Oil and Economic Growth - Columbia | SIPA Center on...

1

Steven Kopits Managing Director

Douglas-Westwood / New York

Oil and Economic Growth A Supply-Constrained View

Center on Global Energy Policy School of International and Public Affairs Columbia University 11th February 2014

2

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3

Demand-Constrained Models

Supply-Constrained Models

Supply Growth

Demand Growth

Oil Prices

Oil and Mobility

The Oil Majors

Oil and Economic Growth

Conclusions

4

Demand versus Supply Driven Forecasting

GDP Growth

Oil Demand Growth

Oil Supply Growth

• exogenous • 𝑓(𝐺𝐷𝑃 𝑔𝑟𝑜𝑤𝑡ℎ) • 𝑓(𝑑𝑒𝑚𝑎𝑛𝑑 𝑔𝑟𝑜𝑤𝑡ℎ)

Demand-driven Forecasting

Oil Supply Oil Demand

Growth GDP

• exogenous • 𝑓(𝑂𝑖𝑙 𝑠𝑢𝑝𝑝𝑙𝑦 𝑔𝑟𝑜𝑤𝑡ℎ) • 𝑓(𝑂𝑖𝑙 𝑠𝑢𝑝𝑝𝑙𝑦 +𝑒𝑓𝑓𝑖𝑐𝑖𝑒𝑛𝑐𝑦 𝑔𝑎𝑖𝑛𝑠)

Supply-driven Forecasting

5


GDP Growth

Demand Growth

Supply Growth

• exogenous • 𝑓(𝐺𝐷𝑃 𝑔𝑟𝑜𝑤𝑡ℎ) • 𝑓(𝑑𝑒𝑚𝑎𝑛𝑑 𝑔𝑟𝑜𝑤𝑡ℎ)

• Traditional forecasting model

• Many forecasters will never see anything but this during their

entire career

• Virtually all forecasters—investment banks, oil companies, and

industry analysts, the US and foreign governments—use

demand-constrained models.

Demand-driven Forecasting

6

Demand versus Supply-Driven Forecasting

GDP Growth

Demand Growth

Supply Growth

• Supply growth is a function of non-OPEC supply and OPEC supply

• OPEC provides the residual: “Call on OPEC”

• OPEC is to stabilize prices with increased production or production

cuts

Traditional Oil Markets Forecasting

Call on OPEC 𝑇ℎ𝑒 𝑅𝑒𝑠𝑖𝑑𝑢𝑎𝑙

7

BP / IEA Forecasting

• A demand-driven interpretation.

“Global liquids consumption is projected to reach 104 Mb/d by 2030 but growth slows to 0.8% p.a. (from 1.4% p.a. in 1990-2010 and 1.9% p.a. in 1970-90).”

“Demand growth comes exclusively from rapidly growing non-OECD

economies. China, India and the Middle East together account for nearly all of the net global increase. OECD demand has peaked and consumption is expected to decline by 5.6 Mb/d.”

BP Energy Outlook, Jan. 2013 (pp. 33, 39)

From BP’s Energy Outlook, 2013

8

BP / IEA Forecasting

BP Energy Outlook, Jan. 2013 (p. 41)

9

BP’s View of the Residual Call on OPEC

GDP Growth

Demand Growth

Supply Growth

Call on OPEC

• BP solves oil supply

growth > demand

growth with rising

spare capacity in

OPEC.

• This means purely

Saudi Arabia, barring

unexpected outages in

other countries—on

which more later.

BP Energy Outlook, Jan. 2014 (p. 32)

10

Assumptions of Demand Constrained Forecasting

• Oil demand is weak

- GDP growth is endogenously weak, or

- Social tastes or demographics have changed

• OPEC is central

- OPEC has enormous leverage

- OPEC discipline is key to industry economics

• Oil prices are balanced on a knife’s edge

- Any excess supply or lack of OPEC discipline will tank oil

prices—and with it, the IOCs

11



Supply Growth

Demand Growth

Oil Prices

Oil and Mobility

The Oil Majors


Conclusions

12


Oil Supply Growth

(OPEC + non-OPEC)

Oil Demand Growth

GDP Growth

• Exogenous, OPEC and non-OPEC considered together

• Assumes limited accommodation from OPEC

Supply-Constrained Forecasting

• A “binding constraint” view of economic growth

• Oil supply growth is insufficient, reducing GDP growth

𝛈 • Inherent Demand

Growth – from unconstrained supply

• Observed demand growth – Growth actually observed in the data, less than inherent demand growth

• Efficiency Gain – Economy decreases energy intensity over time

• Residual If efficiency gains + oil supply growth not sufficient, GDP growth will be limited

13

Supply-Constrained Pre-Conditions

Need to demonstrate….

