Brad Setser

Follow the Money

Cross border flows, with a bit of macroeconomics

Print Print Cite Cite
Style: MLA APA Chicago Close


Good bye, petrodollars …

by Brad Setser
December 8, 2008

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 …


  • Posted by gillies

    construction, debt, tourism, financial services ? racehorses ?

    (all so last century.)

    goodbye dubai ?

    at least detroit can grow grass –

    “GM’s Bust Turns Detroit Into Urban Prairie of Vacant-Lot Farms”

    – today’s article on bloomberg site.

  • Posted by London Banker

    Before you all tire yourselves out dancing on Dubai’s grave, let me observe that Dubai is like a young Manhattan. It is 85 percent driven, ambitious, over-educated expats. It has critical mass as the financial capital of the newly muscular Middle East. It has visionary leadership that has proven resilient for several decades.

    Yes, it is going to hurt and hurt bad. Its major industries are finance, shipping, tourism and oil – all heading for simultaneous bust. But when the smoke clears, Dubai will still be there.

    I wouldn’t write off Manhattan in the 1970s when it was bankrupt. I won’t write off Dubai just yet.

  • Posted by bsetser

    Don’t Dubai’s expats need financing though? And aren’t the main vehicles that have provided that financing either owned by Dubai’s state or its ruling family?

  • Posted by Simon

    Spending huge money on creating a financial capital in the middle of the desert is very likely to turn out to be a very dumb thing to do.

    I can see why they thought it might be a good idea. They saw how much money Goldman Sacs and Meryl Lynch were making out of them and decided this was a great industry.

    Unfortunately their real wealth was created below ground. Last time it was Frankensense this time Oil. Next time …who knows maybe there is still time for them to start allocating capital properly into productive enterprises there is a good long list of possibilities if you use your imagination and don’t just look across the desk.

  • Posted by Twofish

    Dubai is a port city that not in the middle of the desert. It’s also not very oil dependent, and the goal for its government for the last twenty years has been to get out of the oil business before the oil disappears.

    It also happens to be pretty nicely located half way between India and Europe, and it has had a nice progression oil -> finance -> high technology.

  • Posted by ReformerRay

    The disappearance of petrodollars is a matter of everybody falling down together.

    I am too busy crying for the consequences of the stupid u.S. decision to trust to Ronald Reagan to guide financial affairs to worry about anyone else.

  • Posted by don

    Brad – these break-even numbers seem high relative to the ones that must have existed prior to the recent run-up of oil prices (or all these countries were running very large deficits). I think the break-even points can go back down as well.

  • Posted by bsetser

    the break-evens rose substantially from 05 to 08 … they were in the low 20s in say 00-02. They can adjust down. But that process is quite painful. And also contractionary for the world economy — particularly if the oil importers pocket and save the gain from the fall in oil prices.

  • Posted by Geo Economist

    Can the problem be addressed by levying taxes? Does anyone know the tax rates in Dubai?

  • Posted by bsetser

    Dubai doesn’t have taxes, but it does impose some fees — imposing taxes certainly could help raise revenue, but it would be a big change for all the bankers who went to Dubai thinking that they could escape British taxes

  • Posted by Euraussian

    Sometimes it helps to look at a country’s economics as if it were a single corporation, with some unusual constraints. Workers for instance. It is hard for a state to “fire” its citizens, or do a hostile takeover of a neighbour’s resource rich areas. Or offering s hare of future cash flows to foreign investors. Nevertheless, some highly autonomous heads of state (benevolent rulers or worse). appear to have that paradigm to a certain extent. The rhetoric of the Singapore gvt is very much that of a corporate executive (one could say that Singapore is a business with a state attached) And Spore’s SWFs look very much like the investment arms of a large Asian conglomerate. The main difference being that the financial tole of the controlling family is played by the state, but the apparent business logic is quite similar, and other welfare aspects seem to be subordinated to that.

