Introduction OIL PRICE ANALYSIS

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1 OIL PRICE ANALYSIS Prepared by: Vangie Bhagoo-Ramrattan, Head, First Citizens Research & Analytics 19-November-2014 Introduction The combination of strong crude oil supply and weak global demand has pushed crude oil prices to their lowest levels in nearly four years. The volatility of the global oil market has been heightened based on a culmination of various factors currently afflicting energy markets including geopolitical unrest as well as economic uncertainties. There has been changing dynamics in the global energy market, as in the last quarter of 2013, the US overtook Saudi Arabia as the largest producer of crude, Natural Gas Liquids (NGL s) and other liquids, producing more than 10% of the world s output in that particular quarter. The increase in production in the US was mainly driven by rising tight oil 1 production. Some Energy Analysts are suggesting that oil prices will only recover when some of the extra shale oil supply is removed from the market, rather than when/ if OPEC decides to cut production. Saudi Arabia remains the largest supplier of crude oil in the world, accounting for 13.1% of global production in 2013, while non-opec member Russia is in a close second accounting for 12.9%. In 2013, OPEC accounted 42.1% of total world production of crude oil, while Non-OPEC s share was 41.4%. The energy sector is fundamental to the Trinidad and Tobago economy, accounting for an average of 42% of GDP, 53% of government revenue and almost 85% of merchandize export receipts over the last five years. Of course, this dependency places the country in a vulnerable position as swings in the global market directly impacts upon the domestic economy, either directly or indirectly. On 19 November, Petrotrin s President announced that due to falling oil prices, the company budget for the next year will be revised downwards to USD75 per barrel while on the same day, the Minister of Finance and the Economy announced that the national budget has been reworked using oil prices of USD70 per barrel, down USD10. According to the Minister of Finance and the Economy, if oil prices fall to the worse-case scenario of USD70 per barrel, the country will lose USD1 billion in revenue (2% of total government revenue). But the Ministry believes prices will average somewhere between USD73 and USD80 per barrel. The purpose of this report is to highlight recent developments in the international oil market and attempts to discuss the potential impact the market movements will have on the local economy. It also serves to examine the impact that Petrocaribe may have on the region and Trinidad and Tobago at a high level if the terms of the arrangement are modified. The report looks specifically also at the potential impact on Trinidad and Tobago s banking sector from a general point of view. However, due to data limitations, the conclusions are general, and look at the impact at a macro level. Further, this report was written as at 19-November, There are key upcoming events in the market which will have implications for oil prices. OPEC meets on 27 November to determine if the cartel s supply will be cut or maintained in order to influence prices and the outcome of this meeting will have significant repercussions on the direction of oil prices in the coming months. 1 Tight Oil is a term often used to describe shale oil, the supply of which has risen sharply in recent years in North America because of greater use of so-called fracking techniques to extract oil from dense rock formations. Page 1 of 22

2 EXECUTIVE SUMMARY Year to date, the West Texas Intermediate (WTI) Cushing Oil Price (US benchmark) has fallen by close to 23%, closing 14 November at USD75.32 per barrel. The volatility of the global oil market has been heightened based on a culmination of various factors currently afflicting energy markets including geopolitical unrest, economic uncertainties as well as the potential impact of Ebola. China is a major player in the global crude oil market, given that it was the world s second largest consumer in 2013, only behind the US. The weaker economic data coming out from China has added to the bearish view on crude oil prices this year. OPEC meets on 27 November to consider whether they will adjust its output target of 30 million barrels per day for the first half of So far, only a minority of members have called for an output cut. Primarily an energy-based economy, the T&T budget is constructed on an assumed oil price of USD80 per barrel, using the WTI measure and gas price of USD2.75 per mmbtu (Henry Hub). Trinidad and Tobago had 728 million barrels of proven crude oil reserves as of 2014, according to the Oil and Gas Journal (OGJ). The country produced 118,000 BPD of petroleum and other liquids in 2013, of which 81,000 BPD was crude oil including lease condensates, and the remainder consisted mostly of NGL. The direct impact upon Petrotrin from an investment perspective if oil prices continue to decline will be deterioration in the credit rating and a rise in USD bond yields. The yield on Petrotrin s 2019 US dollar bond has already increased by 27 basis points over the last six months. In the short-term we do not believe that the Trinidad and Tobago s credit rating is under threat of being downgraded in the short term. In our view, changes to the rating will come if there is a secular trend of weakening FDI flows into the country via the energy sector, which will affect the country s external accounts, output levels of the energy sector, which will then impact upon the fiscal accounts. We will have to look closely at the evolution of the market for natural gas, as we do think in the medium term, prices will decline based on the further development of shale gas and changing dynamics of Trinidad and Tobago s major export markets. For the next fiscal year, however, the revenue assumption might have to be more conservative to take into consideration the global situation of higher output of crude oil and possibility of reduced demand. While Venezuela has retained that Petro Caribe will be maintained, we believe that the terms and conditions may be adjusted based on the financial circumstances of the state-owned oil and gas company PDVSA, shrinking foreign exchange reserves and guaranteed export arrangements with other countries. CARICOM countries account for about 40% of Trinidad and Tobago s non-energy exports and a prolonged recession in these countries as well as the potential impact of Petrocaribe on the region s external accounts can severely affect T&T s external current account as well as the performance of the exporters of this country. Trinidad and Tobago s Banking Sector can be affected through: o Direct/ Indirect Credit Exposure to the energy sector (which is relatively small) o Foreign exchange shortage situation exacerbated (since energy is the country s major foreign exchange earner) and subsequent impact on the TT dollar against the US dollar. o Contagion effects via trade channels. If non-energy regional imports fall, local exporters may be affected, which can then affect the banking sector s non-performing loan portfolio. o Changes in the central bank s monetary policy stance, which will directly impact the Bank s lending rates and subsequent spread income. Page 2 of 22

