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Perspective

Otto Waterlander

Robert Oushoorn

George Sarraf

Thomas Schlaak

Robert Oushoorn George Sarraf Thomas Schlaak An Unprecedented Market How the Recession Is Changing the
Robert Oushoorn George Sarraf Thomas Schlaak An Unprecedented Market How the Recession Is Changing the

An Unprecedented Market How the Recession Is Changing the Global Gas Market

Oushoorn George Sarraf Thomas Schlaak An Unprecedented Market How the Recession Is Changing the Global Gas
Oushoorn George Sarraf Thomas Schlaak An Unprecedented Market How the Recession Is Changing the Global Gas
Contact Information Abu Dhabi Raed Kombargi Partner Düsseldorf Thomas Schlaak +971-2-699-2400 Principal

Contact Information

Abu Dhabi Raed Kombargi Partner

Düsseldorf Thomas Schlaak

+971-2-699-2400

Principal

raed.kombargi@booz.com

+49-211-3890-245

thomas.schlaak@booz.com

Amsterdam Otto Waterlander Partner

Houston Andrew Steinhubl Partner

+31-20-504-1950

+1-713-650-4183

otto.waterlander@booz.com

andrew.steinhubl@booz.com

Robert Oushoorn Principal

London Jake Melville

+31-20-504-1981

Partner

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Arlington, VA Dan Gabaldon Principal

McLean, VA Eric Spiegel

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Beirut Ibrahim El-Husseini Partner

Munich Walter Wintersteller

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walter.wintersteller@booz.com

George Sarraf Principal

Shanghai

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Nick Pennell

george.sarraf@booz.com

Partner

+86-21-2327-9800

Dallas

nick.pennell@booz.com

Christopher Click

Principal

+1-214-746-6543

chris.click@booz.com

EXECUTIVE SUMMARY Because of the economic recession, for the first time in the history of

EXECUTIVE

SUMMARY

Because of the economic recession, for the first time in the history of international gas markets significant 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 buyer’s 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 flows.

ThE RECESSIon’S IMpACT Since international natural gas markets began to develop in the 1960s, gas

ThE RECESSIon’S IMpACT

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 influence the course of the market. And the recession may not challenge each 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.

SCEnARIo 1: ThE AgEnCIES’ ConSEnSUS Scenario 1 is a relatively optimistic forecast built from outlooks

SCEnARIo 1:

ThE AgEnCIES’ ConSEnSUS

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, emerging economies 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.

Exhibit 1 Gas Demand Destruction under “The Agencies’ Consensus” Scenario

GAS DEMAND DESTRUCTION IN 2009 (%)

2% 2% 2% 2% 0% 0% -2% -2% -3% -4% -5% OVERALL IMPACT -8% Developed
2%
2%
2%
2%
0%
0%
-2%
-2%
-3%
-4%
-5%
OVERALL
IMPACT
-8%
Developed Countries
Emerging Markets
Total World Market
Power Generation
Industrial
Residential
Weighted Average

Source: IEA; EIA; IMF; Booz & Company analysis

SCEnARIo 2: IndUSTRIAl pRodUCTIon This scenario is based on the tradi- tional strong linkage between

SCEnARIo 2:

IndUSTRIAl

pRodUCTIon

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.

Exhibit 2 Gas Demand Destruction under “Industrial Production” Scenario

GAS DEMAND DESTRUCTION IN 2009 (%) 0% 0% 0% -3% -4% -4% -8% -10% OVERALL
GAS DEMAND DESTRUCTION IN 2009 (%)
0%
0%
0%
-3%
-4%
-4%
-8%
-10%
OVERALL
IMPACT
-13% -13%
-17% -17%
Developed Countries
Emerging Markets
Total World Market
Power Generation
Industrial
Residential
Weighted Average

Source: IEA; EIA; IMF; Booz & Company analysis

A MARkET In oVERSUpplY Independent of which scenario proves to be more accurate, a bleak

A MARkET In oVERSUpplY

Independent of which scenario proves to be more accurate, a bleak picture is emerging. Worldwide demand for natural gas will be set back by at least two and perhaps as many as nine years (see Exhibit 3).

