The gulf sovereign wealth funds: myths and reality.

The financial world is abuzz with the issue of Sovereign Wealth Funds (SWFs), especially those that have become swollen by oil revenues in the Arabian/Persian Gulf. There are estimates from highly respected banks and consultants that put the wealth of the Gulf SWFs at about $1.5 trillion, (1) increasing at a very rapid rate with oil at $100 per barrel and higher. Estimates from the consulting firm McKinsey show an accumulation of oil income in the Gulf Cooperation Council (GCC) countries at $2.4 trillion by 2010 and $8.8 trillion by 2020. (2) In spite of significant spending within the GCC, McKinsey expects $5 trillion to be invested outside the Gulf by 2020. (3) Much of this large pool of investments is expected to end up in the Gulf SWFs. The reputedly largest of these funds is the Abu Dhabi Investment Authority (ADIA), which is reported by Deutsche Bank to have about $875 billion under management today. (4)

The corollary of these estimates is that this money must get invested somewhere and where better than in shares in the major financial institutions of Wall Street, which have suffered seriously from their less-than-wise investments in subprime mortgage paper. Of course, underlying this speculation is the fear that one or more major U.S. financial institutions will end up in the hands of highly secretive SWFs that originate in Arab countries. The assumption here is that foreign funds, in particular Arab funds, are nefarious, endanger U.S. security and promote changes in U.S. foreign policy and our way of life.

This paper will argue that the reality is somewhat less scary. It will evaluate the logical amounts held by the SWFs of the Gulf and show that the amounts they manage are half or less of what has been mentioned by the likes of McKinsey and Deutsche Bank. Hence, the amounts available for investments in the United States are relatively small compared to the actual needs of the large U.S. financial institutions that are today in great need of capital support. The paper will argue that no Gulf SWF could come close to taking a controlling stake in such firms as Citibank or JP Morgan, whose highly depressed capitalizations are still above $120 billion and $145 billion, respectively. Perhaps more dangerous to the U.S. economy and "way of life," is that these SWFs may have no appetite for U.S. assets for fear of a xenophobic backlash similar to the one whipped up by U.S. politicians at the time of the Dubai Ports World (DPW) debacle. In effect, such fear is forcing the SWFs to be invested in other countries and in non-U.S. firms, thereby protecting and improving some other countries' "way of life" at the expense of ours.

OIL INCOME

The countries of the Gulf relevant to this paper include the six members of the GCC (Saudi Arabia, Kuwait, Bahrain, Qatar, the UAE and Oman) and Iran. Unfortunately, Iraq is not included. Indeed, Iraq's oil income, while rising with the price of oil, is also used in waging the war, providing subsidies to keep people alive and reconstructing the country. Iraq has no extra cash left after its daily expenses and thus no funds for investment abroad.

The countries of the Gulf produce about 19 million barrels per day (b/d) and about 2.5 million b/d of natural-gas liquids (NGLs). The largest producer is Saudi Arabia, which in 2008 is producing about 9.2 million b/d. (5) This Gulf production is a mix of light and heavy crudes. The light crudes are close in quality to the West Texas Intermediate (WTI) crude sold on NYMEX or the Brent sold on the International Petroleum Exchange (IPE) in London. These two reference prices are the base of most oil pricing in the world today. However, the shipments out of the Gulf also contain a large volume of heavier crude that is sold at a substantial discount. One must also point out that the Gulf countries may produce 19.45 million b/d (6) but do not export as much. Indeed, they refine about 5.5 million b/d (7) themselves, and most of the refinery products are used locally. Saudi Arabia refines about 2.5 million b/d and uses about 2 million b/d locally. Thus, the actual net exports of oil, including the exports of products such as diesel or gasoline and NGLs, total about 17.5 million b/d. (8)

The Arab states of the Gulf only sell their petroleum to the oil majors or to very large utility companies in the Far East. They do not sell to traders. The contracts under which these sales take place tend to provide a formula based on an averaging of prices for NYMEX or Brent crudes or an artificially devised Oman-Dubai market that is used for pricing shipments to the Far East. In all cases, however, the prices computed include a discount compared to the actual NYMEX or Brent price to make up for the distance between the fields of the Gulf and those of Europe or the United States. Hence, when oil is traded at $100/b in New York at NYMEX for WTI, the actual price paid to the Saudis for similar grade oil will be about $90/b. Considering that, on average, the crudes produced in the Gulf are of lower grade than WTI or Brent, the average income may be discounted by as much as 20 percent from the WTI market after the discount for distance. At $100/b in New York for WTI, this would imply that income from oil in the Gulf would be about $1.05 billion per day. On an annualized basis, this would amount to $385 billion per year. By any account, this is a very large amount of money. However, it is a far cry from the amounts estimated by McKinsey, which places the yearly income at about $710 billion per year. Of course, if one forecasts the future with this kind of discrepancy, one can see that the estimated inflow of income into the Gulf will vary wildly, from $3.8 trillion, which is by no means small, to $7.1 trillion, which is indeed staggering.