EA-MJOrlando - NAPE Denver slides - 1610

Valuation Assumptions

Economic Advisors, Inc., Denver 2

● our analyses must include a broad range of considerations

sector - wide (macro) project - specific (micro)- economic considerations - technological

considerations- commercial

considerations<--------------- political considerations ---------->

Oil – recent historyCrude Oil Prices

US EIA, data updated September 2, 2016Economic Advisors, Inc., Denver 3

$/bbl

Oil – recent historyCrude Oil Prices

US EIA, data updated February 2, 2016Economic Advisors, Inc., Denver 4

$/bbl

China

housing slowdown

financial crisis

Great Recession

fraccing

OPEC?

Russia?

Venezuela?

Brazil & PreSal?

ISIS?Syria?Saudi

Arabia?

Mexico liberalization?

Iran?

China?

Agenda:


Political risks in the market for crude oilCommercial / economic factors driving crude oil

markets

Oil – new conventional wisdom


The OPEC era is past; they’ve lost control of the market.

The US is the new swing producer.OPEC open-taps strategy is targeting shale oil

producers.Saudi Arabia is in a battle for market share.

Conclusion (preview - … the short story):


OPEC = Saudi Arabia => dominant firm = price leader = monopolist with competitive fringe deceleration and diversification of energy demand (i.e. China) technological advance in competitive fringe (i.e. fraccing)=> increase in elasticities of D and S => [Price – Cost]

markup=> economic / commercial factors => P ≈ $60 to $80 / bbl

Political Risk per reverbations from Arab Spring (2011) risk to control by traditional elites (political, religious) how long can / will Saudi Arabia ‘pay’ (i.e. Poil < $60/bbl) for

advantage in emerging regional political order? how long can Saudi Arabia afford domestic political order?

Agenda:


Is OPEC a cartel?


D: cartel = an association of suppliers who coordinate to maintain high prices and restrict competition

pluralnotice competing objectives here and here

OPEC is Saudi Arabia


How often do OPEC Member States exceed production quotas?

A: all the timeWho has enough spare capacity to control prices?A:

Source: Medium-Term Oil Market Report 2014, OECD/IEA

Price Leader price setting


Saudi Arabia is price leader dominant firm monopolist with competitive fringe



What has changed for Saudi Arabia (the price leader)A: on demand side, slowdown in China 2000 to 2010 – China accounted for 40% of

growth in global demand for energy 2010 to 2015 – growth in China energy demand

moderates from 10.5%/yr to 1%/yr 2015 to 2025 – China energy demand growth est.

= 2%/yr (Source: Exxon) 2016 – China oil demand growth < 2% (though

possibly understated per ‘teapot’ refinery output, Source: Platts)



What has changed for Saudi Arabia (the price leader)?A: China deceleration => optimal price

What risks were present at +$100/bbl oil? will China industrialize as a oil-intensive

economy? Will China consumer demand for energy be highly

oil-dependent? Or highly diversified? Strategic opportunity to influence path of

development?=> optimal price

quantity

price



S=MC

D

P

Q

MC

MR

Recall monopoly pricing:

moderation in China demand growth

quantity

price



S=MC

D

Q

MC

MR

Notice P-MC markup is lower with more elastic demand

P

more diversified demand can increase elasticity




China => P for current slowdown & to encourage oil-intensive industrialization

Elsewhere EM softness (x – India) => P Developed economies softness and drop in

energy intensity => P




What about the supply side? traditional competitive fringe = conventional

development (read large-fixed cost development prospects)

new competitive fringe = shale oil

production

($)

fixed costs

total costs

cost structure of traditional basins = high ratio of fixed costs to variable costs:need high P to justify investment, need low P to continue production => inelastic supply



production

($)

fixed costs

total costs

cost structure of unconventional shale oil = low ratio of fixed costs to variable costs:production declines rapidly, a broad range of P will justify investment => more elastic supply



Saudi Arabia = monopolist with competitive fringe Supply Side considerations

P in reaction to more and more-elastic supply Demand Side considerations

P in reaction to global economic weaknessP as strategy to discourage elastic mix in demand

But how low should prices be? Shale oil drilling returns at P > $40/bbl, even if short

term Large-fixed-cost investments require confidence P >

$80/bbl for long (20+ yrs?) term=> commercial / economic considerations => P < $80 / bbl

Saudi Arabia price setting


Economic / commercial considerations can justify prices as low as $80/bbl (or $70/bbl? Or $60/bbl?)

