Energy, Politics & Money - 21 March 2023
Independent, objective, and politically neutral analysis of global developments curated from sources covering the world of energy, geopolitics, and money.
In this roundup, we take a step back to take a look at the UBS – Credit Suisse merger from a wider angle and assess where the world is likely headed. What we need to acknowledge is that the merger did not solve the many problems facing Credit Suisse (or the banking industry). It just handed them to UBS which, because it is bigger and more profitable, can carry these problems more easily. But it did not resolve these issues.
The forced merger does solve a short-term problem, i.e. the uncontrolled collapse of Credit Suisse. But it creates a whole new set of problems, such as even greater concentration in the banking sector. In addition, the decision to favor shareholders to the detriment of bond investors created panic in the bond market.
In short, EPM’s assessment is that the current financial crisis is far from over – which is evidenced also by the frantic efforts to keep First Republic bank in the US afloat by both the US baking industry and the US Treasury secretary. And of course, the longer it lasts, the bigger its impact will be on the real economy.
Furthermore, we look at:
The oil price, which has stabilized as traders look forward to Wednesday’s Fed announcement regarding the base interest rate
Pierre Andurand’s forecast for $140 oil by year end
The chaos in Asia caused by the Swiss authorities’ decision to write off $17 billion in AT1 bonds of Credit Suisse
The longer term DNV outlook for energy, including oil and gas, which concludes the developing world is likely to offset declines in energy use in the developed world
The desperate efforts by the US financial industry to prevent First Republic bank from collapsing
The socio-political dimension to the financial crisis story, which is that the general public seems unwilling to accept bailouts of financial institutions as occurred in 2008, as evidenced by protests in Switzerland against the UBS – Credit Suisse merger, which effectively limits what authorities can do in case the crisis were to escalate
China’s lowering of reserve requirement ratio for banks, a preemptive move to manage any spillover from the rising financial uncertainties in the US and Europe
General Energy News
Oil rose on Tuesday, a recovery from a 15-month low hit on Monday, as the rescue of Credit Suisse eased worries about global banking sector risks that could hit economic growth and fuel demand, writes Reuters. Brent crude was up 52 cents, or 0.7%, at $74.31 per barrel and WTI also gained 52 cents, or 0.8%, trading at $68.16. The next focus for investors is the decision by the US Federal Reserve on Wednesday on whether and by how much to raise interest rates when it concludes its two-day meeting.
EPM’s perspective is that the Fed decision should probably be neither too much nor too little to avoid a further drop in oil prices. If it sticks to the earlier expected 0.5% increase, most likely the market will worry the Fed underestimates the financial crisis, which would cause a sell off. If it decides to not raise rates, most likely the market will worry that the financial crisis is worse than thought, which would also cause a sell off. A 0.25% rise is probably required to maintain current oil price levels.
The recent fall in oil prices due to banking jitters is speculative and oil will hit $140 a barrel by the end of the year, hedge fund manager Pierre Andurand said according to Reuters. At the same time, electric vehicles will eventually sap gasoline demand and cause oil demand growth to slow in the coming years, as a result of which he expects demand will peak around 2030.
Looking further ahead, an opinion piece at Reuters says, based on DNV data, that while China, the United States and Europe have been the main sources of economic growth and pollution for the past century, accounting for over half of all historic carbon dioxide (CO2) emissions and energy use, the Indian subcontinent, Southeast Asia and Sub-Saharan Africa are set to overtake them as the key drivers of world energy use through 2050. Countries including India, Indonesia, and Nigeria will boost their collective consumption of primary energy supplies - which includes transport fuels - by nearly 60% through 2050. This will more than offset the expected contraction in energy consumption in China, Europe and North America. Most Asian and African countries will remain overwhelmingly reliant on fossil fuels for at least the next decade, meaning the heavy emissions hubs from mainly in China and South Asia currently will shift to parts of Southeast Asia and lower Africa, undermining efforts to cap pollution totals in all areas.
Meanwhile, Bloomberg reports that Russia has surpassed Saudi Arabia as China’s biggest oil supplier, as refiners took advantage of cheap barrels to feed rebounding demand in Asia’s biggest economy following the end of Covid Zero. The Asian nation imported 7.69 million tons of crude from Russia last month, or 2 million barrels a day, according to Chinese customs data. Flows from Saudi Arabia slipped to the lowest level since June, down 29% from January.
Macroeconomics
Reuters takes a step back to look at the UBS – Credit Suisse merger from a wider angle. The merger, forced upon both companies by Swiss authorities, goes against one of the key lessons of the 2008 financial crisis, it says, as it concentrates even greater risks into one banking behemoth, UBS.
