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INVESTING IN AND FINANCING THE HYDROCARBON SECTOR TO ENHANCE GLOBAL ENERGY
SECURITY: ENERGY CHARTER TREATY AND RISK MITIGATION
Dr. Andrei KonoplyanikDeputy Secretary General, Energy Charter Secretariat
UNECE Energy Week: "Investing in Energy Security“, 16th Annual Session of UNECE Committee on Sustainable Energy,
Item 4: Special Session ‘Investing in and Financing the Hydrocarbon Sector to Enhance Global Energy Security’,
Geneva, Switzerland, 28 November 2007
Table of content
• Towards more risky energy markets?
• Towards more project financing?
• Competition/liberalization vs. investment
• ECT as risk-mitigating instrument of international law
Dr. A. Konoplyanik, UNECE, 28 November 2007 - Figure 2
TOWARDS MORE RISKY ENERGY MARKETS ?
• Energy markets: – from independent to interdependent & complimentary– from monopolistic/monopsonic towards competitive – to more liquid (trade, short-term) - which not necessary means more
competitive (resource vs. markets asymmetry, few import supply sources, long-term) & secure (investment, long-term)
– to more cross-border energy trade & investment• Diversification (multi-dimensional) in energy economy:
– energy mix, suppliers, routes, markets, contractual & business (corporate) structures, pricing mechanisms
• Energy pricing: – cost-plus (fixed prices, negotiated levels) => replacement values (flexible
prices, formula-based, negotiated formulas) => exchange-based pricing (flexible prices, based on perceptions of two groups of players with opposite interests: hedgers & speculators with increasing role of speculators )
• Price behaviour: – increasing volatility, more transparent – less predictable– liquid markets not necessarily lead to price decrease (e.g. oil)
www.encharter.orgDr. A. Konoplyanik, UNECE, 28 November 2007 - Figure 3
Energy/hydrocarbon projects (compared to other industries):– Highest capital intensity (absolute & unit CAPEX per project), – Longest project life-cycles & pay-back periods,– Geology risks + immobile infrastructure,– Cross-border flows + immobile infrastructure,– Worsening natural conditions of resources to be developed, – Highest demand for legal & tax stability,– Role of risk management
=> Higher/highest demand for “quality” of legal and regulatory framework compared to other industries - to diminish energy projects risks
ENERGY ECONOMY: DEMAND FOR QUALITY OF REGULATORY FRAMEWORK
www.encharter.orgDr. A. Konoplyanik, UNECE, 28 November 2007 - Figure 4
ECONOMIC “CIRCLE OF LIFE” OF ENERGY PROJECTS
www.encharter.org
INVESTMENT ENERGY
REVENUE
Dr. A. Konoplyanik, UNECE, 28 November 2007 - Figure 5
End-2006:
2573 BITs2841 DTTs
DEVELOPMENT OF INTERNATIONAL ENERGY MARKETS & OF MECHANISMS OF INVESTMENT PROTECTION/STIMULATION
www.encharter.org
Energy markets Mechanisms of investment protection/stimulation
Global common energy market
Local
Internationalisation
Regional
Globalisation
World markets of individual
energy resources
International law
instruments
Bilateral
Multilateral
Energy efficiency
Investments
+BITs, DTTs
ECT+
Enclaves of stability & investment stimuli in unstable / non-stimulating
legal-economic environment
Increase of general level of investment attractiveness of
domestic legislation
+National
legislation
e.g. RF: Concessions, Free Economic Zones,
PSA
+
Transit
+
e.g. RF: Tax Code, subsoil & investment
legislation
Dispute settlement
+Trade+
Dr. A. Konoplyanik, UNECE, 28 November 2007 - Figure 6
Oil
EU Acquis WTO!?
e.g. EU: derogation from mandatory
TPA (Art..22)
ECT = 1275 BITs
Table of content
• Towards more risky energy markets?
• Towards more project financing?
• Competition/liberalization vs. investment
• ECT as risk-mitigating instrument of international law
Dr. A. Konoplyanik, UNECE, 28 November 2007 - Figure 7
IOC Home State Commercial
BanksCorporate Financing
Internal Cash Flow
Host StateRegional Subsidiaries of IOC
Project А Project B Project C
International Oil Companies (IOC)
FINANCING HYDROCARBON PROJECTS BEFORE THE 1970’s
www.encharter.orgDr. A. Konoplyanik, UNECE, 28 November 2007 - Figure 8
FINANCING HYDROCARBON PROJECTS OVER 1970-1980
www.encharter.org
IOC Home State
Commercial sources (banks,
etc.)
