Unpleasant oil math
There has been a lot of speculation this week about the role speculation has played in the recent run-up in oil prices.
There is little doubt, though, about the short-term economic impact of higher oil prices: an enormous transfer of wealth from the oil-importing economies to the oil-exporting economies.
Back in November, I calculated that a $10 a barrel increase in the price of oil would, absent any increase in domestic spending or domestic investment in the oil-exporting economies:
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, Bahrain and Oman).
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.
I forgot to include China the first time around. That is a rather important oversight. If China imports 4 mbd in 2008, a $10b rise in the price of oil would increase China’s annual oil import bill by about $15b.
Oil — sweet light crude, that is — averaged about $70 a barrel in 2007. The IMF WEO assumes it will average around $95 a barrel in 2008. And if it doesn’t fall from its current levels, it now looks set to average at least $115 a barrel.
The resulting math isn’t hard.
One final note — I’ll be traveling for the first part of next week. Rachel Ziemba and Christian Menegatti — my former reserve and SWF tracking colleagues at RGEMonitor — will be guest-blogging here.
May 24th, 2008 at 9:55 pm
Brad, many thanks for all the informative posts.
I have to wonder if all the money rolling in to oil producing countries isn’t a nuisance to invest, and an incentive to cut production. Perhaps oil in the ground is a better investment than other alternatives.
May 25th, 2008 at 2:22 pm
i understand that when oil goes up $10/barrel the additional money paid out by the united states is actually less than the oil revenues of oil producing states reinvested in the united states.
i also assume that investing suffers from a kind of inertia or rather momentum in that buying in to countries and investments that you already hold, has an additional effect of supporting the value of the earlier investment ?
i also wonder if the oil ‘owned’ by u s based speculators should be taken into account in forming the wider picture ?
.
May 26th, 2008 at 3:15 pm
Gillies,
it’s an interesting idea, which I would like to examine.
You talk about oil “owned” by US based speculators.
As far as I can see, the common way for any speculator to take ownership of oil is by buying a derivative, an oil futures contract, which gives you the right and obligation to take delivery of a certain number of barrels of a certain brand of oil at a specified harbor or dock. Such a derivative is not a contract with a petroleum company or state oil agency, but a standard contract between yourself and another speculator made on an exchange offering these contracts.
You going long, the other party going short or closing a long futures contract.
These futures contract are actually created out of thin air, if you go long, while the other party goes short. If the other party closes a long trade, while you go long, an existing contract just changes hands. When you cover your trade, while the party holding a short position covers its position, then the futures contract is finished and open interest, which is actually the number of open contracts goes 1 contract down.
Now, if you hold your long position into expiry of the contract the link between the real world and the derivatives world is made, as a trader holding a short position into expiry is required to deliver the standardized oil product.
How that Short gets his hand on the to be delivered oil is not your concern, but what becomes obvious is, that speculating in oil will only indirectly influence the cash market. Only if the Short was a foreign state fund owned by an oil exporting nation, then the profit made by the US speculator would actually hurt the profits made by selling oil.
By trading in the oil cash market you would actually be able to take advantage of price increases while the oil exporting nations would not. Unfortunatly when trading in the cash market you need to pay the seller the full value of the oil you buying, meaning you have no leverage at all, while when trading in the futures market you have a 10:1 to 20:1 (or even higher) leverage depending on the margin you have to post for your trade.
As most oil futures contracts will be offset prior to expiration, the profits and losses made are not part of the ‘wider picture’. They are part of the zero-sum game played on the oil futures exchanges.
Cash trades may be included in the ‘wider picture’, as well as futures trades, which have oil-exporting nations as counterparty, but both are very difficult to track, but maybe some insiders can tell us more.
May 26th, 2008 at 6:38 pm
“an enormous transfer of wealth from the oil-importing economies to the oil-exporting economies”
From where to where is the wealth really being transferred?
(OPEC & Russia) to OECD: oil & natgas
OECD to (OPEC & Russia): printed paper, most of it exchanged for promises to get more printed paper in the future.
Then add what Pres. Bush recently told the Arabs: “The rising price of oil has brought great wealth to some in this region, but the supply of oil is limited, and nations like mine are aggressively developing alternatives to oil.”
(Translated: keep in mind that your oil will eventually run out, while we are determined to turn more and more of our crops into biofuels, no matter how many in food importing countries (like yours BTW) starve along the way.)
