Happy New Year. And a prosperous one for all. Our newsletter provides global energy insights. The New Year on the energy scene started with a mini-crisis:  

Russian / Ukrainian Gas Price Spat: On 1^st January, the Russia cut some 30% of it’s gas supply to Ukraine – who then took this from supplies heading for Austria, Hungary, Germany and other European countries further west. This precipitated a crisis which was short-lived but has triggered fierce debate in Germany and other European countries dependent on the security of Russian gas supplies. Chancellor Merkel has initiated a full Energy Review for Germany (25% of Germany’s gas is supplied by Russia) – she probably wants to see more diverse energy sources and suppliers – to mitigate the risk of any future supply disruptions of gas price negotiation or escalation issues. A European debate on Nuclear energy has started, though a cross-party agreement not to open up the debate on decommissioning of Nuclear Power Stations in Germany has currently not been opened up again - yet. Its likely other European countries will follow the lead in announcing energy reviews - and look for increases in energy security over the coming years. This is seen as essential because of the adverse impact of high oil, gas and electricity prices for business and economic growth in European countries (essentially it acts as a drag on economic growth like tax hikes do). An excellent summary of the implications of the Russian moves to increase gas prices is outlined in Irwin Stelzer’s article “Pay up or dance to tune of foreign energy suppliers”.

UK Gas Prices: It’s been an exceptional 6 weeks in the UK with regard to energy prices. Gas prices in the UK sky-rocketed to £1.55 / therm from £0.55 then settled back to range £0.70-£0.90 – prices have increased from £0.20 a few years ago off the back of depleting North Sea supplies and concerns that European supplies might not be forthcoming. Prices in Germany are about £0.40 and in Holland are £0.50 (prices largely linked to crude oil) – despite this the inter-connector was passed gas from Belgium to England at only 67% capacity - supplies were used by European countries during the cold snap rather than exported for a higher price. This probably has a lot to do with safeguarding manufacturing jobs on the European continent – keeping the gas prices down to make sure factories stay competitive in a challenging time for European manufacturing business, competing against the Chinese and Indian plants. It’s likely gas prices will stay high before Ormen Lange gas arrives from Norway late 2007, and LNG terminals are completed in the western parts of the UK by 2010. It seems no-one foresaw that gas would not flow at near full capacity from the continent to the UK during cold snaps – because cold snaps normally inflict both the European continent and the UK at the same time – all regions are competing for the same gas at such times. The “dash-to-gas” which reduced CO2 and sot emissions in the 1990s whilst providing fast and efficient electric supply now looks like it might be far more costly to generate electricity moving forwards. This is likely to drive manufacturing and chemicals plants away from the UK – as they relocate to countries with lower cost energy such as eastern Europe, China and Germany.     

LNG – a bright future: Alternative energy sources to gas are widespread but all have issues – one of the best is LNG (Liquified Natural Gas) because this can be shipped from any gas producing country to a market – albeit shipping and processing costs are relatively expensive. Security of supply is good since one can purchase spot cargos from different countries or engage in long term supply contracts with stable countries (e.g. Australia). LNG is an exceptionally lucrative long term business if gas prices stay high – which is expected because of the massive demand increase from industrialising countries such as India and China. The main LNG producing countries are:

Qatar, Trinidad, Algeria, Malaysia, Australia, Nigeria, Oman, Brunei, Egypt, Abu Dhabi, Russia (Sakhalin Island)

The main markets are:

Japan, Korea, China, India, USA, Italy, Turkey, France, and Spain.

The biggest project by far is RasGas in Qatar and this is expanding dramatically. Qatar only has an indigenous population of 200,000 people so the revenues per person for the country are massive - the country joins the super-league of wealthy nations such as Norway, Luxembourg, USA etc.  The projects, mainly ExxonMobil led joint ventures with QatarGas get extremely low cost gas from the North Field – by far the worlds biggest gas field with reserves thought to be over 1000 TCF (to calibrate you, a large gas field in the Gulf of Mexico is about 0.5 TCF).

