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
All Others, 61.5%
Energy, 25.9%
Healthcare, 10.2%
Military, 2.4%
Source: EIA, CIA World Fact Book, World Health Organization, Bloomberg
2
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
3
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
6) 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
7) Security of supply as an enhanced geopolitical consideration as key supply states use energy as an economic
weapon to leverage consumer states
8) Market distortions caused by increased government intervention through mandates, subsidies, taxes, and regulation
9) Fragility of the energy supply network and susceptibility to disruption by terrorist activity
10) Increased price volatility due to low reserve margins, correlation to U.S. dollar, and inflation expectations
4
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
$100
Actual
Forecast
$90
16,000
$80
14,000
$70
12,000
$60
10,000
$50
8,000
$40
6,000
$30
4,000
$20
2,000
$10
GDP (RH)
Energy Consumption (LH)
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.
5
Population (LH)
2030
2025
2020
2015
2010
2005
2000
1995
1990
1985
1980
1975
1970
$0
1965
0
GDP (in constant 2000 $ trillions)
Energy Consumption (mm toe) and Population (mm)
18,000
1) Industrialization of the Developing World is Driving Demand
Oil Consumption
80%
China 67.6%
Cumulative Growth Since 2000
70%
60%
50%
40%
Middle East 39.6%
30%
India 27.9%
20%
Total World 10.9%
10%
0%
-10%
2000
2001
2002
2003
2004
2005
Source: BP Statistical Review 2009
6
2006
2007
2008
US (1.4)%
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
6) 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
7) Security of supply as an enhanced geopolitical consideration as key supply states use energy as an economic
weapon to leverage consumer states
8) Market distortions caused by increased government intervention through mandates, subsidies, taxes, and regulation
9) Fragility of the energy supply network and susceptibility to disruption by terrorist activity
10) Increased price volatility due to low reserve margins, correlation to U.S. dollar, and inflation expectations
7
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
Production Rate (million barrels per day)
6
5
The aggregate production
decline (from peak output)
at the world’s six largest oil
fields equates to 6.6 million
barrels per day.
4
3
2
1
0
Peak Production
Source: IEA World Energy Outlook 2008; Cantarell
production updated for 2009 per CERA
2007 Production
8
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
6) 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
7) Security of supply as an enhanced geopolitical consideration as key supply states use energy as an economic
weapon to leverage consumer states
8) Market distortions caused by increased government intervention through mandates, subsidies, taxes, and regulation
9) Fragility of the energy supply network and susceptibility to disruption by terrorist activity
10) Increased price volatility due to low reserve margins, correlation to U.S. dollar, and inflation expectations
9
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
US Natural Gas Production by Source
$140
14
$120
12
Deep Water and
Ultra-deep Water
$60
Other
Conventional Oil
Heavy Oil
and
Bitumen
Trillion Cubic Feet
Coal to
Liquids
Oil
Shales
$80
CO2 - EOR
Gas to
Liquids
10
8
6
4
$40
4,000
5,000
6,000
7,000
8,000
9,000
10,000
Reserves (bn bbls)
Source: IEA World Energy Outlook 2008 (left); EIA Annual Energy Outlook
2009 (right); 2009 Global Upstream Performance Review, IHS
Herold/Harrison Lovegrove
Conventional onshore
10
Unconventional onshore
Offshore
2030
3,000
2025
2,000
2020
1,000
2015
0
Enhanced Oil Recovery
(EOR)
$0
2010
2
Arctic
2005
Middle East /
North Africa
2000
Produced
1995
$20
1990
Production Costs ($/ bbl, 2008)
$100
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
6) 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
7) Security of supply as an enhanced geopolitical consideration as key supply states use energy as an economic
weapon to leverage consumer states
8) Market distortions caused by increased government intervention through mandates, subsidies, taxes, and regulation
9) Fragility of the energy supply network and susceptibility to disruption by terrorist activity
10) Increased price volatility due to low reserve margins, correlation to U.S. dollar, and inflation expectations
11
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
Social Infrastructure,
6%
Eastern Europe, 3%
Africa, 3%
Other, 10%
Asia, 20%
Communications,
6%
