Sovereign wealth funds: Foreign invasion?

Oil-fueled investments target debt-ridden Western firms.

In Yeats’s famous poem “The Second Coming,” it is a rough beast slouching out of the desert that threatens the West in the early 20th century. Here in 2009, a beast roams again, this time in the form of eastern sovereign wealth funds that some fear are about to plunder a bankrupt North America. The recent swoop and scoop of Calgary-based Nova Chemicals Corp. by the International Petroleum Investment Co., an SWF wholly owned by Abu Dhabi, the petroleum-fuelled city state, is just one of these deals — and could be the leading edge of a huge wave.

Since the collapse of U.S. consumer spending this winter, many western companies find themselves teetering on the edge of insolvency. In the case of debt-laden polyethylene producer Nova, things were getting desperate. “We looked at all the options,” says Greg Wilkinson, vice-president, public and government affairs. They talked to private equity and, reportedly, pension funds, but all passed on the $200 million the company needed immediately to keep operating.

With bond markets still tight, it didn’t look good for Nova, and the stock (TSX: NCX) skidded from a price above $30 in August to less than $2 in February. But with bankruptcy closing in, the company looked at a quiet offer that came in from IPIC early in the new year. The Abu Dhabi fund offered US$6 a share (a premium of more than 300% to the Feb. 20 closing price) and a US$250-million backstop to get Nova through the current difficulties, all of which was too good to pass up. Pending a review by Ottawa, ownership of Nova, whose Canadian roots go back more than 50 years, looks set to pass to the Middle East.

Should we be worried? Some say yes. SWFs channel the foreign-reserve currency holdings of various governments into investment vehicles. Larger in monetary terms than the hedge fund sector (but still far behind the amount of money held in pension funds), SWFs came into existence when central governments abandoned gold and began converting their holdings to fiat currencies and securities.

The earliest date back to the 1950s, but over the past 15 years they have begun to exert more influence as westerners have reduced their savings rates in favour of ongoing consumption of foreign manufactures and resources. The United States has been importing more oil ever since its own domestic production peaked in 1970, flooding petro funds like IPIC with cash. And that is the basic trend here. We consumed. They sold. They have the money now.

According to a 2008 report from the Institute for the Anaysis of Global Security, a think-tank in the Washington, D.C., area, the influence of these funds is only going to increase. Nearly half of the estimated US$3 trillion or so in SWFs is controlled by the petro states of Abu Dhabi, Dubai, Qatar, Kuwait and Saudi Arabia. As oil continues to deplete in non-OPEC countries (Merrill Lynch has just released a report suggesting non-OPEC oil production has peaked), even more money will flow to these funds, which could balloon to US$15 trillion in another decade or so. This vast transfer of wealth is going to usher in a new economic order that, according to the institute report, “symbolizes not only our economic decline but also the emergence of sovereign wealth funds as power brokers in international relations.”

Western politicians have taken notice. In a speech delivered in January 2008 in Dubai, Canadian Finance Minister Jim Flaherty said SWFs can be a constructive source of investment at times when “capital is at a premium,” though he added, “It must be clear that investments are being made for business reasons, not political ones.” To its credit, Abu Dhabi has taken part in an initiative with the International Monetary Fund to promote transparency at the funds. And IPIC seems to be stepping carefully in Canada.

IPIC has made it clear Nova should continue as is. “They said they want us to run it like we always have,” says Wilkinson. Considering the dismal state of western finance, it might be the best deal Nova could have gotten. After all, beggars can’t be choosers.