petrocapita oct 2009

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Petrocapita Energy Upda

October 2009


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Summary

There has been considerable discussion recently about theparadox of bonds and stocks and commodities going up together- that the bond market is predicting a continuing recession via lowinterest rates and the stock market is predicting a recovery via highequity prices. Why is the bond market behaving so strangely in the

face of a huge recovery stocks and commodities surely one ofthese indicators must be wrong? Maybe, but perhaps there is analternative interpretation that ts the facts.

Markets always appear to act strangely to prot maximisers whennon-prot maximisers are involved. I actually feel that the behaviorof the sovereign debt market makes sense. Virtually every assetclass is exhibiting the short-term effects of a massive monetaryexpansion. Once again assets that are liquid and traded - includingLT sovereign debt are rapidly increasing in price in nominalterms. Monetary authorities have expanded the global moneysupply aggressively allowing speculative activities to re-ignite via

investment and commercial banking intermediaries and at the sametime they are busy monetizing the rapidly expanding governmentdebts - hence low interest rates and rapidly recovering equity prices.

When cross-correlations between assets classes are very high andpositive we should always be asking ourselves whether we are in aperiod of liquidity/money printing induced euphoria.

Ultimately monetary authorities can control exchange rates orinterest rates but not both. If they decide to sacrice exchangerates for low interest rates then, in my opinion, ination is sure to

follow.

CONTENTS

2 Global Oil Production -UKERC

3 North American Natural GasStorage

3 Crude Natural Gas Ratio

3 Natural Gas Supply

Demand Analysis

5 Energy Consumption QuickFacts


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The peak year for discoveries of giant oil elds(ultimate recovery of 500 mbbl oil or more) in theU.S. was 1930in the world, 1962. 80% of the oilproduced in 1995 was found before 1973. We nownd one barrel for every four we consume.

Energy Update

In the last 20 years, only three elds (in Norway,Columbia and Brazil) have been found with more thanone billion barrels each. None produce more than200,000 barrels a day. From 1990 to 2000 a total of

42 billion barrels of new reserves were discovered.In the same period the world consumed 250 billionbarrels.

CHART 1:

EXPLORATION - DISCOVERY - CONSUMPTION

80

70

60

50

40

30

20

100

-10

-20

Source: Association for the Study of Peak Oil,www.asponews.org

12

11

10

9

8

7

6

54

3

2Exploratorydrillingwildcats(thousands)

Annualoildiscoveriesminusannual

consu

mption(billionsofbarrels)

1950 1960 1970 1980 1990 2000

Discoveries greater than consumptionConsumption greater than discoveries

GLOBAL OIL PRODUCTION - UKERC

Despite large uncertainties in the available data,sufcient information is available to allow the statusand risk of global oil depletion to be adequatelyassessed. But the available methodologies canfrequently lead to underestimates of resource sizeand overly pessimistic forecasts of future supply. TheUKERC canvassed the existing research and came tothe following conclusions:

The rate of decline of production is accelerat-ing. The global average decline rate of post-peakelds is at least 6.5%/year and the correspondingdecline rate of all currently producing elds is atleast 4%/year. This implies that approximately3 mb/day of capacity be added each year just to

maintain production at current levels equivalentto a new Saudi Arabia coming on-stream every 3years. An additional 1 mb/day is required to meetdemand growth. From a different perspective,more than two thirds of existing capacity mayneed to be replaced by 2030 solely to preventproduction from falling.

A peak in conventional oil production before 2030appears likely and there is a signicant risk of apeak before 2020.


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NORTH AMERICAN NATURAL GAS STORAGE

Working gas in storage was 3,734 Bcf as of Friday,October 16, 2009, according to EIA estimates. Thisrepresents a net increase of 18 Bcf from the previousweek. Stocks were 397 Bcf higher than last year atthis time and 432 Bcf above the 5-year average of3,302 Bcf. In the East Region, stocks were 114 Bcfabove the 5-year average following net injections of11 Bcf. Stocks in the Producing Region were 252Bcf above the 5-year average of 935 Bcf after a netinjection of 5 Bcf. Stocks in the West Region were 65Bcf above the 5-year average after a net addition of2 Bcf. At 3,734 Bcf, total working gas is above the5-year historical range.

