Who's Afraid Of Petrodollars?

They won't pack the same punch this time around

Petrodollars. That word once stood for an era of huge financial unrest. It started in 1973 when the first oil price shock hit, fueling inflation and panic at the gas pump. The oil-exporting countries--especially the Gulf monarchies--became major foreign investors almost overnight. They churned billions into the global financial system--especially into the U.S. The second oil shock of 1979 brought another wave of petrodollars and more anxiety.

Now, oil has tripled in price since 1998, to more than $30 a barrel, after years of low prices. Does that mean another petrodollar wave is about to rock the global financial system?

Memories of the oil shocks are still fresh. Swamped with cash, commercial banks cranked out huge, hasty loans. The Saudis became huge buyers of U.S. Treasuries, inspiring dire fears about what might happen if they suddenly sold their holdings in a huff. Kuwait encountered nationalist opposition when it used its lucre to buy big chunks of such European companies as Daimler Benz and British Petroleum. Libyan dictator Colonel Muammer Qaddafi suddenly had billions of new dollars with which to foment trouble.

NO SPENDING SPREE. Most experts downplay the risk of a new petrodollar tidal wave. The global economy is much larger and more efficient than it was 20 years ago. Then, "the capacity of the financial markets was completely dwarfed by the massive shift of financial resources that took place," says David C. Mulford, chairman of Credit Suisse First Boston International, who advised the Saudis on investments in 1974-83.

Higher oil prices are certainly a bonanza for the OPEC countries. Their economies, which nearly imploded when prices collapsed to as little as $10 a barrel two years ago, will grow by 3% to 5% this year. Yet few of the big exporters are likely to go on spending sprees in the West. Moreover, while OPEC's new wealth may make some private bankers rich, it's unlikely to have a big impact on Western stock and bond markets. Oil exports this year will earn OPEC's 11 member countries about $250 billion. By contrast, the market capitalization of companies listed on the New York Stock Exchange is $11.2 trillion, an eightfold increase since 1981. Petrodollars just don't have the purchasing power they did in the 1970s and '80s.

In any event, the cartel's members--chastened by a long period of cheap oil--are more likely to use the flood of revenues to pay down debt and build reserves for the next lean spell.

Not that all OPEC countries will use the money wisely. Venezuelan President Hugo Chavez--who seems a throwback to Latin American military strongmen of the mid-twentieth century--has stoked his popularity with promises of largesse from this unexpected windfall.

But Chavez is an exception. It may seem that OPEC countries are making out like bandits. In fact, they're running in place. That's because in real terms, oil prices haven't increased much in the past 20 years. The peak year for OPEC earnings was way back in 1980, when its member countries earned about $280 billion--$20 billion to $30 billion more than they are likely to reap this year--in nominal terms. And OPEC's cash reserves aren't what they were.

For instance, Saudi foreign reserves peaked near $200 billion in 1982, says Sharif Ghalib, senior analyst at the Energy Intelligence Group in New York. Even after this boom, they're unlikely to exceed $100 billion. OPEC official reserves have fallen in nominal terms from $450 billion in 1982 to $340 billion last year.

While the 1990s have been fat years in the West, they have been brutal for OPEC. Particularly harsh was 1998, when $10 oil slashed OPEC revenues to just $110 billion. Not even proud Saudi Arabia was immune. In early 1999 speculators sensed that foreign reserves were dangerously low and attacked the riyal. The Saudis fended off the assault by buying $6 billion in forward riyal contracts. "This year seems a bonanza, but we forget all the problems that 1998 caused," says Robert Mabro, director of Britain's Oxford Institute for Energy Studies.

And despite heavy spending in the past two decades to diversify their economies, nearly all the governments are still dependent on oil. Compounding the problem is that the 12 years of low prices from 1986 to 1998 coincided with rapid population growth in such countries as Nigeria, Iran, and Saudi Arabia.

The Saudis have clearly learned their lesson since the '80s. They are using today's lush earnings to put their financial house in order. With last year's speculative riyal attack in mind, they are carefully rebuilding reserves--which should rise by $20 billion to $30 billion. They're also paying down arrears to domestic contractors. These moves are part of a broader Saudi effort to diversify the economy and generate more growth from the private sector. The Saudis are negotiating local gas-exploration deals with big international oil companies--breaking a major taboo. Kuwait, Qatar, and Oman (a non-OPEC Gulf producer) are pursuing similar policies.

Notwithstanding their new conservatism, the Gulf monarchies still invest abroad. By yearend, Saudi Arabia, Qatar, Kuwait, and the United Arab Emirates should have some $300 billion salted away, some of which they'll put into Western stocks, bonds and property. Qatar and the UAE, with their tiny populations, are already fantastically wealthy. "They don't need money," says Mabro.

MODEL MEXICO. Among the poorer OPEC members, Nigeria, Indonesia, and Algeria are all substantial net debtors. They're unlikely to be profligate, says Fareed Mohamedi, chief economist at Petroleum Finance Co. in Washington, D.C.: "There is too much to be done in places like Nigeria and Iran for them to waste money or spend it willy-nilly."

If there's a model for spending oil wealth wisely, it might be non-OPEC Mexico. Thanks to diversification, the Mexican government has been able to turn this boom into a longer-term boon. Oil is now just 10% of Mexico's exports, but it's still one-third of government revenues. The windfall let the government spend 8% more in the first half of 2000--and rack up a $2.5 billion surplus. In September, Mexico paid down $2.99 billion in debt to the International Monetary Fund.

Who's Afraid of Petrodollars?

The last of the big spenders is Venezuela. Chavez increased spending by 50% this year and promises a 10% boost next year. Money is leaving Venezuela. But that isn't the government investing oil wealth overseas; analysts say it's capital flight in response to Chavez' gutting of the political system and threats to expropriate land.

Chavez--whose plans assume that oil prices will stay near $30 a barrel--may think that the '70s and '80s are back. Most other OPEC countries realized long ago that they can't control oil prices, and that the best policy is to hold their petrodollars for as long as their luck holds.