Energy prices registered mostly small gains Aug. 5 following a previous volatile selloff in both commodity and equity markets in anticipation of an announcement by Standard & Poor's Financial Services LLC, a subsidiary of McGraw-Hill Cos. Inc., that for the first time lowered the US government’s credit rating to AA+ from the top AAA level because of increased political risks and rising debt burden.
Olivier Jakob at Petromatrix in Zug, Switzerland, reported “well-documented rumors” early Aug. 5 of the pending S&P downgrade after the close of that session. “If the rumors were already in the street [that] morning, we can guess that Wall Street was probably already aware of it on Aug. 4, and we would not exclude that the big selloff on Aug. 4 was partly due to information leakage about the downgrade,” he said.
In its first session since that downgrade, the US equities market in early trading Aug. 8 rejoined a global selloff that started overnight in the Asian market in expectation of economic damage from the lower credit rating. The Dow Jones Industrial Average fell more than 250 points within minutes after the opening bell on the New York Mercantile Exchange. The Associated Press news service reported it recovered some of those losses, but then fell again by mid-morning.
“Today could be another ugly one,” warned analysts in the Houston office of Raymond James & Associates Inc. Of the Aug. 5 session, they said, “Volatility remained at the forefront with the broader markets ending flat as investors continue to focus on the strength of the US economy and the debt crisis in the Eurozone. West Texas Intermediate crude ended flat, but not without its fair share of volatility, while North Sea Brent [closed] up 2% on a pipeline explosion in Iran.” Natural gas was flat as hotter weather was offset by an earlier Aug. 4 bearish inventory report.
Jakob said, “The S&P’s weekend downgrade of the US from AAA to AA+ is not helping a good start of this week, and overnight the Shanghai composite lost 3.79% and the Nikkei 2.18%.” He noted, “The S&P 500 index lost a significant 7.19% [last week] and is now down 4.63% for the year, while the NASDAQ lost 8.13% [last week] and is down 4.54% for the year. All the sectors in the S&P 500 were in the red, with the greatest losses in the energy sector (down 10.9%) and the smallest losses in the consumer staples sector (dipping 2.9%).”
Rating repercussions
Jakob said, “Measuring the full impact of the US downgrade is difficult. There are many asset managers that have mandates stating that their Treasury holdings cannot be lower than triple-A but then there will be a problem of finding an alternative for US Treasuries given their market size. Some US states might also start to lose their triple-A ratings. The S&P downgrade of the US to AA+ with negative watch also puts in question the ratings of some other countries (Belgium, that is running without a government since June 2010, has now the same rating as the US; in fact the AA+ class will be made only of the US, New Zealand, and Belgium). Countries (apart from the micro states such as Lichtenstein, Isle of Man, etc.) left with AAA rating by S&P: Australia, Canada, Denmark, Germany, Holland, Norway, Singapore, Sweden, Switzerland, Austria, Finland, France, and the UK. Concerns about France being able to hold its AAA rating are not new, and if S&P wants to maintain some credibility, we do not see how they will not review the AAA ratings of some of the other countries. S&P has warned that further downgrade to the US is possible; that would then put the US down to AA status, joining in that category other countries such as Bermuda, Spain, and Slovenia.”
He questioned however, “Would you rather own Spanish or US debt for the same S&P risk rating?”
Despite widespread discussion of the US debt crisis, Jakob said, “It is still the US market that is providing amongst major indices the best returns (in local currency) for the year. The stock market surge since August 2010 was for a big part the result of the artificial support of the US Federal Reserve Bank's second quantitative easing (QE2) program and as the artificial support is taken off, the market has to move back to a pricing based on fundamentals.”
Jakob added, “After the big selloff in equities of last week, the Federal Open Market Committee (the Fed system’s policy-making arm) meeting [scheduled Aug. 9] will attract a lot of attention, and there are still some expectations that [Fed Chairman Ben] Bernanke will have to do something to support the stock market (we have to keep in mind that in January 2008, Bernanke ordered an interest rate cut of 0.75 basis points [following] the stock market plunge on the Socgen-Kerviel debacle).” Jerome Kerviel, a trader employed by the French Societe Generale Bank, was convicted in 2008 of attempted fraud resulting in losses valued at €4.9 billion.
“Common sense would say the Fed cannot engage in QE3 given that QE2 has been a massive failure,” Jakob observed. “However, we also need to keep in mind that policy makers since 2008 have embarked in a destructive pattern of thinking that ‘doing something is better than doing nothing, even if the something makes no sense.’”
