THE OXFORD INSTITUTE FOR ENERGY STUDIES A RECOGNIZED INDEPENDENT CENTRE OF THE UNIVERSITY OF OXFORD Oil and Gas Value Chain James Henderson April 2017 The Oil & Gas Supply Chain Production Transportation 1 Transmission Market Gas field ■—B äb?q © Oil Treatment & field Separation I Upstream a— Liquefaction Shipping Regasification "Associated" Gas Res & small C&l -~T~^ Traded Gas Market Large Commercial & Industrials ■31 Transport, lubricants and space heating Gas to Power Refining |l=w Gas to Liquids Solar, Ren. & Alts. Traded Power Market or Pool 7ÜK Oil and Gas Field Life Cycle Access esource Assessment asin Evaluation oarse Seismic Distribution of Resource Potential Field Abandonment i Field Production Field life typically 5 to 25 years. Field will be in decline phase for last 30% to 50% of its life. I Rate at which prospective areas are made available by Host Governments for exploration activity by Oil & Gas companies Exploration Evaluation Potential Fields identified from Seismic data Risked exploration economics (success rate 1 in 8) Cost of exploration well $5 - $50 million Reserves Assessment Viability A Carbon from dead sea animals and plants Oil and Gas Deposits Oil Reservoir in Anticline Trap ealing strata Porous Reservoir Rock Source Rock Oil forms at temperatures between about 50°C and 175°C. At higher temperatures, gas is formed. Oil within the Reservoir Sandstone Grain Oil in 'pore' between grains Oil Production Drive Exploration Activity • Oil and Gas is an extractive industry. Companies aim to replace current production with new finds. • Companies often explore in many different regions under differing fiscal regimes, onshore and offshore. • Success rates for exploration wells may be as low as 1 in 5. • Need to take a portfolio approach and a systematic means of evaluating and selecting exploration investments. Finding Oil and Gas - Seismic Survey air-gun is the source of shock waves • compressed air is more environmentally friendly than explosives hydrophones - there are up to 3000 hydrophones on a 3000m cable Finding Oil and Gas - Exploration Drilling Three Fundamental Questions: - Is there hydrocarbon in the target structure ? - If there is, is it oil or gas ? - If there is, how much is there ? 7m Exploration Drilling Derrick Hoisting Equipment-including Line. Travelling Block, Swivel, and Hook Mud Pit Source: Energy Information Administration, Office of Oil and Gas. Drawer*,and Engines OllSllOre We 11 COSti $1 million to $10 million Offshore Well Cost $20 million to $100 million Facilities Concept and Production well schematic Azerbaijan - field development cost $10bn + Bovanenko Field, Yamal Peninsula, Development Cost ~$100 bn 7m Production Profile A conventional oil or gas field production profile Time Fig. 1—A typical oilfield production profile. 1. Initial surge to peak production 2. Plateau at peak for a number of years 3. Gradual decline towards abandonment 4. Water and solids production increases, undermining performance 7bK Midstream and downstream - access to market Rig and Ship Repair Welding Scaffolding Pressure Vessels Fabrication Engineering Services Construction Logistics Storage Exploration • Geophysical Evaluation & Design ■ Field Development Drilling Operations 0 Production ' Bringing the oil to the surface Oilfield Services • Contract Drilling Drilling Related Services & Techniques • Production & Maintenance UPSTREAM Exploration .0 Production ■ 3D Seismic Geophysical Evaluation & Design • Drilling Operations Crude Oil Value Chain 0 Transportation • Gathering and transporting - pipelines, tankers, trucks MIDSTREAM Natural Gas Value Chain 0 Bringing the gas, the surface Field Development Continuing drilling operations^ | Processing Gathering & Processing Fractionation 0 Gasfield Services jperations ■ Contract Drilling Drilling Related Services & Techniques • Production & Maintenance UPSTREAM Refining Fractionation of crude oil into petroleum products Product Blending 0 Marketing Retailing Trading DOWNSTREAM Transportation I & Storage • Transportation (pipelines) • Storage • Liquefaction (for tanker transport) 0 End Users MIDSTREAM • Industrials • Power Generation • Utilities -Residential and Commercial loads DOWNSTREAM Transportation and refining are vital elements of the oil value chain, in order get products to customers Tariffs and margins are the key economic drivers in this segment Regulation and government control can be decisive How a refinery works Carbons Gas Reformer Naptha 8 Gasoline 8 Alkvlation^Kerosene 12 Unit Cracking Unit Gas Oil or Diesel 16 Lubricating Oil Heavy Gas Oil 44 Coker > Residual Boiler Distillation Column Crude oil is heated to high temperature to effectively distil it into different products at different temperatures Secondary processing units are then used to break the oil down into mon specific products of varying quality Markets for oil products Retail gasoline and diesel Jet Fuel 1 IL Petrochemicals and plastics Petroleum Industry, etc. C ruda Oil Oil Refining Facilities "1 Propane Naphtha FCC By-' product Gas" fterbrmate Petrochemical and Chemical Industry Ethylene - Steam Ciackniy Facilities^) 1 (*) Ethylene Plant Dehydrogenallon Process Ethylene Dri ivativss Propylene ■ C4/C5 Fractions' Aromatic J Fractions' ^ Piopylene "Derivatives C4/C5 ' Dei ivatives AfOITIUtie " Dei ivatives Lubricants and industrial oils Shell Lubricants Distributor E (0 o Shale Oil/Gas Extraction CO 0) (/) 0) DC 0) (0 Ü (0 Roughly 200 tank* trucks deliver water lor |H HMkR HQ DfOCaM 1.000 .-CW cnorncw wo bw wo« i Q bo "qq ' Natural gas flow« out ot weo Recovered wale* ts stored pits, theo taken to a treetmen plant Natural gas i* piped to market Well Hydraulic Fracturing Hydraulic tracturmg. or tracing." involves the injection or more than a m*oo gallons of water, sand and chemicals at high pressure down and across into horizontally dnSed wells as fa/ as 10.000 foot below the surface. The pressunzed mature causes the rock layer, in this case tho Marceiius Shaio. to crack. These fissures are held open by the sand particles so that natural gas from tho shato can flow up the wei. Well turns horizontal The shale P25 P50 P75 MEDIAN MEAN 10,000 -I-1-1-1-1-1-1-1-1-1-1-1-1-1-1-1-1-1-1-1-1-1-1-1-1-1-1-1-1-1-1-1 1 2 3 4 5 6 7 8 9 10 11 12 13 14 15 16 17 IS 19 20 21 22 23 24 25 26 27 28 29 30 31 32 33 34 35 36 Months of Production • 420 Barnett Shale wells suggest considerable variance in type-curve methodology. • Mean over-predicts EUR by 10-15%. Labyrinth Consulting Services, Inc. Houston SIPES Slid West Virginia Shale Gas Pad - Drilling Phase Production Phase - Same Location || Shale Gas - Summary • The US shale gas phenomenon reversed the decline trend of US Gas production in the early 2000s. US will be an LNG exporter in 2016. • US shale gas has been successful in terms of production growth due to: • Multiple, extensive, highly prospective plays. • Regulatory system evolved during 100+ years of continuous conventional oil and gas activity. • Landowner mineral rights. • Many competing players in exploration & production and high-tech service sector. • Wide open spaces. • To date industry has failed to replicate this model in Poland, China and UK. • As much about population density, public opinion, regufijw style (and speed) and local industry dynamism as geolo^)^ Commercial Chain Development and rz) Transport rz) production LPG & Condensate Storage ^ Processing rz) Distribution Local Storage 1 Gas Strategies Urban Industry I E (0 o u (0 CD CO CD GC 0) (0 o (0 Domestic Production, Long Distance Pipelines and LNG ro 2,000 E o 1,500 A 500 - 0 1995 2000 2005 I Production Consumed Within Region LNG LNG % of Total ^---■ >ii I . 