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LOOKING FORWARD – EFFECTS OF $50/BBL OIL RISKS. REWARDS. CONSEQUENCES. CRiTiCal THinkinG aT THe CRiTiCal TiMe™ Table of Contents 2 1 here we are today: W Unprecedented production growth and price declines 5 I s this downturn different from historic declines? And will it last longer? 8 T he fallout of $50/bbl 10 The FTI Consulting view 12 Partner with FTI Consulting FTI Consulting, LLP Looking Forward – Effects of $50/BBL Oil RiskS. Rewards. Consequences. Where we are today: Historic production growth begets precipitous drop in commodity prices – creating challenges and opportunities for industry. Major technological advances in the application of horizontal drilling and hydraulic fracturing in the United States have dramatically expanded U.S. oil and gas production, transforming global oil markets. By the end of 2014, U.S. daily crude oil production from tight formations such as shale had increased 230 percent from 2010 levels, and U.S. crude oil production in total increased by 67 percent. A confluence of separate but related factors– massive new supplies from the United States; OPEC’s unwillingness to reduce its output; and a slowing of global oil demand (especially in OECD countries) – has had profound impacts on the global price of crude. In June 2014, WTI crude peaked at $115/bbl. By January 2015, it had dropped below $46/bbl. Historical Oil (WTI) Prices $160 Oil ($/bbl) $140 $120 $100 $80 $60 $40 $20 Ja n -2 00 6 Ju l20 06 Ja n -2 00 7 Ju l20 07 Ja n -2 00 8 Ju l20 08 Ja n -2 00 9 Ju l20 09 Ja n -2 01 0 Ju l20 10 Ja n -2 01 1 Ju l20 11 Ja n -2 01 2 Ju l20 1 Ja 2 n -2 01 3 Ju l20 1 Ja 3 n -2 01 4 Ju l20 1 Ja 4 n -2 01 5 $0 Source - U.S. Energy Information Administration Looking Forward – Effects of $50/BBL Oil RiskS. Rewards. Consequences. FTI Consulting, LLP 1 2 FTI Consulting, LLP Looking Forward – Effects of $50/BBL Oil RiskS. Rewards. Consequences. wHY tHE BottoM FELL oUt oF tHE MarkEt additionally, during this period, there were: despite this dramatic growth in u.s. crude production, wTi prices remained between $80/bbl and $110/bbl from october of 2010 until late november 2014. why didn’t the market respond with gradual declines in price as supplies steadily grew, and what does this tell us about the future? • Geopolitical upheaval in the Middle until recently, the massive new supplies of u.s. crude being introduced into the market had surprisingly little effect on global oil prices. why? because, as these new supplies were coming online, geopolitical conflicts were flaring up in key oil-producing regions around the world. There was a civil war in libya. iraq was facing threats from isis. The united states and europe imposed new sanctions on iran, significantly curtailing its oil exports. all that had the effect of taking more than 3 million barrels per day off the global market – or, roughly the same amount that was being added anew by the united states. • Major supply disruptions in africa and the Middle east significantly reduced their contributions to global supply. east, Crimea and ukraine kept upward pressure on global crude oil prices. • Market participants expected oPeC to function as a cartel and stabilize global crude oil prices. tHE inFLEction Point in the last quarter of 2014: • U.S. production continued to increase through the end of 2014. • Non-OPEC production also continued to increase through the end of 2014. • The Saudi Arabia “wild card”. oil prices were buoyed by the expectation that the saudis would cut production in order to stabilize prices. when saudi arabia announced on Thanksgiving 2014 that it would not cut production and would not revisit the issue for six months, the crude oil sell-off began in earnest. Looking Forward – EFFEcts oF $50/BBL oiL Risks. RewaRds. ConsequenCes. FTI Consulting, LLP 3 some experts believe that NYMEX prices will recover in early 2015 4 FTI Consulting, LLP Looking Forward – EFFEcts oF $50/BBL oiL Risks. RewaRds. ConsequenCes. Is this downturn different from historic declines? And will it last longer? There is disagreement among experts about what the future will bring. Some experts believe that NYMEX prices will recover in early 2015: •In late January, Reuters reported that prices rebounded somewhat on traders’ hopes that “prices will recover as energy companies cut production investment, including U.S. shale production, to alleviate a glut that has wiped out more than half crude’s value since June.” •Investor’s Business Daily has reported that new permits for oil wells in the U.S. declined by nearly 40 percent from October 2014 to November 2014, with permits in the Permian Basin, Eagle Ford and Bakken down by 38 percent, 28 percent and 29 percent, respectively. •Prices may rise in the short run due to different