Commodities The fundamental factors behind rising food and fuel prices The Goldman Sachs Group, Inc....

CommoditiesThe fundamental factors behind rising food and fuel prices

The Goldman Sachs Group, Inc.

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June 2008

Samantha Dart Goldman Sachs International 44-(0)207-552-9350 [email protected]

The structural oil price rally resumes, and starts to contaminate (tighten) the cyclical balance

Goldman Sachs Global Investment Research

3

Decomposing the price into timespreads (cyclical component) and the long-dated price (structural component)

$/bbl

Source: Goldman Sachs Commodities Research.

0

20

40

60

80

100

120

140

160

180

2008 2009 2010 2011 2012 2013 2014

The long-dated, secular component of price

Price = MC + d, where d is a delivery premium in a bull market or a discount in a bear market

In a cyclical bull market the spread is typically positive, reflecting a premium for prompt delivery

In a cyclical bear market the spread is negative reflecting the cost of carrying inventory

The short-term, cyclical component of price


4

WTI timespreads continue to reflect near-term fundamentals, such as inventory levels…

% 1m/60m WTI timespreads (vertical axis); total OECD stocks deviation from 10-year average in million bbls (horizontal)

Source: IEA, NYMEX, and Goldman Sachs Commodities Research.

-60%

-40%

-20%

0%

20%

40%

60%

80%

-200,000 -150,000 -100,000 -50,000 0 50,000 100,000 150,000 200,000


5

… while long-dated WTI prices continue to reflect long-term industry costs

$/bbl

Source: Goldman Sachs Commodities Research.

0.00

15.00

30.00

45.00

60.00

75.00

90.00

1991 1992 1993 1994 1995 1996 1997 1998 1999 2000 2001 2002 2003 2004 2005 2006 2007 2008

33240 33971 34701 35432 36162 36893 37623 38354 39084

Long-dated oil

Marginal costs

Marginal cost is defined as the average of the highest cost (or bottom quartile) producers


6

There is more than 4.0 million b/d of extremely high-cost oil production

$/bbl (vertical axis); thousand b/d (horizontal axis)

Source: Goldman Sachs Equity Research.

0.00

20.00

40.00

60.00

80.00

100.00

120.00

0 4,000 8,000 12,000 16,000 20,000 24,000 28,000 32,000 36,000

2006 2005 2004 2003

Required oil prices shifted upwards dramatically after 2003

It would now require 4 mb/d of extra low-cost spare capacity to sustainably push long-dated oil prices below $70/bbl


7

Increasing long-dated oil prices have driven the front of the curve higher

10.00

30.00

50.00

70.00

90.00

110.00

130.00

150.00

1990 1992 1994 1996 1998 2000 2002 2004 2006 2008 2010 2012

Jun 24, 2008 forward curve

Nov 20, 2000 forward curve

Jun 12, 2007 forward curve

$/bbl

Source: NYMEX.

Long-dated oil prices continues to drive the market higher

The structural oil price rally resumes,


9

Long-dated oil prices had found an equilibrium at biofuel price levels…

Source: NYMEX and CBOT.

Log($/bbl)

2.5

3.0

3.5

4.0

4.5

5.0

5.5

1999 1999 2000 2000 2001 2001 2002 2002 2003 2003 2004 2004 2005 2005 2006 2006 2007 2007 2008

Long-dated WTI price Vegetable oil price

Vegetable oil price gave an indication in 2004/05 of where the new reprice would stop. This time such a price level is unknown


10

… making biofuels economically viable and creating significant growth in their supplies

Source: IEA and Goldman Sachs Commodities Research.

Thousand b/d

0

500

1000

1500

2000

2500

3000

3500

Jan-

00

Jul-0

0

Jan-

01

Jul-0

1

Jan-

02

Jul-0

2

Jan-

03

Jul-0

3

Jan-

04

Jul-0

4

Jan-

05

Jul-0

5

Jan-

06

Jul-0

6

Jan-

07

Jul-0

7

Jan-

08

Jul-0

8

Biofuels

Tar Sands

Orinoco Belt

Post-2004/05 repricing the world has become

dependent upon biofuels and NGLS


11

Substitution: Btu, bushel and barrel convergence started last year

$/mmBtu

Source: NYMEX, ICE and Goldman Sachs Commodities Research.