3 I. Recent Trends in the Oil Market Year to date, the West Texas Intermediate (WTI) Cushing Oil Price (US benchmark) has fallen by close to 23%, closing 14 November at USD75.32 per barrel. For the year, prices hit a high of USD per barrel (23-July), and averaged USD97.07 per barrel. Since August, however, prices have traded well below the year to date mean. FIGURE 1: A Historical Look at Oil Price Movements West Texas Intermediate (WTI) Cushing Oil Price, USD per barrel Great Recession BP Oil Spill Arab Springs Gulf War Chinese Economy Takes Off Uncertain Economic Environment creates supply/ demand concerns Source: Bloomberg, First Citizens Research & Analytics FIGURE 2: Year-To-Date (YTD) Price Movement WTI Crude (USD per barrel) % Source: Bloomberg, First Citizens Research & Analytics High (23-Jul) Low (13-Nov) Average % 70 Dec-13 Jan-14 Feb-14 Mar-14 Apr-14 May-14 Jun-14 Jul-14 Aug-14 Sep-14 Oct-14 Reasons for the drastic drop in prices: 1. Growth in US poroduction 2. Weakening demand from Europe 3. Middle East Violence which threatened supply Page 3 of 22

4 The plunge in oil prices began around end of July and was largely driven by a series of factors. First, the weaker global economic recovery, particularly in the advanced economies has dampened the outlook for fuel demand. For instance, the IMF in October downgraded its projection for global economic growth to 3.3% for 2014, from 3.4% projected just three months prior, with downward revisions for most advanced economies, except the US. Furthermore, in the world s second largest consumer of oil, China, there are increasing concerns of a slowdown in economic growth, with the IMF projecting growth of 7.4% in 2014 and 7.1% in 2015, down from an average of 8.9% recorded over the last five years. Recent data shows that growth is levelling off just above 7%, with the economy now largely driven by higher public investments, particularly on large infrastructural projects. Meanwhile, the US economy continues apace, with sustained economic growth rates, increasing import demand as well as signs of improving labor market conditions. Figure 3 indicates the shift in crude oil market dynamics in The green bars indicate periods when world supply of crude oil exceeded demand, and the orange bars indicate the opposite (demand exceeded supply). There is a clear and direct impact on crude prices as a result of these market dynamics. The imbalance of supply and demand became increasingly apparent in the third quarter of 2014 as demand remained fairly steady, falling just 0.3% (quarter on quarter), while for the same period, supply surged 2.5%. This highlights the glut in the world crude oil market in to the third quarter of 2014 and the primary reason for the decline in prices. FIGURE 3: Global Crude Oil Market: July 2013 September Green bars: Supply exceeds Demand (SS>DD) Orange Bars: Demand exceeds Supply (DD>SS) Imbalance (Millions BPD) WTI Spot (USD/ per barrel) (Right Scale) Source: Bloomberg, First Citizens Research & Analytics Page 4 of 22

