Download Drivers of Demand for Capital in Global Energy

Drivers of Demand for Capital in Global Energy
Randall S. Wade
Managing Director and COO
December 2010
Sector Attributes
• Energy is a building block of economic growth
• Benefits from long-term demographic trends that drive demand
• Demand largely caught up with supply in last five years; supply will struggle to keep pace with demand going forward
• Energy supply is comprised of several heterogeneous markets, each with distinct sub-sectors and underlying fundamentals
• Negative correlation with traditional investment classes such as equities, fixed income
• Commodities provide a natural hedge against inflation
• Long-lived, hard assets
• Inherent volatility in commodity prices
World GDP by Sector
Source: EIA, CIA World Fact Book, World Health Organization, Bloomberg
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Sector Attributes
Technically complex
Complex and interpretive resource evaluation, and sophisticated
engineering required for success
One off, purpose specific design
Project cost risk typically carried by owner (not EPC)
Capital intensive
Very large capital investment required throughout lifecycle. Ability
to ‘protect’ or follow initial investment is crucial
Investment decision heavily reliant on commodity price forecast
Commodity price volatility
Oil prices in 2002 were sub $20/bbl, reached a high of ~$147/bbl
in July 2008, and hit a low of ~$34/bbl in December 2008
Financial flows increasing volatility
Cyclicality
GDP growth drives underlying demand
Significant lag in investment cycle, leading to boom-bust profile
Complex demand-supply
position
Energy markets are complex and intertwined (e.g. upstream
importance to gas transmission, gas price on spark spread)
Structural change driven by:
- Decline of OPEC spare capacity, and rise of NOCs
- Development of unconventional resources
- Impact of the rise of Asia on demand
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Drivers of Demand
Beginning around 2005, EIG believes the world began a 15-20 year secular trend in energy
and energy-related infrastructure requiring massive amounts of investment.
Underlying Factors that Drive Demand
1) Developing world continues to industrialize, coupled with population growth and demographic trends
2) Depletion of aging “elephant” fields that have underpinned global supply for decades
3) Higher replacement costs as conventional supplies began to be replaced with higher cost “unconventional” supplies
4) Chronic under-investment in infrastructure caused by the inherent volatility of the sector and the need for long payback
periods
5) Concerns about climate change and the introduction of price mechanisms for carbon
11) Assertion of market clout by national oil companies and other state actors and the resulting resource nationalism as
energy independence takes on increased political importance
12) Security of supply as an enhanced geopolitical consideration as key supply states use energy as an economic
weapon to leverage consumer states
13) Market distortions caused by increased government intervention through mandates, subsidies, taxes, and regulation
14) Fragility of the energy supply network and susceptibility to disruption by terrorist activity
15) Increased price volatility due to low reserve margins, correlation to U.S. dollar, and inflation expectations
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1) Industrialization of the Developing World is Driving Demand
• World population has more than doubled since 1950
• Urbanization increases demand for energy
• In 2009, for the first time in history, the world’s urban population overtook the rural population
Actual
Source: Historical data from World Bank (GDP), BP Statistical Review 2009 (Energy),
US Census Bureau (Population). Forecasts per EIA International Energy Outlook
2009, IEA World Energy Outlook 2009, World Bank HNP Stats.
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Forecast
1) Industrialization of the Developing World is Driving Demand
Oil Consumption
China 67.6%
Middle East 39.6%
India 27.9%
Total World 10.9%
US (1.4)%
Source: BP Statistical Review 2009
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Drivers of Demand
Beginning around 2005, EIG believes the world began a 15-20 year secular trend in energy
and energy-related infrastructure requiring massive amounts of investment.
