Emerging Trends: Deep Winter for Clean Energy, Brazil Outsells Germany, India’s De-Facto Peg, South Africa Real Rates

Summary

• Clean energy has been a terrible investment. We explore why and what is needed.
• China now imports more from Brazil than Germany. Soy and crude vs. ICE-EV substitution is driving this.
• INR FX vol is at a 17-year low; HUF carry trades shift residence but stay long; and ZAR curve should be pricing in more cuts!

Deep Winter for Renewables Producers

• Renewables are increasing as a share of the DM energy mix, but they have been a terrible investment relative to fossil fuel companies (Charts 1 and 2).
• The main headwinds are:
  • High interest rates. As a relatively young industry, companies in this area are generally unprofitable and rely on subsidies and capital markets to operate. A prolonged period of higher rates could lead to capital crunches and a lack of working capital – especially in rooftop solar.
  • Oil prices have remained high while lack of refining capacity has lifted crack spreads, boosting margins of fossil fuel companies.
  • Increased competition from China. SolarPower Europe, a trade group for the industry, recently wrote to the European Commission stating that soaring stockpiles, high subsidies, and fierce competition among Chinese manufacturers to gain market share in Europe had reduced the price of solar modules, making it harder for domestic firms to compete.
  • Supply chain disruptions and rising costs. This combination has delayed projects and made them uncompetitive relative to the low price locked in for electricity (via power contracts). These contracts have long durations and fixed tariffs to customers.
  • Uncertain subsidy provision. Over half of US offshore wind power contracts since 2022 have been cancelled or are at risk of cancellation due to being unable to receive bonus tax credits available under the Inflation Reduction Act. Consequently, Ørsted, one of the fastest growing offshore wind producers, had to write down two large US projects near New Jersey worth $4bn.
  • Impediments to permits or obtaining grid connection. The typical project built in 2022 took five years from the interconnection request to commercial operations, compared with three years in 2015.
• Poor performance means investors are no longer willing to buy into secular growth. Oil majors like Shell and BP have retracted plans to cut fossil fuel production, while cutting investment in renewables.
• To reverse their fortunes, clean energy producers need inflation-indexed contracts (to pass on costs to customers), reforms to cut grid connection lead times, and lower inflation and interest rates.

China Now Imports More From Brazil Than Germany

• On a 12-month rolling basis, Chinese imports from Brazil overtook Germany in June this year (Chart 3).
• Brazil is a resource supplier to China – its three largest exports to China are soy, iron ore and crude oil, which together comprise 70% of its exports to China.
• China is the top soy importer in the world and relies almost completely on US and Brazil. But YTD, its soy imports from US fell 15% while from Brazil increased 6%.
• Germany, on the other hand, is a supplier of industrial machinery and automobiles, which have seen little growth in recent years on the back of weak demand in China and China becoming self-sufficient in autos production (in fact, in electric vehicles, China is now a net exporter to Germany).

USDINR 1m FX Vol at 17-year Lows

• USDINR 1m FX vol fell to 2.6%, a fresh 17-year low. And even at that level, it is difficult to justify value.
• Implieds are still a touch above realized vol, as the RBI maintains an iron grip on the spot market. And the term premia remain high, making long vol positions difficult to carry.
• RBI’s weekly FX reserves have dropped slightly from the highs, and currently do not suggest large pressure either way for the de-facto peg to break.

Hungary’s Not So Rejigged Monetary Policy Instruments

• Simplification of the NBH monetary policy toolkit from 1 October has shifted excess liquidity to the reserve account (Chart 7). This suggests the HUF carry trade remains in tact – it merely shifted residence from the depo tenders to O/N reserves.
• Balances in excess of required reserves are now renumerated at the base rate, making this the new policy instrument. The o/n depo tenders in place from October 2022 to September 2023 have ended.
• Hungary’s policy rate is nevertheless still an o/n rate, versus the two-week repo rate from the CNB and a seven-day rate from the NBP. It is no longer the case that every day could be MPC day with the depo tenders ending, but the term of the policy rate is the same as before. And, as such, it remains the same as the emergency standing facilities. But the earlier net surplus on the o/n standing facilities is now reduced with the narrowing of the interest rate corridor (to +/-100bps around the base rate from -50/+1200bps after the October 2022 emergency measures).

South Africa’s Elevated Real Rates

• The SARB’s policy rate remains at a 13-year high of 8.25% despite recent improvement in inflation and an exceptionally weak growth outlook. Inflation expectations remain one area of concern for the SARB, further rand weakness and elevated fiscal risks are others.
• With inflation now back within the 3-6% target band for the last four months South Africa’s real ex-post policy rate has risen sharply and is now the highest across the CEEMEA region. But expectations for easing are less than elsewhere in the region with the SARB continuing to sound very cautious.

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