New Pricing Realities in Oil & Gas Aspen Institute Forum on Global Energy, Economy, and Security

Jason Bordoff Columbia University

June 10, 2015

Aspen, Colorado

420 West 118th St, New York, NY 10027 | http://energypolicy.columbia.edu | @ColumbiaUEnergy

2

The 2014-2015 Oil Price Drop Magnitude and Impact

Source: EIA, Bloomberg

-100% -80% -60% -40% -20% 0%

1997-1998

2014-2015

1985-1986

2008-2009

Major Oil Price Collapses in Recent Oil Market History Peak to trough % decline

• The magnitude of the 2014-2015 oil

price drop is comparable to the biggest

oil price collapses in recent history

• The shape of the oil price recovery has

been of much debate, but general

consensus holds that—short of a major

supply shock—oil prices will likely stay

below $100 for an extended period

• Many questions remain about the ‘new

world of oil’:

• What is going to balance the

market? ‘Call on US shale’?

• Greater or lesser volatility with new

Saudi policy?

• Will Saudis maintain policy?

• What about non-OPEC, non-shale?

3

The 2014-2015 Oil Price Drop Winners and Losers

Source: IMF, Citi, Reuters

Oil consumers worldwide

• $50 price drop is equivalent

to $1.5 tn reduction in

spending on oil annually

The global economy

• Global GDP growth boosted

by up to 0.7 percentage

points in 2015 and by up to

0.9 percentage points in

2016 (IMF)

Subsidy reform

Subsidy reforms in India,

Indonesia, Malaysia, Kuwait,

Egypt, collectively representing

nearly 25% of global fossil fuel

subsidies in 2013

Winners Losers

Major producers

• Oil export revenue (OPEC minus Iran) down $100B

in 2014 and set to drop $350B in 2015

• Nigeria: post-election violence largely averted, GDP

outlook pulled down by 2.5% to 4.8% in 2015 by oil

price drop

• Venezuela: GDP projected to drop 7% and inflation

reach 96% in 2015

• Russia: GDP is set to drop by 3.8% in 2015 (IMF) as

a combined result of sanctions and the oil price drop

• Saudi: drew ca. $58 billion from reserves between

Aug ’14 and Apr ‘15

The oilfield services and majors

Upstream CAPEX cut by 20% in ‘15 vs. ‘14

Impact on gas and renewables?

Coming soon from CGEP…

4

Implications for Global Demand

• Strong demand response in Q1

2015 surprised to the upside

• OECD Europe: total oil

demand up by 3.9% y/y in

1Q15

• US: gasoline demand up

3.3% y/y in 1Q15

• India: diesel demand up by

9.3% y/y and gasoline

demand up by 18.7% y/y in

April

• Demand response may be limited

by global macro headwinds (e.g.,

China), strong dollar,

macroeconomic impacts in net oil

exporters, and other factors

-8% -6% -4% -2% 0% 2% 4% 6% 8%

Korea

Europe 5*

India

China

Australia

US

Japan

Q1 '15 vs. Q1 '14

2015 vs. 2014 (est.)

-8% -6% -4% -2% 0% 2% 4% 6% 8%

Saudi Arabia

Iran

Brazil

Russia

Canada

Mexico

Venezuela

Q1 '15 vs. Q1 '14

2015 vs. 2014 (est.)

Source: IEA, JODI

Oil Product Demand in Selected Major Oil Importing Countries

% change y-o-y

Oil Product Demand in Selected Major Oil Exporting Countries

% change y-o-y

5

Implications for Global Supply Time to Redraw the Cost Curve

Source: Citi, Morgan Stanley, Rystad Energy

• High cost projects (e.g. deepwater, oil sands, Arctic) will be challenged at lower oil prices

• High capex megaprojects will probably be needed in the future, but more than $100 billion of

new spending has already been delayed or cancelled

• Is the current price slump setting the stage for another underinvestment cycle as in the 1990s?

• Not only prices, but also costs have come down significantly in 2015 vs. 2014 (ca. 10-20% for

high capex projects and up to 20-40% in US shale plays)

Global Liquid Supply Cost Curve

$ per barrel breakeven

Upstream Capex Set to Decline 20% y-o-

y

$ billion

6

High Cost Projects Pain and Relief

Deteriorating economics

• A substantial portion of pre-sanction

projects do not break even at today’s

oil price levels

CAPEX reductions

• US and Canada account for the vast

majority of capex cuts

• Other high cost areas are more likely

to see deferrals, projects with sunk

costs will likely continue

Higher cost of capital

• Cost of capital and hurdle rates may

rise in more volatile environment

• Fed monetary policy is key to

production outlook

Cost compression

• Service costs have come down substantially

across the board

Efficiency improvements

• Productivity improvements ~25% pa

• Standardization and cost discipline is gaining

ground in deepwater

Fiscal relief

• Countries with high cost production appear

willing to offer better fiscal terms to retain

investments (e.g. UK tax cuts, Brazil

considering local content waivers)

Currency movements

• Non-US producers benefit as much of the costs

are in local currency while revenues are in USD

Challenges Offsets

7

Is the US the World’s New ‘Swing Supplier’?

