Outlook for the Upstream Sector of the Oil and Gas Industry

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1 Outlook for the Upstream Sector of the Oil and Gas Industry August 214 Prepared for: VMA Market Outlook Workshop Boston, MA Prepared by: Spears & Associates Tulsa, OK

2 Oilfield Equipment and Service Sector Global expenditures for oilfield equipment and services have grown at an 11% CAGR since 25. The US accounts for ~45% of the global market. $5 $45 $4 $35 $3 $25 $2 $15 $1 $5 $- Global Oilfield Equipment and Service Spending ($ bil) Sources: Spears 2

3 World Oil Market Assuming continued worldwide economic growth, global oil consumption is expected to grow 1.2% in 214, up 1.1 million bpd to an average of 91.6 million bpd, and 1.6% in 215, to 93.1 million bpd. As has been the case for the past decade, all the incremental growth in global oil demand is coming from emerging economies (which now account for 5% of total demand). Oil use in developed economies continues to trend flat-to-down due to energy efficiency improvements and sluggish economic growth World Oil Demand (million bpd) Sources: EIA; Spears 3

4 Non-US Oil Market Non-US oil consumption is expected to grow 1.6% to an average of 72.7 million bpd in 214, and increase of 1.9% to in 215 to an average of 74.1 million bpd. Non-US oil production is forecast to average 78.1 million bpd in 214, up.3% from last year, and average 78.3 million bpd in 215, up.2%. Non-US oil production remains below the peak of 78.7 million bpd set in 212, prior to the rapid increase in US oil production. While non-us oil consumption continues to grow, non-us oil production has stagnated as the fall in oil exports to the US has offset the rise in consumption elsewhere. Spot Brent prices are expected to trade in the $1- $11/bbl range as increasing global oil demand is offset by continuing declines in net exports to the US, leaving non- US oil production largely unchanged Non-US Oil Consumption (mil bpd) Non-US Oil Production (mil bpd) Sources: EIA; Spears 4

5 US Oil Market US oil demand is projected to average 18.9 million bpd in 214, unchanged from last year. US oil consumption is projected to average 19. million bpd in 215, up.4%. Fuel consumption in the transportation sector has declined due to increased engine efficiency and a drop in miles driven; however, oil demand for fuel/heat/feedstock applications in the industrial sector has increased as economic activity has improved. US oil production averaged 12.3 million bpd in 213, up 11% for the year. It is projected to grow 11% in 214, to an average of 13.6 million bpd, and 7% in 215, to an average of 14.6 million bpd US Oil Consumption (mil bpd) US Oil Production (mil bpd) Sources: EIA; Spears 5

6 US Oil Market Increased US oil output has led to a sharp drop in net US oil imports, which have fallen from 9.4 million bpd in 21 to 6.2 million bpd in 213, and which are projected to decline to 5.1 million bpd (-18%) in 214 and 4.2 million bpd (-17%) in 215. US exports of refined products averaged 3.5 million bpd in 213, up 11% for the year. As recently as 21 US exports of refined products averaged 2.3 million bpd US Net Oil Imports (mil bpd) Sources: EIA; Spears 6

7 US Oil Production US tight oil production now represents 22% of total US crude oil production. Virtually all of the increase has come from the Eagle Ford play in South Texas and the Bakken Shale in North Dakota and Montana US Crude/NGL Production (mil bpd) NGLs Offshore Alaska L-48 Onshore US Tight Oil Production (mil bpd) DJ Niobrara Marcellus Haynesville Bakken Eagle Ford Sources: EIA; Spears 7

8 US Oil Production US oil production is on track to continue to grow at ~8, bpd per year, most of which will be in the form of light sweet crude. Up to this point increased US oil production has been accommodated by backing out imports of light oil. However, few barrels of light oil imports are still available to be displaced; further gains in US oil production will increasingly rely on refinery expansions or exports in order to find a market. It is not clear that US refiners will be able to increase their light crude refining capacity fast enough to keep up with the increase in US oil production. 14. US Crude Oil Production (mil bpd) Source: Tudor, Pickering, Holt & Company 8