1,000 __« t-1-1-1-1-1-1-1-1-1-1-1-1-1-1-1-1-r 2010 Inter-Regional Pipeline Inter-Regional Pipeline % of Total 20% 18% 16% 14% 12% 10% 8% 6% 4% 2% 0% a. Q. 3 CO re 4—1 o Source: BP Statistical Review of World Energy || Bringing Gas to Market - Infrastructure • Challenges: - Low energy density as a gas - Expensive to transport and store - High confidence of both reliable supply and demand needed prior to infrastructure investment. • Long Distance (high pressure) pipelines - Supply and Market (initially) physically 'locked'. - Subsequent network developments and amortised initial investment invites governments and regulatory bodies to enforce competition: • Third party access to pipeline and storage capacity • Removal of gas destination restrictions • Liquefied Natural Gas (LNG) Gas Processing Facility Gas Processing - Function Generalized Natural Gas Processing Schematic Lcjso Operation* Gas Reservoir Oil Reservoir Dry Gas (to Pipeline) Dry (Residue) •> Gas Fractionalor <'° P«P«*r>e) * Optional Step, depending upon me source and type ot gas stream. •Source. Energy Informsiion Administration. Office of Ol and Gas. Natural Gas Division Natural Gas liquids (NGLs) Phone Dcpane Cgmanes Extract valuable Condensate (light oil, propane, butane and some ethane. Remove water & nitrogen Remove C02 and H2S Must meet grid calorific value range and Wobbe index (calorific value divided by sqare root of density) - which determines flame stability. Liquefaction -161°C GAS GAS Treatment and Purification • Removes condensate, C02, Mercury, and H2S •Causes dehydration Refrigerant Loop Storage Corn'oTe'sstdn" Purified gas is cooled to minus 161 C at which temperature it becomes a liquid at atmospheric pressure. Volume reduced by a factor of 600 compared to gas atmospheric pressure. ^yy^ Source: Katherine D'Ambrosio I LNG Import and Regas Terminal Jurong Island, Singapore The Gas into Power value chain Gas Components of Chain _ Gas Flow Productior 0 Transportation & Treatment I Pipeline Tariff Distribution Price paid to Gas Producer Power Components of Chain _Electricity Flow_ ower neration Price paid to Gas Distributor Price paid to Gas Distributor ___________________1___________________I Electricity Transmission & Distribution Revenue Flow Electricity Price paid to Generators \ Electricity Consumers Electricity Price paid by Consumers 1 Gas Strategies 39 7ÜK Transporting Gas nK - From Production Source to Market - Summary As demand for gas has grown and in some cases nearby production sources have declined or not kept pace with consumption growth: • Long distance pipelines have been constructed; notably: • From Norway to the UK and North Europe. • From Russia to Northwest, Eastern and South East Europe. • From Algeria and Libya to Spain and Italy. • Throughout US, Canada and Mexico. Less prominently in: • South America • Asia • Africa • LNG was a key channel of gas supply in Asia (Japan, Korea, Taiwan & more recently India and China) and is becoming more widespread: • European periphery (UK, Spain, France, Italy, Turkey) • New markets for LNG are emerging with some frequency. • The growing volumes of LNG which are not constrained in terms of destination by contractual terms represent a powerful force for price arbitrage between regional markets. OP^ ©M, 7m Investment Economics • Risk versus Reward - Geological - Political/Fiscal - Technological - Market (demand) and Price • Time value of money - High up-front (risk) investments, long field life, multi-year payback period. - Access to finance - cashflow, debt, equity • Competing Opportunities - Global portfolios - Oil.Gas, (Tarsands), (Gas to Liquids) The DCF Calculation as a foundation - companies' must earn an adequate return on investment Time value of money Prvsvnt ViLu4 o I- Future Value 2 3 + H-1 Years □E-Lfpn A. $1 0,0 DO SlQ.QOO * fntrr Option B 510,000 - Interest &t 0,0 DO Provided money can earn interest, any amount of money is worth more the sooner it is received Money available at the present time is worth more than the same amount at a future time because of its earning potential The DCF Calculation as a foundation - WACC concept Weighted average cost of capital is corporate "interest rate" Where: E = market value of equity D = market value of debt rt = CQ£t of oquity rd = cost of debt t = corporate Ta* rate WACC is the cost to a company of financing the capital for a project, including debt and equity Cost of debt = average interest rate for company Cost of equity is theoretical return to investors in the company Cost of Equity = Risk free rate +Beta*(Market return - Risk free rate) Essentially, how much return would an investor expect relative to putting his money with US Treasury stock, or in the stock market The DCF Calculation as a foundation - WACC Calculation Cost of Debt = 5% Cost of Equity Risk Free Rate - -4% Market Return - 8% Company Beta - -1.2 Calculation = 4%+(1.2*(8%-4%) Cost of Equity = 4%+4.8%=8.8% WACC Share of Equity - 50% Share of Debt - 50% Corporate tax rate - 20% Calculation = (8.8%*0.5)+[(5%*.5)*.8] WACC = 4.4%+(2.5%*.8)=6.4% Cashflow Analysis - Revenue Less Costs Cashflow = Revenue less: transport costs, royalty, state tax, federal tax, operating costs, capital costs, abandonment costs. DCF - The Sum of Future Annual Discounted Cashflows DCF--L- +-...+-^ (1 + r)1 (1+r)2 (l + 0n CF = Cash Flow r = discount rate (WACC) A typical spreadsheet summary of a cashflow model OCF Valuation Protected Free Cash Flow Calendar Years erxi.nq December 31 Yean Year 2 Year 3 Year 4 Year 5 Year 6 (S m thousands) EBITDA $8,954 $9,898 $10,941 $12093 $13,367 $13,367 Less D&A 1.112 1 222 1.343 1.476 1.623 1.623 EBfT 7.842 8.676 9.598 10.617 11.745 11.745 Less Cash Taxes (35%) (2.745) (3.037) (3.359) (3.716) (4.111) (4.111) Tax-adjusted EBfT 5.097 5.639 6.239 6.901 7.634 7.634 Pluss D*A 1.112 1.222 1.343 1.476 1.623 1.623 Less Caprtal Expenditures (1.750) (1.750) (1 750) (1.750) (1.750) (1.750) Less Change in Net Working investment (318) (350) (384) (423) (465) (465) Un levered Free Cash f low S4.141 $4,762 $5,447 $6,205 $7,042 $7,042 $19,845 - $4,141 $4,762 $5.44/ $6,205 / $7,042 (I ♦.II)1 (1*.11)2 (1 ♦ .11)' (1 ♦ -11)* (1 ♦ .11)* 7m Analysis to Support the Decision to drill an exploration well * Geologists/Geophysicists: - Interpret Seismic data and assess reservoir size probability distribution. - Assess the probability of source, reservoir and trap. • Reservoir Engineer: - Assess the recoverable reserves and reservoir properties for the 90%,50% and 10% cases. - Assess the number of production wells required. - Develop annual production profile for the life of the field. * Facilities Engineer: - Creates conceptual design for min, mean and max cases with costing and cost phasing. • Petroleum Economist: - Models the cashflow of the three reserve cases including tax or Production sharing effects. Derives the Net Present Value of Cashflows, the Internal rate of return and other metrics. - Integrates the NPVs over the reserve distribution range to derive the Expected Present value. - Performs decision tree analysis based on the probability of the exploration well being successful. - Presents the investment case to management. Create a theoretical cashflow based on assumptions known to date Monte Car o reserve simulation: results and input parameter summary u a. £ « (IS o 9 Modelling and structural parameters Number of Iterations Reservoir Type Trap Type s $5 Recoverable hydrocarbon (bcfYMMbbl, Volumetric parameters OWCVGWC depth (m) ihickness Reservoir- GRV iriKj l-rri'l 1111" Petrophylsical parameters ♦ (%) Sw(fc) Ares N«5 PVT parameters Reservoir Pressure (MPa) Rosurvuir Tonpyrakis peg Factor (Srr'/Rm3) Maid (I evelopmtint |i.Ii.um -Ii; p. Recovery factor M11-1 Preliminary results Miiiiiniirii 78.13 2800.di 18.25 M02 148.12 9.52 20.15 ..n.m 1.00 46.08 :t22.«o ii.<;.ii r-l i Likely 164 oo 280 1.41 25.2*1 8.0/0 224.85 12.23 in.I'. ..'•.K'i I.UO •'I ,im.) (22.(10 ».•■II 5000 GAS Simple I iV M.i iiii'ini 338.45 2»iy.in. 11.1/1 «12.92 1-1.09 39./0 1.00 ■Hi .08 Mr" .00 322.00 0.8-M P90 124 80 P5o 166.48 P10 223.34 2804.81. 2824.