Starting the Models – Assets and Revenues (3) James Henderson April 2021 The Economics of Energy Corporations (2) Outline of the course Overall objective – understand how senior management use economic models to make investment decisions 1.Introduction to key themes in the global energy market 2.Introduction to financial modelling as a management tool 1.Understanding some key concepts 3.Starting two models for an oil and a gas field – revenues and prices 4.Inputting the costs – capital expenditure 5.Operating costs and paying the government 6.A power plant – a buyer and seller of energy 7.Calculating a discounted cashflow 1.Why is it important 2.How is it used to make decisions 8.Testing the investment decisions: running some numbers under different assumptions 9.Answering your questions Increasing interaction between prices of hydrocarbons Starting to construct a real project cashflow model •Revenues –Production of energy –Price received for energy supply • •Cost of Development (Capex) –How much will it cost to put the necessary infrastructure in place? – •Cost of Operations (Opex) –How much will it cost to run the infrastructure and produce energy –How much will it cost to transport it to market? What will the government get out of it? •Operating taxes –Royalty –Export tax –Other social taxes • •Profit Tax –Depreciation is a key assumption • •Alternative forms of taxation –Production Sharing Agreement Time to talk about project parameters •Investment costs –Cost of up-front investment –Timescale •Production –How much energy is produced? –What is the output profile? •Prices –Price of energy sales –Price of energy and other inputs •Operating Costs –Cost to run the asset –Fuel input costs –Transport costs –Taxes A major offshore oil production facility •Multi-billion dollar projects offshore require huge up-front spending •Onshore projects can be more incremental with production Shale oil development in Texas •Each well in a shale development is an individual investment with its own economics •The numbers are smaller, but equally important to investors A combined cycle gas plant •750MW CCGT power plant owned by EDF in France •Cyclical process to maximise efficiency (around 54%) Production Profile 1.Initial surge to peak production 2.Plateau at peak for a number of years 3.Gradual decline towards abandonment 4.Water and solids production increases, undermining performance A conventional oil or gas field production profile Create a theoretical cashflow based on assumptions known to date Oil Production Forecast Key Elements • •Time from first investment to first oil • •Ramp up period • •Peak production • •Peak production period • •Decline rate Let’s model a conventional oil and gas field •Reserves – 500mmbbls oil plus 1000bcf gas • •Start date –in 5th year after first investment • •Peak production – 6% of reserves • •Time to peak – 5 years • •Length of peak – 5 years • •Decline rates – 5% per annum • • Revenues Production x Price •Separate for oil and gas •Oil price a good guide for overall outlook for energy market •Gas price often linked to oil price in contracts, although in some countries is more market-based •Key gas benchmark in US is Henry Hub, where gas is traded •Electricity prices are often regulated, but in US it is traded in a free market environment Some Scenario Planning •We need to have some opinions of fuel prices for our cashflow model • •Future of oil gas and electricity prices is critical to revenues • •We also need to know how often our power plant will be operational (the load factor) • •Impact of changing energy economy is increasingly evident and needs to be discussed • •Strategic planning departments create a base case and various alternative outcomes around it • •The ultimate conclusion needs to be some price forecasts 0% 10% 20% 30% 40% 50% 0% 20% 40% 60% 80% 100% The transition to a lower carbon fuel mix continues… Shares of primary energy † Non-fossils includes renewables, nuclear and hydro 0 5 10 15 20 Renewables Hydro Nuclear Coal Gas Oil Primary energy consumption by fuel Billion toe Oil Coal Gas Hydro Nuclear Non-fossils Renewables 15 Coal Oil Gas Alternative Scenarios for Oil Demand •Broad range of scenarios based on development of energy economy •Spread between high and low demand is over 40mmbpd •New supply will be needed though; existing fields will inevitably decline 350 300 250 200 