February 2015

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The Outlook for Oil in 2015: Supply, Demand and Opec's Big Gamble

Slow Oil Supply Response . . . . . . . . . . . . 2
Oil Price Offers Modest Boost to GDP . . . 3
Consolidation Is Coming . . . . . . . . . . . . . 4

Opec Experiment Moves Into Storage Phase
Opec's Saudi-led strategy of letting the
market balance itself is quickly moving
from its first phase — maintaining production to let a growing crude surplus
develop — into its second, the absorption of that surplus through rising storage levels. But it's the timing of the
third phase, the period of actual market rebalancing, that is of greatest
interest to the industry. When will low
prices shut in enough high-cost nonOpec supply to allow oil prices to
recover? And will production be shut
in swiftly enough to prevent storage
tanks overflowing, triggering another
price collapse? This is uncharted territory for what Mideast Opec delegates
openly acknowledge as the group's
"experiment," but PIW analysis suggests the supply response this year will
be limited, with non-Opec supply
growth of 1.16 million barrels per day
outstripping demand growth of
800,000 b/d.
In the current second phase of the
experiment, rising storage levels are
being facilitated by steep spot price
discounts. Onshore storage is filling up
fast, while some volumes are also
starting to move into floating storage.
Brent crude has already lost $30 per
barrel since Opec's Nov. 27 decision
not to rein in production, and rising
inventory levels are adding to the
downward pressure on the price. But a
full collapse can be avoided as long as
storage is available. Ahead of the
expected 2.4 million b/d surplus in the
first half of this year, the market had to

deal with a 1.9 million b/d supply overhang in last year's fourth quarter of
2014. And the more storage tanks fill
up, the longer the re-balancing will
take, since these massive inventories
will eventually have to be drawn down.
Low oil prices seem certain to start
affecting non-Opec supply later in the
year, but it's countries like Russia that
are likely to be most vulnerable, rather
than the US' fast-rising light, tight oil
supply, which most observers see as
the principal intended target of Opec's
new strategy. But will this supply
response be enough to see some stabilization in prices this year, as forecasts
by Opec and the International Energy
Agency suggest?
The question here is whether the
market will run out of storage space
before the delayed reaction from nonOpec producers succeeds in slowing
global supply. And if prices really collapse, how will Opec react? Saudi
Arabia has indicated that the producer
group has made a permanent change
in policy, but dissent among other
members, notably Venezuela, is growing. A change in Opec policy seems
unlikely before or even at its next
meeting in June, however.
The Opec experiment was never
likely to be a smooth process, and is
not helped by gloomy economic forecasts for 2015, which undermine any
hope that rising demand might ride to
the rescue. US tight oil could prove
more resilient than expected, while
within Opec Iraq continues to hike out-

put. And as events in Yemen demonstrate, geopolitics remains a real wild
card, with potential to both help and
hamper the balancing exercise. A
nuclear deal with Iran could boost supply significantly, while Libya could go
either way. The list of potential
hotspots is long, with instability aggravated by low prices — as in Venezuela
and Nigeria — and some even questioning the potential for disruption in
Mideast Gulf monarchies. Moreover,
geopolitical disruptions, by their
nature, have a habit of springing surprises.
US tight oil producers are already
cutting capital spending, but are also
slashing costs through efficiencies and
technology. That may ultimately stop
US tight oil acting as the market's new
marginal-cost barrel, with other
higher-cost sources instead falling victim to the industry's eventual restructuring — the logical fourth and final
phase of Opec's experiment.
Investment bank Goldman Sachs sees a
new paradigm shaping the industry as
US tight oil producers lower costs, and
capital shuns high-cost deepwazter, oil
sands and other alternative technologies, making the oil industry "more
efficient." But this is unlikely to pan out
for another year or more, says the
bank, which sees Brent at $42/bbl in
the second quarter, rising to $64.50/
bbl in the fourth and $70/bbl in the
first quarter of 2016. n
January 26, 2015
Petroleum Intelligence Weekly

