The Middle East and North African crises

IT’S THE ECONOMY STUPID?

Bill Clinton focused on the economy and defeated G. H. W. Bush in the presidential elections of 1992.  In the process, he made the above slogan famous.  That same slogan was the rallying cry of the winning ticket in 2008.  Will it be again in 2012, or will the recent upheavals in the Middle East and North Africa bring foreign affairs back to the forefront?  It may be too soon to say, but I suspect that the presidential candidates will be less inward-looking than in the past.  Investors will should do likewise and sooner.

It all started in the Ivory Coast last November, where the presidential incumbent refused to cede power to the winner of the election and went on to say that African countries would not go to war to oust him.  His defiance was widely condemned by the UN, European and African countries.  This emboldened many Ivoirians to demonstrate in the streets, but no foreign armed intervention materialized and the standoff continues.

Tunisia was next.  At first, the police and security forces reacted brutally, enflaming the population, but the armed forces soon dissociated themselves from the repression and were instrumental in forcing President Ben Ali to flee.  A similar scenario enfolded in Egypt.  There, the US used its influence to repeatedly call for the ouster of President Mubarak.  As in Tunisia, the Egyptian army refused to use violence to repress demonstrators and facilitated the change in government.  In Libya, Muammar Gaddafi led a violent repression on civilians.  The US called for him to leave as did other governments, but momentum may have swung back in his favor and the country seems on the verge of splitting along historical and tribal lines.  Bahrain, Yemen, Oman are experiencing disruptions to various degrees.  So, it seems, is Saudi Arabia.  Iran is reported to have detained opposition leaders, to prevent large scale demonstrations.

The short and medium-term doesn’t look too bright:

-          Long repressed aspirations and frustrations were suddenly released, and due to the lack of institutional infrastructures, were left to develop according to their own momentum where the end result is unknowable at this time;

-          The demonstrating populations were more united by their rejection of the regimes in power than by what they wanted to achieve afterwards;

-          The successful transition from autocratic regimes to democracy takes (a lot of) time, yet the world establishment pressed for immediate change, raising expectations to unrealistic levels and planting the seeds for disillusionment and instability;

-          Most of the regimes that fell were secular but some of the better organized and more active opposition groups have religious leanings.  A look around the world shows that religion and politics don’t mix very well;

-          As in Yugoslavia, some of the felled authoritarian regimes held together countries with competing ethnic, religious or tribal groups.  While freedom must be welcome, it remains to be seen whether these groups will feel common national identities, and if not, whether the result will be the formation of failed or non-viable states;

-          With the collapse of repressive regimes, police and securities forces have disintegrated.  The armed forces have been reluctant to step in.  Sooner or later, order will have to be reestablished to prevent economic collapses and civil unrest.  The longer this takes, the more difficult it will be;

-          Finally, and for the time being, it is those regimes that have been the most brutal and repressive that have survived, while those that hesitated to shed blood were swept away.  Not a very encouraging lesson.

Without prejudging the final outcomes, it seems that several years may have to pass before new and stable regimes take hold in much of the Middle East and North Africa.  

Given the immediate needs of these countries, their geographic proximity to Europe and their vast energy resources, it is inevitable that Europe and the US will try to help in the transition and rebuilding process.  There are talks of a new Marshall Plan for the region.  France, the UK and the US are pondering how to deal with the shifting political map.  Much has been learned from experiences in Haiti, Afghanistan and Iraq.  One lesson is that rebuilding is arduous and costly.  Another is that foreign sponsors are better off trying to maximize the participation by all segments of the population in the political process rather than trying to steer countries to specific regime structures.

As far as investors are concerned, some lessons can be drawn already.  One is the importance of political risk assessment.  No pundit warned of upheaval coming to the Middle East and North Africa in 2011.  Probably, nobody could.  The point is that, by definition, emerging markets have less stable institutions and less developed financial markets than OECD countries; accordingly, they should carry a substantial risk discount which may, or not, be negated by the premium attached to their higher economic potential.  On a relative basis and over the last twelve months, emerging markets have been overvalued compared to the US.

Second, as the debate about energy independence and clean fuels is revived, the strategic importance of natural gas should become ever clearer.  It is abundant in the US, it is much cleaner than coal (not just regarding CO2 but also mercury and toxic gases), gas-fired power plants are faster and cheaper to build than the alternatives.  Over-production in North America is depressing gas prices, but this may not last too long as new drilling activity slows down and demand rises.  Low cost natural gas producers and power generators are probably worth a look.

The travails of the Middle East may benefit the Russian gas industry.  Already, Gazprom is shipping more gas to Italy to make up for lower Libyan exports.  It will also ship more LNG to Japan to compensate for the shutdown of several nuclear reactors there.  American oil and gas companies have had difficulties in Algeria with state company Sonatrach.  This is not conducive to new investments. 

The recent nuclear accident in Japan may revive European (mostly German, Italian, to a lesser extent British) misgivings about nuclear energy.  Enthusiasm for solar and wind power is confronting the reality of high costs, high subsidies and poor scalability.  Europe and Russia remain far apart about the structure of the gas industry, but they will likely find it to their mutual benefit to try and bridge their differences.

The above observations do not pretend to be definitive; even if they prove generally correct, geographic realities will not change and energy industry trends take years to take full effect.  Pricing, however, takes place at the margin.