Oil prices are currently under pressure from a major supply shock and if it continues, the medium-term implications on the global economy could be positive. The impact of falling demand levels is compounding the supply shock and according to the International Energy Agency, demand for oil this year may contract for the first time in a decade. While supply and demand imbalance could weaken the public finances of exporting nations (Angola, Bahrain, Ecuador, Iraq, Iran, Nigeria, Qatar, Russia, United Arab Emirates, Venezuela), lower oil prices are good news for the world in general and for Europe in particular.
The fall will not, of course, be devoid of consequences on the oil industry, the first being that any cuts in investment expenditure could lead to a sharp slowFdown in business for oil services companies and a steep fall in profitability for shale oil operators.
Europe’s banking sector has once again catalysed market fears over the oil price slide and, since mid-February, banking share prices have fallen in the same proportion as the price of Brent crude (over 30%). It is no secret that European bank exposure to the oil sector is high, both as a proportion of its loan portfolio and, even more significantly, of its core equity.
However, knowing each European bank’s gross exposure actually tells us very little. Certain segments of the oil industry do not, by their very nature, have a high risk profile (trade finance/trading, major/integrated oil companies, midstream/transport and storage, public companies, the gas industry). Conversely, other segments are particularly exposed to plummeting prices (independent producers, shale oil, oil-related services).
In 2015–16, about 50% of the European banking sector’s market capitalisation was wiped out due to concerns over a deterioration in the oil sector outlook. At the time, volumes invested in the oil sector seemed significant. However, we have since realised that exposure to the riskiest segments (oil-related sectors and independent producers) is not enough to significantly threaten European banks’ capital levels. We should soon have confirmation of this and currently estimate that less than 5% of the European banking system’s core equity is really at risk.
While we already know the European banking sector’s gross exposure to the oil sector as of the end of 2019, banks have not yet had the opportunity to communicate in more detail. It won’t be long before they do. However, the cost of risk can now only be expected to rise in Europe. The consequences of moving towards a new oil market equilibrium will come in addition to 2020 growth prospects that have deteriorated due to the Coronavirus pandemic. The weaker growth outlook will also mean an increase in credit losses. European banks have already had to gradually adapt to a world of low interest rates. Their next challenge will be to adapt to a rise in the cost of risk.
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The opinion expressed above is dated March 11th, 2020 and liable to change.
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