    Back to Dubai, that is a political entity with even more characteristics of an Asian family conglomerate. First of all, there is a real family or cluster of families. Second, only a small portion of residents are citizens (=shareholders), and these citizens are usually not “workers” in the conventional sense. The actual workers are relatively easy to fire. Third, there is an existing business model that aspiring city states (Singapore wannabes) can look for in their development ambition: they should try to be developers of commercial real estate (shopping centers, offices, industrial parks), but not let the state’s businesses compete with the tenants. Ports, repair shipyards and even airlines can be synergetic with the real estate development model. An important condition is that there should be few political obstacles to a highly flexible labor market, for instance through large scale temporary immigration and incentives for the right kinds of immigrants. The smaller the native population, the easier to make this work. And of course there must be a locational advantage. Locational advantage is often difficult to see before someone has begun to harvest it.

    What makes Dubai’s strategy (assuming that this is what the strategy (if any) is) questionable is that (a) they must have severely overestimated the potential for attracting tenants (Singapore attracted tenants first, pampered them, made them slightly captive and only then grew capacity slightly ahead of potential demand). Possibly that is related to the difficulty in understanding locational advantage in the Gulf, which is much more complex than SEast Asia (although that was not easy to understand in the late 1960s either) (b) there may be a tendency to expect that whatever happens to Dubai, Abu Dhabi will have the will and the resources to bail it out. In fact the more reckless the spending and resulting crash, the fewer options the rich neighbour would have. That would constitute a seriously soft budget constraint. However the business model requires that tenants are (1) selected for their potential network benefits and (2) attracted but also tied. Without those things one ends up with a lot of buildings that never get out of the bargain rent phase (c) much of Dubai’s latest development looks like there has been a shortage in managerial and coordination skills at the core of the state development function, with too much reliance on agents with poorly designed incentives.

  • Posted by Jason Pinto

    The cost to develop reserves next year will go down as year on year price changes in service companies and basic commodities have gone down very quickly. These were running at 10-30% annually over the previous few years. A major cost in developing wells is steel which has already has come down 20% for us with much more room to come. I am in the industry and can assure you that operators are striking much better bargains now and containing cost increases better. This should help bring down breakeven costs.

  • Posted by Geo Economist

    Unless the US dollar can be valued on purchasing power parity basis in international trade, there is no solution for the US to emerge from the current crisis. That requires us to dismantle the petrodollar system at our own initiative, and declare that petroleum trade can now be denominated in currencies other than US dollars.
    I think we’ve agreed that boosting demand is the immediate problem at hand. As Dani Rodrik points out, reduction in personal taxes largely goes to reduce personal debts/increase personal savings. To boost demand the government has to buy goods/services of real value from the private sector. One problem is that government spending on the infrastructure sector, such as highways, ports, etc takes a long time to flow into the economy.
    Obama’s fiscal stimulus plan appears to be targeted at items that will reflect the spent amount quickly in the economy; such as refurbishment of government buildings to make them more energy efficient and improving computing infrastructure in schools. Without import controls, there will be tremendous leakage of the stimulus towards higher imports. For instance buying computers for schools will increase imports of small electronics from Taipei.
    Consider import controls. Increased input prices will ensure a tremendous collapse in consumer demand. This is observable from the history of import controls in 1971, 1930 and 1890. Import controls increase employment, increase prices and decrease real wages. Anti-inflationary measures such as higher interest rates, wage controls and/or price controls fail to contain the deleterious effects of decreased real wages on demand, as shown from past experience. Thus import controls will ensure a selective benefit for certain powerful entrepreneurs, such as tractor manufacturers in the 1930s, and cripple the economy overall.
    The agreement with China that they will appreciate the RMB has no net effect on domestic dollar prices of imports and domestic demand for imports.
    Dani Rodrik proposes that a coordinated fiscal stimulus plan around the world will solve the problem of leakage of stimulus to higher imports. I’m not sure. There is a huge difference in real wages amongst American and Chinese workers. Irrespective of stimulus packages and slightly different exchange rates, unless there is a massive adjustment of real wage differentials, higher imports will continue in the absence of regulatory obstruction of free trade.
    Obama may choose to continue with stimulus without import controls. He may introduce import controls in future. Either way the US economy appears to be nowhere near a recovery by the end of 2009, as is commonly predicted.
    The only logical solution to the current crisis is therefore, to dismantle the petrodollar system. This allows us to live to fight another day, and addresses most of our immediate problems.
    Consider what happens if the US dollar were to be valued on the basis of purchasing power parity.
    There will be no cause for foreigners to impose import tariffs against our exports. There will be no reason for them to accumulate US dollars through mercantilist policies. Fiscal stimulus spending will not leak away in increased imports.

