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Credit Squeeze Leads to New Priorities for Energy Sector

The financial crisis has slammed into the energy sector and forced the industry to reconsider some of its long-term goals and restructure some of its operations, a BP Canada Energy Co. executive told a Toronto audience Thursday.

Lee Lunde, COO of BP's North American gas division based in Calgary, addressed the annual LDC Forum Canada, which is being held in conjunction with Canada's Industrial Gas Users Association meeting. Lunde told the audience she has spent most of every working day in the past month trying to find ways to understand the credit crunch and the possible impacts it could have on BP's business.

"Frankly, I'm running out of adjectives to describe what's been happening in the markets," Lunde said. "Each of us in this room, as we come to work each day, is trying to figure out what the impacts will be and what we are doing differently as a consequence."

As concern has grown in the financial sector, "stock prices are coming down and the cost to insure against possible defaults is going up. There is an inverse directional relationship between equity prices and the levels of credit default swaps...And that has wide-ranging implications for the energy industry."

Among other things is a "long, growing list of merger and acquisition activity in our business," she said, pointing to, among other things, MidAmerican Energy Holdings Co.'s acquisition of Constellation Energy Group. "I have a feeling we haven't seen the end of this. One thing is clear, the consolidations will continue. Companies that have strong balance sheets, cash and little debt are in a good position."

Liquidity is a topic that comes up every day. "My answer so far is that it is very good," said Lunde. "We have a deep market with many players. The banks actually weren't big players in the physical gas market, and we have many buyers and sellers meeting, and the liquidity is good. That's the good news."

The BP executive said there is "still plenty of liquidity to do risk management, swaps, but the banks were the big participants on the down curve, and that is something to watch for. But if you look at the statistics, the transactions" on the New York Mercantile Exchange, the IntercontinentalExchange, "there's still plenty of participation down the curve."

Lunde said her "new best friends are in the credit department." For its gas sales, Lunde's team considers BP's exposure to its counterparties every day. "We look at forward positions, where they mark, the combination of where we are long term and short term in regard to exposure with that company. We also look at options like pre-pays, insurance, at netting off against a counterparty in contrast to sales...We do business with a number of entities, and we have exposure in the same entities.

"There are a variety of things we look at. It's become my full-time job in the last month."

One concern when dealing with counterparties is with the financial terms of contracts, Lunde said. "The banks were the big players in risk management...for capital projects and infrastructure funding. We're just beginning to see announcements about delays, and producers won't be happy if there are uncertainties around infrastructure [pipeline] projects, about delays in moving gas to market" (see related stories). "Producers ultimately won't be happy to see cuts in drilling programs and pipelines won't be happy about infrastructure delays."

Also impacted by the financial sector problems is the climate change agenda, said Lunde.

"Six months ago, the climate agenda was important," she said. "It's still very important; it hasn't gone away. And it will resurface once we are through this financial crisis..."

Despite all of the changes expected over the coming months, the tighter credit market has a bright side for the energy sector, she said. Service costs, which have risen over the past couple of years, should reverse over the coming year.

"Steel prices doubled over the last couple of years and these prices, other products, labor costs, all of this made many projects uneconomic or marginally uneconomic," Lunde noted. "The silver lining is that costs inevitably come down, and ultimately will attract funding back to the sector."

In any case, BP will continue to allocate a lot of exploration, production and refining capital in North America, she said. "We are spending in the Gulf of Mexico, Western Canada, converting refineries for oilsands, and we went back to the Arctic. North America is where we like to spend our money."

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