strategy in uncertainty - global interdependence …...this information is confidential and was...

This information is confidential and was prepared by Bain & Company solely for the use of our client; it is not to be relied on by any 3rd party without Bain's prior written consent

Strategy in UncertaintyA guide to anticipate and act in a time of uncertaintyJuly 2016

CONFIDENTIAL

This information is confidential and was prepared by Bain & Company solely for the use of our client; it is not to be relied on by any 3rd party without Bain's prior written consent 2

Strategy in Uncertainty

“Prediction is very difficult – especially about the future”- Niels Bohr, quantum physicist and Nobel Prize Winner (1922)


Objectives of these materials

• Introduce a framework and methodology to anticipate and act in times of unprecedented uncertainty

• Share some perspectives on what the signposts are indicating regarding the future energy landscape


• U.S. economy• Canadian economy• Global GDP growth• Capital markets (yield

curve, cost of capital, etc.)• Consumer preferences,

trends, and social media• Energy intensity (per

capita, per $ GDP)• Energy spend as percent of

income or revenue• Generation – utility and IPP• Transmission – electrical

wires and gas pipeline• Global and North American

petrochemical demand• Global development of

potential shale plays• Competitive activity: new

competitors, and asset builds/ expansions

• Licensing of new and existing nuclear plants

• State and federal rules on fracking and disclosures

• EPA regulations on coal-fired generation

• Federal GHG regulation• Global compact on GHG• State and federal rules and

incentives for renewables, energy efficiency, etc. (e.g. RPS, ITC, PTC)

• State and federal subsidies for alternatives to gasoline/diesel

• FERC, NERC, other regulatory body standards and rulings

• Public safety (pipeline and other), reserve margins, etc.

• Cyber-security, geopolitics, and policy

• Fracking techniques / technologies

• PE cracking technological improvements, e.g. coal to olefins

• Utility-scale renewable cost experience curve

• Electricity storage and transmission technology

• Next-gen nukes (incl. modular)

• Coal and gas turbine• Distributed generation• Energy efficiency, demand

mgmt. / response • AMI / "smart meter" /

Smart Grid evolution • New segments of demand,

e.g. long-haul trucking and North American GTL

Crude oil• Foreign imports• Energy independenceCoal• Pricing and supply • Mining and emission

regulations• Import / export dynamicGas and NGLs• Pricing and production• NGL prevalence and frac

spread (oil, NGLs vs. gas)• Fracking constraints• Gas infrastructure• Import / export dynamicsNuclear• Permitting process• Loan guarantees• Next-gen technology• Public opinion

There are many variables that can affect any business: Utility Example

Market environment TechnologyRegulation and

PolicyEnergy costs and

supply

Even if each bullet point represented one bi-modal variable would be 2^45 possible outcomes


CRUDE OIL GREEN POWERNATURAL GAS

Energy costs and supply: on just the production variable, projections vary widely

COAL

Notes: North American production onlySource: Analyst set includes EIA, IEA, Exxon, IHS, among others


And future price forecasts are ‘unusable’…

WTI CRUDE OIL HH NATURAL GAS

0

50

100

150

$200/bbl

2009 2010 2011 2012 2013 2014

Implied price (95% confidence)

Historical priceFutures priceLower confidenceUpper confidence

Source: EIA June 2016; Bain analysis (Probability values created using NYMEX market data)

0

2

4

6

8

$10/MBtu

2009 2010 2011 2012 2013 2014

Implied price (95% confidence)

Historical priceFutures priceLower confidenceUpper confidence


…As history teaches us these forecasts are often wrong

WTI CRUDE OIL HH NATURAL GAS

0/bbped pce (95% codece)toca pcee codecepe codeceues pce

Source: EIA June 2016; Bain analysis (Probability values created using NYMEX market data)

2009 2011 2012 2014 2016 2009 2011 2012 2014 2016


Strategy, as traditionally designed, is about clarity and alignment from ambition to execution at the front line

Bold, inspiring full potential ambition

Plan and routines to align the front line

Initiatives and capabilities to repeat success

Clear choices on where to play and how to win

Roadmap to Deliver Results

Ambition

Whereto Play

Howto Win

Actions that Drive to Full Potential


Roadmap to Deliver Results

Ambition

Whereto Play

Howto Win

Actions that Drive to Full Potential

In periods of heightened uncertainty, however, strategy creation can fall into common traps

Treating uncertainty as “unknowable’”Focusing only on things that can be controlled“Wait and see” stance on market changesDoubling down to protect incumbencyFew reinvention or innovation betsA bet on every square to manage riskLack of direction in front line execution

