The ongoing political and military situation in the Middle East has the potential to alter the map of the region and cause widespread changes in the fortunes of the ruling elite and their backers. In this article, I lay out a scenario of how things could play out in the next few years and how it will impact the investment risks for the region.
The Shifting Sands
Saudi Arabia will not likely win the current war in Yemen. Best case scenario for Saudi Arabia will be a stalemate resulting in a de-facto division of Yemen with parts controlled by the Saudi loyalists. In going to war over Yemen, the new regime in Saudi has taken on more than what they can manage. The war has also exposed the limits of Saudi’s reliance on an air campaign with effectively no ground troops.
It is difficult to determine which of the allies of Saudi Arabia will join the offensive in Yemen. When Pakistan, that had been the beneficiary of Saudi largesse for the past several decades and whose current Prime Minister Nawaz Sharif got saved by the Saudi regime from a rather lengthy jail term under the military dictatorship of Gen. Musharraf, says no to Saudi request for ground forces, then it’s difficult to see which other country will send their ground forces for fight on behalf of Saudi. And one cannot really expect the other regimes in the region to support the Saudi interests in any meaningful way as they hardly have any effective ground forces of their own. Finally, the US with its war fatigue will probably only contribute to air assaults, surveillance and intelligence support.
Both Iraq and Syria are in the process of disintegrating. These artificial constructs are returning back to their natural state where tribal and sectarian affiliations are more important than national interests. The ongoing process will most likely result in division of Iraq into three parts – one controlled by Iran, one controlled by ISIS/Daesh (or a similar Sunni group) and one controlled by the Kurds. Syria will also get divided with one part controlled by Iranian backed interests and the other part controlled by ISIS (or one of its off-shoots).
After the consolidation of territories by different groups, the next phase in the saga is the small scale conflicts inside the Saudi territory (with ISIS/Daesh in the north and Yemen in the South.) The current war has made it clear that the Saudi government has very limited ground force and these forces are probably effective as a defense mechanism. Most likely such attacks on Saudi territory will be guerrilla style raids primarily targeting the oil infrastructure in Saudi (pipelines, port terminals, transport networks). Given the size of the Saudi territory it will be difficult for the Saudi government to defend itself on all fronts and it will find itself under siege losing control of parts of its territory over time.
Within the next 10 to 15 years, the map of the Middle East will likely look quite different. Saudi Arabia will lose control of some of its territory and will be more interested in survival; a new Sunni majority entity will emerge combining parts of Iraq and Syria; and Iran will expand its territory to incorporate parts of Iraq. A independent Kurdistan is very likely. Apart from Saudi, the regional powers with significant influence will be Iran, Turkey, Israel and the US. Several of the smaller states (like the UAE, Kuwait, Qatar, etc.) will continue on viable states making peace with the regional powers.
Implications for Investors
As the turmoil continues, the oil prices will go up as the different conflicts will have an impact on the production capability of the region as well as the underlying uncertainty about the region. Companies that benefit most from this will oil firms who do not have significant operations in the Middle East. O&G companies with exposure to the ME region will obviously be adversely effected.
Other industrial sectors that will be impacted adversely include engineering and construction sectors which have benefits significantly from boom in infrastructure spending in the Middle East. Contractors such as Petrofac (PFC), Samsung Engineering (KRX:028050), Fluor (FLR), Hyundai Heavy (KRX:009540), Foster Wheeler (AMFW) could fare quite badly in the region. Engineering design companies like AECOM (ACM), Hill International (HIL), Atkins (LON: ATK), etc. that have large presence in the Middle East will see reduced revenues from this region as the countries shift their priority from infrastructure to defense.
At the regional level, property developers like Emaar, Nakheel, ALDAR, Dubai Properties, etc., insurance and banking companies that are providing services to property sector and are primarily based in the Middle East will have a difficult time as a result of market uncertainty due to the various conflicts.
Global defense contractors will likely do well in the conflict; companies like Boeing (BA), General Dynamics (GD), BAE (BAESY), Thales (THLEY), Raytheon (RTN), etc. have next to none manufacturing assets in the Middle East but have a long list of clients that will need more weapons, ammunition as well as training, logistics and intelligence support.
This article was originally published in Seeking Alpha. https://seekingalpha.com/article/3219146-investing-outlook-in-the-context-of-ongoing-middle-east-conflicts