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EY Price Point: Global oil and gas market outlook Q4 2018

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A range of upside forces have shifted market sentiment and some parties are talking of $90, or even $100/bbl oil in the short to medium term. Our insights on the outlook for the global oil price in Q4 2018.

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EY Price Point: Global oil and gas market outlook Q4 2018

  1. 1. EY Price Point: Global oil and gas market outlook Q4 | October 2018
  2. 2. Page 2 Q4 | October 2018 EY Price Point: global oil and gas market outlookPage 2 Gary Donald Andy Brogan EY Global Oil & Gas EY Global Oil & Gas Assurance Leader Transaction Advisory Services Leader gdonald@uk.ey.com abrogan@uk.ey.com Q4 overview It would be fair to say that the third quarter of 2018 was an inflection point. A range of upside forces have shifted market sentiment and some parties are talking of $90, or even $100/bbl oil in the short to medium term. The longevity of these forces will determine whether the factors driving the recent spike in prices sustain. In contrast, the long term view on oil prices remains relatively unchanged as uncertainty around the impact of decarbonization policies and uptake of electric vehicles remains.
  3. 3. Page 3 Q4 | October 2018 EY Price Point: global oil and gas market outlookPage 3 The theme for this quarter is reset. Oil markets have come to the realization that the impact of geopolitical factors, strong demand growth and OPEC production discipline cannot be offset by US shale alone. OECD stocks sit at 91 days. The last time we saw similar levels, Brent was trading at prices in excess of $100/bbl. However, questions remain over the longevity of recent upside forces. ? Q4 theme ► Will OPEC and Russia continue to ignore calls to increase output? ► Is demand growth sustainable in a higher oil price environment? ► Will Iranian exports decline further in November once US sanctions become effective? ► Will North American supply growth continue to slow in the fourth quarter?
  4. 4. Page 4 Page 4 Q4 | October 2018 EY Price Point: global oil and gas market outlook The gas market is rapidly shifting from a prolonged supply glut to an impending shortfall. The market has absorbed the additional capacity brought online. China’s booming demand is constrained only by inadequate infrastructure. The pendulum of investment could well be swinging back to gas. OECD stocks continue their decline Stocks of crude oil and refined products provide a buffer against rising prices and price volatility. The length and severity of the most recent downturn was emphasised by inflated stocks. OPEC policy was to reduce stock levels to the five year average. That goal has now been met and stocks continue to fall. Trends Iranian exports of crude oil and condensate fell by 0.6mmbbl/d (28%) in August. Cargoes to South Korea have stopped whilst those to India declined by 70%. For now, Chinese imports have remained relatively resilient. With US sanctions on Iran effective from November, the coming months will be telling. US sanctions on Iran begin to bite Gas demand to the rescue There has long been questions over the returns generated by North American shale, while export capacity added further pressure in the quarter. Slowing growth in North American output was unable to offset the impact of demand growth and falling OPEC output in the third quarter. North American production flat
  5. 5. Page 5 Page 5 Q4 | October 2018 EY Price Point: global oil and gas market outlook Market fundamentals ► Brent and WTI averaged $75.05 and $69.79 per bbl respectively during the third quarter. The overall impression is that oil prices rose compared to the second quarter. On balance that impression is accurate. However, this is predominantly driven by a late spike in September as Iranian exports fell in advance of US sanctions becoming effective in November. ► Despite calls from President Trump, OPEC declined to announce production increases beyond those agreed in June to compensate for declines in output from Iran and Venezuela. ► The Brent-WTI spread increased significantly towards the end of the quarter as US production growth exceeded that of other markets, placing downward pressure on regional prices. Brent tops US$80/bbl to reach highest level since 2014 Upside forces shift market toward undersupply ► The global oil supply and demand dynamic continues to be dominated by demand growth, OPEC supply decisions and North American production. In previous quarters, OPEC production has remained relatively flat, leaving rising North American output to offset global demand growth. That trend didn’t quite continue in the third quarter as North American output growth slowed, pushing the market further into an undersupply position. ► Rising oil prices and the strength of the US dollar will impact demand for crude from emerging markets. The Indian rupee and Chinese RMB have depreciated significantly against the US dollar in 2018 (12% and 6%, respectively). ► Although frontier regions and mature fields in Africa, Latin America and Asia continue to suffer from natural decline, investment has shown signs of recovery with production from these regions expected to stabilize or even grow in future quarters. 55 60 65 70 75 80 85 7/2/2018 8/2/2018 9/2/2018 $/bbl Brent WTI Source: EIA (1.20) (1.00) (0.80) (0.60) (0.40) (0.20) - Starting balance Demand growth OPEC North America Other End balance millionbarrelsperday Movement to Oversupply Movement to UndersupplySource: IEA oversupply undersupply
