Global Oil Markets and Hedging Are Trends Your Friend? Non-OPEC to painfully balance the oil market by moving from record growth in 2014 to production declines in 2016 EnerCom March 2016 Fredrik Sagen Andersen
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OPEC (Saudi) Will Not Protect Price In Supply Driven Downturn 5% 4% World Supply/Demand Trends vs Prior Year -12 months mavg Supply driven downturn 3% 2% 1% 0% -1% -2% Demand driven downturn -3% Jun-03 Jun-05 Jun-07 Jun-09 Jun-11 Jun-13 Jun-15 Source: IEA Global oil demand Non-OPEC Supply incl. proc.gains & biofuels 4
Bearish Headlines 5
Changes In The Supply-Demand Balance Are Happening - The price is doing its magic. If demand keeps on growing more than non-opec supply we need more and more from OPEC Million b/d Global Oil Demand Growth vs Non-OPEC Growth 4.0 3.0 2.0 1.0 0.0-1.0-2.0-3.0-4.0 2003 2005 2007 2009 2011 2013 2015 Source: IEA 6
The Long End of the Forward Curve Has Fallen Too Much $/b Historical Brent Forward Curves 150 140 130 120 110 100 90 80 70 60 50 40 30 20 2008 2009 2010 2011 2012 2013 2014 2015 2016 2017 2018 2019 2020 Historical spot price 15-Jan-08 11-Jul-08 16-Feb-09 12-Jul-10 15-Apr-11 Source: Reuters, DNB Markets 25-Jun-12 27-Aug-13 20-Jun-14 18-Jun-15 26-Feb-16 7
The Headline Oversupply Not Visible In Time Spreads - The graph below suggest that the last drop in oil prices is sentiment driven and not fundamentally driven Brent Price vs Structure of FWD-Curve (Brent 1-3 as leading indicator for Flat Price) $/b flat price 165 145 125 105 85 65 45 25 Jan-2007 Jan-2009 Jan-2011 Jan-2013 Jan-2015 5 4 3 2 1 0-1 -2-3 -4-5 $/b time spread Real Brent Price Brent Fwd Structure Modelled Brent Price Based On Time Spread (1 vs 3) (Based on daily correlation since 2009) $/b 130 120 110 100 90 80 70 60 50 40 30 20 Jan/2009 Jan/2010 Jan/2011 Jan/2012 Jan/2013 Jan/2014 Jan/2015 Jan/2016 Modeled Brent Price, 20 days rolling avg Real Brent Price 8
Short Sellers Have Been In Command the Last Year Non-Commercial Short Positions vs WTI 0 70-50 65 60-100 55 Million barrels -150-200 -250 50 45 40 35 $/b -300 30 25-350 Jan-15 Jul-15 Jan-16 20 Source: CFTC 9
Growing Problem With The Data Quality Recently MBD 3.0 2.5 2.0 1.5 1.0 0.5 0.0-0.5-1.0-1.5 Reported Supply vs Demand - No Match With Stock Change -2.0 1Q2012 1Q2013 1Q2014 1Q2015 1Q2016 Source: IEA Reported Supply vs Demand Reported OECD stock change 10
OECD Stocks Are High And Rising OECD Total Oil Industry Stocks Million barrels 3,000 2,950 2,900 2,850 2,800 2,750 2,700 2,650 2,600 2,550 2,500 Jan Feb Mar Apr May Jun Jul Aug Sep Oct Nov Dec Source: IEA 5 year range 5 year avg 2015 2016 11
No Doubt That It Is The Supply Side That Is More Important - OPECs market share policy is leading to a swing of 3 million b/d of non-opec supply growth from 2014 to 2016 2.5 2.0 Non-OPEC Supply Growth 3 million b/d swing: 1.5 Million b/d 1.0 0.5 0.0-0.5-1.0-1.5 2000 2002 2004 2006 2008 2010 2012 2014 2016 Source: IEA 12
Canadian Producers Are Under Water For How Long? - How long can Canadian producers accept to lose money on their current output Western Canada Select (WCS) 100 90 80 70 $/b 60 50 40 30 20 Cash cost break even for Suncor 10 2009 2010 2011 2012 2013 2014 2015 2016 Source: Reuters 13
2 mbd Of Oil Production Is Cash Negative At Brent Below 40 $/b - With Brent prices at 30 $/b, 5.3 million b/d of world oil production is cash negative 14
No Growth In Non-OPEC Anymore - Despite continued growth in Russia 6.0% 5.0% 4.0% 3.0% 2.0% 1.0% 0.0% -1.0% -2.0% -3.0% Year on Year Non-OPEC Supply - 3 month mavg -4.0% 2004 2006 2008 2010 2012 2014 2016 Source: IEA 4.0% 3.0% Year on Year Non-OPEC Supply Excluding US (3-month mavg) Million b/d Year on Year Russian Supply 1.0 0.8 0.6 0.4 0.2 0.0-0.2-0.4 2003 2005 2007 2009 2011 2013 2015 2.0% Source: IEA, DNB Markets 1.0% 0.0% -1.0% -2.0% -3.0% -4.0% 2004 2006 2008 2010 2012 2014 2016 Source: IEA 15
