1

Oil Hedging Considerations for 2020

13 January 2020

A Focus on Supply

Looking back at the behaviour of oil prices during 2019, the year seems rather uneventful. Brent has hovered around 60 to 70 $/b. This is in contrast to most years since 2013 where we have seen sharp falls as in 2014, 15 and 18, or significant rallies in 2016 and 17. This rather benign overall trading range disguises the largest ever disruption to supply after the attack on Saudi Arabia, as well as the recent clashes between the US and Iran. The market did react very sharply to these events, but sold off again soon after without setting new highs or initiating a new price trend. Much of the commentary explaining price variations over the course of 2019 was focused on the trade dispute between the US and China. Developments on this theme have been seen to be very influential on the future outlook for oil demand. However, it seems, as we shall see, that it is the supply side of the equation rather than demand, that is key to understanding the balance of oil markets this year. The stable and reasonably high oil price environment of 2019, encouraged supply growth. If this continues, it may well be that OPEC’s cut agreed at the end of last year proves to be insufficient to balance the market. But there are questions over sustainability of US production which could lead to a very different outcome if supply reaches a plateau in the US, or falls.

Source: Bloomberg and Investec

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Supply

The Return of Geopolitics

President Trump’s approach to the Middle East since the start of his presidency and indeed the lead up to it, has clearly been in favour of disengagement and reducing military commitments. His line of reasoning was made clear in the address he gave the day after the Iranian missile strikes on the US military presence in Iraq. Trump’s message could have been interpreted to effectively state that the US do not need oil from the Middle East anymore, because they have so much of their own, so why should they spend so much money protecting the crude supply for Europe and Asia? But this policy of reducing military commitments occurred in tandem with a very hawkish stance on Iran leading to a re-introduction of sanctions as the US withdrew from the nuclear deal agreed, brokered by the EU. The sanctions have proved highly effective in limiting Iranian exports of crude, but have also removed the incentive for Iran to cooperate with the US/EU on the nuclear issue or anything else. This has encouraged Iran to try and increase its influence in the region and test how far it can go before provoking a reaction. Consequently there was a steady ratcheting up of incidents throughout last year which started with attacks on vessels in the gulf and culminated with a spectacular drone and missile attack on Saudi oil infrastructure which knocked out over 5% of global oil production. Trump responded with threats over Twitter (“Locked and loaded”, etc), but not much else. Until, that is, the US killed Iranian military commander Qasem Soleimani on 3 January via an airstrike in Iraq near Baghdad airport. The airstrike followed attacks on the American embassy in Baghdad by supporters of an Iran-backed, Iraqi Shia militia. The US justified the action on the grounds of averting an, as yet undisclosed, threat to US interests. Soleimani has played a key part in expanding Iran’s regional influence, but, ironically, he was also instrumental in defeating the Islamic State in Iraq. For now, it seems that the retaliatory missile strike from Iran has ended the present tit-for-tatt between the US and Iran and oil markets have fallen back quickly, just as they did after the drone strike on Saudi Arabia last year. But what if this is not the end and Iran carries out further attacks? If so, how likely is a supply disruption? Iran has often threatened to close the Strait of Hormuz (the narrow entrance to the Arabian Gulf), but this seems an unlikely step as it would immediately draw other international players into conflict against it – this is something Iran will want to avoid. As the chart below shows, it cannot use its own oil exports as a weapon, because they are now so low already.

Source: Bloomberg and Investec

Could Iran launch a further attack on Saudi Arabia? In spite of the audacity of last year’s attack, the effect on oil output was brief. In any case, it is not clear that lashing out at its oil producing neighbours (like Saudi Arabia) by striking production with missile and drone attacks, would act as a reprisal against the US and such an action could also encourage other countries to align against Iran.

