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Oil Nations May Decide To Shift Petrodollars Away From America
BY KIRK SHINKLE

Oil makes the world go round, in more ways than one.

The petrodollar pipeline that recycles billions from oil producers back to the U.S. economy has turned crude-laden nations from Norway to Iran into the world's biggest sources of global savings. These nations are also key sources of foreign demand for U.S. assets.

Now new research predicts a trend that could affect the U.S. economy nearly as much as swings on crude exchanges: Oil producers might be looking to diversify how they spend and invest their cash.

Such changes are worth watching — mainly because the flood of money generated for oil exporters by sustained high crude prices has become a major pillar of support for the U.S. economy.

Over the last two years, oil exporting nations passed Asian central banks as the biggest source of savings in the world, adding an estimated $500 billion to their coffers in 2006 alone.

The recent drop in oil prices may force exporters to cede the top spot. Still, it's clear that their investments in U.S. debt let America continue to fund its huge trade deficit and make up for its lack of savings. The deficit itself is due in no small measure to oil imports.

So keeping track of petrodollar flows is important. But it's not easy.

Bond house Pimco estimated that only about 40% of petrodollar savings during the past four years can be accounted for by recorded asset purchases. The other 60% — almost $700 billion — can't be identified via data tracking asset purchases. Billions of petrodollars flow freely and unchecked through London and the Caribbean.

But new research from Pimco's Ramin Toloui suggested that oil producers are starting to shift from more conservative investments by central banks to less risk-averse sovereign investment authorities.

Longer term, that shift could mean less support for U.S. assets and the dollar if those authorities decide to chase yield elsewhere.

"First, oil exporters tend to seek greater currency diversification in their assets than other major savers in the global economy," Toloui said. "Second, oil exporters as a group are more return-oriented than the other key players, with large holdings in sovereign funds geared explicitly toward generating investment returns. Therefore they are more likely to shift out of U.S. assets if the U.S. dollar comes under stress."

They're even more likely to do so than Asian central banks, which have given up some investment returns to keep the dollar strong. A strong dollar helps keep other currencies (like China's yuan) low.

Other research suggests that longer-term investment patterns by oil exporters favor increased demand for exports from Asia and Europe, possibly at the expense of adding more U.S. financial assets.

But analysts including Toloui are quick to point out that while oil states may shift some investment preferences, no one thinks petrodollar investment in the U.S. is going away any time soon.

By most accounts, this year's oil profits from key producers such as Russia, Norway and Saudi Arabia will continue to flow steadily into U.S. assets, though the mix has already started to shift.

A bigger factor in near-term investment will be the recent decline in oil prices, which has left fewer petrodollars sloshing around the global economy.

"The moment oil prices stabilize or start to fall . . . the scale of petrodollar recycling will go down," said Brad Setser, head of global research at Roubini Global Economics. "If oil prices stay roughly where they are in January, there's going to be a meaningful fall in the pace of growth of oil-state assets."

He sees the balance of power shifting back to Asian central banks. These banks stand to benefit on a number of fronts: from cheaper oil prices, from their already huge account surpluses, and from a willingness to fund U.S. debt.

If oil prices drop even more and petrodollar investment really starts to plummet, the U.S. economy will probably do fine.

Lower oil prices essentially act as a tax break for an even more important driver of global growth — U.S. consumers.