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Aircraft Lessors Sue Insurance Companies for Coverage in Russian Confiscation Debacle

Aircraft Lessors Sue Insurance Companies for Coverage in Russian Confiscation Debacle

Carlyle Aviation Partners’ lawsuit against insurers

The lawsuit was filed on October 31 against over 30 insurers in the Miami-Dade County Circuit Court in Florida.

Summary

After Russia invaded Ukraine in February 2022, a flurry of sanctions was placed on Russia and vice-versa. Carlyle Aviation Partners, an American Company and one of the world’s largest aircraft leasing operators, has lost use of 23 jets as a result. Carlyle has an insurance policy on these planes, which permits it to claim $225 million for damages to any one plane, with a $700 million coverage limit. Carlyle filed an insurance claim for over $700 million with over 30 insurers to cover the loss of the jets. Now, it is suing for unspecified damages, to be determined in court. The lawsuit was filed on October 31 and alleges that their insurers have failed to meet their contractual obligations to cover Carlyle’s loss of the 23 aircraft. A special hearing on the case is scheduled for March 10, 2023.

When Russia invaded Ukraine, Carlyle asked the Russian airline lessees to return the 23 aircraft and terminate the leases. The Russian airlines said that they would not be able to return the aircraft due to restrictions from the Russian Government. The Russian Government had prohibited foreign-owned aircraft from a list of “unfriendly” countries from flying out of the country without a special permit. This list included the United States, the European Union, the United Kingdom and Commonwealth, and Switzerland. Carlyle says in its complaint that it took “all reasonable steps to protect, preserve, and recover these insured assets [the aircraft].” The aircraft remain in Russia, except for one that is in Egypt. However, Egyptian authorities said that they would return the aircraft only if Carlyle paid outstanding parking and storage fees. There were 515 aircraft from foreign lessors in Russia when sanctions were enacted against Russia.

Carlyle Aviation is not the only aircraft lessor filing insurance claims over Russia’s actions. Insurance companies now face multiple multi-million and billion-dollar claims stemming from Russia’s confiscation of aircraft. AerCap Holdings NV, the world’s largest aircraft-leasing firm, also filed claims for $3.5 billion related to Russia confiscating its jets. SMBC Aviation Capital, the world’s second largest aircraft lessor filed a claim in November against Lloyds of London on $1.6 billion of aircraft losses in Russia. Dubai Aerospace Enterprise, the largest plane-leasing firm in the Middle East,  filed a $1 billion insurance claim in May for aircraft held in Russia. This amount is expected to rise, though.

The lawsuit

  • Carlyle Aviation Partners filed a claim against 30 insurers for $700 million for the Russian government’s confiscation of 23 of its jets.
  • The named insurers include American International Group UK, Chubb European Group SE, and Berkshire Hathaway International Insurance Ltd.”
  • Now, Carlyle Aviation seeks unspecified damages, to be determined at trial.
  • Carlyle alleges nine separate breaches of contract and violation of “good faith duties.”
  • Russia has enacted other policies prohibiting the return of the aircraft. Carlyle Aviation notes Russia’s blanket prohibition on the return of aircraft in its complaint, saying that “on March 8 and March 9, the Russian government banned the export or relocation of aircraft, aircraft engines and other components until December 31, 2022.
  • Carlyle’s attorneys are basing much of their legal argument on the policy’s hull coverage. However, hull coverage is usually limited to coverage of damages to the plane, excluding losses from wear and tear, hijacking, and government action.

The seizure

  • Carlyle Aviation leased the 23 planes to 12 different Russian airlines, including Izhavia, NordStar, Smartavia, and UTair, the country’s sixth-largest airline in 2021.
  • Carlyle requested the return of the aircraft on February 27, three days after Russia’s invasion of Ukraine began on Feb. 24, the company said in its complaint.
  • The airlines  told Carlyle Aviation that they could not move the aircraft out of the country, due to airspace restrictions and closures. According to the complaint, these restrictions prohibited flights from  thirty-six countries that included all EU member states, the United States, the United Kingdom, part of the Commonwealth, Canada, and Switzerland. Any of these flights are required to get  special permits.
  • The Russian airlines that the planes were leased to have ignored Carlyle Aviation’s demand to return the aircraft.
  • Carlyle Aviation Partners said that it was bringing the lawsuit because it has “exhausted all avenues to recover the aircraft.” It says that it has followed all required procedures and has not been indemnified.
  • The aircraft remain in Russia, except for one Boeing 737-800 that is being held in Egypt. However, the Egyptian authorities said that they will only return the jet if Carlyle pays outstanding parking and storage fees.

Other aircraft lessors

 

The policy’s exclusions for war

Carlyle’s policy does not cover claims caused by

  • War, invasion, acts of foreign enemies, hostilities (whether war be declared or not), civil war, rebellion, revolution, insurrection, martial law, military or usurped power or attempts at usurpation of power.
  • Any hostile detonation of any weapon of war employing atomic or nuclear fission and/or fusion or other like reaction or radioactive force or matter.
  • Strikes, riots, civil commotions or labour disturbances.
  • Any act of one or more persons, whether or not agents of a sovereign Power, for political or terrorist purposes and whether the loss or damage resulting therefrom is accidental or intentional.
  • Any malicious act or act of sabotage.
  • Confiscation, nationalization, seizure, restraint, detention, appropriation, requisition for title or use by or under the order of any Government (whether civil military or de facto) or public or local authority.
  • Hi-jacking or any unlawful seizure or wrongful exercise of control of the Aircraft or crew in Flight (including any attempt at such seizure or control) made by any person or persons on board the Aircraft acting without the consent of the Insured/Operator.

 

Furthermore, this Policy does not cover claims arising whilst the Aircraft is outside the control of the Insured/Operator by reason of any of the above perils.  The Aircraft shall be deemed to have been restored to the control of the Insured/Operator on the safe return of the Aircraft to the Insured/Operator at an airfield not excluded by the geographical limits of this Policy, and entirely suitable for the operation of the Aircraft (such safe return shall require that the Aircraft be parked with engines shut down and under no duress).

 

Political risk insurance

In political risk insurance, the insurer commits to indemnifying the insured for a percentage of losses from an expropriatory act.  This act includes expropriation, confiscation, nationalization, requisition, and sequestration.

The act must be taken by, or under the order of, the host government in which the foreign enterprise is located. The act must also:

  • Permanently deprive the Insured of all or part of its equity ownership interest in the foreign enterprise
  • Permanently deprive the foreign enterprise of all or part of the applicable physical property or
  • Selectively prohibit or materially impair the operation of the foreign enterprise so as to cause the permanent and total cessation of its activities

 

Importance of insurance brokers

Insurance policies need to be carefully tailored to the needs of the insured. A well-crafted, comprehensive policy can prevent the kind of claim disputes that Carlyle Aviation is having. Brokers walk you through getting the right coverage for your assets, advocate for you, and handle the details of your claims.

 

Securitas

Since 2004, Securitas Global Risk Solutions has helped clients develop credit and political risk solutions. Securitas is focused on developing comprehensive solutions that meet the needs of our clients. Please feel free to call us with any questions, or if we can be of any assistance.

 

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Major Country Risk Developments

Major Country Risk Developments

Posted with permission from greatamericaninsurancegroup.com  Overview The global economy has suffered four shocks...

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Major Country Risk Developments

Major Country Risk Developments

Posted with permission from greatamericaninsurancegroup.com

 Overview

The global economy has suffered four shocks since 2020: the pandemic; a huge fiscal and monetary expansion in response to it; post-pandemic supply side shortages, in which pent-up demand hit supply constraints in industrial inputs and commodities; and finally, Russia’s invasion of Ukraine, which hit energy supplies and prices in a way not experienced before. An economic slowdown appears unavoidable as we approach 2023, with stubbornly high inflation and the response to it [rising interest rates], combined with soaring energy costs – leaving consumers globally with far less discretionary spending.

The IMF is now forecasting global growth of 3.2% in 2022 and 2.7% in 2023. Those estimates have been ratcheted down from earlier estimates. Inflation, meanwhile, is projected to be 8.8 percent in 2022, up from 4.7% in 2021, before declining to 6.5 percent in 2023 and to 4.1 percent by 2024.

The global economy faces a thicket of problems from high inflation, tight monetary policy that seeks to reverse more than two decades of easy money, and geopolitical risks ranging from the rise of far-right autocracies to the ongoing and violent war in Ukraine. Risks to the outlook remain largely on the downside. Monetary policy could miscalculate the right stance to reduce inflation. Policy paths in the largest economies could continue to diverge, leading to further U.S. dollar appreciation and cross-border tensions.

The oil market faces almost unprecedented two-way risks at present. On one hand, the possibility of deep recession-induced, in large part, by soaring energy costs around the world in the wake of the war on Ukraine. Meanwhile Moscow has weaponized gas supplies against Europe. Pending EU sanctions on Russia, Russia may remove some of its oil from the market as soon as winter. In reaction to a price cap plan, Russia may decide unilaterally to withhold supply. Or it may disrupt 1.2 million barrels per day of exports through a pipeline carrying Kazakh oil that passes through Russia. Also, global crude demand will likely surge when China finally eases its Covid-19 restrictions.

By any measure this is a big moment for oil prices, the global economy, and the world’s energy order. Crude prices remain high by historical standards. Yet the Opec+ oil cartel, led by Russia and Saudi Arabia, agreed in early October to cut two million barrels of oil per day from existing production supplies – adding salt to the wound for numerous oil-importing nations. Prices at the pump, which dipped over the summer, will begin climbing again. After months of raising supply, Saudi Arabia decided it was time to change course. The newly announced production cuts are designed to reset the market’s sentiment.