Host State
Joint Ventures
Budget Financing
Government Loans (secured by a sovereign
guarantee)
International Oil Companies (IOC)
Project A Project B
Multilateral & Bilateral
Sources (IFIs,
governments of donor-
states)
Project C Project D
Project E Project F
Corporate Financing
Internal Cash Flow
National / State-Controlled Oil Companies (NOC)
IOC Regional Subsidiaries
New IOC >>>
State
Dr. A. Konoplyanik, UNECE, 28 November 2007 - Figure 9
FINANCING HYDROCARBON PROJECTS DURING THE 1990’s & OVER SUBSEQUENT YEARS
20-40%
IOC Home State
Commercial sources (banks,
etc.)
Host State
Joint Ventures
International Oil Companies (IOC)
Project A Project B
Multilateral and bilateral
sources (IFIs,
governments of donor-
states)
Project C Project D
Corporate Financing
Internal Cash Flow
IOC Regional Subsidiaries
New IOC >>>
Private equity finance sources:Investments by other sponsors International finance marketsInvestment fundsInternational Finance CorporationRegional development banks…
20 – 40 %
State
Budget Financing
Government Loans (under a
sovereign guarantee)
Private debt finance sources:International commercial banksBond marketsLoans from suppliersSpecialized Energy fundsInternational Finance CorporationRegional development banksLocal banks…
60 – 80 %
Commercialsources
(banks, etc.)National / State-Controlled Oil
Companies (NOC)
www.encharter.orgDr. A. Konoplyanik, UNECE, 28 November 2007 - Figure 10
FINANCING ENERGY PROJECTS:FROM EQUITY TO DEBT FINANCING
Equity/debt financing ratio: Pre-1970’s = ~ 100 / ~ 0Nowadays = ~ 20-40 / ~ 60-80,f.i. most recent:
BTC pipeline = 30 / 70Sakhalin-2 (PSA) = 20 / 80(2 fields+pipeline+LNG plant)
� Increased role of financial costs (cost of financing)of the energy projects
�Availability and cost of raising capital = one of majorfactors of competitiveness with growing importancein time (bankability/financiability of energy projects)
www.encharter.orgDr. A. Konoplyanik, UNECE, 28 November 2007 - Figure 11
“Natural advantage” of country A over country B
Final competitive disadvantage of country A over country B
Dr. A. Konoplyanik, UNECE, 28 November 2007 - Figure 12
$/boe $/boe
Country A Country B
t t
Technical costs A
Financing costs A
Technical costs B
Financing costs B
Tot
al c
osts
A
Tot
al c
osts
B
II
“NATURAL” VS. FINAL COMPETITIVE ADVANTAGES OF ENERGY PROJECTS
www.encharter.org
I
III
Table of content
• Towards more risky energy markets?
• Towards more project financing?
• Competition/liberalization vs. investment
• ECT as risk-mitigating instrument of international law
Dr. A. Konoplyanik, UNECE, 28 November 2007 - Figure 13
International Energy: competition & investments
Cross-border energy flows (energy value chains)
Producer states/ exporters
Consumer states/ importers
Transit states/ importers
Non-renewable energy resources: limited number of producers / exporters + national sovereignty on energy resources; Aim of exporters = maximization of Hotellingrent; Competition (for exporters) = diversification of supply routes to existing markets & access to new markets =>CAPEX + time
Aim of importers = to increase import supplies of EMP in order to decreaseenergy pricesfor end-users =>competition is not the end in itself, but the meanto achieve major aim => competition between exporters (!) =>diversification of supply routes from few existing exporters (multiple pipelines) + few new exporters & new supply routes (multiple supplies) => CAPEX + time =>competition (or cooperation !) between few major producers; But: competition leads to increase of energy prices for end-users - if organised as increase of number of traders(especially of small re-sellers) at the market of consumer/importer state under limited supply(restricted, inter alia, by liberalization risks for exporters)
Competition = f (CAPEX + time + …) !!! => investment rules !!!www.encharter.orgDr. A. Konoplyanik, UNECE, 28 November 2007 - Figure 14
Competition & investment: Debate on Third Party Access (TPA)
TPANo Yes
Derogation from MTPA
Negotiatory TPA Mandatory TPAProject Financing
ECT EU 2nd Gas Directive
EU 1st Gas Directive
Art.227+ projects within EU (*)
www.encharter.orgDr. A. Konoplyanik, UNECE, 28 November 2007 - Figure 15
(*) as of May 2007
Common rules for evolving Eurasian energy market: ECT expansion vs. export of EU Acquis ? (map)
Dr. A. Konoplyanik, UNECE, 28 November 2007 - Figure 16
Shared ECT aims & principles; did not take ECT legally binding rules; not ready to take moreliberal rules of EU Acquis
ECT observer-states: 20 states of Europe, Asia (e.g. Middle East, South-, SE- & NE-Asia), Africa, North & Latin America
ECT is fully applicable within the EU as minimum standard; EU went further in liberalizing its internal energy market, BUT whether EU can demand that other ECT member-states follow same model and speed of developing their domestic markets?
