Energy Intelligence examines the vital questions facing the oil industry in 2015: How long will it take for Opec's policy of squeezing high-cost producers to achieve results? How quickly -- or slowly -- will supply and demand start to look more balanced? What does this mean for the direction of oil prices this year and beyond?

1. Opec's Saudi-led strategy of letting the
market balance itself is quickly moving
from its first phase — maintaining pro-
duction to let a growing crude surplus
develop — into its second, the absorp-
tion of that surplus through rising stor-
age levels. But it's the timing of the
third phase, the period of actual mar-
ket rebalancing, that is of greatest
interest to the industry. When will low
prices shut in enough high-cost non-
Opec supply to allow oil prices to
recover? And will production be shut
in swiftly enough to prevent storage
tanks overflowing, triggering another
price collapse? This is uncharted terri-
tory for what Mideast Opec delegates
openly acknowledge as the group's
"experiment," but PIW analysis sug-
gests the supply response this year will
be limited, with non-Opec supply
growth of 1.16 million barrels per day
outstripping demand growth of
800,000 b/d.
In the current second phase of the
experiment, rising storage levels are
being facilitated by steep spot price
discounts. Onshore storage is filling up
fast, while some volumes are also
starting to move into floating storage.
Brent crude has already lost $30 per
barrel since Opec's Nov. 27 decision
not to rein in production, and rising
inventory levels are adding to the
downward pressure on the price. But a
full collapse can be avoided as long as
storage is available. Ahead of the
expected 2.4 million b/d surplus in the
first half of this year, the market had to
deal with a 1.9 million b/d supply over-
hang in last year's fourth quarter of
2014. And the more storage tanks fill
up, the longer the re-balancing will
take, since these massive inventories
will eventually have to be drawn down.
Low oil prices seem certain to start
affecting non-Opec supply later in the
year, but it's countries like Russia that
are likely to be most vulnerable, rather
than the US' fast-rising light, tight oil
supply, which most observers see as
the principal intended target of Opec's
new strategy. But will this supply
response be enough to see some stabi-
lization in prices this year, as forecasts
by Opec and the International Energy
Agency suggest?
The question here is whether the
market will run out of storage space
before the delayed reaction from non-
Opec producers succeeds in slowing
global supply. And if prices really col-
lapse, how will Opec react? Saudi
Arabia has indicated that the producer
group has made a permanent change
in policy, but dissent among other
members, notably Venezuela, is grow-
ing. A change in Opec policy seems
unlikely before or even at its next
meeting in June, however.
The Opec experiment was never
likely to be a smooth process, and is
not helped by gloomy economic fore-
casts for 2015, which undermine any
hope that rising demand might ride to
the rescue. US tight oil could prove
more resilient than expected, while
within Opec Iraq continues to hike out-
www.energyintel.com
February 2015
Slow Oil Supply Response . . . . . . . . . . . . 2
Oil Price Offers Modest Boost to GDP . . . 3
Consolidation Is Coming . . . . . . . . . . . . . 4
Inside
The Outlook for Oil in 2015: Supply, Demand and Opec's Big Gamble
put. And as events in Yemen demon-
strate, geopolitics remains a real wild
card, with potential to both help and
hamper the balancing exercise. A
nuclear deal with Iran could boost sup-
ply significantly, while Libya could go
either way. The list of potential
hotspots is long, with instability aggra-
vated by low prices — as in Venezuela
and Nigeria — and some even ques-
tioning the potential for disruption in
Mideast Gulf monarchies. Moreover,
geopolitical disruptions, by their
nature, have a habit of springing sur-
prises.
US tight oil producers are already
cutting capital spending, but are also
slashing costs through efficiencies and
technology. That may ultimately stop
US tight oil acting as the market's new
marginal-cost barrel, with other
higher-cost sources instead falling vic-
tim to the industry's eventual restruc-
turing — the logical fourth and final
phase of Opec's experiment.
