Light my fire

August 9, 2024

If you have any feedback on this article or are interested in subscribing to our content, please contact us at opinions@muzinich.com or fill out the form on the right hand side of this page.

--------

In our latest roundup of key themes in emerging-market debt, we explore how credit investors can potentially benefit from growing global energy consumption and demand for copper.

The big story:

Global energy consumption has been on a remarkable growth journey, a trend that looks set to continue on the back of rising populations and increasing average living standards.

With two energy carriers – oil and copper – key to the increase in current and future consumption and decarbonisation, how can investors access and benefit from this systemically-important global megatrend?

Oil: The key to mobility and modernity?

The world remains dependent on oil, consuming over 100 million barrels a day.¹ The average barrel is processed into multiple products (Figure 2). Without it, there would be no aviation industry, asphalt, plastic or key consumer goods like synthetic fibres used for medical applications such as intravenous bags and syringes.

Due to the nature of oil wells, production rates fall over time - estimated to be around 8% a year.²  While there are concerns over demand, with a news headline about peak oil consumption every few months, oil is unlikely to run out any time soon.³

Historically, inventory levels have been highly correlated with crude oil prices (Figure 3). Currently there is a c.2.75 billion barrel stockpile, equating to 2 months’ consumption.⁴

Predictions of near-term demand vary. Goldman Sachs estimates modest draws of 100 thousand barrels of oil a day for the next 12 months,⁵ HSBC an average draw of 600 thousand barrels per day over 2024 and 2025,⁶ while some of the more aggressive forecasters like Standard Chartered call for even higher inventory draws of over a million barrels a day over the next 12 months.⁷

Usually, if inventories decline, prices increase. However, given OPEC+’s ongoing role of co-ordination and monitoring, it is difficult to find a scenario where inventories significantly increase and prices fall, which could make an allocation into oil-related credit issuers an appealing option.

Copper: The key to net zero?

Today, 50% of the demand for copper comes from construction and infrastructure applications, with the rest from equipment manufacturing and other industrial uses.⁸ In its ‘Sustainable Development Scenario’, the International Energy Agency (IEA) estimates world demand could hit 33.4 metric tonnes (mt) per year by 2040, nearly 40% higher than it was in 2020.⁹

This is predicted to be primarily driven by the installation of more renewable energy sources, grid investments, battery storage and electric vehicles (EVs). Passenger EVs can consume up to 3.5 times more copper than a traditional petroleum-powered one.¹⁰ Solar panels and wind farms, meanwhile, need 7-10 times more copper per megawatt of electricity production capacity relative to fossil-fuel based systems.¹¹

The demand picture stands in stark contrast with supply. It can take 4-12 years to develop a new copper deposit.¹² It is also becoming more difficult to extract copper; the copper grade – the ratio between copper extracted to the earth processed to extract the copper – has dropped from 2.3% in 1913 to less than 1% today.¹³

Estimates of future demand vary, depending on the view forecasters take on the pace of grid investments. However, the uniting thread is the market will likely be in deficit for some time.¹⁴ A telling forecast is the IEA’s 25-50% gap between copper supply and demand in 2035.¹⁵

The market is already feeling the impact of the supply shortage. Global inventory levels were estimated to be at 2 weeks’ worth of consumption at the beginning of 2024, with an annual deficit of 1-3%.¹⁶ While a 1-3% deficit might not seem catastrophic, it would be enough to run inventory levels down to zero within 2 years.

In any commodity market, a combination of low inventories and deficits results in price increases. It is difficult to say why copper would be any different, making a good case for corporate issuers linked to the commodity.

Copper bottomed

For investors looking to gain exposure to oil or copper, an allocation to emerging markets may be a viable option. For example, it is possible to take indirect commodity exposure via an allocation into local currency or sovereign debt. Chile, the world’s largest copper producer since 1990 with close to 50% of the exports from copper-related products, is a good example.¹⁷ Both the currency and sovereign are directly linked to the value of copper.

However, we believe it is more efficient to take direct exposure via the commodity producer. This allows an investor to tailor their exposure to underlying risk parameters such as duration, credit ratings, capital structure and sovereign risk (i.e. only invest in a company where the sovereign is deemed investible).

As per Fig. 5 below, energy represents 19.6% of the emerging market corporate universe with metals and mining comprising nearly 7%. Outstanding securities total US$240 billion, making it one of the most liquid sectors within the emerging market corporate universe.¹⁸ The largest sub-sector is integrated energy – companies involved across the whole supply chain, from exploration to refining, distribution and marketing, through oil, gas and renewables.

