Several recent political developments have shifted powers in our Middle East game theater analysis; however, our investment implications have remained largely unchanged.
Our view is that election results in Iran, President Donald Trump’s stance on the Middle East, and the selection of Saudi Arabia’s future leader all pose a shift of powers in the region.
Iranian President Hassan Rouhani won re-election in May, indicating a potential shift to more normalization with the rest of the world. Still, this result does not mean complete change for Iran because the president is the second most powerful position. The primary position of power remains with Supreme Leader Ali Khamenei. In the United States, the election of Trump is also significant because his foreign policy on the Middle East differs quite significantly from former President Barack Obama.
In late June, Prince Mohammed bin Salman was appointed Crown Prince and designated successor of Saudi King Salman. This selection was surprising to many because he is only 31 years old and is much more aggressive than the existing or previous Saudi leadership. He is part of a younger generation of princes who are focused on reform and playing a much more active leadership role in the Middle East.
The impacts of these recent developments can be viewed through our game-theoretical analysis summarized as follows:
Endowment power is an initial resource base.
We increased Iran’s endowment power as a result of Rouhani’s re-election. Iran is moving from a clergy/military alliance to a clergy/technocrat alliance, which suggests a shift to more normalization with other players across the globe. At the same time, we’ve decreased Saudi Arabia’s endowment power as the Saudi regime remains under pressure from lower oil prices, creating fiscal strains in their economy. Despite the OPEC “plus” (OPEC + Russia) agreement on production cuts, the price of oil has fallen.
Coalition power is the ability to form and alter coalitions to augment the effectiveness of a negotiating strategy.
The U.S. has undertaken rapprochements with Saudi Arabia and with Israel, while moving in the opposite direction with respect to Iran. Thus, Saudi/U.S. coalition power and Israel/U.S. coalition power have increased.
Risk tolerance is the willingness to take collateral risk of large magnitude or to have negotiations break down without resolution.
Iran’s risk tolerance decreased due to its shift from a clergy/military alliance to a clergy/technocrat alliance. Meanwhile, Russia’s risk tolerance increased with Russian President Vladimir Putin’s increased willingness to meddle in geopolitical events not just in the Middle East, but around the world. This increased willingness comes from the fact that much of Putin’s support domestically comes from the level of respect that Russia receives abroad.
U.S. risk tolerance also increased, given President Trump’s greater willingness to act in the Middle East as compared to Obama.
Lastly, we increased Saudi Arabia’s risk tolerance in light of Crown Prince Mohammed bin Salman’s selection as the King’s successor. In reality, he already had a lot of power shifted over to him, but naming him Crown Prince formalizes his leadership role.
Salience highlights how important the negotiation is to each player.
The only salience change to our Middle East game theater analysis was increased salience of the United States. Like our change in U.S. risk tolerance, when compared to Obama, Trump has taken a greater interest in places like Syria, and we believe this interest is likely to spread throughout the Middle East region.
In aggregate, our investment implications remain unchanged. This theater now has a somewhat diminished degree of influence on our investment thinking than it has at times in the past, but the region’s influence on oil prices and the overall risk environment in the Middle East, Russia, and Europe remains important to our investment decisions.
Nevertheless, the OPEC “plus” (Russia) production cuts agreement in late 2016 was an attempt to reduce inventory and to ultimately increase oil prices. Neither of those objectives has been yet achieved.
From an investment perspective, we believe the equilibrium price range for oil is $45-$50 a barrel, and the U.S.’s breakeven price point limits oil prices from breaking $55/barrel for any significant length of time.