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Another possibility is that a US/Iran confrontation could destabilise Iraq. Both the US action and the Iranian retaliation was carried out on Iraqi soil without the permission of its government. This has put Iraq in a difficult position and its parliament has, as a response to the US action, voted that all foreign forces should leave the country (in due course). Trump further complicated matters by declaring he will impose sanctions on Iraq if it does expel US forces. Could the remnants of IS rebuild if the US did quit Iraq? Would foreign oil companies pull out of Iraq? It’s worth noting how stable Iraqi production was throughout the period when IS occupied significant tracts of the country.

Source: Bloomberg and Investec

Neither the US nor Iran want a full blown war and so, for the reasons cited above, a significant, prolonged supply disruption is perhaps unlikely. Of greater importance is the longer term significance of these events. Will the US now decide that its disengagement policy was a mistake and take steps to reverse it (if it can)? If not, what will fill the void? Iran, Russia, Saudi Arabia and Turkey are all keen to expand their influence in the region to meet their own varied and conflicting interests. The future of the middle east has become even more complicated and hard to predict.

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Iraqi Oil Production History

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Can US Production Growth Continue?

The chart below shows how shale production continued to grow in 2019, further squeezing out net imports. Including natural gas liquids (NGL), US production reached nearly 181 mb/d at the end of last year, up by 1.6 mb/d from the end of 2018. This makes the US by far the largest oil producer in the world, well ahead of Russia (11.6 mb/d) and Saudi Arabia (9.79 mb/d – excluding NGLs). Probably the greatest question-mark over 2020 supply growth is: can the US sustain this rate of production growth?

Source: Bloomberg and Investec

Shale producers have been helped by extra pipeline capacity that become available in 2019 and there is more to come. This has helped to overcome bottlenecks that were a serious problem in 2018 and early 2019. The chart below shows that the price of crude at Midland Texas (an important reference price for oil produced at the largest shale producing region – the Permian) was trading at a significant discount to Brent and US crude futures which deliver at Cushing Oklahoma. This discount narrowed sharply as 2019 progressed and the price at Midland even went into a premium over Cushing.

Source: Bloomberg and Investec

1 Source: US Department of Energy

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US Crude Consumption by Supply Source

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Midland Texas Discount

Brent - Midland Cushing-Midland

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Never-the-less, there are reasons to be cautious about US production growth. The nature of shale wells is that production declines much more rapidly than does conventional production. The chart below shows the breakdown of new drilling in terms of the extent to which is it is replacing the declining output of existing fields, versus providing incremental output. It seems that shale producers need to run to standstill and run harder to increase output.

Investors in US independent producers are growing frustrated by the financial performance of the sector. The chart below shows how the S&P Oil and Gas E&P index has underperformed oil and dramatically underperformed the S&P 500.

Source: Bloomberg and Investec2

2 Indices are constructed based on log changes in Brent and S&P 500, but log changes in Brent are scaled down by the ratio of realised volatility in Brent log changes divided by the realised volatility in S&P 500 log changes, where realised volatility is calculated over the full period covered by the chart.

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Permian Additional Supply Breakdown

Legacy Decline Net Added

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S&P 500 and Brent

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Independent producers have been successful in producing vast quantities of oil, but less so in generating cash. Cash-flow has often been negative as producers plough more and more cash into increasing production. Evidence that US producers are feeling the pinch comes from Rystad Energy which estimates that US shale producers invested 6% less in 2019 than they did in 20183.

Source: Bloomberg and Investec

All of this brings into question how much further US supply can grow in 2020, or even whether it can sustain current levels of production. The IEA estimates that US production will grow from an average of 17.13 mb/d throughout 20194 to an average of 18.37 mb/d in 2020 (+1.24 mb/d). As of the end of 2019, US producers were producing 17.9 mb/d, around 500 kb/d away from the estimated average for 2020. But even to maintain current production, 500 kb/d of new producing wells needs to be added each month. Fortunately, the productivity of new wells continues to increase thanks to evolving drilling techniques and technological advances as can be seen in the chart below.

