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Global Aging 2016: the U.K.'s Generous Age-Related Expenditure Could Lead to a Deteriorating Fiscal Position

Several majors could make a play for Permian producer Endeavor Energy

IEA warns of oil supply lagging demand without significant investment

Permian producers prepared for dip in oil prices to last into 2019

Stocks Rocked the House Post Midterm Elections

Global Aging 2016: the U.K.'s Generous Age-Related Expenditure Could Lead to a Deteriorating Fiscal Position

S &P Global Ratings' analysis of aging in the U.K. is part of a global study conducted to analyze the cost of aging. We presented our findings in "Global Aging 2016: 58 Shades Of Gray," published April 28, 2016. The comparative study explores various scenarios--including a no-policy-change scenario--and the implications that we currently believe these different scenarios could have on sovereign ratings over the next several decades. We included an additional eight sovereigns in this year's report, which expanded the scope of the study's coverage to a total of 58 sovereigns, representing 70% of the world's population. For the 50 sovereigns that we included in the previous edition of our Global Aging series, our findings this year provide an update of our analyses--including information on long-term demographic, macroeconomic, and budgetary trends--all in the context of the countries' current fiscal positions.

It should be noted that since we published our comparative findings in April 2016 we have re-run our simulation on the U.K. specifically for this article, factoring in our June 2016 two-notch downgrade (upon Brexit) and lower fiscal and growth outlooks for the U.K.


  • The U.K.'s overall population is expected to increase by 19.5% between 2015 and 2050, reaching 77.3 million by 2050. According to European Commission forecasts, the U.K. will become the most populated country in Europe by 2050, but the share of working-age population is expected to decline from 65.1% to 58.8% leading to higher age-related expenditure.
  • Under current policy, the government's annual age-related spending is projected to increase by about 2% of GDP. Absent any further reforms or compensating expenditure cuts in other areas, this could lead to a deterioration of the U.K.'s fiscal position, and a possible increase in net general government debt to 189% of GDP by 2050.
  • Since our last Global Aging report in 2013, the U.K. has extended the state pension age and put in place a policy framework for regular review of the retirement age, in an attempt to lower costs.
  • However, state pensions in the U.K. continue to be subject to a generous and costly rule, the "triple-lock", ensuring payments consistently rise in both real and nominal terms presenting a significant cost to the exchequer.

Results For The U.K.

Our analysis suggests that in the U.K., the old-age dependency ratio will rise to 40.7% in 2050 from 26.6% in 2015 (see table 1; the old-age dependency ratio is the number of people aged 65 and older divided by the number of those aged 15-64). Overall, we expect the U.K.'s population will continue to grow and exceed 77 million by 2050. The share of the working age population, however, is projected to fall to 58.8% by 2050 from the current 65.1%.

In our view, an aging population will likely place substantial pressure on economic growth and public finances. Demand for publicly provided health care and long-term care services and state pensions could increase. Without further government reforms, total age-related public expenditures in the U.K. are projected to rise to 18.9% of GDP in 2050 from 16.9% in 2015. Nevertheless, this forecast increase of 2% of GDP is less than the projected 3.7 percentage-point increase for the median of our 58-sovereign sample. We expect that the bulk of the U.K.'s age-related spending will go toward health-care outlays, followed by pension expenditures (see table 1).

State pensions are currently subject to a "triple-lock" guarantee, which requires that they rise each year by the highest of either CPI inflation, wage inflation, or 2.5%. This legislative constraint will contribute to long-term pressures on public spending. We anticipate that although the increase in age-related spending in the U.K. will be moderate until around 2020, spending will likely increase after this period, as more people enter retirement age.

Such a development could suggest a significant deterioration in the U.K's budgetary position in the long term. If unmanaged, the weight of general government spending--including social security--could rise significantly as age-related spending increases, coupled with a rising interest bill as deficits and debt mount. Our analysis suggests that without fiscal or structural policy reforms, net debt could rise to 189% of GDP by 2050 in the U.K., higher than the sample median of 134% of GDP.

Expected Impact Of A No-Policy-Change Scenario On The Ratings

Such macroeconomic and fiscal dynamics, if unaddressed, could lead to a change to the current 'AA' long-term foreign currency sovereign rating on the U.K. Based on the fiscal projections of our study, we derived hypothetical sovereign credit ratings for the U.K. (see table 1). In practice, S&P Global Ratings takes a large number of factors into consideration when determining sovereign credit ratings (see "Sovereign Ratings Methodology" published Dec. 23, 2014). In the very long term, prolonged fiscal imbalances and wealth (as measured by GDP per capita) tend to become the more dominant factors. Using this approach, and no mitigating policy response, our 'AA' rating on the U.K. could come under increasing pressure over the coming decades. By 2035, the U.K.'s fiscal indicators could have weakened such that they would be more in line with sovereigns currently rated in the 'bbb' category. And, in our view, the projected improvement in GDP per capita would not be able to offset the potential fiscal deterioration.

