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 Shale Oil Production Profile 1.Immediate surge to peak production 2.Rapid decline over the first few years 3.Long plateau at low production rates A shale 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 –5 years after first investment • •Peak production – 7% 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 16 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 18 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 19 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 Saudi decision in perspective: time to halt the rise of US shale (and other high cost) production Big-3 production growth v Dec 16 • • • • • • • A close up of a logo Description automatically generated Global economy recovering from a sharp recession Global GDP growth • • • • • • • GDP growth scenarios • • • • • • • Source: Oxford Economics Annual oil demand contracted in 2020, but strong rebound in 2021 Global oil demand • • • • • • • US shale took a big hit in 2020 but is now recovering Market out of balance in 2020 with extreme surpluses that are now gradually unwinding Global supply/demand balance • • • • • • • OPEC and Russia have helped to re-balance the oil market, led by Saudi Arabia Saudi Arabi oil production • • • • • • • OPEC+Russia compliance with production targets • • • • • • Brent fell sharply in 2020 but has recovered well thanks to OPEC production restraint Brent price outlook • • • • • • • 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 Gas prices have been falling and converging Gas increasingly priced relative to competing gas supply Rising supply and a recent fall in demand saw price 2018-2020 Winter 2020/21 underlined risks of short-term market dislocation, in this instance due to cold weather Global gas prices Let’s model a shale gas field •Resources and reserves – 1000bcf with 10% recovery rate • •Start date –year after first investment • •Peak production – 25% of reserves • •Time to peak – 1st year • •Length of peak – 1 year • •Decline rates – 50% in year 2, 35% yr 3, 25% yr 4, 10% from then • • US shale gas production has risen sharply and looks set to continue EIA: Shales to Power Domestic, Global NatGas Production Growth ... US gas is now being exported US LNG projects set to expand Is it worth exporting US gas? European gas price versus US LNG at cost Decline in natural gas prices exaggerated by Covid-19 US (Henry Hub) Gas Price 5-yr average US Gas Market – demand remaining weak due to higher prices US Gas Market – price outlook text Short-Term Energy Outlook - U.S. Energy Information Administration (EIA)