Why the end of the oil boom is problematic for us all

December 2, 2014

Since OPEC decided not to cut production at its meeting last week the tumble in the oil price has generally been considered a good thing for the consumer. What no-one has concentrated on is the fact that declining oil wealth, particularly in the cash-rich Middle East, could make banks in the UK more vulnerable should we get hit with another financial crisis.

Remember 2008? Back then the world’s major banks faced collapse and rushed to find deep-pocketed investors to bolster their balance sheets. This was partly financed by the likes of the Qatari Investment Authority, which is designed to manage the funds from Qatar’s oil and gas reserves. The biggest recipient of the Qataris’ generosity was Barclays, and at one stage the Qatari Investment Authority owned more than 12 percent of the British bank.

The Barclays deal was clouded in secrecy, which probably suited Barclays top brass along with the British government, as both the industry and the UK Treasury tried to stem the panic that was gripping the markets. If Barclays had not managed to find an investor rich enough as the Qatari Investment Authority then the bank faced harsh choices – either it failed to survive, or it was bailed out by British taxpayers, with all of the conditions that come with a publically-funded bailout, a la RBS.

It would appear that the Middle East’s oil wealth has helped get the UK, particularly its banks, out of a few tight spots in recent years. Now that sovereign wealth funds are taking a hit from the sharp decline in the oil price, is there an argument to say that the UK’s banks are less creditworthy than they were when oil was trading above $100 a barrel?

To answer this we need to look at two things, firstly, can, in the event of another financial crisis, the UK manage to bail out its banks, and secondly how long will the oil price remain subdued?

To answer the first point, overseas holders of UK debt own approximately 30 percent of all outstanding gilts. This has been roughly stable since 2006; however, overseas ownership of UK debt peaked at 35 percent in the third quarter of 2008, just as disaster struck the global economy. Overseas investors are the second largest owners of UK gilts after pension funds and insurers.

The Office for National Statistics does not publish the countries that own UK debt, but one can assume that the Middle East may own a large portion of this debt, due to the UK’s historical business links in the region and the willingness with which the Middle East has helped out the UK’s financial sector. Thus, if oil wealth continues to decline, will overseas investors continue to invest in a country like the UK which already has a massive debt problem?

Considering the Bank of England will need to think about selling its not insignificant holdings of gilts – it is the third largest holder of UK debt – the Treasury could find it harder to sell debt in future if oil producers start scaling back their purchases around the same time as the Bank of England thinks about divesting its stake of UK debt accumulated during its quantitative easing programme.

The second point is the oil price. Some analysts argue that we have reached a peak for the oil price and we could be in for a decade or more of subdued prices for the crude market. Right now oil-rich countries like Qatar and Saudi Arabia have shrugged off the oil price decline, and Qatar‘s sovereign wealth fund has said that the drop in the price of oil will not derail its investment plans. But, if the price of oil falls to say $50 or $40 per barrel in the coming years, will it still be so happy to splurge on a British bank that desperately needs re-financing?

Some may say that this is an extreme view, and I take on board that oil falling to $40 per barrel is a tail risk event. However, black swans do exist, as we found out in 2008, and without the oil wealth of some of the Middle East’s most powerful oil producers the global financial system could lose one of its major financial backstops.

No comments so far

We welcome comments that advance the story through relevant opinion, anecdotes, links and data. If you see a comment that you believe is irrelevant or inappropriate, you can flag it to our editors by using the report abuse links. Views expressed in the comments do not represent those of Reuters. For more information on our comment policy, see http://blogs.reuters.com/fulldisclosure/2010/09/27/toward-a-more-thoughtful-conversation-on-stories/