UNIVERSITY OF CAPECOASTSCHOOL OF BUSINESSACCOUNTING AND FINANCE

BUS 407: OIL AND GAS FINANCE AND MANAGEMENT By John G. GATSI

Copyright 2009 Pearson Prentice Hall. All rights reserved.

JOHN GATSI 2011 OIL and GAS FINANCE, UCC12-*

JOHN GATSI 2011 OIL and GAS FINANCE, UCC

Source: US Department of Energy and Natural Gas WeekCrude Oil and Natural Gas Prices (2007-2009)

It also deals with factors determining the demand and supply of energy resources and commodities.Let us remember that energy is neither created nor destroyed but can be converted from one form to another.- Wind energy, solar energy, Hydro related energy , energy from the burning of coal and fire wood.Note that the demand for energy resources is derived demand and may be influenced by cost of conversion, available technologies and possible alternativesThus human beings are key in discussing energy in general and oil and gas in particular

Storage and Depletion of Energy ResourcesEnergy resources can be depletableEnergy resources can be stored Some energy resources may be non storableSome energy resources may be renewedThus extraction and use of energy resources for domestic and industrial purposes must be driven by forward looking policies to save future generations

JOHN GATSIJOHN GATSI

Energy Commodities12-*Energy commodities are those commodities which can provide or are capable of providing energy services for human activities, such as lighting,water heating, cooking, automotive power, etc.Example:Gasoline, diesel fuel, natural gas, propane, coal, or electricity , aviation fuel , Kerosine, Liquified natural gas ( LPG)

Energy ResourcesJOHN G. GATSI 201112-*They are the resources from which energy commodities are generated ExampleCrude oil, natural gas, coal, biomass, hydro, uranium, wind, sunlight, or geothermal deposits

JOHN G. GATSI 2011

Types of EnergyJohn G. Gatsi 201112-*Chemical energy (e.g., oil, natural gas, coal, biomass), Mechanical energy (e.g., wind, falling water), Thermal energy (geothermal deposits), Radiation energy (sunlight, infrared radiation), Electrical energy (electricity), Nuclear reactions (uranium, plutonium.)

John G. Gatsi 2011

Derived Demand for Energy CommoditiesGATSI 2011 JOHN G. GATSI12-*Is the demand for energy commodities derived demand? - YESWhy? Do you buy gasoline and keep in your house because you want it? Then why? Because you need it for your car or vehicle to travel. Thus demand for gasoline is derived demand

GATSI 2011 JOHN G. GATSI

Are energy commodities substitutes?Yes, because one can use natural gas to power an automobile or gasoline, diesel even alcohol etcThe level of substitution depends on technologyThus some vehicles use both gasoline and natural gas but others do not

Are energy commodities necessity 12-*To a large extent yes because human life and human economic activities depend perfectly on one form of energy or the other.It is now clear that oil and gas is part of energy resourcesSo what is the difference?

History of Global oil and gas IndustryWe could trace the emergence of oil and gas even before the birth of Christ In the primitive ages in the Middle East especiallyWe can also trace oil and gas to the time of Herodotus, in 450 BC, 347 AD in China

However, the focus is on when we have a vibrant oil and gas industry in which prices are determined, demand and supply conditions guide the marketAlso where trading transactions are arranged in an organised mannerWhere oil drilling companies emerged and oil marketing companies serve as distribution channels to the consumers

The global oil and gas industry is based on non-renewable energy resources

Modern Oil and Gas IndustryThe modern oil industry started 1859 with the first oil drilling in Titusville, Pennsylvania, in the US . In 1901, drilling of huge quantity of oil started in East Texas.In 1870, John D. Rockefeller established the Standard Oil Company in Cleveland, Ohio, to compete with the existing competitorsIn 1911, Standard Oil was spinned -off into smaller companies monopoly was made illegal under the Sherman Anti-trust Act of 1890

John Gatsi @ Oil and Gas Finance & Mgt 2011 School of Business, UCC12-*Three oil companies, Exxon, Mobil and Chevron were formed as a result

In 1890s Royal Dutch started producing oil in Indonesia Shell Transport and Trading distributed and sold kerosene in Russia and the Far East. In 1907, Shell and Royal Dutch merged become the Royal Dutch ( Shell Group)Due to fall in oil prices in the 1920s after World War I, Standard Oil of New Jersey (Exxon), Royal Dutch Shell and Anglo-Persian (BP) met in Scotland, in 1928 with plans to share the world markets

John Gatsi @ Oil and Gas Finance & Mgt 2011 School of Business, UCC

.12-*The cartel agreement became the Red Line Agreement or Achnacarry Agreement. Four companies ; Chevron, Gulf, Mobil, Texaco) later joined them and the seven companies came to be known as the Seven Sisters,.

