Sustained high oil prices have enabled oil exporters to enjoy a period of unprecedented prosperity. Given the size of these countries’ revenues and balance of payments surpluses, what they do with their petrodollars is increasingly important. In the past, oil exporters have recycled most of their earnings into imports of goods and services and deposits at international banks, helping to support global aggregate demand. The financing needs of oil-importing countries and the fragility of the global economy mean that the choices of oil exporters have a big global impact.
Going forward, high oil prices will continue to bring oil-exporting nations unprecedented wealth and power, but significant further oil-price increases reflecting the scarcity of oil and geopolitical risk factors could lead to the unraveling of the global economy. A good outcome for both oil exporters and the world economy would be keeping oil prices in an $80–$100 per barrel range, recycling proceeds into imports quickly, and channeling some petrodollars to badly needed infrastructure investment in oil-importing developing and emerging economies.
A Windfall Gain
International oil prices have typically been volatile (see Chart 1). But there is something unusual about the current situation. Prices for Brent crude—a benchmark for much of the oil traded today—have hovered around the $100 per barrel mark for nearly fifteen consecutive months, which is unprecedented. The last time they were this high—and even then, only for six consecutive months—was in August 2008, just before the collapse of Lehman Brothers and the onset of the Great Recession, which led to a massive $112 per barrel decline in the price of oil. Recently, oil prices have declined only moderately, despite a relatively weak economic recovery in the advanced economies, a slowdown in the pace of growth in emerging economies, and deep concerns about the stability of the eurozone.
A number of factors appear to be keeping oil prices high. First, the global oil supply has yet to react to high prices and spare capacity remains low. Second, demand from emerging economies continues to grow, in part due to the precautionary stocking of crude oil. Third, supply losses in Libya, Syria, and South Sudan have tightened global markets. The five-year-out forward prices of oil have remained around $90 a barrel. Finally, there is also a risk premium of about $15 to $20 per barrel associated with political and social tensions across the Middle East. An impending oil-exports embargo and financial sanctions against Iran by the European Union and the United States, for instance, could reduce Iranian oil exports by an estimated 0.8 to 1 million barrels per day from around 2.5 million.
High oil prices have boosted the fortunes of oil exporters. In 2011, their combined export proceeds reached an unprecedented $2 trillion, and their aggregate current account surplus amounted to $600 billion or about 11 percent of the group’s total GDP. That amounted to the largest current account imbalance globally—compared to the U.S. current account deficit at $473 billion (see Charts 2 and 3).
How Are Petrodollars Recycled?
There has traditionally been a strong correlation between oil price shocks and global recessions, but the global economy seems so far to have been able to weather $100 per barrel oil prices. This is at least in part because oil exporters have, relatively smoothly, recycled their foreign exchange earnings into global trade and financial markets, offsetting the negative demand shock on the rest of the world (see Table 1 for a detailed breakdown of petrodollars recycling over the past decade). Accommodative monetary policy in most major economies, together with greater efficiency in energy use and diversification away from oil to alternatives, has also helped.
|Table 1. Accounting for Global Petrodollars (2002-2011)|
|Oil Exporters||Oil Production (million barrels per day), March 2012||Cumulative 2002-2011 (U.S.$ billions)|
|Oil Export Revenue||Imports of Goods and Services||Current Account Surplus||Central Bank Reserves*||Gross Capital Outflow**|
|Other oil exporters' total****||2.93||1534.4||1336.0||322.8||59.1||356.0|
|Source: International Monetary Fund; International Financial Statistics; Economist Intelligence Unit; International Energy Agency, Oil Market Report, April 2012; and author’s calculations.|
|*Central Bank reserves in 2011 minus reserves in 2001.|
|**For those countries with unavailable or incomplete capital account data, “gross capital outflow” is estimated as the difference between the current account surplus and the change in the stock of international reserves, which would include external debt repayments.|
|*** Due to data unavailability, Iraq's calculations refer to the 2004-2011 period rather than 2002-2011.|
|**** Excludes Norway and some small producers.|
Of the cumulative oil revenues amounting to more than $12 trillion between 2002 and 2011, on average, about 67 percent was spent on imports of goods and 12 percent was spent on services imports. These aggregate figures mask considerable variation across countries and over time—the more populous oil exporters with more diversified economies generally have a substantially higher ratio of imports to exports. Of the remaining oil revenue earned between 2002 and 2011, around 5 percent ($100 billion in 2011) went toward foreign workers’ remittances and about 15 percent was invested in foreign assets (see Chart 4).
