Edition Fifty Two — July 2016

Oil Prices: Beware Return Of The Financial Bears

Brexit and the energy equation

North Sea Oil and Gas - an industry averse to change

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1

Oil Prices: Beware

Return Of The

Financial Bears

Written by John Richardson from ICIS

THE above chart shows the extent to which this year's oil-price rally has been led by

futures markets. What is significant, though, is that futures activity seems to have

plateaued.

Sure, futures activity could easily go the other way again, driving prices significantly

above the $50/bbl level. But barring a decision by the US Federal Reserve to once

again step away from interest rate rises and China further loosening the credit tap, it

is hard to see why the speculators would want to go deeper into bull territory. The

market remains heavily distorted by the speculators, and so first and foremost you

must analyse futures activity before you then look at physical supply.

2

Right now, I would argue that the Fed looks set on raising interest rates again in

June or July. And in China, credit growth contracted again in April. I believe this

indicates that economic reforms are gathering pace again.

As for the real supply and demand of oil, you should have been asking yourselves

two questions throughout this rally: Shortages? What Shortages?

I'll deal with the Fed, China, and today' crude supply position in more detail later on.

First of all, though, here is some historical context behind the role that financial

markets have played in determining the oil price over the last seven years.

China, Jobs and Economic Stimulus

I believe that that the 2009-2014 rally in crude prices was driven by the fall in the

value of the US dollar, thanks to the Fed's ultra-low interest rate policies. This forced

hedge funds and pension funds etc. to seek an alternative 'store of value'. This store

of value was oil and other commodities.

What seemed to justify this alternative store of value was China's parallel decision to

conduct the biggest economic stimulus programme in global economic history, which

cushioned the country from the impact of the Global Financial Crisis. It was all about

preserving jobs for the Chinese leadership of the time. They didn't care about

anything else, including the long term fundamentals of supply and demand as

overinvestment poured into manufacturing and real estate. To give you an idea of

the scale of what I am talking about, China increased lending by $10 trillion in 2009,

when its nominal GDP was only $5 trillion. Lending was an astonishing $18 trillion

higher by 2013.

The long term economic benefits of this extraordinary rise in credit didn't worry the

financial speculators. Of course not. It is not their job be worried about the long term.

But other people who should have known better, including CEOs of some chemicals

companies, who started talking about a 'new paradigm' of a rising middle class in

China who would very soon be as rich as the middle classes in the West. This not

3

only justified and underpinned the rallies in oil and commodity prices - but crucially

also added further momentum to the rallies.

As this paradigm became the new consensus, the shale-oil industry took off in the

US - aided also by the availability of cheap financing thanks to the Fed's interest-rate

policies. Petrochemicals projects in the US, and elsewhere, were also sanctioned on

the theory that China - and emerging markets growth in general - had entered this

new paradigm.

It all went very badly wrong from September 2014, when it became apparent that

Chinese economic stimulus had, after all, been unsustainable. Crude markets

belatedly woke up to the notion that China's stimulus had left behind vast domestic

oversupply in manufacturing and real, estate, and so a serious bad debt problem.

The scale ofChina's environment crisis, made much worse by this overinvestment,

was also recognised.

What made people wake up to these long-standing realities was that China's new

political leaders admitted the scale of the problems - and, more importantly, they

reversed course. They started reducing credit growth, and so the Chinese bubble

began to dramatically deflate. Credit growth began to decline from January 2014.

And here is another extraordinary number: In 2015, growth in credit was no less than

$4 trillion lower than in 2014.

Back To The Future: Q1 2016

After the January 2016 collapse in oil prices and equity markets, the US Federal

Reserve got cold feet. It began to back away from further interest rate rises, on the

belief that weak crude and equities etc. meant that US economy was in too perilous

a condition to take that risk. This was the signal sent to the oil speculators: The dollar

was going to be weaker for longer than they had expected, and so it was time to get

back into crude as an alternative store of value. This also led to recovery in other

commodity markets, including iron ore.

