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Beyond Ratings Weekly Digest

Your briefing on augmented financial risk analysis

N°136 ▪ 08th March 2018

Beyond Ratings Launches Credit Rating Agency in Line With Paris Agreement and European Commission’s Sustainable Action Plan

On Tuesday, March 6th 2018, Beyond Ratings announced the creation of the first financial rating agency to systematically integrate ESG factors (Environmental, Social and Governance) into its analysis, making it the first credit rating agency to be aligned with the goals of the Paris Agreement.  The creation of the agency is supported by major institutional players, such as l’Agence Française de Développement (AFD), Caisse des Dépôts Group and le Fonds Français pour l’Environnement Mondial (FFEM), along with several leading global organizations dealing with sustainable development issues including Climate-KIC, the Ethos Foundation, and the Global Footprint Network.

As Beyond Ratings co-founder and CEO Rodolphe Bocquet affirmed, “we have been working on this ambitious project since 2016 and we are pleased to see it materialise as institutions agree on the need for a consensual alternative measure to the traditional ratings market”. The publication of the European Commission’s Sustainable Finance Action Plan today confirms our convictions, as it demonstrates a strong interest at the European level for the emergence of new actors in the credit ratings market that are able to translate sustainability and ESG risks into financial analyses.

Indeed, the EC Sustainable Finance Action Plan highlights the importance of credit ratings in ensuring well-functioning financial markets, and “acknowledges the need for greater understanding of and transparency about how credit rating agencies take sustainability factors into account”. What’s more, the Action Plan states that the “Commission will also continue engaging on those issues with all relevant stakeholders, including as regards the possible emergence of new credit rating agencies that would meet this objective” (emphasis added).

The Sustainable Finance Action Plan builds on the recommendations of the High Level Expert Group (HLEG) on Sustainable Finance, which published a final report on January 31st, 2018. Among their recommendations, the HLEG report specifically highlighted that “CRAs should systematically integrate relevant ESG factors and factors related to longer term sustainability into their credit risk analysis and credit ratings”.

These recommendations have been picked up by the European Commission in its Sustainable Finance Action Plan, which includes a dedicated action items on better integrating sustainability into credit ratings and market research. Beyond Ratings welcomes these measures, which confirm our mission and raison d’être. We are confident that 2018 will be the year we can make credit ratings great again!


Interest rates normalization and the US tax reform are changing oil perspectives

We have repeatedly argued on the unsustainable nature of shale industry development in the United States. While the vast majority of observers and analysts were unreservedly enthusiastic about the so-called new technological and economic paradigm of the oil industry, we emphasized the indisputable fact that the whole sector has accumulated a recurring operating deficit of about 25 to 30 billion USD a year since its inception about a decade ago. It is worth recalling the two decisive factors that presided over this so-called “revolution”.

First, the American oil sector’s incomparable capacity for initiative-taking, composed of a very wide variety of actors and companies. Among them, a myriad of entrepreneurs, each operating at a very limited geographical scale but with the highest experience on the ground that allows them to take the boldest initiatives, such as the adaptation of horizontal drilling and hydraulic fracturing techniques. The birth of the shale industry in the United States is fundamentally a result of entrepreneurial temperament and risk-taking, far more than any technological innovation. The role of the big oil companies in the development of the shale industry has been secondary or even marginal. Second, at the risk of repeating ourselves to our most loyal customers and readers, we maintain that the monetary and financial context, born of the 2007/2008 crisis and characterized by an abundance of capital and the unprecedented nominal and real interest rates, has been the sine qua non condition for the development and growth of a sector that has never achieved positive cash flows, even in the favorable oil price contexts of close to 100 USD between 2011 and 2014. At the end of 2017, we estimate the cumulative operating loss of the entire sector at approximately 300 billion USD since 2008, or about 8% of the increase in the balance sheet of the FED over the same period.

In the last few months, investors have finally begun to make dissonant voices heard and to demand a change in the strategy of companies exploiting shale oil & gas resources. After the race to grow production at any cost, the priority seems to shift in favor of return on investment. The normalization of the interest rate curve, initiated by the FED but more obvious on long-term interest rates, is not unrelated to this. The rise in interest rates announced by monetary authorities in the United States and in the world is sufficient to gradually change the economic conditions that are at the origin of the oil overproduction phase that was at first amplified, then fought against, by Saudi Arabia and other OPEC producers. But it is possible that the question posed by the shale industry’s decade-long development that ran contrary to the economic fundamentals of the conventional oil industry finds an answer more quickly than under the sole action of the rise in interest rates. Unexpectedly, the tax reform approved by the US Congress on December 22, 2017 contains such provisions. If the reduction in the general corporate tax rate from 35% to 21% is obviously in line with the interests of the oil industry as a whole, the provisions limiting the deductibility of interest charges and removing the ability to carryback net operating losses are undoubtedly negative factors for companies in the shale industry which, still do not generate positive cash flows and are heavily indebted. The combination of these tax reform provisions, the rise in interest rates and the foreseeable increase in production costs following the recent protection measure of the US steel market (key item of equipment and infrastructure costs of the oil and gas industry), announces a profound change, if not an upheaval, in the economic and financial framework of the shale industry. Many small- and medium-sized companies will inevitably be absorbed by large players: “Big Oil” will be the main beneficiary of the ongoing change. But the repercussions will probably be profound. On the one hand, the cost structure of large oil companies is higher than that of small entrepreneurs. The actual breakeven point of the entire shale oil sector is already well over 100 USD, well above the commonly accepted but false values ​​of 50 to 60 USD. All things being equal, the break-even point in shale oil & gas production will increase further. On the other hand, the reduction in the number of small entrepreneurs will reduce the sector’s capacity for initiative-taking, precisely at a time when uncertainties are accumulating about the future potential of source rocks and the existence of sweet spots (the most productive areas).