That means that over a number of years, about 85 percent of the increased oil proceeds were spent on foreign goods and services (including on paying for imported labor), leaving 15 percent to be recycled through global financial markets. There is also an important geographical shift in the direction of trade. Oil-exporting countries as a group are gradually shifting their trade away from the slow-growing advanced economies and toward the fast-growing emerging and developing countries (see Table 2). China and India are among the major beneficiaries of this shift. During the last five years, oil exporters’ imports from developing economies have increased from 45 percent of their total imports to 50 percent.
|Table 2. Trade with Oil Exporters (US$ Billions)|
|Exports to||2002||2007||Change 2002-07||2008||2011||Change 2008-11|
|Source: International Monetary Fund, Direction of Trade, April 2012; and author’s calculations.|
When oil prices rise sharply, however, all oil-exporting countries have difficulty absorbing their windfall income quickly. This was the case during the 2010–11 period when the gap between the value of these countries’ exports and imports widened sharply (see Chart 5) as did the gap between domestic investment and savings (see Chart 6). This took place despite the fact that many oil exporters, particularly those in the Middle East, had substantially increased government spending on social and infrastructure programs in response to pressures at the regional level associated with the Arab Spring. Sustaining these higher domestic spending levels, however, will require oil prices to remain relatively high. Specifically, “break-even” oil prices have increased sharply and will have to stay in the range of $80 to $100 per barrel for oil exporters to achieve and maintain fiscal balance.
Where is the Money Now?
Of the $3.2 trillion in cumulative current account surpluses that oil-exporting countries amassed between 2002 and 2011, about 40 percent ($1.5 trillion) went to the accumulation of official foreign reserves, boosting the funds available for future imports. The rest was invested around the world, either directly or through sovereign wealth funds (SWFs), or used to repay debt. Bank flows, as measured by oil exporters’ deposits at banks reporting to the Bank for International Settlements, seem to have lost their relative importance as a major recycling channel.
In 2011, oil exporters’ net investments worldwide in financial terms, including purchases of official securities, reached about $590 billion. Among the advanced economies, only the United States has a current account deficit requiring a large amount of foreign financing. Based on the latest data, holdings of U.S. securities by identified oil exporters reached $597 billion by the end of June 2011, compared to about $80 billion in 2001. Nearly one-third of this amount was invested in equities with the rest in long-term bonds and Treasury bills.
These figures suggest that about 16 percent of oil exporters’ cumulative investable funds ($3.2 trillion) from 2002 to 2011 are invested in U.S. securities. But this is surely an underestimate, since a sizable portion of investments in U.S. securities by oil exporters comes into the United States indirectly through UK banks and some of the major offshore banking centers.1 Oil exporters’ large-scale purchases of “risk-free” assets in the United States and other advanced economies can push down interest rates in global markets, indirectly supporting aggregate demand in oil-importing countries.
According to recent estimates by the Sovereign Wealth Fund Institute, oil exporters have a portfolio of global investments amounting to around $2.5 trillion, with Saudi Arabia and the United Arab Emirates accounting for nearly half. These funds facilitate public investment, help stabilize government and export revenues, and accumulate savings for future generations. There is very little information on the exact asset allocation and geographical location of oil exporters’ SWF investments, but they are thought to be stable, given their long-term investment horizon. Some rough estimates indicate that more than half of oil exporters’ investments are in equities; 10 to 20 percent are in bonds; and the rest are in alternative investments such as real estate and cash. Since the 2008–09 crisis, some SWFs have also purchased domestic assets. 2
What is a “Good” Level of Oil Prices?
Today, the benchmark Brent of around $100 a barrel is nearly three times its lowest level in 2008, and the real price of oil (the nominal price deflated by the U.S. consumer price index) is near its highest level. At present, the world economy can probably absorb a small increase in oil prices, assuming monetary policies remain accommodative. A $10 per barrel (or 10 percent) increase in oil prices, for example, is likely to shave off 0.2 to 0.4 percentage points from growth rates in the United States and other advanced economies. The impact on low-income countries, however, could be more severe due to their binding financing constraints and greater vulnerability to higher food prices that result from the increase in oil prices.
A further significant oil price increase, however, is likely to push the world economy into uncharted waters. High oil prices are already pushing up food prices; if sustained, they could lead to inflationary pressures in many developing countries, which would derail their growth. But a major supply disruption that might arise from geopolitical events related to Iran, the third-largest oil exporter in the world, is likely to have a substantially greater adverse impact on the global economy.
For now, the best strategy for oil exporters (and for the global economy) is to keep oil prices within their “break-even” band of $80 to $100 per barrel and prevent sharp spikes. They should also continue to recycle their petrodollars as quickly as possible through imports of goods and services. Some of their international investments should be dedicated to meeting the massive need for infrastructure investment in emerging and developing economies, which are becoming increasingly important markets for their oil exports and sources of imports.
By finding innovative ways to finance these needs, oil exporters’ SWFs might not only be more effective at recycling their excess reserves. They could also contribute to global growth, employment generation, and ultimately social and political stability in poorer countries—a new channel for recycling petrodollars that might prove to be the most profitable investment in the long run.
Shahrokh Fardoust is the former director of strategy and operations in Development Economics at the World Bank and is currently a consultant. The views expressed are those of the author, not the World Bank.
. For a well-researched economic and policy analysis of SWFs see: Udaibir Das, Adnan Mazarei, and Han van der Hoorn (editors), Economics of Sovereign Wealth Funds, IMF, 2010. http://www.imf.org/external/pubs/nft/books/2010/swfext.pdf.