0

5

10

15

20

25

30

Jan-95 Feb-96 Mar-97 Apr-98 May-99 Jun-00 Jul-01 Aug-02 Sep-03 Oct-04 Nov-05 Dec-06 Jan-08

WTI prices Corn prices Sugar prices

Prices are converging on a Btu basis


12

Source: FAO, USDA and Goldman Sachs Commodities Research.

Food demand is stable, feed demand is rising, and fuel demand is exploding

-10

10

30

50

70

90

110

130

60 62 64 66 68 70 72 74 76 78 80 82 84 86 88 90 92 94 96 98 00 02 04 06

Food (grains)

Feed (protein)

Fuel (biofuel)

Indices of per capita consumption, 2006=100


13

Source: FAO, USDA and Goldman Sachs Commodities Research.

Strong demand will require a substantial increase in acreage first time in decades

Index 1960 = 100

0.0

0.5

1.0

1.5

2.0

2.5

3.0

3.5

65 67 69 71 73 75 77 79 81 83 85 87 89 91 93 95 97 99 01 03 05 07 09 11 13 15

Acreage

Yield

Demand

Forecast

In the past, demand growth has been met through yield growth. However, the strong demand growth ahead will create a need for substantial acreage expansion.


14

Source: USDA and Goldman Sachs Commodities Research.

Rapid expansion in fuel use has led to an increase in the trend demand growth for agricultural commodities

Billion metric tons

0.0

0.2

0.4

0.6

0.8

1.0

1.2

1.4

1.6

1.8

2.0

2.2

2.4

2.6

60 62 64 66 68 70 72 74 76 78 80 82 84 86 88 90 92 94 96 98 00 02 04 06 08 10 12 14

2006 - 2015: 2.6%

Food demand

Feed demand

Fuel demand

1979-1988: 1.5%

1988-1997: 1.6%

1997-2006: 1.9%


15

Nearly all recent capacity (not supply) increases have come from non-conventional resources


Thousand b/d

Oil supply growthTotal Crude* NGL/Cond Biofuel Tarsand

World 1050 115 450 425 60OPEC 550 250 300 0 0Non OPEC 500 -135 150 425 60

.

Total oil supply growth ( % composition)Total Crude* NGL/Cond Biofuel Tarsand

World 100% 11% 43% 40% 6%OPEC 100% 45% 55% 0% 0%Non OPEC 100% -27% 30% 85% 12%* for OPEC, average increase in 2008 production capacity


16

Conventional oil supplies have remained stagnant since 2004


Thousand b/d

39000

40000

41000

42000

43000

44000

45000

Jan-00 Oct-00 Jul-01 Apr-02 Jan-03 Oct-03 Jul-04 Apr-05 Jan-06 Oct-06 Jul-07 Apr-08

24000

25000

26000

27000

28000

29000

30000

31000Conventional oil supplies have been

mostly stagnant since 2004

OPEC(right axis)

Non-OPEC(left axis)

This year OPEC simplybrought back online capacity

that was previously shutin


17

Trend oil supply growth has slowed over the past several years to 1.0% per year


% change

-2.0

-1.0

0.0

1.0

2.0

3.0

4.0

5.0

1996 1997 1998 1999 2000 2001 2002 2003 2004 2005 2006 2007 2008E 2009E

Since 2004, annual trend supply growth has slowed to 1.0% from 1.8% and growth

above this level would be difficult given the current

politically constrained environment


18

Rising prices slow demand growth, not simply high prices

Percent

Source: DOE, NYMEX and Goldman Sachs Commodities Research.

-6.00

-4.00

-2.00

0.00

2.00

4.00

6.00

8.00

Jan-05 Jul-05 Jan-06 Jul-06 Jan-07 Jul-07 Jan-08

-30.00

-20.00

-10.00

0.00

10.00

20.00

30.00

40.00

50.00

60.00

70.00

US motor gasoline demand growth(left axis)

US retail motor gasoline price inflation(right axis)


19

Rising prices over the past 6 years have already reduced demand by over 5.0 million b/d


Thousand b/d

60000

65000

70000

75000

80000

85000

90000

95000

1986 1988 1990 1992 1994 1996 1998 2000 2002 2004 2006 2008

0

1000

2000

3000

4000

5000

6000

7000

8000

9000

10000

Over 5 mmb/d of demand is being held out of market by higher prices

Had price remained at $20/bbl, we would likely see global demand over 92.2

mmb/d


20

… at roughly the same rate at which it is currently rising, and at which is rose in 2004-2005

Source: NYMEX and Goldman Sachs Commodities Research.