(11 2844.68 21./9 2/.01 34.13 8.156 193.22 9347 245.14 10.192 315.06 10.6b 24.55 12.02 29.9/ 13.19 35.4« 64.52 /0.03 r"5.45 1.00 1.00 1.00 46.08 46.08 46.08 9r\00 9/.00 9/.00 322.00 322.00 322.00 0.650 0714 0.,"ii.l 3 U o o a E 3 = S Ji N w N ■• US --; ^ id ^ tfl O r- M - ^ -J s '-ININMM^MMrjCSJ RecoveioMe llyilioc.iilton (l>cl MMIil —♦—Pi uli.ilil- (P50I » Possible (Piot --*^ O i 1 _-1 H_ 128.0 178.0 228.0 278.0 Recoverable Hydrocarbon ibef MMbbli I2LI.0 At exploration stage add risk to calculate an Expected Present Value (integration over range of reserves uncertainty) 3,500 3,000 % 1,000 > Q_ NPVvs Reserves Probability EPV = $1,870 mm @10% Discount rate o 10 20 30 40 50 60 70 80 90 100 % Probability Reserves are less than N R If thp fiplH is viahlp n\/pr thp pntirp rangp thpn asRiimft thp NPV nf thp 50% case equals the EPV Decision Tree Analysis Cost of Exploration Well =$50mm 0.2 *(1870-50) = 364 Probability of oil case =100°/ EPV $1,870m Probability o] findin< ydfocarbon = 20% Probability ol gas case = 0% Oil Case Min NPV $800mm Mean NPV $1,870mm Max NPV $2,900mm EPV $1,870mm Gas Case (not evaluated) 0.8 *(- 50) = -40 $324 mm PTObatjility of not finding hydrocarbon = 80% Dry Well This is called the Expected Monetary Value (EMV) at the discount rate used. Risked Rate of Return EMVvs Discount rate 3,000 2,500 2,000 1 1,500 I 1,000 LU 500 0 -500 EMV @ 10% Discount Rate = $ 324 mm ^ y/ Risked Rate of F (eturn = 15% te- ^^^^^ 1 i i i i i i i i i i i i i i 0 5 10 15 20 Discount Rate % Exploration Proposal 'It is recommend that the company drill an exploration well on the prospect at a cost of $50mm. The probability of discovering oil is 20% (in in 5). The mean discovery case has a recoverable reserves level of 900 million barrels of oil and a NPV @ 10% discount rate of $l,900mm. Risked exploration economics indicate an Expected Monetary value of $324mm @ 10% discount rate and a Risked Rate of Return of 15%/ Exploration Success! The Development Decision Congratulations - you discovered oil at a level just above the mean reserves case. The exploration well, in addition to confirming a discovery, has provided useful information on reservoir quality, well flow rate and oil quality. Your share price has soared but you now need to drill four appraisal wells to narrow the uncertainty on the reserves range, work out what it will cost to develop the discovery and what the economics of the project are before you go to the banks and your shareholders to raise more capital. 7iK Production Profile Revenue generated I FiralOil I Draco wry Well Well T Build uPr Paleaj Decline Asandonnenl Economic Limit Major capital expenditure on field development Tinw A graphical output from a DCF model E E w 5,000 4,000 3,000 2,000 0 — -1,000 -2,000 -3,000 -4,000 o CM NPV10 = $2,050 mm IRR= 16% Payback = 10 years Exposure $7 billion Capital Costs Field Operating Costs Shipping Costs Main Export Pipeline Costs Royalty State Tax Federal Tax Cflow 1 Revenue 1 Cashflow The Oil Price since 1860 Pennsylvanian oil boom Russian oil exports began Sumatra production Discovery of Spindletop, Texas Fears of shortage in US Growth of Venezuelan production East Texas field discove red Post-war reconstruction Loss of Iranian supplies Suez crisis Yom Kippur war Iranian revolution Asian financial crisis Netback pricing introduced Iraq invaded Kuwait 1861-69 1870-79 1880-89 1890-99 1900-09 1910-19 1920-29 1930-39 1940-49 1950-59 1960-69 1970-79 1980-89 1990-99 2000-09 2010-19 0 $ 2015 (deflated using the Consumer Price Index for the US) $ money of the day 1861-1944 US average. 1945-1983 Arabian Light posted at Ras Tanura. 1984-2015 Brent dated. Average price over the past 150 years has been around $30-40 in real terms Recent high levels have been an anomaly Key question going forward is whether the OPEC cartel can keep the price above long-run marginal cost Demand is a primary driver Table 1.1 Global oil demand (mb/d), 2015-21 2015 2016 2017 2018 2019 2020 2021 2015-21 OECD Americas 24.4 24.4 24.5 24.4 24.4 24.3 24.2 -0.1 OECD Asia Oceania S.1 8.0 8.0 7.9 7.9 7.9 7.8 -0.3 OECD Europe 13.7 13.7 13.6 13.5 13.4 13.3 13.1 -0.5 FSU 4.9 4.9 4.9 5.0 5.0 5.1 5.2 0.3 Other Europe 0.7 0.7 0.7 0.7 0.8 0.8 0.8 0.1 China 11.2 11.5 11.9 12.4 12.8 13.2 13.6 2.5 Other Asia 12.5 13.0 13.5 14.0 14.4 14.9 15.3 2.8 Latin America 6.8 6.8 6.8 6.9 6.9 7.0 7.1 0.3 Middle East 8.2 8.3 8.5 8.7 9.0 9.2 9.5 1.3 Africa 4.1 4.2 4.4 4.5 4.7 4.8 5.0 0.9 World 94.4 95.6 96.9 98.2 99.3 100.5 101.6 7.2 OECD countries dominate oil demand at present, especially the US Non-OECD is where all the growth is, especially