What s Hot in Oil, Gas and Energy Equipment Leasing

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1 October Follow on head on Master page A October 2013 What s Hot in Oil, Gas and Energy Equipment Leasing By David Yang Effective portfolio risk management is vital to the long-term success of equipment leasing and finance firms lending to the oil, gas and energy sector. EL&F firms can target specific industries to hedge against commodity price shocks, regulatory uncertainty and growth volatility The steadily growing population will consume more and more energy during the next five years. Consequently, anticipated infrastructure expansion will bolster energy exports, and raise energy prices for domestic firms. At the same time, the commercial and industrial sectors will become more energy-intensive as industrial automation, robotics, computerized building management and other technologies become more prevalent. For these reasons, oil, gas and energy industries are significant to the portfolios of equipment leasing and finance (EL&F) firms. Because this sector is expected to benefit from price and consumption growth, IBISWorld projects that energy distributors and generators will grow at an annualized rate of 3.1% to $887.1 billion, while mining, oil and gas extraction industries are anticipated to expand at an annualized rate of 2.2% to $611.8 billion in the five years to Combined, the two sectors are expected to account for 9.3% of the US economy in 2018, presenting many opportunities for EL&Fs. In the coming years, however, geopolitical tensions, natural disasters, industrial accidents and other unpredictable events can all introduce shocks to commodity prices, negatively impacting the sector and, consequently, EL&F portfolios. In particular, EL&F firms may face greater revenue and profit volatility, thereby hampering long-term growth. As a result, effective portfolio risk management, especially against commodity price volatility, is vital to the long-term success of EL&F firms lending to the oil, gas and energy sector. To this end, industry intelligence can be a powerful tool in building a balanced portfolio. This report identifies several strategies to diversify risk across different industries, using IBISWorld s industry risk scores. The risk score, measured on a scale of 1 to 9, tracks an industry s risks pertaining to industry structure, expected future performance and economic forces. A lower risk score indicates a less risky industry. By looking across a single subsector, a supply chain or a growth portfolio, an EL&F firm can diversify and mitigate risk. Diversify across a single subsector EL&F professionals can minimize power plant equipment lease risks by info@ibisworld.com

2 October maintaining a portfolio of companies from all industries in the electric power generation sector. The five industries have a combined average risk score of 4.2, which represents a moderately low level of risk. By lending to coal and natural gas power plants and renewable power plants, EL&F firms can hedge against fossil fuel price shocks. These industries, in turn, hedge against the regulatory risks of nuclear power. Additionally, leasing and financing firms can diversify deal sizes by lending to different industries within the electric power generator sector. In 2013, an average firm in the Nuclear Power industry is expected to generate $538.4 million in revenue, while an average coal and natural gas power plant is expected to generate $470.7 million. As a result, nuclear power and fossil fuel power plants are more receptive to large-ticket leasing for heavy machinery like generators, turbines and boilers. Meanwhile, wind power firms are estimated to generate about $76.2 million. These firms are prime targets for small- to middleticket leasing deals for wind turbines, towers and blades. Finally, small solar power and hydroelectric power firms are expected to generate less than $10.0 million and represent good targets for micro- and small-ticket leasing deals for solar panels. The Coal and Natural Gas Power, Nuclear Power and Hydroelectric Power industries are mature in the electric power generation sector. According to IBISWorld forecasts, these three industries combined will grow at an annualized rate of 1.2% to $149.3 billion over the five years to In contrast, the Wind Power and Solar Power industries are in growth phases and have a considerably lower share of the electricity generation market. These two industries combined are projected to expand at an annualized rate of 9.5% to total $11.1 billion over the five years to As this sector grows, its industries will require lease financing for equipment such as turbines, boilers, water pumps, generators, wind turbines and solar photovoltaic panels. When fossil fuel prices increase, coal and natural gas power plants face higher costs and lower profitability. As a result, fossil fuel generators become less competitive than other electric power generators. However, the reverse is true for renewable power generators, which are less competitive when fossil fuel prices are low. Additionally, hydroelectric, wind and solar power plants are dependent on weather conditions. When rainfall or sunlight is low, hydroelectric and solar power plants may have difficulty supplying electricity, which cuts into power plant revenue. Electric Power Generation Industry 2013 Revenue CAGR (%) Revenue per enterprise Risk score Coal and Natural Gas Power 102, Nuclear Power 35, Hydroelectric Power 3, Wind Power 6, Solar Power SOURCE:

