Professional Documents
Culture Documents
8 February 2010
Barclays Capital does and seeks to do business with companies covered in its research reports. As a result, investors should be aware that
the firm may have a conflict of interest that could affect the objectivity of this report.
Investors should consider this report as only a single factor in making their investment decision.
This research report has been prepared in whole or in part by research analysts based outside the US who are not registered/qualified as
equity research analysts with FINRA.
FOR ANALYST CERTIFICATION(S), PLEASE SEE PAGE 68.
FOR IMPORTANT FIXED INCOME RESEARCH DISCLOSURES, PLEASE SEE PAGE 68.
FOR IMPORTANT EQUITY RESEARCH DISCLOSURES, PLEASE SEE PAGE 70.
Barclays Capital | Global Energy Outlook
In this report we present our energy research analysts’ views on commodities, credit and
equities. Three consistent themes stand out:
1. Crude oil, coal and carbon pricing are expected to strengthen on a 12-24 month
horizon; natural gas and US power prices may take longer to recover.
2. A preference for crude oil and upstream biased investments, relative to natural gas and
downstream oil. We see price support for crude in 2010 and even more so in 2011 as
demand recovers, inventories return to balance and new supply slows. We like the
commodity and oil biased E&P investments in credit and equities.
3. A clear negative view on downstream oil profitability, and investments sensitive to oil
product margins. We expect refining capacity additions to exceed demand growth at
least until 2012. We are negative on independent refiners in credit and equities.
In commodities, we are structurally positive on energy. In the long run, we see demand
growth outstripping supply, and expect prices to rise faster than inflation. Historically,
energy commodities have outperformed energy credit and energy equities, and we expect
that relationship to continue.
In credit, our preferred investments broadly mirror our commodities views. In high grade,
we are Overweight oil services and Underweight refiners. In high yield, we recommend E&P
and pipelines. High grade pipelines are trading with little spread differentiation, and strong
returns in 2009 suggest difficulty in outperforming in 2010. In high yield coal, we expect the
sector to underperform the broader high yield index in 2010, given the current tight
spreads, although we see some opportunities for outperformance: for example, at 335bp,
the discount between MEE 5y CDS and BTU 5y CDS is too wide, and we therefore
recommend selling MEE protection. In US utilities, the best opportunities are among the BBB
regulated and electric utilities; in Europe, we are Underweight the utilities group.
Energy equities have underperformed the underlying commodities in the long run, but have
outperformed the main equity indices, and we expect that pattern to continue. We currently
recommend a more defensive equity investment stance, following the strong
outperformance of high beta names such as oil services in the last 12 months. We are
Overweight the US Majors, ExxonMobil and Chevron, and in Europe we are Overweight Eni.
In US E&P, we recommend the oil biased Apache, Canadian Natural Resources and
Talisman. We are also positive on coal names and recommend Peabody. In oil services, we
see the start of a new capital spending cycle, but also expect a better future entry point into
the shares given their strong recent performance. We remain cautious on US power as our
proprietary Barclays Power Margin Index indicates a deterioration in future electric utility
earnings. Our least preferred sub-sector is the independent refiners, in both the US and
Europe, given the bleak outlook we see for refining margins.
Our research analysts’ views on each asset-class and on individual sectors are summarised
in the following pages. Our detailed research reports are available on Barclays Capital Live.
8 February 2010 1
Barclays Capital | Global Energy Outlook
RESEARCH CONTACTS
Commodities
Gayle Berry Suki Cooper James Crandell Helima Croft
Commodities Research Commodities Research Commodities Research Commodities Research
+44 (0)20 3134 1596 +44 (0)20 7773 1090 +1 212 412 2079 +1 212 526 0764
gayle.berry@barcap.com suki.cooper@barcap.com james.crandell@barcap.com helima.croft@barcap.com
Credit
Jim Asselstine Neil Beddall Laurence Jollon Harry Mateer
US Electric Utilities (HG) Utilities US Metals, Mining & Chemicals (HY) Energy & Basic Industries (HG)
+1 212 412 5638 +44 20 7773 9879 +1 212 412 7901 +1 212 412 7903
james.asselstine@barcap.com neil.beddall@barcap.com laurence.jollon@barcap.com harry.mateer@barcap.com
Gary Stromberg
Co-Head of US High Yield Research
+1 212 412 7608
gary.stromberg@barcap.com
Equities
Paul Cheng James D. Crandell Thomas Driscoll Daniel Ford
US Integrated Oil and Refiners US Oil Services & Drilling US Exploration & Production US Power & Utilities
+1 212 526 1884 +1 212 526 4865 +1 212 526 3557 +1 212 526 0836
paul.cheng@barcap.com jim.crandell@barcap.com thomas.driscoll@barcap.com dan.ford@barcap.com
8 February 2010 2
Barclays Capital | Global Energy Outlook
CONTENTS
COMMODITIES
Oil - Bridge of sighs 8
Power - Twilight 18
CREDIT
US High Grade Energy - Value is elusive in 2010 26
US High Grade Pipelines - As the beta trade winds down, credit selection takes over 28
EQUITIES
US Integrated Oil - Risk/Reward shifts in favor of Super Majors 34
US Independent Refiners - Bottom may be close, but the “Dark Age” continues 38
US Oil & Gas: E&P (Large-Cap & Mid-Cap) - Favor oil-orientated producers 42
8 February 2010 3
Barclays Capital | Global Energy Outlook
8 February 2010 4
Barclays Capital | Global Energy Outlook
Equities
US Integrated Oil We remain positive on the medium term oil outlook, however, ExxonMobil (1-OW) trades at 11.2x our 2010 EPS estimate,
the uncertainty has increased. compared with the S&P consensus P/E of 14.3x.
1-Positive
Until there is more data to establish a clear consensus view on Chevron (1-OW) shares are currently trading at 5.6x on
the pace of recovery and OPEC supply, the risk/reward trade- EV/2010 EBIDA, versus the group average of 6.6x. Chevron also
off now favours the Majors vs the smaller integrateds. has the potential for exceptional production growth.
European We prefer upstream biased companies. Downstream drag on Eni (1-OW) is under-valued, our sum-of-the-parts analysis
Integrated Oil corporate profitability may inhibit growth investment plans. implies 45% upside potential.
2-Neutral Although we continue to model lower costs for 2010, from
2011 onwards we see inflationary pressures returning.
US Independent Any margin uptick will be very modest over the next several Valero (1-OW) is our choice for short-term trading given its
Refiners years. Our global refining industry stance is 3-Negative. geographic diversity and relatively inexpensive valuation.
3-Negative The Gulf Coast could outperform the Rockies/Mid-Continent Sunoco (2-EW) currently offers the cheapest valuation among
heavy oil refiners over the next 1-2 years. the refiners. The shares could be attractive for the long term.
European Nearly 7mb/d of new capacity will be added by 2012 yet oil We re-iterate our 3-Negative stance on European refiners. Our
Independent product demand on our forecasts will be around 2007 levels. 3-Underweights are Petroplus and PKN Orlen.
Refiners With a positive medium term outlook on oil prices, a $10/bl Our 1-Overweights are Saras, GALP, Hellenic Petroleum and
3-Negative increase would reduce the realized refining margin by $0.5/bl. Motor Oil: these are the most complex and flexible refiners and
will continue to generate positive cash flows.
US Exploration & We forecast that production from the five biggest shales Apache trades at a 19% discount to peers on 2011E debt-
Production may be around 50% of total U.S. natural gas production adjusted cash flow vs. a historical discount of 8%.
by the end of 2012. Canadian Natural Resources has a strong long-term record,
2-Neutral
The oil price will have a dominant effect on E&P share leverage to Canadian oil sands, and a cheap multiple.
performance, instead of unhedged gas, which only accounts Talisman should perform well as the shift away from low-return
for 15% of revenue.
areas towards high-return areas becomes apparent.
US Oil Services & We believe land rig demand domestically will improve sharply We emphasize stocks with differentiated international growth
Drilling in 1H10, adding pressure to natural gas prices. prospects, deepwater and subsea exposure, and those geared
Internationally, we expect 2010 will mark the beginning of a towards an increase in exploration activity.
2-Neutral
long up-cycle in exploration and production spending. Our favourites among the large-caps are Weatherford,
Schlumberger, Transocean, Noble, Cameron and Tidewater. In
In the nearer term we are worried the group may be in for a
the small-to-mid caps, our top picks are ION Geophysical, Core
pause, given the OSX has increased 100% since December
2008 versus the S&P 500’s increase of just 35%. Labs, Dril-Quip and Dresser-Rand.
European Oil European service companies face deterioration in earnings as Tecnicas Reunidas (1-OW) is trading at a 50% discount to its
Services & Drilling the lack of work over 2009 hits. However, the first signs of a 2006-08A PE average, yet has seen earnings upgrades and has
next up cycle are becoming apparent. increased backlog by 50%.
2-Neutral
The prospect of a spending upturn has mostly been priced in, Wood Group (1-OW) is trading at 15x 2010F PE versus a sector
and until backlogs begin to move ,we remain 2-Neutral. average of 16x yet 2000-2008 31% pa earnings growth is
expected to continue in the medium-term.
US Natural Gas The competitive advantage of using light feedstocks is The three crucial trends affecting comparative results are
creating record and rapidly expanding demand for NGL. production costs, NGL exposure and MLP structure.
2-Neutral
The E&P oriented diversified gas stocks trade at abnormal Given the above themes we recommend El Paso, ONEOK,
discounts to the pure plays. Questar and Spectra Energy.
US Power Our analysis suggests the group has another 12% of relative We are 2-Neutral on US Power and recommend AES Corp.
underperformance in the first three quarters of 2010 before a We like AES for its: 1) contracted project backlog which adds
2-Neutral
slow but lengthy period of outperformance.
$0.22/share through 2011; 2) $2B of free cash flow in 2012
The Barclays Power Margin Index (BPMI) indicates a (25% to equity); 3) upside to EPS driven by weak US$ versus
deterioration in future earnings. This is reinforced by the Brazil/Euro currencies 4) partnership with China Investment
ratio of Open EBITDA to forecast EBITDA being less than one. Corp., which is buying 15% of AES
US Coal We believe that higher coal prices and strong financial We feel that U.S. coal equities still remain attractively valued
1 performance for equities in 2010 will be a result of improved despite the recent bullish run. In particular Peabody has strong
1-Positive
domestic demand, stronger Atlantic exports and a gradual exposure to both the attractive Powder River Basin and the
reduction of inventories – this should materialize H2 10. robust Asian market.
1
Credit Rating System (for a full definition, please see pages 68-69): Sector view is for the wider US Metals & Mining sector
Sector Weighting: Overweight, Market Weight, Underweight Credit Rating: OW, MW, UW
Equity Rating System (for a full definition, please see page 71):
Sector view: 1-Positive, 2-Neutral, 3-Negative Stock Rating: 1-OW, 2-EW, 3-UW
8 February 2010 5
Barclays Capital | Global Energy Outlook
8 February 2010 6
Barclays Capital | Global Energy Outlook
COMMODITIES
8 February 2010 7
Barclays Capital | Global Energy Outlook
OIL
Bridge of sighs
Costanza Jacazio In our view, 2010 is likely to be a bridging year, acting as a transition between the
+1 212 526 2161 demand-side weakness of 2009 and supply side tightness in 2011.
costanza.jacazio@barcap.com
We expect OECD demand to stabilize and head for its first year of growth since 2005,
and non-OECD demand growth to become more broad-based.
Amrita Sen
+44 (0) 20 3134 2266 We expect non-OPEC output to revert to negative growth in 2010, as last year’s large
amrita.sen@barcap.com upswing in Russian and US production will fades.
Emerging market Asia, led by China, has assumed central stage in the demand recovery that
started in 2009. Chinese oil demand increased by 0.33 mb/d last year, accounting for 60% of
total incremental consumption across the non-OECD. Demand soared in H2 09, with the y/y
pace of growth exceeding 1 mb/d (~15%) from September onwards, the fastest since the peak
of Chinese oil demand shock in 2004. The demand impetus, alongside a massive expansion in
the domestic refinery system, has fed into much higher crude oil import levels. Chinese crude oil
imports have not fallen below 4 mb/d since May and averaged 4.4 mb/d in H2 09, culminating
75 5
70 0
Nov-08 Apr-09 Aug-09 Dec-09 Jun-07 Nov-07 Apr-08 Sep-08 Feb-09 Jul-09 Dec-09
Source: NYMEX, Barclays Capital Source: Mimic, Barclays Capital
8 February 2010 8
Barclays Capital | Global Energy Outlook
at 5 mb/d in December, roughly 800 thousand b/d above 2008 levels. The impressive swing that
Chinese oil demand underwent over 2009 was a major turning point in the market, with respect
to sentiment and fundamental developments, especially for a market that even at mid-year an
outright contraction was treated as a very possible outcome. For 2010, in line with our positive
outlook for the overall pace of the Chinese economy (IMF: +9.0%; BarCap: +9.6%), we expect
Chinese oil demand to continue to grow robustly and remain the single largest contributor to
global oil demand growth. We forecast growth to average 0.38 mb/d, at the higher end of
consensus estimates, which range between +0.31 mb/d (IEA) and +0.4 mb/d (EIA).
