The McKinsey 7S Framework: A Holistic Approach to Harmonizing All Parts of th...
Iran's energy sector at the crossroads
1. Iran's Energy Sector at the
Crossroads
Transition through Gas
Chris Cook
London 15th
June 2015
2. Iran's Energy Sector at the Crossroads
Introduction – Cook's Tour
Looking Back – an oil market review
To the right, the Dollar & to the left, the Euro?
Looking Forward – a Transition though Gas?
3. Cook's Tour – Personal View
Fraud Investigation to Market Regulation to Market
Development
1990/1996 Director, International Petroleum Exchange
1998/2001 “OilClear” - a market-based Dot Com
2000 - Blew whistle on 'micro' oil market manipulation
4. Cook's Tour – Personal View
June 2001 – contacted Iran Central Bank
May 2004 – Iran Oil Bourse project begins
Since 2004, a Long & Winding Road....and eight visits
to one of the finest countries in the world
Some impressions along the way....
8. US and Energy Security - 1973
US secretly agreed 400% oil price increase from $3 to
$12/bbl with Shah of Iran & hence OPEC
Outcomes:
1/ Petrodollar – US agreed with Saudi Arabia to deposit
dollar proceeds in US $ assets
2/ US got oil for T-Bills.....OPEC got blamed for high prices
3/ Alaska, North Sea, US Gulf oil viable & funded at $12bbl
4/ US/UK energy security achieved via stealth carbon tax
10. Enter the Exchanges
Volatility led to risk and formation of oil exchanges
First - New York Mercantile Exchange (NYMEX)
Then International Petroleum Exchange (IPE)
NYMEX introduced West Texas Intermediate (WTI) oil
contract & IPE introduced Brent (North Sea)
13. Enter the 'Wall Street Refiners'
In the 1990s investment banks began to take a role as
financial intermediaries - “Wall Street Refiners”
They began to create new funds for risk averse
'inflation' hedgers to invest in commodity markets
14. Passive Investment
Exchange Traded Funds and Index Funds
Quasi-ownership not debt
Passive investors whose aim is to avoid loss rather
than make profit – 'inflation hedgers'
Middlemen do not take market risk but keep credit risk
& profit from trading on asymmetric information eg
HFT
15. Passive Investment & Inflation Hedging
Speculation - putting capital at risk for transaction profit
– active two way (long or short)
Producer Hedging – off-loading commodity risk in
exchange for dollar risk – short only
Inflation Hedging - off-loading dollar risk for commodity
risk – return OF not return ON capital – long only
16. Financialisation of Oil
Goldman Sachs Commodity Index fund created 1992
& marketed as 'inflation hedging'
BP & Goldman Sachs joined at the head from 1995
BP effectively controlled Brent benchmark from 2001
when Forties field was added to Brent field
17. Financialisation of Oil
BP (IOC) locks in oil price through forward Brent sales
but refiners tend not to buy forward > 3 months
GSCI 'long-only' medium & long term buyer of Brent
GSCI fund buys & rolls over Brent futures contracts
while BP sells & rolls over Brent futures contracts
18. Financialisation of Oil – Prepay
Introduced by Enron c1999 as ('off-balance sheet')
funding invisible to investors & creditors
GSCI lent dollars interest free to BP via J Aron
(Goldman Sachs trading arm)
BP lent oil to GSCI via sale & repurchase with J Aron
19. Financialisation & the Death of Markets
QE and 0% $ interest rates – 'buy anything but dollars'
Correlated bubbles caused by 'inflation hedgers'
Commodity prices lose touch with production,
consumption & inventories
Equity prices lose touch with underlying flows of
dividends and retained profits
23. Macro (medium/long term) Market Manipulation
If producers can support prices they will eg tin, copper
Such 'Macro' manipulation can persist for many years
Enron-style 'Prepay' contracts eg Chesapeake Energy
Producers lend oil to passive investors
Passive Investors lend dollars to producers
24. Macro (medium/long term) Market Manipulation
Investment Banks intermediate producers & investors
Two tier (false) physical market Dark Inventory of oil in
custody with economic value prepaid by investors
