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  • 8/8/2019 An Unprecedented Market

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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

    [email protected]

    Amsterdam

    Otto Waterlander

    Partner

    +31-20-504-1950

    [email protected]

    Robert OushoornPrincipal

    +31-20-504-1981

    [email protected]

    Arlington, VA

    Dan Gabaldon

    Principal

    +1-703-902-5890

    [email protected]

    Beirut

    Ibrahim El-Husseini

    Partner

    [email protected]

    George Sarraf

    Principal

    +961-1-985-655

    [email protected]

    Dallas

    Christopher Click

    Principal

    +1-214-746-6543

    [email protected]

    Dsseldorf

    Thomas Schlaak

    Principal

    +49-211-3890-245

    [email protected]

    Houston

    Andrew Steinhubl

    Partner

    +1-713-650-4183

    [email protected]

    LondonJake Melville

    Partner

    +44-20-7393-3425

    [email protected]

    McLean, VA

    Eric Spiegel

    Partner

    +1-703-902-3813

    [email protected]

    Munich

    Walter Wintersteller

    Partner+49-89-54525-540

    [email protected]

    Shanghai

    Nick Pennell

    Partner

    +86-21-2327-9800

    [email protected]

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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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    when he established the rst management consulting

    rm in 1914.

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    around the world, we bring foresight and knowledge,

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