English | 中文版

Peter Tertzakian
ARC Financial

Eyebrows tend to rise when someone walks into a store and pays the proprietor double the asking price for a sale item. Happiness reigns at the windfall, yet the satisfaction of the sweet sale behind the counter quickly yields to the hushed, bothersome question, “What does this guy know that we don’t?” And so the question must be asked of the Chinese, when on October 10, 2011 one of their state owned oil and gas companies, Sinopec, walked into Canada’s oil patch and offered $2.2 billion for Daylight Energy.

The bid for debt-laden Daylight, a publicly-traded company was over ten bucks a share. On Friday, the market was only paying $4.89 a share, so the more-than-double premium begs the question, “What do the Chinese know that we don’t?” One thing they and their bankers know quite well is that the premium for a large takeover has to be rich and compelling if all shareholders (and the Canadian federal government) are going to agree to the deal.

Fair enough, but there is more to the buyer’s wisdom here. For one thing, they recognize that Daylight has built up a portfolio of natural gas properties in prolific and lucrative plays in Alberta and Northeast British Columbia.

The Fuel of the Future

In fact, what the buyer knows is what shale-saturated North Americans have not fully acknowledged – that natural gas is the favoured fuel of the future, growing globally at an accelerating pace, much faster than oil, on a progressively larger and larger base of consumption. By extension, Sinopec and others abroad realize that Canada’s gas reserves are cheap today, and will be worth a lot more, probably more than double, in a few short years.

To appreciate this notion, recognize that global consumption of natural gas has recently crossed the 300 Bcf/d mark. That’s big. For a sense of scale, on an energy equivalent basis, that’s the same as 50 million barrels of oil a day (the world consumes 89 MMBOE/d right now). Put another way, energy drawn from natural gas is now well over half the amount of what we get from oil. But the big difference between the profiles of these two commodities is that natural gas is compounding its growth by 2.8% annually (about 8.4 Bcf/d per year), while economy-challenged oil is lumbering along at 1.2%. In other words, the demand for natural gas is growing twice as fast as the investor’s darling, oil.

Yet, the real insights come when we break down the global demand statistics by region. Figure 2 shows such a view by dissecting the world of natural gas into six markets: Europe/Eurasia, North America, Asia-Pacific, Middle East, South America and Africa. Not surprisingly, North America and Europe are the largest markets, but the slowest growing.

Moving on to more exciting pastures, Asia-Pacific, which includes the big appetites of countries like China and Korea, displays growth that is the envy of any marketer. Industrialization and switching away from coal and oil in power generation comprise the two big themes. In Japan, switching away from nukes has also been a big driver recently. Collectively, Asia -Pacific is growing its natural gas consumption by nearly 7% per year.

A Baker Buying Bread

South America and Africa are growing steadily, however the hidden story is Middle Eastern consumption, where size and growth are not too distant behind that of Asia-Pacific. While it’s true that China on its own tells an impressive enough story, the Middle Eastern dynamic is the one to watch most closely. Consumption in countries like Kuwait and Saudi Arabia is rising rapidly as their young demographic demands more and more energy to fuel their lifestyles and fast-growing population. Given its abundance, natural gas is the region’s logical fuel of choice to expand their domestic energy use while exporting higher-value oil. Yet implicitly, the trend that’s in play suggests that this region will have less and less natural gas to export to fuel hungry places like China. Most telling is what’s been happening in Kuwait where a temporary LNG regasification facility has been set up this year to bring in natural gas for power generation. What was temporary may become permanent; a subtle announcement last week suggested that Kuwait might soon build a permanent liquefied natural gas (LNG) import terminal.

Symbolically, that will be like a baker going out and buying loaves of bread to make his own lunch!

Qualitatively, the Middle Eastern trend can be embellished even more. This year’s Arab Spring events could lead to wholesale change in the attitude of hydrocarbon-rich Middle Eastern countries over the next decade. A younger face on the region’s politics could demand that even more gas be retained for local use, or certainly not just sold abroad at low price. Right now the Middle East ships out 21% of the world’s export gas market. At a time of accelerating demand in three of the four corners of the world, any deceleration of Middle Eastern exports will only accentuate the need for energy-hungry importers like China and Korea to secure new sources of diversified supply, ergo the moves into Canada. The Sinopec-Daylight deal wasn’t the first of its kind, nor will it be the last.

Meanwhile, investors in North America have orphaned this cleanest of fossil energy sources, discounting its price like a second hand book on a sidewalk table. Few here believe the wonder-fuel will be worth more tomorrow than today, just like cheap words on cheap paper. That’s what happens when markets cater to the same customers for too long; they often end up being gathering places for insular thinking. So, when someone comes in from afar and doubles down on price, we should always ask if they know more than we do.