The recovery in non-OECD demand has not been confined to China alone. Other smaller Asian
economies have also seen consumption pick up strongly in H2 09, while in the Middle East,
soaring Saudi consumption in the summer, due to high power demand and constrained
natural gas supplies, kept demand from the region growing fairly robustly. Crucially, the three
pillars of non-OECD oil demand growth – China, India, and the Middle East – have weathered
the 2009 downturn extremely well. Cumulative incremental demand from these three regions
averaged 0.68 mb/d last year, a deceleration of just 0.22 mb/d relative to the pace of growth
registered in 2008. Undoubtedly, in the absence of such supportive demand dynamics, prices
could have fallen much lower. Even within the non-OECD, countries other than China, India
and the Middle East recorded a small demand decline last year (0.12 mb/d), adding to the
sharp demand contraction across the OECD. Moving into 2010, we expect these marked inter-
and intraregional differences to soften and other non-OECD countries to account for virtually
all the additional growth from the developing world compared with 2009.
While non-OECD oil demand recovered strongly throughout 2009, the improvement in OECD
consumption was far more modest. OECD demand is on track to decline by 2.1 mb/d in 2009,
the largest contraction since 1981. The latest OECD demand reading available (October 2009)
still places the y/y scale of demand decline for the month in excess of 2 mb/d, indicating that
the region has yet to enter a phase of decisive, concerted demand amelioration. While
progress has been slow, signs of improvement can nonetheless be detected. The drag from
Japan on global oil demand growth is decreasing sharply. After falling by almost 700 thousand
b/d in Q1, Japanese oil demand has showed progressively narrower y/y declines, with the fall
for Q4 through November just 158 thousand b/d. In 2010, we expect the y/y pace of
contraction to stabilise and average 0.13 mb/d. This would be a major improvement relative
to the 0.51 mb/d fall we forecast for 2009. Much of that amelioration stems from the removal
of the unfavourable y/y base effects on fuel oil and direct crude oil burning that increased last
year due to the return of a significant tranche of nuclear capacity. In the US, moderate signs of
demand improvement emerged over the summer. The macroeconomic backdrop for 2010
remains supportive, in our view; we forecast US oil demand to increase by 0.15 mb/d, with
Figure 3: Chinese oil demand growth Figure 4: Non-OECD vs OECD oil demand growth
1500 y/y change in Chinese apparent oil demand (kb/d) 3 y/y change in oil demand, mb/d
2
1000
1
500 0
-1
0 -2
-3
-500 OECD
-4 Non-OECD Asia
Other non-OECD
-1000 -5
Nov-03 Nov-05 Nov-07 Nov-09 Feb-08 Sep-08 Apr-09 Nov-09
Source: China Customs Statistics, Barclays Capital Source: EIA, Barclays Capital
8 February 2010 9
Barclays Capital | Global Energy Outlook
some upside risk to this projection. This recovery notwithstanding, US demand will likely
remain well below pre-crisis levels, and we expect it to average 0.55 mb/d below 2008 levels.
Contrary to Japan and the US, in Europe the oil demand recovery has yet to begin. Indeed,
Europe stands out as one of the few regions in which demand declines actually look softer in
the rearview mirror than the more recent data suggest. European demand fell by almost 1
mb/d in Q3 09, the largest y/y drop for any quarter since the onset of the crisis, with this
extreme weakness having continued into October. The abnormal path followed by German
heating oil consumer stocks – heavily front-loaded in the first part of the year – has helped
accentuate this weakening profile across quarters. Yet even allowing for such effects,
European demand has, at best, remained in a bottoming phase. We expect a turning point to
be reached relatively quickly, however, with the advent of cold weather and a steady
improvement in the macroeconomic backdrop making their way into the data. Thus, we
forecast European oil demand to decline by a modest 0.13 mb/d in 2010.
Overall, we project OECD demand to remain flat in 2010, with higher North American
consumption offsetting small declines in Europe and Japan. In our view, risks to this forecast
are skewed to the upside; indeed, we see the scale of the recovery in OECD demand as
providing the most likely source of upside surprise to our global balances through 2010.
Alongside that, the composition of growth across various products will also be crucially
important in setting sentiment and prices. 2009 has been characterised by a stark contrast
between strong gasoline and weak distillates demand, but this divergence, in our view, is set
to fade in 2010. The latest data releases showcase the first signs of a global recovery in
diesel demand. After lagging the acceleration in other products, China’s diesel demand
growth has decidedly turned the corner since September. Moreover, encouraging signs
have also emerged within the OECD. A blast of cold weather in December has helped prop
up distillates demand in Europe and the US. As a result, the pace of erosion of the distillates
inventory overhang has accelerated substantially. In the US alone, more than a third (13.5
mb) of the existing surplus above the 5-year average has been burnt off since the end of
November. And while data are not yet available, the severity of the winter so far in Europe
and Asia makes us believe that the burning off of global distillate surplus is taking place at
an accelerated pace. This rapid progress towards normalisation has been a clearly positive
factor for sentiment but has thus far been highly dependent on favourable weather
patterns. The key question, therefore, remains what will happen once the prolonged cold
snap in key consuming areas dissipates. We believe that economic effects will take over
from weather effects in continuing the erosion of the distillates surplus. Barclays Capital
economic forecasts and projections for good inventory dynamics in the US underpin this
view. Our economists expect final goods inventories to reach a tipping point in late Q1 10.
After a severe period of destocking in H1 09, the pace of decline in wholesale inventories
slowed substantially in the latter part of the year. This swing has indeed been significant,
with the $160bn decline in Q2 09 projected to less than halve in Q4 09; however, smaller
declines have yet to turn into sequential increases. When this transition occurs, trucking
mileages should start rising significantly, ensuring sequential growth in middle distillates at
some point in the early part of 2010. In our view, distillates demand is the part of the
demand barrel geared to benefit the most from the recovery path this year, which should
provide some upside price potential to the relative price of distillates, particularly in H2 10.
Similarly, on the supply side, we expect some of the most pronounced discontinuities caused
by the global economic crisis to taper off over the course of 2010. For OPEC liquids, 2009
showed the largest annual contraction since 1982. OPEC-12 crude output averaged 28.6
mb/d last year, 2.66 mb/d below 2008. From its peak hit in August 2008 to its bottom in
February 2009, the contraction in OPEC output reached almost 4 mb/d. While production has
drifted higher thereafter (with estimates for December 2009 placing it at about 29 mb/d), it is
still almost 3 mb/d below pre-crisis levels. The substantial supply-side pressure OPEC is
continuing to exert while immediate price targets have already been achieved is a testament to
8 February 2010 10
Barclays Capital | Global Energy Outlook
its commitment to defend what it has so painfully gained over the year. Thus, with the oil
balance on the path of normalisation, the $70/bbl level that OPEC’s policymakers have
signalled as the floor to their desired price range at this stage of the cycle will be very hard to
break, in our view. Where the ceiling of that desired range might lie, however, is much less
clear. So far, the producing group has alluded to $80/bbl as the upper end of its comfortable
range. However, with the recovery consolidating, demand data improving and prices pushing
beyond that threshold, we suspect OPEC will gradually relax this ceiling and their price
aspirations will move higher as the year progress. OPEC’s degree of acceptance of any
development in upside momentum will be a crucial price setter in 2010, as neither the
recovery in demand nor the weakness in non-OPEC supplies appears strong enough to drive
the market on their own accord. By sitting on a substantial amount of spare production
capacity, key OPEC producers have the ability to curb upside momentum, should they wish to
do so. Overall, we expect any adjustment in policy to be gradual and take the form of subtle
changes in tone, rather than any dramatic shifts in targets. Improving demand and weakening
non-OPEC supplies should leave OPEC with some leeway for further output rises through the
year without putting at risk the rebalancing of the market currently underway.
OPEC’s supply-side management in 2010 is set to benefit from non-OPEC’s actual and
projected weakness. From the uniformly downbeat non-OPEC output performance of 2008,
2009 proved more of a mix bag, with pockets of weakness coexisting with pockets of
strength. Against a backdrop of continued widespread structural weakness, some areas of
upside surprise emerged. Particularly, the return to positive production growth in Russia,
following a dismal performance in 2008, and the strong bounce back in US production (up
0.43 mb/d y/y) after the hurricane-affected year of 2008 offered some breathing room to an
otherwise faltering supply side. Non-OPEC production growth in 2009 totalled a modest 0.22
mb/d, suggesting a significant degree of continuity with the scale of weakness in recent years,
rather than heralding the beginning of a new phase of strength. Ahead, we believe the
prospects for non-OPEC supplies are set to deteriorate. The likelihood of last year’s strong
production performance from Russia and the US being repeated this year is small, in our view.
In the US, positive y/y effects should fade and potentially revert. Although a bunch of new
projects are scheduled to come on stream in 2010, gross capacity additions are set to fall
short of 2008 and 2009 levels. Similarly, we expect Russian production growth to subside in
2010. Fewer new projects are scheduled to commence production, whereas the better
investment climate that developed in 2009 due to tax incentives might not hold as the
government’s budget concerns diminish with higher and stabilising oil prices.
The projected fall in non-OPEC supply in 2010 should facilitate OPEC’s market management,
aided by the prospect for a significant acceleration in the degree of non-OPEC supply
weakness from 2011 onwards. As a potential phase of severe supply-side tightness draws
closer, its effect on sentiment and prompt prices will likely increase. In this context, there is a
limit to how low prices can go, irrespective of how slowly short-term oil market balances re-
adjust. The projected tightness of the medium term is acting as a key bullish factor in the oil
market, propping up short-term prices and reducing the need for OPEC to engineer a much
faster and painful rebalancing of the market. Hence, after the rollercoaster of the past two
years, 2010 is shaping up as a year characterised by much gentler dynamics in fundamentals
and prices. Demand dislocations should progressively correct, the inventory surplus should be
eroded and OPEC output restrictions ease. In such circumstances, extreme price events look
unlikely. We expect prices to remain prone to some volatility but within a relatively constrained
range, as periods of economic optimism alternate with seldom, but remnants, of economic
pessimism. With the potential of fundamentally-led extreme price upside at a minimum, we
believe geopolitical developments are the most likely source of upside price risk in 2010, as a
series of situations involving key oil producing countries remains unresolved and subject to
possible escalation as the year progresses.
8 February 2010 11
Barclays Capital | Global Energy Outlook
NATURAL GAS
Snow blind
Michael Zenker A steep expected drop in US supply and recovery-led demand growth have supported
+1 415 274 5488 a recent bullish undercurrent in the North American gas market.
michael.zenker@barcap.com
We see incrementally more supply against a stagnant demand outlook in latter H2 2010.
We expect Henry Hub prompt-month prices to average $5.25, up somewhat from our
fall 2009 estimate of $5.05.
Excluding weather, the wide range of potential US LNG imports and the uncertainty
over the displacement of coal by gas in 2010 could also swing the market.
8 February 2010 12
Barclays Capital | Global Energy Outlook
after the current winter. The cold weather is offset in our balances by stronger supply. End-of-
October storage inventory is expected to reach 3.94 Tcf, another record. While this inventory
is not expected to overly spook the market, it nonetheless again removes much of the winter
price upside. More importantly, when the market realizes that supply is trending higher by late
2010, bearish sentiment will be expressed out on the curve, since it would mean supply is
again outpacing demand. This could prompt another round of drilling cuts.
We believe cold weather will support prices in Q1 10 and, as a result, have raised our
price view for the quarter to $5.50 (from $5.20). This could blind the market to what lies
ahead. Owing to a view that higher coal prices will raise the gas-coal switching floor in
Q2 10 and Q3 10, we have raised our price view for those quarters to $5.00 (from
$4.75). Our fourth quarter estimate is strongly influenced by our October storage
estimate of 3.97 Tcf. We believe this will hold Q4 10 prices in check at $5.50
(unchanged). This results in our forecast for 2010 prices of $5.25.
In 2009, we dismissed concerns that the US would be flooded with LNG, but we do not brush
aside that argument in 2010. Global LNG supply is almost certain to outpace global LNG demand
in 2010, creating an unusually large amount of spot LNG (please refer to the Global LNG section
of this report). The real question is where the surplus LNG will land. Neither the US nor Europe
appear to be short of gas at this point, so spot trade will head to the market with favorable prices.
That is, the trans-Atlantic spread, not absolute prices, will drive the destination of spot cargoes.
While higher levels of US gas production and/or LNG imports are self-correcting in that they
will ultimately weigh on US prices, potentially flipping the trans-Atlantic price advantage back
to Europe, timing is important. The US market is expected to remain supported through
winter, mainly on weather risk. Not until the market shifts its attention to the US injection
season will the impact of supply become a focus for the market, in our view.
8 February 2010 13
Barclays Capital | Global Energy Outlook
GLOBAL LNG
Wind of change
Biliana Pehlivanova Europe absorbed the bulk of excess spot LNG cargoes in 2009 while maintaining a
+1 212 526 2492 small price premium to the US.
biliana.pehlivanova@barcap.com
LNG demand should follow the global recovery, but supply is set to spike.
An extended cold spell could offset any oversupply and reset regional price
differences.
Forward price differentials suggest the US is likely to absorb excess volumes in 2010.
The global glut occurred despite underperforming supply. Global liquefaction capacity added a
record 5.8 Bcf/d in nameplate capacity in 2009, but much of this came on line in the second
half of the year. Start-up troubles delayed the ramp-up of production from several of the new
trains, and lost production from existing facilities offset much of the new additions.
Consequently, global LNG supply rose by roughly 1 Bcf/d y/y – a substantial increase, yet well
below what the market was expecting.