ECT member-states: 51 states of Europe & Asia
EU legislation, including the energy legislation, is fully applicable
Based on shared principles and objectives; applicability of the EU legislation in Russia is out of question
EU-Russia Strategic Partnership: EU & Russia
Enhanced energy cooperation based on National Action Plans with Ukraine and Moldova (as well as with Israel, Jordan, Morocco, the Palestinian Authority and Tunisia); partial application of EU energy policies and legislation may be possible in the future
EU Neigbourhood Policy Countires:CIS (Armenia, Azerbaijan, Belarus, Georgia, Moldova, Ukraine) and Northern Africa (Algeria, Egypt, Israel, Jordan, Lebanon, Libya, Morocco, the Palestinian Authority, Syria, Tunisia)
Still in the process of alignment to the EU legislation but fullcompliance not likely before membership
EU Candidate Countries:Turkey (Croatia is already an Energy Community member so applying the EU energy market acquis)
Only EU legislation on internal electricity and gas markets is applicable
Energy Community EU-SEE Countries: Croatia, Serbia, Montenegro, Croatia, Bosnia, FYROM (Macedonia), Albania, UNMIK (Kosova); other Energy Community members are already EU members
EU Members: 27 EU countries
DescriptionStates within the zone Zone
Dr. A. Konoplyanik, UNECE, 28 November 2007 - Figure 17 www.encharter.org
Common rules for evolving Eurasian energy market: ECT expansion vs. export of EU Acquis ? (legend)
Table of content
• Towards more risky energy markets?
• Towards more project financing?
• Competition/liberalization vs. investment
• ECT as risk-mitigating instrument of international law
Dr. A. Konoplyanik, UNECE, 28 November 2007 - Figure 18
ROLE OF THE ECT FOR PROJECT FINANCING (ECT IS A BUSINESS-ORIENTED TREATY)
ECT/Legislation →→→→ ↓↓↓↓ risks →→→→ ↓↓↓↓ financial costs (cost of capital) = →→→→↑↑↑↑ inflow of investments (i.e. ↑↑↑↑ FDI, ↓↓↓↓ capital flight) →→→→ ↑↑↑↑ CAPEX →→→→ ↓↓↓↓ technical costs = →→→→
+ = →→→→ ↑↑↑↑ pre-tax profit →→→→ ↑↑↑↑ IRR (if adequate tax system) →→→→ ↑↑↑↑ competitiveness →→→→↑↑↑↑ market share →→→→ ↑↑↑↑ sales volumes →→→→ ↑↑↑↑ revenue volumes
ECT provides multiplier legal effect in diminishing risks with consequential economic results in cost reduction and increase of revenues and profits
12
1 2 3
Cumulative ∆∆∆∆ costs1 2 3∆∆∆∆ Financial costs ∆∆∆∆ Technical costs
$/boe
After ECT t
1
2
Total costs
$/boe
Before ECT t
Technical costs
Financial costs3
∆∆∆∆ t
www.encharter.org
Dr. A. Konoplyanik, UNECE, 28 November 2007 - Figure 19
www.encharter.org
Thank you for your attention!