Asymmetric information re inventory is profitable for
privileged banks and traders
28. 2008 – Peak Credit
Collapse of Lehman Brothers
Collapse of interbank trust – trade credit freezes
QE & 0% interest (ZIRP) to prevent debt deflation
Systemic solvency problem (unsustainable debt)
Credit intermediary banks systemically short of capital
29. Collapse – July to December 2008
Oil trade credit dries up so oil trade dries up
Oil price collapses from manipulated $147/bbl spike
Saudis cut 1.5m bpd and then in Dec 2008 OPEC
announces 2m bpd cut
Makes no difference
Jan 2009 Obama ('Big Money' President) takes office
30. Market Price Structure
Backwardation
- current (spot) price higher than future price
- no limit to backwardation
- typical of under-supplied market
Contango
- current (spot) price lower than future price
- if contango exceeds cost of storage etc then traders buy
now, sell forward & make risk-free 'arbitrage' profit
- typical of over-supplied market
33. 2009 Supercontango
Supercontango indicative of market oversupply, but rapidly
rising price simultaneously indicated market undersupply
Question. Why did prices rise dramatically in an
oversupplied market?
Answer. Financial buying was opaquely supporting the oil
market price by funding oil inventory
34. High Prices – Cui Bono?
Producers
If a commodity producer can support prices then he will
Brent Complex in terminal decline makes support easy
Market support requires Capital:
Sovereign reserves or
Risk averse ('passive') investment funds
And liquidity
Central Bank Quantitative Easing (QE)
38. Follow the Money – Oil Price & QE
I forecast
$45 to $55
oil post QE
But end of QE
took a long time!
39. 2015 Oil Price Rebound
Brent & WTI prices hit lows of c$45/barrel by mid January
Within six weeks Brent rose 32% while US WTI rose 8%
Not physical demand by refiners: due to financial demand
Question. Where did liquidity come from?
22nd
January European Central Bank announced € QE
Oil price and German Bund yields now 92% correlated
Question. Where did investment capital come from?
Answer. Follow the Money
42. US Energy Security - Outcomes
History does not repeat itself, but it does rhyme
High cost shale crude oil was viable/bankable because
oil prices were supported for 5 years above $80/barrel
Demand for oil products also fell due to efficiency
Renewable energy substituted for carbon fuels
Stone Age did not end because of a shortage of stones
US oil swing producer & security of supply. At a price
Oil market price effectively capped at $60 to $70/barrel
43. Bitter Lake to Bitter End?
US energy security through shale oil is the most significant
market event since 1945
Saudis appear to have been ejected from the US tent
US is now pivoting to the last remaining significant
reserves of undeveloped low cost oil in Iran & Iraq
44. End of the Petrodollar?
There are signs that Saudis may have begun switching
reserves to € assets & access to free € QE liquidity
Petro Euro has long been an ambition of the EU & ECB
Have Saudis switched from Petrodollar to Petro Euro?
45. Is Oil Market Capped at $60 to $70 per barrel?
IOC 'Oil as a Commodity' transaction model squeezed
Irresistible Force of rising E & P costs squeezes NOCs
against Immovable Object of $60/$70 bbl oil price cap
IOC Options
Consolidate – defers the inevitable
Switch to natural gas eg Shell
Compete for last remaining low cost oil in Iran/Iraq
Or - transform to Capital Lite 'Energy as a Service' model
47. Energy Security - Danish Approach
Mandatory overarching operating principle for energy policy
Least carbon fuel cost - for a given output of heat,
electricity or power, minimise carbon fuel input
Danes funded investment via high local taxation
Outcomes
Danish GDP has doubled, while energy use has been flat &
carbon fuel use has declined
Decentralised production & consumption; local heat
networks & renewables – a Natural Grid
49. Other Participant Strategic Aims
Consumer
- stable transparent low pricing
- security of supply
IOC (Middleman)
- security of supply & demand
- stability & transparency....up to a point.....