Western Europe,
38%
Utility & Energy, 43%
Waste & Water, 12%
Middle East, 3%
South & Central
America, 3%
Transportation, 23%
North America, 30%
Source: Amundi PEF
12
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
6) 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
7) Security of supply as an enhanced geopolitical consideration as key supply states use energy as an economic
weapon to leverage consumer states
8) Market distortions caused by increased government intervention through mandates, subsidies, taxes, and regulation
9) Fragility of the energy supply network and susceptibility to disruption by terrorist activity
10) 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)
IEA Reference Scenario
IEA 450 Scenario
1,200
Capacity Additions by 2030, in GW
1,000
800
600
400
200
0
Hydro
Biomass
Wind
Source: IEA World Energy Outlook 2009
14
Solar/geothermal/tidal
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
Generation Cost by Fuel Source
$300
100,000
90,000
Levelized Cost ($/MWH)
80,000
70,000
MW
60,000
50,000
40,000
30,000
20,000
$250
$200
$150
$100
$50
10,000
0
2007
Wind
2010
Biomass & Waste
$0
2020
Solar
Geothermal
Source: EIA Annual Energy Outlook, April 2009 Update (left); California
Energy Commission (right)
15
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
6) 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
7) Security of supply as an enhanced geopolitical consideration as key supply states use energy as an economic
weapon to leverage consumer states
8) Market distortions caused by increased government intervention through mandates, subsidies, taxes, and regulation
9) Fragility of the energy supply network and susceptibility to disruption by terrorist activity
10) 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
Non-OPEC, 32.3
OPEC, 70.6%
Former Soviet
Union, 12.8
Non-OPEC, 12.9%
OPEC, 36.7
Former Soviet
Union, 9.4%
OECD, 18.4
EU, 0.5% OECD, 6.6%
EU, 2.2
Source: BP Statistical Review 2009
17
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
6) 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
7) Security of supply as an enhanced geopolitical consideration as key supply states use energy as an
economic weapon to leverage consumer states
8) Market distortions caused by increased government intervention through mandates, subsidies, taxes, and regulation
9) Fragility of the energy supply network and susceptibility to disruption by terrorist activity
10) Increased price volatility due to low reserve margins, correlation to U.S. dollar, and inflation expectations
18
7) Geopolitical Considerations
Geopolitical influence on sector evident at an increasing rate in the daily news
19
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
6) 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
7) Security of supply as an enhanced geopolitical consideration as key supply states use energy as an economic
weapon to leverage consumer states
8) Market distortions caused by increased government intervention through mandates, subsidies, taxes, and regulation
9) Fragility of the energy supply network and susceptibility to disruption by terrorist activity
10) 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)
140
$140
1.000
$120
120
$120
$100
100
$100
$80
0.600
$60
0.400
$40
Dollar Index
80
$80
60
$60
40
$40
Oil (RH)
Oil (RH)
US CPI (LH)
Source: EIA, Bloomberg
21
Dollar Index (LH)
Jan-10
Jan-09
Jan-08
Jan-07
Jan-06
Jan-05
Jan-04
Jan-03
Jan-02
Jan-01
Jan-10
Jan-09
Jan-08
Jan-07
$0
Jan-06
0
Jan-05
$0
Jan-04
0.000
Jan-03
$20
Jan-02
20
Jan-01
$20
Jan-00
0.200
Jan-00
US CPI
0.800
Oil Price, in $/bbl
$140
Oil Price, in $/bbl
1.200
Drivers of Demand
$26 Trillion of Investment Required Through 2030
4%
Generation
Transport
17%
52%
Refining
Transmission
& distribution
79%
Exploration &
development
48%
23%
Electricity
$13,700 billion
Oil
$5,900 billion
53%
20%
9%
LNG chain
33%
Mining
Transmission
& distribution
86%
3%
Shipping &
ports
1%
58%
14%
Coal
$700 billion
Biofuels
$200 billion
Source: IEA World Energy Outlook 2009
22
Gas
$5,100 billion
Exploration &
development
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)
23
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
24
~
PINON
COOGEE
RESOURCES
~
PINON
LARCHMONT
COOGEE
RESOURCES
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
1,400
1,200
800
600
400
200
Dec-96
Jun-97
Dec-97
Jun-98
Dec-98
Jun-99
Dec-99
Jun-00
Dec-00
Jun-01
Dec-01
Jun-02
Dec-02
Jun-03
Dec-03
Jun-04
Dec-04
Jun-05
Dec-05
Jun-06
Dec-06
Jun-07
Dec-07
Jun-08
Dec-08
Jun-09
Dec-09
0
Source: Bloomberg (Merrill Lynch data)
25
Asset Swap Spread (bps)
1,000