The 2014-2015 Oil Crash

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The causes of the 2014-2015 oil crash and the likelihood of a rebound in 2016.

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End in Sight:

End in Sight The Twin Oil Crashes of 2014-2015 Nawar Alsaadi Nawar Alsaadi - Semper Augustus Capital - DRAFT COPY

What caused the 2014 oil crash?:

What caused the 2014 oil crash? High oil prices 2010-2014 Record CAPEX (2010-2014) Shale oil gusher Slowing global oil demand growth Increasing Supply-Demand imbalance OPEC change of strategy in late 2014 Nawar Alsaadi - Semper Augustus Capital - DRAFT COPY

High prices:

High prices C onventional oil resources scarcity, mid-east instability, a weak dollar along with an urbanizing emerging world created a sustained period of almost uninterrupted rise in oil prices and especially so from 2010 to 2014: Nawar Alsaadi - Semper Augustus Capital - DRAFT COPY From 2010 to 2014 Brent averaged $102 per barrel

CAPEX:

CAPEX Sustained high prices combined with advancement in technology leads record capex spending on global conventional and unconventional oil resources: North America lead the growth in O&G capex spending between 2010 and 2014: N.A. World Total 14.4% 10.2% 11.4% Average O&G capex growth 2010 -2014: Nawar Alsaadi - Semper Augustus Capital - DRAFT COPY

Shale Oil Gusher :

Shale Oil Gusher More then any other unconventional resource, the development of shale oil resources in the United States lead to a surge in US oil and NGLs production, which in turn caused a sizable jump in global oil supply: US Supply Global Oil Supply 6.3m increase Nawar Alsaadi - Semper Augustus Capital - DRAFT COPY From 2010 to 2014 US supply grew by an annual rate of 11.3% vs. 0.34% a nnual growth rate for the rest of the world (ROW) supply (ex-OPEC).

Slowdown in oil demand :

Slowdown in oil demand Sustained high prices along with a slowdown in Chinese growth lead to a slowdown in global oil demand growth especially in 2014: Nawar Alsaadi - Semper Augustus Capital - DRAFT COPY Average demand growth from 2010 to 2014 stands at 1.38m

Supply-Demand Imbalance:

Supply-Demand Imbalance The previous factors conspired to cause a significant supply and demand imbalance by 2014: US is the largest source of supply g rowth in 2013 and 2014: Nawar Alsaadi - Semper Augustus Capital - DRAFT COPY

OPEC changes policy :

OPEC changes policy Fearing a loss of market share due to the rise of competing oil supply sources (Shale oil, Brazil deepwater, Oil Sands..etc) OPEC refrains from cutting its production to balance the market, thus worsening the emerging oil “glut” : Nawar Alsaadi - Semper Augustus Capital - DRAFT COPY

Crash! :

Crash! Excess supply, slow demand, OPEC change of policy leads to a sharp readjustment in the oil price: Nawar Alsaadi - Semper Augustus Capital - DRAFT COPY

What caused the second oil crash?:

What caused the second oil crash? OPEC production surges Long lead time conventional supply projects come online Excessive inventories persist Nawar Alsaadi - Semper Augustus Capital - DRAFT COPY

What caused the second oil crash?:

What caused the second oil crash? It is generally believed that excess supply (especially the US shale oil supply surge) was the cause of the current oil crisis. This is true for what drove the 2014 oil crash, however what sustained the 2014 oil crash into 2015 is a second supply surge by OPEC. Not content with sustaining a high level of production in November 2014, OPEC flooded the market with additional oil production in the spring of 2015. OPEC supply surge was lead by Saudi Arabia and Iraq. Iraq’s supply increase was largely due to maturing IOC long lead supply projects, however the Saudi increase seems to have been designed to flood the market. Nawar Alsaadi - Semper Augustus Capital - DRAFT COPY

Long Lead Projects come online:

