6. INDUSTRY OVERVIEW 6. INDUSTRY OVERVIEW 6.1 OVERVIEW OF THE GLOBAL ECONOMY As in 2010, the global economy is expected to experience a two-speed and uneven economic recovery in 2011 with the overall economic growth likely to be more moderate. The continued divergence in growth performance between the advanced economies and emerging market economies, reflects the continuing impact of the global financial crisis on the potential growth path for the former. These effects include structural problems related to high unemployment, weak fiscal positions and constrained credit conditions. To some extent, growth prospects in the advanced economies will be supported by recent policy stimulus in the USA and Japan, underscoring the governments’ concerns that growth in private sector demand may not be sufficiently strong to sustain economic activity. After experiencing above-trend growth in the previous year, the Asian economies are expected to continue to lead global growth although the momentum will moderate to a pace closer to their long-term averages as the base effect dissipates. While external demand for the region will improve at a slower pace in line with the moderation in the global economy, domestic economic activity in these economies will remain robust, underpinned by positive consumer and business sentiments, improving labour markets and favourable financing conditions. An emerging feature of the global economy in the post-crisis period is that the global growth is increasingly dependent on the emerging economies. While the emerging economies account for about a third of global Gross Domestic Product (“GOP”), they have contributed more than two thirds of global growth in recent years (1990s: one-third), highlighting the growing importance of emerging economies as the new growth centres. In the recent period, changing growth dynamics have brought about new challenges to the emerging economies following the shift in global short-term capital flows from the advanced economies to the emerging market economies. This trend has been further accentuated by the series of quantitative easing measures in the advanced economies that have contributed to a surge in global liquidity. As the monetary policy normalisation or tightening in the emerging economies is expected to continue, it will contribute to the widening of interest rate differential between the advanced and the emerging economies. These large and persistent short-term capital inflows into emerging economies often also exert significant upward pressure on exchange rates and asset prices in these economies. At the same time, the tendency of these flows to reverse in response to global developments is also likely to create greater volatility in financial prices in the emerging economies. For the regional monetary authorities, the challenges in 2011 will revolve around how best to manage the capital flows while concurrently addressing the emerging inflationary pressures arising from high global commodity prices. (Source: Bank Negara Malaysia, Annual Report 2010) The global economic recovery continued to strengthen at varying paces across regions in 2010, largely attributed to sustained fiscal stimulus and accommodative monetary policies worldwide. This was further supported by better economic performance in emerging economies, particularly China and India. In the first half of 2010, emerging and developing economies posted strong growth, supported by consumption and investment activities. Meanwhile, the major advanced economies grew at a moderate pace, despite large public debts and high unemployment. In the remaining half of the year, global growth is expected to be moderate. Major economies, particularly the USA and euro area are expected to continue to expand at a slower pace. Lower consumer spending in the USA and fiscal austerity measures in the euro area affected by the sovereign debt crisis are likely to impact growth. However, strong growth in Asia, particularly China, India and the Association of Southeast Asian Nations (ASEAN) economies as well as oil producing countries will provide the impetus for global growth. For 2010, world GDP growth is envisaged at 4.8% (2009: -0.6%).
6. INDUSTRY OVERVIEW (Conf’d) Prospects for the global economy remain favourable in 2011 with continued improvements in global trade and investment, particularly in emerging and developing countries. In addition, enhanced post-crisis policy coordination, ongoing regulatory reform of the international financial system and efforts to further liberalise trade and investment are expected to facilitate private sector driven growth. However, challenges to the growth momentum remain. These include the high level of public debt and unemployment rate as well as constrained bank lending in developed economies and tightening of monetary policy in several emerging Asian economies to contain inflationary pressures. Global growth is projected at 4.2%, led by China, India and Indonesia, which are expected to grow 9.6%, 8.4% and 6.2% respectively, supported by sustained domestic demand, growth in the USA is expected to range between 3.5% and 4.2%, sustained by a pick-up in private demand, while the euro area is anticipated to grow 1.5%, largely due to export growth in Germany and France. World trade is projected to grow 7.0%, contributed by increasing trade in emerging and developing economies, while trade is expected to grow moderately in developed economies. In line with positive world growth and trade prospects, global foreign direct investment (UFO!”) is also expected to increase between USD1.3 trillion and USD1.5 trillion. (Source: Ministry of Finance Malaysia, Economic Report 201012011) THE REST OF THIS PAGE IS INTENTIONALLY LEFT BLANK 6. INDUSTRY OVERVIEW (Cont’d) 6.2 OVERVIEW OF THE Oil AND GAS INDUSTRY 6.2.1 General introduction to the energy industry The oil and gas industry is part of the energy supply chain that is a main catalyst of economic growth. The energy industry in 2009 was dominated by a global recession. However, in 2010. this contraction has shown sure signs of recovery although it is uncertain how durable this recovery is and will be. The International Energy Agency has developed various projections in respect of the future of energy consumption. These scenarios are: • A New Policies Scenario: assumes the implementation of new measures and policies that have already been announced (including national pledges to reduce green house gases) on a gradual and cautious basis;
• A Current Policies Scenario: a baseline in which the impact of policies which have already been formally announced and implemented are considered; and
• A 450 Scenario: assumes adherence to an energy pathway consistent with the goal of limiting the global increase in average temperature to 2 degrees Centigrade (limiting the concentration of greenhouse gases in the atmosphere to around 450 parts per million of carbon dioxide equivalent).
