Decision making at energy
corporations
James Henderson
November 2018
Key Questions for Company Management
• How much profit can I generate?
• How can I grow the business?
• Where can I grow the business?
• What are the long-term prospects for my industry?
• What are my competitors doing?
• What rules must I abide by?
• What government support can I expect?
• What do my owners / shareholders want out of their investment?
• Have I got enough money to invest in my business?
• How do I stay competitive?
• How important is public opinion and how do I keep it on my side?
Managements have a broad range of responsibities
• text
Important to highlight what the owners want
• Priority will be allocated according to the size, maturity and business
model of the company being evaluated
Total Value Profitability
Pay-out
Net Present Value
Enterprise Value Earnings per share
Price to Cashflow
Price/Earnings Ratio
Dividend per share
Dividend Yield
Dividend Payout Ratio
Price to Earnings Growth
Price to Book Value
Solvency
title• Detailed
breakdown of
company operating
and financial
performance
• Investment analysts
are responsible for
asking fundamental
questions of senior
management
• There is pressure to
perform across a
broad range of
metrics
• A “Sell”
recommendation
can have big
implications
Bad news!
Comparison with Peer Groups
Two elements of investor returns – short and long term
• Investors want a return on their investment
– Dividend pay-out on an annual basis, based on yearly cashflow and profits
– Share price growth, normally based on long-term prospects
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Pencepershare
Key Management Driver = The Share Price
• Management incentives often driven by the share price as one key
objective
Sustained success
Major event
External shock…and recovery
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BP Total Return
Total return to shareholders
• Almost no gain in share price terms over last 4 years
• Shareholders made a 50% return when dividends and other incentives are
included
Performance relative to oil price
• Not as close as you might expect
• The benefits (or otherwise) of vertical integration
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BP Oil Price Total Return
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Index(2014=100)
BP Shell Exxon
Share price relative to Peer Group
• In the shorter term, BP has outperformed its major European and US
competitors
• BP has been in recovery mode, but the final settlement of US court action
has provided a boost
And all three relative to the oil price
• Outperforming in a low oil price environment – the real benefit of vertical
integration
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Oil and gas was not been a good investment relative to the rest of
the economy in 2012-17, but Brexit has changed perceptions
• BP significantly underperformed the FTSE 100 UK Index in the period
2012-17, but has caught up again thanks to the oil price and Brexit
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BP FTSE 100
Bankers and Credit Agencies think about financial solvency
• The key question is “will I get my money (plus interest) back?”
Credit ratings impact the cost of debt, as well as investor preceptions
The DCF Calculation as a foundation
• Management thought process is encapsulated in the DCF model
– Key assumptions include price, cost, tax, long-term outlook, short-term cashflow and the
value of money
• Management must ensure at all times that the combined value of their assets
remains NPV positive, and should aim to maximise the return on their assets
What is the management thought process?
Exploration and production company planning an exploration well
Key Issues
• Current state of company
portfolio
• Past experience in the region
• Geology
• Geography
• Risk of success
• Cost
• Source of funding
• Possible economic outcome
• Partner companies
• Commercial environment
• Political environment
Topics of interest
• Access to licences
• Onshore / offshore
• Infrastructure
• NOCs as partners
• Small independent
companies as entrepreneurs
• Tax incentives
• Arctic / deep-water
What is the management thought process?
Development of an oil discovery
Key Issues
• Size of discovery
• Location / access to
infrastructure
• Tax regime
• Local content requirement
• Development cost
• Net present value
• Future oil price expectation
• Future oil demand expectation
• Local politics
• Legal and institutional
framework
• Type of financing
• Partner credit-worthiness
• Time to cost recovery
• Breakeven oil price
Oil price forecasting – an imprecise art largely based on optimism
• Consensus is normally that
prices will rise from current
levels
• Companies plan using a
“worst case” scenario
assumption – any project
must be viable at “US$xx/bbl
• Scenario planning attempts to
create alternative outcomes
• Safest assumption is that the
consensus will always be
wrong
Various US oil price forecasts
Topics of interest
• Impact of new technology
• Cost inflation/deflation and the
oil price
• Changing tax regimes
• Political risk
• Partner risk
• Oil companies and their local
responsibilities
• Health and Safety
• Shareholder responsibilities
• Corporate and social
responsibility
• Oil spill risk
• Electric and gas-fuelled cars
What is the management thought process?
Development of a gas field
Key Issues
• Access to market
• Export technology
• Total cost
• Outlook for medium and longterm
gas demand
• Outlook for coal demand and
price
• Competing sources of gas supply
• Breakeven gas price
• Associated liquids
• Length of sales contract available
• Price formation mechanism
• Securing finance
• HSE issues
Topics of interest
• Is the gas market becoming like
the oil market
• Is gas the cleanest fossil fuel?
• The impact of Russia on security
of supply concerns
• Shale gas – a good or bad thing?
• Can anywhere else replicate US
shale gas success?
• Pipeline gas versus LNG – which
to choose?
