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Economic and energy conditions in 2018

Economic developments

In 2018 the world economy grew by around 3%,6 in line with the pace of 2017. The United States and China continue to drive the world locomotive, boosted by the effects of expansionary fiscal policies, while euro-area growth moved at a slower rate. The normalization of monetary policy in the advanced countries (especially in the United States) is imposing strong pressures on emerging markets (especially the structurally weaker economies). Geopolitical uncertainty was a persistent feature of the external environment. Protectionist policies, although they represent a threat to global growth, as underscored repeatedly by major institutions such as the International Monetary Fund (IMF), are increasingly being seen as an option for reviving national economies. However, despite the trade war waged by the United States, in 2018 China will post its largest trade surplus with Washington in over a decade, expanding by 17% compared with 2017. In Europe, Brexit negotiations continue without significant progress, with the the British parliament again postponing approval of the preliminary agreement reached between the Prime Minister, Theresa May, and the European Union, while the threat of an infringement procedure and the strains between Italy and the European Union over the country’s fiscal policy strategies seem to have abated for the moment.

The United States entered the ninth year of its expansion. In 2018 the economy grew by 2.2%, buoyed by the recent tax reform approved by the Trump administration. The labor market is solid, with the unemployment rate having fallen continuously since 2009 to its current 3.9%, about 40 basis points lower than the structural rate. The strengthening of the economy beyond its potential has sustained inflation. On average, consumer prices since the beginning of the year have grown by 2.4%, a rate now above the 2% target set by the Federal Reserve (Fed). In order to avoid excessive overheating, the US central bank continued the process of normalizing monetary policy, repeatedly raising the benchmark rate (the Fed Funds rate target); the last increase in December was a quarter of a point, bringing it to a range between 2.25% and 2.5%.

The euro area expanded by 1.8%, but showed signs of slowing down, as indicators of real activity and confidence declined (Purchasing Manager Index and the EC’s Economic Sentiment Indicator). Consumer prices increased by 1.7%, boosted by developments in energy prices; core inflation (the main reference for monetary policy decisions) was still modest at 1%, although it is rising. The labor market is improving: in the first eleven months of the year, the unemployment rate was 8.2% (down compared with the previous year) and real wages rose compared with 2017. The European Central Bank (ECB) announced that its program of extraordinary asset purchases (quantitative easing) would end at the end of 2018, but the central bank said it would continue to reinvest the principal amounts generated by redemptions of maturing securities in order to ensure favorable liquidity conditions. Interest rates should remain unchanged at least until the summer of 2019.

In 2018, the Italian economy grew by 0.9% year on year. The annual unemployment rate was 10.6% and real wages rose, while inflation was 1.1%, with prices accelerating the most in the 2nd Half of the year. The coming months will be particularly important to understand the impact of the fiscal strategy and economic policies on reviving the country’s economic productivity.

Spain continued to expand faster than the euro-area average (2.5% in 2018), sustained above all by especially strong growth in private consumption (2.3%) and investment (5.8%). The improvement in labor market conditions (the unemployment rate is now 15.4%, compared with around 26% in 2013) and low inflation (1.7% on average since the beginning of the year) contributed to expanding the purchasing power of households, improving their confidence in the outlook.

Russia grew by 2.3% in 2018. The low level of inflation (as well as boosting real income) made it possible to lower the cost of credit and consequently increase the volume of 6 Source: Oxford Economics. Report on operations 111 lending, fueling private consumption. In the final part of the year, due to a slowdown in demand and a slight uptick in inflationary pressure, the central bank intervened to increase the official interest rate (+0.25%) on a purely precautionary basis.

Romania continues to expand at a rapid pace (4.2%), mainly thanks to the growth in consumption. Owing to the pressure of strong domestic demand, inflation is still very high (4.6%), exceeding the central bank target range of 1.0%- 2.5%. The monetary policy reference rate was raised by 75 basis points from the beginning of the year (currently at 2.5%) in an attempt to prevent the economy from overheating excessively.

In Latin America, the deterioration in the global macroeconomic situation has shone a light on the structural weaknesses of some countries (i.e. Argentina and Brazil), while other economies (Chile, Colombia, Peru) have displayed considerable resilience. In general, in almost all countries of interest to the Group (the only exception is Argentina and, partly, Mexico) inflation has remained low, which helps foster domestic consumption while ensuring compliance with fiscal constraints. In

Argentina, the robust expansion of the 1st Quarter (3.6% year on year) was followed by an equally strong contraction, with an overall decrease of 2.6%. On the demand side, high inflation (about 33.8%) compressed real household income, while gloomy expectations dampened enthusiasm for new investments.

The crisis of confidence contributed to the depreciation of the currency, pushing inflation well beyond the target level and forcing the central bank to raise its benchmark interest rate during the year.

In an attempt to reassure the markets and to meet its funding needs, the government reached an agreement with the International Monetary Fund (IMF) for an aid plan of over $55 billion, subject to eliminating the primary deficit by 2019 and achieving a primary surplus of 1% of GDP in 2020.