5 FIGURE 4: Top 15 Countries: 2013 Share of Total (Oil) Production Consumption Source: BP Statistical Review 2014, First Citizens Research & Analytics FIGURE 5: Selected Suppliers of Crude Oil 15.0% Production Growth Rate - Crude Oil (year-on year) 10.0% 5.0% 0.0% % -10.0% Non-OPEC OPEC US Average Production Growth Rate over Last 3 Years: Non-OPEC: +1.3% OPEC: +1.7% US: +9.9% Source: BP Statistical Review 2014, First Citizens Research & Analytics Page 5 of 22

6 Figure 5 shows that the US, which is that third largest global crude oil producer, has been able to significantly increase its output since 2011, mainly due to the fact that the US continues to be a leader in research and development into tight oil. According to the Energy Information Administration, the US has the second largest recoverable shale oil resources only behind Russia. Tight oil production in the US has increased significantly in the past few years, going from less than 1 million BPD in 2010 to in excess of 3 million BPD in the second half of Traditional Drivers of Oil Price Movements Seasonal weather across the Globe Severe weather events globally Supply and demand dynamics OPEC Production Decisions OPEC spare capacity levels (gives the market the assurance that supply can be maintained so that high levels of OPEC spare capacity is typically associated with lower prices) (see Section III for details) Current Drivers of Oil Price Movements Non-OPEC Production Levels (e.g. United States) OPEC s Output decision Geopolitical Risk in Middle East (Rise of ISIS, which is seizing major oil refineries in Iraq and Syria, selling black market oil) Pace of Economic Recovery in countries which are large consumers of oil (e.g. China) Page 6 of 22

7 II. China s Demand China is a major player in the global crude oil market, given that it was the world s second largest consumer in 2013, only behind the US. The weaker economic data coming out from China has added to the bearish view on crude oil prices this year. On 21 October, China s GDP data for third quarter 2014 was released, and was slightly above analysts expectations, which resulted in oil prices moving higher. Indeed, the world s second largest economy grew 7.3% (y/y) in the third quarter, exceeding analysts forecast of 7.2%. Despite this, the third quarter result was actually the slowest pace of growth since the first quarter of China s oil demand rose by 7.1% in September, more than double the growth rate in August. FIGURE 6: China s GDP and Consumption Growth Rates (Year on Year) 14.0% % 10.0% % % 4.0% 2.0% 0.0% Oil Consumption Growth China's GDP Growth WTI Oil Prices (USD/ per barrel) (Right Scale) Source: Bloomberg, BP Statistical Review 2014, First Citizens Research & Analytics China s GDP growth rate is positively correlated to the country s oil consumption (0.30). Due to the size of China s economy, the country has become a very influential player in the world energy markets. According to the US Energy Information Administration, China is projected to move from second largest net importer of oil to the largest in the world in China's oil consumption growth accounted for one-third of the world's oil consumption growth in 2013, and EIA projects the same share in Page 7 of 22

8 China has diversified its base for its oil imports due to the robust growth rate in oil demand in China, as well as the geopolitical uncertainties. The country s largest supplier is Saudi Arabia (19%), Angola (14%) and Russia (9%) the top three individual countries. FIGURE 7: China s Consumption and Production of Crude Oil (000 s BPD) % % China's Oil Consumption China's Oil Production Source: Bloomberg, BP Statistical Review 2014, First Citizens Research & Analytics As of January 2014, China held about 24.4 billion barrels of proven oil reserves, the highest in the Asia-Pacific Region and the country s total oil and liquids production, which the fourth largest in the world, only serves its domestic market. Production has not kept up pace with consumption. The EIA projects that China will surpass the US in net oil imports on an annual basis by 2014 as US production and Chinese oil demand increase concurrently. However, the strength of Chinese demand for oil is dependent on several factors, including, the sustainability of high Chinese economic growth rates as well as trade, power generation, transportation sector shifts, and refining capabilities. TABLE 1: Top 10 Annual Net Oil Importers, Millions of Barrels per Day US 6.6 China 6.2 Japan 4.4 India 2.7 South Korea 2.3 Germany 2.2 France 1.6 Spain 1.2 Italy 1.1 Taiwan 1.1 Source: US Energy Information Administration, First Citizens Research & Analytics Page 8 of 22