Underlying Factors that Drive Demand
1) Developing world continues to industrialize, coupled with population growth and demographic trends
2) Depletion of aging “elephant” fields that have underpinned global supply for decades
3) Higher replacement costs as conventional supplies began to be replaced with higher cost “unconventional” supplies
4) Chronic under-investment in infrastructure caused by the inherent volatility of the sector and the need for long payback
periods
5) Concerns about climate change and the introduction of price mechanisms for carbon
11) Assertion of market clout by national oil companies and other state actors and the resulting resource nationalism as
energy independence takes on increased political importance
12) Security of supply as an enhanced geopolitical consideration as key supply states use energy as an economic
weapon to leverage consumer states
13) Market distortions caused by increased government intervention through mandates, subsidies, taxes, and regulation
14) Fragility of the energy supply network and susceptibility to disruption by terrorist activity
15) Increased price volatility due to low reserve margins, correlation to U.S. dollar, and inflation expectations
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2) Depletion of Aging “Elephant” Fields
• There are ~70,000 oil fields in the world
• Bulk of production comes from a small number of very prolific fields, mostly giants and super giants
– World’s 10 largest fields produced 20% of world’s production
– 20 largest fields produced 25%; 16 are post-peak
– Ghawar’s 5.1 million bpd equaled 7% of world total
• Most of the largest fields have been in production for years, and in some cases several decades
Production at World’s Largest Oil Fields
The aggregate production
decline (from peak output)
at the world’s six largest oil
fields equates to 6.6 million
barrels per day.
Source: IEA World Energy Outlook 2008; Cantarell
production updated for 2009 per CERA
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Drivers of Demand
Beginning around 2005, EIG believes the world began a 15-20 year secular trend in energy
and energy-related infrastructure requiring massive amounts of investment.
Underlying Factors that Drive Demand
1) Developing world continues to industrialize, coupled with population growth and demographic trends
2) Depletion of aging “elephant” fields that have underpinned global supply for decades
3) Higher replacement costs as conventional supplies began to be replaced with higher cost “unconventional”
supplies
4) Chronic under-investment in infrastructure caused by the inherent volatility of the sector and the need for long payback
periods
5) Concerns about climate change and the introduction of price mechanisms for carbon
11) Assertion of market clout by national oil companies and other state actors and the resulting resource nationalism as
energy independence takes on increased political importance
12) Security of supply as an enhanced geopolitical consideration as key supply states use energy as an economic
weapon to leverage consumer states
13) Market distortions caused by increased government intervention through mandates, subsidies, taxes, and regulation
14) Fragility of the energy supply network and susceptibility to disruption by terrorist activity
15) Increased price volatility due to low reserve margins, correlation to U.S. dollar, and inflation expectations
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3) Replacement Costs are Increasing as Source of Supply Shifts
• Exploration spending increased by 21% in 2008, and has doubled since 2005
• However replacement rates fell to 88% of production (first year since 2004 in which production was not replaced)
• Finding and development costs soared 66% to $25.50/bbl
• Competition for unconventional resources increased sharply
Expected Costs of Production
Source: IEA World Energy Outlook 2008 (left); EIA Annual Energy Outlook
2009 (right); 2009 Global Upstream Performance Review, IHS Herold/
Harrison Lovegrove
US Natural Gas Production by Source
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Drivers of Demand
Beginning around 2005, EIG believes the world began a 15-20 year secular trend in energy
and energy-related infrastructure requiring massive amounts of investment.
Underlying Factors that Drive Demand
1) Developing world continues to industrialize, coupled with population growth and demographic trends
2) Depletion of aging “elephant” fields that have underpinned global supply for decades
3) Higher replacement costs as conventional supplies began to be replaced with higher cost “unconventional” supplies
4) Chronic under-investment in infrastructure caused by the inherent volatility of the sector and the need for
long pay-back
periods
5) Concerns about climate change and the introduction of price mechanisms for carbon
11) Assertion of market clout by national oil companies and other state actors and the resulting resource nationalism as
energy independence takes on increased political importance
12) Security of supply as an enhanced geopolitical consideration as key supply states use energy as an economic
weapon to leverage consumer states
13) Market distortions caused by increased government intervention through mandates, subsidies, taxes, and regulation
14) Fragility of the energy supply network and susceptibility to disruption by terrorist activity
15) Increased price volatility due to low reserve margins, correlation to U.S. dollar, and inflation expectations
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4) Under-Investment in Infrastructure
• Infrastructure investment depends on stable political, regulatory, and fiscal regimes
• Energy sector is huge consumer of infrastructure and collectively accounts for 43% of global infrastructure investment
• Energy companies affected by global recession
– Demand growth uncertain, credit constrained, balance sheets stretched
– Deleveraging, postponement/cancelation of major projects
– Global upstream oil and gas budgets cut by 19% in 2009, or ~$90 billion
• Near-term fall in energy investment likely to lead to a medium-term shortfall in supply due to development lag
Expected Sector Distribution
Expected Geographic Distribution
Source: Amundi PEF
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Drivers of Demand
Beginning around 2005, EIG believes the world began a 15-20 year secular trend in energy
and energy-related infrastructure requiring massive amounts of investment.
