The Arctic – What Is At Stake?

People. Ideas. Success.

Guggenheim Partners The Melting g Arctic: Business Opportunities pp in Arctic Development p Scott Minerd Global Chief Investment Officer January 2014 Guggenheim G h i IInvestments t t (“G (“Guggenheim”) h i ”) represents t th the ffollowing ll i affiliated ffili t d iinvestment t t managementt bbusinesses i off G Guggenheim h i P Partners, t LLC GS GAMMA Advisors, LLC: Ad i LLC, LLC Guggenheim G h i Aviation, A i ti Guggenheim G h i Funds F d Distributors, Di t ib t LLC, LLC Guggenheim G h i Funds Investment Advisors, LLC, Guggenheim Partners Investment Management, LLC, Guggenheim Partners Europe Limited, Guggenheim Partners India Management, Guggenheim Real Estate, LLC, Security Investors, LLC and Transparent Value Advisors, LLC. This material is intended to inform you of services available through Guggenheim Investments’ affiliate businesses.

The Arctic Shipping pp g Opportunity pp y

•

Climate scientists estimate the Arctic could be ice-free in the late summer as early as 2030 −

Along with the retreat of sea ice, the ice is also becoming thinner and younger, meaning it is much easier to navigate through.

−

The Arctic is warming twice as fast as the rest of the world. The melting of Arctic sea ice is part of a feedback loop that accelerates warming and reduces ice extent.

Receding sea ice will open three main trans trans-Arctic Arctic shipping routes: − − −

•

The Northern Sea Route The Northwest Passage The Transpolar Sea Route

The Arctic is most appealing for certain kinds of shipping: −

−

7M 6M 5M 4M 3M

Because of unpredictable and unreliable conditions in the Arctic, the tight schedule along multiple stops that container shipping relies on is not possible.

Route

Length (km)

% accessible, 2000-2014

% accessible, 2045-2059

Northwest Passage

9,324

63%

82%

Northern Sea Route

5,169

86%

100%

Transpolar Sea Route

6,960

64%

100%

Mostt currentt traffic M t ffi is i destination d ti ti shipping hi i within ithi th the region, i nott transits through the Arctic. o

−

8M

Shipping through the Arctic will initially be most viable for shipping bulk raw materials, rather than for container shipping. o

−

September Average Sea Ice Extent Title 9M

sq. km s

•

Mostly in the form of transporting natural resources from the Arctic, or delivering supplies to extraction areas in the region.

Smaller ships need to be used in Arctic shipping, meaning the cost per g , even if the total voyage y g costs are less. This container is usuallyy higher, is less of an issue for bulk carriers.

Ships transiting the Arctic can reduce speed and thus fuel costs instead of saving time, which may be more attractive for bulk carriers.

Source: Humpert p and Raspotnik, p , The Future of Arctic Shipping pp g Alongg the Transpolar p Sea Route.

Please see Disclosures and Legal Notice at end of Document

2

Arctic Shipping pp g Routes

Please see Disclosures and Legal Notice at end of Document

3

Ice Conditions Could Allow Large g Increase In Arctic Shipping pp g Traffic •

A 2013 study by Smith and Stephenson modeling climate change over the coming decades found that based on ice conditions, it is likely for Arctic traffic to increase substantially by 2040.

•

The simulation found that by 2040 traffic along the Northern Sea Route will increase substantially and venture further away from the coast, where the waters are more navigable.

•

Meanwhile, the Northwest Passage will open up to both polar strengthened ships and ordinary ships, in some cases.

•

The Transpolar Sea Route will be used by polar class vessels, instead of the Northern Sea Route, due to the more direct nature of the route.

Polar class vessell

Polar class vessell

Common ships

Common ships

Northern S R Sea Route t

Transpolar Sea Route

Northwest Passage

Source: New Trans-Arctic Shipping Routes Navigable by Midcentury, Smith and Stephenson (2013).