“Rifle shot” views of the futureBold, but unrealistic or vague ambitionFailure to anticipate competitionRigid pursuit of new business modelsBig and monolithic bets that create “lock-in”Little or no focus on risk managementHeads down and rigid execution

UNDERCONFIDENCE OVERCONFIDENCE

Modified approach is needed


Dealing with Future uncertainties

• The primary means of forecasting by most companies, analysts, and economists today consists of:- Development of a base case (usually based on significant analysis of 3-5 variables

and building a “story” for why that is the most likely- Adjustment of variables to create a “high case” and a “low case”

• Shell created a different concept of “scenario analysis,” which takes 3-5 reasonably likely scenarios, and then builds potential strategies around each scenario, putting probabilities against them and using those to include into hurdle rates for investment decisions

• We have developed a new approach that identifies the “extreme, but plausible corners” of an infinite cube of scenarios. This approach allows us to identify clearly the variables that matter most, set them as “signposts” and monitor for disruptive “tipping points”. There is tremendous economic value to be created if you can see a disruption coming 3-5 years ahead of competitors


Source: IC Insights; ICE Status; Electronic Design; Singularity University

Among economic signposts, experience curves are important to monitor as they highlight “tipping points”

VHS tape becomes

mainstream

DVD is introduced and laserdisc stops production 2 years

laterLaserdisc

offers alternative to

VHS

Streaming technology disrupts music and video

industry


Consumers adopt new technology once its capability and price become more attractive than its predecessor

Note: Videos and DVDs - DVDs and VHS. Includes digital downloads. Music CDs, digital downloads, and streaming services; Forrester ecommerce estimates based on any purchase paid for online (regardless of whether delivered or picked up in store); Source: Forrester; Bain analysis

Legend

ActualPrediction using Forrester forecast

Historical Forecast

MUSIC: ECOMMERCE PENETRATION

VIDEOS & DVDS: ECOMMERCE PENETRATION

Historical Forecast

Legend

ActualPrediction using Forrester forecast

The growth of iTunes, founded

in 2001, contributed to

the acceleration of ecommerce penetration in

music.


Unless there are substitution barriers which may slow penetration

Source: NASA, Financial Times

NORTH DAKOTA FLARING

• Low Gas Prices caused rigs to rapidly shift to “wet” plays

• However, midstream infrastructure was not in place…thereby creating a substitution barrier

• As a result, gas was flared and WTI crude prices decoupled from Brent.

FLARES VISIBLE FROM SPACE

Bakkenformation

Eagle Ford

North

• Bakken flaring burns more than $100 million per month (~30% of production)

• Bakken flares are being replicated in other shale regions, including Texas

• As rail and other infrastructure has been put in place, the WTI/Brent spread has narrowed


We assess the strategic implications in order to understand potential actions to take, now and in the future

ENERGY EXAMPLE


As an example, we developed 8 “corner scenarios” for energy markets

U.S. Energy consumption (Qbtu)

2030 EIA Reference

Hydro-carbon Starved

Gas Land Oil Rebirth

Hydro-carbonWorld

Green Nirvana

Green Power

Feuding Fuels

Green Mandate

1 2 3 4 5 6 7 8

No imports


Collectively, these scenarios covered a wide range of volumes and prices

$60/bbl

$120/bbl

$4/MMbtu

$10/MMbtu

CRUDE OIL NATURAL GAS

Green Nirvana

Green Nirvana

Gas Land

Oil Rebirth


Signposts (the variables most important for identifying disruption) were set to “extend the headlights”

Global Oil Signposts

• Iraq production• Brazil deepwater

production• Other conventional

production• North America Production

• OPEC production levels and spare capacity

• Oil consumption in developed nations

• Economic growth in emerging markets

OPEC’s Influence Demand GrowthProduction Growth

Basin Productivity• Initial production

rates• Drilling days / frack

stages• Well depletion rates• Number of wells

Supply Chain Capacity

• Monthly rig count• Dry vs. wet rig

deployment• Rig costs (day rates

& breakeven)

Access & Regulations• Current and proposed

fracking restrictions• Federal acreage

open/leased• Drilling applications &

permits

Available Resources• Current and

forecasted EUR• Planned E&P capital

investment • Price differentials

(basin vs market)

North America Production Metrics


Watching the signposts on cost of tight gas allowed us to see the explosion three years before everyone else

