Friday 30 December 2011

Cypriot Bank Exposure to the Greek Debt Crisis

Cyprus and its three main banks were downgraded in November 2011 by the three major credit ratings agencies, in no small part due to their exposure to the Greek debt crisis as well as the declining situation in Cyprus. This downgrade was followed by the publication of the banking sector’s January - September 2011 financial results, which revealed a write-down of nearly EUR 1.5 billion of Greek government bonds (GGB) by the Bank of Cyprus, Marfin Laiki and Hellenic Bank, as well as rising impairments due to non-performing loans (NPL) in the private sector.

The downgrade can be summarised as stemming from a declining macroeconomic and fiscal situation in Cyprus itself, as well as Cypriot exposure to Greece:  

a.  Cypriot banks are exposed to Greek government bonds (GGB), which must be written down by approximately 50% of their value in line with the private sector involvement (PSI) agreement of October 26th, 2011.

b. Cypriot banks are exposed to non-performing Greek private sector loans (Greek NPL). According to Moody’s, up to 20% of all Greek private sector loans may be classified as non-performing in the next 18 months. 

c.   Cypriot banks are also increasingly exposed to non-performing Cypriot private sector loans (Cypriot NPL), which have been hard-hit by the declining situation in the real Cypriot economy.

A further potential exposure is seen in the uncertainty surrounding the second Greek bail-out package, which is seen as essential to avoiding a hard default by Greece. A little-known fact of the first bail-out is that any country encountering economic difficulties, expressed in a higher bond yield, may opt out of further refinancing for Greece. With Italian and Spanish bond prices having breached 7% in December 2011, it is increasingly possible that neither these countries nor France will be in a position to raise money for Greece on the open market. This could yet lead to a potentially catastrophic situation.

This article explores the actual exposure of the Cypriot banking system to Greece, and reviews the next steps in the Greek and wider European debt crises. 

View the complete article on the Navigator Consulting Group site (no registration required). 

The Greek Green Energy Bubble – II

The first confirmation of the coming pricing problems in Greek energy sector became visible  yesterday with the publication of the first official proposal on energy price increases by the Hellenic Ministry of Environment and Energy (YPEKA) and the Public Power Corporation(PPC).

These amount to an annual increase of 9.2% for the PPC’s own domestic generation cost plus 3% for the renewable energy cost.

While this is far below the initial suggestion of the Energy Regulatory Authority’s (RAE) 16% increase, as well as PPC’s 20% increase, the proposed increases have caused renewed public outrage.

The President of the Greek Chamber of Commerce and Industry, Mr. Dimitris Asimakopoulos, stated on SKAI TV that energy costs today are higher than social insurance costs in most enterprises.

It must also be remembered that the total cost PPC bill is magnified several times by additional taxes on either the base electricity price, or by the number of square meters of the property being supplied with energy. These include:

·       A municipal tax
·       A special tax on property
·       A tax for the state television and radio broadcaster, ERT
·       Value-Added Tax (VAT)

These indirect taxes routinely increase the electricity bill by at least 2x the price of electricity.

As such, the PPC bill is an example of failed government policy, in that it has transformed what should be a relatively simple billing exercise from an “independent power producer” into a focal point for public outrage and resistance. It is also an example of a massive public policy failure to properly plan for flexible feed-in tariffs for renewable energy, together with the lack of any real limitations on licensing of renewable energy installations.

This also points to the fact that Greece is now in the throes of an inflationary depression. GDP will fall by approximately 5-6% in 2011; inflation is currently running at 2.5% monthly, and higher on an annualised basis, primarily due to new indirect taxes. Together with official unemployment of about 18%, it is painfully clear that the choices in public policy mandated by the Troika and the government have failed, at least in the short term, and will lead to further severe economic damage in 2012.

Related Posts:

December 10, 2011

© Philip Ammerman, 2011
Navigator Consulting Group

Monday 19 December 2011

Public Sector Cutbacks and Political Paralysis in Greece

In May 2011 I attended a conference in Barcelona, at which a European Commission spokesperson gravely assured me that political cooperation between the then ruling Socialist party and the main opposition party, New Democracy was a precondition for success for the bailout programme.

In November, this condition was realised when a government of national unity was formed, comprising deputies from PASOK, ND and the right-wing LAOS party, under a “technocratic” prime minister, Dr. Lucas Papademos.