5-year forward WTI crude oil price in log($/bbl)

y = 0.0023x + 1.4384

R2 = 0.947

y = 0.0023x + 0.4142

R2 = 0.9313

2.5

3.0

3.5

4.0

4.5

5.0

5.5

2001 2002 2003 2004 2005 2006 2007 2008

The implied annual price change in

2004/05 was 54%

The current implied annual price

change is56%

Exp(log(5)) = $148.41/bbl which would be the end of year target for long-dated oil prices given current rate of increase


21

OECD total petroleum inventories will likely increase to slightly above the 10-year average path

Million barrels


2300

2400

2500

2600

2700

2800

2900

Jan Feb Mar Apr May Jun Jul Aug Sep Oct Nov Dec

10y mean 10y max 10y min

20072008


22

We expect prices to rise to $149/bbl by year’s end


$/bbl

40.00

60.00

80.00

100.00

120.00

140.00

160.00

180.00

200.00

Jan-07 Apr-07 Jul-07 Oct-07 Jan-08 Apr-08 Jul-08 Oct-08 Jan-09 Apr-09 Jul-09 Oct-09

Market Forward Curve

Goldman Sachs Forecast

The investment phase continues, forcing demand to adjust

The Revenge of the old economy and beyond,


24

The industry has exhausted spare capacity, ending an exploitation phase and beginning a new investment phase

20

30

40

50

60

70

80

90

65 67 69 71 73 75 77 79 81 83 85 87 89 91 93 95 97 99 01 03 05

Global production capacity

Global output

Source: International Energy Agency (IEA), DOE, and Goldman Sachs Commodities Research.

million b/d

Global oil production and capacity Global refining capacity

million b/d

20

30

40

50

60

70

80

90

65 67 69 71 73 75 77 79 81 83 85 87 89 91 93 95 97 99 01 03 05

Global Refining Capacity

World Petroleum Supply

World Petroleum Demand


25

The oil market is now six years into an investment phase as spare capacity was exhausted in 2001

US data in real 2000 log $

Source: US Bureau of Economic Analysis, Goldman Sachs Commodities Research.

11.0

11.5

12.0

12.5

13.0

13.5

1901 1908 1915 1922 1929 1936 1943 1950 1957 1964 1971 1978 1985 1992 1999 2006

7.0

7.5

8.0

8.5

9.0

9.5

10.0

10.5

11.0

11.5Investment

Phase

Investment Phase

Investment Phase

Exploitation Phase

Exploitation Phase

Exploitation Phase

Exploitation Phase

Net Energy investment(right axis)

Net Energy Capital Stock(left axis)


26

Prices rise in investment phases as costs increase

Log of real prices in $/bbl

Source: Pennwell.

0

1

2

3

4

5

6

7

1925 1933 1941 1949 1957 1965 1973 1981 1989 1997 2005

Investment Phase

Investment Phase

Exploitation Phase

Exploitation Phase

Exploitation Phase

Investment Phase


27

Returns have improved, but not significantly, as costs have also risen along with prices

Average cash return among oil integrated companies

Source: Goldman Sachs Equities Research.

0%

2%

4%

6%

8%

10%

12%

14%

16%

18%

20%

1965 1968 1971 1974 1977 1980 1983 1986 1989 1992 1995 1998 2001 2004 2007E

Real cash return over cash invested 40-year average 5-year moving average

The revenge of the old economy creates a rise in returns, which attracts capital back to the sector

Poor returns in the 1990s caused capital to be redirected into the new economy

But policy constraints put a cap on further increases and on the ability to attract capital, regardless of price increases

demand and tight supply continues to support market

Despite likely US recession, robust emerging market


29

Global growth is expected to moderate this year, particularly in 1H08, but is expected to start recovering in 2H08

Source: Goldman Sachs Economics Research.

