Published: October 01, 2014
World markets for energy have entered a period of dynamic change in both supply and demand. Demand for oil and gas in the emerging economies of China, India, south East Asia and the Middle East continues to grow, fuelled by urbanisation and industrialisation. This is motivating energy companies to explore new territories and invest in production and logistics facilities on one hand, and find efficient means of selling and collecting cash in high-demand regions on the other. The challenge is that emerging supply and demand economies are often amongst the world’s most complex markets, typically with considerable market and regulatory restrictions. The dilemma for CFOs and treasurers of energy companies is therefore how best to manage local idiosyncrasies in key supply and demand countries whilst fulfilling wider corporate objectives. The deployment of a sophisticated cash management strategy that will enable the optimisation of working capital and improve the efficiency of liquidity flows is critical.
According to the International Energy Agency’s World Energy Investment Outlook 2013, published in November 2013, more than $1.6tr was invested in 2013 to provide the world’s consumers with energy, a figure that has more than doubled in real terms since 2000. Much of this cost is to offset declining production from declining oil and gas fields and to replace power plants and other assets that are reaching the end of their productive life, leading to high capital requirements not only upfront but on an ongoing basis. The challenge for multinational energy corporations is not only the level, but also the geographies in which this investment needs to be directed to, many of which are restricted markets with limited currency convertibility and liquidity constraints. While the markets in which energy companies are increasing their investment are diverse, from Kazakhstan to Nigeria, Russia to Iraq, there are common characteristics in the cash, risk and liquidity challenges in these high-growth, high-supply markets.
Corporate investment in complex emerging markets is a long-term, dynamic undertaking, with long project lifecycles and diverse cash flow models that entail frequent and sizable cross-border movements of funds in local and foreign currency. Very often, such projects involve dealing with unfamiliar counterparties and joint ownership structures, typically with state-owned enterprises, leading to further liquidity and risk complexities. These are exacerbated by political risks in certain markets, challenging regulatory environments and market restrictions on currency convertibility and cross-border liquidity which in turn leads to fragmented balance positions frequently known as ‘trapped’ cash. Furthermore, volatility on interest and exchange rates of these currencies add direct and indirect costs to the cash management structure and subsequently to company’s balance sheet
There is a common view that due to the high value of transactions in which they are involved, energy companies are cash-rich and therefore the issue of trapped cash and liquidity constraints are less immediate than for other industries. However, although energy prices continue to be moderately high, and demand is predicted to continue growing, giving reasonable assurance of the return on investment, the huge capital and ongoing costs in extraction and production projects mean that liquidity and working capital considerations can be very significant for energy companies. As a result, CFOs and treasurers are increasingly looking at ways to self-fund this CAPEX and optimising the company’s global liquidity is a crucial element of this strategy. Citi recognises this trend and we are leveraging our global network and local knowledge to work with our clients across this industry to build innovative and bespoke structures that will address their evolving cash management and trade finance challenges. For example, we may work with a customer to optimise funding and liquidity in production zones such as Kazakhstan, Nigeria and Iraq, and also to accelerate collections and facilitate the cross-border automated liquidity flows without loss of value in sales locations such as China. In particular, these customers are keen to gain access to our local expertise and insights to understand and overcome the idiosyncrasies in each market, whilst utilising our global liquidity platform to achieve liquidity optimisation and working capital efficiencies even when connecting the most remote locations.
Many energy companies headquartered in the United States and Europe that are expanding into Middle East and North Africa are witnessing at first hand the implications of a global economy in ways that have been less apparent in the past. For example, quantitative easing in the United States drove down the value of the USD against several currencies, leading to greater FX risks and higher foreign currency costs, particularly in currencies where the FX markets are less liquid. An intelligent cross-currency liquidity structure that is managed efficiently may significantly reduce the frequency and costs of FX activity without adversely impacting FX risk and generate economic benefits through interest differentials and currency volatility.[[[PAGE]]]
As quantitative easing has reduced, we have seen a huge drop in liquidity in emerging markets such as India. Energy companies are therefore facing the issue of how to manage both their direct and indirect FX risks, and how best to maximise the value of overseas investments where the cost of doing business may have increased dramatically. Companies operating in countries such as Russia face complex geopolitical and wider market challenges, not only as a result of the current international contention over Ukraine, but more deeply rooted issues rising from a lack of structural reform and state interference in the private sector, especially the energy sector. The local clearing systems are also presenting distinct characteristics that may create working capital inefficiencies while regulatory regimes may complicate the inclusion of local balances in certain liquidity structures. Liquidity management and ‘trapped’ cash pose particular challenges, with the resulting considerations of interest rate and FX risk.
In today’s challenging environment, where effective liquidity and risk management is critical to success, CFOs and treasurers are increasingly engaging with the business to ensure that treasury is part of every key decision in complex supply and demand markets. As corporates are looking to further enhance visibility and control of scattered pockets of cash and deploy their liquidity in the most efficient manner, treasurers’ role is critical.