in Asia with China leading the way A key question is whether "peak oil demand" is near 7ÜK Two main groupings of oil suppliers - OPEC and Non-OPEC Table 2.1 Non-OPEC supply (mb/d) 2015 2016 2017 2018 2019 2020 2021 2015-21 OECD 23.8 23.3 23.3 23.8 24.4 25.0 25.8 2.0 Americas 19.9 19.4 19.4 19.9 20.6 21.1 21.S 1.9 Europe 3.5 3.3 3.3 3.3 3.2 3.2 3.3 -0.2 Asia Oceania 0.5 0.5 0.6 0.7 0.7 0.7 0.7 0.2 Non-OECD 29.3 29.2 29.0 29.0 29.0 28.9 28.8 -0.5 FSU 14.0 13.9 13.8 13.8 13.8 13.8 13.8 -0.2 Europe 0.1 0.1 0.1 0.1 0.1 0.1 0.1 -0.0 China 4.3 4.3 4.2 4.2 4.2 4.1 4.1 -0.2 Other Asia 2.7 2.7 2.7 2.7 2.6 2.6 2.5 -0.2 Americas 4.6 4.6 4.7 4.8 4.9 5.0 5.1 0.6 Middle East 1.3 1.2 1.2 1.2 1.2 1.1 1.1 -0.1 Africa 2.3 2.3 2.3 2.3 2.2 2.1 2.1 -0.3 Non-OPEC ex PG and biofuels 53.1 52.4 52.3 52.8 53.4 53.9 54.6 1.5 Processing Gains 2.2 2.3 2.3 2.3 2.3 2.4 2.4 0.2 Global Biofuels 2.3 2.4 2.5 2.5 2.6 2.7 2.7 0.4 Total-Non-OPEC 57.7 57.1 57.0 57.6 58.3 58.9 59.7 2.0 Annual Change 1.4 -0.6 -0.0 0.6 0.7 0.6 0.8 0.3 Changes from last MTOMR* 1.1 0.1 -0.5 -0.6 -0.5 -0.4 * • North America is the largest non-OPEC region, primarily the US • Russia is another key player in the global supply mix • All other regions are relatively marginal OPEC accounts for around 40% of global oil supply Table 2.2 Estimated sustainable crude production capacity (mb/d) 2015 2016 2017 2018 2019 2020 2021 2015-21 Algeria 1.15 1.12 1.09 1.06 1.04 1.01 0.99 -0.17 Angola 1.81 1.81 1.77 1.81 1.78 1.76 1.8 -0.02 Ecuador 0.56 0.55 0.55 0.55 0.55 0.54 0.53 -0.03 Indonesia 0.69 0.71 0.71 0.69 0.67 0.65 0.63 -0.06 Iran 3.6 3.6 3.7 3.75 3.8 3.9 3.94 0.34 Iraq 4.35 4.35 4.36 4.4 4.45 4.53 4.62 0.27 Kuwait 2.83 2.87 2.91 2.93 2.94 2.9 2.88 0.05 Libya 0.4 0.4 0.43 0.46 0.49 0.53 0.59 0.19 Nigeria 1.91 1.9 1.84 1.75 1.78 1.85 1.85 -0.07 Qatar 0.68 0.67 0.66 0.66 0.66 0.66 0.66 -0.02 Saudi Arabia 12.26 12.31 12.43 12.45 12.44 12.39 12.33 0.07 UAE 2.93 2.97 3.02 3.07 3.12 3.17 3.2 0.27 Venezuela 2.46 2.46 2.44 2.43 2.45 2.44 2.42 -0.04 OPEC 35.64 35.72 35.89 36.02 36.17 36.34 36.44 0.8 Saudi Arabia is the dominant force within the cartel The Gulf Cooperation Council members make up the biggest bloc Political and religious differences can create huge tension when the group meets to decide on oil price and production strategy 7ÜK OPEC is vital because it is by far the largest exporter and so can influence global trade and prices Map 3.1 Crude exports in 2021 and growth in 2015-21 for key trade routes (million barrels per day} 0.8 (+0J © 0£CD/!&\ 2016 "his map Is without prejudice to the status of or sovereignty over any territory, to the delimitation of Internationa) frontiers and boundaries and to the name of any territory dry or area. OPEC also has some of the lowest cost production in the world, and so can out-compete other producers Estimated breakeven price for production 140 I 120 to 3 100 ra E o O Ü C O 80 -I 60 An Low cost oil = high value Mostly controlled by NOCs Hard to regulate Excess capacity ■ High costoil = lower value Mostly controlled by lOCs ■ Easier to regulate ■ Full utilisation Bakken Eagle Ford LLJ "gl CO 3 * Other Europe, LatAmand Africa 30 40 50 Daily production (Mbpd) Other US Shales 60 7m Saudi Arabia Iran/ Iraq CO 3 as .HO J= LU 5& OPEC countries need to balance their budgets while ensuring that the population is kept happy Estimated breakeven price for 2015 budget Libya $184.10 Iran $130.70 I Algeria $130.50 ---Y Nigeria $122.70 Venezuela $117.50 + Saudi Arabia$106.00 + Iraq $100.60 United Arab Emirates $77.30 Qatar$60.00 I Kuwait$54.00 $0 $25 $50 $75 $100 Sources: Deutsche Bank (Venezuela, Nigeria); the International Monetary Fund (all others) The Wall Street Journal 7ÜK OPEC interventions have been critical oil price events 140 120 o> 100 n o. CO o CM CO C w (/> c o o 80 60 40 20 OPEC PdVSA _ cuts worker's production strike in Venezuela o^cvioo^u^(0r^rocr)o^o i^i^h~iv.rv.t^r^r^r^r^ooooooooooooooro otDoocDoooooooooooooooooooooiooooooooooooooooooo T-T-T-1-T-T-T-T-I-T-T-T-T-T-T-T-T-T-T-r-T-T-T-T-T-T-T-T-T-T-N(NN(N(N^M^(NNCV|r\|(N|fV|(N OPEC formed