Fuel for Thought – Aug 12th

12 Aug, 2011

Chinese inflation is a problem for energy prices: A disturbingly high 6.5% inflation number in China contributed to a week of turmoil in financial markets. Chinese stimulus in early 2009 played a substantial role in engineering a global recovery after the first leg of the global financial crisis. This time round China is leaning on the brakes rather than the accelerator. Marginal demand from China has been a key driver of rising global energy prices over the last two years as set out here. With China battling inflation against a backdrop of a rapid slowdown in global growth, the downside risks for energy prices are increasing.

But some prominent industry analysts don’t agree: Analytical teams at Goldman Sachs, Barclays Capital and a number of other investment banks remain very bullish on energy prices despite the increasing evidence of a global economic slowdown and a rise in systemic financial market risk.  Their supporting logic tends to be built around optimism about a sustained recovery in global growth, particularly in emerging economies, and the ability of policy makers to deal with problems in the banking system.  But as the clouds gather on the horizon it is interesting to note the repositioning of players in the oil market.

Bank stress signals problems for energy investors: Given the scale of energy infrastructure investment required in Europe this decade, it is concerning to see a dramatic increase in bank funding stress this week. The impact of the 2008 credit crunch on bank lending is surely still fresh in the minds of project developers.  In 2008 the problem was primarily driven by bad mortgage and commercial loans. This time round banks are suffering from the credit quality of the government bonds that they hold as capital. Either way, the impact on availability and cost of capital to energy investors is not going to make the infrastructure challenges facing European energy markets any easier.

E.ON  joins RWE in slashing profit forecasts: To round off a rather grim week, E.ON slashed its profit outlook and announced up to 11,000 job losses.  Next to bank financing, the commitment of capital from large balance sheet utilities is the other vital ingredient for European energy infrastructure investment. The fact that both E.ON and RWE are facing a more balance sheet constrained environment means they are likely to be much more selective in how they deploy their investment capital.

Picture of the week:

The oil trading pit at NYMEX, the scene for some wild swings in crude oil futures prices this week.