  6. 6. Page 6 Page 6 Q4 | October 2018 EY Price Point: global oil and gas market outlook ► North American oil production has been the main source of recent oil supply growth. Growth has consistently exceeded expectations and been extraordinarily resilient despite market pressures. ► Growth has levelled off in recent months. If this trend continues, it will likely have a significant impact on the global oil supply and demand dynamic. ► Most forecasts assume that regional production growth will continue for the foreseeable future. The most recent EIA Short Term Energy Outlook predicts an increase of ~1.4 million barrels per day between 2018 and 2019. ► Questions over the sustainability of that growth have been raised for a number of periods in the absence of sustainable positive returns. Export constraints in the Permian basin are now adding additional pressure. 8000 8500 9000 9500 10000 10500 11000 9/1/2017 12/1/2017 3/1/2018 6/1/2018 9/1/2018 kbbl/d US Lower 48 Oil Production Trend line 30/9/17- 30/6/18 Trend line 30/6/18-30/9/18 Market fundamentals ► Iranian oil exports fell to 1.68mbbl/d in August, representing a 28% decline from July as major importing nations elected to reduce imports in advance of November. South Korea has elected to halt Iranian imports altogether. ► China began using Iranian tankers to deliver volumes in July to sustain imports until at least October. India have been more conservative, with the country’s largest refiners not as yet requesting any cargoes for November delivery. China’s response come November will largely determine the outlook for Iranian exports. ► OPEC production remained relatively stable throughout the quarter, excluding the impact of growth from Libya after production restarted at the country’s biggest oil field. In September, OPEC declined to announce plans to increase production to compensate for declines in Venezuelan and Iranian output. US sanctions on Iran begin to bite 27,500 28,500 29,500 30,500 31,500 32,500 - 500 1,000 1,500 2,000 2,500 3,000 May June July August Iranian crude oil and condensate exports by destination (kbbl/d) Other China India Japan South Korea Total OPEC (exc. Libya growth - RHS) Source: S&P Global, Forbes, OPEC Source: EIA Growth in North American production slows
  7. 7. Page 7 Page 7 Q4 | October 2018 EY Price Point: global oil and gas market outlook Market fundamentals OECD stocks continue their decline Source: IEA ► US gas markets remain relatively stable. Rising exports are helping offset production growth. In China, the coal-to-gas switching policy has increased demand from the industrial and residential sectors. With more households targeted to switch to gas this year, LNG import prices in the region are expected to remain elevated as buyers look to secure supplies for the winter. ► Heading into winter, European gas supplies look tight. Storage levels were severely depleted last winter. Injections will need to continue to replenish stocks. Low wind generation, reduced nuclear availability and a rise in the value of EU emissions allowances are also driving higher demand for gas in the power sector. ► Europe and Asia will be competing for LNG cargoes at times this winter, which means price spikes are likely during any cold snaps. 0 2 4 6 8 10 12 $/mmbtu UK NBP Henry Hub LNG Asia FOB Source: EY analysis of data from Thomson Reuters Datastream Growth in gas demand is pushing up prices 84 86 88 90 92 94 96 98 100 102 2009 2010 2011 2012 2013 2014 2015 2016 2017 Daysforwarddemand ► Stocks of crude oil and refined products provide a buffer against rising prices and price volatility. Since stocks peaked in 2015, upside factors have generally failed to significantly move the market as participants knew that there was storage overhang. OPEC stated that their goal was to return inventories to the five year average. That goal seems to have been achieved. ► The market appears to be in a state of structural undersupply, as demand growth exceeds that of supply. We started the quarter with a shortfall (undersupply position) of ~0.25 million barrels per day and ended it with a shortfall of 0.5 half million barrels per day. ► Stocks may continue to fall. If they do, upside forces will begin to have an exaggerated impact on the market’s reaction and crude oil prices.