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February 2015 | 2

Price Slump Will Slow, Not Stop, US Oil Growth
The collapse in oil prices is starting to
affect the outlook for US crude output, as
producers and their financial backers
slash forward price expectations. But most
still insist output will rise, even as spending levels dive, given the forward momentum in the country's key tight oil plays.
According to PIW sister publication Oil
Market Intelligence (OMI), US oil production should, based on current prices, grow
in the range of 1.2 million-1.4 million barrels per day this year, down from growth
of slightly less than 1.6 million b/d in
2014, with the US' Big Three tight oil plays
— the Bakken, Eagle Ford and Permian —
helping sustain output's higher trajectory.
The US growth story also looks likely to
remain intact in 2016, albeit at a more
modest level (PIW Nov.24'14).
If history is any guide, US onshore
stripper wells — those that have produced less than 10 b/d over the past 12
months — and heavy oil wells in the
California Central Valley will be the first
shut in, while marginal shale plays and
fringe areas away from core play "sweet
spots" — where break-even prices of as
low as the mid-$40s per barrel are not
uncommon — will see sharply reduced
activity. If low oil prices persist, there is
likely to be a sharper deceleration in
growth next year, OMI suggests, slowing
to around 825,000 b/d as investment
declines also hit output growth in core
shale areas, queues of already drilled but
uncompleted wells are worked through,
and stripper well declines accelerate.
The seeds of the anticipated production growth slowdown are already evident in rig activity, with the start of 2015
witnessing the biggest weekly drop in the
number of US onshore rigs targeting oil
in more than two decades, according to
data from rig firm Baker Hughes. The
next few months should, analysts believe,
see aggressive efforts by producers to lay
down rigs, with eventual declines in services costs and high-graded drilling programs thereafter putting a floor under rig
usage (PIW Dec.8'14).
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by encouraging further exploitation of
Oil-directed rig numbers fell by 61
the already tireless work done to lower
for the week ending Jan. 9, with the total
production costs. Access to capital
onshore rig count now down by 180
remains a critical wild card, however, but
from the recent peak of 1,930 set in
even that might be addressed if low
mid-October. The Permian and Bakken
prices encourage consolidation and takeareas saw the largest weekly drops
overs in tight oil plays, and see the entry
among key US basins, down by 28 and
of bigger and better financed operators.
eight rigs, respectively. The US onshore
The US shale boom was built on a
rig count is likely to drop by another
mountain of debt, and banks and bond450-plus between now and May, anaholders may be far less willing to extend
lysts at Credit Suisse believe, while
credit as they become painfully aware of
Raymond James analysts think the rig
count could fall by 850 rigs, or
US Rig Count Declines
44%, from peak to trough.
1,940
With US tight oil and other
high-cost non-Opec supply 1,900
sources the clear targets of
Opec's new strategy, merely 1,860
slowing US production growth
1,820
may not be quite the outcome
Saudi Arabia and its allies were 1,780
hoping for. But if oil prices
remain around $40-$50 per bar- 1,740Sep '14 Oct '14
Nov '14
Dec '14
Jan '15
Source: Baker Hughes
rel, further pressure on supply
growth projections is inevitable
US Crude Production
(‘000 b/d)
as producers contemplate even
12,000
deeper cuts in spending.
Recent corporate announce- 10,000
ments already point to reduc8,000
tions of 20%-50% in capital
expenditure this year in most 6,000
cases, even though the indepen4,000
dents which dominate tight oil
output have hedged much of this 2,000
year's production at prices above
0
$85/bbl (PIW Oct.20'14). That
2007 2008 2009 2010 2011 2012 2013 2014 2015 2016
hedging means that the bigger
Source: OMI estmates and projections
impact on output could come if
what lower oil prices mean for highly leverlow prices endure into 2016, for which
aged producers. But that financial vulneraproducers have few hedges in place and
bility could make tight oil players ripe for
by when they will have been weakened
takeover by the integrated majors, whose
financially by a tough 2015.
track record in tight oil to date has been
With capital spending levels so
mixed at best, and who might, notwithclosely linked to operating cash flows,
standing investor pressure to rein in capital
any price rebound should, in theory, lead
spending, be tempted by the prospect of
to a rapid revival in activity. That means
adding high-quality tight oil assets at a disthat a near-term oil price that is low, but
tressed price. n
not catastrophically so, could have
January 19, 2015
unforeseen consequences for Opec, creating a more resilient US tight oil sector
Petroleum Intelligence Weekly

Copyright © 2015 by Energy Intelligence Group, Inc.

