from Follow the Money

Are most petrodollars already in sovereign wealth funds?

November 13, 2006

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Stephen Jen thinks so.

“Most of the petrodollars are already in ‘sovereign wealth funds’, with good exposure to emerging markets and equity markets, including the Nikkei” 

Alas, Jen is wrong.   At least when it comes to the flows.   Most of the Gulf’s oil money is in oil investment funds (sovereign wealth funds) – though Saudi Arabia is a big exception.  But the overall flow of oil money into in the foreign exchange reserves still trumps the flow of oil money into oil investment funds.   At least that is what my work suggests.

Jen isn’t the only one who has a tendency to understate the reserve growth of oil exporters.   At the Euromoney fx conference last week, estimates of reserve growth by oil exporters were all over the map.  The only consistent pattern is that they are generally too low.  

Let’s go through the key countries.

Three important oil exporters clearly have given most of their oil windfall over to their respective oil investment fund to manage: Kuwait (KIA), Abu Dhabi (ADIA) and Norway (the government pension fund).     

In general, setting Saudi Arabia aside, the Gulf countries make use of oil investment funds to manage their oil wealth.    And those investment funds generally do have exposure to both emerging markets and equities, unlike (most) central banks.

However, Saudi Arabia is an important exception.    It doesn’t report a large increase in its formal reserves.   But it also uses a very narrow definition of its reserves.   The Saudi Monetary Agency’s foreign assets have been growing very rapidly: See the lines “deposits with banks abroad” and “investment with foreign securities” in this data release; the data is in riyal, but the conversion is easy.   

Those foreign assets are presumably managed in ways more like central bank reserves than an oil investment fund.   This is a big source of confusion.  But I tend to agree with the folks, with the IMF, who generally include all SAMA foreign assets in their estimates of regional reserve growth.   Their estimates for 2006 GCC reserve growth (see table 20) though are a bit low – largely because their estimate for the Saudis lags the observed increase.

And then there are the oil exporters of North Africa.   The reserves of both Libya and Algeria have increased extremely rapidly.   And both seem to manage their reserves as “reserves” – they have very large deposits in the international banking system.    Nigeria also belongs in this group. 

Then there is Russia.   It has an oil fund.   But that oil fund’s foreign assets are managed by its central bank.   Or at least they have been – I think control has been shifted to the Finance Ministry.   But there isn’t yet an institutional structure for investing in a diverse range of assets (see this World Bank report).    They still seem to appear on the Bank of Russia’s balance sheet, and are a key reason why Russian reserves have grown so rapidly this year.

The available evidence suggests that the Bank of Russia has invested Russia’s (rapidly growing) reserves very conservatively.  Until it started its diversification program earlier this year, the majority of its reserves seem to have been held in short-term agencies.   Right now, Russia’s reserves seem to be in bank deposits.     

Over time, I would expect Russia to move toward the creation of a “sovereign wealth fund” that would allow investment in a broad range of assets.   But I don’t think that has happened to date.   If any of my readers know more, do tell!

If you sum up the growth in Saudi foreign assets, Russian reserves and the reserves of a host of smaller oil exporters without oil investment funds (Algeria, Libya), the total is likely to be quite impressive.   I would be surprised if oil exporters added less than $300b to their reserves this year.    Russia and Saudi Arabia should combine for around $200b.   That isn’t a huge leap.  Russia’s reserves were up $90.2b through October.  Saudi foreign assets (effectively reserves) were up $56b through September.   That includes a very low total for q2 (it seems to be seasonal).  The q1 and q3 increase topped $20b.  Q4 probably will too.

Bottom Line: Sovereign wealth funds are important.   But lots of oil exporters are adding to their old fashioned central bank reserves.    Enough for oil exporters to account for about ½ of global reserve growth right now.   And to have a big impact on global markets …   an impact that is probably comparable to the impact of the growth in Chinese reserves.  

For more, see RGE’s petrodollar watch (subscription required).

One key thing to watch: how quickly will those oil exporters now adding to their central bank reserves create oil funds, and start investing in a much broader range of assets.   Directionally, Jen is right.   He just is leaving a lot of petro-reserves out of his current analysis.   And in that, he is not alone.

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