First Energy Bank New Energy Investment Bank in Bahrain

Recently we have seen a very substantial fluctuation in the prices of oil. How do you see the future evolution of the oil prices in the global market?

This is a dangerous question; you’re not supposed to forecast, especially as a banker. But it is safe to say that the energy business has always been cyclical. In some periods, the cycle’s amplitude has been low, in other periods it has been very high. Some cycles have lasted a few years, others have lasted a few months. By far, the most erratic cycle was what we had last year, when prices shot up to over $140 / barrel, and then they just crashed; they lost $100 / barrel within a matter of months. I have watched the oil cycles for a long time, but I have never seen anything that was so abrupt, so erratic, so fast, and so strong in terms of the amplitude of the cycle. In each case, in spite of these differences, the fundamental drivers of the cycle have always been the same. An upturn in itself sets the stage for a downturn and the downturn sets the stage for the next upturn. When oil prices begin to rise, two trends are set in motion. One, a lot of investment into new supplies, because it is profitable at higher oil prices to produce more. Second, lower demand.

These two trends have the makings of the next downturn. And as oil prices fall, the exact reverse is set in motion again. Exactly what we are seeing today. For example, this big drop in oil prices, what did it cause? It caused billions of dollars in project cancellations. So supplies now are already destined to be much lower in the next few years than they would have been had the prices stayed high. At the same time, because of this drop, there is a very different impact on demand. Now in this case it is complicated because we don’t have just oil prices to worry about, we also have one of the worst recessions in recent history, at least since the Great Depression. And also on top of that we have very strong financial dislocations in the world. So it’s not just the price effect that is acting on demand, it is also the effect of these economic income effects. So today we have unleashed some forces in the global energy sector which almost guarantee an upturn in the oil prices and the tightness in the market in the next few years.

These forces that we have unleashed, in my opinion, will cause prices to gradually increase again in the medium term, but I do not believe they will hit $140/barrel anytime soon, because part of the $140 / barrel story wasn’t just this type of fundamental dynamics, it also had a lot of speculative dynamics, political dynamics, and a lot of financial sector interference in the energy sector which I don’t expect to come back until 2011-12.

You mentioned that there will be a reduction of supply in the future. Do you think we might be heading towards an energy crisis in the future?

The extent of the potential energy crisis depends on the extent, speed and degree of the economic recovery. The fundamentals of this demand are not just prices, as I said, but are also tied to the economic recovery. Today we have excess capacity in the world, not because a lot of capacity was built, but because demand fell. So demand destruction itself caused almost overnight excess capacity which is now making the markets more relaxed. As soon as the market senses that this recession is ending and that economic upturn has begun, the excess capacity that was created by demand destruction could evaporate. And that is where the trick is. At that point, it would be clearer whether it’s a crisis that would emerge or whether it’s a shortage, whether it leads prices only to $80-85 / barrel or leads to $120 / barrel. The outcome would depend on how quickly these fundamentals evolve because with this kind of cyclical behavior, things never come exactly where they should, markets and traders always overreact.

Do you think this is the first sign of the fall of the dollar?

Could be, yes. I think there is some truth to that because markets eventually respond to real prices, or to the “real purchasing value.” What is the real purchasing value of a barrel of oil? The big surge in oil prices is less impressive if you factor in the value of the dollar plus local currency denominated inflation in the countries from which these oil exporters import their stuff, a weaker dollar simply means higher prices for dollar-based commodities. It’s a one-to-one relationship.

The Bahrain-based First Energy Bank (FEB), the world’s first Islamic investment bank focused exclusively on the energy sector. Can you explain to our audience your revolutionary business model?

Well, I am not sure how revolutionary it is, but it’s definitely unique. The time for an energy-focused bank is definitely right. That also might sound counter-intuitive because of the depressed conditions, but that is precisely when one needs to enter the energy sector. As we discussed, it’s a very cyclical business. There are far more risks when someone tries to enter any sector, not just the energy industry, at its peak, when the probability of decline is much higher than the probability of ascent from that peak. If our main objective as a bank is to create and capture value in the energy sector, which is our mission statement, then this can be done by investing in the energy sector assets today when they’re all depressed, and then ride the next wave up. I think it would have been much easier to make even well-intentioned mistakes back when oil prices were $140 / barrel as an investment than it is possible to make today. The relative risk factor has been reduced substantially.

The First Energy Bank as an institution is an absolutely brilliant concept for several reasons, not just because of this cyclicality. The time is right in general in the Middle East and North Africa (MENA) region, for private sector participation in the energy sector, and this wasn’t always the case. Ten years ago, regardless of the market conditions, a First Energy Bank may not have been as appropriate simply because the energy sector was much more dominated by governments in those days. The national oil companies had a total monopoly, the governments had not opened up as much, there were in some countries a few that had opened up and there was some competition among the private oil companies, such as in the UAE where there has been private oil company involvement, but this increase in private sector access to energy assets has been phenomenal in the last several years.