Since then, the true nature of Greek “political unity” has become painfully apparent. While the parties have cooperated to pass a 2012 budget, it is increasingly clear that the implementation of the reform programme as well as the laws already passed has stalled or even reversed.

No party is willing to pay the political cost of the real structural reforms that are required as a condition of the first and second bail-out packages. Instead, there is a continual jockeying for political positioning, while the Prime Minister, bereft of any political party support, tries to remain above the fray.

This lack of implementation is clearly seen in the lack of progress in implementing the “labour reserve” plan. This plan is intended to reduce the central government’s public sector headcount by 30,000 positions in 2011. Under the original plan, some 30,000 people were to be selected based on non-partisan, “objective” criteria, including their educational attainment and years of professional experience. They were to have been placed in a “reserve” status, which means they were to continue receiving a reduced salary (at a 60% reduction), while being required to take on minor tasks for a period of 12 months. If after these 12 months, they had not been permanently re-assigned to another permanent public sector position, they were to have been fired.

This labour reserve was first announced in July 2011, and is included as an objective from the first bail-out agreement in May 2010, but not as an explicit target. The numerical target appeared in the spring of 2011, and was ratified in July 2011.

The record of implementation since then has been slow. Public sector workers who met these criteria were supposed to voluntarily report themselves for inclusion in the reserve. Not surprisingly, few did, and the directors of the administrative units for which they worked did not either. As a result, last week the government had to take the step of threatening to withhold salaries from those workers who did meet the criteria, but failed to step forward.

So far, approximately 16,000 workers have been transferred to the labour reserve. This first round is apparently mainly comprised of workers with at least 33 years of experience, meaning that they are close to retirement anyway. Other press reports indicate that a large portion of these workers has chosen, or may choose, early retirement in advance of being placed in the reserve.

New Democracy objected to the choice of these individuals, and together with other “opposition” parties has issued statements claiming that political motives were behind the choice of many of the people placed on the reserve list. In one instance, New Democracy claimed that it would reverse many of the choices “when it came to power.” In another instance, ND claimed that the previous PASOK government hired 10,862 civil servants in 2011, twice the limit of 5,333 set as a condition of the bailout plan.

Greece’s creditors, and Greek citizens and taxpayers, are therefore confronted with two obvious dilemmas:

a.     If the progress of implementation of the first 30,000-person labour reserve has proven to be so badly-managed, how will Greece implement the full cutback of 150,000 staff it has promised as a condition of the first and second bailout?

b.     If there is such discord while ND and PASOK are members of the same government, what will happen in the next elections, when it is clear that probably one of the two parties will be in opposition?

The entire decision on the labour reserve illustrates the challenges facing the Greek bailout plan. First of all, the decision apparently has been taken based on purely arbitrary numbers: reducing the government headcount by 150,000 will do almost nothing in itself of improving public services, while it will create a financial burden in terms of social spending (unemployment insurance and pensions), as well as reducing consumer disposable income.

Taken together, these three elements may be equivalent to the public spending costs which are intended to be cut through the labour reserve measure. The calculation of this is simple:

Lifetime costs of dismissal =
·       1 year labour reserve at 60% salary for 30,000 staff +
·       1 year statutory unemployment benefits for those on unemployment after termination +
·       early retirement costs (pensions + lump sum payment) for those taking retirement +
·       unspecified higher costs of lost productivity and staff promotions as a result of dismissal +
·       lost income, social insurance and value added taxes due to reduced consumer spending

Second of all, if this is to be managed correctly, there needs to be an integrated strategy and plan for the Greek public sector, including a retrenchment away from areas which it is no longer competent to function, as well as a productivity improvement and e-government plan for the remaining services. None of this has been done.

Third of all, by removing the people with the longest experience in the public sector, the government is inadvertently removing many of the most competent people. While this is not necessarily negative (since many of these people are corrupt or not productive), the fact remains that you cannot simply gut a civil service on the basis of years of service and not expect an even greater dysfunction.  

Fourth of all, using the years of service as a criterion for dismissal is, in most legal jurisdictions, discriminatory, and is likely a violation of employment rights and European law. Rather than protesting on the streets, I would expect the unions to challenge this decision at the Greek Supreme Court, or at the European Court of Human Rights, and win.

This is not to say that I am not in favour of a public sector rollback: I am, but only providing that certain assumptions and conditions are met. As I have stated in many other posts, I believe that there are any number of government positions where more front-line staff are needed, and that these staff need to be more properly remunerated.