They were also called the Majors. The purpose of the cartel agreement was to tabilise world oil prices and supply

.

12-*In the late 1940s(1948) Venezuela succeeded in revising 50:50 sharing agreements with the IOCs

. Falling demand from the European recession and the rising world supply caused a major plunge in oil prices in the late 1950s

12-*This led to reduction in oil producing countries tax revenue, which was already low due to the transfer pricing system implemented by the IOCs within their concession agreements with the host nationsVenezuela, Iran, Iraq, Kuwait and Saudi Arabia formed OPEC (Organisation of Petroleum Exporting Countries) in 1960 as a result.

Nationalisation by OPEC12-*OPEC countries nationalised the producing assets of the Seven Sisters in their countries and broke down the integrated system that the IOCs had created.

Spot and Futures Markets for oil12-*The current spot transactions have their origin in the first and second oil crises. The oil embargo of 1973 and the Iranian revolution of 1979 sparked fears of a shortage in crude supply.

Oil and Gas as International Commodities12-*International commodities are traded in the international markets either on the exchange or over-the counter (OTC)Priced in international currencies such as the dollar, pound sterling , euro etcPrices are determined by factors which are outside national markets

12-*Example :Crude oil prices are determined sometimes by considering demand and supply from the USThe strength of the dollarOPEC supply quotas and non- OPEC supplyGeopolitical developments etc

Copyright 2009 Pearson Prentice Hall. All rights reserved.12-*These non-Arabian oil companies were informally called "The Seven Sisters". They control what is shipped to the United States and how much is refined into gas and heating oil. Originally [the group included:]Exxon (was Standard Oil of New Jersey, then Esso)Mobil (was Standard Oil of New York, which merged with Vacuum Oil)Chevron (was Standard Oil of California)TexacoGulf Oil (controlled by the Mellons)Shell (Royal Dutch Petroleum)British Petroleum (Anglo-Iranian)

Copyright 2009 Pearson Prentice Hall. All rights reserved.

Upstream Oil and Gas Sector John Gatsi 2011 Oil and Gas Finance, School of Business , UCC12-*Three main sectors- Upstream , Midstream and DownstreamSome say two main sectors- Upstream and DownstreamUpstream deals with exploration and production (E&P) activities It includes investment in upstream infrastructure through foreign direct investment (FDI) and indirect investmentInvestment in the sector is capital intensive and risky such that only few IOCs and financiers engage in the upstreamCartel like investors in joint operating agreements with NOCs/ Governments

John Gatsi 2011 Oil and Gas Finance, School of Business , UCC

12-*Most developing countries in Africa depend heavily on FDI to develop the upstream sector

Midstream sector:Deals with refinery of crude oil into various petroleum products- gasoline , kerosene, diesel , aviation oil etcTransport of crude oil from producing countries

Downstream sector :Involves the distribution and marketing of petroleum products

12-*Example of products include:LPGGasoline, Aviation Fuel, Diesel ,Bitumen, Lubricants

Support Services:Security, Logistics & Communication, procurement, storage systems

What is Oil and Gas Finance About?12-*Raising of huge long term capital to invest in the upstream, midstream and downstream operations to generate profit and value for shareholders, product availability to consumers and for governments to generate revenue for national developmentThis definition clearly reflects the thinking of OPEC in September, 1960 in Iraq when they set out the objective of OPEC

Objectives of OPEC12-* to coordinate and unify petroleum policies among Member Countries, in order to secure a steady income to the producing countries; an efficient economic system and regular supply of petroleum to consuming nations; and a fair return on capital to those investing in the petroleum industry

Foreign Direct Investment (FDI) and Oil and Gas12-*

Until the 2000s foreign direct investment inflow to most African countries was insignificant due to less attractive policies which prohibited or placed quotas on FDI inflows. Lack of democracy, poor infrastructure, weak governance institutions, uncompetitive markets and questionable legal regimes also accounted for the low level of FDI into Africa. International Trade and Finance literature indicate that when appropriate domestic policies drive FDI, the impact on the economy reflects improve competition, efficiency, diversified products and services. It is therefore not surprising when African governments spend time to attract FDI so as to improve growth of specific sectors to ensure balanced economic development.

