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Black Gold?
Examining the Winners & Losers from the Oil Price Collapse
Garrett D’Alessandro Bruce Simon, CFA
Chief Executive Officer Chief Investment Officer

2. 2
Table of Contents
EXECUTIVE SUMMARY ...................................................................................................................................... 3
HISTORICAL PARALLELS.................................................................................................................................. 4
ECONOMIC IMPLICATIONS ........................................................................................................................... 12
NET OIL-IMPORTERS................................................................................................................................... 12
NET OIL-EXPORTERS................................................................................................................................... 19
OIL MARKET RECOVERY OUTLOOK............................................................................................................ 21
CURRENT MARKET BALANCE.................................................................................................................... 21
SUPPLY AND DEMAND FUNDAMENTALS .............................................................................................. 22
DEMAND DRIVERS........................................................................................................................................ 23
“CALL ON CHINA” ......................................................................................................................................... 25
DEMAND STIMULATION.............................................................................................................................. 26
SUPPLY DRIVERS .......................................................................................................................................... 27
SUPPLY DISRUPTIONS................................................................................................................................ 30
U.S. LTO ........................................................................................................................................................... 31
RECOVERY OUTLOOK .................................................................................................................................. 37
INVESTMENT POSITIONING ......................................................................................................................... 42
CONCLUSION...................................................................................................................................................... 50

3. 3
EXECUTIVE SUMMARY
Few commodities capture the attention of both the investment community and the general public
like oil. Since the 54% decline that began on June 20 2014, commentary regarding expectations of
future oil prices, as well as the implications across the global economy, industries, and – most
importantly – investment positioning, has captivated investors.1
While many investment firms
have felt compelled to issue immediate and frequent opinions on the dislocation in oil prices, we
believe a more deliberate and patient approach yields greater data points from which more
thoughtful conclusions may arise.
The purpose of this report is to leverage City National Rochdale’s ability to synthesize and distill
independent third-party research, sell-side research, economic data, and industry-specific analysis
into an objective, accessible, and actionable investment analysis addressing the impact of crude oil
prices for our clients. Our observations specifically highlight:
- Historical Parallels: A balanced market is achieved through supply and demand.
Understanding the primary cause of price corrections in the past along with the behaviors and
actions of key participants provides valuable context in terms of identifying the most critical
factors needed to drive a balanced market. Our examination of oil price history suggests that
the period from 1985 – 1986 is most analogous to 2014 – 2015, with the resulting implications
that (1) excess supply is the overwhelming contributor to the price shock, and (2)
rationalization of Non-OPEC supply – specifically U.S. Light Tight Oil (LTO) – is the primary
pathway to a balanced market.
- Macro Analysis: Economic analysis suggests a net positive to global growth, but the
ramifications of lower oil prices will not be uniform. Of the major net oil-importers, we expect
India and China to benefit the most, followed by the United States, Eurozone, and Japan. Net
oil-exporters such as Saudi Arabia, Norway, UAE, and Kuwait have fortress-like capital reserves
to withstand a prolonged period of low oil prices, while Venezuela and Nigeria seem to be at
most financial risk.
- Oil Market Recovery Outlook: Economic development in a number of emerging markets,
discoveries of new energy sources, and technological advances related to extraction techniques
have all greatly influenced the supply and demand balance. Despite a seemingly modest supply
overhang of 1.0 million barrels per day (mmbd) and pronounced decline in U.S. rig count, we
expect a “U”-shaped recovery as opposed to the demand-driven “V”-shaped recovery that
characterized 2008 – 2009. We attribute this expectation to the reduced likelihood of the “Call
on China” that drove oil demand from 2002 – 2014, shift to market-based pricing as opposed to
cartel, operational flexibility unique to U.S. LTO, and access to derivatives.
- Investment Positioning: We favor Integrated Oil & Gas (IOG), Top Tier Oilfield Services,
and Midstream Master Limited Partnerships (MLPs) equities while finding relative value within
Investment Grade IOG issues. We also believe the High-Yield Exploration & Production sector
may eventually offer investors an attractive risk/reward scenario to participate in a potential
upswing in oil prices.
1
West Texas Intermediate (WTI) price decline from peak 2014 price of $107.95 on June 20, 2014, to April 3, 2015, price of
$49.13; sourced from U.S. Energy Information Administration (EIA).

4. 4
HISTORICAL PARALLELS
Developing an appreciation of key similarities and differences between relevant, comparable bouts
of price volatility can help identify the most relevant factors needed to bring the market back into
balance. While the 54% drop in crude prices was alarming in its severity, speed, and lack of any
major trigger point or economic malaise, it was the second time in just six years when oil prices
experienced a comparable decline in terms of magnitude and pace. Investors may naturally
gravitate toward analyzing this time period given recency bias. However, we think the more
appropriate “fit” – from both a supply/demand aspect and price recovery scenario – is 1985 -
1986.
In 2008, the Great Recession brought oil prices down from a peak of $145/barrel (bbl) to $30/bbl.2
However, the 2008 decline arose from a collapse in demand, something we do not believe is
occurring to the same extent in 2015. We also do not think the drop in oil prices portends an
ominous global slowdown as it did in 2008 – something that likely weighs on investor psyches. In
fact, a quick review of historical oil prices in Chart I demonstrates that many severe pullbacks
occurred independent of larger economic or financial market events.3
CHART 1: AVERAGE ANNUAL IMPORTED WTI PRICE
2
WTI peak closing price of $145.31 on July 3, 2008; WTI low of $30.28 reached on December 23, 2008 (EIA).
3
Dark blue shading in Chart I denotes forecast/projected price of WTI from EIA.

5. 5
TABLE 1: HISTORICAL OIL PRICE SHOCKS
Event Time Period
Estimated
WTI %
Chg
Comments
1 1973 – 1974 +302%4
Arab OPEC members enacted an embargo against countries
that supported Israel, such as the U.S., Netherlands, South
Africa, and Portugal, during the Yom Kippur War / 1973 Arab-
Israeli War. The lack of production capacity outside of OPEC,
along with the devaluation of the dollar stemming from the
August 1971 U.S. suspension of Bretton Woods, further
exacerbated the price volatility of oil and resulted in
nationwide gas shortages.
2 1978 – 1980 +100%5
The Iranian Revolution was the largest contributor to the
second global oil shock. Iranian-based oil industry strikers
during the Revolution reduced the output of Iran, the world’s
second-largest exporter of petroleum, to virtually nil. In fact,
Iran had to appeal to the U.S. for kerosene in 1979 to
prevent a total collapse.6
The fuel shortages in the U.S. were
further exacerbated by OPEC’s decision to raise prices by
15% in December 1978, breaking an 18-month price freeze.
This combination of higher prices and curtailed supply led
companies and consumers to aggressively stockpile
inventories.7
3 1985 – 1986 -67%8
The lofty prices that resulted from the Iranian Revolution in
1979 declined by 40% through 1985, as high oil prices
spurred the development of new oil sources, particularly
those from Non-OPEC countries. As the price-setting residual
supplier, OPEC reduced its output to support prices until
Saudi Arabia, frustrated with market share losses and other
OPEC members’ lack of commitment to production quotas,
increased production to recapture lost market share,
culminating in a sharp decline in 1986.
4 1990 +93%9 Iraq’s invasion of Kuwait led to this short-lived price spike.
5 1997 – 1998 -50%10
The Asian Financial Crisis led to a collapse in oil prices, which
in some ways was the final washout from the nearly two-
decade bear market in oil prices that started on the heels of
the Iranian Revolution.
4
Corbett, Michael. "Oil Shock of 1973–74." Federal Reserve Bank of Boston. 22 November 2013. This footnote refers to
both the estimated price change and comments section for 1973 – 1974. The 400% estimate based from the passage
“These cuts nearly quadrupled the price of oil from $2.90 a barrel before the embargo to $11.65 a barrel in January 1974.”
5
Graefe, Laurel. “Oil Shock of 1978–79.” Federal Reserve Bank of Atlanta. 22 November 2013.
6
Myron Kandel and Philip Greer, “Oil-Rich Iran Needed U.S. Kerosene Shipments,” The Chicago Tribune, January 11, 1979.
7
Cooper, Andrew Scott, “In 1979 OPEC’s Swing Producer Came Out Swinging,” Middle East Institute
8
Gold, Russel, “Back to the Future? Oil Replays 1980s Bust,” The Wall Street Journal, January 13, 2015.
9
Hamilton, James. "Historical Oil Shocks" National Bureau of Economic Research (2011).
10
EIA, decline calculated using May 22, 1997 closing WTI price of $12.60 and December 10, 1998 closing price of $10.82.

6. 6
6 2003 – 2008 +355%11
The IMF estimates that global GDP growth averaged 5% from
2004 – 2007. This led to global oil consumption growth of
more than 3% per year. Prices jumped as production growth
largely lagged consumption. Instability in Iraq and Nigeria,
as well as production declines in the North Sea, Mexico, and
Saudi Arabia, contributed to short supply.
7 2008 – 2009 -79%12 Great Recession / Global Financial Crisis.
8 2014 – 2015 -54%
A persistent level of excess supply throughout 2014 due to
U.S. production growth, as well as increased production from
Libya and Iraq despite turmoil in both countries, combined
with moderating global growth, led to a bear market in oil
prices. Oil faltered in June 2014 and accelerated following
OPEC’s decision to maintain production during its November
2014 meeting.
There are a number of similarities between 1985 - 1986 and 2015. This sentiment has been
shared by several oil executives recently, including BP CEO Bob Dudley, who remarked that “this
feels like 1986 to me” during BP’s Q4 2014 earnings call on February 3, 2015. Understanding
comparable periods of price volatility provides valuable insight to industry participants, such as BP,
particularly regarding capital allocation decisions. Investors can also benefit from a similar context,
namely by fixating on what specific causes of an imbalanced market require the most significant
levels of adjustment. We analyzed a number of major traits between both time periods and
discovered several interesting parallels that provide insight into establishing a framework for the
current oil environment.
Oil Prices
Oil prices had reached significant, if not record-setting, prices in the years leading up to the
precipitous drops in 1986 and 2014. WTI peaked in 1979, and while it had declined from that level
through the first half of the 1980s, real and nominal prices still remained elevated, exceeding levels
reached during the 1973 Oil Embargo. From 2011 - 2014, WTI routinely traded between $90/bbl –
$120/bbl, within striking distance of the $145 record achieved before the Great Recession in 2008.
Supply & Demand
High prices established in 1979 and 2008 led to accelerated development of new sources of oil.
From the late 1970s through the early 1980s, these new sources principally came from the former
Soviet Union, Mexico, Alaska, Norway, and the UK while the major source of new oil in recent years
has been from U.S. shale production. From 2010 - 2014, U.S. global market share increased by
approximately 40%, from 11% to 15%. The most important feature these two eras shared was
that these new oil sources were generated by Non-OPEC regions.
11
EIA, gain calculated using January 2, 2003 WTI closing price of $31.97 and closing WTI price of $145.31 on July 3, 2008.
12
EIA, decline calculated using closing WTI price of $145.31 on July 3, 2008 and December 23, 2008 closing price of $30.28.

