Realization of opportunities and risk minimization through strategic partnership

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altPhilip Wolfe, global head of Oil and gas, Resources & Energy group, investment banking, HSBC

In Global Banking and Markets HSBC strategy is “emerging markets focused and fnance led” and this refects our global footprint particularly in the fast growing emerging markets as well as the strength of our fnancing capabilities as the world’s largest bank, one of the world’s largest banks. The title of my presentation today is “Capturing opportunities and mitigating risks through strategic partnerships and joint ventures and it is the prospective from the fnancial community. I think it is pertinent to this conference in Kazakhstan, since the most successful developments here, have almost certainly involved strategic partnerships and joint ventures. I think it need to say the oil and gas industry is very much a team sport no one company will do this on their own.
Before I get into the body of my presentation I am going to very briefy introduce HSBC – in general, in oil & gas and in Kazakhstan.
HSBC is one of the strongest fnancial institutions in the world and we have maintained this position through the course of the Credit Crunch. In terms of market cap today we are close to where we were pre-Lehman in August 2008. Our success has been based upon our global network and helping clients in cross border transactions. We marketed as “The world's local bank”. We serve over 128 million customers worldwide through around 10,000 offces in 83 countries. Most important of the business that I am involved, we have 22 investment banking offces with over 450 dedicated investment and bankers globally.
Within the oil and gas sector, HSBC is particularly strong cross border transactions involving Emerging Markets. Focus in differentiated strength when we work for national oil companies, Asia and Middle East players, emerging market independence. And at the same we really focus on cross border where emerging market deals.
HSBC in Kazakhstan provides corporate and institutional banking, investment banking, trade, global banking, personal banking, custody and clearing services. We established a rep of this area in 1997 and it was converted into HSBC Bank Kazakhstan, a wholly owned subsidiary in 1999 ten years ago. We one of the few international banks to have a full commercial bank operation in Kazakhstan. Over the last two years we have continued to expand our presence in Kazakhstan opening branches in Almaty, Astana, Atyrau
fnancial institutions. We have invested in many fagship projects and we are seeking further investment opportunities. There are some of the relevant transactions we have been involved in Kazakhstan on the slide.
So, apologize for advertisement. Moving on to the discussion which is capturing opportunities and mitigating risks though strategic partnerships and joint ventures
So, what is strategic partnership and joint venture?
I have consulted English dictionary. First of all, what is strategic? It is something that essential in relation to a plan of action; highly important to an intended objective.
What is a partnership? It involves two or more participants, each furnish a part of the capital and the labour,
whereas share of the costs and the share of the profts; it is mutual cooperation to achieve a goal.
And a joint venture is a partnership to share risk or expertise. So, what does it take, next slide please, transaction, to make a venture happen?
First, you need identify the “Business Opportunity” and gain access to it.
Second, then we need to have the “Expertise & Experience” which is labour and technology and track record, so that you can craft that opportunity.
Finally, you need to put a capital in to take that forward.
And bringing these three elements together puts the partners in a position to realize the objectives and generate returns from the venture.
You can see a supply methods on this slide, reminds you who we are. So, let’s take these elements one by one.
In the oil & gas industry it is quite simple – you need to get access to the hydrocarbons and/or the consumers.
Oil & gas companies the challenges are follows: extracting the hydrocarbons and turning it to consumable products and getting it to the consumer that is the key. As you can see on this slide, national oil companies control over the world’s 80% of oil reserves and a faster-growing share of demand and as such have the lion's share of the access to the opportunities.
The FSU is one of the most resource rich regions of the world and Kazakhstan is absolutely critical in that with its supply far exceeding its demand.
If we look specifcally at the Caspian region, it is particularly interesting, very substantial resources of both oil & gas in three key countries (Kazakhstan, Turkmenistan and Azerbaijan). The key challenge is getting the oil & gas from this landlocked region.