Signposts indicated viability

The world began to

notice shale gas’ disruption

ANALYSTS DID NOT PAY ATTENTION TO FRACKING UNTIL IT

WAS DISRUPTIVEE-CURVES SHOWED THE COMING

DISRUPTION OF SHALE

1

2

5

10

20

50

100

10 20 50 100

200

500

1,00

0

2,00

0

5,00

0

10,0

00

2007 price

2006

2004

Slope = 72%

Cumulative # of wells drilled

SWN Fayetteville shale gas well costs

($/Mcf)

2007 price

20152014

2013 20122011

20102009

2008

2007

2005

Note: 2013-15 $/Mcf costs based on % improvement in break-even oil costs over the same periodSource: Argonne National Lab, EIA, Google Trends, The Atlantic, SWN company financials; EIA; Rystad; Company websites and press releases; Bain analysis


We saw the same pattern in tight oil…

Note: Well cost is weighted average well cost, pads and single wellsSource: Rystad; Continental Resources; EIA; Company websites and press releases

Eagle Ford breakeven oil prices ($/bbl)

~15% cost decline (’14-’15)


Estimated 2030 crude

demand

And suggested in 2012 that low cost supply was likely to exceed demand, affecting global clearing prices

4020 60 90

Source: Rystad, IEA, Advanced Resources Int’l, BP Energy Outlook 2030, Bain Analysis

0 8070503010

Cost of production/import(2012 $/bbl)

Crude production (MBD)

2030

2012 average oil price

2016 crude

demand

0550500$5dde ast ad caussaS cosa co couopeO tgt oustaaca Caada y S sa GC


And noted throughout 2014 that over-supply situations led to price declines between 30% and 70%

1986 1991 1998 2001 2008

Source: EIA, IEA

Change in production

Change in consumption


Strategies using this approach have a number of advantages

• Strategies are developed that are robust under multiple scenarios-Clear “no regrets” moves

• Strategies have built-out element of optionality

• Improved capability to monitor the environment provides visibility 3-5 years out into the future further than today’s strategies

-Experience curves-Substitution barriers-Key Technological developments

• Clear decisions are triggered when signposts flash “red” prior to imminent change in the environment

• Signposts accord greater time to execute and adjust


Objectives of these materials

• Introduce a framework and methodology to anticipate and act in times of unprecedented uncertainty

• Share some perspectives on what the signposts are indicating regarding the future energy landscape


Some key questions to consider for the future mix and pricing of energy:

• We have seen why prices have dropped dramatically for both gas and oil, but why have they nearly doubled from their lows over the past few months? What does that imply for the future?

• The disruptive nature of tight oil and gas experience curves is now well known. Are there other disrupters or major tipping points that are likely to come over the next few years?

• Will the history of past boom and bust cycles in the oil industry hold for the future, or are other forces going to change the dynamics?


Dropping NA supply, and disruptions to supply, have been a primary driver of price increases the past few months

0

500

1,000

1,500

2,000

2,500

3,000

Kuwait Canada North Sea Nigeria US Argentina GhanaItaly Columbia Libya Brazil Abu Dhabi Iraq/Kurdistan

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Kirku

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Baghdad’s decision to halt pumping oil from Kirkuk into Turkey

Canadawildfire

Thou

sand

bar

rels

per

day

US rig counts have now started to move up

7,7007,9008,1008,3008,5008,7008,9009,1009,3009,5009,7009,900

WeeklyMonthlyWeekly production plus balancing term

SUPPLY DISRUPTIONS US PRODUCTION

Source: Goldman Sachs


Another potential disruptor is change in energy sources for demand applications (power and transport)

DEMANDSUPPLY INTERMEDIARY

Source: US Energy Information Administration, Bain analysis

Percent of sources

Percent of sectors

• Transport• Conversion• Storage

100

9

9241453

<19

28333

4

2372

1

35

91

11

5

13

15

39

92

1

26

3

44

761

7

22

37


25

50

100

200

500

1,000

$2,000

10 20 50

'15'14

'13

Cumulated produced capacity (GWh) [Log Scale]

Li-ion battery/cell cost ($/kWh) [Log Scale]

'12

Slope: = 75%

Li-ion batteries will likely be one of these disruptors as costs continue to trend down the experience curve

RECENT TRENDS SUGGEST ~25% REDUCTION IN COST FOR EVERY DOUBLING OF PRODUCTION

Note: This only includes cell cost; Cost in $2015 Source: Bloomberg New Energy Finance, Deutsche Bank, Bain DER analysis; CEMAC; FS-UNEP Global Trends in Renewable Energy Investment 2016


These trends suggest price parity for electric vehicles in the near-term

0

10,000

20,000

30,000

40,000

50,000

2013 2016 2019 2022

MSPR ($US)