7. 7
CHART 6: PETROLEUM CONSUMPTION
(mmbd)
Source: EIA
The efforts to increase supply following 1979 and
2008 also coincided with a persistent reduction in
demand from Organization of Economic Co-
Operation and Development (OECD) countries.
While global demand increased following the Great
Recession (a difference between the two time
periods, which we will later discuss), it is likely
that stagnant OECD demand, combined with the
supply surge, contributed to the supply/demand
mismatch that precipitated the sharp drop in
crude in both 1985 – 1986 and 2014.
CHART 2: OIL PRODUCTION MARKET
SHARE 2005 – 2014
CHART 3: OIL PRODUCTION BY REGION
2005 – 2014
CHART 4: NON-OPEC VS. OPEC
MARKET SHARE 1975 – 1985
CHART 5: SELECTED NON-OPEC
PRODUCTION 1975 – 1985
Source (Charts 2 – 5): EIA

8. 8
OPEC
The new sources of Non-OPEC supply in both time periods presented a challenge for OPEC and
Saudi Arabia given OPEC’s role as swing producer, whereby it would limit its production to ensure a
balanced market. OPEC’s emphasis on price led to lost market share to new Non-OPEC entrants,
such as the North Sea and Prudhoe Bay in the 1980s and U.S. LTO from 2010 – 2014. In
September 1985, Saudi Arabia abandoned the quota system and pursued a market-based
approach, ramping up production which led to a 55% decline in crude prices over the next five
months.13
This mirrored Saudi Arabia’s stance and actions in 2014. Rather than rein in its supply,
OPEC elected to maintain production in response to market share losses to U.S. shale and
weakness in oil prices. This surprise move during its November 2014 meeting led to a 28% decline
in oil prices from November 2014 through year-end 2014.14
Monetary Policy
If one extends comparisons beyond oil,
similarities in monetary policy emerge.
In 1985 and 1986, monetary policy
was relatively “easy” with the Federal
Funds Rate (FFR) ranging from 6 - 8%.
While a 6 - 8% FFR is not reflective of
“easy” monetary policy in 2015, this
FFR level was in fact quite loose when
compared to the mid-to-high-teens
FFR of the early part of the 1980s. In
fact, 1985 - 1986 marked the easiest
monetary policy for FFR in the 1980s.
Despite the expectation of an increase
in the FFR in 2015, the expected level
of tightening and absolute level of the
FFR would also be considered easy
monetary policy.
U.S. Dollar (USD)
Similarities between these periods also arise when examining the strength of the U.S. Dollar
(USD). September 1985 was not only when Saudi Arabia shifted to a market-based production
system, but was also when the Plaza Accord was signed. The Plaza Accord was the G5 response to
a USD that had appreciated tremendously against a number of currencies in the years leading up
to 1985. In comparison, the USD appreciated by 13% against a basket of global currencies in
2014.15
U.S. trade partners are largely pursuing a “beggar thy neighbor” strategy in 2015 and the
prospect of a coordinated effort to strengthen currencies against the USD is virtually nil. The
13
September 1985 and March 1986 WTI month-end price per barrel was $28.29 and $12.62, respectively.
14
WTI closing price prior to OPEC November 27, 2014, meeting was $73.70; year-end 2014 WTI price was $53.45.
15
Watts, William. "Dollar Has Its Best Year since 2005." Marketwatch, 31 Dec. 2014.
Source: FRED
CHART 7: EFFECTIVE FEDERAL FUNDS RATE

9. 9
comparison is still relevant as far as to recognize the strong USD that prevailed during both time
periods.
While these are limited data points with imperfect comparisons, we believe the overall key
similarities – growth in Non-OPEC supply, a supply surge outpacing demand, and a defensive
response by OPEC to impair Non-OPEC supply – are sufficient to “fit” 2014 – 2015 into the 1985 –
1986 template. This collection of parallels may also have been what Bob Dudley recognized when
expressing a comparison between the current period and 1986, and is also relevant when
ascertaining the various financial and macroeconomic implications.
If our assessment is that the current turmoil in crude markets is independent of any extraneous
event, i.e. financial or geopolitical, and does not portend a global recession, the economic
ramifications from the 1986 decline could be used as a proxy for 2015. UK-based Lombard Street
Research’s Dario Perkins does some of this work16
:
“Looking at Fed transcripts from the period, officials’ early concerns were all about financial
risks. They were worried the oil-price crash would drag down ‘less developed countries’
such as Mexico, with possible contagion to global markets. This is similar to the discussions
investors have recently been having about Russia. Mexico did struggle, with GDP dropping
3% in 1986, but global equities shrugged off the anxieties.
As far as the domestic U.S. economy was concerned, the impact was mainly confined to the
energy sector. Oil-dependent states suffered severe recessions, with employment
contracting sharply. Unemployment hit double digits in Texas, Alaska and New Mexico, with
what FOMC members called ‘severe effects’ on local financial institutions and state budgets.
Yet the national economy continued to grow, with only a mild slowdown in the first half of
1986 followed by a decent recovery in H2. Paul Volcker described the situation as one of
‘micro problems’ that hadn’t ‘escalated into big macro problems’. Other officials noted that
the positive impact of lower energy prices on consumers soon outweighed the initial
negative effects on production. This suggests we shouldn’t be too scared about the wider
implications of a shale crash, not least because the energy sector is smaller than it was back
then.”
This expectation is generally consistent with our research, and subsequent parts of this paper
examine the expected macroeconomic implications. However, while this 1986 case study is
helpful, it is incomplete without addressing two notable differences.
Today, over-the-counter (OTC) crude oil derivatives are routinely used for hedging and speculation.
In contrast, 1982 was when the New York Mercantile Exchange first introduced crude oil futures,
and it wasn’t until October 6, 1986 when Koch Industries and Chase Manhattan Bank structured
the first OTC oil-indexed price swap.17
The advent of OTC derivatives has added a level of
complexity to analyzing energy markets and led to a growing debate as to the extent of the
influence of derivatives on the price formation process.
What this simply means is that – data and technology limitations notwithstanding – the energy
market in 1986 likely had less tail risk relative to 2015 as the available data was representative of
16
Perkins, Dario. "Lessons from the 1986 Oil Crash." LSR Daily Note, 20 January 2015.
17
"Oil Derivatives: In the Beginning." Energy Risk Magazine, 1 July 2009

10. 10
the global energy market. Today, the vast majority of crude oil positions are held in less
transparent OTC derivatives markets.18
This means that accessing and analyzing readily available
data is not necessarily representative of the entire market. Further, it exposes investors to a
greater degree of tail risk, whereby despite constructing an accurate macroeconomic narrative and
investment approach, a small cluster of mismanaged counterparty risk at a financial institution
could lead to outsized, adverse capital market reactions. Derivatives also allow producers to lock
in prices. This can enable operators to bring on supply that may not be beneficial for correcting
production-led market imbalances.
Another notable difference between 2015 and 1986 is the level of spare capacity maintained by
OPEC. In 1986, OPEC spare capacity was 10.0mmbd, representing 16% of total global demand of
62.0mmbd.19
In 2015, OPEC spare capacity is 3.0mmbd, just a 3% margin against 93.1mmbd of
global demand.20
Historical figures demonstrate that current spare supply is not much greater than
what was deemed insufficient a few years earlier and led to subsequent price shocks.
OPEC had reduced production for several years prior to 1985 to defend prices. This played a
meaningful role in the level of excess capacity that built up. OPEC has not held back production in
recent years, and its current stance of maintaining production would suggest (a) that the likelihood
of OPEC spare capacity materially rising is low and (b) that a balanced market could occur at a
much quicker pace relative to the three years following 1986. One potential supply wildcard
toward a balanced market is the presence of U.S. LTO and its potential representation of spare
capacity. U.S. LTO is discussed in our Supply & Demand Fundamentals section.
18
EIA
19
Till, Hilary. "Oil Futures Prices and OPEC Spare Capacity." J.P. Morgan Center for Commodities. Encana Distinguished
Lecture Series (2014): 50.
20
EIA
CHART 8: OPEC SURPLUS CRUDE OIL CAPACITY
Source: EIA – March 2015

11. 11
Notwithstanding the differences in derivatives and OPEC spare capacity, the 1985 – 1986 “model”
seems to be quite applicable to 2014 – 2015, with the relevant observations as follows:
- High prices established roughly five years prior to 1985 – 1986 and 2014 – 2015 encouraged
development of additional, Non-OPEC sources of oil, many of which had higher breakeven and
marginal costs compared to OPEC producers.
- In both time periods, Non-OPEC producers rapidly increased production, threatening OPEC’s
market share.
- Excess supply, as opposed to significant demand erosion, led to an imbalanced market in both
periods. Rather than act as a swing supplier, OPEC – led by Saudi Arabia – chose to maintain
market share given its position as lowest marginal cost producer, shifting the burden of supply
rationalization to higher-cost producers such as U.S. LTO.
- Demand stimulation resulting from lower prices may close the imbalance, but we believe the
most constructive pathway to a balanced market will be reduced U.S. LTO production.

12. 12
ECONOMIC IMPLICATIONS
The collapse in oil prices is resulting in a $1.7T wealth transfer from net oil-exporting countries to
net oil-importing ones.21
On March 5, 2015, The World Bank’s Chief Economist suggested that the
50% drop in oil prices could lead to a 0.7% – 0.8% boost to GDP, a reasonable estimate given the
number of large economies that import a considerable portion of their oil needs.22
This is
consistent with Oxford Economics’ estimate that a $20 decline in oil prices results in a 0.4%
increase in global growth, IMF’s expectations of 0.7% GDP improvement, and JP Morgan’s estimate
of a 0.6% increase to 2015 GDP. Our analysis suggests considerable gains for notable net oil-
importers juxtaposed against concentrated angst for oil-exporters. We focus first on the regions
set to benefit from the drop in oil prices followed by the challenges net oil-exporters will encounter.
NET OIL-IMPORTERS
There are several ways in which reduced oil prices can benefit net importers of oil. First, lower oil
prices can act as a real income boost to consumers. Second, it can be a tremendous help in
balancing a country’s finances through improved trade balances as well as potential reduction of
fuel subsidies. Lastly, lower oil can temper inflation concerns and provide more flexibility with
regard to monetary policy. The extent to which various regions can benefit will depend on the
scale of oil imports, composition of their economies, debt levels, and relative strength of their
currencies.
Our analysis of selected net oil-importing regions/countries identifies a number of prevailing
themes. The first is that consumers and industry will experience purchasing power gains, although
the net benefit to each region’s economy becomes murkier when accounting for various subsidies
and government pricing schemes. The second is that much of the developed world has
considerable debt, and low oil prices can raise the specter of disinflation/deflation. Deflation can
influence consumer sentiment whereby real gains are saved as opposed to spent. Consequently,
the economic boost that is expected via improved consumption never materializes.
UBS recently conducted an exercise incorporating a number of economic factors to simulate the
impact to GDP from a $15 decline in the price of oil for a number of countries. We applied the
modeled GDP effects within UBS’s study for selected regions and countries to estimate GDP
impacts across a number of potential price outcomes in Chart 9.23
With the exception of Japan, the
results in Chart 9 are consistent with the data presented in Chart 10, which would suggest
countries and regions where net imports of oil represent a significant portion of GDP will benefit
most, all else equal.
21
“Concentrated Pain, Widespread Gain: Dynamics of Lower Oil Prices.” BlackRock. February 2015.
22
"Oil Price Plunge Holds Promise and Peril." Let's Talk Development: A Blog Hosted by the World Bank’s Chief Economist. 5
Mar. 2015. http://blogs.worldbank.org/developmenttalk/oil-price-plunge-holds-promise-and-peril
23
UBS estimated a 0.15%, 0.25%, 0.30%, 0.30%, and 0.08% impact to GDP for the U.S., Eurozone, China, India, and Japan,
respectively, for a $15 decline in the price of Brent. We applied this impact against a number of potential Brent price
outcomes using the 2014 average annual price of Brent ($99 – EIA).