Please see Disclosures and Legal Notice at end of Document

4

The Northern Sea Route Also known as the Northeast Passage, the Northern Sea Route (NSR) lies mostly along Russia’s northern border, and is approximately 2,600 nautical miles long.

The route would be applicable for trade between Asia north of Singapore and northern Europe. − Trade between northwestern North America and Europe could also benefit:

•

•

−

The distance between Vancouver and Rotterdam is 8 days shorter than through the Panama Canal.

In 2010, just 4 permits were issued for full transits of the NSR. − This increased to 41 in 2011, 46 in 2012, and 71 in 2013.

•

The amount of cargo transported has increased at a slower pace: from 824,000 tons in 2011 to 1.26 million in 2012, and 1.36 million in 2013. − Most of this cargo traveled in an east-to-west direction.

•

Distances and Days Saved from Kirkenes (Norway) and Murmansk (Russia) Destination

Via Suez Canal

Through Northern Sea Route

Days Saved

Distance, Nm

Speed Knots

Days

Distance, Nm

Speed Knots

Days

Shanghai China

12,050

14.0

37

6,500

12.9

21

16

Busan, Korea

12,400

14.0

38

6,050

12.9

19.5

18.5

Yokohama, Japan

12,730

14.0

39

5,750

12.9

18.5

20.5

Source: Tschudi Shipping Company A/S, cited in Lloy’d’s, “Arctic Opening: Opportunity and Risk in the High North”.

Northern Sea Route Transits 80

71

70 60 50

41

46

40 30 20 10

4

0 2010

2011

2012

2013

Source: Northern Sea Route Information Office, Guggenheim Investments. Data as of 12/31/2013.

Please see Disclosures and Legal Notice at end of Document

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The Northern Sea Route: Studies and Projections j A study by DNV calculated the cost of an NSR transit vs. a Suez Canal route. Costs factored in ice projections, speed, fuel consumption, and additional costs from building and operating ships suitable for the Arctic. − − − −

•

The study found that Arctic transit from Tokyo would be economically attractive for part of the year in 2030.

They y project p j 1.4 million TEU of 3.9 million TEU from Tokyo y will be transported p across the Arctic,, which translates to about 480 transit voyages. y g By 2050, these numbers rise to 2.5 out of 5.6 million TEU for 850 voyages. The predicted amount of containers that will be transported through the Arctic corresponds to about 8% of the total container trade between Asia and Europe in 2030, and about 10% in 2050.

The study also found shipping from central ports in Asia (Hong Kong) is likely to become marginally profitable only with high bunker prices and a long summer sailing season in 2050. Traffic across the Arctic from the southern ports in Asia (Singapore) will not be profitable due to a longer sailing route than via Suez.

Other projections on NSR shipping vary widely: − − − − −

“Freight volume…is expected to triple by 2017.” (Der Spiegel) “Cargo transport will nearly tenfold…to some 19 million tons in 2020.” (Murmansk Governor Dmitriyenko) “The volume to be transported along the NSR will increase…to 50 million tons in 2020. Oil and gas will make up the bulk of this increase.” (Bambulyak and Frantzen, 2009) “Maritime experts sayy two percent of global g shipping g could be diverted to the Arctic by y 2030, reaching g 5 percent by y 2050.” ((The Arctic Institute)) South Korea’s Maritime Institute estimates the NSR could account for a quarter of Asia-Europe trade by 2030.

100

Million Tonnes

•

80

Transit

60

The Northern Sea Route - East

40

The Northern Sea Route - West

From Murmansk to Northern Sea Route's Starting Point

20

0 2016

2020

2030

Source: The Issues and Prospects of an Expanded Arctic Transportation Network, Alexei Konovalov (2012), Haver Analytics, Guggenheim Investments. Actual data as of 12/31/2011.