He said, “Apart from inflation, the problem for the Fed is that the market is now awash in liquidity; there is too much of it, and it is not being used because the issue is [lack of] confidence in the markets and the political class rather than a dearth of liquidity. The cash asset held by commercial banks in the US has nearly doubled since the start of the year, the [Investment Company Institute] data is showing that investors continue to reduce their holdings in equity mutual funds, and last week the Bank of New York Mellon…announced it was charging on cash deposits higher than $50 million. The Bank of New York Mellon is a major trust bank, and it is seeing such massive outflows from assets back into cash that it is forced to now charge a fee for cash holdings.”
The Aug. 5 fall of the stock market finally halted “when Italy promised that it would take hard measures to liberalize its economy (we think that Greece promised the same a year ago), and when a source ‘leaked’ to the world media that, after sleeping over it, the European Central Bank might in the end consider buying Italian and Spanish bonds.” Jakob said, “With the weekend panic over the US downgrade, the ECB [gave on Aug. 7] a greater hint that it will start to buy Italian and Spanish bonds. There are still some concerns about the implementation of the Greek rescue as it is getting more and more evident that there are less and less European countries able to finance a contribution to the European rescue fund. France is trying to push for a rapid legislative acceptance of the Greek rescue plan before too many countries opt-out due to their inability to finance it.”
Meanwhile, Raymond James analysts noted “an ironic twist of events” when the US Postal Service reported Aug. 5 it will “most likely default” on payments to the US government. The USPS is downgrading staff and mail service frequency in order to curb expenditures.
In other news, Raymond James said, “The world's natural gas markets are actually further away from converging than they were 5 years ago. North America's structural gas glut shows no signs of being alleviated anytime soon, whereas both Europe and Asia-Pacific are increasingly feeling upward gas price pressures due to rising LNG dependence, especially post-Fukushima. An amalgamation of the various markets could come about in one of two ways: Either North American gas prices will rise to the levels of Europe and Asia (parity with oil), or European and Asian prices will plummet to the level of North America. Neither of these scenarios seems remotely realistic until at least the second half of this decade, though the bullish scenario is more plausible in the long run.”
James Zhang at Standard New York Securities Inc., the Standard Bank Group, reported the term structure for Brent and WTI weakened slightly due to market conditions, “and the front-end of Brent even shifted into a slight contango this morning.” Meanwhile, oil products recovered more strongly on Friday, which pushed European refinery margins higher by around 50¢/bbl.
Net for last week, WTI dropped $8.82/bbl and Brent lost $7.37/bbl, as part of a broadly-based risk aversion move across many risky assets.
Adam Sieminski, chief energy economist, Deutsche Bank AG, Washington, DC, said, “The US debt downgrade has created another round of uncertainty. Deutsche Bank's strategists believe that the direct effects of the downgrade (repo markets, money funds, munis, banks) should not be too severe, especially since the S&P action was only one ‘notch’ down and not two. In our view, it is the change in positioning among foreign debt holders, households, and a broad spectrum of US institutional investors that matters. If a downgrade is associated with a sell-off in risky assets, then the positioning changes could be magnified.”
Sieminski expects attention this week may turn to real economy data in China. “One hope for the industrialized world is that emerging market growth will prove resilient in the face of the muted US and EU growth outlook. Consequently any signs that industrial production and retail sales activity in China are weakening would threaten another bout of equity market jitters, in our view. Indeed, further losses on the S&P 500 would then be indicative of the economy moving into recession, with the resultant dangers this poses for the energy and industrial metals sectors,” he said.
Energy prices
The September contract for benchmark US light, sweet crudes regained 25¢ to $86.88/bbl Aug. 5 on NYMEX. The October contract recouped 26¢ to $87.30/bbl. On the US spot market, WTI at Cushing, Okla., was up 25¢ to $86.88/bbl.
Heating oil for September delivery increased 4.78¢ to $2.94/gal on NYMEX. Reformulated blend stock for oxygenate blending for the same month rose 6.8¢ to $2.81/gal.
The September contract for natural gas was unchanged at $3.94/MMbtu on NYMEX. On the US spot market, gas at Henry Hub, La., dropped 7.1¢ to $4.03/MMbtu.
In London, the September IPE contract for North Sea Brent climbed $2.12 to $109.31/bbl. Gas oil for August fell $21.50 to $912.50/tonne.
The average price for the Organization of Petroleum Exporting Countries’ basket of 12 benchmark crudes lost $4.18 to $103.30 bbl. So far this year, OPEC’s basket price has averaged $107.48/bbl.
Contact Sam Fletcher at [email protected].
