特別レポート
Dear Client, I am visiting clients in Saudi Arabia, Abu Dhabi, and India this week, and as such there will be no regular Weekly Report. Instead, we are sending you a Special Report written by my colleague Marko Papic, Senior Vice President, BCA's Geopolitical Strategy service. Marko argues that the Middle East has reached a stable equilibrium, as much as is possible, and will not drive the news or markets in 2017. I hope you will find this report both interesting and informative. Best regards, Peter Berezin, Senior Vice President Global Investment Strategy Highlights The Middle East is not a major geopolitical risk in 2017. Saudi-Iranian and Russo-Turkish tensions will de-escalate, for now. The OPEC production cut will go through; oil prices will average $55/bbl in 2017. Geopolitical risk continues to rotate to the Asia Pacific region. Trump, Iranian elections, and Iraqi instability pose risks to the view. Feature The Middle East has dominated the news flow for the past five years, for good reason. The carnage in Syria and Iraq is tragic and reprehensible. However, the investment relevance of the various regional conflicts is dubious. For all the attention paid to the rise of the Islamic State, we would remind clients that the group's conquest of Iraq's second-largest city Mosul in June 2014 did not cause a spike in oil prices but rather marked the end of the bull market (Chart 1)! From an investment perspective, the only dynamic worth watching in the Middle East is the "Great Game" between regional actors, which have been looking to fill the vacuum left by America's dramatic geopolitical deleveraging (Chart 2). The U.S. strategy is permanent and driven by global interests, namely the rise of China and the need to shift resources towards East Asia. Given the incoming Trump administration's laser focus on China, we expect that the U.S. will remain aloof from the Middle East. Chart 1Ironically, Worry About The Fall Of ISIS Chart 2While The U.S. Military Deleverages... Does the recent détente between Russia and Turkey in Syria, and between Iran and Saudi Arabia over OPEC production cuts, signal that the Middle East has finally found geopolitical equilibrium? We tentatively think the answer is yes. This will reduce the importance of the region as the primary source of geopolitical risk premia, which BCA's geopolitical strategists have expected to shift to Asia for some time.1 Saudi-Iranian Tensions Are On Ice Chart 3...The Saudi Arabian Military Leverages Up Since the U.S. decision to deleverage from the region in 2011, Saudi Arabia has leveraged up, becoming one of the world's largest arms purchasers and involving itself overtly and covertly in several regional conflicts in the process (Chart 3). Saudi insecurity deepened following President Barack Obama's decision to leave no troops in Iraq. The last U.S. soldier of the main occupation force left Iraq on December 18, 2011. The very next day, on December 19, Iraq's Shia Prime Minister Nuri al-Maliki, a close ally of Iran, issued an order for the arrest of the Sunni Vice-President Tariq al-Hashimi. The move by al-Maliki set off what essentially became a civil war in the country, with the Sunni minority eventually turning to ever-more radicalized militant groups for protection. From the Saudi perspective, Iraq is a vital piece of real estate as it is a natural buffer between itself and its Shia rival Iran. While the Fifth Fleet of the U.S. Navy, based in Bahrain, continues to guard against any Iranian incursion via the Persian Gulf, there is very little space between the Saudi oil fields and Iran if Iraq falls into Iran's orbit. The subsequent five years saw Iran and Saudi Arabia fight several proxy wars in Iraq, Syria, and Yemen. These included direct military action by Iran in Iraq and Syria against Saudi-backed militants and by Saudi Arabia in Yemen against Iranian-backed militants. It also included oil politics, with Saudi Arabia announcing in November 2014 that it was ending years of its price-setting strategy. These strategies ultimately proved to be unsustainable and BCA's Geopolitical Strategy called the peak in Saudi-Iranian tensions in February 2016.2 Why? First, because oil prices collapsed! Geopolitical adventurism is a luxury afforded to those with the means to pursue adventures. The combination of low oil prices, domestic social outlays, and an expensive war in Yemen forced Saudi Arabia to burn through $220 billion of its foreign reserves between July 2014 and December 2016, equivalent to 30% of its central-bank holdings!3 There is a relationship between high oil prices and aggressive foreign policy in oil-producing states (Chart 4). Political science research shows that the relationship is not spurious. As Chart 5 illustrates, petrol states led by revolutionary leaders are much more likely to engage in militarized international disputes.4 This relationship is