9 III. OPEC OPEC meets on 27 November to consider whether they will adjust its output target of 30 million barrels per day for the first half of So far, only a minority of members have called for an output cut. Saudi Arabia has been hinting that they are comfortable with lower oil prices, while Kuwait has said that an OPEC cut in supply is unlikely. OPEC spare capacity levels gives the market the assurance that supply can be maintained, so that high levels of OPEC spare capacity is typically associated with lower prices. Spare capacity is defined by the EIA as the volume of production that can be brought on within 30 days and sustained for at least 90 days. Saudi Arabia, which is the largest producer with OPEC and the world s largest exporter of crude, historically has had the greatest spare capacity. In figure 8, during the period , OPEC s spare production levels were low, thus limiting the cartel s ability to respond to demand and price increases. Crude oil price increases in 2015 may be limited as the producer of 40% of the world s crude oil, OPEC has relatively restricted production spare capacity based on the EIA s projection as shown in figure 8. The EIA is projecting WTI crude oil price at USD71.11 per barrel (in real 2010 dollars) in Q115 and to end 2015 at USD72.36 per barrel, compared to USD91.26 per barrel at the end of the third quarter FIGURE 8: OPEC Spare Production Capacity and WTI Crude Oil Prices Spare Capacity <2.5 million barrels per day Projectio ns Q101 Q102 Q103 Q104 Q105 Q106 Q107 Q108 Q109 Q110 Q111 Q112 Q113 Q114 Q115 0 Spare Capacity (Millions BPD) (Right Scale) WTI Real Price (USD/ barrels per day) Source: US Energy Information Administration, First Citizens Research & Analytics Page 9 of 22

10 OPEC s oil output is likely to remain around the same level next year as 2014, and the group is unlikely to cut the ceiling on its production at a meeting next month despite the recent sharp slide in global oil prices, according to OPEC s General Secretary. According to OPEC, likely demand for OPEC oil next year would likely be between 29.5 million and 30 million barrels of oil a day next year, roughly the same as this year and suggested that the price decline does not reflect market fundamentals. OPEC also said that the current oil price weakness would likely hit shale oil output, and expects that the weakness in prices would eventually temper supply growth. Essentially there seems to be a lot of political wrangling. Saudi (and the other price-makers) is trying to keep price low to reduce the attractiveness of shale oil in order to preserve market share. It will be interesting to see how this unfolds, since China has already indicated plans to divert oil imports from Saudi to Colombia. According to analysis done by Deutsche Bank, the following represents the break-even Brent prices for the various Emerging Markets and major oil players: o Latest estimates suggest that the (Brent) spot price is now below the level needed to balance the budget in Bahrain (USD136 per barrel), Oman (USD101 per barrel), Saudi Arabia (USD99 per barrel), Nigeria (USD126 per barrel), Russia (USD100 per barrel), and Venezuela (USD162 per barrel). o Within this group, Saudi Arabia has a substantial net foreign assets estimated at USD768.5 billion at the end of 2014 that would enable it to withstand lower oil prices for a sustained period without necessarily needing to borrow or tighten policy. The same is true to a lesser extent for Russia. This means that these two countries will be better able to withstand a sustained period of weakened oil prices, without significantly hurting the respective economies. o But Nigeria will exhaust its limited oil savings well within a year at current prices in the absence of any adjustment. o Venezuela has no meaningful cushion to absorb this shock (Venezuela had USD billion in International Reserves at the end of October 2014). o Breakeven prices remain below the spot price in Kuwait (USD75 per barrel), Qatar (USD71 per barrel), and United Arab Emirates (USD80 per barrel). Page 10 of 22

11 Dec-14 Apr-15 Aug-15 Dec-15 Apr-16 Aug-16 Dec-16 Apr-17 Aug-17 Dec-17 Apr-18 Aug-18 Dec-18 Apr-19 Aug-19 Dec-19 Apr-20 Aug-20 Dec-20 Apr-21 Aug-21 Dec-21 Apr-22 Aug-22 Dec-22 WTI Futures (USD/ per barrel) WTI Futures Price (USD per barrel) IV. Energy Futures Contracts (Prepared by Proprietary Portfolio Management, FCIS) Energy futures are derivative instruments that allow the buyer to lock in the price of a commodity at a specific date. Once the buyer locks in to a futures contract, they will pay that price, regardless of whether the market price has changes. As at 17 November, WTI Crude Futures show that up to July 2016, the market is expecting that prices will remain stable at around the USD76.00 per barrel. This means that market players can lock in a price of USD76.64 for delivery in July The market also shows WTI prices climbing to USD80 per barrel in December FIGURE 9: WTI Future Contracts and One-Month Change in Contract Prices /2014 5/ / / / / /2019 Delivery Date WTI Futures (17-Nov-2014) 70 WTI Futures (1-Oct-2014) 65 Delivery Date Source: Bloomberg, First Citizens Research & Analytics Page 11 of 22

