Regulators may worry when Arab investors acquire stakes in Western companies, yet vast reserves of petrodollars have kept down interest rates and buoyed financial assets.

It is a fact that as oil prices continue to set new records, investors outside Europe and the United States are increasingly shaping trends in financial markets. Petrodollar investors have a newfound influence, and the more than tripling of oil prices since 2002 makes them the largest and fastest-growing component of a broad shift in global economic markets a shift that also includes Asian central banks, private-equity firms, and hedge funds. High oil prices are, in effect, a tax on consumers, generating windfall revenues for oil-exporting nations, which in 2006 became the world’s largest source of net global capital flows, surpassing Asia for the first time since the 1970s. A majority of these revenues have been recycled into global financial markets, making petrodollar investors increasingly powerful players.

It is a further fact that the influence of petrodollar investors is likely to continue to grow over at least the next five years. The exact size of future petrodollar foreign investments will depend on oil prices, which are subject to considerable uncertainty. Nonetheless, we can estimate the general direction of petrodollar assets using three benchmark price points and research on global energy demand by the McKinsey Global Institute (MGI).

At $50 per barrel of oil the annual net capital outflows of the petrodollar countries would amount to $387 billion a year through 2012. This total represents an extraordinary infusion of capital into global financial markets at a rate of more than $1 billion per day.

At $70 a barrel petrodollar flows into global markets would grow even larger, reaching $628 billion annually by 2012, implying new petrodollar investments of nearly $2 billion a day.

By 2012 the total stock of petrodollar foreign assets would grow to $6.9 trillion.

Even if oil prices declined to $30 a barrel, petrodollar foreign assets would grow at a robust average rate of 6 percent annually, to reach about $4.8 trillion in 2012, when the oil-producing countries would add $147 billion to the global financial system. That figure is larger than petrodollar surpluses throughout the 1990s.

Without a doubt, this flood of oil money is creating new dynamics, and the rise of petrodollar investors feeds growing concern about their government connections and influence on markets. Since facts about these powerful new investors have been scarce, our research aims to ground the debate by providing new data and analysis.

By my personal estimate, investors from oil-exporting nations owned $3.4 trillion to $3.8 trillion in foreign financial assets at the end of 2006.

The $64,000 question is: What’s the broader effect of the surge in petrodollars?

Since 2002, oil prices have tripled, and much of the incremental increase has ended up in the investment funds and private portfolios of investors in oil-exporting countries. Most of the money is then recycled on global financial markets, whose liquidity is therefore rising.

In fixed-income markets, this added liquidity has significantly lowered interest rates. We at Blackhawk estimate that total foreign net purchases of US bonds have brought down long-term rates by about 130 basis points. Twenty-one of them can be attributed to purchases by the central banks of oil-exporting countries, an impact as large as that of the capital flows from financial hubs such as the Cayman Islands, Luxembourg, Switzerland, and the United Kingdom, though less than half the impact of Asia’s central banks on US interest rates. Petrodollars have added liquidity to international equity markets as well. Taking into account the allocations of GCC investors, we estimate that each year equity markets receive $200 billion in petrodollars, accounting for about $2 trillion or 4 percent of their capitalization.

Some observers worry that this new liquidity is having an inflationary effect on asset prices, perhaps fueling bubbles. Our analysis shows that this concern isn’t justified in public-equity markets. Although their capitalization has risen rapidly since the 2000 stock market decline, we find that rising corporate profitability and share buybacks (often using debt) are the main reasons. In Japan and the United States, private-equity ratios have declined in recent years, while in Europe they have risen only incrementally. (In China, India, and some other emerging markets, however, they have increased.)

The story is different in global real-estate markets. According to research by the Economist Intelligence Unit, real-estate values in developed countries have increased by $30 trillion since 2000, reaching $70 trillion in 2005 and far outstripping GDP growth over the same period. This rise reflects not only the preference of petrodollar investors for global real estate but also the home-equity loans and larger mortgages that low interest rates and risk spreads have made possible.