Figure 5: Energy sector breakdown

Source: ICE Index Platform, ICE BofA Emerging Market Corporate Liquid Index, as of 28th July 2024. For illustrative purpose only.

Integrated energy companies are strategically important to their country of origin and the majority are partially or fully government owned. We believe this sub-sector might be an attractive way to gain medium-level risk exposure to the oil sector with opportunities available globally and across the ratings spectrum.

For investors looking for maximum sector beta, the exploration & production (E&P) sector could be an option, with opportunities in high-yield frontier and Latin American E&P specialists. Low-beta exposure can be accessed via the gas distribution sub-sector, where contracts are commonly fixed with ship-or-pay minimum volume commitments. This allows investors medium-term access to the sector, with less sensitivity to day-to-day volatility.

Within metals and mining, copper is the largest sub-sector,¹⁹ representing 56%  (Figure 6), and is highly skewed to investment grade (75%) as management tend to run conservative and bond-friendly balance sheets. Latin America is the largest region (66%), with opportunities in Chile, Mexico and Brazil. In Asia, Indonesia stands out as a potential source of exposure.

The month in credit

July was positive for all credit markets and EM corporates were no exception, with the ICE BofA Emerging Market Corporate Liquid index gaining 1.4%, aided by the performance of Asia high yield and its property sector.²⁰  Greater determination by Chinese policymakers to support regional growth set a positive tone.  

Another positive theme was the continued recovery of distressed credits in the Latin American telecoms sector, in-line with the reopening of the region’s high-yield primary market.²¹

Within Latin America more broadly, central banks and governments maintained their focus on economic recovery and stability. In Argentina, the government continued to exhibit fiscal discipline, posting a sixth consecutive monthly surplus and launching an asset regularisation regime to attract c.US$100 billion to boost reserves.²²

In Mexico, higher rates started to bite into economic growth with GDP growing only 0.2% quarter-on-quarter.²³ In a coordinated move, the US and Mexico joined forces to counteract moves by China to circumvent US tariffs on steel and aluminum.

In Brazil, headline inflation accelerated in July, although remained below the ceiling of the target band. The rise was partly due to base effects, but underlying measures also rose and remain consistent with inflation between the target centre and ceiling.²⁴ As a result, we believe the central bank will likely leave the benchmark interest rate at 10.5% for a second consecutive meeting.

In contrast, Chile saw a contraction in core inflation and cut interest rates to 5.5%, while also being reaffirmed with an ‘A’ rating and stable outlook by Fitch Ratings.

We also saw positive ratings news in Turkey as Moody’s upgraded its sovereign rating from B3 to B1 – the first upgrade in over a decade, while maintaining a positive outlook.²⁵ As the country’s credibility and effective monetary policies gain traction, macroeconomic stability and stronger institutions may in turn help the country’s underlying credit strengths, such as its diversified and competitive economy and comparatively strong fiscal and debt metrics.

Ukrainian credit outperformed after a favourable sovereign debt exchange was announced with bondholders. This was a surprise as the sovereign made a significant improvement in its original proposal, raising recovery rates from 25 cents to 35-40 cents on the dollar, terms which have been blessed by the International Monetary Fund.²⁶

Meanwhile, Thailand held investment discussions around the ambitious Southern Land Bridge project.²⁷ The project aims to link the Gulf of Thailand and Andaman Sea  to shorten sea transportation times and capture transshipment volumes from ports in Malaysia and Singapore. 

We also witnessed the possibility of a rise in unorthodox policies, with the prospect of Indonesia increasing its debt-to-GDP ratio to 50% from the current 39% raised by the country’s president-elect. This contrasts with the outgoing administration’s conservative stance and could increase the budget deficit beyond the current allowance.²⁸

The primary market continued to gather steam, with July’s issuance of US$13.5 billion taking the year-to-date total to US$242 billion, ahead of forecasts. Quasi-sovereigns were the month’s most prolific issuers, contributing 42% of supply, mostly from Asia. There was also significant issuance by utilities, with approximately 50% of year-to-date supply coming in July.²⁹

Overall, market fundamentals appeared to improve. JP Morgan lowered its full-year default forecast for the emerging market high-yield market from 4% to 3.6%, driven by an improving picture in Latin America and Europe.³⁰

EM election calendar

Source: Muzinich & Co as of August 2024. For illustrative purposes only.

Credit

Past performance is not a reliable indicator of current or future results.