12 V. Oil Prices and Trinidad and Tobago Global oil prices have deteriorated sharply in recent weeks, dipping to levels not seen since The volatility of the global oil market has been heightened based on a culmination of various factors currently afflicting energy markets including geopolitical unrest, economic uncertainties as well as the potential impact of Ebola. The decline in prices have largely come due to supply side factors, however weakening demand has also played a part. The glut in the market (see figure 3 for evidence) stems from the increased production levels in the US. Weakening macroeconomic fundamentals in some of the large economies (and therefore large consumers of oil) have also resulted in the bearish turn in the oil market. Primarily an energy-based economy, the T&T budget is constructed on an assumed oil price of USD80 per barrel, using the WTI measure and gas price of USD2.75 per mmbtu (Henry Hub) Trinidad and Tobago had 728 million barrels of proven crude oil reserves as of 2014, according to the Oil and Gas Journal (OGJ). The country produced 118,000 BPD of petroleum and other liquids in 2013, of which 81,000 BPD was crude oil including lease condensates, and the remainder consisted mostly of NGL. Petroleum and other liquids production in Trinidad and Tobago peaked at 179,000 BPD in However, it has declined overall since then because of maturing oilfields and operational challenges, according to IHS Energy. TABLE 2: The economic contribution of the energy sector is as follows: Average ( ) Share of GDP 42.14% Share of Government Revenue (fiscal year) 52.66% Share of Merchandize Export Receipts 84.3% Share of Total Employment 3.28% Source: Review of the Economy, 2013 (Ministry of Finance and the Economy) Gas revenue impacts more heavily upon government revenue than oil. So if gas prices hold at above the assumed budget price of USD2.75/mmbtu, then it should be sufficient to offset the fall in oil price. However, this will depend on the sharpness of the decline in oil prices. (There is a 0.50 correlation between WTI and Henry Hub prices since 1991). (See figure 11). Over the period , government energy revenue increased almost five-fold, while crude oil production fell 28% and at the same time, natural gas production rose also five-fold. (See figure 10). While there is no data to substantiate this claim, the movement in government energy revenue can be more greatly attributed to the sharp increase in natural gas production over the period. Page 12 of 22

13 FIGURE 10: Production vs. Spot Prices (Crude Oil and Natural Gas) 55, ,000,000 50, ,000,000 45, ,000,000 25,000,000 40, ,000,000 35, ,000,000 30, ,000,000 5,000,000 25, Crude Oil Production (000 Barrels) WTI Crude Oil Prices (USD/ barrels per day) (Right Scale) Henry Hub (USD/ mmbtu) Natural Gas Production (mmcf/d) (Right Scale) Source: Bloomberg, Central Bank of Trinidad and Tobago, First Citizens Research & Analytics FIGURE 11: WTI Crude Oil Prices vs. Henry Hub Natural Gas Prices WTI Oil (USD, bbl) Henry Hub (USD,mmbtu) (Right Scale) Source: Bloomberg, First Citizens Research & Analytics Page 13 of 22

14 TABLE 3: Correlation Matrix WTI Prices Government Energy Revenue Ammonia Prices Methanol Prices WTI Prices Government Energy Revenue Ammonia Prices Methanol Prices Source: Bloomberg, Central Bank of Trinidad and Tobago, First Citizens Research & Analytics Based on the correlation matrix in table 3, there is a high positive correlation between WTI, Ammonia and Methanol spot prices and further, a moderately high positive correlation between ammonia and methanol prices to government energy revenue. Therefore, there is a possibility that further declines in oil prices will impact upon downstream prices, and ultimately upon the revenue stream of the government. FIGURE 12: Crude Oil Production vs. Crude Oil Reserves 58, , , , , , , Crude Oil Production (000 barrels) Crude Oil Reserves (billion barrels) (Right Scale) Source: Bloomberg, Central Bank of Trinidad and Tobago, First Citizens Research & Analytics Page 14 of 22

