Caspian Energy at the Crossroads

Energy Cooperation, Smart Markets & Transition through Gas

Bogazici University

Chris Cook &Mahmood Khaghani

17 March 2017

About Me

Forensic Accounting – insolvency & fraud investigation

Regulation – enterprise & markets

Market Development

Networked Market Development

Resilience

Resilience

Resilience – adaptability to change

Resource Resilience

Human Resilience

Financial Resilience

Reality-based Economy

Location

- three dimensional Space

Energy

- material (resources – static energy); immaterial (dynamic/kinetic energy)

Intellect

- subjective (knowhow, know who)

- objective (data patterns & representations, IP)

Energy Economics

Location and Intellect have demand and a subjective price in a unit of account such as $ or €

Energy cost is the only objective cost

Protocols and Instruments

Protocols

- agreements which govern relationships between persons and allocate use value & risk

- eg companies; constitutions; mortgage loan agreements

Instruments

- tradeable agreements/contracts (financial assets)

- eg currency, debt, derivative, company share (equity)

Market Paradigms

Market 1.0 – decentralised but disconnected, physical market presence

Market 2.0 – centralised and connected, market presence via middlemen

Market 3.0 – decentralised but connected, network market presence

Trend to Services

Intermediary middlemen use finance capital to fund assets and finance risk

– Market price risk– Credit risk

Service providers use intellectual capital and do not own assets or take market or credit risk

With the right business model (agreements & instruments) service providers out-compete middlemen

Oil Market History

ExchangesPhysical Middlemen Financialisation

The Age of the Middleman

Commodity Market Stability & Transparency

Producers require stable, transparent high prices

Consumers require stable, transparent low prices

For Middlemen price stability & transparency = Death

Oil as an Asset: 2001/2008 – Bubble & Collapse

Fall of Enron

Bubble & Collapse

Oil as an Asset: 2001/2008 – Bubble & Collapse

BubbleNorth Sea producers funded Dark Inventory with prepayment

& this removed Brent/BFOE benchmark crude oil from market

Price gradually rose & mid 2008 spiked to $147/bbl

CollapseIn 2008 crisis oil trade/flow finance dried up, killing demand &

inventory was dumped on the market

Price fell from $147/bbl in July to $35/bbl by December 2008

In 2 years financialised oil price moved from $80 to $147 to $35 to $80 per barrel while physical oil supply varied by 3%

Physical & Financial Oil Markets Compared

Oil as an Asset: 2009 to 2014 - the Big Long

If Producers can support/manipulate prices by funding inventory they will maybe for decades eg tin, copper

Enron-style prepay contracts enable price support- Producers lend oil to risk averse 'passive' investors- Passive investors lend dollars to producers

Oil as an Asset: Oil Price & QE

In 2012 I forecast $45 to $50 oil post QE

But end of QE took a long time!

2009 to 2014: Petrodollars funded US Shale oil

US Energy Security

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 efficiencyRenewable energy substituted for carbon fuelsUS oil swing producer & security of supply. At a priceOil market price is now effectively capped at $50 to $60/barrel

Bitter Lake to Bitter End?

US energy security through shale oil is the most significant market event since Bitter Lake 1945

Saudis are now dispensable & the Petrodollar deal is over

US is now pivoting to the last remaining significant reserves of undeveloped low cost oil in Iraq, Kurdistan

End of the Oil Age

“The Stone Age did not end for lack of stone and the Oil Age will not end for lack of oil” - Zaki Yamani

Affordability – austerity & automation cut purchasing power

Substitution- renewable energy – Chilean solar now $2.4c/kWh- Fifth Fuel/Efficiency

Energy Intensity– declining Energy Return on Energy Invested (EROEI)

The Aramco Question

If oil price outlook is good why would Aramco do an IPO?

Oil-as-a-Commodity market paradigm squeezes producersIrresistible Force - rising E & P costs (EROEI)Immovable Object - $50/$60 bbl US shale oil price cap

IOC OptionsSwitch to natural gas eg ShellCompete for last remaining low cost oil in Iran/IraqVertically integrate eg Saudis, oil traders

Or - transform to 'capital lite' Energy-as-a-Service paradigm

Resource Resilience

Since 1980 Denmark's GDP rose 78%, while energy use has been stable and carbon fuel use declined

How?

