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Drivers of Demand for Capital in Global Energy Randall S. Wade Managing Director and COO

Drivers of Demand for Capital in Global Energy Randall S. Wade Managing Director and COO December 2010. Sector Attributes. Energy is a building block of economic growth Benefits from long-term demographic trends that drive demand

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Drivers of Demand for Capital in Global Energy Randall S. Wade Managing Director and COO

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  1. Drivers of Demand for Capital in Global Energy Randall S. Wade Managing Director and COO December 2010

  2. Sector Attributes • Energy is a building block of economic growth • Benefits from long-term demographic trends that drive demand • Demand largely caught up with supply in last five years; supply will struggle to keep pace with demand going forward • Energy supply is comprised of several heterogeneous markets, each with distinct sub-sectors and underlying fundamentals • Negative correlation with traditional investment classes such as equities, fixed income • Commodities provide a natural hedge against inflation • Long-lived, hard assets • Inherent volatility in commodity prices World GDP by Sector Source: EIA, CIA World Fact Book, World Health Organization, Bloomberg

  3. Sector Attributes Technically complex Complex and interpretive resource evaluation, and sophisticated engineering required for success One off, purpose specific design Project cost risk typically carried by owner (not EPC) Capital intensive Very large capital investment required throughout lifecycle. Ability to ‘protect’ or follow initial investment is crucial Investment decision heavily reliant on commodity price forecast Commodity price volatility Oil prices in 2002 were sub $20/bbl, reached a high of ~$147/bbl in July 2008, and hit a low of ~$34/bbl in December 2008 Financial flows increasing volatility Cyclicality GDP growth drives underlying demand Significant lag in investment cycle, leading to boom-bust profile Complex demand-supply position • Energy markets are complex and intertwined (e.g. upstream importance to gas transmission, gas price on spark spread) • Structural change driven by: • Decline of OPEC spare capacity, and rise of NOCs • Development of unconventional resources • - Impact of the rise of Asia on demand 3 3

  4. Drivers of Demand Beginning around 2005, EIG believes the world began a 15-20 year secular trend in energy and energy-related infrastructure requiring massive amounts of investment. Underlying Factors that Drive Demand • Developing world continues to industrialize, coupled with population growth and demographic trends • Depletion of aging “elephant” fields that have underpinned global supply for decades • Higher replacement costs as conventional supplies began to be replaced with higher cost “unconventional” supplies • Chronic under-investment in infrastructure caused by the inherent volatility of the sector and the need for long pay-back periods • Concerns about climate change and the introduction of price mechanisms for carbon • Assertion of market clout by national oil companies and other state actors and the resulting resource nationalism as energy independence takes on increased political importance • Security of supply as an enhanced geopolitical consideration as key supply states use energy as an economic weapon to leverage consumer states • Market distortions caused by increased government intervention through mandates, subsidies, taxes, and regulation • Fragility of the energy supply network and susceptibility to disruption by terrorist activity • Increased price volatility due to low reserve margins, correlation to U.S. dollar, and inflation expectations 4

  5. 1) Industrialization of the Developing World is Driving Demand • World population has more than doubled since 1950 • Urbanization increases demand for energy • In 2009, for the first time in history, the world’s urban population overtook the rural population Actual Forecast Source: Historical data from World Bank (GDP), BP Statistical Review 2009 (Energy), US Census Bureau (Population). Forecasts per EIA International Energy Outlook 2009, IEA World Energy Outlook 2009, World Bank HNP Stats.

