Tag Archives: Europe

The Greek Drama

Contributor View written by Daniel Lacalle. Mr. Lacalle is an economist, fund manager and author of Life In The Financial Markets (Wiley) and The Energy World Is Flat (Wiley). You can follow him on Twitter at @dlacalle.

“You can check out any time you like but you can never leave.” -Hotel California

The Greek drama continues to unfold and puts pressure on European markets despite the fact that Draghi´s “monetary laughing gas” continues to pump €60bn per month into the slowly recovering European economy.

The call by the ruling party, the communist Syriza, for a referéndum in Greece, is the last episode of a soap opera that´s starting to be sadly comical.

For once, Syriza is calling a referéndum on State fiscal policy, something that the Greek constitution specifically forbids. It is simply a measure to try to make citizens forget the atrocious negotiating tactics of their government, who could have reached a benefitial agreement much earlier without putting the country on the verge of a bank run.

Additionally, the government is trying to show to the citizens that the Troika proposals are unacceptable when the difference between the document presented by Syriza and the EU´s suggestions are minimal (0.5% of GDP).

The real drama is that none of the measures announced will solve Greece´s real issues. No, it´s not the euro, or the austerity plans. It´s not the cost or maturity of debt. Greece pays less than 2.6% of GDP in interest and has 16.5 years of average maturity in its bonds. In fact, Greece already enjoys much better debt terms than any sovereign re-structuring seen in recent history.

Greece´s problem is not one of solidarity either. Greece has received the equivalent of 214% of its GDP in aid from the Eurozone, ten times more, relative to gross domestic product, than Germany after the Second World War.

Greece´s challenge is and has always been one of competitiveness and bureaucratic impediments to create businesses and jobs.

Greece ranks number 81 in the Global Competitiveness Index, compared to Spain (35), Portugal (36) or Italy (49). In fact it has the levels of competitiveness of Algeria or Iran, not of an OECD country. On top of that, Greece has one of the worst fiscal systems and limits job creation with a combination of agressive taxation on SMEs and high bureaucracy. Greece ranks among the poorest countries of the OECD in ease of doing business (Doing Business, World Bank) at number 61, well below Spain, Italy or Portugal.

Greece´s average annual déficit in the decade before it entered the euro was already 6%, and in the period it still grew significantly below the average of the EU countries and peripheral Europe.

Between 1976 and 2012 the number of civil servants multiplied by three while the private sector workforce grew just 25%. This, added to more than 70 loss-making public companies and a government spend to GDP figure that stands at 59%, and has averaged 49% since 2004, is the real Greek drama, and one that will not be solved easily.

One thing is sure, the Greek crisis will not finish by raising VAT – impacting consumption – and increasing taxes to businesses, nor making small adjustments to a pension system that remains outdated and miles away from those of other European countries. A new 12% “one-off” tax on companies generating profits of more than 500,000 euro will not help job creation and will likely incentivise more tax fraud.

The inefficacy of subsequent Greek governments and Troika proposals is that they never tackle competitiveness and help job creation, they simply dig the hole deeper raising taxes and allowing wasteful spend to go on.

From a market perspective the risk is undeniably contained, but not inexistent. Less than 15% of Greek debt is in the hands of private investors. Most of the country´s debt is in the IMF, ECB and EU countries’ hands. The most impacted by a Greek default would be Germany, which holds bonds of the hellenic republic equivalent to 2.4% of its GDP, and Spain, at 2.8% of GDP, small in relative terms.

Additionally, the ECB prints “one Greece” every three months.

However, the main risk for the Eurozone comes from a prolongued period of no-solutions. Not a Grexit but a “Gredrag,” dragging on for months with half baked attempts to sort the liquidity crisis.

