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How Long Will This High Price Episode Last? Special presentation for the IPAA Carl Calabro, Director, Market Analysis Markets Group Strategic Advisors in Global Energy June 16, 2005 Key Conclusions The world is entering an episode of higher and more volatile prices than anything witnessed in the past two decades. The higher long-term prices are the result of a number of cyclical and structural factors coming together in the last two years. This new price episode is likely to last few years, or until some of the cyclical trends are impacted by higher prices. Higher prices will change the industry as profoundly as lower prices did after 1986. Markets & Countries | Page 2 Energy Security Re-Emerge as a Strategic Driver In the aftermath of 9/11, security in the Middle East has reemerged as a key global concern. The US presence in Iraq, and the avowed goal to “democratize” the region has raised the issue of the stability of a number of regimes in the Gulf. Internal tensions, terrorist attacks in the GCC countries have heightened the perception of oil facilities being at risk. Finally, the emergence of China as a large importer of Middle Eastern crude has added to the perception that a race to secure energy sources is emerging. In a world dominated by security concerns rather than by globalization (pre 9/11), energy security has added a bullish factor to the perception of future prices, helping to lift the long term crude prices. This is unlikely to change during the second Bush Administration, which remains focused on the war on terror. Markets & Countries | Page 3 Setting the Stage in 2003 and 2004 Chain Reaction In The Oil Market Stock Depletion Demand Growth Tight Refining & Tanker Capacity Political Instability Hedge Funds $ HIGH PRICE Venezuela + Iraq OPEC’s Stock Management Markets & Countries | Page 4 When Structural And Cyclical Events Collide Oil Fundamentals Soaring Demand Cyclical Structural Low Supply Growth OPEC Spare Capacity gone Cyclical Structural Stretched Infrastructure: Refining Structural High prices Transportation Production Energy Security Structural Hedge Funds’ Role Structural Exogenous Elements Markets & Countries | Page 5 Why The World Has $50 + Oil Several Factors Feeding Each Other In This New Episode High Oil Demand Economic cycles and impact of high oil prices $$$ Flow Stretch infrastructure creates bottlenecks $60 $55 $50 $45 $40 $35 $30 High Oil Prices Low Supply Growth O-03 F-04 J-04 O-04 F-05 OPEC Loose Excess Capacity Political Risks Highs Supply Anxiety Markets & Countries | Page 6 Its The Economy Stupid…. The Key Cyclical Driver Global Economy Vs. Oil Demand World GDP, % Oil Demand % Growth 5.0 % Economy Underpins 4.0 % 3.0 % Transportation Urbanization Industry 2.0 % 1.0 % 0.0 % -1.0 % 1990 1992 1994 1996 1998 2000 2002 2004 Oil demand growth remains tightly correlated to economic growth. The rise of Asian economies in the 1990’s has helped re-establish this relationship. Markets & Countries | Page 7 Demand Strength Is The Key Driver But Weaker Than 2004 2000 3.00 2001 2002 2003 mmb/d 2004 2005 2.72 Other 1.84 1.50 Other 0.68 Other Asia 0.9 % 0.66 Asia 0.9 % 1.0 % How Can The World Cope With This Growth? 