  8. 8. Page 8 Q4 | October 2018 EY Price Point: global oil and gas market outlookPage 8 Uncertainty around the energy mix of the future is drawing questions on the value of oil and gas assets on the balance sheets of oil and gas companies today1. Energy consumers are more environmentally aware, alternative energy technologies are advancing at accelerating rates and governments are setting more ambitious targets for decarbonization. Many argue that the industry is at a crossroads, or at least progressing towards one at pace. Some commentators have argued that investors should be challenging the price assumptions adopted by oil companies when valuing their reserves, which underpin the value of oil and gas assets. There always has been, and always will be, a lot of speculation about what the future price of oil will be. As a result of the level of uncertainty, together with the range of views available in the market, it is easy to challenge a company’s price assumption. De- carbonization is one of many factors that will likely impact future oil prices, but not necessarily the most influential factor. Oil demand growth, the emergence (or absence) of improved extraction technologies and geopolitical factors could all have greater influence on price than decarbonization – in both the short and long term. Arguments have been offered up to suggest that IOCs are overstating their asset position by using overly optimistic price assumptions. It has been highlighted that price assumptions used by companies for impairment testing differ from their publically disclosed investment appraisal thresholds. This isn’t unusual or surprising. Investment thresholds are multidimensional and incorporate perceived risk and risk appetites as well as required returns at a given price – a much broader concept than a determination of a ‘best estimate’ of future prices used in impairment testing. After all, a company applying the futures curve (being a reasonable indication of where the market saw prices at least in the near term) as their investment threshold in early 2014, would currently be receiving serious challenge over the investment decisions they made at that time. Reserve valuation in the age of decarbonization: What is the right price? 1 Sarasin & Partners publication: Are oil and gas companies overstating their position?
  9. 9. Page 9 Q4 | October 2018 EY Price Point: global oil and gas market outlookPage 9 Reserve valuation in the age of decarbonization: What is the right price? (continued) Oil price assumptions of IOCs are above the IEA’s Paris aligned price trajectories. The world may or may not meet the goals of the Paris Accord. Market consensus, as indicated by the range of views available (slide 11) when compared to IEA’s Sustainable Development and Beyond 2 degrees scenarios, seems to indicate that the targets will not be met. IEA’s modelling of up to ten future scenarios whilst stating that there are ‘too many variables in play’ 2 to generate a forecast, only supports the potential for uncertainty around each scenario being realized. In addition, analysis performed by Wood Mackenzie suggests that recent M&A transactions have been based on long term oil price assumptions of between $60-$70/bbl, a range comparable with prices used by IOCs when testing for impairment. Companies must determine a best estimate of future prices. It is an auditor’s role to attest that those assumptions are in accordance with the relevant accounting standard. In the case of impairment testing of