an unprecedented market
TRANSCRIPT
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Perspective Otto Waterlander
Robert Oushoorn
George Sarraf
Thomas Schlaak
A Ureceete MaretHow the RecessionIs Changing the
Global Gas Market
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Booz & Company
Contact Information
Abu Dhabi
Raed Kombargi
Partner
+971-2-699-2400
Amsterdam
Otto Waterlander
Partner
+31-20-504-1950
Robert OushoornPrincipal
+31-20-504-1981
Arlington, VA
Dan Gabaldon
Principal
+1-703-902-5890
Beirut
Ibrahim El-Husseini
Partner
George Sarraf
Principal
+961-1-985-655
Dallas
Christopher Click
Principal
+1-214-746-6543
Dsseldorf
Thomas Schlaak
Principal
+49-211-3890-245
Houston
Andrew Steinhubl
Partner
+1-713-650-4183
LondonJake Melville
Partner
+44-20-7393-3425
McLean, VA
Eric Spiegel
Partner
+1-703-902-3813
Munich
Walter Wintersteller
Partner+49-89-54525-540
Shanghai
Nick Pennell
Partner
+86-21-2327-9800
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1Booz & Company 1
EXECUTIVE
SUMMARY
Because of the economic recession, for the rst time in the
history of international gas markets signicant demand
destruction will occur in 2009 and perhaps also in 2010,
setting back the market by up to nine years. Combined with
the completion of gas export infrastructure projects currently
under way, the reduced demand could lead to an oversupply
in the market of 5 to 15 percent until well into the next decade.
In addition, large recent discoveries of unconventional gas
sources in the U.S. and the potentially shifting position of the
U.S. in world markets may add to the pressure. The implica-
tions for suppliers, buyers, and infrastructure companies
cannot be overstated. To reduce the risks of huge oversupply
and concomitant price pressure, large incumbent suppliers
have a strong incentive to manage supply through increased
cooperation. Buyers must review their assumptions to take
advantage of the current buyers markete.g., by joining
together to access previously inaccessible sources of gas and
spread the risk. Infrastructure providers may need to rethink
their business models to take advantage of opportunities that
may arise from changing trade ows.
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Booz & Company2
ThE RECESSIonSIMpACT
Since international natural gas
markets began to develop in the
1960s, gas has been a tremendously
successful fuel, with sales growing
continuously at an average rate of
nearly 4 percent per annum between
1965 and 2007. Until a year or so
ago, before the current deep and
lengthy recession, most analysts
had predicted that through 2030,
world gas demand would grow at
about 2 percent a year, approximately
twice the growth rate of oil.
However, the economic downturn
upended even the most conservative
scenarios. Demand for industrial
goods in developed countries has
dropped precipitously, hitting energy-
intensive industries particularly hard.Analysts project automobile manufac-
turing in Europe to fall by 25 percent
in 2009. Output in the chemical
industry, the basis of many industrial
value chains, is expected to drop
at a similar rate, while output in the
steel industry, another large energy
consumer, is declining by 30 percent
or more in North America and the
European Union. History shows
that demand for natural gas closely
correlates with changes in industrial
output in developed countries. Thus,
with deeply negative forecasts for
industrial output in 2009, and
potentially 2010, gas demand will
be particularly hard-hit.
But other factors are at play as well.
Industry is only one of the major
consumers of natural gas; demand
for natural gas in power production
and domestic heating will also
inuence the course of the market.
And the recession may not challengeeach region of the world in the same
way. To gauge the potential impact
of the current economic crisis on
worldwide gas supply and demand,
we analyzed two scenarios.