When comparing our new post-Brexit results for the U.K. with what we found in our April 2016 pre-Brexit simulation, it seems that future budgetary challenges now appear to be more significant. This is a result of several factors, the main reason being our write-down of key fiscal and economic indicators for the sovereign.

When we compare our post-Brexit 2016 simulation with our 2013 report, we are now projecting specific age-related spending to be lower, mostly on the back of reduced specific health-care expenditures.

Alternative Scenarios Could Result In Drastically Different Economic And Fiscal Prospects

In addition to our no-policy-change scenario, we have considered several other long-term scenarios (see table 1). Two of these scenarios are: the U.K. undertaking radical structural reforms to its social security system, freezing all age-related spending at the current level (as a percentage of GDP); or the U.K. balancing its budget by 2019. Based on these scenarios, fiscal indicators in the U.K. appear to hold up much better--especially if the government were to undertake structural reforms to prevent age-related spending from rising or move to consolidate its budget for a sustained period.

The Effects Of Age-Related Spending On Sovereigns' Future Creditworthiness

The base-case scenario is not a prediction. Rather, it is a simulation that highlights the importance of age-related spending trends as a factor in the evolution of sovereign creditworthiness. In our view, it is unlikely that governments would, as a general matter, allow debt and deficit burdens to spiral out of control or that creditors would be willing to subscribe to such high levels of debt. In fact, as we have observed in many sovereigns in our 2016 Global Aging report, governments are often able to confront the prospects of unsustainably rising debt burdens by implementing budgetary consolidation or reforms of their social security systems.

Aging Population Data And Scenario Results: United Kingdom
2015 2020 2025 2030 2035 2040 2045 2050
Demographic and economic assumptions
Population (mil.) 64.7 66.9 68.8 70.6 72.3 74.0 75.7 77.3
Working-age population (% of total) 65.1 63.0 61.9 60.8 60.0 59.6 59.4 58.8
Elderly population (aged over 65; % of total) 17.3 18.7 19.8 21.4 22.7 23.3 23.5 23.9
Old-age dependency ratio (%) 26.6 29.6 31.9 35.2 37.9 39.1 39.6 40.7
Real GDP (% change) 2.3 1.1 1.3 1.7 2.0 2.1 2.0 1.8
Age-related government expenditure (% of GDP)
Pensions 7.6 7.4 7.8 7.9 8.2 8.4 8.1 8.1
Health care 7.9 8.1 8.3 8.5 8.7 8.8 8.9 9.0
Long-term care 1.2 1.2 1.3 1.3 1.4 1.4 1.4 1.5
Unemployment benefits 0.3 0.2 0.3 0.2 0.2 0.2 0.2 0.2
Total 16.9 16.9 17.6 17.9 18.5 18.9 18.8 18.9
Scenario 1: No policy change (% of GDP)
Net general government debt 83.5 87.7 98.4 112.7 128.5 146.8 166.7 189.0
General government balance (4.4) (3.6) (5.8) (6.9) (8.2) (9.5) (10.3) (11.5)
General government expenditure 43.2 42.3 44.5 45.6 46.9 48.2 49.0 50.2
Interest payments 2.4 3.5 5.0 5.7 6.4 7.3 8.2 9.3
Hypothetical long-term sovereign rating AA a aa a bbb bbb bbb bbb
Scenario 2: Balanced budget in 2019 (% of GDP)
Net general government debt 83.5 81.2 74.0 69.1 65.0 62.6 60.6 58.9
General government balance (4.4) (0.2) (1.4) (1.5) (1.9) (2.1) (1.9) (1.9)
Hypothetical long-term sovereign rating AA aa aaa aaa aaa aaa aaa aaa
Scenario 3: No additional age-related spending (% of GDP)
Net general government debt 83.5 87.6 95.7 104.4 111.7 118.6 126.2 134.9
General government balance (4.4) (3.5) (4.9) (5.3) (5.7) (6.0) (6.4) (6.8)
Hypothetical long-term sovereign rating AA a aa a a a a a
Scenario 4: Lower interest rate (% of GDP)
Net general government debt 83.5 86.2 90.0 95.0 100.9 108.2 116.2 125.0
General government balance (4.4) (3.0) (3.8) (4.4) (5.2) (5.8) (6.0) (6.4)
Hypothetical long-term sovereign rating AA aa aa aa a a a a
Scenario 5: Higher growth (% GDP)
Net general government debt 83.5 84.9 90.3 98.3 107.2 117.6 128.6 140.4
General government balance (4.4) (3.4) (5.3) (6.0) (7.0) (7.8) (8.2) (8.9)
Hypothetical long-term sovereign rating AA aaa aa aa a a a a

Several majors could make a play for Permian producer Endeavor Energy

Oil majors Exxon Mobil Corp., Chevron Corp., Royal Dutch Shell PLC and ConocoPhillips are all considering making first-round bids for Texas-based oil producer Endeavor Energy Resources LP.

