Oil Shock Hits Different in a World of Shrinking Petrodollars

Energy shocks now coincide with tighter global financial conditions, emphasizing the importance of understanding country-specific risks, external buffers, and focusing investments on companies resilient to market volatility. International markets offer opportunities amid lower valuations compared to the U.S.

Oil shocks once carried a built-in cushion for global markets. As prices rose, so did the recycling of surplus dollars from oil exporters back into financial assets. That cushion has largely disappeared. Today, energy spikes are increasingly tightening events, draining dollar liquidity rather than replenishing it.

The shift reflects a change in the global monetary plumbing. In earlier cycles, Persian Gulf exporters generated large current-account surpluses that were reinvested into U.S. Treasuries, bank deposits and global equities. Now those flows are smaller, and offshore dollar creation depends more on Chinese state-owned commercial banks and global banks operating in the eurodollar system, in which banks outside the U.S. hold, lend and borrow greenbacks.

Unlike sovereign wealth flows, bank-driven dollar supply is not virtually automatic. When risk rises, banks retrench, shrinking balance sheets and restricting credit rather than recycling liquidity.

The implications are significant. An oil shock that once helped generate investable liquidity now behaves more like a funding squeeze, amplifying the divergence between energy exporters and importers.

At the peak in 2010–2014 oil price run, crude exporters recycled an estimated $400 billion to $800 billion annually into global assets, based on U.S. Federal Reserve, Energy Information Administration and IMF data. By 2025, that figure had fallen to roughly $200 billion to $250 billion as Gulf economies spend more domestically, their fiscal balances tighten and the U.S. has reduced its reliance on imported oil. Less surplus capital is available to flow back into markets.

Dual Terms of Trade and Funding Shocks Hit Some, but Not Others

 This helps explain why oil shocks now transmit differently. When prices rise, energy-importing regions such as Europe, Japan and much of emerging Asia must secure more dollars to pay for fuel at a time when dollar supply is not expanding. The result is a net drain on global liquidity, creating a terms-of-trade shock and a funding shock.

The regional effects are uneven. The U.S. is relatively insulated, benefiting from energy production and dollar strength, though higher real yields and tighter financial conditions limit equity upside. Europe remains more exposed, with higher energy costs squeezing margins and a stronger dollar tightening financial conditions. Japan sits in between, with currency weakness supporting exporters but not fully offsetting the drag on domestic demand.

Emerging markets show the widest dispersion. Energy importers face pressure from rising costs and tighter dollar funding, while commodity exporters such as Brazil and Argentina benefit from improved terms of trade, particularly as energy and agricultural prices rise together.

The broader point is that oil shocks have shifted from being liquidity-neutral or somewhat supportive because the surge in oil exporter revenues used to be recycled back into global financial markets, offsetting the drain on oil importers. This cushioning mechanism had  effectively channeled hundreds of billions in surplus revenues into U.S. dollar assets, maintaining global liquidity.

But now, without this petrodollar recycling, and more dollar creation increasingly dependent on bank balance sheets, higher energy prices coincide with tighter global financial conditions, creating a more restrictive liquidity environment.

Major Energy Importers Not Caught Off Guard

Yet not all importers are equally vulnerable. China has built considerable strategic petroleum reserves, has plenty of domestic coal, benefits from its renewables buildout, as well as natural gas pipelines from Russia and Central Asia, not to mention its nuclear power fleet. Just more than three weeks into the Iran conflict, in U.S. dollar terms Chinese stocks have outperformed U.S. benchmark, with the CSI 300 Index declining 3.6% vs the S&P 500 Index’s 5.3% fall.

Zooming out, Europe has sharply lessened its dependence on Russian gas since February 2022, when the Ukraine-Russia conflict broke out. It has continued with its renewables buildout and shifted to U.S.-sourced LNG imports. Russian still delivers 13% of Europe’s gas imports, but that’s down from around 40% in 2021, while the U.S. provides about 27% now and Qatar, before the conflict with Iran began last month, was only 3.5%. Despite Ukraine gas shock and sanctions on Russia, over the last four years the benchmark EURO STOXX 50 Index has returned an annualized 13.9%, outperforming the S&P 500 Index’s 11.5%, and also in dollar terms.

Given their high dependence on oil and LNG imports from the Persian Gulf, Japan and South Korea are thought to be particularly vulnerable now. But both have built significant strategic energy reserves and maintain strong external buffers, including substantial foreign-exchange reserves and relatively stable external balances. Those preparations do not eliminate the Iran energy shock, but they can smooth its impact and reduce the risk of disorderly adjustment.

At the same time, many non-U.S. equity markets are starting from lower valuations, with a greater share of macro risk already priced in. By contrast, U.S. equities continue to trade at higher multiples and remain sensitive to the second-order effects of persistent inflation and higher real rates.

Macro Aware, but Bottom-Up Focused

For investors, the implication is less about broad risk aversion and more about relative positioning. It’s important to remain cognizant of the varying country risks in a world where energy is scarce in the near term, liquidity is now constrained globally, and the terms-of-trade are shifting. Funding resilience and the ability to weather tighter financial conditions may be more or less evident depending on foreign exchange reserves and external debt levels, as well as current account balances and the overall credibility of a country’s policy framework.

As active, bottom-up investors, it is even more crucial to focus capital on those companies that can prove resilient during market squalls and even improve their competitive positions once the storm passes – a characteristic we refer to as a resilient foundation. Broad market volatility often causes securities prices to diverge from their business fundamentals, creating meaningful opportunities with a high margin of safety over a reasonable time horizon.

We’re seeing those opportunities emerge across non-U.S. and emerging markets. Europe’s experience over the last four years speaks to the benefit of continued diversification, especially given the still challenging valuations in the U.S. relative to non-U.S. equities.

To be sure, we do expect the risk premium in the Middle East to remain elevated for the foreseeable future. The conflict provides further evidence for the continued self-reliance initiatives in Europe, Asia and the U.S., that have all been driven by periodic hostilities not just around the Persian Gulf, but also in the ongoing war in Eastern Europe and in economic feuds involving supply chains, tariffs and broader trade wars. Oil and gas flows as well as critical minerals and metals clearly can’t be taken for granted anymore.

Once the conflict in the Persian Gulf cools down, demand for U.S. assets and the dollar will decrease and global liquidity will expand again. That will clear the way for the strong fundamentals of many attractively priced non-U.S. companies to drive returns again, just as they did in 2025, before the latest war began.