Regulators may worry when Arab investors acquire stakes in Western companies, yet vast reserves of petrodollars have kept down interest rates and buoyed financial assets. What’s the broader effect of the surge in petrodollars?
Diana Farrell and Susan Lund
January 2008
As oil prices continue to set new records, investors outside Europe and the United States are increasingly shaping trends in financial markets. Petrodollar investors have a newfound influence, and the more than tripling of oil prices since 2002 makes them the largest and fastest-growing component of a broad shift in global economic markets—a shift that also includes Asian central banks, private-equity firms, and hedge funds.1 High oil prices are, in effect, a tax on consumers, generating windfall revenues for oil-exporting nations, which in 2006 became the world’s largest source of net global capital flows, surpassing Asia for the first time since the 1970s (Exhibit 1). A majority of these revenues have been recycled into global financial markets, making petrodollar investors increasingly powerful players.
Moreover, the influence of petrodollar investors is likely to continue to grow over at least the next five years. The exact size of future petrodollar foreign investments will depend on oil prices, which are subject to considerable uncertainty. Nonetheless, we can estimate the general direction of petrodollar assets using three benchmark price points and research on global energy demand by the McKinsey Global Institute (MGI).
At $50 per barrel of oil the annual net capital outflows of the petrodollar countries would amount to $387 billion a year through 2012 (Exhibit 2).2 This total represents an extraordinary infusion of capital into global financial markets at a rate of more than $1 billion per day. At $70 a barrel petrodollar flows into global markets would grow even larger, reaching $628 billion annually by 2012, implying new petrodollar investments of nearly $2 billion a day. By 2012 the total stock of petrodollar foreign assets would grow to $6.9 trillion. Even if oil prices declined to $30 a barrel, petrodollar foreign assets would grow at a robust average rate of 6 percent annually, to reach about $4.8 trillion in 2012, when the oil-producing countries would add $147 billion to the global financial system. That figure is larger than petrodollar surpluses throughout the 1990s.
Without a doubt, this flood of oil money is creating new dynamics, and the rise of petrodollar investors feeds growing concern about their government connections and influence on markets. Since facts about these powerful new investors have been scarce, our research aims to ground the debate by providing new data and analysis.
Where petrodollar assets are held
By our estimate, investors from oil-exporting nations owned $3.4 trillion to $3.8 trillion in foreign financial assets at the end of 2006.3 That sum is invested overseas in a number of ways.
Central banks
Some petrodollars end up as resources held by central banks, which invest in foreign assets to stabilize currencies against balance-of-payment fluctuations. The primary investment objective of central banks is stability, not the maximization of returns. They hold foreign reserves, mainly in the forms of cash and long-term government debt—at present, largely US Treasury bills. Among the oil exporters, Saudi Arabia has the largest central-bank funds, with an estimated $250 billion in 2006.
Sovereign wealth funds
Most oil-exporting countries have set up state-owned investment funds, often called sovereign wealth funds, to invest oil surpluses in global financial assets. Unlike the reserves of central banks, these funds hold diversified portfolios that range across equities, fixed-income vehicles, real estate, bank deposits, and alternative investments, such as those provided by hedge funds and private-equity firms. Most sovereign wealth funds allocate their portfolios in a relatively traditional way across asset classes, often relying on external global asset managers. To date, the funds have rarely taken majority shares in foreign companies. The largest sovereign wealth fund among oil exporters, the Abu Dhabi Investment Authority (ADIA), reportedly has total assets of up to $875 billion (Exhibit 3).
