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Will Higher Oil Prices Boost The Global Economy?

Oil tanker loading

The recent oil price rally is sure to boost petrodollar inflows into the government coffers and sovereign wealth funds of oil producing nations.

A part of those petrodollars could flow back into the global markets if oil producing countries boost investments in various asset classes, according to some large investment banks.

The post, Will Higher Oil Prices Boost The Global Economy?, was first published on OilPrice.com.

These potential new petrodollar inflows could be a shot in the arm for global markets at a time when central banks around the world are starting to normalize their monetary policies.

Yet, as oil producers struggle to patch up budget deficits caused by the oil price rout of 2014-2016, it shouldn’t be taken for granted that the increased petrodollar incomes at sovereign wealth funds and forex reserves of the oil nations will necessarily translate into a huge ‘recycling’ of the newly earned dollars into the global markets.

That’s because many of the oil exporters—especially those in the Middle East—still need to plug budget gaps and finance increasingly investment-intensive projects at home. Case in point—OPEC’s largest exporter and de facto leader Saudi Arabia, which plans hundreds of billions of U.S. dollars-worth of mega projects while it continues to run budget deficits and its net foreign assets struggle to post any significant gains.

Between 2014 and 2016, the combined oil revenues of the world’s oil producing nations plunged from US$1.6 trillion in 2014 to less than US$800 billion in 2016, according to JPMorgan Chase & Co. analysts led by Nikolaos Panigirtzoglou. The plummeting revenues from oil in that period limited the ability of the sovereign wealth funds and central banks of the oil exporters to buy foreign assets. According to JPMorgan, the oil countries’ funds and FX reserve bodies may have spent US$160 billion less on equities and US$80 billion less on bonds in 2015-2016.

Now, “The increase in oil prices is generating a shift in flows and incomes across the world, effectively reversing the previous big shift seen between 2014 and 2016,” JPMorgan said in a note earlier this week, cited by Bloomberg.

Related: Iran Pushes Back Against The OPEC Deal

According to JPMorgan and other analysts, the higher oil prices would benefit equity markets more than the bond markets, and in FX, the euro more than the U.S. dollar.

“The rise in oil prices should create a positive flow in equity markets this year,” JPMorgan reckons. “Where the rise in oil prices poses more risk is in bond markets as the squeeze in oil consumers is reversing their previous saving impulse of 2015/2016, creating a bearish flow for bond markets this year.”

According to Michael Hewson, chief market analyst at CMC Markets, the rise in oil prices coupled with rising yields are helping to underpin equity markets for now.

“It’s this move higher in crude oil prices, along with the rise in demand, that is helping fuel the recent rise in yields as well as the positive tone for equity markets. However, if it continues too far, we could start to see it act as a drag on equity markets, if prices along with yields start to move even higher,” Hewson said in a commentary on Tuesday.

Related: Higher Prices Set To Send U.S. Oil Stocks Soaring

In FX, with oil prices possibly rising further, to say $80 a barrel, the wealth funds of oil exporters could diversify their FX reserves, potentially pressuring the U.S. dollar, Mansoor Mohi-uddin, head of currency strategy at NatWest Markets in Singapore, told Bloomberg.

If oil prices continue to increase, the Brent price—which has typically had a positive correlation with the euro in the past decade but not in the past year—could again start having a positive correlation with the European currency. In this case, “all the Middle East’s largest energy producers are likely to build excess FX reserves increasing the risk of renewed dollar diversification out of the region,” Mohi-uddin said, adding that the U.S. dollar could struggle to appreciate versus the euro.

Higher oil prices are boosting oil producers’ coffers now, but it’s not clear yet if the petrodollars will be heavily reinvested in global asset classes as countries may need to address budgetary and monetary issues and policies at home first.

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