Percent

'05

'06'07E

'08E09E

0

1

2

3

4

5

6

7

8

9

10

11

12

13

BRICS China US Euroland Japan World

Trend


30

… however, OECD oil demand growth has been comparable to recessionary levels for the past 2 years

Year-over-year growth in %


-3.5%

-2.5%

-1.5%

-0.5%

0.5%

1.5%

2.5%

3.5%

4.5%

5.5%

6.5%

1986 1988 1990 1992 1994 1996 1998 2000 2002 2004 2006 2008

-5.5%

-3.5%

-1.5%

0.5%

2.5%

4.5%

6.5%

8.5%

OECD oil demand(left axis)

OECD GDP(right axis)


31

Non-OECD countries have been the engine of oil demand growth over the past few years, and will likely remain so in 2008

Change year over year in thousand b/d


-500

0

500

1000

1500

2000

2500

3000

3500

1986

1987

1988

1989

1990

1991

1992

1993

1994

1995

1996

1997

1998

1999

2000

2001

2002

2003

2004

2005

2006

2007

E

2008

E

OECD Non-OECD


32

Stagnation: producer country demand has squeezed the consumer countries' access to resources

Trend demand growth

Source: BP Statistical Book and Goldman Sachs Commodities Research.

-2%

-1%

0%

1%

2%

3%

4%

5%

6%

7%

8%

1990 1991 1992 1993 1994 1995 1996 1997 1998 1999 2000 2001 2002 2003 2004 2005 2006 2007

High-growth consumers

Low-growth consumers

Producers


33

Middle East oil exports have not increased substantially since 2000

Thousand b/d (both axis)


10000

12000

14000

16000

18000

20000

22000

24000

26000

28000

1Q19

95

4Q19

95

3Q19

96

2Q19

97

1Q19

98

4Q19

98

3Q19

99

2Q20

00

1Q20

01

4Q20

01

3Q20

02

2Q20

03

1Q20

04

4Q20

04

3Q20

05

2Q20

06

1Q20

07

4000

4500

5000

5500

6000

6500

7000Middle East demand is up 35% since 2000 (right axis)Supply is up 2.0 million

b/d since 2000 (left axis)

However, exports are below 2000 levels

(left axis)


34

And despite the recent fuel subsidy cuts, estimated impact on demand is limited

Thousand b/d, unless otherwise indicated

Source: IEA, Bloomberg and Goldman Sachs Commodities Research.

CountryLevel (kb/d)

Share of global

Change (kb/d)

Share of global

Average case

High case

What changed

Indonesia 1,221 1% 5 2% (4) (8) 33% gasoline price increase to $2.44/gal; 28% diesel price increase to $2.23/gal in May08

Sri Lanka 89 0% 1 0% (0) (0) 31% gasoline price increase to $5.97/gal; 38% diesel price increase to $3.86/gal in May08

Taiwan 1,006 1% 33 16% (2) (3) 12% gasoline price increase to $4.35/gal; 17% diesel price increase to $3.97/gal in May08

Egypt 664 1% 48 23% (3) (6) 50% gasoline price increase to $1.25/gal; 46% diesel price increase to $0.76/gal in May08

Pakistan 396 0% 21 10% (1) (2) Four fuel price increases so far this year have raised gasoline and diesel prices 15% year on year, leaving current prices at $3.91/gal and $2.54/gal, respectively

Russia 4,113 5% 31 15% (7) (14) Gasoline prices up 11% year-on-year in 1Q2008, at $3.64/gal

J ordan 102 0% (1) 0% (0) (1) 6% gasoline price increase to $3.98/gal in May08

Syria 276 0% 4 2% (0) (1) 11% gasoline price increase to $3.37/gal in Mar08

Chile 260 0% 6 3% 0 0 Announced an 8% subsidy to gasoline prices in J un08

Malaysia 535 1% 24 12% (2) (4) 40% gasoline price increase to $3.14/gal; 67% diesel price increase to $3.03/gal in J un08

India 2,789 3% 147 71% (2) (5) 10% fuel price hike in J un08, raising gasoline and diesel prices to $4.50/gal and $3.10/gal, respectively

China 7,542 9% 329 159% (11) (22) 16% gasoline price increase to $2.84/gal; 18% diesel price increase to $2.97/gal in J un08

Total 1 8,127 9% 148 71% (32) (64)

Bangladesh 87 0% 2 1% (0) (0) Announced intentions to increase fuel prices in the near term

Total 2 27,207 32% 798 386% (32) (64)

* For Bangladesh, estimated impact on 2008 average demand was calculated assuming a 25% fuel price increase as of J une 2008.

2007 oil demand Demand growthEstimated 2008

demand loss

Speculation blamed, but not the cause


36

Once again speculators are the focus of attention

Source: Factiva, NYMEX, and Goldman Sachs Commodities Research.

