Tuesday 31 May 2016 4:59 am

These three perilous trends spell disaster for Saudi Arabia

“How the mighty have fallen!”– 2 Samuel 1:27

What a difference a year makes in terms of political risk in the energy markets. Just 12 short months ago, all talk was of a resurgent Russia and corresponding security of supply issues in Eastern Europe, as the Kremlin seemed the world’s greatest destabilising force. Traditionally stable Saudi Arabia barely got a mention.

Now the tables have turned, as unhappy Ukraine has morphed into just another frozen conflict, with Europe (“thank God there is no immediate geopolitical crisis on our doorstep”), the US (“thank God this is off our plate”) and Russia itself (“thank God Ukraine has not emerged as a pro-Western, economically successful alternative to our gormless economic illiteracy”) all quietly acquiescing in the outcome. But the same political equilibrium does not describe conditions in Riyadh anymore. Instead, it is very much risk on in Saudi Arabia.

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The Saudi government, led by the favoured son of the Saudi King, the remarkably young and untried Deputy Crown Prince, Mohammad bin Salman, faces three daunting challenges at once: geopolitical, macroeconomic, and over the succession to the throne, any one of which could derail the over-confident Prince’s efforts to modernise his medieval country.

Regionally, the stars are far from in line for the House of Saud, as the Sunni-Shia sectarian rivalry for dominance in the Middle East tilts toward hated Iran. Egypt, another of the great Sunni powers, is an economic mess. Likewise, outsider Turkey is distracted by Putin mini-me Recep Tayyip Erdogan’s never-ending efforts to establish himself as a President with quasi-divine powers. In contrast, the smaller Shia grouping is both more politically coherent and more militarily successful. Iran has been brought in from the cold by the United States, and Shia champion Russia has just about managed to bolster the bloodstained Assad regime in Syria.

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This has put Prince Mohammad in a bind, as Saudi Arabia’s regional enemies are on the march. His response, an ill-advised intervention into the morass of Yemen’s civil war, shows no signs of yielding any positive military results, in contrast to the decisive intervention of Iran and Russia in Syria. At best, Yemen seems to be a stalemate; at worst, it could become the House of Saud’s Vietnam.

Economically, Prince Mohammad also finds himself in surprising peril. Just this month Moody’s downgraded Riyadh’s credit rating over concerns about its over-reliance on oil revenues. The end of January 2016 found Saudi capital reserves still falling by $14bn a month, a trend which has steadily continued. While the Saudis still have a substantial $582bn in reserves, even this will not last forever. As this column has long assessed, the House of Saud is wedded to its John D Rockefeller strategy for dealing with the shale threat; it will accept immediate losses to try and protect market share and drive its new competitors out of business.

Read more: Saudi Arabia is acting like a drunken gambler in its oil war

The problem is the Saudis have badly miscalculated. First, continued technological innovations have made shale far more resilient than the Saudis believed possible. Second, shale production is unlike most energy sources in that it can be turned on and off relatively easily. As such, unwittingly the Saudi strategy has made shale the ceiling on global energy prices, ready to be brought online if prices rise as the Saudis eventually hope comes to pass.

Lastly, the Saudis know precious little about private energy markets, as their vast holdings are state-controlled. Yes, their energy strategy regarding shale may drive the original wildcatters out of business, but who cares? The entire history of the US industry is the story of visionary oil producers developing fields and then falling apart, only for established eastern money to come in and scoop up the long-term profits. A very similar scenario is at play now. The Saudis have gambled big against shale, and they have gambled badly.

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Given all this, and the fragile health of King Salman, who is to say the Deputy Crown Prince will retain his position when the present Crown Prince, Mohammed bin Nayef, comes to the throne? The Crown Prince has been conspicuously silent about the temporary dominance of his much younger nephew, but I’d guess he is not thrilled with it. No, far better to let Mohammad bin Salman stew in his own juices, and then when bin Nayef succeeds to the throne to dump the bumptious upstart.

However you look at it, and much to its peril, Saudi Arabia has become a far too interesting place, one that analysts would be well advised to study in great detail.

City A.M.'s opinion pages are a place for thought-provoking views and debate. These views are not necessarily shared by City A.M.