Investment bank Goldman Sachs sees a
new paradigm shaping the industry as
US tight oil producers lower costs, and
capital shuns high-cost deepwazter, oil
sands and other alternative technolo-
gies, making the oil industry "more
efficient." But this is unlikely to pan out
for another year or more, says the
bank, which sees Brent at $42/bbl in
the second quarter, rising to $64.50/
bbl in the fourth and $70/bbl in the
first quarter of 2016. n
January26,2015
Petroleum Intelligence Weekly
EI White Paper
Opec Experiment Moves Into Storage Phase
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2. The collapse in oil prices is starting to
affect the outlook for US crude output, as
producers and their financial backers
slashforwardpriceexpectations.Butmost
still insist output will rise, even as spend-
ing levels dive, given the forward momen-
tum in the country's key tight oil plays.
According to PIW sister publication Oil
Market Intelligence (OMI), US oil produc-
tion should, based on current prices, grow
in the range of 1.2 million-1.4 million bar-
rels per day this year, down from growth
of slightly less than 1.6 million b/d in
2014,withtheUS'BigThreetightoilplays
—theBakken,EagleFordandPermian—
helping sustain output's higher trajectory.
The US growth story also looks likely to
remain intact in 2016, albeit at a more
modestlevel(PIWNov.24'14).
If history is any guide, US onshore
stripper wells — those that have pro-
duced less than 10 b/d over the past 12
months — and heavy oil wells in the
California Central Valley will be the first
shut in, while marginal shale plays and
fringe areas away from core play "sweet
spots" — where break-even prices of as
low as the mid-$40s per barrel are not
uncommon — will see sharply reduced
activity. If low oil prices persist, there is
likely to be a sharper deceleration in
growth next year, OMI suggests, slowing
to around 825,000 b/d as investment
declines also hit output growth in core
shale areas, queues of already drilled but
uncompleted wells are worked through,
andstripperwelldeclinesaccelerate.
The seeds of the anticipated produc-
tion growth slowdown are already evi-
dent in rig activity, with the start of 2015
witnessing the biggest weekly drop in the
number of US onshore rigs targeting oil
in more than two decades, according to
data from rig firm Baker Hughes. The
next few months should, analysts believe,
see aggressive efforts by producers to lay
down rigs, with eventual declines in ser-
vices costs and high-graded drilling pro-
grams thereafter putting a floor under rig
usage(PIWDec.8'14).
EI White Paper
Oil-directed rig numbers fell by 61
for the week ending Jan. 9, with the total
onshore rig count now down by 180
from the recent peak of 1,930 set in
mid-October. The Permian and Bakken
areas saw the largest weekly drops
among key US basins, down by 28 and
eight rigs, respectively. The US onshore
rig count is likely to drop by another
450-plus between now and May, ana-
lysts at Credit Suisse believe, while
Raymond James analysts think the rig
count could fall by 850 rigs, or
44%, from peak to trough.
With US tight oil and other
high-cost non-Opec supply
sources the clear targets of
Opec's new strategy, merely
slowing US production growth
may not be quite the outcome
Saudi Arabia and its allies were
hoping for. But if oil prices
remain around $40-$50 per bar-
rel, further pressure on supply
growth projections is inevitable
as producers contemplate even
deepercutsinspending.
Recent corporate announce-
ments already point to reduc-
tions of 20%-50% in capital
expenditure this year in most
cases, even though the indepen-
dents which dominate tight oil
output have hedged much of this
year's production at prices above
$85/bbl (PIW Oct.20'14). That
hedging means that the bigger
impact on output could come if
low prices endure into 2016, for which
producers have few hedges in place and
by when they will have been weakened
financiallybyatough2015.
With capital spending levels so
closely linked to operating cash flows,
any price rebound should, in theory, lead
to a rapid revival in activity. That means
that a near-term oil price that is low, but
not catastrophically so, could have
unforeseen consequences for Opec, cre-
ating a more resilient US tight oil sector
by encouraging further exploitation of
the already tireless work done to lower
production costs. Access to capital
remains a critical wild card, however, but
even that might be addressed if low
prices encourage consolidation and take-
overs in tight oil plays, and see the entry
of bigger andbetterfinanced operators.
