Oil PricesThe shale, the plunge and the outlook

DR. EROL MET INSEM ENERJ İ , SUSTAINABIL ITY , ENERGY & MANAGEMENT IAEE EURASIAN CONFERENCE – AUGUST 2016 BAKU- AZERBAI JAN

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20

40

60

80

100

120

140

160Brent (USD/bbl; 2005-2016)

Peak 145 $/bbl

Financial recovery

Global ffinancial

crises

Ddemand growth 2007-2008

Lowest 28 $/bbl

Shale boom

Steady State

Deep at 35 $

Oil prices- the last 10 years

Sources : IEA, Platt's

0 1 -Jan -1

6

1 1 -Jan -1

6

2 1 -Jan -1

6

3 1 -J an -16

1 0 -Fe b -1

6

2 0 -Fe b -1

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0 8 -Au g-1

62025303540455055

Bre nt, U SD/bbl 2 0 1 6

49.9$/b

Oil Price Range has significant impacts on the economy of producing countries

60$ /b range is the level that covers the cost of 90% of all production techniques.

50$/b and below create high risks with many producing countries

40 $/b range above breakeven point of many OPEC countries but way too low for new investments

Shale plays lie at the higher end of the non-opec marginal cost curve, as infrastructure build-outs, decline rates, high levels of rig activity keep costs high

Sources : Cost Figure : Rystad Energy / Deloitte and Country Risk Figure: Oliver Wyman Analysis

Average Cost $/bbl

Production mb/d

60 70 80 90

80

90

10

10 20 30 40 50

70

60

50

40

30

20 $27

$41

$50 $51 $52

$65

$70

On Shore Middle East

Offshore Shelf Heav

y O

il

Onshore Russia Onshore RoW

Deepwater

Ultr

adee

pwat

er

N.AmericaShale

OilS

ands

Arcti

c

OPEC Avg.

Non-OPEC Avg.Global Avg.

Oil Production and Consumption- Regional Dynamics

World Oil Production growth in 15 years is 22.4% Sustained production growth, avg 5 years : 1.9% 2015 growth : 3.2%

Rate of increase in production is dominant in North America by 42.2%, whereas OPEC proved a stable growth by 8.8 %

Rate of increase in consumption has been dominant in Asia Pacific and Middle East (17%)

World Oil Consumption growth in 15 years is 23.4% Steady consumption growth, avg 5 years : 1.4% 2015 growth : 2.0 %

2010 20150

102030405060708090

100

35.1 38.2

34.3 33.8

13.8 19.7

Oil Production, mb/d

OPEC NON OPEC NORTH AMERICA

8.8%

42.2%

2010 20150

20

40

60

80

100

42.7 42.0

36.2 42.0

9.9 11.0

Oil Consumption mb/d

Total North America + Europe Total Asia Pacific + Mid EastROW

17%

Source Data : BP Statistical Review

18%

Global supply and demand approached a balanced state..

Demand growth in 2016 expected*; 1.4% mb/d Total demand expected*; 2016 : 96,1 mb/d; 2017 :

97,4 mb/d While OECD demand is not growing, demand growth in

Non OECD countries dominates the growth.

Source : Oil Market Report, IEA

Average 1.2 mb/d oversupply in market for a period of 9Q

Supply growth 600.000 b/d Total supply 2016 : 96 mb/d

2013 2014 1Q15 2Q15 3Q15 4Q15 2015 1Q16 2Q16 3Q16 4Q16 2016 42.0

43.0

44.0

45.0

46.0

47.0

48.0

49.0

50.0

51.0

46.145.8

46.5

45.3

46.746.3

46.246.6

45.9

46.7 46.546.4

45.947.2

47.1

48.8 49.0 49.248.5

48.6

49.7 50.150.4

49.7

Demand Growth, mb/d

Demand OECD Demand Non-OECD

Perfect Storm!Three important pillars of the low oil price period

1- Implied Oversupply of the Oil Markets 2- Strong USD 3- OPEC trying to keep market share

2013 2014 1Q15 2Q15 3Q15 4Q15 2015 1Q16 2Q16

-0.6

0.81.5

2.2

1.31.7 1.6

1.3

0.2

Supply Demand Balance mb/d

Avg 1.2 mb/d for a period of 9Q

Jan-14

Mar-14

May-14

Jul-14Sep

-14

Nov-14Jan

-15

Mar-15

May-15

Jul-15Sep

-15

Nov-15Jan

-16

Mar-16

May-16

Jul-16

2535455565758595

105115

75

80

85

90

95

100

Oil Prices & U.S $

Crude b/$ $ TWBC

Average 1.2 mb/d oversupply in market for a period of 9Q

Strong USD since the end of 2014, trade weighted basket

OPEC not imposing quota keeping the growth

Sources: Oil Market Report EIA, World Bank and OPEC

Contributors and consequencesMiddle East back in Playfield A period of slower demand growth

in Asia Pacific

Iraq’s oil production shows steady increase , 1.1 mbd increase in 2015 reaching to 4.0 mbd

Iran, after sanctions, now back to the stage with potential to add 1.0 mbd capacity in 2016

Low Oil prices has led to lower energy investments.

Total annual investment in Energy has dropped from 90b$ to around 40b$ in a period of 3 years.

Around 200 energy investment projects being pushed back on an annual basis

Economic growth in China, representing 40% of the growth of the world oil consumption has slowed down

The equivalent demand dropped by 1.0 mbd compared to 2014 levels.

Sources: BP Statistical Review and World Bank

Oil Prices and Supply Demand Characteristics* past 10 years

• Oil prices have rallied between 30$ - 140$ range over the last 10 years. The main drivers were; 2005-2008: Demand growth, slow response from production, OPEC

politics on higher prices, instabilities in oil producing countries. 2008 : Global financial crisis 2008-2014 : Economic recovery, OPEC politics toward high prices and

balanced s/d, price level allowed new investments 2014- 2016 : Sustained over supply, new technologies, production

increase in Mid East, OPEC’s market share 2017 - .. : Potential balanced s/d outlook ?

