. corn farmers will have just 675 million bushels of corn at the end of August, before next year’s harvest begins. That’s just an 18-day supply. The slim reserves mean traders will likely bid up crop prices further at any weather event that reduces next year’s planting. ‘We need to get good crops, all around the world, in all of these commodities. You just don’t have much foot room for error.’”

Think of it: a mere “18-day supply” of corn—here, in the USA. That’s scary. If there are any global disruptions in the food supply–including drought, war, closing the Suez Canal, earthquake in Japan, Tsunamis, rising oil prices, etc.–that “18-day supply” might evaporate and America might temporarily run out of corn.

What’s the probability that we’ll “get good crops, all around the world” before next fall’s harvest? Very small.

The global food distribution system is already stretched so thin, that even a small disruption could have massive, international consequences.

• March 8th, NYTimes:

“Gasoline prices have risen by nearly a third in the last year . . . . Nouriel Roubini, the New York University economist who became known for his pessimistic [but accurate] forecasts before the [A.D. 2008] financial crisis, said that an increase in oil prices to $140 a barrel could even cause some advanced economies to dip back into recession. . . . What it is going to do is leave us with anemic and sporadic growth that to most Americans will still feel like a recession.”

America may suffer a longer “recession”. The people of third world countries like Egypt will suffer a depression. Our recession may be tolerable. Their depression may be unendurable.

• March 7th, Washington Times:

“Tipping point for oil seen at $150 per barrel. Dennis P. Lockhart, president of the Federal Reserve Bank of Atlanta . . . spelled out what level of oil prices might trigger Fed action, pinpointing the record level around $150 set in 2008. Many economists say those oil prices helped throw the economy into a recession. “I think at the $120 range—it’s a manageable level. Around $150 it becomes a much more serious concern.” . . . Despite widespread worries that the Fed could stoke inflation by accommodating high oil prices, Mr. Lockhart said inflation is not a problem, especially because wage gains — the biggest cost for most businesses — remain anemic.”

“Anemic wage gains” mean that as the price of gasoline and food rise, the working people of the world will not enjoy a comparable increase in income. That implies that “de common folk” (as usual) will be financially squeezed across the globe. With that stress will come a greater global predisposition for political unrest.

• March 7 (Bloomberg):

“Options traders are betting more than ever that crude oil is heading to $200 a barrel as some websites call for a national “Day of Rage” on March 11 and March 20 in Saudi Arabia and anti-government protests in the Middle East and North Africa. Saudi Arabia produced . . . one third of OPEC output and almost six times as much as Libya . . . . ‘The price of oil is going up, whether you like it to or don’t,’ said Juerg Kiener, chief investment officer at Swiss Asia Capital Ltd. in Singapore. ‘If Saudi Arabia fails, then I say you have a fire in the house.’”

While some warn that the economic “tipping point” may be $140 to 150/barrel, traders are beginning to bet on $200/barrel.

• March 10th (AP):

“CAIRO – Saudi police have opened fire at a rally in the kingdom’s east in an apparent escalation of efforts to stop planned protests. Government officials have warned they will take strong action if activists take to the streets after increasing calls for large protests around the oil-rich kingdom to press for democratic reforms. . . . gunfire and stun grenades were fired at several hundred protesters marching in the city streets Thursday.”

I don’t expect Saudi Arabia to be overthrown. But if it happens, the global price for oil is likely to skyrocket—at least until some stability is restored. As a consequence of skyrocketing oil prices, food prices will also skyrocket, third world nations will suffer further political unrest, and prices for oil will be driven even further.

• America also has food supply problems. Food stamps are setting records. They’re now being sent to more than 44 million Americans. And another 15 million qualify—one out of every 5 Americans. Very few countries are absolutely immune to political unrest caused by higher oil and food prices.

• The Arab countries of the Middle-East are not generally self-sufficient for food.
1) If Arab unrest causes the price of crude oil to rise; and,

2) Crude oil is critical to making fertilizer, operating tractors, trucks and machines needed to plant, harvest and ship food; then,

3) A rise in the price of crude oil must cause a correlative rise in the price of food—in the very Arab countries that are already in a state of unrest.

So, when the already-angry Arabs see the price of their food rising to levels they can’t afford, they’ll become even angrier . . . which will cause even greater “Arab unrest” . . . which should cause even higher prices for crude oil . . . which should cause even higher prices for food . . . etc., etc..

If anyone can tell me how the spiral of Arab unrest, higher oil prices, higher food prices and more Arab unrest can be alleviated without violence, chaos and perhaps millions of deaths, I’m all ears.

PUNCHLINE: On February 10th, the Associated Press reported that, “Chinese officials said they were preparing for a severe drought in several provinces, causing wheat prices to spike.

The global food distribution system is already stretched to the near-breaking point. It’s a virtual certainty that sooner or later . . . this year, next year, the year after . . . the food distribution system will fail and millions of people may be forced to choose between starvation and a shooting revolution. Millions. In the context of such catastrophe, the price of food (if you can find any for sale) may be astronomical.

It might not be a bad idea to stock up on food now, while it’s still affordable . . . and still available.

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