Finally consider the recent price action of grains and oilseeds and see whether holding that printed paper is a wise strategy for maintaining purchasing power in terms of critical real things.
Only logical conclusion for oil exporting countries: cut their exports to just cover their imports, and for the GCC specifically, start investing in solar water desalinization plants to enable them to grown their own food.
May 27th, 2008 at 3:11 pm
gillies —
i would put it a bit differently.
take the case where oil rises by $10 a barrel, and that $10 rise leads to the equivalent of a $10 a barrel increase in the savings of the oil exporting economies and a $10 fall in savings in the oil importing economies, with no changes in investment. Then there is a rise in the surplus of the oil exporting economies, and an equal rise in the deficit (or fall in the surplus) of the oil importing economies.
So what matters is whether the oil exporters have a higher a desire to hold dollar assets than a mix of Europe, the US and Asia — all of whom will either borrow more/ save less. And it isn’t at all clear that the oil exporters have a higher propensity to hold dollars than say China. Russia and Norway clearly have a lower propensity and the gulf is a mystery.
then throw in some increase in imports in the oil importers — which clearly favors Europe and Asia over the US, as the US exports little to the oil producing world — and the overall impact is even more ambiguous.
May 27th, 2008 at 4:59 pm
someone (who may be mistaken, i don’t know ) published figures to show that the extra bill for oil to the u s was in fact less than the extra money reinvested in the u s.
in other words extra money shelled out by e g european countries to e g saudi arabia ended up in the u s to a sufficient extent that it outweighed money paid out by the u s.
if as you claim, you don’t know - this may be so. it does not of course stop the long term transfer of u s assets to oil producers, but it must mollify the ‘oil shock’ effects of a $10 rise ?
.
May 27th, 2008 at 5:51 pm
the argument is only true if you don’t deduct the funds europe and asia would have invested in the us (but couldn’t b/c of higher oil) from the total.
the combination of dollar weakness and strong oil also suggests that oil exporters demand for $ isn’t what it used to be.
No doubt cheap financing helps the us sustain a bigger deficit than otherwise would be the case, but it is still debt that has to be paid back, or equity that no longer generates income for americans.
I would put more emphasis on:
a) the smaller increase in the price of oil in euros
b) European sales of goods to the oil exporting economies
c) UK financial intermediation (with all the fees) of the oil surplus, in part because the UK (despite all of its talk about the good of transparency internationally) has been very willing to accomodate the oil exporters desire for a lack of transparency ….
d) the fact that gas is already heaily taxed makes the % increase at the pump a bit smaller, and a bit less of a psychological and economic shock (in part b/c europeans drive smaller cars/ use less gas).
May 28th, 2008 at 2:35 pm
there don’t seem to be many people around - so i will go on . . .
as you point out, the effects of a $10 rise in the price of a barrel of oil are many, if you follow up the results further downstream. money isn’t just spent once.
and the effects that you choose to emphasise seem like sensible policies to me - (a) a more stable currency (b) more exports to oil exporting countries, and (d) heavy taxes on energy, and smaller more economical cars.
in fact these three of the four points seem to me so obviously prudent that i am driven to wonder if the united states actually desires a high oil price global economy from some perceived geopolitical advantage in generating middle east tension.
power, whether in the united states administration or elsewhere, always pretends to be solving the problems that it is in fact creating. it helps to bear that in mind when confronted by baffling policies.
May 28th, 2008 at 9:04 pm
I see that there is some censorship in this blog, and harder one than in NYT blogs, because a quote of “NYT” is deleted with some other. Here goes one, again:
“This is not an energy policy. This is money laundering: we borrow money from China and ship it to Saudi Arabia and take a little cut for ourselves as it goes through our gas tanks.”
Thomas Friedman
May 28th, 2008 at 9:17 pm
Something strange is happening in this blog that comments appear and disappear randomly.
Maybe it’s the update to 10.5.3 and Safari 3.1.1, but I’ve seen comms in other post that I can’t read now.
I’ll try with Firefox.
May 28th, 2008 at 10:55 pm
It seems that this website doens’t work on Safari.
So I’ll try with Firefox, copyiing and pasting old comments, adding comment numbers:
2. koteli Says:
May 25th, 2008 at 7:49 pm
Dear Mr. Setser,
It’s nice to see that the oil math of an 10$ increase of a barrel has huge consequences in the USA bill.
