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Hill Vaden:

All right, welcome back to EnergyCents, an S&P Global Commodity Insights podcast covering all topics on the intersection of energy and finance. This is your host, Hill Vaden, and I'm here as always with your other host, Sam Humphreys. Sam, how's it going?

Sam Humphreys:

I'm good. Thank you, Hill. How are you?

Hill Vaden:

I am doing well. I think we can out that this is a second take for the intro because I forgot to press record the first time we did it yesterday, so we're a little delayed in this recording, but only 24 hours.

Sam Humphreys:

But it's okay. That's fine. That's barely no time, so it's all right.

Hill Vaden:

That's show business.

Sam Humphreys:

Exactly.

Hill Vaden:

All right. This is part of our Changemakers series where we try to interview people from outside the company who are working within energy, given all that's going on with energy and the changing sector that it is. We speak for the next 30 minutes or so with Spiro Youakim, who is Global Head of Natural Resources and co-head of European Energy and Renewables at Lazard. He also wears a European metals and mining hat as part of their financial advisory group. Can you tee up some of the conversation and give some ideas for people to listen to things?

Sam Humphreys:

Yeah, absolutely. This was an excellent conversation that we had, and we were focused primarily on Europe and capital raising for European investment into energy, both renewable and molecular and electron and just the future of that, particularly with global politics the way they are at the moment and the overall environment of mergers and acquisitions globally, how that impacts activity within Europe. It was a fascinating conversation. I think Spiro does a much better job at explaining it than I do. What about you? What's something you think we should be listening up for?

Hill Vaden:

I just think Lazard does ... They do a great job in the financial advisory business and kind of working on that geopolitics and energy. Spiro, I think, leaves things really optimistically in terms of Europe, which has been in an awkward position from the perspective of energy lately on the back of the Ukraine war and other things, so there's a hint of optimism toward the end for Europe. It's a very good conversation and I think people will enjoy it.

Sam Humphreys:

Absolutely.

Hill Vaden:

All right, Spiro, thanks so much for joining us today for this conversation. We're going to go ahead and dive in, but as we do, can you spend a couple of minutes introducing yourself and describing your role with Lazard?

Spiro Youakim:

Yes, thank you. I've been at Lazard now for 17 years. I have two roles at the firm. I head our natural resources practice globally, which is mostly metals and mining and basic industries, and then I co-head our energy and renewables group in Europe. It's a good dual role for me. I started as a mining banker, then migrated to oil and gas and now a broader exposure. The variables and the drivers are mostly the same. Geopolitics is very important. Financial markets and interpretation thereof is very critical. These are complex capital-intensive, multidimensional industries, and so there is no dull day in the office.

Hill Vaden:

Great. You and Sam are sitting together today in London, as I speak to you remotely from Houston. Can you give us a little overview on what you're seeing in financial conditions around energy from the perspective of a European financial participant?

Spiro Youakim:

Obviously, very particular times. I think there has been somewhat a shift, particularly in the oil markets, after the changes that we all know that have occurred in the geopolitics in the US. There are concerns that demand for energy will probably be more tepid than initially anticipated, albeit I think that the growth of that demand is unwavering. It's probably more in the velocity thereof and the celerity thereof than anything else.

That obviously has weighed on oil prices. We have seen some real tension over the past few weeks, albeit the moderation of the narrative around the tariffs has the effect of easing that a bit. I think fundamentally, we're looking at uncertain times in demand conditions in the near term. The long-term picture is always strong and robust. That hasn't changed. It's really the near term dynamics which have shifted a bit. I think there is a reality around interest rates as well, the value of the US dollar, the so-called US exceptionalism as it relates to the strength of the dollar or not, and the impact thereof on financing conditions and interest rates and cost of capital, particularly in the US and in the developed markets.

A very shifting environment, quite a lot of uncertainty, quite a lot of volatility, which I would say occupy a very meaningful amount of time in our conversations with clients. It's in these market conditions where independent advisors such as ourselves really raise to the challenge because we have a very independent perspective and very broad perspective on these metrics, and our clients are soliciting us pretty much every day to try and understand these shifting dynamics.