Long Lead Projects come online Record oil industry capex levels (slide 4) from 2010 to 2014 lead to a notable increase in the Rest of the World (ROW) supply in 2014 and 2015, thus exacerbating the global supply problem: Key areas benefiting from long lead production increase: Canada, Brazil and the North Sea. 1.3m cumulative production increase Nawar Alsaadi - Semper Augustus Capital - DRAFT COPY

Inventories Skyrocket :

Inventories Skyrocket The net result of the sustained supply-demand imbalance since 2014 has created a historic increase in global petroleum inventories: Elevated inventory levels have weighted heavily on prices, and will likely continue to pressure prices in the foreseeable future. Nawar Alsaadi - Semper Augustus Capital - DRAFT COPY

I What will solve this crisis? :

I What will solve this crisis? Higher oil demand Lower oil supply Lower inventories Nawar Alsaadi - Semper Augustus Capital - DRAFT COPY

Demand:

Demand Demand has responded to lower oil prices. 2015 oil demand growth has been the strongest in 5 years: Markets experiencing strong demand growth in 2015 are: China, India and the United States 1.8m increase Global oil demand is running at least one year ahead of what the IEA projected in its Medium Term Oil Market Outlook released in February 2015. Nawar Alsaadi - Semper Augustus Capital - DRAFT COPY

Will demand grow further?:

Will demand grow further? Oil demand elasticity is small, however due to the large size of the market, slight elasticity is sufficient to have a meaningful impact on the supply-demand balance. An IMF study covering oil demand elasticity between 1990 and 2009 concluded that a 1% change in oil prices leads to 0.019% change in demand over the short term, and a 0.072% over the long term. In the context of stable global GDP growth in 2016. T he effect of the sharp and sustained decline in oil prices since 2014 should lead to an acceleration in oil demand growth in 2016. Nawar Alsaadi - Semper Augustus Capital - DRAFT COPY

Supply :

Supply Global oil supply is still growing strongly due to the 2015 OPEC surge and continued supply growth from long lead oil supply projects. Global supply growth in 2015 has reached a whopping 3m barrels, thus bringing cumulative 2014-2015 supply growth to a massive 5.4m barrels . Despite the apparent strength in supply, the fundamentals underpinning the recent strong supply performance are unraveling. Nawar Alsaadi - Semper Augustus Capital - DRAFT COPY

Can supply growth be sustained?:

Can supply growth be sustained? Non-OPEC supply growth has decelerated materially. OPEC strong supply growth in 2015 is unlikely to be repeated in 2016, and so despite the removal of Iranian sanctions. Substantial CAPEX cuts are leading to an acceleration in the global net decline rate from 2.5% to 3.1% (CoreLabs). 2016 new capacity additions appear increasingly insufficient to replace net declines and meet demand growth. Prices are too low to incentivize new supply to come online. Historic Non-OPEC supply growth (including the 2016 IEA estimates ): 3m barrels swing New supply projects approvals down to multi year lows. *WSJ - WoodMac Nawar Alsaadi - Semper Augustus Capital - DRAFT COPY

Prices are substantially below the breakeven cost for new supply:

Prices are substantially below the breakeven cost for new supply Nawar Alsaadi - Semper Augustus Capital - DRAFT COPY

$50-60 Brent is the minimum required to stabilize non-OPEC supplies.:

$50-60 Brent is the minimum required to stabilize non-OPEC supplies. Super Majors such as BP, Total and Shell have indicated that $60 Brent is the price they requires to balance their business by 2017. Rystad Energy indicates that a price in excess of $70 Brent is required to meet long term demand: Nawar Alsaadi - Semper Augustus Capital - DRAFT COPY

Brent Futures prices are too below global breakeven levels:

Brent Futures prices are too below global breakeven levels Brent futures doesn’t cross $50 until January 2017: Brent futures doesn’t cross $60 until November 2019: Brent prices are too low to incentivize investments in additional supplies Nawar Alsaadi - Semper Augustus Capital - DRAFT COPY

The world is already at risk of a supply shortfall :