The oil outlook is changing in the United States in the direction of a stagnation of production and a reality check on real production costs. There are more reasons to doubt than to endorse the IEA’s peremptory assertion that “Over the next three years, gains from the United States alone will cover 80% of the world’s demand growth” (Oil 2018 Report, IEA). In the context of the structural weakness of the potential for conventional oil discoveries worldwide confirmed year after year (Rystad Energy Press Release, 2017), the current consensus of a global oil market characterized by a lasting excess of supply and a low price is called into question.

Olivier Rech, Head of Energy-Climate Research



Sovereign Risk

Closely watch the oil price, inflation could come back faster than expected!

Changes in oil prices in recent years have strongly affected the evolution of consumer prices in France and the Eurozone. The movements in oil prices (see chart below) are transmitted very quickly to inflation via the energy component of the HICP (Harmonized consumer price index) which represents c. 9% of the total index both in France and the Eurozone). This component includes the price of fuel and oil heating, which react directly to the price of a barrel of crude oil. Economic analysis tools make it possible to quantify the direct impact of the oil prices on HICP inflation via this energy component. According to the Banque de France, an increase of EUR 10 per barrel of Brent crude oil has a direct and very rapid impact – in less than one quarter – of 0.3 point for the Eurozone and 0.25 point for France on the headline HICP. It should also be noted that the existence of taxes on volumes, and not on the value of energy consumption, acts as a buffer shock on the change in the final energy price.

Oil price and energy component of the HICP in France and the Eurozone (YoY %)

However, the transmission of changes in oil prices does not stop there. Indeed, oil enters the production of many goods and services, such as chemistry or air transport. It therefore indirectly affects non-energy inflation. According to the Banque de France, this indirect effect is 0.1 point in the Eurozone and 0.15 point in France.

Sources: Beyond Ratings, Insee


How unequal are women?

Gender Inequality Index (world)

The Gender Inequality Index (GII) reflects gender-based disadvantage in three dimensions: reproductive health, empowerment, and the labour market. It ranges from 0 (where women and men fare equally) to 1 (where one gender fares as poorly as possible in all measured dimensions) and provides some useful context to the imperfect Human Development Index (HDI).  For example, the GII reveals that, despite a better HDI, the USA is much more unequal than China from a gender point of view. Similarly, Qatar and Portugal reached almost the same HDI level despite a huge difference in terms of gender inequality. In 2015, World Bank published a study showing a strong inverse relationship between gender inequality and growth, and that causality is not just due to disparities in education levels. This should encourage policy makers to invest in decreasing gender inequality as a means of fostering growth.

Good news for growth (and secondarily for women) GII plunges from 0.51 in 1995 to 0.36 in 2015…equality is on track!

Sources: Beyond Ratings, UNDP, Gender Inequality and Growth (WB)

Carbon/Climate Change

European Greenhouse Gas Emissions Reductions: a mixed bag

2010-2015 evolution of GHG emissions in EU-28 countries (territorial, excl. LULUCF, top 5 emitters in bold)

Today we wished to highlight the 2010-2015 evolution of greenhouse gas (GHG) emissions in the European Union. A positive fact is that, in recent years, emissions have decreased in almost all EU-28 countries. However, notable disparities are to be observed regarding the magnitude of the evolution, with decreases of more than 20% in Denmark, Malta and Finland, but rather stable emissions in Portugal or Ireland. If we map evolution levels with the carbon intensities of GDP, we see that emissions tend to decrease less in the countries that have the highest GHG intensities (mainly Eastern European countries). However, carbon issues are also related to size and, among top emitters, only Poland distinguishes itself due to its high carbon intensity. It remains that Italy and the UK stood out in terms of emissions reductions over 2010-2015 based on total emissions. It should be noted that we only looked here at emissions without LULUCF (land use, land use change and forestry) and without imported emissions. Although there is no close relationship between carbon intensities and carbon emission trends, it is interesting to note that these trends can be a key differentiating factor when analysing country exposure to carbon risk.

Sources: Beyond Ratings, Eurostat


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Photo credit via Visualhunt/CC BY-SA or other: Front page ▪ Credit 1: CECAR – Climate and Ecosystems Change Adaptation R; Credit 2: Tony Webster; Credit 3: Kiefer.; Crédit 4: NASA Goddard Photo and Video / Research notes ▪ Credit 1: DnDavis (via; Credit 2: zhu difeng (via Fotolia); Credit 3: Mny-Jhee (via Fotolia); Credit 4: xmentoys (via Fotolia)


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