Category Archives: Energy

Energy

A Short Term Outlook For Gas Prices: Russia Calls The Shots (Again)

Energy, Global Economy, On the cover, Sin categoría

Gas prices have held up well, in part on the prolonged cold spell. However, in absence of weather support, by the summer prices will have to be lower in order to take the rise in LNG and Russian gas (161BCM) expected.

It is widely recognized that there’s a big build in LNG supply coming (extra 8bcf/d from the summer, ie three-quarters of UK consumption)) and that Gazprom is planning to increase its sales to Europe (by about 2bcf/d over the year = 20% of UK demand).

So likely that European gas storage will be filled relatively early. Unfortunately, storage levels are still relatively high (equal to almost 3bcf/d of extra supply if returned to normal levels over 3 months). Nevertheless, should storage still close to current levels rather than drop to 25-30% fullness, that would add 9bcf/d to demand over the next 3 months.

Economic recovery may lift demand, and Spain has started 2009 with January consumption up 4.2%. However, the industrial production is still more than 10% below 2008 levels.

The big mover for LNG would be a recovery in Japan, which looks encouraging even when industrial production is still 20% below 2008. South Korea and Taiwan are picking up but together these two countries are only half of Japan’s LNG demand.

Last year, in Europe, Gazprom’s gas buyers sharply reduced volumes early in the year. These are huge numbers – about 14-15bcf/d (ie almost the entire consumption of the UK and Germany combined). This was a”no-brainer” for the gas buyers. Their contracted price is based on oil prices with a 6-9 month lag. So deferring gas take until later in the year meant the gas would be cheaper.

Going forward, it looks likely that gas prices now are close to the lowest level for the year. Hence, the buyers are likely to want to take the gas now (saving about $2-2.5/mmbtu).

As a result of coal’s decline, gas at higher prices would no longer be the preferred fuel for generating power in the UK (where most of the swing occurs between coal and gas).

• Coal has come down as concern surfaced about the extent of policy tightening in China. The Australian coal price has been hit hardest, but clearly this has been the driver for South Africa (and European) coal over much of the past year.

• Marginal generation costs in the UK now favour coal dispatch.

So, gas prices will have to drop (or coal prices have to rise) in order to stimulate enough demand to take the Russian gas. Coal market fundamentals look positive once the trend of Chinese coal import data post-tightening is evident in 1 month time. So near-term, the market balance is more likely to be brought back into balance by falling gas prices enhancing power station competitiveness (along with Europe maintaining high storage levels over the summer), but more expensive coal and lower Russian gas might balance the equation.

So the x factor to bring gas markets to balance is Russia. Unless Gazprom allows a smaller off take, there could be as much as 10bcf/d trying to find a home in the UK/European power sector over the coming 3-6 months. That’s too much for UK/Europe to absorb; so up to 5bcf/d could end up headed for the US. I struggle to believe Russia will work on volume alone given they have a 6% decline in the base. If they allow a lower off-take, US pricing won’t get dragged down in this environment.

The current forward curve has Henry Hub some $0.5/mmbtu above UK’s NBP, so there is not much scope for UK prices to drop without impacting LNG flows and depressing US prices.

In summary, the picture is not that oversupplied if Gazprom volumes (161BCM) include storage and some level of flexibility. Chinese coal buying might keep gas prices more competitive than coal for power generation, and we are seeing LNG projects delayed (Shtockman, Australia) or sending lower volumes to Europe (Yemen). Looks like the picture of oversupply that the market discounts is too extreme. Not that my view will imply gas price appreciation, but the massive downside predicted by some looks less evident to me.

Can Spain afford to be "green"?

Energy, Global Economy, On the cover, Sin categoría,

(This article was published in Spain’s Cotizalia on February 11th 2010)

What timing. After months preparing for a trip to Madrid, I arrived on Thursday 4th, amid the market and debt debacle. A day after the market crash and four days before the presentation of the Spanish Secretary of State for Economic Affairs here in London. The macroeconomic forecasts “from -0.3% GDP growth in 2010 to +3% in 2012 by doubling the exports” worry me. What country will Spain double its exports to in two years with the Euro at all time highs and competitiveness at historical lows?

I have the luck or misfortune of following the economy of 58 countries. What country in the world is forecasting to increase its imports from Europe between 2010 and 2011? No idea. And above all, how can Spain take away market share from other exporting countries in an environment of aggressive competition?

Amid all this, people wonder why the markets fell and different articles comment on the role of “short speculators”. Too bad no one called us “long speculators” or “saviors of enterprises requiring capital increases” in 2009.

