Transition through Gas

NOCs and Energy Security

Chris Cook

London 16th June 2015

Energy Security – Stakeholder Needs

NOCs - stable transparent pricing & security of demand

Consumers - stable transparent pricing & security of supply

IOC's – security of supply & demand: stability & transparency....up to a point.....

Traders & Banks – stability & transparency are Death

Energy Security: 1945 Bitter Lake

Energy Security: 1973 Oil Shock – price up 400%

Energy Security - US Approach

US secretly agreed $12/bbl with OPEC via Shah of Iran

Outcomes:

1/ Petrodollar – US agreed with Saudi Arabia to deposit dollar proceeds in US $ assets

2/ US got oil for T-Bills.....OPEC got blamed for high prices

3/ Alaska, North Sea, US Gulf oil viable & funded at $12bbl

4/ US/UK energy security achieved via stealth carbon tax

2008 Oil Price Spike & Crash

Supply steady – consumption varied by <3%

2009 Supercontango

2009 Supercontango

Supercontango indicative of market oversupply, but rapidly rising price simultaneously indicated market undersupply

Question. Why did prices rise rapidly in an extremely oversupplied market?

Answer. Financial buying was opaquely supporting the oil market price by funding oil inventory

High Prices – Cui Bono?

Producers If a commodity producer can support prices then he will Using declining Brent Complex this is easier than ever

Market support requires Capital: Sovereign reserves or Risk averse ('passive') investment funds

Market support requires liquidity Central Bank Quantitative Easing (QE)

North Sea Benchmark – Declining Production

North Sea Benchmark – Brent Complex

Follow the Money – Oil Price & QE

I forecast $45 to $55oil post QE

But end of QE took a long time!

Oil Price & QE Again

2015 Oil Price Rebound

Brent & WTI prices hit lows of c$45/barrel by mid January

Within six weeks Brent rose 32% while US WTI rose 8%

Not physical demand by refiners: due to financial demand

Where did liquidity come from? European Central Bank announced € QE on 22nd

January Oil price and German Bund yields now 92% correlated

Q. Where did investment capital come from?

A. Follow the Money

Follow the Money – Saudi FX Reserves

US Oil Production

“History does not repeat itself, but it does rhyme”

Support of oil prices above $80/bbl for 5 years & petrodollar funding for bank loans enabled shale oil development

Demand for oil products also fell due to efficiency gains particularly transport

Renewable energy substituted for carbon fuels

Stone Age did not end because of a shortage of stones

….and the Oil Age will not end because of a shortage of oil

US is swing producer & has security of oil supply at a price

Oil market price is now effectively capped at $60 to $70/barrel

So NOCs must now focus on cutting costs and the cheapest oil of all.....Negabarrels of oil savings

Bitter Lake to Bitter End?

US energy security through shale oil is the most significant market event since 1945

Saudis appear to have been ejected from the US tent

US is now pivoting to the last remaining significant reserves of undeveloped low cost oil in Iran & Iraq

End of the Petrodollar?

There are signs that Saudis may have begun switching reserves to € assets & access to free € QE liquidity

Petro Euro has long been an ambition of the EU & ECB

Have Saudis switched from Petrodollar to Petro Euro?

Is Oil Market Capped at $60 to $70 per barrel?

IOC 'Oil as a Commodity' transaction model squeezed

Irresistible Force of rising E & P costs squeezes NOCs against Immovable Object of $60/$70 bbl oil price cap

IOC Options

Consolidate – defers the inevitable

Switch to natural gas eg Shell

Compete for last remaining low cost oil in Iran/Iraq

Or - transform to Capital Lite 'Energy as a Service' model

Energy Security: 1973 Oil Shock – Price up 400%

Energy Security - Danish Approach

Mandatory strategic operating principle for energy policy

Least carbon fuel cost - for a given output of heat, electricity or power, minimise carbon fuel input

Danes funded investment via high local taxation

Outcomes

Danish GDP has doubled, while energy use has been flat & carbon fuel use has declined

Decentralised production & consumption; local heat networks & renewables – a Natural Grid

Problems - NOCs and Energy as a Commodity

Existing legacy infrastructure fragmented, fragile & often inefficient (often <20% output efficiency)

