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Beyond Ratings Weekly Digest

Your briefing on augmented financial risk analysis

N°129 ▪ 18th January 2018



From economy to geopolitics: the far-reaching implications of quantitative easing monetary policies

It is now accepted that the world order that seemed to be emerging in the early 2000s following the disappearance of the Soviet Union is obsolete. The advent of a multipolar world is driven by the emergence and, if we place ourselves in a centuries-old historical perspective, by the rebirth of powers that combine demographic weight, economic vitality and autonomy in international relations. The Syrian crisis in recent years illustrates the fact that a growing number of actors are able to play a part in the international balance of power, either directly or indirectly through alliances, historical or circumstantial. In addition to the turmoil affecting the Middle East, the restoration of Russia as a major diplomatic and military actor, the confirmation of China as a systemic economic actor, a more discreet initiative has taken shape over the last eighteen months: The Three Seas initiative. Supported by Poland and, to a lesser extent, Croatia, the Three Seas Initiative aims to bring together countries covering the continental space between the Baltic, Adriatic and Black Seas in an informal setting.

Twelve countries have already participated in the first two meetings held in August 2016 and July 2017. The objective displayed by the promoters of the Initiative is to associate the Balkan countries as well as Ukraine. The demographic mass of the whole, ranging from 112 million inhabitants for the first twelve countries to 127 million for the sixteen countries, and up to 172 million including Ukraine, appears consistent with the objective of establishing a continuous zone to counterweight Germany in the West and Russia in the East. The levers for the integration of this area, generally perceived as the periphery of Europe, are the transport, road and rail, and energy infrastructures. The concerted development of energy infrastructures and interconnections is a classic element of territorial integration, as European policy has shown for several decades. But the Three Seas Initiative also has the explicit ambition of significantly changing the source of energy supplies for all member countries and reducing an excessive dependence on Russia, at least considered as such by Poland.

We will not discuss the Polish position in its sovereign relations with Russia and, to a lesser extent, with Germany, but the decisive element which largely underlies the edifice of the Three Seas Initiative. The support given by President Trump in July 2017 for the second meeting held in Warsaw leaves no room for doubt: the energy diversification of the member countries of the Initiative would rely mainly on LNG imports from United States where gas production is now largely unconventional, resulting from source rocks. If peremptory assertions and highly promising and spectacular scenarios have been prevailing across the globe for the past decade, the economic equation of the shale gas revolution born in the United States is still not demonstrated. Multiple alerts on companies’ financial positions and preliminary aggregate data support the fact that the entire shale sector, including gas and liquids, again experienced a massive negative cash flow in 2017, comparable in magnitude to those observed in previous years (between 15 and 20 billion USD). The low price of gas in the United States remains a price reflecting artificial oversupply. After several years of disbelief from most observers, the link between the highly accommodating monetary policy by historical standards and cash negative hydrocarbon production in the United States, is finally acknowledged. Based on the number of liquefaction capacity projects, growth potential of US LNG exports (around 75 billion m3 per year) appears to be compatible in order of magnitude with the net gas imports of the twelve countries of the Three Seas Initiative plus the four Balkan countries (about 45 billion m3 per year). Nevertheless, the economic analysis of the sector leaves no doubt: even with an artificially low domestic price as has been the case since 2009, the price of LNG exported from the United States does not compete with that of Russian exports by pipeline. If this were the case, there is no doubt that the terms of the recently signed first export contract from the United States to Poland, with deliveries planned from 2018, would have been disclosed and widely commented.

The Three Seas Initiative will certainly have positive results in terms of infrastructure development. On the other hand, if the proposed gas strategy is confirmed, the foreign trade of its member countries will be severely impacted, it may increase the cost of gas supply for the Western European countries and the integrity of the European continent will be dangerously threatened. Some research in economics rightly argues, contrary to the neo-classical doctrine, that monetary creation is not neutral and drives the evolution of private and public debt. The implications are in fact much deeper: monetary creation is a strategic lever that may affect the geopolitical landscape and modify risk profiles of states. The Three Seas Initiative is one example.