Please see Disclosures and Legal Notice at end of Document

6

The Northern Sea Route: Time and Cost Savings g •

•

One study found that shipping along the NSR is currently less costly than through the Suez Canal for selected routes. Specifically, the study examined a scenario of shipping LNG from Hammerfest, Norway to Tobata, Japan (See table to the right) Japan.

In 2010, the bulk carrier Nordic Barents carried 41,000 tons of iron ore from Kirkenes, Norway to Lianyungang, China, saving 17.5 days relative to the Suez route. − − − − − −

•

Shipping LNG from Melkoya, Norway to Yokohama, Japan saves 21.4 days, for total roundtrip cost savings of: − − − − −

•

Distance: 6,500 nm vs. 12,180 nm Speed: 12.03 knots vs. 13 knots Time: 22.5 days vs. 40 days Fees: $5/ton icebreaker assistance fee vs. $5/ton Suez fee Fuel cost: $300,000 saved Environmental savings: 1560 tons of CO2

Timecharter/day: $150,000 * 21.4 * 2 = $6,420,000 Bunkers burn off 0.1% LNG/day * 21.4 * 2 = $2,200,000 Suez round voyage cost = $150,000 NSR tariff t iff = ($632,000) ($632 000) Savings = $8,138,000

HammerfestNSR-Tobata

HammerfestSuez-Tobata

423

616

Total Fuel Cost

$1,032,000

$2,170,000

Suez Canal Fee

-

$413,000

$339,000

-

Insurance/day

$2,295

$2,086

C Crew C t/d Cost/day

$5 479 $5,479

$5 479 $5,479

Maintenance Cost/day

$7,326

$6,600

24

32

Operational Cost

$357,000

$451,000

Depreciation Cost

$1,580,000

$1,927,000

Total Cost

$3,307,000

$4,960,000

Navigation Hours

Ice Breaker and Ice Pilot Fee

Total Voyage Days

Source: Study of Feasibility of the Northern Sea Route from Recent Voyages, Otsuka, Izumiyama, and Furuichi (2013), Guggenheim Investments.

Shipping iron ore from Kirkenes to Shanghai saves 18 days, for total one way savings of: − − − − −

Timecharter/day: y $15,000 $ , * 18 = $270,000 $ , Bunkers fuel 33 * 700 * 18 = $416,000 Suez cost = $250,000 NSR tariff = ($375,000) Savings = $560,000

Source: Tschudi Shipping Company, Guggenheim Investments.

Please see Disclosures and Legal Notice at end of Document

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The Northwest Passage g •

Potentially applicable for trade between Asia north of Shanghai and the northeast of North America −

Distance saving between northwest North America and Europe was also demonstrated by the recent transit of the Danish-American, Nordic Orion, carrying coal from Vancouver to Finland, which saved 5 days relative to the Panama Canal and $80,000 in fuel.

•

Several potential routes, the more northerly routes, are more direct but more prone to ice blockage.

•

Ice conditions will not improve as quickly as in the NSR. − −

The route is currently ice free for about two months a year.

This is especially problematic because of the many narrow straits on the route, where ice tends to collect. o

−

Narrow straits also limit the size of ships, in addition to shallow areas along the Northwest Passage (NWP).

There is also less infrastructure in the region, and currently less of a political push to develop the route.

•

The Northwest Passage will face pressure not only from the significantly widened Panama Canal, but also from rail transport across North American for Asian trade to the U.S. east coast.

•

The simulation study by Smith and Stephenson found that by the 2040-2059 period the NWP will be the most efficient route for transits to or from eastern North America for polar strengthened vessels vessels, and will be an efficient option for ordinary ships most of the time time.

Please see Disclosures and Legal Notice at end of Document

8

The Transpolar p Sea Route •

The Transpolar Sea Route (TSR) is a direct route through the middle of the Arctic Ocean.

•

The TSR as a viable shipping route is a long-term prospect, as the route is currently covered by ice, even in the summer.

– However, H iicebreakers b k h have already l d ttransited it d the th route, t and d even with ith iice still till presentt th the route t may b become available il bl ffor use.