Today there are still some countries where the private sector can easily participate in the downstream, refining and marketing side and sometimes in the service sector. The upstream sector however – the actual oil and gas production from the ground – is still closed to the private sector such as in Saudi Arabia, where you cannot go as a private company, whether as a bank or an oil company.

Others are very open like Qatar and Libya, which is not just open but is booming because of the degree of openness in Libya that has happened over the past several years after the easing up of sanctions that then led to this enormous pent-up demand for foreign capital and foreign technology to come in and develop the resources. In our second quarterly review, we have a whole feature on Libya, maybe you should have a look at that too. Egypt is also very open and very competitive; the availability of service sector opportunities for the private sector has increased substantially in the MENA region, while the downstream was always – to some extent – available, but now it’s opening up even more.

And by downstream I don’t just mean refining oil and having petrol stations, but I’m also including the downstream of the gas sector which is mostly petro-chemicals. The petro-chemical complexes here have a very large number of private sector investors, and we’re looking at that also. So from the First Energy Bank perspective, this is an excellent time, not just because – as I said – we’re entering at the bottom of the cycle, but because the actual opportunities available for private participation are much higher than they were five or six years ago. So it’s a very target-reaching environment for us, from whichever side you want to look at this.

On top of that, in today’s market, one of the biggest constraints for private sector investment is finance. Because, you have a credit problem, you have a liquidity problem, a lot of relatively small companies – not small by other standards, but within the energy sector which is a very capital intensive industry by the way, small companies – need credit in order to execute their projects. Which present opportunities.

That’s a third advantage for First Energy Bank, because that’s not a problem we have. First Energy Bank has a paid-up capital of US $1 billion. Our capital is intact. But, in the energy sector, a billion dollars is not necessarily that much money. Some of the projects we look at are several hundred million each. No sound investment strategy will put 20-30% of a bank’s capital in one project. So in these circumstances, what we’d like to do normally is bring other partners, raise other funds, so that we distribute both the capital obligations of a project as well as the risk of the project.

Usually our first port of call is our own shareholders, the shareholders who put up the billion dollars to form the bank in the first place, who obviously have a very strong interest in energy projects. That’s why they built the bank. So every time we have a project like this, which sounds very interesting and we’ve done a lot of new divisions, we’ve looked at it inside out and in every fashion, and we are convinced enough to put our own capital into it and take it to some of our top investors.

Can you describe your shareholders for us to understand better your corporate structure?

We have over 20 different shareholders. The largest one has only ten percent, and we have six shareholders that have ten percent of the bank. They are the most blue-chip organizations in the region, including sovereign wealth funds, other strong financial institutions and high net-worth individuals.

Now, for this liquidity problem, can you describe for us who are your investors, what kinds of institutions are they?

Some of them are not a secret, I can tell you, for example “ADWEA” which is the Abu Dhabi Water and Electricity Authority, is a significant shareholder. Libya Investment Authority is a significant shareholder, and they are a very strong sovereign well-fund.

And clients?

That is entirely dependent on the project. For some of the projects, which are in the service sector, we will approach a kind of organization which would be the user of the output of the project. For example, one of our projects is called MENAdrill, a drilling company that we believe could one day be one of the largest private sector drilling companies in the whole Middle East region.

We are focusing right now on shallow water off-shore drilling that we believe is going to be a major activity both in the Gulf and in the Mediterranean, on the Libyan and Egyptian coasts as well as here in the Gulf. Our potential partners in this project will be companies who need drilling offshore rigs. In some cases, in this part of the world, they would be the national oil companies, or the international oil companies that have contracts to explore and produce here.

Let me now move to the way in which we have diversified our portfolio. We have several projects under consideration. You could categorize them into six or seven different energy sub-sector categories, each of which will have a different set of interested clients. One is actual oil and gas production, companies that have producing assets in this region but they may have some financial difficulties, in terms of funding their further development. Second is utilities. And they represent entirely different risk-reward ratios than oil and gas production, which have significant upside potential and higher risk, while utilities provide steadier income. They are generally government-backed, and are therefore not very risky, with good double-digit returns on your investment, but no real growth potential.

The third category, as I was explaining before, is the service sector. The service sector could be drilling, well head maintenance, work-over programs, and so on. We have several potential investments in that category. Another sector is renewables, which is important now in spite of the decline in both oil and gas prices – I’m kind of impressed actually and surprised – that the enthusiasm about renewable energy has not gone away. For this part of the world, there is significant interest here and in the overall MENA region in solar energy. I am personally a big believer in solar energy especially in the Middle East; there are some minor technical glitches about protecting the solar panels from sand storms and so on which are being resolved, and I think over time the technology will improve and costs will come down.

There are other projects that are related to energy sector infrastructure, which takes many shapes and forms. As you can see, even though we are energy-focused, within the energy sector, we are very diversified. I forgot to mention downstream. It’s another area where there is significant upside and steady income for the future, and we are interested in some petro-chemical opportunities.