Underlying Factors that Drive Demand
1) Developing world continues to industrialize, coupled with population growth and demographic trends
2) Depletion of aging “elephant” fields that have underpinned global supply for decades
3) Higher replacement costs as conventional supplies began to be replaced with higher cost “unconventional” supplies
4) Chronic under-investment in infrastructure caused by the inherent volatility of the sector and the need for long payback
periods
5) Concerns about climate change and the introduction of price mechanisms for carbon
11) Assertion of market clout by national oil companies and other state actors and the resulting resource nationalism as
energy independence takes on increased political importance
12) Security of supply as an enhanced geopolitical consideration as key supply states use energy as an economic
weapon to leverage consumer states
13) Market distortions caused by increased government intervention through mandates, subsidies, taxes, and regulation
14) Fragility of the energy supply network and susceptibility to disruption by terrorist activity
15) Increased price volatility due to low reserve margins, correlation to U.S. dollar, and inflation expectations
13
5) Climate Change and Price Mechanisms for Carbon
• Atmosphere currently contains ~455 ppm of CO2-equivalent greenhouse gases (“GHG”)
• IEA analyzed one scenario (“450 Scenario”) in which countries take coordinated actions to stabilize GHG at 450 ppm
• A low carbon future requires a major transformation of the sector (both in terms of sources of energy and required infrastructure)
Source: IEA World Energy Outlook 2009
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5) Climate Change and Price Mechanisms for Carbon
Renewables depend on government subsidies in order to compete against fossil fuel
generation
US Renewable Generating Capacity
Source: EIA Annual Energy Outlook, April 2009 Update (left); California
Energy Commission (right)
Generation Cost by Fuel Source
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Drivers of Demand
Beginning around 2005, EIG believes the world began a 15-20 year secular trend in energy
and energy-related infrastructure requiring massive amounts of investment.
Underlying Factors that Drive Demand
1) Developing world continues to industrialize, coupled with population growth and demographic trends
2) Depletion of aging “elephant” fields that have underpinned global supply for decades
3) Higher replacement costs as conventional supplies began to be replaced with higher cost “unconventional” supplies
4) Chronic under-investment in infrastructure caused by the inherent volatility of the sector and the need for long payback
periods
5) Concerns about climate change and the introduction of price mechanisms for carbon
11) Assertion of market clout by national oil companies and other state actors and the resulting resource
nationalism as energy independence takes on increased political importance
12) Security of supply as an enhanced geopolitical consideration as key supply states use energy as an economic
weapon to leverage consumer states
13) Market distortions caused by increased government intervention through mandates, subsidies, taxes, and regulation
14) Fragility of the energy supply network and susceptibility to disruption by terrorist activity
15) Increased price volatility due to low reserve margins, correlation to U.S. dollar, and inflation expectations
16
6) Resource Nationalism
• International Oil Companies (“IOCs”) only own 7% of the world’s oil reserves
• National Oil Companies (“NOCs”) operate as an extension of the government (e.g. Saudi Aramco, Pemex, PDVSA), or as
autonomous entities that concurrently support government objectives (e.g. Petrobras, Statoil)
– Activities of NOCs are frequently inefficient and/or not market-oriented
• NOCs produce the majority of the world’s oil and hold most of the world’s proven reserves
• IOCs are increasingly relegated to exploring in high-risk areas in order to secure reserves (Arctic, ultra-deep water,
unconventional)
World Proved Oil Reserves, 2008
World Oil Production, 2008
in million bpd
Source: BP Statistical Review 2009
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Drivers of Demand
Beginning around 2005, EIG believes the world began a 15-20 year secular trend in energy
and energy-related infrastructure requiring massive amounts of investment.
