OIL PRICE OUTLOOK UPDATE PRICING IN THE SELLOFF

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1 AUGUST 25, 215 Summary Since our last report Current view on oil price and market forecasts on July 27, the Brent price has fallen by around $11/bbl, moving below our expected fundamental range of $5-65/bbl, and is currently trading at the $43-44/bbl level. While we do not consider an oil price in the $4s as justifiable beyond the short term, we downgrade our forecast for the 215 average Brent price from $6./bbl to $53.6/bbl, reflecting the increased speculative nature of the oil price, and anticipate Brent will find a new supply/demand equilibrium by year end/beginning of 216. We expect Brent to trade at around $45/bbl throughout 3Q15 ($48.8/bbl on average in 3Q15) and then recover to $5/bbl on average in 4Q15. Evgenia Dyshlyuk +7 (495) (ext ) Evgenia.Dyshlyuk@gazprombank.ru Alexander Nazarov +7 (495) (ext ) Alexander.Nazarov@gazprombank.ru Vladimir Kravchuk +7 (495) (ext ) Vladimir.Kravchuk@gazprombank.ru Konstantin Asaturov +7 (495) (ext ) Konstantin.Asaturov@gazprombank.ru Our new projections of the oil price for 215 are generally in line with the Economy Ministry s average Brent forecast, which was revised down from $6/bbl to $52/bbl, according to media reports yesterday. According to our technical analysis, the new technical target for Brent is $35.85/bbl, with psychological support at $4./bbl on the way, while a technical rebound is possible from any price level. With no new risk factors weighing on the supply side, the recent drop in the oil price, in our view, was primarily driven by investors fears about the end of the China-led commodity super-cycle and the market s rebalancing of crude supply/demand forecasts, factoring in a new supply outlook. On the supply side, we saw no new risk factors over the past month. Market expectations regarding the timing/volumes of additional oil supplies from Iran have not changed since end July. OPEC s oil production increase in July the fifth consecutive monthly rise did not come as a surprise to the market, which lives on the hypothesis that the cartel will stick to its strategy of retaining/growing market share. US oil production is still projected to decline through mid-216. Finally, high-cost upstream projects, such as deepwater and oil sands, are being scaled back, as anticipated. Heighted concerns regarding the economic slowdown in China and a major selloff in the Chinese stock market in recent weeks, followed by yuan devaluation, adversely affected global financial markets and the oil price. Fears about the end of the Chinaled commodity super-cycle on the back of prevailing crude oil surplus supply triggered new bear oil price scenarios with Brent in the $4s for this and next year. Average Brent price forecast revision for 215, $/bbl 1Q15 2Q15E 3Q15F 4Q15F 215F Bloomberg consensus high low EIA GAZPROMBANK current new Source: Bloomberg; EIA Short-Term Energy Outlook, August 215; Gazprombank estimates Research Department 1 Copyright Gazprombank (Joint Stock Company)