150 100 50 0 -50 -100 2000- 2005- 2010- 2015- 2020- 2025- 2030- 2035- 2005 2010 2015 2020 2025 2030 2035 2040 India China Other non-OECD OECD Total 0.0 0.5 1.0 1.5 2.0 2.5 3.0 3.5 2000 2010 2020 2030 2040 Other* Electricity Gas Oil Transport demand continues to be dominated by oil… Transport energy consumption by fuel type Billion toe Transport energy consumption growth by region Mtoe *Other includes biofuels, gas-to-liquids, coal-to-liquids, hydrogen 17 0% 20% 40% 60% 80% 2016 2020 2030 2040 Evolving transition ICE ban Alternative scenario: impact of faster growth in electric cars… Electric car sales as a share of total car sales Share 100% Share of total passenger Vkm powered by electricity 0% 20% 40% 60% 80% Share 100% 2016 2020 2025 2030 2035 2040 Evolving transition ICE ban 18 Oil production is dominated by three countries •Saudi Arabia, Russia and the US account for more than one third of global oil output • •The Middle East is the dominant region, accounting for around 35% of output • •OPEC countries generate 42% of the world’s oil, giving the cartel a strong lever over prices • •Many traditional non-OPEC countries are now in decline, other than the US trolololo OPEC meeting Dominate exports Russia taking a more important role Oil becoming geo-political key again given 3 big producers Impact of OPEC •OPEC accounts for around 40% of global oil production •It tries to act as a cartel to control the oil price within an “acceptable” range •Most recent cut was in November 2016 – price has risen from $45 per barrel to $70 OPEC decisions about future oil production and oil prices are critical for new projects •Need to maximise oil revenues • •Historic strategy to preserve oil for future generations • •Now the question is whether there is a long-term future for oil? • •Largest reserve holders risk failing to monetise resources • •Low cost producers do not want to allow higher cost producers to take market share • •How to find the optimal balance? Strategy from Dec 2016 – avoid very low oil prices by cutting production •What happens next? An oil glut from US shale or an oil shortage due to lack of investment and growing demand? Saudi Arabia started a price war in March 2020 – bad timing! Brent spot price • • • • • • • OPEC+ agreement collapsed in March and supply surged • • • • • • • A screenshot of a video game Description automatically generated A screenshot of a video game Description automatically generated Global oil demand has rebounded strongly but growth is flattening off due to high prices Global oil demand growth (annual) • • • • • • • Global oil supply growth increasingly reliant on OPEC Global oil supply growth • • • • • • • Global balance of supply and demand for oil before and after the start of the Russia-Ukraine war Global oil supply and demand balance • • • • • • • What happens if Russian oil exports are banned globally? How to replace Russian export barrels • • • • • • • OPEC cannot meet its own target to replace production lost in pandemic recession OPEC+ production and quota targets • • • • • • • US production is very reactive to price and is recovering after sharp drops Oil production from US shale plays • • • • • • • Other Non-OPEC supply upside is limited Production growth from Non-OPEC countries • • • • • • • Price outlook is uncertain given political as well as commercial risks Forecast for Brent oil price • • • • • • • Russia oil is now trading at a huge discount as many countries and companies refuse to buy it Differential between Urals Blend (Russian crude) and Brent (global benchmark) • • • • • • • Gas Price 2020 2030 2040 0 100 200 300 400 500 1990 2000 2010 Industry Non-combusted Power Buildings Transport Growth in natural gas demand… Bcf/d 600 Gas consumption by sector Gas share by sector 0% 10% 20% 30% 40% 50% 1990 2000 2010 2020 2030 2040 Industry Buildings Transport Non-combusted Power Less gas switching Renewables push Faster transition Even faster transition Prospects for gas demand could be dampened Gas demand growth 2016-2040 % per annum -0.5% 0.0% 0.5% 1.0% 1.5% Gas share of primary energy 1990-2040 15% 17% 19% 21% 23% 25% 2.0% 27% 1990 2000 2010 2020 2030 2040 Evolving transition Less gas switching Renewables push Faster transition Even faster transition Evolving transition •MARCH 2022 •EUROPEAN AND UK GAS SUPPLY •European gas prices from 2005 to Q1-2021 were generally 15-25 