  6. China 67.6% Middle East 39.6% India27.9% Total World 10.9% US (1.4)% 1) Industrialization of the Developing World is Driving Demand Oil Consumption Source: BP Statistical Review 2009

  7. Drivers of Demand Beginning around 2005, EIG believes the world began a 15-20 year secular trend in energy and energy-related infrastructure requiring massive amounts of investment. Underlying Factors that Drive Demand • Developing world continues to industrialize, coupled with population growth and demographic trends • Depletion of aging “elephant” fields that have underpinned global supply for decades • Higher replacement costs as conventional supplies began to be replaced with higher cost “unconventional” supplies • Chronic under-investment in infrastructure caused by the inherent volatility of the sector and the need for long pay-back periods • Concerns about climate change and the introduction of price mechanisms for carbon • Assertion of market clout by national oil companies and other state actors and the resulting resource nationalism as energy independence takes on increased political importance • Security of supply as an enhanced geopolitical consideration as key supply states use energy as an economic weapon to leverage consumer states • Market distortions caused by increased government intervention through mandates, subsidies, taxes, and regulation • Fragility of the energy supply network and susceptibility to disruption by terrorist activity • Increased price volatility due to low reserve margins, correlation to U.S. dollar, and inflation expectations 7

  8. 2) Depletion of Aging “Elephant” Fields • There are ~70,000 oil fields in the world • Bulk of production comes from a small number of very prolific fields, mostly giants and super giants • World’s 10 largest fields produced 20% of world’s production • 20 largest fields produced 25%; 16 are post-peak • Ghawar’s 5.1 million bpd equaled 7% of world total • Most of the largest fields have been in production for years, and in some cases several decades Production at World’s Largest Oil Fields The aggregate production decline (from peak output) at the world’s six largest oil fields equates to 6.6 million barrels per day. Source: IEA World Energy Outlook 2008; Cantarell production updated for 2009 per CERA

  9. Drivers of Demand Beginning around 2005, EIG believes the world began a 15-20 year secular trend in energy and energy-related infrastructure requiring massive amounts of investment. Underlying Factors that Drive Demand • Developing world continues to industrialize, coupled with population growth and demographic trends • Depletion of aging “elephant” fields that have underpinned global supply for decades • Higher replacement costs as conventional supplies began to be replaced with higher cost “unconventional” supplies • Chronic under-investment in infrastructure caused by the inherent volatility of the sector and the need for long pay-back periods • Concerns about climate change and the introduction of price mechanisms for carbon • Assertion of market clout by national oil companies and other state actors and the resulting resource nationalism as energy independence takes on increased political importance • Security of supply as an enhanced geopolitical consideration as key supply states use energy as an economic weapon to leverage consumer states • Market distortions caused by increased government intervention through mandates, subsidies, taxes, and regulation • Fragility of the energy supply network and susceptibility to disruption by terrorist activity • Increased price volatility due to low reserve margins, correlation to U.S. dollar, and inflation expectations 9

  10. 3) Replacement Costs are Increasing as Source of Supply Shifts • Exploration spending increased by 21% in 2008, and has doubled since 2005 • However replacement rates fell to 88% of production (first year since 2004 in which production was not replaced) • Finding and development costs soared 66% to $25.50/bbl • Competition for unconventional resources increased sharply Expected Costs of Production US Natural Gas Production by Source Source: IEA World Energy Outlook 2008 (left); EIA Annual Energy Outlook 2009 (right); 2009 Global Upstream Performance Review, IHS Herold/Harrison Lovegrove

  11. Drivers of Demand Beginning around 2005, EIG believes the world began a 15-20 year secular trend in energy and energy-related infrastructure requiring massive amounts of investment. Underlying Factors that Drive Demand • Developing world continues to industrialize, coupled with population growth and demographic trends • Depletion of aging “elephant” fields that have underpinned global supply for decades • Higher replacement costs as conventional supplies began to be replaced with higher cost “unconventional” supplies • Chronic under-investment in infrastructure caused by the inherent volatility of the sector and the need for long pay-back periods • Concerns about climate change and the introduction of price mechanisms for carbon • Assertion of market clout by national oil companies and other state actors and the resulting resource nationalism as energy independence takes on increased political importance • Security of supply as an enhanced geopolitical consideration as key supply states use energy as an economic weapon to leverage consumer states • Market distortions caused by increased government intervention through mandates, subsidies, taxes, and regulation • Fragility of the energy supply network and susceptibility to disruption by terrorist activity • Increased price volatility due to low reserve margins, correlation to U.S. dollar, and inflation expectations 11

