Egypt May Be More Than Short Term Problem

Jim Brown
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Brent crude rallied to close at $102.34 on Wednesday as the demonstrations in Egypt turned violent and worries increased about the future of the conflict. Egypt may not be a major oil producer but it is the gatekeeper for global trade by virtue of its control of the Suez Canal.

Currently analysts believe the political problems of President Mubarak will not result in a closure of the Suez Canal or the Sumed pipeline BUT the canal has been closed multiple times in the past.

The Sumed pipeline was created in 1977 as an alternative to shipping oil through the Suez. It has a capacity of 2.5 mbpd but currently flows around 1.1 mbpd. The canal has between 1.1 - 1.8 mbpd in tanker shipments. The Suez of course ships a lot more than oil.

The canal was closed for several months in 1956 during the "Suez Crisis." That was a war fought by Britain, France and Israel against Egypt after Egypt decided to nationalize the canal. This came after Britain and the U.S. withdrew an offer to finance Egypt's Aswan Dam project. That withdrawal came after Egypt recognized the People's Republic of China at the height of tensions between China and Taiwan. Britain and France were also strongly opposed to Nasser's plan to annex the Sudan.

During World War One Britain and France blockaded the canal to prevent non-allied shipping.

Egypt blockaded it again for eight years following the Six Day War with Israel in 1967.

There have been numerous instances of temporary blockages, ship boarding, confiscation of cargo, etc and various forms of control over the canal itself.

However, none have occurred since the post 1967 blockade. If the canal was blocked today it would cause a serious political uproar since it is depended upon by nearly every country to ship goods quickly without going 6,200 miles around Africa.

For this reason I seriously doubt Egypt would anger the world and especially the U.S., France, Britain and Russia because of some internal political event. The instant military and financial repercussions to Egypt would be far worse than the internal conflict.

Nevertheless Egypt does play an important role in the Middle East. Egypt has been the strongman in the Arab world with a modern army and air force and 82 million citizens. The peace treaty with Israel went a long way towards keeping other Arab countries from threatening Israel.

Egypt has been politically stable for over 30 years. It may not have been an ideal government or political environment but it was stable with Mubarak at the helm. That stability is now threatened and with it the peace of the region. It is more than the initial worries over oil shipments.

If protestors are successful in unseating the Mubarak regime it would embolden anti government revolutions in numerous other countries. We have already seen Jordan dissolve its government as it tries to head off a confrontation of its own. Yemen has also made changes in hopes of avoiding a meltdown. As each domino falls it increases the likelihood of a bigger country falling to the contagion.

Saudi Arabia is of course the one to worry about. With its daily production of 8.5 mbpd it is the swing supplier for OPEC. If Saudi Arabia fell into a civil war that oil production could be threatened and prices would rocket higher.

The big problems in the Middle East are not just a change in the government. It is what the new governments would look like. Nobody knows and there are plenty of elements thirsty for power that could throw a monkey wrench into the entire Middle East structure. A country in civil war is ripe for takeover and the Middle East countries tend to change hands more often than other parts of the world.

If the Egypt problem continues to escalate I would expect world markets to decline. Investors hate uncertainty and this would be a good way to kill not only the global recovery but endanger the financial markets as well. Regional economic uncertainty could take months or even years to recover depending on the new cast of players.

Tourism in Egypt is already dead. Tourism in neighboring countries also undergoing political demonstrations is also dying. Most of these countries are already on the edge of financial troubles and removing those billions in tourist dollars is going to be a painful budget loss.

In reality a change in government in multiple Middle East countries could be a long term positive for tens of millions of oppressed and poverty stricken people. If democracy prevails it could be a rocky road for the next couple years but eventually a new prosperity could appear that brings these people into the 20th century.

Until then be very wary of the headlines over the next week. Watch for an escalation of violence I Egypt and for an increase in news stories about Saudi Arabia. If things go horribly wrong the $102 close in Brent crude today will only be the starting point.

Jim Brown

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