Structural changes in the European gas market and recent dynamics in gas pricing

Bain & Company presentation at Cyprus Natural Gas Conference

Nicosia, Cyprus 7/8 June 2012

This information is confidential and was prepared by Bain & Company solely for the use of our client; it is not to be relied on by any 3rd party without Bain's prior written consent

Objective of the document

Give a brief overview of the European Gas Market, taking into account the recent dynamic in supply and demand Illustrate how the drivers of gas demand have been affected by recent regulatory evolution, with particular focus on renewable energy Share some insights on the future development of the market and the role of Take-or-Pay contracts

This information is confidential and was prepared by Bain & Company solely for the use of our client; it is not to be relied on by any 3rd party without Bain's prior written consent

Agenda

International gas market overview Recent evolution of European gas market dynamics Key issues for future market evolution

This information is confidential and was prepared by Bain & Company solely for the use of our client; it is not to be relied on by any 3rd party without Bain's prior written consent

International gas market overview

International natural gas flows in 2010
Import

350 Bcm
113.9 55.9 16.6 16.0 6.2 9.4 20.1 44.1 4.1 5.4 12.1 36.5 5.5 17.3 10.9 8.8 6.5 17.7 14.9 6.3 5.2 32.0 21.0 18.8 8.2 Pipeline Gas LNG Gas 20.9 92.4

Import 200 Bcm

7.0 5.8

9.8

Continental Europe (mainly by pipe) and Far East (LNG) heavily rely on natural gas imports
Source: BP Statistical Review of World Energy June 2011 www.bp.com/statisticalreview
This information is confidential and was prepared by Bain & Company solely for the use of our client; it is not to be relied on by any 3rd party without Bain's prior written consent

International gas market overview

US increased production of unconventional gas
Shale gas production in the US
7 6 US LNG Imports, Trillion Cubic Feet 5 4 3 2 1 0

EIA LNG import forecasts

Forecast 2005

Forecast 2007

Forecast 2010

Significant downward revision of LNG import forecast in the USA, mainly as a consequence unconventional gas production
Sources: EIAs Shale Gas and the Outlook for U.S. Natural Gas Markets and Global Gas Resources for Shale gas production in the US; EIAs Annual Energy Outlook 2005, 2007, 2010 for EIA LNG import forecasts
This information is confidential and was prepared by Bain & Company solely for the use of our client; it is not to be relied on by any 3rd party without Bain's prior written consent

International gas market overview

Pricing polarization
60
Large scale exploitation of unconventional gas

Oil equivalent

40

APAC

Price gap APAC RoW further increased in 2011 for Fukushimas aftermath

Ger (BAFA)

20
USA (HH) 0
20 10 20 04 20 05 20 11 20 06 20 07 20 08 20 09

The three main gas consumption areas (US, EU, APAC) have experienced divergent price evolution, with US price independent from oil price trends
Source: BP Statistical Review of World Energy June 2011 www.bp.com/statisticalreview;
This information is confidential and was prepared by Bain & Company solely for the use of our client; it is not to be relied on by any 3rd party without Bain's prior written consent

International gas market overview

Continental reach of the different gas supplies
Continental production 70 Bcm North sea 250 Bcm

ILLUSTRATIVE

Russia 220 Bcm

Atlantic basin 10 Bcm

North Africa 80 Bcm

Middle-East 40 Bcm

Increased presence in the market of a diversified range of gas producers

This information is confidential and was prepared by Bain & Company solely for the use of our client; it is not to be relied on by any 3rd party without Bain's prior written consent

Agenda

International gas market overview Recent evolution of European gas market dynamics Key issues for future market evolution

This information is confidential and was prepared by Bain & Company solely for the use of our client; it is not to be relied on by any 3rd party without Bain's prior written consent

Recent evolution of European gas market dynamics

Gas demand in Europe and increase in import spot volumes
Gas demand in the main European countries Spot LNG imports to Europe
Appearance of the WW gas glut related to the US unconventional gas Availability of new Qatari LNG trains

