Pioneering Energy Flow Transformation in Emerging Markets
by David Aldred, Treasury and Trade Solutions (TTS) Sales Head for Middle East, North Africa, Turkey and Pakistan and EMEA Energy, Power & Chemicals Sales Head; Amit Agarwal, EMEA Head Liquidity Management Services, TTS, Citi; and Dimitrios Raptis, EMEA Head of Market Management, Liquidity Management Services, TTS, Citi
World markets for energy have entered a period of dynamic change in both supply and demand. Demand for oil and gas in the emerging economies of China, India, south East Asia and the Middle East continues to grow, fuelled by urbanisation and industrialisation. This is motivating energy companies to explore new territories and invest in production and logistics facilities on one hand, and find efficient means of selling and collecting cash in high-demand regions on the other. The challenge is that emerging supply and demand economies are often amongst the world’s most complex markets, typically with considerable market and regulatory restrictions. The dilemma for CFOs and treasurers of energy companies is therefore how best to manage local idiosyncrasies in key supply and demand countries whilst fulfilling wider corporate objectives. The deployment of a sophisticated cash management strategy that will enable the optimisation of working capital and improve the efficiency of liquidity flows is critical.
Investment challenges for energy companies
According to the International Energy Agency’s World Energy Investment Outlook 2013, published in November 2013, more than $1.6tr was invested in 2013 to provide the world’s consumers with energy, a figure that has more than doubled in real terms since 2000. Much of this cost is to offset declining production from declining oil and gas fields and to replace power plants and other assets that are reaching the end of their productive life, leading to high capital requirements not only upfront but on an ongoing basis. The challenge for multinational energy corporations is not only the level, but also the geographies in which this investment needs to be directed to, many of which are restricted markets with limited currency convertibility and liquidity constraints. While the markets in which energy companies are increasing their investment are diverse, from Kazakhstan to Nigeria, Russia to Iraq, there are common characteristics in the cash, risk and liquidity challenges in these high-growth, high-supply markets.
Similarity of risks across diverse markets
Corporate investment in complex emerging markets is a long-term, dynamic undertaking, with long project lifecycles and diverse cash flow models that entail frequent and sizable cross-border movements of funds in local and foreign currency. Very often, such projects involve dealing with unfamiliar counterparties and joint ownership structures, typically with state-owned enterprises, leading to further liquidity and risk complexities. These are exacerbated by political risks in certain markets, challenging regulatory environments and market restrictions on currency convertibility and cross-border liquidity which in turn leads to fragmented balance positions frequently known as ‘trapped’ cash. Furthermore, volatility on interest and exchange rates of these currencies add direct and indirect costs to the cash management structure and subsequently to company’s balance sheet
There is a common view that due to the high value of transactions in which they are involved, energy companies are cash-rich and therefore the issue of trapped cash and liquidity constraints are less immediate than for other industries. However, although energy prices continue to be moderately high, and demand is predicted to continue growing, giving reasonable assurance of the return on investment, the huge capital and ongoing costs in extraction and production projects mean that liquidity and working capital considerations can be very significant for energy companies. As a result, CFOs and treasurers are increasingly looking at ways to self-fund this CAPEX and optimising the company’s global liquidity is a crucial element of this strategy. Citi recognises this trend and we are leveraging our global network and local knowledge to work with our clients across this industry to build innovative and bespoke structures that will address their evolving cash management and trade finance challenges. For example, we may work with a customer to optimise funding and liquidity in production zones such as Kazakhstan, Nigeria and Iraq, and also to accelerate collections and facilitate the cross-border automated liquidity flows without loss of value in sales locations such as China. In particular, these customers are keen to gain access to our local expertise and insights to understand and overcome the idiosyncrasies in each market, whilst utilising our global liquidity platform to achieve liquidity optimisation and working capital efficiencies even when connecting the most remote locations.
The impact of globalisation
Many energy companies headquartered in the United States and Europe that are expanding into Middle East and North Africa are witnessing at first hand the implications of a global economy in ways that have been less apparent in the past. For example, quantitative easing in the United States drove down the value of the USD against several currencies, leading to greater FX risks and higher foreign currency costs, particularly in currencies where the FX markets are less liquid. An intelligent cross-currency liquidity structure that is managed efficiently may significantly reduce the frequency and costs of FX activity without adversely impacting FX risk and generate economic benefits through interest differentials and currency volatility.