Recent Reforms in Sub-Sahara Africa12-*The recent reforms in Sub-Saharan African countries including Ghana resulting in democratic governance, accountability and transparency institutions, improved social and economic infrastructure such as telecommunication, national and personal security, openness of markets and deregulation of investment laws have accounted for the surge in FDI inflows. Privatisation is clear product of liberalisation of African economies. Privatisation though questioned by most socialist driven experts, have resulted in mergers and acquisitions of state-owned enterprises(SOEs) which formed the first phase of improved FDI into Ghana. The current phase of FDI into Ghana is driven by democratic governance, macroeconomic stability, stable political environment, rule of law, improved infrastructure and exploitation of natural resources including oil and gas.

What Drives Foreign Direct Investment Inflows To Ghana?12-*

Foreign direct investment deals with cross-border investment into real assets and real economic activities of the recipient nation. Thus buying into the stock of shares of companies listed on an exchange could be described as portfolio investment and not FDI. Multinational or Transnational Corporations are motivated by the following to invest in cross-border direct economic activities:Market- Seeking FDI- This is explained by the market attractiveness of the recipient country due to the size of the economy, current growth rate and prospect for stable growth. The economic indicators of Ghana over the past two decades have been remarkable though not the best. The recent rebasing of the gross domestic product of the country with per capita income in excess of $1,300 thereby admitting the country into the club of lower end middle income nations provides a better prospect to attract more FDI.

12-*Efficiency Seeking FDI- This is explained by the availability of quality infrastructure that makes cost of production competitive. The quality of transport and telecommunication infrastructure, administrative cost of doing business and availability of finances. Thus the cost of bribery and corruption can negatively affect FDI inflows since they have the potential of increasing cost of doing business.Natural Resource Seeking FDI- African countries with natural resources especially oil and gas tend to attract more FDI than the rest. Since the start of commercial oil production in Ghana FDI activities have increase and promises to improve. This implies oil and gas exploration and development will attract more FDI to Ghana. Exchange of critical technology and skills development are considered to be the main benefit of FDI since nations aspire to engage in outward FDI in the future.

The OLI Paradigm12-*O- Owner specific or home market such that a Multinational firm will engage in FDI when it established home competitive advantageL- Location specific ie foreign market thus the firm must be attracted by specific characteristics of the foreign market that makes it possible to take competitive advantage; technological, financial, human capitalI-internationalisationHow does it apply to investment in oil and gas industry in Ghana?

The Gravity Model and Investment in oil and GasCopyright 2009 Pearson Prentice Hall. All rights reserved.12-*Derived from Newtons Law of gravityThat places with dense population tend to attract commodities, resources, people and finance than less populated areas.Thus new oil finds in Africa in large commercial quantities, with flexible investment climates and regulationsMay serve as incentives in attracting FDI into these countries in general and to their oil and gas industry in particular.

Copyright 2009 Pearson Prentice Hall. All rights reserved.

Some FDI Strategies12-*Greenfield investmentMergers and AcquisitionsJoint VenturesStrategic AlliancesFranchise and Licensing

Oil prices have bounced off the bottom at the end of last year, and have more than doubled in 2009. During the 3Q, WTI prices generally stayed in the $60-70/bbl range, and during the 4th quarter, broadly between $70-80/bbl. In contrast, natural gas prices generally eroded through the first 3 quarters of 2009, dropping close to $2 per million BTUs, a level most analysts never thought wed see again. Gas prices remain very volatile and have strengthened in the 4th quarter, but further upward momentum is largely in the hands of Mother Nature.Oil and natural gas prices have disconnected to the point that on a BTU-equivalent basis, oil was recently more than four times as expensive as gas.WTI prices averaged about $62/bbl in 2009, down from about $100/bbl in 2008. The Henry Hub average for 2009 was about $4/million BTUs, down from about $9/mmBTUs in 2008.

(Weekly WTI chart 4)