Source: EIA, Baker Hughes

• US rig count down by 55% since Oct

’14, but production up to 9.6mbd in

May ‘15

• Saudis as high as 10.5 mbpd in May

• US tight oil production resilient, and

don’t forget rising offshore production

• Has market balancer role shifted to

US?

• Swing producer or marginal

producer?

Key uncertainties:

• Shape of the supply curve

• Access to capital

• Productivity gains and high-grading

• Service cost compression

• Partially drilled but uncompleted wells

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US vs. Saudi Rig Count No. of rotary rigs operating

US Rig Count - LHS

Saudi Rig Count - RHS

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US Crude Oil Production and Rig Count

US Crude Production - RHS

US Rig Count - LHS

8

‘Call on US Shale’ Not Quite Swinging Yet

Source: Citi, EIA, EBW Analytics

• So far, mainly stock builds and demand response have balanced the oversupplied oil market

• Increased or decreased price volatility?

• US shale can respond faster than conventional, but not as fast as Saudis

• High Saudi production leaves little spare capacity buffer, although OPEC’s role as

effective cartel has long been overstated

• Light sweet buffer more effective than heavy sour one in dampening Brent & WTI

spikes

• Atlantic Basin overhang plus weight of global inventories provides some cushion too

EIA Revision of US Crude Production (Jun vs. May ’15)

Million b/d

9

Crude Export Policy Affects Production & Trade Outlook

Source: EIA, Bloomberg

• US crude exports are already up sharply thanks to Canada, Commerce FAQs, product exports,

and potential swaps with Mexico in the near future. West African light oil displaced.

• Consensus emerging about beneficial impacts lifting the crude oil export ban, but remains

politically challenging. Movement building on Capitol Hill.

• Slowdown in US supply growth & narrow LLS-WTI-Brent spreads raise questions about

urgency of issue. Low gasoline price raise concerns about rebound being attributed to policy

change.

-4,000-3,000-2,000-1,000

01,0002,0003,0004,0005,0006,000

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-07

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-14

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US Exports and Imports of Petroleum Products and Crude Oil Exports Thousand barrels per day

Gross Exports - ProductsGross Exports - CrudeGross Imports - ProductsNet Imports - Products

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Brent WTI and LLS Prices $ per barrel

Brent

LLS

WTI

10

What About the Rodney Dangerfield Barrels?

Source: Goldman Sachs

• Goldman Sachs believes US shale + Iraq + already committed and low breakeven projects

are sufficient to meet global demand through 2020

• What about high capex long-lead time projects (e.g. deepwater, oil sands)?

Breakeven Cost of Oil Production by Category

$ per barrel

11

Deepwater Cost Curve Shifting Lower, But Delays Are Likely

Source: Goldman Sachs

• The industry has poor track record of delivering

deepwater megaprojects at cost and on budget, even

at high oil prices

• Price pressure focuses minds on efficiency e.g. via

standardization and better planning

• Cost compression (partly due to pre-2014 overbuild

cycle) also provides some relief

• Brazil: most pre-salt projects break even below $60,

but Petrobras’ troubles may limit investment outlook

• West Africa: most pre-sanction deepwater projects

in Angola and Nigeria are high breakeven ($60+),

high risk of delays and cancellations without fiscal

relief

• US GoM: development of large discoveries in Lower

Tertiary remain economic thanks to better than

expected flow rates (15+ kbpd) and cost deflation

Deepwater Is Among the Worst-Hit Project Type

Split of major pre-sanction development projects with $60+ breakeven by development type

12

North Sea Lower Oil Prices are Just Another Challenge

• North Sea oil has long been challenged by

high development and production costs,

ageing infrastructure and looming

decommissioning liabilities

• Short-term production impact not yet apparent

• Medium-term outlook shifted from marginally

positive to marginally negative (ca. 100 kbpd

decline forecasted by Citi in each of the next

two years)

