The Citadel Conversation

A Conversation With Citadels Mark Stainton, and Leading Energy

Expert, Daniel Yergin of IHS Cambridge Energy Research Associates

Renowned as one of the worlds foremost energy experts, Dr. Daniel

Yergins insights into the economics and politics of energy markets
are closely followed by CEOs, government leaders and investors
worldwide. In this edition of The Citadel Conversation, we ask
Dr. Yergin and Mark Stainton, Head of Global Energy at Citadel,
to share their views on topics ranging from the prospects for U.S.
energy independence to the ramifications of the shale gas boom.

Citadel is pleased to share The Citadel

Conversation, a series of conversations with some
of the worlds leading economists, policy experts
and market analysts. We believe that powerful
ideas drive markets around the globe. By sharing insights and ideas from provocative thinkers
we hope The Citadel Conversation will provide
readers with renewed curiosity and informed
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The views expressed in The Citadel Conversation
reflect those of the individuals being interviewed.
These perspectives are neither endorsed by
Citadel nor reflect our view on investments.

THE CITADEL CONVERSATION | PAGE 1

Q: The recent boom in U.S. oil and natural gas production has revived talks of energy independence
a promise first made during the Nixon Administration. How close is that to a reality today?
Yergin: The U.S. has turned a corner. Our production is up 25% since 2008 and
our automobiles are getting more energy efficient. When people are talking
about energy independence, they really mean oil independence. What we
are predicting is that U.S. oil imports will continue to go down and we will see
more and more of our imports coming from our neighbor to the north, Canada.
Q: In The Quest, you write that were moving from a world with one billion cars to a world with two billion cars and the challenge will be how to
develop the energy to power those one billion new cars. What type of fuel
do you think will power that two-billionth car?
Yergin: More likely than not, gasoline. But that two-billionth car will be far
more efficient than that billionth car. It will take another five to 10 years to
determine whether the electric car is a niche vehicle, a get-around-town
vehicle, or a mass market product. In places where you have cheap natural
gas, there will be more natural gas vehicles on the road, especially in fleets and
long-distance trucks.
Q: How do you account for the potential growth of natural gas vehicles on
the energy trading desk?
Stainton: From an investment point of view, we spend a lot of time analyzing
market trends, but our focus is on the shorter term the next three, six or nine
months rather than the next five years. While natural gas vehicle fleets have
grown in the U.S., it is not having a material effect on the U.S. natural gas market in 2012 nor will it until a significant investment in infrastructure takes
place to allow those natural gas-powered vehicles to be used more widely.
Q: How do you look at shale gas and its potential as a source for electricity
and the notion that it might be exported from the United States?
Stainton: Shale gas has been a game changer in energy markets. Since 2008,

natural gas prices have been on a one-way trend, falling from $13 to less than
$2 earlier this year. Its hard to believe, but five years ago, the U.S. was actually
talking about importing large volumes of natural gas. Shale gas has completely
changed all that. Now, were seeing growth in industrial plants and chemical
plants being built on the Gulf Coast, along with natural gas export terminals.
Those facilities, once completed, will structurally increase demand for natural
gas in North America. Since most of these facilities wont come online until 2015
or 2016, this coming structural change is not driving our short-term trading
strategies, but were keeping our eye on these developments for the long term.
Q: Shale gas now represents 38% of U.S. production. Will it continue to
grab a greater share?
Yergin: The number-one energy innovation in the 21st century has been shale
gas in terms of scale and impact. Gas is about 25% of our total energy consumption and that number is going to continue to climb. Shale gas could reach
50-60% percent of our gas production by the end of this decade. Despite the
decline in prices that Mark described, companies are going to continue to drill to
preserve their leases. As gas prices decline, were also seeing companies shifting
from natural gas to tight oil because the economics are so much more beneficial.
Q: When do you think the U.S. will see the effect of the shale boom translate into GDP growth or other broader economic benefits?
Yergin: Shale has turned out to be a very bright spot in a drab economy.
Those 600,000 new jobs created directly and indirectly by the development
of shale gas have certainly helped with the unemployment rate. Theres been
a big boost to domestic manufacturing, construction, engineering, pipelines,
transportation and terminals. And as natural gas pushes coal out of electric
generation, our CO2 emissions also go down.
Stainton: The impact of shale gas on the U.S. economy has already been
substantial. Lower gas prices have driven down electricity prices for U.S.