Source: ICE data platform. as of 31st July 2024. EMGB - ICE BofA Emerging Markets External Sovereign Index EMCB - ICE BofA Emerging Markets Corporate Plus Index,  EMIB - ICE BofA High Grade Emerging Markets Corporate Plus Index, EMHB - ICE BofA High Yield Emerging Markets Corporate Plus Index, Q690 - ICE BofA Custom Emerging Markets Short Duration Index, EMRA - ICE BofA Asia Emerging Markets Corporate Plus Index, EMIA - ICE BofA High Grade Asia Emerging Markets Corporate Plus Index, EMHA - ICE BofA High Yield Asia Emerging Markets Corporate Plus Index , EMRL - ICE BofA Latin America Emerging Markets Corporate Plus Index, EMIL - The ICE BofA High Grade Latin America Emerging Markets Corporate Index, EMHL - ICE BofA High Yield Latin America Emerging Markets Corporate Plus, EMRE - ICE BofA EMEA Emerging Markets Corporate Plus Index, EMIE - ICE BofA High Grade EMEA Emerging Markets Corporate Plus Index, EMHE - ICE BofA High Yield EMEA Emerging Markets Corporate Plus Index,. Index performance is for illustrative purposes only. You cannot invest directly in the index. Indices selected provide best proxy for highlighting performance of emerging market corporate bonds. For illustrative purposes only.

Yield to Worst

Source: ICE data platform. as of 31st July 2024. EMGB - ICE BofA Emerging Markets External Sovereign Index EMCB - ICE BofA Emerging Markets Corporate Plus Index,  EMIB - ICE BofA High Grade Emerging Markets Corporate Plus Index, EMHB - ICE BofA High Yield Emerging Markets Corporate Plus Index, Q690 - ICE BofA Custom Emerging Markets Short Duration Index, EMRA - ICE BofA Asia Emerging Markets Corporate Plus Index, EMIA - ICE BofA High Grade Asia Emerging Markets Corporate Plus Index, EMHA - ICE BofA High Yield Asia Emerging Markets Corporate Plus Index , EMRL - ICE BofA Latin America Emerging Markets Corporate Plus Index, EMIL - The ICE BofA High Grade Latin America Emerging Markets Corporate Index, EMHL - ICE BofA High Yield Latin America Emerging Markets Corporate Plus, EMRE - ICE BofA EMEA Emerging Markets Corporate Plus Index, EMIE - ICE BofA High Grade EMEA Emerging Markets Corporate Plus Index, EMHE - ICE BofA High Yield EMEA Emerging Markets Corporate Plus Index,. Index performance is for illustrative purposes only. You cannot invest directly in the index. Indices selected provide best proxy for highlighting performance of emerging market corporate bonds. For illustrative purposes only. 

 

References

1.Statista, as of 22 May 2024
2, 3.International Energy Agency, World Energy Outlook 2023, as of October 2023. Latest data available used.
4.US Energy Information Administration Short-Term Energy Outlook, July 2024.
5.Goldman Sachs, Global Supply and Demand Table, April 2024
6.HSBC Global Research, as of June 3, 2024. “Oil markets – OPEC+ roadmap leaves unanswered questions.”
7.Standard Chartered, Commodity Roadmap, June 2024
8.International Energy Agency, as of 3rd May 2021. Total copper demand by sector and scenario, 2020-2024. Latest available data used.
9.International Energy Agency, World Energy Outlook 2023, as of October 2023. Latest data available used.
10.Bloomberg, BNEF Transition Metals Outlook 2023
11, 13.Material World - A substantial story of our past and future, Ed Conway, 2023
12.University of Arizona, Superfund Research Center, as of 2024. Copper mining and processing: Lifecyle of a mine.
14.JP Morgan, 25th June 2024, Metals Weekly: Copper – deferred not derailed.
15.International Energy Agency Critical Minerals Outlook 2024
16.Bank of America, as of April 2024
17.Nasdaq, ‘Top 10 Copper Producers by Country, as of March 4, 2024
18, 19. ICE Index Platform, ICE BofA Emerging Market Corporate Liquid Index, as of 30th July 2024.
20.ICE BofA Index Platform, as of July 31, 2022 – This index tracks the performance of US dollar (USD) denominated emerging markets non-sovereign debt publicly issued in the major domestic and Eurobond markets.
21.Asharq Al-Aswat, as of July 30, 2024. “China’s leaders vow to step up policy support for economy”.
22.Reuters, July 16, 2024. “Argentina posts six months of fiscal, financial surpluses”
23.Bloomberg, as of July 30, 2024. “Mexico’s Economic Growth Undershoots Forecasts as Woes Mount”
24.Trading Economics, as of July 10, 2024.
25.The National, as of July 20, 2024 – “Turkey receives first ratings upgrade from Moody’s in a decade on improved governance’
26.Bloomberg, as of July 22, 2024 - “Ukraine, Key bondholders reach deal on US$20bn overhaul”
27.The Nation, as of June 1, 2024. “Land bridge project draws interest from over 100 companies: ministry”
28.Financial Times, as of July 10, 2024 “Indonesia’s president elect plans sharp rise in debt”
29.JP Morgan, Global Credit Research, as of July 26, 2024 - EM corporate weekly monitor
30.JP Morgan, Global Credit Research, as of 8th July 2024 – EM corporate default monitor

