Global macroeconomic Energy Transitionmeets

Sovereign Credit Rating Evolution

What scenarios ?7th February 2014

Key issues addressed:• Why does mainstream finance

underestimate energy and climate issues?

• The come-back of sovereign risks

• RISKERGY’s innovative approach of Sovereigns financial rating

• Scenarios

1. Mainstream finance underestimates energy and climate financial materiality

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

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

1. Forward oil prices are artificially low

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

1. CO2 emission rights prices are not incentives

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

Increased volatility weighs on investments decision

and their profitability

1. Energy impact on GDP growth is underestimated

Emerging hedging strategies on oil import/export for Sovereigns facing

increased price volatility

1. Energy impact on GDP growth is underestimated

2. The come-back of sovereign risks

2. Sovereign risk is key to credit risk assessment

Sovereign bonds account for 41% of global international bonds issues (outstanding amount of 41000 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

2. Sovereign risk is key to credit risk assessment

Sovereign debt impact

Sovereign debt volume

Sovereign debt maturity < EOTW

Sovereign debt currency

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)

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) (What “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 economy’s output and the financial robustness of the state budget are not explicitly taken into account

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,2013

2. Energy subsidies dangerously weigh on primary balances

Ex post correlation between financial ratings and energy dependency ratio

1 2 3

-40%

-20%

0%

20%

40%

60%

80%

14% 0%

-27%

69%

47%

16%

Var. médiane des nota-tions janv.04-févr.12

Indépendance énergé-tique médiane 2004

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

3. RISKERGY’s innovative approach of sovereign financial ratings

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

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)

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

?

3. Global view of Riskergy’s approach

Scenarios and shocks

Supply

Demand

Regulation

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

3. RISKERGY energy performance indicators (1/2)

Energy dependence

Energy dependence ratioFood dependance 

ratioImports 

concentration

Strategic stocks

Energy demand growth

Energy return on energy investedExploitable fossil fuel reserves

Energy contribution to 

economic development

Access to energyEnergy intensityEnergy 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 productionEconomic exposure to 

extreme climate events

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 risksExternal factors

3. Our collaboration scheme

Academic research

Market access

Data management

Energy scenariosModel Hybridation:

macro economy and energy

Regional and national models

Rating methodology

validated by the Regulator: ESMA

Linkage between macro-economic and

monetary/fiscal models

OptimizationRegulatory

requirements and identification of client needs/expectations

Marketing and decision making

toolsFund raising Relations with

international instituionnal investors

4. Scenarios and Riskergy

4. Scenarios

Big3 methodologies Regulation guidelines RISKERGY R&D

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

4. Institutional forecast : IMF

4. Institutional forecast : IMF (2)

IMF Forecast : ALPLBT model bias

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

ESMA methodology guidelines … but not for scenarios !

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

4. RISKERGY scenario options (Work in progress)

Oil Diagnosis x CoalDiagnosis 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

Thanks for you attention

Michel LEPETIT, michel.lepetit@riskergy.com, 06-03-26-93-18Rodolphe BOCQUET, rodolphe.bocquet@riskergy.com , 06-34-18-73-97

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