Weather forecasting
For 2010, the rapid growth of LNG supply is more certain. The liquefaction trains that started in
2009 are gaining speed. If all produce at capacity and 2010 plant additions come on line as
planned, global LNG supply would grow by more than 6.0 Bcf/d y/y this year, a staggering 25%
jump. However, given the history of chronic delays and liquefaction plant glitches, this estimate
is likely too high. A more reasonable assumption for incremental LNG production growth in
2010 is 4.5-5.5 Bcf/d, in our view. Still, this would be a large jump that the global market would
be challenged to absorb.
In contrast to 2009, global LNG demand should grow this year. Green shoots have blossomed in
many markets, and the global economy is on pace for a healthy recovery in 2010. Yet once again,
the magnitude of the expected expansion in supply threatens to flood the world with LNG
volumes well in excess of the potential increase in demand. Assuming a strong, but not full,
recovery of Asian demand and taking into account new re-gasification facilities coming on line in
capacity-constrained markets, LNG takes in the Pacific Basin and the Middle East could grow by 2
Bcf/d this year, following a 0.5 Bcf/d y/y drop in 2009. South American and Mexican consumers
could contribute a further 0.5-0.7 Bcf/d y/y growth in global demand. Against an estimated 5
Bcf/d y/y increase of global LNG supply next year, this would leave more than 2 Bcf/d of LNG
looking for a home in the US and European markets in 2010.
8 February 2010 14
Barclays Capital | Global Energy Outlook
LNG is evolving into a dynamic and increasingly nimble marketplace. With spot cargoes now
frequent and given the growing number of market participants seeking to arbitrage regional
price differentials, LNG is connecting the geographically fragmented gas world. In this context,
global gas prices are likely to maintain their newly acquired regional link. With the colder-than-
normal winter weather recently, Asian markets are again leading in spot LNG prices, albeit
with a relatively small premium to the Atlantic Basin. Weather has the potential to clean up
global LNG balances, but short of a major extended cold weather event, the ramp-up of
liquefaction plants and the moderation of heating load as the winter wanes should pressure
spot LNG prices around the world to again trade closely in 2010.
3
2
1
0
-1
-2
-3
Feb-08
Apr-08
Mar-08
May-08
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Nov-08
Dec-08
Jul-08
Sep-08
Oct-08
Jan-09
Feb-09
Apr-09
Mar-09
May-09
Jun-09
Jul-09
Aug-09
Sep-09
Oct-09
Nov-09
Dec-09
8 February 2010 15
Barclays Capital | Global Energy Outlook
COAL
In our view, there are a number of sources of upside. First, supply bottlenecks remain in key
exporting nations such as South Africa and Australia. Rail problems and port congestion
issues have not been resolved, and the recent downturn has been characterised by a lack of
investment in infrastructure to address these problems. As a result, should coal import
demand rise strongly, the export capacity is likely to falter yet again, much like a repeat of
what happened in early 2008. Second, there could well be stronger-than-expected Indian and
Chinese imports. Despite the strength in Chinese coal demand, we expect coal imports to ease
about 2% y/y, as we see a resolution to the deadlock between producers and utilities that
characterised much of 2009. We forecast Indian imports to rise 20% y/y, even after factoring
in that their ambitious capacity addition plans may not always come to fruition. Nonetheless,
both countries continue to grow extremely strongly, with coal as their preferred fossil fuel for
power generation. As a result, their import requirements could surprise to the upside. The
third factor is disappointments in Indonesian exports. Despite strong growth in production,
uncertainties remain regarding the new mining law. The Indonesian government is expected
to release four implementation regulations in that will hopefully clarify certain clauses in the
mining law and reduce regulatory uncertainty. However, controversial parts of the law remain.
The final source of upside risk is coal gaining back a larger share of demand relative to gas in
power generation in the US and partly in Europe. The very weak gas market in 2009 led to coal
demand falling about 10% y/y on both sides of the Atlantic. With higher gas prices compared
with domestic coal prices (contracts agreed on 2009 levels) in the US, we expect coal to regain
some of its lost market share this year, though to a lesser extent in Europe, as forward gas
prices remain well in the money.
By region, we expect Newcastle to continue to outperform API 4 mainly due to strong Asian
demand and API4 to continue to battle high European stockpiles despite buoyant Indian
demand. That said, more competitively priced Richards Bay coal compared with Newcastle
has drawn Chinese buying into South Africa recently, thereby squeezing the differential
8 February 2010 16
Barclays Capital | Global Energy Outlook
between the two to $5/t by late 2009, from almost $15/t in late November. With China
looking to exploit any arbitrage opportunity that arises, the spread between the two prices
is likely to remain tight, though with Newcastle prices at a premium to API-4. Across the
forward curve, we see strength at the front as bringing about curve flattening, which could
present a risk to the release of stockpiles back into the market. We forecast averages of
$90/t, $84/t and $90/t for the API 2, API 4 and Newcastle, respectively, in 2010.
Much of the impetus for this latest price rally has been weather-related. We see cold
weather in China as a key driver of the strength in API 4 and Newcastle coal. A jump in
China’s power needs is imposing tremendous stress on its supply system, reflected in falling
stocks at power generators across the country; in some cases, shortages have already led to
power rationing. Domestic prices have gone from strength to strength. In early January,
Qinhuangdao (QHD) FOB prices surged above $112/t, and delivered prices in Guangzhou
moved closer towards $130/t, encouraging interest in overseas coal not just in Australia
and Indonesia but also in South Africa. At the same time, a cold snap in the Atlantic is
driving up power demand and gas prices, improving the relative attractiveness of burning
coal. While weather remains the greatest upside risk to our baseline forecasts, other
fundamental factors turned constructive over the course of 2009. The agreement of an
$85/t term price between Tokyo Electric Power and Xstrata (versus a buyer’s target of
$75/t) is telling of underlying concerns about tight supplies beyond the very short term, a
striking contrast with market sentiment this time last year.
Thus, for 2010, we continue to view coal markets constructively and, in our view, despite
being one of worst performing commodities in 2009, prices are set to increase strongly,
with an average increase of 15-20% annually. China remains the key to our global balances,
and with the expectation of a slow but steady recovery in Europe, the supply bottlenecks
that plagued the coal market in early 2008 could well re-emerge this year, given the lack of
investment in export infrastructure to increase flexibility and capacity. The wild movements
in prices at the beginning of this year already serve as a testament to these risks.
Figure 1: Barclays Capital coal supply and demand balance and price forecasts
Mt 2003 2004 2005 2006 2007 2008 2009E 2010F
Japan 107 118 120 119 126 131 114 114
China 7 10 16 31 41 31 82 88
India 13 15 24 29 35 36 49 59
Europe 167 160 156 169 163 161 144 140
Others 193 217 153 231 250 259 246 265
Total imports 487 521 469 578 616 618 635 665
y/y change (%) 6.9% -9.9% 23.2% 6.6% 0.3% 2.7% 4.8%
Indonesia 88 105 129 183 195 200 215 224
Australia 103 107 107 111 112 125 140 151
China 73 74 61 54 45 36 18 21
Russia 0 0 68 76 74 70 80 74
South Africa 70 67 74 67 67 68 67 70
USA 3 3 19 20 24 21 20 23
Colombia 44 51 55 58 65 69 65 67
Others 8 18 32 41 46 40 37 37
Total Exports 389 426 545 611 627 629 642 668
y/y change (%) 9.5% 27.8% 12.2% 2.7% 0.2% 2.1% 4.0%
Global trade balance -98 -94 76 33 11 11 7 3
API 2 (US$/t) 44 72 61 63 87 144 71 90
API 4 (US$/t) 31 54 47 50 62 120 66 84
Newcastle (US$/t) 27 53 47 49 66 128 72 90
Source: McCloskeys, Ecowin, Barclays Capital
8 February 2010 17
Barclays Capital | Global Energy Outlook
POWER
Twilight
James Crandell Power consumption growth is likely to follow a rebound in the economy in 2010 after
+1 212 412 2079 two consecutive years of demand losses.
james.crandell@barcap.com New supply is knocking at the door, primarily via more renewables capacity.
Expectations for future power prices have largely moved with gas prices.
A longer-term contango for heat rates suggests a recovery in power prices, though it
may lie beyond 2010-11.
The past year was one for the record books for power consumption. Average growth had
been 2.4% from 1973 to 2007, and there had been just three years of annual contraction –
1974, 1982, and 2001 – which correspond to major economic downturns. It is the only
recession to have seen consumption fall for two consecutive years, and it showed the
largest annual contraction – at 3.6% – since data collection began. As a consequence,
demand for US power is back to 2004-05 levels.
At an end-use level, the pullback in electricity consumption was steepest in the industrial
sector. The magnitude of the recent pullback exceeded the dips in previous recessions,
specifically those of the early 1980s and in 2001. What also separates the recent recession is
the weakness in residential and commercial power use, previously demand stalwarts. In 2009
(through October), residential consumption was down 0.9%, commercial usage was down
2.4%, and industrial demand was down a striking 11.6% (Figure 1).
In aggregate, 2010 should show a partial uptick as the economy recovers and temperatures
regain their bite, versus 2009’s moderation. It may take several years to reach the 2007
peak, but our forecast for super-normal growth next year (owing to a hastened industrial
recovery and normal growth in residential and commercial) of 3.5% should support prices.
With a few years of demand growth lost in the contraction of 2008-09, the market may
have hoped for a supply contraction to match. Unfortunately, this is a near impossibility in
power markets. With new build uneconomic given the price environment (low forwards),
growth in supply may seem surprising. Coal and wind additions are the most meaningful,
with the former a result of plants under way before the recession and the latter due to
increasing renewables mandates. Coal capacity could grow almost 16 GW in the next four
years, about half of which arrives in gas-dominated regions. Further wind build is more
uncertain. Though we expect similar nameplate growth in wind resources as in coal, these
will operate at a lower capacity factor, and still, there is much risk to future growth in wind.
8 February 2010 18
Barclays Capital | Global Energy Outlook
(through September). Virtually all of the total demand loss has been borne by coal-fired
generation. Although petroleum and solar were down about in 2009, the magnitude of the
drop in GWh terms is very small. That wind and natural gas-fired generation were net
winners last year explains why coal generation fell by more than aggregate generation.
Our research has highlighted the high level of coal/gas displacement in the power sector (see
Natural Gas Weekly Kaleidoscope: How will coal surprise in 2010? 1 December 2009). While
low natural gas prices are primarily responsible, changing load profiles and higher contract
coal prices also played a role in the displacement. We estimate that displacement has been on
the order of 20,000 aMW (or 3.0 Bcf/d at a 7.5 MMBtu/MWh heat rate). Next year, we believe
natural gas prices will need to compete with coal for part of the year (about $5.00/MMBtu for
gas), saving gas inventories from becoming too bloated. As a result, we expect a partial
reversal of the relationship between the two fuels in 2010. We project that coal will reclaim
some share, up 10.3% in output from 2009. Natural gas, the marginal fuel in many regions, is
the clear loser, and we forecast gas generation will fall 6% in 2010 (Figure 2).
Looking at the heat rate (the ratio of power prices to gas prices) is often more instructive
than focusing on power prices. Heat rates were stronger for much of 2009, a result of
operations and maintenance costs claiming a greater share as natural gas prices plunged
and the shift in output between coal and gas-fired units. As gas prices rallied for much of
Q4 09, power prices remained a laggard, and heat rates fell. The ups and downs resulted in
heat rates that were little changed from pre-recession 2008 levels.
While it is true that forward power prices have moved in tandem with forward natural gas
prices, particularly for regions in which gas is on the margin, it is important to note the
differentiation. In most regions, the curve is upward sloping, suggesting that the market is
pricing in a recovery, or tightening, of the power market. Interestingly, the majority of these
curves are backwardated in the front. While this could simply reflect selling pressure on
power at the front of the curve, it also likely depicts oversupply and a period of fundamental
looseness for power, until higher power prices (relative to gas) are realized. As discussed
above, the pace of demand recovery will be essential for the recovery of the power markets.
Solar
Petroleum
Coal
Natural
Total
W,W, & G
Gas
-15.0%
-20.0%
Jan-08 May-08 Sep-08 Jan-09 May-09 Sep-09
2009 through September 2010E
Source: EIA, Barclays Capital Source: EIA, Barclays Capital
8 February 2010 19
Barclays Capital | Global Energy Outlook
CARBON
This is a low
Trevor Sikorski Out to 2012, the market is long EUAs by some 224 Mt, and 2013 is a net short of 170 Mt.
+44 (0) 20 313 40160
We expect 2010 to trade similar to 2009, but some better price support in the latter
trevor.sikorski@barcap.com
half of the year.
We look for prices to average about 15 €/t over the second half of 2010.
Average EUA prices should continue to increase in 2011 and 2012, rising to 18 €/t in
2011 and 24 €/t in 2012 as 2013 short positions are increasingly priced in.
For the power sector, 2009 was a year of low emissions. EU-27 power demand was down an
estimated 8.5% y/y. Within that, thermal generation also fell, given better hydro and wind
availability in most regions, with the exception of the Nordic countries, which actually had a fall
in hydro. In the thermal generation sector, the very weak gas market led the Dec 09 NBP
contract to shed 50% of its value over the year, and, as a result, gas generation remained in the
money for most of the year. The weak gas market was driven by low European demand and a
counter-cyclical increase in supply due to a significant increase in LNG regasification capacity in
the UK. Consequently, gas generation tended to be used more than coal in terms of y/y
reductions, providing a further reduction in European emissions.
