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The Origins of the Global Oil Price

Collapse and Potential Investment


Opportunities
Arthur E. Berman, Petroleum Geologist
Labyrinth Consulting Services, Inc.
Houston, Texas
February 25, 2016

Labyrinth Consul4ng Services, Inc.

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Slide 1

The Origins of the Global Oil Price Collapse and Poten4al Investment Opportuni4es
The current oil price collapse represents devalua4on from over-investment in

unconven4onal oiland most commodi4esbecause of cheap capital, a


classic bubble.
It is part of a larger structural adjustment of the global economy to
unprecedented debt levels and prolonged low interest rates.
OPECs decision to increase produc4on is part of a stratagem to stop capital
providers from funding non-commercial 4ght oil projects and to increase its
market share.
High energy costs have resulted in low economic growth.
Con4nued oil prices of $30 per barrel or less are the only reasonable path to
higher growth and a balanced oil market.
Oil prices will recover more quickly than most forecasts as long as OPEC holds
the line long enough to force a behavior change.

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Slide 2

Energy Is The Economy: A Cri4cal Prologue


People think that the economy runs on money but it runs
on energy Nate Hagens.
Oil prices & the economy must be viewed through the debt
lens.
The end of cheap oil in the 21st century led to nancial
disloca4ons and ul4mately, the Financial Collapse of 2008.
Monetary policy focused on forcing consump4on and
investment: zero interest & further expansion of credit.
This resulted uninten4onally in the longest period of high
oil prices in history and a boom in unconven4onal oil
produc4on.
The bubble deated in 2014.
Over-produc4on con4nues because cash ow is cri4cal to
service debt despite losses on every barrel produced.
There is no quick solu4on. Produc4on must fall much lower
than present levels and this will only happen by prolonged
economic pressure.
Under-investment will cause a sharp oil-price rebound in a
few years.
An OPEC produc4on cut is more likely once U.S. produc4on
shows meaningful decline.
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Slide 3

The End of Normal for Oil Markets in 2014: Oil Over-Supply & Price Collapse
World Liquids Market Balance (Supply minus Demand)

2.50

$140

2.44

Avg Brent Price 2011-2013: $111

2.00

2.24

Brent Price (RHS)


1.61

1.50

1.07 1.03
0.80

0.50

Supply
Surplus (LHS)

0.30

$80

$60

Avg Brent Price 2015: $52

0.00

-0.50

$100

1.38

1.27

1.00

1.62

$120

1Q11 2Q11 3Q11 4Q11 1Q12 2Q12 3Q12 4Q12 1Q13 2Q13 3Q13 4Q13 1Q14 2Q14 3Q14 4Q14 1Q15 2Q15 3Q15 4Q15
-0.07
-0.10
-0.22
-0.30
-0.30

$40

Brent Crude Oil Price (Dollars Per Barrel)

Market Balance--Liquids Production Surplus or Deficit (Millions of Barrels Per Day)

3.00

-0.51
-1.00
-1.10
-1.50

Supply
Deficit (LHS)

$20

-0.81

2014-2015

-0.95
-1.13

Source: IEA OMR January 2015, EIA & Labyrinth Consulting Services, Inc.

$0

Energy markets have been characterized by low oil prices and over-supply since
mid-2014.
Supply decit before Jan 2014, supply surplus a`er.
Prices fell from 2011-2013 average of $111 per barrel to average of $52 in 2015.
Without an OPEC cut, 2016 prices will probably be in the $30 per barrel range.

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Slide 4

Origins of Over-Supply & Price Collapse in Increasing Scarcity of Conven4onal


World Conventional & Unconventional Liquids Production
Conventional Liquids

Unconventional Liquids

100

World Peak Aug 2015


96.9 mmbpd

Increasing Proportion of Unconventional Oil

Millions of Barrels of Liquids Per Day

95

90

4-year production plateau 2005-2009

Unconventional Oil

85

Conventional
Peak Jan 2011
86.2 mmbpd

80

Conventional Oil

75

Sep-2015

Jan-2015

May-2015

Sep-2014

Jan-2014

May-2014

Sep-2013

Jan-2013

May-2013

Sep-2012

Jan-2012

May-2012

Sep-2011

Jan-2011

May-2011

Sep-2010

Jan-2010

May-2010

Sep-2009

Jan-2009

May-2009

Sep-2008

Jan-2008

May-2008

Sep-2007

Jan-2007

May-2007

Sep-2006

Jan-2006

May-2006

Sep-2005

Jan-2005

May-2005

Sep-2004

Jan-2004

May-2004

Sep-2003

Jan-2003

Source: EIA, Drilling Info, Statistics Canada & Labyrinth Consulting Services, Inc.
May-2003