 

This material is not intended to be relied upon as a forecast, research, or investment advice, and is not a recommendation, offer or solicitation to buy or sell any securities or to adopt any investment strategy. The opinions expressed by Muzinich & Co are as of August 2024 and may change without notice.

--------

Index descriptions

EMGB - ICE BofA Emerging Markets External Sovereign Index tracks the performance of US dollar and euro denominated emerging markets sovereign debt publicly issued in the major domestic and eurobond markets.  Qualifying securities must have risk exposure to countries other than members of the FX-G10, all Western European countries and territories of the US and Western European countries.

EMCB - ICE BofA Emerging Markets Corporate Plus Index tracks the performance of the US dollar and euro denominated emerging markets non-sovereign debt publicly issued in the major domestic and eurobond markets. Qualifying issuers must have risk exposure to countries other than members of the FX G10, all Western European countries, and territories of the US and Western European countries.

EMIB - ICE BofA High Grade Emerging Markets Corporate Plus Index is a subset of the ICE BofA ML Emerging Markets Corporate Plus Index (EMCB) including all securities rated AAA through BBB3, inclusive.

EMHB - ICE BofA High Yield Emerging Markets Corporate Plus Index is a subset of the ICE BofA ML Emerging Markets Corporate Plus Index (EMCB) including all securities rated BB1 or lower.

Q690 - ICE BofA Custom Emerging Markets Short Duration Index tracks the performance of short-term US dollar and euro denominated emerging markets non-sovereign debt publicly issued in the major domestic and eurobond markets.

EMRA - ICE BofA Asia Emerging Markets Corporate Plus Index is the subset of the ICE BofAML Emerging Markets Corporate Plus Index, which includes only securities issued by countries associated with the region of Asia, excluding Kazakhstan, Kyrgyzstan, Tajikistan, Turkmenistan, and Uzbekistan.

EMHA – The ICE BofA High Yield Asia Emerging Markets Corporate Plus Index is a subset of ICE BofA Emerging Markets Corporate Plus Index including all securities rated BB1 and lower with a country of risk within the Asia region.

EMIA -  The ICE BofA High Grade Asia Emerging Markets Corporate Plus Index is a subset of ICE BofA Emerging Markets Corporate Plus Index including all securities rated BBB3 and higher with a country of risk within the Asia region.

EMRL - ICE BofA Latin America Emerging Markets Corporate Plus Index is a subset of The ICE BofA Emerging Markets Corporate Plus Index including all securities issued by countries associated with the geographical region of Latin America.

EMIL - The ICE BofA High Grade Latin America Emerging Markets Corporate Index is a subset of ICE BofA Emerging Markets Corporate Plus Index including all securities rated BBB3 and higher with a country of risk within the Latin America region.

EMHL - ICE BofA High Yield Latin America Emerging Markets Corporate Plus is a subset of ICE BofA Emerging Markets Corporate Plus Index including all securities rated sub-investment grade based on the average of Moody's, S&P and Fitch, and with a country of risk associated with the geographical region of Latin America.

EMRE - ICE BofA EMEA Emerging Markets Corporate Plus Index is a subset of The ICE BofA Emerging Markets Corporate Plus Index including all securities issued by countries associated with the geographical region of Europe, the Middle East and Africa including Kazakhstan, Kyrgyzstan, Tajikistan, Turkmenistan and Uzbekistan.

EMIE - ICE BofA High Grade EMEA Emerging Markets Corporate Plus Index is a subset of ICE BofA Emerging Markets Corporate Plus Index including all securities rated BBB3 and higher with a country of risk within the Europe, Middle East and Africa regions.

