Note: This post is by Rachel Ziemba, filling in for Brad Setser
Despite the fact that the price of oil and in fact almost all commodities has slid in recent days, they are up substantially in recent months. This year so far the price of oil has averaged over $95 a barrel and over $93 in the last six months - a tremendous jump up from the 2007 average of $71.5 (all figures a simple average of WTI, Brent and Dubai Fateh, as used by the IMF).
Source: EIA, federal reserve, my calculations.
Such levels may not continue, particularly in light of US economic weakness. Oil demand is falling in the OECD. Much depends on the value of the US dollar and how long financial investors are long commodities. But some factors do point to sustained high oil prices, despite a US economic slowdown. After all much of the demand growth for energy comes not from the US but from emerging markets, and they may find it more difficult to lower demand. Furthermore as I discus below, oil exporters have become more accustomed to higher oil prices and might find it harder to rein in their spending should oil prices drop.
So where has the oil windfall gone? Oil exporters have been spending a significant share of new oil revenues - as much as 2/3 of incremental revenues, meaning that they are starting to erode the imbalances - despite their large headline current account surpluses. How might those patterns change over the next five years. How oil exporters, especially in the emerging world spend the windfall at home and abroad has major implications for global and local economies and the cost of assets. And also on the price of oil, because most are choosing not to invest much in an energy sector with rising costs - Saudi Arabia is reportedlly spending more to achieve the same output as some of its fields are depleted. This post draws upon an updates a few previous works,
The central banks of emerging economy oil exporters added over $400 billion in foreign exchange reserves last year. Their oil funds likely added at least another $100 billion. This is of course about what China added in reserves over the course of the year.
Cumulative current account surpluses from 2002-2007 of GCC countries exceed $700 billion -a broader group of emerging economy oil exporters doubles that figure to close to 1.5 trillion. At first, oil exporters saved most of the proceeds and paid off external and domestic debt incurred in the 80s and 90s. But spending is heading up too - and it may be hard to pull back in the case of a slump in the oil price.
Most of this spending is imports of goods, labor etc to support higher private consumption and capital spending by public and private sector. Even those countries that saved less are starting to invest in human and physical capital in an effort to diversify away from oil. Subsidies to counter rising domestic and global prices further also add fiscal costs.
Europe benefits more from recycling through the trade channel than the US. In part this demand for European products has offset the higher cost of crude oil. imports from Asia have also risen.
In much of this post I present one scenario, that oil might average $90 this year and for the rest of the decade. This level is arbitrary. However much of the analysis holds even if the oil price drops to $75/80 or rises to $100. Should oil price fall below $70 some projects might have to be pulled online. Should it fall further, some countries might start tapping their savings. Should the oil price rise, spending rates could accelerate at an even faster pace. All the spending projections assume that non-hydrocarbon exports and all imports will continue to grow at the 2006/7 rates.
Despite increased domestic spending and investment, with oil at $90, oil savings would be large and will likely exceed 2007 levels. The GCC’s import bill likely costs an average of $50 dollars of each barrel meaning as much as $40 might be saved. A price of $80, implies around $25-30 of savings. Plenty of funds to invest, if only they can find somewhere to do so. Despite the high savings rates, oil exporters are clearly getting more used to higher prices as spending has been catching up to revenue growth.
With imports coming from Europe and Asia their price in dollars is rising along with those currencies. All the more reason many oil exporters are trying to diversify their assets away from dollars just as they try to diversify their economies away from hydrocarbons. Both are fraught with some difficulty. Particularly those countries that won’t step away from dollar pegs.
In 2007, about 2/3 of new hydrocarbon revenue is now spent either on imports or other domestic spending up from about a half of new revenue in 2002-2005. If trends continue the share spent domestically will only increase. The chart below estimates the share of each barrel of oil spent on the import bill and that saved for the GCC as a whole.