15 FIGURE 13: Impact of Shale Gas on LNG Exports to the US 70, , ,000 40,000 30,000 20,000 Gradually declining trend in T&T s LNG Exports to the US , LNG Exports to US US Dry Shale Gas Production (Trillion cubic feet)(right Scale) Source: Bloomberg, US Energy Information Administration, First Citizens Research & Analytics Crude production in Trinidad and Tobago has been on secular decline since 2005 with the rise of the downstream and petrochemical industries, evidenced by the almost 50% decline in output since In 2014 though, there are some positive signs, particularly from the marine side in terms of crude oil and condensate production. Total crude oil and condensate output rose close to 10% YTD, driven by a 15% increase in offshore production, compared to a 2.4% decline in onshore output. Large players like BPTT and Repsol have been able to significantly ramp up production during the year, increasing by 115% and 34%, respectively, year to date up to August The uptick in marine production is driven by increased exploration and development activity by several companies, which would have recorded significant discoveries in the past few years, including Repsol, Petrotrin, BP and Trinity. The Trinidad and Tobago energy market is now dominated by downstream and gas, despite recent efforts by the government to boost the upstream sector. Trinidad and Tobago is the world s sixth largest exporter of LNG and the largest LNG exporter to the US, however, US imports has been declining since the develop of its shale resources. Since 2008, Trinidad and Tobago accounted for an average of 57.5% of US LNG imports T&T is the world s largest exporter of ammonia and second largest exporter of methanol as there are 11 ammonia plants and seven methanol plants. Page 15 of 22

16 FIGURE 14: US Import of LNG by Country (Volumes in Millions of Cubic Feet) Yemen Trinidad Qatar Peru Norway Nigeria Egypt Canada Source: US Energy Information Administration, First Citizens Research & Analytics The Minister of Finance and The Economy has indicated that the USD80 per barrel assumption for the budget is based on the following: o Saudi Arabia the biggest player in OPEC. Saudi requires a price of USD92 per barrel to balance their budget. o Shale oil producers require prices at USD80 USD85 per barrel to break even. Prices below this level result in cut in investment and output. Page 16 of 22

17 Bottom Line: In terms of production of crude oil and condensate production in 2014, Trinmar, Petrotrin, Repsol and BPTT are the largest players (in that order). Petrotrin s revenue will be materially impacted by the decline in oil prices. The direct impact upon Petrotrin from an investment perspective if oil prices continue to decline will be deterioration in the credit rating and a rise in USD bond yields. Petrotrin s 2022 Eurobond was trading at a yield of 5.151%, with the corresponding price of as at 6-Novmeber 2014, compared to (5.033%) at the start of the year. FIGURE 15: Petrotrin s Eurobond Yield, Year to Date (%) Dec-13 Jan-14 Feb-14 Mar-14 Apr-14 May-14 Jun-14 Jul-14 Aug-14 Sep-14 Oct-14 Source: Bloomberg, First Citizens Research & Analytics Impact of Lower Oil Prices: Investors are starting to demand higher premium to hold Petrotrin s Eurobonds Petrotrin 2022 Petrotrin 2019 In a low oil price environment, energy companies tend to cut back on investment and all types of expenditure as certain projects are no longer economically viable, which will further impact FDI as international oil companies may not want to raise funding or debt lines may no longer be available. Based on the foregoing, we expect that oil prices will dip below USD70 per barrel by the end of the year given the imbalance in demand and supply, and based on the assumption that OPEC does not cut supply at its 27 November meeting. We then expect price to end 2015 around USD75 per barrel and USD80 per barrel by the end of Our fairly pessimistic view is largely based on increased in production in the US and to a lesser extent on relatively lower global demand. The impact therefore on T&T may be lagged, as future investments into the economy via the energy sector may be curtailed by large multinational oil players. The economic growth model in Trinidad and Tobago is arguably unsustainable in the long term, given the high dependence on an exhaustive resource Page 17 of 22