A geopolitical breach is also underway, as the decades-old alliance between the U.S. and Saudi Arabia frays in favor of the Saudis tightening their six-year partnership with Russia. Tensions between Saudi Arabia, the world’s largest crude oil exporter, and the U.S., the world’s largest consumer, come as signs of a deepening energy crisis ensues alongside the Russian war in Ukraine. Both Saudi Arabia and Russia stepped up their pursuit of production cuts to halt a recent slide in oil prices which have fallen from $120 per barrel in June to around $90 last month – a drop that has hit Russian state revenues. Russia needed a substantial production cut to raise prices – since Russian oil has been trading at large discounts after European buyers turned away. The U.S. wants to restrict Russia’s oil revenues to starve its military of funding for the war, which makes Saudi Arabia’s continued cooperation with Moscow a growing source of tension between the Saudis and the U.S. In short, Opec+ oil producers have imposed significant cuts in oil supply amid one of the tightest crude markets in recorded history, and ahead of a potential decline in Russian exports over the coming months. The move is a very big gamble on a fragile global economy’s tolerance for more energy inflation.

Energy prices have shot up far above the cost of extraction, production and generation. The result is a massive redistribution of the economic value of energy from consumers to producers. Consider Saudi Arabia: in the previous five years, its exports typically hovered around $20 billion a month. Since the Russian invasion of Ukraine, the value of its monthly exports shot up to $40 billion. Other petrostates are obviously also beneficiaries. Meanwhile, other big emerging economies in addition to India, such as Brazil, Turkey, and South Africa, are facing import bill increases that far exceed any export growth those economies may have had during this period.

Then there is Russia which has racked up enormous surpluses. This is not just a function of high energy prices but also the collapse in its imports. But still, it has made enormous amounts selling oil and gas this year. Russia’s trade surplus has more than tripled since last year, according to the World Bank.

Meanwhile, the U.S. and other G7 countries have advanced a plan to impose a price cap on Russian oil sales – a move that could lead to lower supplies from Russia alongside a tightening of European sanctions against Moscow which takes effect in December. Opec+ producers worry that a price cap planned only for Russia now could later become a precedent for wider use against other producers. The U.S. Treasury has estimated that the G7 plan to cap the price of Russian oil exports would yield $160 billion in annual savings for the 50 largest emerging markets, as Washington insists that the scheme it has championed would put a lid on rising energy costs around the world. However, there are still doubts and uncertainty in the oil market about the extent to which this novel experiment, never before attempted, will work in practice, what its effects will be on the market and how Russia will react.

According to the U.S. Treasury, Europe and East Asia are the two regions most dependent on net oil and oil product imports, which account for 4.7% of GDP, or $55 billion annually. In 16 emerging markets ranging from Mali to Turkey, El Salvador and Thailand, net oil imports account for more than 5% of GDP.

To date, a decline in Russian oil exports to Europe has been largely offset by shipments rerouted to customers such as China, India, and Turkey. However, the International Energy Agency has forecast that Russian oil production will fall sharply once the EU embargo comes into full force – a risk that would drive up energy prices without a price cap in place, according to U.S. officials. A price cap would stabilize world energy prices. Many emerging markets would benefit (from the needed price break) compared to the hammering their economies are currently experiencing. Opec Gulf producers have grown alarmed at the possibility that such a mechanism could one day be applied to them.

Meanwhile, the divergent outcomes of emerging economies will be determined by how well their economies are managed, whether they export commodities, and their level of indebtedness. Before the pandemic, depressed private investment and demand kept inflation too low for central banks that targeted 2%. In that world, government deficits helped by putting upward pressure on inflation. This also tended to push up interest rates, not a bad thing when central banks worried more about rates being stuck at zero. The upshot was that, as far as markets were concerned, governments’ capacity to borrow was infinite.

That world is now over. Inflation in many countries is too high, and structural forces threaten to keep it there for some time. Having belatedly realized this, central banks are raising rates at the fastest pace in 40 years. While some countries acknowledge inflation is a problem they continue to borrow as though limits do not exist. After the stimulus-inflated levels of 2020 and 2021, budget deficits fell sharply across developed markets this year, to an average 4.3% of GDP, according to independent estimates. However, budget deficits in developed countries are projected to rise to 6.1% in 2023 and 6.9% in 2024.

Several European governments are borrowing to defray higher energy costs over the coming winter. Markets are forgiving of those borrowing/spending plans for several reasons. First, by lowering headline energy prices, subsidies make it less likely that high inflation becomes embedded in the public’s thinking and is thus sustained. Second, these outlays are seen as necessary and temporary.

The most vulnerable economies in the developing world are having to run very tight monetary policy at a time when they are dealing with a slowing global economy and energy security. There are debt defaults already underway from lower-income countries that have borrowed in dollars. Bailouts by the International Monetary Fund (IMF) have hit record highs as rate rises push up lower-income countries’ borrowing costs.

USA

Sharp increases in U.S. interest rates and a soaring dollar are causing global alarm. The strength of the U.S. dollar continues to matter because it tends to impose contractionary pressure on the global economy. The roles of the U.S. capital market and the dollar are far bigger than the relative size of its economy suggests. The U.S. capital markets are mostly those of the world, while its currency is the world’s safe haven. Thus, whenever financial flows change direction from or to the U.S., markets around the world are affected. One reason is that most countries care about their currency exchange rates, particularly when inflation is a worry. The danger is greater for countries with heavy liabilities to foreigners, and worse if the debt is denominated in dollars. Many countries will now need help.

The recessionary forces emanating from the U.S. and the rising dollar come on top of those created by the big real shocks. In Europe, above all, its higher energy prices are simultaneously raising inflation which in turn is weakening real demand. Meanwhile, the determination by China to eliminate the coronavirus at all costs, is hitting its economy, as well as its ability to fill overseas orders in a timely fashion.

While the reserve status of the dollar and Treasury debt insulates the U.S. from some of the pressures buffeting the UK, U.S. fiscal policy is just as mis-calibrated. While the sitting U.S. Administration touts the Inflation Reduction Act, which lowers U.S. deficits by $240 billion over a decade, the Administration also passed a law which increased spending on veterans’ affairs, infrastructure, and semiconductors, while taking executive actions that vastly expands various food and health benefits for the needy, as well as cancelling student debt worth between $400 billion to $1 trillion.

Adding that to the 2021 stimulus and the associated interest expense, the Committee for a Responsible Federal Budget, estimates that the Administration will increase deficits by $4.8 trillion, or 1.6% of GDP over a decade. The relaxed attitude toward all this additional debt is shaped by the Administration economists’ assumption that real interest rates – the nominal rate minus inflation- will remain around zero for the coming decade. Federal debt is much more manageable when real rates are lower than the economic growth rate. They have some justification: real rates were well below the economy’s growth rate for a decade before the pandemic.

On the other hand, massive deficits, the Federal Reserve tightening in response to flare-ups of inflation and diminished private savings could all elevate real rates in coming years- as occurred after then- Federal Reserve Chairman Paul Volker crushed inflation in the early 1980’s.

There is some talk of globally coordinated currency intervention, as happened in the 1980’s – which first, weakened the dollar and then, stabilized it. Until the Federal Reserve is content with where inflation is going, that cannot be the case this time. Currency intervention aimed at weakening the dollar by just one or even several countries is unlikely to achieve sufficient stability.

A more important question is whether monetary tightening is going too far and in particular, whether the principal central banks are ignoring the cumulative impact of their simultaneous shift towards tightening. An obvious vulnerability is in the eurozone, where domestic inflationary pressure is high, and a significant recession is probable in 2023. However, the president of the European Central Bank has stated clearly: “We will not let this phase of high inflation feed into economic behavior and create a lasting inflation problem. Monetary policy will be set with one goal in mind: to deliver on our price stability mandate”. Even if this should turn out to be overkill, central banks have little option. They must do what it takes to curb inflation expectations.

We are unsure how much tightening might be needed. In such times the perceived sobriety of borrowers matters a lot. This is true of households, businesses, and not least, governments. The financial tide is going out: only now will we notice who has been swimming naked.

Germany

The government unveiled a 200 billion euros “protective shield” for businesses and consumers struggling with soaring energy costs, the largest aid package adopted by a European country since the start of the energy crisis.

The centerpiece of the plan, financed by new borrowing, is an emergency cap on gas and electricity prices that have soared since Russia first slashed its gas exports to Europe over the summer. Disruptions in the flow of gas from Russia have pushed up prices for the fuel to record levels and raised fears of a winter gas shortage in the eurozone’s largest economy. Companies have cut production and consumers faced with rising inflation have reined in spending. A flash estimate published by Germany’s statistical agency showed that inflation hit a 70-year high of 10.9% in September.

A joint forecast by Germany’s leading economic institutes predicts the country will slip into recession next year, with GDP contracting by 0.4%-0.6%. Leading German policymakers assert that the country is in an energy war for its prosperity and freedom. The recently announced 200 billion euros aid for consumers and businesses, will be financed through new government borrowing and channeled through the reactivated Economic Stabilization Fund (WSF), an off-budget facility that was set up in 2020 to help companies survive the lockdowns and other public health measures imposed during the pandemic.

Despite the setting up of this “protective shield” around the economy, Germany is sticking to a fiscal policy based on stability and sustainability. A group of experts are working on details of a gas price cap and will present recommendations in mid-October. It is expected that prices for a set, basic volume of gas and electricity will be capped, with usage higher than that priced at market rates. Energy suppliers would be compensated by the state for having to sell their gas and electricity to consumers for a lower price. The German economy minister scrapped a previous gas levy on all consumers. The levy had been designed to help energy companies (such as Uniper, which had been plunged into crisis after being forced to buy expensive alternatives to Russian gas on the spot market) but was rendered moot by the government’s decision to nationalize Uniper in September.

The German government has warned of the risk of electricity shortages this winter. The government insists that despite new aid measures, German energy use must be reduced. Consumption, particularly in the private sector, is not falling as much as the government wants. The idea of a gas price brake has long been discussed in the German government, but it is contentious. The fact that so much of German gas is imported means any reduction in its price would require massive subsidies which would then pump new purchasing power into the private sector. This would stoke inflation and would be destabilizing and problematic for lower income households.

Germany is relying on highly polluting coal for almost a third of its electricity, as the impact of government policies and the war in Ukraine leads producers to use less gas and nuclear energy. In the first six months of 2022 Germany generated 17% more electricity from coal (over the same period last year). The leap means almost one-third of German electricity generation now comes from coal-fired plants, up from 27% last year. Production from natural gas, which has tripled in price since the beginning of the Russian war on Ukraine, fell 18% to only 11.7% of total generation.

