Missing OPEC

The Unwelcome Return of Boom-Bust Oil

Price Cycles

Presentation to the Dallas Federal Reserve conference, “Oil and the

Economy: Adapting to a New Reality”

Houston Branch Office, November 18, 2016

www.rapidangroup.com

t. +1 301.656.4480

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Robert McNally

The Rapidan Group

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Some Historical PerspectiveOn Oil Price Volatility

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Demand & Supply Inelasticity Means Imbalances = Wild Price SwingsStandard Oil, Texas Railroad Commission, Seven Sisters, OPEC used to manage supply to stabilize prices

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Since 2008 the Oil Market Has Been in a Post-OPEC, New Boom-Bust Era

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No Spare Capacity, No Peace

TX and other US oil states

Seven Sisters’ Middle East concessions

After 1972, OPEC

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Have Crude Oil Prices Bottomed?

Busts Can End Three Ways

1. Blood (military force/social upheaval/geopolitical conflict removes supply)

2. Sweat (sub-lifting cost prices squeeze enough high-cost production out) or

3. Tears (plummeting prices impel policymakers – in recent times OPEC and sometimes some non-OPEC energy ministers - to mandate emergency production cuts)

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Mostly sweat, mixed with

some tears and blood Tears

Tentatively, blood and sweat, mixed with

some tears

Blood Tears

Market Eager to Pounce on Bottom Courtesy of Shale or OPEC

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Anti-Freeze - Iran and Saudi Arabia Added an Eagle Ford Since February

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Algiers – OPEC Surprised, But With Enhanced Verbal Intervention Instead of

Cuts

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The Next Big Surprise?

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Every Five Years or So, Major Surprise Develops and Hits the Market

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Surprise #1 – Non-OPEC Supply Curve Steeper than Believed

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Surprise #2 – Shale Oil Bursts from Nowhere

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10m

b/d

Total US Crude Production Forecast, Reference CaseSource: EIA Annual Energy Outlook

2008 Forecast 2009 Forecast 2010 Forecast 2011 Forecast

2012 Forecast 2013 Forecast 2014 Forecast

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Surprise #3 – Saudi Won’t Swing

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Surprise #3 – Saudi Won’t Swing

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Surprise #4 – “Peak Demand” Predictions Fall Far Short

Source: EIA Annual Energy Outlook 2016

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• Peak demand in transport sector includes massive declines in gasoline use

• Other fuels (diesel, jet fuel, electricity, etc.) grow in use while gasoline fades

• Diminished gasoline use is due to efficiency gains in light duty vehicles (see below from AEO 2016), sharp diversion from history

EIA Assumes US Oil Demand Peaks, Then Declines Because Gasoline ImplodesUnrealistic vehicle efficiency gains underpin massive decline in transportation sector gasoline demand

Imploding gasoline demand?

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US Demand Forecasts Show Future Decline – But Where’s the Recession? Prices rise while demand remains flat in EIA’s base forecast

Big Battle Shaping Up Over Fuel Economy Standards in Washington

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Millennials May Want to Drive as they Start Families and JobsWhich would disappoint environmental groups

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History Shows Washington Shirks from Biting Fuel Economy Standards

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After gas prices drop, DOT reduces car standard

Amidst low pump prices, SUVs proliferate via light truck “loop hole.” Congress freezes CAFE in ‘97

CAFE standards raised after pump price increases…..

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Reality Check: Forecasters Seeing Thirstier Demand Growth

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Let’s Not Forget About Frantic Inventory BuildingThe US built inventory cover in periods of high spare capacity, but China and India will fill in a tight market

• India and China have both announced plans to acquire 90 days of import cover• We expect China will work aggressively to import an additional 2-400 million barrels of crude in the coming years• India will be slower to ramp up; 39 million barrels of storage will likely be filled in the next 12-18 months, but plans

to fill an additional 91 million barrels by 2020 are ambitious and could be delayed

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Barrels at Risk “Base Case” - Moderate GDP (60% odds): Disruptions average 1.2 mb/d through 2021; 2.6 mb/d threatened

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Our Price Scenarios and Probabilities

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Our Price Scenarios and Probabilities

Thank You

www.rapidangroup.com

t. +1 301.656.4480

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Robert McNally

The Rapidan Group