tangible oil and gas properties under IFRS, those assumptions should be ‘reasonable and supportable’, reflective of management’s ‘best estimate’ and, where available, give greater ‘weight to external evidence’. There is a wide range of variables at play that will determine future oil prices. As with any estimate, as additional information comes to light on those variables, such information will be fed into the views of market participants. Price assumptions adopted by IOCs are within the range of possible future outcomes as supported by external evidence (slide 10). Whatever assumptions are underpinning those estimates, the IOCs are not alone in adopting them. The views of market participants support those assumptions. 2 EIA World Energy Outlook 2017
  10. 10. Page 10 Page 10 Q4 | October 2018 EY Price Point: global oil and gas market outlook Brent futures Consistent with the increase in spot prices, the futures curve has been lifted by the impact of upside forces. Brent futures for delivery in 2020 and 2021 have also increased as consumers attempt to reduce their exposure against any further increases in spot prices before Iranian sanctions become effective in November. This data is effective as of 26 September 2018. 20 30 40 50 60 70 80 90 100 110 120 Sep/12 Sep/13 Sep/14 Sep/15 Sep/16 Sep/17 Sep/18 Sep/19 Sep/20 Sep/21 Sep/22 Sep/23 Sep/24 $/bbl Historical Brent Futures Curve September 2018 Futures Curve June 2018
  11. 11. Page 11 Page 11 Q4 | October 2018 EY Price Point: global oil and gas market outlook Oil price outlook Brent: Brokers’ and consultants’ price estimates ranges and averages WTI: Brokers’ and consultants’ price estimates ranges and averages For both crude benchmarks, banks and brokers predict (on average) marginally higher oil prices in 2018 and 2019. The trend is reversed in the midterm. Consultants focus primarily on the analysis of a long-term sustainable oil price, while the banks/brokers balance their views on the basis of current market conditions. Consistent with the recent trend in spot prices, we note an uplift in the near term outlook since the previous quarter. However, no significant movement is noted in the longer term where other market forces dominate. Consultants’ forecasts result in averages of US$78.1/bbl and US$74.5/bbl vs. banks’/brokers’ averages of US$68.0/bbl and US$64.1/bbl for Brent and WTI, respectively in 2022. This data is effective as of 26 September 2018. US$68.0 US$78.1 US$64.1 US$74.5Brent: Average price forecast in 2022 WTI: Average price forecast in 2022 Banks/brokers Consultants Banks/brokers Consultants Source: Bloomberg, banks’/brokers’ reports, consensus economics, consultants’ website 30 40 50 60 70 80 90 100 2018 2019 2020 2021 2022 $perbarrel Bank/Broker range Consultants range Bank/Broker average Consultants averageBank/broker average Bank/broker range 30 40 50 60 70 80 90 100 2018 2019 2020 2021 2022 $perbarrel Bank/Broker range Consultants range Bank/Broker average Consultants averageBank/broker average Bank/broker range