EMHE - ICE BofA High Yield EMEA Emerging Markets Corporate Plus Index is a subset of ICE BofA Emerging Markets Corporate Plus Index including all securities rated BBB3 and higher with a country of risk within the Europe, Middle East and Africa regions.

The MSCI EM Index is a free-float weighted equity index that captures large and mid cap representation across emerging market countries. The index covers approximately 85% of the free float-adjusted market capitalisation in each country.

LDMP - ICE BofA Local Debt Markets Plus Index is designed to track the performance of emerging markets sovereign debt publicly issued and denominated in the issuer's own currency.

J0A0 - The ICE BofA ML US Cash Pay High Yield Index tracks the performance of US dollar denominated below investment grade corporate debt, currently in a coupon paying period that is publicly issued in the US domestic market.

C0A0 - The ICE BofA ML US Corporate Index tracks the performance of US dollar denominated investment grade corporate debt publicly issued in the US domestic market.

HE00 - The ICE BofA ML Euro High Yield Index tracks the performance of EUR dominated below investment grade corporate debt publicly issued in the euro domestic or eurobond markets.

ER00 – The ICE BofA ML Euro Corporate Index tracks the performance of EUR denominated investment grade corporate debt publicly issued in the eurobond or Euro member domestic markets.

CLCURFGB Index – Global Copper Refined Total Production - Yearly. This sector contains the copper production data for Chile, release by COCHILCO.

Important information

Muzinich and/or Muzinich & Co. referenced herein is defined as Muzinich & Co., Inc. and its affiliates. Muzinich views and opinions.  This material has been produced for information purposes only and as such the views contained herein are not to be taken as investment advice. Opinions are as of date of publication and are subject to change without reference or notification to you. Past performance is not a reliable indicator of current or future results and should not be the sole factor of consideration when selecting a product or strategy. The value of investments and the income from them may fall as well as rise and is not guaranteed and investors may not get back the full amount invested. Rates of exchange may cause the value of investments to rise or fall. Emerging Markets may be more risky than more developed markets for a variety of reasons, including but not limited to, increased political, social and economic instability; heightened pricing volatility and reduced market liquidity.

Any research in this document has been obtained and may have been acted on by Muzinich for its own purpose. The results of such research are being made available for information purposes and no assurances are made as to their accuracy. Opinions and statements of financial market trends that are based on market conditions constitute our judgment and this judgment may prove to be wrong. The views and opinions expressed should not be construed as an offer to buy or sell or invitation to engage in any investment activity, they are for information purposes only.

This discussion material contains forward-looking statements, which give current expectations of future activities and performance. Any or all forward-looking statements in this material may turn out to be incorrect. They can be affected by inaccurate assumptions or by known or unknown risks and uncertainties. Although the assumptions underlying the forward-looking statements contained herein are believed to be reasonable, any of the assumptions could be inaccurate and, therefore, there can be no assurances that the forward-looking statements included in this discussion material will   prove to be accurate. In light of the significant uncertainties inherent in the forward-looking statements included herein, the inclusion of such information should not be regarded as a representation that the objectives and plans discussed herein will be achieved. Further, no person undertakes any obligation to revise such forward-looking statements to reflect events or circumstances after the date hereof or to reflect the occurrence of unanticipated events.

United States: This material is for Institutional Investor use only – not for retail distribution. Muzinich & Co., Inc. is a registered investment adviser with the Securities and Exchange Commission (SEC). Muzinich & Co., Inc.’s being a Registered Investment Adviser with the SEC in no way shall imply a certain level of skill or training or any authorization or approval by the SEC.

Issued in the European Union by Muzinich & Co. (Ireland) Limited, which is authorized and regulated by the Central Bank of Ireland. Registered in Ireland, Company Registration No. 307511. Registered address: 32 Molesworth Street, Dublin 2, D02 Y512, Ireland. Issued in Switzerland by Muzinich & Co. (Switzerland) AG. Registered in Switzerland No. CHE-389.422.108. Registered address: Tödistrasse 5, 8002 Zurich, Switzerland. Issued in Singapore and Hong Kong by Muzinich & Co. (Singapore) Pte. Limited, which is licensed and regulated by the Monetary Authority of Singapore. Registered in Singapore No. 201624477K. Registered address: 6 Battery Road, #26-05, Singapore, 049909. Issued in all other jurisdictions (excluding the U.S.) by Muzinich & Co. Limited. which is authorized and regulated by the Financial Conduct Authority. Registered in England and Wales No. 3852444. Registered address: 8 Hanover Street, London W1S 1YQ, United Kingdom. 2024-08-06-14188