•

Over the long-term, as demonstrated by the Smith and Stephenson study, the TSR could replace NSR as the most efficient route for polar class vessels, and even some ordinary ships with the assistance of an icebreaker.

•

Advantages: − Most M t direct di t route t (up ( to t 41% di distance t savings i b t between Tokyo T k and d northern th Europe) E ) − Few draft and beam restrictions, can accommodate all but the very largest Ultra Large Crude Carriers − No country can claim it

Port of Origin

Port of Destination

Distance in Nautical Miles

Days at sea at 17 knots

Via Suez Canal

Via TSR

Via Suez Canal

Via TSR

Distance savings in %

Tokyo

Rotterdam

11,192

6,600

27.4

16.1

-41%

Shanghai

Rotterdam

10,525

7,200

25.8

17.6

-32%

Hong Kong

Rotterdam

9,748

8,000

23.9

19.6

-18%

Singapore

Rotterdam

8,288

9,300

20.3

22.7

+12%

Source: The Future of Arctic Shipping Along the Transpolar Sea Route, Humpert and Raspotnik (2012).

Please see Disclosures and Legal Notice at end of Document

9

Challenges g for Arctic Shipping pp g •

Ice − −

•

More open water = unpredictable ice flows Even as ice diminishes, diminishes first first-year year ice disappears first first, allowing much harder/more difficult multi-year ice to drift into lanes, potentially gathering in chokepoints

Weather − − − −

•

•

Costs −

Ice breaker fees o Average cost for escort through NSR around $200 $200,000.

000 o However, not all ships require icebreaker escorts.

−

Slower speeds due to conditions Icebreakers or ice class cargo vessels burn more fuel Insurance Equipping ship for ice Permits o Russia currently requires permits for ships using any part of the NSR. In the past, this process has been time consuming. o New N agency, N Northern h S Sea R Route Ad Administration, i i i opened in March to develop infrastructure and increase NSR traffic, which should help speed up permit applications.

−

Storms – polar lows (small storms that are difficult to detect and d predict) di t) Cold Fog (visibility) Sea spray causing icing

− − −

Difficulty of forecasting future climate. No one knows how global climate change will develop. −

August ice extent was up over 20% last year, demonstrating unpredictability even in the near-term

•

Shortened shipping season

•

Remoteness – rescue and emergency

•

Unreliable shipment times

•

Lack of infrastructure and infrastructure financing − − − − −

Refueling stations Transshipment ports Ship-to-shore communication Marine surveys/ice charts Lack of mariners with Arctic experience

−

•

Many of these costs are offset by the fact that costs are saved elsewhere. o Ice breaker fee, but no canal transit fee o Higher insurance, but no piracy insurance o Outfitting ship for ice, but no anti-piracy equipment

Smaller ships p = higher g cost p per container/ton of freight g − −

Many ships used elsewhere would require two icebreakers Draft and beam restrictions due to narrow and shallow straits

Please see Disclosures and Legal Notice at end of Document

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22% % of the World’s Undiscovered Oil and Natural Gas •

The Arctic currently accounts for about 11% of global oil production and 26% of natural gas production.

•

In 2008, the United States Geological g Survey y ((USGS)) estimated that the Arctic contained some 412.2 billion barrels of undiscovered oil and oil equivalent, 84% of which is estimated be offshore.

•

Over two-thirds of this was estimated to be natural gas – approximately 1,669 trillion cubic feet, representing 30% of global undiscovered natural gas (approximately equivalent to Russia’s entire current proven reserves of natural t l gas). )

•

Some 90 billion barrels were estimated to be oil – 13% of the estimated global total of undiscovered oil, (approximately three times the current total proven reserves of oil of the United States).

Undiscovered Oil Arctic – Eurasia 4%

Arctic – N. America 9%

Rest of World 87%

Source: Circum-Arctic Resource Appraisal, USGS (2008), Guggenheim Investments.

