from Follow the Money

Good bye, petrodollars ...

December 8, 2008

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Estimates of the break-even oil price in Saudi Arabia’s budget vary, ranging from under $40 a barrel to around $50 a barrel.

Sometimes that is because of different assumptions about Saudi Arabia’s actual production -- the more the Saudis cut back production, the higher the oil price they need to balance their budget.

Sometimes that reflects different assumptions about the relevant oil price: the price Saudi Arabia gets on its actual production blend is a bit lower than the benchmark price for sweet light oil.

And sometimes it just reflects a failure to adjust for the games the Saudis play with their budget.

Formally, the Saudis plan to spend 410 billion Saudi Riyal -- or $109 billion -- in 2008 (more here). That incidentally is less that the 443 SAR ($118 billion) the Saudis actually spent in 2007, as spending ran a bit over the 380 billion SAR ($101b) in the formal budget. I don’t believe for a second that the Saudis are really going to spend less in 2008 than in 2007. Rachel Ziemba -- who watches the local press closely for RGE -- thinks the Saudis actual 2008 spending will come in around 532b SAR ($142 billion).

That works out to a break-even price for the Saudis’ blend -- using the IMF’s assumption of 7.5 mbd of exports -- of around 51 or 52 dollars a barrel.

My calculation ignored the Saudis non-oil revenue. But it also ignored the Saudis production costs. Neither amounts to all that much though, so I doubt my rough math is too far off. The IMF estimated the Saudis 2008 break-even price at $50 a barrel.

Moreover, Saudi spending has been growing at something like 15% a year, if not a bit more -- remember, the Saudis had to increase their budget substantially just to assure that salaries kept up with inflation. And the Saudis probably aren’t going to scale back spending immediately. They don’t want the Saudi economy to come to a sudden halt. Projecting existing spending patterns out, I wouldn’t be surprised if the Saudis spent 585 SAR ($156) in 2009 -- a spending level that produces a crude estimated break-even price of the Saudi blend of around $57. For sweet light, that works out to an oil price of $60 or more ..

Sweet light doesn’t current trade for anything like that. There is a reason why SAMBA estimates that the Saudis might soon run a rather substantial (over 20% of GDP) budget deficit if sweet light crude is at $40 .

Not that the Saudis need to worry all that much right now. The Saudis added close to $60 billion to their reserves in the third quarter of 2008 alone. They are in a good position to use the Saudi Treasury’s accumulated petrodollars (and replenished domestic borrowing capacity, as the Saudi government has repaid a lot of domestic debt) to cover a temporary dip in oil revenues. That after all is the point of saving funds when times are good.

The Russians -- who need an oil price of $70 (if not a bit more ... ) to cover their budget -- aren’t in quite as good a position. Particularly when they also need to draw on their reserves to bailout (or take over) their corporate sector ...

Indeed, if oil stays at $40-45 a barrel, only Norway would still be adding to its stock of petrodollars (or petroeuros). Most other oil exporters would be sellers.

The IMF (see table 4/ p. 30) puts the break-even price for Algeria and Libya in the 50s.

And I don’t buy the IMF’s estimates for the break-even price for Kuwait, the UAE and Qatar. Not in the sense of providing an accurate picture of the true drain on each country’s oil revenue.

The IIF puts Kuwait’s break-even price at around $50 counting a significant (one-off) transfer to the social security system. The National Bank of Kuwait puts Kuwait’s break-even price at $54 a barrel even if the one-off transfer payment is excluded. I like the IIF’s work on the Gulf, but in this I would bet the National Bank is closer to being right.

The UAE number seems to be for the federal budget -- and thus excludes the budgets of individual sheikdoms. Moreover, Martin Wolf’s wonderful phrase "what looked like private lending turned out to be public spending" applies with unusual force in most of the Gulf, where a lot of the bigger local borrowers have close links to the state. And there was more private lending in the UAE than in most places.