I think in Europe there is probably somewhat a regain of a momentum stemming from the fact that, as we all know, European growth and European market conditions have been more tepid or more benign than they were in the US. I think that at the moment, we're witnessing an awakening on the fact that, everything else being equal and on a risk-adjusted basis, the European market is undervalued, the European market is underappreciated despite the fact that the engines for growth and the engines for value creation are there or thereabout. I think what we are likely to see is a regain of interest towards Europe and towards European energy, energy dynamics and energy companies that we hadn't seen as a prevalent way as we are seeing it at the moment. I'm overall optimistic, but I'm more optimistic on European prospects for energy companies than I have been say over the past two, three years.

Sam Humphreys:

If we are taking a look at Europe, the last couple of years we've seen some big merger and acquisitions globally with some huge players obviously combining their portfolios. In Europe, there has been a focus on low-carbon power combining that with traditional oil and gas companies as well. Is that a trend that you think is going to continue or is there a bit more of a lean towards single source, sticking with oil and gas, for example, like some of the players are doing at the moment?

Spiro Youakim:

Not single source. I think you have seen there is a reorientation of capital towards hydrocarbons. There is a greater emphasis of CapEx intensity towards hydrocarbons, more capital and more financial resources being directed towards hydrocarbons in the context of generating growth in oil and gas production, which has higher operating margins and higher return on capital employed.

I think that the reality is that the juxtaposition of the two will continue to be a dynamic that European companies will have in probably as concrete a way as we have seen them doing. Just the shift of impetus and emphasis will go more towards hydrocarbons. There continues to be two large energy companies in the form of Total and Equinor who remain very committed to their electron strategies. I think that that will continue to prevail as the diversity of the European market that effectively will be a mainstay over the next 10 years.

I think we have probably been a bit too sanguine around the predominance of renewables as a vector for growth when it started becoming part of the equation in a more concrete way in 2019, 2020, obviating the notion that obviously the demand for energy and demand for hydrocarbons continues to account for a large majority of the overall demand. I think it's this narrative which has been nuanced in the form of capital allocation strategies that have been redesigned to emphasize investments in hydrocarbons, which over the broad spectrum of companies that we know have generated higher free cash flow conversion rates and higher return on capital employed, which then are the direct drivers for shareholder value over the long term.

Hill Vaden:

As we're thinking about energy today, some of what has kind of put Europe in the news over the past several years has been some of the energy, I think it was called by many an energy crisis with the Ukraine invasion, and some of the lost access to natural gas. What are some of the supply sources where Europe feels it perhaps has a competitive advantage as it's looking forward in this kind of energy transition or energy expansion?

Spiro Youakim:

I think when you look at every year, Lazard produces a study called Levelized Cost of Energy and Levelized Cost of Storage. You can look at the sources of energy and the cost thereof and the extraction cost and the exploitation costs across the spectrum, both from the standpoint of the commodities themselves as well as the geographies. As you relate this to Europe, Europe has been dependent on import of energy from Russia, Belarus, Ukraine. This has obviously been shifting a bit since 2022.

We have seen expansion of trade of hydrocarbons into Europe through other means. We have seen that effectively has been somewhat related by the, or relayed by the large energy traders and you know them, it's Gunvor, it's Trafigura, it's Vitol, who have had record volumes in order to supply that deficit in Europe. That particular element has reset also the trading companies and the paroxysm of their usefulness as it relates to the energy equation in Europe.

I think that over time, reason has prevailed. Towards the middle of 2023 reason has prevailed, and we have seen flows coming back normally into Europe. Obviously, the extent of the production increase of power through renewable sources has plugged some of that gap and it will continue to do so. That, I think, will continue to be the case because other than the energy groups, you have still very focused, one-dimensional renewable companies that have expanded, that have grown, that have extended the purview of their asset base. New projects have been brought on stream, capital has flown quite unreservedly at least up until 2024, middle of 2024 to renewable sources of energy across Europe. That has had the effect of bridging some of that gap. I think we will continue to see those trends manifesting themselves in that way in the course of the next forthcoming period.