Shale Production Has Started To Drop - And with the current rig count production is set to drop by more than 1 million b/d by the end of 2016?? Thousand b/d Legacy production decline vs new production 500 450 400 350 300 250 200 150 100 50 0 Mar-07 Mar-09 Mar-11 Mar-13 Mar-15 Mar-17 Source: EIA US Drilling Productivity Report Legacy decline Start up of new wells 6 Model Oil Production Based On Current Rig Count 5 Million b/d 4 3 2 1 0 Jan-07 Jan-09 Jan-11 Jan-13 Jan-15 Jan-17 Source: EIA US Drilling Productivity Report Model production at current rig count Reported production (EIA DPR) 16
Enormous Cuts In Global Oil Spending Will Continue in 2016 - This sets the stage for lower production/lower production growth in the future 17
Accelerating Decline Rates In Russia - Source: IEA 18
How Will The Huge CAPEX-cuts Affect Decline Rates? Million b/d 95 85 75 65 55 45 35 Net Oil Need Of 12 Million b/d Before 2020? (Assuming 3% net decline rate and oil demand growth of 1 mbd p.a) 2000 2002 2004 2006 2008 2010 2012 2014 2016 2018 2020 Source: DNB Markets, Rystad Energy Global output of crude, condensate and NGLs Observed decline rate Oil demand growing 1 mbd per year Decline rate 3% 12 kbd 100 98 96 94 92 90 88 86 84 82 80 96.2 7.4 Global crude, Nonaccelerating net condensate and NGLs output in decline rate of 2015 3% by 2020 2015 vs 2020 Global Oil Balance 4.8 Non-OPEC fields under development 2.3 OPEC fields under development 3.6 Required new shale oil to balance 99.5 World liquids demand by 2020 (1 mbd pr year-2015 was 94.5 mbd) Million b/d 95 85 75 65 55 45 35 Net Oil Need Of 17.5 Million b/d Before 2020? (Assuming 4% net decline rate and oil demand growth of 1 mbd p.a) 2000 2002 2004 2006 2008 2010 2012 2014 2016 2018 2020 Source: DNB Markets, Rystad Energy Global output of crude, condensate and NGLs Observed decline rate Oil demand growing 1 mbd per year Decline rate 4% 17.5 kbd 100 98 96 94 92 90 88 86 84 82 80 96.2 12.5 Global crude, Net decline rate condensate and of 4% by 2020 NGLs output in 2015 2015 vs 2020 Global Oil Balance 4.8 Non-OPEC fields under development 2.3 OPEC fields under development 8.7 Required new shale oil to balance 99.5 World liquids demand by 2020 (1 mbd pr year-2015 was 94.5 mbd) Source: DNB Markets, Rystad Energy 19
Distillate Has Been Weak, But Gasoline Strong - Gasoline is still performing in US, China and India Million b/d 9.5 9.0 8.5 US Gasoline Demand 4 week mavg (Product Supplied) 8.0 Jan Jan Feb Mar Apr May Jun Jul Aug Sep Oct Nov Dec Million b/d US Distillate Demand 4 week mavg (Product Supplied) 4.8 4.6 4.4 4.2 4.0 3.8 3.6 3.4 3.2 3.0 Jan Jan Feb Mar Apr May Jun Jul Aug Sep Oct Nov Dec Source: US DOE Range 5 year avg 2015 2016 Source: US DOE Range 5 year avg 2015 2016 Million b/d 0.50 0.40 0.30 0.20 0.10 0.00 Year on Year India Oil Demand (3-month mavg) -0.10 Jan-07 Jan-09 Jan-11 Jan-13 Jan-15 Source: Thompson/Reuters 5.0% 4.0% 3.0% 2.0% 1.0% 0.0% -1.0% -2.0% Year on Year Global Oil Demand (12-month mavg) -3.0% 2004 2006 2008 2010 2012 2014 2016 Source: IEA 20
Driving Distance On The Rise As Gasoline Prices Drop - Lower oil prices are incentivizing more driving Total US Vehicle Miles Travelled - Billion Miles, 12 month mavg 6.0% Year on Year Change In US Driving Distance 3110 3090 3070 3050 3030 3010 2990 2970 2950 2930 Jan-09 Jan-10 Jan-11 Jan-12 Jan-13 Jan-14 Jan-15 Jan-16 4.0% 2.0% 0.0% -2.0% -4.0% -6.0% Jan-07 Jul-08 Jan-10 Jul-11 Jan-13 Jul-14 Jan-16 Source: US Federal Highway Administration - Traffic volumes collected from 4000 roadside monitoring stations across the US, published with a two-month delay Source: US Federal Highway Administration - Traffic volumes collected from 4000 roadside monitoring stations across the US, published with a two-month delay 21