particularly pronounced when oil sells at above $70 per barrel. At that price, oil producing states become more prone to disputes than non-oil states, regardless of leadership qualities. Second, Saudi Arabia's military campaign in Yemen proved to be a disaster. The kingdom intervened in March 2015 to reinstate the democratically elected President Abdrabbuh Mansour Hadi, who had been removed from power by Iranian-linked Houthi rebels. The real reason for the intervention was for the Saudis to gauge their war-making capabilities, test their recently purchased military equipment, and put a check on Iranian influence in the region. A quick, successful war in Yemen would have been a template for future interventions in Iraq and Syria on behalf of Sunni allies, and would have cemented Saudi Arabia's position as a regional power in the wake of the U.S. withdrawal. As BCA's Geopolitical Strategy warned, however, defeating the experienced Houthis would not be easy and Saudi Arabia would ultimately hesitate to commit to a land war.5 The intervention has resulted in disaster for Saudi Arabia on several levels: Houthis remain in control of the capital Sana'a and largely the same territory that encompassed the former Yemen Arab Republic (North Yemen); The Saudis, desperate for a ground-force presence, have turned a blind eye to Al Qaeda's and ISIS's control of almost a third of the country in the south and coastal regions; Saudi forces have taken considerable losses, including some high-tech and high-priced items; The conflict has exposed severe military deficiencies, from the low level of strategic and tactical planning of senior staff, to the poor communication of units at the middle level, to the pervasive low morale and training of the rank-and-file. The biggest loss for Saudi Arabia has been that of leadership. What began as a pan-Sunni intervention led by Riyadh, with considerable involvement by the UAE and Egypt, has seen the Saudis lose almost all their allies. The UAE removed its troops in mid-2016 (in somewhat of a diplomatic spat with Riyadh) and Egypt has subsequently held military exercises with Russia, a Saudi rival in the region, and decided in December to provide military advisors to the Syrian Arab Army. All the talk about a "Sunni NATO" is over. Saudi Arabia's experience in Yemen, combined with the decline in its currency reserves, forced it to come to terms with reality, and eventually agree to an oil production cut with Russia and Iran. Thus it took Saudi Arabia exactly five years, from the U.S. withdrawal in Iraq in 2011, to realize the limits of its regional power. Bob Ryan, Senior Vice President of BCA's Commodity & Energy Strategy, correctly forecast the OPEC cut and expects the deal to be successfully implemented in 2017.6 One reason Bob is confident is that both Saudi Arabia and Russia are looking to privatize their energy sector significantly by 2018. Russia has sold 19.5% of Rosneft and the Saudis want to conduct an IPO of 5% of their state-owned oil company Aramco. It makes no sense to do this IPO in an environment of low oil prices. Furthermore, sovereign debt issuance to cover budget deficits will become cheaper when oil prices are higher. Geopolitics are aligning with Bob's view as well. Saudi Arabia's attempt to counter Iranian influence in the region has failed both militarily and via oil politics. Riyadh is focusing inwards, on its "Vision 2030" reforms, which will entail considerable domestic upheaval as a result of its comprehensive effort to remove the ultra-conservative religious establishment from power.7 This is now coming to light, with Deputy Crown Prince Mohammed bin Salman recently announcing harsh punitive measures for any cleric who incites or resorts to violence against the reform agenda. Bottom Line: Saudi Arabia's bid for regional hegemony is over, at least for now. The country is focusing inwards, on long-term political and social reforms and economic diversification. Its efforts to bring Iran to heel with low oil prices and with direct military confrontation in Yemen have failed. The oil production-cut deal between Saudi Arabia, Iran, and Russia should hold as a result of the de-escalation of Saudi-Iranian tensions and the socio-economic priorities of all three states. BCA's Commodity & Energy Strategy service is overweight energy relative to other commodities as a result.8 Is The Russia-Turkey Détente Sustainable? Turkey and Russia have concluded a political and military détente in Syria with surprising speed. This has made one of our major geopolitical risks for 2017 - a Turkish-Russian confrontation over Syria - already obsolete. Much as with Saudi Arabia, Turkey has had a bite of regional hegemony, did not like the bitter taste, and has decided to make a deal with its rivals instead. For Turkey, the real concern over the past five years has been American inaction in Syria. President Recep