The Oil Gas Tipping Point & Great Laker Business Case Economics...

1 © Wärtsilä

The Oil Gas Tipping Point & Great Laker Business Case Economics…

SNAME Great Lakes SectionMarriott Downtown Key Center11 February 2016Cleveland, OH

John Hatley PE LNG Initiatives ( MBA, MSE)

Americas VP Ship PowerWartsila North America, Inc.

Cell +1 281 221 [email protected]

XXXXXXXXXXXXXXXXXXXXXXXXXXXXXXXXXXXXXXXXXXXXXXXXXXXXXXXXXXXXXXXXXXXXXXXXXXXXXXXXXXXXXXXXXXXXXXXXXXXXXXXXXXXXXXXXXXXXXXXXXXXXXXXXXXXXXX

Keys

Global Energy Policies, market gamesmanship ?

Future Ahead, structural shifts?

As a vessel owner, all I want to knowis the tipping point…

What fuel strategy do I choose to to boost my bottom line?

2 © Wärtsilä

A “Commodity Play” on fuel energy costs seeking competitive advantage for market share.

Agenda

3 © Wärtsilä

What ? Fuel Price vs. CostEnergy

Why & How ? No. Am ECA & EmissionsOwner ChoicesAbatement: SCR, Scrubber, LNG

Business Case Cargo, Investor, Banker Views1000 Ft. Great LakerInvestment Returns

Oil Price Shock ! Business Case: Robust or Fragile?Stress Test

Conclusions Business Case Appendix

Agenda

4 © Wärtsilä






Quiz…. Fuel Price ?

a) HFO 290.83 $ / ton ….

b) MDO 314.68 $ / ton .…

c) LNG 363.01 $ / ton ….

5 © Wärtsilä

Which is the lowest price ?

The Price Paid for what it Cost

6 © Wärtsilä

: the amount of money that you pay for something

: the price of something : the amount of money that is needed to pay for or buy something

Quiz… Fuel Answer Key

a) HFO 290.83 $ / ton ….

b) MDO 314.68 $ / ton .…

c) LNG 363.01 $ / ton ….

7 © Wärtsilä

Which is the lowest price ?

Key concept… purchase energy, not tons or gallons, which is the lowest cost per unit of energy?

7.77 $ / million BTU



Reference Common Values that will vary…HFO 37,430 BTU/kg MDO 40,500 BTU/kg LNG 46,720 BTU/kg density 980 kg/ m3 850 kg/ m3 430 kg/ m3

Agenda

8 © Wärtsilä






Emission Control Areas

9 © Wärtsilä

2015 ECA 0.1% Sulfur

10 © Wärtsilä

Works with high S HFO Low total lifecycle cost Use everywhere

Scrubber targets SOx, Selective Catalytic Reducer targets NOx, LNG targets CO2, NOx, PM, SOx.

Source: 2015 Exhaust Gas Cleaning Scrubbers Dec 2015 011415.pptx

How clean is Natural Gas compared to Diesel ?

DF Natural Gas Engine

DieselEngine

0

20

40

60

80

100

Emissionvalues [%]

CO2

NOx

SOx

Particulates

-25%

-85%

-99%

-99%

Gas = ULTRA CLEAN

LNG provides significant emission reductions compared to traditional diesel engines

No. Am. ECA Fuel Sulfur Limit

12 Wärtsilä

Source:http://www.dnvusa.com/industry/maritime/publicationsanddownloads/publications/newsletters/technical_regulatory/2012/north_american_emission_control_area.asp

Fuel Sulfur 0.10 % limit commences 1 January 2015

North America ECA SOx & NOx

13 © Wärtsilä

Fuel Sulfur2012… 1% Limit2015… 0.1% Limit

EPA Category 3 2016… NOx Tier III & EPA Category 2 … NOx Tier 3, 4

Decision Tree… New Build Vessel

14 © Wärtsilä

New Build

Diesel

HFO

LNG

Scrubber … Fuel Sulfur Compliance

LNG Compliance

ECA January 2016 multiple emission requirements; both fuel sulfur limits (2015) and engine emissions (EPA Tier 3,4 ) requirements in effect, new builds and major conversions require new engines plus compliance methods.

New tier EPA engine + after-treatment SCR

0.1% Sulfur… Fuel Compliance

New tier EPA engine + after-treatment SCR + Scrubber

New tier EPA engine + LNG cryogenics

New Build Attributes

15 © Wärtsilä Source: Wartsila Moss White Paper: Exhaust Gas Cleaning: How to Choose the Correct Scrubber, Jennifer Ahlback, 2014.