On a long term basis, irrespective of the scenario selected, world primary energy demand is set to increase substantially. It should be noted that these projections take into account the fact that whilst energy demand is increasing, there have been significant improvements to energy intensity (i.e. the amount of energy required to create each unit of GOP). Figure 3 below shows primary energy demand projections by scenarios.
Figure 3: World Primary Energy Demand (By Scenario) 6. INDUSTRY OVERVIEW (Cont’d)
According to the Current Policies Scenario, the increase in energy demand is expected to average 1.4% per year over the 2008 -2035 period. In the New Policies Scenario, world energy demand is expected to increase by 1.2% per year reaching 16,750 million tonnes of oil equivalent, (Mtoe) by 2035, (an increase of 36% during the period 2008 -2035) and in the 450 Scenario, global energy demand continues to increases, but by an average of 0.7% per year (22% increase over the period 2008 -2035). The most rapid growth in energy demand is expected to occur in nations outside the Organization for Economic Cooperation and Development (“OECD”). 6.2.2 The Oil and Gas Industry: Sector Landscape 184.108.40.206 The Petroleum Value Chain The primary petroleum value system is as shown in Figure 4 below. …..d.. lr.-n~ U Dl:1’/,.lllS-lII~ A,’.:/M1!Io Figure 4: The Primary Petroleum Value System The oil and gas value chain comprises three component activities (upstream, midstream and downstream) performed by three categories of industry specific players; these being: • Integrated Oil Companies: defined as companies engaged in the E&P of oil and gas, as well as at least one other significant activity in oil refining, marketing and transportation, or in the chemical industry. The majority of National Oil Companies are Integrated Oil Companies and these companies normally have upstream, midstream and downstream activities. (National Oil Companies are companies which operate as an extension of the government or a government agency, such as Oil and Natural Gas Corporation of India, Pertamina of Indonesia and Petronas of Malaysia, where their role is to support their government’s programs either financially or strategically);
• Independent Oil Companies: exclusively in the E&P segment of the industry, with limited or no downstream marketing or refining within their operations. Independent Oil Companies are further sub-divided into Large Capitalized Independents (Large Cap Independents) or Small Cap independents (also called Junior Independents); and
• Service Companies: companies that perform services for the Integrated Oil Companies and the Independent Oil Companies and support all components of the value chain.
6. INDUSTRY OVERVIEW (Cont’d) It is the objective of Hibiscus Petroleum to initially be a Junior Independent oil and gas company. As a Junior Independent oil and gas company undertaking E&P activities, our Company shall be impacted by several types of regulatory and fiscal systems. Host governments are generally the owners of hydrocarbon resources and regard these resources as a primary source of fiscal revenue for the state. To generate the fiscal revenues, they design and promote taxation structures that attract industry participants to their jurisdiction by providing a fair balance between sector risks and fiscal costs in that jurisdiction with financial returns. An overview of the petroleum taxation framework is provided in Figure 5 below. Global Petroleum Fiscal StructuresI 1
I Concessionary Arrangements (,__sprivate ownership of minerai resources) I1 Service Contracts (servlcef” Istaken III cash)II
Contractual Arrangements 1(statere.tallls ownership) Production Sharing Contracts (fee Istalcen 1Il1dnd, generally a share of proQictlonl
II Risk Service Contracts IPure serv~~ontracts I (element of risk) I Figure 5: Types of Petroleum Taxation Systems Found Worldwide 220.127.116.11 Geological Factors The oil and gas E&P business is fundamentally built around the exploration, discovery and exploitation of oil and gas deposits found deep underground. It has to be understood that the prevalence of hydrocarbons is not a random geological event. It is the product of complex geological processes that take place only in certain specific conditions. The key components are source rock (deeply buried sediments rich in organic matter), migration pathway (cracks or porous rock, through which newly formed petroleum can escape toward the surface) and finally, a layer of impermeable stone or clay or salt is required to trap the petroleum and create a reservoir or field. Apart from these basic geological conditions, time (a few million years) and temperatures (100 to 135 degrees centigrade) are also required, such temperatures being the environmental conditions at sub-surface depths between 10,000 and 13,000 feet. 6. INDUSTRY OVERVIEW (Cont’d)
18.104.22.168 Technical Implementation Factors Extraction of hydrocarbons require the deployment of complex technical solutions in remote and climatically hostile environments (generally offshore or deep inland, or even sometimes in desert or remote Arctic areas). The selection of the optimal technical solution is a process of securing and applying the relevant human expertise, utilizing the necessary tools and contracting with competent service providers and equipment manufacturers.
