By Angus McDowall

DUBAI (Reuters) - Saudi Arabia mourned on Sunday the death of Crown Prince Sultan, as King Abdullah prepared to nominate his new heir and choose a new occupant of the key defense minister's job.

With much of the rest of the Middle East in turmoil, U.S. Defense Secretary Leon Panetta expressed confidence in Riyadh's ability to stage an effective transition in the area of defense after the death of the crown prince.

Prince Sultan, who had been heir to the Saudi king since 2006 and defense and aviation minister since 1962, died of colon cancer in New York on Saturday.

While most analysts expect the veteran Interior Minister Prince Nayef to become crown prince, there is less certainty about the defense role, a key post in a country that uses multi-billion dollar arms deals to cement relations with top allies.

In making the appointments, King Abdullah must maintain a delicate balance of power in a royal family that has thousands of members, dozens of branches and dominates Saudi Arabia's government, armed forces and business.

"Balance is always the concern of kings," said Khaled al-Dakhil, a political science professor in Riyadh. "It's to keep the balance within the family at all levels."

Speaking in Indonesia, Panetta expressed confidence over the future of Saudi defense policy.

"I believe that we can have an effective transition in Saudi Arabia with regards to the defense area," he said. "We've been able to have these transitions before. I think I feel confident that we can go through this transition as we move to a new defense minister."

RESHUFFLE POSSIBLE

The changes to top Saudi personnel might prompt King Abdullah to undertake the first major government reshuffle of his reign, an event that has long prompted speculation.

However, analysts said he might prefer to wait to avoid any perception that changes were being made under pressure.

With Sultan's funeral scheduled for Tuesday in Riyadh, the government is preparing for an influx of foreign dignitaries and leaders, reflecting Sultan's status as a major figure in Saudi foreign and defense policy over several decades.

State-owned news channel Ekhbariya devoted most of its coverage on Sunday to the death, carrying a photograph of Sultan praying as it broadcast interviews with commentators and black-and-white footage of him inspecting Saudi troops in the 1960s.

However, businesses and government buildings remained open in the absence of a formal mourning period, and only a few small state-run events, including exhibitions and a tourism festival, were canceled.

King Abdullah's appointments this week will determine the direction of Saudi Arabia for years, if not decades, to come as the world's top oil exporter prepares to tackle long-term internal and foreign problems.

Unemployment is high, as the Saudi population is growing more quickly than suitable jobs are being created. Rising domestic energy consumption is reducing the amount of oil available for export while liberal and conservative Saudis support starkly different visions of development.

Meanwhile, the Arab spring uprisings have destabilized neighboring Bahrain and Yemen, feeding Saudi concerns that regional rival Iran might use the unrest to expand its influence across the Gulf.

King Abdullah, who is thought to be in his late 80s, has now ruled Saudi Arabia for six years as king, but as de facto regent for another decade before that. His 16 years of rule have allowed him to put a stamp of cautious reform on the Middle East's largest economy.

He has opened up business sectors that were off-bounds to private investors, liberalized Saudi capital markets, reduced the role of religion in education and pushed for some more rights for women.

Prince Nayef and his younger full-brother, Riyadh Governor Prince Salman, are around a decade younger than King Abdullah and the next possible candidate for king, Prince Muqrin, is a decade younger still.

King Abdullah is likely to activate the Allegiance Council he set up in 2006 to regulate the kingdom's opaque system of succession.

The council does not legally have to come into force until after Abdullah's death, but analysts in the kingdom say he is unlikely to bypass the body by simply appointing the new crown prince himself.

"Considering the fact that the Crown Prince died at this time, with the situation in the Middle East and the Arab world in turmoil now, it would be positive to activate the council and give it a chance to choose the new crown prince," said Dakhil.

Defense

The appointment of a new defense minister is important in ensuring continued balance between different wings of the family. The job also entails responsibility for major defense purchases that Riyadh has used to strengthen its relations with top allies including the United States, Britain and France.

Leadership of the kingdom's armed forces also delivers a powerbase to whichever prince is in charge, making it a pivotal position.

Prince Sultan's son, Prince Khaled bin Sultan, is now the deputy defense minister and has for many years been seen as a strong candidate to replace his father as minister one day.

However, analysts said it was not certain he would be appointed to the role by King Abdullah.

Saudi newspapers carried full-page condolence messages from princes and Saudi companies and devoted pages of coverage to Sultan's death.

(Additional reporting by Asma Alsharif in Jeddah, Nour Merza in Dubai and Phil Stewart in Bali)