Estimated Undiscovered Arctic Oil and Gas Resources

Undiscovered Natural Gas

billion barrels s of oil equivalent

250 Oil

200

Gas

Arctic Eurasia 22%

NGL

150 100 Rest of World 70%

50

Arctic – N. America 8%

0 Russia

US

Norway

Greenland

Canada

Source: Circum-Arctic Resource Appraisal, USGS (2008), Ernst & Young, Guggenheim Investments.

Source: Circum-Arctic Resource Appraisal, USGS (2008), Guggenheim Investments.

Please see Disclosures and Legal Notice at end of Document

11

22% % of the World’s Undiscovered Oil and Natural Gas

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12

Arctic Oil and Natural Gas: Long-Term g Production Prospects p •

While the Arctic accounts for a large share of undiscovered oil, its share of total resources is smaller. −

Additionally, the cost of producing a barrel of oil from the Arctic ranges from $35 to $100 per barrel barrel. While this makes Arctic production currently viable, much cheaper conventional sources exist.

•

The Arctic’s 11% share of global oil production is likely to remain fairly steady over the coming decades.

•

A study by the Norwegian government found that while the Arctic will become an increasingly large share of non-OPEC conventional production and dA Arctic ti oilil output t t will ill d double bl b by 2050 2050, A Arctic ti oilil will ill actually t ll d decrease tto 8% of world oil production by 2050. −

•

Arctic Oil Production in Relation to Global Supply

However, if oil prices rise more than expected, the Arctic’s share could increase to 16% of world production.

The same study found that the Arctic’s share of natural gas production will decrease more substantially, from 26% currently, to 10% by 2050.

Source: The role of the Arctic in future global petroleum supply, Lindholt and Glomsrod (2011)

Long Term Oil Supply Cost Curve

Arctic Gas Production in Relation to Global Supply

EO OR

Coal to Liquids

Source: International Energy Agency, Guggenheim Investments

Source: The role of the Arctic in future global petroleum supply, Lindholt and Glomsrod (2011)

Please see Disclosures and Legal Notice at end of Document

13

Mining g •

The Arctic is believed to hold some of the world’s largest reserves of coal (Alaska alone is believed to have 17% of the world’s coal reserves), gold, silver, tin, nickel, copper, platinum, cobalt, iron ore, lead, zinc, and rare earth elements (REEs).

•

Most mineral development p to date exists in Russia, with Alaska and Canada being g relatively y unexplored p and underdeveloped. p

•

Russia’s Norilsk mine produces 22% and 40% of total global supply of nickel and palladium. Copper and platinum are also mined in significant quantities in Norilsk.

•

Alaska is home to the world’s most productive zinc mine, Red Dog.

•

Rare earth R th elements l t are also l d deemed d tto b be one off th the mostt attractive tt ti areas for f investment i t t in i the th Arctic, A ti particularly ti l l iin Al Alaska, k given i itits colossal l l mountain t i ranges. There are believed to be significant deposits of REEs in Alaska and in Canada’s Yukon.

Arctic Share of Global Mineral Extraction 45% 40%

40%

35% 30%

26%

25%

25% 22%

20%

20% 15%

15%

11%

10%

10%

9%

5% 0%

Palladium

Gem stones

Rare Earth Elements

Nickel

Diamonds

Platinum

Cobalt

Zinc

Tungsten

Source: The Coming Arctic Boom, Scott Borgerson (2013), IISS, Schroders, Guggenheim Investments.

Please see Disclosures and Legal Notice at end of Document

14

Infrastructure •

Developments in any industry (energy, minerals, shipping) will require substantial investment in infrastructure. −

•

According to Lloyd’s, investment in the Arctic could reach $100 billion over the next 10 years, years largely in infrastructure infrastructure.

Transportation needs are significant in every region of the Arctic. − − −

Existing infrastructure will become more expensive to maintain as temperatures increase and the permafrost layer becomes unstable.