70

The origins of this situa4on are found, ironically, in increased scarcity of petroleum
resources.
Increasing propor4on of unconven4onal oil since 2000: deep-water, oil sands, 4ght oil.
4-year produc4on plateau 2005-2009.
Conven4onal produc4on peak in 2011.
World produc4on peak in August 2015?
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Slide 5

Highest Oil Prices in History, 2010-2014


Oil Prices in 2015 Dollars
$160

$140

Sept 2007-Sept 2008:


13 months >$90

Sept 1979-Sept 1981:


26 months >$90

$120

$100

Feb 1986-Oct 2003


17 years of $34 average oil price

1974 Arab
Oil Embargo

$80

$60

$40

$20

1979 Iran-Iraq War

OPEC Production Cut

Jul-15

May-14

Jan-12

Mar-13

Nov-10

Jul-08

Sep-09

May-07

Jan-05

Mar-06

Nov-03

Jul-01

Sep-02

May-00

Jan-98

Mar-99

Nov-96

Jul-94

Sep-95

May-93

Jan-91

Mar-92

Nov-89

Jul-87

Sep-88

May-86

Jan-84

Mar-85

Nov-82

Jul-80

Sep-81

May-79

Jan-77

Mar-78

Jul-73

Sep-74

May-72

Jan-70

Mar-71

Source: EIA , U.S. Federal Reserve System & Labyrinth Consulting Services, Inc.

$0

Nov-75

CPI-Adjusted WITCrudeOil Price (Dollars Per Barrel)

Nov 2010Sept 2014:


45 months
>$90

2008 Financial
Crisis

A`er the Financial Collapse of 2008, oil prices fell briey below $40 per barrel but
recovered quickly because of 3.2 mmbpd OPEC produc4on cut.
Prices were more than $90 per barrel for 45 months between November 2010 and
September 2014. Longest period of high prices in history.
By comparison, high prices in early 1980s did not last as long but triggered almost 2
decades of low oil prices.
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Slide 7

High Oil Prices Fueled U.S. Tight Oil Produc4on


OPEC Crude Oil ProducBon Compared To January 2008
Algeria

Angola

Ecuador

Iraq

Kuwait

Libya

Iran

Qatar

Saudi Arabia

Federal$Funds$Interest$Rates$January$2000>January$2015$

United Arab Emirates

Nigeria

Venezuela

7%#

$160#

Iraqi producBon has increased


2.3 mmbpd since January 2008

2.50

$140#

6%#

5%#

Iraq

1.50

Interest$Rate$

$100#

1.00

0.50

4%#
$80#
3%#

Jan-16

Jul-15

Oct-15

Jan-15

Apr-15

Jul-14

Oct-14

Jan-14

Apr-14

Jul-13

Oct-13

Jan-13

Apr-13

Jul-12

Oct-12

Jan-12

Apr-12

Jul-11

Oct-11

Jan-11

Apr-11

Jul-10

Oct-10

Jan-10

Apr-10

Jul-09

Oct-09

Jan-09

Apr-09

$40#

1%#

Jan015#

Aug014#

Oct013#

Mar014#

May013#

Jul012#

Feb012#

Dec012#

Apr011#

Sep011#

Nov010#

Jan010#

Jun010#

Aug009#

Oct008#

Mar009#

May008#

Jul007#

Dec007#

Feb007#

Apr006#

Sep006#

Nov005#

Jan005#

Jun005#

Aug004#

Oct003#

Mar004#

May003#

Jul002#

Dec002#

Feb002#

0%#

Apr001#

ProducBon decreases in Libya due to


civil war, in Iran due to sancBons

Sep001#

-2.00 Source: EIA STEO & Labyrinth ConsulBng Services, Inc.