  • Posted by Geo Economist

    There’s also a hypothesis that accumulation of US dollars in forex reserves worldwide has to do with mercantilism rather than the compulsions of the petrodollar system. If this is correct then the solution is to default on US Treasury debt securities. It would be the same as 1971. Then we defaulted on conversion of dollars to gold. Now we can default on conversion of Treasury securities to dollars.
    This will free us up to re build the economy. It will leave our territories intact. We can increase our global dominance at some later point in time once again as needed.

  • Posted by Gonzalo Lira

    What about Venezuela? What price oil for Chavez to keep up his Santa-Claus-of-the-Revolution pose? And at what price oil for Chavez to become the repressionary Grinch of the region?

  • Posted by bena gyerek


    is it really true that the fall-off in petrodollars will be dollar neutral because of the commensurate fall in dollar value of oil exports? how much of middle eastern oil revenues comes from europe? how much of that is recycled into euros (this one i think i know – it’s zero, right?).

    my point is that although the net demand from the middle east for dollars may be flat, i suspect that the current ongoing net sale by the middle east of other oil-importer currencies like the euro will ease off significantly with falling oil trade, i.e. these countries will experience a positive balance of payments and upward pressure on their currencies relative to the dollar. do you agree?

    also, in your calculations for russia, how do you account for changes in gas prices (which appear to be highly correlated with oil but with a long lag)?

  • Posted by bena gyerek

    sorry, in the previous post instead of “falling oil trade” i obviously meant “falling oil export receipts”

    btw, a suggestion for the title of your next post: “farewell chinese growth”. exports look to be down (yes negative) 7% for november. at what point do people stop saying “slowdown” and start saying “recession”?

  • Posted by Manc Trader

    For your $60 b.e. estimate for 2009 you are assuming the 7.5 mpd. Is it not possible that drastically lower prices and world wide stimulus next year could push that up and keep b.e. around $50.
    Anyhow just curious how stable the export number is doesn’t really change the thesis of your piece.
    Great blog

    Manc Trader

  • Posted by bsetser

    Manc — it works both ways. Higher export volumnes = lower break-evens. But lower export volumes (i.e. OPEC restraints to support prices) = higher break-evens. 7 or 6.5 mbd of exports for Saudi seems quite possible to me. Remember the stimulus is offsetting a large contraction in private demand; it is unlikely to keep the global economy from slowing or even shrinking next year (the trade data coming out of east asia is scary)

    Bena Gyerek — I took my estimate for Russia’s break-even from a Citi economist i trust. One interesting tid bit i remember from an OECD paper is that the Russian government captures a higher share of the oil than of the gas windfall …

    as for the impact on the dollar — my sense is that a fall in oil prices is dollar positive. Less b/c of the diversification flows. And more because the US is an energy intensive economy and the oil exporters import very little from the US — so a rise in oil prices is intrinsically worse for the US than for more energy intensive economies with more exports to the oil-exporters.

    As for the higher oil = more dollars that the oil exporters want to sell for other currencies argument, it all depends on the dollar share of their assets v the increase in the US need for financing v the increase in europe’s need for financing. And setting Russia aside, i don’t have a hard number on the extent of dollar sales associated with oil exporters who are paid in dollars rebalancing their portfolios.

