2013 Energy Sector Outlook

Mike Lorusso
is Managing Director and Group Head of CIT Energy Finance.  He is responsible for overseeing all financing activities within the
energy sector of CIT.

Q: Do you expect to see an increase in M&A activity this year? Which areas of the energy sector will be most active?

A: The energy industry is driven by both M&A activity and investment in capital projects. The level of this activity is determined by a variety of factors, such as the overall health of the economy, commodity prices and their effect on valuations and the growth prospects of certain sectors. Due to the attractive growth potential for developing shale oil & gas resources, we expect the oil & gas sector to be reasonably active in 2013. Similarly, we expect modest to high activity in the power sector as it moves to take advantage of the abundance of cheap gas reserves to fuel power plants in the U.S. and the desire to utilize more renewable resources.

Q: What concerns does the industry have regarding government oversight?

A: The industry faces two types of government oversight concerns: one is environmental regulation and the other is tax subsidies. The primary concern with environmental regulation for the oil & gas sector is the potential restrictions on hydraulic fracturing or “fracking,” which is a technology to extract oil & gas from shale rock formations. The Federal government has so far deferred to states on this issue with only a few states placing restrictions.

The other concern is tax subsidies related to renewable energy. Congress already extended the wind energy production tax credit for one year, but there is waning support for this. The sentiment for wind is that it has had tax subsidies for several years with the intention for the industry to become self-sufficient. Due to its continued need for subsidies and the desire for tax reform I expect wind power to lose tax support. On the other hand, solar is a relatively new industry with subsidies through 2016 and it is quickly becoming more cost effective. Thus there could be reduced but continued tax support for solar.

Q: What are your expectations for natural gas and its impact on the sector?

Over the past year natural gas has traded in a range of approximately $2.00 to $3.75 per million British thermal unit. There are existing market forces that will provide some floor and ceiling on its price to keep it within a similar range with an upward trend for the next several years. Drilling and production decreases at the low end of the range and the abundant supply plus the ability to switch fuel consumption away from gas maintains some ceiling on the price. Thus natural gas should remain a relatively cheap form of energy for the next several years. The effect of this will be a continued trend to expand the use of natural gas both as a fuel and feedstock in the chemicals industry.

There is currently only one liquefi ed natural gas (LNG) export facility being constructed in the U.S. Several companies have submitted applications for licenses but it’s not likely that many of these facilities will be built, thus the volumes would not be large enough to have a significant impact on prices.

To add, using natural gas in vehicles may not catch on because it poses a huge need for infrastructure. The most likely application would be where there is a concentration of vehicles sharing infrastructure, such as municipal bus fleets, sanitation vehicle fleets, etc. I would expect it will be a long, slow process before we see widespread conversion to natural gas vehicles.

Q: How are emerging technologies impacting the energy sector?

A: The oil & gas sector has benefited greatly from new technologies, which have led to the ability to economically extract resources from shale rock formations previously thought to be unattainable. In the power sector, fossil fuel plants and renewable energy have demonstrated incrementally improving costs and efficiencies, but we haven’t seen the advent of a new “disruptive technology” or an innovation that would create a new market and eventually disrupt or displace an earlier technology.

Q: How will pending rulings from the Environmental Protection Agency affect the energy sector this year?

A: Perhaps the number one most-anticipated EPA ruling this year will focus on greenhouse gas emissions limits on new power plants. The worst offender in this tends to be coal plants, especially older ones. Many utilities who own the majority of these plants have already announced plans to close certain plants due to the costs associated with upgrading and operating those plants. Natural gas plants would be affected next, but to a much lesser extent. Renewable fuel plants would of course benefit from this, but they are only a small percentage of the power supply.

Q: What is the purpose for the Keystone pipeline?

A:The Keystone pipeline serves two purposes: the first is to bring Canadian oil into storage facilities in Cushing, Oklahoma where it will join U.S.- produced oil; the second is to move the oil from there to refineries and terminals in the Gulf Coast. However, what is interesting and overlooked is that two phases of Keystone are already completed and bringing Canadian oil into the U.S., and an existing pipeline between Oklahoma and the Gulf Coast recently reversed its flow to move this oil to the Gulf Coast. So all Keystone XL will do is increase existing capacity to bring oil into the U.S. and transport it to the Gulf.

The major opposition to Keystone XL is the environmental impact of the pipeline’s route and that it will further facilitate the U.S.’s consumption of fossil fuels.

Q: Is private equity still actively investing in energy? Are there projects that have found more favor with private equity companies?

A: Private equity is very interested in the energy sector due to its potential growth opportunities. However, since the sector is quite specialized, complicated and somewhat unique compared to other industries, many generalist private equity firms do not pursue energy. The firms that invest in the energy sector do so through a variety of means. In the oil & gas sector they can invest directly by getting behind a management team exploring for oil & gas production, or indirectly by investing in companies that provide the support services to those production companies.

In the power and mid-stream sector certain firms will directly invest by owning the physical assets and infrastructure such as both conventional and renewable power plants, storage facilities and pipelines.

Q: When do you expect the U.S. to achieve energy independence?

A: There is a lot of debate around the thesis of U.S. energy independence. One fact to be understood is the global interdependence and trade of energy as a commodity product. For example, the U.S. may be a large importer of oil, but we are also a major exporter of refi ned petroleum products. My opinion is that we first must view this as North American energy independence, which would include the vast Canadian oil deposits from oil sands and shale formations. With that consideration North America may be able to reduce our need for oil imports to a level where we could be essentially “energy independent” in about a decade.

Q: Are there any additional trends you expect to see in the coming year?

A: I expect a continuation of existing trends with some added volatility. For example, oil & gas prices should continue to trade within the range we have seen over the past year or so with some occasional dramatic sudden moves. Fracking activity for oil & gas production will continue, as will the need for related infrastructure, such as pipelines, rail transportation and terminals. In the power sector I would expect a continuing movement towards natural gas power plants. In renewable energy the wind industry has become mature and stagnant so we will see diminished activity, as well as some consolidation.

Q: What would you like to see as the headline coming out of the energy sector at the end of the year?

A: “U.S. Government Adopts a Bipartisan ‘All Of The Above’ Energy Policy That Employs a Balanced Approach Utilizing All Resources.”


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