The shift from gas to coal was sharper in the second quarter. Coal-fired electricity increased by an annual rate of 23% in the three months to June, while electricity generation from natural gas fell 19%. At the beginning of 2022 more than 50% of German gas imports came from Russia, a figure that fell slightly over the opening half of the year. Opposition groups accused the government of “madness” over its decision to idle the country’s three remaining nuclear power stations from the end of this year. Electricity generation from nuclear energy has already halved after three of the six nuclear power plants that were still in operation at the end of 2021 were closed during the first half of this year. The government now says it will keep on standby two of the remaining three nuclear power stations, which were all due to close at the end of this year.

The figures highlight the challenge facing European governments in meeting clean energy goals going forward. Germany has been trying to reduce its reliance on coal, which releases almost twice as many emissions as gas and more than 60 times those of nuclear energy, according to estimates from the Intergovernmental Panel on Climate Change.

One bright spot from the data was an increase in use of renewable energy. The proportion of electricity generated from wind power rose by 18% to 26% of all electricity generation, while solar energy production increased 20%.

The success in moving away from gas towards other energy sources could mean that the risk of hard energy rationing over the winter are less severe now, even with little or no Russian gas flows. However, a recession in the eurozone’s largest economy is still expected – as a large part of the impact comes via higher prices and because industries and households still rely on gas for heating. German industrial production slid 0.4% between July and September. Production at Germany’s most energy intensive industries fell almost 7% in the five months after Russia’s invasion of Ukraine. The consensus is that the demand destruction caused by the surge in prices will send the German economy into recession over the winter.

 

Meanwhile, Germany’s manufacturing export model appears under threat. Voices in government are arguing that having already suffered from reckless reliance on Russian gas, Germany’s economic dependence on another belligerent autocracy in the form of China has left it dangerously exposed.

Media reports suggest that Germany’s economy ministry run by the Greens, is looking to reducing support such as state investment and export guarantees for German companies operating in China. The stated intention is to achieve diversification rather than reducing exports from or investment in China overall. However, reduction in operations in an economy the size of China’s is unlikely to be made up by foreign markets elsewhere, it may well form part of a long-term reorientation away from manufacturing mercantilism.

The dangers to the German and wider EU economies from Berlin’s export-orientated model have long been clear. Since the early 2000’s, by suppressing domestic wages and demand, and prioritizing current account surpluses, Germany ultimately shifted production home and unemployment to the rest of the eurozone.

This model is also more at odds with the EU’s stated approach to trade policy. Traditionally, the German export lobby (and its supply chain satellites in central and eastern Europe) has been important in pushing for free trade agreements – even in these days it is often more interested in investing in consumer markets like China than exporting there.

The Greens have emerged as Germany’s chief Russia and China foreign policy hawks – and have pointed out the difficulties and contradictions of this position. A draft EU deal with the South American Mercosur trading block signed in 2019, is widely known as “cars for beef”. It gives European automakers access to Brazil’s vast consumer market, overriding the protests of French and Irish cattle farmers against Brazilian imports. In the final days of its six-month EU presidency in 2020, Germany also drove through the bilateral Comprehensive Agreement on Investment (CAI) with China, largely designed to protect German operations in China.

Germany has passed a law, making companies responsible for human rights abuses in their supply chains, ahead of similar initiative by the EU. Brussels has also enacted a ban on products made with forced labor. But German industry leaned against such moves. Germany’s domestic legislation does not create a new civil liability for companies, and their obligations to find and eliminate abuses are considerably weaker in lower tiers of their supply chains.

For now, Germany is having enough trouble with its rushed attempt to do without Russian gas. Fundamental structural change in business and the country’s political economy will take a lot longer. Still, if the EU is serious about reorienting its trade policy and Germany about rebalancing its economy towards domestic demand, ending the export bias is an important step. In the meantime, reducing artificial incentives for companies to become dependent on China is a good development in itself.

Eurozone

Europe needs to replace Russian gas. That makes liquified natural gas (LNG) imports to Europe more important. Not every country on the continent has sufficient infrastructure to import the LNG sent from the U.S., Qatar and elsewhere. Floating storage and regasification units [FSRU’s] offer countries a cheaper, flexible solution to importing liquified gas.

Relatively quickly, these vessels-refitted from LNG tankers- can anchor up, connect to the local gas networks and turn imported super-cooled gas into piped methane. Moreover, building an offshore regasification plant can cost $10 billion compared with the roughly $500 million new-build cost for an FSRU.

Since the Ukraine war countries such as Germany, which has no onshore LNG terminals, have scrambled to lease available vessels. Germany plans to charter three for this winter. The Netherlands expects gas to flow soon through two FSRU’s recently arrived at the port of Eemshaven, where a new floating terminal sits close to the north-western border with Germany. Germany’s gas storage has filled up faster than planned. France announced that its reservoirs were 90% full.

These relatively small vessels have two redeeming features. They are quick to set up and can later be repurposed back into LNG tankers or for other types of commodities.

Meanwhile, pressure is building on the EU to launch emergency action to support the strategically important European smelting industry as another plant announced savage production cuts. Germany’s Speira is the latest aluminum producer to slash production because of soaring energy costs as the crisis deepens for one of the continents key industrial sectors. The  recent cuts add to calls for help to save a sector that is facing an existential threat from skyrocketing power prices and comes ahead of a meeting of EU energy ministers that aim to soften the pain for households and business through emergency interventions.

The nonferrous metals trade body said industry problems, which have led to unprecedented cuts to smelter production over the past year, will deepen unless the EU intervenes. The industry is concerned that the winter ahead could deliver a decisive blow to the operations of many companies. The cost of energy has become far higher in Europe than in Asia and the U.S. following Russia’s cutting gas supplies to the continent. This is threatening to wipe out corners of the regions industry. Speira explained that energy prices have become too high to maintain production in Germany and the company expects little price relief in the near-term. Europe is facing similar challenges at many other aluminum smelters. Companies are preparing to curtail 50% of all smelter production until it becomes possible to sustain value.

The move to reduce smelter production at the Rheinwerk plant near Dusseldorf to 70,000 tons a year beginning in October, follows Aluminum Dunkerque, Europe’s largest primary smelter for metal, announcement that it would reduce output by more than 20%. The latest wave of cutbacks follows indefinite shutdowns of Norsk Hydro aluminum smelter in Slovakia and a zinc smelter in the Netherlands run by Nyrstar, which is controlled by commodities trading giant Trafigura.

While Europe only accounts for 6% of global aluminum production, the metal is of strategic importance because of its use in aerospace, defense, and the auto sector, as well as in buildings and to produce drink cans. Known as “solid electricity,” aluminum is one of the most vulnerable sectors to the surge in energy prices that shot up after Russia cut gas supplies to Europe.

Before the crisis, electricity was about 40% of an aluminum smelter’s costs with one ton taking five megawatt hours of electricity to produce, enough to power the average home for about five years. Producers now say it is nearly impossible to sign long-term power supply deals when their current contracts expire with electricity prices up over 10-fold of their average over the previous decade. Gas, which is used to generate power, heavily influences electricity prices.

Italy, one of the world’s most heavily indebted governments, has seen its bond yields shoot higher this year, even though incoming right-wing Prime Minister Giorgia Meloni has promised fiscal rectitude. In part, that’s because the European Central Bank is no longer backstopping member governments by purchasing additional debt.

UK

Recently proposed tax cuts outlined by the new UK government [now partially withdrawn] caused great alarm. They were intended to be permanent and to reduce deficits by boosting growth – without details on exactly how that would be accomplished. It was not so much that the package was large, but that the government did not seem to consider its ramifications before announcing it.

The 6% fall in the value of the British pound and a half-percentage point rise in government bond yields following the unveiling of the government’s plan, reflect the markets belief that the Bank of England would need to raise interest rates more in response to the package, while investors (including foreigners) would be buying a lot more British debt. Some estimates put the sum at $240 billion of new debt needed to finance the budget deficit in 2023 and $90 billion being sold by the Bank of England as it unwinds the bond buying of previous years. In total, that’s equivalent to a staggering 12.2% of British GDP. The Bank of England said it would buy  bonds to stabilize markets. As markets demand higher bond yields as compensation for greater supply and greater risk, so too UK deficits will widen as net financing needs rise further.

Surging wholesale gas prices are putting the UK on a path to exceed 18% inflation, the highest rate among larger western economies. This projection heaps more pressure on UK’s Conservative government to address a worsening cost of living crisis; and comes as gas prices for next-day delivery surged by 33%. Rapidly increasing prices for natural gas have left recent economic projections out of date. UK rate of inflation has exceeded expectations in most months of this year as price rises have spread through the economy. The energy regulator Ofgem indicated that the projected price increases to households of average usage of energy from October -January will be up 75%. Meanwhile, the strength of the pound [versus the euro and dollar] remains close to its lowest levels since 1985. Sterling is down 20% against the dollar in 2022, putting it in contention for the worst performer among G10 currencies this year, running neck and neck with the Japanese yen.

Markets are pricing in a 1.5 percentage point interest rate increase by the Bank of England- to 3.75% in November. British banks have also begun pulling mortgage loans in response to rising yields on government bonds (gilts), with mortgage rates expected to rise substantially.

The turmoil in the UK underlines the importance of fiscal restraint, especially with inflation at 40-year highs and central banks raising interest rates aggressively. In the UK it seems a major experiment is underway as the state simultaneously accelerated spending/borrowing while the central bank steps on the brakes by hiking interest rates.

The IMF has been closely monitoring developments in the UK and has stressed that given elevated inflation pressures, it does not recommend large and untargeted fiscal packages. The Fund said it understood the UK government’s desire to help families and businesses deal with the energy price shock while boosting growth with supply-side reforms. But it raised the concerns that tax cuts, which will disproportionately benefit high earners, will likely increase inequality in the economy.

Brazil

The last time the left was in power in Brazil, the country’s most important company was caught up in a multibillion-dollar corruption scandal and was almost buried under a mountain of debt. After emerging from the scandal and financial turmoil of the previous decade, $76 billion oil and gas giant Petroleo Brasileiro [Petrobras] is now  leaner, more profitable and a cash machine for its owners.