in 1960s to break the power of the "Seven Sisters" First attempt at intervention was in 1967 during the Arab-Israeli conflict 7m The oil market has been significantly out of balance Figure 3.3 Global demand / supply balance 2.5 2.0 ■ - i Implied Stock (MMisc to i. j Bai (RHS) 1.0 0.5 Ü E Oil Demand 0.0 -0.5 -1 JO -1.5 Oil Supply -2.0 - -2.5 2004 2O05 2006 2007 2003 2009 2010 2011 2012 2013 2014 2015 2016 2017 2018 2019 2020 2021 Supply and demand have seen a significant mismatch over the past three years, mainly sue to rising supply The change in stocks is a critical issue - if they are rising then there is too much oil in the market At present stocks are close to record highs Significant Non-OPEC supply potential exists, especially in the US Figure 2.6 Selected sources of non-OPEC supply changes, 2015-21 I 400 I 200 I 000 800 600 400 200 ■ 200 ■ 400 I I I H I I <# if • The rise of US shale is the most important factor in the oil market at present • The flexibility of output, and its responsiveness to price, is a very new phenomenon • Other producers with longer-term investment horizons are struggling to react OPEC manoeuvres since 2014 _Q ■uy ZD 120 100 80 60 40 20 0 c TO Saivc// decides to compete with US shale OPEC meeting fails to reach agreement in Doha Signs of US production decline Oil price collapses to $27- calls for OPEC meeting m m in m m LD TO X) , ' i o S io o o X> o Q. OJ LT) i UD O > O IX) o I c co I IX) O I IX) o >-ro i IX) o I ID o I Q. O) I IX) o I > 0 1 X) o X) I ro I X) o IX) X) X) X) ro I x> o >-ro X) o X) o Q. O) i X3 O I OPEC agrees to cut output and co-operate with non-OPEC > o c ro i. (X) g o The rise of US shale has raised questions about the continuing relevance of OPEC Saudi Arabia has decided to compete for market share, to force out higher-cost producers However, the strategy has not been very successful - are we entering a new era of low oil prices? Falling oil price = lower cashflow = lower investment Capital expenditure declines slowed and cash from operations increased from the second quarter of 2016 as crude oil prices stabilized cash flow items and Brent price billion 2016S; Brent in 2016 $/b 180 160 140 120 100 80 60 40 20 0 cash from operations Q1 Q2 Q3 Q4 Q1 Q2 Q3 Q4 Q1 Q2 Q3 Q4 Q1 Q2 Q3 Q4 Q1 Q2 Q3 Q4 Q1 Q2 Q3 Q4 2011 2012 2013 2014 2015 2016 Source: U.S. Energy Information Administration, Evaluate Energy, Bloomberg Note: b=barre! Companies have dramatically cut back investment in oil exploration and development over the past two years This will inevitably lead to a slowdown in supply - a classic commodity cycle The key question is whether there will be a supply crunch and a price spike, and what impact this might have for the longer term Oil products and refining capacity are also important Figure 4.1 Changes in regional demand and refining capacity Demand Capacity OECD Amerkas OECD Europe OECD Asia FSU Oceania China Other Asia Non-OECD Middle East Africa Americas Lower oil prices encourage higher refining margins as well as demand growth Refining capacity expansion is focused on developing markets in Asia and the Middle East Oil product prices move in tandem with crude prices, but tend to provide £Xtfa profit when oil prices are low 7bK Downstream Oil Value Chain The downstream oil business Refining margins (US$/bbl) USGC MeoLm Sour Coking I NWE Light Sweet Cracking Sngapore Medium Sour Hydrocracking 07 Refining margins have risen as crude prices have fallen Refining utilisation (% capacity Refinery utilisation is a critical factor in oil economics -below 80% is a bad sign North America ■ Middle East I S. & Cent. America ■ Africa I Europe Asia Pacific I CIS ■ World The Gas Commercial Chain - Pricing & Risks Regulated/ Market Margin Production 0 Transmission/ LNG Regulated/ Market Price r Gas Market Contract Price Regulated/ Market Margin ~^"^^( Power * T^V, Stn J Regulated/ Market Price -K\ Power 1-/| Market | Physical Flow - Volume Risk Revenue Flow - Price Risk Quality / Credit / Contract Risks 1 Gas Strategies 74 7m >^ ü c cd UJ H—' CD CO c C/D CO CD o Gas Market Evolution - Away from long-term contracts to market-based pricing Non-competitive market Merchant pipes "Strategic" relationships No consumer choice Supply security Competitive market Mature market Stage of market development Intensive growth Initial growth Competitive supply Regulated transport Consumer choice Security from portfolios & futures markets Basis-priced transportation Storage, load balancing & services competitive Long-term contracts ® Time Short-term contracts Spot/forward deals Pricing mechanism's development stages: Futures trading (7) - cost-plus or market related based on alternative fuel prices (2) - escalation formulas, based on either alternative fuel prices or gas markets (3) - based on traded prices and futures prices (commodities markets) 1 Gas Strategies Source: Gas Strategies 75 7ÜK Historically regional pricing has been prevalent 98 99 00 01 02 03 04 05 06 07 08 09 10 11 12 13 14 15 0 • For many years prices in different regions were close, despite limited interconnectivity • A supply-demand imbalance from 2010 saw a huge disparity emerge, with Asia paying a significant premium 7m Global gas prices since 2012 25.00 0.00 3-Jan-12 3-Jan-13 3-Jan-14 3-Jan-15 3-Jan-16 3-Jan-l' ^^"Europe ^^»Asia ^^»US Global gas prices have started to converge for four key reasons: - Less demand growth than expected in Europe (decline) and Asia (slower growth) - Increasing prevalence of LNG, which connects markets - A growing oversupply of gas - The availability of US LNG exports, which has introduced a new market-based prici mechanism Global LNG Supply 2008 - 2030 Existing, Under Construction & FID'd 600 500 400 ro R 300 u 00 200 100 Malaysia Indonesia 2008 2010 Source: Author's Assumptions Mozambique ■ Tanzania Canada ■ USA Australia ■ Russia ■ Brazil Qatar Peru Papua New Guinea ■ Oman Norway ■ Nigeria Trinidad ■ Yemen Malaysia ■ Libya ■ Israel ■ Iran ■ Indonesia ■ Eq. Guinea Egypt ■ Cameroon ■ Brunei ■ Angola ■ Algeria ■ Abu Dhabi > □ 0!£ European Balance - Low Asian LNG & European Gas 7iK Demand Case 2015 - 2030 u CO 800 700 600 500 400 300 200 100 New LNG LNG 'Glut' Supply Needed 5 Years 2015 -100 -200 LNG Available for Europe ■ Russian Pipeline Gas 50 bcma minimum) Other Pipeline Ga Domestic Production (including Norway) 2020 2025 T-1 2030 LNG 'Glut' cleared by: • Additional coal to gas switching in Europe. • 'Induced' spot demand in Asia. • Reduced US LNG send-out ©M, 7m Indicative Price Paths -Low Asian Demand Scenarios 12 Brent Curve) (with Concessions) 2 0 2015 2016 2017 2018 2019 2020 2021 2022 2023 2024 2025 Europe does not need Russian Gas above 150 bcma until 2023. System needs new LNG beyond current supply under development in 2027, so prices rise to LRMC by then. Gazprom's pipeline supplies to Europe are a significant competitive threat to LNG producers (llKllMMntMg. eyerie A«he«fren AKTIV • Gazprom has surplus production potential in West Siberia • It has a very low delivered cost in Europe • Russia is essentially the Saudi Arabia of the gas market - its actions can determine price and volume for competitors Coal prices (US$/t) show what happens when a fuel is in decline Northwest Europe marker price US Central Appalachian coal spot price index Japan coking coal import cif price Japan steam coal import cif price Asian Marker price 98 99 15 0 Coal prices have collapsed in the face of increasing environmental challenges In particular US coal producers have been put under pressure by shale gas Elsewhere, countries are questioning how much coal they can afford to bur^ Unfortunately, a lower prices also stimulated demand The Gas versus Coal dilemma in Europe 9.00 8.00 Coal price ■COLO (U u i_ Q_ (J 5.00 4.00 3.00 2.00 1.00 0.00 ^^^^^ Gas price 30 35 40 45 50 55 60 65 70 75 80 85 90 95 100 Coal Price (US$/tonne) 'Current Carbon 'Euro 20 Carbon 'Euro 35 Carbon The decline in coal prices has meant that it is cheaper to use it in power generation than gas The carbon price, which should advantage gas, has been too low to make a difference Coal has become the back-up fuel of choice for renewables in Germany