Commodities Strategy | November 2015 Lower For Longer Oil Market Update Seth Kleinman Managing Director [email protected] +44 (0) 207 986 4556 Pedro Medeiros Director [email protected] +55 21 3282 9960 See Appendix A-1 for Analyst Certification, Important Disclosures and non-US research analyst disclosures Citi Research is a division of Citigroup Global Markets Inc. (the "Firm"), which does and seeks to do business with companies covered in its research reports. As a result, investors should be aware that the Firm may have a conflict of interest that could affect the objectivity of this report. Investors should consider this report as only a single factor in making their investment decision. Certain products (not inconsistent with the author’s published research) are available only on Citi's portals. This presentation was approved for distribution on 12 October 2015; the disclosures in Appendix A1 are current as of the same date. Agenda Four key themes ● (1) Saudi pulling back production because crude has nowhere to go ● (2) Are low oil prices really positive for medium-term demand growth? ● (3) North America shale vs. Deepwater vs. OPEC supply in the medium-term ● (4) Asia is the only market short left – But, there are potential impacts from other sources 1 Current State of Play: Global Oversupplies are Heading into Storage 1Q’15 saw crude stocks blow-out before strong refinery runs started to shift the oil surplus downstream. Crude and petroleum product stocks are now both at elevated levels and weekly observed oil inventories are showing little sign of coming down from record levels. OECD and China crude OECD and China petroleum OECD and China oil stock stocks (bln bbls) product stocks (bln bbls) changes (m b/d) 1.75 1.37 2012 2013 2014 2015 2.5 2012 2013 2014 2015 Crude build (m b/d) Product build (m b/d) 2.0 1.32 1.70 Oil build (m b/d) 1.5 1.27 1.65 1.0 0.5 1.22 1.60 0.0 1.17 1.55 -0.5 -1.0 1.12 1.50 -1.5 -2.0 1.07 1.45 -2.5 Jan Feb Mar Apr May Jun Jul Aug Sep Oct Nov Dec Jan Feb Mar Apr May Jun Jul Aug Sep Oct Nov Dec Jan-12 Jul-12 Jan-13 Jul-13 Jan-14 Jul-14 Jan-15 Jul-15 Weekly observed oil stocks Weekly observed crude and Weekly observed ex-US oil (bln bbls) product stocks (bln bbls) stocks (bln bbls) 1.05 0.65 0.35 1.70 Products 2012 2013 2014 2015 2012 2013 2014 2015 Crude - RHS 0.63 0.34 1.65 1.00 0.61 0.33 1.60 0.59 0.32 1.55 0.95 0.57 0.31 1.50 0.90 0.55 0.30 1.45 0.53 0.29 0.85 1.40 0.51 0.28 1.35 0.49 0.27 0.80 1.30 0.47 0.26 1.25 0.75 0.45 0.25 Jan Feb Mar Apr May Jun Jul Aug Sep Oct Nov Dec Jan-13 Jun-13 Nov-13 Apr-14 Sep-14 Feb-15 Jul-15 Jan Feb Mar Apr May Jun Jul Aug Sep Oct Nov Dec Source: Chinese Customs, EIA, Euroil, PAJ, KNOC, PJK, International Enterprise, Citi Research 2 Saudi Pulling Back on Production As Crude Has Nowhere to Go OPEC OSPs to Asia ($/bbl) Saudi Crude Burn (m b/d) 5 Arab Light (Saudi) 1.0 2009 2010 Basrah Light (Iraq) 4 Iran Light 0.9 2011 2012 3 Kuwait 0.8 2013 2014 2015 2 0.7 1 0.6 0 0.5 -1 0.4 -2 0.3 -3 0.2 -4 0.1 -5 0.0 Aug-12 Jan-13 Jun-13 Nov-13 Apr-14 Sep-14 Feb-15 Jul-15 Jan Feb Mar Apr May Jun Jul Aug Sep Oct Nov Dec Saudi Crude Stocks (m bbls) Saudi Crude Production (m b/d) 340 2011 2012 2013 2014 2015 Implied Saudi Production (k b/d) JODI IEA 320 11.0 10.5 300 10.0 280 9.5 260 9.0 240 8.5 220 8.0 Jan Feb Mar Apr May Jun Jul Aug Sep Oct Nov Dec Jan Feb Mar Apr May Jun Jul Aug Sep Oct Source: JODI, Saudi Aramco, Cargo Tracking, Citi Research 3 Demand Growth So Far Has Not Been Enough to Tighten Global Markets Global oil demand growth by selected counties (monthly, m b/d) 3.5 Russia ● Oil demand posted gains of 1.8-m b/d y/y growth in Argentina 3.0 1H’15 with Citi expecting 1.6-m b/d of y/y growth in Mexico 2.5 2H’15. Brazil Thailand 2.0 China ● Yet the composition of oil demand growth shows a 1.5 India German Road 1.0 two-speed response to lower prices. Big net oil Fuels Spain importers such as the US, China and India account for 0.5 Italy the bulk of the gains while the rest are witnessing 0.0 UK mediocre