2 AUGUST 25, 215 Iran: still expecting increased oil exports no earlier than 2H16 The latest projections by the market and industry experts regarding Iran confirm our view that large-scale additional crude supplies from the country should be expected no earlier than summer 216 (see our Oil and Gas Weekly of April 1, 215). According to the August Bloomberg survey, investors are not very optimistic regarding Iran s ability to quickly grow crude output after the removal of sanctions. The majority of the survey respondents expect the country s production additions to be less than 1 mln bpd by end 216, while roughly a third of respondents expect an increase of below 5 kbpd. Almost half of the respondents believe that Iran will be able to add to the global oil supply only in 2H16 or later. The most recent forecast by the US Energy Information Administration (EIA) is somewhat more conservative: in its Short-Term Energy Outlook report from August, the EIA projects Iranian crude supplies to increase by about 3 kbpd on average in 216, with most of the growth occurring in the second half of the year. The EIA s forecast assumes that implementation of the sanctions relief will occur in 2Q16. The latest estimates of Iran s crude stocks (which can be sold immediately after the sanctions are lifted) are also in line with market expectations. According to the Bloomberg survey, 55% of respondents estimate Iran s oil stocks in the range of 2-44 mln bbl (less than 1% of current global oil supply) and 35% of the respondents at below 2 mln bbl. These estimates are broadly in line with previous estimates, based on information from US officials (7-17 mln bbl) and other sources (3-35 mln bbl), supporting the view that Iran s oil stocks may have a short-term effect on the oil price. According to OPEC data based on direct communication, Iran s crude oil production in July averaged 3.13 mln bpd, or 13 kbpd above the 214 average (see Graph 1). Iran s rig count remained unchanged at 54 in 1Q15 and 2Q15 (see Graph 2). Graph 1. Iran crude* production in 7M15, kbpd Q15 2Q15 JUL 215 * based on direct communication Source: OPEC Monthly Oil Market Report from August 215 Graph 2. Iran rig count in 7M Q15 2Q15 JUL 215 Source: OPEC Monthly Oil Market Report from August 215 OPEC: growth in oil production amid oversupply is no surprise The continuing upward trend in OPEC s crude production supports the hypothesis that in an environment of heightened competition among suppliers OPEC may adopt a strategy of retaining/growing its market share. In July, OPEC s crude production increased for a fifth consecutive month (see Graph 3). According to OPEC data based on secondary sources, the cartel increased crude production by roughly 13 kbpd to mln bpd. The growth was driven by Iraq, Angola, Saudi Arabia, Iran, and UAE, offsetting lower output in Libya, Nigeria and Qatar, as well as minor production declines in other countries. 2

3 1Q14 2Q14 3Q14 4Q14 1Q15 2Q15E 3Q15F 4Q15F 1Q16F 2Q16F 3Q16F 4Q16F 1Q14 2Q14 3Q14 4Q14 1Q15 2Q15E 3Q15F 4Q15F 1Q16F 2Q16F 3Q16F 4Q16F AUGUST 25, 215 Graph 3. OPEC crude production vs. oil price in 7M JAN FEB MAR APR MAY JUN JUL* OIL PRODUCTION, MBPD AVR. BRENT OIL PRICE, $/BBL * according to secondary sources Source: OPEC Monthly Oil Market Report from August 215; Bloomberg In line with this hypothesis, the EIA does not expect Saudi Arabia and other OPEC countries to cut production to accommodate additional Iranian volumes. In its latest Short-Term Energy Outlook report from August, the EIA forecasts OPEC s crude production (excluding condensate and other liquids) to average 3.86 mln bpd in 215, up by roughly 8 kbpd YoY, and to remain relatively flat YoY at 3.83 mln bpd in 216 (see Graph 4). The largest contributors to the growth are expected to be Iraq in 215 and Iran in 216. The EIA forecasts OPEC surplus production capacity, concentrated in Saudi Arabia, to decrease from 2. mln bpd on average in 214 to 1.6 mln bpd in 215 and then to increase to 2.1 mln bpd in 216 (see Graph 5). While typically surplus capacity below 2.5 mln bpd indicates a relatively tight oil market, the low forecast for 215 is not very relevant in the context of high current and projected levels of global oil inventories. Graph 4. OPEC forecast crude* production in 2H15-16, mln bpd Graph 5. OPEC forecast crude* surplus production capacity in 2H15-16, mln bpd * excluding condensate and other liquids Source: EIA Short-Term Energy Outlook, August 215 * excluding condensate and other liquids Source: EIA Short-Term Energy Outlook, August 215 3

