Perspective on Risk - August 18, 2022
Operational Risk & Vacation; Loan Market Conditions; Climate Change - Interesting Effects; Wildfire Insurance; Podcast
Hope everyone is having a nice summer.
Operational Risk & Vacation
My vacation was supposed to begin with a nice river cruise down the Rhine. The first concern we has was that the water levels in the Rhine was approaching levels where the boat could not pass a certain point. Already, cargo ships on the Rhine were traveling with only half loads, if they transited the route at all.
They started off the cruise with an orientation, and indicated that later that evening we would have an emergency drill. Immediately after that statement, the alarms went off. Cool! I thought, now that they had our attention they would make us drill right there and then.
Oops. Instead there was a fire near the kitchen in one of the boats lithium batteries, We all evacuated and at this point a river cruise became a bus tour. We were lucky in that the fire happened while we were still docked in Amsterdam, and not on the river.
This set off an ad-hoc response by Viking management, struggling to find transportation, hotels and food for 200+ customers. The responsibility fell on the cruise director to arrange all of this; there did not appear to be an organized contingency plan, nor much support from corporate. Befitting the ad-hoc response, some decisions were made well, but overall they struggled. As is usual, the first information provided proved wrong. There were no backup boats. When 200 people suddenly descend on a restaurant, it probably shouldn’t surprise us that it took 2.5 hours to receive pretty over-cooked schnitzel. They probably shouldn’t have had schnitzel for dinner three days in a row. I won’t go into all of the details.
Overall, reinforced the need for firms to have thorough contingency planning and to train on those plans routinely.
Loan Market Conditions
I no longer have internal insight into market conditions; I can just read what is out there. In 2008, even as Bear Sterns High Grade fund was blowing up and subprime lending becoming a huge problem, if you spoke with some risk managers their primary concern was that they were stuck holding large syndicated positions on their balance sheets that they hadn’t been able to off-load (Boots comes to mind). Some anecdotal reports show loan prices trading at a discount, which probably means some folks are over their hold limits.
It sounds as if their are a few large deals that may currently be stuck (Citrix, Wm Morrison, Tenneco).
Unwanted debt from buyout boom stuck at investment banks (FT)
Tens of billions of dollars worth of debt has been stuck on bank balance sheets left over from financings that had been struck before a sell-off rattled financial markets and a slowdown gripped the global economy.
The sharp fall in the value of corporate bonds and loans has banks such as Bank of America and Goldman Sachs stomaching large losses already on the financing packages they have not yet sold on to the investing public.
And bankers are reluctant to cut new deals for private equity groups before they are able to, a process that top executives said would likely be measured in quarters, not weeks or months.
Prices have adjusted to reflect circumstances.
Climate Change - Interesting Effects
The weather/climate has had an interesting intersection with Europe’s power and economic issues. We think of warming as possibly increasing demand for energy (for cooling), but what we are seeing is that there are potentially material supply disruptions.
Within the European grid, Norway and France are the large net exporters of power, Germany was close to flat (but dependent on Russian oil and gas as inputs), and the other countries were net importers.
Alexander Stahel has an excellent 30 tweet stream that provides an overview of the European energy conundrum. He points out that the marginal electricity price is driven by the price (and availability) of natural gas. With gas in short supply and at a high price, additional coal is required. This is all exacerbated by declining nuclear production in France.
With this as background…
Norway is moving to limit its power exports as it experiences a drought. Norwegian power is particularly important for the UK.
Drought has Oslo on edge of critical water shortage (courthousenews.com)
Norway has been experiencing drought for half a year. Little rain and snowmelt and an unmodified consumption of water have reduced the water level in Lake Maridal from 88% of normal to 69%. Maridal is the largest lake in Oslo and serves the main drinking water supply for the city.
Norway Moves to Limit Power Exports in Blow to Europe (Bloomberg)
Norway gets almost all of its electricity from its vast hydro resources. Historically, it has been able to export a hefty surplus and still have among the lowest prices in Europe. But after a dry spring, hydro reservoirs in the worst impacted area stand at 49.3%, compared with a median of 74.9% for the 2000-19 period.
Refilling reservoirs will be prioritized over power production when levels fall below seasonal averages, Energy Minister Terje Aasland said Monday. The country is one of Europe’s top exporters of electricity, sending about a fifth of its output to its neighbors but low water levels in southern Norway mean the government says it needs to act now to prevent domestic shortages this winter.
In France, more than 70% of power comes from nuclear.
France to Curb Nuclear Output as Europe’s Energy Crisis Worsens (Bloomberg)
Electricite de France SA said it’s likely to extend cuts to nuclear generation as scorching weather pushes up river temperatures, bringing the energy crisis in the European Union’s second-largest economy into sharp focus.
Europe’s biggest producer of atomic energy, usually a net exporter of power for most of the year, is importing now.
Under French rules, EDF must reduce or halt nuclear output when river temperatures reach certain thresholds to ensure the water used to cool the plants won’t harm the environment when put back into waterways.
Earlier, in the context of my vacation, I mentioned the water level of the Rhine.
Rhine River Withers to Crisis Level as Europe Craves Energy (Bloomberg)
The Rhine River is set to become virtually impassable at a key waypoint in Germany, as shallow water chokes off shipments of energy products and other industrial commodities along one of Europe’s most important waterways.
The marker at Kaub, west of Frankfurt, is forecast to drop to the critical depth of 40 centimeters (just under 16 inches) early on Aug. 12, according to the German Federal Waterways and Shipping Administration. At that level, most barges that haul goods from diesel to coal are effectively unable to transit the river. It’s forecast to continue dropping, to 37 centimeters the following day.
Companies including chemicals giant BASF SE and steelmaker Thyssenkrupp AG rely on the river to supply major industrial plants with fuels and raw materials.
The Rhine transports some 75% of Germany’s hard coal imports, which is needed to offset the declining Russian oil and gas.
Wildfire Insurance
The market, based on capacity and experience, is only willing to take on the risk at a price that the California Wildfire Fund is unwilling to pay. In essence, they are making a bet with taxpayer money. Same thing happens with hurricane insurance in Florida.
California Wildfire Fund goes without reinsurance again in 2022 (Artemis)
For now a third year in a row, the California Wildfire Fund is going without reinsurance or any form of risk transfer in 2022, as the market pricing on offer still does not meet the Fund’s goal of extending its durability.
Podcasts
Insights: Dan McCrum on bringing down payment giant Wirecard's house of cards
Wirecard filed for insolvency in June 2020 claiming €1.9 billion dollars was “missing” from its balance sheet and slowly the whole sorry story came to light, with everything from embezzlement, racketeering, pornography and the eventual firing and arrest of its CEO Markus Braun.
Summer Research Highlights
The mathematics of burger flipping
Flipping food on a grill makes it cook faster, obviously.
Cooking time is greatly improved by one to three flips.
Subsequent flips provide diminishing returns but can lead to a maximum of 29% improvement in total cooking time.
For Your Enjoyment
Trading Floor Antics (Stories.Finance)
Thanks for linking to Stories.Finance - Doug Lucas