18 (hydrocarbons), coupled with the shifting dynamics of the global energy markets, made more acute by the fact that the energy sector is highly reliant on the ability of multinational corporations to invest into the sector. On a micro-level however, because our energy sector comprise of mostly large multinational players, if oil prices were to decline further for a sustained period, key projects/ investments by those corporations may be reevaluated, as companies seek to rationalize expenses on the possibility of lower revenue. Government borrowing will increase only if oil prices and gas/ downstream prices fall concurrently, and there is a squeeze on government revenue from the sector, particularly given our outlook for a significant increase in government expenditure in the run up to elections The FY 2015 budget forecasts total government revenue of TTD60.4 billion, with 35% coming from the energy sector. Total expenditure is budgeted at TTD64.7 billion, resulting in an overall fiscal deficit of 2.3% of GDP. According to the budget statement, oil and gas companies have advised that investments amounting to USD3.3 billion will take place in 2014, with projections of USD3.2 billion in 2015 and USD3.0 billion in The TTD21.2 billion budgeted for energy revenue for 2015 is based on oil price of USD80 per barrel and gas of USD2.75/ mmbtu. Assuming a dip in oil price to a worse-case low of USD70 per barrel at the end of 2015 and a low of USD3.70/ mmbtu for natural gas, we believe that the impact will be fairly benign on the fiscal accounts of Trinidad and Tobago, but caution if the worse-case scenario is breached, and the global economy deteriorates greater than anticipated, and if the imbalances in oil market are not resolved, there will be a severe impact on T&T, in the short-to-medium term. FIGURE 16: Government of Trinidad and Tobago Eurobond Yield, Year to Date (%) Jan-14 Feb-14 Mar-14 Apr-14 May-14 Jun-14 Jul-14 Aug-14 Sep-14 Oct-14 Nov-14 Source: Bloomberg, First Citizens Research & Analytics TRITOB 2020 TRITOB 2024 TRITOB 2027 Page 18 of 22

19 In the short-term we do not believe that the sovereign s credit rating is under threat of being downgraded. In our view, changes to the rating will come if there is a secular trend of weakening FDI flows into the country via the energy sector, which will affect the country s external accounts, output levels of the energy sector, which will then impact upon the fiscal accounts. We will have to look closely at the evolution of the market for natural gas, as we do think in the medium term, prices will decline based on the further development of shale gas and changing dynamics of Trinidad and Tobago s major export markets. However, at this time, we do not foresee a rating downgrade due to the weakness in the oil prices. The sovereign US Dollar Eurobonds have not been adversely impacted by the fall in oil prices (see figure 16). In fact, yields continue to decline over the year to date period, indicating that investors view Trinidad and Tobago as stable, demanding a lower risk premium to hold government debt. In terms of the national budget assumptions, our view is that if oil prices continue to fall, then the government may be forced to adjust expenditure, but given that it is an election year (general elections are due in 2015), it may be a politically difficult move to cut expenditure. For the next fiscal year, however, the revenue assumption might have to be more conservative to take into consideration the global situation of higher output of crude oil and possibility of reduced demand. VI. Petro Caribe We also have to consider the impact upon the falling oil prices on Venezuela and sustainability of the Petro Caribe Arrangement. Under the Petro Caribe initiative, Venezuela provides crude oil and refined products to many countries in the Caribbean and Central America, offering favorable financing and long repayment terms that often feature barter arrangements instead of cash transactions. Venezuela s economy is under pressure, with high inflation, low growth, and a foreign exchange crisis, not to mention unpredictable economic policy. The country s break-even oil price is estimated at USD162 per barrel, relative to the current price of USD77.81 per barrel. Venezuela is the world s largest owner of oil and natural gas proven reserves and is the third-largest exporter crude oil to the US. In 2013, the country was the world s ninth largest exporter and 12th largest producer of petroleum and other liquids. The fiscal and external accounts of Venezuela are both highly dependent on the energy sector. If oil prices decline further, there will be additional pressure on Petroleos de Venezuela S.A. (PDVSA). PDVSA is Venezuela s state-owned oil and natural gas company. It is the country s largest employer and accounts for a significant chunk of government revenue and export earnings (exact contribution unavailable). On 19 November, President Nicolas Maduro raised taxes almost across the board and also ordered that a USD4 billion loan from China to be added to international reserves as oil prices continued to decline. The move to increase reserves came after the country s international reserves fell to an 11-year low of USD19.4 billion on 14 November. While Venezuela has retained that Petro Caribe will be maintained, we believe that the terms and conditions may be adjusted based on the financial circumstances of the state-owned oil and gas company PDVSA, shrinking foreign exchange reserves and guaranteed export arrangements with other countries, like China (which imports 6% of its crude oil from Venezuela). Page 19 of 22