But NOT P ≈ $40/bbl Assume OPEC gain = +2MBPD, but @ $40/bbl = >

+$80M/day But monopolist incurs loss on pre-existing production=> cost to Saudi Arabia = 10MBPD x ($40-$60/bbl) =

-$200M/dayWhat is Saudi Arabia buying with this cost?

A: signal to large-fixed-cost projects – ‘do not invest’ (e.g. Arctic [Shell, Russia], Canada oil sands, Brazil PreSal, Mexico)

?: but once signal has been received, what are they buying then?

Agenda:


Gulf States divideSunni vs Shia

Ahl al-Sunnah = ‘People of the Tradition’

632 AD – followers of Abu Bakr, friend and father-in-law to Prophet Muhammad

> 80% of global Muslim pop’n > 90% in Egypt, Saudi

Arabia, Jordan, United Arab Emirates

consideration to literal tradition (e.g. Wahhabiism)




Shiat Ali = ‘the party of Ali’

632 AD – followers of Ali, cousin and son-in-law to Prophet Muhammad

~ 10% of global Muslim pop’n significantly in Iran,

Iraq, Yemen, Lebanonconsider ayatollahs as

agents of spiritual precepts



Ahl al-Sunnah = ‘People of the Tradition’

632 AD – followers of Abu Bakr, friend and father-in-law to Prophet Muhammad

> 80% of global Muslim pop’n > 90% in Egypt, Saudi

Arabia, Jordan, United Arab Emirates

consideration to literal tradition (e.g. Wahhabiism)

Shiat Ali = ‘the party of Ali’

632 AD – followers of Ali, cousin and son-in-law to Prophet Muhammad

~ 10% of global Muslim pop’n significantly in Iran,

Iraq, Yemen, Lebanonconsider ayatollahs as

agents of spiritual precepts

Stakeholders in Market for Oil


domestic poli/econ interests

geo-political interests

Russia (producer / price taker)Iran (producer / price taker)China (consumer / price takerUS (consumer / price taker)Saudi Arabia (producer / price setter)

how will key stakeholders influence oil markets as they pursue domestic political/economic interests and broader geopolitical interests?

Stakeholders in Market for Oil


domestic poli/econ interests

geo-political interests

Russia (producer / price taker)

- efficiencies of scale- needs for hard currency=> Supply

- influence FSU (Ukraine)- influence in Gulf (Syrian naval base)=> Supply

Iran (producer / price taker)

- rebuild economy=> Supply

- security / prosperity via Shia influence in Gulf pro: Bashar al-Assad, Syria; Yemeni rebels anti: Syrian rebels, ISIS Supply

China (consumer / price taker

- diversify to consumer-driven economy- improve environment=> Demand

- Pacific region influence=> ?Supply, ?Demand

US (consumer / price taker)

- improve economy- increase energy security- improve environment-=> ? (not touching this one)

- Gulf region stability- Pacific region influence- climate change=> ?Supply

Saudi Arabia (producer / price setter)

- maximize net returns to fund state Price to $60 - $80 / bbl Supply

- security / prosperity via Sunni influence in Gulf pro: Syrian rebels, Yemeni gov’t anti: Iranian coalitions maintain US as consumer of Saudi crude Price => Supply

quantity

price


Geopolitical impact on pricing

Secon&politics

D

P= $60 to $80

Q

MC

MR

P= $40

Q

RussiaIran

US

Saudi Arabia

China

Looking forward - oil:




A: they wouldn’t.

A: they wouldn’t.

A: less critical per capital constraints.

A: Yes / No

A: the emerging priority.

A: long-term objective.



Outlook:


Oil: OPEC will curtail production to raise prices as they

confirm Iran is a manageable riskLarge, fixed-cost investments are discouraged fr non-

OPEC producers (Canadian Oil Sands? Alaska? Brazilian PreSal? Mexico? Russia?)

* But look for Saudi Arabia to limit price increase to < $80/bbl

Questions?


Date post:	07-Jan-2017
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EA-MJOrlando - NAPE Denver slides - 1610

Economy & Finance