Excess baggage as systems require host support; chemicals, tanks, waste stream sludge, piping/pumps, controls/automation, soot blowers…

Diesel + SCR

LNG

HFO + SCR + Scrubber

Wartsila NOx Reducer System

16 © Wärtsilä

Soot Blower

Air

Pump

Mixing Duct

Dosing Unit

NOR Reactor

Controls

Urea Tank

CompressedAir

Urea Mixing & Injection

LNGPac System

17 © Wärtsilä

Source: http://www.wartsila.com/media/news/26-08-2014-wartsila-launches-new-technical-solution-for-fuel-gas-handling

18 © Wärtsilä

Exhaust Gas Fan

Alkali Feed Module

Bleed-Off Treatment

Process Tank

Alkali Storage Tank

CW Pump

Heat Exchgr

Scrubbing Water Pump

Exhaust Gas Analyzer

Sludge Tank

Water Measurement

Water Measurement

De- Plume Unit

Holding Tank

Decision Tree… Retrofit Existing Vessel

19 © Wärtsilä

Existing Vessel

Diesel

HFO

LNG

Scrubber … Fuel Sulfur Compliance

LNG Compliance

ECA January 2016 multiple emission requirements; fuel sulfur limits (2015) and engine emissions (EPA Tier 3,4 ) requirements in effect, however existing retrofits may avoid major conversions & qualify without new tier engines or SCR.

New tier EPA engine + after-treatment SCR

0.1% Sulfur… Fuel Compliance

New tier EPA engine + after-treatment SCR + Scrubber

New tier EPA engine + LNG cryogenics

2015 ECA + 2016 NOx Refit Existing Vessel Choices

1. Consume compliant Low Sulfur Distillate… champagne fuel + Selective Catalytic Reduction for NOx

2. Switch to LNG fuel: safe, clean, abundant, affordable, & available natural gas LNGReduction: CO2, NOx, SOx, PM

3. HFO Alternative Compliance… install scrubber for Sox + Selective Catalytic Reduction for NOx

4. Abort the Port

3 May 2023

ECA & EPA force timely choices existing retrofit vessels

Agenda

21 © Wärtsilä






Cautionary Remarks

Each investment case requires careful analysis, inclusion, and weighing a broad variety of issues stemming from technical, financial, operational, regulatory, and other areas.

The purpose of this exercise is to illustrate a Business Case example and how a few of many key considerations may be transcribed into financial modeling as an aide to decision making.

Readers are advised that neither the Author nor Wartsila nor it’s subsidiaries are responsible for any errors, omissions, or updates to this information contained herein or assumptions or derivations whatsoever.

22 © Wärtsilä

This presentation is no substitute for your good and responsible decision making. Please utilize prudence and caution when making investment decisions along with securing the advice and guidance of professionals.

4 Viewpoints

23 © Wärtsilä

SHIP OWNER

BANKER

PUBLIC

Transport safely at

optimal cost reliably

At fair return capturing

risks

Are risks understood

& I’m repaid !

Ultimate Environment

Safety

CARGO OWNER

4 Key Metrics

24 © Wärtsilä

SHIP OWNER

BANKER

PUBLIC

All In Charter

Freight rate $ / ton

Return on Investment:

ROIC, EBITDA, cash flows

EBIT, Times Burden Cover,

cash flows

Ultimate Environment

Safety

CARGO OWNER

The Route… Duluth to Gary

25 © Wärtsilä

100% “ECA” Bound route, 136 hour 1464 nm round trip includes locking & maneuvers & 0.5 days load/unload per port, 269 operating days per year, seasonal 59,800 tons taconite average load

Source: http://www.vesseldistance.com/

Business Case Vessel

US Corporation, US Flag, Jones Act

Great Lakes 1,000 Footer Self Unloader Bulker

Refit Existing Vessel in 2016 …

EPA Category 3 ( > 30 liters /cyl. ) Tier 3

74,000 Tons Capacity

Speed 14+ knots with margin, Twin Screw

Installed power 16,090 HP ( 12,000 kW )

Manning 20

Major Class Society

26 © Wärtsilä

Speed provides 47 annual round trips, … competitive vessel size transports low cost freight

Source: https://en.wikipedia.org/wiki/MV_American_Century

Recall ?

27 © Wärtsilä

Then… 5 August 2014

28 Wärtsilä

LS180 1% 636 $/mt… LSMGO 0.1% 971 $/mt… LNG 500 $/mt

Source: http://www.bunkerworld.com/prices/port/us/hou/

Cargo Owner Transport safely at optimal cost reliably

29 © Wärtsilä

Cargo owner finds transport savings with LNG plus advantage captures significant emissions reductions supporting green goals.

Cargo Owner Transport safely at optimal cost reliably

30 © Wärtsilä

Cargo owner finds 4 year charter transport savings with LNG, $2.8 million over diesel and $1.1 Million over HFO + scrubber, competitive advantage LNG with lowest freight & least emissions.

