25 December 2017

Mohammed Bin Salman and the Bleak Future of Saudi Arabia

Three years ago, I wrote a two-part post about the bleak future of the House of Saud and the Kingdom.

My point was that Saudi Arabia faced a number of internal and external problems that it might not be able to address and could find itself on the path of destruction.

Internally, they had an archaic succession system that would inevitably lead to ruthless competition or jousting among second generation princes. Their economic future was in doubt due to excessive spending and low oil prices.

Their perennially persecuted Shia minority was on the verge of rebellion.

And to top it off, badly needed reforms were impossible to implement due to the delicate balance between the legitimacy providing House of Wahhab and the ruling House of Saud.

Externally, the royal family's direct ties to Sunni terrorist organizations, their bitter rivalry with the Muslim Brotherhood and their implacable hatred towards Iran shrank their room of maneuver considerably.

And I suggested that if Iran managed to have the embargo lifted, as, at the time, it was on the verge to do, Saudi Arabia would find itself painted into a very small corner.

All of these issues have remained unresolved and most of them have been exacerbated by world events and the reckless moves of Crown Prince Mohammed Bin Salman (MBS), the winner of the Game of Thrones.

MBS is a young, ambitious and by all accounts highly volatile leader.

His solution to Saudi Arabia's problems was to diversify its economy, eliminate a bunch of subsidies, bring in direct foreign investment, push for a moderate Islam and turn the country into a regional superpower by limiting Iran's influence.

The economic bit was courtesy of McKinsey, the Iran part was wholly conceived by the Crown Prince himself.  On paper this all looks good. But evidently, success will be determined by how these are implemented.

Can you cut subsidies without creating social unrest? Can you go against the House of Wahhab, your family's unique source of legitimacy? Can you bring in foreign investment if the rule of law consists of your words? And finally can you go against Iran and do so on the cheap?

My preliminary answer is, good luck with that. I believe that this will not end well for MBS and the Kingdom.

Let me explain why.

Costly Belligerence and Dubious Alliances

Like all former rulers of Saudi Arabia, MBS is convinced that Iran is the Kingdom's mortal enemy.

He believes that the Islamic Republic is quietly creating a Shia Crescent around Saudi Arabia by re-aligning Iraq and Syria.

The Crescent is the Mario Brothers moustache on the right.

In and of itself this is not surprising, as I've written many times, Shia-Sunni animosity is almost as old as Islam and they are each other's worst enemy. Jews and Christians are not even close.

When the dynamic duo Javad Zarif and Hassan Rouhani managed to get the embargo lifted, MBS decided to take Iran on.

Since Saudi Arabia was not capable of winning a war with Iran, MBS could only fight the Islamic Republic through proxies.

That's why Saudi Arabia has been backing all the Sunni terrorist groups in Syria and Iraq. And that is why MBS attacked Houthi rebels in Yemen. And it is also why he pressured Lebanese Prime Minister Hariri to resign from Riyadh.

Part of his strategy was to ensure that the US stayed on the sideline. To achieve this goal, he formed a surprising alliance with Netanyahu and spent hundreds of billions to buy weapon systems from the US.

He also provided generous financial support to General al Sisi in Egypt to keep Muslim Brotherhood on the defensive. At the same time, he maintained reasonable relations with Turkey despite Erdogan's belligerent outbursts about Morsi's overthrow.

The fundamental problem with this part of his plan is that it is way too expensive.

Take the Yemen war. Since the 200,000 strong Saudi army is good only to suppress civilian unrest, the Yemen war had to be conducted through a sustained bombing campaign. Bombs are not cheap. Its initial cost was estimated to be about one billion dollars a month.

Now it is costing $200 million a day with no end in sight.

In case your calculator's is not within easy reach, that's $6 billion a month or $72 billion a year.

No one knows the actual cost of supporting Sunni thugs in Syria and Iraq but by now they should be in the tens of billions dollars. There is also the need to finance Egypt's al-Sisi and a host of other client states in the region.

Add to that the $110 billion arms and equipment he promised to buy from the US military industrial complex to placate Donald Trump and you can see the Kingdom's ledger going into deep red.