22.214.171.124 Health and Safety Factors Industry players in the oil and gas E&P sector have to contend with a plethora of safety and occupational health hazards by virtue of the hostile conditions existing in the areas where oil and gas deposits are found.
126.96.36.199 Environmental Factors The influence of environmentalists and the legislation they are currently promoting is increasing, particularly post the Kyoto Protocol.
188.8.131.52 Oil Price Fluctuation Supply and demand economics combined with political factors govern the price of oil worldwide. 184.108.40.206 Long-term Investment Horizons The development and production of oil and gas fields are long term projects (particularly gas).
220.127.116.11 High Level Competition The securing of oil and gas assets is highly competitive in general. In our Regions of Interest, it is estimated that more than 100 companies are currently members of the SEA Scout Check -a group comprising companies that are operators of at least one oil and gas field in the Asia Pacific region. This grouping does not include non-operating (i.e. do not manage the day-today operations of an oil or gas asset) entities with purely investor interests in oil and gas assets.
18.104.22.168 Risk Even-though many elements of high technology are deployed in the process of prospecting for oil and gas deposits, many wells that are finally drilled, are dry. These wells represent costly investments and the majority of them yield results which indicate that projects are not viable. Such macro statistics make technical risk management a major consideration in this business sector and the presence of a high level of technical experience is always an asset.
6.2.3 Oil and Gas Industry: Market Outlook The demand outlook of the global oil and gas industry depends on the scenario that is believed to be appropriate. According to projections in the World Energy Outlook 2010, population growth and economic drivers increase (in absolute terms) the consumption of oil between 2010 and 2035 in the Current Policies and New Policies Scenarios. However, if radical policies are invoked and successfully implemented globally to reduce petroleum based fossil fuel utilization and the 450 Scenario crystallizes, then oil demand will likely fall over the 2010 -2035 period (but in absolute terms still remain relatively high). 6. INDUSTRY OVERVIEW (Cant’d) Figure 6 depicts the trends for each of the above-mentioned trends.
Figure 6: World Primary Oil Demand (By Scenario) Against this demand driven backdrop, it is becoming increasingly apparent that: • New production from super giant and giant oil fields is insignificant and the average size of oil and gas fields is falling; Le. the current sizes of new discoveries are not as large as previous finds but nevertheless, an improved oil price regime and in some cases, better fiscal terms for smaller fields, allow for these fields of reduced (in-place) volumes to be commercially exploited. See Figures 7 and 8 below for current trends in the size of discoveries.
Figure 7: World crude oil production from super-giant (>5 billion barrels of ultimately recoverable oil) and fliant (>500 million barrels of ultimately recoverable oil) fields 6. INDUSTRY OVERV’EW (Cont’d)
Figure 8: Conventional oil (crude and natura’ gas liquids) discoveries and production worldwide • Producers of oil and gas have to explore and produce from deeper water depths to meet demand. The maximum water depth of offshore wells being drilled is increasing (see Figure 9 below).
Figure 9: Maximum operational depth of offshore exploration and production wells worldwide • Unconventional geological plays (e.g. tar sands, shale becoming more prevalent and gaining in importance. gas and basement) are • Secondary and tertiary recovery programs, technology are also being prioritized. underpinned by various forms of • Independent oil companies will continue to playa significant role in the oil and value chain (see Figure 10 below). gas
6. INDUSTRY OVERVIEW (Cont’d)
This situation of a demand~led business sector, underpinned by a forecast of strong oil prices going forward (see Figure 11 below) coupled with an overall increase in the number of opportunities globally (originating from the factors that are stated above) results in a fertile environment in which to establish or grow an oil and gas E&P bUSiness.
t •/ .I I J.. en
Figure 11: Possible scenarios for oil price trends 6. INDUSTRY OVERVIEW (Cant’d) In the near term, it is clear that the contraction in activity levels seen in 2009 is now regarded as a temporary phenomenon and all indicators show that activity levels in the E&P industry are reverting to pre-Global Financial Crisis levels (see Figure 12 below). The more recent reports from the Innovation Energy Environment demonstrate that the activity levels of drilling rigs used to confirm the presence of sub-surface deposits of hydrocarbons have bounced back from a 2009 dip. It should be noted that drilling rig utilization is a Jagging indicator of activity levels in the oil and gas domain as the drilling of a well is normally preceded by a great deal of seismic data acquisition and interpretation worK
The current estimates (by the Innovation Energy Environment) of investments in wells being drilled both onshore and offshore globally are shown in Figures 13 and 14 below.
6. INDUSTRY OVERVIEW (Conf’dj
Year Sources for Section 6.2 of this Prospectus are as follows: Innovation Energy Environment; Panorama 2010; The Oil Context and Trends in 2009 Innovation Energy Environment; Panorama 2010; Activities and Markets in Exploratjon~ Production World Energy Outlook © DEeD lEA, 2010, International Energy Agency World Energy Outlook © OECD lEA, 2008, International Energy Agency Management Team THE REST OF THIS PAGE IS INTENTIONALLY LEFT BLANK