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3Booz & Company
SCEnARIo 1:
ThE AgEnCIESConSEnSUS
Exhibit 1Gas Demand Destruction under The Agencies Consensus Scenario
Source: IEA; EIA; IMF; Booz & Company analysis
Power Generation
Industrial
Residential
Weighted Average
-4%
-8%
0%
-3%
Developed Countries
GAS DEMAND DESTRUCTION IN 2009 (%)
Emerging Markets Total World Market
OVERALL
IMPACT
2% 2% 2% 2%
-2%
-5%
0%
-2%
Scenario 1 is a relatively optimistic
forecast built from outlooks published
by a number of well-known agencies,such as the U.S. Energy Information
Administration (EIA), the International
Energy Agency (IEA), and the Inter-
national Monetary Fund (IMF). In
this scenario, world gas demand will
fall by approximately 2 percent in
2009 (see Exhibit 1). Underlying this
assessment is the belief that whereas
developed economies will be badly
damaged by the crisis, emergingeconomies will continue to generate
natural gas demand growth of 2
percent throughout the year. These
agencies believe that overall demand
for natural gas will begin to rise
again in 2010.
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Booz & Company4
This scenario is based on the tradi-
tional strong linkage between indus-
trial production and gas demand
and on discussions we have had with
major gas producers on actual offtake
developments in the last quarter of
2008 and early 2009. This forecast
predicts an 8 percent drop in world-
wide gas demand this year (see
Exhibit 2), which is substantially
more pessimistic than the Agencies
Consensus scenario. This conclusion
is based on an expected decline of
17 percent in industrial gas demand
in developed economies, and an equal
decline of gas use in power production,
which is also experiencing demand
destruction due to the recession.
We assume that demand in emerging
economies will be down 3 percent,
with some local growth offset by
reduced demand for exports from
those countries. Although there have
been some indications recently that
major economies are not in free fall
anymore, under this scenario, demand
destruction will continue into 2010,
albeit at a slower pace.
SCEnARIo 2:IndUSTRIAlpRodUCTIon
Exhibit 2Gas Demand Destruction under Industrial Production Scenario
Source: IEA; EIA; IMF; Booz & Company analysis
-17% -17%
0% 0% 0%
-10%
Developed Countries
GAS DEMAND DESTRUCTION IN 2009 (%)
Emerging Markets Total World Market
OVERALL
IMPACT
-4% -4%
-3%
-13% -13%
-8%
Power Generation
Industrial
Residential
Weighted Average
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5Booz & Company
Independent of which scenario proves
to be more accurate, a bleak picture
is emerging. Worldwide demand fornatural gas will be set back by at
least two and perhaps as many as
nine years (see Exhibit 3).
In Booz & Companys view, it may
take until after the middle of the
next decade for demand to reach the
level that prerecession assessments
had forecast for 2010. By that time,structural demand destruction of
between 101 and 422 bcm (billion
cubic meters) will have been built up.
This calculation is based on the belief
that gas demand will at best enjoy a
growth rate of nearly 2 percent per
A MARkET In
oVERSUpplY
Exhibit 3World Gas Demand 20062020 Under Different Scenarios
Source: IEA; Booz & Company analysis
GAS DEMAND DESTRUCTION (BCM)
2011 2015 2020
95Agencies Consensus Scenario 101 110
395Industrial Production Scenario 422 461
2006
3,400bcm
3,300
3,200
3,100
3,000
2,900
2,800
2,700
2,600
2,500
2,400
2007 2008 2009 2010 2011
9 years
2012 2013 2014
Prerecession
Outlook Agencies
Consensus
Scenario
Industrial
Production
Scenario
2015 2016 2017 2018 2019 2020
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Booz & Company6
Exhibit 4Global Supply Demand Overview 20082015
Source: IEA, Navigant Consulting, Oil & Gas Journal, Booz & Company global gas model, Booz & Company analysis
2008
0
200
2,400
2,600
2,800
3,000
3,200
5%15% surplus
Gas sources
2009 2010 2011 2012 2013 2014 2015
269 444 410 423 407 383 338Maximum Surplus
(bcm)
Production from current fields and infrastructure
Conventional pipeline
LNGUnconventional
Demand in Agencies Consensus Scenario
Demand in Industrial Production Scenario
year once the recession is over, a
preeconomic crisis forecast that, by
and large, incorporated changes in gasdemand driven by environmental
considerations and energy efciency
improvements. However, there is a
risk that when economic and gas
demand growth returns, it may be
lower than what we had become
accustomed to in periods of previous
normal economic growth. Indeed,
future economic growth may be
constrained in many of the majoreconomies by the large decits that
have now been built up in an
attempt to reverse the recession
and stimulate growth.