Daniel Yergin
Daniel Yergin is Vice Chairman of IHS and Founder of IHS Cambridge Energy Research Associates (CERA); a Pulitzer
Prize winning author; and a highly respected authority on energy policy and international politics and economics.
Dr. Yergin is the author of the new bestseller The Quest: Energy, Security, and the Remaking of the Modern World, which
has been hailed as a must read for understanding the future of energy markets and the global economy. He received the
Pulitzer Prize for his previous bestseller, The Prize, and won the United States Energy Award for lifelong achievements in
energy and the promotion of international understanding.
Dr. Yergin serves on the U.S. Secretary of Energy Advisory Board; as a Trustee of the Brookings Institution; and on the
Advisory Board of the Massachusetts Institute of Technology Energy Initiative. He received his B.A. from Yale University
and his Ph.D. from Cambridge University, where he was a Marshall Scholar.

Mark Stainton
Mark Stainton is Head of Global Energy at Citadel. The Global Energy strategy invests in the Global Crude and Refined
Product markets, U.S. and European Natural Gas, European Power Trading, and Agricultural markets and is active in
options markets across commodities. The team is based in Citadels London and Chicago offices.
Mr. Stainton joined the firm in 2006 and is a member of Citadels Portfolio Committee. Prior to joining Citadel, he was
Head of CDO and Exotic Credit Trading at Deutsche Bank, overseeing the global business with teams in London, New York,
Tokyo and Singapore. Previously, he spent three years with JPMorgan Chase in London, where he was a specialist in interest rate and currency products. He began his career at McKinsey & Company.
Mr. Stainton holds a bachelors degree in mathematics from Oxford University.

THE CITADEL CONVERSATION | PAGE 2

consumers and industries, which has been a huge benefit to manufacturers,

chemical plants and other energy-intensive segments. Oil refineries, chemical and fertilizer plants are also benefitting. The next big leap will occur when
the major new infrastructure based on natural gas is completed over the next
three to four years.

to promoting what they call new energies, but the country to really watch is
Japan especially as it moves away from nuclear power and steps up R&D
spending on renewable energy. Necessity is the father of invention.

Natural gas is changing the political discourse about energy in

this country. Its not just about greater energy security; its also
the recognition that shale gas is a major boon to our economy.

Yergin: We should be supporting a diversified energy mix. In order to attract

researchers willing to make a career commitment, we need a steady funding stream, rather than just seeing it go up and down. In 2004 and 2005, we
saw a lot of confidence by venture capital funds that began investing heavily
in renewables. But, fast forward to today and theres much less enthusiasm
because people realize energy is different than IT. It takes longer, its capital
intensive and youre trying to replace, in many cases, a lower-priced source
with a higher-priced source and theres a great deal of regulation and politics involved. The history of the energy sector is the history of innovation, but
things can take a long time. Even shale gas, which seemed to burst on the scene
in 2008, was 25 years in development.

- Daniel Yergin
Yergin: Natural gas is also changing the political discourse about energy in
this country, for the reason Mark just mentioned. Its not just about greater
energy security; its also the recognition that shale gas is a major boon to our
economy. Both parties have recognized that shale gas significantly benefits the
economy, improves our competitive position and helps revitalize our manufacturing base.
Stainton: Theres an enormous political decision coming up over the next two
to three years, which is, how many natural gas export terminals will the U.S.
allow to be built? If the government allows more export terminals, U.S. natural gas prices will converge with global prices. This will effectively transfer a
significant amount of wealth to the producing companies, but will increase
costs for consumers and industrial companies in the U.S. If the government
limits the number of export terminals, then U.S. natural gas prices will remain
depressed, which will give a significant advantage to consumers and companies at the expense of the producers. Its a difficult but important decision.
Yergin: At this point, it seems likely that we will end up with somewhere
between three and six liquefied natural gas (LNG) export facilities. Those facilities will take up some of the market surplus, but wont have a major impact on
domestic natural gas prices. Prices will go up at some point anyway because of
the economics of drilling, but will remain fairly moderate compared to what
people remember from six years ago.
Q: The Quest provides a fairly upbeat assessment of the future of coal. Isnt
this going against conventional wisdom?
Yergin: In all of our scenarios, coal demand continues to grow. Not in the U.S.,
where its really fallen, but as gas prices eventually go up somewhat, coal could
start to regain some market share. Its global. Coal dominates Chinas electric
generation and its power system, which is considerably bigger than the U.S.,
and dominates in India and other emerging countries as well.
Stainton: Weve definitely seen that. Imports of coal in India and China have
grown significantly; both have substantial programs to dramatically increase
the production of domestic coal. Theres been more coal burned in the past few
years than ever before.
Q: What does that mean for the fortunes of U.S.-based coal companies?
Stainton: It means U.S. coal companies need to export.
Yergin: Yes this is part of the new debate in the U.S., which Mark has alluded
to namely, what role will the U.S. play as an energy exporter. This is something that would never have been on the political agenda five or six years ago.
Q: How do you see the future for renewables? Have the predictions about
their part in the energy mix panned out? Where do you think they will fit in
over the next 10 to 20 years?
Yergin: From todays perspective, we can see that the enthusiasm about renewables back in the 1980s was really about very immature technologies. Today, it is
a much more sophisticated business, with a great deal of technological advance,
growth and scale. Its now a $167-billion dollar business with global players and
global competition. Most of the gain in renewable electricity has been in wind,
which accounts for 4% of U.S. electric generation and an even higher share in
Europe. Solar is much smaller, but costs have been coming down and in seven
to eight years solar could be the next surprise. China has a strong commitment