3 Source: Rystad Energy, December 2019: https://www.rystadenergy.com/newsevents/news/newsletters/OfsArchive/ofs-december-2019/ 4 Source: IEA November Oil Market Report: https://www.iea.org/topics/oil-market-report

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2015 2015 2015 2015 2016 2016 2016 2016 2017 2017 2017 2017 2018 2018 2018 2018 2019 2019 2019 2019

Free Cashflow

OCCIDENTAL PETROLEUM CORP EOG RESOURCES INC PIONEER NATURAL RESOURCES CO

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The Oxford Institute of Energy Studies published a paper analysing technical reports and patents relating to US shale and which found that there continues to be considerable innovation in the US which could pave the way for continued growth many years into the future, even at prices as low as 50 $/b5.

From outside the US and OPEC+

The OPEC+ and OPEC members that are exempt from production cuts, combined with the US, account for two thirds of global production. Other significant sources of production are Canada, Europe, China and Brazil:

(mb/d) 2018 2019 Change

Canada 5.52 5.65 +0.12

Europe 3.31 3.71 +0.40

China 3.93 3.92 -0.01

Brazil 2.87 3.22 +0.35

Total 15.63 16.50 +0.86

Source: IEA, Investec

The IEA sees these countries adding the best part of 1 mb/d in 2020. In Europe, the Sverdrup Oil field is expected to add significantly to Norway’s oil production, while in Brazil production exceeded 3 mb/d last November for the first time ever and is set to climb further this year6.

5 Source: Oxford Institute of Energy Studies, Prospects for US shale productivity gains: https://www.oxfordenergy.org/publications/prospects-for-us-shale-productivity-gains/?v=79cba1185463 6 Source: IEA November Oil Market Report: https://www.iea.org/topics/oil-market-report

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Demand

Deal or No Deal?

Throughout 2019, scarcely a week went past without a development in the ongoing saga of the US/China trade dispute and consequent speculation as to the impact on the outlook for oil demand, that became almost too tedious to talk about – and it’s not over yet!

Brent rallied up to the high 60s at the end of 2019 as it became clear that the US and China had agreed the terms of a so-called Phase 1 deal. Trump announced that it would be signed on the 15th of January. A trade deal between the US and China is seen as being positive for oil demand in 2020 and hence bullish for prices. There are good reasons to be cautious though:

The Phase 1 deal involves only a partial unwinding of tariffs and may not of itself make much difference

It is not clear that the signing of a Phase 1 deal necessarily means that a comprehensive deal is now likely – significant differences still remain

Even if a comprehensive deal is signed this year, it may not be soon enough to have much effect on oil demand in 2020

If a deal is completed with China, there are signs that Trump will simply turn his attention to trade with the EU, which would could be negative for the oil demand outlook

As can be seen on the table below, oil demand growth has been at or just above 1 mb/d over the last couple of years, while global GDP growth has been around 3 to 3.5%

Investec Economists expect global growth in 2020 to be 3.3%7. The IEA expects oil demand growth of 1.3 mb/d, which is already higher than 2018 and 19

Global GDP US GDP China GDP Oil Demand (mb/d)

2014 3.6% 2.5% 7.4%

2015 3.5% 2.9% 7.2%

2016 3.4% 1.6% 6.7% +1.1

2017 3.8% 2.4% 6.8% +1.8

2018 3.6% 2.9% 6.5% +1.1

2019 2.9% 2.3% 6.2% +1.0

2020 3.3% 1.8% 5.9% +1.3

Source: IMF, Investec GDP forecasts, IEA

Consequently, variations in the demand outlook, which has been a preoccupation for the oil markets over the last 12-months, may not be as variable as the supply outlook. Also, oil prices look to have become less sensitive to macro trends than it was the case in 2018. The chart below which uses volatility scaling to bring Brent volatility down to the same level as the S&P 500, shows that trends in oil price kept pace with equities in 2018, but, particularly since last summer, equity markets have accelerated and oil has failed to keep up.