Constrained Supply

• Demand is likely higher than demonstrated

• Oil supply growth is constrained

• Oil is a key enabling commodity (can affect GDP)

• Constrained oil supply is materially affecting economic activity

• Efficiency gains are likely not enough

• GDP growth is off trend

Traditional Forecast (Demand-driven)

• “Peak demand” largely unsupported

• Oil prices sustaining in the face of supply growth in excess of

forecast demand

14

Full Cycle Gas Economics

Source: Barclays Capital

• Natural gas prices will continue to rise

• Median required breakeven price is around $8 / mmbtu

E&P Capex per Barrel

80

90

100

110

120

130

140

Jan

-06

Jul-

06

Jan

-07

Jul-

07

Jan

-08

Jul-

08

Jan

-09

Jul-

09

Jan

-10

Jul-

10

Jan

-11

Jul-

11

Jan

-12

Jul-

12

Jan

-13

Jul-

13

Electric Power - Gas

Electric Power Sector - Coal



Supply Growth

Demand Growth

Oil Prices

Oil and Mobility

The Oil Majors


Conclusions

15

80

85

90

95

100

105

2004 2005 2006 2007 2008 2009 2010 2011 2012 2013

mb

pd

Actual (EIA) - Last ThreeMonths of Period

Expected Based on GDPGrowth @ 2.5% Eff. Gain

Expected Based on GDPGrowth @ 1.2% Eff. Gain

• Oil demand historically

increases by 0.75 * GDP

growth (inherent demand

growth)

• Implies 23%+ oil consumption

growth from 2004-2013

• Actual oil supply growth was

only 7.5%

• By 2008, the world economy

was missing a quantity equal

to the output of Saudi Arabia

• Today, compared to 2004 Q4,

we’re missing a Saudi Arabia

and an Iraq

• That’s why oil is expensive

Source: EIA. IMF, Douglas-Westwood analysis

Observed Oil Supply; and Oil Demand anticipated

based on GDP growth

39% Global GDP Growth

7.5% Oil Supply Growth

• Demand growth = GDP growth – 1.2% annual efficiency gain without oil price pressure

• Demand growth = GDP growth – 2.5% annual efficiency gain with oil price pressure at recent levels

Inherent Demand

16

Liquids Supply Since 2005

• Total production up 5.8 mpbd

since 2005, of which 1.7 mbpd

is OPEC NGL’s (non-crude)

• OPEC liquids production

(crude + NGL) is unchanged

since 2005

• US unconventional liquids

(shale oil and NGL) up 5.1

mbpd—literally all net crude oil

production growth—since

2005.

• Canadian oil sands up 1.2

mbpd from 2005

• Legacy, conventional system

still peaked in 2005.

• Oil supply growth entirely

leveraged to unconventionals

Source: EIA STEO

World Liquids Production Growth, 2005-2013, Oct-

Dec averages, excludes OPEC NGLs

5.1

1.2

(1.8)

1.3

3.0

0.9

(0.7) (1.0)

-3.0

-2.0

-1.0

0.0

1.0

2.0

3.0

4.0

5.0

6.0

US (incl.Shale Oil,

NGL)

Canada (incl.Oil Sands)

Opec (incl.Iraq)

All others

mb

pd

Change Dec 2013 vs. Dec 2005


17

OPEC Liquids Supply since 2005

• OPEC crude essentially

unchanged in last three years,

1.8 mbpd less than 2005

• Most growth is NGLs, up 1.7

mbpd since 2005

• Iran, Libya, and Nigeria

together down 2.4 mbpd since

2010

• Saudi up nearly 700 kbpd from

2010, close to 1979 levels

• Iraq up only 1.2 mbpd since

2005—US adds more in a year

now

• US shale oil and NGLs would

be easily the second largest

producer in OPEC

Source: EIA STEO, three month averages ending December

of each year

OPEC Liquids Production Growth 2005-2013

1.2

(3.0)

0.1

(0.0)

1.7

0.5

(2.4)

0.7 0.6

0.3

-4.0

-3.0

-2.0

-1.0

0.0

1.0

2.0

Iraq Iran, Libya,Nigeria

SaudiArabia

OtherOPECCrude

OPECNGLs

mb

pd



18

5.1

1.2

(1.8)