13. 13
JAPAN
Japan imports 100% of its oil needs, and net oil imports represent a significant portion of its GDP.
This would suggest that the decline in oil prices would have a pronounced positive impact, but the
extent of that impact is somewhat muted. In terms of positives, Japan’s overall trade deficit would
be balanced if oil prices average $50/bbl (Brent) and the USD/JPY exchange rate remains at
~120.24
Consumers would also experience an increase in real income, but there are two factors
that may dampen the contribution to GDP from this channel. As UBS mentions:
“Although Japan has a relatively high dependency on imported oil the weight of energy
products in its consumer price basket is quite low compared with other developed
economies. That means the real income-related benefits for Japan's consumers from
weaker oil prices are relatively low compared with elsewhere."25
The second factor is demographics and savings rates. Japan has the world’s oldest population,
with nearly 24% of its population aged 65 or older.26
As a result, any real gains from lower oil
prices have a much higher likelihood of being saved as opposed to spent.27
Low oil prices could
also adversely impact the Bank of Japan’s (BoJ) ability to achieve its 2% annual inflation target. If
the BoJ attempts to stoke inflation, the Yen could weaken and thus crimp some of the purchasing
power acquired through lower oil prices.
Japan provided revised Q4 2014 GDP figures on March 10, 2015, and the impact of lower oil prices
does not seem to have materialized quite yet. GDP was +0.2% (+0.7% annualized), revised down
from preliminary estimates of +0.3% (+1.0% annualized). Downward revisions to Consumption
and CapEx were the main contributors, which suggest low oil prices may take some time to flow
through the Japanese economy.
24
"Japan: Mixed Impact of Low Oil Prices." (2015): 4. DBS Group Research.
25
UBS December 4, 2014
26
Euromonitor International: Japan in 2030: The Future Demographic
27
Bart van Ark, Chief Economist of The Conference Board – February 2015
CHART 10: NET IMPORTS OF OIL ($B) AND
NET IMPORTS OF OIL AS % OF GDP 2014
CHART 9: ESTIMATED NET IMPACT TO
GDP AFTER ONE YEAR
Source: Financial Times, Haver Analytics, Thomson Reuters
Datastream, Fitch, Citi Research (all December 2014)
Source: UBS – December 2014

14. 14
CHINA
According to the EIA, China has surpassed the U.S. as the largest importer of oil. The country
currently imports nearly 60% of its oil needs, and the EIA estimates that this will increase to nearly
70% by 2020. China’s reliance on oil imports would seem to indicate that low oil prices should be
very beneficial to GDP. China is also the world’s leading exporter of manufactured goods and lower
oil prices should translate into lower input costs. If end-product pricing remains firm, these lower
input costs should translate into higher profit margins.
As with Japan, the consumption benefit may be somewhat diminished, although for different
reasons. China has long capped domestic oil prices at roughly $80/bbl. With Brent near $55/bbl,
the average Chinese consumer has seen a 25% reduction in energy costs as opposed to the 40% -
50% consumers in less subsidized regions have. China also increased consumption taxes for oil
products such as gasoline, diesel, and jet fuel. Low oil prices will also add to the deflationary
concerns. Overall, analysts estimate the impact to China’s GDP from current oil prices ranges from
0.7% to 1.2%.28
INDIA
India may have the most pronounced benefit from lower oil prices relative to other net oil-
importing countries. Oil imports and its current account deficit each represent at least 5% of its
GDP. India accounts for one-third of the world’s poor, which has required its government to
maintain a number of subsidies ranging from fuel to food.29
The rout in oil prices provides an
unambiguous benefit to lower-income consumers and also allowed Prime Minister Modi to eliminate
diesel subsidies. In fact, a number of analysts expect that every $10 drop in oil prices narrows
India’s current account gap by 0.5% of GDP and reduces its fiscal deficit by 0.1%.30
Similar to China, India imports significant oil but its exports are highly diverse, which should lead
to expanded margins given the reduced production input costs. However, in contrast to Japan,
China, the Eurozone, and even the U.S., India’s primary monetary concern is inflation, which
currently runs above 5%. A lower oil price will likely reduce inflation as well as give the Reserve
Bank of India room to maneuver in the event easing is required.
28
Bank of America Merrill Lynch Global Research estimates a 10% decline in oil would increase China’s GDP by 0.15%.
Brent is down roughly 45%, leading to the 0.7% estimate. Capital Economics China economist Julian Evans-Pritchard
suggested that Chinese GDP would rise by 1% for a 30% decline in oil. With Brent down 50% from average closing, this
would indicate a GDP increase of 1.2%. Citi Research’s Ivan Szpakowski estimates low oil will boost China’s 2015 GDP by
1.1%. These estimates are consistent with CNR’s application of UBS GDP projections shown in Chart 8.
29
Olinto, Pedro, Kathleen Beegle, Carlos Sobrado, and Hiroki Uematsu. "The State of the Poor: Where Are the Poor, Where
Is Extreme Poverty Harder to End, and What Is the Current Profile of the World’s Poor?" The World Bank - Economic
Premise 125 (October 2013)
30
Singh, Rajesh Kumar. "Falling Oil Prices Shrink Trade Deficit to 11-month Low." Reuters. Reuters, 13 Feb. 2015.

15. 15
EUROZONE
The Eurozone imports over $400B of oil, which is 90% of its petroleum needs. With oil imports
accounting for over 3% of its GDP, the impact of the sharp reduction in oil prices should be
material. However, isolating this impact is challenging given the number of countries enacting
substantial structural reforms as well as the Eurozone’s launch of its massive quantitative easing
(QE) program.
For example, Spain reported Q4 2014 GDP of 0.7%, which represented the highest quarterly
increase since 2008. Annual GDP was 1.4% and ahead of consensus as well, while household
spending grew by 0.9%. Germany reported Q4 2014 GDP of 0.7%, nearly double consensus
expectations, whereby domestic demand was 0.5%, ahead of foreign trade and capital
investment.31
The increase in consumption could lead investors to conclude that the effects of low
oil are flowing through the Eurozone, but Spain has been benefiting from employment reforms
enacted in 2012. In Germany, labor groups were able to secure attractive pay hikes, which
resulted in reported negotiated monthly wage increases of 3.1% in 2014. Clearly some of the
positive economic news may be driven primarily by country-level factors as opposed to lower oil
prices.
The potential for an economic boost due to low oil prices also comes with a number of caveats.
Germany is considered the leading standard of excellence for manufacturing and export efficiency
in Europe. While Eurozone countries may benefit from lower input costs, unless additional share is
captured from Germany and other global exporting powerhouses, the overall benefit from lower oil
prices may accrue primarily to a few Eurozone countries. The economic climate in a number of
European countries is also challenging, and while the savings from lower oil prices will benefit
consumers, if sentiment is poor enough due to high unemployment, a higher portion of real gains
from reduced oil prices may be saved as opposed to spent, reducing the overall net benefit to
economic growth.
We would also be remiss not to mention the Eurozone’s vast QE program and the accompanying
depreciation of the Euro relative to the USD as a result. Oil is priced in USD and thus any
depreciation of the Euro against the USD crimps the net benefit attributed to lower oil prices.
Nonetheless, investors should not underestimate the benefit that lower oil could have on peripheral
economies coming off very low bases of economic growth. Portugal’s Economy Minister Antonio
Pires de Lima expects the economy to grow by 2.0% if oil averages 20% less than the $97/bbl
used in planning its budget (Brent crude as of the time of this report was approximately 40% less
than the $97/bbl budget). This compared to the prior estimate of 1.5%. In February 2015, the
OECD increased its estimate for Italy’s 2015 GDP from 0.2% to 0.6%, in part due to lower oil
prices. While the increase may seem small, it essentially represents an upward growth revision of
200%.
Overall, the Eurozone should benefit from lower oil prices, but the gains to each country will vary.
In addition, the numerous reforms and continent-wide QE program will also have marked impacts
on economic growth. As a result, while the 0.8% benefit to 2015 GDP as suggested in Chart 9 is
plausible, it may also be accompanied by the highest level of variance.
31
Martin, Michelle, and Ilona Wissenbach. "German Consumers in Driving Seat of Economy as Pay Improves." Reuters.
Thomson Reuters, 24 Feb. 2015

16. 16
UNITED STATES
Typically, low oil prices have led to a prominent increase in U.S. GDP as consumers spent the
windfall savings, while the trade balance improved due to the reduced drag of cheaper oil imports.
However, the boom in U.S. tight oil has increased the country’s profile as an energy producer and
may have altered how sensitive U.S. GDP is to oil prices. Based on the most recent data from EIA,
oil imports account for just 33% of oil consumed in the U.S., the lowest level since the early 1980s.
This means that the boost to the U.S. trade balance from lower oil imports may not be as
pronounced as in prior years and may be why a number of firms are anticipating just a 0.2% -
0.5% net benefit to GDP.32
The rapid development of U.S. LTO also benefited growth in fixed private investment in recent
years. Now, lower oil prices could pressure energy-related fixed investment. Although the impact
to GDP should be very modest given that capital spending related to the Oil & Gas industry
accounts for just 10% of total private nonresidential investment, it will still be a slight headwind, as
opposed to a non-factor, when assessing the impact to GDP in prior oil price declines.33
In fact,
UBS estimates just a 0.1% contribution to GDP for every $10/bbl decline in oil prices today as
compared to a 0.2%-0.3% boost prior to the shale revolution.34
32
Goldman Sachs estimates a 0.4% increase to 2015 GDP, IMF estimates a 0.2% - 0.5% increase to 2015 GDP, UBS GDP
simulation estimates 0.5% increase to GDP.
33
"Outlook 2015." BCA Research - The Bank Credit Analyst 66.7 (2015): 9. Print.
34
UBS – December 2014
CHART 11: U.S. NET IMPORTS OF CRUDE OIL AND PETROLEUM PRODUCTS 1973 –
FEBRUARY 2015
Source: EIA

