oil profits, world markets, petrodollars

How oil profits move world markets

03.02.2006

by Simon Nixon

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As the oil price rises, money flows out of the pockets of consumers in the West into those of the governments of the Middle East. But where does it go next?

How much money are we talking?

Oil exports from the Middle East were estimated to be worth around £384bn in 2005, according to the IMF. To put that in perspective, that is 44% higher than the previous year and some $250bn more than in 2003. It was also far more than the Middle East has seen in previous oil booms. Adjusted for inflation, the region’s oil exports were worth a comparatively meagre $197bn in 1980 and $123bn in 1974. And with political tensions already pushing prices higher this year, there is no sign of this bonanza coming to an end. In fact, these vast windfalls are increasingly one of the main factors driving world markets.

What’s happening to the money?

Governments receive the bulk of the extra oil revenues through taxes and royalties and at the moment they appear, for want of any other obvious things to do with it, to be investing it mainly in the global debt markets. As in previous oil booms, this is driving down real interest rates and helping to fuel a global lending boom. However, whereas in the 1970s boom much of the lending was to shaky Latin American countries that inevitably went bust, this time it is being lent via the bond markets to debt-soaked Western governments and consumers, particularly in the US. Oil exporters are effectively lending much of the money they’re making from dearer oil back to their customers.

Is that a bad thing?

Not necessarily. Petrodollars have recently been helping to finance the US trade deficit, which now stands at an eye-popping 6% of GDP. Without this support, the US dollar would probably be worth a lot less than it is today and US interest rates might be a fair bit higher as a result. So, by lending the cash back to the US, the oil economies have at least made sure that one of their biggest markets stays economically stable and that the effect of the rising oil price has been relatively benign. However, with global bond yields so low, Middle Eastern countries are increasingly looking for alternative uses for their oil windfall, something that could lead to subtle shifts in the balance of world markets. They have, for example, begun to spend and invest far more in their domestic economies. During the oil booms of the 1970s, most of the big oil exporting countries were still largely undeveloped. Almost everything had to be imported. There were few homegrown businesses of any size and investment opportunities were thin on the ground. Today, the economies of the Middle East are thriving and the region resembles a vast building site. Dubai, where 15% of the world’s largest cranes are said to be in use, is now a major tourist destination. And all the Gulf States are competing to become regional business centres, investing billions of dollars in offices, hotels and infrastructure. The government of Saudi Arabia recently announced plans to build a new city on the Red Sea, which will cost $27bn. All this spells lucrative work for local firms, many now run by sophisticated and highly trained executives and this in turn is fuelling a local stockmarket boom.

How have local stockmarkets done?

The Saudi Arabian stockmarket was up more than 100% last year and now has a market capitalisation of US$633bn, making it the biggest emerging market in the world, but far from the cheapest one. It now trades at a mind-boggling 50 times this year’s earnings (the UK market trades on a multiple of just 14 times). Meanwhile, the UAE stockmarkets were also up more than 100% last year, the Kuwait market rose 78%, and Qatar’s went up 70%. One recent initial public offering (IPO, see page 38) in Qatar proved so popular that the authorities had to hire a stadium to accommodate all the prospective investors who had come to register for shares. Many of these stockmarkets are still in their infancy – Qatar still only has 32 stocks, for example – but the combination of sky-high valuations, abundant liquidity and Western standards of regulation is sure to lure new companies to the markets. Expect many more IPOs.

Are these local firms sticking to their home markets?

Far from it. In the past year, Middle Eastern groups have made a number of high-profile cross-border acquisitions. For example, Dubai International bought Tussaud Group; Middle-Eastern investors bought the Italian mobile-phone group Wind and – most spectacularly – Dubai Ports World, the port operator, launched a £4bn bid for P&O. This is a far cry from the pattern evident in the past, when Middle Eastern investors were content to be passive investors in other people’s deals. Investment bankers now report a huge appetite in the region for deals. And with access to massive amounts of cheap funds, Middle Eastern bidders are usually able easily to outbid potential rivals.

What the oil boom means for the dollar

Over time, the amount of cash pouring into the Middle East could help undermine the dollar and bolster the euro. The switch away from buying US bonds with the oil dollars to a greater focus on spending and investment tends to favour Europe over the US. Partly, this reflects Arab wariness of the US after the freezing of many Arab accounts following September 11. Europe is also closer and economic links are well estab¬lished. The EU ran a $10bn trade surplus with Middle Eastern oil-exporting countries in the first nine months of 2005, while the US ran a $28bn deficit. That may be negligible alongside America’s $600bn total current account deficit, but if the euro¬zone surplus rises and the US deficit falls, the dollar will suffer.