This prolongued agony is unlikely to help investors´confidence. And it might raise questions of the possibility of similar illogical behavior from other fringe parties close to Syriza´s views in the Eurozone, particularly in Spain and France. Because behind this all what lies is an ideological agenda, not the best financial deal for the country. Syriza could be looking to do something similar to what Nestor Kirchner did in Argentina in 2005, cut ties with the IMF and agree to alternative financing with Venezuela at double the cost just for ideological reasons.

Greece exiting the euro remains a distant possibility, despite the headlines. The much publicised “Russian solution” forgets that Russia is not stupid and doesn´t lend at better terms or with easier conditions – think of Syria and Ukraine.

A Grexit would not solve Greece´s challenges, as the country spent decades unsuccesfully trying to solve structural imbalances before joining the euro with competitive devaluations and failed keynesian bets on public spending.

Greece doesn´t need to be a failed state. But governments seem to be inclined to prefer a bank-run and capital controls than to reduce unnecessary spending. The fact that Syriza´s first measure was to re-open the public TV network – undoubtedly a “priority” in a debt crisis- shows how little they care about the “social urgency”.

Greece should stay in the euro, open its economy to business, attract capital, privatize inefficient public sectors, incentivize high productivity sectors with tax deductions, and reduce wasteful spend, not feed the government machine with ever rising taxes to get a few crumbles left by the survivors of the disaster.

If not, in three years time we will be talking of the “Greek crisis” again.



For a Competitive Energy Policy

20/9/2014 El confidencial

“Industry will gradually lose its competitiveness if this course of increasing subsidies is not reversed soon”, Kurt Bock, CEO BASF

Europe needs to exit the crisis through competitiveness and security of supply.

Europe must change an energy policy that has forgotten companies and households with the objective of  being “the greenest of the class” without paying attention to costs and competitiveness.

European companies and families cannot continue to bear the costs of planning mistakes and subsidy generosity, because the situation is dramatic.

Europe’s energy policy has forgotten companies and households with the goal of being the greenest of the class.

In Europe, electricity costs are on average 50% higher than in the USA and in industrial gas, almost 75%. Between 2005 and 2012, thanks to the shale gas revolution, gas prices in the US fell by 66%, while in Europe they were up 35%. In turn, power prices in the United States fell by 4% while soaring 38% in Europe. It’s the difference between an energy policy that promotes efficiency and replacement through low costs, and Europe’s policy of promoting forced substitution through subsidies.

European companies are among the ones paying the highest prices for electricity and gas in the OECD. A German medium-sized industrial company pays twice the electricity tariff than a counterpart in Texas, according to Ecofys. The average of the Spanish industrial sector pays more than twice what the comparable US one.

The “green” policies and the development of renewables have allowed wholesale electricity prices to fall; while at the same time, adding fixed costs and subsidies, consumer prices have skyrocketed . For example, in Germany wholesale generation prices have fallen nearly 38% since 2005 and the average electric bill has gone up 60%. A mistake that destroys jobs and businesses that needs to be tackled. In countries like Spain  we must differentiate wind power, which represents 20% of the energy generated in 2013 and 19% of the cost, from solar, which represents only 5% of energy produced and 20% the total cost of generation.

Green policies and the development of renewables have allowed the price of wholesale electricity down; but adding CO2 costs, fixed costs and subsidies, consumer prices have soared

The European Union is less than 14% of CO2 emissions in the world, but 100% of the cost. Interestingly, despite the green policies of  the EU, the United States has reduced CO2 emissions since 2005 by 12% to 1994 levels, a more significant reduction than Europe’s.

All these problems result in lower industrial production, increased offshoring of companies, difficulties to compete and, of course, less employment.

For these reasons, the energy policy of the European Union must comply with the principles of safety, diversification and competitiveness.

Keep betting on renewables without passing the bill to businesses and families. Subsidies must be changed to tax incentives, as in the US. This prevents planning mistakes when estimating demand, subsidies and costs as the tax incentives are only provided when demand is real through agreements with consumers (PPAs, power purchase agreements). Every year I hear that solar will be competitive next year. And every time I hear it, the electricity bill goes up.  After nearly a decade of subsidies, solar and wind technologies promoted by many leading European companies are competitive and at grid parity in some countries, without subsidies. To continue to demand subsidies in mainland Europe is at least suspect.