US SUV Market Share Expanding Again US Light Trucks market share and total car sales 58% 22 Light Trucks Market Share 56% 54% 52% 50% 48% 46% 44% 42% 20 18 16 14 12 10 Annualized Million Cars Sold 40% Jul-08 Jul-10 Jul-12 Jul-14 8 US Light Trucks Market Share(LHS) US New Car Sales (RHS) 22
How to Explain Chinese Gasoline Demand - With Chinese SUV sales up 58% in 2015 it is maybe not that strange that gasoline demand is performing strongly Chinese SUV sales Thousands of SUVs sold per month 700 600 500 400 300 200 100 0 Jan-05 Jan-08 Jan-11 Jan-14 Source: ThompsonReuters Datastream 23
The 2016 Oil Price Score Card 2016 Oil Price Scorecard Comments Oil Price Weight Overall Outlook Fundamentals The market still looks over supplied in 2016 but the call on OPEC is increasing by 1.6 million b/d according to IEA. The upside is capped by falling production costs, large US spare capacity in the form of available oil rigs/drilled uncompleted wells and OPECs market share strategy. But OPEC spare capacity is very low and non-opec supply growth will fade soon while geopolitical risk is high and rising. Average price 55 $/b Global Fundamental Balance The global supply-demand balance is still looking over supplied for 2016, but much less over supplied than in 2015 as the call on OPEC is increasing by 1.6 million b/d in the latest IEA forecast. The problem is however that OPEC looks to produce more than the call. BEARISH HIGH Crude vs Product Balance (Margins) Refinery margins will probably be weaker in 2016 than in 2015 as particularly the Middle East is bringing on new capacity and as oil demand growth will be weaker in 2016 than in 2015. For the first and last quarter of 2016 the weak diesel market may lead to refinery run cuts, but we believe margins will be strong during the gasoline season. BEARISH LOW OECD Stock levels Stock levels are record high, but we do not believe the market will run out of storage capacity BEARISH MEDIUM OPEC Spare Capacity Core OPEC spare capacity is low at only 2.3% of global oil demand according to IEA data. In reality the spare capacity is probably even lower since Saudi is probably producing close to capacity. BULLISH HIGH US Oil Statistics - Fundamentals US oil production growth which was 1.6 million b/d in 2014 and about 0.8 million b/d in 2015 is forecast to drop to negative in 2016 and US crude stocks will draw down in 2016. BULLISH HIGH Global Demand Growth Global oil demand growth is positively affected by the lower prices in 2015 but this effect is seen to fade in 2016. We have factored in weaker global demand growth for 2016, but the higher starting point of OECD oil demand next year means year on year growth will still be decent for OECD also in 2016. NEUTRAL MEDIUM OPEC Supply Non-OPEC Supply Political Risk Venezuela, Iraq, Iran, Saudi, Nigeria, Russia, Israel, MENA, Brazil, etc Other Factors Financial Money Flow OPEC (Saudi) is seen to contiunue its policy of targeting market share instead of price. And we estimate that Iran will increase its output from the current 2.9 million b/d to about 3.6 million b/d by the summer, starting the ramp up in Q1-2016. BEARISH HIGH Total non-opec supply growth is seen negative in 2016, down from a record growth of 2.2 million b/d in 2014 and 1.2 million b/d in 2015. BULLISH MEDIUM Political risk is on the rise. Key risk is from countries like Venezuela, Iraq, Libya, Brazil. The Iran deal will probably bring meaningfully more OPEC barrels to the market, but generally the sunnishiite conflict and IS has increased the total risk in the Middle East and weak economic conditions in countries like Venezuela and Brazil is threatening the social stability. There is a non-negligible risk related to conflict/power struggle inside the Saudi Royal family and the escalating tension between Iran and Saudi Arabia after Saudi executed an important Shia cleric. Total financial net oil length is significantly down since the peak. There is hence room room for a rebuild of positions if the sentiment should change. Triggers could be geopolitics, a strong gasoline season, accellerating decline rates, write downs of resources from shale oil companies, etc. A stronger USD has provided headwinds for the oil price since 2014, but this effect is probaly fading for 2016 as we do not believe in a further strengthening of the USD for the coming year. BULLISH BULLISH HIGH LOW 24