growth. France Road Fuels -0.5 Australia ● And the impact of the oil price drop was a 2015 -1.0 South Korea story, with 2016 prices seen to be flattish y/y. While -1.5 Jan-14 Mar-14 May-14 Jul-14 Sep-14 Nov-14 Jan-15 Mar-15 May-15 Jul-15 there could be lagged impacts of the 2015 oil price drop stretching into 2016 oil demand, much of the new US, India, and China accounted for the lion’s share of global oil demand growth (2014-15, m b/d) demand growth looks like it would need to come from rising economic activity. This is given that Citi sees 2.5 US, India, China The Rest Brent average annual prices at $54 in 2015 and $53 in 2.0 2016. 1.5 ● Given Citi’s bearish macro view, with the potential 1.0 of China dragging other EMs and the world into a recession, this bodes bearish for 2016 oil demand. 0.5 0.0 -0.5 -1.0 Jan-14 Apr-14 Jul-14 Oct-14 Jan-15 Apr-15 Jul-15 Source: Energy Ministry Data, Citi Research Estimates 4 Crude Demand has been Outpacing Product Demand ● The 1Q’15 bumper 1.8-m b/d y/y growth in products Despite strong product demand, crude demand has demand outpaced run rate growth prompting much been even stronger (m b/d) stronger margins which were then buoyed by 3.0 summer gasoline dynamics. Petroleum Products Demand Crude Runs 2.5 Product Stockbuild ● This has prompted refiners globally to ramp-up runs, with crude runs expected to be 2-m b/d higher 2.0 y/y. This is now materializing in downstream stockbuilds, 1.5 as one-off demand factors in 1Q’15 fade and the demand outlook is tempered. 1.0 ● Product stocks should keep building therefore, 0.5 compressing margins, which could be set-up for lower-than-expected run rates come 1H’16. 0.0 1Q15 2Q15 3Q15 4Q15 Product stocks at Singapore and ARA trading hubs have Northwest Europe cracking margins have softened blown out (m bbls) ($/bbl) 105 2011 2012 2013 2014 2015 100 95 90 85 80 75 70 65 60 Jan Feb Mar Apr May Jun Jul Aug Sep Oct Nov Dec Source: IEA, EIA, PAJ, PJK, International Enterprise, EUROIL, Citi Research 5 (1) Falling energy prices weigh heavily on exporter revenues. Oil Exporter Revenues Saudi Arabia Government Revenue Revenue % YoY OPEC nominal OPEC real 1400 70 1000 1200 50 1000 800 30 800 600 10 600 -10 Riyal Billions 400 % YoY Growth 400 USD Billion USD -30 200 200 -50 0 0 -70 2000 2002 2004 2006 2008 2010 2012 2014 1975 1980 1985 1990 1995 2000 2005 2010 2015 ● OPEC revenues have suffered substantially as energy price declines have outpaced increased output. The effects are seen most clearly in the collapse of government revenues. ● Saudi Arabia, Venezuela, other oil exporters lose the most, while energy importers (i.e. India, Japan) gain. Sources: EIA, Bloomberg, Citi Research 6 Emerging Market Growth Has Relied Heavily on Commodity Exports Sixty-three developing economies were considered "extremely commodity dependent" with commodities accounting for more than 80 percent of export earnings in 2012/13. During the boom years, the value of commodity exports from developing countries jumped from $2.0 trillion in 2009/10 to $3.2 trillion in 2012/13 Commodity exports as a percentage of the gross Saudi Arabian Oil Demand Growth Has Outperformed domestic product by region India’s, even with a lower base (m b/d) 250 India Saudi Arabia 200 150 100 50 0 -50 2008 2009 2010 2011 2012 2013 2014 2015 Source: UNCTAD 7 (2) Slowing Chinese economy and diminishing trade share China Total Trade Volume World Trade Volume versus GDP Growth Exports Imports World Export Growth World GDP Growth 40.00% 30% 30.00% 25% 20.00% 20% 10.00% 15% % YoY % % yoy 6mma % yoy 0.00% 10% -10.00% 5% 0% -20.00% Jan-11 Jun-11 Nov-11 Apr-12 Sep-12 Feb-13 Jul-13 Dec-13 May-14 Oct-14 Mar-15 1981-1985 1991-1995 2001-2005 2011-2014 ● World trade has lagged GDP, signalling a potential cyclical factor (China growth slowing) or a structural one (the shifting of the global supply value chain). ● EM terms of trade have worsened, compounding current deficits and restricting central bank capabilities to stimulate growth (see Brazil, Argentina, Russia).