Sam Humphreys:

Does that directly relate to policy changes that are happening within Europe because we've had a big push within Europe to drive towards renewables, for example? Particularly, when it comes to financing projects, having those green credentials on the portfolio is kind of beneficial. Do you think that's going to change in the future?

Spiro Youakim:

No, I think this will continue. I think there is a clear admission that every source of energy has its place because of its usefulness, because of the reality of the power infrastructure in Europe, because of its abundance, because of extraction costs, because of interest rates. I think it's important to remind people that when interest rates go up, the value of, say for instance, offshore wind projects go down a lot. Availability of capital to expand offshore wind across the backdrop of a high interest rate is more relative and less available in terms of capital intensity. Consequently, I think there is an admission that every source of energy has its place. Every source of power has its place.

Clearly, the move towards decarbonisation and towards getting to carbon neutrality over the near future, in 2030 and then 2050, this will continue to be the case. It's the pace at which you do it, the momentum and the way in which you achieve it. We continue to see that, for instance, thermal coal is a major driver of power in certain countries in Europe. Against that backdrop, renewable energy accounts for about 80% in other countries. As I see it, also wearing my metals and mining hat, each one of these sources has its place. There are conducive realities and conducive conditions for each one of them. This, in my view, will not change.

Over time. Of course, you will see coal being utilized much less in relative terms and in absolute terms as well, and that, everyone has accepted. In reality, what we have to admit is that the pace at which renewable energy has grown has been dented to some extent by the economic backdrop that we have seen over the past 18 months. The reality of the industrial layout in Europe continues to be more admissive of traditional sources of energy. I think every one of those will continue to have its place.

The move towards more fulsome decarbonisation is unabating in my view, and it will continue to gather momentum at different paces of course, but it will continue to gather momentum in our view over the next 20 to 30 years.

Hill Vaden:

We're talking today on April 29th, and quite by coincidence, this is the hundredth day of the Trump administration leading here in the US. I'm curious how your conversations with clients have changed this year. What is new, newly important, or newly concerning to some of the folks that you're working with, if anything?

Spiro Youakim:

Yeah, look, I think there is a real desire to better understand how policy and how decisions are being made globally, but also in the US. There is the economic aspect of the US, but also there are the broader geopolitics. There is the impact of tariffs, especially impact of tariffs on Chinese growth. I'll give you an example. If the tariffs are not to move and stay where they are at the moment, there are expectations that Chinese growth will come down to about 3%, which will have a material impact on demand for oil demand, for copper demand, for all future-facing commodities that we look at with and on behalf of our clients. There is a cost of capital reality in that if the US dollar declines in relative terms, vis-a-vis other currencies, the cost of refinancing US debt will be higher, everything else being equal. That has an impact on financing flows across the world.

There is a desire or a willingness for our clients to understand against the backdrop of certain projects having been either canceled or slowed down by virtue of either legislation or intention to recalibrate the emphasis of the US in the business plans of European companies. There has been a desire to understand where else can they invest and where else they can redeploy capital, how to preserve and grow the installed asset base in the US. For most of our clients who are very global, the US accounts for a very meaningful proportion of their overall value creation.

These are very dynamic conversations obviously. We rely a lot on our geopolitical advisory team at Lazard. We rely a lot on our leadership who is very insightful about US dynamics. I don't see panic though. I don't see frustration. I see just a pause to understand these new realities and reflect them in corporate strategies. Broadly speaking, the questions that we're getting, would that be stagflation and what would that mean in terms of demand for commodities, interest rates? Would that be other legislative pressures that we need to foresee in order to recalibrate our capital allocation strategies globally, and vis-a-vis the US? What is the value of our assets in the US? How will they change vis-a-vis other assets in order to formulate a value proposition to the investment community? All of those questions you would expect big companies to ask, and obviously, they spend a lot of time discussing those things with us.

Sam Humphreys:

You've really hit on a point there. We are in a big period of uncertainty at the moment with a lot of things changing, but from uncertainty, there's often opportunity. Have you seen, it's very early days, any creative or new ways of innovating to finance certain projects and to raise capital? Or is it a bit too soon to

Spiro Youakim:

No. Look, I tell you we have been ... It's a very good question because it is really something that we are spending a lot of time on at the firm. Let's start with one obvious reality, which is that all large clients of ours who are well-financed, who are strong investment-grade companies, have unfettered access to capital. These companies can access capital and debt capital in its traditional form everywhere and anytime. A strong balance sheet, a strong credit rating, and we are a credit-rating agencies offices here obviously, capital is unfettered, and it's available.