The curtailment in economic activity and the falls in power sector emissions have shifted
market expectations to persistent length. As the year closes, we expect 2009 to be 129 Mt long
(with allocations exceeding emissions) and the phase to be 224 Mt long. The fact that the
expected annual and phase length did not completely collapse the market was testament to the
importance of utility hedging patterns against some reluctance from industrials to sell. In terms
of utilities, the fact that they remain short of allowances in aggregate and that they hedge a
number of years in advance means that the buy side of the market has been fairly good this
year. On the sell side, the reluctance of industrials to sell at lower prices has been driven by
expectations of post-2012 shorts, the ability to bank surplus allowances and an improvement in
underlying credit markets. Given these combined factors, prices remained fairly rangebound
during the year with few excursions outside of 13-15 €/t. When prices started to fall below that
level, the sell side started to evaporate, and when they rose, it helped to bring some more of
that industrial length into the market.
contraction of 3.9%. Given this, our forecast for the phase sees a long market out to 2012, with
the competing factor of an improvement in economic outlook being more than offset by bigger-
than-expected reductions from the power sector. We are forecasting that:
Out to 2012, the market is long EUAs by some 224 Mt – a slight reduction from our
previous report (238 Mt). 2013 is a net short of 170 Mt. The estimates of market
balance for the phase are sensitive to the levels of economic growth assumed and the
speed of recovery in Europe during the coming three years. Our estimates are for a very
moderate pace of recovery over the coming years.
Although emissions begin to increase in 2010, due to moderate economic growth, the
relatively low level of industrial output will keep this in check. The net long position in
the market increases in that year due to the increase assumed in the cap, with more NER
being allocated to new power sector installations.
EUA Allocation (cap) 2107 2003 2065 2083 2099 2490 10741
Emissions 2071 2119 1937 1988 2037 2437 10517
Emissions – cap -36 116 -129 -96 -62 -54 -224
Note: phase 1 = annual average, 2007 emissions = 2165 Mt. Source: CITL, Barclays Capital
The Q1 10 price story is now one of industrial length versus utility buying, driven by the much
colder-than-expected start to the new year. We continue to expect some industrial selling finally
manifesting itself in Q1 10, although even here there are two opposing dynamics. One, the credit
position of the industrials has improved drastically, while order books are having modest
improvement (still down on last year). The underlying conservative nature of the smaller industrial
participants, and the free nature of the EUAs that are often maintained on the balance sheet at zero
value, may lead to “passive banking” and may conspire to keep this length off the market. This
would be price sensitive and we would think any price movements up towards the 15 €/t area
would be met with some additional industrial volumes coming for sale. Two, the industrials
certainly have more length, with industrial output some 17% down on last year, and while credit is
much better, it is still not where it was before the financial crisis of last September. As such, in a bad
year for underlying business performance, the ability to boost bottom lines and profitability will
likely still be there to stimulate some selling.
The big issue here is whether long industrials look at any weakness in current prices (sub-14 €/t)
and decide that they may be too low to tempt them to cash in current volumes – to de-hedge, in
effect. If there is a real concern that cashing in today at the low is going to mean having to buy more
at much higher prices in a few years’ time, the keeping off the market of the significant length we still
think is out there could provide better price support than we have been expecting.
The cold start to 2010 is the other factor that should provide price support. The cold weather
increases power demand for any space heating done through electrical heaters, increasing the
need for thermal generation, and has a strong effect on the price of gas, making coal more
competitive and increasing the emissions levels from the total level of thermal generation. Both of
these bring the utilities into the buy side and should help provide some greater price support to
absorb some of the industrial length.
Given these competing features, our price forecast for Q1 10 is 12.0 €/t, while for H2 10 it is 15 €/t.
8 February 2010 21
Barclays Capital | Global Energy Outlook
GEOPOLITICS
Iraqi parliamentary elections could have some important implications for oil output in the
region.
The stand-off over Iran’s nuclear program could heat up in 2010 and raise fresh fears about a
potential military confrontation that could threaten the security of the Strait of Hormuz and Gulf
energy suppliers. The US and its European allies are preparing to impose punitive sanctions on Iran
following Tehran’s failure to meet President Obama’s end-of-December deadline for progress in the
nuclear negotiations. The White House is likely to focus initially on targeting dozens of Iranian
Revolutionary Guard (IRGC) front companies. The guards’ role in the Iranian economy has expanded
dramatically during President Ahmadinejad’s tenure in office. In September, the IRGC bought a
controlling stake in the Telecommunication Company of Iran, and members of the infamous security
organization acquired large interests in oil and gas fields, airports, health clinics and engineering and
construction firms.
The US Congress is also moving ahead with its own sanctions legislation. In December, the House of
Representatives passed legislation that authorizes President Obama to impose sanctions on
companies that supply Iran with gasoline, assist in the construction of refineries in the country and
8 February 2010 22
Barclays Capital | Global Energy Outlook
provide the insurance and shipping services that enable Iran to import refined petroleum products.
The Israeli government is working closely with the US Congress to shape the legislation. At a lunch at
Barclays Capital last month, Moshe Yaalon, Israel’s Vice Prime Minister and Minister for Strategic
Affairs, said he was “very optimistic” that tough economic sanctions could change the Iranian
regime’s behaviour, given the unprecedented domestic opposition it is facing in the wake of the
disputed June elections. In late December, thousands of demonstrators again took to the streets of
Tehran and other cities to demand the ousting of the government. The government’s inability to
quash the protest movement has led some leading Iran analysts to suggest the country may be
witnessing a nascent velvet revolution similar to that which swept communist regimes from power
in Eastern Europe in 1989.
Despite the rising domestic discontent in Iran, sanctions may still not alter the regime’s nuclear
calculus. Even if Congressional legislation forces European and Indian companies to stop
supplying refined petroleum products, Iran will still be able to obtain the products from the spot
market in the Gulf. While this will undoubtedly be more expensive and increase the pain in a
country with double-digit inflation and unemployment, it might not be as effective as US
lawmakers would hope. Iran already appears to be stockpiling gasoline in anticipation of new
sanctions. Its January gasoline imports are expected to jump 23% from the previous month. If
sanctions do not force the Iranian government to change course, the Obama Administration
will likely face pressure at the end of 2010 to opt either for a containment strategy – similar to
the one the US pursued in relation to the USSR in the cold war – or to pursue a military strike
against the nuclear facilities. Obama's senior military advisors have publicly stated on numerous
occasions that a military strike would likely only set the Iranian nuclear program back two to
three years and could cause additional unrest in the Middle East.
Iraq is facing an important transition year in 2010, with parliamentary elections scheduled for March
and the US preparing to withdraw all combat troops by the end of August. Both events could have
important implications for the government’s ambitious efforts to triple oil output by the middle of
the next decade. The Maliki government held two oil licensing rounds in 2009 and is close to
concluding service contracts with international oil companies to develop nearly a dozen fields,
including the giant Rumalia, Majnoon and West Qurna fields. However, the 7 March elections could
lead to a shift in the government’s energy policies if Maliki does not prevail. In October, the head of
the parliamentary oil committee warned that a new government could revise or even cancel the
contracts, insisting that “there are no guarantees for the oil companies that the new government will
follow the same path in dealing with them”. Prime Minister Maliki pulled out of the ruling United Iraqi
Alliance in September, citing a desire to build a more broad-based political movement. His State of
Law coalition, which includes several Sunni parties, will now face the Iraqi National Alliance, which
includes some of the most prominent Shiite political parties such as the Islamic Supreme Council of
Iraq (ISCI) and Moqtada al-Sadr’s Sadrist Trend party. It should be noted that ISCI has a different oil
policy than Maliki and has called for greater regional autonomy for the South and more oil revenue
to remain in the region.
Senior US commanders in Iraq have warned that the months following the polls could be particularly
tense as the various parties engage in protracted horse-trading to form a new government. It also is
unclear when the oil laws – which cover issues such as revenue allocation; contract terms; foreign
access to the fields; and the role of local, regional and the central government in setting oil policy –
will be passed. Kurdish members of parliament are currently blocking the legislation to force the
government to recognize the legality of the two dozen oil contracts signed by the Kurdistan regional
government and to secure a favourable resolution to the Kirkuk impasse. Finally, despite the steady
decline in violence since the peak of the civil war, a series of car bomb attacks in December and
January targeted government institutions in central Baghdad, similar to the coordinated bombings
there in August and October. Therefore, the security situation remains fragile and could imperil
investment in the country.
8 February 2010 23
Barclays Capital | Global Energy Outlook
8 February 2010 24
Barclays Capital | Global Energy Outlook
CREDIT
8 February 2010 25
Barclays Capital | Global Energy Outlook
Oil field service and refining remain the cheapest sub-sectors, but we think only oil field
service is poised to outperform. Although the North American oil services industry appears
to be working through a trough that is likely to persist for much of 2010, we believe activity
levels have bottomed and service-intensive shale activity will remain robust. For refining,
wide spreads may offer room for outperformance in early 2010, but we remain
Underweight, given our long-term bearish call on the sector and our view that 2010
consensus estimates remain too high. The refining industry is still interesting from a trading
standpoint, but we recommend that buy-and-hold, long-term investors avoid it. We are
Overweight the oil field service sector and Underweight the refining category.
Both the independent E&P and integrated sectors are rich versus U.S. corporates. In light of
our strategy team’s view that financial spreads will continue to normalize in 2010, we
expect the independent E&P sector to perform in line with the market and the integrated
sector to again lag the broader index. Within the independent E&P and integrated buckets,
we prefer companies with leverage to oil rather than natural gas, given the challenging
supply/demand dynamics of the latter. We are Market Weight the independent E&P sector
and Underweight the integrated category.
Investment recommendations
Buy Nexen cash (OW); Sell Suncor CDS (OW). Although execution issues at Nexen’s
Long Lake will remain a concern in 2010, we find the company well positioned, given its
leverage to oil prices. We think SUCN’s asset divestiture program will keep it out of the
primary market in 2010.
In oil field services, Weatherford International Ltd (WFT) (NR) has attractive relative
value. We believe current spreads are pricing in downgrades at both Moody’s and
Standard & Poor’s (a reasonable assumption, in our view) and leverage should improve
after 1Q10.
8 February 2010 26
Barclays Capital | Global Energy Outlook
We believe sector themes in 2010 will resemble 2009: higher average commodity prices, oil
prices outperforming natural gas, lower unit costs, an uptick in M&A activity, and continued
new issue supply. One notable difference is financial leverage: we estimate that debt/EBITDA
for our peer group of 30 energy companies likely peaked in 2009 at 4.0x, and we forecast a
decline to roughly 3.3x in 2010. Our Overweight recommendations are: Hilcorp Energy,
Petrohawk Energy, SandRidge Energy, and Targa Resources Partners. In loans, we favor
Dresser second-lien term loans and Venoco second-lien term loans. We continue to believe
the two high yield oilsands producers (Connacher Oil and Opti Canada) have the greatest
relative operating leverage to oil prices.
Investment recommendations
Hilcorp Energy (OW): We continue to like Hilcorp’s bonds given its exposure to oil
prices, good hedging profile, declining y/y leverage trends, and strong
management/operations team.
SandRidge Energy (OW): We believe the start-up of the company’s Century Plant in
mid-2010 should help SandRidge meet its goal of reaching 500 mmcfe/d in production
in 2012.
Targa Resources Partners (OW): Net leverage of 3.1x is the lowest in the peer group,
and we anticipate continued equity financing for potential larger drop-downs or
acquisitions, as per management.
8 February 2010 27
Barclays Capital | Global Energy Outlook
Following strong results in 2009, pipelines will likely have difficulty outperforming the
market in 2010. Given the significant number of investment grade companies that are
structured as master limited partnerships (MLPs), which generate persistent free cash flow
deficits when growing and make frequent use of the capital markets, the sector was a prime
candidate to benefit from the thawing capital markets in 2009. In 2010, however, we expect
M&A activity to pick up as multi-year organic spending projects wind down. Furthermore,
although direct commodity price exposure across the sector is typically limited (there are
exceptions), weak natural gas prices would have negative implications for pipeline volumes
and basis differentials. Entering 2010, we are Market Weight pipelines.
In general, the investment grade pipeline sector is trading with little spread differentiation
between credits. We prefer pipeline opcos (especially interstate natural gas pipelines),
diversified companies (operating risk spread across different aspects of the hydrocarbon
value chain) and MLPs that are expected to wind down from multi-year spending programs.
Investment recommendations
Midcontinent Express Pipeline LLC (NR) has good relative value. MCEXPP is attractively
valued relative to comps and the credit quality of its shippers. We expect regulatory
approvals in late 2009 and 2010 to drive improved leverage metrics.
Boardwalk Pipeline Partners, LP (NR) is cheap. Despite having one of the lowest-risk
business mixes in the high grade MLP category, in addition to a strong GP and decreasing
capital spending requirements, we think BWP is trading 15-20bp cheap to fair value.
Buy Energy Transfer Partners, L.P. (OW). Although ETP’s intrastate business will remain
under pressure due to lower natural gas prices and compressed basis differentials, we
expect ETP to succeed in flipping Standard & Poor’s negative outlook back to stable by
mid-2010 with a combination of successful project execution and equity offerings.
