2019 Sitton Energy Market Outlook

E N E R G Y

2019 M A R K E T

O U T L O O K

FROM

RAILROAD COMMISSIONER

RYAN SITTON

ENERGY

TABLE OF CONTENTS

T

his report outlines my analysis and predictions for global energy markets as we head into an era of unprecedented opportunity for Texas oil and gas producers.

Over the last year, Texas oil production has been robust and natural gas production has continued to increase. And we are just getting started! This year, Texas oil production will exceed 5 million barrels per day for the first time in our state’s history. The industry is placing a needed emphasis on energy transportation infrastructure to enable us to get our product to market. Without these needed investments, product will be stranded and/or not produced. Global demand for energy continues to grow and no one does a better job than Texas of responsibly producing energy. I hope you find this report helpful and I appreciate the opportunity to serve you.

2019 MARKET

OUTLOOK

from Commissioner .......................pg 01 01 Letter Ryan Sitton 02 Oil ............................................................. pg 05 03 Natural Gas .............................................. pg 11 04 Key Environmental Trends .......................pg 15

“Energy and persistence conquer all things.”

–Benjamin Franklin

A Letter From Commissioner 01 Ryan Sitton The second half of 2019 and most of 2020 will be a robust but volatile time for Texas oil and gas producers. I anticipate larger price fluctuations throughout the year based on changing market fundamentals and infrastructure obstacles. This stands in contrast to the relatively stable markets we saw in 2018. In last year’s version of this Market Report, I predicted that WTI prices would spend the majority of the year between $58-$66 per barrel. In fact the average WTI price for 2018 was $67.28 – the highest level since 2014. However, WTI prices cratered in Q4 of 2018 and fell below $45 per barrel. The crash in prices is directly tied to increased shale production. Energy experts around the globe continue to marvel at the United States’ growth in shale development (going from basically 0 in 2010 to over 7 million BPD at the beginning of this year).

Prices recovered in Q1 of 2019 as a result of OPEC and Russia collaboration and other global factors that are discussed later in the Oil Section herein. I anticipate that WTI prices will be in the $60-$65 per barrel range for most of the next twelve months but that depends heavily on continued OPEC and Russia cooperation and other global factors like Iran and Venezuela. With the oil market over supplied by as much as 250,000 barrels per day, prices will be hyper sensitive to key supply and demand drivers.

shut in their wells and not produce the oil, or to flare the natural gas that is trading for less than zero at times because of the lack of “takeaway capacity” (the pipelines that take the product from where it is produced to market). We are currently flaring about 2.5% of Permian natural gas production (350 million cubic feet/ day flared / 14,169 billion cubic feet/day produced).

These challenges are being addressed, but energy transportation infrastructure (pipelines, port and other export facilities) does not get built overnight. There have been enough pipeline projects announced to address these bottlenecks, but when and if they get built are still unanswered questions. We also have work taking place at Texas ports that will enhance our ability to quickly and efficiently ship energy overseas. Offshore oil export terminals, LNG export facilities, and deepening and widening ship channels are all activities that are underway to enhance our ability to capitalize on Texas’ significant energy opportunities.

“Every single Texan benefits from a thriving oil and gas economy.”

Last year the United States shattered its 1970 previous record for annual oil production (9.64 million barrels per day (BPD)).

The new record set in 2018 was 10.96 million BPD – up 17% from 2017. In December 2018 U.S. production grew to 11.96 million BPD. In 2019 U.S. annual oil production will average over 12 million BPD. The United States, and Texas specifically, is producing significantly more oil than it did just five years ago (Texas production is up 60% over 2014 production).

The challenges associated with all this increased production are mainly manifested in the nature of transportation infrastructure (and to a lessor extent processing infrastructure). We simply do not have enough oil and natural gas pipelines in the ground to handle the increased production. We also need more oil and natural gas export facilities to ship our energy around the world. As a result, Texas has seen an increase in flaring in the Permian Basin even though we are only flaring less than 5% of production (by comparison, North Dakota is flaring as much as 20% of its production). New oil wells also produce associated natural gas that does not have anywhere to go because the pipelines are full. The options for producers are to

1

Global energy demand grew by 2.3% in 2018, the highest rate of growth this decade. Natural gas accounted for 45% of that global growth. Demand for all fuels increased, with fossil fuels meeting nearly 70% of the growth for the second year in a row. Together, China, the United States, and India accounted for nearly 70% of the rise in energy demand around the world. The United States saw the largest increase in oil and gas demand worldwide (driven primarily by petrochemical expansions and increased demand for jet fuel). Energy demand is not slowing down and Texas is well positioned to meet that demand.