The conclusions I draw from the current situation are that neither the Troika, nor the government, are working on a real, means-tested plan which is based on common sense and reality. There are many short-sighted, spasmodic gestures which look good in an academic context or on paper, but cannot be implemented in the real world. The fact that the Greek political parties are, without exception, positioning themselves for February elections while avoiding real structural reform only exacerbates the situation.

Because I do not believe the situation will change in 2012, my longer-term conclusion is now quite simple: only a European political decision keeps Greece in the Eurozone. January 2012 will bring a renewal of the war of words between the Troika and Greece, with additional instability for the Eurozone. A future exit of Greece from the Eurozone, or a termination of the second bail-out package, can no longer be discounted.   

© Philip Ammerman, 2011
Navigator Consulting Group

Friday 16 December 2011

Hoping for a White Christmas

The new austerity packages agreed at the European summit conference on Friday, December 9th means different things to different people.

To Nikolas Sarkozy and Angela Merkel, it was an attempt to convince markets and voters that constitutionally-required austerity and an oversight role on national budgets would be enough to stave off an impending financial disaster. To David Cameron, it was a step too far: a surrender of national sovereignty, ostensibly due to the spectre of overbearing regulation of the City by Brussels.

To the average European voter, it is yet another confusing European summit, during which important decisions are made which he or she can barely understand, but which promise a fundamental and lasting change over his or her future. In these decisions, the European voter has no vote.

To a financial markets economist, it is yet another legalistic attempt to solve the problem which, while perhaps inevitable given the practical constructs of the Eurozone and the European Union, nevertheless does almost nothing to bring about a solution to the current debt crisis.

It is this last issue which we should be focusing on, not the pseudo-nationalistic conflict between Sarkozy and Cameron or lurid editorials about a German takeover of Europe which make for such amusing headlines. Germany is as exposed to the crisis as France.

The fundamentals of the European (and global) debt crisis remain the same:

·       European governments need to finance over EUR 1 trillion in 2012.

·       European banks need to raise capital by at least EUR 120 billion while taking a write-down of Greek debt by another EUR 100 billion. My own estimates for European bank refinancing needs is far higher, on the order of EUR 300-500 billion, based on a balance sheet analysis and over-optimistic NPL provisions.

·       European banks need to deal with urgent problems of non-performing loans, hedge fund and property melt-downs, and a host of other problems on the asset side of their balance sheets.

·       The global economic is grinding to a halt and will decelerate further as austerity programmes take effect.

·       Political paralysis is increasing ahead of US and French elections in 2012 and fragility in a range of other coalition governments.

In January-February 2012, two or more European economies are going to lose their triple-A rating, and yields on sovereign refinancing issues will hit emergency levels. Whether or not this results in a financial panic or substantial action by European institutions and the IMF remains to be seen. Indications are that the IMF support loan by European governments and central banks will proceed; the EFSF is trying to raise capital: it remains to be seen whether this is enough.

It is also not impossible that Japan is hit by the first signs of a financial crisis. Debt to GDP will probably reach 250% in 2012. Political stability is increasingly difficult and certainly not prepared for any kind of austerity programme. The Fukushima clean-up costs are mounting. Whether the Japanese consumer will continue to fund the system is open to question, particularly given the scandals surrounding Olympus and other companies. 

To this unsavoury financial situation, we can add the fact that global political risk is hitting unprecedented levels, and 2012 will almost certainly see the outbreak of military or civil conflict in the Middle East/Persian Gulf that will affect Europe and the United States.

There is elevated risk on a number of fronts:

·       Iran continues its search of a nuclear weapon
·       Syria is in the beginning stages of a full-scale civil war, where external powers may intervene, and where a Russian-US fleet stand-off may occur
·       Egypt risks uncontrolled civil-religious conflict and an intensification of a Hamas-led intifada against Israel
·       Lebanon, where Hezbollah remains ascendant, and may be forced into action depending on the situation in Syria

The US has ostensibly left Iraq, although sizable military forces remain; Iran is expected to intensify its presence there. In Afghanistan, troop withdrawals start at the end of 2012. Relations with and in Pakistan continue to deteriorate. Turkey continues to follow a dangerous economic and political policy in certain areas.