And you call it transfer of wealth!
At the same time you are politically neutral on USA, and you just give us numbers, global numbers of transfers of wealth!
I’m not an economist, but as far as I know, in free-marker capitalism nobody buys what they don’t want. So, this huge transfer of wealth is voluntary!
You can complain about it as an alcoholic complaining about gin’s price. Nothing else.
On the other hand, where did the money come to USA from? From the work of their citizens? Watch, please, to James Bond’s 007 films…!
And the hundreds of military bases around the world? Ask Chileans about Milton Friedman… or to Chavez about free market.
Did you think that this discourse would last forever?
Do you think that the world is more scared by Chavez than by W. Bush or more scared of Blackstone than Citigroup?
You don’t have policies for USA, but you have policies for China and the Arabs. A bit too pretentious from a Kansas boy, or too politically correct?
The day USA economists make figures about weapon transfers, energy consumption of imperial policy, illegal wars, corrupt health care costs, and massive off-shoring… you’ll no be able to see what you’ve already lost, but stop talking about democratic countries.
Check China’s resolution on the earthquake and Katrina’s solution. Just compare and buy the best!
Let’s give a try to those barbarians that are sucking wealth from the West!
At least, we’ll have something to compare to, don’t you think so?
They won’t do it much worse if they don’t want to blow up the planet earth!
Best whishes,
4. koteli Says:
May 26th, 2008 at 12:10 pm
“This is not an energy policy. This is money laundering: we borrow money from China and ship it to Saudi Arabia and take a little cut for ourselves as it goes through our gas tanks.”
Thomas Friedman
June 1st, 2008 at 8:26 am
Brad, can I cite your calculations in one russian journal? BTW, what do you think about tha sustainability of USD/RUB in case of huge inflows of petrodollars in russian economy?
June 1st, 2008 at 2:07 pm
unokai — feel free to cite me calculations.
I have lost faith in my capacity to predict when a country facing pressure for a currency appreciation will allow that appreciation. So I am not sure if Russia can sustain its euro/dollar basket peg. Pressure — judging from the pickup in reserves — seems to have increased. I am by contrast convinced that it would be in Russia’s interest to allow the Ruble to adjust. The current uptick in inflation seems to me to be at least in part a lagged response to very strong reserve growth around this time last year. Inflationary pressures now seem as strong in Russia as in the Gulf — and, well, real rates now look very negative, which adds to the pro-cyclical aspects of Russia’s current set of policies.
June 14th, 2008 at 4:35 pm
thank you, Brad. btw, what do you think about so called Export Land Model?
http://www.theoildrum.com/node/4092
Oil-importing countries create value by importing fuel, creating goods using the energy, and exporting the goods.
As exports decline, importing countries will not be able to create as much value, and the currency of those countries will drop. As the currencies drop the exporting countries will be more reluctant to sell the oil.
This is a positive feedback loop. It does slightly impact the other positive feedback loop:
As the exports decline, prices go up. As prices go up exporters earn more money despite the decline. Earning more money makes the local economy grow. Growing economies use more oil. Exports decline. Am I right?
June 18th, 2008 at 11:52 am
Brad, Stephen Jen used the same analysis:
http://www.morganstanley.com/views/gef/archive/2008/20080616-Mon.html
What do you make of this implication?
“Implication 4. Depressing global real interest rates. The world still suffers from a problem of excess savings, in our opinion. As the US C/A deficit shrank (now below 5% of GDP, and expected to reach only 4.5% of GDP by year-end), the trajectories of the C/A surpluses of oil-exporting countries and China are fairly robust. This combination of a sharp decline in the US savings deficit and large savings surpluses in several parts of the world, including oil exporters, suggest that the world’s real interest rates should fall to equilibrate the world’s savings and investment. The G10 10Y real interest rate has just set a generational low of 1.35% – roughly half as high as the potential growth rate of the G10 economies. Another way to understand the low real yield is that the marginal propensity to consume is lower for the oil exporters than it is for the oil importers, despite the large spending on infrastructure by the former. As wealth is transferred from the latter to the former, the world’s interest rate should fall. Yet, another way of thinking about the low yields in the world is that SWFs could have invested their new proceeds in relatively safe sovereign bonds, waiting to deploy the capital into risky space when the global economic conditions improve.”