4 JAN 14 JAN 14 FEB 14 APR 14 JUN 14 AUG 14 OCT 14 DEC 14 FEB 15 APR 15 JAN 14 AUGUST 25, 215 US: oil production still projected to decline through mid-216 As stated previously, US crude production is projected to decline in 2H15 and 1H16. The EIA estimates that the country s crude output, which began to decline in May (see Graph 6), was down by 1 kbpd MoM in July. Reduced investment on the back of weak oil prices has resulted in the lowest count of oil-directed rigs in nearly five years (see Graphs 7 and 8) and well completions that are significantly behind 214 levels. The horizontal rig count, down by 51% from its peak in November 214, points to a slowdown in US oil production (see Graph 9). Graph 6. US rig count vs. crude oil production dynamics in 214-5M15, mln bpd Graph 7. US rig count vs. oil price in 214-8M , , ,5 1, DECREASE FROM MAX POINT: -54% TOTAL RIG COUNT US CRUDE OIL PRODUCTION, KBPD TOTAL RIG COUNT WTI PRICE, $/BBL. Source: EIA Source: Baker Hughes, Gazprombank estimates Graph 8. US oil and gas count in 214-8M15 Graph 9. US rig count by type of drilling in 214-8M15 2,5 2,5 2, 1,5 DECREASE FROM MAX POINT: -43% 2, 1,5 1, 5 DECREASE FROM MAX POINT: -58% 1, 5 GAS OIL Source: Baker Hughes, Gazprombank estimates VERTICAL HORIZONTAL DIRECTIONAL Source: Baker Hughes, Gazprombank estimates In its Short-Term Energy Outlook report from August, the EIA reiterated its expectations that US crude production will decrease through mid-216 and resume growth later in the year. Further, the agency revised down its forecast of the country s crude production for 215 and 216 by roughly 1 kbpd (to 9.4 mln bpd) and by 4 kbpd (to 9. mln bpd), respectively (vs. 8.7 mln bpd in 214) (see Graph 1). According to the EIA, oil prices, particularly in 2Q15 (average WTI of $58/bbl, Brent $62/bbl), were still high enough to support development drilling at core shale plays (Bakken, Eagle Ford, Niobrara, and Permian basins). Yet, the recent fall in oil prices and the lowered outlook for oil prices (average WTI of $54/bbl, Brent $59/bbl in 216) are expected to prolong and deepen onshore production declines, the EIA says. Lower oil 4

5 AUGUST 25, 215 prices are anticipated to slow the rate of recovery in onshore drilling activities and well completion totals, despite continued increases in rig/well productivity and declining drilling and completion costs. In our last report we indicated that the analyst median estimate of the breakeven oil price for the two largest US shale oil fields Eagle Ford and Bakken as of October 214 was in the range of $5-75/bbl. Graph 1. US forecast crude* production in , mln bpd Q15 2Q15E 3Q15F 4Q15F 1Q16F 2Q16F 3Q16F 4Q16F * including lease condensate Source: EIA Short-Term Energy Outlook, August 215 High-cost upstream projects: scaling down, as expected In line with expectations, high-cost upstream projects, such as deepwater and Canadian oil sands, are now being scaled down on the back of weak oil prices. In its Monthly Oil Market Report from August, OPEC cites estimates by Wood Mackenzie that point to the deferral of $2 bln of investment in large upstream projects over the past six months. The consultancy estimates that 46 of the world s largest presanctioned projects, which are uneconomic at an oil price of $6/bbl and below, are now targeting start-up in These projects combined account for 2 bln boe of reserves, of which over 6% is oil/condensate. Over half (1.6 bln boe) of the reserves put on hold are deepwater projects (US Gulf of Mexico, offshore West Africa). The prospect of lower oil prices has also put significant investment in Canada's high-cost oil sands in the crosshairs, with the deferral of around 5.6 bln bbl. In its Monthly Oil Market Report from August, OPEC revised its forecast of non-opec oil supply in 216 down by 4 kbpd to 57.7 mln bpd due to, among other factors, revisions of future projects. We expect more substantial downward revisions on a longer-term horizon, helping the oil price to find a new equilibrium. China: heightened fears of economic slowdown and end of the commodity super-cycle The major selloff in the Chinese stock market in recent weeks on the back of rising concerns about the economic slowdown, followed by yuan devaluation, as well as thus far unsuccessful efforts by the Chinese government to stabilize the equity market, contributed to the oil price decline, as investors feared the end of the Chinaled commodity super-cycle. The pace of economic growth of China, which became the world s largest net oil importer at end 213 and accounted for around 4% of growth and 12% of global oil consumption in 214, remains a major uncertainty factor for global oil demand. 5

