Will the eurozone survive 2012?03 Jan, 2012
Europe faces an existential crisis in 2012. Credit market stress in response to ballooning sovereign debt levels has forced governments to announce a series of ill-conceived bailout packages. Policy intervention has become increasingly frequent and elaborate, but has failed to address the underlying causes of the credit market revolt. There appears to be a lack of political will to commit to fiscal consolidation, debt restructuring and bank recapitalisation on a scale required to restore market confidence. To brush over this, European leaders have chosen austerity and further leverage as their policy weapons. It is hard to envisage an orderly resolution to the crisis if they continue down this path.
The numbers do not add up
Debt refinancing from both European governments and banks will place an enormous strain on global financial markets in 2012. The scale of the problem is well summarised by Satayajit Das (a risk expert, former options trader and author of ‘Extreme Money’) in a recent article:
“Time is running short. European Sovereigns and banks need to find €1.9 trillion to re-finance maturing debt in 2012. Italy alone requires €113 billion in the first quarter and around €300 billion over the full year. European banks need €500 billion in the first half of 2012 and €275 billion in the second half. This means they need to raise €230 billion per quarter in 2012 compared to €132 billion per quarter in 2011. Since June 2011, European banks have been only able to raise €17 billion compared to €120 billion for the same period in 2010.”
In Dec 2011 the European Central Bank (ECB) intervened on a huge scale to provide lending facilities to Europe’s ailing banks over a 3 year horizon, action which may provide temporary relief. But the ECB has no mandate to monetise sovereign debt to the scale of the refinancing requirements illustrated in Chart 1 (eurozone relative to GDP) and Chart 2 (in absolute terms for Europe’s peripheral economies). Since sovereign bonds make up a large part of the capital base of European banks, the fate of sovereigns and banks is closely intertwined.
Credit market pricing is pobably the most reliable source of information on the risk of a eurozone breakup and it is flagging trouble. Michael Platt, CEO of Bluecrest Capital Management (a $30 billion hedge fund that has navigated through the financial crisis with outstanding returns), was clear as to the severity of the threat in a rare interview appearance in mid December:
“In my opinion, what’s going on now is significantly worse than 2008… The market prices the probability of a euro breakup to be distinctly non-zero, despite what the politicians say.”
2012: recession or breakup?
It is important to recognise that a disorderly eurozone break up in 2012 is a long way short of a foregone conclusion. There are policy measures, such as further debt monetisation, that may be used to buy time to restructure debt and recapitalise the banking system. However failure to resolve the debt crisis is causing substantial damage to European economic growth. This is partly through damage to market, business and consumer confidence as a result of uncertainty around the crisis impact and resolution. But it is also via a very tangible tightening in bank lending as Europe faces a renewed credit crunch.
The nature of the political response, focusing on the symptoms rather than the cause, means the situation is likely to deteriorate before meaningful steps are taken to resolve the crisis. As a result, a European recession in 2012 appears almost inevitable. Whether or not this is accompanied by a disorderly eurozone breakup would appear to be a question of political will.
The impact of the debt crisis on European energy markets has grown over the last six months. Commodity prices have softened, access to capital has tightened and investment projects have been cancelled. But the impact of a disorderly breakup of the eurozone is something entirely different. The probability and nature of such an event is very hard to predict, although credit market pricing is flashing a clear warning signal.
Prudent risk management is not about predicting the future, but it does involve confronting a credible threat. In our view, the threat that a eurozone breakup poses to most European energy companies warrants careful impact analysis and contingency planning. We look at some prudent risk management steps that energy companies can take to strenghten their business against the impacts of a eurozone breakup in next week’s article.