It is true that there is no firm deal in place and Bruce Riedel doubts that the Saudis have the money to pay for the package. But it is also true that if MBS wants Trump on his side, he will have to find the money.

Case in point:
President Donald Trump told Saudi King Salman he would support the purchase of American military equipment to keep Saudi Arabia safe in a phone call Saturday. (...)
The discussion between the two leaders also came hours after an anti-corruption purge that led to the arrest of dozens of high-profile Saudis, including the billionaire founder of Kingdom Holding Co., Prince Alwaleed bin Talal, a nephew of King Salman.
The message is clear.

Trump says, if you pay protection money, I will not get involved in your dealings even to save bin Talal who owns sizeable shares of Apple, News Corp, Four Seasons and a bunch of other important American companies.

The irony in all this is that these are mostly self-inflicted wounds.

The decision to attack Houthi rebels in Yemen is a perfect illustration. The Yemen crisis is complicated, but one thing was clear at the outset: as late as April 2015, "the United States National Security Council spokesperson Bernadette Meehan remarked that “It remains our assessment that Iran does not exert command and control over the Houthis in Yemen"."

I am not suggesting that Iran is not helping out the Houthi rebels, what I am saying is that when MBS decided to bomb the poorest Arab country back to the Stone Age to stop Iran, their involvement was much less than he claimed.

Now of course, they are in it up to their eyeballs. But that's largely thanks to MBS' misguided belligerence.
Iran is gradually increasing its support for the Houthi rebels in Yemen. Rather than eliminating the Iranian presence in the country, the Saudi-led war is giving Tehran the opportunity to become more influential there than ever. The Houthis remain fiercely independent of Iran, but they will need Tehran's backing more as the stalemate continues.
MBS is so uninformed that he now believes that it is the Hezbollah who is preventing him from winning that miserable war. And apparently that's why he forced Hariri's resignation.
But Prince Mohammed sent [Hariri] home with a task: to get Hezbollah to withdraw its fighters from Yemen. That demand proved, the Western and Arab diplomats said, that the prince was not well-informed on Yemen, sometimes called “Riyadh’s Vietnam.” Hezbollah, a Western diplomat said, had only about 50 fighters in Yemen, with Iran playing a much larger role in training and aiding the Houthi insurgents there.
 Abdulaziz al-Husseinya, acute malnutrition. Photo Iona Craig
Besides being a colossal strategic mistake that helped Iran, Yemen war was also an amazingly stupid PR move.

The image was one of that King Salman spending almost quarter of a billion for a month-long summer vacation in French Riviera, while millions of Arab children were dying of cholera (the worst outbreak on record) and famine thanks to Saudi attack and subsequent blockade.

It was also a very expensive mistake.

As Saudi net foreign assets declined by $200 billion, MBS realized he simply did not have the money to do all this.

Since he could never back down or reverse a strategy, his next move was to find a way to get the money.

Extortion Rackets: International and Domestic

Three days after he promised Trump that he would spend billions to buy military goods, MBS tried to squeeze Qatar.

He figured that, since he promised protection money to Trump, the Orange Man would not get involved (he didn't) and Qatar would either cough up a big chunk of money or face invasion.

As I wrote at the time, Qatar immediately moved to purchase a triple insurance policy against a possible Saudi intervention. Iran, Turkey and Russia all said that this would be a very unwise move with serious consequences.

So where does a Prince go when he needs a few hundred billion dollars?

Why, to other Princes of course.

As you know, he rounded up 200 wealthiest Saudis, most of them members of the Royal Family, and charged them with corruption. Besides Alwaleed bin Talal, other senior royal family members like Prince Miteb [or Mutaib] bin Abdullah, the former commander of the powerful National Guard and the son of the late King Abdullah and Prince Turki bin Abdullah the former Governor of Riyadh are among the detainees.