  • Posted by bena gyerek


    my thinking was actually the other way round. i am assuming that the bulk of unspent dollar oil receipts are reinvested by oil exporters in dollar assets. however, the bulk of oil exports do not go to dollar economies – i.e. the eurozone, the uk, japan, etc all have to buy dollars in order to pay for their oil imports. this means exports to non-dollar countries generate a long-term staple ongoing demand for dollars that are then being recycled by oil exporters into dollar assets. the implication is that a fall (not a rise) in the oil price (as calculated in eur, gbp, jpy, etc) should lead to a fall in this staple demand for dollars.

    you mention about oil exporters importing more from europe than the usa. this could be important in the medium-long term, as middle eastern governments cut their spending in line with lower oil revenues. but as you imply in your article, the short-medium term impact will be a fall off (or reversal) of their portfolio inflows into dollar assets.

    btw, any more detail on russia’s finances would be useful. do you have a report from your citibank source? i live in europe and am crapping my pants about the security implications of another economic meltdown in russia.

    how you calculate the russian government’s reliance on gas revenues depends entirely on whether you view gazprom as an independent company (as russian national accounts no doubt do) or as a branch of the russian government (a jv of the foreign affairs, industry and social welfare depts).

  • Posted by credulous_prole

    Many people, especially Westerners, don’t “get” Dubai.

    I recall walking around and seeing frightened faces on the south asian and south-east asian slaves that serve their white patrons and arab overlords.

    I also witnessed the contumely of the natives, even in their interaction with upper-class whites. I recall teen-age emirati boys shoving middle-aged bankers in the lounge at the airport: quite funny, really!

    Sure, maybe someone serving at the pleasure of the local junta will recall a great time, but the place will return from whence it came in due course.

    I believe we should give the gulf states to Iraqis or Syrians, since they are proper arabs, not bedouin gangsters.

  • Posted by cdr

    See, it s fast this hockey game.

    No more buying of void assets from that petro source anymore; and as Russia is de-dollarizing itself while showing seemingly strange happiness to take any rubble in exchange for every Treasury that doesn’t exist., so another source of IOU-some-Treasuries-later-on-that-they-get-created excess demand is seizing up fast, leaving behind the one question of who’ll be the last holder of this empty bag of nothing. To answer: in exchange for not getting stuffed with nothing in exchange for oil, no dollar price of barrel is really too small. It seems that no dollar price of any of European or China’s oilless articles too is getting small enough. At this stage. And you can throw in the pig meat ban onto that pile of synthetics.

  • Posted by Useful Analysis

    As for the higher oil = more dollars that the oil exporters want to sell for other currencies argument, it all depends on the dollar share of their assets v the increase in the US need for financing v the increase in europe’s need for financing.

    I’m not sure I follow this. Assuming that a very high share of Middle East oil exporters’ assets is dollar denominated, reduction in those assets as a result of falling oil prices automatically implies reduced demand for dollars (which is what bena gyerek is pointing out).
    How does the US vs Europe increased need for financing impact the exchange rate fall from the above reasoning?

  • Posted by DJC

    Crude Oil Prices Extremely Oversold

    Trend Analysis – Crude oil is clearly in the overshooting to the downside phase, having plunged through the original target of $80, then overshot support at $60, with the final break of the low of $50 and now assaulting on the $40 support level. Further immediate support exists along decades old resistance areas generated during the 1980’s in the region of $35. Therefore this suggests further crude oil downside is limited. However the deep retracement suggests a wide trading band of between $80 and $35, therefore expectations of much price volatility during the base building process during much of 2009.

    Therefore those now calling on crude oil to head towards $20 are reminiscent of calls for crude oil to hit $200 earlier this year, the overshoot that was going to occur has occurred with the expectations there there is little further downside remaining in future price action. However a bottom has to be formed that will take time to occur.

    MACD – The MACD indicator is extremely oversold which implies that further immediate downside is extremely limited which suggests a significant multi month corrective rally is imminent.

  • Posted by DJC

    Obama for Change?