The US shale boom was built on a
mountain of debt, and banks and bond-
holders may be far less willing to extend
credit as they become painfully aware of
whatloweroilpricesmeanforhighlylever-
aged producers. But that financial vulnera-
bility could make tight oil players ripe for
takeover by the integrated majors, whose
track record in tight oil to date has been
mixed at best, and who might, notwith-
standing investor pressure to rein in capital
spending, be tempted by the prospect of
adding high-quality tight oil assets at a dis-
tressedprice. n
January19,2015
Petroleum Intelligence Weekly
US Rig Count Declines
1,940
1,900
1,860
1,820
1,780
1,740
Sep '14 Oct '14 Nov '14 Dec '14 Jan '15
Source: Baker Hughes
US Crude Production
12,000
10,000
8,000
6,000
4,000
2,000
0
2007 2008 2009 2010 2011 2012 2013 2014 2015 2016
(‘000 b/d)
Source: OMI estmates and projections
February 2015 | 2
Price Slump Will Slow, Not Stop, US Oil Growth
Copyright © 2015 by Energy Intelligence Group, Inc.energy-intelligence @energyintel

3. EI White Paper
Lower oil prices are expected to apply
the brakes to non-Opec supply growth
this year, but not to the extent that it will
be outpaced by relatively modest pro-
jected growth in demand. This reflects
the growth momentum built up in cer-
tain key non-Opec plays over the past
few years, and means that the main
short-term consequence of Opec's deci-
sion to maintain output and let prices fall
will be a further fattening of already
ampleinventories(PIWJan.19'15).
The latest supply/demand assess-
ments by PIW sister publication
Oil Market Intelligence (OMI) show an
average 2.4 million barrel per day sur-
plus in the first half of 2015, dropping
to a still hefty 1.32 million b/d in the
second half, assuming crude prices stay
at current levels. OMI sees non-Opec
supply growth this year of 1.16 million
b/d, down by around 600,000 b/d from
estimated 2014 growth levels, but still
comfortably — or uncomfortably, from
Opec's perspective — ahead of pro-
jected 2015 oil demand growth of just
800,000 b/d. These projections also
assume that Opec perseveres with its
new strategy and maintains crude out-
put at 30 million-30.5 million b/d.
The fall in prices means the drivers
for global oil supply have shifted radi-
cally from the pattern of the past few
years — the focus is no longer on ram-
pant non-Opec growth and possible
output policy responses from Opec,
but instead on how growth rates in
areas such as US tight oil might moder-
ate and how decline rates in mature
areas might accelerate.
Opec's strategy, led by Saudi
Arabia, is to sit tight, maintain out-
put, and wait for lower prices to rein
in high-cost production and re-bal-
ance the market. And lower prices
will slow non-Opec growth, as pro-
ducers respond to reduced cash flow
by trimming capital spending, and as
investors and lenders similarly lose
some appetite for oil sec-
tor exposure. Shut-ins of
low productivity wells,
such as stripper wells in
the US, and cancellation or
delays to high-cost mega-
projects in areas such as
the deepwater will grab
the headlines, but else-
where, significant forward
momentum is likely to keep US tight
oil plays such the Eagle Ford and the
Bakken, and to a lesser extent the
Permian Basin, moving forward,
albeit at a slower rate.
The hardest hit among non-Opec
producers is expected to be Russia,
caught by the combination of low
prices and Western sanctions, which
have in turn spawned a currency crisis
and an economic downturn. But there
is also expected to be an acceleration
in decline rates in mature plays in the
North Sea, China, Indonesia, Mexico,
Argentina, Azerbaijan, Australia, Egypt
and several other smaller producers.
Although the US' output expansion
is expected to slow, output should still
see growth in the 1.2 million-1.4 mil-
lion b/d range this year, down from
growth last year of slightly less than
1.6 million b/d. In addition, continued
increases from Canada, Brazil and a
few others should counter most other
non-Opec declines.
Two key countervailing assump-
tions underlying the supply outlook
are that prices remain at current lev-
els rather than moving significantly
lower, and that geopolitical disrup-
tions do not take a big chunk out of
supply at any stage. Both are of course
possible, the former particularly given
the additional price pressures created
by the build-up in inventories.
The stockbuild is just one result of
Opec's strategy, with the weakness in
benchmark crude futures leading to a
pronounced shift in the forward price
curves for both Brent and West Texas
Intermediate into deep contango. This
creates sufficient incentive to store
the crude the market doesn't cur-
rently want in both onshore tanks
and, at greater cost, in tankers off-
shore. But it also creates a major drag
on any price recovery when a flatten-
ing curve begins to bring that oil back
out of storage. n
January 26, 2015
Petroleum Intelligence Weekly
Lower oil prices should be good for the
global economy and for oil demand,
and if prices remain at current levels,
most analysts expect a small additional
boost to demand growth throughout
2015 and a bigger one in 2016 as a
global economic recovery takes root.