8 February 2010 28
Barclays Capital | Global Energy Outlook
We expect coal credits to underperform the broader high yield market in 2010. High yield
coal credits compose approximately 60% of the metals and mining sector. While we believe
the metals and mining sector will perform in line with the market in 2010, we expect coal to
underperform, offset by outperformance from the higher-beta aluminium/steel credits. The
majority of the coal credits are BB rated, currently trading in the 5.5-7.5% yield context.
While we expect the U.S. coal market to improve gradually in 2010 as electricity
consumption increases and inventories decline, we believe current spread levels already
reflect this improvement. We see few catalysts for spreads to tighten further, especially
given the low likelihood, in our opinion, of any meaningful upgrades by the rating agencies.
Investment recommendations
“Barbell” approach—sell Peabody Energy (BTU) bonds, reach for yield among other
BB rated credits, and own International Coal Group (ICOUS). We believe there are few
catalysts to send BTU spreads tighter given current levels; therefore, we expect the BTU
notes to underperform an improving market in 2010. Accordingly, we recommend
selling BTU bonds and buying “yieldier” BB rated coal credits, such as Arch Coal (ACI),
Drummond Company (DRUMCO), or Massey Energy (MEE). In each case, we think the
swap allows investors to take out several points and pick up 100-150bp of yield, moving
into another BB rated coal credit with solid fundamentals. We also recommend owning
the ICOUS 10.25% unsecured notes due 2014 (10.5% yield), which we think are trading
cheap relative to James River Coal (JRCC) and Murray Energy (MURREN).
Sell MEE 5y CDS. We believe MEE’s credit fundamentals will remain strong over the next
few years, with free cash flow approximating 15% of total debt and net leverage
expected to remain at 1.0-1.5x. We think the best approach to going long the credit is
selling 5y CDS, given that it is trading 335bp wide of BTU 5y CDS (we think the
relationship should approximate 150bp). While we acknowledge that MEE CDS levels
are affected, in part, by index technicals (MEE CDS is a constituent of HY CDX 8-13,
while BTU CDS is not), we think the current 335bp differential relative to BTU is too
wide, especially given that it has been as tight as 75bp in the past four years.
8 February 2010 29
Barclays Capital | Global Energy Outlook
Moderate capital expenditure reductions and some pre-financing activity last year
Timothy Tay, CFA
will reduce likely new debt issuance this year by 10-15%.
+1 212 412 5548
timothy.tay@barcap.com We expect most regulatory jurisdictions and the rating agencies to remain
constructive this year.
The agencies remain constructive on the sector, with most rating outlooks stable. Credit
metrics have also remained stable, with rate increases and cost reductions offsetting the
negative effects of the recession. With most companies predicting flat to modest sales
growth in 2010, we expect business conditions to improve in late 2010 to 2011.
We have a preference for debt at the regulated utility operating company level, because of
the low business risk and strong asset protection characteristics of these business units.
Although we continue to regard many of the A rated regulated utilities as stable core
holdings, we think the best opportunities for outperformance can be found among the BBB
rated regulated utilities and electric utility holding companies.
Investment recommendations
Buy Baltimore Gas & Electric (CEG) Unsecured Notes 5.9% 2016 (OW). With low
business risk, an improving regulatory environment in Maryland, and deleveraging at the
parent company Constellation Energy, this regulated electric distribution company
offers attractive relative value at +155bp, in our view.
Buy Jersey Central P&L (FE) Unsecured Notes 7.35% 2019 (OW). With low business
risk, supportive regulation in New Jersey, solid credit metrics, strong asset protection,
and a protective limitation on liens covenant, the unsecured debt of JCP&L offers
attractive relative value at +155 bp.
8 February 2010 30
Barclays Capital | Global Energy Outlook
Further large scale consolidation will not be seen. We do not envisage large-scale M&A in
the sector, although smaller acquisitions, asset swaps and investments will likely continue,
together with an increased interest in regulated networks. Capex will probably remain at
high levels to ensure security of supply, the development of renewable generation assets
and the connection of new generation plants to the grids. We expect most utilities to
continue with their strategies of focusing on core competencies, disposing non-core
activities, optimising cash flow and containing capex.
Stable results expected for 2010: Despite limited guidance for 2010, we expect financial
performance to be stable compared with 2009 due to the high levels of forward sales and
hedging undertaken, with evidence of demand stabilisation potentially leading to limited
demand growth in 2H10.
Investment recommendations
Veolia (OW) has good relative value. Veolia is well placed to benefit from an economic
recovery and has implemented measures to improve credit metrics through focusing on
being cash flow positive through cutting capex and disposing non core assets
National Grid (OW) has good relative value. With c.95% of its revenues being
regulated and operations split 50/50 between the UK and US, NG is well diversified.
Although considered shareholder friendly, short term M&A is not anticipated due to
ongoing Rate Case applications in the US. Pre-funding of its borrowing needs for
2010/11 should be supportive for spreads.
United Utilities Plc (UW) is vulnerable to spread widening. We believe CDS and US$
bonds at UU Plc remain vulnerable to further spread widening. Despite being rated 2-3
notches lower than National Grid and Veolia, CDS trades at similar levels and should be
c.15bp wider. UU’s Finance Director will leave the company in May 2010 with the search
for his replacement ongoing, which could result in a change in the financial profile.
8 February 2010 31
Barclays Capital | Global Energy Outlook
8 February 2010 32
Barclays Capital | Global Energy Outlook
EQUITIES
8 February 2010 33
Barclays Capital | Global Energy Outlook
US INTEGRATED OIL
8 February 2010 34
Barclays Capital | Global Energy Outlook
We believe 3Q09 marked the start of a new production growth cycle for ExxonMobil. We
estimate that the company could increase output close to 3% this year and 2.7% annually
between 2009 and 2013. Our estimate does not incorporate the effect of the pending XTO
Energy acquisition (given that Barclays Capital is the advisor to XTO Energy in this
transaction). In 2006, the only year that ExxonMobil achieved visible production growth in
the last decade, the stock was up 36%, a strong outperformance relative to the market and
its peers (XLE up 17% and S&P up 14%). In addition, although we believe the shares will
likely underperform other high-beta oil shares in a rapidly rising oil price environment, XOM
should outperform the general market and its peers based on our current base assumption
of a range-bound market in the next several months. In terms of valuation, XOM also
appears inexpensive following its marked underperformance since early 2009, particularly
after mid-December (XOM down 8% compared with XLE up 2% and SPX down 1%). Based
on our 2010 oil price assumption of $80/barrel, we estimate XOM now trades at 10.9x our
2010 EPS estimate, compared with the S&P consensus P/E of 13.9x. Historically, XOM has
traded in line with the broad market forward P/E, except at the extreme ends of the
commodity price cycle. XOM also appears to be inexpensive compared with other
integrated oil shares. On the basis of our EV/2010 EBIDA estimate, XOM now trades at 7.2x
compared with the group’s average multiple of 6.4x. Historically, it has traded at a premium
of roughly 2.0x.
We expect Chevron will continue to report a strong reserve replacement ratio (RRR) in 2011
and 2012, which could help support the stock. We think that a robust RRR is a precondition
for potential rising future production. Moreover, we believe that the new CEO and
Chairman, Mr. John Watson, will undertake aggressive cost reduction and efficiency
improvement measurements, particularly in Chevron’s downstream organization, which
should help the company’s financial performance over the next 6-18 months. Finally, based
on Mr. Watson’s comments, we think that the risk of Chevron making a large acquisition
over the next 12 months appears to be low. We maintain our 1-OW rating, given its limited
M&A risk, strong long-term project pipeline, potential upside to its production guidance,
and inexpensive valuation. The shares are currently trading at 5.4x on EV/2010 EBIDA, a
discount to the group’s average of 6.4x, which we believe is unjustified. In our view, CVX
offers one of the strongest production growth and operation improvement opportunities
among the Super Majors.
8 February 2010 35
Barclays Capital | Global Energy Outlook
Rahim Karim
+44 20 3134 1853 A better year ahead but challenges remain for the decade
rahim.karim@barcap.com 2010 looks as if it will be significantly better year for earnings and cash flows than 2009.
Barclays Capital, London Although above-ground inventories are high, we believe OPEC production restraint will keep
oil prices at $80/bl this year, 30% higher than the 2009 average. We expect downstream
profitability to remain under pressure with a multi-year downturn in refining as new, low
cost capacity comes onstream. One of the tensions facing the integrated companies in 2010
is that the downstream drag on corporate profitability may inhibit the growth investment
Sector View
plans that might make sense in this more robust oil price environment. Although we
2-NEUTRAL
continue to model lower costs for 2010, from 2011 we see inflationary pressures returning
KEY OVERWEIGHTS: and we have costs rising in line with our rising oil price assumptions.
Eni Dollar earnings to rise 44% in 2010: We estimate that the Euro integrated companies will
Ticker have seen full year 2009 dollar earnings fall 53% on average. The company we expect to
ENI.MI deliver the best earnings momentum this year is Shell with estimated EPS up 63%. In part
Price Target this reflects the sharper than average fall in 2009 profits: almost a quarter of the earnings
EUR 26.00 recovery we expect for Shell is represented by lower pension charges.
Price (04 Feb 2010)
EUR 16.52 Cost reduction still a focus: The oil companies have worked hard in 2009 to reduce costs,
Potential Upside/Downside the majority of which seem to have been made in the downstream segment. BP is currently
57% targeting US$4bn of cost savings. Royal Dutch Shell has claimed US$3.5bn at the nine-
month 2009 stage. Total was targeting a US$1/bl saving on operating performance. What
may become clear during 2010 is the extent to which the cost savings that have been
achieved can be sustained in a flatter exchange rate environment, and with the higher own
energy costs we would expect given our higher oil price assumption. Cost reduction
initiatives have given an impression that company managements are back in the driving
seat, although looking back over the past decade it would appear that most cost trends are
generic and it is difficult for companies to sustain a competitive edge.
Production growth continues to be a challenge. The companies from which we expect the
biggest production increases in 2010 are BG, Total and OMV. After 4% growth from BP in
2009, we anticipate a 0.4% decline in 2010. This highlights the difficulties the bigger caps
face in consistently growing production – 2009 was a good year for BP, 2010 will be a good
year for Total and 2011 for Shell, on our forecasts.
Dividends safer in 2010: The capex picture looks slightly mixed for 2010. We expect BP and
Total spend to be similar to 2009 levels. Shell has already signalled that its 2010 spend will
be US$28bn – down US$3bn on the US$31bn planned for 2009. Even with this lower spend
we still see Shell paying its dividend out of debt in 2010, together with BG, Repsol and
Statoil. However, payout ratios for the group look much more supportive than in 2009 at
c.45% versus 65% in 2009.
8 February 2010 36
Barclays Capital | Global Energy Outlook
8 February 2010 37
Barclays Capital | Global Energy Outlook
US INDEPENDENT REFINERS
Using year-end 2009 as the base line, we think the sector will mostly be stuck in a narrow
trading range of +/- 15%–20% over the next 12 months or longer. For long-only accounts,
we do not believe a buy-and-hold strategy will yield a meaningful return in 2010, and
suggest adopting an aggressive short-term trading strategy based on the direction of the
U.S. light product inventory trend. Historically, refining stocks have followed their
underlying margin trend with a two- to four-week lag, while the margin trend has typically
moved in the opposite direction to light product inventory levels (versus their seasonally
adjusted five-year average) with another two- to four-week lag.
For long/short accounts, we believe the U.S. refiners could perform better than the
European and the Asian refiners over the next 2-3 years. In addition, we think that the U.S.
Gulf Coast heavy oil refiners could perform better than the Rockies/Mid-Continent heavy oil
refiners over the next 1-2 years. Finally, the California refining market could rank among
the weakest U.S. markets over the next several months, in our view.
8 February 2010 38
Barclays Capital | Global Energy Outlook
8 February 2010 39
Barclays Capital | Global Energy Outlook
Complexity is a positive
Our least preferred stocks are Petroplus and PKN Orlen: Petroplus' marginal capacity
leaves it as the refiner of last resort in our view. This operational gearing is great in an
upturn but very painful in the sustained downturn we expect in the coming years. We
rate Petroplus 3-Underweight with a CHF17/share price target. PKN continues to face
balance sheet challenges
Preferred stocks – Saras, GALP, Hellenic Petroleum, Motor Oil: Despite our negative
view on the sector, we recognise that the most complex, flexible and efficient refineries
will continue to generate positive cash flows. Our preferred portfolio represents a
combination of discount valuation, asset quality and flexibility, a clear strategic focus
and strong balance sheet. In essence, quality counts. Our top picks are Saras, GALP and
Motor Oil. Our key 3-Underweights are PKN Orlen, Petroplus, Neste Oil and Grupa Lotos.
8 February 2010 41
Barclays Capital | Global Energy Outlook
8 February 2010 42
Barclays Capital | Global Energy Outlook
Among the mid-cap names, Petrohawk Energy (HK) has large positions in both the
Haynesville and Eagle Ford Shale plays. In the Haynesville, Petrohawk controls 345,000 net
acres, much of it in the established core. During 2010, testing of the Bossier shale, which
overlies the Haynesville, could add to the reserve potential of the play. In the Eagle Ford
shale, Petrohawk owns 225,000 acres in the gas/condensate part of the field and another
89,000 acres that may be in an oiler part of the play. We believe drilling results this year
could significantly de-risk the company’s acreage and add to the asset value potential.
8 February 2010 43
Barclays Capital | Global Energy Outlook
At an inflection point
James D. Crandell We expect a recovery in global E&P spending led by NOCs to occur in 2010.