  12. 4) Under-Investment in Infrastructure • Infrastructure investment depends on stable political, regulatory, and fiscal regimes • Energy sector is huge consumer of infrastructure and collectively accounts for 43% of global infrastructure investment • Energy companies affected by global recession • Demand growth uncertain, credit constrained, balance sheets stretched • Deleveraging, postponement/cancelation of major projects • Global upstream oil and gas budgets cut by 19% in 2009, or ~$90 billion • Near-term fall in energy investment likely to lead to a medium-term shortfall in supply due to development lag Expected Sector Distribution Expected Geographic Distribution Source: Amundi PEF

  13. Drivers of Demand Beginning around 2005, EIG believes the world began a 15-20 year secular trend in energy and energy-related infrastructure requiring massive amounts of investment. Underlying Factors that Drive Demand • Developing world continues to industrialize, coupled with population growth and demographic trends • Depletion of aging “elephant” fields that have underpinned global supply for decades • Higher replacement costs as conventional supplies began to be replaced with higher cost “unconventional” supplies • Chronic under-investment in infrastructure caused by the inherent volatility of the sector and the need for long pay-back periods • Concerns about climate change and the introduction of price mechanisms for carbon • Assertion of market clout by national oil companies and other state actors and the resulting resource nationalism as energy independence takes on increased political importance • Security of supply as an enhanced geopolitical consideration as key supply states use energy as an economic weapon to leverage consumer states • Market distortions caused by increased government intervention through mandates, subsidies, taxes, and regulation • Fragility of the energy supply network and susceptibility to disruption by terrorist activity • Increased price volatility due to low reserve margins, correlation to U.S. dollar, and inflation expectations 13

  14. 5) Climate Change and Price Mechanisms for Carbon • Atmosphere currently contains ~455 ppm of CO2-equivalent greenhouse gases (“GHG”) • IEA analyzed one scenario (“450 Scenario”) in which countries take coordinated actions to stabilize GHG at 450 ppm • A low carbon future requires a major transformation of the sector (both in terms of sources of energy and required infrastructure) Source: IEA World Energy Outlook 2009

  15. 5) Climate Change and Price Mechanisms for Carbon Renewables depend on government subsidies in order to compete against fossil fuel generation US Renewable Generating Capacity Generation Cost by Fuel Source Source: EIA Annual Energy Outlook, April 2009 Update (left); California Energy Commission (right)

  16. Drivers of Demand Beginning around 2005, EIG believes the world began a 15-20 year secular trend in energy and energy-related infrastructure requiring massive amounts of investment. Underlying Factors that Drive Demand • Developing world continues to industrialize, coupled with population growth and demographic trends • Depletion of aging “elephant” fields that have underpinned global supply for decades • Higher replacement costs as conventional supplies began to be replaced with higher cost “unconventional” supplies • Chronic under-investment in infrastructure caused by the inherent volatility of the sector and the need for long pay-back periods • Concerns about climate change and the introduction of price mechanisms for carbon • Assertion of market clout by national oil companies and other state actors and the resulting resource nationalism as energy independence takes on increased political importance • Security of supply as an enhanced geopolitical consideration as key supply states use energy as an economic weapon to leverage consumer states • Market distortions caused by increased government intervention through mandates, subsidies, taxes, and regulation • Fragility of the energy supply network and susceptibility to disruption by terrorist activity • Increased price volatility due to low reserve margins, correlation to U.S. dollar, and inflation expectations 16

  17. 6) Resource Nationalism • International Oil Companies (“IOCs”) only own 7% of the world’s oil reserves • National Oil Companies (“NOCs”) operate as an extension of the government (e.g. Saudi Aramco, Pemex, PDVSA), or as autonomous entities that concurrently support government objectives (e.g. Petrobras, Statoil) • Activities of NOCs are frequently inefficient and/or not market-oriented • NOCs produce the majority of the world’s oil and hold most of the world’s proven reserves • IOCs are increasingly relegated to exploring in high-risk areas in order to secure reserves (Arctic, ultra-deep water, unconventional) World Proved Oil Reserves, 2008 World Oil Production, 2008 in million bpd Source: BP Statistical Review 2009