From EPM’s perspective this was a case of managing the short-term (preventing an uncontrolled collapse of Credit Suisse, which would have been the equivalent of a nuclear explosion deep inside the world of finance) at the expense of the longer term (no fundamental solution to the problems of Credit Suisse, just adding them together with USB to make them less prominent). We hope there is a plan also to really deal with the Credit Suisse problems USB has now inherited, otherwise the current “reshuffling of Credit Suisse problems” will cause problems for UBS on another day. Additionally, Reuters says, the way the merger was organized upended global finance, as it favored shareholders to the detriment of bond investors.
This, as we noted yesterday at EPM, has created a new problem for global finance, as it caused everyone in the bond market to re-evaluate positions – which in instances such as these usually means a panicked rush to the door. This element of the overall deal had added to the problems in global finance, in other words.
Yesterday we discussed how the decision by the Swiss authorities to write off $17 billion in AT1 bonds of Credit Suisse was causing panic in the financial market. Nikkei Asia reports that on Monday, it led to an intensification of the sell-off in Asian financial shares, that had originally started with the SVB collapse, as AT1 bonds are particularly popular with wealthy individuals in Asia due to their relatively higher returns and perceived low risk of principal loss.
Japan’s leading lenders -- Mitsubishi UFJ Financial Group, Sumitomo Mitsui Financial Group and Mizuho Financial Group -- all declined by around 2% on Monday, following losses of more than 10% last week in the immediate aftermath of the American bank’s collapse. The Hong Kong-listed shares of UK based HSBC Holdings and Standard Chartered dropped by 6% and 7%, respectively, while other major lenders in the city, such as Bank of East Asia and HSBC subsidiary Hang Seng Bank, slid by around 5% and 3% from their Friday close.
Investors believe this financial crisis is far from over, writes Reuters, as risk indicators remain at elevated levels. An indicator of credit-risk in the euro zone banking system, the so-called FRA-OIS spread measuring the gap between the euro zone three-month forward rate agreement and the overnight index swap rate, hit its highest levels since mid-July last week. The cost of insuring exposure to European junk bonds also rose to the highest since mid-November. In the US junk spreads, the premium investors demand to hold the riskier debt over US Treasuries, rose to the highest since October last year, as did investment grade credit spreads, which indicate the premium investors demand to hold highly rated corporate bonds over safer US Treasuries. Lastly, the ICE BofAML MOVE Index, a measure of expected volatility in US Treasuries, surged to its highest level since the financial crisis.
Further evidence that things are not over yet is First Republic bank in the US. It has already received a $30 billion bailout package from the big banks in America, but remains in trouble. On Monday its shares crashed 47%, and in response JPMorgan Chase’s CEO Jamie Dimon is leading discussions with Chief Executives of other big banks about another bailout writes the Wall Street Journal. Ratings agency S&P Global downgraded First Republic deeper into junk status, citing persistent risks to the lender's liquidity, which will not make the rescue operation any easier of course.
Janet Yellen will signal further US government backing for deposits at smaller American banks if needed, the Financial Times reports. Amid mounting evidence that panicked depositors are pulling savings out of regional banks, the US Treasury secretary is expected to announce that guarantees offered to all depositors at the failed Silicon Valley Bank will be replicated at other institutions if needed.
There is a socio-political dimension to this story also, which we at EPM wish to highlight. The Swiss government pledged to make as much as 109 billion francs available to make the UBS – Credit Suisse merger happen. On top of that, there’s a guarantee from the Swiss National Bank of 100 billion francs that isn’t backed by a government guarantee. To put this into context, the pledge equates to 13,500 francs per Swiss, writes Bloomberg. The combined sum of 209 billion francs is equivalent to about a quarter of Switzerland’s gross domestic product and exceeds total European defense spending in 2021. The price tag for Switzerland’s largest ever corporate rescue could add up to more than three times the 60 billion-franc bailout of UBS in 2008.
With the 2008 fresh in mind, there is a public push back in Switzerland against the merger, writes Bloomberg. About 200 protesters gathered outside Credit Suisse headquarters in Zurich following the bank’s collapse. The demonstrators, chanting “revolution” and “eat the rich,” threw eggs at the building. The EPM perspective on this is that public sentiment globally is much less likely today to support bailouts of financial institutions than they were in 2008 – where we would like to note that 2008 caused the global Occupy movement. This public push back will limit what authorities can do if the current crisis were to spiral out of control.
Seeing what’s happening in the western world, and the markets in Asia closely connected to those of the western world, China, which has not gone through a period of raising interest rates, yesterday announced it will lower the reserve requirement ratio (RRR) for financial institutions by 0.25 percentage point. Nikkei Asia reports this will pump 500 billion to 600 billion yuan ($72.6 billion to $87.2 billion) of liquidity into the financial markets. Chinese officials appear to be watchful for any spillover from the rising financial uncertainties in the US and Europe, Nikkei says, who sees this move as preemptive.