Tayyip Erdogan has spent a lot of political capital opposing Syrian President Bashar al-Assad. He had hoped that a successful revolution would create a new client state for Turkey, yielding Turkey overland access to Persian Gulf energy sources. Erdogan was therefore beyond dismayed when President Barack Obama failed to intervene in Syria in 2013 following Assad's use of chemical weapons. The chronology of what happened next is important: Russia intervened two years later, in September 2015, to stem the progress of anti-Assad rebels and save the regime from collapse. Two months later, a Russian Sukhoi Su-24 was shot down by Turkish F-16s in the Turkey-Syria border area. Turkey and Russia broke relations for a while, but tensions did not escalate. Ankara faced a coup attempt in mid-July 2016, which the ruling party linked to the U.S.-based Islamist preacher Fethullah Gülen. The Obama administration refused to extradite Gülen without concrete evidence of his involvement. By late July, Turkish officials were calling Russia a "friendly neighbor" and a "strategic partner." In early August, Erdogan met Russian President Vladimir Putin in St. Petersburg, after issuing a letter with an apology to the family of the shot-down pilot. Then, on August 24, Turkey invaded Syria. The military intervention, dubbed "Operation Euphrates Shield," was officially launched to fight the Islamic State, a common pretext these past three years. Erdogan officially stated that he also aimed to fight Assad's regime, but this appeared to put Ankara and Moscow back on collision course, and statements from the Turkish side have since been "corrected." The real reason for the intervention was not to fight ISIS or Assad, but rather to curb the gains made by the various Kurdish militias on the ground in Iraq and Syria. In particular, Ankara intervened to prevent the Kurdish People's Protection Units (YPG) - the armed wing of the Syrian Democratic Union Party, which is affiliated with the Turkey-based Kurdistan Workers' Party - from linking up with its now vast territory held in the north of Syria (Map 1). The territory, which our map shows has expanded considerably as the YPG has claimed mostly Islamic State-held areas, is split between Rojava, the main territory east of the Euphrates river, and the Afrin enclave near the Mediterranean Sea. For Turkey, the proximity of such a vast Kurdish-held territory so close to its own Kurdish southeastern region presents a national-security nightmare. The operation's strategic goal was to capture Al-Bab, the stronghold of the Islamic State in northern Syria and a strategic point between the two YPG-held swaths of territory. However, it has taught the Turks that they have no experience fighting a prolonged battle, especially against local insurgents and militants who know the region. Since the first attack on Al-Bab's western part, the Turkish army has suffered three defeats and retreated to initial positions. With Turkey stuck in Al-Bab, the Russian air force has now begun to bomb Islamic State positions to help their tentative new ally. This level of operational coordination is notable and important. It suggests that Turkey, a NATO member state, is now reliant on Russian air strikes for ground support rather than on American sorties flying out of NATO's air base in Incirlik, Turkey. Turkey even claims that U.S. presence in Incirlik is obsolete if it receives no help from the U.S. Air Force around Al-Bab. How sustainable is the Turkey-Russia détente? We suspect it will be quite sustainable, at least in the short term. Ankara has moved away from demands for Assad to step down, with the Deputy Prime Minister, Numan Kurtulmus, recently stating that Turkey would not "impose any decision" on the Syrian people regarding future leadership. The assassination of the Russian ambassador in Turkey also failed to derail Russo-Turkish cooperation. Beyond the short term, however, the question remains what Turkey intends to do about Kurdish gains, which are considerable in both Syria and Iraq. The town of Manbij, for instance, is strategically located west of the Euphrates and was supposed to be ceded to Turkey by the Kurds. The situation could grow even more complicated for Turkey as the Kurdistan Regional Government (KRG) in Iraq may proclaim independence after the Islamic State stronghold of Mosul is liberated in early 2017.9 The YPG in Syria could then ask to join their fellow Kurds in Iraq in forming a unitary state. Although unlikely, this scenario is probably on Turkey's mind, as it would mean that the Kurds inside Turkey may intensify their anti-government insurgency. Note, however, that this scenario does not bother Russia. As far as Moscow is concerned, it has succeeded in keeping Assad in power, its Syrian naval base in Tartus is secure, and it has proven its ability to project power outside of its immediate sphere of influence (Ukraine, Crimea, Georgia, and the Caucasus), thus advertising its "Great Power" status. Bottom Line: For the time being, the Russian-Turkish détente will hold. The real risk is not a Turkish-Russian confrontation, but rather a wider Turkish engagement in both Syria and Iraq against the Kurds sometime in the future. We suspect that the Turkish military experience in Syria may make the Turks think twice about engaging in a large-scale war against the Kurds across three states. But given the erratic policymaking out of Ankara in recent years, it is difficult to say this with any confidence. The geopolitical risk of Turkish imperial overreach will continue to weigh on Turkish assets in 2017. Risks To The Sanguine View There are many reasons why investors should stay up at night in 2017, but the Middle East is not one of them. The process of U.S. deleveraging from the region has been painful and costly (from a human perspective especially), but it has ultimately forced regional powers to figure out how to carve out the leftover space between them. There are a few questions left to answer, starting with the Kurdish question. But, for the most part, we do not expect to see the major players - Iran, Saudi Arabia, Turkey, Russia, Egypt, or Israel - come to blows with each other. There are three major risks to this sanguine view. The U.S. Is Back! The current semi-stable equilibrium will definitely be thrown off track if the Trump administration decides to sink its teeth fully into the Middle East. We expect President-elect Donald Trump to authorize greater military action against the Islamic State, including more intense air strikes. However, this is not a qualitative reversal of Obama's deleveraging policy. A real reversal would be if Trump decided to follow the advice of Iran hawks in his government - of whom there are several - and increase tensions with Tehran. This is unlikely, given Trump's focus on China and his willingness to improve ties with Russia, a nominal ally of Iran. In fact, there has been almost no talk of Iran from either President-elect Trump or any of his advisors since the election. Furthermore, while U.S. oil imports from OPEC are no longer declining, they are still massively down since their peak in the mid-2000s (Chart 6). It is unlikely that Trump will commit resources to a region of diminishing importance to U.S. interests. Change Of Guard In Tehran. While the risk of Washington saber-rattling with Iran is overstated, what happens if the moderate President Hassan Rouhani is defeated in the upcoming May election? Hardliners are arguing that the nuclear deal with the West has done nothing for the economy, the main pillar of Rouhani's 2013 platform. This is not true. Headline inflation ticked up in late 2016, but remains well off the 40% levels in 2013, while GDP growth has been in the black throughout Rouhani's term, and net exports have bottomed (Chart 7). However, the flow of FDI into the country has been tepid, probably due to ongoing uncertainty with the government transition in the U.S. Both European and Asian businesses are waiting to see if the incoming Trump administration wants to revive sanctions. Meanwhile, skirmishes between U.S. and Iranian vessels - purportedly controlled by the hardline Islamic Revolutionary Guard Corps - have increased in the Persian Gulf. Perhaps the hardliners in Tehran are hoping that they can bait the hardliners in D.C. into a pre-election confrontation that sinks Rouhani. Iraqi Instability. Although the Iraqi government is set to take over Mosul from the Islamic State some time in Q1 2017, the fact remains that the country is bitterly divided between Sunnis and Shia amidst sluggish oil revenues. While the production cut deal will raise revenues marginally, revenues will still be well below their highs (Chart 8). Defeating the Islamic State militarily is one thing, but the real challenge is for Baghdad to reintegrate the Sunni population, which largely lives in territory devoid of oil production. A renewal of civil strife and terrorism targeting Iraqi civilians, which could happen as the Islamic State militants blend back into the wider population, may be a risk in 2017. Chart 6U.S. Imports From OPEC Remain Low Chart 7Iranian Economy Improves Under Reformist Rule Chart 8Iraqi Oil Revenues Still Down From Highs A word on Israel may also be in order. Israel has not played a major geopolitical role in the region for the past five years and we suspect it will not in the next five. It is secure from its neighbours, who cannot match it in terms of military capability, and remains preoccupied with domestic politics and internal security. Meanwhile, the days when the region unified against Israel are over. Sectarian and ethnic conflicts have gutted Israel's traditional enemies. And former foes, particularly Egypt and Saudi Arabia, are now close allies. The one geopolitical threat that remains