18 17

CAGR ~22%
10 9 7 5 4 2 '00 '01 '02 '03 '04 '05 '06 '07 '08 4 7 6

13

'09

'10

'11

With stagnating demand and impressive increase of spot LNG imports, gas importer struggled to fulfill their minimum Take obligations
Sources: Eurostat for Gas demand in the main European countries; GIIGNL for Spot LNG import to Europe
This information is confidential and was prepared by Bain & Company solely for the use of our client; it is not to be relied on by any 3rd party without Bain's prior written consent

Recent evolution of European gas market dynamics

The development of European hubs and the increase in trading activity
Main European hubs
UK: NBP (National Balancing Point) Netherlands: TTF (Title Transfer Facility) Austria: CEGH (Central European Gas Hub) Germany: NCG (Net Connect Germany) France: PEG (Points d'Echange de Gaz) Italy: PSV (Virtual Trading Point) Belgium: ZEE (Zeebrugge)

Volumes traded in main hubs

A Gas Hub is a platform that can be either physical or virtual (or both the things) where gas marketers exchange gas volumes

TTF NBP ZEE PEG PSV NCG CEGH

Main European gas markets

Main European hubs

TTF

ZEE

PSV

PEG

CEGH

GASPOOL

NCG

As a result of the oversupply situation and the increased liberalization, traded volumes in the European gas hubs experienced a rapid growth Source: IEA
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Recent evolution of European gas market dynamics

Decoupling of oil and hub-indexed gas prices
Decoupling begins
TTF prices stop follow oil trends as oversupply develops

Typical oil-indexed price formula (not accounting for any price reduction) Year-ahead gas traded price at TTF Hub (continental Europe reference hub price)

Low TTF prices as an effect of new pipelines and releases from storage facilities

All European utilities have a supply portfolio mostly related to LT oil-indexed contracts... ...while end-user market is instead influences by lower spot prices... ...this is causing significant losses to European utilities which increasingly ask for a oil/hub indexation mix price to their suppliers

European spot prices have become increasingly decoupled from the upward moving oil price dynamics
Source: Bain elaboration
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Recent evolution of European gas market dynamics

Renegotiations triggered over the last years

The likes of E.ON, GdF Suez, ENI, Econgas and BOTAS have renegotiated their LTCs with the major exporters to Europe, e.g. Russias Gazprom, Norways Statoil and Dutch GasTerra using standard price review clauses [...] some level of indexation to cheaper spot gas prices was introduced into mainly oil-indexed LTCs Oxford Energy Forum, August 2010

Gazprom said in its report that as a result of talks in 2010, price agreements were reached with E.ON Ruhrgas, GDF Suez, Eni, GasTerra and others. In some cases, Gazprom has agreed to alter contracts for a three-year period to include a ratio of up to 15% spot prices and 85% oil-indexed prices Platts, 16 August 2011

Price renegotiations triggered by the Buyers have granted the introduction of a hub-indexation into the purchasing formulae
This information is confidential and was prepared by Bain & Company solely for the use of our client; it is not to be relied on by any 3rd party without Bain's prior written consent

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Agenda

International gas market overview Recent evolution of European gas market dynamics Key issues for future market evolution

This information is confidential and was prepared by Bain & Company solely for the use of our client; it is not to be relied on by any 3rd party without Bain's prior written consent

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1) Transient or structural oversupply?

Displacement of gas power plants by renewables Demand evolution Delocalization of energy-intensive industrial cycles Increase in households heating efficiency Fossil and (in the long run) nuclear capacity substitution by CCGT
Enduring impact of unconventional gas / new gas discoveries

Weak demand in the short term, potential recovery with power replacement

Supply evolution

Gas thirst by Asia Pacific Countries Infrastructural development (e.g. US liquefaction capacity)

International supply dynamics impacted by APAC evolution

European network integration

European Policy Directives

Security of supply through increased diversification Promotion of gas competition

Promotion of a long market to boost competition

Very unlikely in the mid-term a return in a tight market; in the short term oversupply will persist
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1) Transient or structural oversupply?