    Mr. Obama’s second part of his sentence recommending reform proposes to do just the opposite. He has thrown his support fully behind Treasury Secretary Henry Paulson, by pretending that the way to revive the economy and banks it to inflate a debt-fueled real estate boom once again. Prospective home buyers are supposed to go even further into debt in order to provide the banks with enough extra interest charges to earn the money to become solvent again. (They are as deep in negative equity as the subprime mortgage debtors they and their affiliates have victimized.) When Mr. Obama speaks of “strengthen[ing] those assets,” namely, homes and office buildings, “then that will strengthen the financial system as a whole.”

    But it will weaken the economy, leaving it even more debt-strapped.

  • Posted by DJC

    Fed approves Chinese bank CCB to operate in US

    Tuesday, Dec 09, 2008

    The US Federal Reserve said Monday it had authorized China Construction Bank, a leading Chinese state bank, to operate in the United States.

    The proposed New York City branch of CCB “would engage in wholesale deposit-taking, lending, trade finance, and other banking services,��� the Fed said in a statement.

    The US central bank recalled that China Construction Bank Corporation (CCB) is 57.0 percent owned by the Chinese state, 19.7 percent by US banking group Bank of America and 5.7 percent by Temasek Holdings, a sovereign wealth fund owned by the government of Singapore. The remainder of the capital is publicly traded.

    CCB is the second-largest bank in China, with total assets of approximately 1.1 trillion dollars, it noted.

  • Posted by bena gyerek

    useful analysis

    i think brad’s point is that a lower oil price mean that the usa and europe need to borrow less to finance a given volume of oil imports.

    e.g. if the world only consisted of saudi arabia and the usa (and ignoring demand and supply elasticities) an exogenous change in the oil price would be dollar neutral. e.g. assume saudi sold $100 oil to usa each year, and spent the proceeds $50 on imports from usa and $50 on us treasuries. then the oil price halves, so saudi sells $50 of oil and buys $50 of imports. dollar is flat.

    however, my point is that oil demand comprises a lot more than the usa. consider the case where saudi sells $100 to usa, $100 to europe, buys $100 imports from europe and spends $100 on us treasuries. then the oil price halves, meaning that saudi now sells $50 oil to each of the usa and europe, and spends the proceeds buying $100 european imports (i.e. us treasury purchases fall to zero). in this case there would be strong upward pressure on euro vs dollar.

    an interesting corollary is how demand elasticities affect the picture. my totally ignorant gut reaction is that us demand for oil may actually be more elastic than european because of the large tax wedge charged in europe, which makes the (relatively high) price charged at the european pump proportionately less sensitive to changes in the underlying crude price. if so, falling oil prices would result in a greater proportionate fall off in european vs us oil export proceeds.

  • Posted by David Heigham

    Looking a little further ahead, brad is implying that even the Saudi budget break even price of oil cannot go up much more without getting in loudhailer distance of the long term limit on oil prices – the price of oil derived from coal. For a process no more environmentally dirty than oil production and refining, I have the impression that plausible guesstimates for large scale oil from Coal are in the $80-100 per barrel.

  • Posted by Useful Analysis

    @bena: thanks a lot for the explanation, i get it now.

  • Posted by Ying

    New industry to consider for Obama: recycling, renewable, organic

    Disappearance of advertising, fashion, luxury goods(auto,cosmetics….),chemical, and processed food industry

    free time with family, children, friends and neighbors nearby

    from self-interest to the interest of all the sufferings

    zero growth rate

    disappearance of consummerism

    sympathy, respect and peace

    Americans go for it, the whole world will follow!

  • Posted by gillies

    someone help me with this :

    suppose that you are an oil producing economy, and the oil price is hovering around your break even level – budgetary options will be, as suggested somewhere above, getting more limited.

    now you click on bloomberg or roubini to find on your screen – news of the ‘printing press’ brought into play to finance ‘stimulus packages’.

    printing press + zirp = incipient inflation.

    printing press + zirp + incipient inflation = time to evacuate treasury market before there is a bond crash.

    so collapse of bond market could happen faster than the ‘stimulus packages’ and infrastructure investments take effect. o p e c members might be cornered into unavoidable decisions.