Nov000#

Financial Crisis
ProducBon Cut

$20#

Libya

Libya

Jan000#

Jul-08

Oct-08

2%#

Iran

Saudi Arabia

-1.00

-1.50

$60#

Jun000#

-0.50

Jan-08

Saudi Arabia
0.00

WTI$Oil$Price$January$2015$US$Dollars$

$120#

2.00

Apr-08

Millions of Barrels of Crude Oil ProducBon Per Day Compared To January 2008

3.00

$0#

High oil prices partly because of supply interrup4ons from Libya (-1.4 mmbpd) and Iran
(-1.0 mmbpd). These losses were largely oset by increases from Iraq (+2.35 mmpbd)
and Saudi Arabia (+0.6 mmbpd).
High prices also caused by extraordinary monetary policies enacted in response to the
Financial Collapse.
8 years of zero-interest rate policies discouraged conven4onal investments in CDs,
money markets and Treasury bonds.
High yield corporate bonds from U.S. E&P companies oered beoer margins with only
moderate perceived risk.
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Slide 8

Expansion of Credit and of U.S. Tight Oil Produc4on


Leading Non-OPEC Liquids ProducCon Compared to January 2014
United States
2.5

China

Mexico

Canada

Russia

The U.S. is responsible for more than 70% of NonOPEC over-producCon. Brazil & Canada are
responsible for most of the rest
U.S.

1.5

Brazil
0.5

China
Jan-16

Dec-15

Oct-15

Sep-15

Jul-15

Aug-15

Jun-15

Apr-15

May-15

Mar-15

Jan-15

Feb-15

Dec-14

Oct-14

Nov-14

Sep-14

Jul-14

Aug-14

Jun-14

Apr-14

May-14

Mar-14

Mexico

Nov-15

Canada

Russia
Jan-14

Feb-14

Millions of Barrels of Liquids Per Day Compared to January 2014

Brazil

-0.5

-1

Source: EIA & Labyrinth ConsulOng Services, Inc.

Debt caused the Financial Collapse and more debt was created to remedy the problem.
$57 trillion in new debt since 2007.
Global debt is now $199 trillion286% of GDP.
U.S. debt is 269% of GDP. China is even higher.
U.S. is responsible for more than 70% of non-OPEC over-produc4on since Jan 2014 (+2.2
mmbpd). Brazil (+1.6 mmbpd), Canada, China and Russia are responsible for most of the
rest.
This over-produc4on is the main cause of the global oil supply imbalance.

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Slide 9

U.S. Produc4on Has Not Declined As Much or As Early As Most Predicted


STEO U.S. Production Forecast Price Deck

U.S. Crude Oil Production & Forecast


$70

-570 kbpd since April


(~60 kbpd/month)
Forecast for -1.38 mmbpd
by Sept. 2016 (-117 kbpd/month JanSept)
-820 kbpd less than Jan 2016

$58.00

$56.00

$55.00

$53.00

$52.00

$51.00

$49.00

$48.00

$46.00

$45.00

$43.00

$44.00

$43.00

Jan-17

$42.00

Dec-16

$41.00

$40.00

$39.00

$38.00

$37.00

$36.00

$10

Dec-17

Nov-17

Oct-17

Sep-17

Aug-17

Jul-17

Jun-17

May-17

Apr-17

Mar-17

Feb-17

Nov-16

Oct-16

Sep-16

Aug-16

Jul-16

Jun-16

May-16

Apr-16

$0

Jan-16

Nov-17

Jul-17

Sep-17

May-17

Jan-17

Mar-17

Nov-16

Jul-16

Sep-16

May-16

Jan-16

Mar-16

Sep-15

Nov-15

Jul-15

May-15

Jan-15

Mar-15

Nov-14

Jul-14

Sep-14

May-14

Mar-14

Source: EIA STEO February 2016 & Labyrinth Consulting Services, Inc.
Jan-14

$35.00

$20

6.5

6.0

$34.00

Nov 1970 will


remain U.S. peak
by 350 kbpd

$30

$33.50

October est. -490,000 bopd


November est. -420,000 bopd
December est. -450,000 bopd
January est. -570,000 bopd