Ship Owner A fair return capturing risks

31 © Wärtsilä

Compelling fuel payback for vessels running on LNG fuel; an initial screening tool … not a good investment metric.

ROCE Investment Criteria

32 © Wärtsilä

ROCE: reflects the company fundamental earning power.

Source: Robert Higgens, Analysis for Financial Management, 10 th Edition, pg 53-55.

Return on Capital Employed (Return on Invested Capital, ROIC ) reflects the company fundamental earning power as it removes the distorting effects of leverage inherent with Return on Equity (ROE).

Shipping companies often target 12% ROCE


33 © Wärtsilä

Investor finds LNG Competitive Advantage for return on capital… LNG hurdle rate is highest & yet preserves cargo owner millions transport savings and emission reduction.

34 © Wärtsilä

Warren Buffett… World Famous Investor

EBITDA as equivalent to earnings for a company is tantamount to the Egyptian Pyramids: forever state of the art…with never a need to be replaced, improved or refurbished…

The Pyramids

Earnings Before Interest Taxes Depreciation Amortization

EBITDA may overstate available cash flow… when used carefully and fully understood it may indicate what is available to pay bank debt and shareholders.

Often viewed as one of many economic indicators of company performance by financiers/investors/bankers.

Is often utilized when company has significant fixed assets.

35 © Wärtsilä

36 © Wärtsilä

LNG fuel has strongest EBITDA… + $3.6 Million over HFO+ Scrubber and + $5.0 Million atop MDO.

Years

EBITDA

MDO Fuel

HFO + Scrubber

LNG Fuel


Banker Are risks understood & I’m repaid !

37 © Wärtsilä

Banker finds debt cover is weakest on MDO fuel, favorably stronger on alternatives, LNG is strongest.

The Pyramids

Earnings Before Interest Taxes

EBIT = Revenue minus expenses, excluding tax & interest

EBIT may conservatively understate available cash flow… when used carefully and fully understood it may indicate what is available to pay bank debt and shareholders.

Often viewed as one of many economic indicators of company performance by financiers/investors/bankers.

EBIT nulls the effects of different capital structures and tax rates. EBIT was the precursor to EBITDA.

38 © Wärtsilä

39 © Wärtsilä

Years

EBIT

Banker Are risks understood & I’m repaid !

LNG has strongest EBIT… Depreciation 10 Year MACRS ½ Year Convention… Dry docking years 5,10,15,20

LNG Fuel

HFO + Scrubber

MDO Fuel

Agenda

40 © Wärtsilä






US #1 Shale Resources

41 © Wärtsilä

1,161 tcf gas & 120 billion barrels oil

Development rapid with technology advances in horizontal drilling, fracking, and computer seismic abilities.

In 5 years US became world’s largest producer of gas

Strong infrastructure & know how

Source:http://www.eia.gov/conference/2013/pdf/presentations/kuuskraa.pdf

Shale Gas

42 © Wärtsilä

Shale Oil

43 © Wärtsilä

28 November 2014

44 © Wärtsilä

Source: http://www.reuters.com/article/us-opec-meeting-idUSKCN0JA0O320141128

Key OPEC Vienna meeting sets stage for market share battle. Brent begins steep fall.

5 January 2015

45 © Wärtsilä

Source: http://www.forbes.com/sites/nathanvardi/2015/01/05/saudi-arabias-750-billion-bet-drives-brent-oil-below-54/

Exert Discipline in the Marketplace amongst OPEC and Non OPEC countries... Key focus on market share… oil prices plunging.

Discipline Target US or Russia ?

46 © Wärtsilä

Russia suffering double whammy:

Oil rich Ukraine and Black Sea burdened by politics under imposed sanctions as oil takes severe price slide…

Ruble plunges down against USD

Source: http://online.wsj.com/articles/ruble-hits-new-low-as-oil-prices-drop-1417441184

Source: http://www.usnews.com/news/articles/2014/11/10/an-oil-price-cold-war-with-saudi-arabia-not-so-fast-experts-say

Source: http://www.businessinsider.com/ruble-plunging-again-2014-12p://online.wsj.com/articles/ruble-hits-new-low-as-oil-prices-drop-1417441184

1 December 2014

December 31, 2014

Source: http://www.businessinsider.com/citi-saudi-arabia-wont-win-this-oil-standoff-2014-11 47 © Wärtsilä

Profits negative… Severe Pain

Profits squeezed…Manageable Pain

45 $/BBL

Key Oil Production Cost

40$/BBL

Total Liquids Production

Brent Breakeven Price

2014 Production

48 © Wärtsilä

US vaults to 1st in production oil and other liquids

OPEC

OPEC

OPEC

OPEC

OPEC

OPEC

OPEC

OPEC

Source: ttps://en.wikipedia.org/wiki/List_of_countries_by_oil_production

http://www.eia.gov/beta/international/rankings/#?prodact=53-1&cy=2014

Saudi Arabia11.6 m BBL/day

https://en.wikipedia.org/wiki/List_of_countries_by_oil_production

https://en.wikipedia.org/wiki/List_of_countries_by_oil_production

Government Breakeven Budgets

49 © Wärtsilä

Severe shortfalls @ prices under 100$/BBL, present oil glut & soft prices challenge sustainability beyond short run