Including debt, Endeavor, which holds more than 300,000 acres in the prolific Permian Basin, could be valued at $12 billion to $15 billion. Core acres are located in Martin, Midland, Upton, Glasscock, Reagan and Howard counties. The company's net production in the second quarter was 64,000 barrels of oil equivalent per day, 75% of which was oil.

Many of the majors have highlighted their renewed interest in the U.S. shale plays. Having announced plans earlier this year to triple its Permian oil production to 600,000 barrels per day by 2025, Exxon is viewed by many as the most logical would-be buyer of Endeavor. Back in 2014, Exxon inked a seven-year deal with the producer to expand its presence in the basin.

Exxon's third-quarter shale oil output from the Permian was up 57% on the year due to the ramp-up to the current 38 rigs in the Midland and Delaware basins. The company's third-quarter Permian production increased 170,000 boe/d, or 11%, on the quarter.

While Chevron could be a contender, the company already has a sizeable position in the Permian, analysts said. "Chevron is another possibility although we think its existing position of 1.7 [million] acres (0.5 million Midland and 1.2 million Delaware) is likely adequate, with the focus likely to be more on acreage swaps and trades to core up its position," RBC analyst Biraj Borkhataria wrote in a Nov. 13 note.

Analysts said ConocoPhillips and Shell are less likely to emerge as bidders.

"Despite the company's positive disposition to the play, we would not expect Shell to bid for such a large package given the company has been clear that inorganic activity is included within its $25 [billion] to $30 [billion] capex framework per annum, meaning limited headroom to execute such a large deal," Borkhataria said.

Should a sale occur, it would follow a rash of Permian-based transactions, including Concho Resources Inc.'s purchase of RSP Permian for $8 billion and Diamondback Energy Inc.'s purchase of Energen Corp. for $9.2 billion. Additionally, on Oct. 31, BP PLC closed on its $10.5 billion acquisition of BHP Billiton Group's U.S. shale oil and natural gas assets.

In emailed requests for additional details on a sale, officials from Endeavor, Exxon, Shell and ConocoPhillips declined to comment. An inquiry to Chevron was not immediately returned.

Endeavor, which is family owned, agreed to explore a sale after receiving inquiries from prospective bidders, although the family reportedly would prefer an IPO next year so it could retain control. JP Morgan Chase & Co. and Goldman Sachs Group Inc. were reportedly selected to arrange the possible transaction.

IEA warns of oil supply lagging demand without significant investment

The International Energy Agency warned in its World Energy Outlook 2018, released Nov. 13, that without sufficient oil production investment, the world faces a possible oil supply gap during the early 2020s.

"Oil and natural gas will be part of the energy system for decades to come — even under ambitious efforts to reduce greenhouse gas emissions in line with the Paris Agreement," the report said.

Under existing and planned policies included in the report's new policies scenario, trucking and aviation demand will drive global oil consumption to 102.4 million barrels per day by 2025. Meanwhile, the IEA projects currently producing oil fields will supply just 68.0 MMbbl/d.

"The level of conventional crude oil resources approved for development in recent years … is only half of the level needed to meet demand growth in the [new policies scenario]," the report said.

"If these approvals do not pick up sharply from today's levels, U.S. tight oil production would need to triple from today's level to over 15 [million barrels per day] by 2025 to satisfy demand," the report said. "With a sufficiently large resource base, this could be possible. But it would require levels of capital investment that would far surpass the previous peaks in 2014."

Among trends to 2040, the IEA outlined a "major shift in the geography of oil demand."

According to the report, developing economies will see oil demand grow by 18 MMbbl/d from 2017 to 2040, offsetting a demand decline of 10 MMbbl/d in developing economies.

The IEA projects global oil demand from trucking will grow by 3.9 MMbbl/d, while global oil demand from petrochemicals grows by 4.8 MMbbl/d.

At the same time, the IEA expects oil use in cars will peak in the mid-2020s. It projects approximately 300 million cars on the road by 2040 will avoid 3.3 MMbbl/d of oil demand that year, while efficiency improvements in nonelectric cars will avoid more than 9 MMbbl/d of oil demand in 2040.

The IEA projects automotive demand for oil will decline by 5 MMbbl/d from 2017 to 2040 in advanced economies, offsetting demand growth of 5.4 MMbbl/d in developing economies.