The world is already at risk of a supply shortfall Wood Mackenzie's analysis estimates that $1.5 trillion of uncommitted spend on new conventional projects and North American unconventional oil is uneconomic at $50 a barrel. (September 2015). Mr James Webb, Upstream Research Manager for Wood Mackenzie explains: "As the upstream industry responds to the low oil price , investment is down $220 billion in 2015 and 2016 compared with our pre-oil price crash projections. (September 2015). Oil companies have canceled or delayed final investment decisions on about 150 projects that are tied to 125 billion barrels of oil equivalent, which could stay underground for several years longer than expected amid a steep drop in crude prices, energy investment bank Tudor, Pickering, Holt & Co. (December 2015 ). “By not sanctioning projects today, you’re putting a hole in production in 2017, 2018 and 2019 — potentially a big hole,” said David Pursell , head of macro research at Houston energy investment bank Tudor, Pickering, Holt & Co. (December 2015 ). Nawar Alsaadi - Semper Augustus Capital - DRAFT COPY

Declines never sleep:

Declines never sleep Global natural decline rates in mature fields (70% of production) stand at 9% (WEO 2013), equating to 5.3m in annual decline on 85m barrels of crude production. Mitigated decline rates (70% of production) stand at 6.2% to 6.4% (WEO 2013), equating to 3.75m at mid-point on 85m barrels of crude production. Current Net decline (100% of production) rates stand at 3.1% (CoreLabs – October 2015), equating to 2.6m on 85m barrels of crude production. This is compared to a historical net declines of 1.5% to 2% (DNB Markets– August 2015). Lowered capex spending will lead to an acceleration in the net global decline rate. Nawar Alsaadi - Semper Augustus Capital - DRAFT COPY

Will declines accelerate?:

Will declines accelerate? “ If you go back to the 2008 and 2009 period ... we saw an increase worldwide in decline rates for all companies, basically for the entire industry , increase by a percent or two. And that's very significant" John Watson – Chevron CEO. Using data going back to the oil drop in the mid 1980s, analysts at Bernstein calculated the rise in depletion rates was 3 percentage points within two years after an oil price collapse began. Reuters, February 2015. We have identified 5 mb /d of project delays and cancellations between 2017 and 2019, while the reduction in maintenance Capex, infill drilling and EORs is likely to raise global average decline rates to over 5-5.5%. All of this will start to show up in steep declines in 2017 supplies.  Energy Aspects – October 2015. Mitigated decline rates increased meaningfully in 2009: Nawar Alsaadi - Semper Augustus Capital - DRAFT COPY

Offshore managed mature declines to accelerate as infill drilling collapses :

Offshore managed mature declines to accelerate as infill drilling collapses Total offshore production stood at 22m in 2015. (Rystad Energy) Mature offshore production stood at 15m in 2015. (Rystad Energy) Collapse in infill drilling is expected to remove 1.5m in mature offshore production in 2016 as managed declines accelerates to 10%. (Rystad Energy) New offshore projects sanctions scratches to a halt as industry gets squeezed by low prices. Reduced infill drilling and slow new project sanctions will further accelerate decline rates. Nawar Alsaadi - Semper Augustus Capital - DRAFT COPY

Accelerating decline rates impact:

Accelerating decline rates impact Needed oil supplies at 2% decline rate and 1m per year demand growth: Needed oil supplies at 4% decline rate and 1m per year demand growth: An increase in the net decline rate from 2% to 4% means an additional 9m barrels are required to satisfy demand over the next 6 year. Nawar Alsaadi - Semper Augustus Capital - DRAFT COPY

US offshore strength is masking the weakness onshore. :

US offshore strength is masking the weakness onshore. Total US production appears resilient: GoM production is surging: Nawar Alsaadi - Semper Augustus Capital - DRAFT COPY 4.9% decline 19.37% increase 8.8% decline Onshore shale and conventional production declining rapidly

US shale productivity hits a wall :

US shale productivity hits a wall After rising sharply from early 2015 until the summer months, US shale productivity plateaued since last August 2015: Expiring hedges, shrinking cash flow, rising debt service burden and a collapsing rig count indicate that US production declines will continue beyond 2016 and well into 2017: Nawar Alsaadi - Semper Augustus Capital - DRAFT COPY

