Investments into energy are usually capital intensive. Energy industry reflects a complex chain from upstream to midstream and further to downstream. Each segment has its own specificities, economics and risks. Complexity is also translated by rising Marginal Costs. Hence, even with the price increase, the profitability margin can decline. Likewise, Marginal Costs increase can lead to a non-profitability of reserves before depletion.
Rising prices also stimulate new hydrocarbon technologies, such as shale gas and shale oil in North America.
Access to capital is the key issue. Capitalization of companies on the stock exchange depends on the amount of profitable reserves. But the assessment of profitable reserves depends on energy price. For example, higher the price of oil is, more profitable reserves can be accounted. Hence, the gas price decline in the US following the shale gas revolution impacted on decrease of profitable reserves of many companies.
Energy investment represents a large spectrum of risks. Risks can be economic, political, legal & regulatory as well as environmental. Risks are accounted by companies in terms of discount rates. However, not all risks are translated, for example growing transaction costs. Noteworthy, energy projects are specific in a way that they always produce externalities, this includes environmental externalities.
Project finance in oil and gas are still safer and more consistent than in nuclear. The latter represents a high spectrum of economic risks, constant governmental intervention (security and waste management). Discount rates for nuclear projects are higher than in oil and gas. Hence, sector specificities in project finance have to be considered. In addition, world regions vary on specificities of risks, on sizes of resources and of markets. Noteworthy, State-market relation in the energy sectors has been always very important. However, regional specificities need to be still assessed.
Energy investments are among the most complex and most capital intensive. One can not understand an energy policy without taking into account the economic dimension of the issue. Therefore, one of the leading business analysts Mr Mattew Winlsow explains about project finance and investment risks in various energy sectors.
Matthew Winslow, Project finance consultant and founder of the Scylax LLC
2. Are there differences between project finance for oil and gas projects in comparison with coal and nuclear projects?
3. What role do governments play in the energy industry?
4. What are the industry trends that will affect the energy industry in the future?
Obligatory learning material
S. Bhattacharyya, Energy economics, Spinger 2011, pp 485-501
[Focus on net present value of projects, discount rates, rate of return, risk free rate of return]