Bain presentation for Cyprus Natural Gas Conference

Structural changes in the European gas market

This information is confidential and was prepared by Bain & Company solely for the use of our client; it is not to be relied on by any 3rd party without Bain's prior written consent

Structural changes in the European gas marketand recent dynamics in gas pricing

Nicosia, Cyprus – 7/8 June 2012

Bain & Company presentation at Cyprus Natural Gas Conference

Objective of the document

• Give a brief overview of the European Gas Market, taking into account the recent dynamic in supply and demand

• Illustrate how the drivers of gas demand have been affected by recent regulatory evolution, with particular focus on renewable energy

This information is confidential and was prepared by Bain & Company solely for the use of our client; it is not to be relied on by any 3rd party without Bain's prior written consent 2

focus on renewable energy

• Share some insights on the future development of the market and the role of Take-or-Pay contracts

Agenda

• International gas market overview

• Recent evolution of European gas market dynamics


• Key issues for future market evolution

International gas market overviewInternational natural gas flows in 2010

92.4

20.9

9.4

5.4

6.2

44.1

20.1

4.15.5

12.1

17.3

36.5

55.9

16.6

6.5

32.0 21.0

18.8

14.9

6.3

5.2

17.7

8.2

LNG Gas

Pipeline Gas

Import∼∼∼∼350 Bcm

Import∼∼∼∼200 Bcm

16.0

113.9


Source: BP Statistical Review of World Energy June 2011 www.bp.com/statisticalreview

5.4

10.9 8.8

7.0

5.8

9.8

Continental Europe (mainly by pipe) and Far East (LNG)heavily rely on natural gas imports

2

3

4

5

6

7

US LNG Imports,

Trillion Cubic Feet

International gas market overview US increased production of unconventional gas

Shale gas production in the US EIA LNG import forecasts


0

1

2

US LNG Imports,

Trillion Cubic Feet

Forecast 2005 Forecast 2007 Forecast 2010

Sources: EIA’s Shale Gas and the Outlook for U.S. Natural Gas Markets and Global Gas Resources for “Shale gas production in the US”; EIA’s Annual Energy Outlook 2005, 2007, 2010 for “EIA LNG import forecasts”

Significant downward revision of LNG import forecast in the USA, mainly as a consequence unconventional gas production

International gas market overview Pricing “polarization”

40

60

Oil

equivalent

APAC

Ger (BAFA)

Large scale exploitationof unconventional gas

Price gap APAC – RoWfurther increased in 2011

for Fukushima’s aftermath


0

20

2004

2005

2006

2007

2008

2009

2010

2011

USA (HH)

Source: BP Statistical Review of World Energy June 2011 www.bp.com/statisticalreview;

The three main gas consumption areas (US, EU, APAC) have experienced divergent price evolution, with US price independent from oil price trends

International gas market overview “Continental reach” of the different gas supplies ILLUSTRATIVE

Russia220 Bcm

North sea250 Bcm

Continental production70 Bcm


Increased presence in the market of a diversified range of gas producers

North Africa80 Bcm

Atlantic basin10 Bcm

Middle-East40 Bcm

Agenda





910

13

18

17

CAGR ~22%

Recent evolution of European gas market dynamics Gas demand in Europe and increase in import spot volumes

Gas demand in the main European countries Spot LNG imports to Europe

•Appearance of the WW gas glut related to the US unconventional gas

•Availability of new Qatari LNG trains


'00

2

'01

4

'02

5

'03

4

'04

7

'05

9

'06 '07

7

'08

6

'09 '10 '11

With stagnating demand and impressive increase of spot LNG imports, gas importer struggled to fulfill their minimum Take obligations

Sources: Eurostat for “Gas demand in the main European countries”; GIIGNL for “Spot LNG import to Europe”

TTF

• UK: NBP (National Balancing Point)

• Netherlands: TTF (Title Transfer Facility)

• Austria: CEGH (Central European Gas Hub)

• Germany: NCG (Net Connect Germany)

• France: PEG (Points d'Echange de Gaz)

• Italy: PSV (Virtual Trading Point)

• Belgium: ZEE (Zeebrugge)

Recent evolution of European gas market dynamics The development of European hubs and the increase in trading activity

A Gas Hub is a platform that can be either physical or virtual (or both the things) where gas marketers

exchange gas volumes

Main European hubs Volumes traded in main hubs


NBP

PEG

ZEE

PSV

CEGH

NCG

TTF

Main European gas markets Main European hubs NCGGASPOOLCEGHPEGPSVTTF ZEE

As a result of the oversupply situation and the increased liberalization, traded volumes in the European gas hubs experienced a rapid growth

Source: IEA

Recent evolution of European gas market dynamics Decoupling of oil and hub-indexed gas prices

Typical oil-indexed price formula(not accounting for any price reduction)

Year-ahead gas traded price at TTF Hub(continental Europe reference hub price)

Decoupling begins

Low TTF prices as an effect of new pipelines and releases from storage

facilities

TTF prices stop follow oil trends as oversupply

develops


European spot prices have become increasingly decoupledfrom the upward moving oil price dynamics

• All European utilities have a supply portfolio mostly related to LT oil-indexed contracts...

• ...while end-user market is instead influences by lower spot prices...