6 FEB 15 APR 15 JUN 15 AUG 15 FEB 15 APR 15 JUN 15 AUG 15 AUGUST 25, 215 According to China s official statistics, the country s GDP grew 7% in 1Q15 and in 2Q15. However, economists debated whether the growth in 1H15 was this robust, providing own estimates in the range of 4-6%. China s macroeconomic data (IM, PMIs, exports) in 2Q15 and July were weaker than expected, raising concerns about the economic slowdown, particularly in commodity-intensive sectors. The final reading of the Caixin/Markit purchasing managers index (PMI) in July revealed that China s manufacturing sector was shrinking by more than previously expected. The official manufacturing PMI in July was down to a five-month low. Moreover, major components of both indices (new orders, output, raw material inventory) were weaker. In recent weeks, Chinese shares suffered their worst fall in nearly six years, diminishing investors confidence in Beijing s ability to stabilize the equity market. The rescue steps by the Chinese government, including the introduction of a stock-purchasing program financed by the PBoC and commercial banks and a halt to new stock listings, have been unsuccessful thus far. The Chinese government s investigation into a possible coordinated equity selloff did little to turn things around. This dragged down global financial markets, further affecting the oil price (see Graphs 11 and 12). The Chinese government continues its efforts to stabilize the situation. Today the PBoC lowered its benchmark one-year lending rate by 25 bps to 4.6% from Wednesday. The benchmark deposit rate will also be cut by 25 bps to 1.75%. The RRR, the minimum level of reserves banks must hold, will be lowered by 5 bps. The rate cut is intended to reduce financing costs to help the SME segment and support the real economy, while the reserves ratio cut could unlock up to RMB 65 bln ($11.38 bln) for Chinese banks to lend. Following its announcement on August 11 that the yuan s daily reference price would be changed from the official fix to the ending price of the previous trading session, the PBoC lowered the yuan s reference rate by 4.65% in total over the course of the next three days. The new mechanism helps China s goal of inclusion of the yuan in the IMF s Special Drawing Rights (SDR) basket as a step toward liberalization of financial markets. Meanwhile, the weaker yuan (market exchange rate down by 3.27% from August 1) imposed greater pressure on the oil price. Graph 11. Shanghai Index vs. Brent price in 8M15 Graph 12. S&P5 Index vs. Brent oil price in 8M15 5,5 7 2,15 7 5, 4,5 4, 3, ,1 2,5 2, 1,95 1,9 1, , 4 1,8 4 SHANGHAI INDEX BRENT, $/BBL. S&P5 INDEX BRENT, $/BBL. Source: Bloomberg Source: Bloomberg Nevertheless, Capital Economics believes that downside risks to China s short-term growth are overstated. According to the firm, recent policy easing will result in stronger activity, albeit with a lag, while the Chinese government still has plenty of resources to prevent growth from slipping much further. 6

7 JAN 14 FEB 14 APR 14 JUN 14 AUG 14 OCT 14 DEC 14 FEB 15 APR 15 JUN F 216F 217F AUGUST 25, 215 In May, OPEC revised its forecast of China s real GDP growth in 215 from 7.% (the official target) to 6.9% amid slowing economic growth, particularly in manufacturing (overcapacity, weak production dynamics) and real estate. In August, OPEC reiterated its forecast of China s real GDP growth at 6.9% in 215 and 6.5% in 216. The current Bloomberg consensus suggests that China s real GDP growth will stand at 6.9% in 215 and 6.7% in 216. The current consensus estimates of China s growth for 3Q15 and 4Q15 stand at 6.9%, suggesting that the country s economic performance in the remaining four months of this year will be more indicative for longer-term revisions. Graph 13. China s PMI dynamics in 214 and 7M15 Graph 14. China s historical and forecast real GDP growth, % % 11% 1% 9% 8% 7% 6% 5% Source: Bloomberg Source: Bloomberg 7

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