Good News For Gas: Investors Seeking Good Projects

Times are changing, confidence is waning, especially when it comes to the natural gas industry's hopes for investment coming into Europe. But to cheer things up a bit, industry representatives shared their insights and tips for helping to draw investment into the industry at the European Autumn Gas Conference in Vienna, Austria.

Preceding a session entitled "Investing and Confidence in the Emerging European Gas Model," an instant poll question was posed to attendees who chose where they thought the investment euros were going to go in the European energy sector: wind, nuclear, coal, solar or natural gas.

Chairman James Ball commented: "This is interesting, because for first time ever wind has won. Natural gas got 45% in 2008; last year it got 30%; and now we can see it's at second to last place, at 11%. So the subsidy generators will continue to dominate with a massive 70% of investment. I hope they don't eat coffers and they've got their bailout fund all lined up."

"Let me start with one piece of good news," said Robin Baker, Managing Director, Global Head of Energy Project Finance, Societe Generale. "There is lots of money around, actually desperately looking for a home."

He noted that the global project finance market had peaked in 2011, but that this year it had fallen quite significantly, especially in Europe.

Still, Mr. Baker was adamant: "I don't know of any good project that has not gone ahead because of lack of finance. Perhaps more importantly, if you look at deals being done today the banks are in the middle of finalizing a debt package for Equus LNG, which is probably in the region of USD 20 billion. So the money is there and investors are very keen to find new places to invest their money."

He said there were three sources of debt: commercial banks, whose business had been dominated by the European banks; export credit agencies, which had stepped up and provided moderate growth in 2011 and could continue to do that; and the capital markets, which he said were extremely liquid.

"We need to ask ourselves what is needed to attract these three sources of finance to this business," said Mr. Baker, who promised to outline what he saw as the four necessary elements.

Of the project fundamentals, he said: "Before look at contracts, price indexation or anything else, we ask ourselves 'does this project provide something that someone wants?' and 'does it do it at a competitive price?'

"Then we want to know if there are competent sponsors who are going to do what they say they're going to do; thirdly, we need to know there's a fair allocation of risks and rewards and that everyone involved in it is incentivized to do what they should do, and that's where look at contract structure.

"Finally," said Baker, "we look at the stability of regulation. This is not just the regulation that affects that profit directly, it's the whole industry regulation. So if you're financing a gas pipeline for example and the government changes its policy on renewables versus gas and the pipeline is not of any use, there's always the danger of wanting to renegotiate the contract, saying 'the government's changed the rules on us - we don't really need this pipeline anymore.'"

He said he believed a lot of natural gas infrastructure was really low risk and ideal for investors that had huge amounts of pension or insurance money, looking for a safe home. Mr. Baker addressed the European natural gas industry: "This is a good place for the funding and these projects will get financed - please give us these four criteria, including stability of regulation, to be able to do this."

The next speaker was Gareth Griffiths, Chief Commercial Officer Global Merchant Trading and Origination, E.ON Energy Trading, who said it was for him the most exciting time to be in the energy sector; he pledged to the delegates to explain why he felt that way.

Mr. Griffiths showed a complex depiction of what the energy sector looked like. "It's very critical that one understands the inter-relatedness of the markets and regions," he explained. "There are geographic elements to the energy system, commodity one, carbon ones, gas ones, coal ones and oil ones. You have to understand the dynamics of this to understand the risks and opportunities of the marketplace.

"Our view," he explained, "is that European gas is bounded by a 'coal floor' - an indexed coal price - which is determined mostly by the supply and demand requirements of China or Asia. And it's also capped by the oil price in Europe, because of its link to long-term contracts."

He said it was prudent to compare this to the past, like 10 years earlier in the UK when the decline in indigenous supply and potential growth of gas in power markets would require investments in pipelines, regasification capacities and CCGTs. "That's obviously been proven to be incorrect," he remarked.

"In today's system, we need to take into account the European debt crises, American recoveries and changes in poltical leadership in China. At the same time, renewables brings volatility to the market and creates a new dynamic to the system and regulation does too. We have to understand how these impact the economics and price."

He forecast that in the future, it would likely be more difficult but more exciting.

"If you look at trends in technology - shale gas being a good example - there are undoubtedly technological wildcards out there that we haven't taken into account yet," commented Mr. Griffiths, who questioned whether gas hubs sent the right signals to the gas market, noting that there were no long term bids on natural gas past the winter of 2015 on the screen of data he showed to delegates.

"Hubs provide us with an assessment of the supply-demand balance at any given time and the clearing price that would be required to manage the tightness in the market at any given time; what they don't do is provide us with the liquidity to hedge our future investments. If an investment window is 3-5 years, you can't even manage the first year's projects with this screen."

Gas flows, he said, would flow according to how they were contracted and according to the economics, i.e. to the highest priced market. "In theory, all markets should have the same price, like the oil market. But constraints to the system create imperfections and prevents the free flow of energy."

As for future models going forward, Griffiths contended that future models needed to take into account the particular infrastructure in question. "If we're looking at LNG, we have to take into account east-west differentials and arbitrages; if we look at storage, we have to take into account renewables technologies and the intermittency that will exist."

According to him, various investors - whether they be oil and gas producers, retailers or power producers - took different approaches and adopted different solutions to the problem.

"In the end, the best answer I can see is a mixed view where one takes investment decisions, trading opportunities, the optimization and mixes them together, and at the end of the day will be highly dependent on liquidity and the depths of the trade market in order to realize our visions that come out as part of the energy system."

Klaus Reinisch, CEO of Petronas Energy Trading Ltd., explained that his company, based in Malaysia, had made investments in Europe, starting in the early 2000s, including an LNG terminal and gas storages.

"The challenge I face every time I go to the Petronas Towers to my stakeholders, and to rather risk averse Asian investors, is market signals aren't there," he explained. "What's happened just in the last year, the price spreads have literally collapsed; volatility has disappeared this year. The market really hasn't helped me at all."

Given that background, Mr. Reinisch said that the challenge he faced was how to convince stakeholders to continue to invest in the European market.

"You have to have a long-term view," he stated. "Without a long-term view, price signals won't work. In effect, your job is to convince your stakeholders to ignore the price signals, which is a very difficult challenge: simply saying 'the market isn't showing what the reality is.'

"There's certainly an appetite for more infrastructure investments, certainly an appetite for transportation - especially in the UK market - but we can no longer rely on liberalized market pricing signals."

He said that advantage of some Asian and Middle Eastern investors was that they didn't have to rely on external finance.

"You can justify these investments on the value of optionality - when there's no signal on spreads, there's no signal on volatility in the market, but one way to justify it is to say 'I'm buying an option - a long-term option. I have faith in the European gas market, faith in the European energy market, and the value is optionality.'"

Reinisch concluded that the number one thing for Asian investors was certainty, but noted a headline in the Financial Times: "Ministers Crush O&G Bill in the UK"

"They can't agree between themselves what to do in the energy world; how do you think this is helping me to go to my investors? How can I say this is a great market to invest when they're fighting internally?" he queried. "This is something we need to change and offer constructive feedback to our policymakers: get some certainty, put something in place for the next 10 years that allows us to invest."