The Brazilian economy grew by 1.3% in 2018 compared with 2017, sustained by investment, which represented the main component with an expansion of 4.4%, and an increase in private consumption (favored by modest inflation of 3.7% from the beginning of 2018) and exports, both of which outperformed expectations.

Chile continued to expand (4.0% in 2018 compared with 2017), driven by private consumption and investment. On the demand side, the low level of inflation (2.7% on average since the beginning of the year) helped increase household purchasing power, while the improvement in confidence buoyed investment (6.1%).

These economic developments prompted the central bank to raise its reference rate by 25 basis points, bringing it to 2.75% in October.

Colombia posted growth of 2.5%, thanks to the contribution of private consumption and investment. Inflation (3.2% on average since the beginning of the year) is stable around the central bank’s average target (3%). The monetary policy reference rate was held at 4.25%, thereby leaving the liquidity conditions unchanged. The program announced by the Colombian central bank to increase its foreign reserves denominated in US dollars does not appear to have had any impact on the markets.

In Peru, accommodative monetary conditions (the interest rate was reduced by 150 basis points compared with the 1st Quarter of 2017 and has been unchanged at 2.75% for months) and the implementation of a countercyclical fiscal policy (government spending was increased by 3% compared with the 1st Half of 2017) have enabled the economy to recover strongly, growing by 3.7%. Inflationary pressure was slight at 1.3%. From the point of view of the public finances, the low level of debt (the debt/GDP ratio is about 26%) gives the country room to prolong the fiscal stimulus, although the government has set ambitious deficit reduction targets for the coming years.

Mexico grew by around 2.1% compared with 2017. Consumption continues to drive expansion, although inflation remained high (4.9% on average since the beginning of the year). The victory of Andres Manuel Lopez Obrador in the parliamentary elections last July, and the signing of a new trade agreement reached with the United States and Canada (USMCA) have reduced the climate of uncertainty that impacted the economic context in the first part of the year. This could boost expectations for the economy and investment

The following table shows the GDP growth rates in the main countries in which Enel operates.

Annual real GDP growth

%
20182017
Italy0.91.6
Spain2.53.0
Portugal2.12.8
Greece2.21.4
Argentina-2.62.9
Romania4.26.8
Russia2.31.5
Brazil1.31.1
Chile4.01.6
Colombia2.51.8
Mexico2.12.3
Peru3.72.5
Canada2.13.0
United States2.92.2
South Africa0.71.3

Fonte: Istituti Nazionali di Statistica ed elaborazioni Enel su dati ISTAT, INE, EUROSTAT, IMF, OECD, Global Insight.

International commodity prices

During 2018 the oil market was characterized by two distinct phases. The first nine months of the year saw a continuous and generalized rise in prices, with Brent increasing to $86 a barrel in early October, a level not seen since the end of 2014. By contrast, the 4th Quarter saw prices plunge 40% to $54 a barrel towards the end of the year.

From the point of view of the fundamentals, the trend in the first three quarters of 2018 was driven by several factors:

  1. growing world demand, accompanied by deeperthan-expected cuts in production, which at the end of March drove OECD inventories below the average of the last five years;
  2. concerns about the sharp drop in Iranian output after the US administration withdrew from the nuclear agreement; and
  3. the continuous decline in output in Venezuela; and
  4. outside of OPEC, the cuts imposed by the Canadian province of Alberta.

During the 4th Quarter of the year, despite the production difficulties within the OPEC countries, the now unstoppable growth of American shale oil and worrying signals of a slowdown in global growth, with obvious negative repercussions for oil demand (in October OECD inventories returned above the average of the last five years) contributed to the sharp fall in prices. The production cuts announced by the OPEC countries and Russia during their last meeting in Vienna appear insufficient to stabilize the market for the moment.

The European gas market also experienced periods of considerable volatility during the year. While the early months of 2018 were characterized by strong demand, sustained by especially harsh temperatures, which sharply depleted stocks and pushed them below their average level of recent years, the unusual price tensions registered during the summer were generated by two main factors:

  1. robust demand for injected storage to restore inventory levels; and
  2. strong demand in Asia, which diverted flows of LNG to the Far East.

From October the situation was completely reversed. The sudden drop in the price of oil and the large flow of LNG bound for Europe (in November imports reached 8 billion cubic meters, a level not seen since 2011), together with less than buoyant demand, contributed to a slow and steady decline in prices.

Develpments in the coal market in 2018 reflected the specific characteristics of the two main basins, the Atlantic and the Pacific.

In Europe, the competition between gas and coal for use in electricity generation was the main source of volatility that affected the European market. The sharp rise in gas prices during the 1st Quarter and the sudden rise in CO2 prices not accompanied by an equally strong rise in coal prices made coal plants more competitive than CCGTs, leading to a rise in demand in Europe.

The weak performance of prices during the 4th Quarter was mainly due to the fall in demand and the low levels of the Rhine (owing to the severe drought in the previous summer in Northern Europe) which limited coal traffic.

In the Pacific, China was again the main market mover. While during the 1st Half of the year Chinese demand was sustained by cold winter temperatures and an expecially hot summer, in the final part of the year the strains on market fundamentals eased, with a consequent drop in prices as the Chinese authorities again intervened to curb volumes of imported coal.