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Global macroeconomic Energy Transition meets Sovereign Credit Rating Evolution What scenarios ? 7th February 2014.

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Presentation on theme: "Global macroeconomic Energy Transition meets Sovereign Credit Rating Evolution What scenarios ? 7th February 2014."— Presentation transcript:

1 Global macroeconomic Energy Transition meets Sovereign Credit Rating Evolution What scenarios ? 7th February 2014

2 Key issues addressed: Why does mainstream finance underestimate energy and climate issues? The come-back of sovereign risks RISKERGYs innovative approach of Sovereigns financial rating Scenarios

3 1. Mainstream finance underestimates energy and climate financial materiality

4 1. Three main market failures Oil price signal has proven to low No price signal on CO2 emissions Classic economy does not integrate energy as a wealth production factor

5 1. IEA has systematically sent a biased price signal on oil prices

6 1. Forward oil prices are artificially low

7 1. When there is a signal, it is not heard …

8 1. CO2 emission rights prices are not incentives

9 Strong shift in price trend for raw materials since 2000 Increased correlation of raw material prices with oil prices 1. Energy impact on GDP growth is underestimated

10 Increased volatility weighs on investments decision and their profitability 1. Energy impact on GDP growth is underestimated

11 Emerging hedging strategies on oil import/export for Sovereigns facing increased price volatility 1. Energy impact on GDP growth is underestimated

12 2. The come-back of sovereign risks

13 2. Sovereign risk is key to credit risk assessment Sovereign bonds account for 41% of global international bonds issues (outstanding amount of billion $) The financial crisis has further increased the link between sovereign credit risk and financial institutions credit risk Sovereign credit rating remains a ceiling for corporate credit rating. There has been a recent shift in market appreciation of sovereign risks: from no risk rate to potential default of OECD countries and emerging countries new instability Evolution in regulation are under way whereby OECD sovereign bonds will no longer bear zero risk for Capital Adequacy Ratio

14 2. Sovereign risk is key to credit risk assessment Sovereign debt impact Sovereign debt volume Sovereign debt maturity < EOTW Sovereign debt currency

15 2. Main limitations of current methodologies for assessing sovereign risks (Big 3) As underlined by the recent ESMA survey, to little expertise is dedicated to sovereign risks (low profitability of business model)

16 2. Main limitations of current methodologies for assessing sovereign risks (Big 3) Ratings eventually depend on a very limited number of criteria, GDP/Capita being one of the main driver (no anticipation on Irish crisis) (W hat Hides Behind Sovereign Debt Ratings? - António Afonso, Pedro Gomes, and Philipp Rother - November 2006) Ratings suffer from a strong inertia and sudden adjustments prove to have a pro-cyclical effect and to increase volatility Current methodologies are snapshots of few key indicators and do not integrate forward looking analysis, corresponding to long term risk drivers and average duration of sovereign bonds Energy and climate risks for the economys output and the financial robustness of the state budget are not explicitly taken into account

17 Energy subsidies amout to up to 3% of world GDP and 8% of total public spending Energy subisdies prove an obstacle to investments in key development sector such as health and education « The paper shows that for some countries the fiscal weight of energy subsidies is growing so large that budget deficits are becoming unmanageable and threaten the stability of the economy, », IMF, Energy Subsidy Reform - Lessons and Implications, Energy subsidies dangerously weigh on primary balances

18 Ex post correlation between financial ratings and energy dependency ratio Evolution of financial ratings and energy independance of 41 countries (18 EU, 20 other Europe + 3 row) : 2. Energy dependency and financial rating prove correlated, whereas current methodologies do not provide ex ante insight on this issue

19 3. RISKERGYs innovative approach of sovereign financial ratings

20 3. A collaborative research program 3,8M budget 36 months (april 2013 to april 2016) 4 firms, 3 research labs and Caisse des Dépôts Market oriented research aiming at developping a new commercial methodology for sovereign rating

21 3. Riskergy main objectives Develop macro-economic models linked with fiscal and monetary models, as support of forward looking analysis of sovereign solvency Integrate energy as a production factor: GDP= F(W,L,E) Develop a financial rating methodology compliant with ESMA requirements Identify early signals of financial risks linked with energy and climate resiliency of economies (enabling potential differenciation of issuers with equivalent ratings)

22 3. Our modeling approach: Supply shock (Fukushima, Ormuz, Irak, Lybia, Russian gaz …) Demand shock: +1% world GDP => + 0,7% oil consumption Voluntary regulation: carbon tax Climate change risks (floods, storms, droughts…) What if? Energy and or Climate shock Solvency ?