Investors keen to expose themselves in companies exposed to LNG processing and shipment should look at companies like ExxonMobil, BP, QatarGas, Shell, Total, BG, Woodside and ChevTex – plus the big state companies operating in those respective countries (Petronas, Oman LNG, ADNOC, ADCO, QatarGas). Other companies participating in the joint ventures are Matsui, Marubeni, Mitsubishi, Kogas etc

Companies both private and state run, are opening degasification plants – albeit returns on these plants and the pipeline transport to customers is lower risk and has lower returns. Many are being constructed for example in China and India.

Because an LNG processing plant costs upwards of $2 billion, only the larger oil companies and gas marketing companies have so far been involved. Barriers to entry into this business are very high – and although returns can eventually be very high, the up front capital costs puts a lot of banks and investors off.

Refining update – refinery capacity continues to be tight with utilization at well over 90% in most regions and countries. Hence refinery margins are particularly high. In the mid 1990s, refiners could commonly expect between $0.5 and $1.5 per barrel profit margin – now this has sky-rocketed to a range of $7 to $15 in most areas and for most products. Refining is now a business with healthy returns, albeit the initial capital cost of building a refinery is of course high – some $1 - $2 billion for a medium sized refinery complex. Because of the high initial capital costs, big cash sink, long pay back period, long planning periods, future environmental legacy issues/liabilities, plus memories of under-performing investments in the 1990s, banks are still reluctant to lent money for refinery building. Hence refinery capacity can be expected to be stretched for quite some years – and margins remain high. Smaller refineries with environmental issues have been forced to close or were closed in the 1990s because of over-capacity and non profitability. Companies that specialise in refining, and sweating old refinery assets that have mainly depreciated capital expenditures – can expect a profitable few years – as demand from China, India and USA is likely to outstrip supply. 

Further exacerbating the problem of capacity shortages are the ever increasing array of new products to meet differing environmental regulations and product qualities. This has affected product prices particularly in the USA – where different states have different product specifications and requirements. This has caused prices to be higher than would normally be envisaged.

Companies heavily exposed to refining include Shell, ExxonMobil, BP, ConocoPhillips, CevTex, Caltex, Sinopec, Petrochina, Petronas, Petrobras and Valero. Valero is a specialist oil refining company, US based, which has expanding over the last 5 years to acquire old refineries – one of only a few pure refining (non integrated) oil companies. The Ultramar refineries were integrated into this company some years ago.

Outlook for energy -  For those who are interested in the ExxonMobil outlook for energy, you can view this full presentation by clicking here. Anyone in any doubt about whether the energy business is a growth business or not should read this presentation. There will be a massive demand for energy of all types from the Far East and as populations grow and people become more wealthy and demand energy for transport, home electricity, heating and air conditioning, plus manufacturing – the oil majors along with state oil and energy companies will need to provide sources of energy into the market – be it oil, gas, coal, nuclear, renewables, electricity or any other type of fuel/energy source. Skills shortages for engineers who are capable of finding and developing new energy sources will likely stay a major constraint moving forwards for the next few decades – and countries are likely to get ever more desperate for secure energy sources, leading to political tensions (as seen recently with the Russia/Ukraine disagreement).

Sugar – so what’s sugar got to do with energy? It’s a commodity that can be produced from sugar cane, sugar beat, or corn that can then be converted into ethanol and methanol to power cars, relatively easily. It’s also renewable – e.g. it grows, can be harvested and grown back again – and hence it is broadly carbon neutral. The price of sugar has barely moved higher in the last few years because of improving farming methods and efficiencies. But EnergyInsights.net predicts that sugar prices will start to follow oil and gas price escalation trends as countries “cotton on” to the potential of sugar to provide a secure energy source via indigenous farming. Hence, investors looking for the next big trend should seriously consider investing in sugar and land where sugar is farmed. Example could be the corn belt of USA, sugar beat areas such as northern Holland, and East Anglia in the UK, and sugar cane plantations in Brazil. A company heavily exposed in sugar is Tate & Lyle. As populations increase, this land should also increase in value if building permission can be granted. So expect a healthy increase in methanol plants in rural sugar and corn farming areas - particularly those large tracts of land close or accessible to major population centres.