Shorter winters are limiting the use of ice roads.

This will create a need for new infrastructure in many areas areas, including: o o o o

Roads Bridges Airports Railways

•

Pipelines and tankers are needed to make development of energy resources viable.

•

Though estimates of increased shipping differ, in any scenario more infrastructure will be needed in a variety of areas: −

Ports o Under optimistic scenarios, by 2030 cargo volume along the NSR could equal q the volume currently y handled by yp ports such as New York/New Jersey or Vancouver. o Existing ports are far too small to handle the projected increase in traffic. o Transshipment hubs could become especially important.

−

There are only approximately 50 icebreakers worldwide, far below what will be needed. Furthermore, Russia alone accounts for 25 icebreakers, while the U.S. has just two.

Ice class vessels will become increasingly needed as Arctic shipping becomes more viable and more attractive.

Ocean charting and surveying, marine navigation aids Marine communications, traffic monitoring and control Search and rescue capabilities

− − − −

Please see Disclosures and Legal Notice at end of Document

15

Other Opportunities pp Renewable Energy • • •

Norway has invested heavily in renewable energy, which now constitutes nearly 60% of its total domestic energy consumption.

Iceland derives over 80% of its energy supply from renewable sources, mostly geothermal.

There are a number of opportunities to replicate this successful model elsewhere in the Arctic, particularly in Alaska, with its wind and hydroelectric resource potential.

Water • • •

Most of the world’s fresh water is locked up at the poles, with Canada serving as a reservoir for 20% of the world’s fresh water.

Russia’s major rivers flow into the Arctic Ocean and Alaska is also a vast storehouse of fresh water.

Long-term supplies of pure mountain water can be shipped to any deepwater port on the planet.

Fishing • •

The Arctic already accounts for 10% of the global fishing catch.

As Arctic ice recedes and access becomes easier, the region will play an increasingly important role in the global fishing industry.

Other • • • •

The Arctic is an attractive tourist destination due to its unique environment, diverse cultures, and opportunities for hunting, boating, and sports tourism.

In 2004, 1.2 million passengers traveled to Arctic destinations on cruise ships. Just three years later, the number more than doubled.

8% of the world’s wood reserves lay within the Arctic.

Trans-Arctic telecom cables, satellite ground stations, and data centers also offer opportunities

Please see Disclosures and Legal Notice at end of Document

16

Economic Fundamentals Are Mostly y Favorable Gross Debt to GDP, 2012

Projected Real GDP Growth, 2013-2018 Average

120%

3.5%

100%

3.0% 2.5%

80%

2.0%

60%

1.5%

40%

1.0%

20% 0%

0.5% Canada

Denmark

Finland

Iceland

Russia

Sweden

US

Source: IMF, Guggenheim Investments.

0.0%

Canada

Denmark

Finland

Iceland

Russia

Sweden

US

Russia

Sweden

US

Source: IMF, Guggenheim Investments.

GDP per Capita, 2012

Ease of Doing Business Rank, 2012

$80,000 $ ,

120

$70,000

100

$60,000 80

$50,000 $40,000

60

$30,000

40

$20,000 20

$10,000 $0

Canada

Denmark

Source: IMF, Guggenheim Investments.

Finland

Iceland

Russia

Sweden

Alaska

0

Canada

Denmark

Finland

Iceland

Source: IMF, Guggenheim Investments.

Please see Disclosures and Legal Notice at end of Document

17

The Arctic Is a Large, g , Fast Growing g Region g Share of Global GDP, 2012

Real GDP Growth by Region (2002=100)

12%

11 5% 11.5%

250 Arctic

10%

225 World

8%

200

7.0%

Others 6%

4%

Canada 3.3%

175

Developed Markets

150

US

2.5% 125

2% Russia

100

0% Arctic

Brazil

India

China

2002

2004

2006

2008

2010

2012

Source: IMF, Guggenheim Investments.

Please see Disclosures and Legal Notice at end of Document

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