7 Source: Investec Global Economic Overview, December 2019: please click here

9

Source: Bloomberg, Investec8

8 Indices are constructed based on log changes in Brent and S&P 500, but log changes in Brent are scaled down by the ratio of realised volatility in Brent log changes

divided by the realised volatility in S&P 500 log changes, where realised volatility is calculated over the full period covered by the chart.

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9S&P 500 and Brent - base date 03/01/2018

S&P 500 Index 1st Brent Index

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Oil and the Energy Mix

Oil is more expensive than gas or coal on an energy equivalent basis, except where gas is priced off oil formulae (as in Asia), but the prices have tended to move in sympathy with one another. Through much of 2019 though, gas and oil prices diverged significantly. The oversupply of gas in the US due to rampant domestic production has now been able to spill over into international markets due to the advent of Liquefied Natural Gas (LNG). This enables something that was never possible in gas markets in the past – moving gas globally.

Source: Bloomberg and Investec

LNG has actually been available for years, but it is in the last year or so that LNG from the US and other projects around the world, have really started to make an impact in transforming gas into a global transportable form of energy rather than a domestic landlocked form of energy.

It is tempting to look only at overall supply and demand for barrels of crude oil, but this ignores the complexity of demand for different components of the barrel of oil, some of which compete with gas. The lightest elements of the barrel, the natural gas liquids and naphtha, are heavily used in the petrochemical industry to produce products such as plastics. This is seen as a major source of demand growth for oil. The IEA estimated that a third of oil demand growth out to 2030 could come from petrochemicals9. But natural gas can also be used to produce petrochemicals and hence its lower prices could undermine this source of oil demand growth. The chart below shows that naphtha and propane prices generally been subdued relative to Brent as gas prices have fallen, while crude is dependent on middle distillates like jet and diesel to hold up the overall price of a barrel.

9 Source: IEA, Petrochemicals set to be the largest driver of world oil demand: https://www.iea.org/news/petrochemicals-set-to-be-the-largest-driver-of-world-oil-demand-latest-iea-analysis-finds

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Global Energy Prices

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Source: Bloomberg and Investec

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BOE Ratios to Brent

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The Balance

Inventories Rose Moderately in 2019

Oil markets were reasonably balanced in 2019 and inventories rose only a little ahead of demand.

Source: EIA, Bloomberg, Investec

OECD inventories remain close to the 5-year average, a level which OPEC has always said it was targeting. Strong summer demand in the US, left its petroleum inventories a little lower at the end of 2019 than at the start of that year.

Source: EIA, Bloomberg, Investec

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OECD Crude and Liquid Fuel Inventories

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13

OPEC+ Cut

As the market was broadly balanced in 2019, the question facing OPEC+ at the final OPEC meeting of 2019, was how it should respond to anticipated supply growth in 2020, in the absence of strong demand growth.

The meeting was characterised by the usual overruns in meetings and delays to press conferences, that we have come to expect. However, it did deliver on a cut of 500 kb/d into 2020, whereas little over a week before the meeting, the mood from OPEC members had suggested that a cut was unlikely. Consequently, the news of the cut helped markets higher and Brent came close to breaking 65 $/b for the first time since the drone strikes on Saudi Arabia in September. As ever though, when considering the possible impact of OPEC cuts, the devil is in the detail and the details were not very clear.

OPEC did publish an allocation table10 showing that the latest cuts are to be split around 370 b/d to OPEC members and 130 b/d to non-OPEC members. But the table did not give overall quotas, just the breakdown of the latest cuts. To see what these cuts really mean, it is necessary to apply them to the previous quotas and compare them to recent production. Carrying out this exercise using data from the IEA, leads to the conclusion that production will increase by over 100 kb/d. This is mainly because recent Saudi production has been significantly below their old production limit (assuming it has settled down to the 9.80 mb/d recorded before the drone strikes) and is around 350 kb/d below their new limit. However, Saudi Arabia has pledged, voluntarily, to produce 400 kb/d less than its new limit (subject to an important caveat that we will come back to), which means that it needs to cut a little bit further, but not by the 167 kb/d that the allocation table suggests.