The deal is simple:
The judicial official clarifies that this is still "a pre-investigation". "We're asking people who took the money to give it back," he says. 
"It's a friendly process," chimes in the anti-corruption official who says everyone was told "we'll show you the evidence and we'll solve the problem".
In other words, even though they are accused of corruption. if they pay there is no prosecution. The first one to pay up was Miteb bin Abdullah. He signed a cheque for one billion and he was promptly discharged.

The goal is to collect at least $100 billion.
A businessman in Riyadh, who has seen some of the documents, had told me 1,900 bank accounts, including ones belonging to family members of suspects, were frozen. I ask officials in the Ritz-Carlton about reports of cash and assets totalling 800 billion dollars.
"Even if we get 100 billion back, that would be good," replies the official from the Special Committee. 
MBS is so desperate that there are some reports that Alwaleed bin Talal is being beaten up and tortured to break his unwillingness to part with his money.

While the Crown Prince froze assets worth about $190 billion, realistically, he could not get more than a few tens of billion dollars from these guys and sooner or later he will have to let them go.

The largest contributor is likely to be bin Talal and he is, reportedly, on the hook for $6 billion, that is, if he agrees to pay. Which I doubt, unless he is really being tortured.

If MBS confiscate their assets on the basis of corruption allegations, he can kiss his dream of bringing in foreign investment. One thing capital abhors is the absence of a solid legal system that protects assets.

Desperation setting in, MBS next move was to sell the Kingdom's crown jewel, the world's biggest company.

Floating Aramco

Initially, MBS claimed that the Aramco IPO would cover only about 5 percent of the company. Then he decided to put the whole thing on the market. Aramco is owned by Saudi Arabia and it constitutes their biggest source of revenue. Selling it will force the Kingdom to release its accounts and make its transactions transparent.

Which may prove to be a big problem as Aramco has invested in many more areas and separating portfolios would likely to be painful. Plus the Royal Family used it as a slush fund and correcting the books ahead of the IPO could be a big headache.

More importantly, in the long run, Aramco is not a valuable company. One analyst likened it to buying Blockbuster in the age of Netflix, suggesting that when all major automakers are phasing out the combustion engine it might be foolish to invest in oil.
Over 70 percent of every barrel of Aramco crude is used for autos and trucks in one way or another, Mr. Nasser said. (...) With a worldwide push to eliminate the internal combustion engine, the demand for oil five years from now will be far less than it is today.
The Saudis valued the company at $2 trillion. According the Financial Times, the actual number is more likely to be $900 billion.
Start with a $54-a-barrel oil price and factor in a steady lift from inflation over the first five years. Then, as well as adopting the new 50 per cent tax rate, the FT has left the royalty rate intact at 20 per cent. On these assumptions Aramco would be worth nearly $900bn. Any lost tax revenues would mostly be replaced by a dividend to the state. Sell 5 per cent of Aramco and on this valuation it should raise $42bn.
The last sentence tells you why MBS went for floating the whole of Aramco while simultaneously extorting money from other members of the Royal Family.

His foreign adventures and the financial squeeze is just one side of his problems. Domestically, he is facing major challenges.

Cutting Subsidies and Confronting the House of Wahhab

One of the reasons MBS is having hard time funding his proxy wars has to do with massive subsidies in Saudi Arabia.
According to a report by Jadwa Investment, energy subsidies cost the Saudi government around $61bn in 2015, or 9.3% of GDP.(...) Moreover, with domestic users paying the equivalent of $0.03 per KWh for electricity, which is 60% less than international prices, the government spent $23bn on electricity subsidies in 2015.
That's just the energy sector.

Two thirds of working Saudis are employed by the public sector. Their wages and housing and car allowances represent 45 percent of government spending ($128 billion).

Naturally, MBS announced that he was cutting both the energy sector and wage subsidies.
Petrol jumped from SR0.60 ($0.16) to SR0.90 ($0.24) per litre for high-grade Octane 95. 
Natural gas prices increased from $0.75 to $1.25 per million British thermal units (Btu), while ethane prices more than doubled, from $0.75 to $1.75 per million Btu.
His "Vision 2030" aims to cut public sector employment to 40 percent of government spending by 2020. In September 2017, he implemented cuts to public salaries and allowances ranging between 15 and 20 percent. Overtime bonuses were reduced by up to 50 percent.