20 Most of the Caribbean are Petro Caribe beneficiaries (except Barbados and Montserrat). The IMF has already warned large recipients like Jamaica of a possibility of a halt to the arrangement, suggesting that stress tests should be done to include this scenario. Figure 17 shows the countries that are risk of changes to the Petrocaribe arrangement, showing that Cuba, Dominican Republic, Jamaica and Haiti are the most vulnerable. Cuba s mineral imports constitute a large portion of total imports, and at the same time, is the largest recipient of Petrocaribe. However, of concern to Trinidad and Tobago is the fact that many of our trading partners are very dependent on mineral imports, and at the same time, runs very large external current account deficits, placing them in a very precarious position. If Petro Caribe is modified, then there may be a balance of payments crisis in the region, given the already strained external liquidity conditions with most of the countries recording external current account deficits in excess of 20% of GDP. This can result in a rapid erosion of US dollar reserves and pressure on fixed exchange/ pegged rate regimes, and of course, inability to service external debt, if the situation deteriorates significantly. The countries with a fixed exchange rate regime may most likely suffer the most (the ECCU); given that FX reserves will be quickly eroded under this situation, exacerbated by persistent lower foreign exchange inflows from a weak external environment and narrow export bases. CARICOM countries account for about 40% of Trinidad and Tobago s non-energy exports and a prolonged recession in these countries can severely affect T&T s external current account as well as the performance of the exporters of this country. FIGURE 17: Caribbean - Exposure To Higher Fuel Import Costs Note: Bubble size indicates daily oil import quota from Petrocaribe ('000 b/d). Source: Business Monitor International Page 20 of 22

21 VII. Impact on Trinidad and Tobago Banking Sector If large multinational energy players hold back on investments into the Trinidad and Tobago market, then employment in the energy sector may be affected. This may have an impact upon the Bank s exposure to this sector (institutional and on an individual level). Credit exposure by sector shows that the energy sector only accounts for a small portion of Banks overall loans, with RBL, First Citizens and CIBC under 1%, and Scotia with the highest exposure of 9% as at the end of the respective bank s financial year FIGURE 18: Commercial Banks: Large Exposure by Sector (March 2013) Other Services 4% Transport, Storage and Communication 1% Construction 11% Agriculture 0% Consumers 2% Distribution 2% Government 34% Manufacturing 1% Real estate 14% Financial 20% Electricity and Water 4% Energy and Mining 7% Hotel and Restaurant 0% Source: Central Bank of Trinidad and Tobago, First Citizens Research & Analytics The country s largest earner of foreign exchange is the energy sector, providing 75% of the supply in Therefore, if the sector is facing a lower price environment, then there will be lower FX inflows. The FX shortage which is currently a major concern will therefore continue to pose a significant challenge for the banking sector and their ability to meet customers demand for foreign exchange. Contagion via the trade channels can negatively impact the financial institutions. If Petro Caribe is modified, then the fallout in economic performance can impact upon the local financial sector. If regional non-energy import demand falls, local exporters may find it difficult to meet financial commitments to local financial institutions, as such under this scenario, commercial banks non-performing loans may increase. Page 21 of 22

22 We think that interest rate policy in Trinidad and Tobago will be tightened at a gradual rate for the rest of this year, and into next year. November is next CBTT Monetary Policy Committee Meeting. We expect that a 25bps increase in the repo rate to 3.25% may be implemented by the end of the year, to rise further to 3.75% by Q in response to anticipated higher US interest rates. CBTT will likely hold at 3.75% till year end 2015 as it could be that long before public spending restarts following the May General Elections. The commercial banks average prime lending rate will increase, which should increase the banks spread income. We do not think that the current movements in energy prices will result in a deviation of the current monetary policy stance adopted by the central bank. US dollar shortage (due to current shortage, lower energy revenues and falling demand for T&T natural gas) might force the Trinidad and Tobago dollar to depreciate against the US dollar. This may encourage imported inflation, where the costs eventually trickle down to consumers, which can stoke headline inflation and force the central bank to be more aggressive towards monetary policy (raising rates faster than our baseline). The implications for commercial banks may be two-fold: operating in a higher interest environment, as well as increased FX expenses associated with a depreciating TT dollar. The latter will be minimal, based on the managed float the CBTT operates. DISCLAIMER This report has been prepared by First Citizens Investment Services Limited, a subsidiary of First Citizens Bank Limited. It is provided for informational purposes only and without any obligation, whether contractual or otherwise. All information contained herein has been obtained from sources that First Citizens Investment Services believes to be accurate and reliable. All opinions and estimates constitute the author s judgment as at the date of the report. First Citizens Investment Services does not warrant the accuracy, timeliness, completeness of the information given or the assessments made. Opinions expressed may change without notice. This report does not constitute an offer or solicitation to buy or sell any securities discussed herein. The securities discussed in this report may not be suitable to all investors, therefore Investors wishing to purchase any of the securities mentioned should consult an investment adviser. Page 22 of 22

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