+1 212 526 4865
james.crandell1@barcap.com
A spike in domestic drilling activity in 1H10 could spell trouble for natural gas prices.
BCI, New York Many stocks appear fairly valued; we recommend a selective approach to investing.
8 February 2010 44
Barclays Capital | Global Energy Outlook
CAM 0
Price Target '95 '96 '97 '98 '99 '00 '01 '02 '03 '04 '05 '06 '07 '08 '09
US$ 46.00 Monthly Data
Price (04 Feb 2010)
Source: Baker Hughes, Barclays Capital
US$ 37.88
Potential Upside/Downside
21% International – The beginning of a long recovery
For the international markets, we believe 2010 will mark the beginning of a long upcycle in
Tidewater Inc.
Ticker
exploration and production spending. International spending levels likely bottomed during
TDW the fourth quarter of 2009 and activity levels look set to improve by 10%-12% in 2010. We
Price Target
expect the majority of the pickup in activity to be driven by the national oil companies
US$ 55.00 (NOCs) and for spending increases to be skewed toward Russia, Southeast Asia, the Middle
Price (04 Feb 2010)
East, North Africa, and Brazil. Although pricing pressure is likely to abate with the increase in
US$ 44.83 demand, margins for the major oil service companies will likely remain under pressure
Potential Upside/Downside through at least the first half of the year as a result of lower pricing for contracts
23% renegotiated during 2009.
ION Geophysical Corp. In contrast to North America, our bullish view on international activity levels is primarily
Ticker driven by a positive long-term stance on oil prices. In our opinion, the global oil markets
IO remain supply constrained, and accelerating decline rates and the depletion of the existing
Price Target resource base argue for elevated prices. Over the intermediate term, we believe oil prices
US$ 8.00 will remain above levels needed to encourage drilling activity and, barring any major
Price (04 Feb 2010) economic event, the price of oil is likely to move steadily higher over the next several years.
US$ 4.80
Potential Upside/Downside Figure 2: Oil Prices vs. International E&P Capital Expenditures
67%
350,000 $120
Core Laboratories
300,000
$100
Ticker
CLB
Int'l E&P CAPEX ($ mil)
250,000
Average Oil Price (WTI)
$80
Price Target
200,000
US$ 136.00 $60
150,000
Price (04 Feb 2010)
$40
US$ 116.60 100,000
Potential Upside/Downside
$20
50,000
17%
0 $0
1986 1988 1990 1992 1994 1996 1998 2000 2002 2004 2006 2008
8 February 2010 45
Barclays Capital | Global Energy Outlook
8 February 2010 46
Barclays Capital | Global Energy Outlook
30 120%
25 100%
20 80%
15 60%
10 40%
x
5 20%
0 0%
(5) (20)%
(10) (40)%
1996 1997 1998 1999 2000 2001 2002 2003 2004 2005 2006 2007 2008 2009 2010F
8 February 2010 47
Barclays Capital | Global Energy Outlook
8 February 2010 48
Barclays Capital | Global Energy Outlook
currently more attention in the industry is focussed on already existing plans. This should
turn as we enter a new cycle. The Gas Turbines division is also seeing stronger demand as
operators are using the low gas prices to run existing units hard. This should lead to more
maintenance work. As a result Wood Group has gone from a historic premium to the sector
of 100-200bp and is now trading on 15x 2010F PE versus a European sector average of 16x.
The historic premium we attributed to its lower than average risk business model and
average 2000-2008 31% pa earnings growth (24% if the 20% fall in 2009 is included) a
level of earnings growth we expect to continue in the medium-term.
In seismic, no pricing increases have been seen yet and although activity levels have been
confirmed for H1 10 these will be at the low margins of late 2009, which in some cases is
0% at the operating level. As we move through 2010 more activity should arise, but we see
new vessels entering the market, such that the year-end 2010 world fleet is bigger than that
in 2008 and is still growing. Whilst it is true that the companies are uniquely geared to
pricing increase, we feel that the increasing number of vessel will inhibit pricing recovery
and hence the up-turn will commence later than expected.
In the offshore construction universe, the stocks have been supported by encouraging
exploration success in Brazil and the Gulf of Mexico. Coupled with deferred projects in West
Africa we should see new awards in 2010. However, with few awards in 2008, let alone
2009, earnings do not yet factor in the downturn and any new contract awards will not
result in vessel utilisation until 2012. Hence we face a potential utilisation lull and with it
aggressive bidding for projects that could hamper any earnings recovery.
Given that we are firm believers in the longer-term up-cycle for the sector, but hesitant
shorter term a potential avenue for equity investing is the convertible bonds outstanding in
the sector. Several oil service convertible bonds embed a 3-5yr call option on the sector.
These include Acergy 2.25% Oct 2013, PGS 2.7% Dec 2012 and Subsea 7 3.5% 2014 Oct
2014 (Subsea 7 also has shorter-dated instrument). The Subsea 7 convertible is the most
equity-sensitive, as its share prices is within 10% of its conversion price. The Acergy
convertible has some but lower equity sensitivity, as its share price would need to rise by
more than 50% to reach the conversion price. The PGS convertible has minimal equity
sensitivity as its share price must more than triple to attain the conversion price. However,
its yield to maturity is greatest, at 7.1%, versus Acergy 2.0% and Subsea 7 0.9%.
8 February 2010 49
Barclays Capital | Global Energy Outlook
US NATURAL GAS
Sector View Clear divide between the best and the worst
2-NEUTRAL
We expect three trends to dominate comparative results and, hence, relative performance
for companies in the diversified natural gas group. Given: 1) large-scale shifts in the source
KEY OVERWEIGHTS:
of production, 2) the increasingly competitive landscape for pipeline construction, and 3)
El Paso Corp. the shortage of NGL infrastructure, we believe the sector’s fortunes divide readily into
Ticker winners and losers.
EP
Price Target
Production value driver: low-cost, visible inventory
US$ 13.00
Price (04 Feb 2010)
Best-positioned producers have high-quality, low-cost, multi-year development inventories
US$ 9.89 where scale of operations and ability to move down the learning curve can offset the
Potential Upside/Downside inevitable return of oilfield service inflation. Furthermore, with corresponding gathering and
31% pipeline access to markets increasingly being borne by producers, strategies need to be in
place to minimize these costs. Investors have missed the sharp improvement in Rockies
ONEOK Inc. production economics that is tied to a sizeable reduction in west-to-east location
Ticker
differentials.
OKE
Price Target
NGL exposure a distinct positive
US$ 50.00
Price (04 Feb 2010) Widening of the oil/gas ratio has significantly improved the outlook for the NGL markets.
US$ 41.38 Operators are aggressively drilling for wet gas. Sprayberry/Wolfberry, Granite Wash, Eagle
Potential Upside/Downside Ford shale, DJ basin, Marcellus shale, Bakken shale, the Barnett combo area, and numerous
21% other plays are contributing to a surge in NGL supply which is outstripping current
infrastructure. The competitive advantage of using light feedstocks is creating record and
Questar Corp.
rapidly expanding demand for NGL output.
Ticker
STR
MLP structure creates uplift in value
Price Target
US$ 51.00 MLPs create an uplift of 30%-35% in valuation based on after-tax cash flows with
Price (04 Feb 2010) confirmation in the trading multiples between C-Corps and MLPs. Lower WACCs provide
US$ 40.75 sizeable competitive advantage to building new pipelines. MLPs have consistently
Potential Upside/Downside dominated new construction where last mile barriers are not an issue, capturing the bulk of
25% the build-out of the Rockies, Barnett shale, Fayetteville shale, Haynesville shale, and
Woodford shale, and are the likely beneficiaries of the emergence of the Eagle Ford shale.
Spectra Energy Corp.
MLPs dominate the NGL value chain.
Ticker
SE
Price Target Diversified gas stocks are trading at a discount
US$ 24.00
While the pure E&P names trade near fair value based on historical cash flow metrics, the
Price (04 Feb 2010)
E&P-oriented diversified gas stocks trade at abnormal discounts to the pure plays. Our
US$ 20.93
recommendations take advantage of this discount as well as the three themes noted above.
Potential Upside/Downside
15%
8 February 2010 50
Barclays Capital | Global Energy Outlook
Questar looks well positioned to grow production volumes 15%-20%. Anchor assets
include the lowest cost position on the Pinedale anticline along with drilling inventories in
the sweet spots of the Haynesville, Bakken, and Woodford (Anadarko) shales, and the
Granite Wash play of western Oklahoma. The latter three plays have high liquids content in
their output, adding to the economics. Questar’s Pinedale position has been enhanced
markedly by the sharp reduction in Rockies basis. Midstream assets grow in conjunction
with rapid expansion of production. Regulated operations provide free cash and strengthen
credit. At current prices Questar’s E&P assets are selling for under 4x cash flow.
Spectra’s eastern pipes are the gateway for all of the major eastern and midcontinent shales
to access the domestic market’s highest value end markets. Western Canadian gathering
and transportation assets are the primary outlet for the Montney and Horn River shales.
SE’s Ontario gas distribution territory grows at 2x the North American average, has
incentive rates, and offers high-value, negotiated rate storage to the U.S. Northeast.
Principal NGL exposure is through SE’s 50% ownership in DCP Midstream which operates
the largest array of processing plants in the US with outlet production that is 2x the next
largest competitor. We estimate that this geographic footprint will support more than $1bn
in annual growth capital, driving earnings expansion in the 8% area for the foreseeable
future. Coupled with the current 4.5% yield, SE provides a compelling risk/reward story.
Symbol 2/4/10 2009e 2010e 2011e 2009e 2010e 2011e 2009e 2010e 2011e
EP 0.4% 8.8x 12.5x 8.6x 9.0% 5.6% 8.4% 5.8x 7.3x 6.1x
OKE 4.3% 14.5x 14.5x 13.1x 11.7% 8.6% 9.3% 7.4x 9.5x 9.0x
STR 1.3% 15.2x 18.9x 15.5x 7.8% 8.1% 9.6% 6.4x 5.9x 5.2x
SE 4.8% 17.5x 13.8x 11.8x 6.8% 9.3% 10.3% 11.0x 9.2x 8.5x
(1) EBITDA - Maintenance Capital / Enterprise Value
Source: Company filings, Barclays Capital estimates
8 February 2010 51
Barclays Capital | Global Energy Outlook
US POWER
Sector View Potential risks to our view are new environmental regulations from the
2-NEUTRAL Environmental Protection Agency (EPA) in 2Q10 and a faster-than-expected
economic recovery.
KEY OVERWEIGHTS:
Our top pick is AES Corp. (AES), which is a global infrastructure and free cash flow
Constellation Energy
Ticker
story with little exposure to the U.S. power markets.
CEG
Price Target Too early to go positive
US$ 39.00
Power has been in a bear market since year-end 2007. Although the underperformance of
Price (04 Feb 2010)
the group has been impressive (down 23% vs the S&P 500) making a contrarian stance
US$ 32.75
Potential Upside/Downside alluring, our year-end review of the fundamentals and comparison to the last power
19% downturn in 2001 leads us to conclude that it is too early. In light of this conclusion, we
recommend AES, a power stock that has only modest exposure to the electric commodity
AES Corp. markets.
Ticker
In the next few sections, we review the factors that pushed us to conclude that an
AES
overweight in power may be premature.
Price Target
US$ 16.00
Price (04 Feb 2010) Duration too short
US$ 11.84 We reviewed the duration of the last bear market for power stocks which began in 2001 for
Potential Upside/Downside clues on how long it might take to resolve the current downturn. We find the current
35% experience very analogous to the 2001 downturn as it shares three factors: 1) oversupply
(high reserve margins), 2) high credit costs (CDS spreads), and 3) low natural gas prices.
Figure 1 maps this bear market, which began in January 2008, to the 2001 version.
Unfortunately, at the two-year anniversary, we are still a full year short of the duration of
underperformance seen in the previous downturn.
8 February 2010 52
Barclays Capital | Global Energy Outlook
15%
10%
5%
0%
-5%
-10%
-15%
-20%
-25%
1 91 181 271 361 451 541 631 721 811 901 991
Trading Days Into Cycle
2001-2005 Power Relative Performance 2008 to Date Power Relative Performance
Source: FactSet, Barclays Capital estimates
160% 30%
The Figure suggests that the group has another 12% relative underperformance in the first
three quarters of 2010 before bottoming and commencing a slow but lengthy period of
outperformance. Of course, the U.S. power market is not one market, but a collection of
several regional markets. Some of these markets, notably the Middle Atlantic, New England,
and Houston Ship Channel have more constructive reserve margin forecasts than the
country. Two of our recommended power stocks, Entergy (ETR; 1-Overweight) and Public
Service Enterprise Group (PEG; 1-Overweight), serve these “tighter markets.”
8 February 2010 53
Barclays Capital | Global Energy Outlook
225
200
Indexed Values
175
150
125
100
75
50
Dec-04
Apr-05
Aug-05
Dec-05
Apr-06
Aug-06
Dec-06
Apr-07
Aug-07
Dec-07
Apr-08
Aug-08
Dec-08
Apr-09
Aug-09
Dec-09
Power Stocks Index Barclays Power Margin Index
Furthermore, as the BPMI assesses future gross margin opportunities for power companies
on an unhedged basis, the index also suggests a bias for deterioration or backwardation in
future earnings. This observation is reinforced by another tool we use to determine
whether to be bullish on power stocks, namely the ratio of open EBITDA to forecast EBITDA.