Huge carbon fuel waste between NOCs & consumers

NOCs compete for sales of energy-as-commodity

More NOC Problems

Intractable conflict between NOC resource sovereignty & IOC need for reserves on balance sheet

Adversarial relationships with traders & banks

NOCs & Consumers lose from opacity & volatility

Volatility & bank capital shortage makes conventional financing & funding increasingly difficult

Energy as a Service

Least Carbon Fuel Cost Principle - minimise carbon fuel system input for given electricity, heat or power output

Market Structure & Instruments Energy Swaps – production sharing supply

agreements – Capital Partnership Energy Credits – risk sharing of energy prepay credit

instruments – Guarantee Society

Energy Swaps

NOC supplies flow of oil or natural gas to consumers

NOC agrees proportional shares of product or service output with service providers & consumers

Balance of output is available to investors

Investment may be conventional (eg $ bank loans) or unconventional (energy loans of prepay energy credits)

Oil/Product Swap

RefineryRefinery

Investors

Consumers

Service Providers

%Prepay

Oil

NOC

Products

Gas/Power Swap

Generator (eg CCGT)

Generator (eg CCGT)

Investors

Consumers

Service Providers

%Prepay

Gas

NOC

Power asService

Prepay Energy Credit

What it is

- promise issued by NOC in exchange for value received

- returnable in payment for NOC supply

What it is not

- Debt - no right to demand money from NOC

- Derivative – no right to demand delivery by NOC

- Equity – no ownership right in respect of NOC asset

Requires trust between NOC and Acceptor/Investor

Energy Loans – prepay energy credit funding

Energy Loan Proposition

- consumers pay in advance & lock in price

- NOCs obtain interest free credit & lock in price

- investors obtain energy return

- investors may pay for consumption or sell to consumers

Requirements

- physical energy market & pricing benchmark

- accounting system

- framework of trust – Guarantee Society agreement

Energy-as-Service – Value Propositions

NOCs & Consumers - share cost of supply infrastructure

Service Providers - receive agreed %age of revenues - balance of revenues available to investors

Investors - buy prepay credits & so make energy loans

Consumers – pay for energy delivered using either conventional payment or energy prepay credits

Example - Caspian Energy Grid – KAT Core

Turkmen Gas/ Power Hub

Tried & tested - Marchwood (UK) – 58% efficient CCGT

Tried & Tested - BritNed and NorNed HVDC Links

BritNed 260km - 600MW NorNed 580km - 600MW

KAT Core - Outcomes

Turkmen NOC exports power to Caspian littoral states

Energy savings fund development of infrastructureTurkmen NOC conserves gas which is then available

for generation or exportAzerbaijan & Kazakhstan NOCs release production

for export through reduced local carbon fuel requirement

Caspian energy market & pricing benchmarkMinimise funding costs: energy loans bear no

compound interestIncreased resilience - Grid also capable of carrying

regional renewable energy power & load balancing

Energy Security - Transition through Gas

Security of demand for NOCs

Supply of oil & gas as a service

Collaboration, stability & transparency adopted as market standard Win/Win behaviour

Shared services, costs & risks via market framework agreement

Energy Security - Transition through Gas

Optimal low carbon financing & funding via Energy Loan direct investment in carbon fuel savings

Least carbon fuel cost principle minimises CO2 emissions: higher the carbon fuel price, the more $ profit in saving it

Instead of oil priced in $ (or €) and gas indexed against oil, dollars, euros & oil are priced in energy value of gas

Energy Security - Transition through Gas

Optimal low carbon financing & funding via Energy Loan direct investment in carbon fuel savings

Least carbon fuel cost principle minimises CO2 emissions: higher the carbon fuel price, the more $ profit in saving it

Instead of oil priced in $ (or €) and gas indexed against oil, dollars, euros & oil are priced in energy value of gas

Beyond OPEC

OPEC has been dead and on life support for years as a puppet of the Saudis

Global oil market pricing through Brent Complex is completely corrupt with no replacement in sight

Dollar and euro banking systems essentially bankrupt

New multilateral global oil & gas institutions are needed to bring together producers & consumers directly

Non-OPEC NOCs well placed to share costs of creation of a new oil & gas market trading & funding platform