17. 17
These neutral factors are likely to be more than offset by consumers, who will experience an $85B
windfall from the drop in oil prices.35
Employment should remain strong and unaffected by the
slowdown in the energy sector given employment growth accounted for just 0.6% of new hiring
over the past five years.36
This should result in the continuation of strong consumer confidence
and eventually lead to spending. The question is when, as market observers have been
underwhelmed by reported consumption figures in recent months.
The Federal Reserve Bank of Atlanta (FRBA)
tries to answer the question of timing,
forecasting a short-run drag on GDP before
the eventual boost (Chart 12). The FRBA’s
conclusion is that the decline in energy prices
is good news for the US economy, but “we
may have to be patient.”37
It’s worth noting that the dramatic shift in
the country’s role as a global producer of oil
has also led to some potential concerns
regarding the leading contributors of oil
within the U.S. According to EIA, five states
along with the Gulf of Mexico produce over
80% of U.S. crude oil. Those five states are
Texas, North Dakota, California, Alaska, and
Oklahoma, with other smaller producers
including Wyoming, Louisiana, and New
Mexico. States such as Texas have fairly
diverse economies, while oil revenues fund
85% of Alaska’s government.
While it’s reasonable for these states to entertain significant challenges, and even state-level
recessions in the case of Alaska, the severe economic outcomes experienced within these states in
1986 seems remote. In the early 1980s, oil and gas represented 20%, 22%, and 19% of the
GDP’s of North Dakota, Oklahoma, and Texas compared to 5%, 9%, and 8%, respectively, today.38
The impact of a more diverse economy can be seen in the February 2015 tax collections for Texas.
In February 2015, taxes related to oil production declined by 41% year-over-year. This steep
decline was more than offset by increases in sales tax, motor fuel taxes, and hotel occupancy
taxes, perhaps early signs that lower oil prices are translating into renewed consumption. These
various gives and takes resulted in a 4% year-over-year increase in total tax collections.39
35
Hunter, Andrew. "How Hard Will the Oil Price Slump Hit Mining Investment?" Capital Economics – U.S. Economics Weekly
19 January 2015.
36
"Outlook 2015." BCA Research - The Bank Credit Analyst 66.7 (2015): 9.
37
Altig, Dave, and Pat Higgins. “The Long and Short of Falling Energy Prices.” Federal Reserve Bank of Atlanta, 4 Dec. 2014.
38
Brown, Stephen, and Mine Yucel. "The Shale Gas and Tight Oil Boom: U.S. States’ Economic Gains and Vulnerabilities."
Council on Foreign Relations (2013)
39
Texas Comptroller of Public Accounts
CHART 12: IMPACT TO REAL GDP & REAL
CONSUMPTION FROM OIL PRICE DECLINE
Source: Federal Reserve Bank of Atlanta – December 2014

18. 18
Oil-producing states also have strong fiscal balances. According to Pew Charitable Trusts, Alaska
could operate solely on its reserve funds for over 600 days. Aside from California, the largest oil-
producing states are above the U.S. median of 25 days, with Alaska, North Dakota, and Texas
ranking first, third, and sixth, respectively, in terms of ability to fund operations exclusively with
reserve funds. Despite these healthy reserves, the longer prices remain depressed, the more
pointed the discomfort for oil-producing states, particularly for those with significant reliance on oil
revenues, such as Alaska. Oil-producing states with more balanced economies should be able to
muddle through, with a number of news headlines potentially overstating the impact of the decline
in oil prices relative to what the final data illustrate.
Source: Pew Charitable Trusts – March 2015
CHART 13: DAYS STATES CAN RUN ON RESERVE FUNDS (ESTIMATED 2015)

19. 19
NET OIL-EXPORTERS
The ramifications of lower oil prices for net oil-exporting countries are somewhat less nuanced than
those of net oil-importers. The significant presence of oil has led to many of these countries
developing economies that are largely built around this one natural resource. As a result, while low
oil prices will be negative for this group of countries, it will be especially painful for those whose
fiscal budgets require significantly higher oil prices, have low levels of capital reserves, and derive
nearly 100% of government revenue from oil exports. Data presented in Charts 14 and 15 help
distinguish those that are facing a very difficult situation from those that may be in full-blown crisis
mode.
Libya, Iraq, Nigeria, and Venezuela each require significantly higher oil prices to balance their fiscal
budgets and also rely on oil for over 70% of their total country revenues. In addition, these
nations have relatively small foreign exchange reserves and sovereign wealth funds to help
mitigate the pain of a prolonged downturn in prices. The lack of capital also reduces the ability to
defend currencies and increases the likelihood of both budget cuts and higher taxes to help shore
up country finances. These collectively end up amplifying the economic pain from the decline in oil
prices and also increase the risk of social unrest. Conversely, Saudi Arabia, Norway, UAE, Qatar,
and Kuwait have fortress-like balance sheets and sterling credit ratings. Norway can lay claim to
the world’s largest sovereign wealth fund and plans to spend 3% of it in 2015 to offset the drag
from its oil industry.40
40
Milne, Richard. "Norway Faces Up to Prospect of North Sea Slowdown." Financial Times. 23 Feb. 2015.
Source: SWF data from Sovereign Wealth Fund Institute
(2014). Foreign Exchange Reserve data from CIA World
Factbook (2014)
Source: Break-even prices for all countries except
Nigeria, Venezuela, and Norway from IMF (January
2015). Nigeria and Venezuela break-even from Deutsche
Bank (January 2015), Norway break-even from Fitch
Ratings (January 2015). Oil as a % of GDP data from EIA
(2014) and Natural Resource Governance Institute
(2014).
CHART 14: NET OIL-EXPORTER
BREAKEVEN PRICE AND OIL AS % OF GDP
CHART 15: NET OIL-EXPORTER FOREIGN
EXCHANGE RESERVES AND SOVEREIGN
WEALTH FUNDS (SWF)

20. 20
Low oil prices have added to the laundry list of challenges facing both Iran and Russia due to the
sanctions imposed on them prior to the rout in oil. Iran’s sanctions emanated from its nuclear
program. At the time of this report, Iran and the UN Security Council had come to a framework
from which a comprehensive agreement may be struck by June 2015. The potential lifting of
sanctions should benefit Iran from a capitalization standpoint, as limits on crude exports and
foreign investment are lifted. In addition, sanctions have restricted Iran’s access to $100B in
foreign exchange.41
Russia’s military escapade with Ukraine resulted in a number of sanctions, which combined with
geopolitical risks, pressured the ruble. The drop in oil prices only magnified this damage, and since
Russia imports most goods aside from energy, a much cheaper ruble materially decreases living
standards for Russians. In addition, Russian banks and companies are estimated to owe foreign
creditors approximately $600B. If not for Russia’s foray with Ukraine, these debts would be
slightly easier to address as the sanctions placed on Russia ban these companies from refinancing
with Western banks.
The main risk that arises from these countries largely lies in tail events. A number of these
countries had volatile social and political climates even before oil declined, and the marked
reduction in income and financial resources now adds to the various pressures these respective
governments are facing. So while net oil-importers will capture the lion’s share of GDP gains from
net oil-exporters, the paradox of low prices may lead to destabilization of these regions which, in
turn yields an unexpected price shock, allowing these countries to claw back some of the lost GDP.
41
Giles, Chris. "Winners and Losers of Oil Price Plunge." Financial Times. 15 Dec. 2014.

21. 21
OIL MARKET RECOVERY OUTLOOK
Unlike price volatility attached to geopolitical actions in 1979 or the Great Recession in 2008, the
2014 retreat in oil prices appears to have a much more simplistic root cause – a persistent
overhang of 900,000 barrels/day that was unable to be absorbed through moderating global
demand. Economic results for Europe and China led to economists ratcheting down growth
expectations, which directly impacted oil consumption forecasts. When coupled with additional
production capacity, market participants were quick to re-rate the price of oil based on these new
forecasts. OPEC’s decision at its November 2014 meeting to maintain production despite oil’s
weakness further contributed to another 27% decline from November through year-end 2014.
CURRENT MARKET BALANCE
As illustrated in Chart 16, 2014 featured a growing level of excess supply. As we enter Q2 2015,
excess supply is expected to peak at 1.5mmbd before production declines in the second half of
2015. We expect greater volatility heading into Q2 and Q3 as increased production weighs on oil
prices and believe this period could present potentially attractive entry points across the industry,
provided that market balance can be achieved by Q1 2016. A balanced market is conducive, if not
necessary, for firming up prices before a recovery takes hold. While the composition and pace of
the recovery matter, establishing a level of price stability is the first step in contemplating
investment positioning. The balance of this segment addresses the main determinants for
correcting the existing supply/demand mismatch.
CHART 16: WORLD LIQUID FUELS PRODUCTION AND CONSUMPTION BALANCE
Source: EIA – March 2015

22. 22
SUPPLY AND DEMAND FUNDAMENTALS
The supply and demand landscape has changed remarkably over the past decade. Exceptional
economic growth in a number of emerging markets and technological advances that have led to the
emergence of new and retrievable sources of oil have had notable effects on traditional drivers of
supply and demand – conventional oil and OECD countries, respectively. However, before
reviewing a number of these changes, a brief overview of oil’s microeconomic model may be
helpful in understanding price responses in relation to changes in supply and demand.
All asset classes can be subject to volatility independent of fundamentals during periods of market
stress. Oil may be subject to a greater degree of price volatility that seems to disconnect from
fundamentals given its linkage to geopolitical events as well as the trend toward the financialization
of commodities. Nonetheless, underlying fundamentals still influence end prices, and the short-
term inelasticity of oil can result in sharp price responses to supply and demand, even without the
prevalence of extraneous events.42
If demand picks up, oil prices can rise steeply in the short term as consumers are not able to
quickly throttle down their usage or find alternatives. There is also a considerable lag factor for
new supply to come on line to absorb the increases in demand. The supply side reflects the
incentives of producers who – even in the face of a decline in price and income reduction – will
maintain production as long as income exceeds marginal production (cash) costs. Oil has a higher
level of elasticity over longer time periods, as consumers and producers can alter behaviors, but
the implication of short-term inelasticity is a steep supply and demand function, which leads to
greater price swings in response to seemingly minor changes.43,44
42
Hamilton, James. "Understanding Crude Oil Prices." National Bureau of Economic Research (2008)
43
McBride, Bill. “A Comment on Oil Prices.” Calculated Risk. 15 December 2014.
44
Taylor, Simon. “The Oil Price and Short and Long Run Supply.” Simon Taylor’s Blog (Professor in Finance at Cambridge
University) 18 January 2015.
 D0 and S0 represent what most people
envision in a typical supply and demand
function, a relatively “wide” X, which implies
more modest price responses to changes in
supply or demand.
 D1 and S1 reflect the steeper function of oil
supply and demand, leading to a much
“narrower” X. P0 reflects Brent price per
barrel based on this theoretical function and
assumed equilibrium of 93.0mmbd.
 For simplicity, we ignore the slight demand
moderation in 2014 and focus solely on
supply. S2 represents an increase of
1.0mmbd in supply, matching the
approximate supply overhang through the
latter half of 2014.
 P1 is the new price of Brent at roughly $55,
highlighting the sharp pricing response to a
slight increase in supply. If using D0, the
expected price would be just 10% lower than
$100 in reaction to a 1.0 million barrel (mmbl)
supply increase.
CHART 17: THEORETICAL OIL SUPPLY AND DEMAND FUNCTION