9 US Oil Production US crude oil exports are restricted by law, except for administrative fiat. US crude oil exports averaged.12 million bpd in 213, up 7% for the year, and are on track to average ~25, bpd in 214. Recently there has been an effort to amend the definition of crude oil used in the law prohibiting US oil exports so as to exclude very light condensates, which account for a significant portion of the increase in US crude oil production. If adopted, this would potentially allow the export of several hundred thousand barrels of condensate, alleviating some of the pressure on oil prices US Crude Oil Exports (mil bpd) The pressure to allow crude oil exports will increase along with supply. However, we do not expect restrictions to be substantially lifted until after 216. Sources: EIA; Spears 9

10 Oil Prices The spot WTI price has been trading over $1/bbl; however, prices are expected to slide to around $9/bbl by the end of this year as US oil production growth remains strong, US oil demand growth remains minimal, like-for-like opportunities to displace oil imports grow scarcer, and relief from restrictions on US oil exports remain limited over the near-term. Spot WTI prices are expected to average $97.5/bbl in 214, down.6%, and $9/bbl in 215, down 8%. If a combination of increased crude oil exports and refinery expansions does not absorb most of the expected growth in US oil production, then US crude oil prices are likely to fall to the point (below $8/bbl) that operators cut back drilling activity in order to reduce the growth in production. $1 $95 $9 $85 $8 $75 $7 $65 $6 US Spot WTI Prices ($/bbl) Sources: NY Merc; Spears 1

11 US Gas Market US gas use is estimated to average 72.4 bcfd in 214, up 1.5% from last year. The increase is primarily being driven by industrial consumption, rather than weathersensitive residential use. However, US gas demand is forecast to fall.4% in 215, to an average of 72.1 bcfd, assuming normal weather next winter. US gas production is projected to reach 69. bcfd in 214 (up 3.7%) and 69.9 bcfd in 215 (up 1.2%) US Gas Consumption (bcfd) US Gas Production (bcfd) Sources: EIA; Spears 11

12 US Gas Production Shale gas production is estimated to have accounted for 45% of overall US gas output in 213. US shale gas production exceeded 3 bcfd bcf in 213, up 13%. Most of the growth in US shale gas production since 211 is due to the Marcellus Shale, which produced 9.3 bcfd in 213. Other leading shale gas producing regions in 213 were the Barnett Shale (5.2 bcfd), Haynesville Shale (5.5 bcfd), and Eagle Ford (3.3 bcfd). US gas exports is projected to average 4.3 bcfd in 214 (unchanged from last year) and 4.6 bcfd in 215 (up 6.7%). US gas exports are positioned to rise sharply after 215. Thirteen US Gulf Coast LNG export projects with a combined capacity of 18.3 bcfd have been proposed to the FERC. However, most observers believe that no more than 8. bcfd of this capacity will actually be built US Shale Gas Production (bcfd) Other Woodford Fayetteville Marcellus Bakken Barnett Eagle Ford Haynesville US Gas Exports (bcfd) 1 Sources: EIA; Spears 12

13 Gas Prices US spot natural gas prices are estimated to average $4.35/mmbtu in 214, up 19%, in response to the drawdown in gas inventories. Once storage returns to normal levels, it is expected that gas prices will fall in order to stimulate demand. US spot gas prices are projected to average $4./mmbtu in 215 (assuming normal weather). $5. $4. $3. $2. $1. US Spot Gas Prices ($/mmbtu) $. Sources: Natural Gas Week; Spears 13

14 US Activity The cost to drill and complete new wells fell in 212 and 213, but has begun to increase this year. Spending on new wells is projected to total $157 billion in 214, up 4%, and rise to $165 billion in 215, up 5%. US rig count is forecast to average 1,87 active rigs (up 6%) in 214, but drilling activity is expected to roll over in 215 as US oil prices decline due to the difficulty of accommodating increased US oil production in the absence of relief from the current ban on US crude oil exports. Overall US rig count is forecast to fall 1% in 215, to an average of 1,845 active rigs. The net impact of new federal and state HSE regulations on US E&P activity has been negligible to date, but concerns remain , 1,5 1, 5 Drilling and Completion Spending ($ bil) Average Active Rig Count Gas related Oil related Source: Baker Hughes; Spears 14