4

What once again added further momentum to the rally was China's decision to

loosen credit, which grew by some 58% in Q1 over the first quarter of 2015. The

detail didn't matter here. All that mattered to the crude-market speculators was the

wider belief that China had, somehow, turned the corner. The renewed economic

stimulus created the erroneous idea that China could spend its way out of trouble.

Now, though, thanks to stronger US GDP growth and continued robust jobs growth,

Fed chairman Janet Yellen has indicated that two to three interest rate rises could,

be on the cards later this year - with the first hike possibly in June or July.

And in China, credit growth fell in April. Total social financing plunged to 751 billion

yuan during month compared with 2.34 trillion yuan in March.

Any sensible analyst would have told you that China's Q1 rise in lending was

unsustainable - and that, of course, it was a drop in the ocean compared with the $4

trillion of credit withdrawn from the economy in 2015.

What told you it was unsustainable was that this represented another example of a

victory for the short-term thinkers who in China, who prefer to prop-up immediate

growth rather than deal with the longer-term issues. But you also had to bet that the

reformers would reassert control - and, indeed, this has happened. In this particular

instance, local governments temporarily gained the upper hand because of their

struggle to cover their liabilities.

The end result - and may have already seen early signs of this in the above chart -

could well be speculators switching back to the US dollar, as is strengthens - away

from their alternative stores of value.

Actual Supply And Demand of Oil Itself

Last is not meant to be least. Of course, this matters. But in all the noise created by

the speculators, the sound made by the data on physical production, storage and

demand can sometimes be impossible to hear.

5

Take last year's oil-price rally as an example. Remember how we kept being told that

the US rig count was falling? This took Brent from $45.19/bbl in mid-January to

$69.63/bbl on 8 May.

Meanwhile, US shale oil producers continued to push the innovation envelope on

cost reductions. Each rig in operation had also become much more productive.

Thepractice of 'fracklogging' - storing oil in rocks ready to be fracked when prices

recovered - also increased. And thanks to stronger futures prices, the shale oil

industry was able to take out new hedges. This put them in the position to be able to

sell at lower prices in the physical market because they had locked higher futures

returns. Saudi Arabia also stuck with its market share strategy, whilst the global

economy remained weak. This all led to the fall in oil prices during H2 2015.

The physical justification for today's rally is on even more shaky ground.

We were first told that there would be a production freeze agreement at the April

Doha meeting. I never believed that this on the cards - and, of course, it didn't

happen.

We did then, however, see a dramatic decline in production as a result of wild fires in

Canada, attacks on Nigerian pipelines and more upheavals in Iraq. But I think that

this was seized upon by markets whilst they overlooked some signs of long supply

elsewhere. And, of course, this decline could well prove to be temporary.

Signs of long supply elsewhere includes oil in storage. Global oil stockpiles, including

floating storage, have increased for the last ten consecutive quarters, according to

this Hellenic Shipping News article, which adds:

It is estimated that almost 9% of the global VLCC fleet is currently booked for floating

storage, which is a 40% increase in tankers by number since December. Reuters

reported that at least 40 laden VLCCs anchored off Singapore as floating storage,

storing estimated volumes of up to 47.7m bbl, thought to be the highest level in at

least five years.

6

Crucially, also the contango is narrowing. Last week, the one-month arbitrage on

Brent in floating storage was -$0.48/bbl, while the 12-month arbitrage was at -

$6.11/bbl, implying there was no profit incentive to store oil on ship. Storage costs

are a minimum of $0.74/bbl, and so there has to be a risk of destocking.

Iran is also raising production. By the summer its exports are expected to rise a

further 200,000 bbl/day to reach 2.2m bbl/day the middle of this summer.

And nobody should be surprised over reports that the US rig count has stopped

declining, with early signs that the rig count may actually increase.The US is the

world's new 'swing producer'. The inventory of drilled but uncompleted US wells has

been building, driven by companies with contracted drilling services. Ccompanies

have merely postponed, rather than cancelled, completion of wells. This could add

400,000 bbl/day to supply.

Let's not forget yesterday's OPEC meeting. There was again, of course, no

agreement to freeze, never mind cut, production.