Long Term Oil Price Forecast Current (The forecast is for the average of the rolling 1 st month ICE Brent future contract) Historical Historical Nominal $/b Real (2015) $/b 2001 24.4 32.7 2002 25.0 32.9 2003 28.8 37.1 2004 38.3 48.0 2005 54.5 66.1 2006 65.1 76.5 2007 72.4 82.7 2008 97.3 106.9 2009 61.7 68.1 2010 79.5 86.3 2011 111.3 117.1 2012 111.7 115.1 2013 108.7 110.4 2014 99.5 101.5 2015 53.6 53.6 Price target Forecast Nominal $/b Real (2015) $/b 3 months 45 6 months 55 12 months 65 24 months 70 2019-2023 60-80 $/b Spot Brent History & FWD looking 140 120 100-120 range gone (forever?) 100 80 60 40 20 0 1996 1999 2002 2005 2008 2011 2014 2017 2020 Source: Reuters, DNB Markets New normalized price range in 2015 USD Forecast nominal FWD (nominal) Historical 25
The time to repair the roof is when the sun is shining John F. Kennedy, SotU 1962 26
100 Dollar Crude Was Appealing Companies had good hedges in place Mix of different strategies and products swaps, collars, 3-ways etc. 100% 90% 80% 70% 60% 50% 40% 30% 20% 10% 0% Source: 10K Hedge ratios per Dec 31 2012 Year 1 Year 2 Year 3 EOG Chesapeake Pioneer Whiting Continental Concho Noble Cimarex Crescent Oasis Devon 27
Hedge Ratios Dropped With Falling Prices Those same companies sharply reduced their hedged volume Hedge ratios lowest when hedges were needed the most? Hedge ratio 2013 2014 2015 2016 80% 70% 60% 50% 40% 30% 20% 10% 0% Year 1 Year 2 Year 3 Source: 10K (EOG, CHK, PXD, WLL, CLR, CXO, NBL, XEC, CPG, OAS, DVN) 28
The Forward Curve Doesn t Predict the Future Snapshot of willingness to provide supply and demand of forward prices Long term prices should reflect the cost of marginal barrel - They do incentivise investment (cuts) in future oil 160 WTI historical vs forward (monthly) 140 120 100 80 60 40 20 0 Jan-08 Jan-09 Jan-10 Jan-11 Jan-12 Jan-13 Jan-14 Jan-15 Jan-16 Jan-17 Jan-18 Jan-19 Source: BBG Since November 2014 the forward curve has predicted a brighter future 29
And It s Hard to Forecast - Price expectations for 2018 now lower than outlook for 2016 was in September Jan. 2013: analysts expected 2016 price 99.7 (avg Bloomberg survey) The crowd that is the market exaggerates trends overshooting Source: Thomson Reuters Oil Poll 30
Tough Choices are Rewarded When Markets Decline 31
Opportunistic vs Apocalyptic Hedging Should not be about picking the tops and bottoms Markets are not rational, cash flow must be protected Consider risks of hedge losses in high price scenarios vs risk of bankruptcy in a weak market Cost of hedging rises considerably when it s most crucial - 40 put for 2018 is 5.5 USD/bbl now - 40 put for 2016 was 10 cents/bbl two years ago Firm strategy flexible execution Time 0-12 months 13-24 months 25-36 months 37-48 months Hedging ratios 50-70% 30-50% 0-40% 0-30% Normal hedge ratio 60 % 40 % 25 % 15 % 32
Summary Trends typically overshoot in commodities prepare to outlast them Hedges aren t supposed to always be profitable Maintain financial flexibility through smoothing out revenue - Maintain capacity when times are tough - Avoid firesales - More time to adjust strategy, reorganise, negotiate with creditors - Solid hedging policy can reduce finance costs and increase debt capacity - Stability in financial ratios, rating and financing costs 33