15 US Activity US well count is on track to approach 47,5 new wells in 214, up 3% from last year. For 215 we expect that the total number of new wells drilled will remain unchanged, but that the number of new oil wells drilled will fall 3% while the number of new gas wells drilled will increase 9%. A total of 1.5 million producing oil and gas wells were working in the US at the start of 214, up 1.5% from the year-ago level. Due to the continued strong price of oil which has both lifted new oil well drilling and also extended the life of older wells, the number of active US oil wells is estimated to be up 2.9% over the past year. However, the number of active US gas wells is estimated to have fallen.3% from the year-ago level as abandonments exceeded new gas wells drilled for the third time in four years , 5, 4, 3, 2, 1, New Wells Drilled by Type () Dry Holes Gas Wells Oil Wells Producing Wells Oil Gas 15 Source: Baker Hughes; Spears

16 Canada Activity The cost to drill and complete new wells is projected to total $28 billion in 214, up 19%, and then hold steady in 215. For 214 Canadian drilling activity is forecast to average 38 active rigs (up 8%). The forecast for 215 calls for Canadian rig activity to fall 3% to an average of 367 active rigs Drilling and Completion Spending ($ bil) Average Active Rig Count Gas related Oil related 5 16 Source: Baker Hughes; Spears

17 Canada Activity Canadian drilling activity is forecast to see about 11,7 new wells drilled (up 12%). Over 23, producing oil and gas wells were working in Canada at the start of 214, up.7% from the yearago level. The number of active oil wells in Canada is estimated to be up 4.8% since the start of 213 while the number of active gas wells in Canada is estimated to have fallen 1.6% over the same time span , 14, 12, 1, 8, 6, 4, 2, New Wells Drilled by Type() Dry Holes Gas Wells Oil Wells Producing Wells Oil Gas Source: Baker Hughes; Spears 17

18 International Activity Overall International drilling activity in 214 is projected to average 1,347 active rigs (up 5%), accounting for about 14,5 new wells (up 4%). The forecast for 215 calls for rig activity to increase 5% to an average of 1,415 active rigs and almost 15,2 new wells drilled. On a regional basis, International activity in 215 is expected to realize the following changes: Africa (+8%), Mid East (+6%), Europe (+6%), Central and South America (+4%), and the Far East (+3%). The massive cost of deepwater field development is beginning to strain the balance sheets of even the most well-capitalized companies, forcing the cancellation of some projects and delay of others as operators look for ways to cut costs. 1,6 1,4 1,2 1, Intl Average Active Rig Count Offshore Land Intl New Wells Drilled by Type () Offshore Land 2 18 Source: Baker Hughes; Spears

19 Oilfield Manufacturing Surface and Subsea Equipment Global spending on surface and subsea pressure control equipment (Christmas tree valves, casing and tubing heads, chokes, safety shutdown systems and actuators, gauges, fittings, etc.) will exceed $26 billion in 214, up 1%, and is projected to total about $31 billion in 215, up 17%. Unit Manufacturing Unit manufacturing is mostly related to the CAPEX budgets of pressure pumping, wireline and coiled tubing service companies. Full utilization of frac equipment is prompting service firms to order new equipment. $35. $3. $25. $2. $15. $1. $5. $. $7. $6. $5. $4. $3. $2. $1. $. Surface and Subsea Equipment Market ($ bil) Subsea Surface Unit Manufacturing Market ($ bil) Source: Spears 19

20 Summary US oil prices are expected to average around $1/bbl in 214 but decline to ~$9/bbl in 215 as oil production growth remains strong, oil demand growth remains sluggish, opportunities to displace oil imports grow scarcer and relief from restrictions on crude exports remains limited in the near term. US gas prices are expected to rise 25% in 214 in response to the drawdown in gas inventories but then weaken in 215 ahead of an anticipated jump in gas exports. Overall US rig activity is projected to rise 6% in 214 but fall 1% in 215 as oil prices weaken. Overall well count is projected to rise 3% in 214 and hold steady in

21 Legal Matters Copyright 214, Spears and Associates, Inc. All rights reserved. Disclaimer: This communication is based on information that Spears and Associates, Inc. believes is reliable. However, Spears and Associates, Inc. does not represent or warrant its accuracy, completeness, or any other aspect of this information. The viewpoints and opinions expressed in this report represent the views of Spears and Associates, Inc. as of the date of this report. These viewpoints and opinions may be subject to change without notice. This message should not be considered as a recommendation to buy or sell any securities. In no event shall Spears and Associates, Inc. be liable for incidental or consequential damages associated with reliance on any statement or opinion contained in this report. 21

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