Impact of renewables example of Italy

Gross Capacity (GW)

50
160

Fuel cost adjusted - Power price (/MWh)

average hourly power price in April

2009 2012

40

41 3

140

120

30 24 20 4

30 27
2

13

Biomass
100

Geothermal PV
7
80

3 5 6

Wind
60

Hydro
40

10

18

18

18

18
20

2008

2009

2010

2011

9 10 11 12 13 14 15 16 17 18 19 20 21 22 23

Note:adjusted with 2012 fuel costs

The growth of renewables (Photovoltaic) with priority of dispatch has displaced volumes from CCGTs and depressed peak power price
Source: GSE Data
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2) There will be a recoupling to oil-indexed prices?

Hub-based supply difficult to implement in a low-production market
US/UK
Supplier/Importer
Spot contracts

Continental Europe
Supplier
LT contracts Spot contracts

Gas hub Wholesaler/ Retailer End-user market Captive market

Importer/Wholesaler

Gas hub

Retailer End-user market Captive market

Transparent gas market Prices determined by demand/supply balance Large share of internal production and a large number of players

Prices historically linked to LT oil-indexed contracts Currently showing a coexistence of LT and spot contracts with oil/hub-indexed prices Large share of imported volumes and few national players

European market has a inherently different structure than US: long term ToP contracts will continue to be the staple of supply portfolios...
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2) There will be a recoupling to oil-indexed prices?

Pricing depends on complex interactions
Gas oil substitution for domestic demand Process industry delocalization Renewable source Fossil/nuclear plants replacement CO2 emission concerns ...

Demand
Diversification needs Security of supply ...

European and National Policies

Supply PRICE FORMATION MECHANISM

Infrastructure development WW demand/supply imbalances LNG arbitrage opportunities Technological breakthroughs in E&P ...

Antitrust measures Regulations on end-user prices Hub liquidity Degree of liberalization ...

Regulatory framework

Strategy of main players

Long vs short portfolio Commercial strategy (mkt share defence vs margin defence) Downstream/upstream integration ...

..however, how ToP contracts will be priced would depend by several contrasting factors
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Conclusions

The European gas market will be in oversupply for few years to come, but in the mid-long term gas is required to replace declining internal production and aging fossil/nuclear generation fleet The extent of this long term demand recovery will depend on renewable energy sources integration in the electricity grid Long-term, ToP gas contracts will still maintain a strategic relevance in terms of security of supply and volatility mitigation, especially in Countries with low level of domestic production Worldwide gas offer, boosted by new discoveries and enhanced infrastructures may imply increase in competition among suppliers and a review of old pricing models; however, the extent of this will depend on the relative gas thirst of US, European and Asian markets

This information is confidential and was prepared by Bain & Company solely for the use of our client; it is not to be relied on by any 3rd party without Bain's prior written consent

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Bain & Company Italy contacts for gas business

Roberto Prioreschi Director Position

Head of the Energy & Utilities Practice in Italy 17- year consulting experience Strategy, cost efficiencies and reorganization Business planning, budgeting and reporting system/scorecard Operations rightsizing and cost reduction in manufacturing systems M&A and Post Merger Integration

Alessandro Cadei Partner

Member of the European Practice Energy & Utilities 12- year consulting experience Strategy and business development Commercial strategy and business planning Organization and rightsizing M&A and Post Merger Integration

Luigi Corleto Principal

Member of the Practice Energy & Utilities 7 - year consulting experience Strategy and business development Performance improvement and cost reduction Operations streamlining M&A and Post Merger Integration

Main areas of expertise

Selected clients served in Gas & Power market

Contacts:

roberto.prioreschi@bain.it +39 - 335.7615190

alessandro.cadei@bain.it +39 - 335.7529747

luigi.corleto@bain.it +39 - 338.9381273

This information is confidential and was prepared by Bain & Company solely for the use of our client; it is not to be relied on by any 3rd party without Bain's prior written consent

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