Q: Whats your view on renewables as a matter of government policy?

Obviously, they still require a lot of government support.

Q: From a trading or investment perspective, do you see any trading opportunities in renewable energy, or is it still too small of a market to merit a lot
of attention from your standpoint?
Stainton: At the moment, renewables are heavily driven by political decisions
rather than the pure economic or market decisions we analyze. More broadly
speaking, we follow the issue because the growth of renewables in one country affects commodity prices that we trade. The significant growth of wind, in
particular, in the U.S. and northwest Europe impacts both energy prices and
the demand for the carbon fuels that we trade. Plus, we trade electric energy
itself in European markets and in France, Germany, Spain and the U.K., the
significant growth of wind has had a meaningful impact on the power prices.
Q: Do you look at renewables as a competitive business in terms of scale?
Wind, by all accounts, is really almost a conventional energy source now.
Stainton: Within my team, we dont currently trade companies or stocks; we
are only trading the commodity. My personal view on renewables is that it is a
necessary development. We need to build a more diversified and sustainable
mix of energy across the globe and renewable sources are a key component of
that. Its unclear, at this point, which one of the renewables will have the best
economies of scale, but it makes sense to develop these technologies.
Yergin: Mark just made a very important point. When you look at a world
economy that could double in size over the next 20 to 25 years, you realize
were going to need both energy diversification and more energy options to
support that scale of growth.
Q: In 20 years, what percentage of the U.S. energy consumption mix will
still rely on hydrocarbons?
Yergin: In two decades, the world may be using something like 35% more
energy. Renewables will grow, but so will conventional energy demand. The
striking thing is that the share of consumption coming from fossil fuels may
decline from over 80% to maybe 75%, but were not going to see the big shift
over the next 20 years. The big changes in the mix will come after 2030, when
we will really start to see the impact of the work scientists, engineers, entrepreneurs and companies from all over the world are conducting today.
Q: Given the new development of shale in the U.S., whats going to be the
impact on our relationship with the Middle East, and how do these countries view the shale boom?
Yergin: The Middle East is watching whats happening in the U.S. with great
interest. Obviously, they want to know what it means for their export markets.
Theyre also interested in the technology that brought about the shale boom.
Saudi Arabia now wants to develop shale gas so it can use more natural gas in
electricity generation to free up oil for export. Looking at the growth of U.S. oil
and natural gas, the growth in Canadian oil sands and what Brazil may achieve
with pre-salt deposits, were really seeing a rebalancing of world oil markets
with much less Eastern Hemisphere oil coming to the Western Hemisphere
and much more going to Asia.