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February 2015 | 3

Slow Oil Supply Response Points to Big Stockbuild
Lower oil prices are expected to apply
the brakes to non-Opec supply growth
this year, but not to the extent that it will
be outpaced by relatively modest projected growth in demand. This reflects
the growth momentum built up in certain key non-Opec plays over the past
few years, and means that the main
short-term consequence of Opec's decision to maintain output and let prices fall
will be a further fattening of already
ample inventories (PIW Jan.19'15).
The latest supply/demand assessments by PIW sister publication
Oil Market Intelligence (OMI) show an
average 2.4 million barrel per day surplus in the first half of 2015, dropping
to a still hefty 1.32 million b/d in the
second half, assuming crude prices stay
at current levels. OMI sees non-Opec
supply growth this year of 1.16 million
b/d, down by around 600,000 b/d from
estimated 2014 growth levels, but still
comfortably — or uncomfortably, from
Opec's perspective — ahead of projected 2015 oil demand growth of just
800,000 b/d. These projections also
assume that Opec perseveres with its
new strategy and maintains crude output at 30 million-30.5 million b/d.
The fall in prices means the drivers
for global oil supply have shifted radically from the pattern of the past few
years — the focus is no longer on rampant non-Opec growth and possible
output policy responses from Opec,
but instead on how growth rates in
areas such as US tight oil might moderate and how decline rates in mature
areas might accelerate.

1.6 million b/d. In addition, continued
Opec's strategy, led by Saudi
increases from Canada, Brazil and a
Arabia, is to sit tight, maintain outfew others should counter most other
put, and wait for lower prices to rein
non-Opec declines.
in high-cost production and re-balTwo key countervailing assumpance the market. And lower prices
tions underlying the supply outlook
will slow non-Opec growth, as proare that prices remain at current levducers respond to reduced cash flow
els rather than moving significantly
by trimming capital spending, and as
lower, and that geopolitical disrupinvestors and lenders similarly lose
some appetite for oil sec2015 Quarterly Oil Market Balances
tor exposure. Shut-ins of
Chg. vs.
low productivity wells, (million b/d) Q1 Q2 Q3 Q4 2015 2014
Demand
92.81 92.72 94.32 95.12 93.75 +0.80
such as stripper wells in OECD
45.43 44.92 45.93 46.13 45.61 -0.06
47.37 47.80 48.39 48.99 48.14 +0.86
the US, and cancellation or Non-OECD
Supply
95.41 94.94 95.15 96.93 95.35 +1.40
58.63 58.27 58.21 59.93 58.67 +1.16
delays to high-cost mega- Non-Opec
Opec NGLs & Other
6.57
6.44
6.67
6.84
6.65
+0.14
projects in areas such as Call on Opec Crude 27.60 28.01 29.44 28.35 28.36 -0.54
Opec Crude
30.20 30.22 30.26 30.16 30.04 +0.10
the deepwater will grab Implied
Stock Chg.
+2.60 +2.21
+0.83
+1.81 +1.60