Addressing the problem of overcapacity . Europe cannot be “green” yet subsidize inefficient coal technologies, pay unnecessary capacity payments, or maintain excess capacity, with reserve margins above 17%. And all paid by consumers.

Replacement, not accumulation. Europe cannot allow new generating capacity when consumers pay the accumulated excesses. The new generation capacity has to come from replacement, and the change should be done at lower costs.

Addressing the problem of overcapacity. Europe may not want to be the greenest yet subsidize inefficient coal technologies hold unnecessary capacity payments, payments for unjustified subsidies interruptibility or maintain excess capacity … And all paid by consumers

Solving the problem of security of supply,developing local energy sources  -shale gas, oil, renewables-, as well as improving interconnection between European countries to use “hubs” to reduce dependence from Russia and other countries, using the various -almost idle- storage facilities and regasification terminals.

Do not demonize technology in a regional and ideological way . Citizens should know that replacing nuclear and gas power with renewables would increase electric bills by three or four times. Remember that the average best price of renewable generation is today 68 euro/ MWh, “only” twice the wholesale price in Germany, and 30% higher than in Italy.

Electricity prices in Europe in 2003 were among the lowest in the OECD and today they are some of the highest. Why? Because the final consumer bill was loaded with all kinds of fixed concepts. In Spain more than 62% of the bill are regulated costs, taxes and subsidies. The European average is 54%.

Europe’s energy policy can not be about “not in my garden”. Pretending to eliminate nuclear power plants when most countries have a few miles, in France, dozens of nuclear reactors, is ridiculous. France has the lowest power prices in Europe and a safe, reliable and competitive nuclear fleet is one of the reasons why tariff prices have not soared. The other is that France did not jump to subsidize tens of thousands of Gigawatts of expensive renewables in early stages of technological development. As long as nuclear power is competitive, efficient and safe, Europe must continue taking advantage of it.

The challenges faced by Europe in its energy policy are enormous. But the opportunity is exciting, and the foundation to make Europe a competitive, self-sufficient world power is already in place.

Technology replacement should be achieved through lower cost,  the same way as crude oil ended with whale oil . Not because it was decided by a committee, but because the cost was lower.

The mistakes of 2007 began with optimistic estimates of demand growth, with errors of up to 35%, and so it came to be the first time in history since the industrial revolution in which governments incentivised the most expensive technologies. Europe’s decision to substitute cheap energies for expensive ones have cost many lost jobs and industries.

Security of supply must be achieved, also, from a flexible and diversified energy mix which must be cheap and efficient. Not via subsidies, but through the tax incentives that prevent “fake demand signals” and prevent overcapacity.

Energy is the cornerstone of the future of Europe. Sinking competitiveness would likely worsen the crisis. Europe has the tools, using all technologies, to ensure an abundant and cheap energy supply. Anything else would bring it to repeat the mistakes of 2007.



Important Disclaimer: All of Daniel Lacalle’s views expressed in this blog are strictly personal and should not be taken as buy or sell recommendations.

Eurozone Banks Face the Toughest Stress Test

El Confidencial 26/7/14

“Stress tests are like Cuban universities, everyone passes, but the title is worth nothing.” 

If anything has been shown in the recent episodes of negative surprises from some European banks – from Portugal to France or Germany – is that European banks have not yet solved their problems. We confuse the important exercise of transparency and improvement carried out since 2012 with a magic solution to a problem created by a decade of excess. Is impossible to assume that banks have cleaned up their balance sheets when non-performing loans reach EUR 932 billion across Europe, 7.6% of total loans in the eurozone, according to Price Waterhouse Coopers .