Source: https://alfinnextlevel.files.wordpress.com/2014/04/oil_breakeven_deutsche_bank_oct_14.png40 $/BBL

Brent Crude Oil Prices

50 © Wärtsilä

Source: http://www.nasdaq.com/markets/crude-oil-brent.aspx?timeframe=1y

THEN

NOW

Oil severe price 70% price drop past 18 months as abundant supplies face weak demand from China and stagnant EU.

What’s the impact of the steep fall in oil prices !

Is competitive advantage of LNG robust or fragile ?

51 © Wärtsilä

Recent … 28 January 2016

52 © Wärtsilä

Port Houston Delivered Price

LS380 1% Sulfur 139 $ / ton

LSMGO 0.1% Sulfur 333 $ / ton

Source: http://www.kpibridgeoil.com/

LS180 1% 139 $/mt… LSMGO 0.1% 333 $/mt…

LNG Price 08 February 2016

Fixed Liquefaction Charge 4.60 CAD $/ GJVariable Sumas Gas Basis + 3.00 CAD $/ GJTotal FOB LNG Price 7.60 CAD $/ GJ

conversion to million BTU x 1.05435 LNG FOB price 8.02 CAD $/ mm BTU

exchange rate x 0.72 USD $ / CAD $ Price LNG FOB 5.77 US $ / mm BTU

53 © Wärtsilä

Allow 2.00 US $/mmBTU transport = 7.77 or LNG 363 $/mt

Owner A fair return capturing risks of oil fall 28 Jan 2016

54 © Wärtsilä

LNG emissions and millions transport savings remains for shipper but returns narrow for investor amidst oil glut steep price dive.

Fuel Stress Test: 100% ECA

THEN 5 August 2014

12.20% @ LNG 500 $/mt 4.34% @ MDO 971 $/mt 7.76% @ HFO 636 $/mt

55 © Wärtsilä

Deviation

ROCE

NOW 28 January 2016

13.94% @ LNG 363 $/mt 17.96% @ MDO 333 $/mt18.15% @ HFO 139 $/mt

LNG robust despite steep crude drop; today choose HFO scrub for best ROCE, but sustainable? Most volatile returns MDO, then HFO, least LNG… holds cargo share with compelling emissions + transport savings. Overall HFO + Scrubber often 2nd place.

Agenda

56 © Wärtsilä


Why & How ? No. Am ECA & EmissionsOwner ChoicesSCR, Scrubber, LNG Abatement

Business Case Cargo, Investor, Banker Views185K BBL ATBInvestment Returns



XXXXXXXXXXXXXXXXXXXXXXXXXXXXXXXXXXXXXXXXXXXXXXXXXXXXXXXXXXXXXXXXXXXXXXXXXXXXXXXXXXXXXXXXXXXXXXXXXXXXXXXXXXXXXXXXXXXXXXXXXXXXXXXXXXXXXX

Keys

Global Energy Policies, market gamesmanship ?

Future Ahead, structural shifts?

As a vessel owner, all I want to knowis the tipping point…

What fuel strategy do I choose to to boost my bottom line?

57 © Wärtsilä

A “Commodity Play” on fuel energy costs seeking competitive advantage for market share.

APPENDIXBusiness Case Details

58 Wärtsilä

Financials

59 Wärtsilä

Key Values

60 Wärtsilä

Key Values

61 Wärtsilä

Fuel Attributes

62 © Wärtsilä

Utilize fuels specific for regional case... As fuels widely vary, the historic dollars per ton or gallon is challenging to use as differing fuels host widely varying energy content, density, value... These values shown are generally representative.

EBITDA

63 © Wärtsilä

EBIT

64 © Wärtsilä

Weight Average Cost Capital WACC

65 © Wärtsilä Source: http://www.investopedia.com/walkthrough/corporate-finance/5/cost-capital/wacc.aspx

WACC may be used as a hurdle rate against which to assess ROIC (ROCE) performance.

Cost of Capital - Divisional & Project Costs ( WACC cont. )


WACC must be adjusted up or down to properly reflect project risks that differ from those of the overall firm.

Net Present Value & Internal Rate of Return


Selection Guide Measures of Merit

68 © Wärtsilä

Source: Fundamentals Ship Design Economics, Lecture Notes, Professor Harry Benford, Revised June 1981

Measures of Merit ( continued )

69 © Wärtsilä


Measures of Merit ( continued )

70 © Wärtsilä