There is a real chance that shipping through either the Straits of Hormuz or Suez will be interrupted, either temporarily, or as a strategic objective. In the case of a wider conflict in the Gulf, Saudi petroleum pumping stations and refineries in Dhahran and other eastern cities will be targeted, as will the other Gulf states. Such a conflict is likely to emerge either as a result of the Iranian programme; the Syrian civil war; or a potential Egyptian implosion. In each case, these events will create massive economic and political uncertainty, and may lead to unrestricted warfare.

The prevailing hope right now is for a quiet Christmas and New Year. It is unknown whether this will be possible.

© Philip Ammerman, 2011
Navigator Consulting Group

Saturday 10 December 2011

The Coming Crash of the Renewable Energy Bubble in Greece

Since George Papandreou came to power in the October 2009 elections in Greece, a central policy priority has been the promotion of “green energy.” As part of this policy, between EUR 10-15 billion in renewable energy (RE) projects have been licensed. These include large, industrial-scale wind and photovoltaic projects, as well as smaller installations of up to 1-5 MW.

A further, large-scale project called Helios is being considered, which would cost a further EUR 20 billion, and generate up to 10 GW of power through photovoltaic installations across Greece. The Helios project is supposed to export its electricity to Germany, although it is difficult to see how this will be technically feasible. Despite the fact that a complete feasibility study is not yet ready, Helios has already become a condition of a second bail-out package for Greece, with the government promising to allocate revenue from Helios to repay the second bail-out.

As with many initiatives launched by the Greek government, the medium-term economic consequences of this policy have apparently been ignored in favour of short-term benefits. This is seen by the method in which the licensing procedure has been implemented.

Investors have been invited to submit proposals for renewable energy generation. Under this plan, each investor is able to sell the power either directly to consumers or consume it for their own use, or (more frequently) sell the power to DEH, the Public Power Company, at a feed-in tariff set by the Greek Regulatory Energy Authority (RAE).

Unfortunately, there has been no prior control over either the number or location of the applications permitted, nor has there been a cap on the energy generation capacity licensed. As a result, investors have responded in far greater numbers than imagined.

The process has not been without its political clientilism. In an effort to appease farmers, for instance, the Ministry of Agriculture made extraordinary efforts to get farmers to apply for RE production licenses, with many public assurances that their applications would be approved. As a result, thousands of farmers responded, with the result that the number of applications is at least double the original forecast. These farmers already benefit excessively from EU Common Agricultural Policy subsidies, and will soon increase their reliance on the state through renewable energy generation.

Besides the overcapacity in applications, a second problem is the magnitude of the price difference between electricity generated by hydrocarbons and renewable sources. In 2010, for instance, DEH’s average price per kwh for electricity generation from all energy sources (mainly lignite, natural gas and petroleum) was between 9-10 Euro cents per kwh. The equivalent generation costs for wind energy are typically budgeted at 25 cents/kwh, while the generation cost for photovoltaic energy are budgeted at 50 cents/kwh.

Although photovoltaic prices will fall due to falling prices of solar panel production, the feed-in tariff has been set by law and does fall over time, but not nearly enough, and certainly nowhere near the price of conventional energy generation.

The ultimate irony in all this is that the government will not pay for these investments at all. The costs of the investment will be passed onto the Public Power Corporation, who in turn will pass it on to the consumer. So in a recession, Greek consumers are going to be hit by yet higher electricity prices, in order to pass on economic benefits to a small minority of renewable energy entrepreneurs.

So far, although thousands of projects have been announced, few have actually broken ground and fewer still have been commissioned due to a lack of working capital, regulatory delays and other factors. But the impact of adding higher-cost, renewable energy to the grid will not be long in making itself manifest.

In January 2003, for instance, total production capacity from RE totally 206 MW. In January 2010, this had reached 1200 MW. In October 2011, this had reached 1,840 MW. Wind installations remain the largest installed power source, followed by photovoltaics.

This is not to say that renewable energy investments should not be a long-term goal. But like everything else, any investment should take into account a wider strategy framework and proceed based on an understanding of financial equilibrium in the sector. Any major investments in this sector should be implemented taking into account the following factors:

a.     The installed lignite-fired stations and means of transforming these into gas CHP units or alternate technologies to avoid carbon dioxide emission fines from 2013 onwards

b.     Positioning renewable energy stations around installed distribution capacity and ensuring that investments in distribution are sufficient to match the new energy output

c.     An annual cap on new licenses in order to avoid either a capacity or a pricing shock as the new capacity comes online

d.     Flexible pricing of feed-in tariffs to reflect changes in producer prices, particularly given that solar panel production prices have been dropping dramatically (they have fallen by nearly 50% in the last 12 months) due to overcapacity

e.     Learning from the experiences of Germany and Spain, who have both been forced to cut the feed-in tariff both due to overcapacity as well as due to changing producer prices.