23. 23
DEMAND DRIVERS
The demand story over the past 12 years has been characterized by two distinct periods bifurcated
by the Great Recession in 2008. In the five years prior to 2008, both OECD and Non-OECD regions
drove oil demand. Following the Great Recession, oil demand was almost entirely carried by Non-
OECD consumption, specifically China.
Price inelasticity was a consistent theme from 2003 – 2008 as global demand from China stoked
consumption that significantly exceeded production growth. This led to a threefold increase in
prices. During that time, global petroleum consumption increased by 8.0mmbd; 47% of this
growth was accounted for by demand from China, followed distantly by India and Singapore.
Japan experienced the largest cumulative drop in demand, while Europe was a negligible
contributor to demand growth largely due to reduced oil consumption in Germany and Italy.
The demand picture changed markedly following the Great Recession in 2008 with global
consumption increasing by 5%, or 5.0mmbl in aggregate from 2008 – 2014. China, the Middle
East, and Central and South America were the largest contributors to net demand consumption. As
discussed in the first segment of this paper, OECD regions such as Europe, North America, and
Japan experienced very significant declines in consumption. This cohort reduced consumption by a
total of 4.1mmbl, nearly matching the 4.4mmbl increase in demand from Asia.
The contrasting trajectories between Non-OECD and OECD demand stems principally from the
trend of higher standards of living in Non-OECD regions compared to improving energy intensity in
OECD regions. Energy intensity refers to how much energy is required (consumed) to produce a
unit of GDP. From 1992 – 2012, energy intensity declined by 1.9% annually in the U.S., meaning
CHART 18: SELECTED COUNTRIES
CUMULATIVE MMBL GROWTH 2003 – 2007
Source: EIA
CHART 19: SELECTED COUNTRIES
CUMULATIVE MMBL GROWTH 2008 – 2013
Source: EIA

24. 24
that 30% less energy was required in 2012 than in 1992 to produce the same economic output.45
Some of this decline can be attributed to technological advancements as well as composition of
GDP. The economies of many OECD countries typically skew toward services as opposed to
manufactured goods, so the resulting demand from more manufacturing-oriented Non-OECD
regions, and thus more energy-intensive economies, has a disproportionate impact on oil demand.
In contrast to the reduced energy intensity of the U.S. and other OECD countries, the
industrialization of Non-OECD countries has led to increased demand for energy-reliant goods and
services. For example, China leads the world in new car registrations, outpacing the U.S. by 12%.
Nascent car markets in Brazil, India, and Russia are likely to experience accelerated growth in
comparison to mature markets in Japan and Europe.
While other Non-OECD nations may more meaningfully contribute to future oil demand, historical
data demonstrates the outsized impact from China. As a result, we believe contemplating a
demand-driven path toward a balanced market is best addressed through an analysis of China’s
ability to maintain its torrid demand. We also believe that low oil prices can stoke demand and
consider the effects of demand stimulation.
45
World Bank. "GDP per Unit of Energy Use (constant 2011 PPP $ per Kg of Oil Equivalent)."
http://data.worldbank.org/indicator/EG.GDP.PUSE.KO.PP.KD
Source: World Bank – 2011 (Most Recent Available
Data)
Source: Statista – January 2015
CHART 20: GDP PER UNIT OF ENERGY
USE
CHART 21: 2014 NEW CAR REGISTRATIONS
(000’s)

25. 25
“CALL ON CHINA”
The growth of Non-OECD countries combined with their higher-energy intensities has been the
predominant driver of oil demand over the past decade. Current prices have been impacted to a
large extent by additional supply, but moderating demand from Non-OECD countries, specifically
China, has played a role in the decline of oil prices.
Global demand is projected to grow by 0.8mmbl while supply is expected to grow by roughly
1.5mmbd.46
Under current conditions, it would take two years to bring the market into balance.
These estimates were made prior to March 4, 2015, when China reduced its GDP target from 7.5%
to “around 7%.” Further, a number of economic research firms believe China’s GDP is at risk for
further downward revisions.
The prior charts clearly show that other large Non-OECD nations have not come close to matching
China’s petroleum demand so any shortfall from this country is unlikely to be met by other high-
growth emerging countries. As for developed nations, OECD oil demand peaked in 2005, and
overall efficiency efforts, economic maturity, and alternative sources of energy are expected to
continue the trend of reduced oil consumption in these countries.
With China’s economy slowing, the near-term global demand outlook seems tepid. The overall
composition of China’s GDP, whereby fixed investment represents roughly 50%, also suggests that
the impact of moderating growth could have a more pronounced impact on oil demand. Fixed
investment largely relates to China’s efforts to drive infrastructure and industrialization, which rely
heavily on the transportation, power, and industrial sectors. These three sectors globally are large
consumers of oil; in fact, transportation accounts for over 50% of global oil consumption.47
Since
China’s economy has been heavily reliant on importing oil to drive growth in fixed investment
projects, even a seemingly mild downturn could have outsized ramifications on demand for crude.
One potential bright spot has been reports of China aggressively stockpiling crude through its
Strategic Petroleum Reserve (SPR). However, Citi Research expects the pace of stockpiling
through the SPR will be offset by a reduction in net imports. Net imports grew by 8.9% in 2014
compared to demand growth of 5.3%.48
Import growth was largely attributed to stockpiling related
to significant refinery capacity expansion. With those projects now complete, net imports should
grow at a modest pace.
Given the magnitude of China’s oil consumption, it’s certain that current oil prices impound China’s
reduced GDP expectations. However, our focus is to determine if the “Call on China”, which drove
demand for nearly 12 years, will be a significant or marginal contributor to correcting the
supply/demand mismatch in the near term. Given the factors listed above, we are skeptical of
China’s ability or interest to spur significant upside demand.
46
EIA
47
IEA
48
Szpakowski, Ivan. "China Oil: What Low Prices Mean for Chinese Oil Demand." Citi Research. 7 January 2015.

26. 26
DEMAND STIMULATION
The price shocks in 1979 led to reduced
demand from 1980 – 1982, but when prices
started to decline at an accelerated rate in
1984, consumption picked up by 3.2%.49
In
fact, U.S. demand increased by an average
of 2.6% annually from 1984 – 1988.50
With
oil prices roughly half of where they were
just a year ago, it would not be surprising to
see some boost in global demand. Non-
OECD regions consumed 45.0mmbd of oil in
2014. Assuming low prices lead to a 1%
increase in annual Non-OECD demand, an
additional 450 thousand barrels per day
(kbpd) would materialize, reducing the
market imbalance by nearly 50%.
However, it’s difficult to model net global
demand growth from lower oil prices given
the secular decline in demand from OECD
regions. This would suggest that a more
constructive path toward a balanced market
is likely to be through the supply side.
49
EIA
50
EIA
Source: EIA
CHART 22: U.S. ANNUAL CHANGE IN OIL
CONSUMPTION VS. WTI PRICES 1980 –
1988

27. 27
SUPPLY DRIVERS
The rapid development of U.S. LTO is the primary contributor to global supply growth over the past
five years. U.S. LTO is possibly the only reason for fewer price shocks following the Great
Recession, given that supply growth estimates outside of U.S. LTO by leading institutions, such as
the IEA, have largely proven to be overly optimistic.51
As illustrated in the charts below, while U.S.
LTO supply grew by 74% from 2005 – 2014, aggregate Non-OPEC supply growth excluding the
U.S. was just 4%, while OPEC supply growth was 5%. The contrast between U.S. LTO and OPEC
production hints at several key differences between OPEC and Non-OPEC participant behavior and
composition of oil sources.
51
“In fact, in contrast with North American supply, global oil supply has surprised on the downside” p.11 of IEA’s Medium-
Term Oil Outlook 2014.
Source (Charts 23 and 24): EIA
CHART 23: OIL PRODUCTION BY REGION 2005 – 2014
CHART 24: OPEC PRODUCTION 2005 – 2014

28. 28
TABLE 2: OPEC VS. NON-OPEC
OPEC NON-OPEC
Production Motives
OPEC nations have used oil as the
foundation of their economies, and
thus this resource becomes important
for political, social, and economic
goals that may be unrelated to or
even inconsistent with profit
maximization. For example, some
OPEC nations heavily subsidize oil
costs for their citizens as essentially a
sovereign right.
Certain Non-OPEC producers
incorporate similar motives to OPEC
producers, but by and large, Non-
OPEC production tends to be focused
on profit and capital-return
maximization.
Development Entities Nationalized Oil Companies (NOCs)
Some NOCs but a high number of
Investor-Owned Companies (IOCs)
Source Characteristics Typically large, onshore, conventional
Increasingly unconventional,
relatively smaller fields
Extraction Costs
Varies, with some countries like
Venezuela having heavy and sour
crude, while the bulk of OPEC –
especially Middle East and North
Africa (MENA) – having some of the
cheapest reserves to find, develop,
and produce.52
Relatively high due to complex
geology (deep water, shale),
composition of source (oil sands),
and technologies required to access.
It’s difficult to fully appreciate the difference between OPEC and specifically MENA oil fields and
reserves relative to the rest of the world until marginal and breakeven costs have been
incorporated. These differences have very stark consequences for both the near-term and long-
term global supply outlook and also suggest supply must be addressed solely through the U.S.
LTO market.
52
Darbouce, Hakim, and Bassam Fattouh. "The Implications of the Arab Uprisings for Oil & Gas Markets." The Oxford
Institute for Energy Studies (2011).
CHART 26: GLOBAL LIQUIDS COST
CURVE
Source: Rystad Energy – January 2015
CHART 25: MARGINAL PRODUCTION
COSTS
Source: Morgan Stanley – December 2014

29. 29
As Chart 25 demonstrates, MENA fields enjoy some of the lowest cash costs. In contrast, the U.S.
market – in this case a very broad and sweeping generalization – has on average $28/bbl cash
costs. This figure includes cheaper, conventional oil along with typically higher-cost LTO, so a
more accurate estimate of average cash costs for LTO would be greater than the $28/bbl. The
implications of this higher estimate become clearer when incorporating Rystad Energy’s estimated
breakeven prices in Chart 26.
Onshore Middle East has an average breakeven of $25/bbl but marginal costs – in the case of
countries such as Saudi Arabia, Iraq, and Iran – of just $5/bbl – $8/bbl. Offshore Shelf,
represented by regions such as the Outer Continental Shelf in the Gulf of Mexico, has average
breakeven costs of $40/bbl with cash costs of $10/bbl. In contrast, North American Shale (NAM
Shale) has an estimated breakeven of $62/bbl and a marginal cost in all probability higher than the
$28/bbl U.S. average. This high proportion of cash costs relative to breakeven for U.S. LTO
speaks to the more complex and capital-intensive process of LTO extraction and likely encouraged
Saudi Arabia’s decision to maintain production in November 2014.
We believe that a supply-led approach to correcting the existing production overhang rests on an
analysis of the likelihood of supply disruptions and reining in of U.S. LTO. We believe the latter is
the most influential factor, and given unimpressive production elsewhere (Chart 30, p.34), greater
confidence in a price-bottoming process can be established as signs of reduced U.S. LTO production
materialize.