As for demand, the summer lull season in the northern hemisphere, when many

people take their holidays, is set to occur in August and July.

If this market turns, those who want to short oil have plenty of physical ammunition to

support their positions.

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7

Brexit and the energy

equation

Written by Kurt Cobb from Resource Insights

The fretting in the financial markets after Great Britain's voters narrowly decided to

leave the European Union (EU), a move dubbed Brexit, was less about immediate

effects--there aren't any since it would take Britain up to two years to withdraw--and

more about a foreboding that other countries will want out, too.

In addition, some think it likely that Scottish independence will once again be on the

agenda. Scots were heavily in favor of remaining in the EU.

Centrifugal political forces are bad for business since they spell uncertainty and

ultimately disruption if they come to fruition as they did in Britain regarding the EU.

And, Britain, of course, isn't the only country in Europe facing breakaway

movements. The people of Spain's Catalonia region have for some time sought a

referendum on independence from Spain. Only last year Catalan separatists won a

majority in the regional government. The movement cites cultural and linguistic

reasons for independent statehood, reasons that could be asserted by many groups

across Europe and lead to more instability.

The larger question is why there is building discontent with global economic and

political integration not only in Europe, but also in the United States as evidenced by

the candidacies of Donald Trump and Bernie Sanders.

The slim defeat for pro-EU forces has been explained as a vote against EU

immigration and business regulation policies and against the loss of national

sovereignty. But there is also a feeling afoot that the move toward greater integration

through the EU and through global and regional trade agreements is designed

8

primarily to enrich global financial elites--all the while subjecting middle- and lower-

class wage earners to stagnant and even falling incomes as they compete against

cheap labor in developing countries.

In the conversation about the rising revulsion against further integration, one factor is

not being discussed: energy. With oil, natural gas and coal, the world's primary

energy sources, all far below their high prices of the last decade, all would seem well

on the energy front.

Britain, of course, had been reaping the benefits of oil and natural gas deposits in its

sector of the North Sea since the 1970s. However, after 2005 the country ceased to

be a net exporter of crude oil and natural gas liquids. Imports of natural gas have

risen steeply with 2014 imports reaching 19 times what they were in 2000. Both

these trends point to the decline of the North Sea fields and Britain's re-entry into the

league of oil and gas importers, a sudden reversal of a previous long-term trend and

a net negative for the British economy.

As you'll see below, this trend combined with the effects of high energy prices on

productivity growth had a negative effect on the incomes of middle- and lower-class

voters who simultaneously paid a higher proportion of their incomes for increased

energy bills. This double whammy has likely contributed to discontent among such

voters who were looking for a way to express their frustration and found it in the

Brexit vote.

Returning to the trends mentioned above, the year 2005 turned out not only to be an

inflection point for the North Sea fields, but also for the worldwide oil markets. Prices

rose inexorably and spiked in 2008 to their highest ever. After prices dipped to

around $35 per barrel in the wake of the financial crash that followed, they rose

sharply again regaining $100 by early 2011 and hovered around record average

daily prices for more than three and a half years. The high prices were related to

rising demand from Asia, but also to a dramatic slowdown in the growth of oil

production worldwide.

9

If the cause of our current economic difficulties was, in part, high oil prices which

slowed the world economy, then an energy connection comes into view. Current low

oil prices become a symptom of economic weakness rather than merely a reflection

of excess supply. (Much of the world outside of North America also experienced high

natural gas prices during this period in the form of high landed costs for liquefied

natural gas in Japan and Europe, far higher than the U.S. pipeline price during this

period.)

Moreover, high energy prices in general can be linked to slower productivity growth.

And, we have seen global productivity growth far below the expected trend since

2005, a year that was as noted an inflection point for oil prices. Now, here's the

important part: Productivity growth is the basis for rising wages. With declining

productivity growth employers are less likely to raise wages as those raises would

eat into profitability.

There are other reasons why wage earners may not be receiving wage increases,

but lack of productivity growth is an important one.