the headlines, but elseSource: Energy Intelligence's Oil Market Intelligence
where, significant forward
tions do not take a big chunk out of
momentum is likely to keep US tight
supply at any stage. Both are of course
oil plays such the Eagle Ford and the
possible, the former particularly given
Bakken, and to a lesser extent the
the additional price pressures created
Permian Basin, moving forward,
by the build-up in inventories.
albeit at a slower rate.
The stockbuild is just one result of
The hardest hit among non-Opec
Opec's strategy, with the weakness in
producers is expected to be Russia,
benchmark crude futures leading to a
caught by the combination of low
pronounced shift in the forward price
prices and Western sanctions, which
curves for both Brent and West Texas
have in turn spawned a currency crisis
Intermediate into deep contango. This
and an economic downturn. But there
creates sufficient incentive to store
is also expected to be an acceleration
the crude the market doesn't curin decline rates in mature plays in the
rently want in both onshore tanks
North Sea, China, Indonesia, Mexico,
and, at greater cost, in tankers offArgentina, Azerbaijan, Australia, Egypt
shore. But it also creates a major drag
and several other smaller producers.
on any price recovery when a flattenAlthough the US' output expansion
ing curve begins to bring that oil back
is expected to slow, output should still
out of storage. n
see growth in the 1.2 million-1.4 milJanuary 26, 2015
lion b/d range this year, down from
growth last year of slightly less than
Petroleum Intelligence Weekly

Oil Price Offers Modest Boost to Global GDP
Lower oil prices should be good for the
global economy and for oil demand,
and if prices remain at current levels,
most analysts expect a small additional
boost to demand growth throughout
2015 and a bigger one in 2016 as a
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global economic recovery takes root.
Some early impacts are already visible
— US consumers, partly thanks to the
low retail fuel taxes they pay, have been
first to react, driving more miles and
buying bigger cars. But overall, econo-

mists warn that an exuberant demand
reaction should not be expected.
As the International Monetary Fund
said in October when it downgraded
global economic growth for 2015 to

Continued on p4

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3.8% from the 4% predicted last July,
the recovery remains "brittle, uneven
and beset by risks." The historically less
bullish World Bank sees a low oil price
adding just one-tenth of a percentage
point to global GDP growth this year,
and with an eye on the sputtering eurozone, Japan, and China's economic
gear-shift, forecasts growth in the
global economy in 2015 at 3%. It sees
some support from the oil price and the
US economy, but also the risk of a new
financial crisis, especially if investors
exit Asia as and when Western banks
start raising interest rates. "The global
economy is running on a single engine
[the US]," says World Bank Chief
Economist Kaushik Basu. "This does
not make for a rosy outlook."
A number of factors — taxation,
subsidies, currencies and the availability of alternative energy sources —
complicate how lower oil prices are
passed on to consumers, economists
warn, noting that the elasticity of oil
demand is greater when prices rise

then when prices fall. "You don't get as
much demand back as you lost from
prices going up," one market-watcher
says. "You don't rip out your insulation."
Much like their counterparts in the US,
consumers in Asia are enjoying lower
fuel prices, but in countries like China,
India and Indonesia, the simple translation of cheaper crude into cheaper
pump prices is complicated by recent
subsidy and tax changes and shaky currencies that make oil more expensive in
local money (PIW Jan.12'15).
Oil demand growth should be better supported from this year on by a
sustained and even recovery in the
world economy, but that demand
growth will continue to be heavily concentrated in non-OECD economies,
buoyed by some additional buying from
China and India for their strategic
stockpiles. Despite modest GDP growth,
OECDs economies are expected to continue to cut back on oil use. Overall,
PIW estimates point to limited annual
demand growth this year of 800,000

February 2015 | 4

barrels per day, up from growth of
720,000 b/d in 2014.
There could be surprises to the
upside, if Asia's smaller economies take
off, or in the US, which could easily add
100,000 b/d to that total as more jobs
are created, net of likely oil job losses in
producing states like Texas and North
Dakota. Africa could also deliver more
demand growth than anticipated from
a low base, but some trends will remain
intact despite lower oil prices. China
ceased to be such a big engine of oil
demand growth as of 2013, and is
expected to see demand growth of just
200,000 b/d this year, while possibly
substantial structural declines in
demand are set to continue in Japan
and Europe. Oil demand may also be
affected by a tightening of environmental regulations, while policies aimed at
improving energy efficiency in vehicles
will also blunt any demand increase. n
January 19, 2015
Petroleum Intelligence Weekly