    – and maybe this is what all the leaning on china is about ? china and the oil exporters and other bond holders might have to sit tight and be patient while the medicine takes effect, for a helicopter policy to begin to work.

    – and they might not ‘have the courage’ to do that. they might be tempted to slide sideways from zero interest bonds to zero interest cash and zero interest gold.

    now imagine that you are a japanese spectator at this game –

    the arabs (oil producers) have no spare chips to play with as the oil price is below their “break even” point. meanwhile the chinese have told mr paulson or his successor : ‘no deal.’

    engineered dollar collapse becomes a possibility. nobody knows. the yen becomes the new safe haven, and takes off, choking toyota and sony to death – and everyone remembers the plaza accord. what would you do ? would you sit tight and wait for two other rival nations to make their moves and pursue their agendas ?

    and if so – what would your political opponents say or do ?

    if the above is too rambling to follow – i am suggesting this: that bernanke’s helicopter or money printing policy would take time to kick in and take effect – time in which other much more rapid moves might be made. i am suggesting that all the current ‘advice’ to china (and by implication to japan) is coded messages to say ‘sit tight on your treasuries while we attempt to ‘stimulus package’ our economy. to which the coded answer is ‘you must be joking !’

    * * * * * * *

    perhaps, then, there are certain drastic ‘end game’ financial manoeuvres which could only be carried out while the treasury / bond markets were closed. otherwise i would see ‘printing money’ – then sitting back to wait for the effects to kick in to the general economy – as simply providing an opportunity for others to exit the burning theatre.

    there may be a flaw in my thinking – if so, i will be corrected. but after each fine tuning of the numbers, it would be wise to stand back and look again at the new and rapidly changing situation from the perspective of other major actors.

    2009 news. general motors is subsidised to keep making cars that don’t sell. the dollar is going to be printed to finance loans to businesses that might otherwise go down the same road. toyota is getting choked to death by its own rising yen. would there be scope there for radical policy change or a general political cull of a whole generation of politicians ?

    October 2009 newspaper story : “EVEN AS RECENTLY AS DECEMBER 2008 NO-ONE WOULD HAVE PREDICTED . . . . “

  • Posted by gillies

    how about this one ?


  • Posted by unokai

    Brad, 70$ for Russia is the wrong estimate! gibberish! its based on the assumption that import will not shrink in 2009. but its falling rapidly, I see it! nobody wants to by cars (the main russian import).

    import will fall dramatically in 2009, but the results will be mild – Russia is self-sufficient concerning energy and food. overconsumption will stop, but its a good thing!

    70$ is not realistic, the critical level is something around 40$ or even lower

  • Posted by bsetser

    unokai — i hope you are right … $70 is citi’s estimate for the budget and i get a similar number from the balance of payments for the oil and gas price needed to cover Russia’s 08 imports. obviously, if imports fall by 30%, a lot changes. then again, ending overconsumption usually means a recession (see the US, late 08 .. )

    my point re: petrodollars is two fold.

    a) in addition to the gulf states — which do tend to have a high share of their assets in dollars, tho it varies from from state to state (the saudis have a higher $ share than many others) — there are a set of oil exporters that actually buy a lot of euros. Norway for one. But also russia …

    whether or not this the overall process is dollar negative or not hinges a lot on the dollar share of the Gulf’s reserves and sov funds, which isn’t known. it incidentally certainly tends to be yen and even Asia negative ..

    b) while the initial effect of an anticipated rise in oil prices is more savings, over time spending and investment tends to adjust up. and setting aside venezuela — which buys a lot of us goods — most oil exports tend to buy more goods (far more goods actually) from europe and Asia than the US. the process of spending the oil surplus is clearly $ negative (see the Imf WEO chapter in 2006).