See Graphs 1-3 for Energy Demand by Resource for 2000, 2019 and 2040.

As your Texas energy regulator, my mission is to ensure that Texas producers are responsibly producing as much oil and natural gas as possible. Texas energy production funds critical services like schools and roads for Texas families. Every single Texan benefits from a thriving oil and gas economy.

“Thank you for the opportunity to serve as your Texas energy regulator.”

– Commissioner Ryan Sitton

Energy Demand by Resource 2000, 2019 and 2040 605 Quadrillion BTUs 403 Quadrillion BTUs

10% 20%

13%

9% 2000

39%

23%

4% 2019

22%

32%

28%

39% = 77 million BOE/d

739 Quadrillion BTUs

32% = 101.11 million BOE/d

5% 17% 2040

31%

31% = 118.13 million BOE/d

25% 22% Petroleum and Other Liquids

Natural Gas

Coal

Nuclear

Renewables

2

OIL

02 OIL In 2018 global oil production outpaced consumption:

2019 Projections: • Global Demand for Crude Petroleum Products to 101.11 million BPD

• Global Demand for Crude Petroleum Products was 99.2 million BPD

• Global Supply for Crude Petroleum Products to 101.36 million BPD

• Global Supply of Crude Petroleum Products was 100.1 million BPD

• Global Crude Petroleum Market to be OVER supplied by 250,000 BPD on average

• Global Crude Petroleum Market was OVER supplied by 900,000 BPD

*Our estimates for 2019 are based on a variety of sources including EIA, IEA, market reports and other publicly available data and our own analysis.

For context, Graph 4 below shows the world supply and demand balance for the last six years along with the price of WTI:

04 104 102 100 98 96 94 92 90 88 86 84 82

World Crude Oil Supply & Demand (Million Barrels Per Day) $120.00 $100.00 $80.00 $60.00 $40.00 $20.00 Q1 Q2 Q3 Q4 Q1 Q2 Q3 Q4 Q1 Q2 Q3 Q4 Q1 Q2 Q3 Q4 Q1 Q2 Q3 Q4 Q1 Q2 Q3 Q4 Q1 Q2 Q3 Q4 Q1 Q2 2014 2015 2016 2017 2018 2019 2020 2013 World Production

Markets over the last six years:

5

World Consumption

Quarterly WTI price

2013 1.1 million BPD UNDER supplied

2015 1.39 million BPD OVER supplied

2017 420,000 BPD UNDER supplied

2014 210,000 BPD OVER supplied

2016 290,000 BPD OVER supplied

2018 900,000 BPD OVER supplied

$0.00

In spite of the market being on average oversupplied for the next year, some of the same Key Factors we saw last year are supporting prices.

Those factors include: 1. Saudi Arabia and Russia continue to carefully manage oil production.

They could extend an agreement to restrain output to balance the market (they will meet in late June/early July 2019 to discuss a path forward) which would support higher oil prices.

05

5%

2. President Trump’s decision to not extend waivers for importers of Iranian oil causing their production to decrease to close to zero which supports higher prices.

3. The chaos in Venezuela has continued to decrease their oil production to less than 1 million BPD which supports higher oil prices.

32% 45%

China India United States Other

18%

4. Does the global economy continue to expand (IMF forecasts for global growth are 3.7% for 2019 – the highest level since 2010)? If it does, that supports higher oil prices.

5. Oil demand growth is almost entirely comprised of growth in China (whose rate of growth is slowing), India and the United States where growth is driven primarily by petrochemical projects. If these countries’ demand meets expectations that would support prices.

2019 Key Demand Growth Regions

Key Demand Growth for 2019 China India U.S.

380K BPD 220K BPD 540K BPD

According to the International Energy Agency (IEA), “IEA continues to see no peak in oil demand, as petrochemicals and jet fuel remain the key drivers of growth, particularly in the United States and Asia, more than offsetting a slowdown in gasoline due to efficiency gains and electric cars.”