As Latin America’s largest economy prepares to choose a new president, very different visions are on offer for the state-controlled group.

Incumbent rightwing leader, Jair Bolsonaro, has spoken of privatizing Petrobras [the region’s largest oil and gas producer and the most valuable listed business]. His main challenger and the frontrunner, leftist ex-president Luiz Inacio Lula da Silva, intends to reassert greater government influence over Petrobras – once considered the crown jewel of the Brazilian economy.

Lula’s manifesto calls for the oil giant to once again be an integrated energy company, present in fertilizers, renewables and biofuels- areas at one point it largely decided to exit in order to focus on its core activity of pumping deep-water crude. There would also be a bigger role for the company in Brazil’s eventual clean energy transition. Lula wants the company to work towards having national self-sufficiency in refined derivatives, such as petrol and diesel, and stop charging international prices for fuel sold domestically. Lula’s ambition is for Brazil to be an exporter of petroleum products and an exporter of crude oil.

Lula’s resource populism taps into public discontent in Brazil over high living costs, a sentiment inflamed by bumper profits at Petrobras. Like other oil majors, the company benefited from a rise in crude benchmarks triggered by Russia’s invasion of Ukraine. Brazilian consumers didn’t. In addition to beating predictions of 27% increase in net income to $10.1 billion during the second quarter of 2022, Petrobras was the world’s biggest corporate dividend payer in the period, according to research by a leading Wall Street investment firm.

Private shareholders, including western financial institutions, together hold almost two-thirds of Petrobras’ equity, but with more than half of the voting rights the Brazilian state wields control. Despite a recent tumble, the Sao-Paulo-listed preference shares are up 50% so far in 2022, outperforming the local stock index.

Mr. Lula’s campaign proposals have unnerved some investors. The fear is a return to the days of political interference in the running of Petrobras under Lula’s Workers Party, which ruled Brazil for 13 years until 2016. Shareholders accused the then PT government of using Petrobras as an arm of the government. Some shareholders fear a return to old habits should Lula be reelected. One worry is that renewed diversification plans requiring extra investments could hit the company’s profit margins and cash generation.

Still, others hope that Lula, who governed Brazil for two terms between 2003-2010, will prove pragmatic on economic matters and avoid radical interventions in the economy, the private sector, and Petrobras in particular. It’s recalled that during Lula’s time in office, Petrobras found vast offshore oil and gas deposits known as deep-salt reserves that ranked among the world’s largest discoveries in decades. Mismanagement and meddling in the company took a heavy toll. Under Lula’s chosen successor Dilma Rousseff, Petrobras was forced to keep prices artificially low in a bid to tame inflation. A former chief executive estimated this cost the group some $40 billion. Elsewhere, refinery projects went over budget and unfinished. Borrowing exceeded $130 billion by 2015, making Petrobras the most indebted company in the sector.

Since those crises, the group has tightened compliance and reduced its gross debt below $54 billion. It has looked to offload assets such as mature fields, petrol stations, and refineries, concentrating instead on exploration and production in the Atlantic Ocean. The company has embraced recovery, not only financially, but also in its governance and credibility.

Still, the Bolsonaro era has not been without tumult. The rightwing populist has regularly attacked Petrobras over petrol costs and fired three chief executives in little over a year. But as a measure of the robustness of its overhauled internal procedures, the company has maintained a policy of moving refinery gate prices in line with dollar-based rates on external markets. Brazil produces enough crude for its own needs but lacks adequate refining capacity to meet domestic demand – and must rely on shipments of derivative products from abroad.

Local businesses point out that oil is a global market – and that there is no room for artificial prices or price controls. With at least one-fifth of diesel consumed in Brazil coming from overseas, importers need to be able to buy at the international price and sell in Brazil. Lula’s advisers have sought to soothe concerns. They have advanced a theory of one way to implement his pledge to “Brazilianize fuel prices” via reference values formulated by a government agency, with vendors free to follow or ignore them. This theory is, so far, not taking hold.

Privatization of Petrobras is viewed as the best possible outcome by some. This would remove the threat of government intrusion, and hence would free the company’s share price, which is considered undervalued compared to many of its peers.

If the polls are correct and Lula triumphs, investors can find some comfort in current legal reforms and new corporate governance norms at Petrobras approved in the wake of the ‘car wash’ scandal. These are designed to prevent government’s using state-controlled enterprises for political gain and oblige ministers to reimburse any costs incurred as a result of enforced subsidies. But as the controlling shareholder, the state can still effectively shape company strategy by replacing the board and the top job.

South Korea

 

The Bank of Korea will not confirm that a currency swap arrangement with the U.S. Federal Reserve will go into effect soon – as the Korean won continues to slide against the dollar to the lowest levels since March 2009. The won has fallen 155 against the dollar since the beginning of 2022, more than any other major currency in Asia apart from the Japanese
yen.
Korea is struggling to defend its currency as the Federal Reserve sharply raises interest rates to curb inflation. Expectations of a currency swap deal have grown after it was revealed that both countries had expressed interest in reopening a currency swap line. The Bank of Korea and the U.S. Federal Reserve signed a $60 billion currency swap agreement in March 2020 as an emergency measure to stabilize foreign exchange markets, but the deal expired at the end of 2021.

Calls for an emergency swap deal have intensified amidst expectation that the dollar’s rally -near its highest level in more than two decades against major currencies- to continue at least until the end of the year. The consensus is that such a deal, which will allow South Korea to borrow U.S. dollars at a present rate of exchange for won, as a last resort to stabilize the volatile market.

Authorities in South Korea and other Asian markets are preparing for worst-case scenarios as the dollar is likely to continue to rise with the Federal Reserve’s rate hikes, but there is not much they can say to reverse the trend other than gradually raising their own interest rates to slow the pace.

Export-dependent countries such as South Korea are under increasing pressure, with the country’s growing trade deficit and higher oil prices dimming the won’s outlook. South Korea reported a record trade deficit of $9.5 billion in August.

The authorities have stepped up oversight of currency markets, with the Bank of Korea asking currency dealers to provide hourly reports on dollar demand after a series of verbal warnings failed to halt the won’s descent.

A South Korean panel that overseas the country’s massive National Pension Service, the world’s third-largest pension fund, is drawing up new rules to improve its foreign exchange management policy – as a top priority.
Meanwhile, the government is trying hard to defend the psychologically important Won 1,400:US$1 threshold. It has intervened in the market to slow the pace of the won’s decline.

The won is not the only victim of a surging dollar in Asia. The renminbi has breached the psychological level of Rm7 : US$1 despite Beijing’s verbal warnings and other attempts to shore up the currency.
Separately, South Korea’s science ministry has indicated that “sense of crisis” is gripping the country’s semiconductor industry, as Korea braces for greater challenges from U.S. and China in an intensifying global chip war.

There is growing fear among Korean officials and industry executives that the country will shed production facilities as domestic chipmakers, lured by subsidies and tax incentives, rush to build semiconductor plants in the U.S. China is catching up fast in the memory chip sector on the back of generous state funding.
New Korean legislation passed in August have laid the legal groundwork to support the semiconductor industry against severe competition from the U.S., China, Japan, Europe, and Taiwan. It reflects a sense of crisis about South Korea’s competitiveness on the global stage and the new legislation is designed to strengthen Korea’s competitiveness in supply chain and security.
The complaint is that Korean companies have received relatively smaller tax benefits from the government and suffered from a lack of talent compared to China, the U.S. and Taiwan. Industry officials want the South Korean government to provide more support for domestic chipmakers as the U.S., China, and Europe boost investment in the sector.
South Korea remains the world’s biggest memory chip producer, with Samsung and SK Hynix together controlling about 70% of the global Dram market and more than half of the Nand flash market. Dram chips enable short-term storage for graphic, mobile and server chips, while Nand chips allow for files and data to be stored without power.

But the Korean chipmakers technological edge over U.S. rivals in the Dram business appears to be narrowing, while Chinese chipmakers are expanding their market share in the Nand flash market. Apple indicated that it is evaluating sourcing Nand chips used in some iPhones used in China from a Chinese chipmaker. Analyst have also noted that much of the R&D being conducted by Korean companies on next generation semiconductor technologies are taking place in the U.S.
The Korean government has taken the lead in mounting a turnaround to this challenge, emphasizing that semiconductors will determine the fate of the economy, while promising greater backing for the industry. It has expanded tax breaks, reduced red tape and introduced two pending bills known as the K-Chips Acts that are aimed at bolstering new activity. The government also intends to provide funding for essential infrastructure for chip production facilities such as electricity and water supply. The aim is to develop large ‘chip clusters” that will gather production and research and development to attract foreign chipmakers to Korea. The government also intends to train 150,00 people over 10 years to boost the semiconductor workforce, thereby addressing concerns over a lack of adequate local talent in the sector.

By Byron Shoulton, FCIA’s International Economist
For questions / comments please contact Byron at
bshoulton@fcia.com

What is Trade Credit Insurance?

If you are a company selling products or services on credit terms, or a financial institution financing those sales, you are providing trade credit. When you provide trade credit, non-payment by your buyer or borrower is always a possibility. FCIA’s Trade Credit Insurance products protect you against loss resulting from that non-payment.

Since 2004, Securitas Global Risk Solutions (“Securitas”) has worked with insurers to help clients worldwide develop credit and political risk transfer solutions that provides value on numerous levels.  As an independent trade credit and political risk insurance brokerage, Securitas is focused on developing comprehensive solutions that meet the needs of clients, ensuring complete understanding of policy wording and delivering excellent responsive service.

 

 

 

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Major Country Risk Developments

Major Country Risk Developments

Posted with permission from greatamericaninsurancegroup.com  Overview The global economy has suffered four shocks...