23 3. Global view of Riskergys approach Scenarios and shocks SupplyDemandRegulation Transmission Links Risk exposure Risk transmission Risk mitigation Sovereign risk sensitivity Economic performance Financial robustness Institutional strength Financial markets access and risks External factors Modeling Level 1: Poles Imaclim Level 2: National Macro-éco national Level 3: solvency and debt pricing Qualitative approach

24 3. RISKERGY energy performance indicators (1/2) Energy dependence Energy dependence ratio Food dependance ratio Imports concentration Strategic stocks Energy demand growth Energy return on energy invested Exploitable fossil fuel reserves Energy contribution to economic development Access to energy Energy intensity Energy subisdies Energy sector weight in GDP Energy R&D Ressources competition Energy Infrastructure reliability Energy consumption mix Quality of electricity (P,T,D) Climate vulnerability of electric sector Investments in new installed capacities Reform and adaptation capacity Gvtal measures towards low C economy Energy taxation scheme Investments in NRE Energy flexibility per usage Environmental performance GDP CO2 intensity Energy consumption per capita for transportation Legal environmental framework for energy production Economic exposure to extreme climate events

25 3. RISKERGY energy performance indicators (2/2) Energy dependence Energy dependence ratio … Energy contribution to economic development Access to energy … Energy Infrastructure reliability Energy consumption mix … Reform and adaptation capacity Gvtal measures towards low C economy … Environmental performance GDP CO2 intensity … Economic Performance Financial robustness Institutional strength Financial markets access and risks External factors

26 3. Our collaboration scheme Academic research Market access Data management Energy scenarios Model Hybridation: macro economy and energy Regional and national models Rating methodology validated by the Regulator: ESMA Linkage between macro-economic and monetary/fiscal models Optimization Regulatory requirements and identification of client needs/expectations Marketing and decision making tools Fund raising Relations with international instituionnal investors

27 4. Scenarios and Riskergy

28 4. Scenarios Big3 methodologies Regulation guidelines RISKERGY R&D

29 4. Big3 methodology is standard & poor Forecast : Current year + 2 years Mostly external scenarios (+ national scenario) Institutions : IMF / World Bank / OECD … Note : Interestingly in most institutional macroeconomic scenarios, the price of oil is a key element, often provided by IEA Market futures

30 4. Institutional forecast : IMF

31 4. Institutional forecast : IMF (2)

32 IMF Forecast : ALPLBT model bias

33 4. ESMA regulation => simple methodologies Data Availability Quality Traceability Methodology (but taking into account sovereign risk specificities) Comparability (but not between different asset classes) Robustness Scoring rating Qualitative analysis is mandatory Institutional analysis : the capacity to pay the will to pay

34 ESMA methodology guidelines … but not for scenarios !

35 4. RISKERGY scenario options (Work in progress) National policy IEA new policy scenario national options and not 450 scenario Infrastructure & long term evolutions are mostly given Qualitative analysis for climate issues : impact ; resilience

36 4. RISKERGY scenario options (Work in progress) Oil Diagnosis x Coal Diagnosis x Gas US Diagnosis x Gas UE Diagnosis x Gas Asia Diagnosis x National Electricity Diagnosis With Diagnostic = overcapacity / in equilibrium / undercapacity / stress Scenario choices 1 scenario BAU 1 scenario Oil :undercapacity 3-4 stress

37 Thanks for you attention Michel LEPETIT, Rodolphe BOCQUET,

38 2. Energy current account deficit is a driver of debt increase in a number of countries OPEC oil revenues 2012 > 1000 Mds $ French oil trade deficit in 2011 = 3,2% of GDP


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