Germany

The Baltic Dry Index (BDI) usually steals the headlines when it comes to discussion of the world’s shipping fleets, and is often quoted when analysis of the global economy refers to international trade.

The Dry Index is a measure of bulk shipping rates and although the Baltic Exchange quotes a range of vessel sizes and types, it is often the large dry bulk carriers carrying iron ore, coal and grains that steal the limelight.

This is hardly surprising; the volume of such bulk commodities is a measure of global economic activity and the rates charged for carrying such commodities are in part a reflection of the level of demand or volumes. But not in total, of course: the supply of space also plays its part as is the case in the current market.

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Japan is facing an electricity crunch this summer, potentially so severe, that companies such as Komatsu, the world’s No. 2 maker of construction machinery, have said they will move factories overseas if electricity supply isn’t guaranteed.

Bloomberg reports that all but one of Japan’s 54 reactors are now offline after the March 11 earthquake and tsunami last year crippled Tokyo Electric Power Co.’s Fukushima Dai-Ichi nuclear station. The reactors, which previously supplied 30 percent of Japan’s electricity, have either been closed by the disaster, by government order or not allowed to restart after regular maintenance shutdowns. The remaining one reactor is due to close on May 5 for maintenance.

“Did You Pay the Gas Bill?”

As a result, Japan’s fuel import bill has sky rocketed. Liquefied natural gas imports rose to a record in 2011 as utilities have been forced to rely on fossil fuel power plants to replace idled reactors. Japan imported 1.75 million kiloliters of oil, or about 369,000 barrels a day, for power generation in February, more than four times as much as a year ago, according to data from the Ministry of Economy, Trade and Industry in a separate article, while imports for power generation were up 15 percent from January alone.

There seems to be a government-led imperative to get some of these nuclear plants back online as Kansai Electric, the utility most dependent on nuclear at 49 percent of generating capacity, warns it may fall nearly 20 percent short this summer. The company serves the Kansai area of western Japan that covers an area the size of Belgium, has an economy worth $1 trillion — about the size of Mexico’s — and is home to the cities of Osaka and Kyoto as well as factories of Sharp Corp. and Panasonic Corp., Bloomberg reports.

Bring Back Nuclear, They Say

Although much controversy remains, even some local politicians and the general public appear to be favoring re-starts as employment suffers in areas where plants dominate the local economies. Overseas reaction to nuclear energy post-Fukushima, however, vary. Germany still plans to close all its plants by 2020, and even in France questions are being asked about expansion to what is one of the world’s most comprehensive nuclear generating networks.

But emerging markets are still showing enthusiasm for nuclear power as a secure provider of low greenhouse gas-emitting base-load electricity.

In Turkey, China is said to be close to securing a contract to finance and build a plant on Turkey’s Black Sea coast, in spite of the Chinese touting older technology. China is developing newer technologies off its own back as it is prevented from poaching the technologies of Westinghouse and Areva, who are constructing plants for the Chinese in what is currently the world’s largest nuclear construction program — but don’t be surprised if the Chinese “discover” very similar solutions to the technical challenges solved by Western firms.

Meanwhile, Turkey already has another plant planned with a Russian manufacturer, and Russia’s Rosatom is said to be keen to bid for the construction of two plants in the UK’s program of plant replacements, according to the Telegraph. It would seem that while many countries share Japan’s safety concerns, the cost associated with the alternatives — whether they are self-inflicted by Co2 emission targets or real ones such as import bills – mean nuclear remains a viable alternative if not an outright necessity.

Outside of Europe, the Netherlands is often overlooked in the debt crisis debate and analysis, largely because it lacks the GDP of other core countries — $780 billion as compared to Germany’s $3.28 trillion and France’s $2.56 trillion. (Even Spain at $1.41 trillion and Italy at $2.01 trillion are considerably larger.) But the Netherlands is also overlooked because of its relatively small landmass and population.

It is a mistake to dismiss the Dutch as peripheral to the workings and future of the EU. The country punches well above its weight both economically and, more importantly, politically. In the halls of EU power brokers, the Netherlands has been a keen advocate of austerity, a natural extension of its Germanic approach to hard work and fiscal conservatism — a doctrine that has served it well over the years, achieving a high standard of living and a pivotal role as the entreport to the industrial heart of Europe.

So the recent political crisis faced by the Liberal-led coalition in the country is all the more intriguing for what it tells us about possible futures for the European Union.

