What I Plan to Present to Energy’s Biggest Players at Windsor Castle: Part I

by | published March 3rd, 2015

Greetings from London!

I’ve made the trip “across the pond” to address the Annual Energy Consultation of the Windsor Energy Group (WEG).

This highly exclusive series of private meetings is held at Windsor Castle outside London, and features some of the most gifted and powerful energy minds in the world.

Once again, Marina and I will be taking you inside.

This is the seventh year I have addressed this high-level meeting. WEG was founded under a royal charter from Queen Elizabeth II, and the annual conclave occurs while the royal family is in residence at Windsor, the oldest inhabited castle in the world.

It brings together some of the major energy figures from six continents, along with policy makers, private sector leaders, and ambassadors.

As is custom, these discussions will take place under Chatham House rules. Those rules dictate that the conclusions and themes can be made public, as long as the opinions aren’t attributed to named individuals.

These rules allow for frank exchanges, which rarely happens at other high-powered gatherings.

These are the folks who will decide what the energy market looks like over the next 12 months.

And what I learn here will give us a rare (and profitable) peek into where the energy market goes from here…

Given London’s leading position as the international location of choice for raising capital in the energy markets, what I learn here will be invaluable. More energy-related deals are funded in London than anywhere else in the world.

In fact, as significant new market developments collide, the importance of “The City” (London’s financial district) in funding major energy projects will be tested in 2015.

As it turns out, the topics I’m going to address involve several of these same issues.

Addressing a $5 Trillion Global Problem

I have been invited to brief the assembled notables on three vital aspects of the current energy market: infrastructure, consolidation, and debt. Each is fundamental to the capital structure that’s essential to a world that’s increasingly hungry for energy.

Today’s issue will coverthe first two items, while our next discussion will address the 800 lb. gorilla in the room – the worsening energy debt picture.

First, the infrastructure crisis is intensifying. Across the globe, the absolute majority of the physical assets needed in the upstream-midstream-downstream process must be replaced. In addition, billions of people remain without access to electricity, heat, or transport fuel.

The combination of replacing what exists along with what is needed will cost anywhere from $2 to $5 trillion between now and 2035. The lower figure is what’s needed to keep pace with expected demand in places that already have access to energy. The higher figure includes adding a minimum connection to those currently without.

So where will all of these trillions be coming from?

Some will be provided by private sector entities “in the business” of providing energy. Meanwhile, other financing will be obtained from sovereign wealth funds (especially in oil-producing countries), national and state-owned oil and power companies, major energy holdings, and an array of ancillary elements that require reliable power for industry, commerce, and services.

However, a disturbing trend has emerged. Even at the “lowball” estimates, we are coming in at least 40% short of what must be provided, with the chasm becoming even deeper if the higher financing projections are used. This shortfall promises to have significant (and unsavory) consequences.

Rather than using the need to replace and upgrade the infrastructure as an opportunity to design a more efficient and diversified network, too much of the “new” infrastructure will resemble the old. That will only increase the damage to the environment as fossil fuels remain the fuel of choice, and as the system continues to rely on a patchwork of ineffective components.

Of particular concern here is Asia, where the preponderance of global energy demand will move over the next several decades. To keep the lights on in this area of the world, dirty low-grade coal and a deteriorating delivery system for oil and natural gas products will be the only real options.

In that scenario, those currently cut off from energy would continue to have none. To borrow a phrase from Karl Marx, that would leave a rising “lumpen” population literally in the dark, unable to participate in any genuine economic promise, and becoming ripe recruits for more radical solutions.

Finally, the inability to prevent the current system from collapsing will increasingly require more of the cost to be borne by end users. In what may be a harbinger of wider things to come, the spiraling energy costs paid by European consumers may well be the experience elsewhere, as rising electricity and fuel prices become the norm as a “solution” to fix the infrastructure.

Low Oil Prices and High Debt Fuels Consolidation

The second factor is consolidation, which is already well underway among oil companies, thanks to an almost 60% slide in crude prices through the end of last year.

That decline is now over and oil is rising slowly. But the M&A consequences of the drop are just getting started.

The fourth quarter of 2014 saw the first wave in this trend, following the $44 billion consolidation at Kinder Morgan Inc. (NYSE:KMI) and the $34.6 billion merger of Halliburton Co. (NYSE:HAL) and Baker Hughes Inc. (NYSE:BHI).

Even so, the action in 2015 promises to be much heavier, involving a rising number of companies.

Here’s why: In the oil patch, larger companies tend to absorb smaller ones to book their reserves. Put simply, the share prices of the big boys are based upon reserves in the ground, not the current production already working its way through the system. And the current environment of low oil prices and higher debt encumbrances have combined to put a number of companies in harm’s way.

That makes them ready targets for consolidation. The better the current field and project assets are, the more attractive the target.

Given the often complicated property ownership and debt carryovers, this consolidation may result in bothfewer players and a range of spin-offs. In all probability the spin-offs will emphasize midstream assets ending up as separate companies, with some contractual preferences coming from former parent companies.

But the terrain will be changing, and the participants along with it.

The third development I am presenting at Windsor may be the most disturbing. It has the potential to single-handedly create an energy crisis, so it’s best that we spend some time discussing it on its own.

For those who missed the derivative-fueled mortgage backed security mess of a few years ago, don’t despair. Energy debt is worsening.

In fact, what’s now emerging in energy may just make that episode pale in comparison.

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