- Booking (ownership) of reserves to satisfy shareholders
Trader (Middleman) - stability & transparency are Death
Bank (Middleman) – asset ownership by borrowers
50. Problems - Iran and Energy as a Commodity
Existing legacy infrastructure fragmented, fragile &
often inefficient (often <20% output efficiency)
Huge carbon fuel waste between well & consumer
Iran competes within OPEC for sales of energy-as-a-
commodity
51. More Problems
Intractable conflict between Iran resource sovereignty &
IOC need for reserves on balance sheet
Adversarial relationships with traders & banks
Iran & Consumers both lose from opacity & volatility
Volatility & bank capital shortage makes conventional
bank financing & funding increasingly difficult
52. Energy as a Service
Least Carbon Fuel Cost Principle - minimise carbon fuel
system input for given electricity, heat or power output
Market Structure & Instruments
Energy Swaps – production sharing supply
agreements – Capital Partnership
Energy Credits – risk sharing of energy prepay credit
instruments – Guarantee Society
53. Energy Swaps
Iran supplies flow of oil or natural gas
Iran agrees proportional shares of product or service output
with service providers & consumers
Balance of output is available to investors
Investment may be conventional (eg $/€ bank loans) or
unconventional (energy loans of prepay energy credits)
54. Oil for Product Swap
RefineryRefinery
Investors
Consumers
Service
Providers
%Prepay
Oil
NIOC
Products
55. Gas for Power Swap
Generator
(eg CCGT)
Generator
(eg CCGT)
Investors
Consumers
Service
Providers
%Prepay
Gas
NIGC
Power as
Service
56. Prepay Energy Credit
What it is
- promise issued in exchange for value received
- returnable in payment for supply
What it is not
- Debt - no right to demand money
- Derivative – no right to demand delivery
- Equity – no ownership right in respect of sovereign asset
Requires trust between Promissor & Acceptor/Investor
57. Prepay Energy Credit funding – Energy Loans
Energy Loan – Value Proposition
- consumers may pay in advance & lock in price
- Iran obtains interest free credit & locks in price
- investors obtain return in intrinsic value of energy
- investors may use for consumption or sell to consumers
Requirements
- physical energy market & pricing benchmark
- accounting system
- framework of trust – Guarantee Society agreement
58. Energy-as-Service – Value Propositions
Iran & Consumers - share cost of supply infrastructure
Service Providers - receive agreed %age of revenues -
balance of revenues available to investors
Investors - buy prepay credits & so make energy loans
Consumers – pay for energy delivered using either
conventional payment or energy prepay credits
62. KAT Core - Outcomes
Turkmen NOC exports power to Caspian littoral states
Energy savings fund development of infrastructure
Turkmen NOC conserves gas which is then available for
generation or export
Azeri & Kazakh NOCs release production for export through
reduced local carbon fuel requirement
Caspian energy market & pricing benchmark
Minimise funding costs: energy loans bear no compound interest
Increase resilience – Caspian Energy Grid also capable of
carrying regional renewable energy power & load balancing
63. Energy Security - Transition through Gas
Security of demand for Iran
Supply of oil & gas as a service
Collaboration, stability & transparency adopted as market
standard Win/Win behaviour
Shared services, costs & risks via market framework
agreement
64. Energy Security - Transition through Gas
Optimal low carbon financing & funding via Energy Loan direct
investment in carbon fuel savings
Payment of subsidies through Energy Dividend of energy credits
Least carbon fuel cost principle minimises CO2 emissions:
higher the carbon fuel price, the more $ profit in saving it
Instead of oil priced in $ (or €) and gas indexed against oil,
dollars, euros & oil are priced in energy value of gas
65. Beyond OPEC
OPEC has been dead and on life support for years as a
puppet of the Saudis
Global oil market pricing through Brent Complex is
completely corrupt with no replacement in sight
Dollar and euro banking systems essentially bankrupt
New multilateral global oil & gas institutions are needed to
bring together producers & consumers directly
Non-OPEC NOCs are well placed to share costs of
creation of a new oil & gas market platform