Not only are these targets achieved through concerted communication and dialogue, but CFOs are also setting group-wide targets and metrics to drive centralisation, the consistent use of the ERP (enterprise resource planning system) or TMS (treasury management system) and common processes and controls. Scalability of the global liquidity structure to effectively support the international growth strategy is also a key objective for energy companies.
As an example, an increasing trend is the closer collaboration with Procurement to consolidate and streamline across the end-to-end supplier spend process. Effective management, metrics and initiatives focused on improving ‘days sales outstanding’ (DSO), ‘days payable outstanding’ (DPO), supplier spend and other business-to-business flows (e.g., Supplier Finance and Corporate Purchasing Card) are beginning to have a profound effect on a company’s efficiency and financial metrics. The aim of all these initiatives is not only to improve efficiency and control, but also to provide visibility over cash and risk across the business, an essential first step in an effective strategic treasury plan.
Banking relationships are key to the success of initiatives to optimise visibility over liquidity and risk, but also to reduce these risks. While there may be regulatory reasons to hold accounts with local banks in certain instances, energy companies are looking to their global banking partners such as Citi to expand their infrastructure into newly emerging markets, including the so-called ‘frontier markets’ that often have a less developed financial and regulatory infrastructure, to allow a consistent approach to account management, connectivity, cash and liquidity management, as far as local market conditions allow. By doing so, they gain access to a trusted partner that can help navigate local complexities whilst delivering international best practices in cash and liquidity management and achieve economic benefits and operational efficiencies at group level. For example, dealing with separate project accounts, complying with rule on commingling of funds and both injecting and extracting liquidity from joint venture companies are specialist capabilities that require Citi’s combination of both local and global expertise and solutions.
It is not just regional and global liquidity and risk concerns that are becoming more pressing, local cash and treasury management needs are also becoming more complex. For example, as energy companies expand their global footprint and advance the technology they are using, the number and diversity of their supplier base is increasing dramatically. This requires new approaches to supporting local payment instruments, processes and market conventions, and ensuring sufficient liquidity in the relevant currencies as funding these local accounts from a centralise pool in a timely manner is important. At the same time, centralisation of payment processes wherever possible, such as through payment factories and shared service centres, remains a priority, together with multi-currency liquidity solutions to manage local liquidity requirements without the need to hold large local balances. Similarly, exploration and production of energy has become more sophisticated, requiring more people on the ground, and therefore a deeper level of local service.[[[PAGE]]]
Given the importance of working capital to international energy companies, treasurers are approaching Citi to find innovative ways to avoid trapped cash, which is becoming a growing issue as the number of markets, and the potential revenues in these markets increases. High-demand countries such as China are typically a particular priority. Not only is China the world’s largest purchaser of oil and gas, a trend that is set to continue, but the pace of regulatory change and relaxation of rules for both foreign currencies and RMB offers particular opportunities for energy companies. For example, recent regulatory changes on RMB liberalisation facilitate the repatriation of local balances in a fully automated way and enable energy companies to expand their global liquidity structures and release significant amounts of cash from their balance sheet.
Energy companies have led the corporate world in exploring new geographic frontiers and expanding into markets that are ‘frontier’ markets today but will be ‘business as usual’ for many more industries in the years to come. These pioneering corporations are increasingly demanding end-to-end solutions from production to sales and distribution that combine efficiency, liquidity and risk optimisation whilst complying with local regulations, market practices and complex ownership models. Global banks such as Citi play a vital role in creating and supporting these innovative solutions, combining local expertise and on-the-ground solutions with regional and global cash, liquidity, risk management, together with a consistent approach to secure, reliable and transparent communication. By combining a flexible, robust treasury policy and innovative, proven banking solutions, energy companies are able to take the next crucial steps in their investment strategy, both in supply and demand markets, though both organic growth, local partnerships and mergers & acquisitions (M&A). Furthermore, as new acquisitions introduce new liquidity flows, currencies, systems and banking relationships into the group, it is important to have a clear and robust onboarding process to avoid fragmenting liquidity and losing visibility and control over flows and balances.
The energy markets are experiencing a transformation as sustainability, environmental and social responsibility, and energy security become increasingly important for consumers, governments and energy companies themselves. The transformation agenda is being reflected throughout these companies’ activities, not least in treasury. Mature companies with a well-established global footprint are demanding sophisticated, innovative solutions from their banks to provide visibility, harmonise processes and information, and optimise efficiency and control. Treasurers of companies that have embarked on international expansion more recently, often those headquartered in emerging markets are seeking advice and support from banks such as Citi to understand and implement best practices in cash and treasury management. From local salary payments in frontier markets to regional and global liquidity platforms, energy companies rely on global banks such as Citi to inform and deliver on treasury policy, processes and structures for liquidity and risk worldwide.
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