  12. 12. Page 12 Page 12 Q4 | October 2018 EY Price Point: global oil and gas market outlook Gas price outlook Henry Hub: Brokers’ and consultants’ price estimates ranges and averages UK NBP: Brokers’ and consultants’ price estimates ranges and averages For Henry Hub, consultants forecast (on average) higher prices than banks/brokers. The NBP forecasts of banks and brokers exceed that of consultants. Banks’ and brokers’ view of the outlook for Henry Hub is essentially flat with the increase throughout the forecast period, representing little more than inflation. In contrast, consultants’ estimates reflect a steady upward trend, reflecting a view on demand growth and production economics. The outlook for Henry Hub remains relatively consistent with June 2018. Increases are noted for NBP as demand from emerging markets continues to grow. NBP estimates for UK NBP are scarce with only 6 and 3 data points available from banks/brokers and consultants, respectively. This data is effective as of 26 September 2018. US$3.7 GBP54.1 GBP53.7UK NBP: Average price forecast in 2022 Banks/brokers Consultants Source: Bloomberg, banks’/brokers’ reports, consensus economics, consultants’ website Banks/brokers Consultants US$3.1Henry Hub: Average price forecast in 2022 2.0 2.5 3.0 3.5 4.0 4.5 2018 2019 2020 2021 2022 $permmbtu Bank/Broker range Consultants range Bank/Broker average Consultants average Bank/broker range Bank/broker average 35 40 45 50 55 60 65 70 2018 2019 2020 2021 2022 GBppertherm Bank/Broker range Consultants range Bank/Broker average Consultants average Bank/broker range Bank/broker average
  13. 13. Page 13 Page 13 Q4 | October 2018 EY Price Point: global oil and gas market outlook Brent oil price estimates Appendix Bank/broker 2018 (US$/bbl) 2019 (US$/bbl) 2020 (US$/bbl) 2021 (US$/bbl) 2022 (US$/bbl) High 85.0 85.6 90.0 89.0 85.0 Average 72.9 73.3 72.2 70.5 68.0 Median 73.5 74.5 70.0 69.8 68.5 Low 60.5 54.1 52.2 60.0 58.0 Source: Bloomberg, Banks’/Brokers’ reports, consensus economics. Source: Consultants’ websites, Oxford Economics, Wood Mackenzie. Consultant 2018 (US$/bbl) 2019 (US$/bbl) 2020 (US$/bbl) 2021 (US$/bbl) 2022 (US$/bbl) High 76.5 76.5 75.1 85.1 90.7 Average 70.7 68.9 72.2 75.2 78.1 Median 74.1 69.4 72.0 73.5 75.3 Low 54.1 58.8 69.7 71.1 72.5 This data is effective as of 26 September 2018.
  14. 14. Page 14 Page 14 Q4 | October 2018 EY Price Point: global oil and gas market outlook WTI oil price estimates Appendix Bank/broker 2018 (US$/bbl) 2019 (US$/bbl) 2020 (US$/bbl) 2021 (US$/bbl) 2022 (US$/bbl) High 79.0 80.0 83.0 81.0 81.0 Average 67.9 68.3 67.4 65.4 64.1 Median 67.7 67.8 65.0 64.4 64.1 Low 58.0 55.0 53.0 53.5 51.5 Source: Bloomberg, Banks’/Brokers’ reports, consensus economics. Source: Consultants’ websites, Oxford Economics, Wood Mackenzie. Consultant 2018 (US$/bbl) 2019 (US$/bbl) 2020 (US$/bbl) 2021 (US$/bbl) 2022 (US$/bbl) High 69.3 69.7 71.9 81.1 86.7 Average 65.0 64.5 68.4 71.4 74.5 Median 68.0 65.3 67.0 69.0 73.1 Low 50.6 55.3 66.5 67.0 68.6 This data is effective as of 26 September 2018.
  15. 15. Page 15 Page 15 Q4 | October 2018 EY Price Point: global oil and gas market outlook Henry Hub gas price estimates Appendix Bank/broker 2018 (US$/MMBtu) 2019 (US$/MMBtu) 2020 (US$/MMBtu) 2021 (US$/MMBtu) 2022 (US$/MMBtu) High 3.3 3.6 3.7 3.7 3.8 Average 2.9 3.0 3.0 3.1 3.1 Median 2.9 2.9 3.0 3.0 3.0 Low 2.7 2.5 2.6 2.6 2.6 Source: Bloomberg, Banks’/Brokers’ reports, consensus economics. * Brokers have reported figures in $/mcf. We have used a conversion ratio of 1.037 for mcf conversion to MMBtu. Source: Consultants’ websites, Oxford Economics, Wood Mackenzie. * Wood Mackenzie has reported figures in US$/mcf. We have used a conversion ratio of 1.037 for mcf conversion to MMBtu. Consultant 2018 (US$/mmbtu) 2019 (US$/mmbtu) 2020 (US$/mmbtu) 2021 (US$/mmbtu) 2022 (US$/MMBtu) High 3.1 3.6 4.0 4.0 4.2 Average 3.0 3.1 3.4 3.6 3.7 Median 3.0 3.1 3.2 3.5 3.7 Low 2.9 2.9 3.1 3.2 3.3 This data is effective as of 26 September 2018.