200 mile EVToyota Camry

0

10,000

20,000

30,000

40,000

50,000

15' 16' 17' 18' 19' 20' 21' 22'

MSRP + 5 year TCO ($US)

200 mile EVToyota Camry

TCO PRICE PARITY FOR EV EXPECTED BY 2020

PURCHASE PRICE PARITY FOR EV EXPECTED BY 2022

Source: Ark Investment Management


As electric vehicle prices reach parity, consumers will increasingly adopt electric vehicles

Purchase price parity

TCO parity

Source: Bloomberg New Energy Finance; Ecowatch; ICCT

Brazil’s adoption of flex-fuel vehicles was much more

rapid, reaching 94% of new car sales in 2013


Battery enhancements will also enable increased energy storage for alternative energy

…INCREASING ALTERNATIVE ENERGY APPEAL AS THESE TECHNOLOGIES RAPIDLY

COME DOWN THE LEARNING CURVE

AS BATTERY PRICES FALL, ALTERNATIVE ENERGY WILL INCREASINGLY BE PAIRED

WITH BATTERIES…

0

200

400

600

800

1,000

1,200

1,400

2015 2020 2025 2030 2035 2040

Total GW capacity

Cumulative small-scale solarSolar without batteriesSolar paired with batteries

Source: Cleantechnica; Lazard Levelized Cost of Energy Analysis 9.0; GWEC

0

100

200

300

LCOE ($/MWH)

09' 10' 11' 12' 13' 14' 15'

WindSolar


All this will decrease demand for fossil fuels and impact oil/gas prices moving forward

-15

-10

-5

0

2015

0

2020

-1

2025

-3

2030

-7

2035

-11

2040

-13

Expected Mb/d oil offset by EVs

Source: Bloomberg New Energy Finance; Ecowatch; IEA

0

25

50

75

100

125

150

2015 2020 2025 2030 2035 2040

Global oil and liquids demand

EVS EXPECTED TO REDUCE OIL DEMAND CONSIDERABLY…

…BUT CURRENT DEMAND FORECASTS MAY NOT TAKE S-CURVE INTO ACCOUNT

IEA expects relatively flat line growth in oil

demand

Decreasing demand for oil should

maintain lower oil prices

Potential for Peak Oil Demand in mid 2020’s


Additionally, fuel cells could further disrupt the oil and gas marketplace

ADVANTAGES OF FUEL CELLS FUEL CELL ADVANCEMENTS

• Higher efficiency than diesel or gas engines

• Zero pollution

• Faster refueling than EVs

• Greater range than EVs

• Potential weight advantages

• Toyota has spent an estimated $8.8B and 20 years developing fuel cell technology

• In 2015 Toyota released the Mirai, one of the first commercial fuel cell vehicles

• Toyota also announced royalty-free use of approximately 5,680 fuel-cell-related patents to encourage innovation

As fuel cell costs come down, fuel cell vehicles could further disrupt oil prices and overall mix of energy sources

Source: Toyota; SeekingAlpha


Given the emergence of these signposts, what does this mean for the energy market?

• Short term uncertainty will remain within the energy market- Typical approaches to forecasting will provide false accuracy

• Comparative changes in costs of alternative technologies will provide guidance around future trends. Tracking experience curves for key technologies can highlight when “tipping points” will be reached.

• More specifically, Li-ion batteries will continue to become more cost efficient, allowing EV’s to displace traditional gas powered vehicles

• Solar/Wind energy will increasingly use these batteries to improve alternative energy storage while they become more cost efficient

• These newer technologies will offset demand for traditional fossil fuels, putting continual pressure on prices and margins (assuming no major supply disruptions)

• Trends in other emerging technologies (such as fuel cells) will need to be monitored to spot disruption before it happens


Appendix


Real breakthrough in storage will come with next generation batteries (not expected until ~2030)

Source: DOE Electricity Advisory Committee, BCC Research, Electrical Power and Research Institute (2010)Notes: “Other” includes flow batteries, lead acid, and thermal peak shaving (i.e., ice storage)

Experience curve effect

BY 2020, BATTERIES STILL NOT COST COMPETITIVE WITH PEAKERS FOR

LARGE-SCALE PLACEMENT

NEW LI-ION TECHNOLOGIES PROMISE HIGHER POWER DENSITIES, BUT THE

TRUE BREAKTHROUGH WILL BE LI-AIR

1860 1910 1960 2010 2020 2030

Lead-Acid

25-45

Nickel-Iron

30-40

Nickel-Cadmium

35-60

Nickel-Metal

Hybride50-75

Lithium Ion

110-140

Li-ion w/ SiNanowire 400

Li-Air~4000

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