There was also a seemingly technical change introduced to bring the treatment of very light petroleum products, known as condensate, into line with OPEC members from the point of view of production limit calculations. OPEC has always excluded condensate from its numbers even though it adds nearly 20% to its total production. From now on, condensate will also be excluded from the production of non-OPEC signatories. It is perhaps not exactly clear what this means in terms of limits, but it may be reasonable to assume that Russia, which pushed for this policy as its condensate production had sent its production over its limit, will not now need to reduce production. This could be offset by the inability of Kazakhstan and Angola to raise production up to their limits. Taken together with the Saudi commitment to undercut its limit, may mean that the effect of the cuts is to take around 400 kb/d out of the market. This assumes that Iraq, which has regularly flouted its production limits and will be overproducing by 250 kb/d this year if it does not fall into line, does now comply. Additionally, Saudi Arabia has said that its voluntary cut of 400 kb/d is contingent on others complying.

A table setting out the figures can be found in Appendix A.

Has OPEC Done Enough?

Probably the greatest uncertainty surrounding the prospect for oil markets finding a balance in 2020, is the outlook for growth in US shale. Assuming an effective cut by OPEC+ of 400 kb/d and taking the IEA’s forecasts for other production, the table below shows the market balance for various rates of US supply growth and plausible demand growth scenarios.

US Output

Demand +0.00 +1.00 +1.24* +2.00

+1.00 -0.28 0.72 0.96 1.72

+1.15 -0.43 0.57 0.81 1.57

+1.30* -0.58 0.42 0.66 1.42

+1.45 -0.73 0.27 0.51 1.27

+1.60 -0.88 0.12 0.36 1.12

* Latest IEA forecast11

This table suggests that demand growth rates are unlikely to be the main driver of whether the market reaches a balance or not this year. Meanwhile, unless US production falls below the level already reached at the end of last year (which was nearly 0.8 mb/d above the average of last year), the market is likely to be in a surplus in 2020.

10 OPEC Additional Volume Adjustments, December 2019: https://www.opec.org/opec_web/static_files_project/media/downloads/press_room/Additional%20adjustment%20volumes.pdf 11 Source: IEA November Oil Market Report: https://www.iea.org/topics/oil-market-report

14

The Market

Becoming More Bullish

Though speculators are nothing like as bullish as they were in early 2018 when Brent was also heading over 70 $/b, they are more bullish than at any time in 2019. Speculative bets, on Brent and US crude futures, that oil prices would rise increased sharply from November onwards. Meanwhile investors believing oil prices would fall, cut their short positions.

Source: CFTC, Bloomberg, Investec

Producer hedging (selling future oil production) has also picked up significantly from the summer where producers had their lowest level of forward sales over the last two years.

Source: CFTC, Bloomberg, Investec

But producer activity dropped off into the end of the year as markets rallied further, at least at the front end of the curve. It seems that producers hoped longer dated prices would see more of the benefit of moves at the front of the curve.

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Bar

rels

Brent + WTI Managed Money Positions

Short Long Net

100m

130m

160m

190m

220m

250m

280m

310m

1500m

1600m

1700m

1800m

1900m

2000m

2100m

2200mJan

-18

Feb

-18

Mar-1

8

Ap

r-18

May-1

8

Jun

-18

Jul-1

8

Au

g-18

Sep

-18

Oct-1

8

No

v-18

Dec-1

8

Jan-1

9

Feb

-19

Mar-1

9

Ap

r-19

May-1

9

Jun

-19

Jul-1

9

Au

g-19

Sep

-19

Oct-1

9

No

v-19

Dec-1

9

Op

tio

ns

Po

siti

on

s (B

arre

ls)

Futu

res

Po

siti

on

s (B

arre

ls)

Producer Hedging (Brent + WTI )

Futures Options

15

In November Brent broke down through the uptrend it had followed since it touched the mid-50 $/b area in early October. But the recovery since the OPEC meeting enabled it to break through all of its moving averages. The highs of the Iran crisis has brought Brent briefly back to levels seen after drone strike on Saudi Arabia last September, but short of the high of 2019 at 75 $/b.