geopolitical scenarios unfolding, such as renewed disruptions in Libya, a decision to halt the Kurdistan project, or an announcement from the Saudis that they have decided to reverse course and cut production. •Prices may rise as E&P and service companies significantly cut their capital expenditures for exploration and production and reduce the size of their labor force. Looking Forward – Effects of $50/BBL Oil RiskS. Rewards. Consequences. FTI Consulting, LLP 5 Other experts believe that prices will stay low for some time. These experts focus on the current environment, which is driven in no small part by changing supply and demand conditions. As production has increased, the amount of proved reserves in the U.S. has increased by more than 50 percent in the last half decade. And against this backdrop, demand for crude oil continues to slide in key markets, decreasing by nearly 300,000bbl/day in OECD countries between 2013 and 2014, with numbers expected to remain essentially flat for 2015 and 2016. North American Rig Count 1,600 1,400 1,200 1,000 DIR. 800 HORZ. VERT. 600 400 200 0 Source - Baker Hughes In addition, these experts believe that a significant share of production comes from low-cost wells and that breakeven costs are likely to decline further due to technology improvements, the sunk nature of many costs (including commitments for rail and pipeline 6 transportation), and price reductions for land rigs, pressure pumping, etc. Lower break-even costs could have the effect of slowing declines in production from North America, prolonging the low price environment. FTI Consulting, LLP Looking Forward – Effects of $50/BBL Oil RiskS. Rewards. Consequences. other experts believe that prices will stay low for some time Looking Forward – EFFEcts oF $50/BBL oiL Risks. RewaRds. ConsequenCes. FTI Consulting, LLP 7 The fallout of $50/bbl e&P firms will face strong headwinds in 2015, but the “dispatchability” of shale oil operations – the ability to ramp production up or down quickly in response to market conditions – could lessen the impact on nimble operators. as reported by the FinancialTimes, bernstein Research found that from 2000 until very recently, oil companies consistently experienced increases in oil prices after final investment decisions, i.e., projects approved in the 2004 to 2011 time period saw an average rise of $18/bbl in the price of crude by the time these investments began producing. at the same time, much of this time period coincided with a period of very low borrowing costs. This combination created a sustained surge in oil and gas investment, much of which was funded with debt rather than 8 equity. The FinancialTimes found that oil and gas producers and refiners with debt both at the end of the 2008 crash and at the end of 2014 had, in aggregate, twice the amount of net debt at the end of 2014, and net debt-to-ebiTda ratios that had increased from 0.7 to 1.8. as the FinancialPost reported in mid-december 2014, Goldman sachs reviewed the Top 400 global oil and gas projects, ranked by size, and concluded that no more than a third would breakeven at $70/bbl oil. at the same time, however, many of the highest cost projects (e.g., kazakhstan’s kashagan FTI Consulting, LLP Looking Forward – EFFEcts oF $50/BBL oiL Risks. RewaRds. ConsequenCes. field) exhibit complex ownership structures and government involvement, which makes simply stopping the project much more difficult, particularly if the producing country is in need of revenue. shale oil production – the major factor driving the downturn in oil prices – is very easy to dial up or down, depending on market circumstances. spudding a shale well can take just a few weeks; ramping down an operation can be done in a matter of days. and many companies have announced plans in 2015 to continue drilling these wells without actually “completing” (i.e., fracturing) them – conserving funds in the short term, while positioning themselves to jump back into the market quickly should the underlying price environment improve. Looking Forward – EFFEcts oF $50/BBL oiL Risks. RewaRds. ConsequenCes. FTI Consulting, LLP 9 The FTI Consulting view against this backdrop, who will gain and who will struggle if oil prices remain in the $45/bbl and $65/bbl range for a sustained period of time? simply put, consumers of energy, particularly petroleum, will gain. Consumers of energy will be better positioned. This group includes petrochemical producers, energyintensive manufacturers (especially those that use petroleum or products whose prices are correlated with petroleum), other industrial manufacturing operations, transportation, agriculture and general consumers. for example, eia projects that u.s. drivers will each spend about $550 less on gasoline in 2015 than they did in 2014, assuming prices stay low. Petrochemical companies that use oil and natural gas as feedstocks will gain. with one of their largest operating costs significantly reduced, they will be more profitable and more competitive on a global scale. 