We believe the best way to play energy is through companies whose job it is to react to change and monetize the most compelling opportunities.

Transcription

1 Cenkos News 16th January 2013 Global Energy One of our long-term themes that we have had little or no exposure to for some time now is commodities. Despite compelling, long-term opportunities being created by rapid urbanisation in the emerging markets, we have been deterred in the short-term by the way commodities and resource stocks have responded to monetary policy. Yet we do want to own commodities for the long-term and one sub-sector that has caught our attention is energy. Energy stocks have not behaved in the same way as their metals and bulks cousins. Instead of putting in market-beating performances on any hint of monetary injections, they have steadily de-rated over the past 12 months and underperformed the wider market. We believe the energy sector offers investors compelling value and a very attractive investment opportunity. This note will provide you with reasons why we believe energy is a powerful theme, insight into the changing uses of energy and how we would look to capture the potential rewards. Energy Consumption Trends Chart1. Global Energy Consumption in mtoe We believe the best way to play energy is through companies whose job it is to react to change and monetize the most compelling opportunities. natural disasters the world s thirst for energy continues to grow. If we break the global consumption data down into OECD and non-oecd economic groups we can see that OECD energy consumption is plateauing due to weaker economic activity following the financial crash, greater efficiency in energy consumption - particularly in transportation fuels and increased environmental intervention from a carbon emissions perspective. Chart 2. OECD Energy Consumption mtoe Chart 1 shows the rise of energy consumption in millions of tonnes of oil equivalent (mtoe) across the complete energy mix from Despite financial crashes and Therefore, the key drivers to global energy consumption are the industrialising non-oecd countries.

2 Chart 3. Non-OECD Energy Consumption in mtoe The Energy Mix There are also sub-trends occurring within the energy mix as consumption reacts to supply and pricing. The chart below shows how the energy mix has changed since Chart 5. Global Energy Mix Since 1990 It s no coincidence that the thirst for energy has been driven by economic development. The chart below demonstrates the strength of growth coming from the non- OECD countries relative to OECD growth that has struggled to reach pre-crisis levels. Chart 4. Economic Development (% Growth of GDP) Oil, Nothing Can Do It Better Yet! Oil remains the dominant source of fuel although its prominence has slipped. In 1990, it accounted for 39% of all energy consumed, whilst in 2011 it accounted for a smidge over 33%. The overall decline in oil s weighting within the energy mix can be based on a number of factors: high prices forcing substitution, efficiency in energy usage, carbon emissions targets etc. Despite this, the overall amount of oil being consumed continues to rise driven, again, by non-oecd consumption. Data source: World Bank We are big champions of economic development in emerging economies and the chart above demonstrates that this growth needs fuelling. The Chinese now consume more energy than the US with less than half the economic output. If we use the US as a blueprint, it s not hard to visualise Chinese energy consumption growing if the country s economic output continues to climb. Whilst we are not in the peak oil (or peak energy) camp, we do think this sort of growth will continue to put a strain on energy supplies and subsequently prices. Although OECD oil demand has fallen and continues to fall, non-oecd consumption has picked up the baton. Global activity now consumes close to 90 million barrels a day or 32 billion barrels a year. There is estimated to be approximately 1.6 trillion barrels of oil in proved reserves (i.e. oil considered accessible under current drilling & pumping technological know-how and pricing) which gives us just over 50 years worth of oil.

3 Chart 6. Global Oil Consumption in Barrels per Day Oil is getting costlier to extract with many estimating that an average price of $80 to $100 p/b is required to provide sufficient economic incentive to maintain production. Should we panic? Probably not. New discoveries, higher prices and technological advances will increase the amount of oil that is recoverable (increasing proved reserves). Chart 7 shows how these influences have increased reserves over the last 31 years. Chart 7. Proved Oil Reserves in Million Barrels of Oil Technological breakthroughs in engineering are breaking down new frontiers: Energy companies are doing on a daily basis what was thought impossible only five years ago. Source: Google Images Higher pricing encourages substitution for cheaper alternative fuels, however, substitution in power production and heating has almost been exhausted. Today, oil s main use is in transport fuels. Without a credible alternative to oil based products in powering cars, planes and shipping it s feasible that oil usage will continue to climb as demand for travel grows due to a rapidly expanding middle classes in emerging markets. A Golden Age for Natural Gas Nonetheless, many of the world s big oil basins are in decline. Most of the low hanging fruit has been picked leaving behind reserves that are either hard to get to (deep water) or in an unconventional form (tight oil 1 ). 1 Tight oil is a term given to an unconventional source of oil found in shale. It is sometimes referred to as shale oil. Its extraction uses the same hydraulic fracturing technology as shale gas. Consumption of natural gas is set to boom due to its abundance; keeping prices competitive and encouraging substitution. New extraction techniques such as hydraulic fracturing (fracking) have added unconventional sources such as shale gas to reserve totals. Natural gas is also the least carbon intensive fossil fuel and should be less affected by future policies curbing greenhouse-gas emissions. These factors, as well as rapid urbanisation, increased transportation and high prices elsewhere, are placing natural gas in a leading position as the energy source of the future. The liquefaction of natural gas has resolved a transportation problem that kept gas consumption relatively local to production sites. Approximately 58% of all inter-regional trade is done by pipeline, however, LNG terminals and additional capacity are being added at a rapid pace.