Number of cites (left axis); % change year over year (right axis)

0

50

100

150

200

250

2003 2004 2005 2006 2007 2008

0%

10%

20%

30%

40%

50%

60%

Media citations to 'Oil Speculation' % Change in long-dated oil price

Reference to oil speculators

reached a peak in 2004, the last time the market

re-priced

Today the market is re-pricing and oil

speculation references are

increasing once again


37

Cyclically, the commodity markets havebehaved normally, pricing an economic slowdown

%, 1-60 month WTI crude oil timespread (left axis);$/bbl, WTI crude oil price at $100/bbl back-end (right axis)


-40%

-20%

0%

20%

40%

60%

80%

Jan-96 Jan-98 Jan-00 Jan-02 Jan-04 Jan-06 Jan-08

60

70

80

90

100

110

120

130

140

150

160

170

180

+2 Standard Deviations

+1 Standard Deviation

-2 Standard Deviations

-1 Standard Deviation

10-year average

OPEC increases production into Asian Financial Crisis

September 11, 2001

Historically warm winter,speculative liquidation

Cyclical weakening as world economy slows


38

Speculative positions mainly drive changes inWTI timespreads

1st-60th month timespread in $/bbl (left axis); million barrels (right axis)

Source: NYMEX, CFTC and Goldman Sachs Commodities Research.

-15

-10

-5

0

5

10

15

20

Jan-07 Apr-07 Jul-07 Oct-07 Jan-08 Apr-08

0

50

100

150

200

250

300

Net speculative length(right axis)

1st-60th month timespread(left axis)


39

Weaker timespreads (the cyclical component) have been offset by stronger long-dated prices (the structural component)

$/bbl

Source: NYMEX.

-10

-5

0

5

10

15

20

11-May-07 11-Jul-07 11-Sep-07 11-Nov-07 11-Jan-08 11-Mar-08 11-May-08

60

70

80

90

100

110

120

130

1st-60th month WTI timespread(left axis)

5-yr forward WTI price(right axis)


40

REG AC

I, Samantha Dart, hereby certify that all of the views expressed in this report accurately reflect my personal views, which have not been influenced by considerations of the firm's business or client relationships.

DisclosuresJune 25, 2008


42

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Definitions

Outperform (OP). We expect this stock to outperform the median total return for the analyst's coverage universe over the next 12 months. In-Line (IL). We expect this stock to perform in line with the median total return for the analyst's coverage universe over the next 12 months. Underperform (U). We expect this stock to underperform the median total return for the analyst's coverage universe over the next 12 months

Coverage views: Attractive (A). The investment outlook over the following 12 months is favorable relative to the coverage group's historical fundamentals and/or valuation. Neutral (N). The investment outlook over the following 12 months is neutral relative to the coverage group's historical fundamentals and/or valuation. Cautious (C). The investment outlook over the following 12 months is unfavorable relative to the coverage group's historical fundamentals and/or valuation.

Current Investment List (CIL). We expect stocks on this list to provide an absolute total return of approximately 15%-20% over the next 12 months. We only assign this designation to stocks rated Outperform. We require a 12-month price target for stocks with this designation. Each stock on the CIL will automatically come off the list after 90 days unless renewed by the covering analyst and the relevant Regional Investment Review Committee.


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The Global Investment Research Division of Goldman Sachs produces and distributes research products for clients of Goldman Sachs, and pursuant to certain contractual arrangements, on a global basis. Analysts based in Goldman Sachs offices around the world produce equity research on industries and companies, and research on macroeconomics, currencies, commodities and portfolio strategy.

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This research is for our clients only. Other than disclosures relating to Goldman Sachs, this research is based on current public information that we consider reliable, but we do not represent it is accurate or complete, and it should not be relied on as such. We seek to update our research as appropriate, but various regulations may prevent us from doing so. Other than certain industry reports published on a periodic basis, the large majority of reports are published at irregular intervals as appropriate in the analyst’s judgment.

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Our salespeople, traders, and other professionals may provide oral or written market commentary or trading strategies to our clients and our proprietary trading desks that reflect opinions that are contrary to the opinions expressed in this research. Our asset management area, our proprietary trading desks and investing businesses may make investment decisions that are inconsistent with the recommendations or views expressed in this research.

We and our affiliates, officers, directors, and employees, excluding equity analysts, will from time to time have long or short positions in, act as principal in, and buy or sell, the securities or derivatives (including options and warrants) thereof of covered companies referred to in this research.

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