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Liquidity matters: Corporates may need half a trillion of additional working capital requirement financing in 2021

Liquidity matters: Corporates may need half a trillion of additional working capital requirement financing in 2021

Used with Permission from eulerhermes.com

Summary

      • In 2020, Working Capital Requirements in the West increased (+5 days in North America and +1 day across Western Europe) while it dropped in regions such as Latin America (-3 days), Eastern Europe (-2 days) and APAC (-1 day). Inventory management and government support explain most of this divide. In the US and EU, severe lockdowns pushed companies into a “forced” stockpiling mode, which was fortunately tempered by the “invisible bank”, i.e. the very accommodating management of payment terms between customers and suppliers, , partly financed by liquidity support measures. 2020 saw a surge in WCR across industrial sectors: +13 days for metals to 95 days, +9 days to 117 days for machinery, +4 days to 84 days for paper and +3 days to 87 days for automotive.
      • Looking ahead, we estimate that large companies will face a record increase of EUR453bn in WCR  in 2021, equivalent to +4 days of turnover, up to EUR8.4trn. This comes in a context of the strong demand rebound triggered by the grand reopening, alongside severe shortages in inputs, labor and final goods. The surge in WCR already observed in most developed economies will ramp up in 2021, while WCR would remain well under control in a few emerging countries, notably in China (-6 days). In both the US and the Eurozone, we expect WCR to rise by +4 days.
      • While all sectors will see a rise in WCR, consumer goods sectors could see the biggest jump. Last year was a year of divergence. We expect many global sector WCR levels to resynchronize on the upside in 2021, with retail (+9 days up to 52 days) and agrifood (+8 days up to 81 days) seeing the largest rises, followed by industrial sectors such as metals (+7 days up to 103 days), transport equipment (+5 days) and machinery (+4 days).
      • Stocks matter: Along with the “just in case” model of inventory management, and the end of “just in time” for most sectors, rebuilding stocks in an environment of supply shortages will be the key driver of the increase in global WCR, notably across Western European countries. In 2020, Days Inventory Outstanding surged by +5 days in North America and by +1 day in Western countries, while the drop in inventories across Emerging Markets made up for the stockpiling in developed economies. In 2021, we expect pent-up demand and the massive restocking policies of Western companies in the midst of global supply-chain disruptions to weigh notably on their WCR levels. However, in 2022, reduced supply bottlenecks should mitigate the soaring inventory fallout on developed countries’ WCR.
      • State support matters, too: The additional WCR needs represent less than 20% of non-financial corporates’ net cash positions in the Eurozone. However, total deposits of non-financial corporates cover at best 30% of total debt, with France the most vulnerable. Our estimations for the Eurozone show that NFCs’ net cash positions (deposits – new loans up to EUR1mn) increased by EUR547bn in 2020, almost three times more compared to 2019. This compares to EUR102bn of expected additional WCR needed to be financed in 2021, i.e. 17% of 2020 net cash positions. Since the end of 2020, net cash positions have continued to increase in the Eurozone (EUR38bn as of May 2021), with Germany (+EUR18bn) and Italy (+EUR7bn) on top of the list, while in France net cash positions fell by -EUR9bn. However, if the grace periods on state-guaranteed loans are not extended beyond 2021, cash buffers will decrease as total deposits on non-financial corporates cover 30% of total debts at best, with only 23% in France, one of the lowest ratios.

A glance at the change in Working Capital Requirements in 2020 for 36 countries reveals a divide between Advanced Economies and Emerging Markets for the very first time. The WCR level in the West increased (+5 days in North America and +1 day across Western Europe) while it dropped in regions such as Latin America (-3 days), Eastern Europe (-2 days) and APAC (-1 day). Inventory management explains most of this diverging trend (see Appendix).

In EMs, total inventory levels were minimally impacted as demand for goods picked up and has remained strong since the summer of 2020. In contrast, the more severe lockdowns in the US and EU pushed companies into a “forced” stockpiling mode. France, Denmark and Spain, for example, saw their inventory outstanding level surge by +5 days, +7 days and +10 days, respectively, last year. The very accommodating management of payment terms between customers and suppliers fortunately tempered these increases in inventories in some Eurozone countries. France, for example, succeeded in seeing its WCR drop by -2 days over the year, thanks to longer payment terms to suppliers (+6 days) in relation to shorter payments from customers (-1 day).

Massive stockpiling always weighs on WCR levels and cash balances accordingly. However, it is not always a bad thing: it can pay off if it arises from companies’ expectations about future demand growth, to be sure of being able to cater to clients’ orders on time after the crisis period. Conversely, if stockpiling results from an inability to deplete current inventories fast enough, it usually brings on cash shortages for the company, which could end up going bust in the worst case. The different levels of change in WCR from one sector to the other also depend on where they are located in the global supply chain scale in regards to the final consumer. The more a sector is capital-intensive, the more it undergoes a significant WCR rise as any supply disruptions are more expensive when a plant has to temporarily stop production due to a lack of inputs.

2020 saw a surge in WCR across industrial sectors (see Figure 1): +13 days for metals to 95 days, +9 days to 117 days for machinery, +4 days to 84 days for paper and +3 days to 87 days for automotive. These sectors were forced into stockpiling during lockdowns instead of shutting down their plants because of how high closure costs usually are for capital-intensive activities. Overall, metals and machinery were the two losers in regards to last year’s changes in WCR: The Covid-19 crisis has highlighted how inflexible their manufacturing tools are in case of a sudden change in the economic cycle, especially from the inventory point of view. Conversely, the sectors most exposed to the boom of remote work saw their WCR level massively benefit from resilient demand and destocking. This includes electronics ranging from semiconductors to computers (-13 days down to 94 days) as the sector saw skyrocketing demand in 2020. Household equipment saw a fall in WCR of -5 days (down to 92 days), thanks to better-than-expected sales during lockdowns while construction also registered a fall in WCR (-4 days down to 76 days) as the sector cashed in on the shutdowns of new building programs to sell off all inventories left.

The two special cases are pharmaceuticals and automotive, which both saw their respective WCR rise by +3 days, pushing them up to a ten-year record high: 106 days of turnover for the former and 87 days of turnover for the latter. In spite of selling its medicines through drug stores, the pharmaceuticals sector unfortunately bears a very high level of WCR because drug makers usually deal with public hospitals and social security programs with very long payment terms. Conversely, pharmaceuticals has always generated a high level of cash flow so that it can easily support longer payment terms. The high WCR in the automotive sector has more to do with car dealers closely linked to carmakers by the fact that they share the same brand and usually support the funding of the largest part of car inventories.

WCR, just like Days Sales Outstanding (DSOs), tend to increase both in recession and recovery times. In Figure 2, we try to graph the effect that unprecedented liquidity support measures by governments have had – and continue to have – on compressing WCR variations. Initially designed to avoid hysteresis effects (bankruptcies and unemployment), and unlike the 2008-09 crisis, the Covid-19 crisis response has been very much focused on avoiding liquidity gaps and preserving B2B flows and credit. Using IMF data on liquidity support measures (state-guaranteed loans, moratoria on debt, subsidies) and our own WCR calculations (2021 forecasts explained hereafter), we see the lifeline from governments to help suppliers (the invisible bank) continue to finance their clients. In Europe, for instance, the WCR change has been quite limited, alongside very generous liquidity bridges. Also note that initial conditions (WCR levels, structure of the economy), as well as varying intensities of the crisis or recovery, certainly explain specific country developments (Spain and China for e.g.) In large Emerging Markets, we see that liquidity gaps may have been only partially bridged and that corporates will be faced with binding financing constraints as they return to pre-crisis activity.

Figure 1: Global sector WCR in 2020, in number of days (worldwide average)
Figure 1: Global sector WCR in 2020, in number of days (worldwide average)
Sources: Bloomberg, Euler Hermes, Allianz Research

 

Figure 3 summarizes the results of our WCR forecasts in 2021 for a few Western countries. France clearly appears to be the weak link in our sample as the country whose cash needs are likely to be the highest in order to finance the additional WCR of EUR31bn. Germany and Spain follow, with EUR17bn of additional WCR each, albeit a difference in level (EUR383bn for Germany and EUR109bn for Spain). The Netherlands’ additional WCR of EUR15bn expected in 2021 has to be monitored because this country was previously known for keeping its WCR low. Positioned as a big European platform country for international trade, it is no doubt paying more attention to enough restocking to avoid any fallout of supply-chain disruptions on its WCR. With its additional WCR of EUR153bn expected for the ongoing year, the US accounts for a third of the global additional WCR of EUR453bn needed to be funded in 2021, for a total of more than EUR2600bn.

Figure 3: Breakdown and 2021 forecasts of WCR amounts (EUR bn)

In 2021, nearly every country will see an increase in WCR levels, but the rise will be more significant across the northern hemisphere, given the dynamism of demand in the Eurozone and its massive restocking policies against very low levels of inventories (see Figure 4). Hence, we expect an increase of +4 days on average in WCR across Europe in 2021, ranging from +6 days in France and +7 days in Switzerland to +10 days in Austria and a more worrisome +15 days in the Netherlands. For the US, we expect a rise of +4 days in 2021.

Similarly, when looking at sectors, the rise of WCR is likely to affect all 18 that we monitor, in line with the return to growth prompted by the grand reopening and massive vaccination campaigns, which will improve demand prospects. Hence, we expect WCR to resynchronize on the upside in 2021 at a global level, with the largest increases seen in sectors linked to final consumer goods or closely related to them. Yet, sectors considered as strongly industrial should also see their WCR rise in 2021, such as metals, pharmaceuticals, transport equipment and machinery due to surging commodity prices, which will raise their production costs.

Figure 4 Inventories by sector
2021 WCR forecasts by sector (number of days)
Global demand by sector (new orders + backlogs of work)

Which sectors are the ones to watch? Agrifood (+8 days up to 81 days), retail (+9 days up to 52 days), transport (+ 4 days up to 32 days) and household equipment (+5 days to 97 days). We also expect large rises in WCR for metals (+7 days up to 103 days), pharmaceuticals (+5 days), transport equipment (+5 days) and machinery (+4 days). Last year, the transport equipment (aeronautics) sector benefited from the large destocking of Boeing’s 737 Max planes since these were allowed to fly again from the last quarter of 2020.