Going back to the Spanish Government presentation… Imagine the CEO of any publicly traded company which had breached the consensus estimates for three years in a row submitted such bullish growth plan and think how much his companies shares would drop. Obvious.

Fortunately, my meetings on Friday left me much calmer. The companies are doing their homework and, as always, it will be the private sector which will rescue the economy. I hear no one expects a quick economic recovery and corporates, which are close to the customer and the export industry are preparing themselves for several years of less than modest growth. I hear excellent plans to cut costs by 30-40%, diversification efforts and, above all, restraint in capex and debt control.

And in this day an issue did pop up constantly. In Spain there is little more that can be done in infrastructure and renewable spending for a few years. The drastic cut of the civil works and infrastructure spending is imminent. Spain has invested in infrastructure like an emerging country, but with the demand of a mature market, and now it has an enormous excess capacity while it needs to digest, and pay, the national debt increased through a stimulus plan that brought debt to GDP to 11% devoted to infrastructure and civil work with no returns, ie spending that generates debt but does not generate GDP.

In this environment, power prices are at historic lows due to overcapacity and lack of demand, and yet the fact that renewables account for 40% of the electricity generated in some days make the premiums for these technologies (especially solar) to generate a tariff deficit of between €1bn and €1.2bn, a bill that is transferred to future generations.

This deficit is generated by the monstrous deception that is to have a government that raises electricity tariffs by a maximum 3-4% annually in one of the countries that pays less for electricity in Europe, while the real energy costs, including renewable premiums, is much higher. And this then becomes debt, owed to the power companies, that must be placed in the market to be securitised… And we have spent many months waiting for the tariff deficit securitization while the figure of debt rises month after month, which is unacceptable and introduces even more uncertainty in the power stocks. This is the national problem of Spain: to fix it all with debt, and now the bubble of debt is almost unbearable. The government has to refinance €60bn, saving banks and autonomous regions €150bn, etc … Let’s see just what kind of spreads will be required to place this paper.

Spain’s GDP is approximately €1.06 trillion, premiums for renewables account for 6 billion euros, 0.6% of GDP, and the accumulated tariff deficit is 11 billion, or about 1% of GDP. Additionally, the tariff deficit expected for the next two years is an additional €4 billion. Spain, at the same time, wants to install about 5,000 additional megawatts of wind generation and other 2,300 megawatts of solar by 2012.

Well, friends, do numbers. Either the government passes the real tariff to the consumer, which is unlikely given there is a 20% unemployment, or the bubble and its financing becomes unsustainable and with it the green economy model. Green energy costs. Let’s face it. Now it’s time to face whether the green energy model is sustainable in a weak economic and high debt environment.

Urgent: Refineries for Sale. Cheap… or Free

Energy, Global Economy, On the cover, Sin categoría

refineria

(This article was published in Spanish in Cotizalia on February 4th 2009)

The results of Shell, Chevron and BP have shown once again the extremely serious problem plaguing the oil industry: refineries lose more money every quarter and completely offset the positive results of exploration and production or gas trading. In fact, the refining sector in the OECD has generated returns of c3% below the cost of capital since 2003. Tony Heyward, CEO of BP, Europe’s largest oil company, was forced to acknowledge at the presentation of Tuesday’s results what has been a concern for the investment community for years.”Refining margins shall remain depressed for the foreseeable future.”

Indeed, the world finds itself with excess refining capacity of more than four million barrels a day. In addition, between China, India, Saudi Arabia, Russia and Korea there are planned refinery projects for more than 8 million barrels a day, many of them justified for purely political reasons. Even if half of them were canceled, the overcapacity will remain for at least 10 years. Meanwhile, Europe and the United States see the value of refining assets plummet every day, well below replacement cost, and no buyers. ENI has been unable to sell its refinery in Livorno and Total is not only unable sell its Flanders plant, but due to government intervention they are forced to keep it operating despite the fact that Total loses around € 100 million per month in the refining area.

The situation is desperate, even for companies like these, who do not have debt problems. As you can imagine, much of the refinery projects were built with the frightening words “security of supply” and “strategic” as a justification, regardless of the volatility, low return and very high investment requirements. We have not learned from the debacle of 1981-86, which led to curtail refinery capacity in the OECD by 20%.

In the past, integrated oil companies wanted to sell the message of their refining activity as an alternative to volatile oil prices, but it has proven to be a source of massive capex requirements and destruction of market value for the sector.