$40

Mar-16

7.5

7.0

$50

$31.68

8.31

8.0

$60

WTI Price (Dollars Per Barrel)

9.13

8.5

8.00

Millions of Barrels of Crude Oil Per Day

9.0

+1.25 mmbpd
(2 mmbpd liquids)
since Jan 2014
(OPEC +1.1
mmbpd)

9.69

9.5

Feb-16

10.0

U.S. crude oil produc4on has declined about 570,000 bopd since the peak in April 2014,
about 60,000 bopd per month.
EIA forecast is for a total decline of 1.4 mmbpd by September 2016 ( ~100,000 bopd per
month) before increasing again based on $43 per barrel WTI by year-end 2016 and $58 by
year-end 2017.
Price deck has WTI at $43 per barrel by December 2016 & $58 by December 2017.
Forecast suggests that the oil market is suciently in balance now for prices to increase but
that produc4on will not respond to price signals un4l later in 2016very op4mis4c.

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Slide 11

U.S. Crude Oil Stocks


U.S. Crude Oil Stocks
5-Year Range

2015 Inventory

2016 Inventory

550

Millions of Barrels of Crude Oil

500

2016
2015

450

152 million barrels


above the 5-year average

400

5-Year Range
350

Dec

Dec

Nov

Nov

Oct

Oct

Sep

Sep

Aug

Aug

Jul

Jul

Jul

Jun

Jun

May

Apr

May

Apr

Mar

Feb

Mar

Jan

Feb

Jan

Source: EIA & Labyrinth Consulting Services, Inc.

Jan

300

Liole chance that oil prices will increase beyond the head-fakes and sen4ment-driven price cycles of
2015 and early 2016 un4l U.S. crude oil storage begins to decrease.
Oil stocks are currently 152 million barrels above the 5-year average and 128 million barrels above the
5-year maximum.

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Slide 15

Cushing & Gulf Coast Working Storage U4liza4on


Cushing and Gulf Coast Crude Oil Storage
Gulf Coast

Cushing

400,000

Capacity

Utilization
105%

Working Storage Capacity

100%

350,000

90%

84%

Percent Utilization (RHS)

85%
80%

300,000

Cushing Inventory (89% Capacity)


250,000

75%
70%
65%
60%
55%

200,000

50%
45%
40%

150,000

35%

Gulf Coast Inventory (83% Capacity)

30%

100,000

Percent Utilization of Working Storage Capacity

Storage Inventory and Working Capacity (Thousands of Barrels of Oil)

95%

25%
20%
15%

50,000

10%
5%

Jan-16

0%
Feb-16

Dec-15

Oct-15

Nov-15

Sep-15

Jul-15

Aug-15

Jun-15

Apr-15

May-15

Feb-15

Mar-15

Jan-15

Dec-14

Oct-14

Nov-14

Sep-14

Jul-14

Aug-14

Jun-14

Apr-14

May-14

Mar-14

Jan-14

Source: EIA & Labyrinth Consulting Services, Inc.


Feb-14

Cushing and Gulf Coast storage make up almost 70% of U.S. working storage.
These areas are currently at 84% of capacity. Cushing at 89%.
As long as storage volumes remain above 80% of capacity, oil prices will be crushed.
Un4l U.S. oil produc4on declines substan4ally, storage will remain near capacity.

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Slide 16

dividends, cut or eliminated share buybacks, implemented


supplier rate reductions, reduced capital spending by 20 to
40% (figure 2), and imposed sta reductionsor at least hiring
and salary freezes. Drilling activity in the United States declined
by more than 50% in the past 12 months.

The Future Looks BeoerMaybe

FIGURE 2: Capex cut by 20% in 2015, with more in store for 2016
Global capex spending trends and estimates, public companies (USD billions)
+12%

43
66
45

539

2010
Midstream

51
81
62

64
88
65

29

91
89
64

19%

128
29

101
63

28

24

23
631

710

745

167
103
63

741

172
28

106
65

29

541
379

2011
Chemicals

2012

2013

Oil field services and equipment

Note: Does not include national or state-owned oil companies.