Some early impacts are already visible
— US consumers, partly thanks to the
low retail fuel taxes they pay, have been
first to react, driving more miles and
buying bigger cars. But overall, econo-
mists warn that an exuberant demand
reaction should not be expected.
As the International Monetary Fund
said in October when it downgraded
global economic growth for 2015 to
Oil Price Offers Modest Boost to Global GDP
Continued on p4
February 2015 | 3
Slow Oil Supply Response Points to Big Stockbuild
2015 Quarterly Oil Market Balances
Chg. vs.
(million b/d) Q1 Q2 Q3 Q4 2015 2014
Demand 92.81 92.72 94.32 95.12 93.75 +0.80
OECD 45.43 44.92 45.93 46.13 45.61 -0.06
Non-OECD 47.37 47.80 48.39 48.99 48.14 +0.86
Supply 95.41 94.94 95.15 96.93 95.35 +1.40
Non-Opec 58.63 58.27 58.21 59.93 58.67 +1.16
Opec NGLs & Other 6.57 6.44 6.67 6.84 6.65 +0.14
Call on Opec Crude 27.60 28.01 29.44 28.35 28.36 -0.54
Opec Crude 30.20 30.22 30.26 30.16 30.04 +0.10
Implied Stock Chg. +2.60 +2.21 +0.83 +1.81 +1.60 —
Source: Energy Intelligence's Oil Market Intelligence
Copyright © 2015 by Energy Intelligence Group, Inc.energy-intelligence @energyintel

4. EI White Paper
3.8% from the 4% predicted last July,
the recovery remains "brittle, uneven
and beset by risks." The historically less
bullish World Bank sees a low oil price
adding just one-tenth of a percentage
point to global GDP growth this year,
and with an eye on the sputtering euro-
zone, Japan, and China's economic
gear-shift, forecasts growth in the
global economy in 2015 at 3%. It sees
some support from the oil price and the
US economy, but also the risk of a new
financial crisis, especially if investors
exit Asia as and when Western banks
start raising interest rates. "The global
economy is running on a single engine
[the US]," says World Bank Chief
Economist Kaushik Basu. "This does
not make for a rosy outlook."
A number of factors — taxation,
subsidies, currencies and the availabil-
ity of alternative energy sources —
complicate how lower oil prices are
passed on to consumers, economists
warn, noting that the elasticity of oil
demand is greater when prices rise
then when prices fall. "You don't get as
much demand back as you lost from
prices going up," one market-watcher
says. "You don't rip out your insulation."
Much like their counterparts in the US,
consumers in Asia are enjoying lower
fuel prices, but in countries like China,
India and Indonesia, the simple transla-
tion of cheaper crude into cheaper
pump prices is complicated by recent
subsidy and tax changes and shaky cur-
rencies that make oil more expensive in
local money (PIW Jan.12'15).
Oil demand growth should be bet-
ter supported from this year on by a
sustained and even recovery in the
world economy, but that demand
growth will continue to be heavily con-
centrated in non-OECD economies,
buoyed by some additional buying from
China and India for their strategic
stockpiles. Despite modest GDP growth,
OECDs economies are expected to con-
tinue to cut back on oil use. Overall,
PIW estimates point to limited annual
demand growth this year of 800,000
barrels per day, up from growth of
720,000 b/d in 2014.
There could be surprises to the
upside, if Asia's smaller economies take
off, or in the US, which could easily add
100,000 b/d to that total as more jobs
are created, net of likely oil job losses in
producing states like Texas and North
Dakota. Africa could also deliver more
demand growth than anticipated from
a low base, but some trends will remain
intact despite lower oil prices. China
ceased to be such a big engine of oil
demand growth as of 2013, and is
expected to see demand growth of just
200,000 b/d this year, while possibly
substantial structural declines in
demand are set to continue in Japan
and Europe. Oil demand may also be
affected by a tightening of environmen-
tal regulations, while policies aimed at
improving energy efficiency in vehicles
will also blunt any demand increase. n
January 19, 2015
Petroleum Intelligence Weekly
Low oil prices will likely spur a big
wave of industry consolidation this
year, but it could take some time to
develop. Oil companies traditionally
use mergers and acquisitions as a way
to unlock value during periods of low
oil prices, with the strong preying on
the weak. All indications suggest the
current downturn will be no different.