1.3

3.0

0.9

(0.7) (1.0)

-3.0

-2.0

-1.0

0.0

1.0

2.0

3.0

4.0

5.0

6.0

US (incl.Shale Oil,

NGL)

Canada (incl.Oil Sands)

Opec (incl.Iraq)

All others

mb

pd



Liquids Supply Since 2005

• Total spend since 2005 on upstream

exploration and production:

$4 trillion

• Of which, $350 bn on US and Canadian

unconventional oil and gas…

• …and another $150 bn on LNG and GTL

• $3.5 trillion was spent maintaining the

2005 legacy oil and gas system

• About $2.5 trillion* was spent on legacy

crude oil production—94% of the

petroleum liquids supply today.

• Result: legacy oil production has fallen by

1 mbpd

• Peak oil for legacy system: still 2005

• For comparison: ‘98-’05, $1.5 trillion

spend added +8.6 mbpd crude

production

• Compared to ‘98-’05 period, vaporized

GDP of Germany

Source: EIA STEO, Barclays, DW Analysis

$350 bn

7% of supply

$2,500 bn

93% of supply

* GDP of Germany is $3.5 trn, Italy $2.0 trn

World Liquids Production Growth, 2005-2013, Oct-

Dec averages, excludes OPEC NGLs

19



Supply Growth

Demand Growth

Oil Prices

Oil and Mobility

The Oil Majors


Conclusions

20

Motorization and Oil in Historical Context

Source: EIA

• Motorization in West: 1.2 bn people, +30 mbpd supply, 12 years

• Motorization in the East: 1.3 bn people, +4 mbpd crude, 8 years

• Based on historical precedent, anticipated growth would be

2.7% per year, not 0.8%

20

30

40

50

60

70

80

mb

pd

World Crude Oil Production (C+LC): 1960-2011

World Crude Oil Production, million barrels per day

21

China Key Driver of Oil Demand Growth

• How far? Japan, Korea, Taiwan: 0.5-0.6x US oil consumption per capita

• When? S curve is 20-30 years—about one generation

• Potential is enormous—50 mbpd in 2030 versus 10.5 now (if the oil supply

were available; US is at 18.5 mbpd now)

• Total non-OECD demand growth to 2030 could be 60 mbpd—2/3 as much

as total production today.

• How does this translate in 0.8% growth?

5

10

15

20

25

30

35

40

45

50

55

millio

n b

arr

els

per

day

China as Japan (1960-1973)

China as Korea (1976-1996)

China - EIA IEO 2010

Source: EIA, Douglas-Westwood Analysis

China Unconstrained Demand

China is here.

22

Petroleum Liquids – 2030 Forecast

• Exxon, BP, EIA: 103-107 mbpd

• Total, IEA: 95-96 mbpd

• Kjell Aleklett (ASPO Europe): 75 mbpd (ex-shales)

• These are all peak oil forecasts—not much changed in last few years

Source: EIA

Oil (Petroleum Liquids)Supply Forecasts to 2030

70

75

80

85

90

95

100

105

110

2030

Mil

lio

ns b

arr

els

per

Da

y

Exxon 2040 (2012)

EIA AEO 2012

BP 2030 (2012)

IEA 2011

Total SA 2012

Uppsala 2010

23

• Assuming 100 mbpd supply by 2030, US

consumption would be expected at 14

mbpd—down 1/3 from 21 mbpd in mid

2007

• Rate of long term decrease: 1.5% per

annum, 2.3% on a per capita basis

− Per capita, still puts US in 2030 on par

with Japan, Korea today.

Source: Douglas-Westwood projections

based on EIA data

Global Oil Consumption 2005 - 2030

Determining Demand Trends

24

OECD and Non-OECD Oil Consumption

• OECD consumers providing 50% of new non-OECD oil consumption

since Dec. 2007

• OECD consumers providing 28% of new non-OECD oil consumption in

last year

OECD countries in

systemic crisis: USA, UK,

Ireland, Iceland, Greece,

Spain, Portugal,

Hungary, Italy, France,

Cyprus, Estonia, Latvia,

Lithuania, Netherlands,

Japan

Non-OECD countries in

systemic crisis: ?