CRUDE NATURAL GAS RATIO

The oil/natural gas ratio has moved down sharplyfrom the extreme trading of just 4 weeks ago.

NATURAL GAS SUPPLY DEMAND ANALYSIS

Highlights from the recent Bernstein Energy reportWhy $5 Gas Is Still Cheap: Its Cyclical, Not Secular:Highlights Gas investors are now faced with two controver-

sial questions: what is the marginal cost of supplyand where are we in the cycle? Although somepeople believe that gas has become structurally

Energy Update (continued)

CHART 2: WTI CRUDE VERSUS NATURAL

GAS RATIO (SEPTEMBER 2009)

23.5023.0022.5022.0021.5021.0020.5020.0019.5019.0018.5018.0017.5017.0016.5016.0015.5015.0014.5014.0013.5013.0012.5012.0011.5011.0010.5010.009.509.008.50

2004 2005 2006 2007 2008 2009 Monthly

9/1/2009(CL V9 / NG V9)

CHART 3: WTI CRUDE VERSUS NATURAL

GAS RATIO (OCTOBER 2009)

17.50

17.00

16.50

16.00

15.50

15.00

14.50

14.00

13.50

13.00

12.50

12.00

11.5011.00

10.50

10.00

9.50

9.00

8.50

8.00

7.50

7.00

6.50

6.00

2004 2005 2006 2007 2008 2009 Monthly

10/1/2009(CL Z9 / NG X9)

16.29


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cheaper, the evidence we have seen suggests theopposite: the long-term upward trend in the costof gas continues. However, we now nd ourselves

in a severe cyclical downturn. We believe that thecyclical recovery will be relatively quick and that,

as a result, pricing will approach and surpass themarginal cost of $7.50/mcf in the early part of2010.

The secular upward trend is unchanged because

even though shale gas is clearly abundant, thereis little evidence that producing it is cheap. Weexpect that most shales will be like the BarnettShale very strong initial results followed by yearsof rising F&D as companies either drill further fromthe core or drill wells too close to each other.Furthermore, shale gas still accounts for only 11%

of the total market, meaning that other gas drillingmust continue as well. We also believe that muchof the improvement in initial-production ratesseen in the past two years has been due to E&Psspending more on expensive completion tech-

niques, not due to improving geologic prospects. In terms of the cycle, the long-anticipated reduc-

tions in onshore supply have begun, with onshoreproduction 1.5% lower in July of this year than inJune. We expect these production trends to con-

tinue and to accelerate, and we believe that gasproduction may be down as much as 10% year-over year by December. There are a few reasons

why it has taken time for the reduced rig countto impact production, but current rig counts areclearly unsustainable over the long term. Cana-dian production has also been reduced by lower

rig counts, and hence imports to the US have

dropped materially. We think that LNG will not pose a material threat

to a recovery in US gas prices. Imports to the UShave been just 1.3 Bcfd so far in 2009 and withprojects being delayed the anticipated ood ofLNG will be smaller than expected. More im-

portantly, the world continues to have an LNGshortage relative to regassication capacity, andwe expect that demand for LNG will be muchstronger internationally than in the US.

We believe that the recovery of gas prices will beled by declining supply of gas, not by a surge indemand. Reductions in supply on a year-over-

year basis will be over 5 Bcfd, which is muchlarger than the reductions in industrial demand,which was never greater than 2.5 Bcfd year over

year. We continue to model relatively weak indus-trial demand going forward, with little recovery inthe coming years. We believe there will be some

growth in the electric power segment but theremay be a brief reduction in gas demand for power

of around 1 Bcfd once gas again becomes moreexpensive than coal.



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ENERGY CONSUMPTION QUICK FACTS

US Foreign Oil Dependence: In 2002, net importsaccounted for 53% of U.S. oil consumed and isprojected to rise to 70% by 2025. 50 percentof US oil comes from the Western hemisphere;Canada and Mexico are its top suppliers. Butthen completing the list are countries like Saudi

Arabia, Venezuela and Nigeria major players inthe global oil market with authoritarian regimes orpolitically unstable governments. So consider therange of implications for US oil supply if one ofthese nations were to undergo a transformation ofpower, civil unrest or even a natural disaster. TheUS certainly got a foreshadowing of this in 2008when gas prices reached $4 a gallon.