Sources: Bloomberg, AlixPartners

2014
Downstream

2015

2016E

Exploration and production

are still attractive. Those measures should serve as a roadmap


for other players that face continuing challenges (figure 3).
In total, we estimate that overall capital spending by public
companies worldwide declined by nearly 20% in 2015 from
record 2014 levels, with the E&P sector declining by more than
30%. Capital spending reductions
byOrder:upstream
11/9/2015
The New Oil
in charts - FT.com producers are
expected to continue this year, which will help rebalance
supply and demand and eventually help boost commodity
prices. In the short term, however, spending reductions will
have a pronounced, negative impact on the oil field services
and equipment sector and require even more aggressive
cost reductions.
Meanwhile, oil and gas M&A activity in the first half of 2015
dropped to a multiyear low (figure 4) as buyers and sellers
struggled with asset valuations in a volatile pricing environment.
However, US E&P operators with high debt and large
impairments will likely have to resort to asset sales as access to
capital recedes.

Looking
we expect
the start
ofofaspending
slow and
steady
The
worlds to
big 2016,
energy groups
have shelved
$200bn
on new
projects. Wood
Mackenzie,
the
energy
consultancy,
says
that
companies
have
deferred
46
Early actions by companies across the value chain enabled
recovery in prices, driven by global supply-and-demandbig oil and gas
projects with 20bn barrels of oil equivalent in reserves, which is more than Mexicos entire
those companies to lower break-even costs across active basins
dynamics.
Transportation
fuel
caused
by to be
proven
holdings.
Wood Mac says that
thedemandparticularly
number of major upstream projects
expected
in the United States by 30% or more, which should make 2016
on
one
hand.
fully
approved
during
2015
could
probably
be
counted
growth in developing economiesis largely responsible for
year for them. Those companies aggressively reset
an easier
Large reduc4on in E&P investment in 2015 and probably even greater in 2016.
sustaining global oil demand and for generating only minimal
SaudiArabia
their cost structures with suppliers; took organizational actions
growth in some markets.

Deferred investments in 2015 equivalent to 20 billion barrels of reserves.


FIGURE
A substan4al supply decit will result in the not-too-distant future.
3: Drilling down: North American break-even costs
A price spike seems unavoidable.
Unconventional oil plays
Likely 2016 break-even estimates
Basin/Play

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Break-even Range (USD/bbl)

Low

High

Niobrara

$ 32.50

$ 48.45

Anadarko

$ 32.91

$ 69.19

Marcellus

$ 33.18

$ 41.80

$ 37.12

$ 70.24

Slide 19

An Oil Price We Can Live With


IMF Projected 2016 Fiscal Break-Even Oil Prices
$160

$137

$140

Fiscal Break-Even Price (Dollars Per Barrel)

$120

$110

$100

$86

$89

$94

$95

$97

Average

Oman

Libya

$115

$119

$80

$69

$70

Iraq

UAE

$60

$49
$40

$20

Source: IMF
$0
Kuwait

Saudi Arabia

Qatar

Bahrain

Algeria

Iran

Yemen

IMF projec4ons indicate that Saudi Arabia and its Gulf State block need ~$75 per
barrel to balance their scal budgets.
OPEC average is $94 per barrel.
Key operators in the three main U.S. 4ght oil plays need ~$70 per barrel to break
even.
$70-80 per barrel accommodates the lower-cost producers.

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Slide 21

The Origins of the Global Oil Price Collapse and Poten4al Investment Opportuni4es
Widespread defaults and bankruptcies are possible in the
rst half of 2016.
An OPEC cut in mid-2016 is likely. Without this, the price
recovery will be very slow.
It is unlikely that prices will return to $90-100 levels except
for brief spikes.
The global economy will remain weak un4l de-leveraging
occurs and will be unable to sustain high oil prices.
There will be investment opportuni4es by bewng long (1-3
years) on oil prices at the earliest signs of movements
toward market balance.
There will be opportuni4es playing oil-price vola4lity cycles.
These bets involve considerable risk and will require
diligent and expert monitoring of events.
Investors should be willing to lose their en4re investment
because of extreme market uncertain4es.
Energy investment cannot be successful without awareness
of the co-rela4onship of energy and the total economy.

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Slide 22