CRUDE OIL PRICE PERSPECTIVES
Disclaimer The opinions expressed in this presentation by Lateral Capital Management, Inc. (“LMCI�) are not an investment recommendation and are not meant to be relied upon in reaching an investment decision. LCMI and its employees, consultants and contractors are not acting in an investment, tax, legal or any other advisory capacity. The opinions expressed herein address a limited number of aspects regarding a potential investment in securities of the companies mentioned and are not a substitute for a comprehensive investment analysis. Any analysis presented herein is illustrative in nature, limited in scope, based on an incomplete set of information, and has limitations as to its accuracy. LCMI recommends that potential and existing investors conduct a thorough investment analysis of their own, including a detailed review of the companies' SEC filings, and consulting a qualified investment advisor. This material is based on information obtained from sources believed to be reliable, but the reliability of that source information. Any opinions or estimates constitute a best judgment as of the date of this presentation and are subject to change without notice. LCMI explicitly disclaims any liability that may arise from the use of this material. 1
Executive Summary Market fundamentals suggest that crude prices are more likely to decline than increase from the current spot Brent price of ~ $50 / bbl
Even with crude prices down 60+%, the US is still producing more than most middle-eastern nations
Global demand & supply dynamics have resulted in a global shortage. But…
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… the shortage is almost entirely driven by an drastic, short-term increase in unanticipated outages in several crude basins all at once
Even with the production declines, U.S. crude storage is at record levels
U.S. crude production per well has rapidly increased
The U.S. is close to not having any domestic onshore crude storage capacity (!)
It is estimated that there are over 4,000 U.S. wells that have been drilled and only need to be fracked to bring them online (the “fracklog”)
Which is relatively cheap and not very time consuming
They break even cost for these wells is in the $50 to $60 / bbl range
If crude prices continue to climb, U.S. producers will “turn on the taps” for millions of barrels a day of capacity
The Middle Eastern rig count has gone exponential, suggesting supply cuts are unlikely in the near-to-medium term
Many nations have social welfare budgets that can only be met via higher prices or higher production – the production cuts to counter U.S. production are just not feasible
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Outline 1.
US Production Declines vs Crude Oil Decline
2.
US Cost Reductions & Well Efficiencies
3.
US Production Declines in Context
4.
US Consumption vs Crude Oil Decline
5.
US Storage Limits
6.
US Production Flattens the Global Cost Curve
7.
US Production vs OPEC
8.
Middle East Welfare Spending & Rig Count
9.
Recent Supply Shortage …
10. … from Temporary Unplanned Outages
11. Higher Prices & US E&P Capex Increases 12. US$ & Crude Oil
U.S. production has hardly budged The U.S. rig count is down 60+%, in line with the crude price decline, but U.S. production is down ~ 10%
There is anecdotal evidence that a number of onshore shale producers have increased production in recent weeks, in response to WTI crude prices now in excess of their marginal cost of production
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Rig efficiencies make the rig count a less relevant metric When the U.S. rig count stops declining, each incremental new wells will benefit from years of efficiency and cost gains
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A longer term perspective puts production declines in perspective It is interesting to speculate how many barrels of crude the U.S. would currently be producing if crude prices had remained at the $100 / bbl level
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U.S. consumption has not responded to price incentives Conservation efforts, technological innovations and other factors have restrained US oil consumption for the last decade. Increased global oil demand is highly dependent on China and India
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Lower oil prices haven’t stimulated enough US demand Several regions of the U.S. are experiencing crude storage shortages and there are forecasts that total U.S. onshore storage may soon be at full capacity
This situation could lead to a decoupling of Brent and WTI crude prices
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The influence of U.S. shale on global supply is apparent starting in 2014 Onshore shale makes it very difficult for the global crude market to break-out above the $50 to $60 / bbl range
Onshore shale has flattened the cost curve making production declines by OPEC less effective at increasing prices
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OPEC may “jaw bone� the market about production cuts However, the OPEC production decline required to offset U.S. shale and move to higher prices on the cost curve would be draconian
Economics 101 tells us that Saudi Arabia would be irrational to reduce production when the largest producer in the world (effectively the US) has a materially higher cost structure. Production declines by OPEC would benefit US producers by increasing their output without much impact on global prices The global cost curve is relatively flat around $50 / bbl for all 15 Mbbl/d of potential onshore shale production. i.e. OPEC would need to reduce production by ~ 10 Mbb/d to move the global price of crude
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Middle East Budgetary Constraints The middle east rig count suggests OPEC is not committed to reducing production – partly because they need to meet their social welfare obligations
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The crude shortage is real. However‌ The drop in supply has been rather drastic. However, it is not entirely a reaction by producers to lower prices
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‌ most of the unplanned outages are short-term in nature If the unplanned outages resolve themselves, crude prices will decline. If the outages do not resolve themselves, U.S. producers will increase production at current (or higher) prices
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Thousands of US Wells Can Start Flowing in Short Order Most onshore shale producers are profitable around the $40 to $60 / bbl range. Onerous debt commitments make them more likely to increase production It is estimated that there is an onshore shale backlog of 4,000+ wells that have been drilled but not yet fracked (the “fracklog�) These wells can be brought into production at relatively low cost (all the heavy lifting has already been completed) and on short notice
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Market price expectations would ramp U.S. E&P Most onshore shale producers are profitable around the $40 to $60 / bbl range. Onerous debt commitments make them more likely to increase production beyond their marginal EPS break-even
The consensus forward prices would result in an increase in exploration capex
e.g. PXD’s CEO recently stated that if prices remain at or above $50 / bbl that he will increase the E&P capex buget
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The uncoupling of US$ and crude may be temporary The historical relationship between the US$ and crude prices is not central to our U.S. production thesis, but it does suggest there may be additional pressures for the crude price to decline
With the U.S. Fed increasingly signally to the market that there will be 2 or 3 rate increases in the remainder of 2016, it is reasonable to assume that, if the historical relationship is restored, it is more likely that crude prices will decline, rather than the US$ depreciate
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Recap Market fundamentals suggest that crude prices are more likely to decline than increase from the current spot Brent price of ~ $50 / bbl
U.S. production is going to set the global crude price for the foreseeable future
Any time crude rallies into the $50 to $60 / bbl range the U.S. producers can rapidly ramp up their production
To offset the U.S. impact on prices, OPEC would need to reduce their production by an unsustainable amount
The current crude price (~ $50 / bbl) is strongly influenced by temporary, unplanned outages
Unless Chinese demand grows faster than expected and/or U.S. production costs unexpectedly increase, there is limited upside in the global crude price and a lot of downside
Demand needs to work its way through a large storage glut
It is not just Iran that will be increasing production, we expect other MENA producers – with large social welfare budgets that only balance at $100 / bbl – will need to increase production to compensate for lower prices
Even low-cost OPEC producers, like Qatar, are experiencing budget deficits of more than 10% of GDP
OPEC production declines cannot realistically move global crude prices enough to compensate for the lost output
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