• ...this is causing significant losses to European utilities which increasingly ask for a oil/hub indexation mix price to their suppliers

Source: Bain elaboration

Recent evolution of European gas market dynamics Renegotiations triggered over the last years

“The likes of E.ON, GdF Suez, ENI, Econgas and BOTAS have renegotiated their LTCs with the major exporters to Europe, e.g. Russia’s Gazprom, Norway’s Statoil and Dutch GasTerra using standard price review clauses

[...]

some level of indexation to cheaper spot gas prices was introduced into mainly oil-indexed LTCs”

Oxford Energy Forum, August 2010


Price renegotiations triggered by the Buyers have grantedthe introduction of a hub-indexation into the purchasing formulae

“Gazprom said in its report that as a result of talks in 2010, price agreements were reached with E.ON Ruhrgas, GDF Suez, Eni, GasTerra and others. In some cases, Gazprom has agreed to alter contracts for a three-year period to include a ratio of up to 15% spot prices and 85% oil-indexed prices”

Platts, 16 August 2011

Agenda





1) Transient or structural oversupply?

Demand evolution

Supplyevolution

• Displacement of gas power plants by renewables

• Delocalization of energy-intensive industrial cycles

• Increase in households’ heating efficiency

• Fossil and (in the long run) nuclear capacity substitution by CCGT

• Enduring impact of unconventional gas / new gas discoveries

• Gas thirst by Asia Pacific Countries

• Infrastructural development (e.g. US liquefaction capacity)

Weak demand in the short term, potential recovery with power

replacement

International supply dynamics impacted by APAC evolution


Very unlikely in the mid-term a return in a “tight” market; in the short term oversupply will persist

evolution

European Policy Directives

• Infrastructural development (e.g. US liquefaction capacity)

• European network integration

• Security of supply through increased diversification

• Promotion of gas competition

by APAC evolution

Promotion of a “long market” to boost competition

1) Transient or structural oversupply?Impact of renewables – example of Italy

30

40

50

2427

3

2

30

7

13

3

41

Fuel cost adjusted - Power price (€/MWh)Gross Capacity (GW)

Biomass

Geothermal

PV 80

100

120

140

160

2009

2012

average hourly power price in April


Source: GSE Data

The growth of renewables (Photovoltaic) with priority of dispatch has displaced volumes from CCGTs and depressed peak power price

0

10

20

2008

4

18

2009

5

18

2010

6

18

2011

7

18

Wind

Hydro

0

20

40

60

0 1 2 3 4 5 6 7 8 9 10 11 12 13 14 15 16 17 18 19 20 21 22 23

Note:adjusted with 2012 fuel costs

End-user

Supplier

Importer/Wholesaler

End-user

Retailer

Gas hub

LT contracts

Spot contractsSupplier/Importer

Wholesaler/Retailer

Gas hub

Spot contracts

Continental EuropeUS/UK

2) There will be a recoupling to oil-indexed prices?“Hub-based” supply difficult to implement in a low-production market


Captivemarket

End-usermarket

End-usermarket

Captivemarket

• Transparent gas market

• Prices determined by demand/supply balance

• Large share of internal production and a large number of players

• Prices historically linked to LT oil-indexed contracts

• Currently showing a coexistence of LT and spot contracts with oil/hub-indexed prices

• Large share of imported volumes and few national players

European market has a inherently different structure than US: long term ToP contracts will continue to be the staple of supply portfolios...

2) There will be a recoupling to oil-indexed prices?Pricing depends on complex interactions

PRICE

Demand

Supply

European and

National Policies

• Gas oil substitution for domestic demand• Process industry delocalization• Renewable source• Fossil/nuclear plants replacement• CO2 emission concerns• ...

•Diversification needs•Security of supply•...

• Infrastructure development• WW demand/supply imbalances• LNG arbitrage opportunities• Technological breakthroughs in

E&P• ...


..however, how ToP contracts will be priced would depend by several contrasting factors

PRICE FORMATION MECHANISM

Strategy of main players

Regulatory framework

Policies

•Antitrust measures•Regulations on end-user prices

•Hub liquidity•Degree of liberalization•...

• Long vs short portfolio• Commercial strategy (mkt share

defence vs margin defence)• Downstream/upstream integration• ...

Conclusions

• The European gas market will be in oversupply for few years to come, but in the mid-long term gas is required to replace declining internal production and aging fossil/nuclear generation fleet

• The extent of this long term demand recovery will depend on renewable energy sources integration in the electricity grid

• Long-term, ToP gas contracts will still maintain a strategic


• Long-term, ToP gas contracts will still maintain a strategic relevance in terms of security of supply and volatility mitigation, especially in Countries with low level of domestic production

•Worldwide gas offer, boosted by new discoveries and enhanced infrastructures may imply increase in competition among suppliers and a review of old pricing models; however, the extent of this will depend on the relative gas “thirst” of US, European and Asian markets

Bain & Company Italy contacts for gas business

Alessandro CadeiPartner

Luigi CorletoPrincipal

Roberto PrioreschiDirector

Position

• Strategy, cost efficiencies and re-

• Head of the Energy & Utilities Practice in Italy

• 17- year consulting experience

• Strategy and business development

• Member of the European Practice Energy & Utilities

• 12- year consulting experience

• Member of the Practice Energy & Utilities

• 7 - year consulting experience

• Strategy and business development


Main areas of expertise

Selected clients served in Gas & Power market

• Strategy, cost efficiencies and re-organization

• Business planning, budgeting and reporting system/scorecard

• Operations rightsizing and cost reduction in manufacturing systems

• M&A and Post Merger Integration

• Strategy and business development• Commercial strategy and business

planning• Organization and rightsizing• M&A and Post Merger Integration

• Strategy and business development• Performance improvement and cost

reduction• Operations streamlining• M&A and Post Merger Integration

Contacts: [email protected]+39 - 338.9381273

[email protected]+39 - 335.7529747

[email protected]+39 - 335.7615190

Bain presentation for Cyprus Natural Gas Conference

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