When we talk about the bank stress tests (“stress tests”), many analysts regard them as the definitive marks, not as what they really are: a dynamic analysis of constantly changing circumstances . And, of course, these tests are not infallible, as we have seen so many times (Dexia, Savings banks, Cypriot banks, etc..).


It is an analysis that uses a common methodology for all countries, in which the impact on the capital ratio of a bank of various risk events is analyzed .

The general public tends to think of banks as “entities that collect deposits and make a lot of money,” and this is wrong. Because we tend to look at the P&L (accounted profit and losses), and not the cash flow and balance sheet.

A bank, for every Euro received from deposits usually borrows up to 25 times. That deposit is actually a loan, it is not sleeping in a safe.

For every Euro that the entity gives as a loan, banking rules allow the use of more or less capital depending on the risk that is assumed for the operation. If the bank lends to a very safe company with a low probability of default, the percentage of capital required for the loan is very low. The rest is debt.

These loans, if they work, generate a profit, and during the life of such loan the bank generates a margin between the cost of money and the interest rate charged… if the bank gets the principal back. If not, the balance sheet will deteriorate rapidly.

Whhen things go wrong, such “capital” shrinks very quickly. This is why people do not understand how in 2007 a ​​bank could have reasonable solvency and liquidity ratios and in 2008 be on the verge of bankruptcy. A citizen does not see how fast the core capital can disappear when a large percentage of loans become risky (non-performing), which means that there is a high degree of probability that the borrower will not be able to pay the interests and principal. This rapid decline in the middle of a recession can leave the bank without resources.

As such, stress tests aim to analyze whether in a drastic change in the economic environment, banks would retain the 10-11% of capital that they have on average today.


The stress tests aim for two objectives. Firstly, analyze the impact on banks’ fragile financial structures of events like a recession, losses on sovereign bond portfolios, aggressive currency depreciation, etc.. Furthermore, the test stress tries to be righteous enough to not make an unnecessarily negative exercise that endangers the public trust in the institutions.


Many large banks are currently generating returns of around 4% (return on equity), far below the typical target levels of around 15%.

Research by EY suggests that banks will find it extremely challenging to achieve this kind of RoE uplift. Cost reductions of around 35% or revenue growth of more than 20% might be required just to achieve their average cost of equity (10%). Should banks wish to reach 15% RoE they would be required to reduce costs by 66% or grow revenues by 44% — a goal beyond the scope of most banks in the current climate.

A problem of low Return on Equity (peripherals around 2%, average eurozone banks below 6%)  and high exposure to government loans is not solved in two years, but deposits have stabilized and banks have sold large packages of toxic real estate assets. That does not make the sector “totally healthy”.

The stress tests of 2014 will be very demanding and assume , among other risks:

  • An adverse scenario of falling GDP in Europe of 0.7% in 2014, -1.5% in 2015, plus a 21% drop in house prices, added to increased inflation.
  • Losses in the portfolio of sovereign bonds from increases in their risk premiums. Increases of 150 basis points in European premium or 200bps in the US sovereign bonds. Assumes a drop of 6.5% off in Spain, for example, 6% in France and 7.6% in Italy and 4.4% in Germany in the 5-year bonds.
  • Possible 25% depreciation of the Hungarian and Polish currencies , and 15% of the Czech, Romanian or Croatian.

Although these may seem aggressive estimates, the expected impact on banks is relatively small .

However, do not forget that these exercises are theoretical and, like everything else, reality often shows unexpected effects. But the exercise is important.

Do not expect the credit will grow dramatically because banks pass the theoretical examination of the stress tests.

Although the level of private credit has begun to recover slowly, with an expected growth of 0.5% to the private-sector, 4.4 billion euros in 2014 -, the European Union remains, by far, the most bloated financial system in the OECD.