Consolidation Is Coming, But May Take Time
Low oil prices will likely spur a big
wave of industry consolidation this
year, but it could take some time to
develop. Oil companies traditionally
use mergers and acquisitions as a way
to unlock value during periods of low
oil prices, with the strong preying on
the weak. All indications suggest the
current downturn will be no different.
But before widespread deal-making
can happen, oil price volatility must
subside so that companies can find
common ground on asset values.
At present, the bid-ask spread for
potential deals is too wide, as prospective sellers have not reconciled
themselves to the new price realities
after Brent's 50% fall since June to
less than $50 per barrel. The price
slide has brought M&A activity to a
standstill over the past three months
and has resulted in some agreed deals
being aborted, including United Arab
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Emirates-based Dragon Oil's $800
million bid for Irish independent
Petroceltic, and some assets being
pulled off the market, such as US independent Newfield's interests in China.
The big exception has been the
$13 billion takeover of troubled
Canadian independent Talisman
Energy announced last month
by Repsol, for which the Spanish
major has been accused of overpaying
(PIW Dec.22'14).
The Western majors have a big
decision to make about whether to
pursue acquisitions. They are committed to capital discipline, having sacrificed growth to protect cash flow, and
most are in fact looking to sell assets
to help cover expected cash-flow deficits this year. At the same time, sanctions against Russia have deprived
them of access to key long-term
growth assets — a portfolio void that

could be addressed opportunistically
via M&A (PIW Jul.28'14).
Large acquisitions would draw
intense scrutiny from investors, who
were already fed up with majors'
profligate spending and weak returns
even before the collapse in oil prices.
Still, the majors boast strong enough
balance sheets to handle big purchases. Exxon Mobil has been linked
with bids for BG and Anadarko
Petroleum, but says "bolt-on" assetlevel deals in US shale are more likely.
Holding treasury shares worth some
$350 billion, Exxon can entertain
almost any deal. Few believe the
majors will actually double down on
the failed "supermajor" strategy, however, so any deals will have to offer a
compelling mix of cash flows and flexible capital spending requirements —
in addition to growth.
Ambitious national oil companies

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(NOCs) from Asia and Middle East are
more likely to lead the way, as overseas
M&A targets suddenly look more
obtainable. After refraining from major
deals in 2014 amid China's corruption
probes, Sinopec and PetroChina look
ready to make a big splash in M&A
markets this year, as do some expansion-minded Southeast Asian NOCs
such as Thailand's PTT Exploration &
Production and Indonesia's Pertamina.
China's NOCs spent roughly $20
billion on upstream M&A in 2013, but
just $3 billion last year. Sinopec has
cash available after divesting 30% of
its retail business for around $17.5
billion and is reportedly looking for
new acquisitions. PetroChina is also
evaluating new M&A opportunities,

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while China National Offshore Oil
Corp. is likely to refrain from large
acquisitions after its 2012 purchase of
Canadian independent Nexen. PTTEP
has a $3.5 billion war chest with
which it is expected to target entry
into US shale. UAE-backed firms
Mubadala Petroleum and Taqa may
also be looking to fill gaps in their
portfolios, with Energy Minister
Suhail al-Mazrouei saying periods of
low prices historically "create the best
value" for buyers.
M&A opportunities are expected
to grow over the course of the year as
low prices increase the cash-flow
pressures on some firms, particularly
smaller, weaker independents. The US
independent sector, which has been

heavily financed by high-yield "junk"
bonds in recent years, will likely see
the most M&A action, but there will be
no shortage of targets worldwide.
Iraq's semiautonomous northern
region of Kurdistan, Brazil and East
Africa also offer substantial growth
opportunities and could become
active hubs for deals. In the US, there
are junk credit ratings on roughly 100
E&P companies with production of
some 4.5 million barrels of oil equivalent per day (PIW Nov.24'14). Despite
capital expenditure cuts, the sector is
expected to outspend cash flow by
60% this year, pointing to worsening
debt metrics. n
January 26, 2015 Petroleum
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