Oil Brings U.S. Closer to OPEC Dependence, Replacing Japanese

By Daniel Kruger

July 14 (Bloomberg) -- Petroleum exporting nations from Saudi Arabia to Russia are not only charging Americans record high prices for fuel, they are also poised to become the biggest creditor to the U.S. government.

Holdings of Treasuries by oil producers and institutions such as U.K. banks that are proxies for Middle East nations rose 44 percent this year to $510.8 billion through April, four times faster than the rest of the world, according to the Treasury Department's most recent data. At the current pace, they'll surpass Japan, which holds $592.2 billion, as the largest owner this month.

While the investment of so-called petrodollars into government debt is helping to temper a rise in borrowing costs as the U.S. finances a record budget deficit, it highlights America's dependence on foreign money. New York's Chrysler Building was bought last week by Middle East investors.

``We should be very happy that they're buying U.S. Treasuries because they're keeping interest rates low, and that's a positive for bond investors,'' said Gary Pollack, who helps oversee $12 billion as head of fixed-income trading at Deutsche Bank AG's Private Wealth Management unit in New York. ``Whether there's geopolitical risk is something else.''

The benchmark 10-year note's yield fell 2 basis points, or 0.02 percentage point, to 3.96 percent last week, according to BGCantor Market Data. It touched 3.78 percent on July 10, the lowest since May 21. The price of the 3.875 percent security due in May 2018 rose 5/32, or $1.56 per $1,000 face amount, to 99 10/32.

McKinsey Study

Yields on 10-year notes are 21 basis points lower because of the investment by oil-producing nations, New York-based consulting company McKinsey & Co. said in October, when oil was $86 a barrel. Prices touched a record $147.27 on July 11.

Assets held by oil exporters swelled to $4.6 trillion at the end of 2007, according to McKinsey. They're pouring that money into Treasuries as losses on alternatives such as equities and corporate debt mount amid the collapse of the U.S. subprime mortgage market. Merrill Lynch & Co. indexes show Treasuries have returned 2.5 percent this year, while major stock indexes in the U.S., Europe and Asia have tumbled at least 10 percent.

The Organization of Petroleum Exporting Countries held $153.9 billion in Treasuries at the end of April, Russia had $60.2 billion and Norway owned $45.3 billion, according to the Treasury Department. Combined, that represents a 113 percent increase from 12 months earlier.

Oil producers own a majority of the $251.4 billion in Treasuries held in the U.K., an 85 percent increase.

Surpassing China

Since the 1960s the U.K. has acted as a financial center where international investors purchase and hold securities, according to the Bank of International Settlements. Morgan Stanley's chief Treasury strategist, George Goncalves, estimates that only $50 billion of the U.K.'s Treasuries are owned by investors based in the country. The rest belong to investors primarily from OPEC and Russia, as well as China, he said.

The Treasury will release data on May holdings on July 16.

Oil-producing nations have surpassed China, which owns $502 billion of U.S. government debt, and are increasing their holdings as Japan cuts back. The nation reduced its stake in Treasuries by 3.6 percent the past 12 months.

The rise in oil-based economies is reminiscent of the 1980s, when Japan enjoyed an export-fueled boom.

Back to the '80s

Holdings of U.S. long-term securities by the Japanese surged almost sevenfold in the five years ended in 1989 to $180 billion as it reinvested its dollar-based reserves. Purchases of landmarks such as New York's Rockefeller Center and the Pebble Beach golf course in Pebble Beach, California, by the Japanese raised concern that the U.S.'s economic primacy was eroding.

Questions of whether purchases by foreigners are a threat to U.S. economic sovereignty are again being raised. The Chrysler Building was acquired last week by the Abu Dhabi Investment Council for an undisclosed price. Last month a Dubai fund was part of a group that paid $2.8 billion for the General Motors Building in Manhattan.

``It's a net transfer of wealth from the United States to the oil exporting economies on a very, very significant scale,'' said Brad Setser, an economist with the Council on Foreign Relations and former acting director of the Treasury's Office of International Monetary and Financial Policy. ``That is a reality. Anybody who is pursuing a policy with large deficits is implicitly planning on relying on demand from those countries.''

Transfer of Wealth

The United Arab Emirates had $964 billion in foreign assets at the end of 2007, followed by Russia with $811 billion, McKinsey said in a report last week. Soaring oil prices have also given Algeria, Iran, Libya, Nigeria and Venezuela more clout in foreign markets, McKinsey said.

Senators Barack Obama of Illinois and John McCain of Arizona, the presumptive presidential candidates for the Democratic and Republican parties, have taken positions on foreign oil wealth that may be difficult to reconcile with the U.S.'s need to attract $2 billion per day in foreign investment to fund its current account deficit. The shortfall in the broadest measure of trade totals $653 billion.

``I am concerned if these sovereign wealth funds are motivated by more than just market considerations,'' Obama said in February. ``We are over time transferring wealth to those countries, and that's something I intend to stop as president.''

`Way Of Life'

McCain told Germany's Sueddeutsche Zeitung newspaper the same month that Russia's membership in the Group of Eight leading industrial nations should be revoked and the G-8 should revert to a ``club of market-based democracies.'' In May he pledged to work in ``partnership'' with Russia to on weapons proliferation.

Compromises may have to be made when it comes to purchase of Treasuries by oil exporters, said Michael Cheah, who manages $2 billion in bonds at AIG SunAmerica Asset Management in Jersey City, New Jersey.

Goldman Sachs Group Inc., BNP Paribas and Societe Generale SA say oil prices are heading higher because of increasing fuel consumption in emerging markets, regardless of a U.S. downturn.

As long as the U.S. continues to borrow and oil exporters continue to lend, Cheah said, ``this is a vindication of the American way of life.''

To contact the reporter on this story: Daniel Kruger in New York at dkruger1@bloomberg.net