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Other Key Oil Indicators 30,000

6,000

25,000

5,000

20,000

4,000

15,000

3,000

10,000

2,000

5,000

1,000

0

2009

2010

2011

Permits in Texas

2012

2013

2014

2015

2016

2017

2018

2019

Production

Texas Drilling Permit and Production Trends

Number of Permits

06

0

Texas Crude Oil Production (Thousand Barrels per Day)

Graph 6 shows the number of drilling permits the Texas Railroad Commission has received by year over the last decade as well as production volumes. As the graph indicates the number of permits is down but we have a record inventory of DUCs (drilled but uncompleted wells) which is why production continues to climb.

For the first time in Texas’ history, the state will produce over 5 million barrels per day in 2019, in spite of the drop in drilling permit numbers. Longer laterals drilled horizontally are allowing operators to recover more oil with fewer wells. Efficiency gains have also increased as operators gain experience with the numerous shale formations in the Permian Basin.

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07

U.S. Exports of Crude Oil and Petroleum Products (Thousand Barrels Per Day) 9000 8000 7000 6000 5000 4000 3000 2000 1000 0 2009

2011

2013

2015

2017

2019

2021

Graph 7 shows total U.S. energy exports and makes clear that U.S. energy is a major global energy supplier.

Since the crude oil export ban was lifted in 2015, the U.S. has become the 4th largest crude oil exporter in the world. “In 2018, net imports of oil and petroleum products fell from 3.8 million bpd to 2.4 million bpd. EIA forecasts net imports will dwindle to 1.1 million bpd next year and just 100,000 bpd in 2020. In the final three months of 2020, EIA thinks the U.S. will become a net exporter by about 900,000 bpd.”

Infrastructure is the biggest challenge to Texas’ ability to continue increasing oil production. Roads, schools, pipelines and refineries all need to be built/enhanced to support the workforce and business operations of Texas energy producers. Next year, the U.S. is on track to become a net energy exporter. How much we can grow those exports will be a function of infrastructure investments.

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NATURAL GAS

03 NATURAL GAS Natural Gas continues its climb as the cheapest and most abundant global source of energy. The United States leads global supply growth and is poised to become a major player in LNG. China is the dominant leader in global demand growth as it attempts to restrain its utilization of coal and improve air quality. China represents one third of the projected global demand growth over the next five years.

Our estimates for 2019 are based on extrapolated data published by EIA: Global Demand for Natural Gas projected to 360 BCF per day

Global Demand for Natural Gas in 2018 was 355 BCF/day.

Global Supply of Natural Gas projected to 373 BCF per day

Global Supply of Natural Gas in 2018 was 366 BCF/day.

Global Natural Gas Market will be OVER supplied by 13 BCF per day

Global Natural Gas Market was OVER supplied by approximately 11BCF/day

Texas natural gas production led the nation at 26 BCF/day representing 28.5% of U.S. production.

U.S. natural gas production grew 10.2% from 2017 to 2018 and is projected to grow another 8% up to 91 BCF/day in 2019. In February of 2019 the United States exported 4.6 BCF/day in natural gas exports and in all of 2018 the U.S. was a net natural gas exporter.

The IEA describes natural gas as follows: “Natural gas supplies 22% of the energy used worldwide, and makes up nearly a quarter of electricity generation, as well as playing a crucial role as a feedstock for industry. Natural gas is a versatile fuel and its growth is linked in part to its environmental benefits relative to other fossil fuels, particularly for air quality as well as greenhouse gas emissions.”

Graph 8 that they created shows China’s dominance in natural gas demand growth.

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Natural Gas Consumption Growth 2017-2023 China Middle East North America Other Asia India Africa Latin America Eurasia Europe -20

-10

0

10

20

30

40

50

60 bcm

11

70

80

90

100

110

120

130

“The cheapest natural gas in the world is in the United States.�

-T. Boone Pickens

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KEY ENVIRONMENTAL TRENDS

04 KEY ENVIRONMENTAL TRENDS Controversial environmental proposals like the Green New Deal were announced in early 2019. Several of those proposals call for an end to the utilization of hydrocarbons and carry a price tag of around $93 trillion. As shown in Graph 3 on page 2, renewables are only projected to comprise 17% of the global energy mix in 2040. The sponsors of these controversial proposals have suggested eliminating the combustion engine, air travel and even eating meat (to reduce emissions from cows) among other things to achieve their targeted reductions.