In Booz & Company’s view, it may take until after the middle of the

Exhibit 3 World Gas Demand 2006–2020 Under Different Scenarios

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

bcm

Prerecession 3,400 Outlook Agencies’ 3,300 Consensus Scenario 3,200 3,100 3,000 Industrial 2,900 Production
Prerecession
3,400
Outlook
Agencies’
3,300
Consensus
Scenario
3,200
3,100
3,000
Industrial
2,900
Production
Scenario
2,800
2,700
2,600
9 years
2,500
2,400
2006
2007
2008
2009
2010
2011
2012
2013
2014
2015
2016
2017
2018
2019
2020
GAS DEMAND DESTRUCTION (BCM)
2011
2015
2020
Agencies’ Consensus Scenario
95
101
110
Industrial Production Scenario
395
422
461
Source: IEA; Booz & Company analysis
year once the recession is over, a pre–economic crisis forecast that, by and large, incorporated

year once the recession is over, a pre–economic crisis forecast that, by and large, incorporated changes in gas demand driven by environmental considerations and energy efficiency 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

Exhibit 4 Global Supply Demand Overview 2008–2015

normal economic growth. Indeed, future economic growth may be constrained in many of the major economies by the large deficits 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 financing, a substantial number of new gas infrastructure development projects 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 final investment decision (FID),

3,200 3,000 5%–15% surplus 2,800 2,600 2,400 200 0 2008 2009 2010 2011 2012 2013
3,200
3,000
5%–15% surplus
2,800
2,600
2,400
200
0
2008
2009
2010
2011
2012
2013
2014
2015
Maximum Surplus
269
444
410
423
407
383
338
(bcm)

Gas sources

Production from current fields and infrastructure

Conventional pipeline

LNG

Unconventional

Demand in Agencies’ Consensus Scenario

Demand in Industrial Production Scenario

Source: IEA, Navigant Consulting, Oil & Gas Journal, Booz & Company global gas model, Booz & Company analysis

now not expected for a few years. If we assume that all projects currently pre-FID

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 supply–demand 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 in North 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

(liquefied natural gas) imports to meet its demand for gas, partially providing the basis for a number of gas liquefaction projects around the world. If, however, the U.S. becomes self-sufficient 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 already have a final investment decision are completed, a situation of oversupply develops that may last until well into the next decade.

nAVIgATIng ThE dIffICUlT lAndSCApE The global gas market has rapidly shifted from favoring sellers to

nAVIgATIng ThE dIffICUlT lAndSCApE

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 structures and buyer behavior in the longer term, with gas prices potentially decoupling from oil prices.

The second option—sitting out the storm—therefore 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 exporters to 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 influence 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 global supply 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 production reductions.

IMplICATIonS And oppoRTUnITIES Today’s global natural gas market environment is highly uncertain. Yet with careful

IMplICATIonS

And

oppoRTUnITIES

Today’s global natural gas market environment is highly uncertain. Yet with careful consideration, sellers and buyers may find that the current situation can also provide interesting opportunities for carving out advantageous positions (see Exhibits 5 and 6).

Exhibit 5 Implications and Potential Considerations for Sellers

National Oil Companies (NOCs)

With lower-than-expected produc- tion and revenue, project profitability 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

Sellers
Sellers

NOC

IOC

IMPLICATIONS

- 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

- 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

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 capabilities—e.g., via acquisition of specialized IOCs or contractors

- Position for and respond to likely NOCs-induced supply 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

Source: Booz & Company analysis

project portfolios in line with new forecasts. Opportunities will arise in aggressively taking advantage of

project portfolios in line with new forecasts. Opportunities will arise in aggressively taking advantage of lower 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

Exhibit 6 Implications and Potential Considerations for Buyers

across the globe. They could optimize portfolio benefits by accelerating the building of cross-market connections and 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 fulfilling

Buyers
Buyers

Importers/Utilities

Infrastructure Companies

IMPLICATIONS

- The changed market offers opportunities to diversify imports and/or access gas as we move away from a supplier’s 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 customers—e.g., large industrials and power generators—will try to benefit by seeking lower-priced gas

- 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

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 power

- 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 trading hubs

Source: Booz & Company analysis

their minimum offtake obligations. Opportunities will arise to renegoti- ate prices and other contract condi-

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 portfolios—for 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 financing. 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 from “volume” plays, in which a company seeks baseload positions, to “access” plays, in which the value resides in a company’s 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 circumstances in the international gas market may also offer unprecedented opportunities for all types of players along the gas value chain.

ConClUSIon Today’s world’s gas market is at an unprecedented juncture. The world- wide economic downturn—set

ConClUSIon

Today’s world’s gas market is at an unprecedented juncture. The world- wide economic downturn—set off by the credit crunch—has 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 chain—suppliers, buyers, and infrastructure compa- nies—need 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.

About the Authors Otto Waterlander is a partner with Booz & Company based in Amsterdam.

About the Authors

Otto Waterlander is a partner with 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 principal with 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 Düsseldorf. He specializes in strategy development and organizational design for clients in the energy sector, with a focus on gas producers and utilities.

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