A Massive Wealth Transfer Is The Reason For This Market Crisis

by: Massimo Armanini


The collapse in oil prices is causing a massive transfer of wealth.

The speed at which the Opec countries need to divest is too high.

The improved disposable income available to consumers takes time to filter to financial markets.

First of all, a few data and very rough calculations:

  • The annual Opec oil export is equal to around 24 million barrel a day or 9 billion barrels a year.
  • The proceeds from this export have decreased say by 60 USD a barrel since the oil price moved from say 100 to say 40 (but we know it is moving to less then 30).
  • That means that the Opec countries are exporting the same quantity of oil, but are receiving around USD 540 billion a year less. That is a very large amount.

To put it in context: Opec countries' GDP was around $3.4 trillion in 2014, up from $1 trillion in 2004 when the oil price was around $40/b. To provide another point of reference, the size of Abu Dhabi Investment Authorities and SAMA Foreign Holdings combined are estimated at around $1.6 trillion (these are the Sovereign funds of Emirates, Saudi Arabia and Qatar). If you take away around $540 billion of exports, it means at least 20% of GDP disappears. In a few years the above mentioned Sovereign Funds will be very small. Note that I am not counting the effect of lower prices of natural gas.
Now consider what is really happening.
Since 2004 there has been an incredible transfer of wealth with oil moving from around 40 USD/barrel to over 100 USD/barrel. The Opec countries (and Russia) simply cashed in billions, without any effort, investment or even smart investing ability. The importers (largely Europe and China) had to pay the oil 'tax' and see their wealth decrease.
The Opec countries took the money and wasted away a good part of it (see Venezuela), bought luxury goods and properties (see real estate prices in London), bought political support locally (see Saudi Arabia), sometimes sponsored terrorist activity, but definitely almost never really invested in productive assets or sound industries or useful infrastructure in their own economies. They also saved part of the wealth by investing abroad, becoming the proud owners of trophy real estate assets in London, Paris, Milan and invested heavily in financial assets.
Now the process is reversing, and a massive wealth transfer is happening again, now leaving Opec poorer and Europe and China richer. I don't need to discuss the role of the shale oil revolution or analyze the effect of the lift of Iran sanctions on oil prices, but we could assume low oil prices are here to stay.
The next logical step is... the collapse of stock markets and possibly of the price of luxury real estate assets.
The adjustment is causing a trauma: Opec countries need to sell the assets they bought when they were the lucky winner of the oil price bubble lottery. I think the current dramatic fall of the stock markets is caused by the large selling pressure coming from Opec (and Russian) investors in need of financial resources to balance their desperate situation. Opec countries should prepare themselves to a dramatic fall in GDP taking them back where they were few years ago (say a GDP of 1.5 trillion from the current 3.4), this is not easy or painless or even feasible without very significant social unrest.
The same is true for Russia.
In the long run Europe and China are better off, but it takes time for the benefit of lower oil prices to have an impact on financial markets. In terms of disposable income and companies' earnings we should see the positive effect in the coming months, a huge amount of wealth is moving from few Opec institutions and individuals to millions of European and Chinese (and Indian) consumers. Wealth is moving from few holders to millions, and the few have to sell large quantities of financial assets immediately depressing asset value; at the same time European consumers are enjoying the benefit of lower energy prices but this does not immediately boost new demand for financial assets. In addition the stock markets decline is scaring the consumers and possibly causing a financial distress in the banking sector.
The wealth effect on European, Chinese and Indian consumers will slowly filter through the system and the stock markets will recover. But in the meantime, tighten your seat belts!

Disclosure: I/we have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours.

I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it. I have no business relationship with any company whose stock is mentioned in this article.