Saudis, who were used to King Abdullah's largesse (his response to the Arab Spring was to add $130 billion on wages and subsidies in 2011) were not happy.

Sensing social unrest, MBS first brought back water subsidies then wage cuts were rolled back. He also slowed down the phasing out of energy subsidies.

This is important because the rule of the House of Saud is made possible by two elements.

One is the tacit understanding between the rulers and the ruled that in exchange for high income and steep subsidies that give them a very high standard of living, the populace accept to obey the King without question.

Secondly, the King accepts to enforce the conservative religious principles of the House of Wahhab in exchange for legitimacy they bestow upon him.

Reducing wages and subsidies nullify the social contract between the ruler and the ruled.

Being rather reckless, MBS is also attacking the other pillar of his monarchy: after the subsidy-wage cut debacle, "Saudi Arabia’s crown prince, speaking at a major investment conference, has promised his kingdom will return to “what we were before – a country of moderate Islam that is open to all religions and to the world.”

Then, before the 200 Saudi Princes were taken to their ritzy prison he ordered the arrest of many prominent clerics.
Before the arrests on Saturday of his fellow royals and former ministers on corruption allegations, Prince Mohammed had stripped the religious police of their arrest powers and expanded the space for women in public life, including promising them the right to drive
Dozens of hard-line clerics have been detained, while others were designated to speak publicly about respect for other religions, a topic once anathema to the kingdom’s religious apparatus.
The clergy has not come out with strong words but that does not mean that they will accept this radical change lying down.

The same goes for the Princes. Even if they cough up extortion money they will not simply go to their merry way.

To begin with, they will fight corruption allegations by pointing the finger to the Crown Prince. It would be much more difficult to wear the mantle of anti-corruption crusader if the world suddenly didn't discover that, in the last couple of yearsyou purchased a $300 million for a chateau with a custom made wine cellar and tried to cover it up through shell companies.

Or you bought a $500 million mega yacht from a Russian vodka billionaire or bid $450 million to a newly discovered Leonardo Da Vinci portrait.

I thought the timing of the article and the damning details, like numerous shell companies hiding all these purchases, indicated inside information.

Can MBS Survive?

Lay people usually assume that if you control the army and the police force you can get away with anything.

You can, if you have the support of the business classes, your legitimacy is not questioned and your economy is doing well enough to keep your citizens from protesting.

Ask Macciavelli.

In this instance, MBS has gone after the business classes, he attacked the only institution that gives the House of Saud legitimacy and he is unable to keep his economy afloat.

My point is that he simply cannot govern with all three elements in jeopardy.

His reform movement will be resisted by the House of Wahhab as they did nearly 40 years ago. They will be instrumental in turning the population against him.

And the other members of the Royal Family will definitely give a helping hand to the House of Wahhab.

Previously, most of them, like Miteb bin Abdullah who was the Commander of National Guard, had important institutional power positions. They likely command a lot of respect and allegiance in those institutions and they will use that.

Conversely, MBS lacks the same respect as the architect of a very unpopular war where the poorest Arab country is being destroyed by Saudi Arabia with millions of civilians dying in the process.

Moreover, his new Palestinian peace plan ( a direct result of his alliance with Israel) will not endear him to Arab masses. According to the New York Times this is the plan MBS presented to Mahmoud Abbas whom he summoned him right after Hariri:
The Palestinians would get a state of their own but only noncontiguous parts of the West Bank and only limited sovereignty over their own territory. The vast majority of Israeli settlements in the West Bank, which most of the world considers illegal, would remain. The Palestinians would not be given East Jerusalem as their capital and there would be no right of return for Palestinian refugees and their descendants.
Netanyahu wouldn't put it so starkly, even though it is evidently his wet dream.

In fact, his bizarre episode with Hariri could now be construed as an effort to destabilize Lebanon on behalf of Israel.

In short, I don't see a clear way out for MBS or a happy ending.

Or the Kingdom for that matter.

That potential outcome never troubled me but looking at Yemen it fills me with Schadenfreude.

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