-100%

0%

100%

200%

300%

400%

500%

600%

700%

800%

(6.0)

(4.0)

(2.0)

-

2.0

4.0

6.0

8.0

10.0

Jan-08 Jul-08 Jan-09 Jul-09 Jan-10 Jul-10 Jan-11 Jul-11 Jan-12 Jul-12 Jan-13 Jul-13

Pe

rce

nt

of

no

n-O

ECD

Oil

Dem

and

Gro

wth

fro

m

OEC

D C

on

sum

ers

Ch

nge

in O

il C

on

sum

pti

on

sin

ce D

ec. 2

00

7,

mb

pd

Change in non-OECD Demand from Dec. 2007 (lhs)Change in OECD Demand from Dec. 2007 (lhs)Share of non-OECD Demand from OECD Consumers (rhs)Share from OECD Consumers, year on year (rhs)

Source: EIA

Change in OECD and non-OECD Oil Consumption since Start of the Great Recession

25



Supply Growth

Demand Growth

Oil Prices

Oil and Mobility

The Oil Majors


Conclusions

26

Oil price forecasts generally fall into one of three schools:

• Futures Curve: The NYMEX futures curve sees oil prices falling below $90 / barrel by 2020. Underlying this is the

implicit assumption that oil will somehow become cheaper or easier to find and produce, in contrast to the experience

of the last decade.

• “Operators’ Forecast”: Absent a convincing oil price model, a number of oil companies are using a “best guess”

approach, which assumes that oil prices will remain around or above $100 / barrel on a Brent basis. This is not

scientific, but many, if not most, oil company executives think this seems plausible and sufficiently conservative for

investment decisions.

• DW Forecast: Douglas-Westwood uses a unique supply-constrained model which has proved itself successful in both

explaining and predicting oil prices and country level demand. This models assumes the global economy is

constrained by a struggling oil supply, with the oil price rising to the global carrying capacity (similar to the monopoly

price). Global carrying capacity should continue to increase by up to 7% theoretically, and about 4.5%, empirically.

Oil Price Outlook

$50

$70

$90

$110

$130

$150

$170

$/b

arr

el c

rud

e, B

ren

t b

as

is

"Operator's Forecast"

Brent Oil Price

Brent NYMEX Futures

DW Brent Forecast

Source: EIA, NYMEX, DW Forecast

Brent Oil Prices – Historical and Forecast

27

Source: EIA, BP, Douglas-Westwood analysis

Oil Supply and Demand under Supply- and Demand-Constrained Approaches

Why no price collapse in 2013?

$60

$70

$80

$90

$100

$110

$120

0.0%

1.0%

2.0%

3.0%

4.0%

5.0%

6.0%

2013 2014

Bre

nt

Oil

Pri

ce

$/b

bl

Ch

an

ge

on

Pre

vio

us

Ye

ar

Oil Supply (EIA)

Oil Demand (BP / IEA)

Inherent Demand (DW)

Brent Price (EIA)

Max Brent Price (DW)

• Demand-Constrained : Supply-growth substantially in excess of demand

growth should have crashed oil prices. But that didn’t happen.

• Supply-Constrained: With a global economy starved for oil, economic activity

expanded to absorb excess supply, prices returned to carrying capacity.

28

Source: EIA

US and China Annual Oil Consumption Growth (3 mma)

But a supply constrained models depends on China

• A demand-constrained model is driven primarily by demand in China

• China sets the price, and causes the oil supply to be rationed

• China has been all but absent from oil markets in recent times

• This has allowed supply growth to increasingly flow to the advanced economies—

US consumption has jumped since Q4 2013

• Without pressure from China, the OECD countries growth may not be constrained

-4.0%

-2.0%

0.0%

2.0%

4.0%

6.0%

8.0%

10.0%

12.0%

14.0%

Ap

r-1

0

Ju

n-1

0

Au

g-1

0

Oct-

10

De

c-1

0

Feb

-11

Ap

r-1

1

Ju

n-1

1

Au

g-1

1

Oct-

11

De

c-1

1

Feb

-12

Apr-

12

Ju

n-1

2

Au

g-1

2

Oct-

12

De

c-1

2

Feb

-13

Ap

r-1

3

Ju

n-1

3

Au

g-1

3

Oct-

13

De

c-1

3

USA

China

29

19.2

22.3

20.1

0

0

0

0

0

1

1

1

1

1

1

18

19

20

21

22

23

24

Jan-2

000

Jul-2

000

Jan-2

001

Jul-2

001

Jan-2

002

Jul-2

002

Jan-2

003

Jul-2

003

Jan-2

004

Jul-2

004

Jan-2

005

Jul-2

005

Jan-2

006

Jul-2

006

Jan-2

007

Jul-2

007

Jan-2

008

Jul-2

008

Jan-2

009

Jul-2

009

Jan-2

010

Jul-2

010

Jan-2

011

Jul-2

011

Jan-2

012

Jul-2

012

Jan-2

013

Jul-2

013

mb

pd

US Oil Cons. (12 mma)

US Cons. at LT Trend

US Cons. Pro Forma Recovery

US Predicted "Peak Oil" Cons.