How large is the 2016 imbalance? :

How large is the 2016 imbalance? Assuming 31.8m barrels in OPEC production in 2016 (up from 31.3m in 2015). Assuming 57.7m barrels of non-OPEC supply as per IEA November OMR. Assuming 1.2m of demand growth (95.8m total demand) as per IEA November 2015. The market will be over supplied by 500K barrels. Excess supply shrinking Nawar Alsaadi - Semper Augustus Capital - DRAFT COPY

Can 500K imbalance sink the market?:

Can 500K imbalance sink the market? A 500K average imbalance on standalone basis is small, however when combined with an already elevated inventories, it is problematic: An additional 500K in excess production could add an additional 182m barrels to storage or basically double the current 200m barrels excess. Nawar Alsaadi - Semper Augustus Capital - DRAFT COPY

Several factors could eliminate the 500K IEA assumed imbalance for 2016:

Several factors could eliminate the 500K IEA assumed imbalance for 2016 According to the IMF data (slide 16), demand growth accelerates long term in response to low prices. Yet, the IEA is forecasting a deceleration in demand growth in 2016 despite higher IMF global 2016 GDP estimates compared to 2015 (3.5% to 3.1%) and persistent low prices which argue for a boost in demand. Demand growth on par with 2015 would add 800K of additional demand to the IEA 2016 demand estimate. Decline rates are likely to accelerate as both investments in existing production and new production are curtailed. An additional 1% acceleration in net declines leads to 800K-900K decline in global oil supplies. The IEA has historically underestimated demand by an average of 700K per year: Nawar Alsaadi - Semper Augustus Capital - DRAFT COPY

Will OPEC ever act?:

Will OPEC ever act? OPEC policy is lead by Saudi Arabia and Saudi oil policy is driven by three key factors: Maximize oil revenues. Maximize long term oil demand. Contain emerging supply competition. Saudi Arabia constantly seeks to balance these three policy drivers. A close examination of these objectives that Saudi interests will be optimized at $60 to $70 Brent ($55 -$65 WTI ). At such a price level range high cost oil supply growth will be contained. Global oil demand will remain robust. Oil revenues will be maximized. Long term volatility will be reduced as sufficient industry investments lead to stable oil supply. Recent comments by Saudi officials have signalled $60 to $80 Brent ( FT November 2015 ) as their desired price range. Saudi royals and officials have also recently stressed the need sustained investments in the industry to ensure future stability. Current oil prices and the associated severe industry capex cuts run contrary to the three key Saudi oil policy objectives. A change of Saudi oil policy over the next 6 months is highly likely should oil prices fail to rally to $50 Brent in 1H-2016 . A modest 1m cut by the GCC countries (Saudi Arabia, UAE, Kuwait and Qatar) could radically change the outlook for the oil market in 2016 and align prices with Saudi objectives. OPEC historical production has rhymed with their quota. Nawar Alsaadi - Semper Augustus Capital - DRAFT COPY

How much supply can Iran bring to the market in 2016? :

How much supply can Iran bring to the market in 2016? Despite Iranian claims that they can ramp up production by 1m barrels in short order. Those claims have been disputed by a number of experts. An extensive analysis of Iranian fields and decline rates by Sanford Bernstein concluded the following in November 2015: Our analysis of production recovery after significant negative events including wars/sanctions enhanced by our technical knowledge of Iranian fields and historical development problems show us that an immediate Iranian recovery to the tune of 500,000 bpd as soon as sanctions are lifted in early 2016 is untenable. A more bullish report by Reuters Oil Research (December 2015) concludes that Iranian production will average 3.38m in 2016 vs. 2.8m in 2015, thus equating to 580K barrels increase. Most observers suggest that 3–3.5 million b/d is a more realistic target over a period of a year after the removal of sanctions, if not longer. Chatham House March 2015 Nawar Alsaadi - Semper Augustus Capital - DRAFT COPY