30. 30
SUPPLY DISRUPTIONS
The U.S. was the largest contributor to oil supply growth in 2014, but contributions from Iraq also
surprised industry analysts.53
In addition, through many parts of 2014, Iran’s production tested
and in some cases exceeded the 1.0mmbd production limit enacted through Western sanctions.
Given the involvement of the Islamic State of Iraq and the Levant (ISIS or ISIL) within Iraq, Iran’s
participation in this conflict, and more importantly, the observed spillover of ISIS into Yemen and
Syria, supply disruptions are plausible. Aside from Iraq, production could be put at risk by other
exporters with poor capital reserves that face a greater likelihood of civil unrest.
While the prospect of supply disruptions and the impact to market balance may be
underappreciated, the reality is that these events relate to geopolitical, essentially conflict-fueled
events, and are not likely related to economically motivated behaviors of market participants. It is
also far too difficult to ascertain when and if production will come off line. Despite the fighting in
Iraq, the country produced a record 4.0mmbd in 2014, exceeding its previous milestone set in
1979. As a result, we believe investors are better off acknowledging supply disruptions as a tail
event and spending more time understanding U.S. LTO dynamics.
53
This sentence refers to Chart 27, which reflects the top contributors to global oil supply growth. So while countries such
as Saudi Arabia supplied 9.7mmbd of crude oil in 2014, the actual growth from 2013 was just 0.08mmbd or 80kbpd; total
OPEC production growth from 2013 to 2014 was -916kbpd (March 2015 OPEC Monthly Report Table 5.5).
CHART 27: TOP CONTRIBUTORS TO GLOBAL OIL SUPPLY GROWTH 2014
Source: EIA – February 2015

31. 31
U.S. LTO
Investors may question why the bulk of supply curtailments must be enacted by U.S. LTO given the
higher breakeven and marginal costs of other sources of oil. We believe there are two primary
reasons: one relates to the economic profiles of significant net-exporting nations (OPEC and Non-
OPEC), and the second relates to a number of factors unique to LTO.
Many of the higher-cost sources presented in Chart 25 are from nations that simply have no
alternative from a production standpoint. Nearly 100% of the Venezuelan government’s revenue is
derived from oil sales. This figure stands at 70% for Nigeria and 50% for Russia. With the
exception of Russia, neither Venezuela nor Nigeria has finances that can fund social and economic
programs in the medium term or perhaps even short term. As a result, investors should expect
that these nations will continue to produce oil regardless of price.
The second reason why we believe the production burden falls on U.S. LTO is because of its relative
production flexibility. U.S. LTO is a unique source of oil in terms of its geological composition.
Conventional oil tends to be extracted from reservoir rock, which is typically closer to the surface.
For example, the average conventional Texas oil well is 3,500 ft in depth.54
LTO is extracted at
levels significantly below this level and features far less permeable rock formations. The overall
pressure levels are also much higher relative to the rock where conventional oil is extracted, so
when fissures are made through the hydraulic fracturing process, a much higher level of oil is
initially recouped with LTO. As a result, the underlying payback and internal rate of return (IRR)
profile is considerably different than other sources of oil.
54
“The Depth of Oil Wells.” Energy & Capital. 3 November 2014.
EXHIBIT 1: CONVENTIONAL AND UNCONVENTIONAL OIL AND GAS DEPOSITS
Source: EIA

32. 32
As can be seen in the chart above, other sources of oil have far longer payback periods and more
importantly, have much longer lead times whereby “turning off” production is not feasible. In
contrast, the quick payback period provides significant flexibility for LTO operators whereby
production can be scaled down much more quickly than other sources of oil. Notwithstanding the
expected first-half production increase in 2015 from 2014 wells coming on line, one way to proxy
for reduced future production is through analyzing U.S. rig counts. Despite the slow start,
particularly with horizontal rigs, which represent the bulk of U.S. drilling, producers seem to have
started to rapidly adjust.
CHART 28: KEY ECONOMIC METRICS FOR PRINCIPAL SOURCES OF OIL SUPPLY
* Estimates based on $90/Brent
Source: Rystad Energy – January 2015

33. 33
Chart 29 is an indexed rig count. The value 100 represents the peak value, with figures below
representing the percentage change from the peak. For example, in the 1985 – 1986 period, rig
counts had declined by nearly 70% by week 25. In fact, by week 31 of that period, the rig count
had bottomed out. In contrast, it took nearly two years for rig counts to bottom out following
peak values in 1997.
The 2014 – 2015 period is interesting in that horizontal rig counts continued to increase despite the
aggregate rig count declining. What this could represent is skepticism by operators that the
decline in oil prices would be sharper than what has ultimately materialized. The good news is that
since the initial delay, rig counts have declined very sharply, almost matching the pace that rig
counts fell during the Great Recession. If this rate of decline continues, a bottom in rig counts
could be achieved within another 8 to 16 weeks.
Reduced U.S. LTO production would bode well for global supply/demand balance as U.S. LTO has
been the main driver of supply growth in 2015, and OPEC spare capacity is modest relative to past
price collapses. If U.S. LTO production is effectively rationalized, EIA’s expectations for a much
healthier market at the end of 2015 seem quite reasonable. This would suggest that Q2 and Q3
could set the stage for establishing a more constructive approach to the oil sector, given
inventories should peak in Q2.
CHART 29: INDEXED RIG COUNT
Source: Baker Hughes – April 10, 2015

34. 34
In fact, U.S. inventories have been an area of keen focus for the market since February 2015.
Given the parabolic increase in stockpiles, we believe it’s important to address if this could impact
or prolong the period of excess supply. While the rapid pace of stockpiling is a concern, it reflects
not only increased production but also the impact of both planned and unplanned refinery outages.
CHART 31: WEEKLY U.S. CRUDE OIL STOCKS (MMBL)
Source: EIA – April 3, 2015
CHART 30: NON-OPEC PRODUCTION GROWTH
Source: EIA – March 2015

35. 35
The first quarter is when refineries switch from winter-blend to summer-blend fuels. This process
requires that some of their capacity is taken off line so the facilities can be modified to process
summer fuels. As a result, each Petroleum Administration for Defense District (PADD), which
refers to the various refinery regions in the U.S., will have significant levels of capacity offline. As
illustrated in Charts 32 and 33, in February and March, the amount of capacity offline can range
from 3% in the case of PADD 5 (Chart 32) to nearly 15% for PADD 1 (Chart 33). These planned
outages contribute to stock builds in the first quarter, but by May most refineries are ready for the
summer driving season.
Unplanned outages may have had a larger impact on inventories than planned outages in 2015.
U.S. Steelworkers (USW) had been striking at what accounted for 15 refinery sites (20% of U.S.
refining capacity) from February – March. When strikes occur, the refinery owners can hire
temporary workers, idle parts of the plant, idle the entire plant, or do a combination of all three.55
At the time of this report, the USW and Royal Dutch Shell – negotiating on behalf of companies
operating the refineries that were subject to striking employees – struck a deal that would bring
workers back to the refineries during the month of April. Since that national agreement, talks have
moved toward securing local contracts, with some uncertainty still present with respect to when all
refineries will be back on line.
It’s helpful to frame the potential impact of the strikes on inventories. The March 27, 2015 EIA
Weekly Petroleum Status Report noted that inventories increased by 4.8mmbl from the previous
week. Tesoro operates several refineries that were subject to the USW strike. Its Golden Eagle
refinery in Martinez, CA refines 166kbpd and was idled during the strike. Assuming 90%
utilization, if this refinery was operating for a full week, it would have drawn on 1.0mmbl or 21% of
the inventory that was built up in the prior week. BP’s Whiting refinery in Indiana is one of the
55
Temporary workers may still maintain the plant even if no refining is occurring – hence idle the entire plant while still
employing temporary workers.
CHART 32: PLANNED REFINERY
OUTAGES - % OF CAPACITY OFFLINE
– ATMOSPHERIC CRUDE
DISTILLATION UNIT (CDU)
CHART 33: PLANNED REFINERY
OUTAGES - % OF CAPACITY
OFFLINE – FLUID CATALYTIC
CRACKING UNIT (FCCU)
Source (Charts 32 and 33): EIA – March 2015

36. 36
largest suppliers of gasoline to seven Midwestern states. It was affected not only by the strike but
also unplanned operational issues. The Whiting refinery is capable of refining 413kbpd yet had to
idle significant parts of the facility due to unplanned operational and strike issues.
As striking workers return, the refineries should draw down on these higher levels of inventories.
The previously referenced EIA Weekly Petroleum Status Report indicated that gasoline inventories
decreased by 4.3mmbl in the comparable week. This is good news in that it demonstrates
consumers have maintained, if not potentially increased, end-product demand due to lower oil
prices. This suggests the inventory build could be quickly reversed and reduces the likelihood that
inventories will remain a persistent overhang on supply concerns.
In conclusion, it seems that U.S. LTO is on pace to match EIA’s as well as a number of analysts’
expectations for reduced production growth in the second half of 2015 with a much tighter market
materializing by Q4 2015. The reduction in supply should be supportive of oil prices but does not
suggest a sharp, upward directional outlook. In fact, the flexibility of U.S. LTO makes it an ideal
swing producer, allowing for rapid production curtailments as well as quick deployment. This could
play a meaningful role in potentially capping prices and influences our recovery outlook.