• Domestic versus export markets
• Subsidised prices
What is the management thought process?
Construction of a fossil fuel power station
Key Issues
• Economics of project
• Pricing mechanisms
• Likely plant utilisation
• Availability of government support
• Security of supply for fuel input
• Expected cost of fuel input
• Availability of renewable energy at
zero marginal cost
– Domestic
– Imported
• Grid infrastructure requirements
• Country plan for power generation
mix to 2050
• Possible carbon capture technology
• Development of off-grid power
sources
Topics of interest
• Biogas as an alternative power
source
• Carbon capture and storage –
will it ever be viable?
• Coal versus gas power – the
energy trilemma
• Is gas-fired power the ideal
back-up for renewables?
Carbon capture and storage
Carbon capture and storage
What is the management thought process?
Government trying to optimise the energy system
Looking healthy Big problem to solve
Key Issues
• Security of supply
• Cost of supply
• Environmental impact of supply
– CO2
– Air pollution
• Local employment issues
• Management of strategic energy
assets
• Energy efficiency versus energy
supply
• Energy prices and subsidies
• Revenue generation potential
– Taxes
– Dividends fro state companies
– Trickle down impact of successful
domestic industry
• Local, regional and international
politics
Topics of interest
• Different issues for importing and exporting
countries
• Risks for hydrocarbon producers
• Economic cost of switching to a low carbon
economy
• Prioritising economic cost, security of
supply and environmental impact
• Maintaining economic competitiveness in
the global market
• Achieving global consensus on key issues
• Political timescales versus energy sector
timescales
• Corporate influence on political decision-
makers
• Public opinion versus economic reality
What is the management thought process?
Wholesale buyer of gas
Key Issues
• Price
• Price mechanism
• Length of contract
• Competing fuel prices (coal, oil)
• Implied cost of power
• Future gas demand
• Security of supply
• Alternative gas supplies
• Pipeline gas or LNG
• Likely market regulation
• Customers for the gas
Topics of interest
• Deregulation of gas markets has put wholesale
buyers at greater risk
• End-users now have much more choice about
price and supply
• The rise of renewables is making gas demand
much more volatile
• Contracts must be much more flexible
• Spot purchases can provide flexibility and price
diversification
• Security of supply becomes an issue is hubs are
not liquid enough
• Gas projects are long-term; buyers need to
provide some guarantee of offtake to
encourage investment
What is the management thought process?
Major truck fleet owner or shipping magnate
Key Issues
• Relative fuel prices (short and long-term)
• Distance driven before re-fill / re-charge
• Environmental legislation
• Customer demands (public opinion)
• Cost of changing technology
• Re-fuelling infrastructure
• Commitment of truck/car/ship
manufacturers
• Longer term technology advances
• Competitor activity (what is everyone else
doing?)
• Social responsibility
Topics of interest
• Maritime shipping emissions legislation (IMO)
• Power of engines (LNG trucks versus electric
vehicles)
• Trucking fleets with own infrastructure and
standard routes
• Commitment of vehicle manufacturers – when
does the market demand change
• Battery technology a key constraint
• Fuel efficiency versus change in fuel
• Impact of lower oil prices – reduces incentive to
change
• Status quo effect – no-one ever got fired for
choosing IBM
Sulphuremissions
The environmental case is
relatively clear….
…but is only of interest to
companies if the oil and gas
price differential is wide
What is the management thought process?
Construction or maintenance of a gas pipeline
Key Issues
• Sources of throughput
• Long-term future of fuel
• Payback timescale
• Government support (regulated
prices)
• Alternative uses for pipeline
• Security of gas producing company
• Security of gas buyer
• Availability of finance
• Cost of dismantling asset
Topics of interest
• Alternative uses for gas pipelines
– Hydrogen (electrolysis or methane conversion)
– Biogas (local grids)
– CO2 (if CCS works)
• Pipeline networks are major national assets
with strategic implications
• Pipeline tariffs may rise if the assets useful life
shortens
– Need to recover cost sooner
What is the management thought process?
Construction of a renewable energy power station
Key Issues
• Geography
• Meteorology
• Cost of technology
• Government support
– Prices
– Finance
– Renewables targets
• Local support / resistance
• Grid suitability
• Back-up generation
• Economic return (guaranteed?)
• Local service sector and R&D
Conclusions
• The Energy Trilemma – Price versus Environmental Impact versus Security of
Supply
• Economics normally trumps everything else
• Uncertainty creates a disincentive to invest, which creates its own security of
supply risks
• Government support beyond renewables is almost inevitable – what does this
say for free markets?
• As fossil fuels near the end-game, declining prices will affect energy companies
but will also affect consumer choices
• Government revenues will also be significantly affected, with potential serious
geo-political impacts
• Shareholders of energy companies have some interesting choices to make –
what returns do they want from their investments?
• Renewables are causing huge disruption to the global energy economy – they
are necessary to reduce global warming, but have potential security of supply
implications
Some challenges
• Human resources
• Bank financing
• Environmental pressure groups