Source: Bloomberg, Investec

The behaviour of the US dollar has also influenced oil prices. US dollar strength tends to weaken oil prices in USD terms, this provides another link between oil prices and the macro world and interest rates. Correspondingly, the price of oil rallied into the end of last year as the dollar weakened against the Euro.

Source: Bloomberg and Investec

45

50

55

60

65

70

75

80

85

90

Jan-1

8

Ap

r-18

Jul-1

8

Oct-1

8

Jan-1

9

Ap

r-19

Jul-1

9

Oct-1

9

Jan-2

0

ICE

Bre

nt

Fro

nt

Co

ntr

act

($/b

)

Recent Brent Price History

Price

50-day Ave

100-day Ave

200-day Ave

1

1.05

1.1

1.15

1.2

1.25

0

10

20

30

40

50

60

70

80

90

100

Dec-1

5

Ma

r-16

Jun

-16

Se

p-1

6

Dec-1

6

Ma

r-17

Jun

-17

Se

p-1

7

Dec-1

7

Ma

r-18

Jun

-18

Se

p-1

8

Dec-1

8

Ma

r-19

Jun

-19

Se

p-1

9

Dec-1

9

EUR

ICE

Bre

nt

Fro

nt

Co

ntr

act

($/b

)

Brent and EUR

Brent EUR

16

Looking at the very long term, there is a downward sloping trend-line from the all-time high in 2008 that forms a resistance around 90 $/b, which Brent has not come close to testing. On the downside, there is a support from the rally up from 2016 lows.

Source: Bloomberg and Investec

0

20

40

60

80

100

120

140

160

Jan-0

0

Sep

-00

May-0

1

Jan-0

2

Sep

-02

May-0

3

Jan-0

4

Sep

-04

May-0

5

Jan-0

6

Sep

-06

May-0

7

Jan-0

8

Sep

-08

May-0

9

Jan-1

0

Sep

-10

May-1

1

Jan-1

2

Sep

-12

May-1

3

Jan-1

4

Sep

-14

May-1

5

Jan-1

6

Sep

-16

May-1

7

Jan-1

8

Sep

-18

May-1

9$

/b

Brent

17

Summary

The sharp sell-off in oil prices in 2014 came as a great surprise to oil markets as there was a prevailing view that 100 $/b was the right price for oil and demand was growing. But the market had failed to look at the supply side of the equation where it was becoming clear in the summer of 2014, before the sell-off started in the Autumn, that US production was growing strongly and would over supply the market. Over the last 12 months, the market has again been focused on demand and in particular has become obsessed with the US/China trade deal. Supply has only come into focus when there has been a glaringly obvious threat to it.

However, most of the uncertainty in the outlook for the balance of the market in 2020 comes from supply rather than demand. Chief amongst these uncertainties is US output. If shale producers are able to drive down costs further through technical advances and find the cash to keep drilling, prices could be forced well below 60 $/b. OPEC has limited room to continue responding to non-OPEC growth (how much further would Saudi Arabia be prepared to cut?) which would raise the prospect of OPEC returning to the market share strategy of 2015/16 which saw Brent fall to 25 $/b.

By reaching nearly 18 mb/d of production at the end of 2019, the US was already within 500 kb/d of its forecast average for 2020 and the market looks set to be oversupplied during the first quarter of 2020. This may well depress prices in the coming months, though the blame might get attributed to next phase of the US China trade talks going slower than expected (assuming they do). Equity and oil markets do tend to become strongly correlated when they are falling though, so anything that causes equities to shift from continually setting fresh new highs, to a down-trend, could well take oil prices down with it.