3 October Finally, this sector is subject to regulatory uncertainty. Nuclear power plants are subject to growing public concerns regarding the safety of nuclear power. A more stringent regulatory environment can cut into revenue and profitability for nuclear power plants. Solar and wind power generators are also dependent on government subsidies to compete against fossil fuel power. While the current political climate is favorable to renewable power, policy shifts can hinder its growth. Diversify across a supply chain EL&F professionals can also diversify portfolio risk by lending to companies across an entire supply chain. The Oil Drilling and Gas Extraction and Oil and Gas Field Services industries operate in the upstream oil and gas sector and extract crude oil and natural gas resources from fossil fuel reserves. Extracted fossil fuel is then refined by the downstream Petroleum Refining industry into products like gasoline and diesel fuel or directly distributed to consumers by the Natural Gas Distribution industry. Upstream oil and gas extractors and field service providers benefit from rising fossil fuel prices. These firms can wholesale oil and gas at higher prices, thereby bolstering revenue and demand for EL&F services. On the other hand, increasing fossil fuel prices result in higher purchase costs for downstream petroleum refineries, which cuts into refinery profitability. Natural gas distributors also face higher purchase costs. While petroleum refineries and natural gas distributors can pass on some costs to end-users, higher fossil fuel prices typically lead to downward pressure on profitability, which, in turn, lowers demand for equipment leasing. Falling profit margins can cause smaller firms to exit the downstream oil and gas sector, effectively shrinking the primary market for equipment leasing. Smaller operators often lease to manage capital costs; in contrast, larger firms have sufficient capital resources to absorb a drop in profit margins and directly purchase heavy machinery. As a result, EL&F firms can hedge against oil and gas price shocks by holding a portfolio of leases from all four of these industries. The industries have an average combined risk score of 5.3, which represents a medium-to-high risk level. Equipment leases to firms in slower-growing mature industries provide more stability, while demand for equipment leases is greater in fastgrowing industries. The four industries in this supply chain offer diversity in terms of growth. IBISWorld forecasts that the Natural Gas Distribution industry will grow at an annualized rate of 3.9% to $166.2 billion over the five years to Over the same period, Oil and Gas Industry 2013 Revenue CAGR (%) Revenue per enterprise ($ m) Risk score Petroleum Refining 731, , Oil Drilling and Gas Extraction 328, Natural Gas Distribution 137, Oil and Gas Field Services 109, SOURCE:

4 October the Petroleum Refining industry and Oil Drilling and Gas Extraction industry are both projected to expand at slower annualized rates of 2.5%. Field service providers are anticipated to experience even slower annualized growth of 1.3% from 2013 to Finally, EL&F firms can easily diversify deal sizes by offering smalland medium-ticket leases to oil and gas extraction firms, while reserving large-ticket leasing deals for petroleum refineries. The average petroleum refinery is estimated to generate $5.3 billion in 2013, while oil and gas extraction and field services firms are significantly smaller, generating about $48.9 million and $10.2 million, respectively. High-growth portfolio Another option for EL&F firms is to target a group of high-growth industries, relying on a large number of deals to minimize damages from defaults. For instance, firms from the mining and power generation sectors can provide ample opportunities for equipment leasing and financing deals because they are highly capitalintensive, requiring drills, pumps, storage tanks, solar panels, turbines and other machinery. However, the stone and sand mining industries are also highly competitive, resulting in a steady level of attrition among firms in these three industries. These industries are also dependent on mineral prices, which exhibit high levels of volatility. Wind, solar and geothermal power firms also operate in a challenging environment, facing regulatory uncertainty and heavy competition from fossil fuel generators. Nonetheless, the total revenue for the above five industries is projected to grow at an annualized rate of 6.5% to $48.7 billion over the five years to In contrast, the oil, gas and energy sector is projected to grow at a considerably slower annualized rate of 2.7% during this time. These five industries are also mostly comprised of moderately sized firms, with annual revenue per firm ranging from $1.9 million to $76.2 million in As a result, EL&Fs can target these firms with a large number of small- to mediumticket lease deals. Rapid growth in these industries will fuel demand for equipment leasing and financing, bolstering revenue for EL&F firms. Mining and Power Generation Industry 2013 Revenue CAGR (%) Revenue per enterprise Risk score Stone Mining 15, Sand and Gravel Mining 10, Wind Power 6, Geothermal Electricity Plant Operation 2, * Solar Power *Estimated risk score based on IBISWorld s Specialized Industry Reports Collection SOURCE:

5 October About IBISWorld Inc. Recognized as the nation s most trusted independent source of industry and market research, IBISWorld offers a comprehensive database of unique information and analysis on every US industry. With an extensive online portfolio, valued for its depth and scope, the company equips clients with the insight necessary to make better business decisions. Headquartered in Los Angeles, IBISWorld serves a range of business, professional service and government organizations through more than 10 locations worldwide. For more information, visit or call Conclusion Leasing and financing professionals can target industries within a subsector or a supply chain, using deals from different industries to hedge against commodity price shocks, regulatory uncertainty and growth volatility. Alternatively, leasing portfolios can be built by targeting highgrowth industries, relying on strong revenue growth to minimize default risks. In the coming years, the oil, gas and energy sector will face risks associated with fossil fuel prices, government regulations, natural disasters and other unpredictable events. As a result, effective industry analysis will be critical for the long-term success of EL&F firms lending to the oil, gas and energy sector. Contact: Savannah Haspel VP, Public Relations IBISWorld Phone: savannahh@ibisworld.com

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