• Smaller projects and field redevelopments

offset some of the mature field declines

• High-capex projects will likely be delayed, but

tax breaks (e.g. in UK) and service cost

deflation can partially offset the negative

impact of the oil price drop

13

Canadian Oil Sands Long-Term Outlook Sharply Downgraded

• Most Canadian oil sands developments (esp.

mining) are not economic at today’s oil prices

• Long-term (2030) production outlook cut by 1.1

mbpd (from 6.4 mbpd to 5.3 mbpd)

• Canadian production will increase through 2020,

albeit at a slower pace than expected (+140 kbpd

vs.+ 210 kbpd annually, according to the IEA)

• As of mid-May, nine major Canadian oil sands

projects had been deferred due to the price drop

• Capex cuts and delays will primarily affect

production post-2016, already sanctioned

projects will not likely to be stopped by lower

prices

• Alberta’s new social democratic government

presents further uncertainties to the investment outlook

Canadian Project Delays and Cancellations

Source: Rystad Energy, Morgan Stanley

Canadian Oil Sands Projects on the Cost Curve

14

Russia Short-Term Resilience, Medium-Term Struggle?

Source: Citi, Bank of America

• Russian production has proved resilient in

the short-term (up by 100 kbpd y/y in Q1 ’15)

• Ruble cost deflation and efficiency gains

have helped offset impact of lower oil prices

in the short-term

• Medium-term outlook is more negative as

lower oil prices and Western sanctions weigh

on investments

• IEA expects Russian production to drop by

560 kbpd in ‘14-’20, Bank of America

forecasts 300 kbpd drop in ‘15-’19

• Greenfield developments in East Siberia,

tight oil development in the Bazhenov basin

(previously expected to produce at 500 kbpd

by 2018) and field redevelopment projects in

mature areas will be hardest hit

Russian Oil Production Up in the Short-Term Million b/d

Russian Oil Production Growth in the Medium-Term Million b/d

15

Arctic A Long-Term Bet On Healthy Oil Prices and Demand

• Arctic developments are not viable at

today’s oil prices…

• … but Arctic exploration is a long-term play

with at least 10 to 15-year development

cycle – current price outlook is irrelevant, if

operators expect high prices and

continuing oil demand growth in the 2030+

time horizon

• Shell continues drilling campaign in Alaska,

Chevron pulled out of Beaufort Sea drilling

program in Canada, Exxon’s Kara Sea

exploration suspended due to sanctions

against Russia, some Norwegian projects

have been pushed to the right

• Environmental opposition may prove as big

of a challenge as engineering and

economics

16

Implications for Global Crude Oil Flows

• North American production growth will continue, backing out further seaborne imports, albeit at

slower pace than previously expected – net imports decrease less than expected through 2020

• The Atlantic Basin has shifted into a persistent crude surplus due to the displacement of light

sweet African crudes from North America, keeping Brent in a structural contango

• Europe and Asia are increasingly import-dependent, but Asian buyers enjoy more leverage as

exporters compete aggressively for market share (see Saudi OSPs)

• Canadian and Mexican crudes will be increasingly exported outside North America through

2020; about 300 kbpd of US condensate can also be exported outside the region

• US crude oil export restriction and Iran negotiation are key uncertainties for trade flows

17

Implications for Global Refined Product Flows

• Product markets will continue to expand and globalize in the medium-term thanks to growing

product exports from the US, Asia and the Middle East

• US has emerged as the world’s largest gross oil product exporter and it is projected to become

a net exporter of gasoline by 2017 (IEA). Crude export restrictions drives more product exports.

• With the ‘hollowing out’ of the European refining sector, Europe will become increasingly

dependent on middle distillate imports

• The Middle East is not only exporting record amount of crude but also refined products from a

number of new mega-refineries

18

Implications for Global LNG Flows US Export Story Not Over

Source: Wood Mackenzie, Citi Research

Map of Future Global Gas Flows • Sabine Pass starts 2015; Cameron,

Freeport, Cove Point under

construction (51mtpa vs Qatar 77

mtpa); >2 FIDs planned for 2015

• Some US projects may be pushed

out; less advanced probably

cancelled (costly FERC approval)

• US LNG is well-positioned in the

global competition (mainly

brownfields with ready access to

developed natural gas sources)

• Closing of the arbitrage gap between

US and Asia/Europe is likely

temporary, and only affects

uncontracted projects

• US exports look increasingly

competitive in Europe

Thank you

For more information contact

Jason Bordoff Professor of Professional Practice in International and Public Affairs

Founding Director, Center on Global Energy Policy

Columbia University

jbordoff@columbia.edu

(212) 851-0193