The WCR levels for electronics (+1 day), energy O&G (+2 days) and telecom (+0 days) are expected to remain around their long-term historical levels. Their WCR are better suited to withstand any upward pressures despite the acceleration of the recovery around the world. Now more than ever they have become instrumental to the new industrial background taking shape through global digitalization, which puts them in a strong position to set payment terms for both customers and suppliers.

Our WCR forecasts highlight a ten-year high level in 2021 for some sectors, notably agrifood (at 81 days), retail (52 days), pharmaceuticals (111 days), automotive (92 days) and machinery (121 days). These record levels could put companies at risk if they are denied additional credit lines from banks when they need to finance their operating cycle on a rise.

Furthermore, agrifood and retail are two specific sectors strongly destabilized by the booming remote work and e-commerce models, respectively. Not only has e-commerce prevailed over brick-and-mortar retail throughout the world, but also it is faster than before the Covid-19 crisis. Yet, meeting customers’ demands online usually requires e-commerce players to bear a higher level of stocks than retail outlets. It is all the more required now that consumption patterns have shifted towards durable goods, and government income support strengthened demand, while transportation services were limited. The conjunction of booming demand for consumer durables from Asia and supply-side bottlenecks created by sanitary restrictions in ports and terminals have kept shipping costs elevated for several months and made it all the more important to keep high inventories in the West.

However, stockpiling can also result from an inability to deplete current inventories fast enough. As a result, it can usually bring on cash shortages that could even push a company to go bust in the worst case. If replenishing current inventories, particularly in the northern hemisphere, is fueling the rise in WCR globally, changes in payment terms granted to clients should add to this upswing over 2021. This is because a relaxation in payment terms is usually an easy way of getting back market shares that could have been definitively lost by the supply disruptions that occurred last year due to the pandemic.

 

In the Eurozone, companies’ available cash surpluses generated by massive state support policies (notably direct liquidity support and state-guaranteed loans) appear to be significantly higher than the looming additional amounts of WCR.

Our estimations for the Eurozone show that the net cash positions (deposits – new loans up to EUR1mn) of non-financial corporates increased by EUR547bn in 2020, almost three times more compared to 2019. This compares to EUR102bn of expected additional WCR needed to be financed in 2021, i.e. 17% of the 2020 net cash positions. Since the end of 2020, net cash positions have continued to increase in the Eurozone (EUR38bn as of May 2021), with Germany (+EUR18bn) and Italy (+EUR7bn), on top of the list, while in France net cash positions fell by –EUR9bn, which suggests non-financial corporates have started to use their deposits in addition to new loans for operating activities (see Figure 6). German companies benefit from half of the French amount of cash surpluses stemming from public support policies back in 2020 (EUR93bn against EUR197bn in France). The positive point is that the first five months of 2021 show a further rise in cash generation of EUR18bn, which will fully cover the additional WCR expected in 2021. This stems from either additional public support programs or German companies’ profitability generating positive cash flows again since the beginning of the year alongside recovering export flows.

Figure 7 Available cash positions in 2020

While reassuring, it is important to bear in mind that these excess net cash positions are also needed for the repayment of all other debts. Therefore, this cash cushion might evaporate much quicker than expected, notably if the grace periods on state-guaranteed loans are not prolonged beyond the end of 2021 and companies need to start reimbursing their debt. Looking at the share of total coverage of the stock of loans & debt securities by total non-financial corporates’ deposits, France and Belgium appear to be most vulnerable despite the high levels of available cash. Indeed, total deposits cover 23% of total stock of total debt against around 30% in Germany and Italy (see Figure 8).

Fig 8 Share of coverage of total stock of loans and debt securities

About Securitas

Since 2004, Securitas Global Risk Solutions (“Securitas”) has helped clients worldwide develop credit and political risk transfer solutions that provides value on numerous levels.  As an independent trade credit and political risk insurance brokerage, Securitas is focused on developing comprehensive solutions that meet the needs of clients, ensuring complete understanding of policy wording and delivering excellent responsive service.

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Major Country Risk Developments

Major Country Risk Developments

Posted with permission from greatamericaninsurancegroup.com  Overview The global economy has suffered four shocks...

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900 West Valley Road Suite 701, Wayne, PA 19087

Call Us

484-595-0100

Climate Change and its Impact on Country Risk

Climate Change and its Impact on Country Risk

Used with Permission from Atradius.us

Climate change raises country risk, but offers business opportunities as well.

Summary

      • Climate change has a negative impact on economies worldwide, their public finances and international trade. The consequences of climate change thus raise the country risk related to export transactions and international contracting.
      • Changing rainfall patterns, sea level rise and natural disasters mainly affect countries in Africa, the Caribbean and the Asia-Pacific region. These countries often combine a high vulnerability to climate change with a poor readiness to respond to the consequences of it.
      • Internationally operating companies develop technologies and build infrastructure that are used for the climate adaptation initiatives of the countries affected. In this way they make a positive contribution in the battle against climate change.

In a period when the Covid-19 pandemic swept the planet like a shockwave, scientists and policymakers kept that other big problem, climate change, on their radar. Fortunately they did, because – just like the pandemic – global warming is a major threat to humanity and action is urgently needed. But there is a second parallel. Like Covid-19, climate change not only causes personal suffering, it also involves great financial and economic damage. Increasing drought, sea level rise and natural disasters affect the incomes of individual citizens and businesses and represent high costs for governments. Or, as the IMF points out in a recent background paper, “climate change redistributes income and affects asset valuations, with repercussions for public and private sector balance sheets, financial flows and financial stability, trade, and exchange rates”. As a result, climate change affects the country risk related to foreign trade and projects in countries around the world in several ways.

Meanwhile, climate change also offers opportunities. Development of new technologies and investments in, for example, irrigation, desalination plants and the energy transition have a positive impact on economic growth and create new jobs.

In this Research Note, we first pay attention to the most prominent consequences of climate change for individual countries: changing precipitation patterns, sea level rise and the climate change-related increase of natural disasters in coastal areas. The focus will be on the countries which feel the impact the most: emerging economies in Africa, Latin America and the Asia-Pacific region. Using the ND-GAIN index for climate change, we identify which countries are doing poor regarding their vulnerability and readiness for these various kinds of impact.

Fortunately, there is a bright side of climate change as well. In the last section of this note we mention a series of projects that show how internationally operating companies are involved in the fight against and adaptation to climate change.

The ND-GAIN index: mapping the vulnerability and readiness of countries for climate change

A useful methodology for mapping the consequences of climate change for country risk is provided by the Notre Dame Global Adaptation Initiative (ND-GAIN). This group of scientists from various disciplines, affiliated with the University of Notre Dame (Indiana, USA), publishes the ND-GAIN Index for 181 countries annually, with sub-indices for both countries’ vulnerability and the degree to which they are ready to effectively use investments to respond to the consequences of climate change (their ‘readiness’). The underlying data and country rankings are used by private companies as well as non-governmental organizations and governments in making decisions related to production, investments, policy choices and communication.

The ND-GAIN index measures the first component, vulnerability to climate change, by including the consequences for food supply, access to water, health, the ecosystem, the living environment and infrastructure, whereby for each of these six components six indicators are included. Examples of these 36 indicators are the expected impact on agricultural crops, dependence on natural resources, the expected increase in floods and the impact of sea level rise. The second component, readiness, is measured against a total of nine economic, political/administrative and social indicators. Examples are the business climate, political stability and the quality of the ICT infrastructure in the country concerned.

Changing rainfall patterns: major threat to agriculture-intensive Africa

Higher temperatures and the changing rainfall patterns make it such that relatively dry countries become even drier and wet countries wetter. Prolonged drought can occur anywhere in the world, but some regions and countries are more severely affected than others. Vulnerability to drought is exacerbated, among other things, by poverty and incorrect use of land. It is therefore no surprise that African countries are the most vulnerable. Most of these countries are located in Southern and Central Africa, some others in Asia (India and Nepal).

In 2019, the impact of climate change was clearly visible when southern Africa was hit by extreme drought. But too much rain can be a problem as well. In the Horn of Africa, weather conditions changed from an extreme drought in 2018 to heavy rainfall in 2019, resulting in floods and landslides. In East Africa, heavy rainfall contributed to strong crop growth, but also brought a severe locust plague.

Higher temperatures and heavy rainfall threaten public health

Due to the temperature rise in the coming years and the more frequent change in precipitation patterns, extreme weather events will occur more often. These consequences of climate change will have a negative impact on public health, agriculture and energy supply. With regard to public health, African countries in particular are vulnerable. A rise in temperature and heavy rainfall make the living environment suitable for insects that transmit diseases such as malaria and dengue fever.

Agriculture is the sector most vulnerable to a rise in temperature and changed precipitation patterns. Risks include a decrease in production, an increase in pests and diseases and floods that affect infrastructure. The figure below shows all countries in the world where the agricultural sector as a percentage of GDP represents 20% or more. It clearly shows that mainly African countries are exposed to outsized agricultural sectors. In many of them, it concerns mainly subsistence agriculture.

African Countries Reliant on Agriculture

In many countries, the agricultural sector creates the most jobs. The figure below shows the countries where the agricultural sector has a share of 50% or more in total employment.

African Countries Affected by Failed Crops

Failed crops increase food insecurity and deteriorate living standards in many countries. The ND-GAIN index also includes a so-called food score. It measures the vulnerability of a country to climate change in terms of, among other things, food production and demand for food. Indicators that are considered include the expected change in grain yields, expected population growth, dependence on food imports, population in rural areas and agricultural capacity. Figure 3 shows the countries that emerge as most vulnerable from this food index.

Most Vulnerable Countries to

Figure 4 presents a matrix of the countries’ ND-GAIN scores for both their vulnerability and their readiness. Almost all of the most vulnerable countries listed in figure 3 are in the top left quadrant. This means that these countries are vulnerable and have taken few measures to adapt to climate change. Somalia (SOM) and Niger (NER) are in the weakest position. Antigua & Barbuda (ATG, in blue) has a poor score for the food sub-index and is also relatively vulnerable to climate change, but the country has already taken steps to address the consequences, bringing it in the top right quadrant.

