from Follow the Money

Oil math

November 26, 2007

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Blog posts represent the views of CFR fellows and staff and not those of CFR, which takes no institutional positions.

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I loved the FT.com’s interactive oil map – particularly the graph showing the global flow of oil.

I was also impressed by Qing Wang’s analysis of the impact of rising oil prices on China.   China imported about a bit more than $70b worth of oil in 2006, enough to reduce China’s trade surplus by 2.7% of China’s GDP.   Wang calculates – based on Chinese import data – that $10 a barrel rise in the price of oil over the course of the year would increase China’s import bill by about $13.5b (and, absent an increase in the domestic gasoline prices, cut into the profits of China’s state oil companies by a bit over $14b).   

That was a somewhat smaller increase than I expected – which just shows the advantage of looking at the numbers.   So how much, by comparison, would a $10 a barrel increase in the price of oil impact other economies, assuming no offsetting increase in spending and investment in the oil exporting states and thus no offsetting increase in exports to the oil-exporting states? 

Using the BP data, I estimate that a $10 a barrel increase in the price of oil would: 

  • Increase the US trade deficit by about $50b over the course of the year.
  • Lead to a $46b (euro 31b) deterioration in the EU-25 trade balance.  The EU-25 imports a bit less oil than the US (12.6 mbd v 13.7 mbd) even though it produces less oil than the US and has a somewhat larger economy.  

And conversely, each $10 increase in the barrel of oil means:

  • An additional $57b for the GCC states (Saudi Arabia, Abu Dhabi, Dubai and the other emirates, Kuwait, Qatar and Oman) to spend or invest.
  • An additional $25-26b for Russia.
  • An additional $10b for the Iranian government.
  • An additional $9.5 or so for the socially conscious burghers of Norway to stash away in their already quite substantial sovereign wealth fund.
  • An additional $8b or so for Venezuela.

Or, to put it a bit differently, I suspect that the Gulf states will need oil to average $50 a barrel over the course of the year to cover their import bill.   Spending and investment have picked up significantly.     But if oil averages $100 a barrel, they will have enough funds to spend and invest over two times as much as they did in say 2002 and still have another $285b to invest globally.    If oil averages $70, they only have around $114b. 

It isn’t a total shock why investment bankers – and commercial banks needing a bit more equity capital -- have suddenly discovered the Gulf.  In 2004 and 2005 the Gulf states were still worried that oil might fall back to its 2001-02 level and wanted to build up their cash reserves.  Now they are looking for a rather considerable return on their money.   I am not quite sure how various Gulf funds will achieve their 15-20% rate of return target though without taking on large risks.

Conversely, the US trade deficit would be roughly $250b smaller if oil averages $50 a barrel rather than $100 a barrel next year.  China’s surplus would be $65-70b larger.  

This very rough analysis hasn’t looked at who benefits from more spending and investment in the oil exporting economies.   But on that point there is near-universal agreement.   Europe and Asia sell a lot more to the big oil exporters than the US. 

The US consequently gets hit on both sides: it imports more oil than Europe and way more oil than China (even if Chinese imports are growing fast), and it sells an a lot less than Europe and I suspect China to the big oil exporting economies.    That isn’t a great combination. 

Steps to encourage energy conservation and reduce US oil consumption could – particularly if they reduced the global price of oil – contribute to external adjustment.   The role energy policy could play in bringing down the trade deficit hasn’t received enough attention.  Especially since the needed policies could be adopted by the US unilaterally.    A lower oil price would cut into the savings surplus in the Gulf and cut the US import bill.    It might support the beleaguered dollar.

A lower oil price might also contribute to a range of US foreign policy goals.   Right now the governments of the major oil exporting are financial powers, and in some cases, financial super-powers.   Several are not exactly close US allies. 

Reverse the arrows on the global flow of oil in the BP graph and you have a pretty good picture of the global flow of funds associated with oil.   It is a big flow out of the US.    

There is a secondary flow that is also attracting a lot of attention – how the oil exporters invest the dollars they get in exchange for selling their oil.   With oil where it is, that matters a lot for the relative values of different currencies.    But it is also a subject worthy of a post in its own right.   

Suffice to say that it increasingly looks like a real energy policy might do more to support the dollar than almost anything else.

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