Where the Netherlands Economy Stands

The Netherlands has slid into recession this year, resulting in a sharp rise in its projected 2013 deficit to 4.6 percent. At the same time, the spread between Dutch and German 10-year bonds has risen over 20 basis points as the markets have worried the country may lose its triple-A rating, a fear heightened by the political deadlock.

The crisis is about how to bring that down to the 3.0 percent target, which the country has been at the center of insisting other European states should aim for. Although the Netherlands has led by insisting Greece, Portugal, Ireland, Spain and Italy must adopt harsh austerity measures if they are to qualify for any support, nevermind bailouts, the government cannot now agree on how to bring its own house in order.

A row between the Liberals and the far-right Party for Freedom (PVV) means the government is short on votes needed to push reforms through, even after three weeks of secret talks. A report by the “Euro-sceptic” (as the FT put it) research group Lombard Street, a UK consultancy, is probably not helping things.

Will the Netherlands Leave the Euro?

The FT states the report was prepared for the PVV and is pessimistic about the euro-zone’s future. Under its worst-case scenario that Greece, Portugal, Italy and Spain all have to leave the euro-zone after failed bailout attempts, it concludes that the Netherlands would save €120 billion over three years if it left the single currency now bolstering the PVV’s antagonism toward cuts, which would not be necessary if the country was not part of the Euro.

The report painted a bleak future for European core countries Germany, the Netherlands, Finland and probably France, saying austerity programs and internal devaluation would be unable to restore peripheral European economies to competitiveness, meaning the euro-zone would become a transfer union.

Will the Netherlands drop out of the Euro and go it alone, as the report recommends? No, almost certainly not, but the very fact such hard-line positions are holding any credence in the Hague underlines how troubled the core states are at the almost inevitable prospect of them having to fund bailouts in southern states for years to come.

Image source: Business Insider

Continued from Part One.

In the autumn of 2010, the International Monetary Fund thought Greece would shrink by a rather modest 2.6 percent in 2011. We now know the economy last year fell about 7 percent. The Greek fiscal position was bad not only because of a lack of effort, but also because the economic problems were far stronger than expected; the fear is that with 25%+ unemployment and a severe economic squeeze just starting, Spain will contract more than expected. Major deficit reduction in the wake of economic collapse is near enough impossible, the FT suggests, yet the more Spain resists deficit reduction, the greater the eventual scale of the problem will be.

An article in the Independent postulates a third cause for concern among investors, which unfortunately runs counter to the previous positions; namely that austerity, demanded by the EU, is driving the Spanish economy further into the mire and making the need for a rescue (which the EU might not be able to afford) all the more likely.

The problem is Spain cannot address both fears. They either implement austerity measures to satisfy conventional wisdom and their EU paymasters, or they try to reduce debt via growth, which essentially involves stimulating the economy – almost impossible to do while simultaneously reducing government spending and trying to balance the books.

As with Greece, Germany is claiming that the existing facilities are sufficient, but it may be, just as with Greece, that the market has other ideas and that in order to avert a run on Spanish debt, eventually the richer northern states will have to stump up a bailout for Spain as they did for Greece.

The scale of the problem, however, is on a whole different magnitude with Spain.

Image source: dw-world.com

While General Motors and its European counterparts have been having some overcapacity problems in Europe, Volkswagen, Europe’s leading carmaker, is the shining star as far as Eurozone manufacturing — and sales success — goes.

VW reported record profits last week, amid speculation that the European auto market will contract once again in 2012 — the fifth consecutive year of contraction. Volkswagen’s profits doubled from the previous year to €15.4 billion ($20.6 billion), and revenue increased about 26 percent to €159 billion, according to this New York Times new hit.

In at least one way, it doesn’t matter to Volkswagen that the Eurozone is suffering: The company reported that its “two Chinese joint ventures, Shanghai Volkswagen and FAW-Volkswagen, together sold 2.26 million vehicles in 2011, up nearly 18 percent from 2010,” according to the article. Overall, the company broke the 8-million-vehicles-sold threshold for the first time, led by its VW and Audi brands; it clocked 8.27 million total sales.

While GM has been forced to begin talks with Peugot to cut costs (as my colleague Stuart reported on last week), VW seems to be sitting pretty with its extra stash of cash — but will the fuzzy feelings last for long?