What we have seen is the rise of private credit, and the rise of private credit from one single source. A lot of the very large, alternative asset managers, Blackstone, Apollo, others, have insurance pools and private credit strategies that can invest in lieu of traditional, conventional sources of finance and can allocate capital across the capital structure from senior debt to preferred to hybrid to equity. This form of financing has been increasingly coveted by our clients, large and small, wanting to understand them better, wanting to have relationship with these sources of capital better across the spectrum of financing products. That's the first point.

The second point I would say is that a lot of the infrastructure capital that is sourced from investors such as Brookfield, for instance, are willing to commit capital to allow companies to isolate some assets to illustrate their value, help them fund the growth of these assets without resorting to balance sheet capacity at the level of the main company. That creates a different source of finance, cheaper, longer, without cannibalizing other sources of finance that these companies can get and without hindering on balance sheet capacity.

We have seen also the return of project finance. Project finance had all but disappeared for a long period of time when other sexier forms of capital came to the fore. Project finance is coming back because it has a place, because it understands long-term financing needs, it understands risk allocation, it understands risk mitigation. Project finance is coming back, which means multilateral funding agencies, export credit agencies are back into the mix of financing sources and relationships that our clients need to have. This is a new dynamic or a returning dynamic.

If anything, compared to say five, six years ago, sources of financing have expanded, have been wealthier, richer, more diversified, allowing our clients to source finance from a variety of sources depending on the need, depending on the construct, depending on the users of funds that they need to allocate the capital for. All of that, obviously, we help them decipher them, understand them, access them with the independent angle that we can bring to that.

It's a long-winded answer to your question, but if anything, there is no dearth of financing sources at the moment. There is more diversity, more volume of finance, broader financing sources. Obviously, it adds complexity from time to time, but this is what we do to help our clients navigate those.

Hill Vaden:

I'm going to ask again on some of your European perspective, but if we look at the world's largest oil majors, the European headquartered firms are trading at a discount to their American peers. A lot of these large electron-oriented companies in Europe are trading at a large premium to both the US-based oil and gas companies and the European-based oil and gas companies. What would you say about the valuation and the multiple expansion opportunities?

Spiro Youakim:

I think what investors are very keen to have is clear strategy, lack of complexity, alignment of objectives around capital allocation, maximization of free cashflow without jeopardizing or compromising the future of the company. Continue to invest in higher returning projects, higher returning verticals of the business, whilst maintaining a reasonable and well-aligned, well-understood framework of capital returns has the effect of improving shareholder value. I think the European majors have understood that very clearly.

It takes a long time to shift strategies and to see that shift translating itself in valuation multiple uplift, it's not because you decided in a boardroom that it will have immediate effect. This is mostly driven by the shareholding base being in a show-me mode. Let's see how the results manifest themselves in terms of free cash conversion, ROIC leverage over a few quarters, and then we'll give you the reward for that. I think that is what we have observed over the past few years.

Again, I think what we have seen is that it's really driven by the investors interest in or focus on having a risk adjusted growth being at the center of a stronger free cash generation strategy that rewards them, as well, adequately over the cycle and over a sustainable period of time. I suspect that this will continue to be the narrative over the next few years.

Sam Humphreys:

All right. We always like to round off our conversation with just a very short near-term look forward. It is slightly unfair for me to ask you this, but is there anything that you think we should be watching out for in the next six months that we should be paying particular interest to?

Spiro Youakim:

Resurgence of Europe. Europe will be back. European companies will be back. The undervaluation of European companies will be adjusted over the medium term. More capital will be allocated to European companies. The risk-adjusted growth at lower valuation that Europe offers across the energy spectrum will be more prevalent and therefore more coveted over the next six months.

Hill Vaden:

All right, well Spiro, thank you. We look forward to continuing the conversation soon.