What are your challenges as the First Energy Bank as of your second year of existing?

This is our first year of operations. We got our license last September, so that was only 3-4 months of last year, but 2009 will be our first full calendar year in operation. There are a lot of challenges, some of them related to the fact that we’re operating and competing while still building the bank. Everything is not yet fully in place. This is one challenge I am sure we will totally overcome before the end of this year. The other challenge is what I mentioned to you about more difficult liquidity for good deals. It’s not a big challenge, because we have such a diverse group of potential investors, that even if a few of them are a little bit careful the others are a little more aggressive, so we’ll eventually solve it, it just takes longer.

In terms of return on investment, what is your plan, or how much would you like to achieve?

In a year like this, plans are there to be revised constantly. Our current strategy and business plan is constantly evolving because it is driven by the opportunities themselves. And in a year like 2009, the worst thing one can do is say “this is my strategy, this is what I’m going to do.” 2009 is the best year for anyone to be opportunistic, because the whole premise of this is to identify unique opportunities created by the current crisis and to go after them.

This is not true every year, by the way, once this crazy fluctuation is over and we get to what I call a cruising altitude, then you should have a somewhat firmer sense of your strategy. But right now, in a very broad sense, the business plan or approach is to have this diversified portfolio. Some with very high upside, but slightly higher risk, some with no real upside but steady cash generation, diversification within the sector, renewable, conventional oil, gas, upstream downstream, service infrastructure, diversification by sector, diversification in terms of which countries of the region we are in.

So, diversification by country, by sector and by risk-reward profile is a very important consideration for us as a strategy. Another aspect of the business’ general strategy is that this is the first year of operations. As I said, we’re still setting up and doing business at the same time. A lot of these energy sector projects are medium to long term return. There is no overnight gratification here, it really takes time. Some of the best success stories in the energy sector are people who entered at the bottom of the cycle, which we have done, but then had the ability to wait for the cycle to fulfill itself. In my opinion, this is going to happen in the next two or three years, but sometimes it takes as long as 10 or 11 years. So that is something you cannot plan; plan all you want but these are not things that are in your hands.

What is in your hands is the quality of the projects you look at, the level of due diligence that you do, the opportunistic approach, your ability to source deals and execute. Once you do this, you have to have the nerves, the wisdom, and the support from the board to wait it out.

You are fairly newly-established; you have been on the market for one year. What is your communication strategy, how do people know about you?

Well, this interview is one way. Thank you for this opportunity to show the FEB flag. Our corporate communications department has done a superb job. We have participated in some conferences. We have had some exposure in newspapers just by the news media. We have had some very simple ads like the normal stuff. And frankly, I strongly believe that in this particular business, you don’t need millions of fans, you need a few hundred good contacts. And in the energy sector we have that.

Both my background and the background of some of the senior staff on my team have very strong relationships and access to the energy sector. It’s not about publicizing in all the papers; it’s about knowing the right targets and the right people. We want people, other banks, national companies, to know that we are one of the most insightful, thoughtful people in the global energy sector today. We understand the energy business, we understand what is going on in the MENA region, in the energy sector, we are thoughtful, we are insightful, we have access, we have a network. In other words, we are real when it comes to energy sector investments. This is true already, but it would be interesting over time to spread this word to a wider audience.

We are delivering an award for the greenest company, so one question that needs to be asked is what is your policy in terms of sustainable development, especially considering you are in the energy sector, so it’s very important?

I touched on this briefly already when I mentioned that renewable energy is definitely part of our portfolio. We are very interested, especially in solar energy in the Middle East. But we’re not necessarily limited to solar, there could be other possibilities in renewable energy. I am very impressed that the governments in this part of the world who are the biggest producers of conventional energy are not just giving lip service to this renewable energy but are actually investing in it. There is serious investment in renewable energy in Abu Dhabi as you know, but it goes beyond that, there is now enormous interest in Saudi Arabia in solar energy, there is solar energy in North Africa. We have two very interesting projects that we are trying to finalize in this area as well. So renewables are definitely part of the game.

To finalize the interview, what is your long term vision for First Energy Bank; would you like to stay local, would you like to go global?

I think if we are successful in the next say 2-3 years in building a truly substantial portfolio of energy sector projects which then pay off, there could be all kinds of options for First Energy Bank. At the end of the day, this is a decision that the board of directors has to make. But we are not limited to MENA. Even today there is no rule in our mandate that says you have to be in the MENA region. We happen to be focused on MENA simply because we believe we can add the most value to specific projects here given our access, but we are also looking at several projects which are in North America and Europe, and eventually we are going to start looking at Asia. There are new areas around the world including Latin America and the former Soviet Union. I am very interested in the potential of a country like Kazakhstan in terms of potential that is not yet developed, Kazakhstan is one of the best new opportunities in the world. So absolutely, going global is definitely part of the plan.