The company has yet to fully report what happened in Q4 2011 for all ten of its brands — not just the high-flying Audi and VW marks — on March 12. A report in the Wall Street Journal maintains that 2012 will be a challenging year for all automakers, not just because of the down Eurozone economy (Moody’s forecast sees a 6.2 percent decline in 2012 y-o-y).

While the article quotes a Morgan Stanley analyst as saying that only VW and Hyundai should be profitable in 2012, a separate report indicates China’s not buying cars like it used to — auto sales fell 24 percent in the wake of the Lunar New Year, but potentially more worrisome, rose only 2.5 percent in 2011 to 18.5 million, according to the China Association of Automobile Manufacturers (CAAM).

Interestingly, VW may stand to gain a bit of a cash infusion from the European Central Bank (ECB) in the form of cheap loans to boost the Euro auto industry, according to BusinessWeek. (Peugot is also in line for the handout, but arguably, they need it much more.) In an interview, Stefan Rolf, VW’s head of securitization, said that the company is “considering accessing the LTRO” — an ECB program that is a cheaper source of cash than selling bonds.

Looks like even VW is hedging against another global downturn any way it can.

Europe’s car companies could be said to mirror the European economies in the sense that there’s a stark contrast between the haves and have-nots, or between the profitable and the loss-making.

Unlike the US, where all carmakers were pulled down post-2008 and some teetered on the edge of bankruptcy while others actually went into Chapter 11, European carmakers are much more of a mixed bag. And before I get comments about government subsidies, let me say this: while they have over the years detrimentally impacted the structure of the European car industry, today’s winners and losers do not split neatly down the line between beneficiaries of state largesse and not.

In stark contrast to its parent, now (free of onerous pension obligations and high union pay rates) a highly profitable enterprise, General Motors’ European operations (which includes Vauxhall in the UK and Opel in Germany) lost $747 million last year, with $562 million of that coming in the final quarter of the year and including a restructuring charge of $200 million.

It has lost money in Europe for a decade, but targeted breaking even in 2011 as talks broke down to sell the business to Magna a year back. Even so, the loss is a marked improvement from the $2 billion deficit in 2010, the Telegraph reports, but is in stark contrast to a year of record global profits for GM group, where profits surged to $9.19 billion from $6.17 billion.

Perversely, GM’s rescue plan may include the closure of Europe’s most efficient car-making plant, Ellesmere Port in the UK, because GM is prevented from closing German plants until 2014 due to union agreements — even though the Bochum plant in Germany, which has a capacity of 160,000 cars but is said to need 3,100 employees to operate, compared to Ellesmere’s 187,000 capacity with only 2,100 employees.

Continued in Part Two.

Continued from Part One.

It is widely believed by many, and even openly discussed in Brussels, that Greece could be the first to go. If it does, Portugal may well follow. It seems untenable that Italy could fail, but without collective support, it’s just as hard to see how it can stay.

Italy has €33 billion of debt coming due in the final week of January and a further €48 billion in the last week of February. Germany failed to get away a €6-billion sale last week (admittedly at miserly yields) — does Italy have a chance, and if they did, at what rate? Already it is paying over 7 percent while it sees those outside the single currency paying 2-3 percent; how much of their future will they be willing to sacrifice? The moment the first country leaves the single currency, interbank finance will stop. No one will know how to value a debt or who to trust as remaining solvent. As loans to firms and individuals turn bad, bank finance will become even more scarce than it already is.

Source: Economist

Those at the eye of this particular banking storm will be the French banks, as this graph from the Economist illustrates.

The next major opportunity (maybe the last major opportunity this year) is the EU summit on Dec. 9. Previous summits came and went without agreement, but half the world watches and thinks Germany will change its mind at the last minute, agreeing to collectivization of debts via euro bonds or some similar mechanism in return for control of the peripheral states’ fiscal sovereignty.

The other half of the world is taking Germany’s stance to date: that they will not take on what they see as profligate states’ responsibilities; and that all that is needed is fiscal rigor in the form of cutting debts, raising taxes and selling assets to set the world to rights. Which side proves to be right is, in true European style, unlikely to be clear-cut. Further fudging, procrastination and delay is almost certainly going to be the outcome.

In the meantime, metal markets have continued to slide in the face of fear — fear of the impending European recession, fear of a sovereign default and also fear of a slowing China resulting in a hard landing for Asia. Neither of the first two factors are, on the face of it, likely to be resolved satisfactorily in the next few months; the probability is that prices could slide further.