Graph a sensitivity chart.. % oversupply vs price variation

Change in drives

Pricing and investments strongly influenced by slow / conventional productions techniques

Producers and political stabilities determine the boundaries of the price band

New technologies allow very fast exploration to production stages , in large quantities

Less impact from producers cartels

More fluid, therefore more volatile markets

More rigid, less

volatile

Less rigid, more volati

le

Surge of Oil Production in US

US oil production increased around 1.0 mbd every year since 2012

Approximately 4.0 mbd production increase from 2012 to 2015 ; equivalent to Iraq’s production

From 2008 to 2014, total US oil production has risen dramatically by 73% from around 5.0 to 8.6mbd

Shale Oil production was very quick, reaching to 5.0mbd level in five years time

The shale sectors contribution to GDP was about 1.5%

Source: US Energy Information Administration

Shale Oil has been the name of the game

Future Outlook – Influencers of the S/D characteristics and price outlook

1. Can the Shale Oil Industry sustain production levels with low oil prices and for how long ?

2. How the Oil Producing Countries (mainly OPEC) would respond to the new Economics of Oil ?

3. What has been the impact of low oil prices in the Conventional World and to the investments in E&P world ?

4. How the policies around the climate change and environmental policies and would the technological developments in the Renewable Energy Industry make energy prices competitive to oil ?

IMPORTANT DISCUSSION POINTS

Can the Shale Oil Industry sustain production levels with low oil prices and for how long ?

Bakken Region Permian Region

Source: US Energy Information Administration

Eagle Ford Region

Can the Shale Oil Industry sustain production levels with low oil prices and for how long ?

Significant drop in the number of active rigs since 2015,

Increased productivity per well Reduced operating costs, at a level of 30$ The upward production trend would be

temporarily disrupted 50-70$/b level could trigger idled rigs back to

action quickly

Shale Oil revolution likely to continue until at least 2020 but with much slower rate!

Production mbd

Tight oil

Other fluids

15 mbd

HistoryHistory Projection

Tight Oil

Natural Gas Plant Fluids

Bio Fuels

Crude Oil

Other Fluids2015 2040

10 mbd

15 mbd

US Production of Petroleum and other liquids 2000 -2040

2000Source: Energy Information Administration

Active Rigs

How the Oil Producing Countries (mainly OPEC) would respond to the new Economics of Oil ?

• OPEC has chosen to stay competitive on pricing in November 2014

Represents 40% of the Oil Market Low cost production compared to

shale Longer term continuity per well Higher Spare capacity Large yet to find fields

OPEC likely continue to remain on the market prices with no quota impose to push prices up

1Q - 03

4Q - 03

3Q - 04

2Q - 05

1Q - 06

4Q - 06

3Q - 07

2Q - 08

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2Q - 17

0.00.51.01.52.02.53.03.54.04.55.0

0.00.51.01.52.02.53.03.54.04.55.0

OPEC Spare Capacity, mb/day

1213.4; 81%

279.2; 19%

Proven Oil Reserves, bn b

OPEC Non-OPEC

Sources: BP Energy Outlook and OPEC

What has been the impact of low oil prices in the Conventional World and to the investments in E&P world ?

• Spending on Exploration and new investments has fallen down by almost 50% since 2014

• Reduced investments likely to remain low next 5 years

• Total World Rig count dropped significantly since the beginning of the low oil price period

• North America

Investment spending by the global oil industry has fallen by $1 trillion since prices collapsed in 2014.

Add notes McKenzie .. New projects on exp.

Source: Wood McKenzie Source: Energy Information Agency, US

How the climate change and environmental policies would effect the demand side ?

Source: World Bank

Source: Oil and Gas Journal

The impact of the climate change, in terms of water and food resources will be more prominent in Mid East, North Africa and Asia Pacific leading to more pressure on GDP growth in these regions

Significant cost reductions achieved in renewables, mainly in Solar Systems have a potential for fast growth and therefore oil industry will be more dependent on transport industry.

High Oil Reserve regions likely to see more pressure due to effects of the climate changes

Outlook for the Oil Prices? Main driver of the oversupply, shale oil production

increase in the U.S. has slown down Since low Oil Prices, significant reduction in

investments and exploration activities Demand would likely to continue at a pace of 1.2-

1.4mbd rate , leading to a more balanced S/D characteristics.

Shale Oil, by nature, quick to response market conditions

Existing stocks might suppress the S/D driven price hike towards in 4Q of 2016

• Oil price likely to increase in 2017• Forecast expectations dominate around 55 $

range for 2017 and moving up to 65-70$ range in 2018

Survey by WSJ on Sept 2015:2016 average 58.7$/b

Source: Wall Street Journal (above) and collected data from EIA, EIU, World bank, Morgan Stanley, Barclays

Conclusions

Perfect storm, a combination of over supply, strong $ and weakened demand was the main driver of the oil price plunge.

Conditions of perfect storm no longer exist leading to more balanced supply demand characteristics and therefore markets are expected to see a price increase in 2017.

Although forecasting on future outlook of oil prices has proven “big surprises” for many experts, there exists sufficient technical base for price range of 50-60 $ /b in 2017.

Shale Oil, although the production hike has ended and reached to a stable level in the US, the potential for duplication in other countries and versatility of the new technologies to expand quickly in the existing fields, still warrants a quick pick up of the production

Lack of investments, mainly in offshore projects and new exploration projects would impact the production growth in the conventional side, whereas OPEC would have the potential to fill the gap.