At the end of the day, a refinery creates value only if it can extract superior returns by using cheap and low quality oil (heavy) to produce high priced gasoline and products. Expensive oil, with the differential between heavy and light crude at a 10 year low, added to excessive costs, declining demand and efficiency improvements have led refining margins to plummet to $ 3.8/barrel on average, the lowest levels of the past 15 years. And this even when refineries are running at an average of 80% capacity. But the differentiating factor is that excess capacity far exceeds the most optimistic expectation of improving demand.

Some might say that this is scaremongering, that refining is a cyclical business and that when demand recovers everything will be fine (amazing to see how many times one hears this lately). I disagree. None of these large oil companies look to their activities on a short-term basis, and yet all of them seek to reduce refining capacity, the sooner the better. Apart from ENI and Total, Royal Dutch Shell aims to reduce its capacity by 15%, Valero has closed its plant to 200,000 bbl/ day in Delaware, BP wants to reduce its capacity by 14%, Chevron also … In summary, the 10% fall of demand in 2009, that all oil companies see as structural, not cyclical, will lead to the closure of at least 3.4 million barrels per day, up to 18% of the entire European capacity, between 2010 and 2020. And still capacity will be more than adequate.

Spain has refineries to bore, nine, with a capacity of over 1.1 million barrels a day. Within the complicated picture of the sector, some are reasonably profitable. For this reason, they could be sold without any problem at a price close to $1 billion per plant. The opportunity to raise cash and reduce investments has to be taken. But beware of waiting around for the return of the “golden age of refining” which may be decades away … or not return.

Three recommendations for utilities

Energy, Global Economy, On the cover, Sin categoría

(This article, like most in this blog, was published in Cotizalia in Spanish)

The utility sector faces this year the need to renew their strategic plans and give the market an attractive message for shareholders. It is not easy, as most companies have clear that the next five years will not see the electricity demand growth the industry enjoyed between 1990 and 2008. So the biggest risk facing the sector is to give overly optimistic messages or growth targets that are difficult to digest by the market, which would negatively impact their shares. And remember what a dreadful market performance we have seen in the past two years among large integrated utilities like Enel, Gaz de France-Suez and E. On even when they have published acceptable results.

Transmission companies are fully regulated, so they have it relatively easy, because their investment plans are guaranteed by the government with a minimum return. The complex part is to justify the multiples at which they trade (the highest since 2000) without giving the market an assessment of their minimum growth in regulated assets (RAB). Added to the equation the fact that the regulators have a nasty habit of delaying the simplest decisions for months, and the risk increases. It is therefore absolutely necessary to clarify the regulatory environment, and confirm the growth expectations. If not, we return to the regulatory risk discount that affected National Grid and the Spanish companies for years.

Large integrated groups have a harder task ahead. They face an environment without significant growth in demand, with some excess capacity in generation, and the industry no longer has the strong balance sheets that facilitated large corporate mergers. With a sector in Europe committed to divest more than €15 billion, it is difficult to see asset price inflation to levels of 2004-2006, as it’s a buyer’s market. Therefore, the challenge is to clarify how to create shareholder value when the macroeconomic environment is complex.

From my point of view, the Spanish companies can boast of having managed the 2009 crisis better than their European competitors. And they should exploit three key areas:

– The first is to clearly show their competitive advantage in costs. For example, compared with European companies, the Spanish, on average, have reduced their costs in 2009 by 7%. This ability to manage complex environments is essential to create value.

– The second is to focus on Return on Capital Employed and managing the investment process. Being bigger is not better or more profitable. Spanish companies have shown to be capable of generating superior returns to its peers (9.8% compared with those of Europe, 8%) while reducing unnecessary investments in over €8 billion despite the fall in demand for electricity and gas in Spain, which has been above the European average.

– The third is to commit to a policy of Total Shareholder Return. Once the process of reducing corporate debt has been completed, and so far it has been done remarkably well, with more than €13 billion average reduction in debt in the sector, the message should focus on profitability for shareholders. The key is to reduce exposure to low-return assets, crystallising value in the most attractive ones, as they did floating the renewables divisions, and could do again with the distribution or nuclear generation, while ensuring a minimum absolute dividend and the improvement in book equity.

This is a year in which companies will have to compare themselves with others, and show that they do better than average. Focusing on returns generated at the bottom of the cycle, ensuring shareholder remuneration and managing the balance sheet will be what differentiates the winners from the losers in the market. The empire-building strategies of European multinationals have driven the sector to a six-year relative minimum PE to the market. Now it’s time to differentiate strategies.