Buyer Credit Pricing for Natural Gas Exports Using Country Risk Ratings

Abstract

It is important for exporters of commodities, including natural gas, to price their exports correctly in times of excess demand. It is equally important for providers of buyer credit for importers of natural gas to price the finance for the shipments correctly. Pricing buyer credit is vital for the lender’s goals, which includes shareholder wealth maximization if the lender is a bank or a corporation, but, more importantly pricing credit is important for the optimization of the risk and return relationship and the diversification of unsystematic risks in export loan assets. In this chapter, the price of natural gas from a gas exporting country, such as Australia, is deemed to be the amount of export finance that might be required as buyer credit. Export returns thus represent the change in the amount of export finance required by buyers. A higher buyer credit change means a greater amount of credit required. Using country risk ratings, a risk premium is ascribed to this buyer credit in order to avoid mispricing of exports and buyer credit in times of excess demand for gas and thus buyer credit. Importer country examples of the US and China are investigated. It is posited that country risk ratings can determine the magnitude of the risk premium to be applied to buyer credit, consistent with risk/return trade-off theory.

Appendix

Definitions and explanations of pure political risk components (ICRG 2011).

Government stability ratings are an assessment of a government’s ability to remain in office by carrying out declared policy plans. The subcomponents of this factor are government unity, legislative strength and popular support. According to the ICRG ratings, socio-economic conditions relate to pressures that conspire to constrain government action or to fuel social dissatisfaction. The subcomponents in this category are the level of unemployment, the degree of consumer confidence and the level of poverty.

The investment profile factor affects the risk to investment not covered by other political, economic and financial components and is made up of contract viability and expropriation, profit repatriation, and payment delays.

Internal conflict is an assessment of political violence in a country and its impact on governance. The highest rating means that there is no armed or civil opposition to the government and the government does not engage in arbitrary violence (either direct or indirect) against its own people. Under this rationale the lowest scores would apply to those countries where there is ongoing civil war. The subcomponents of this risk factor are thus, civil war or coup threats, terrorism or political violence, and civil disorder.

External conflict measures are an assessment of the risk to the incumbent government from foreign action, which includes non-violent external pressure (e.g., diplomatic pressure, withholding of aid, trade restrictions, territorial disputes, and sanctions) to violent external pressure (such as, cross-border disputes and all-out war). The subcomponents of this category of pure political risk are cross-border conflict, and foreign pressures.

Corruption is an internal assessment of the political system. Corruption distorts the economic and financial environment and reduces the efficiency of government and business in the way foreign direct investment is handled. Corrupt practices enable people to assume positions of power through patronage rather than ability. By so doing, an inherent instability is introduced into the political process. Examples of corruption include special financial payments and bribes, which ultimately may force the withdrawal of or withholding of a foreign investment. However, excessive patronage, nepotism, job reservations, “favor for favors”, secret party funding, and suspiciously close ties between government and business have a lot to do with corruption. A black market can be encouraged with these forms of corruption. The potential downside is that popular backlash may lead to the rendering of the country ungovernable.

Military in politics is a problem because the military are not democratically elected. Their involvement in politics is thus a diminution of accountability. Other substantial ramifications are that the military becomes involved in government because of an actual or created internal or external threat. Government policy is then distorted (for example, defense budgets are increased at the expense of other pressing budgetary needs). Inappropriate policy changes may be a result of military blackmail. A full-scale military regime poses the greatest risk. Business risks may be reduced in the short-term but in the longer-term the risk will rise because the system of governance is susceptible to corruption and because armed opposition in the future is likely. In some cases, military participation will represent a symptom rather than a cause of higher political risk.

Religious tensions emanate from the domination of society and or governance by a single religious group that seeks to replace civil law and order by religious law. Other religions are excluded from the political and social process. The risk involved in such scenarios involves inexperienced people dictating inappropriate policies through civil dissent to outright civil war.

The law and order components are assessments of the strength and impartiality of the legal system and popular observance of the law respectively.

Ethnic tensions relate to racial, nationality or language divisions where opposing groups are intolerant and unwilling to compromise.

The democratic accountability component is a measure of how responsive government is to its people. The less responsive it is the greater the chance that the government will fall. This fall will be peaceful in a democratic country but possible violent in a non-democratic country. The institutional strength and the quality of the bureaucracy is a measure that reflects the revisions of policy when governments change. Low risk in this area applies to countries where the bureaucracy has the strength and expertise to govern without major changes in policy or interruptions in government services. That is, bureaucracies have a degree of autonomy from political pressure with an established independent mechanism for recruitment and training.