  • European banks are the most intervened, regulated ans State-controlled of the OECD. Not only due to the weight of public sector banks, but because of the disastrous intervention in the M&A and divestment processes , with governments pushing to lend at all costs. let’s not forget the “crowding out” effect of government debt versus households and businesses, encouraging the purchase of sovereign debt through regulation, as explained here  and in English here.
  • In Europe the banks finance 80% of the real economy , while in the U.S. is about 30%.
  • Total assets of the banking system of the euro area accounted for 349% of GDP in 2013 . A reduction of 12% since 2008. Much higher than the U.S. or Japan (Chart courtesy of Merrill Lynch) figure. While it is true that part of it is because European banks have more deposits, it shows a bloated banking system.

  • Additional credit expansion is not the solution , as we forget where we came from … A brutal credit growth since 2001, as the graph below shows (mdbriefing.com). Morgan Stanley estimates that European banks have sold or refinanced only between 20 and 25% of the 700 billion of non-performing loans that the regulation required them to urgently address in 2014.

Banks cannot drink and sing at the same time. It is impossible to strengthen balance sheets, avoid taking excessive risks while lending like 2008 just because we think that credit is the solution. First because they can’t and second because they shouldn’t.

The stress tests of 2014 are not the same as those of 2011. European banks have improved.  Non-performing loans are expected to be reduced in 2014 while operating profit is estimated to be up 4.2% after three years of decline . The risks still exist, but it is not as severe as it was in 2011. Forcing to lend at any cost is a great danger.

Liquidity injections by the ECB do not solve a key problem. Where do we put all that money?  Europe has an average of 25% industrial overcapacity. When I asked on CNBC a senior manager of the ECB where they thought they were going to invest 400 billion euros of TLTRO, he failed to give me a single key sector where those funds would be deployed.

Credit is growing again, but it should not reach the levels of 2004 to 2010 again. As Von Mises said, “no one should expect that any logical argument or any experience could ever shake the almost religious fervor of those who believe in salvation through spending and credit expansion.” 

I’m afraid that with negative deposit rates, liquidity injections and stimuli, we aim to re-ignite the credit bubble before the European banking system recovers its strength. Then, when it bursts, we will surely blame the ‘free market’… and de-regulation. 

Important Disclaimer: All of Daniel Lacalle’s views expressed in his books and this blog are strictly personal and should not be taken as buy or sell recommendations.

Iraq and Ukraine move the commodities market

Geopolitical black swans are impacting commodities this morning, with Iraq conflict worsening and Russia threat of cutting supplies to Ukraine.

Brent is at $113.02/bbl and WTI at $107.32/bbl driven by concerns about Iraq. Markets are reacting well as the physical market is not affected so far but concerns are justified.

Iraq produces 3.5mbpd, or 4% of global production and is seen as a key source of future supply growth. Production is mostly in the fields in the South, so far unaffected by the latest attacks, concentrated in the North, according to JP Morgan.

So far the physical market has not seen a relevant disruption, but markets will remain nervous as long as Malaki continues to lose the grip of the key cities, and the terrorists get close to Baghdad.  Expect oil to move closer to $115/bbl Brent as the market analyses the risk of losing exportable production.

The Islamic State in Iraq and the Levant (ISIL) have seized the city of Tal Afar in Northwestern Iraq yesterday but have not continued to advance to Baghdad, so far only concentrating on northern Iraq. The rebels have control of Mosul, the second largest city in Iraq, along with Tikrit and the small towns of Dhiluiya and Yathrib, north of Baghdad. Iraq’s military spokesman Qassim Ata yesterday said that the Iraq army had killed more than 279 members of the rebel group. President Obama has indicated that he is reviewing military options to help Iraq in fighting the rebel groups.

Kurdistan PM is mentioning in the BBC the possibility of splitting Iraq into three separate regions.