    Run the process in reverse, and in the first instance the oil exporters cut into their savings (which one would think would hurt the dollar — though there is no such evidence right now) and in the second instance they cut their imports (which hurts europe and asia more than the US).

    but then there is a second impact — which is that a rise in oil prices tends to hurt more energy intensive economies more, and the US is the most energy intensive economy in the g-7. ergo it slows the us, and thus hurts the $. run that in reverse and you get a dollar positive process …

    Suffice to say there isn’t a clear answer

  • Posted by adiemuso

    I Think we have to consider the Interest Rate Parity side of the story apart from the BOP aspect.

    Interest Rate Expectations have a larger role in the strength or weakness of a currency like the USD and/or EURO.

    Long Term Yields are a good indicator of market expectations.

    Im really puzzled on how the US is going to bankroll their massive debts, deficit and loose monetary and expansionary fiscal policies.

    Clearly, like bena gyerek has pointed out, this topic has been discussed here many times round, I am still not convinced that the future increase in supply of USTs is not a major issue in the face of possible weakening or diminishing demand.

    And, to offset the burgeoning supply of USDs resulting from the declining Oil prices, some USD denominated assets have to rally from its current levels. US Stocks? US Property? Gold? or US Treasuries?

  • Posted by Useful Analysis

    there are a set of oil exporters that actually buy a lot of euros. Norway for one. But also russia …

    Yes. Most of Norway’s oil exports are to Europe rather than to the US. I remember reading that Norway once proposed a new oil bourse to trade in Euro since it was operationally more inconvenient to trade using dollars on the London exchange while the actual sale is to Euro countries. Norway being a NATO member and close US ally, this shows that petrodollar recycling has to do with the central bank reserve currency and not with the currency in which oil is priced.

    and setting aside venezuela — which buys a lot of us goods — most oil exports tend to buy more goods (far more goods actually) from europe and Asia than the US.

    but then there is a second impact — which is that a rise in oil prices tends to hurt more energy intensive economies more

    Demand for the US dollar is mostly in the form of foreign demand for dollar denominated debt at low interest rates (in a credit crisis this morphs as dollar demand for servicing the dollar debts), OPEC demand resulting from petrodollar re cycling, EM central bank demand due to currency interventions and forex reserve accumulations of most foreign central banks. Compared to these factors I’m not sure demand for US dollars caused by export revenue is a significant factor.
    Given the high level of deficits cooling of the domestic US economy due to higher oil prices should be dollar positive since it would probably reduce consumption and trade deficits, thereby reducing the supply of dollars in the exchange markets.

  • Posted by Useful Analysis

    In my post above I’m referring to low US export revenues, and reduction in US consumption and US trade deficits from higher oil prices leading to a weaker US dollar.

  • Posted by adiemuso

    Fed Weighs Debt Sales of Its Own -WSJ

    “The Federal Reserve is considering issuing its own debt for the first time, a move that would give the central bank additional flexibility as it tries to stabilize rocky financial markets.

    Government debt issuance is largely the province of the Treasury Department, and the Fed already can print as much money as it wants. But as the credit crisis drags on and the economy suffers from recession, Fed officials are looking broadly for new financial tools.”

  • Posted by samac

    Moody’s did a good report called “Demystifying Dubai” in October. Broke down all the quasi governmental agencies, government backed property developers, and national champions (eg. Emirates airlines).

    Conclusion was that at 1x Debt/ GDP, Dubai was dependent on a bail-out for Abu Dhabi.

    Moody’s did not look at taxing power. Though an income tax is probably not too feasible, there is a VAT implementation pending. Seems like a 5% VAT with 5% coupon sovereign debt and 1x Debt/GDP puts you in a good position to service debt.

    At least if you ignore all the private debt that funded speculative real estate investments.

    There’s also a somewhat erratically collected 5% tax on rental leases (but no property tax or transfer tax).

  • Posted by bsetser

    I liked the moody’s report. Also liked a recent Citi report on the GCC.