Indeed, petrodollars have helped increase global leverage in many forms. Low interest rates and credit spreads have enabled the rise of hedge funds and the private-equity boom, which may have stalled for the moment. Although low rates and spreads have created ample liquidity for consumer credit in the United Kingdom, the United States, and many other countries, a reassessed appetite for risk could burst this global credit bubble, causing pain to lenders and borrowers alike. In mid-2007 problems in the US subprime-mortgage market sparked a re-pricing of credit risk and a credit crunch. A note of caution is therefore warranted, despite the bullish impact of petrodollars on the liquidity of world financial markets.

Despite the many beneficial effects of petrodollars in increasing global liquidity and spurring the growth of various financial-asset classes throughout the world, the rise of investors in oil-exporting countries is creating growing concerns.

One worry is that the huge size of petrodollar sovereign wealth funds, coupled with their relatively high appetite for risk, could make global capital markets more volatile. The limited transparency of these funds amplifies the anxiety. Our research, however, finds that their investment portfolios are widely diversified not only across asset classes and regions but also through a number of intermediaries and investors. Diversification reduces the risk that the funds could make financial markets more volatile. Moreover, petrodollar investors have a track record of sensitivity about the broader market impact of large flows and use derivatives and intermediaries to lessen it. ADIA, for instance, reportedly invests 70 percent of its funds through external asset managers intermediaries who know they must move slowly in markets to avoid adverse price adjustments. Direct petrodollar investors tend to adopt a relatively low profile.

A second concern has also attracted growing attention among financial-market regulators in Europe and the United States: the prospect that sovereign wealth funds could use their growing financial heft for political or other noneconomic motives. The rise of large government investors in financial markets is a new phenomenon and one at odds with the shrinking role of state ownership in real economies. Given the limited transparency and enormous size of these investors, some observers question the motivations underlying their investment strategies. How will state investors behave as public shareholders or owners of companies in foreign markets? Will they seek to maximize value creation and long-term growth, or will their investments reflect the political objectives of their governments and the interests of businesses in their home countries? Financial markets require the free flow of information to function efficiently. The presence of huge, opaque players with noneconomic motives could distort the pricing signals that other investors need. A growing number of economists and policy makers in Europe and the United States now support the creation of disclosure standards for government investors.

Most sovereign wealth funds have historically invested at least part of their assets through external managers, which should help ease these anxieties. To the same end, it would be in the funds’ interest to increase their voluntary disclosures about their size, investment objectives, target portfolio allocation, and internal risk-management and governance procedures; this information would allow well-managed funds to stand out and demonstrate a spirit of cooperation. Some observers consider Norway’s Government Pension Fund a model because it makes its asset allocation, investment criteria, and investments available to the public on its Web site.

Regulators in Europe and the United States should ensure that they base any policy decisions about the activities of sovereign wealth funds on an objective appraisal of the facts. It will be essential to differentiate between the direct acquisition of corporations by state-owned enterprises and by government investment companies in oil-exporting regions, on the one hand, and the passive investments of sovereign wealth funds in debt and equity markets, on the other. Sovereign wealth funds typically hold a diversified portfolio of assets in public debt and equity securities rather than large stakes in foreign companies.

A final concern: the long-term economic impact of higher oil prices. In the 1970s their rise sparked inflation in the major oil-consuming economies and sent global banks on a petrodollar-fueled lending spree in Latin America. Both developments inflicted significant economic pain on the countries involved. Today higher oil prices have been a boon for global financial markets, but, paradoxically, inflation hasn’t risen very much. Can higher oil prices really be good for the world economy? As we have seen, petrodollars are creating inflationary pressures in markets for illiquid investments, such as real estate, art, and companies. If the pressures move beyond those markets, the potential asset price bubbles could burst. So far the world economy has accommodated higher oil prices without a notable rise in inflation or an economic slowdown, but this may change in the future.

The new oil weapon is without a doubt becoming more powerful and disruptive than any time in the history of mankind.