- Credit Risk
- Sovereign Debt
The challenge of integrating geostrategic issues in sovereign ratings
US Secretary of State Mike Pompeo recently took a position of which the importance largely went unnoticed and received little comment. On March 12, 2019, as part of a major annual global oil industry event, he explicitly called on industry representatives to support US foreign policy. This call to politicize energy in general and hydrocarbons in particular is unprecedented for three reasons. In the first place, by speaking directly and openly to industry representatives, the Secretary of State means that for the US administration, diplomacy is not the privileged framework for relations and conflict resolution between sovereign States. Secondly, the Secretary of State calls for the politicization of access to energy on all continents where the United States believe they have to promote their strategic interests, which suggests the possibility of a shift towards an aggressive form of the principle of extraterritoriality claimed by the US judicial system. Thirdly, the lever of this strategy lies in the revival of US oil and gas production materialized in 2018 by the net exporter status. However, the development of the exploitation of source rock hydrocarbons during the last decade is inseparable from the capital flows made possible by the status of the US dollar as the main world reserve currency and by the unconventional monetary policy implemented by the Federal Reserve first in the middle of the 2000s, then massively from 2009.
The unconventional character of shale oil and shale gas production in the United States owes as much to the implementation of the fracturing technique of source rocks, which had long been considered unproductive by petroleum engineers around the world, as to the amounts of capital and debt that were and are still needed to finance negative cash flows for the entire sector. From the beginning of the 2010s, information provided by the industry made it possible to conclude that the sector was not economically viable, even at market prices prevailing at that time. At the end of 2012, total negative cash flows, cumulative since the mid-2000s, already reached 150 billion USD. The International Energy Agency has been particularly slow to recognize this situation since the diagnosis of structurally negative cash flows was only mentioned for the first time in the 2016 edition of the "World Energy Outlook" and in the Oil Market Report dated December 13, 2016. The most recent analysis of the IEA (“Investment Analysis: The journey of US light tight oil production towards a financially sustainable business”, July 26th, 2018), which concludes that "current trends suggest that the shale industry as a whole may finally turn a profit in 2018" is again contradicted by facts as, over the first three quarters of 2018, 75% of companies exploiting source rock hydrocarbons still had negative cash flows. It turns out that the year 2018 nevertheless confirms the new status of the United States as a net exporter of oil and gas. This change of status thus results directly from an economic model for which sustainability has not yet been demonstrated and which does not comply with the standards of the conventional hydrocarbons industry, historically little indebted.
The controversy over the economic fundamentals of the shale sector takes on a new dimension as, along with this change of status, the US foreign policy has adopted in recent months a marked hardening: insistent and repeated calls from the administration to NATO member states to increase their national defence spending to 2% of their GDP, open opposition to the Nord Stream 2 gas pipeline project between Germany and Russia, announcement by the Ambassador to Poland of the installation of permanent US troops (not confirmed by the Pentagon as of date of writing), unilateral withdrawal from the Intermediate-Range Nuclear Forces Treaty signed in 1987. The position of Secretary of State Pompeo thus seems to confirm the analysis previously developed by Beyond Ratings that shale oil and gas productions, driven by an unsustainable economic model, would ultimately serve, further than the benefits of energy policy, foreign policy objectives, particularly on the continental European scene.
The evolution of the position of the United States raises questions under several angles. At the domestic level, given the country's degraded macroeconomic and financial fundamentals, as evidenced by the record deficit of the fiscal balance over the last months. The rise of military spending as advocated by the current administration does not seem compatible with the restoration of these fundamentals. At the international level, the call from the United States to increase national defence budgets contravenes the difficult trade-offs in public spending that many countries face in the context of often excessive public debt. In addition, the pressure on third party countries regarding their energy supplies is likely to lead to a destabilization of international energy markets and translate into additional costs for importers and loss of revenue for exporters. In short, one may consider that the evolution of the position of the United States contributes to spreading risks that could lead to the deterioration of the energy, macroeconomic and strategic situations of third party countries. The importance of this diagnosis is reinforced by the eminently disputable nature of the economic conditions that allowed the emergence of the shale sector and still allow its survival.
The case briefly presented in this Insight raises a general issue of ethical nature to the community of analysts, which is in no way limited to the United States: to what extent can sovereign debt ratings take into account the possible geostrategic implications of policies and strategies conducted by States controlling a projection capacity beyond their borders?
Olivier Rech, Head of Energy-Climate Resources
Sources: Beyond Ratings