37. 37
RECOVERY OUTLOOK
Despite a more balanced market toward the back half of 2015, we expect the recovery in oil prices
to be gradual and adopt more of a “U” shape as opposed to “V.” The primary reasons center on:
- Tepid demand expectations
- Operational flexibility of U.S. LTO
- Access to derivatives markets by LTO producers
- Well deferrals
- LTO productivity gains
Our demand discussion suggests that with the “Call on China” likely off the table, incremental
demand will fall on much smaller regions and the effects of demand stimulation through lower oil
prices. The net effects may not be supportive of a rapid move to $100/bbl (Brent).
The most important factor influencing our “U”-shaped recovery expectation continues to be supply.
While a balanced market will lead to some level of price support, we believe the ability for U.S. LTO
to rapidly deploy production could stunt and prolong a price recovery. Any short-term upward
price spike can provide a window for offline LTO operators to commence production. This is due to
the unique operational aspects of LTO previously discussed, which leads to a relatively short
payback period.
This short payback period is associated with steep decline curves, whereby 60 - 80% of an LTO
well can be extracted within one to three years of production. As a result, an enterprising operator
can capitalize on a spike in oil prices to sell forward one to two years of production. This action
would essentially guarantee additional supply brought to market for the duration of the derivative
contract. This combination of wells that could come online rather quickly could lead to a persistent
level of market overhang, similar to the shadow housing inventory that plagued the recovery of the
U.S. real estate market following the Great Recession.
In addition, while rig counts have declined considerably, a number of companies, such as
Continental Resources, Apache, Anadarko Petroleum, and EOG have begun to postpone well
completions in recent months. These well deferrals, known as the “fracklog,” are a new take on
storage economics. Rather than pay additional capital to extract the oil and then store it,
operators simply “store” the oil in the ground by deferring the fracking process until the advent of
a more attractive pricing environment. Unlike many other sources of oil, the completion costs for
shale wells can account for up to two-thirds of the total cost.56
Wood Mackenzie estimates that the total fracklog by the end of 2015 will be below the current
3,000 number of deferred wells.57
Baker Hughes reported 9,544 new wells were drilled in Q4
2014, which suggests deferred wells per Wood Mackenzie represent about one month of new well
formation. This element of potential supply seems relatively modest but could weigh on sentiment.
Lastly, LTO operators have been greatly increasing efficiency. BHP Billiton, which entered the U.S.
LTO market through its 2011 acquisition of Petrohawk, recently indicated that its drilling costs
declined by 17% while its drilling time improved by 11%. BHP can now drill more wells per rig,
which is helping drive capital costs down.58
This implies that as productivity increases, breakeven
costs could decline. It also suggests that the reduction in rig count may not lead to as steep a
56
Kemp, John. "Shale Producers Postpone Oil Well Completions." Reuters. Thomson Reuters, 20 Feb. 2015.
57
Crooks, Ed. "Demystifying the ‘Fracklog’" Financial Times, 19 Mar. 2015.
58
Hume, Neil. "BHP Highlights Shale Productivity Gains " Financial Times, 26 Feb. 2015.

38. 38
decline in production assuming additional strides in efficiency. The combination of these factors
supports our “U”-shaped recovery expectation. It is also consistent with futures curves, which
have modest slopes, and consensus estimates.
Earlier in this report, we demonstrated the significant volatility that has accompanied oil prices.
We also presented the notion that the supply/demand function for oil can lead to sharp price
responses relative to minor supply and demand changes. Under those prior observations, we
would be remiss to not include risks to our outlook.
CHART 34: WTI FUTURES CURVE CHART 35: BRENT FUTURES CURVE
Source: FactSet (Charts 34 and 35), futures curves as of April 6, 2015
CHART 36: CONSENSUS ESTIMATES
Source: FactSet, estimates as of April 6, 2015

39. 39
Downside to Oil Prices:
- Lifting of Iran Sanctions: As of April 6, 2015, Iran has come to a tentative agreement with the
members of the UN Security Council in Lausanne, Switzerland. This should pave the way for a
formal accord when the two groups meet again in June 2015 and would lift the economic
sanctions, which were enacted in late 2011 in response to Iran’s nuclear program. Iran’s oil
exports are limited to 1.0mmbd, or roughly half of its export levels prior to the sanctions.59
In
the March 2015 OPEC Monthly Report, Iran’s production stood at 3.0mmbd compared to
4.2mmbd of production prior to sanctions. If Iran is able to secure a comprehensive agreement
that lifts the restrictions, it could add 0.7mmbd – 1.0mmbd of production, which could pressure
prices.
- Libya: The civil war in Libya has profoundly impacted the country’s oil production. Since the
Arab spring in 2011, Libyan oil production has declined tremendously, and its ability to maintain
production has continuously been tested. Despite this civil war, Libyan production increased
sharply from Q2 2014 to Q4 2014, adding 0.5mmbd to supply. This increase was not expected
and contributed to market imbalances. Through March 2015, Libyan production has again
succumbed to attacks by ISIS.60
We view Libya as a potential downside risk given its current
production is so low that further deterioration has limited impact. In contrast, if the violence
quells, Libya could increase production markedly, matching if not exceeding its 0.5mmbd
increase in parts of 2014.
- Extraction tax reductions: Numerous countries are reducing extraction taxes and providing
incentives to offset some of the pressure oil producers are facing. The UK’s Chancellor George
Osborne reduced production taxes by 6% and 17% for old and new fields, respectively.61
In
China, the National Development and Reform Commission (NDRC) is raising the price per barrel
at which “abnormal gains” taxes are levied, from $55 to $65 (Brent).62
59
Bousso, Ron, and Timothy Gardner. "Iran's Oil Exports Surge Above West's Sanctions Cap: IEA." Reuters. Thomson
Reuters, 11 Apr. 2014
60
Malsin, Jared. "ISIS Allies Try to Cut Off Libya's Oil Revenue." Time. 16 Mar. 2015.
61
Gosden, Emily, and Andrew Critchlow. "Oil and Gas Industry Bolstered by Reduction in Tax Rates and New Investment
Allowances Worth £1.3bn over Five Years." The Telegraph. 16 Mar. 2015.
62
Szpakowski, Ivan. "China Oil: What Low Prices Mean for Chinese Oil Demand." Citi Research. 7 January 2015.
CHART 37: LIBYA PRODUCTION ANNUAL CHART 38: LIBYA PRODUCTION QUARTERLY
Source: OPEC (Charts 37 and 38)

40. 40
Tax relief may also have a very material impact in the U.S., specifically North Dakota, due to a
tax incentive that exempts producers from the state’s 6.5% oil extraction tax if WTI prices
average under $55.09/bbl for five consecutive months. Many operators, as well as North
Dakota’s tax commissioner Ryan Rauscherger, believe this tax break will go into effect, with a
number of producers anticipating June 2015 as the time period for when this occurs.63
North
Dakota is the second-largest oil-producing state in the U.S., and the timing of this event would
coincide with the period when production is expected to decline.
- U.S.-led demand erosion: The U.S. has been one of the brighter economic stories in the past
few years, but recent economic news has been somewhat underwhelming. Challenges faced in
other regions of the world are well documented, but if the U.S. economy moderates, oil demand
could drop, further widening the supply/demand gap.
Upside to Oil Prices:
- OPEC Market Intervention: Saudi Arabia seems committed to maintaining production but cartel
members, such as Nigeria, requested emergency OPEC meetings in late February 2015. OPEC
is scheduled to meet in June 2015, and it seems unlikely that Saudi Arabia will intervene and
reduce production. In the event that Saudi Arabia surprises the market with a production cut,
prices could move sharply upward. Even a small cut could propel prices given the signaling
impact of a Saudi Arabia “put” on production.
- Stronger than expected demand stimulation: Transportation is the largest consumer of oil
globally. In our prior discussion on inventories, we noted the drawdown of gasoline inventories,
suggesting consumers in the U.S. are taking advantage of the lower pricing environment.
Morgan Stanley also notes that OECD oil demand is much more elastic than Non-OECD
demand, meaning low prices could result in surprise consumption increases from OECD
countries.64
China has taken advantage of low oil prices to build its Strategic Petroleum Reserve (SPR). The
country will have potentially five new SPR facilities open in 2015, which could store an
additional 100mmbl of capacity. To put this in context, China’s annual oil consumption is
approximately 11.0mmbd. Assuming five new tanking units were available and China filled
them to capacity over the course of the year, demand would increase to 11.3mmbd.65
This
would represent incremental demand growth of 2.5% due to lower oil prices. The overall net
effect would probably be lower given potential demand declines stemming from broader
economic challenges and technical limitations on filling tanks to full capacity, but it would
nonetheless be demand stimulation.
Other countries are also adding to their strategic reserves, or in some cases starting reserve
programs. According to the IEA, India approved a $338MM budget to begin work on the
country’s first strategic oil reserves.
63
Scheid, Brian. "Tax break, time limits may cause Bakken oil ‘surge’ this summer." The Barrel Blog. Platts, 20 Mar. 2015.
64
Longson, Adam. "Crude Oil – 2015: It Likely Gets Worse Before It Gets Better” Morgan Stanley. 5 December 2014.
65
(100mmbl/365 days) + 11.0 = 11.3mmpd

41. 41
EIA estimates 2015 production of 94.1mmbd against demand of 93.1mmbd. If low prices result
in incremental demand stimulation of just 1%, the market would be in balance, and oil prices
could move up. Despite tepid global growth expectations, low oil prices can jolt demand to
reduce the modest slack in the market.
The risks to our outlook manifest in the following ways. Downside risks will either put further
pressure on oil prices or extend the length of the recovery, but our “U”-shaped expectation already
implies a more protracted timeframe relative to a “V.” Upside risks may predominantly lead to
price spikes, but we think the magnitude of those moves will be capped by aggressive deployment
of U.S. LTO in response to higher prices. This combination of risks presents a backdrop of price
volatility as opposed to a directional trade, and we have structured our Investment Positioning to
limit downside risks while still allowing investors to participate in potential upside “beta”
opportunities.

42. 42
INVESTMENT POSITIONING
History has demonstrated that market dislocations within the oil industry can provide ripe
opportunities for long-term investors. We examined the recoveries following 1986, 1998, and 2008
oil price collapses to compare how equity prices moved in relation to WTI. We found that after the
initial shock of lower oil prices, asset prices began to embed reduced expectations, reducing the
sensitivity to crude oil price movements and mitigating downside risk.
The recoveries above still require investors to accept a level of volatility to capture eventual upside
movements. However, the volatility within the S&P Energy Index was much lower relative to the
underlying WTI price and was generally range bound, suggesting a bottoming process within asset
valuations and prices. The combination of a lengthy 10 month period of price volatility from June
2014 – April 2015, and a number of sectors within the oil & gas industry having sold off make us
more constructive on the space.
We also appreciate the contrarian notion that negative analyst ratings are coincident or lagging
indicators relative to future stock performance. Chart 40 provides the historical percentage of sell-
side analysts’ Buy, Hold, and Sell ratings of Exxon Mobil (XOM) against its stock price. Increasing
analyst bearishness, as reflected by a higher percentage of Sell ratings, generally occur near the
bottom of prices.
CHART 39: SELECTED RECOVERIES – WTI PRICE VS S&P ENERGY INDEX
1) Nearly four year recovery
period for WTI, including a
volatile rebound and pullback in
1987.
2) Equity uptrend decouples from
retrenching WTI prices in Q2
1998.
3) Oil and gas equities were
generally range bound despite
a nearly 18 month long 40%
decline in WTI.
4) From October 2008 – February
2009, oil and gas equities had
stabilized despite WTI dropping
an additional 50% over the
same period. If not for the
global asset sell-off tied to the
Global Recession in March
2009, the S&P Energy Index
may have recovered faster.
Source: FactSet
1
2
3
4