Olivier Rech, Head of Energy-Climate research



Sovereign Risk

Is Dagong right about United States creditworthiness?

On Tuesday January 16th, China’s Dagong Global Credit Rating Co downgraded the United States sovereign rating to BBB+ from A-, and just to make sure the message is heard loud and clear, this rating comes with a negative outlook. The United Sates are now at the same level as Peru, Colombia and Turkmenistan on Dagong’s scale or as Thailand, Mexico and Spain on Standard & Poor’s scale.

Below are some takeaways from Dagong’s statement:

“Deficiencies in the current U.S. political ecology make it difficult for the efficient administration of the federal government, so the national economic development derails from the right track”.

“Massive tax cuts directly reduce the federal government’s sources of debt repayment, therefore further weakens the base of government’s debt repayment”.

“The virtual solvency of the federal government would be likely to become the detonator of the next financial crisis”.

Overall, we think that BBB+ does not reflect the fundamentals of the United States any more than AAA or even AA+. These very different ratings are far more political than fundamental. Indeed, for the three U.S. based credit rating agencies (CRAs), it is easy to understand why the country still enjoys top ratings. As for the China based CRA, we must keep in mind that China is one of the biggest holders of U.S. Treasuries (c. USD 1.2 trillion) and to limit systemic risk, we should see China stopping purchases of U.S. Treasuries in favour of European and emerging market’s debt. The truth is certainly between the two, but this downgrade is enough to relieve worries about a trade war between the world’s two largest economies… In the meantime, if one of the big three CRAs would downgrade the United States, it would have dire consequences on all financial markets, especially in the country of Uncle Sam..

Sources: Beyond Ratings, Reuters



Close the gap

Male/female salary and working hours gaps (2016)

A new law requiring Iceland’s biggest companies (public or private over 25 employees) to prove that they offer men and women equal pay went into effect on January 1, 2018. Each company has a prove or pay approach and may have to pay a daily fine if not compliant. All other factors being equal, it is quite challengjng to prove that wages are equivalent for male and female employees at the company level, but at country level, it is a nightmare to benchmark each others performance. The creation of an accurate index to rank countries requires the control of parameters such as education, age structure of workers per sex, economy breakdown and actual working hours per sex from a top-down approach (surveys would be too costly of an option from a bottom-up perspective) but, whatever the solution, it still fails to evaluate priceless domestic tasks mainly performed by women, in Iceland and elsewhere.

Sources: Beyond Ratings, ILO


Carbon/Climate Change

Germany: which objectives for climate policy?


GHG Emissions vs. Actual INDC* (Mt CO2 eq.)

While negotiations have begun in recent weeks between German Chancellor Angela Merkel and Martin Schulz, the local press has echoed a possible and worrying abandonment of the country’s climate policy. The Christian Democratic Party (CDU) and the German Social Democratic Party (SPD) were supposed, according to these firsts dealings, to abandon the current goal of reducing CO2 emissions by 40% by 2020 compared to 1990, replaced by a new target of a 55% reduction by 2030. But in the agreement text to come out of this week’s negotiations, there is no longer any mention of delaying the target. “We commit to the climate targets 2020, 2030 and 2050,” it reads. “We want to close the action-gap to reach the 2020 climate target as fast as possible”. The reasons for such a procrastination in the country’s climate policy could come from the economic importance of coal-fired power plants in Länder with high electoral potential for the SPD (North Rhine-Westphalia, Brandenburg, Saxony and Saxony-Anhalt). Indeed, coal-fired power plants still account for nearly 40% of the country’s electricity production, as they partly replaced the stopping of nuclear power plants, following the German nuclear exit decommissioning in 2011 after the Fukushima accident. The chart below already shows a net shutdown of the GHG emissions reduction process following this decision and highlights the fact that whether Germany keeps its first objective in place or not, it is still unlikely to meet it.

Sources: UNFCCC, World Bank, Beyond Ratings

*National source





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