April 13, 2016    3 minute read

Oil Prices, SWFs and Financial Consequences

   April 13, 2016    3 minute read

Oil Prices, SWFs and Financial Consequences

The hottest topic in analysing the current financial panorama is undoubtedly linked to the decline in oil prices, with its adverse impacts on the global financial markets. This massive dump creates uncertainty and we all know that financial operators do need predictable conditions and factors in order to make rational decisions, attributing probabilities to all possible scenarios with statistical inferences.

The impossibility of analysing the current oil market conditions with accurate and reliable forecasts make us thinking about a tail situation, a situation with low probability of occurrence and a huge impact on the whole financial

Although it is not possible to forecast with a certain plausibility and explicitly investigate a cause-and-effect scheme, it is known that low oil prices do create political consequences, negatively affecting oil based economies: Venezuela, Russia, Norway but also Middle-East countries. This situation of economic distress reflects itself on public finances, violently damaging Sovereign Wealth Funds’ balance sheets.

Sovereign Wealth Funds as Public Financial Actors

SWFs are financial institutions with a clear public origin, with an amount of assets-under-management of more than 3.8 trillion dollars in 2010: more assets than hedge funds and private equity funds in the same period. Thus, the origin of those type of institution is strictly linked to the economic fiscal and monetary policies of a country with a large quantity of currency reserves.

As a matter of fact, SWFs are created as pools of assets by governmental initiatives in order to level public expenditures with a long-time horizon and with a counter-cyclical objective: the primary rule for that kind of institutions is to accumulate resources in period of economic growth and to mobilise them in period of economic depressions, in order to smooth the consequences of boom-and-busts cycle in the commodity markets.

It is clear that a distressed situation in SWFs balance sheets does affect international financial markets: SWFs are institutional investors with a considerable amount of assets-under-management, primarily invested in public companies in the most developed countries’ financial markets.

A Great Enigma

An economic depression in a commodity-based country forces its SWF to mobilise resources to smooth its negative impacts both on domestic economic and political system and on public finance accounts. These resources could be obtained by selling assets that are invested in the most liquid markets, in order to limit losses: those kinds of markets are purely financial ones.

In this way, it is possible to partially explain one of this period greatest enigmas: why have oil prices and developed stock markets become so strictly positively correlated while empirical data seemed to suggest a negative correlation between oil price and stock markets from the 1950s onwards?

Excuses and Life Lessons

The author personally knows and recognises that the conclusions of this short article are not excessively surprising or the result of complicated and particularly brilliant analysis, but do wish to underline that it is possible to overcome apparently insurmountable problems step by step, focusing our attention on singular aspects and then connecting our conclusions in a global vision.

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