Qatar’s formal budget almost certainly doesn’t capture a lot of spending through various "private" foundations -- nor the funds needed to finance various quasi-private investment plans. $60 a barrel was the number that was floating around Doha this summer ...

The IIF believes that the Gulf will run a small ($50 billion) current account surplus if oil is around $55 a barrel. I personally would expect the Gulf to perhaps run a current account deficit if sweet light oil is at $55 in the absence of a major fiscal contraction (and a major cut in various "private" and quasi-private investment plans). And there is no doubt that the Gulf would run a substantial (think $50-75b) current account deficit if oil is the low 40s.

Bye-bye petrodollars. There isn’t much reason for the US to worry though. The US oil import bill will fall nearly as fast as the oil exporters reserves ...

Indeed, some Gulf states are already in a position where they are selling off some of their foreign assets. Not to cover a fiscal deficit. But to bailout their over-extended private and quasi-private firms.

If the domestic stock market is slipping, the local sovereign wealth fund can start buying shares of local firms ...

If the banks are short local currency liquidity, reserve requirements and loan to deposit caps can be lifted. Or the sovereign fund can place a large local currency deposit with the banks .... the UAE, for example, recently put $20 billion on deposit with local banks.

If a firm (or investment company) cannot refinance its external debts, it can get a loan from a sovereign fund ...

Stephen Kotkin recently reviewed Christopher M. Davidson’s book on Dubai. The reviewer was a bit more positive on Dubai’s model than I would be, even arguing that a purge of recent financial excesses woudl be salutary ("the world’s searing financial debacle could turn out to be salutary for an overleveraged Dubai, reining in local inflation as well as an insane real estate market.") Maybe. But Dubai’s biggest vulnerability is that it was built with borrowed money not oil revenue. Absent a bit of help from further up Sheikh Zayed road, Dubai is in a real pinch ...

The region’s sovereign funds are facing increasing local demands just when the slump in global markets has cut into the value of their portfolios. The IIF argues that the Gulf funds held 40-50% of their assets bonds, and thus have withstood the credit crisis relatively well. That is -- in my view -- only true if SAMA is counted as a sovereign fund. ADIA held between 12-18% of its assets in safe bonds, with the majority in equities. The KIA’s portfolio, I suspect, probably wasn’t that different than ADIA’s portfolio. The KIA started taking on more risk after 2004.

To be sure, Kuwait, Abu Dhabi and Qatar are still fabulously wealthy. But they aren’t quite as wealthy as they once were. And all of a sudden they actually will have to make choices rather than having more to spend on everything. Whether prestigious investments abroad or ambitious projects at home ...

I always thought the notion that sovereign funds were intrinsically stabilizing forces in the market was overstated. For one, the absence of disclosure meant that it was impossible to know precisely how they impacted markets. But more importantly, their market impact likely would vary over time.

In practice, they were big buyers of risk assets when risk was under-priced in 2006 and the first part of 2007. They seem to have kept on buying in the later part of 2007 -- helping to stabilize the market at no small cost to themselves. At some point in 2008 they got cold feet (or at least some did) and started to build up their cash positions. At least that is my best guess. And now they are likely to need to sell into a down market.

Setting aside the period in late 2007 and early 2008 when they bought in a down market, sovereign funds generally seem to have added to the boom during the boom times (which isn’t necessarily stabilizing) and then joined nearly everyone else in pulling back from risk. They haven’t always been a stabilizing presence in global markets.

Then again, the whole point of having a sovereign funds is to protect the sovereign funds’ home country against macroeconomic volatility -- not to prop up global markets (or global banks). They shouldn’t ever have been expected to always be a stabilizing force in global markets.

By contrast, the sovereign funds themselves should have anticipated that they would be called on to support their home countries in bad times. And in retrospect, that means that they probably should have had a higher portion of their assets in investments that would hold their value when global growth slowed -- not in assets whose value is linked to global growth.

After all the price of oil is also a function of global growth

And most oil exporters still need to worry about the size of the external portfolio when oil is down, not when oil is up ...

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