THE CITADEL CONVERSATION | PAGE 3

Q: Is there a possibility of more political instability, especially with the

smaller producing countries who now find themselves in a more competitive market?
Yergin: There are several reasons to expect continued uncertainty and
instability. First, there is the standoff over Irans nuclear program. Second,
the Arab Spring will result in a decade of uncertainty over the direction of
these new regimes. Third, there is a significant youth bulge in many Middle
Eastern countries, generating millions of young people who do not have jobs
or many economic opportunities. Fourth, you still have Al-Qaeda. Another
very important player to watch is Yemen, which has a 1,100-mile border with
Saudi Arabia. And theres Syria, which is experiencing a very bloody civil war,
really a proxy war between Iran on one side and the Sunni Arab countries and
the West on the other. On top of all of this is the recent wave of awful attacks
on American interests across much of the region. All of this suggests were not
headed for a new era of calm in the Middle East, nor stability in the regions
relations with the rest of the world.
Q: How does China as it becomes the worlds largest importer of oil
become more involved in the security issues of the Middle East?
Yergin: Sometime around 2020, China will overtake the U.S. in oil consumption. As China gets more reliant on oil and grows more ambivalent about the
U.S.s role in policing the international sea lanes, it will want to establish a presence commensurate with its economic heft and its role as a huge oil importer.
It will best for everyone if this is done collaboratively, reflecting the common
interests the two countries have as importers, consumers and stakeholders in
a stable global oil market.
Q: How do you view the geopolitics of energy when looking at short-term
trading issues?
Stainton: I agree with Dans view of the Middle East. Despite the outlook for
growth in energy production in the U.S., Canada and Brazil, the scale of supply
in the Middle East is still enormous. For the foreseeable future, the Middle
East will play an integral role in energy prices. While we obviously monitor
political developments in the Middle East, its not an area where we feel we
have a trading advantage, unlike some of the other areas were working on.
Governments, more broadly, have had a significant impact on prices beyond
the Middle East and we look at those events closely as well. Uncertainty over
the euro, speculation over additional rounds of quantitative easing, the overall investment environment all these factors play a role in commodity prices
and impact trading strategies.
Q: Its hard to believe, but just a few years ago the big debate was about
peak oil. Why do predictions about future supply always seem to turn
out to be so wrong?
Yergin: When you look at the history of the oil business going back to Colonel
Drake in 1859, you see these recurring patterns when people say the end is
near. The arguments people were making in the 1880s, 1920s, 1940s or 1970s
all sound remarkably similar to the peak oil concerns of recent years. And in
each case, its technology, its know-how, its new areas that change that picture. The energy industry is high tech, it takes a long time, its expensive and
there are many geological and political risks. But, when all is said and done,
price signals still spur new developments in oil, natural gas, alternatives and
new technologies and in how we use energy.

When you look at the history of the oil business going back
to 1859, you see these recurring patterns when people say
the end is near....When all is said is done, price signals still
spur new developments in oil, natural gas, alternatives
and new technologies and in how we use energy.
- Daniel Yergin

Stainton: I agree basically, markets have worked. Price increases create

incentives for ingenuity and encourage new technologies across the whole
spectrum. The market price mechanism has definitely worked. It has been
able to keep the system in balance.
Q: On a narrow point, what about the reliability of power in the United States?
Will all the power be there, when people want it, as the economy grows?
Stainton: One major challenge centers on power transmission networks
specifically, how we will be able to incorporate new and increasingly volatile
forms of generation into their supply networks. Weve seen this a little bit in
the U.S. with respect to wind generation in Texas the difficulty of transferring
all this power to consumers that need it. In Germany, the huge growth in both
wind and solar, combined with the shutdown, almost overnight, of one third of
its nuclear fleet, has created serious imbalances in their transmission system.
Theyve had to run expensive oil power plants to keep the transmission grid
stable. As the energy mix and the sources of electricity generation in the U.S.
continue to shift, the transmission grid and networks will need to adapt.
Yergin: The other thing that I worry about is what I call in The Quest the bad
new world of cyber vulnerability. Our electricity grid is a prime example of
critical infrastructure that is a target for people who want to bring harm to
major countries, including the United States.

One major problem with the economics of building a new

renewable energy plant is theres no real way to store energy
right now. As battery technology improves, it could become a
game changer for the energy mix.
- Mark Stainton
Stainton: Dan makes a very interesting point in The Quest about the need
for new sources of energy to power all of our smart phones, iPods and other
gadgets. A potential side benefit of the growth of these devices is the leaps
being made in battery technologies. One major problem with the economics
of building a new renewable energy plant is theres no real way to store energy
right now. As battery technology improves, it could become a game changer for
the energy mix moving forward.
Q: Whats the future of the nuclear energy industry in the United States?
Yergin: In the U.S., two new nuclear projects are now underway with government support, including protections against changes in government
regulation. In a sense, the government is insuring against action by government. Beyond that, in an era of low natural gas prices, it is very hard for
utility companies to think about new nuclear power projects with its big costs,
regulations and long time horizon. Theres more discussion now about small,
modular nuclear plants their designs and the degree to which government
will support them.
Q: After this election, well have a second term of the Obama Administration
or a new Romney Administration. What are the first steps the country
needs in putting together a comprehensive energy policy? What would you
all advise?
Yergin: There are four things I would say. First, continue a strong commitment to energy R&D because that really is the future. Second, in more
practical terms, we need to bring greater predictability to the government regulatory process. Third, in terms of unconventional oil and gas, more efficiency
in leasing access to public lands would be very helpful. Fourth, we really need
to focus on the cyber vulnerability of our critical infrastructure.
Stainton: The most important thing to provide is a clear and stable environment where companies can make medium- to long-term investment decisions
with confidence. This will help the U.S. considerably.

THE CITADEL CONVERSATION | PAGE 4