US Demand Outlook

• Normal US oil consumption growth trend: 1.8% per annum

• Break trend 2005, US off trend twice now in last nine years

• Consumption should be 22.3 mbpd, actual 19.2 mbpd (-14%)

• The US is still a major exporter, but also the fastest growing oil producer.

How does this affect US consumption and GDP growth?

• Does increased US oil production allow the US to consume more oil?

Source: EIA

US Oil Demand – 2000 to 2013

Current Cons.

Normal growth trend: +1.8% p.a.

Cons. on long term trend

Trend from Arab Spring

Constrained trend: -1.5% per annum

30



Supply Growth

Demand Growth

Oil Prices

Oil and Mobility

The Oil Majors


Conclusions

31

Oil Consumption, VMT and Prosperity are Related

• VMT, oil consumption and GDP growth have historically

been almost directly correlated.

Source: US Department of Transportation, EIA, Douglas-Westwood analysis

Index of US Vehicle Miles Driven and Oil Consumption (1970 = 100)

32

Stay at Home: US Miles Driven

• Peak driving was 2005—not 2007!

• The US has lost mobility as it has lost oil consumption

• New hires in the US cannot use any more oil—and this affects mobility

• 1 in 6 cars missing from the road

Source: DS Short, US Department of Transportation

US Vehicle Miles Driven

33

Vehicle Ownership

• Also, “peak car

ownership”, in 2006

• Predates the recession

Source: Michael Sivak, UMTRI, “The Reasons for the Recent Decline of Young Driver Licensing in the U.S.”

Car Ownership in the United States

34

0%

10%

20%

30%

40%

50%

60%

70%

80%

90%

100%

18-24 25-34 35-44 45-54 55-64 65-74 75+

2007

2011

Not because seniors don’t want to drive

• Relative probability for buying a car for 25-44 year olds has fallen.

• Relative probability of buying a car for age 45+ has risen--substantially

Source: Michael Sivak, UMTRI, “MARKETING IMPLICATIONS OF THE CHANGING AGE COMPOSITION OF VEHICLE BUYERS IN THE U.S.”

Relative Probability of Buying a Car in the US by Age

35

Driving and Employment

• No car, no job: Only 19% of persons aged 18-39 without a

driver’s license hold a full time job.

• Unemployment represents 80% of the reason young people

are driving less

Source: Michael Sivak, UMTRI, “The Reasons for the Recent Decline of Young Driver Licensing in the U.S.”

Employment Status of Person’s without a

Current Driver’s License

Source: HDLI, “Drop in teen driving tracks with teen unemployment”, http://www.iihs.org/iihs/news/desktopnews/drop-in-teen-driving-tracks-with-

teen-unemployment-hldi-study-finds

Ratio of teen drivers to prime-age drivers and unemployment

spread between teens and prime-age workers

36

Evidence of Oil Price Pressures on Behavior

Source: : Michael Sivak, UMTRI, “A Comparison of CAFE Standards and Actual CAFE Performance of New Light Duty Vehicles”

• Achieved new vehicle fuel economy has exceeded required

standards—suggests price pressures influencing consumer

choice

• However, if oil (gasoline) prices ease, the pressure on the

consumer to conserve rapidly dissipates

Achieved and “Projected Achieved” CAFE Standards -8%

-6%

-4%

-2%

0%

2%

4%

6%

8%

Fe

b-0

9

Ma

y-0

9

Au

g-0

9

Nov-0

9

Fe

b-1

0

Ma

y-1

0

Au

g-1

0

Nov-1

0

Fe

b-1

1

Ma

y-1

1

Au

g-1

1

Nov-1

1

Fe

b-1

2

Ma

y-1

2

Au

g-1

2

Nov-1

2

Fe

b-1

3

Ma

y-1

3

Au

g-1

3

Nov-1

3

Annual Rate of Improvement in New Vehicle Mileage

Six month moving average

Annual Rate of Improvement in New Vehicle Mileage

Annual Rate of Improvement in Gasoline Consumption

37

50

60

70

80

90

100

110

120

199

6

199

6

199

7

199

8

199

8

199

9

200

0

200

0

200

1

200

2

200

2

200

3

200

4

200

4

200

5

200

6

200

6

200

7

200

8

200

8

200

9

201

0

201

0

201

1

201

2

201

2

201

3

Ind

ex

of

Ac

tivit

y A

ug

. 2

00

5 =

10

0

(Pe

ak

) 12 mma

Monthly

LT Trend

And it’s not just cars: US Airline Departures

• US commercial airline departures are 16% below their 2005 peak…

• …and departures are 30% below trend (even allowing for recession)