Certainly the expected rally in metals for which a relatively tight supply market should be providing support (like copper or like aluminum where production costs are above metal prices for many producers) is looking less and less likely. Unfortunately, with Europe’s future the cause of so much uncertainty and fear, it could get worse before it gets better.

–Stuart Burns

Just about everyone outside of Europe’s ruling elite sees the Euro as a train crash in slow motion.

Every day, we open our papers or turn on our screens to be greeted by yet more depressing reports of rising bond yields, squeezed bank lending, austerity measures and slowing growth, but just how bad are things and where is it likely to lead?

Drawing on data in recent articles in the FT and the Economist, the situation looks pretty dire and as to the likely outcome, that depends on whom you ask. Germany’s Angela Merkel would tell you all those struggling states such as Greece, Portugal, Italy and Spain need to do is apply brutal austerity measures and the bond markets will conclude everything is under control and financing cost will drop. The problem with that stance is the markets haven’t bought into the German view of the problem, and so matters have continued to deteriorate. Meanwhile, the financial infrastructure of Europe is freezing solid.

The euro zone and those countries around it that rely on the single currency block for a large chunk of their trade, such as the UK, are going into a recession — if they’re not already there. The probability, if the single currency doesn’t implode, is that it won’t be a long or deep recession, although contraction is in the making, as the Economist explains.

September’s sharp decline in industrial orders is an early sign that companies are cutting back, the magazine says, quoting research at JPMorgan. The world’s largest maker of ball bearings, Swedish SKF, said to be a bellwether of industrial demand, predicted a further softening of investment demand going forward. Consumers are likely to defer big purchases as long as the crisis is unresolved and credit is scarce, the bank said; a drop in demand for capital equipment, durable consumer goods and cars will strike at the euro zone’s industrial heartland, including Germany. GDP could drop by 0.5 percent in Germany next year and up to 2 percent across the EU, according to the FT.

Conditions are ripe for a recession. There is a credit crunch as banks have stopped lending on the wholesale market, tighter fiscal policy as countries desperately apply austerity measures to fend off the bond markets, and a dearth of consumer confidence as unemployment rises and talk of recession becomes widespread. Not only are banks not lending to each other, but investors are wary of lending to banks that have euro zone bonds on their books. Banks are shedding assets both to raise cash and to increase their capital reserves in order to meet EU capital adequacy targets. First to exit are banks’ loans to emerging markets such as those in Eastern Europe and Turkey. The flow of funds back into euros is probably the unseen hand that has been perplexing forex dealers convinced the euro should have collapsed by now.

Fiscal tightening cannot but weaken growth. Neither capital investment nor consumer demand will rise in the early stages of these long-term austerity plans. As consumer confidence spirals downward, a process that is already very evident in the UK, firms will hold leaner stocks, reduce discretionary spending and defer capital projects.

Public reaction to the austerity measures has already resulted in rioting on the streets; the great unknown is whether governments can carry their electorate with them as the cuts bite. Tax receipts will fall as economies, at least in the peripheral states, contract at the same time as welfare payments rise with unemployment, making it harder for states to meet their obligations. The pressure to default and to exit the euro will rise.

So which countries will fall first?

Continued in Part Two.

–Stuart Burns

A draft of the European Commission study on joint Ëœeurobonds,’ reported by the Financial Times last week, makes the intriguing suggestion that gold could be used as collateral for fundraising by European states being priced out of the commercial market. The idea is that governments would use their physical gold holdings to underwrite if not all, then maybe the first 20 to 25 percent of the bond losses, making such gold-backed eurobonds considerably more attractive than current state-backed bonds.

Between them, the central banks of the eurozone hold some 10,792 metric tons of gold 6.5 percent of all the yellow metal that has ever been mined worth some $600 billion. Let’s be clear here; the suggestion is not that countries such as Greece or Italy should sell their gold — that would be illegal under the Maastricht Treaty and politically unacceptable in most cases — no, the suggestion is the gold is pledged to guarantee the first loss portion of bonds adding considerably to the security for any bondholder and, so the theory goes, justifying a much lower interest rate.

As the article points out, Italy’s central bank holds 2,451 tons of gold, worth about €100 billion. While that pales in comparison to its total debt stock of nearly €2 trillion, it could alleviate some of the short-term funding pressure. Italy needs to raise about €600 billion over the next three years. If it used gold as collateral for the first 20 percent of the new bonds, it could cover its needs until mid-2014.