Allowing anybody and everybody to apply for licenses looks good in attracting investment or burnishing Greece’s green credentials, but will be disastrous for the consumer, particularly since the government is now using electricity bills from DEH as a tax collection device.

This is all coming to a head in the next month, because as Kathimerini reports, DEH has asked to a price increase of 19% in electricity charges to consumers from 2012 onwards. This price increase is due to the following issues:

a.     Any increase of 15% or below will be insufficient to reimburse alternative energy producers for the cost of selling their electricity to DEH.

b.     The cost of electricity generation from natural gas has increased by 15% in 2011 due to the government’s decision to raise the tax on natural gas generation.

Although the price increase will be far smaller than what has been asked for, DEH is not in a favourable financial position. EBITDA in the 9 months of 2011 fell to EUR 794.7 mln, a decline of 35% over 2010. DEH attributes this to an increase in energy input prices by 15%, together with a decline in demand of 5%. This EBITDA will hardly be sufficient to implement the company’s investment programme, which calls for a large-scale increase in RE generation to offset the future fines for carbon dioxide emissions. This has been estimated by some sources to cost DEH between EUR 0.9 – 1.2 billion per year from 2013 onwards.  

As a result, there is a typically confusing situation in the Greek energy sector:

·       DEH is being used as an instrument of social policy and tax collection, while at the same time being called upon to implement a complex transition from high-carbon power generation to low-carbon generation under Greece’s commitments to EU policy.

·       Although fuel feedstock costs and taxes on natural gas are increasing, DEH cannot pass on these cost increases to consumers due to regulatory constraints. At the same time, it is committed to buying a growing share of third-party generate RE electricity at high prices.

·       The change in the power generation mix requires added investment in electricity distribution, the investment for which will have to be undertaken in the next 5 years. Adding Helios to the equation increases transmission costs dramatically.

·       All this is being done at a time of an inflationary contraction in Greece. It is inflationary primarily due to the impact of higher taxes. It is a contraction of unprecedented dimensions in Greece, perhaps last seen in World War II. Adding higher energy prices to Greek consumers will exacerbate the situation.

·       Besides popular unrest and a “won’t pay” movement, DEH’s troubles are complicated by the fact that its own unions are against the levy of the new real estate tax on DEH, and by the fact that part of the company’s assets will probably be put up for privatisation.

In a normal economic system, dealing with this situation could be solved by a mix of low-cost funding from the European Investment Bank, public-private partnerships between DEH and third-party investors, and a strategic energy investment plan. This would require a single management authority for energy, staffed by competent personnel, able to form a consensus between different stakeholders.

It would require an investment vision and plan on a 15-20 year basis, using a mix of base case and worse case financial forecasting. It would require the depoliticisation of energy policy and management. It would require comprehensive planning of ancillary factors, such as increasing biogas generation to deal with organic waste; the planning of energy-intensive investment zones; a reasonable import replacement and export generation policy; and a proper labour market planning system designed to assure self-sufficiency in human resources needed to implement the plan.

A further issue which has to be finally acted upon is hydrocarbon exploration in Greece. Although this has been announced, there has been very little movement in licensing and exploration. Yet oil and gas reserves are almost certainly there, given similar geology in the Adriatic and eastern Mediterranean basins.

In such a system, many of DEH’s union concerns can be adequately addressed, provided they are included in the planning process, and the planning process is transparent and means-tested. Although labour costs and privatisation are an issue at present, over the long term there are several options for a fair solution to these issues.

For instance, the replacement of lignite-fired stations by gas CHP stations is a definite possibility, maintaining employment while improving efficiency and lowering the generation cost while also meeting emissions targets. DEH and its unions have already shown flexibility in their joint ventures for renewable energy: there is no reason the same flexibility could not be shown for far larger gas-fired plant investments.

For obvious reasons, it is difficult to hope such a change will occur soon given the political constellation in the country. Nevertheless, there are a number of signs of progress, and it is hoped that further progress is forthcoming. Before these will manifest themselves, however, it is almost certain that overcapacity in the RE sector will create a pricing problem or contract renegotiation. 

© Philip Ammerman, 2011
Navigator Consulting Group