EUR/MWh, with peak of 32 EUR/MWh •Monthly average TTF Front-Month prices hit a new record in July 2021 and rose dramatically thereafter •This was partly due to an already tight market, especially with lower imports from Russia •It was also affected by fears of getting through winter with lower than usual storage stocks… •… and concerns over Russian supply in the context of the build-up of Russian troops on Ukraine’s borders European gas prices – Monthly averages Data from Refinitiv 36 32 EUR/MWh (Sep-Oct 2008) •MARCH 2022 •EUROPEAN AND UK GAS SUPPLY •Huge volatility in daily prices in Jan/Feb 2022, between 69 and 98 EUR/MWh – Spread of 29 EUR/MWh •Immediate spike on Day 1 of Russian invasion of Ukraine – Further increase since then. On 7 Mar 2022, TTF Front-Month was 13 times higher than 7 Mar 2021 , and 3 times higher than on 16 Feb 2022 •Fears of physical interruption in supplies via Ukraine (pipeline damage) or complete cessation of supplies from Russia (sanctions or counter-sanctions) European gas prices – Daily TTF front-month prices Data from Refinitiv 37 •MARCH 2022 •EUROPEAN AND UK GAS SUPPLY •In winter, storage withdrawals account for a significant share of supply •In Jan/Feb 2022, LNG imports surged as higher prices attracted cargoes •Pipeline supply remained by far the largest source of supply – Uptick in pipeline supply in Feb due to higher flows from Russia – However, this was still significantly lower than in Jan-Feb 2021 •Total supply down 8% y-o-y in Jan-2022 and down 11% in Feb-2022 (lower demand due to mild winter) European supply by source in Jan/Feb 2022 Data from ENTSOG, Kpler, GIE, Argus, and Platts 38 11% Total supply: Jan 2021: 2,039 mmcm/d Feb 2021: 1,879 mmcm/d Jan 2022: 1,885 mmcm/d Feb 2022: 1,678 mmcm/d Jan-Feb 2021: 1,963 mmcm/d Jan-Feb 2022: 1,787 mmcm/d 39% 22% 28% 12% 48% 22% 19% 12% 45% 10% 33% •MARCH 2022 •EUROPEAN AND UK GAS SUPPLY •Slump in flows from Russia between 27 Sep and 11 Nov 2021, and between 1 Jan and 23 Feb 2022 •Upsurge from 24 Feb, as day-ahead prices moved to significant premium over long-term contract prices •Norwegian flows relatively high and stable since 25 Sep 2021 •Flows from North Africa also at maximum capacity, despite cessation of transit via Morocco to Spain •Flows from Azerbaijan (on Turkey-Greece border) at 30 mmcm/d equivalent to 10.95 bcma •Lack of significant upside potential for non-Russian pipeline imports beyond, for example, around 10 bcm Pipeline imports by supplier (mmcm per day) Data from ENTSOG 39 •MARCH 2022 •EUROPEAN AND UK GAS SUPPLY •Surge in European LNG imports since Q4-2018, with seasonal peak in March-May (2019-2021) •High European prices attracting cargoes since Q4-2021, helped by increase in US LNG exports to Europe •Jan-2022 record Euro LNG send-out (13.0 bcm) and Feb second-highest daily average (but fourth-highest monthly total [10.4 bcm], behind April & November 2019 [10.9 bcm], which had more days in the month) European LNG imports (mmcm/d) 40 Annual LNG imports: 2017: 46.9 bcm 2018: 53.7 bcm 2019: 101.9 bcm 2020: 93.6 bcm 2021: 86.6 bcm Note: This refers to EU-27 + UK, and excludes Turkey. Data from Kpler for LNG send-out (GWh/month converted at 40 MJ per Sm3) •MARCH 2022 •EU PLAN TO REDUCE IMPORTS OF RUSSIAN GAS •In October 2019 and 2020, European stocks peaked at 100-101 bcm – These were supply-long years •In October 2016, 2017, and 2018, this peak was 89-93 bcm – In 2021, this peak was 80 bcm •European stocks c.10 bcm lower than ‘usual’ at the start of winter 2021/22 •European storage stocks on 26 Mar 2022 are close to 2017 level, but still down 4.2 bcm y-o-y •Net injections since 24 March – stocks potentially 27.5 bcm on 1 April. Target of storage 80% full by 1 Nov 2022 means 52.5 bcm of injection in summer 2022 – 4.5 bcm more than in 1 Apr – 1 Nov 2021 European gas storage stocks Data from GIE 41 European stocks on 26 March: 2017: 26.5 bcm 2018: 18.9 bcm 2019: 41.3 bcm 2020: 56.7 bcm 2021: 31.2 bcm 2022: 27.0 bcm The impact on gas prices has been global Gas price becoming more global thanks to LNG Rising supply and a recent fall in demand saw price falls 2018-2020 Winter 2020/21 was cold and started price rebound Russia-Ukraine war has impacted global markets, not just EU Global gas prices Huge margin for US gas Competing fuels an issue at high prices Coal is looking more attractive than gas even though the carbon price has risen