is Iran. However, that threat remains dormant as long as Israel maintains nuclear supremacy over Iran and as long as the U.S. remains a security guarantor for Israel. We do not see either changing any time soon. Investment Implications The main investment implication of our thesis that the Middle East has found a new equilibrium is that the region will not dominate the news flow in 2017. Short of a major Turkish blunder in Syria and Iraq, we see the current status quo largely frozen in place. Saudi Arabia appears to have conceded, for now at least, its inferior place in the geopolitical pecking order. Investors have plenty of things to worry about in 2017, such as general de-globalization, a potential Sino-American trade war, geopolitical tensions in East Asia, and elections in four of the five largest euro-area economies. Our geopolitical team's long-standing thesis that geopolitical risk is rotating out of the Middle East and into East Asia is therefore fully playing out.10 Chart 9KSA-Russia Production ##br##Pact Aims at Lowering Inventories In the near term, the geopolitical equilibrium should allow Saudi Arabia, Iran, and Russia to maintain their six-month agreement to cut production by up to 1.8 million b/d. The stated volumes to be cut are comprised of 1.2 million b/d from OPEC, 300,000 b/d from Russia, and another 300,000 b/d from other non-OPEC producers. The goal of this agreement is to reduce global oil inventories to more normal levels, which our commodity strategists believe will happen by the end of 2017 (Chart 9). Bob Ryan, of the Commodity & Energy Strategy, forecasts U.S. benchmark WTI crude prices to average $55/bbl in 2017. The incoming Trump administration will focus its Middle East policy on cooperating with regional actors against the Islamic State. Investors should expect to see more American "muscle" dedicated to the fight, perhaps at the risk of causing civilian casualties (which the Obama White House was careful to avoid). The downside of this strategy is that as the Islamic State loses its territory and ceases to be a caliphate, it will revert to being a more conventional terrorist organization. Its foreign fighters may return home to Europe, Russia, and elsewhere, while home-grown militants will seek to sow further Sunni-Shia discord, especially in Iraq. Unfortunately, this trend will keep our thesis of "A Bull Market For Terror" intact, which lends support to U.S. defense stocks.11 Marko Papic, Senior Vice President marko@bcaresearch.com Oleg Babanov, Editor/Strategist obabanov@bcaresearch.co.uk 1 Please see BCA Geopolitical Strategy Strategic Outlook, "Strategic Outlook 2017: We Are All Geopolitical Strategists Now," dated December 14, 2016, available at gps.bcaresearch.com. 2 Please see "Middle East: Saudi-Iran Tensions Have Peaked," in BCA Geopolitical Strategy Monthly Report, "Mercantilism Is Back," dated February 10, 2016, available at gps.bcaresearch.com. 3 According to the estimates of BCA's Commodity & Energy Strategy, "Tactical Focus Again Required In 2017," dated January 5, 2017, available at ces.bcaresearch.com. 4 Please see Cullen S. Hendrix, "Oil Prices and Interstate Conflict Behavior," Peterson Institute for International Economics, dated July 2014, available at iie.com. According to Hendrix, revolutionary leaders are "leaders who come to power by force and attempt to transform preexisting political and economic relationships, both domestically and abroad." The definition is broad and includes leaders who used force in order to gain prominence. 5 Please see BCA Geopolitical Strategy Client Note, "Does Yemen Matter?" dated March 26, 2015, available at gps.bcaresearch.com. 6 Please see BCA Commodity & Energy Strategy Weekly Report, "2017 Commodity Outlook: Energy," December 8, 2016, available at ces.bcaresearch.com. 7 Please see BCA Geopolitical Strategy Special Report, "Saudi Arabia's Choice: Modernity Or Bust," dated May 11, 2016, available at gps.bcaresearch.com. See also Emerging Market Equity Sector Strategy, "MENA: Rise Early, Work Hard, Strike Oil," dated October 4, 2016, available at emes.bcaresearch.com. 8 Please see BCA Commodity & Energy Strategy, "Tactical Focus Again Required In 2017," dated January 5, 2017, available at ces.bcaresearch.com. 9 Please see P. Ronzheimer, C. Weinmann, and K. Mössbauer, "Kurden Brauchen Mehr Deutsche Abwehrraketen," Bild, dated October 28, 2016, available at http://www.bild.de/politik/ausland/mossul/kurden-brauchen-dringend-milan-systeme-48495330.bild.html. 10 Please see BCA Geopolitical Strategy Monthly Report, "The Great Risk Rotation," dated December 11, 2013, available at gps.bcaresearch.com. 11 Please see BCA Global Investment Strategy and Geopolitical Strategy Special Report, "A Bull Market For Terror," dated August 5, 2016, available at gis.bcaresearch.com. Strategy & Market Trends Tactical Trades Strategic Recommendations Closed Trades
