Daily Comment (September 26, 2023)

by Patrick Fearon-Hernandez, CFA, and Thomas Wash

[Posted: 9:30 AM EDT] | PDF

Our Comment today opens with a new report from the International Energy Agency that could further discourage needed investments in fossil fuel supplies and could help drive energy prices even higher in the coming years.  We then review a wide range of other international and U.S. developments with the potential to affect the financial markets today, including additional confirmation that the European Union intends to clamp down on its trade with China and signs of preparations for a partial shutdown of the U.S. government which could begin on Saturday.

Global Climate Change Policy:  The International Energy Agency has issued a new report estimating that global use of fossil fuels would have to fall 25% by 2030 in order for nations to meet their goal of net-zero greenhouse gas emissions and realize their hopes of limiting global temperature increases.  The report comes amid intensifying pushback against the IEA from the world’s oil and natural gas industry, which is accusing the agency of being too alarmist and too reckless in discouraging the fossil energy investments needed to fuel the world until greener technologies are ready for wider use.  We have also noted that many governments around the world, especially in Europe, have started to step back from their most aggressive climate-stabilization policies amid pushback from voters.

  • While the report also called for faster deployment of green energy technologies, it warned they may not be ready soon enough. Therefore, “Prolonged high prices would result if the decline in fossil fuel investment in this scenario were to precede the expansion of clean energy.”  In the IEA’s view, an orderly transition is “far from guaranteed.”
  • Coupled with potential supply disruptions associated with the U.S.-China geopolitical rivalry, we think the regulatory and financial-market headwinds against fossil-fuel exploration and development will likely crimp supplies going forward. That’s a key reason why we think mineral commodities will be in a prolonged bull market in the coming years, once we get past the soft growth or recession that seems likely in the near term.

Saudi Arabia:  Energy Minister Prince Abdulaziz bin Salman told the annual conference of the International Atomic Energy Agency that the Kingdom of Saudi Arabia will adopt a strict “Comprehensive Safeguards Agreement” with the agency that will allow IAEA inspectors to monitor Saudi nuclear activities.  The move provides more evidence that Saudi Arabia is pushing hard to win a U.S.-run nuclear processing facility as part of its price for normalizing relations with Israel.  Besides the nuclear processing facility, the Saudis are also seeking security guarantees from the U.S.

  • Saudi-U.S.-Israeli negotiations toward normalization are continuing.
  • In the meantime, it is increasingly clear that the Saudis are holding down crude oil production to boost global energy prices and heap additional pressure on President Biden for concessions.
  • Along with the recent dearth in new fossil fuel development, the cut in production by Saudi Arabia and its allies continues to boost global oil prices. So far this morning, Brent crude is trading down 0.7% at $91.29 per barrel, but that’s still up dramatically from only about $71.75 in early summer.
  • The rise in energy prices has also increased worries that consumer price inflation will prove stickier than earlier thought, prompting the Fed to keep interest rates higher for longer. As a result, the yield on the benchmark 10-year Treasury note closed yesterday at a multi-year high of 4.541%.

European Union-China:  During a speech in Beijing, EU Trade Commissioner Dombrovskis warned yesterday that China’s “lack of reciprocity and a level playing field [in trade], coupled with wider geopolitical shifts, has [sic] forced Europe to become more assertive.”  Coming so soon after EU Commission President von der Leyen’s recent announcement of an anti-subsidy probe into Chinese electric vehicle exports, and shortly before Dombrovskis was scheduled to meet Chinese Vice Premier He Lifeng, the trade commissioner’s statement helped confirm that the EU has swung around to a more protectionist stance regarding trade and investment with China.

  • Dombrovskis also warned today that the EU’s anti-subsidy investigation would include vehicles made by Western companies in China.
  • Although Chinese-made EVs currently account for only a modest share of European sales, their rapidly advancing quality and lower costs are expected to help them capture a huge amount of market share in the coming years.
  • Almost all of the Chinese-made EVs currently sold in Europe are from Chinese-owned European brands such as Britain’s MG, owned by China’s SAIC (600104.SS, CNY, 14.86), or from joint ventures between European and Chinese companies.

South Korea:  Lee Bok-hyun, governor of the Financial Supervisory Service, said he thinks South Korea has now met most of the conditions to be included in the FTSE Russell World Government Bond Index.  The index managers are expected to meet soon to decide on any changes in index constituents.  If they decide to include South Korea, the country is expected to account for up to 2.5% of the index, which would likely translate into around $65 billion of additional purchases of the country’s government bonds.

United States-South Pacific Islands:  President Biden yesterday hosted the leaders of 16 different South Pacific nations at the White House as part of an effort to keep them from falling for China’s recent diplomatic, military, and economic overtures.  At the meeting, Biden announced several new embassies and aid programs for the region.  However, Solomon Islands Prime Minister Sogavare failed to show up for the meeting, illustrating his increasing alignment with Beijing.

U.S. Government Shutdown:  Some lawmakers are reportedly working on an emergency bill to protect active-duty troops from losing their pay in the event of a partial government shutdown which could start on Saturday.  As during the shutdown of October 2013, the legislation would aim to protect troop morale and avoid imposing financial difficulties on military families.  However, unlike the legislation in 2013, this bill would also apply to members of the Coast Guard.

  • Even if troop pay is protected, more than half of the Defense Department’s large civilian workforce would likely be furloughed.
  • That illustrates how the economy could face a large hit to demand in the event of a partial shutdown. In addition, Moody’s (MCO, $322.81), the last major credit assessment firm with a AAA rating on Treasury debt, warned yesterday that it would consider a shutdown to be “credit negative” for U.S. obligations.
  • As we argued in our Comment yesterday, a shutdown could potentially have a big impact on today’s “slow bicycle economy,” which has likely lost enough momentum to become more susceptible to recession even if there is only a modest hit to demand or confidence.

U.S. Electrical Vehicle Industry:  Ford Motor (F, $12.58) announced it will pause construction of a controversial factory in Dearborn, Michigan, where it planned to make electric vehicle batteries using technology from Chinese green-tech giant Contemporary Amperex Technology, or CATL (300750.SZ, CNY, 206.27).  Ford said the pause was caused in part by the on-going United Auto Workers’ strike, but it also cited unspecified other issues.  That could mean the company has gotten cold feet after being criticized for relying on Chinese technology and seeing how many governments around the world are stepping back from their climate-change regulations.

  • Regarding the strike, today both President Biden and Former President Trump will visit the UAW picket lines in Michigan to show their support for the workers. Biden’s visit will mark the first time a sitting president has ever joined the strikers on a picket line.
  • Of course, the visits by such high-stature politicians are likely to further encourage the strikers. Despite the UAW being happy with some recent concessions by Ford in the negotiations, it doesn’t look like the work stoppage will end anytime soon.

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