OPINIONS

Staying ahead of the global pack – it's all about the planning

Philip Thomas
Project Manager for Scenarios, World Energy Council
http://www.worldenergy.org

Post date: Tuesday, 20th December 2011

We live in uncertain times – there is uncertainty about a strong economic recovery in the US and Europe, uncertainty whether the ‘Arab Spring’ will spread to the more stable regimes of the MENA region, uncertainty whether the economic growth of China will continue at current rates, uncertainty about climate change. We may not realise it, but these uncertainties and their resolution will affect the way energy is produced and consumed the world over.

To most people, energy means two things – oil that goes into a car and electricity that comes out of a wall. In truth, the global energy system is much more complex and interconnected than just the extraction of oil and the generation of electricity.

Energy projects require decades of planning and execution. Given the scale of investment and manpower that energy companies have to commit, a holistic and robust strategic approach to planning is essential. Scenario planning is one such approach. Conceived by Pierre Wack in the 1970s, a scenario-based approach to planning helped Royal Dutch Shell prepare for the “oil shocks” before any of its peers.

The resulting competitive advantage transformed Shell into one of the world’s most successful oil companies. Today, scenario planning is used by many organisations to help them evaluate real options in an environment of uncertainty. The application of scenario planning requires a thorough understanding of the system in which it is being applied. The first step is to identify what is “predetermined”, i.e. events which will occur no matter how the future manifests itself.

Wack explains this in his paper (Scenarios: uncharted waters ahead) as: “Suppose, for example, heavy monsoon rains hit the upper part of the Ganges River basin. With little doubt you know that something extraordinary will happen within two days at Rishikesh…in Allahabad…and at Benares, two days after that.

You derive that knowledge not from gazing into a crystal ball but from simply recognising that future implications of a rainfall that has already occurred.”

Having done this, the next step is to identify “drivers” - factors which shape and influence the system. Classical examples of energy drivers are population growth, per capita income and GDP growth.

In addition to such hard energy drivers, you also have soft drivers which are more difficult to quantify and are equally important.

Factors affecting consumer behaviour and acceptance, and geopolitical risk, fall under this category. It is difficult to get a feel for drivers which cannot be expressed as numbers, and for which historical numerical data does not exist.

Scenario practitioners must therefore be adept at recognising patterns. The clustering of drivers, predetermined elements and critical uncertainties are the building blocks of scenarios.

‘Critical uncertainties’ are factors whose resolution will move the future into different scenarios. Identifying critical uncertainties is the key to building robust scenarios. In these uncertain times, companies are using scenarios more and more. One of the most significant areas in the energy sector attracting attention in recent years has been the ability of companies to strategically position themselves as the gas market moves from one state into another. The dynamics of gas markets have been changing over the past few years. Two main drivers have been responsible for this – the physical growth in the LNG (liquefied natural gas) market and the shale gas revolution in the US and Canada.

Gas markets which have so far been characterised by regional variation are now moving towards consolidation on the global level. The pace of this move will be dictated by the outcome of the interaction between market regulation and investment decisions around long-term infrastructure projects, such as transnational pipelines, LNG liquefaction and regasification terminals. A critical uncertainty that will influence the formation of the gas price in the future will be the shift (or not) from oil indexation to hub-based pricing.

Currently, Europe is the battleground for this war of pricing standards. At present, there is a sizeable spread between the spot price of gas and the long-term contract price of gas. This widening spread has caused the renegotiation of long-term gas contracts under “take-or-pay” clauses between producers and consumers. Both Gazprom and Statoil have modified contracts, such that a fixed percentage of gas is available at the spot price while the bulk of the volume remains fixed to the oil-indexation formula. Producers of gas argue that long-term fixed prices with annual contracted quantities ensure security of demand which enables them to put up the investment needed for pipeline projects.

On the other hand, large scale consumers of gas, mostly power plants, dispute this by stating that electricity markets do not offer enough price security to continue the purchase of gas under long-term, fixed price contracts.

It is a Catch 22 situation, and one that will pay high dividends to the player who places his bets wisely. Over the next few decades gas consumption is set to grow worldwide, especially in Asia. Anticipating this demand, Qatar has recently stepped up its LNG production.

As Asian demand has not yet caught up with supply, these additional LNG volumes have been making landfall in Europe – this is what has depressed the European spot price of gas.

Added to this, the US has been awash with shale gas as a result of new horizontal drilling techniques which became economically viable as the price of gas increased.

In the short term, there appears to be plenty of gas, but this gas will be sucked up as demand meets supply in Asia and the impact of regulatory directives in Europe like the LCPD (large combustion plant directive) which will boost the construction of CCGTs (combined cycle gas turbines). With all these predetermined elements, drivers and critical uncertainties in play, scenario planning has become an increasingly popular approach to identify and make use of opportunities which may arise in the future. Those who apply it well will stay ahead of the pack.

This article was first published in Global Trader Guide to Global Markets, Winter 2011. To read the entire publication, click the ebook.