Still, there are good reasons to question the sustainability of US production as well as its prospects for further growth. Investors are not going to continue funding oil and gas production that does not make them money, indefinitely. Though these challenges are diminished if Brent remains at 60 $/b or above for extended periods.

Finally we have the possibility of supply disruption. The market is quick to react when they occur or look imminent, but is able to look beyond them very soon afterwards, as the remarkable fall in prices after the massive disruption to Saudi supply last September shows. Tensions in the Middle East may create more price uncertainly this year though and further incidents may prompt the market to price in a more sustained supply risk premium that it has been accustomed too. The Middle East is not the only source of potential price disruption, indeed there are even candidates that are in favour of limiting fracking amongst the Democrat Party contenders for the US presidential election later this year.

Overall, the strength of US and other non-OPEC+ supply, has the potential to put downward pressure on prices this year. If so, unless OPEC manages to find a way of cutting production, market forces will need to do the job. This could lead to an erratic decline in prices with a lagged effect on supply due to hedging programmes and wells that have already been drilled but not completed, that insulate producers from the falls.

18

What to Look out For in 2020

Here is a brief summary of some of the factors which could have a bearing on oil prices in 2020 and which could help in interpreting the sustainability of price trends during the course of this year: OPEC Production

OPEC production figures for January and February should be closely monitored to see whether members are complying with the cuts. These will be available in the middle of February and March respectively (see Appendix B)

It will be particularly interesting to see whether Iraq finally cuts back its production and, if not, whether Saudi Arabia abandons its voluntary 400 kb/d additional cut

The next key decision point will be the March meeting where OPEC+ will review the performance of the cuts and may decide to extend, end, or vary them

Technical Levels

Downside o There are various support levels provided by moving averages between 60 and 65 $/b o The uptrend from the lows of 2016 is now around 58 $/b for Brent. This is now a key support area. The

corresponding level on US WTI is 49 $/b o If the 60 $/b area is broken, we have support at the summer 2019 lows around 55 $/b and the end of 2018 low

at 50 $/b

Upside o Though Brent has traded intraday above 70 $/b on middle east tensions, it has not closed above 70 $/b, so

this is an important resistance area o The high of 2019 was around 75 $/b, providing another resistance o Above that we have the high of 2018 around 85 $/b and a long-term down sloping trend-line resistance coming

down from the all-time high from 2008 – these seem a long way off at present though US Shale

Quarterly filings of US independent producers will provide a guideline to the health of US independent producers. We may see more consolidation in this sectors in the search for economies of scale. We may also see further bankruptcies12

The monthly drilling data published by the US Energy Information Administration should be closely watched for variations in the productivity of new wells as well as the decline rate of existing production. A drop off in new well productivity or increasing decline rates could suggest challenges in maintaining production (and vice versa)

Global Growth & Equities

The bull run in equities continues particularly in the US. Low interest rates are helping to encourage yield hunting investors into stocks. A sharp unwind in equity prices could well be negative for oil

Middle Eastern Risks

Iraq may be forced to choose between being allied to the US or Iran. In voting to expel US troops, it may already have made that choice. Meanwhile, it has to deal with domestic unrest, the possible resurgence of the remnants of Islamic state and the desire of Kurds in the northern oil producing regions, for autonomy

It is highly unlikely we will see US sanctions on Iran being lifted anytime soon, so Iranian influence on oil markets will come via its activities that may disrupt other producers. The opportunities to cause prolonged disruption without attracting a wide collation of international opponents, are limited in the short to medium term though

Apart from Saudi Arabia and Iran, Russia and increasingly Turkey are increasing their influence in the Middle East and North Africa. Both Russia and Turkey recently said they were backing Libya’s Tripoli based government in opposition to most Arab countries and Egypt who support its rival: General Haftar

Inventories

Inventories are the acid test of views on the balance of supply and demand

It is likely they will build early in the year as an overhang of excess, per-OPEC cut production, comes through the system combined with a seasonal lull in demand and strong US production

After that, summer demand will need to bring inventories down, but will it be enough to hold up support prices in the second half of the year?