On the supply side, because of the
magnitude of the demand uncertainty,
and the reduced access to project
nancing, a substantial number of
new gas infrastructure developmentprojects have been canceled or delayed
until demand growth returns. Those
recently shelved included a large
liquefaction project in Russia, and
projects in Algeria, Nigeria, Australia,
and Egypt were put on hold pend-
ing nal investment decision (FID),
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7Booz & Company
now not expected for a few years. If
we assume that all projects currently
pre-FID are put on hold for the fore-seeable future, then the world-wide
natural gas supplydemand
balance should face a surplus of 5 to
15 percent. This surplus, expected
to continue until well into the next
decade (see Exhibit 4, page 6), will
be driven in part by additional lique-
faction plants, export pipelines,
and increased production of gas
from unconventional sources inNorth America. The recent huge
discoveries of unconventional gas
reserves in the U.S. may add to the
pressure of an oversupplied world
market. Indeed, up to now expecta-
tions were that the U.S. would become
more and more dependent on LNG
(liqueed natural gas) imports to
meet its demand for gas, partially
providing the basis for a number ofgas liquefaction projects around the
world. If, however, the U.S. becomes
self-sufcient in its gas supply, as
some analysts now predict, the risk
of oversupply in other regions may be
increased even further.
Even if only projects that alreadyhave a fnal investment decision are
completed, a situation of oversupply
develops that may last until well
into the next decade.
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Booz & Company8
The global gas market has rapidly
shifted from favoring sellers to
favoring buyers. And because the
speed of this change is unprecedented,
we may well see similarly unprec-
edented reactions from market partici-
pants. The large incumbent exporters,
such as Russia, Qatar, Norway, and
Algeria, are faced with a stark choice:
Either compete head-on with each
other and with smaller companies
for market share while demand falls,
or sit out the storm, accept the volume
and revenue loss, reduce production,
and strive to maintain prices and
pricing structures. The implications
of head-to-head competition are
unappealing; they include severely
depressed price levels of some dura-
tion and altered contract structuresand buyer behavior in the longer
term, with gas prices potentially
decoupling from oil prices.
The second optionsitting out the
stormtherefore appears more
appealing. However, it is unlikely
that players will want to shoulder
the burden of reducing sales volume
alone. Therefore the anticipated over-
supply may trigger increased coor-
dination among the large exportersto manage world gas supply. The 10
largest gas exporters,
which control some 80 percent of
worldwide gas supply and are led
by the large national oil companies
(NOCs), such as Gazprom (Russia),
Qatargas (Qatar), Statoil (Norway),
and Sonatrach (Algeria), have incen-
tives to do so given their large market
shares. In addition, a structure already
exists in which the large producers
meet and discuss market developments:
the Gas Exporting Countries Forum
(GECF). The international oil compa-
nies (IOCs), with their limited equity
shares in national gas production, are
not in a position to greatly inuence
decisions by the NOCs, and have little
choice but to follow along. A further
reason to expect the large NOCs
to lead the management of globalsupply is the entry of a group of new
producers into the market in the next
few years that have motivations and
strategic concerns potentially quite
different from those of the large
incumbent suppliers. For instance, by
2015, smaller players like Angola and
Peru are expected to have started their
export programs. With no established
positions to defend or lose, these
new players may well be unwilling to
initiate or even agree to productionreductions.
nAVIgATIngThE dIffICUlTlAndSCApE
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9Booz & Company
Todays global natural gas market
environment is highly uncertain.