But before widespread deal-making
can happen, oil price volatility must
subside so that companies can find
common ground on asset values.
At present, the bid-ask spread for
potential deals is too wide, as pro-
spective sellers have not reconciled
themselves to the new price realities
after Brent's 50% fall since June to
less than $50 per barrel. The price
slide has brought M&A activity to a
standstill over the past three months
and has resulted in some agreed deals
being aborted, including United Arab
Emirates-based Dragon Oil's $800
million bid for Irish independent
Petroceltic, and some assets being
pulled off the market, such as US inde-
pendent Newfield's interests in China.
The big exception has been the
$13 billion takeover of troubled
Canadian independent Talisman
Energy announced last month
by Repsol, for which the Spanish
major has been accused of overpaying
(PIW Dec.22'14).
The Western majors have a big
decision to make about whether to
pursue acquisitions. They are commit-
ted to capital discipline, having sacri-
ficed growth to protect cash flow, and
most are in fact looking to sell assets
to help cover expected cash-flow defi-
cits this year. At the same time, sanc-
tions against Russia have deprived
them of access to key long-term
growth assets — a portfolio void that
could be addressed opportunistically
via M&A (PIW Jul.28'14).
Large acquisitions would draw
intense scrutiny from investors, who
were already fed up with majors'
profligate spending and weak returns
even before the collapse in oil prices.
Still, the majors boast strong enough
balance sheets to handle big pur-
chases. Exxon Mobil has been linked
with bids for BG and Anadarko
Petroleum, but says "bolt-on" asset-
level deals in US shale are more likely.
Holding treasury shares worth some
$350 billion, Exxon can entertain
almost any deal. Few believe the
majors will actually double down on
the failed "supermajor" strategy, how-
ever, so any deals will have to offer a
compelling mix of cash flows and flex-
ible capital spending requirements —
in addition to growth.
Ambitious national oil companies
Consolidation Is Coming, But May Take Time
February 2015 | 4
Copyright © 2015 by Energy Intelligence Group, Inc.energy-intelligence @energyintel

5. (NOCs) from Asia and Middle East are
more likely to lead the way, as overseas
M&A targets suddenly look more
obtainable. After refraining from major
deals in 2014 amid China's corruption
probes, Sinopec and PetroChina look
ready to make a big splash in M&A
markets this year, as do some expan-
sion-minded Southeast Asian NOCs
such as Thailand's PTT Exploration &
Production and Indonesia's Pertamina.
China's NOCs spent roughly $20
billion on upstream M&A in 2013, but
just $3 billion last year. Sinopec has
cash available after divesting 30% of
its retail business for around $17.5
billion and is reportedly looking for
new acquisitions. PetroChina is also
evaluating new M&A opportunities,
while China National Offshore Oil
Corp. is likely to refrain from large
acquisitions after its 2012 purchase of
Canadian independent Nexen. PTTEP
has a $3.5 billion war chest with
which it is expected to target entry
into US shale. UAE-backed firms
Mubadala Petroleum and Taqa may
also be looking to fill gaps in their
portfolios, with Energy Minister
Suhail al-Mazrouei saying periods of
low prices historically "create the best
value" for buyers.
M&A opportunities are expected
to grow over the course of the year as
low prices increase the cash-flow
pressures on some firms, particularly
smaller, weaker independents. The US
independent sector, which has been
heavily financed by high-yield "junk"
bonds in recent years, will likely see
the most M&A action, but there will be
no shortage of targets worldwide.
Iraq's semiautonomous northern
region of Kurdistan, Brazil and East
Africa also offer substantial growth
opportunities and could become
active hubs for deals. In the US, there
are junk credit ratings on roughly 100
E&P companies with production of
some 4.5 million barrels of oil equiva-
lent per day (PIW Nov.24'14). Despite
capital expenditure cuts, the sector is
expected to outspend cash flow by
60% this year, pointing to worsening
debt metrics. n
January 26, 2015 Petroleum
Petroleum Intelligence Weekly
Copyright © 2015 by Energy Intelligence Group, Inc.energy-intelligence @energyintel