Written By: Morgan Jones – Corporate Finance
A slew of recent arrests in Saudi Arabia have investors on edge. In a surprise move, Crown Prince Mohammed bin Salman conducted sweeping arrests of high-ranking and public officials under what was deemed to be “a corruption purge”. The sweeping arrests were presented as an effort to clear out the corruption endemic to the Saudi government.
However, the instability stemming from his actions have given pause to foreign investors with large interests in the Kingdom. Increased tensions in the Middle East centered on Saudi-Iranian relations have sparked fears that the regional instability could yield a military conflict. Rather than an out-and-out conflict between the two regional powers, the conflict would likely take place in one of the many theatres in which their rivalry is currently playing out. The block of high-profile nationals arrested ranged from politicians and members of the business community, to ministers and princes.
The move was unprecedented in a country such as Saudi Arabia, where bold-faced corruption has instilled in many Saudi citizens a sense of resignation that they will never see these corrupt officials face justice. Prince Mohammed bin Salman is being celebrated by those same citizens exhausted with the corruption impunity. More importantly, this could lead to a more efficient bureaucracy and facilitate the reforms currently pursued by the Crown Prince. Prince Mohammed bin Salman has been the face of modernization as he has introduced reforms, such as allowing women to drive and developing a new business hub.
Of particular interest to investors is the announcement that Saudi Aramco—the Kingdom’s state-owned oil company—will hold an initial public offering, allowing foreign investors to own stakes in the company for the first time in its history.
But concerns exist that the prince has now concentrated power around himself. Amongst the ranks of those arrested are nearly every major political rival that could counterbalance bin Salman’s rule when he inherits power from King Salman. While talk of a coup is both alarmist and reckless, the consolidation of power smacks of a move towards a more autocratic government in the Kingdom. While investors are typically not skittish when strongman leaders are involved, there is less appetite for the risk accompanying regional conflict in an already-depressed oil market. Oil markets have yet to recover from the 2014 price collapse.
Major producers, including OPEC (Organization of the Petroleum Exporting Countries) members and non-OPEC members alike, have had to adjust to the new reality, as the oil price settles at a lower rate for the foreseeable future. With the commodities recovery still sluggish, the OPEC production cap was expected to restore prices to a pre-collapse level. But the OPEC agreement has been largely ineffective. Whether the poor recovery is due to member countries shirking the production caps or unresponsive markets, prices have been chronically low for the past three years. The latest culprit appears to be an overall glut in global markets, depressing prices and limiting the recovery.
With the legs taken out from the Middle East’s oil revenues, some fear that the short-term may have some regional turbulence in store. And there is reason to fear regional turbulence.
The Lebanese Prime Minister Saad Hariri shocked the world when he resigned his government post on live television. Fuelling rumors that Hariri—a dual Lebanese-Saudi citizen—may have been swept up in the arrests is the fact that he made his announcement from Riyadh. In addition, Hariri took the opportunity to lambast the Hezbollah faction of the Lebanese government, with which he shares power, a known proxy of the Iranian regime. The Iranian government was not spared from criticism during his televised resignation—lending further credence to rumors of Saudi meddling.
While the Saudi-Iranian rivalry is on full display in Lebanon and Syria—where Saudi Arabia has supported rebel factions, while Iran backs the Bashar al-Assad regime—their sabre-rattling is no fiercer than the Yemeni theatre. The civil war in Yemen has raged on for years now, with Riyadh backing the embattled government regime and Tehran supporting the rebel factions—a reversal of their roles in Syria.
The two countries appear to be at their closest point of conflict than they have for some time. Prince Mohammed bin Salman made an announcement following a missile launch from a rebel-held airport in Yemen. The missile, which was headed for Riyadh, was intercepted by US-provided missile defense technology. Allegedly, this ballistic missile was provided to the rebels by the Iranian regime, a move which the prince likened to an act of war. Iran’s similarly fiery retort that this allegation was false provided no comfort to those hoping against an escalation of hostilities in Yemen. What will likely occur is a ramping up of the endemic violence plaguing Yemen’s civil war.
However, a proxy war in Lebanon poses a much greater risk to regional stability than does the same in Yemen. Lebanon is much more strategically placed, and could further destabilize the surrounding region: Israel, Turkey and already-destabilized Syria. If a drawdown does not take place between these two rivals, the oil-rich region could devolve into skirmishes or outright regional war.
A realistic assessment would see the region carved up into factions. These factions would likely be drawn along ideological lines, as Saudi Arabia and Iran represent the two major factions of the Islamic faith: Sunni and Shia respectively. Although there are greater nuances to the region than simple religious affiliations, this is likely what will be used to whip up public support for war. Additionally, the two rivals have spent decades poaching and drafting potential regional allies and sponsor states.
The region is, effectively, a cauldron ready to boil over. While it seems difficult to extricate from the current situation, the United States would likely be drawn into the clash thanks to the growing relationship between President Donald Trump and Crown Prince Mohammed bin Salman. Worryingly this may prompt some other proxy—likely Russia—to enter the fray and escalate conditions beyond a containable theatre of war.
These “maybes” and “what-ifs,” however, are worst-case scenarios. Barring some catastrophic event, the two Middle Eastern powers will, hopefully, end their Gulf supremacy chest-thumping. The immediate drop in Saudi stocks following the high-profile corruption arrests will likely level out. In the long-term this is expected to bring about stability in the Kingdom, while the concentration of power around Crown Prince Mohammed bin Salman will likely usher in a new era of liberal overtures in Saudi Arabia.
Although the country will see more potential autocracy, hopefully this corruption purge will boost the lacklustre reforms introduced by the prince’s regime. Nonetheless, the short- and medium-terms will see investors seek more stable stock markets while Saudi Arabia gets its house in order.
With commodities down, and Brexit still weighing over European markets, that leaves few safe bets. At present, US and Japanese stocks have been bullish—with US stocks reaching record highs. While the freewheeling heights of the stock market are cause for concern of a crash or drawdown, the fears of US tax reform will temper the markets and create some stability.