Some caveats: This chart and many that follow standardize variables in terms of the share of each barrel of oil they represent. In other words they show how much of each barrel went to pay for imports, netting out non oil exports and how much was saved. It allows comparisons across countries and time. Data comes from the IMF, national central banks, ratings agencies, some commercial banks - and in some cases work I have done with Brad Setser or on my own.
Focusing on the current account surplus does understates the official savings rate in some countries. Countries like Russia and the UAE have attracted significant private inflows which decrease the current account surplus (net savings), meaning that the total official savings excceeds the headline current account. Conversely in Saudi Arabia, the current account surplus has tended to exceed the publicly reported increase in SAMA’s foreign assets (and those it manages on behalf of other government entities). The investment of private individuals accounts for the gap between official asset growth and the surplus on the current account.
Saudi Arabia provides a good example of spending evolution. Unlike its GCC neighbours it lacks a dedicated investment fund - though plans are afoot to start one. Oil export proceeds not spent by the Saudi government (or Aramco) are deposited with the Saudi Arabian Monetary Agency (SAMA).
Until late 2006, foreign asset growth (expressed here as 12 month rolling sums adjusted for valuation gains from fx and equities) tracked the oil price (12m average). However, spending caught up. Despite relatively stable oil revenues, savings fell. Not until oil prices rose sharply in late 2007 fall did the savings rate follow. In fact for the last four months, SAMA foreign assets have risen by an average of $15b a month.
What about government spending?
2007 was the first year that spending growth outstripped revenues in the GCC and many other oil exporters. 2008 budget plans imply even higher current (especially wages and subsidies) and capital expenditures. Even countries that have traditionally saved more (Kuwait) are ramping up spending especially on capital projects and in some cases transfers to the population or pension funds. In fact, government spending might have been higher but for project delays.
With megaprojects in the works in a variety of sectors including energy and other infrastructure, capital spending will likely continue to rise. So too will current spending particular as GCC countries. All oil exporters are spending more domestically. Whether it be on flagship capitals or special economic zones or to build infrastructure. Russia and Libya are among those that announced big spending plans.
Capital Expenditure in GCC countries
Pressure to spend varies. Countries with higher populations tend to spend more. They may also have more absorptive capacity, despite the inflationary effects on their economies. Russia is scaling up spending now.
Already in 2007, several oil exporters ran or came close to running fiscal deficits (Venezuela, Iran and Nigeria come to mind). High domestic spending isn’t necessarily a bad thing, it prompts adjustment which diminishes the distortions- and could, if targeted, reduce domestic inequities. It may not have had such effect though. The biggest challenge for oil exporters is both to capitalize on their resource endowments and at the same time to really diversify their economies. As yet, few countries are unlikely to be ready for the oil to vanish or slump tomorrow. Even Dubai with its development of non-oil sector benefits from the flurry of oil funds in Abu Dhabi and elsewhere in the region.
If oil averages $90 a barrel this year and over the next 5 years import growth will erode current account surpluses. In fact many GCC countries might have very small current account surpluses.
It is easier to scale up than scale down spending.
Other oil exporters might absorb their surplus sooner. Russia is a prime example. forecasting that far out though is fraught with difficulty.
The bottom line is that if trends continue, oil exporters will continue to run large surpluses even as they absorb more funds domestically. Yet looked at it another way, oil exporters could start tapping their oil funds in the even of a not very large oil price fall. Should commodities be infected by US weakness - rather than seeming to be the primary haven, countries may well start tapping their savings. But it seems as though somewhat high oil revenues are here to stay. But with underlying supply fundamentals, petrodollars - official and private should continue to be a major force in global markets. In particular, as long as countries like those in the GCC maintain currency pegs, they will continue to be petrodollars, rather than petroeuros, despite attempts to diversify. And in that case, they will continue to finance the US current account.
But that doesn’t mean that it will necessarily get easier to track them. Despite a presumed dollar share of GCC assets, they are undercounted in the US data. A less updated version of this chart, and much more on GCC foreign assets, can be found in a January paper.