Energy, Politics, & Money - 2023.08.18
Providing independent, objective, & neutral analysis of global developments curated from sources covering the world of energy, geopolitics, & investment.
In this roundup, we take a closer look at China’s real estate problems. The issue once again comes to the forefront as Evergrande files for bankruptcy protection in the US, while another developer, Soho, issued warnings for its future after a 93% decline in its profitability. This comes on the back of Country Garden, China’s biggest private developer by sales, missing interest payments on two international bonds.
What these real estate challenges indicate, in our view, is that China is dealing with a significant economic problem. Evergrande’s problems, and by extension the problems of China’s real estate sector, became known 18 months ago already. Clearly, the situation has not substantially improved since then.
At EPM we see this as a significant risk to the global economy. Fundamentally, its due to our view that the global economy walks a tightrope. We continue to believe the global wave of interest rate increases will cause a significant recession over the coming months (as historically the real economy responds to monetary measures with an 18 – 24-month lag).
As such, we believe China does not have the ability to absorb any additional shocks, especially in the form of the Chinese economy falling into recession. This is a real possibility, we believe, because the Chinese real estate issue is not isolated, the challenges they face are wide spread throughout the economy, and because the Chinese government is limited in what it can do. Moreover, real estate is the largest engine of Chinese economic growth, which means that if real estate grinds to a halt, so follows the entire Chinese economy.
Furthermore, we look at:
The end to the oil price’s seven-week winning streak, under the influence of China’s real estate problems
The US Federal Reserve’s view on the outlook for inflation, which indicates further rate hikes are ahead
The meeting between US president Biden and the presidents of South Korea and Japan at Camp David, and the US objective behind this diplomatic effort
The current oil demand impact of the global EV fleet, and its outlook – 20 million barrels per day by 2040
The WoodMac assessment that government targets to increase wind power installations are “unrealistic”
General Energy News
Oil prices looked set to end a seven-week winning streak, as concerns about China's slowing economic growth and the possibility of more US interest rate hikes outweighed signs of tightening supply, writes Reuters. Brent crude started Friday at $84.12 while WTI was at $80.61, some 3% lower than at the start of the week.
Macroeconomics
Some 18 months after the company first missed a debt repayment, China Evergrande Group has filed for bankruptcy in New York on Thursday, seeking to protect its US assets from creditors as it undergoes restructuring, writes Nikkei Asia. Evergrande filed for Chapter 15 protection, which is meant for insolvency cases involving non-U. S. companies and other cross-border parties. According to the filing, the company is also in the process of restructuring in Hong Kong, and the Cayman Islands. Evergrande subsidiary Tianji Holdings also filed for Chapter 15 protection with the New York Southern District bankruptcy court in Manhattan on Thursday.
In the EPM view, this is something to keep a close eye on!
Firstly, because in our view the global economy is walking a tightrope. Indeed, since the start of global fights against inflation through aggressive interest rate hikes, it has performed better than many expected, including EPM. But, we believe, that does not mean everything is well. In our assessment it typically takes 18 – 24 months for monetary tightening to start to affect the real economy. At the same time, global indebtedness is higher than it has ever been, while poverty is rising sharply even in the developed western economy. In this situation it does not require much to go from “better than expected” to “2008”. This is what the 2007 / 2008 period should have taught you.
Secondly, because Evergrande is the most indebted company in the world, with liabilities in excess of $300 billion. And bankruptcies when such values are at stake could well cause a domino effect.
Thirdly, because the role real estate plays in the Chinese economy, and the role the Chinese economy plays in the global economy. If things go really bad in China, considering the shaky foundation of the global economy, EPM believes this would create a economic problem worse than what we projected at the start of the unprecedented monetary tightening.
As to the third and last point, Nikkei Asia also reports that just hours after China Evergrande Group filed for bankruptcy, mainland developer Soho China disclosed a sharp fall in its profit and outlined its dire financial situation. Soho China, a Hong Kong-listed midsize developer that focuses on commercial estates, reported a net profit of 13.61 million yuan ($1.89 million) for the first six months of the year, down 93% from a year earlier. Soho China also warned of "material uncertainty" over its future due to an unpaid tax bill at a subsidiary. If Soho China is deemed to have defaulted on the tax payment, a portion of the company's bank borrowings with a total principal and interest value of 4.24 billion yuan will become due immediately.
In response to these development, Nikkei Asia has created an overview of China’s real estate situation. It highlights that the country is experiencing a broad decline in residential housing prices, and a decline in real estate investment, while the local and regional government debt levels are such that the ability for the central government to intervene through stimulus is hindered.
Earlier this week EPM discussed why the ability of the Chinese government to intervene is more limited today than during earlier periods. One reason was the massive amounts of debts left behind by earlier state interventions in times of economic stress, most recently during Covid but also before that during the 2008 Global Financial Crisis. The other reason was pressure on the Renminbi that would result in case of further debt creation. As to this point, the Chinese central bank is already intervening in the foreign exchange market to support the Chinese currency, writes the Financial Times.
Over in the US, Federal Reserve officials at their policy meeting in July largely remained concerned that inflation would fail to recede and that further interest-rate increases would be needed, writes Bloomberg. The most recent rate hike last July already brought the target range for the Fed’s benchmark rate to 5.25% to 5.5%, the highest level in 22 years.
Geopolitics
US president Biden will host the presidents of South Korea and Japan at Camp David today, writes Reuters. As EPM reported earlier, the objective of the US is to help the two countries overcome historic grievances, such that they can collaborate more effectively, under the US security umbrella, to counter the rise of China.
Climate Politics
Government targets to increase wind power installations would see annual capacity additions reach 80 gigawatts (GW) per year by 2030, requiring $100 billion in secured investment in the supply chain by 2026, Reuters writes based on a Wood Mackenzie report. More realistically, WoodMac says, is an annual capacity increase of 30 gigawatts (GW) a year by 2030, which would require $27 billion of secured investment by 2026. But, it says, "Nearly 80 GW of annual installations to meet all government targets is not realistic, even achieving our forecasted 30 GW in additions will prove unrealistic if there isn't immediate investment in the supply chain".
The Electrification of Transport
So far, the growing fleet of electric cars, vans, trucks and buses has displaced just a sliver of demand – 1.5 million barrels of oil per day in 2022. But batteries are on the march, writes BloombergNEF, and oil consumption displaced by EVs will rise to over 20 million barrels per day by 2040, it says. Demand for road fuels peaks at 49 million barrels per day in 2027. “From then on, demand begins to decline structurally, reaching 35 million barrels per day by 2040,” BNEF said in its most recent outlook.