www.encharter.org
Back up slides
ENERGY CHARTER AND RELATED DOCUMENTS
www.encharter.org
Political DeclarationEUROPEAN ENERGY CHARTER
Legally Binding Instruments
En e
rgy
Eff
icie
ncy
Pr o
toco
l
En e
rgy
Tra
nsi t
Pro
t oco
l
ENERGY CHARTER TREATY
TRADE AMMENDMENT
INVESTMENT SUPPLEMENTARY TREATY
- in force- negotiations not finished yet
Dr. A. Konoplyanik, UNECE, 28 November 2007 - Figure 21
• Energy Charter Treaty:- Unique coverage of different areas for energycooperation:
• investment, trade, transit, energy efficiency, dispute settlement,• energy materials & products + energy-related equipment,• 51 member-states (52 CPs) + 19 observer-states + 10 observer
international organisations- First and only one multilateral investment agreement with high standard of investment protection, incl. dispute settlement
• Energy Charter process:
- Implementationof ECT,
- Specialized forum for “advanced” discussionof the issues of energy markets evolution that might create new risksfor development of energy projects in ECT member-states,
- Platform for preparation of new legally binding instrumentsto diminish such risks within ECT member-states (e.g. broadening & deepening of ECT & upgrading its “minimum standard”).
www.encharter.org
ENERGY CHARTER SPECIFIC ROLE
Dr. A. Konoplyanik, UNECE, 28 November 2007 - Figure 22
• Based on:o well-established practice of BITs (about 400 BITs at the
beginning of the 1990’s - around 2500 BITs as of today)
o investment chapter XI of NAFTA (US, Canada, Mexico)
o some interaction with then proposed “Multilateral Agreement for Investment” (MAI – aborted in 1998)
• Within 51 member-states ECT is equal to 1275 BITs
• MFN and National Treatment for investors:o hard-lawobligations (binding guarantee) of non-
discriminatory treatment for post-establishment phase,
o soft-lawobligations for pre-establishment phase (stage of making investment)
ECT = THE FIRST MULTILATERAL INVESTMENTAGREEMENT (1)
www.encharter.org
Dr. A. Konoplyanik, UNECE, 28 November 2007 - Figure 23
• Protection against key political/regulatory risk:o expropriation and nationalisation,o breach of individual investment contracts,o unjustified restrictions on transfer of funds
• Reinforced by access to binding international arbitration in case of dispute:
o State-to-state, and (NOVELTY!)investor-to-state => direct dispute settlement at investor’s choice at ICSID, UNCITRAL or ICC Stockholm,
o Awards: � final and enforceable under NY convention,�usually as entitlement to payment (no risk of vicious circle for
retaliating measures),� retroactive to start of dispute, may include interest (no incentive
to delay process)
ECT = THE FIRST MULTILATERAL INVESTMENTAGREEMENT (2)
www.encharter.orgDr. A. Konoplyanik, UNECE, 28 November 2007 - Figure 24
SELECTED INTERNATIONAL INVESTMENT-RELATED AGREEMENTS
NoNoNoYesYesGeneralNon-LB
APEC (21)
NoNoNo NoYesGeneralLBOECD (30)
YesNoNoYesYesGeneralLBMERCOSUR(4)
YesNoNoYesYesGeneralLBNAFTA (3)
YesNoYes/No*Yes(Yes?) (Services)
GeneralLBWTO (149)
YesYesYesYesYesEnergyLBECT (52/53)
Dispute Settlement
Energy Efficiency
TransitTradeInvestmentScopeLegal Status
Organisation(member-states/CPs)
* application of GATT Art.V to grid-bound transporta tion systems is under debate
=> Plus specialised energy-related organisations: OPEC, IEA, IEF, UN ECE (broader than just energy), IAEA, …=> Plus specialised “regional” organisations: BSEC, BASREC, …
www.encharter.orgDr. A. Konoplyanik, UNECE, 28 November 2007 - Figure 25
Level of liberalization
EU–15 (prior to 01.05.2004)
ECT
ECT member-states (51+1 REIO)
Russia/CIS/Asia/ …EU–25 (after 01.05.2004)
Level of liberalization
ECT & EU acquis: “minimum standard” within evolving Eurasian common energy space vs. more liberalized model
EU–27 (after 01.01.2007)
ECT1 (*)
Domestic legislation of ECT member-states
YesNoUnbundling
YesNoMandatory TPA
EU Acquis (2-nd EU Gas Directive)ECTLegal norms (examples)
Dr. A. Konoplyanik, UNECE, 28 November 2007 - Figure 26 www.encharter.org
2 2-nd EU Gas Directive(2003)
EFTA = EU-15/25/27+3
Energy Community Treaty EU+SEE (27+8)
3
ECT observer-states (20)
1 1-st EU Gas Directive (1998)
3 3-rd EU liberalization package (draft –19.09.2007)
(*) ECT = integral part of EU Acquis (ECT = minimum standard)
Level of liberalization -general tendency
2