• For every two aircraft taking off from US airports, one is missing

• And the trend continues to decline.

Source: US Department of Transportation, Douglas-Westwood analysis

US Commercial Airlines (System) Departures: Peak = 100 (Aug. 2005)

-16%

-30%

38

• Ethane/Ethylene production growth linked to low natural gas prices and

abundant supplies of natural gas liquids

• Jet fuel down 14%

• Heating fuel down 35%

• But on-road diesel up by 1% and gasoline down by only 4%

• Refutes proposition of reducing driving attributable to changed tastes

or demographics—people are struggling to hang on to mobility

And it’s worse in other sectors

Source: EIA

Product Supplied in the US: Change from 2005 to 2013

-70%

-64%

-46%

-35%

-27%

-14%

-4%

1%

72%

-100% -80% -60% -40% -20% 0% 20% 40% 60% 80% 100%

Residual Fuel Oil

Distillate to Power

Asphalt

Heating Oil

Pet Coke

Jet Fuel

Gasoline

Diesel Fuel

Ethane/Ethylene

39



Supply Growth

Demand Growth

Oil Prices

Oil and Mobility

The Oil Majors


Conclusions

40

Listed Oil Majors: Capex and Crude Oil Production

• Oil production has faltered, even as capex has soared

• Capex productivity has fallen by a factor of five since 2000

• Observed decline trend now approaching 5% per year

Crude Oil Production and Capex

$50

$73

$109

$199

$192

$262

13.8

15.3

16.1

15.4

15.9

14.4

14.0

12.0

12.5

13.0

13.5

14.0

14.5

15.0

15.5

16.0

16.5

0

50

100

150

200

250

300

Cru

de

oil

pro

du

cti

on

(m

bp

d)

US

$ b

illi

on

CAPEX ($Billions) LHS OIL PRODUCTION RHS

Combined data for BG, BP, COP, CVX, ENI, OXY, PBR, RDS, STO, TOT, XOM

Source: Bloomberg via Phibro Trading LLC

41

Upstream Spend Continues Strong


• Upstream spend (capex) has risen strongly in the last decade, with industry

expectations, only six months ago, for continued strong gains

Upstream Spend – Actual and Forecast (includes both NOCs and IOCs)

42

Parts of the Industry Look Great

Source: Douglas-Westwood

• Current revenues and backlog are at record levels throughout much of

the industry

• Q1 2013 subsea hardware orders were the best ever—by far

• But profitability has lagged.

Subsea Hardware Orders

0

1,000

2,000

3,000

4,000

5,000

6,000

1Q

07

2Q

07

3Q

07

4Q

07

1Q

08

2Q

08

3Q

08

4Q

08

1Q

09

2Q

09

3Q

09

4Q

09

1Q

10

2Q

10

3Q

10

4Q

10

1Q

11

2Q

11

3Q

11

4Q

11

1Q

12

2Q

12

3Q

12

4Q

12

1Q

13

2Q

13

3Q

13

Subsea O

rder

Valu

e (

US

$ m

illio

n)

GE Oil & Gas

FMC

Dril-Quip

Cameron

Aker Solutions

12-Month Moving Avg

43

Costs are Rising Fast


• Profits have lagged because costs are rising faster than revenues.

E&P capex per barrel has been rising nearly 11% per year.

• Brent oil prices have been largely flat.

• A number of projects have consequently been deferred, cancelled

or return for re-evaluation.

E&P Capex per Barrel

44

Turbulence in the Oil Sector

* Goldman Sachs calculated economic breakeven oil price; Mad Dog breakeven price for Phase I and II together

45

• Costs have outpaced revenues by 2-3% per year. Profitability is down 10-20%.

• The vast majority of public oil & gas companies require oil prices of over

$100/bbl to achieve positive free cash flow under current capex and dividend

programs

• Nearly half of the industry needs more than $120/bb. The 4th quartile, where

most US E&Ps cluster, needs $130/bbl or more.