When this ratio is below 1, as it is currently, future earnings are likely below current, and
vice versa. To become bullish this ratio would need to exceed 1, indicating a tightening
market with improving fundamentals.
The EPA will make decisions regarding the future regulation of acid rain (SO2), smog (NOx),
Mercury emissions, Ash storage, and, potentially, CO2 in 2010. A strict set of rules could
cause early shutdown of coal plants that are older and less efficient but that would need to
make significant pollution control investments to be kept on line. We estimate that 8% of
U.S. supply is fourth quartile coal plants built on average in 1960 and having efficiency 45%
worse than a new plant. Of these, 81% are not outfitted with significant pollution control
8 February 2010 54
Barclays Capital | Global Energy Outlook
equipment. If we were to assume that these plants were required to shut between now and
2015, our reserve margin forecast would change and predict a stronger rebound in power
stocks as shown in Figure 4. Of course, this would be an outcome that would favor nuclear,
renewable, and gas-fired gencos disproportionately to coal-fired companies.
The GDP growth forecast in our reserve margin forecast is 3.5% in 2010, 3.1% in 2011, and
2.5% to 3% thereafter. Should we see a more robust recovery, power markets could
improve more rapidly than our base case. On the optimistic side, if we mimic the recovery
following the recession at the beginning of the 1980s with 7% GDP growth in 2010, 4% in
2011 and 2012 before returning to trend, the bear market could be one quarter from over.
The graph of this outcome is below.
Figure 4: Reserve Margin vs. Relative Power Performance Figure 5: Reserve Margin vs. Relative Power Performance
(EPA Case) (1980s Recovery Model)
Relative Performance of
National Reserve Margin
Source. SNL Financial, Energy Information Administration, Bureau of Economic Source. SNL Financial, Energy Information Administration, Bureau of Economic
Analysis, Barclays Capital Analysis, Barclays Capital
8 February 2010 55
Barclays Capital | Global Energy Outlook
US COAL
Although we find attraction in all the coal equities in our universe, we continue to
favor producers with exposure to the Powder River Basin (PRB), as we continue to
believe PRB coal is relatively underpriced in the market, based on its cost advantages
over other types of coal and its significant cost advantage over natural gas.
8 February 2010 56
Barclays Capital | Global Energy Outlook
China's massive import jump, which supported international pricing over much of 2009,
could slow and/or reverse. In our opinion, this concern is likely to be mitigated by
Chinese coal consumption in the coming years likely being buoyed by an aggressive
expansion of the country’s electric grid, which is expected to remain largely coal-fired
for the foreseeable future. Unless China is able to overcome myriad internal supply
constraints, the likelihood of it becoming a net exporter as it was in past years seems
very low.
A weakening in the U.S. economy could once again depress power demand and natural
gas prices. Even in this bearish scenario, it is doubtful that fuel switching from coal to
natural gas would accelerate beyond levels experienced in 2009 given coal’s low-cost
profile and position as the primary source of base-load power generation in the United
States.
In recent months, U.S. coal equities have experienced a dramatic run upward with the
strong rebound in the Asian metallurgical market, as U.S. met coal producers enjoyed a
significant increase in export opportunities. Nonetheless, we believe U.S. coal equities
remain attractively valued, and that these equities are discounting a material amount of
skepticism that is unjustified.
Although all of the companies in our coverage group are leveraged to a strong recovery in
U.S. thermal demand, and, in our view, are attractively valued, we continue to prefer coal
equities with PRB exposure such as Peabody Energy (BTU), Arch Coal (ACI), and Alpha
Natural Resources (ANR), all rated 1-Overweight. Moreover, Peabody, in addition to its
strong PRB production platform, is the only equity within our coverage group with direct
exposure to the robust Asian market through its operations in Australia. We believe that
Appalachian producers are at a disadvantage given the region’s ongoing labor and
regulatory hurdles, which threaten to drive costs up and squeeze margins relative to other
producers. We believe ultimately strong U.S. net exports will benefit all U.S. producers
through a tighter U.S. market.
8 February 2010 57
Barclays Capital | Global Energy Outlook
Independent Refiners
Alon USA 6.91 3- UW/3-Neg 7 1 US 21.1 43.0 24.3 17.6 24.6 19.8 (4.5) (4.1) (4.8) 37.1 (21.0) (11.6) 2.3 (1.60) (1.11) (67)
CEPSA 21.81 3-UW/3-Neg 22 1 Europe - - - 8.3 8.9 8.2 20.9 22.9 16.7 (8.4) (7.8) (0.1) 3.7 0.95 1.61 69
Delek 6.90 2 - EW/3-Neg 8 16 US 11.3 8.7 9.1 11.9 9.4 9.8 (23.0) (69.0) (69.0) (8.0) (3.7) 2.1 2.2 0.05 0.33 (462)
ERG 9.73 2-EW/3-Neg 11 8 Europe - - - 14.4 7.9 6.5 (31.5) 24.3 13.1 (15.2) 3.4 7.3 4.1 0.40 0.47 17
Frontier Oil 12.56 2 - EW/3-Neg 13 4 US 89.3 11.0 6.6 38.3 12.5 8.5 (25.1) 83.7 17.9 (15.0) (3.1) 2.7 1.9 0.15 0.81 461
Galp 11.12 1-OW/3-Neg 14 21 Europe - - - 17.4 13.5 12.1 32.3 20.5 18.0 (1.9) (0.2) 0.9 1.8 0.54 0.54 0
Hellenic Petroleum 8.51 1-OW/3-Neg 9 3 Europe - - - 9.8 10.0 8.7 12.1 15.3 10.6 (5.5) (6.7) (3.6) 3.5 0.56 0.64 16
Lotos Group 26.70 3-UW/3-Neg 28 5 Europe - - - 7.1 10.5 7.0 4.7 9.0 4.3 (35.6) (44.2) 2.9 0.0 2.98 2.42 (19)
MOL 17,600 2-EW/3-Neg 15,500 (12) Europe - - - 10.0 7.4 5.7 15.6 11.4 7.4 (2.2) 0.8 4.7 2.6 1,546 1,855 20
Motor Oil 9.90 1-OW/3-Neg 11 11 Europe - - - 12.1 10.0 7.9 13.8 10.9 8.3 1.3 3.2 10.7 5.1 0.91 1.15 27
Neste 11.00 2-EW/3-Neg 12 5 Europe - - - 11.8 13.7 10.9 38.5 31.4 15.0 (26.8) (19.2) (3.5) 1.4 0.35 0.66 88
ORL 192.0 2-EW/3-Neg 205 7 Europe - - - 12.0 9.8 8.1 8.3 10.9 7.6 1.2 2.1 6.3 6.9 0.18 0.19 10
Petroplus 18.06 3-UW/3-Neg 17 (6) Europe - - - 18.1 8.5 5.8 (4.7) (197.7) 9.6 (20.8) (4.0) 7.7 0.0 (0.09) 0.62 (776)
PKN Orlen 32.80 3-UW/3-Neg 23 (30) Europe - - - 6.0 7.2 6.6 17.6 134.1 50.7 (1.2) (5.3) (0.9) 0.0 0.24 2.70 1,002
Saras 2.02 1-OW/3-Neg 2 19 Europe - - - 14.9 7.3 5.8 (73.1) 14.9 9.9 (6.8) 8.8 12.2 5.0 0.14 0.16 21
Sunoco 25.67 2 - EW/3-Neg 30 17 US 9.0 7.1 6.5 9.5 8.2 7.8 (78.3) 32.1 19.7 (11.7) (4.0) (4.6) 4.7 0.80 1.66 124
Tesoro Petroleum 11.91 2 - EW/3-Neg 13 9 US 7.4 7.7 5.0 7.3 7.7 5.7 (17.0) (18.3) 29.8 13.0 (15.8) (4.5) 1.7 (0.65) 0.35 (126)
Valero 18.11 1-OW/3-Neg 21 16 US 11.9 6.7 5.3 11.4 7.7 6.5 (31.0) 32.9 14.5 (8.3) 10.0 1.7 3.3 0.55 1.07 77
Average 5 25.0 14.0 9.5 13.2 10.3 8.4 (6.9) 9.2 10.0 (6.4) (5.9) 1.7 2.8 27
For full company reports mentioned in our equity valuation tables, including valuation methodology and risks, please go to our Global Equity Research portal on Barclays Capital Live.
Barclays Capital Share prices and target prices are shown in the primary listing currency and EPS estimates are shown in the reporting currency.
Equity Rating System (for a full definition, please see page 71):
Stock Rating: 1-OW, 2-EW, 3-UW Sector view: 1-Pos=1-Positive, 2-Neu=2-Neutral, 3-Neg=3-Negative
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1) EV/EBITDAX is used instead of EV/EBITDA, as EBITDAX is more commonly cited for E&P
2) EV/PICF is used instead of EV/EBIDA, where PICF = Pre-interest Cash Flow = EBITDAX – Cash Income Tax
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Propane
Amerigas Partners L.P. 40.03 3-UW/2-Neu 36 (10) US 8.2 9.4 9.7 - - - 10.3 13.0 13.7 11.6 9.7 9.4 6.7 3.08 2.72 (12)
Ferrellgas Partners L.P. 21.67 3-UW/2-Neu 20 (8) US 10.7 9.3 8.6 - - - 20.8 22.4 17.3 8.9 10.2 11.6 9.2 0.97 1.05 9
Inergy L.P. 33.95 1-OW/2-Neu 39 15 US 10.6 9.0 7.5 - - - 22.6 41.8 27.3 9.5 9.3 10.1 8.1 0.81 0.79 (3)
Suburban Propane Partners L.P. 44.96 3-UW/2-Neu 46 2 US 9.0 10.3 9.5 - - - 9.1 10.9 9.4 12.3 10.6 11.9 7.4 4.13 3.84 (7)
Average (0) 9.6 9.5 8.8 15.7 22.0 16.9 10.6 10.0 10.7 7.9 (3)
E&P Sector
Encore Energy Partners L.P. 19.48 RS/2-Neu 23 18 US 9.8 10.3 10.0 - - - 12.2 12.6 11.8 13.1 12.6 13.1 11.0 1.55 1.10 (29)
Constellation Energy Partners 4.22 3-UW/2-Neu 3 (41) US 3.5 3.6 3.5 - - - 4.0 4.7 4.2 46.2 41.5 43.8 12.3 0.90 (0.38) (142)
Linn Energy LLC 25.18 1-OW/2-Neu 25 (1) US 8.7 8.5 9.0 - - - 10.3 10.1 12.0 14.5 14.9 13.5 10.0 2.50 2.01 (20)
Average (8) 7.3 7.5 7.5 - - - 8.8 9.1 9.3 24.6 23.0 23.5 11.1 (64)
All Pipelines 6 10.1 9.0 7.8 (20.2) 13.6 30.8 10.6 10.3 12.1 6.7 (9.5)
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Distribution Companies
New Jersey Resources 35.11 3-UW/2-Neu 38 8 US 36.2 9.5 9.1 - - - 14.7 13.6 13.3 1.4 9.1 9.3 3.9 2.57 2.57 (0.1)
Nicor 39.46 3-UW/2-Neu 38 (4) US 6.3 6.2 6.3 - - - 14.5 13.5 14.0 8.4 8.7 8.1 4.7 2.93 2.88 (2)
Piedmont Natural Gas 24.89 3-UW/2-Neu 25 0 US 9.4 9.1 9.0 - - - 14.9 15.2 15.6 7.5 7.7 7.8 4.3 1.64 1.61 (2)
Southwest Gas 27.31 3-UW/2-Neu 27 (1) US 5.3 5.1 5.3 - - - 13.6 12.8 12.9 10.0 10.7 10.2 3.5 2.14 2.11 (1)
WGL Holdings 31.73 3-UW/2-Neu 32 1 US 7.3 7.5 7.1 - - - 12.5 14.3 13.3 9.9 9.4 10.1 4.6 2.21 2.27 3
Average 4 11.5 7.5 7.3 13.7 13.4 13.2 7.5 8.8 8.9 4.4 (0.3)
Power
AES Corporation 11.84 1-OW/2-Neu 16 35 US 9.4 8.7 7.8 - - - 11.0 10.7 9.3 (12.3) 6.6 12.8 0.0 1.11 1.14 3
Allegheny Energy 20.49 1-OW/2-Neu 30 46 US 6.8 5.9 5.4 - - - 9.5 9.5 8.1 (2.1) 3.2 2.5 2.9 2.15 2.26 5
Ameren Corp. 24.98 2-EW/2-Neu 21 (16) US 5.9 6.1 5.9 - - - 9.1 10.8 10.3 (0.5) (0.9) (1.5) 6.2 2.31 2.34 1
Calpine Corp. 10.89 2-EW/2-Neu 11 1 US 9.3 10.7 10.1 - - - 43.6 NM - 9.2 5.8 5.2 0.0 0.06 0.30 400
Constellation Energy Corp 32.75 1-OW/2-Neu 39 19 US 5.1 6.6 5.6 - - - 10.0 10.0 9.2 16.5 (4.5) 9.9 2.9 3.28 3.35 2
Covanta Holdings 17.51 2-EW/2-Neu 21 20 US 9.3 8.6 8.5 - - - 23.0 17.9 16.7 (14.2) (2.4) 0.4 0.0 0.98 0.88 (10)
Dominion Resources Inc 36.86 2-EW/2-Neu 33 (10) US 7.8 7.6 7.3 - - - 11.3 11.5 11.1 - 1.5 - 5.0 3.21 3.26 2
Dynegy Inc. 1.58 2-EW/2-Neu 2 11 US 6.0 9.2 8.3 - - - - - - (18.8) (22.7) (2.2) 0.0 (0.33) (0.23) (31)
Edison International 32.50 2-EW/2-Neu 36 11 US 5.7 5.3 5.0 - - - 10.9 9.7 9.7 - (14.3) - 3.8 3.35 3.30 (1)
Entergy Corp 77.11 1-OW/2-Neu 94 22 US 7.3 7.1 6.9 - - - 11.6 11.4 10.7 - 10.3 - 3.9 6.75 6.69 (1)
Exelon 44.75 2-EW/2-Neu 55 23 US 5.9 6.2 6.5 - - - 10.9 12.1 10.7 - 3.3 - 4.5 3.70 3.79 2
FirstEnergy Corp 41.92 2-EW/2-Neu 46 10 US 7.3 7.7 7.3 - - - 12.7 11.5 9.4 (3.4) 1.5 4.4 5.2 3.64 3.59 (1)
FPL Group Inc 48.02 1-OW/2-Neu 57 19 US 8.7 8.7 7.9 - - - 11.9 11.1 10.6 - (16.0) - 3.7 4.34 4.37 1
Mirant Corp 13.15 3-UW/2-Neu 12 (9) US 4.6 6.8 8.0 - - - 5.1 10.4 13.6 10.9 1.3 15.9 0.0 1.26 1.64 30
NRG Energy 22.10 2-EW/2-Neu 26 18 US 6.4 7.5 8.3 - - - 8.2 11.4 14.5 14.1 10.0 11.2 0.0 1.94 2.14 10
Ormat Technologies 33.66 2-EW/2-Neu 38 13 US 15.2 12.9 10.9 - - - 24.0 22.1 18.1 (6.0) (2.5) (2.3) 0.6 1.52 1.47 (3)
PPL Corporation 28.62 2-EW/2-Neu 32 12 US 7.4 6.1 6.4 - - - 16.5 8.7 9.3 - 0.2 - 4.8 3.28 3.32 1
Public Service Entrp Group Inc 29.64 1-OW/2-Neu 36 21 US 6.0 5.8 5.9 - - - 9.5 9.3 9.7 - (0.3) - 4.5 3.18 3.19 0.5
RRI Energy, Inc. 4.56 2-EW/2-Neu 5 10 US 46.3 8.5 5.5 - - - - (41.5) 14.3 (16.7) 9.9 23.5 0.0 (0.11) (0.06) (45)
Average 13 9.5 7.7 7.2 14.0 8.6 11.5 (1.9) (0.5) 6.7 2.5 19
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APPENDIX
Valuation Methodology and Risks for Key Overweights
US Integrated Oil
Eni (ENI.MI)
Valuation Methodology: Our price target for Eni's shares is derived using a discounted cash flow methodology, using a 10% discount rate. Our
calculation includes our estimate of value created from future growth based on the company's past and expected future return spread over its
cost of capital. The cash flows in our calculation comprise both dollar and local currencies. Our price target is set in local currency, based on the
dollar exchange rate on the date the target is initially published. Subsequently, the corresponding ADR price target in US dollars will move with
the prevailing exchange rate on a daily basis. If the dollar exchange rate relative to the local currency moves significantly compared with the rate
used when the local currency price target was initially published, we re-calculate and re-publish the local currency price targets using the current
dollar exchange rates. Our price targets are not market linked.
