Bountiful Barrels: Where to Find $140 Trillion - Barrons.com

Bountiful Barrels: Where to Find $140 Trillion - Barrons.com: "MONDAY, JULY 14, 2008
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Bountiful Barrels: Where to Find $140 Trillion
By ANDREW BARY | MORE ARTICLES BY AUTHOR
Dow Chemicals overpaid for Rohm & Haas -- but it's not all bad news.
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MONDAY, JULY 14, 2008
FEATURES MAIN
Bountiful Barrels: Where to Find $140 Trillion
By ANDREW BARY | MORE ARTICLES BY AUTHOR
Dow Chemicals overpaid for Rohm & Haas -- but it's not all bad news.
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THE NEAR-DOUBLING in oil prices in the past year to $144 a barrel is leading to a huge transfer of wealth to petroleum-producing countries -- and that has implications for global interest rates, currencies and stock markets around the world.
[oil barrels]
Domelounksen/age fotostock
Oil-exporting nations are pulling in some $7 billion a day, or $2.5 trillion annually, according to a Morgan Stanley analyst.

The revenues of oil-exporting countries now are running at about $7 billion a day, or $2.5 trillion annually, according to Stephen Jen, chief currency economist at Morgan Stanley. Even more impressive is the value of the oil reserves of petroleum-exporting countries, which now total an estimated $140 trillion, nearly three times the size of global equity markets, which have a combined market value of around $50 trillion. Annual global economic output runs at $60 trillion.

In a recent report titled A Monumental Petro-Wealth Transfer, Jen calculated the value of the oil reserves of three groups of exporting countries. He values those of Saudi Arabia and five other key oil producers in the Persian Gulf region at about $65 trillion, based on $135 oil. This figure is for members of the Gulf Cooperation Council, which includes Saudi Arabia, the United Arab Emirates, Kuwait, Bahrain, Qatar and Oman -- about $4 million per GCC citizen. There's another $60 trillion of oil in the ground in Iran, Iraq, Venezuela and other members of the Organization of Petroleum Exporting Countries, Jen estimates, plus some $16 trillion of oil reserves in non-OPEC exporting countries like Norway, Canada and Russia. Jen notes that Saudi Arabia alone is generating $1 billion of oil-export revenues every day, and its reserves, the largest in the world, are worth about $35 trillion at today's oil prices.
[oil bar chart]

Oil bears are apt to be comforted by these figures because they suggest that something may be out of whack if the value of the planet's oil reserves so dwarfs the size of the world's public companies. There already may be a self-correcting mechanism playing out if high oil prices depress demand and lead to lower prices in the year ahead.

It's also true that the world's 1 trillion barrels of proven oil reserves won't be monetized at once. Global production is about 30 billion barrels a year. Still, as Jen writes: "If oil prices don't retreat back to low double-digit levels, oil exporters will enjoy a massive wealth transfer from the rest of the world."

Jen, who couldn't be reached last week, argues that most oil wealth will be transformed into paper assets as countries like Saudi Arabia, Kuwait and the UAE invest oil revenues in global stocks and bonds. Key vehicles for channeling these investments are sovereign wealth funds, which invest more aggressively than central banks. Sovereign wealth funds typically invest in global stocks, real estate and other assets, as opposed to government bonds.

Sovereign wealth funds from the Mideast have generated headlines with their equity investments in financial companies like Citigroup (ticker: C) in the past year. Many of these investments have proven to be embarrassing, however, as stocks have dropped sharply.
[oilchart2]

Last week, the Abu Dhabi Investment Authority led a group that agreed to buy the Chrysler building in New York for more than $800 million. The ADIA is believed to be the largest sovereign wealth fund, with over $500 billion in assets. Jen estimates that oil exporters' sovereign wealth funds could increase their assets to $3.3 trillion in 2010 from the current $2.3 trillion.

But where has all the money gone? Equity investing by oil-rich funds certainly hasn't done much to support global stock markets in 2008.

THE GOOD NEWS FOR Western oil-consuming countries is that oil exporters' bond investments appear to be helping keep down inflation-adjusted interest rates. Jen points out that the long-term real interest rate among the major industrialized nations of the G-10 is at a 25-year low of 1.35%. The average real rate in the 1990s was 3.6%.

Jen says a surplus of savings in oil-exporting countries, as well as in China, helps explain why global rates have remained relatively low despite rising inflation, now running at about 4% in the U.S. and Western Europe. He writes that low real yields show that the "marginal propensity to consume is lower for the oil exporters than it is for the oil importers, despite the large spending on infrastructure" by petroleum producers. The construction boom in the Persian Gulf has strained resources and led to inflation rates of 10% to 11% in Saudi Arabia, Kuwait and the UAE.

The Bottom Line:
Bond investments by oil exporters are helping hold down interest rates. The long-term real interest rate among major industrialized nations is at a 25-year low of 1.35%.

Jen thinks oil exporters may be parking money in "sovereign bonds" while awaiting an upturn in the global economy that may make the funds more comfortable with stocks and other riskier assets. He also believes that oil exporters in the Mideast and elsewhere will increasingly diversify their currency holdings away from the U.S. dollar to emerging-market currencies.

The key issue is the duration of the current wealth transfer to Saudi Arabia and other oil producers. If oil prices stay high, the trend could last for years, reshaping the ownership of financial and real assets around the world and prompting increased political scrutiny in Western countries of the recycling of petrodollars.

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