Source: Goldman Sachs

Oil Price Required by Oil Companies to be Free Cash Flow Neutral After Capex and Dividends

The Industry Needs $100+ Oil Prices

46

-80,000

-60,000

-40,000

-20,000

0

20,000

40,000

60,000

80,000

199

3

199

4

199

5

199

6

199

7

199

8

199

9

200

0

200

1

200

2

200

3

200

4

200

5

200

6

200

7

200

8

200

9

201

0

201

1

201

2

201

3

201

4Inte

gra

ted

Oil

s F

ree

Ca

sh

Flo

w (

$ m

n)

Oil price increase

greater than E&P Cost

Oil price

increase

less than

E&P Cost

Recession

&

recovery

Integrated Oils Free Cash Flow Post Working Capital, Dividends and Capex

Source: Goldman Sachs

Shell: “Sharper focus on fewer projects.”

“Shell said it was dropping its oil and gas production growth targets,

in a sign of how difficult it is becoming for supermajors to

increase output.”

The Majors Respond

• Shell: Discontinue production guidance and focus on increased cash flow generation.

• Shell: No Alaska 2014

• Major divestment programs

47

The Oil Cost Curve

Approval threshold Based on anticipated oil price levels

Cost inflation

Projects

at Risk of being canceled

or delayed with

Cost Inflation

Projects

at Risk of being canceled

or delayed

without Cost

Inflation

Iraq, most other

Middle East

Most GoM Fields,

Pre-Salt Brazil

GoM Lower Tertiary,

Cheaper Shales

Marginal Shales,

Heavy Oil,

Russian Greenfield

Increased CapEx to OFS providers Increased CapEx +

Bespoke Technology Innovation

Innovate or eliminate as a class

Govt take becomes

central issue

• Some high cost projects will be abandoned. More will be “pushed to the right” as operators use their current capex

budgets to pay for earlier years’ cost overruns.

• Operators will begin to take a closer look at their budgets, particularly related to deepwater exploratory drilling. Cost-

effective solutions will be in demand, opening a new chapter on technology development.

• Reducing government take (tax and royalties) will be a key focus of operator efforts. Governments will respond in an

attempt to keep the operators in play, as they have been or are doing in US, Russian and Norwegian Arctic.

48

Conventional Oil Production

• The conventional oil system—including Iraq, excluding Canada, US unconventionals

and NGLs—peaked in 2005

• Oil systems normally follow symmetrical advance and decline around a peak.

• Crude production has been maintained primarily by a massive increase in upstream

spend, bringing production to the left from inherently lower “natural” levels

• How does oil production regain trend? Fast? Slow? Or at all?

Source: BP Statistical Review 2013, EIA STEOs 2008, 2013; smoothed data

Change in Legacy Crude Oil Production from 2005 to 2012

66

68

70

72

74

76

78

80

82

84

199

7

199

8

199

9

200

0

200

1

200

2

200

3

200

4

200

5

200

6

200

7

200

8

200

9

201

0

201

1

201

2

Mb

pd

Crude Production Forward

Iraq

Crude Oil Normal Decline

49

E&Ps Cutting Capex One after Another

Capex Set to decline

Statoil to Postpone 2020 Production Target

• Statoil Chief Executive Helge Lund -- cut costs $1.3 billion a year starting in 2016 in a bid to

counter escalating oil sector costs.

• Chevron -- 5% decrease in 2014 Capex from $42 billion in 2013.

• Hess capex down 30% over two years

• Shell capex down 20% for 2014.

• BG expects 2015-2016 capital expenditure to fall to $8-10 bn from $12 bn(BG est.) in 2013.

50

Listing Oil Majors: Capex

• Capital discipline now a key theme at oil majors

• Cash flow growth over production growth

• Implies unraveling

• Substantial deterioration in outlook since October 2013

• Oil majors face a very challenging climate

Historical and Forecast Crude Oil Production and Capex (Provisional, subject to Revision)

Combined data for BG, BP, COP, CVX, ENI, OXY, PBR, RDS, STO, TOT, XOM

Source: Bloomberg via Phibro Trading LLC

273

193

$0

$50

$100

$150

$200

$250

$300

2000 2001 2002 2003 2004 2005 2006 2007 2008 2009 2010 2011 2012 2013 2014 2015 2016 2017

Up

stre

am S

pe

nd

, US

Do

llars

, b

illio

ns

Historical Capex

Current Forecast Capex

Forecast Capex based on Hess

DW Oct. Provisional Forecast

Industry "Consensus"

51



Supply Growth

Demand Growth

Oil Prices

Oil and Mobility

The Oil Majors


Conclusions

52

Supply-Constrained Oil and Economic Growth

• In order to argue for a supply-constrained model, there must be a

residual prepared to adjust up or down for increased or decreased oil

supply.