Underlying Factors that Drive Demand
1) Developing world continues to industrialize, coupled with population growth and demographic trends
2) Depletion of aging “elephant” fields that have underpinned global supply for decades
3) Higher replacement costs as conventional supplies began to be replaced with higher cost “unconventional” supplies
4) Chronic under-investment in infrastructure caused by the inherent volatility of the sector and the need for long payback
periods
5) Concerns about climate change and the introduction of price mechanisms for carbon
11) Assertion of market clout by national oil companies and other state actors and the resulting resource nationalism as
energy independence takes on increased political importance
12) Security of supply as an enhanced geopolitical consideration as key supply states use energy as an
economic weapon to leverage consumer states
13) Market distortions caused by increased government intervention through mandates, subsidies, taxes, and regulation
14) Fragility of the energy supply network and susceptibility to disruption by terrorist activity
15) Increased price volatility due to low reserve margins, correlation to U.S. dollar, and inflation expectations
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7) Geopolitical Considerations
Geopolitical influence on sector evident at an increasing rate in the daily news
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Drivers of Demand
Beginning around 2005, EIG believes the world began a 15-20 year secular trend in energy
and energy-related infrastructure requiring massive amounts of investment.
Underlying Factors that Drive Demand
1) Developing world continues to industrialize, coupled with population growth and demographic trends
2) Depletion of aging “elephant” fields that have underpinned global supply for decades
3) Higher replacement costs as conventional supplies began to be replaced with higher cost “unconventional” supplies
4) Chronic under-investment in infrastructure caused by the inherent volatility of the sector and the need for long payback
periods
5) Concerns about climate change and the introduction of price mechanisms for carbon
11) Assertion of market clout by national oil companies and other state actors and the resulting resource nationalism as
energy independence takes on increased political importance
12) Security of supply as an enhanced geopolitical consideration as key supply states use energy as an economic
weapon to leverage consumer states
13) Market distortions caused by increased government intervention through mandates, subsidies, taxes, and regulation
14) Fragility of the energy supply network and susceptibility to disruption by terrorist activity
15) Increased price volatility due to low reserve margins, correlation to U.S. dollar, and inflation expectations
20
10) Oil vs. US Dollar and Inflation
• Oil has been a strong hedge against inflation (0.86 correlation)
• Oil has provided a similarly strong hedge against the US dollar (-0.80 correlation)
Source: EIA, Bloomberg
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Drivers of Demand
$26 Trillion of Investment Required Through 2030
Source: IEA World Energy Outlook 2009
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Capturing the Market Opportunity
Investment demand is growing across the entire energy value chain on a global basis
Upstream
Infrastructure
Reserve-based Development
Production Payments
Forward Oil Sales
Midstream
Gas to Liquids
Pipeline
Gathering Systems
Processing Facilities
Gas Storage
Bunkering
Production Platforms
Drill Ships
FPSOs
Drilling Rigs
Transportation
LNG Tankers
Specialty Tankers
VLCC Vessels
LNG
Synfuels
Processed Gas
(methanol, fertilizer, DME)
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Gas to Electrons
Renewables
Wind
Solar
Biofuels
Geothermal
LNG Regasification Terminals
Gas Sales, Pipelines,
Gas-Fired Power Plants,
Electricity T&D
Capturing the Market Opportunity
Opportunity
Current Dynamic
EIG Portfolio Examples
Energy-related
Infrastructure
• Pipelines, gathering systems, compression,
processing, and rigs for energy companies
looking for growth capital or to recycle capital
currently tied-up on their balance sheet
Oil versus Gas
• Onshore and offshore primary and tertiary oil
recovery plays recognizing the relative value of
oil versus gas on a BTU equivalent basis in the
current market
Renewable Energy
• Wind, geothermal, solar, and biofuels primarily in
the US and Europe in response to the
implementation of carbon regimes
Recapitalization of
Mature Assets
• Operating assets with significant existing cash
flow as a source of liquidity for large energy
companies in a credit constrained environment
China/Asia Energy
Demands
• Enhanced activity in existing EIG Austral-Asian
platform recognizing continuing resource
nationalism and demand for energy and
resources
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~
~
Impact of the Credit Crisis
• Contraction in global GDP took pressure off near-term supply/demand fundamentals and caused one to two year “time out” in the
otherwise dominant secular trends in the industry
• Two key impacts of the credit crisis:
– Re-pricing of risk across the credit spectrum, particularly for illiquid assets
– Contraction in suppliers of capital: “survivors” continue to be price makers, not takers
US Corporate Bonds, B-rated
Source: Bloomberg (Merrill Lynch data)
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