World Oil Reserves: The US has 2.4 percent ofthe worlds proven oil reserves, meaning theoil that we know is there and can be pumpedusing existing technology. But thats a modestpercentage considering the US consumes moreof it than any other country and also consideringthe US is one of the largest oil producers. Noother country that produces as much oil alsoconsumes so much. To put this numbers ina global perspective, the Middle East has 61percent of the worlds proven oil reserves. Iranalone accounts for 11.2 percent.

Transportation: Transportation is one of the larg-est consumers of energy in the world, accounting


Thousand barrels per day, 2007

Canada

Mexico

Saudia Arabia

Venezuela

Nigeria

Algeria

Angola

IraqRussia

U.S. Virgin Isl.

CHART 4: TOP SUPPLIERS OF OIL TO THE US

Source: Monthly Imports Report, January 2009, EnergyInformation Administration

0 1,000 2,000 3,000

2,455

1,532

1,485

1,361

1,134

670

508

484414

346

100%

90%

80%

70%

60%

50%

40%

30%20%

10%

0%

CHART 5: WORLD OIL RESERVES

Proved oil reserves as a percentage of world total, at end of 2007

Source: BP Statistical Review of World Energy, June2008, BP

NorthAmerica

South andCentral

America

Europe,Eurasia

Middle East Africa Asia Pacic

3.2%9.0% 11.6%

61.0%

9.5%3.3%


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for 58 percent of liquid fuel consumption in OECDcountries in 2004.

Coal: Coal is the most abundant fossil fuel pro-duced in the US and is used to generate nearly

half of all electricity in the United States. TheUnited States has the worlds largest known coalreserves, 263.8 billion short tons, which are pro-

jected to sustain the US demand for electricity for225 years. The consumption of coal is expectedto increase at an average annual rate of 2 percentfrom 2005 to 2030. Countries such as China,India and the US have vast reserves of coal andcan extract coal relatively cheaply, making it aneconomically attractive source of energy.

Renewable Energy: Renewable energy is thefastest growing source of energy, with projectedconsumption increasing by 2.1 percent annuallyfrom 2005 to 2030. Renewable energy is gener-ally more expensive to produce than energy fromfossil fuels and current projections show that it isnot a realistic substitute for traditional fossil fuelsupply in the foreseeable future.

China: Oil consumption in China has increased8% annually since 2002, doubling from 1996-2006. China is capable of overtaking the U.S.as the worlds largest energy consumer by 2010according to the EIA. In March 2009, the Chinese

government agreed to nance oil-eld develop-ments with Brazilian and Russian oil companiesin exchange for guaranteed supplies of crude oil.China will loan the Brazilian oil company Petro-bras (PBR) $10 billion for the development of itspre-salt elds. In return, Brazil will supply Chinawith 100,000 to 160,000 barrels of crude oil perday. Petrobras (PBR) has reached similar agree-ments with Unipec, a subsidiary of China Petro-leum and Chemical Corporation. Petrobras (PBR)will sell between 60,000 and 100,000 barrelsof crude per day to Unipec in exchange for $10

billion in loans from Unipec and the China Devel-opment Bank. In March 2009, the China Devel-opment Bank signed a $15 billion nancing dealwith Russias government-controlled oil companyRosneftand a $10 billion deal with Transneft in ex-change for future oil supplies. In exchange for theloans to Russian oil companies, China will receiveoil supplies and a new pipeline spur to China.For China, the deals secure 15 million tons of oil(300,000 bpd) every year for the next 20 years.China has also agreed to loan Venezuela $12 bil-

lion in order to develop oil projects that have thepotential to increase Venezuelan exports to Chinafrom 330,000 bpd to 1 million bpd by 2015.Chinas nancing contracts with Petrobras (PBR)and Rosneft are part of the countrys strategy ofsecuring future energy contracts in order to meetthe countrys rising demand for energy.


CHART 6: WORLD ENERGY DEMAND

1980 2020 1980 2020 1980 2020

300

150

60 1.2

Source: Global Energy Network

(Million Barrels/Day Oil Equivalent)

Total Energy Non-Fossil Wind & Solar

Non-Fossil Wind & Solar

Fossil

Fuels

Developing

Nuclear, Hydro& Biomass

Industrialized

} }

Wind

Solar


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Calgary, Alberta T2S 2T4

Canada

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