The Kurdistan Regional Government has taken over security of the giant Kirkuk field (260k b/d of production) in the North Remaining oil production in the northern oil fields is another 435k b/d. Iraq has the 5th largest proven oil reserves & is the 2nd largest crude producer in OPEC, behind Saudi Arabia, at 3.5 mbpd. OECD oil inventories were 2,624mb at end April, 77mb lower than the 5-yr average & 53mb lower than last year.

My thoughts:

– The US is unable to get involved in a war. The fact that the US will likely be oil independent (including Canada) in 2016 gives little incentive to take action.

– There is very little real western support for Malaki and the country is currently too corrupt so there is risk of a bad public image and lack of popular support problem.

– Oil companies in the South have very strong armies and security is very tight. I see low risk of oil supply disruptions and the ports are working adequately.

– The three large oil companies must have anticipated these issues as they shipped most of their needed equipment last year. They also doubled security.

– Low probability of the ISIS reaching Baghdad but strong probability of a country that ends up broken in three (Kurdistan, a Sunni North capital Tikrit and a Shiia South capital Baghdad).

Helping reduce the geopolitical risk on oil is the FT reporting that US liquids production hit 11.27 mbpd in April, and is today above its previous peak in 1970 of 11.3 mbpd. With a higher percentage of NGLs, still crude production was 8.3 mbpd in April (now 8.5m), lower than the record high of 10 mbpd in November 1970.

UK gas rises +7.1% at 45p/therm and European gas seems to rise in sympathy as Gazprom threatens to cut supply to Ukraine after the deadline to pay the outstanding bill of $2bn passed with no agreement on  a timetable of payment or price. The Ukraine government is mentioning that the price has to be revised to international levels and that they cannot pay this figure or the revised price of $8.5/mmbtu. The EU is looking for an option that includes a revision of the price for a long term contract and gradual payments. Gazprom will cut off supplies unless Ukraine pays for the gas up front.

Gazprom however, will not disrupt supplies to Europe. 33% of Europe’s gas comes from Gazprom and 50% of it is transported through Ukraine. Ukraine has enough gas in storage (13bcm) to hold on to summer demand as its annual consumption is 33bcm according to UBS. Europe also has a record amount of gas in storage after a very warm winter.

Europe’s largest gas supplier after Gazprom is Statoil who mentions it can “easily” offset any short-term disruption of Russian supply.

 Coal remains weak at $80.40/mt holding on to its support level despite news that freight rates for panamax dry bulk vessels are now below opex, and long-term forward rates have fallen below break-even. Chinese coal import is the most important trade for panamaxes and chinese imports of thermal coal are expected to be lower in 2014 than in 2013. Capesize rates have come down 43% YTD and forward rates for Q4 fell 4% this Friday.Adding to this a 100 milion tonnes of Australian capacity growth, the outlook for both coal prices and the Baltic Dry is not positive. Freight companies are growing the fleet by 4% this year so oversupply is even higher.

The Baltic Dry index is down 3% this month (-60% YTD) driven by oversupply of reights and weakening Chinese imports.

 CO2 rises 53bps at €5.74/mt helped by backloading efforts to reduce the impact on CO2 prices of lower industrial demand and poor thermal output.

US gas rises 65bps at $4.67/mmbtu helped by the past six weeks injection data. It would require a very aggressive change in injection data in the next months to justify prices below $4/mmbtu… I believe we are going to see $5/mmbtu sooner rather than later. Weekly natural gas storage injection of 107 Bcf way below the consensus median injection estimate of 112 Bcf and the bears’ view of 161bcf. Total working storage is now at 1,606 Bcf, 727 Bcf below last year’s level and 877 Bcf below the 5-year average of 2,483 Bcf.

Power prices in Europe are reacting mildly… Germany at €34.70/mwh (-5.35% YTD), Nordpool at €30.78/mwh (-4% YTD). Spanish power prices are down 1.2% YTD and French -5.5% YTD.


Important Disclaimer: All of Daniel Lacalle’s views expressed in his books and this blog are strictly personal and should not be taken as buy or sell recommendations