There are plenty of precedents. Italy, for example, received a $2 billion bailout from the Bundesbank in 1974 and put up its gold as collateral while in 1991, India used its gold as collateral for a loan with the Bank of Japan; and Portugal, Brazil and Uruguay have all either sold gold or used their gold to support raising of funds in the past.

Likewise Greece has some 111.5 tons of gold currently worth about $5.4 billion, and using the “20% rule,” may allow borrowing of up to $27 billion. The problem with Greece is the real possibility the country could leave the Euro or experience widespread default; what value would be put on the bonds then? Older debts are looking at 50-percent haircuts.

Source: The Guardian

Collectively, Europe holds sizeable gold reserves, as the table illustrates.

A report in the Guardian newspaper goes one step further: issue IMF bonds supported by gold, pledged from all the central banks. Leading gold holders such as the US, Germany, France, China, Switzerland, Russia, Japan, India and the European Central Bank, which hold the bulk of the world’s 988 million ounces, could allocate a proportion to form the core of a new crisis institution. The article suggests this new fund could issue gold-backed bonds to European and other nations as bridging finance whenever there is a threat of default.

The probability is Germany will pour cold water on this idea, just as they have all previous ones that don’t involve massive and immediate debt reduction and austerity programs (providing the austerity is outside Germany, that is). But we thought that after all of the hot air we hear about gold as a great investment, here at least is one good use to which those mountains of yellow metal can be put.

–Stuart Burns

The game has changed for the nuclear industry post-Fukushima, at least in the Western world, if not globally. After previous nuclear incidents, there usually was a pause while national bodies reviewed the reasons for the event and upgraded safety standards, but the Fukushima incident seems to be impacting Europe much like Three Mile Island did the US.

Germany, one of Europe’s biggest operators of nuclear power, used to run 17 reactors until Berlin closed four of them in July and committed to closing the rest by 2022. Belgium is looking to accelerate the closure of its seven plants and Switzerland is going the way of Germany. Even in France, where nuclear power generates more than 75 percent of electricity, the new socialist contenders for next year’s elections campaign on a platform that includes a drastic drop in nuclear-generating capacity to below 50%.

Who Benefits and Who Suffers?

As a result, not just generators are feeling the winds of change. Siemens pulled out of a technology joint venture with Russia’s Rosatom to develop new nuclear technologies. Recognizing that any new plants are likely to be in emerging markets, firms like France’s Aerva have started work on the Atmea, a smaller, cheaper reactor, in partnership with Japan’s Mitsubishi Heavy Industries rather than relying solely on the firms’ technologically advanced but high-cost EPR reactor design, best suited to highly regulated markets within Europe.

Likewise, Rosatom, which since Fukushima has continued securing new orders from China, Vietnam, Belarus and Bangladesh, is seeking new technology partners that can help it develop safer, more robust systems without pricing itself out of a market which will soon be competing with Chinese as well as existing South Korean manufacturers. Although Rosatom has a monopoly over Russia’s 11 civilian nuclear power plants and accounts for one-fifth of new reactors under construction worldwide, Sergei Kirienko, Rosatom’s president, admitted last week that there is a risk of world demand for nuclear reactors collapsing after Fukushima, saying competition has been much tougher.

For now, Britain is holding to its ambitious program for 12 new reactors by 2025, needed (the conservative part says) as part of a wholesale restructuring of Britain’s electricity market aimed at helping the country meet tough carbon reduction targets, as well as keep the lights on. However, start dates keep slipping back and although some operators have committed to land purchases for the new sites, no one believes the first plant will be operational by the previously stated date of 2018. Nor are the conservative coalition partners the Liberal Democrats on board with the plans for nuclear power, much preferring to push for wind or renewable power plants in spite of growing evidence they cannot meet base-load requirements.

Not surprisingly, the share price of both nuclear power-generating companies and manufacturers of nuclear power plants has underperformed in an already falling market. The future is unlikely to be quite as dire as some currently fear, but clearly growth is not going to be coming from established nuclear-producing countries such as the US, Europe or Japan. It will come from emerging markets desperate to reduce reliance on coal-fired power generation — and for whom the level of technological sophistication won’t be required to be as high as it is for Europe.

–Stuart Burns