The new role of oil wealth in the world economy

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With oil prices having more than tripled since 2002, petrodollar investments have become the world’s largest source of net global capital flows and are leading to a broad shift in global economic markets, an analysis by the McKinsey Global Institute (MGI) says.

“High oil prices are, in effect, a tax on consumers, generating windfall revenues for oil-exporting nations [and] surpassing Asia for the first time since the 1970s,” observe the authors, Diana Farrell and Susan Lund. 

The majority of these revenues have been recycled into global financial markets, making petrodollar investors increasingly powerful actors, the authors reveal. 

Moreover, the influence of petrodollar investors is likely to continue to grow for at least the next five years, MGI predicts. 

At $70 a barrel – a low estimate considering the current price of about $88 a barrel – petrodollar flows into global markets would grow by $628 billion annually by 2012, implying new petrodollar investments of nearly $2 billion a day, the authors calculate. At this price, the total stock of petrodollar foreign assets would grow to $6.9 trillion by 2012, they add. 

Even if oil prices declined to $30 a barrel, petrodollar foreign assets would grow at an average annual rate of 6% to reach about $.8 trillion in 2012, according to MGI predictions.

Farrell and Lund point out that despite the beneficial effects of petrodollars in increasing global liquidity and spurring the growth of various financial-asset classes throughout the world, the rise of investors in oil-exporting countries is also a cause for concern. The authors’ primary concern is the huge size of petrodollar sovereign wealth funds coupled with their relatively high appetite for risk, raising the question of whether their growing financial muscle could be abused for non-economic motives.

“The rise of large government investors in financial markets is a new phenomenon – and one at odds with the shrinking role of state ownership in real economies,” write Farrell and Lund. 

MGI suggests that it would be in the funds’ interest to voluntarily disclose their size, investment objectives, target portfolio allocation, and internal risk-management and governance procedures. This information would allow well-managed funds to stand out and demonstrate a spirit of cooperation, the authors believe. 

For regulators in Europe and the US, it will be essential to differentiate between the direct acquisition of corporations by state-owned enterprises and government investment companies in oil-exporting regions on the one hand and the passive investments of sovereign wealth funds in debt and equity markets on the other, according to MGI. 

The analysis concludes by saying that it comes as a surprise that the world economy has thus far accommodated higher oil prices without a notable rise in inflation or an economic slowdown, but cautions this might change in the future. 

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