1.83 US Other US 0.76 Asia Europe Asia 2.4 % Asia Asia 3.4 % 2.2 % 6.4 million b/d Markets & Countries | Page 8 Drivers Of Chinese Growth Several Sectors Underpinning Product Strength Industry Industrial output is booming across the board Increased household consumption Urbanization Increasing car fleet, trucks shifting to diesel Transportation Asian Demand Growth Chinese Refinery Runs 1,000 6,500 China India 6,000 1,500 kb/d Up 36% 5,500 800 5,000 600 4,500 400 Rest Of Non-OECD Asia 4,000 200 3,500 3,000 0 kb/d kb/d 1998 2000 2002 2004 2001 & Countries 2002 Markets 2003 2004 | Page 9 2005 US-Chinese Synergy Drives Up Diesel Demand The Axis Of Diesel Diesel Demand In the United States and China More Chinese Goods Exported To The US 3.8 3.6 3.4 3.2 3.0 2.8 2.6 2.4 US Diesel Demand (left axis) China Diesel Demand (right Axis) forecast 2.7 2.5 2.3 2.1 1.9 1.7 1.5 1.3 mmb/d J-02 J-02 J-03 J-03 J-04 J-04 J-05 J-05 mmb/d Port of LA Incoming Cargo And Diesel Demand 400 Loaded Incoming TEUs US Diesel Demand (right axis) 3.4 350 3.2 300 3.0 2.8 250 2.6 200 Jan02 2.4 Jul- Jan02 03 Jul- Jan- Jul- Jan03Markets 04& Countries 04 | Page 05 10 US Product Demand Gives a Hand Gasoline Growth Slowing, Diesel Growth Has Created Problems 9.3 9.2 9.1 9 8.9 8.8 8.7 8.6 8.5 8.4 8.3 Gasoline demand increased 8% between 2000 and 2005 People live farther away and use bigger cars US Distillate Demand mmb/d 4.4 US Gasoline Demand forecast 700 kb/d 2000 2002 2004 2005 4.3 4.2 4.1 4 600 kb/d Between 2000 and 2005 distillate soared with a 15% growth. 3.9 3.8 Transportation of imported goods throughout the country underpins diesel consumption. 3.7 3.6 3.5 mmb/d 2000 2002 2004 2005 Markets & Countries | Page 11 Refinery Utilization Is Stretched FSU IS The Only Region With Significant Spare Capacity Average Yearly Utilization Rates In Selected Regions 2002 And 2004 97% 96% 92% 95% 89% 86% 83% 60% 79% 57% US EU Middle East Asia/Pacif FSU Does not include teapot capacity in China Refinery utilization in the Asia/Pacific market is the most stretched, as refiners try to meet Chinese demand. Next year will see the last round of significant specification changes for distillates in the US and Asia, and its impact on production should not be underestimated. Markets & Countries | Page 12 Non OPEC Growth Sluggish Decline Rates Hamper Growth Year-on-Year Growth In Non-OPEC Crude Non Opec - Non FSU Crude Non-OPEC NGLs 1,600 FSU Crude 1,400 1,200 1,000 800 600 400 200 0 -200 1998 1999 2000 2001 2002 2003 2004 2005 Markets & Countries | Page 13 OPEC Has Lost Its Excess Capacity Spare Capacity Is A Luxury 3.0 2.5 mmb/d Saudi Non Saudi 2.0 1.5 1.0 Historical Spare Production Capacity 9.0 million b/d 8.0 7.0 Saudi Spare Capacity 6.0 Other Spare Capacity 0.5 0.0 Sep- Mar- Sep- Mar- Sep03 04 04 05 05 5.0 4.0 3.0 2.0 1.0 0.0 1985 1990 1995 2000 2005 Markets & Countries | Page 14 OPEC’s Mostly Talks Saudi Arabia Acts $55 $50 WTI Price And OPEC’s Arguments About It “ US Gasoline Market Is to Blame” $45 $40 “ It is Speculator’s Fault” $35 “Fundamentals Are Tight” $30 J-04 F-04 M-04 A-04 M-04 J-04 J-04 A-04 S-04 O-04 N-04 D-04 J-05 F-05 M-05 2003 – 1st Half 2004 OPEC Performing “Stock Management” Strategy OPEC Willing To Bring Speculators To The Oil Markets 2nd Half 2004 - 2005 OPEC Limited To Cash In High Prices Saudi Arabia Tries To Limit The Upside Losing Leverage To Control Marker Prices Markets & Countries | Page 15 Why Is OPEC Not Able To Respond? Not The Right Crude Total Crude Supply, Left Axis