Permian producers prepared for dip in oil prices to last into 2019

Mindful of the lessons learned during the 2014-2016 oil and gas price collapse, large independent producers in the Permian Basin are shielded from the current U.S. oil price slide, thanks to conservative budgeting, new access to Brent crude pricing at the Houston Ship Channel and greater efficiency.

The price of West Texas Intermediate crude oil bounced back above $60 per barrel on the morning of Nov. 12, a slight improvement over the end of the previous week but still well below the $76.40/bbl reached in early October. If prices remain near $60/bbl, that will be more than enough for most producers to see healthy returns, as many have budgeted for prices at $50/bbl or below. Even though prices spiked more than $20/bbl above anticipated levels for several months, Permian producers largely made only slight increases to budgets as they looked to the long term.

"The industry has been conservative in oil price assumptions," Williams Capital Group LP analyst Gabriele Sorbara said. "I would say a majority of 2018/2019 budgets are contemplated on $50-$60/bbl WTI."

EOG Resources Inc., one of the largest producers in the region, assembled a capital budget for 2018 assuming oil prices at $40/bbl and gas prices at $2.50/Mcf, and the company intends to take a similar approach in 2019.

"We're not going to increase capital at the expense of efficiencies and returns. We will develop our assets and spend capital at a pace that will optimize our learning curve and allow sustainable improvement to our well productivity and cost structure," EOG CEO William Thomas said. "Any production growth is strictly the result of disciplined capital allocation to high-return assets. … We are continuously resetting the company to deliver strong returns, even in a low to moderate oil price environment."

When capital budgets for 2018 were assembled, most Permian producers assumed that WTI would hover around the $50/bbl level for much of the year. Even though they recognized far more revenue during the second and third quarters than initially anticipated, they seem content to stay the course at similar levels for 2019.

"What matters for companies is the long-term expectation," said Raymond James & Associates analyst Pavel Molchanov, who anticipates that most companies will continue to build budgets based on prices near $50/bbl. "The futures pricing for 2019 is pretty close to what it was a year ago."

Unlike the situation facing Permian producers during much of the price collapse, many independents have a new advantage, in spite of pipeline constraints: exports to Europe and Asia through the Houston Ship Channel. The exposure to offshore markets and Brent crude prices has allowed them to increase their revenues, as Brent crude was trading at more than $71/bbl on Nov. 12.

Pioneer Natural Resources Co. CEO Timothy Dove said during the third-quarter earnings call that his company would stick to its $3.4 billion budget for 2018 and is likely to take a similar course in 2019. But Dove said Pioneer is now able to avoid the consequences of a WTI price drop due to large amounts of its Permian crude being exported.

"We are now essentially a Brent-priced company if you talk about our oil sales," he said.

Another lesson learned from the price collapse was a continued push for efficiency, with producers using new technologies and methods to cut costs while increasing production. During Anadarko Petroleum Corp.'s third-quarter earnings call, executives said the company's more efficient operations would allow it to recognize "double-digit" production growth while maintaining a budget anticipating $50/bbl prices.

Apache Corp., which is increasing its Permian operations with the development of the Alpine High play, said it would operate in 2019 with a capital budget of $3 billion, lower than in 2018. "If changes in expected cash flow dictate, we have the flexibility to reduce our activity levels accordingly," CEO John Christmann said. The move by Apache and other producers to follow long-term price expectations and not become overly exuberant over higher prices earlier this year may have allowed companies to hold steady heading into 2019.

"Capital spending should be either stable from what it is this year or modestly higher, but no one should expect cuts in capital spending from recent levels because this year's capital programs always lagged behind the uplift we saw in prices we saw in the summer months," Molchanov said.

Stocks Rocked the House Post Midterm Elections

After the S&P 500 logged its 9th worst Oct. on record, losing 6.9%, it has bounced back 2.6% month-to-date through Nov. 9, 2018. Though the monthly returns for the eight Novembers following the historically bad Octobers were only positive twice – in 1978 (President Jimmy Carter midterm year) and 1933 – the fact there was a midterm election this year may help the chance of a solid rally if history repeats itself. Historically, the S&P 500 has been positive in most periods after the midterm elections.

In the months of Nov. and Dec. during historical midterm election years, the S&P 500 gained 14 of 22 times in Nov. and in 15 of 22 times in Dec. with a combined 2-month gain in 17 of the 22 midterm election year-ends. In percentage terms, the S&P 500 gained in 64% of midterm election Nov. months and 68% of the following month that when combined into a 2-month return resulted in gains 77% of the time. Also, the magnitude of the average gains in the 2-month period was 6.1%, more than the magnitude of the average loss of 4.1%.