Investors

Investor positions became more bullish towards the end of last year, but at relatively moderate levels. Investor activity tends to exacerbate moves at the front end of the curve and add to momentum in market trends

12 WSJ, Oil and Gas Bankruptcies Grow as Investors Lose Appetite for Shale, January 2020: https://www.wsj.com/articles/oil-and-gas-bankruptcies-grow-as-investors-lose-appetite-for-shale-11567157401

19

Appendix A – OPEC+ Production Table and Estimated Impact

Baseline1 Dec 2018 Cut1 Old Limit Dec 2019 Cut2 New Limit Recent Production3 Supply Change

Algeria 1.060 0.032 1.028 0.012 1.016 1.020 -0.004

Angola 1.530 0.047 1.483 0.000 1.483 1.370 0.113

Congo 0.330 0.010 0.320 0.004 0.316 0.320 -0.004

Ecuador 0.530 0.016 0.514 0.000 0.514 0.460 0.054

Equatorial Guinea 0.130 0.004 0.126 0.001 0.125 0.120 0.005

Gabon 0.190 0.006 0.184 0.002 0.182 0.210 -0.028

Iraq 4.650 0.141 4.509 0.050 4.459 4.720 -0.261

Kuwait 2.810 0.085 2.725 0.055 2.670 2.630 0.040

Nigeria 1.830 0.055 1.775 0.021 1.754 1.770 -0.016

Saudi Arabia 10.630 0.322 10.308 0.167 10.141 9.790 0.351

UAE 3.170 0.096 3.074 0.060 3.014 3.090 -0.076

Total OPEC 11 26.860 0.814 26.046 0.372 25.674 25.500 0.174

Iran 2.150

Venezuela 1.160

Libya 0.690

Total OPEC 3 0.000 0.000 0.000 0.000 0.000 4.000 0.000

Total OPEC 26.860 0.814 26.046 0.372 25.674 29.500 0.174

Azerbaijan 0.800 0.02 0.780 0.007 0.773 0.760 0.013

Kazakhstan 2.030 0.04 1.990 0.017 1.973 1.840 0.133

Mexico 2.020 0.04 1.980 0.018 1.962 1.910 0.052

Oman 1.000 0.03 0.975 0.009 0.966 0.980 -0.014

Russia 11.750 0.23 11.520 0.070 11.450 11.580 -0.130

Others 1.220 0.03 1.192 0.010 1.182 1.290 -0.108

Non OPEC Total 18.820 0.383 18.437 0.131 18.306 18.360 -0.054

Grand Total 45.680 1.197 44.483 0.503 43.980 47.860 0.120

1. IEA October 19 Oil Market Report covering the month of September

2. OPEC December 19 cut allocation table

3. October production figures from the IEA November 19 Oil Market Report, except that Saudi Arabian figures are from Aug 19 and non-OPEC members are from Sep 19

Adjustments

Saudi pledge to undercut by 400k b/d -0.400

Russian production assumed to remain unchanged after condensate rule change 0.130

Kazakh production assumed to not to increase yet -0.133

Angola assumed not to be able to reach target -0.113

Adjusted change in supply -0.396

Source: IEA and Investec

20

Appendix B – Reporting Schedules and Key Dates

IEA Oil Market Report

The public version of the report can be found a Publication dates are as follows:

16 January

13 February

9 March

15 April

14 May

16 June (forecasts extended to 2021 in this report)

10 July

13 August

15 September

14 October

12 November

15 December The report is published at 9am London time OPEC 2020 Meetings

• 5 March • 9 June • November/December – not yet fixed US Inventory Numbers

3:30 pm each Wednesday (Except in weeks with a US public holidays when the release is at 4:00pm on Thursday)

21

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