Risks: Our Eni share price target and recommendation depend on our estimates of profitability and cash flow and the rate at which we discount
the cash flows. These estimates in turn are based on assumptions for oil prices and downstream margins. These assumptions depend on the
Barclays Capital European Oil & Gas equity research team's estimates for future energy supply-demand patterns, exchange rates, commodity
prices. All of our estimates are subject to revision and may be materially different from eventual outcomes. In addition the company operates on
a global basis in many regions with sometimes unstable political regimes and changing fiscal terms. The actions of OPEC can also have a
significant influence on the oil market. All estimates assume no marked changes in the current political landscape. Both upstream and
downstream operations are subject to planned and unplanned downtime. Eni has a significant Gas & Power business in Italy, part of which is
regulated and may be subject to regulation changes in future.
US Independent Refiners
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on the Barclays Capital European Oil & Gas equity research teams estimates for future energy supply-demand patterns, exchange rates,
commodity prices. All of our estimates are subject to revision and may be materially different from eventual outcomes. In addition individual
refineries are subject to crude supply disruptions or operational failures.
Galp Energia (GALP.LS)
Valuation Methodology: Our price target for GALP's shares is derived using a discounted cash flow methodology, using a 12% discount rate for
refining and power generation and 10% for the upstream assets. Our calculation includes our estimate of value created from future growth
based on the company\'s past and expected future return spread over its cost of capital. The cash flows in our DCF calculation comprise both
dollar and local currencies. Our price target is set in local currency.
Risks: Our GALP share price target and recommendation depends upon our estimates of profitability and cash flow and the rate at which we
discount the cash flows. These estimates in turn are based on assumptions for oil prices and downstream margins. These assumptions depend
on the Barclays Capital European Oil & Gas equity research teams estimates for future energy supply-demand patterns, exchange rates,
commodity prices. All of our estimates are subject to revision and may be materially different from eventual outcomes. In addition individual
refineries are subject to crude supply disruptions or operational failures. GALP also faces additional risk to changes in the Brazilian fiscal regime
given its significant upstream exposure there.
Hellenic Petroleum SA (HEPr.AT)
Valuation Methodology: Our price target for Hellenic Petroleum\'s shares is derived using a discounted cash flow methodology, using a 12%
discount rate. Our calculation includes our estimate of value created from future growth based on the companys past and expected future return
spread over its cost of capital. The cash flows in our DCF calculation comprise both dollar and local currencies. Our price target is set in local
currency.
Risks: Our Hellenic Petroleum share price target and recommendation depends upon our estimates of profitability and cash flow and the rate at
which we discount the cash flows. These estimates in turn are based on assumptions for oil prices and downstream margins. These assumptions
depend on the Barclays Capital European Oil & Gas equity research teams estimates for future energy supply-demand patterns, exchange rates,
commodity prices. All of our estimates are subject to revision and may be materially different from eventual outcomes. In addition individual
refineries are subject to crude supply disruptions or operational failures.
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US Natural Gas
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Risks: Estimates are subject to the level, relationship and volatility of oil & gas prices. Weather and economic activity impacts demand for
products and services. Limited foreign activities are exposed to currency fluctuations and political instability. Regulated pipelines are subject to
prudency review of costs and capital investments plus, over time, allowed returns fluctuate with the level of interest rates.
ONEOK Inc. (OKE)
Valuation Methodology: Our price target of $50 is based on shares trading at 85% of our NAV analysis using 2011 estimates comprised of an
asset value of $8.229B less net liabilities of $1.813B / 109.99MM shares = $58.33 times 85% = $49.58 rounded to $50.
Risks: OKE owns 47.7% ownership interest in OKS, and natural gas distribution business, where results are tied to regulatory approvals of current
and future rate relief requests and Energy Services, where results are impacted by natural gas prices, basis differentials and costs of obtaining
storage and pipeline capacity.
Questar Corp. (STR)
Valuation Methodology: Our price target of $51 is based on shares trading at 80% of our NAV analysis using 2011 estimates comprised of an
asset value of $13.340B less net liabilities of $2.234B / 175.8 MM shares = $63.18 times 80% = $50.54 rounded to $50. Our current NAV is using
normalized commodity decks of $6/Mcf Gas, $80/BBL Oil, 58% NGL/Crude relationship.
Risks: Earnings are exposed to natural gas prices especially the value of gas in the Rockies. E&P volume estimates are dependent on timely
access to drilling locations on the Pinedale Anticline. Regulated subsidiaries are dependent of federal and state agencies for approvals of allowed
ROEs, a negative posture could hamper earnings growth.
Spectra Energy Corp. (SE)
Valuation Methodology : Our price target of $24 is predicated on the weighted average of four valuation metrics: 1) 2011e EPS of $1.77 and P/E
multiple of 14.0x, 2) 2011e dividend of $1.04 and yield of 4.5%, 3) EV/EBITDA of 8.0x, and 4) NAV of $26.08. Weightings are 50% dividend yield
and 16.7% for other three methods.
Risks: The risk to our forecast is primarily three items. (1) The level of growth capital and the returns earned on the assumed spending. Given the
high percent of rate base, spending assumptions will be more variable than the returns earned in our forecast. (2) Sensitivity to crude (NGL)
prices is significant. Each dollar swing in crude prices equates to about $15mm in EBIT from net equity barrels generated from field service
operations. Canadian frac spread exposure equates to $12.5mm for every 50 cent /mmbtu change in margin. (3) In aggregate rate base
operations are roughly earning their allowed returns. With nearly $9 billion in rate base, changes in the current return parameters would also
influence results quickly.
Constellation Energy (CEG)
Valuation Methodology: Our $39 price target reflects the average of: $32 for an Integrated Utility average 10.7x 2011 P/E aplied to $2.22, $0.84
for Supply at 9x and NPV for $0.50 of hedge value; $39 for 7.1x 2011 Open EBITDA of $1.44B and 5x Supply EBITDA of $329M, net debt of $4.2B
including hedge NPV and imputed debt of $1.8B, and 197M shares; and $46 for a sum of parts asset-based valuation which includes $13.2B of
enterprise value, $4.2B in net debt and 197M shares.
Risks: Risks to the outlook include wholesale commodity prices, generation development market conditions, the outcome of regulatory
proceedings, rating agency actions including the current Moody's review, interest rates, and access to the capital markets.
AES Corp. (AES)
Valuation Methodology: Our price target of $16 reflects 7.1x Proportional EBITDA $3.27B in 2011 less net debt of $12.6B and 790M shares
which is $13.50, 13.5x 2011 EPS of $1.27 which is $17.25 and a sum of parts which is $15.75.
Risks: As a global power company and electiric utility, AES is exposed to merchant power risk, country risk, currency risk (particularly in South
America), regulatory risk, and counterparty risk. The company's liquidity is currently tight and the outcome of a range of negotiations and
counterparty exposure in the power sector could have damaging effects.
US Coal
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ANALYST(S) CERTIFICATION(S)
With respect to our respective contributions in this report, we, Costanza Jacazio, Amrita Sen, Michael Zenker, Biliana Pehlivanova, Yingxi Yu,
James Crandell, Trevor Sikorski, Helima Croft, Harry Mateer, Stefanie Leshaw Chachra, Gary Stromberg, Chris Gault, Laurence Jollon, Brian
Chavarria, Jim Asselstine, Timothy Tay, CFA, Neil Beddall, Paul Y. Cheng, CFA, Lucy Haskins, Rahim Karim, Lydia Rainforth, Thomas R. Driscoll,
CFA, Jeffrey W. Robertson, James D. Crandell, James C. West, Mick Pickup, Richard Gross, II, Daniel Ford, CFA, Greg Orrill, Peter D. Ward, CFA,
hereby certify that: (1) the views expressed in this research report accurately reflect our personal views about any or all of the subject securities
or issuers referred to in this research report; and (2) no part of our compensation was, is or will be directly or indirectly related to the specific
recommendations or views expressed in this research report.
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Market Weight: The analyst expects the six-month total return of the rated debt security or instrument to be in line with the six-month expected
total return of the Barclays Capital U.S. 2% Issuer Capped High Yield Credit Index, the Pan-European High Yield 3% Issuer Capped Credit Index
excluding Financials, or the EM Asia USD High Yield Corporate Credit Index, as applicable.
Underweight: The analyst expects the six-month total return of the rated debt security or instrument to be below the six-month expected total
return of the Barclays Capital U.S. 2% Issuer Capped High Yield Credit Index, the Pan-European High Yield 3% Issuer Capped Credit Index
excluding Financials, or the EM Asia USD High Yield Corporate Credit Index, as applicable.
Not Rated (NR): An issuer which has not been assigned a formal rating.
Rating Suspended (RS): The rating has been suspended temporarily due to market events that make coverage impracticable or to comply with
applicable regulations and/or firm policies in certain circumstances including where Barclays Capital is acting in an advisory capacity in a merger
or strategic transaction involving the company.
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Distribution of Ratings:
Barclays Capital Inc. Equity Research has 1446 companies under coverage.
41% have been assigned a 1-Overweight rating which, for purposes of mandatory regulatory disclosures, is classified as a Buy rating; 46% of
companies with this rating are investment banking clients of the Firm.
44% have been assigned a 2-Equal Weight rating which, for purposes of mandatory regulatory disclosures, is classified as a Hold rating; 41% of
companies with this rating are investment banking clients of the Firm.
13% have been assigned a 3-Underweight rating which, for purposes of mandatory regulatory disclosures, is classified as a Sell rating; 35% of
companies with this rating are investment banking clients of the Firm.
Barclays Capital offices involved in the production of equity research:
London
Barclays Capital, the investment banking division of Barclays Bank PLC (Barclays Capital, London)
New York
Barclays Capital Inc. (BCI, New York)
Tokyo
Barclays Capital Japan Limited (BCJL, Tokyo)
São Paulo
Banco Barclays S.A. (BBSA, São Paulo)
Hong Kong
Barclays Bank PLC, Hong Kong branch (BB, Hong Kong)
Toronto
Barclays Capital Canada Inc. (BCC, Toronto)
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