43. 43
Analysts were quite negative on the prospects of XOM in 6/30/2002, with nearly 20% of analysts
assigning a Sell rating on the stock. However, this excessive bearishness coincided with what
would be a multiyear bottom in the stock. Analysts progressively increased their negativity on
XOM from 2008 through 2010, with Sell ratings accounting for 0% of total analyst estimates in
6/30/2008 to 13% by 9/30/2009. Just 15 months later, XOM would be 7% higher than its
9/30/2009 closing price.66
In contrast, XOM declined by 27% from 1/1/2008 to 9/30/2009, despite
a sell-side community that assigned far more bullish prospects to XOM during this period.
The purpose of Chart 40 is not to deride the ability of sell-side analysts but to showcase that
increased pessimism, even by those that are considered experts, generally materializes after the
bulk of price erosion has occurred. Chart 40 refers solely to XOM but when combined with our
analysis of prior recoveries, is helpful in establishing the idea that oil-related equities may be
pricing in greatly reduced and thus achievable expectations.
This thesis is also supported when comparing the price movements of WTI relative to growing
spare capacity, after crude oil prices have already dropped by a significant degree. This paper has
discussed the impact and concern surrounding excess capacity in the US. Inventories may
continue to grow but if we proxy historical OPEC spare capacity, crude oil prices had bottomed in
many cases before peak inventories materialized. As the red areas in Chart 41 illustrate, WTI
prices rallied in 2002, 2009, and 2013 as OPEC spare capacity increases. At this stage, investors
that fixate on inventory levels may be monitoring lagging and coincident indicators from an
investment standpoint, essentially data with little to no incremental value relative to future prices.
66
XOM closing price on 12/31/10 was $73.12, 7% higher than closing price of $68.61 on 9/30/09
CHART 40: EXXON MOBIL (XOM) PERCENTAGE OF BUY/HOLD/SELL RATINGS
Source: FactSet – April 2015

44. 44
The collective analysis from prior recoveries, historical impact of increasing negative analyst
ratings, and oil price behavior ahead of peak inventory levels leads us to take a more constructive
stance on oil-related asset exposure. We don’t believe – as discussed in our recovery outlook –
that a sharp directional trade is warranted. Prices may be bottoming and asset prices may
impound lower expectations, but ultimately a low pricing environment can still pose a number of
operational and financial challenges for a broad subsect of the oil and gas industry.
Our investment approach underscores mitigating the risk that could materialize should the
probability for downside risks increase while still providing the opportunity to participate in upside
movements. As previously mentioned, our downside risks primarily entail a longer recovery period
and the potential for a further collapse in prices. As a result, we favor the following sectors within
equity and fixed income.
CHART 41: OPEC SPARE CAPACITY
Source: EIA – April 2015

45. 45
IOG’s business models feature both upstream and downstream operations, and the earnings
volatility relative to pure-play Exploration & Production (E&P) tends to be lower. In fact, we believe
that the downstream and refinery operations of many IOGs acts as a buffer to reduced operating
results from the upstream/E&P segments when oil prices decline.
Upon first glance, IOGs may seem somewhat boring relative to the equities and credits of
companies in other parts of the energy sector that have been savaged during this pullback.
However, a number of IOG equities have declined substantially, in excess of 20%, since the
pullback in crude. IOGs had also been cheap relative to their historical averages even before the
collapse in oil prices. Since then, certain valuation metrics of IOGs are approaching 2008 levels.
TABLE 3: CNR EQUITY & FIXED INCOME POSITIONING
CHART 44: DIVIDEND YIELD S&P 500 VS
IOG SECTOR 2001 – 2014
Source (Charts 43 and 44): FactSet
CHART 43: HISTORICAL P/B (TOP) & P/S
(BOTTOM) VALUATION IOG SECTOR 2001 -
2014

46. 46
Chart 43 shows that since 2009, the Price to Book (P/B) and Price to Sales (P/S) ratios for IOGs
have compressed, now matching or below levels seen during the 2008 Great Recession. The
average and median values for P/B and P/S from 2001 – 2014 were 1.9x and 0.9x, respectively.
Current P/B and P/S multiples of 0.9x and 0.6x imply discounts of approximately 40%-50% from
long-term historical values.
Another way of assessing value is between the implied spread between the dividend yield of the
S&P500 and IOG sector. Data from Chart 44 highlights nearly a 150 basis point (bps) spread
between the dividend yield of IOGs and S&P 500. While there are numerous reasons for these
discounts that have been addressed in previous segments of this paper, a substantial level of
pessimism seems to be impounded in IOG earnings expectations.
Our outlook also calls for a “U”-shaped recovery, implying a lengthier time horizon for price
improvement relative to a “V”-shaped recovery, and incorporates expectations of US LTO
operational flexibility capping upward price movements in oil. This means longer-term investors
can capitalize on the attractive valuations and defensible, competitive dividends of IOGs, while they
make significant strategic and financial maneuvers to better participate in the next upswing in
prices.
IOGs have performed relatively poorly compared to other energy sectors despite high oil prices in
recent years. This contributed to the valuation multiple compression illustrated in Charts 43.
Unimpressive returns on capital stemmed from greater capture of incremental profitability per
barrel to oilfield service companies and governments via higher extraction taxes. Morgan Stanley
estimates that over the past decade, similar IOG projects have experienced cost inflation of over
100% while production related taxes increased by 600-700 bps.67
The decline in oil prices is allowing IOGs to potentially reverse this trend with oilfield services and
governments. We believe the longer the period of depressed prices, the greater the potential
pressure the IOGs can apply to the supply chain. Previous sections of this paper have already
addressed possible changes to extraction taxes that would benefit producers. In addition, a
number of Q4 2014 earnings calls have hinted at the oncoming pressure and concessions IOGs will
seek to secure. This combination of an integrated business model, defensible cash flows, healthy
credit metrics, scale, and capacity to pursue strategic transactions when other competitors may be
undercapitalized, are all reasons we favor high quality IOGs in both our equity and fixed income
portfolios.
We think the pressure applied by IOGs to the supply chain will squeeze a number of middling
oilfield service companies. These companies are likely to lose share to the leading oilfield service
participants. The equities we have targeted within the oilfield services segment are high quality
with strong and competitive margins and returns. These companies also feature broad service
portfolios, with exposure to many regions, as well as leading technology to optimize reservoir
returns. Lastly, M&A within this sector, specifically between Haliburton (HAL) and Baker Hughes
(BHI), will lead to just two companies – HAL/BHI and Schlumberger – controlling nearly 60% of the
oilfield services market.68
Our High Dividend & Income team has long preferred the equities of Midstream MLPs. These
entities do not take on title risk associated with oil, and are instead paid based on volume/take-or-
pay contracts. A number of the MLPs within our equity portfolios have interstate pipeline
67
Rats, Martijn. “2015 Outlook: Don’t Let a Good Crisis Go To Waste”. Morgan Stanley. 4 December 2014.
68
Slorer, Ole. “Pain and Gain – Upstream Spending Playbook, Feb. 2015.” Morgan Stanley. 11 February 2015.

47. 47
operations with income typically secured by long-term contracts, adding another level of income
and cash flow insulation. MLPs were also tested in 2008 – 2009 and despite the steep pullback in
oil, increased distributions by 7.9% and 3.2% in 2008 and 2009, respectively.69
The prior history
of maintaining and increasing distributions, the competitive relative yields, and strong business
models that may be misunderstood in terms of exposure to oil prices, provide an attractive entry
point for investors focused on midstream MLPs.
We believe our equity tilt towards high quality IOGs, leading oilfield service companies, and
midstream MLPs along with our investment grade exposure to IOGs establishes a compelling
foundation to participate in the current oil environment. The high level of uncertainty combined
with an appreciation of downside risks drives our focus on more defensible franchises that can
generate value through a combination of income and capital appreciation. Further, we believe the
more protracted the trough, the greater the likelihood that the underlying franchises within these
sectors become better-positioned for the eventual recovery.
We also recognize the need to position investors for the possibility of a more rapid swing upward in
crude oil prices. Despite the attraction some investors may have towards the equities of oil-related
companies that have suffered the sharpest declines, we believe that those may still pose a high
degree of capital impairment risk, as the underlying operations typically require much higher oil
prices to generate the earnings necessary to support higher equity valuation. Instead, we think
investors could capture similar returns to equities, albeit with a better risk proposition, by
potentially investing in the high-yield E&P sector.
The high-yield comparable universe presented in Charts 45 and 46 show that while many B and BB
rated securities cluster within a relatively narrow band in terms of yield to maturity (“YTM”), CCC-
rated E&P issues trade at a much steeper discount on a YTM basis. As Chart 45 illustrates, B-
rated E&P have an average YTM of approximately 9%, yielding roughly 300 bps more than BB-
rated E&Ps. However, CCC-rated E&Ps imply materially impaired credit quality relative to B-rated
E&Ps such that the YTM spread is nearly 2000 bps. This implies wide disparity amongst the CCC-
rated universe of E&Ps. Consequently, diligent analysis of the underlying issuers could uncover a
number of inefficiencies that investors can exploit.
69
Michael Clarfeld and Chris Eades. “MLPs Will Weather the Storm.” ClearBridge Investments. February 2015.

48. 48
Table 4 highlights the disparity between CCC-rated E&Ps. Bond A and Bond B are both actual
credits, but we have withheld the issue names as the example is intended solely for illustrative
purposes. Despite relatively similar coverage and credit ratios, Bond A trades at a steep discount
relative to Bond B. There may be a number of reasons this is warranted, or there may be some
pricing inefficiencies. We believe the primary conclusion is that the CCC-rated arena within E&Ps
may offer a number of inefficiencies enterprising investors can exploit. If credit analysis can
conclude CCC-rated credits can remain in compliance of debt covenants under a number of stress
tests, certain bonds may offer the prospect of very attractive relative income as well as the
potential for equity-like upside as prices improve.
CHART 45: NET DEBT/EBITDA VS YIELD
TO MATURITY (YTM) INDEX
CHART 46: EBITDA/INTEREST VS YIELD
TO MATURITY (YTM) INDEX
Source: Data for Charts 45 and 46 from FINRA and pulled from FactSet – March 2015
TABLE 4: ILLUSTRATIVE DISPERSION OF HIGH-YIELD CREDITS
Bond A Bond B
Bonds Senior Senior
Maturity 10/15/2018 9/30/2022
Moody's Rating B3 B3
S&P Rating CCC+ CCC+
Coupon 9.63% 6.88%
Size ($mn) 450 350
Recent Price 68.00 89.50
Yield To Worst (%) 22.89% 8.81%
Next Call Date 10/15/15 09/30/17
Next Call Price 102.41 105.16
EBITDA/Interest 4.9x 4.9x
Net Debt/EBITDA 2.5x 1.7x
Source: FINRA data pulled from FactSet – March 2015