|
Article Excerpt
The energy markets, over the past few months, proved that they are not immune to the travails of the economy. Lower crude prices, the woes of the credit market, and diminishing demand have conspired to sink oil prices, reflecting a pullback that is being experienced throughout the broader energy market. And the slump in one area impacts another, underscored by the questions facing alternatives, which no longer seem as compelling alongside cheaper traditional fuels.
Mergers & Acquisitions brought together top names in the space to discuss the tectonic shifts facing the energy markets. The conversation focused first on the regulatory environment and then moved to what it all means for dealmaking. Taking part in the discussion were Greenhill Capital's Frank Pottow, Pine Brook Road Partners' Craig Jarchow, Douglas Korn of Irving Place Partners (FKA: Bear Stearns Merchant Banking), Debevoise & Plimpton's Maurizio Levi Minzi, and Harris William & Co.'s Andrew Spitzer. The following is an edited version of the discussion.
Mergers & Acquisitions: Since the volatility seen in the energy market has seemed to take a lot of people by surprise, historically has energy operated in its own cycles, similar to healthcare, or was the precipitous drop in oil and gas prices something that could have been expected in light of the economy's downturn?
Jarchow: Of course, you are going to have the fundamentals of supply and demand. And we are headed toward a time of economic weakness, so we are seeing a reduction in both oil and gas prices. In a sense, this was predictable because this is a cyclical business.
What you want to do in a downcycle is make sure that you are not long assets or long inventory. You want to be in a position in which you can play the margins in oil and gas, because when you get a reduction in prices, you also see service costs decline. There is a delay in the reduction of service costs, but if you are long assets or long inventory, it's not so easy to play that.
So, as investors, we try to be asset and inventory light. You don't want to pay for reserves. If you avoid large reserve or asset transactions at a peak, you'll be in position to play the margin when the prices go down.
Mergers & Acquisitions: Given the rapid fall, can we now safely say that the record prices in oil were driven by speculation, or was oil, at $147 per barrel, representative of a fundamental peak, driven by supply and demand?
Pottow: Picking up on Craig's earlier point, oil and gas are cyclical commodities. They are driven in part by supply and demand, but when you talk about supply-and-demand fundamentals, you have to ask about the timeframe. Are you talking about a long-term, secular trend or are you talking about a shorter term, cyclical trend? Or are you talking about an extremely short-term capital flow? I think those questions are all very different.
For example, the longer-term supply trends might focus on deliverability or the relative state of production by the global energy players. For demand, those trends will be driven by the economy, so to assume that the industry is recession proof is ridiculous.
Look at natural gas: You'll have shorter term trends, such as inventories. Natural gas is stored in the summers to be used in the winter, and those inventories are very important, and may play a bigger role in prices than deliverability or overall growth and demand.
Then you have an even shorter term timeframe when look at the growth in what you might call speculative inventories, which is the capital flow within the sector. You had a period that started in 2002 until about June 30, 2008 in which there was a phenomenal increase in the amount of capital investing in commodity-related investments; energy-related investments in particular.
I think what we're seeing now is that there are three different trends playing out. Supply and demand will go up and down over the three different timeframes and sometimes they exacerbate the other. What we have seen during the past three months is an exacerbation of all of those trends. Global demand is going down, and is expected to go down in the face of a very pronounced global recession. You have an increase in deliverability of supply, because over the past five years energy companies have invested substantially more capital, increasing the productive capacity. Oil at $140 per barrel made those projects look very attractive. Also, a lot of energy companies, particularly mid-sized companies in the US, had capital expenditure budgets well in excess of their annual cash flow, so that only added to the deliverability, which typically has a lag effect.
I also think you have seen a dramatic unwinding of what might be considered speculative investment positions. And if these investments are leveraged, margin calls could further drive liquidity away from the sector. But all of those are important factors.
Korn: There is a distinction between oil and gas, since oil is a part of the worldwide economy and is traded globally. Gas is largely a North American phenomenon. There is some importing of LNG (liquified natural gas), but it's really a North American play.
The long-term dynamics of oil - from a demand point of view - would seem to be strong. A year ago, people were caught up in the euphoria of the emerging markets and the demand coming from areas like China, Russia and India, which seemed to have this relentless thirst for oil. While to some degree it's true, that euphoria was short lived because we seeing demand destruction come from two things: the high prices and the economic downturn. So on the oil side, despite the demand equation, the sentiment is heading in the wrong direction for many of the reasons Frank described.
Gas, though, is largely a North American market. There has been a tremendous amount of capital flowing into North American gas, so I think...
|