Yet with careful consideration,sellers and buyers may nd that
the current situation can also
provide interesting opportunities
for carving out advantageous
positions (see Exhibits 5 and 6).
National Oil Companies (NOCs)
With lower-than-expected produc-tion and revenue, project protability
may be at risk for NOCs. In addition,
buyers will seek to renegotiate
contracts, thus putting prices and
pricing structures at risk. NOCs
should assess the implications of
reducing production and bring their
IMplICATIonS
AndoppoRTUnITIES
Exhibit 5Implications and Potential Considerations for Sellers
Source: Booz & Company analysis
IMPLICATIONSSellers
- Production and export volumes are lower than planned with corresponding
lower revenue
- Project profitability is at risk
- New NOCs are still entering the playing field
- Prerecession price levels come under pressure; oil indexation at risk- Importers/buyers will seek opportunities to renegotiate contractual terms
POTENTIAL CONSIDERATIONS
- Assess potential for and impact of lower production, both
economic impact and competitive position versus established and
effect on emerging exporters
- Assess company-specific demand scenario and revisit project portfolio
to bring it in line with this new outlook, for both pre- and post-FID projects- Aggressively take advantage of reverse capital expenditures inflation:
leverage the inevitable oversupply in contractors, rigs, and materials
- Seek to improve netbacks through transport route optimization by
introducing geographic swaps
- Look for opportunities to secure captive demand through expanded
downstream plays, gas to power, etc.
- Expand capabilitiese.g., via acquisition of specialized IOCs
or contractors
NOC
- IOCs face similar implications as NOCs as part of joint ventures
- High-tech projects with high development and marginal costs could
become uneconomic
- Highly leveraged IOCs become more exposed and possibly vulnerable
to takeover
- Geopolitical issues may restrict playing field
- Position for and respond to likely NOCs-inducedsupply reductions,
including reducing costs to improve local competitive position
- Accelerate building of cross-market capabilities to optimize sources
and netbacks and increase relevance
- Assess which assets/operations might become most distressed and
pursue acquisition possibilities
IOC
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Booz & Company10
Exhibit 6Implications and Potential Considerations for Buyers
Source: Booz & Company analysis
IMPLICATIONSBuyers
- The changed market offers opportunities to diversify imports and/or
access gas as we move away from a suppliers market- Demand destruction results in less revenue, especially in OECD
countries and the industrial segment
- Importers faced with TOP obligations have less room to maneuver within
the context of their long-term contractual obligations
- Noncaptive customerse.g., large industrials and power generatorswill
try to benefit by seeking lower-priced gas
POTENTIAL CONSIDERATIONS
- Assess potential to reduce offtake from suppliers under long-term
contracts, while ensuring not to jeopardize long-term security of supply- Take advantage of opportunities to rebuild the gas portfolio by
identifying and pursuing long-term portfolio changes now:
- Reconsider gas suppliers
- Assess vertical integration, including upstream
- Expand market presence to create arbitrage potential
- Consider changes to partner with other importers to enlarge oppor-
tunities and ability to consume risk, and to increase bargaining powerImporters/Utilitie
s
- Value in LNG supply chain may be shifting from volume plays
seeking baseload positions to access plays seeking multiple positions
- The changing market dynamics may result in inertia with customers before
they decide on future course of actions
- Reduced access to project financing, higher financing costs, and less
clarity on project timing puts projects at risk
- Actively broker buyers and sellers to secure pre-FID investments by
segmenting and reevaluating each group
- Assess the upside potential of alternative business models for gas
infrastructure in the future:
- Will the throughput model continue to dominate?
- Is an access model based on optionality feasible?
