Energy Risk in Asia

Last month risk management professionals from all over the Asia-Pacific region gathered in Singapore for the inaugural Energy Risk Asia conference. Oliver Holtaway reports on some of the highlights

Demand for all types of energy is growing in Asia, increasing both environmental and security of supply concerns. At the same time, the growth of derivatives trading in the region suggests that risk management is rising up energy companies' agendas.

Energy Risk was pleased to welcome over 150 delegates from Australia, China, Indonesia, Malaysia and Vietnam to the inaugural Energy Risk Asia conference, held in the refined surroundings of the Meritus Mandarin Hotel in Singapore on June 20 and 21. Over the two days, energy risk professionals networked, heard presentations from senior industry figures, and debated the issues of the day.

The programme kicked off with a panel discussion that assessed the security of global natural resources, featuring Charles Foo, managing director of Keppel Offshore and Marine, John Bampfylde, energy risk manager at Australian utility Tarong Energy, and Richard Ng, head of commodity derivative sales at Deutsche Bank.

"Whether we like it or not, we will be dealing with oil and gas for a long time to come," said Foo. "The simplest and cheapest way to achieve energy security is to reduce demand: energy efficiency is the top priority."

A delegate asked what percentage of energy consumption could realistically be saved through energy efficiency measures. While acknowledging the difficulty in making such an estimate, both Foo and Bampfylde said that their gut feeling put this figure at around 40–50%.

Diversification of resources will also play an important role, Foo continued, with supplementary sources of energy such as associated gas being "there for the taking." He also predicted that LNG could surpass oil in the global fuel mix by 2030.

Bampfylde approached the question of spiralling energy consumption from a regulatory perspective. "It is very hard to build a regulatory framework that covers all the bases," he argued. "The question is, how do you shape regulation to allow capital to invest more?" The best example of this, he said, was the Enron model, despite the collapse of Enron itself.

Ng noted that although Asia is the fastest-growing oil demand region in the world, regulated prices in China and India are discouraging investment in supply. As a result, Asia will have to rely increasingly on the Middle East and Russia for energy supply, leaving it open to a high degree of political risk.

A delegate asked the panel what percentage of new supply projects will need to be hedged before they go ahead, given that most new oil and gas projects have been in the hands of oil majors and national oil companies that have tended not to hedge.

Ng replied that, while the larger state-owned companies won't require hedging, newer and smaller companies that require capital markets funding to execute new projects would do well to hedge 30–50% of their future production, in order to obtain favourable borrowing rates.

The panel discussion was followed by a keynote address from Michael Lewis, global head of commodity research at Deutsche Bank, which would prove to be one of the most popular presentations of the event.

Lewis argued that despite what some oil consumers say, high oil prices are not the result of a speculative bubble, but rather a fundamental rally in commodities. "Our sense is, there is a fundamental repricing in oil," he said.

Opec has been very successful in defending the oil price in the past, he argued. Only in 1998 and 2001, when global growth was slowing rapidly, did Opec fail in this regard.

"We expect Opec to defend high prices as long as world growth stays above 3% year-on-year," he said. "They will be keen to do this because of the weakness of the dollar, which is reducing purchasing power [for Opec producers]. We think the floor is around $55/bbl."

Geopolitics and weather events will continue to buoy prices, he said, while disappointing non-Opec products growth caused by chronic under-investment provides a bullish fundamental driver on the supply side.

"Every single month, we are seeing downward revisions to expected non-Opec production," he noted. "Financial markets are responding to this aggressively, with the back of the curve lifting because of this supply/demand challenge – especially when you factor in the depletion rate, estimated at 3.5% yearly, of existing oil production facilities."

He closed by warning that the options markets are underestimating the risk of price spikes, in oil but especially in US natural gas. A hot US summer and increased hurricane risk could produce these spikes, he said, noting that we are entering into the high point of a 20-year hurricane cycle.

After breaking into two streams, one focused on risk management techniques and the other on the LNG market, the conference then reconvened in the afternoon for a panel discussion on the development of the biofuels market.

Leonard Gomes, research and business development manager at POIC Malaysia, an industrial cluster producing palm oil, noted that rising crude prices had initially been the driver behind interest in biofuels, but green issues are now also driving demand. However, he noted that most projects are not yet commercially viable and rely on government subsidies. He estimated that oil prices would need to be around $90 a barrel for biofuel projects to break even. "The demand is there, but there are supply side difficulties," he said.

Peter McGuire, managing director of Commodity Warrants Australia, an investment firm offering retail investments in commodity futures, was bullish about the biofuels sector due to increasing global energy demand, and predicted increased interest in Asian markets.

"Everything is pointing towards more consumption, and that bodes well for biofuels," he said. "A lot of investors are now coming into the biofuels market, and hedge funds and pension funds are now looking at this market too," he added.

At the end of the first day, delegates gathered for a cocktail reception that featured the inaugural Energy Risk Asia awards.

The environmental theme continued the following day, with a panel discussion on the development of Asia's carbon markets.

Theodore Backhouse of Deutsche Bank noted that the key issue from project owners is the wish to relate pricing of Asia's project-related carbon credits back to the EU's emissions trading scheme.

"We've seen steady increase in the European emissions allowance (EUA) price," he said, adding that he sees €25 per tonne of CO₂ as the long-term price for EUAs. He noted, however, that since February the discount at which project-based carbon credits (CERs) trade to the EUA price has steadily increased.

"At the beginning of the year, a fully guaranteed CER traded at about 90% of the EUA price – now it is more like 70%," he said. This reflects concern over the implementation of the UN-supervised CER registry and the imposition of CER import limits by EU member states, he explained: "Political risk is the main risk."

He also noted that the Indian and Chinese Clean Development Mechanism (CDM) markets are developing differently.

"India has a huge number of unilateral CDM projects, whereas in China, projects are required to have buyers lined up in advance," he said. "The Indian market takes on far more market risk."

Architrandi Priambodo of Asia Carbon then gave a more detailed rundown of the non-market risks faced by project developers, including methodology risk, host country approval risk, registration risk and verification risk. Fellow panellist Chintan Shan, general manager of Indian CER trader and consultant Senergy Global, picked up on this theme, arguing that the process-driven, documentation-heavy approach of the CDM was slowing project investment.

"There is massive potential for CDM projects across Asia, but not enough are going through," he said.

Finally, the conference closed with a thought-provoking and well-received presentation on risk management tools, in particular different value-at-risk models, from Philip Ng of BP Singapore, which reminded delegates that while risk analysis may be a science, risk management remains something of an art.

Energy Risk would like to thank all delegates and speakers for attending, and look forward to seeing you – and hopefully many new faces – next year in Singapore.