9

Even without government mandates like the Green New Deal, the U.S. is lowering greenhouse gas emissions. Graph 9 is from an EPA report and shows the downward trend in U.S. greenhouse gas emissions.

Gross U.S. Greenhouse Gas Emissions by Gas (MMT CO2 Eq.)

9,000

HFCs, PFCs, SF6 and NF3 Subtotal Nitrous Oxide

8,000 7,000

6,371 6,316 6,425 6,532 6,625 6,710 6,908 6,968 7,033 7,071 7,232 7,117 7,157 7,199 7,333 7,339 7,270 7,370 7,161 6,709 6,939 6,787 6,546 6,710 6,760 6,624 6,492 6,457

Methane Carbon Dioxide

MMT CO2 Eq.

6,000 5,000 4,000 3,000 2,000 1,000 2002 2003 2004 2005 2006 2007 2008 2009 2010 2011 2012 2013 2014 2015 2016 2017

1990 1991 1992 1993 1994 1995 1996 1997 1998 1999 2000 2001

0

According to the IEA, in the United States, the emission reductions seen in 2017 were reversed, with an increase of 3.1% in CO2 emissions in 2018. Despite this increase, emissions in the United States remain around their 1990 levels, 14% and 800 MMT of CO2 below their peak in 2000. This is the largest absolute decline among all countries since 2000.

15

10

U.S. 2017 CO2 Emissions From Fossil Fuel Combustion by Sector and Fuel Type 2,500

Relative Contribution by Fuel Type

MMT CO2 Eq.

2,000 Petroleum

29.5%

1,500

Coal

44.7%

Natural Gas

25.8%

1,000 500 0

U.S. Territories

Commercial

Residential

Industrial

Electric Power

Transportation

Graph 10 shows U.S. CO2 emissions from fossil fuel combustion by sector, by fuel type. Electric power and transportation, two of our most fundamental energy needs, are made affordable by the energy production taking place in Texas.

They have also stated “Current federal and real economy commitments, combined with market forces, will drive U.S. emissions to 17% below 2005 levels by 2025, roughly two-thirds of the way to the original U.S. target.”

Even environmental groups opposed to President Trump’s withdrawal from the Paris agreement have acknowledged “Today we are almost halfway to the original U.S. target under the Paris Agreement of 26-28 percent below 2005.”

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Texas Natural Gas Production and Flaring (Thousand Cubic Feet) 2,500,000,000 2,000,000,000 1,500,000,000 1,000,000,000 500,000,000 0

Q1

Q2 Q3 2015

Q4

Q1

Q2 Q3 2016

Q4

Texas Natural Gas Production

Q1

Q2 Q3 2017

Q4

Q1

Q2

Q3 2018

Q4

Texas Flared Volumes

Natural gas flaring in Texas has received significant attention in recent months because of increased flare volumes due to takeaway capacity constraints. Graph 11 shows the amount of gas flared and the amount of gas produced in Texas. No one likes flaring, but as the graph shows, Texas is flaring a very small percentage of the gas it is producing (less than 5%). Several new pipelines are being built that will alleviate this bottleneck over the next 24 months.

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“One does not have to be a scientist to make the link between energy supply and social advances.”

- Vaclav Smil, Energy and Civilization

DISCLAIMER: Certain information set forth in this presentation contains “forward-looking information”, including projections about future energy supply, demand and price (collectively referred to herein as forward-looking statements). Except for statements of historical fact, information contained herein constitutes forward-looking statements and includes, but is not limited to, the (i) projected supply and demand numbers for multiple energy sources, and (ii) future price predictions for certain energy sources.

These statements are not guarantees of future performance and undue reliance should not be placed on them. Such forward-looking statements necessarily involve known and unknown risks and uncertainties, which may cause actual performance and financial/price results in future periods to differ materially from any projections of future performance or result expressed or implied by such forward-looking statements.

Although forward-looking statements contained in this presentation are based upon reasonable assumptions, there can be no assurance that forward-looking statements will prove to be accurate, as actual results and future events could differ materially from those anticipated in such statements. The Author undertakes no obligation to update forward-looking statements if circumstances or his estimates or opinions should change. The reader is cautioned not to place undue reliance on forward-looking statements Political ad paid for by the Ryan Sitton Campaign