  18. Drivers of Demand Beginning around 2005, EIG believes the world began a 15-20 year secular trend in energy and energy-related infrastructure requiring massive amounts of investment. Underlying Factors that Drive Demand • Developing world continues to industrialize, coupled with population growth and demographic trends • Depletion of aging “elephant” fields that have underpinned global supply for decades • Higher replacement costs as conventional supplies began to be replaced with higher cost “unconventional” supplies • Chronic under-investment in infrastructure caused by the inherent volatility of the sector and the need for long pay-back periods • Concerns about climate change and the introduction of price mechanisms for carbon • Assertion of market clout by national oil companies and other state actors and the resulting resource nationalism as energy independence takes on increased political importance • Security of supply as an enhanced geopolitical consideration as key supply states use energy as an economic weapon to leverage consumer states • Market distortions caused by increased government intervention through mandates, subsidies, taxes, and regulation • Fragility of the energy supply network and susceptibility to disruption by terrorist activity • Increased price volatility due to low reserve margins, correlation to U.S. dollar, and inflation expectations 18

  19. 7) Geopolitical Considerations Geopolitical influence on sector evident at an increasing rate in the daily news

  20. Drivers of Demand Beginning around 2005, EIG believes the world began a 15-20 year secular trend in energy and energy-related infrastructure requiring massive amounts of investment. Underlying Factors that Drive Demand • Developing world continues to industrialize, coupled with population growth and demographic trends • Depletion of aging “elephant” fields that have underpinned global supply for decades • Higher replacement costs as conventional supplies began to be replaced with higher cost “unconventional” supplies • Chronic under-investment in infrastructure caused by the inherent volatility of the sector and the need for long pay-back periods • Concerns about climate change and the introduction of price mechanisms for carbon • Assertion of market clout by national oil companies and other state actors and the resulting resource nationalism as energy independence takes on increased political importance • Security of supply as an enhanced geopolitical consideration as key supply states use energy as an economic weapon to leverage consumer states • Market distortions caused by increased government intervention through mandates, subsidies, taxes, and regulation • Fragility of the energy supply network and susceptibility to disruption by terrorist activity • Increased price volatility due to low reserve margins, correlation to U.S. dollar, and inflation expectations 20

  21. 10) Oil vs. US Dollar and Inflation • Oil has been a strong hedge against inflation (0.86 correlation) • Oil has provided a similarly strong hedge against the US dollar (-0.80 correlation) Source: EIA, Bloomberg

  22. Drivers of Demand $26 Trillion of Investment Required Through 2030 Source: IEA World Energy Outlook 2009

  23. Capturing the Market Opportunity Investment demand is growing across the entire energy value chain on a global basis Renewables Upstream Infrastructure Midstream Gas to Liquids Transportation Gas to Electrons Wind Solar Biofuels Geothermal Pipeline Reserve-based Development LNG Tankers Gathering Systems Production Payments Specialty Tankers Processing Facilities Forward Oil Sales VLCC Vessels Gas Storage Bunkering Production Platforms LNG LNG Regasification Terminals Drill Ships Synfuels Gas Sales, Pipelines, FPSOs Processed Gas Gas-Fired Power Plants, (methanol, fertilizer, DME) Drilling Rigs Electricity T&D

  24. ~ ~ Capturing the Market Opportunity

  25. Impact of the Credit Crisis • Contraction in global GDP took pressure off near-term supply/demand fundamentals and caused one to two year “time out” in the otherwise dominant secular trends in the industry • Two key impacts of the credit crisis: • Re-pricing of risk across the credit spectrum, particularly for illiquid assets • Contraction in suppliers of capital: “survivors” continue to be price makers, not takers US Corporate Bonds, B-rated Source: Bloomberg (Merrill Lynch data)

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