However, the consuming markets are in multiple directions and someone said the other day, we are in Kazakhstan you are jessant to three of the brick countries. The existing pipelines for both oil & gas have greatly opened up this opportunity, but there is so much more to be done. The technical, political and fnancial challenges are very considerable and will not be solved by any one party or just one country.
Technology is key, especially in increasing challenge environment where oil is getting more diffcult. Projects are larger and more complex, including offshore deep water, harsher environments, heavier oil and more remote reserves of both oil & gas and this requires considerable project management skills and engineering expertise. And fnally, lo-
cal knowledge there should never be underestimated if you want to get things done in a foreign market.
Moving into the next point, the third of the elements, and today capital and fnancing is a relatively scarce. Up until about 18 months ago capital was freely available and anyone could provide it or source it. It has become a bit more challenging and it is now a scarce commodity. When we thing about fnancing, it is frst of all, the sources of equity. This is the IOCs, the NOCs, increasingly the sovereign wealth funds, and fnancial investors. From the debt side you got the banks (syndicated loans), bonds, export credit agencies.
It is nearly always necessary to access multiple equity providers and various sources of debt in order to fund today’s ever growing projects. Often the capital structure needs to be sliced and diced with differing risks and returns allocated to each tranche of debt and equity. Each equity investor has their own return hurdle and these will likely vary based upon the type of investment opportunity and their perception of the risks involved. It worth noting that the right combination of equity investors and project sponsors greatly supports both the fnancability and the amount of the debt fnance.
Let’s look into where capital is needed in the future and where its likely to come from. This is a global prospective. Signifcant capital is required here in FSU, Middle East, Africa, Brazil and Canada.
So, where are the sources of capital? Big IOCs are increasingly important as fnancial strength matters. The three big US IOCs have a combined market cap of half a trillion USD. The big four European IOCs have a combined market cap of the same half a trillion USD. And in the large Russian IOCs have about US$350bn, although, much of their capital needs to go into their domestic market. But the national oil companies and sovereign wealth funds are even bigger.
Middle Eastern national oil companies have an estimated combined value of $2,000bn. I think it is under estimation, there probably 3 or 4. Middle Eastern sovereign wealth funds have an estimated combined value today of $1,600bn. Asian national oil companies which are increasingly important have an estimated combined value of $600bn and Asian sovereign wealth funds have further US$600bn. There is no doubt, that many NOCs require a lot of capital, but others may be the direct or indirect source of capital for the global oil & gas industry in the future.
If we look at these 3 categories (access, expertise and capital) and compare IOCs and NOCs it is clear that strengths and weaknesses differ between these groups. IOCs have some limited access to hydrocarbons, some access to consumers, but that is mostly in the mature markets. There relative strength in technology and access to capital. NOCs are more complicated, and there are two categories.
There are the net producers, such as KMG. That have unrivalled access to hydrocarbons and there is the net consumers you have access to customers but it very short in hydrocarbons.
To summarise, I think the IOCs are somewhat homogenous, but NOCs vary considerably in terms of their relative strengths and weaknesses.
The key challenge is to aligning partners’ interests. If all companies were the same the only opportunity would be economies of scale. But the difference is to create challenges that must be solved, but that really opportunities.
What do NOCs and IOCs have to contribute to a joint venture and what do they want in return? Also what is the fscal regime?
Critically it must be fair and stable, so there is both incentive and predictability. And the key is balance. So long
as the relationship between all these parties is balanced and equitable, you can create win situations and create value.
To create a balanced and fair partnership there must be complete clarity as to what each partner contributes and what each partner takes out in return. Balanced partnerships and joint ventures generally last a long time.
So key success factors for JVs: frstly, fscal stability, and this is the responsibility of the host government or national oil company. Secondly, local access which may be from private local partners or state related entities. Thirdly, fnanc-ing is likely to come from a combination of IOCs, NOCs, domestic or international banks, export credit agencies and other fnancial institutions. And it fnally, technical expertise may be delivered by IOCs or international or local service companies. In summary many different partners bring different value added to create successful partnerships and JVs.