How about the rest OPEC?:

How about the rest OPEC? Iraq production growth has been strong in 2015, however reduced investments due to low oil prices will likely restrain supply growth going forward. The IEA expects Iraq’s 2016 production to be broadly flat with Q3-2015 levels at around 4.2m barrels. Bullish forecasters (Thomson Reuters Oil Research) expect Iraq’s production to average 4.38m barrels in 2016 or about 200K increase from current levels. Saudi Arabia has theoretical sustainable capacity in excess of 12m, thus can potentially add an additional 2m barrels to the market, however there is no indication that Saudi Arabia is planning to pump beyond its 10.25m 2015 average. Saudi Arabia have always maintained an excess capacity cushion. The rest of OPEC is pumping at maximum, and according to the IEA MTOMR, beside Iraq and Iran no other OPEC country is expected to add meaningful capacity between 2015 and 2020. Libya is a wild card, potential stability in Libya could lead to a sizable increase in their production. Nawar Alsaadi - Semper Augustus Capital - DRAFT COPY

Call on OPEC & Market Balance :

Call on OPEC & Market Balance According to the November IEA OMR, the call on OPEC for 2016 has been raised to 31.3m barrels. (Current OPEC production is 31.7m). The call on OPEC is expected to rise to 31.9m by Q3/2016 and to 32.1m by Q4/2016. Oil prices have a high correlation with the increase or decrease for the call on OPEC. The rising call on OPEC signal that the market will balance by 2H-2016. Nawar Alsaadi - Semper Augustus Capital - DRAFT COPY

What’s the proper long term price for oil?:

What’s the proper long term price for oil? According to Sanford Bernstein oil prices always trend back toward the marginal cost of production: Depending on the source, the current marginal cost of oil production ranges from $70 to $85 Brent. Nawar Alsaadi - Semper Augustus Capital - DRAFT COPY A Monte Carlo simulation by ConocoPhillips ( November 2015 ) conclude that long term oil prices should average in the $70 to $75 range. Several credible pricing models indicate that current oil prices are substantially divergent from their long term average.

Goldman says lower for longer, are they right?:

Goldman says lower for longer, are they right? In January 2015 Goldman Sachs made the bearish prediction that oil prices will stay low for longer. As we exit 2015, we see that Goldman Sachs was right, but where they right or just lucky? In their January 11 th 2015 bearish call Goldman Sachs made the following supply and demand assumptions for 2015? Non OPEC supply: 57.7m OPEC crude supply: 30.15m OPEC NGLs: 6.6m Total Supply: 94.45m Demand: 93.8m Supply/demand imbalance: 650K How did 2015 actual demand and supply numbers turned out compared to What Goldman Sachs expected? IEA Non OPEC Supply: 58.3m Goldman miss: 600K IEA OPEC crude supply: 31.3m Goldman miss: 1.15m IEA Demand: 94.6m Goldman miss: 800K GS bearish 2015 projection was saved by an unexpected 1.15m OPEC production increase. Goldman Sachs expects 2016 Supply/demand imbalance to average around 400K* Will they get lucky again? * Lower for Even Longer September 2015 Nawar Alsaadi - Semper Augustus Capital - DRAFT COPY

Conclusion :

Conclusion The conditions leading to the 2014 oil collapse such as record capex, strong non-OPEC supply growth and weak demand have been reversed. OPEC’s 2015 supply surge is unlikely to be repeated. Global decline rates will likely accelerate in 2016 and beyond. Global inventories remain elevated, and will take at least a year of sizable supply deficits to reduce. Oil prices are too low to incentivize new supply, the prospects of an oil shortage in 2017 to 2019 are increasing. Most supply and demand models indicate a balancing market by 2H-2016. There is an increasing chance that OPEC/Saudi Arabia will act to reduce supply in the next six months if prices fail to rally above $50 Brent. A multitude of supply and demand models indicate that long term oil prices should exceed $70 Brent. Nawar Alsaadi - Semper Augustus Capital - DRAFT COPY

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