Mandate - minimum carbon fuel input for a given output of electricity, heat or power

Least energy cost policy; not Least DK (or €, $, £) Cost

Massive investment in renewables, heat, energy efficiency, transport

Outcome – decentralisation - to a Natural Grid

Natural Grid - Denmark

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

Prepay Instruments

Taxation

Energy Credits

An Energy Credit is a Promise issued by an energy producer in exchange for value received and which he will accept in payment for energy production

An Energy Credit is notDebt Contract - the holder may not demand moneyForward (Derivative) Contract– the holder may not demand deliveryEquity Share – the holder has no asset ownership or dividend

An Energy Credit holder may simply use the credit to pay for energy supplied by the Promissor or by another energy producer who will accept it

Investors & Consumers trust producers to supply energy for which they may pay using Energy Credits – this requires a “Trust Framework”.

Nordic Enterprise Trust has developed an “Energy Clearing Union” Trust Framework

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Energy Clearing Union

Energy producers accept each others promises/credits in payment for energy supplied

Producer performance guaranteed through membership of Guarantee Society (mutual assurance – P&I Club)

Issuance, risk management, dispute resolution, by a service provider consortium

Energy Loans – Value proposition

Producer

- sells energy forward and locks in price

- interest-free energy loan until unit returned vs supply

Consumer

- prepays for energy and locks in price

Investor

- direct 'inflation hedge' investment in energy

- Consumers buy credits from Investors at best price below physical energy price & return vs supply

Fifth Fuel - Intellect

Mega Watts - generation of power/electricity

Nega Watts - generation of power/electricity savings

Energy as a Commodity Energy is generated & sold at wholesale bid price Energy savings are generated at the retail price Fifth Fuel generates energy savings

James Watt Steam Engine

Atmospheric Engine James Watt Steam Engine

A 1778 Smart Energy Trade

James Watt's steam engine was much more efficient at pumping water than Newcomen's Atmospheric Engine

James Watt agreed that he would receive one third of the coal saved in pumping water (ie Nega Tonnes of coal)

First Smart Energy Trade – Intellectual value exchanged for the value of carbon fuel savings

Not pumps-as-a-commodity - Pumping-as-a-Service

Outcome - 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 resource 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

Re-powering

Existing 1000 MW generation 25% fuel efficiency: new CCGT generation 60% efficiency

CCGT sold for profit costs $550m

Fuel savings at current price gives 3.5 year payback

Smart Market financing & funding - Technology/Carbon Fuel Swap - Generation-as-a-Service

CNG for Transport Swap

Vehicle Companies(eg taxis & buses)

Vehicle Companies(eg taxis & buses)

Investors

TransportUsers

Service Providers

%Prepay

NaturalGas

Gas Producer

Transport asa Service

%

% Pay

CNG Transport-as-a-Service

Gas producers supply gas & receive %age share of transport revenues

Manufacturers & service providers supply equipment, vehicles, services for %share of transport revenues

Investors - buy prepay fuel credits

Consumers – pay for transport use either with conventional currency eg $ or prepay carbon fuel credits

Energy Subsidy

Energy dividend made in energy prepay credits not bank-issued credits

- incentive to save energy

- not inflationary

- savings may be used to invest through energy loans

- credits may be exchanged for other value

Outcome – Smart Market

Conventional Smart Grid involves smart management of connected grid supply and demand

But – power dispatched using least $ cost ranking order

In a networked energy swap/credit market power is dispatched using least carbon fuel cost ranking order

Outcome – Smart Market

Outcomes - Policies

Energy standard – standard unit of energy as benchmark for investment

Energy Dividend - energy subsidy paid in energy credits

- incentive to save energy & exchange credits for value

Energy pool investment fund

Green Deal – energy loans invested directly in renewable energy (MegaWatts) and energy saving (NegaWatts) projects

Outcomes – Economic

Energy Cooperation – compete on quality of service but cooperate on costs

Capital Efficiency – finance capital is replaced by 'smart' intellectual capital

Fifth Fuel – the higher the price of finite resources, the more profitable it is to save them

Institute for Resilience

Global post-doctoral research & development network to address major international challenges

Public/Private – Public research funding & private development

Faculties – Resource resilience – least resource cost development – Human resilience – capacity building– Financial resilience – energy economics

Launch – Caspian Energy Grid/Union initiative

Institute for Resilience

Academic/Private – Initial Founders – Turkey, Iran, Norway– Financial resilience – Turkey/Norway– Resource resilience Iran/Norway

Government Policy– Caspian Development Forum

Enlarged European Energy Union?

€/EU-centric energy-as-commodity market model (Post-Brexit Proposal - Chatham House)

Eurasian Energy Clearing Union

Caspian–Centric - Eurasian Energy Clearing Union

Caspian

Eurasian

Euro/ECO-Caspian

ECO-Caspian

ECO, Russia

TurkeyIranNorway

EU, EEA + UKSwitzerland

Energy Charter, SCO