From the perspective of the US energy business, the European debt crisis can feel very far away.
The impacts of ongoing sovereign debt debates are felt first in markets for government bonds and currencies; one can only guess what the extent will be of ramifications on government commitments to clean energy or business activity levels in developed and emerging economies.
But as the financial crisis showed, the interlinked and leveraged nature of contemporary finance gives market crises a whack-a-mole feel: suppressing damaging volatility in one market creates unexpected problems in another.
Today, a California homeowner defaults and Iceland goes bankrupt.
The energy sector escaped much of the impact of the early iterations of the financial crisis, now grinding into its fifth year, but this time around the escape may not be so easy or obvious. A conservative approach to financing following the collapse of Enron, strong demand for commodities and related products from China and other emerging economies, and hundreds of billions of dollars in support from the US stimulus and associated programs, muffled for energy companies the impact of financial shakeups that brought down banks, carmakers and governments in recent years.
But a combination of specific problems impacting institutions with deep exposure to energy trading, a foreign-currency crunch in Asia and the prospect for accelerated rebalancing of the global commodity economy as domestic US energy production expands, is expected to ripple across the energy business and analysts preparing 2012 outlooks are issuing warnings for the sector.
In the most immediate future, European banks will be pulling back on lending and trading activities that provide liquidity to both exchange-traded energy markets and bilateral energy commodities trade in the US.
French banks like Societe General and Credit Agricole have been major players in global energy markets, and the European sovereign debt crisis has forced them to take off risk as they face turmoil in both the markets for government bonds and shrinking short-term lending between banks.
The short-term bank lending in the so-called “repo” or “overnight” markets is the lubricant that keeps cash flowing through the financial system and its lockup can threaten the very existence of financial institutions.
Threats to repo lending brought down Bear Stearns and were at the heart of the financial crisis that brought down Lehman Brothers and triggered the broader recession.
With European banks conserving capital in an effort to avoid a replay of September 2008, cutting exposure to energy trading and energy lending is an obvious way to keep money inside the institution.
This month alone both SocGen and Credit Agricole have announced they will shutter the majority of their US energy trading operations, reducing the need to put up huge amounts of collateral to maintain trading positions. The banks also lend money to other financial groups that provide liquidity to energy markets and fund energy companies, including hedge funds.
In Barclays Capital’s 2012 outlook, analysts cite recent data indicating hedge fund positions in all commodities, including energy, have been pared back sharply since the middle of 2011.
One stage removed from the immediate threat of a liquidity crisis in energy trading and lending is the potential for a slowdown in trade originating from Asian countries, particularly China, as manufacturers there seek new ways to finance deliveries of solar panels, windmills and other energy components to international customers.
European banks are major suppliers of dollars to Asian manufacturers and exporters face limitations in accessing their own currency because of capital controls.
The amount of financing pulled in the current crisis could hit $390 billion based on previous trends, recent analysis by Reuters BreakingViews estimates, and includes a 50% increase in the cost of borrowing in Asia since the middle of 2011 as part of the impact from retreating European banks. This trade finance issue is similar to the problem facing energy market players in the energy trading space, but with a longer tail and a broader set of potential outcomes.
If Chinese solar panel manufacturers find themselves unable to ship cheap solar components to the US, will US solar companies turn to domestic providers and pay higher prices in a tightening market? Sinovel, a Chinese firm, is by some estimates now the world’s second largest wind company; without access to dollars its export-oriented business growth plans could be dealt a blow in 2012.
As in all crises, some firms would benefit and others suffer, but the sector already faces widespread uncertainty in financing and building projects that use Chinese and other Asia-sourced components, and a slate of cancellations or delays would do little to boost the industry or the broader economy.
Weight Of The World
The European crisis could help accelerate an ongoing rebalance in the world’s economy, the head of commodities at the Bank of America Merrill Lynch argued this week, with increased domestic US production of natural gas and oil lending tailwinds to the trend.
“The world cannot keep accumulating claims on US assets indefinitely,” head of Global Commodities and Multi-Asset Strategy Francisco Blanch said in presenting the bank’s 2012 commodities outlook as part of a broader presentation called “When Europe Sneezes.”
An unwinding of the global imbalance, in which developed countries take on debt to acquire goods and commodities from emerging markets, has already begun in the manufacturing sector and now shows signs of spreading to commodities, including energy, Blanch said.
While volatility will remain the trend in 2012, Blanch expects light at the end of the tunnel for the US economy because of increased energy production from shales, underlining the potential for winners as well as losers from a European debt-triggered market shift. Shale oil production increases have been “phenomenal” the bank said, and Blanch predicts that production will provide a tail wind for the US economy over the next 3-5 years, building on still-growing production from natural gas shales that has contributed to economic growth over the past 2-3 years.
The energy sector has been agitating for change for years as it seeks to rebuild and grow. Its challenge in 2012 may be to navigate that change as it stems from an unexpected source.
This Breaking Energy Comment reflects the views of the author alone, in this case, Breaking Energy Managing Editor Peter Gardett. Join the Breaking Energy discussion by leaving a comment below or joining a conversation on our Discussions page.
Photo Caption: A trader works on the floor of the New York Stock Exchange on December 12, 2011 in New York City. Following fresh investor doubts about Europe’s debt crisis, the Dow Jones industrial average slid 162 points, or 1.3%.