• This must be GDP growth, assuming the efficiency gains are

bounded.

• What do we need to demonstrate if this is true?

53

Supply-Constrained Oil and Economic Growth

• Need a plausible model showing the mechanism of constraint.

• Need to see some empirical evidence.

54

Oil Efficiency and GDP

• In normal times, oil efficiency in GDP increases by 1.2% / year

• In “stressed” times, 2.0% is possible

• For six recent quarters, US efficiency up 3.8% -- 2.3% GDP growth

• OECD GDP growth probably capped at 1.0-2.0%

• A constrained oil supply is reducing OECD GDP growth by 1-2%

1.2%

2.0% 2.5%

3.8%

4.5%

8.0%

-0.3% 0.5% 1.0% 2.3% 3.0%

-1.0% -2.0%

0.0%

2.0%

4.0%

6.0%

8.0%

"Normal"unstressed

"Stressed" MaxSustainable

New VehicleMPG

Improvement

Requiredefficiecy gainfor 3% GDP

growth

Maxefficiencygains in

recession

Efficiency Gains

Implied Max GDP Growth

55

GDP Growth Forecasting Errors

• Fed and CBO forecasts: Consistently over-estimated the pace of

GDP growth

• We seem to have some sort of unexplained factor holding back

growth

US Federal Reserve GDP Growth Forecasts Source: Wonkblog ,

http://www.washingtonpost.com/blogs/wonkblog/wp/2013/06/19/

this-graph-shows-how-bad-the-fed-is-at-predicting-the-future/

CBO GDP Growth Forecasts Source: Wonkblog ,

http://www.washingtonpost.com/blogs/wonkblog/wp/2013/06/19/

this-graph-shows-how-bad-the-fed-is-at-predicting-the-future/

56

Unexplained Weak Recovery

57

Dire Long-term Growth Forecasts

Source: IMF WEO 2013, Statoil Energy Perspectives 2013

• Statoil sees a much darker future than the past

• Long-term growth rates down 1% compared to pre-recession period

• Why such pessimism?

• Failed states?

Advanced Country / OECD GDP Growth Rates

Source: IMF WEO 2013, Statoil Energy Perspectives 2013

EU / Europe GDP Growth Rates

2.4%

0.9%

1.4%

0.0%

0.5%

1.0%

1.5%

2.0%

2.5%

3.0%

3.5%

4.0%

Avg

. A

nn

ual

Fiv

e Y

ear

GD

P G

row

th R

ate

EU (IMF)

Europe (Statoil)

EU Avg '90-'07 (IMF)

EU Avg '10-'13 (IMF)

EU Avg '11-'40 (Statoil)2.7%

1.8% 1.5%

0.0%

0.5%

1.0%

1.5%

2.0%

2.5%

3.0%

3.5%

4.0%

4.5%

Ave

rage

Fiv

e Y

r G

DP

Gro

wth

Rat

e

IMF Advanced Country

OECD (Statoil)

OECD Avg '90-'07 (IMF)

OECD Avg '10-'13 (IMF)

OECD Avg '11-'40 (Statoil)

58



Supply Growth

Demand Growth

Oil Prices

Oil and Mobility

The Oil Majors


Conclusions

59

• Demand-constrained models dominate thinking about oil demand,

supply, prices and their effect on the economy

• The data have not supported these models in recent years; the data do

fit a supply-constrained model

• A supply-constrained approach will not be applicable if China falters, US

short term latent demand is sated, and oil supply growth is robust.

• For a supply-constrained model to be valid, oil must be holding back

GDP growth as an implicit element of model construct.

• If the supply-constrained approach is right, then GDP growth depends

intrinsically on increasing oil production.

• Without such increases, OECD GDP growth will continue to lag

indefinitely, with a long-term GDP growth rate in the 1-2% range entirely

plausible, and indeed, likely.

• In turn, if this is true, then current national budget deficit levels and debt

levels will prove unsustainable, and a second round of material and

lasting adjustment will be necessary.

Conclusions

60

Thank you

Steven Kopits Managing Director

New York, NY

[email protected]

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