- Aggressively take advantage to reverse capital expenditures inflation:
leverage the inevitable oversupply in contractors and materials
- Reposition projects to better align with marketplaces and tradinghubs
InfrastructureCompanies
project portfolios in line with new
forecasts. Opportunities will arise
in aggressively taking advantage oflower costs for contractor services and
materials due to oversupply in those
markets. Furthermore, this can be the
moment to initiate geographic swaps
with other players to optimize logis-
tics costs, to assess integration down-
stream to secure captive demand, and
to expand capabilities by taking over
specialized companies whose value
has dropped.
International Oil Companies (IOCs)
For the IOCs, many of the implica-tions and opportunities are similar
to those faced by the NOCs, because
they are usually part of joint ventures.
Simply put, they should be poised for
NOC-induced supply restrictions and
cost reductions. They need to cut costs
and manage working capital closely.
The opportunity for IOCs may lie
in the fact that they typically have a
portfolio of stakes in different plays
across the globe. They could optimize
portfolio benets by accelerating the
building of cross-market connectionsand capabilities.
Importers/Utilities
Demand destruction leads to reduced
revenues, especially for those com-
panies with large exposure to the
industrial segment. Players that are in
long-term take-or-pay (TOP) contracts
may experience problems in fullling
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11Booz & Company
their minimum offtake obligations.
Opportunities will arise to renegoti-
ate prices and other contract condi-tions, and chances will appear to take
advantage of increased supply on spot
markets. Nevertheless, buyers should
be cautious not to damage long-
term relationships with NOCs; they
will need these alliances in the long
term. This may also be a good time
to rebuild gas supply portfoliosfor
example, by partnering with other
importers to access new sources of gas
and share risk, or by entering existing
upstream plays, taking advantage of
the current lower valuations.
Infrastructure Companies
Clearly, for infrastructure players the
main risks are in reduced project prof-
itability and reduced access to project
nancing. Also, customers who might
otherwise be candidates for adding
LNG capacity or other pipeline assets
will tend to delay making decisions
on projects. Infrastructure compa-
nies should be aware that the value
in LNG projects may shift fromvolume plays, in which a company
seeks baseload positions, to access
plays, in which the value resides in
a companys available capacity in
multiple locations and opportunities
for optimizing arbitrage. At any rate,
infrastructure companies should take
advantage of falling prices for materi-
als, labor, and construction services to
push project costs down.
The unprecedented circumstancesin the international gas market
may also offer unprecedented
opportunities for all types of players
along the gas value chain.
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Booz & Company12
Todays worlds gas market is at an
unprecedented juncture. The world-
wide economic downturnset off by
the credit crunchhas the potential
to profoundly change the behavior of
market participants, prices, and pric-
ing structures. To a large extent, the
change that the market will experience
depends on supply decisions made
by large NOCs. Also, developments
in the production of unconventional
gas in the U.S. based on the recent
huge reserves discoveries will play a
crucial role, with a potentially shift-
ing position of the US in the global
supply/demand balance adding to the
situation of oversupply. Yet all play-
ers along the value chainsuppliers,
buyers, and infrastructure compa-
niesneed to carefully assess the
current new dynamics: Those players
who fully understand the implications
of the current market conditions and
the opportunities they may offer can
emerge from this crisis stronger than
they went into it.
ConClUSIon
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13Booz & Company
About the Authors
Otto Waterlander is a partnerwith Booz & Company based in
Amsterdam. He is the leader
of our global natural gas
practice and specializes in
strategy-based transformation
for global clients along the
energy value chain.
Robert Oushoorn is a
principal with Booz & Company
in Amsterdam. He specializes
in strategy development for
clients along the natural gas
value chain, including pro-ducers, midstream players,
infrastructure companies,
and utilities.
George Sarraf is a principalwith Booz & Company based
in Beirut. He advises our energy
and utility clients in the Middle
East on strategy development,
organizational design, and
transformation programs.
Thomas Schlaak is a principal
with Booz & Company based
in Dsseldorf. He specializes
in strategy development and
organizational design for
clients in the energy sector,
with a focus on gas producersand utilities.
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