Discounts Of Arab Medium In Selected Markets vs. 76 Sweet Crude Supply, Right Axis 23 74 21 72 19 US 17 68 15 66 13 Asia $1 -$1 -$3 -$5 70 Europe -$7 Jan-04 Jan-05 -$9 -$11 -$13 64 11 mmb/d mmb/d 1Q02 4Q02 3Q03 2Q04 1Q05 4Q05 Wrong Quality Spurs Soaring Discounts Markets & Countries | Page 16 Why Hedge Funds Are Flocking In? Sliding Dollar And Low Interest Rates Falling Dollar And Rising WTI $50 WTI (left axis) Euro/Dollar XR (right axis) Interest Rates and WTI 0.84 0.82 $45 0.80 $40 0.78 $35 0.76 2Q04 3Q04 4Q04 1Q05 45 Nominal Crude Price Federal Funds Rate 9 40 8 35 7 30 6 25 5 20 4 15 3 10 2 5 1 0 0 $/d 1988 1991 1994 1997 2000 2003 The recent rallies of the last three months are related to pouring money into the oil futures market by all types of investors. Investment in commodities is a great opportunity to cash in in Asian growth, but a growing problem for the stability of oil prices Markets & Countries | Page 17 % Increasing Interest In Far Out Contracts Flattening The Price Curve Price and Open Interest For WTI Futures PRICE 55 DEC-05 DEC-06 DEC-07 50 45 OPEN INTEREST DEC-08 DEC-09 70 60 50 DEC-05 DEC-06 DEC-07 DEC-08 DEC-09 40 30 40 35 20 30 10 25 0 Jan04 Mar04 May04 Jul04 Sep04 Nov04 Jan05 Jan04 Mar04 May04 Jul04 Sep04 Nov04 Jan05 Funds have been putting their money on far out WTI contracts It has pushed WTI prices well over $40/b through the end of the decade. And Flattened the entire price curve, exacerbating the front-month contango in WTI and further weakening short-term fundamentals by encouraging further stock builds. Markets & Countries | Page 18 Eyes Focused On The 2nd Half Little Downside In The Short Term The Framework : Sliding Dollar, US Deficit Supply Anxiety for 4Q High Oil Demand Supply Anxiety Investors in need of hedging Stretched Infrastructure Investors willing to cash in the upside Mar Apr May Sep Dec Markets & Countries | Page 19 Building Stocks and Anxiety 4Q Anxiety Keep Prices Strong 2005 Oil Demand vs. Price Curve Of WTI* Demand 89.0 left axis: mmb/d Contango* right axis; $/b 88.0 $55 $54 87.0 $54 86.0 85.0 $53 84.0 $53 83.0 The World Might Have Problems To Cope With Oil Demand In 4Q 2005 $52 82.0 $52 81.0 80.0 $51 May Jun Jul Aug Sep Oct Nov Dec *WTI Futures Prices As Of April 14, 2005 Markets & Countries | Page 20 How Long Does It Take To React To High Prices? The Reaction Time Shows Asymmetric Risks Key low Impact Refining 30 months 10 years Upstream Economic Impact Of High Prices Economic Meltdown High Impact 3 – 5 years 1 Month Higher Risk to Economic Downturn Expensive oil may trigger investments in upstream or downstream, or may potentially affect demand in the long run. But the only short term element able to change the outlook is a potential economic meltdown. Markets & Countries | Page 21 The Economic Cycle Has Peaked But What Next Is Difficult To Predict Steroids Effects Waning US Growth Is Slowing Inflation driving interest rates up Growing By Borrowing Not Sustainable trade deficit impacting $ value No country has managed to consume and invest 6% more than it produces for long. Asian Banks Willing To Subsidize Forever? Adjustment of Imbalances is Necessary Managed adjustment Slowdown Crisis Triggered Adjustment Meltdown Oil Demand Slowing Markets & Countries | Page 22 Corporate Offices 1300 Connecticut Avenue, N.W. 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