Climate Change Vulnerability Versus Readiness of Problems in the Food Sector

Faulty energy supply

Drought can also have a negative impact on energy supply if hydropower is an important source in a country’s energy mix. In 2019, drought seriously disrupted the energy supply in Zambia and South Africa, with a significant impact on the economy as well. Countries where hydropower has a large share in the energy supply are mainly located in Latin America. BP data shows that in Latin America around a quarter of the energy supply is generated by hydropower in Ecuador, Brazil, Venezuela and Peru. There are also some countries in Asia where hydropower takes up a large part of the energy supply, such as Vietnam and Sri Lanka where hydropower accounts for 14% and 12% respectively of total energy consumption. For Africa, the International Energy Agency states that hydropower accounts for about 17% of the continent’s electricity supply on average. Countries where hydropower provides more than 80% of electricity are Congo-Kinshasa, Ethiopia, Malawi, Mozambique, Uganda and Zambia.

Since Africa is very vulnerable to climate change, the energy supply is most exposed. Forecasts indicate that southern Africa will be facing more droughts, while East Africa will have more rainfall. As a result, hydropower capacity is expected to decline in Congo-Kinshasa, Mozambique, Zimbabwe, Zambia and Morocco. An increase is foreseen in Egypt, Sudan and Kenya.

Support for adaptation measures

Low-income countries are most vulnerable to climate change. These countries lack the financial resources and technology to increase their resilience and adapt to changing weather conditions. That is why these countries are receiving support from various organisations. For example, the World Bank helps countries to adapt to climate change with investments and technological assistance. To this end, it has set up the Adaptation and Resilience Action Plan. With regard to agriculture, its aim is to increase the resilience of farmers and support them with climate-smart solutions. For example, the development of climate-smart agriculture involves improved seeds and diversification of food production. Improved agricultural technology also includes manure, tractors and irrigation systems.

Sea level rise: huge problem in Asia-Pacific and the Caribbean

One of the most obvious consequences of climate change is sea level rise. As global average temperatures increase, polar ice caps in Greenland and Antarctica, sea ice in the polar regions and glaciers and snow in high-altitude parts of the world are melting, causing sea levels to rise. Another factor is that warmer water has a greater volume than cold water. Estimates of sea level rise to the end of the century range from 60 to 220 centimetres, depending on the extent to which humanity will succeed in reducing CO2 emissions. At first sight, this increase may still seem limited, but it has major consequences. According to calculations by American research group Climate Central, by 2050 the habitat of no less than 300 million people is at risk of being flooded once a year on average. At the end of the century, the habitat of 200 million people would be permanently below sea level, depending on coastal defences being built or population relocations. For many of the approximately 110 million people who already live in areas below sea level, the authorities will have to take measures to keep them safe as well.

The threat posed by sea level rise is especially relevant in Asia, the Pacific and the Caribbean. This is of course largely related to the elevation of the coastal areas, but also the height and quality of the coastal reinforcement present. Research using a so-called Digital Elevation Model supplemented with machine learning techniques shows that the coastal areas of China, Bangladesh, India, Vietnam, Indonesia and Thailand together account for about 75% of the aforementioned 300 million people whose habitat is endangered within 30 years.

Whereas for large countries in Asia it often concerns limited parts of the country, in the island states in the Pacific and the Indian Ocean most of the area is often threatened by the rising sea levels. For example, three-quarters of the population of the Marshall Islands lives in threatened areas, in the Maldives about one-third. In this sense, a large size of a country or economy is a mitigating factor for sea level rise, as only part of the country is affected.

Small Islands Most Vulnerable to Sea Level

The small island states in the Pacific and the Caribbean generally have limited administrative and technical capacities and limited financial resources. However, there are differences. For example, the Maldives, a country with a relatively high GDP per capita, can be found in the quadrant with vulnerable countries that are more than average ready for the consequences of climate change. In order to guarantee the high income from tourism, the government has invested heavily in coastal reinforcement and land reclamation.

Small island states dependent on foreign funding

Fiji is also on the right side of the vertical median, while still being financially vulnerable. For example, the World Bank has calculated that the country will still have to invest approximately 100% of its GDP in the coming ten years to prepare the country for the expected sea level rise and the increase in natural disasters. Fiji, like other island states in the Pacific and the Comoros (off the east coast of Africa), is mainly dependent on foreign funding. Support is coming from the IMF and World Bank, neighbouring countries such as Australia and New Zealand, or from countries that provide aid or provide loans for political-strategic reasons. For example, the IMF supported the Comoros after a cyclone disaster with ample emergency aid, Micronesia receives aid from the US to build a buffer for the future (with limited success) and Samoa receives loans from China. The Solomon Islands have exchanged a long-term relationship with Taiwan for a financially more favourable relationship with China.

Increasing natural disasters in coastal areas

The countries vulnerable to sea level rise are often also affected by increasing natural disasters, such as severe storms and hurricanes. As of now, there is no scientific consensus on a direct link between climate change and hurricanes, but in recent decades natural disasters in coastal areas have been increasing. A causal relationship can be explained by the fact that a warmer atmosphere heats the surface water at sea, which in turn increases the severity of hurricanes. Since the early 1970s, the number of hurricanes in the heaviest categories has nearly doubled worldwide, while the durations of the hurricanes and also the highest wind speeds have increased by almost 50%.

Natural disasters have a major impact. For example, in 2019 alone, natural disasters caused 11,755 deaths worldwide, while 95 million people were affected. Some of this is not related to climate change (such as earthquakes, while even without climate change there would be hurricanes), but the fact that floods were responsible for 43.5% of the number of deaths, extremely high temperatures for 25% and storms for 21.5%, makes it plausible that climate change did play a major role. Storms and floods were responsible for 68% of the deaths. The World Bank reports that 75% of the damage caused by natural disasters since 1980 has been attributable to extreme weather events and that climate change threatens to push some 100 million people into extreme poverty over the next ten years.

The differences per region and per country are large, but here too the poorer countries are generally hit harder than the high-income countries. According to the World Bank, low- and middle-income countries experienced 32% of storms in the period 1998-2018, but 91% of the storm-related fatalities. On the list of countries most affected by natural disasters published by the United Nations University Institute for Environment and Human Security (UNU-EHS), countries in Asia and the Pacific again dominate, alongside countries in Central America and the Caribbean in particular.

Top 15 Countries Hit by Natural Disasters

The impact of severe natural disasters is often relatively large for small island states, just as with the threat of sea level rise, and is therefore an important factor in determining the level of country risk. For several of the island states, ND-GAIN does not give a vulnerability score and therefore no ND-GAIN overall score. However, looking at only the readiness score of ND-GAIN for countries that have to deal with natural disasters (and which therefore also takes into account the extent to which these countries deal with other consequences of climate change), we can conclude that the picture is diverse. Mauritius, Brunei and Costa Rica score relatively well in this respect, while Guinea-Bissau, Bangladesh, Papua New Guinea, Nicaragua, Cambodia and Guatemala score poorly in terms of ‘readiness’. Large countries that combine a relatively high risk of natural disasters with a poor readiness score are (again) Bangladesh and, to a lesser extent, the Philippines and several Latin American countries.

The bright side of climate change: business opportunities

Many emerging economies are vulnerable to one or more elements of climate change. Heat, drought and changing rainfall patterns are a major threat to agriculture-intensive Africa. Sea level rise and increasing natural disasters in coastal areas create problems in Asia, the Pacific and the Caribbean. Though some countries are lagging, many of them, often helped by multilateral or bilateral partners, take measures for both the short and long term, thereby creating business opportunities.

In fact, this applies to all channels through which climate change affects country risk. Businesses active in the development of new technologies for and construction of irrigation and desalination plants have a large playing field in Africa. Meanwhile, the great untapped potential of renewable energy in Africa offers opportunities. The French company Mascara Renewable Water for example has partnered with a local company to build a solar-powered desalination plant in South Africa which will convert sea water into fresh water. Netherlands-based Independent Energy B.V. exports to countries across Africa, the Middle East and South America, where there is interest in solar energy systems, but a serious lack of knowledge about how to build them properly.

On a much bigger scale are the opportunities created for construction and maritime companies active in the construction of offshore wind farms. Taiwan, for example, has contracted Siemens Gamesa, a leading supplier of wind power solutions, the Denmark-based multinational renewable energy company, Ørsted, and Dutch companies like Heerema Marine Contractors, Van Oord Offshore and Boskalis Westminster Dredging to be part in large offshore wind projects.

Countries affected by sea level rise and natural disasters in Asia and the Caribbean are in need of expertise when it comes to coastal defense and water management. Kiribati, the extensive island state in the Pacific, will seek support from China and other allies to elevate islands from the sea, partly through dredging. The Maldives, in the Indian Ocean, combine coastal defense and land reclamation with the development of a port and other improvements of the infrastructure, creating various opportunities for Indian and other foreign companies.

Climate change in the first place is a threat for most countries in the world, and especially the less wealthy ones in Africa, Latin America and the Asia-Pacific region. Internationally operating companies can benefit from the opportunities climate change creates and, meanwhile, make a positive contribution to the climate adaptation initiatives of these countries.

 

Used with Permission from Atradius.us
Since 2004, Securitas Global Risk Solutions (“Securitas”) has helped clients worldwide develop credit and political risk transfer solutions that provides value on numerous levels.  As an independent trade credit and political risk insurance brokerage, Securitas is focused on developing comprehensive solutions that meet the needs of clients, ensuring complete understanding of policy wording and delivering excellent responsive service.

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Lithium Market Set to Boom – A Risk Focus on the Lithium Triangle

Lithium Market Set to Boom – A Risk Focus on the Lithium Triangle

As the global economy continues to put the Covid-19 slump behind it, the market for electronic devices and an anticipated surge in electric vehicle demand has re-sparked interest in lithium, a highly reactive and conductive metal vital to the global economy. Found in only a handful of countries, with a small number of companies dominating its production, demand and prices have the potential to boom. In such a scenario, the potentially conflicting demands of consumers, mining companies, and lithium-rich countries warrants a look at political risk, particularly in South America’s Lithium Triangle, the home of 58% of the world’s lithium reserves.

