Calm in Saudi Arabia Speaks Volumes

The contrast between Libya and Saudi Arabia on Feb. 23 couldn't have been more striking. As Qaddafi loyalists fought rebel forces east of Tripoli, oil majors such as Total (TOT) and ENI (E) cut or suspended their Libyan oil production, while the U.S., Britain, and Italy prepared to send ships and planes to evacuate their citizens. On the other side of the Arab world, Saudi King Abdullah returned from three months of medical treatment abroad laden with gifts for his subjects. Abdullah, known as the people's king, announced $36 billion worth of new jobless benefits, education and housing subsidies, and debt write-offs. The government even unveiled a new sports channel.

The world is focused on the tragic events unfolding in Libya, which have alarmed U.S. policy makers and spooked markets into bidding oil above $100 a barrel. Yet a nonevent—the unrest that is not occurring in Saudi Arabia—could prove just as important in determining the future of the region and the world economy.

If Saudi Arabia's people—including a sizable Shiite minority—keep supporting Abdullah's regime, then the country can bring its vast reserves of oil into play to make up for any production lost in Libya or other crisis-crippled states. If instead Shiite unrest spills over from neighboring Bahrain into the Saudi state and puts production at risk, the world will be in a very dangerous place.

Observers like Peter Zeihan, of geopolitical consultants Stratfor, are betting that Saudi Arabia will escape the turmoil. "Odds are the Saudis would hold on because they have much better social control in the form of policing powers, and they are better able to insulate the minority group that might like to see a change from events in the outside world," he says.

It would be unwise to say definitively that Saudi Arabia will emerge unscathed. Yet 86-year-old Abdullah has proven an able ruler. Under him and his influential Oil Minister, Ali Ibrahim al-Naimi, the kingdom has expanded its oil production capacity to about 12 million barrels a day; actual production is about 8.4 million barrels a day. The government has a 35,000-man force just to protect key oil and gas installations. "I don't really see any credible risk to their oil infrastructure," says Jarmo Kotilaine, chief economist at Jeddah-based National Commercial Bank.

The kingdom is also investing in its citizens, including minority Shiites in the oil-producing region of the Eastern Province, through generous social programs. Saudi Aramco, the giant state oil company, has made sure to employ a large number of Shiite workers to give them a stake in its success.

Ordinary Saudis have started to benefit from King Abdullah's educational programs. Yasser Abbass, a 28-year-old Shiite, got full tuition and board while studying for a master's in business administration at a California university. "The government's program took care of most of my expenses during my studies, including tuition, health coverage, and monthly allowance," says Abbass, who returned to the kingdom and got a job as an investment banker in Riyadh.

The kingdom's role as the world's main oil exporter is more critical than ever as Libya, Africa's third-largest oil producer, and Algeria, the continent's fourth, confront popular uprisings. Libya pumps 1.6 million barrels a day, according to data from the Organization of the Petroleum Exporting Countries, and exports mostly to Europe.

"Saudi Arabia has built up its spare production capacity so it can handle any supply interruption in the market," says Carsten Fritsch, a Frankfurt-based analyst at Commerzbank. "Saudi Arabia can handle it unless there is a combined impact of protests in North Africa and in another large Gulf Cooperation Council oil producer." So far, none of the major Persian Gulf oil producers have seen the kind of political instability that has affected production in Libya.

Saudi Arabia has about 3.5 million barrels of untapped daily production capacity for emergencies, the International Energy Agency says. That's more than double Libya's output. The Saudis would need at least 30 days to bring this capacity online, says Erik Kreil, the U.S. Energy Dept.'s specialist on oil market disruptions. Minister al-Naimi said on Feb. 22 that OPEC is ready to step in to meet a shortage caused by a disruption in shipments from Libya. "Saudi Arabia and OPEC will be ready to meet that shortage, if and when it happens," he said.

Despite al-Naimi's assurances, Brent oil futures, the benchmark price for two-thirds of the world's crude, have climbed 10 percent since Feb. 15—just before Libya began to unravel and passed $108 a barrel for the first time since 2008. Prices will continue to escalate while the Saudis tap their spare capacity and refiners, chemical makers, and speculative traders scramble for their piece of a shrinking global supply, Kreil says.

Oil traders are haunted by the specter of 2002-2003, when political unrest and an oil industry strike in Venezuela interrupted the flow of crude exports from one of the primary suppliers to the U.S. market. While the world waited for the Saudis to deliver on promises of extra crude, oil futures traded in New York surged 51 percent in the span of three months to the highest price since the outbreak of the first Gulf War more than 12 years earlier. A similar runup now in the Brent contract used to price Middle East crude would translate into prices in excess of $160 a barrel. If the Venezuelan experience is any guide, prices from such a spike would not stay high for long. After Saudi supplies began flowing in the spring of 2003, U.S. crude prices tumbled 37 percent in two months.

The difference between 2003 and now is that the current crisis is in the Mideast, where upheaval has proved contagious. Gianna Bern, a former BP (BP) crude trader now at Brookshire Research and Advisory, puts it this way: "The real concern is that if we see these sorts of disturbances spread to Saudi Arabia or Iran, then we're going to see turmoil in energy markets go to another level, an unprecedented level."

All the Arab states that emerged from the collapse of the Ottoman Empire after World War I are vulnerable, Stratfor's Zeihan says, because none have managed a normal transition of political power. Saudi Arabia has been under the thumb of the same family since its establishment. Even if Saudi Arabia avoids unrest this time, it has to continue Abdullah's reforms to prevent an upheaval. Says former U.S. Ambassador to Saudi Arabia Richard Murphy: The Saudis need to keep creating jobs and more importantly give their citizens "a sense of participation in government."

The bottom line: Saudi Arabia has thus far escaped tumult thanks to tighter market controls and better social programs than its neighbors.

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