4 factors such as negative roll yields can adversely affect long-term performance in a systematic rolling investment strategy. Chart 10. The Damming Effects Negative Roll Yields Have on Performance Qatargas The world s biggest Liquefied Natural Gas (LNG) production with an output of 77 million tonnes per year. Source Google Images This is set to increase inter-regional trade and LNG s share of it. Qatar has the largest LNG export capacity in the world and there are currently twelve LNG liquefaction projects under construction, seven of these projects are based in Australia alone. No doubt eyes are firmly fixed on the lucrative Asian gas markets that are already tight following the Fukushima incident; encouraging a switch from nuclear power to natural gas. CRUD is an Exchange Traded Commodity that is designed to track the DJ-UBS Crude Oil Total Return Index which is comprised of WTI Crude Oil Futures contracts. The Index buys contracts three months out and rolls them every two months. The rolling process is systematic and doesn t involve any discretion. Data Source: Bloomberg We believe the best way to play energy is through companies whose job it is to react to change and monetize the most compelling opportunities. Under Construction: Chevron s US$52billion Gorgon liquefied natural gas project on Barrow Island, Western Australia. It is Australia s largest natural resource development. Chevron s partners include other multi-national oil & gas companies such as Royal Dutch Shell and ExxonMobile and customers Osaka Gas, Tokyo Gas and Chubu Electric. Source: Google Images Investing in Energy What is the best way to access these trends? We could buy the physical commodity in anticipation of higher prices although storing large volumes of highly combustible materials has its problems. A simpler way, if we wanted to bet on the future direction of prices, would be to buy (or sell) futures contracts. This solves the physical issues but Energy companies across the globe are reacting to changing demands and consumption patterns. Major oil & gas companies are turning to more unconventional sources of oil to improve reserves, whilst at the same time they scramble for prime natural gas assets. Some are diversifying further into renewables; recognising the longterm viability of some alternative energy sources. The bizarre thing is that the market doesn t see the utility in owning these companies. Giants such as Exxon, Chevron, BP, Royal Dutch Shell and Total S.A. are trading on single digit multiples that barely exceed their dividend yield. These companies are still able to raise their dividends at inflation beating rates, buy back their own shares and pay down debt activity that is worthy of investment in its own right.

5 It is not just the majors that are looking cheap. Exploration and Production companies (E&P) are trading on valuations that price their proved reserves as low as $10 per barrel. In reality, it would cost a Chevron or a BP closer to $20 to find, set-up and extract the same oil. It therefore makes economic sense to buy good quality E&P companies in a bid to secure additional reserves. Owning big expensive pieces of kit such as drilling rigs etc. can be an inefficient use of capital. Equipment and Service providers are able to hire out in-demand equipment at generous rates. For example, deep water drilling rigs can go for as much as $500,000 a day. Expensive Stuff: Semi submersible drill rigs can cost 10 s s millions to build or $100,000 s a day to hire. The depth of water and type of geology to be drilled are significant factors in determining the overall cost of hire. Whether to hire or not will be a decision guided by the quality of the find, its longevity and best use of a firm s assets to finance the operation. Image source: Google Images Despite this hefty price tag, service equipment providers help improve returns on investment for drilling companies by reducing their upfront capital expenditure bills, provide expertise that improves project efficiency and minimise health and safety exposures. With so much going on it can be a mind boggling sector to cover. Investment in large multi-national companies can cover most of the opportunities allowing investors to capitalise on that company s ability to monetise the commodities it extracts, processes and markets. For example, holders of Royal Dutch Shell over the past five years would be quietly pleased with their investment despite volatile oil prices and the machinations of monetary policy. Chart 11. Performance of Royal Dutch Shell B Shares (TR) Data source: Bloomberg Alternatively, investors could turn to a sector specialist and purchase their expertise through a dedicated energy fund and combine the most compelling opportunities in integrated oil & gas, equipment service provision and exploration & production. Either way, we view energy as a very attractive theme and at current prices it is cheap to get either specific or overall exposure to. Ben Byrom Cenkos Channel Islands Investment Management Ltd. Cenkos Channel Islands is a trading name of Cenkos Channel Islands Limited ( CCIL ), Cenkos Channel Islands Investment Management Limited ( CCIIML ) and the registered business name of Cenkos Jersey Limited ( CJL ). Cenkos Investment Management is a trading name of CCIIML. CCIL is licensed and regulated by the Guernsey Financial Services Commission and is a member of both the London Stock Exchange and the Channel Islands Stock Exchange. Registered Office: PO Box 222, Level 5, The Market Buildings, Fountain Street, St Peter Port, Guernsey, GY1 4JG. Registration No CCIIML is licensed and regulated by the Guernsey Financial Services Commission. Registered Office: PO Box 222, Level 5, The Market Buildings, Fountain Street, St Peter Port, Guernsey, GY1 4JG. Registration No CJL is regulated by the Jersey Financial Services Commission in the conduct of Investment Business Registered office: PO Box 419, 13 Broad Street, St Helier, Jersey, JE4 5QH. Registration No This material is for your information only and is not intended to be used by anyone other than you. This is not an offer or solicitation with respect to the purchase or sale of any security. This presentation is intended only to facilitate your discussions with Cenkos Channel Islands as to the opportunities available to our clients. 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