Why Lithium is in Demand

The critical component of lithium-ion batteries, lithium’s demand corresponds to global demand for manufacturing electronics such as smartphones and electric cars, which are expected to have a 70% increase in demand in 2021 and throughout the decade, driven by consumer interest and by growing efforts in many countries to phase out internal combustion engine vehicles. In Europe, lithium-ion battery production is projected to increase from 28 GWh (gigawatt hours) in 2020 to 368 GWh in 2025. United States’ production capacity of the batteries is projected to more than double from 42 GWh in 2020 to 91 GWh in 2025 according to S&P global market intelligence, though it also projects the U.S. share of the market to decrease from 9% in 2020 to 6% in 2025. According to Seeking Alpha, lithium demand will increase by 600% by 2040.

Low Prices and a Potential Boom

An oversupplied market in early 2020 saw a decline in lithium demand, mainly due to Covid-19. According to data from Trading Economics, (shown below), lithium prices declined 45% between July 2019 and July 2020.

Trading economics lithium Prices graph

Yet the chart above shows a recent spike in prices. Lithium prices jumped up 41% in the Chinese market in January 2021, causing a significant rebound in global price. Simon Moores, Managing Director of Benchmark Minerals (@sdmoores) noted the jump in early February.

Who is Buying Lithium?

China is by far the world’s biggest owner and buyer of lithium. China has gained a dominant position (called a “stranglehold” by one mining trade source) of the main precious metals in the electric vehicle supply chain: lithium, cobalt, and nickel. Additionally, China manufactures most electric vehicles made in the world. As countries move to transition away from internal combustion vehicles, a range of countries appear poised to increase domestic production of lithium-ion batteries and electric vehicles, with accompanying demand for lithium resources.

Simon Moores' tweet on global lithium prices

Where is Lithium Being Produced?

Lithium deposits and production are highly concentrated in a few countries, most notably Australia—the world’s largest producer of lithium—and the Lithium Triangle—Argentina, Bolivia, and Chile.  The Lithium Triangle has 58% of the world’s identified lithium resources, according to the January 2021 U.S. Geological Survey. S&P Global also projects a 199% in South American lithium supply as new lithium brines (saline groundwater enriched in dissolved lithium) begin production and existing salars (a lithium brine reservoir) increase production. Between 2008 and 2018, Australian lithium production jumped from 24.7% of the global lithium supply to 60%.[12] This is largely due to its ability to export lithium to China. According to a 2018 survey by Bacanora lithium, four companies produce 73% of the world’s lithium:

(Tianqi Lithium owns an additional 24% of SQM.)

Political Risk in the Lithium Triangle

The anticipated surge in lithium demand and prices has renewed focus on South America’s Lithium Triangle.

Bolivia

Bolivia, owing to its large reserves and a recent political history, garners the most attention regarding political risk.  The left-wing populism of former President Evo Morales has promoted state regulation of key resources for well over a decade. The Morales government nationalized the oil and gas sector in 2006 and power companies beginning in 2010.

Argentina

A painful economic recession in 2019 led to the electoral victory of current President Alberto Fernandez and Vice-President Christina Kirchner, a former president whose previous administration was noted for taking on heavy debt and state intervention into key sectors.  Under her administration in 2012, Argentina nationalized YPF, an oil company.  Just last year, the Fernandez administration expropriated its leading grain exporter, Vicentin, after it declared bankruptcy.  While Fernandez is enjoying a bump in popularity, with 56% of Argentinians expressing confidence in the overall direction of the government in 2020, (up from 24% 2019), the country’s economic struggles remain.  As with Bolivia, Argentina’s recent history of using expropriation and nationalization in economic policymaking makes it a political risk concern regarding how it plans to utilize its lithium reserves as demand grows. 

The Lithium Triangle

 

Argentina

  • Lithium resources: 19.3 million tons
  • 2020 mine production: 6200 metric tons
  • Largest deposit: Sal de Vida, 1.1 million metric tons
  • Estimated percentage of GDP from mining: 5.3%

 

Bolivia

  • Lithium resources: 21 million tons
  • Annual mine production: about 400 metric tons
  • Largest deposit: Salar de Uyuni, 5.5million metric tons
  • Estimated percentage of GDP from mining:
  • 13.5% (2015)

 

Chile

  • Lithium resources: 9.6 million tons
  • 2020 Mine production: 18,000 metric tons
  • Largest deposit: Salar de Atacama 7.5 million tons
  • Estimated percentage of GDP from mining: 10%, mostly from copper.

 

Sources: US Geological Survey, Mineral Commodity Summaries 2020;  Statista.com, Major countries in worldwide lithium mine production from 2010 to 2020; TradingEconomics.com

Chile

Chile has been a major source of lithium in recent years, but has disappointed investors as other countries have outpaced its mining growth.

While Chile has generally rejected expropriation of lithium investment and has historically allowed private investment in the mining sector, the role of the state in taxing and regulating mining is tied up in current debates in Chile about constitutional change, environmental protection, and community rights.  Chile’s legislature has re-opened a charged debate over mining royalities, while Chile’s President Sebastian Piñera vowed to facilitate private and state partnership to double the country’s output of Lithium carbonate to 230,000 metric tons.

Analysis

Despite the recent slump, lithium’s long-term profit potential remains strong owing its importance to the global economy.  In many resource-rich countries, such as those in the Lithium Triangle, lithium mining’s economic potential will draw foreign investors who will face powerful political demands to see tangible community benefits from mining. This political mix raises risk concerns not just of increased taxation or regulation, but of expropriation and nationalization in countries with a history of state-intervention in key sectors such as mining.

For international investors, political risk insurance helps safeguard investments in the event of nationalization, expropriation, confiscation, currency inconvertibility, civil unrest and property damage.

Pie chart of world lithium resources

Since 2004, Securitas Global Risk Solutions (“Securitas”) has helped clients worldwide develop credit and political risk transfer solutions that provides value on numerous levels.  As an independent trade credit and political risk insurance brokerage, Securitas is focused on developing comprehensive solutions that meet the needs of clients, ensuring complete understanding of policy wording and delivering excellent responsive service.

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Pandemic Invokes Force Majeure

Pandemic Invokes Force Majeure

In mid-February, during the height of the Coronavirus crisis in China, the China Council for the Promotion of International Trade (CCPIT), a state-run organization, reported that it had issued over 1,600 “force majeure” certificates, in an effort to protect Chinese companies from legal issues related to non-compliance with their contractual obligations.  These certificates at the time covered a value of about $15.7 billion. By the first week of March, the number of Chinese force majeure declarations had risen to over 4,800 companies covering contracts worth $53.8 billon.

What is a “Force Majeure” Declaration?

When a company declares “force majeure,” it is invoking a clause, typically noted in its contract with its clients, that states that due to circumstances beyond its control, it is unable to fulfill the terms of the contract.

Invoking the clause is an effort to typically delay or possibly be released from contractual obligations without legal or financial liability.  According to one legal definition: “Generally, force majeure refers to the occurrence of an extraordinary event beyond the reasonable control of a party and prevents that party from performing its obligations under a contract.”

Force majeure clauses are common, but vary from industry to industry.  On a personal level, property owners may be familiar with mortgage contract language stating various natural disasters or “Acts of God” that can relieve the owner of contractual obligations.

The oil and gas sector and other industries that utilize long-term supply contracts often have extensive force majeure clauses that also include human interventions such as government action, terrorism, war, and strikes that can cause a break in operations beyond the control of one of the parties to a contract.

From industry to industry, and company to company, the details and specificity of force majeure clauses vary widely, and are being tested by the economic disruption wrought by the Coronavirus pandemic.  According to one source, “if you’ve seen one force majeure clause, you’ve seen one force majeure clause.”

According to the World Bank, there is no template or standard wording for force majeure clauses or for the events that may or may not cause a force majeure declaration.

While no template exists, global organizations are attempting to introduce some basic standards. For example, the International Chamber of Commerce (ICC) updated its model force majeure contract language only recently (it includes terms like “plague” and “epidemic”).

While these efforts are useful in moving international business toward common terms and language, declarations of force majeure still remain subject to often dueling legal opinions and the decisions of specific courts and arbitrators.

A Legal Burden

According to one analysis, China’s above-noted attempt to offer companies blanket force majeure certificates are likely to be contested legally.  One reason noted is that the standard for a force majeure declaration may be different domestically in China than it is internationally – where many trade contracts are based on English common law, in which force majeure events are extensively enumerated and specific.

Some contracts may not contain reference to public health events such as epidemics or pandemics.  Additionally, if challenged legally, the burden is on the company making the declaration to prove that the events were unforeseen, unavoidable, and left the company in an impossible situation with no alternatives to meet its contractual obligations.  Already, some companies have taken their Chinese counterparts to task, rejecting their force majeure claims and setting up legal battles.

Seek Legal Advice

To avoid costly legal conflict, companies will often seek out a workable solution to avoid a force majeure declaration. The need to work out the details of myriad contractual obligations is said to be one of the main reasons that the International Olympic Committee and organizers of the 2020 Tokyo Summer Olympics took a longer time than most other sports leagues and planners of sporting events to declare a postponement due to Coronavirus.

The input of a trained legal advisor is invaluable when seeking to understand force majeure clauses and tailor contract language that is either specific or broad enough to account for a range of potential events – including public health crisis.

Legal counsel can also help draft language that conforms with both the details of doing business in a specific industry and existing legal precedents concerning force majeure declarations.

Get Proper Coverage

In the current environment, there is considerable likelihood that companies will face a force majeure declaration from either a supplier or buyer, or may even have to contemplate making a such a declaration due to unforeseen and unavoidable circumstances of Covid-19.

In addition to sound legal advice, companies need to have insurance coverage that meets a range of contingencies including force majeure.  The team at Securitas Global Risk Solutions has the necessary experience to discuss and advise clients on force majeure and trade credit insurance.  If you would like to discuss further, please contact Peter Seneca at 484-595-0100 or email him at pseneca@securitasglobal.com.

Disclaimer: The text above is for informational purposes only, and does not constitute legal advice.  Seek the input of a legal practitioner for more detailed information and advice on contract language and force majeure declarations.

 

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