Israel and emerging markets debt
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Article Type
Research
Topics
Emerging Markets Debt, Macro
Published
October 11, 2023
Read time
3 mins
Authors
Euart MacKerron, CFA
Jeff Grills, CFA
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Over the weekend, Hamas launched an attack on Israel which resulted in significant deaths, bombings and the escalation of tensions in the Middle East. For the emerging markets, relative to the scale of events in Israel, reaction has been fairly muted for most Middle Eastern and North African credits thus far.

 

As of Mondays close, Israel sovereign bonds were 25 to 35 basis points (bps) wider on spread, subordinated bank notes and energy bonds were 3 to 5 points lower. Within the Middle East, investment-grade bonds were 5 to 15 bps wider and high yield bonds were 0.5 to 1.5 points lower. Brent crude rose $4 a barrel and bund yields declined 11 bps. However, the latter also reflects relatively dovish monetary policy comments from central bank officials over the weekend.

 

The wider impact of recent events will depend on the nature and length of the conflict going forward. However, for Israel it is fair to expect there will be fiscal loosening, potential inflationary pressures from currency passthroughs - in the immediacy, the central bank has vowed to protect the currency from volatility - and some disruption to economic activity as reservists are called up from a tight labor market.

 

For corporates, the impact will likely vary. Israel's electric company declared a state of emergency following the incursion and was preparing to carry out any necessary grid repairs in the south. It is too early to estimate any asset damage, but it is likely limited given that the company is the monopoly transmission and distribution operator in the country and there are no reports of major power outages.

 

One Israeli chemical manufacturer has assets in areas close to the events, but so far says that activities continue to function. The firm could face some short-term disruption to fertilizer exports from the Port of Ashdod, north of Gaza. The impact on a banking sector, which enters this period with relatively sound fundamentals, will depend on how the economy responds. Should any weakness in loan quality or deposit flows become a material concern, we would expect the banks to be supported to maintain confidence.

 

The precautionary shut down of production at the Tamar gas field reflects 1). its processing platform being 25 kilometers west of Ashdod in relatively close proximity to the escalating conflict and 2). its export orientation being of a less critical nature to Israeli power supply.1 Production at Leviathan and Karish is so far unaffected as their infrastructure is relatively distant from current events off Israels northern coastline.2 Karishs production is sold entirely to domestic power and industrial companies, accounting for approximately 50% of Israels gas demand, which was reflected in the operators statement that it remains fully committed to underwriting the energy security of Israel during these challenging times.

 

The suspension of production from the Tamar gas field has potential ramifications for the country's main electric company, which sources the majority of its natural gas from Tamar.3 The company will likely be able to replace its Tamar supply from a combination of gas from the Leviathan and Karish fields (which together produce enough gas to meet domestic demand), liquid natural gas (LNG) and alternative sources such as fuel oil and coal. In a more adverse scenario, where production from other gas fields could be impacted due to their vulnerability as critical infrastructure targets in an escalated conflict or due to a prolonged period of pressure from switching fuel supplies, it is anticipated that the Israeli government would provide support to the company, similar to their actions during the energy disruption of the Arab Spring.

 

Beyond Israel, Egypt is perhaps most at risk from escalation in the conflict, not just from the potential cost of a refugee crisis at its border but also from a disruption in Israeli gas supplies. Amid severe balance of payments pressures in recent years, 2022s record gas export revenues of $8.4 billion were a welcome reprieve. Israel, as its natural gas production has ramped up and without its own LNG processing infrastructure, has increasingly exported surplus production from Tamar and Leviathan to Egypts LNG terminals. Although there are currently no reports of disruption to export pipelines, in the event that there is a prolonged disruption to these activities, such that Egypt moves into a gas deficit, it would add to already prevalent financial and inflationary pressures in the country.

 

Additional spread premium will now be warranted across the Gulf due to the risk of the conflict becoming more regional, but absent an escalation such that the conflict moves beyond Israels borders, emerging market debt is likely to treat the conflict as a relatively localized event. Neither Israel or its immediate neighbors are significant commodity exporters - unlike the challenges posed by Russia and Ukraines meaningful contributions to global energy and agriculture commodity flows. As far as broader Middle East implications, most of the region is already investment grade and the impact to asset pricing should be fairly muted, as it has been already. Given allegiances, eyes will refocus on potential disruption to Irans oil flows, which are near a five-year high. Yet as we have seen with the reorientation of Russias oil exports, imposing a more punitive sanctions regime on purchases of Iranian crude - and disrupting global oil markets - would likely prove difficult due to buyers being primarily outside the G7s sphere of influence.

 

1Chevron told by Israel to shut down Tamar gas platform, Seeking Alpha, October 9, 2023.

2Israel's oil and gas sector, International Trade Administration, September 28, 2022.

3Israel orders Chevron to shut down production at major natural gas field located off southern coast, CNN, October 9, 2023.

Important disclosures

Authors

Euart MacKerron, CFA
Research analyst

Euart MacKerron, CFA, is a credit research analyst responsible for emerging markets corporates for Central and Eastern Europe and the Middle East and Africa regions. 

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Jeff Grills, CFA
Head of US Cross Markets and Emerging Markets Debt

Jeff Grills, CFA, is head of US cross markets and emerging markets debt responsible for the oversight of the fixed income teams for emerging markets debt, US centralized trading and quantitative solutions.

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Israel and emerging markets debt
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