Very quickly looking at some case studies in upstream oil & gas sector from various continents and in other emerging markets. All of these are cross border cooperation and involve both NOCs and IOCs. First one I want to highlight is Dragon Oil. Dragon Oil has been active in Turkmenistan since 1998. It has worked collaboratively with the State Agency in Turkmenistan for over 10 years. Dragon has delivered the expertise and the capital (with the support of its majority shareholder ENOC).
And Today Dragon produces 42,000 bpd of oil and has gross 2P reserves of 645 million barrels of oil. In addition it has very signifcant gas resources of over 3 tcf which has very strategic value as we have heard in other presentations last few days.
Cannot say too, but HSBC is acting as joint Financial Advisor and Rule 3 Advisor to the Independent Committee of the Board of Dragon Oil in relation to the approach by the Emirates National Oil Company who are looking to acquire the remaining shares in Dragon Oil that it does not own.
The next case study is quite a unique one. HSBC was very honoured to be retained by the Saudi Ministry of Petroleum in relation to the partition neutral zone concession. The PNZ was started in 1949 when the Saudis granted Getty Oil a concession to jointly operate this area on its behalf of the Saudi government working with the Kuwait Oil Company.
Chevron is the successor company to Getty and its 60-year concession was due to expire in February of this year. Based upon a long relationship and mutual respect the Ministry Working Team and Chevron successfully negotiated a 30-year extension that is win-win for both parties.
Chevron will be able to book signifcant proven reserves and continue to produce approximately 130,000 bpd net from the PNZ. This represents almost 5% of Chevron’s global oil and gas production. The Concession is the last remaining oil exploration and production concession in either the Kingdom of Saudi Arabia or Kuwait, there is operated by a foreign frm. Chevron has also committed to explore for and develop both conventional and the heavy oil reserves. And importantly it is undertaking a steam-food pilot to produce from the heavy oil.
The next case study is in Brazil. The pre-salt felds are huge discoveries and will require signifcant expertise and capital to development.
Tupi alone is apparently the largest, but it is larger than the entire UK North Sea. Prior to the late 1990s foreign oil companies could not compete with Petrobras. But, in the second rounds, licensing rounds in 2000 and 2001 BG, Shell, Repsol, Petrogal successfully partnered with Petro-bras to win these very prospective licenses.
Interestingly Hess which initially won its license on its own but farmed out later to both Petrobras and Exxon mobile. There is no doubt that Petrobras will be better placed
to deliver multiple projects through its various partnerships with major IOCs and other IOCs who bring both technical and management expertise as well as signifcant access to capital.
Last case study, Ghana is another exciting upstream province that has been successfully explored through win-win partnerships. Kosmos Energy, a well fnanced management team with specifc technical expertise partnered with a local Ghanaian group and the state to win the West Cape Three Points Block in 2004.
Tullow and Anadarko entered Ghana in 2006 and were subsequently awarded the Deepwater Tano Block in partnership with a local Ghanaian group and the state. Tullow has been fantastically successful and I think it is particularly strength. It has been track record in Africa and its project management skills. Of late it has almost, also demonstrated a strong fnancing capability through its successful US$2 bn reserve based landing facility as well as a US$565 million rights offering.
The two Blocks have now been unities as the Jubilee feld which is a huge success, based upon a number of powerful partnerships amongst small/ medium sized IOCs, local players and the Ghanaian National Petroleum Company the future very bright.
So to conclude, partnerships and joint ventures are critical to realize many of today’s major projects in both upstream and the downstream. They often involve one or more NOCs and one or more energy market. Successful partnerships are built on mutual understanding of partners’ relative strengths, clarity of respective objectives. But, also balanced contributions and sharing of risks and returns between all partners and providers of fnance. HSBC has an “emerging market focused and fnance led” bank is ready to provide advice and capital to our core clients and we hope to work with it all in Kazakhstan going forward.

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