10 Most producers and service companies will continue to struggle. This group includes highly leveraged e&P companies that are receiving far less in revenue for every unit they produce. They face difficult options – e.g., restructuring/ streamlining operations, selling off assets, renegotiating with lenders and leaseholders, or going into bankruptcy. for example: •Companies active in the north sea substantially increased capital spending over the past five years. because of ever-worsening production decline curves, they may struggle to survive, as will regional and municipal governments dependent on oil revenues, such as the city of aberdeen, the center of the north sea oil services industry. FTI Consulting, LLP Looking Forward – EFFEcts oF $50/BBL oiL Risks. RewaRds. ConsequenCes. •There will be rapid consolidation in the u.s. e&P industry, and service companies are already being particularly hard-hit. •alternative and emerging fuels – such as biofuels – may become uncompetitive. To the extent there is carry over to natural gas prices, wind and solar companies will also see erosion of their market. •Coal companies and related businesses may also suffer, especially if natural gas prices remain low. costs and capital expenditures in advance of the drop in crude oil prices. as a result, their balance sheets are strong and strengthening in the e&P and oil services industries, there will be rapid consolidation with survivors more attractive due to more stable revenues and lower operating costs. in addition, refining will become more attractive than production, and investor preferences will shift from earnings growth to stronger balance sheets. •while the e&P sector as a whole will continue to struggle with diminishing returns and capital expenditure reductions, companies with the greatest efficiencies and strongest balance sheets will be relatively better off. for example, integrated oil companies began cutting operating Looking Forward – EFFEcts oF $50/BBL oiL Risks. RewaRds. ConsequenCes. FTI Consulting, LLP 11 Partner with FTI Consulting Whether you represent a company positioned to take advantage of the recent market shifts, or one simply looking to retain existing market share, FTI Consulting provides unparalleled expertise and innovative thought-leadership in the oil and gas industry to help you address your critical opportunities or challenges – whether they are event-driven or long-term scenarios: •Deals based on oil priced before the drop will be increasingly uneconomic, breeding disputes – including issues around reserve study values, and how (and when) the acreage was developed •Forensic investigations to determine what happened and, importantly, when •Portfolio realignment activity will be necessary throughout the vertically integrated chain from oil and gas exploration and production to fuel and petrochemical production •SEC/DOJ activity around financial reporting issues (impairment charges or lack thereof) and disclosures in MD&A, press releases and earnings calls •Lease/contract renegotiations •Public policy (e.g., crude oil exports) analysis •Investor relations •M&A and restructuring communications •Activist defense •Valuation •Corporate finance •Intelligence gathering on overseas sources of potential supply and demand •Litigation support •Strategic stakeholder communications •Financial and regulatory due diligence •Core restructuring and asset sales and acquisitions 12 FTI Consulting, LLP Looking Forward – Effects of $50/BBL Oil RiskS. Rewards. Consequences. Contacts for FTI Consulting’s Energy, Power & Product Segment Bert Conly Senior Managing Director Corporate Finance +1 214 397 1604 Brian Kennedy Senior Managing Director Strategic Communications +1 202 346 8826 John Klick Global Segment Leader Economic Consulting +1 202 312 9145 Ken Stern Senior Managing Director Forensic & Litigation Consulting + 1 212 651 7172 [email protected] [email protected] [email protected] [email protected] About FTI Consulting FTI Consulting, Inc. is a global business advisory firm dedicated to helping organisations protect and enhance enterprise value in an increasingly complex legal, regulatory and economic environment. FTI Consulting professionals, who are located in all major business centres throughout the world, work closely with clients to anticipate, illuminate and overcome complex business challenges in areas such as investigations, litigation, mergers and acquisitions, regulatory issues, reputation management and restructuring. www.fticonsulting.com ©2015 FTI Consulting, Inc. All rights reserved.