  16. 16. Page 16 Page 16 Q4 | October 2018 EY Price Point: global oil and gas market outlook NBP gas price estimates Appendix Bank/broker 2018 (GBP/therm) 2019 (GBP/therm) 2020 (GBP/therm) 2021 (GBP/therm) 2022 (GBP/therm) High 60.0 61.6 65.2 58.0 58.0 Average 56.2 56.8 56.2 53.3 54.1 Median 56.8 58.5 56.1 53.7 53.4 Low 50.0 46.0 46.0 45.0 51.0 Source: Bloomberg, Banks’/Brokers’ reports, consensus economics Source: Consultants’ websites, Oxford Economics. *Oxford Economics has reported figures in US$/MMBtu. We have used exchange rate forecast by Oxford Economics from USD to GBP. ** GLJ has reported figures in US$/MMBtu. We have used exchange rate forecast by GLJ from USD to GBP. Consultant 2018 (GBP/therm) 2019 (GBP/therm) 2020 (GBP/therm) 2021 (GBP/therm) 2022 (GBP/therm) High 55.0 51.1 53.8 55.4 56.2 Average 53.9 50.5 51.9 52.8 53.7 Median 54.5 50.5 51.5 52.5 53.6 Low 52.2 50.0 50.5 50.5 51.5 This data is effective as of 26 September 2018.
  17. 17. Page 17 Page 17 Q4 | October 2018 EY Price Point: global oil and gas market outlook Key contacts Important notice Price outlook data incorporated within this publication is effective as of 26 September 2018. Given the rapidly evolving nature of the market and views of market participants, analysis can become quickly outdated. It should be noted that our analysis is not for the purpose of providing an independent view of the outlook for oil and gas prices. Instead, we are collating the views of market participants. Price outlook data should not be applied mechanistically. Instead, careful consideration should be given to the purpose of any value assessment with price forecasts assessed in the context of the other key assumptions, such as, resources/reserves classification, production rates, discount rates and cost escalation rates together with an appreciation of the key sensitivities in any such analysis. Adi Karev EY Global Oil & Gas Leader +852 2629 1738 Derek Leith EY Global Oil & Gas Tax Leader +44 12 2465 3246 Andy Brogan Global Oil & Gas EY Transactions Advisory Services Leader +44 20 7951 7009 Jeff Williams EY Global Oil & Gas Advisory Leader +1 713 750 5916 • Gary Donald EY Global Oil & Gas Assurance Leader +44 20 7951 7518 • EY | Assurance | Tax | Transactions | Advisory About EY EY is a global leader in assurance, tax, transaction and advisory services. The insights and quality services we deliver help build trust and confidence in the capital markets and in economies the world over. We develop outstanding leaders who team to deliver on our promises to all of our stakeholders. In so doing, we play a critical role in building a better working world for our people, for our clients and for our communities. EY refers to the global organization, and may refer to one or more, of the member firms of Ernst & Young Global Limited, each of which is a separate legal entity. Ernst & Young Global Limited, a UK company limited by guarantee, does not provide services to clients. For more information about our organization, please visit ey.com. How EY’s Global Oil & Gas Sector can help your business The oil and gas sector is constantly changing. Increasingly uncertain energy policies, geopolitical complexities, cost management and climate change all present significant challenges. EY’s Global Oil & Gas Sector supports a global network of more than 10,000 oil and gas professionals with extensive experience in providing assurance, tax, transaction and advisory services across the upstream, midstream, downstream and oil field subsectors. The Sector team works to anticipate market trends, execute the mobility of our global resources and articulate points of view on relevant sector issues. With our deep sector focus, we can help your organization drive down costs and compete more effectively. © 2018 Ernst & Young LLP. All Rights Reserved. EYG no. 011697-18Gbl ED None This material has been prepared for general informational purposes only and is not intended to be relied upon as accounting, tax or other professional advice. Please refer to your advisors for specific advice. ey.com/oilandgas

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