So, here's what all this had to do with the Brexit vote: Stagnant or declining living

standards breed discontent among a populace used to rising standards. Pro free

trade and economic integration forces argue that such integration into larger trading

federations leads to greater prosperity. When the prosperity disappeared as it did

in Ireland, Spain and Greece, significant political movements arose in the latter two

(Podemos in Spain and Syriza in Greece) which question further integration and

suggest at least substantial alteration of the terms of EU membership. The effect on

British wage earners was more subtle, but found its expression in the Brexit vote.

Likewise, real American median wages have been generally slumping since 2007.

The long-awaited recovery in wage growth has yet to appear in the United States

even as a boom in oil and natural gas related to extraction from shale deposits

boosted incomes in states where the boom occurred.

As in Europe, American voters have been looking for the reason for their declining

prospects, and two candidates for president this year suggested a reason that

10

makes sense to those voters: Global trade agreements have depressed American

wages. Donald Trump said he would 'renegotiate' the North American Free Trade

Agreement (NAFTA). Bernie Sanders outright opposed NAFTA in 1993 while a

congressman and continues to oppose agreements he believes punish domestic

labor.

While supposedly unfair trade and financial agreements may be a cause for the

decline of middle- and lower-class fortunes, they cannot be the sole cause. That's

becausewage stagnation began long before NAFTA and long before the introduction

of the Euro.

It's instructive to note that in the United States median hourly wages leveled off in

1973, the year of the Arab Oil Embargo. Energy costs in the United States rose

dramatically after that though they returned to lower levels in the 1980s and 1990s.

Still, the country was increasingly dependent on foreign oil and sent more and more

of its income abroad during this period to pay for that oil. During the recently expired

oil and natural gas boom in the United States, high prices enriched those involved

while transferring wealth from those who weren't. The effect on overall wages seems

to have been slightly negative.

None of this definitively proves that stagnant wages are caused by high energy

prices, increasing energy imports or skewed trade agreements. But there is strong

evidence that all three are implicated. Not surprisingly, energy is the theme that is

being neglected in this discussion because energy is currently in a cyclical price

trough, one that may very well have resulted from the dampening effect previously

high prices had on economic and productivity growth.

Such effects are hard to pin down. And, the mythology brought to us by the public

relations arm of the fossil fuel industry is that we need not worry about sufficient

energy supply--a story they've been touting since the lows in oil prices in 1998. Every

step of the way on the path to the price spike of 2008, the industry said big new

supplies were just around the corner.

11

When a special kind of hydraulic fracturing made new oil deposits available in the

United States, only prices near $100 a barrel made them economical (as we can see

by the widespread bankruptcies among those companies reliant on such deposits in

the recent low-price environment).

It's those high prices which I believe have slowed the economy making oil now seem

temporarily plentiful. If we don't go into a major recession or depression, a rise in

demand could send prices soaring and put further pressure on overall productivity

growth while increasing energy bills for households. That would set the stage for

more discontent among those who believe that increased economic global

integration is hurting rather than helping them.

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BP 2016: Global

Energy Production at a

Glance

Written by Euan Mearns from Energy Matters

Oil, gas, nuclear, hydro and new-renewables production all grew in 2015 while coal

production declined by 4%, the first significant decline for many decades. But global

CO2 emissions were still up by 0.1%. Notably, CO2 emissions rose in Germany,

Austria, Portugal, Spain, Italy and Ireland.

12

New renewables (wind, solar, biomass etc) continue their meteoric rise from a feeble

base and still only represent 2.8% of the global energy mix (that excludes biomass

used throughout developing countries). Fossil fuels still dominate with 86.1% of

primary energy in 2015 compared with 86.8% in the year 2000.

The BP statistical review of World Energy was published on 8th June. This post

gives a broad overview of energy production trends and CO2 emissions in 9 simple

charts. BP provide annual averages for all major energy classes with series that

begin in 1965. All charts are plotted using million tonnes of oil equivalent (Mtoe)

which is a means of allowing apples to be compared with oranges.

Figure 1 One may be tempted to

say that global oil production

rose by 3.2% despite the rout in

oil prices. The reality is that a

3.2% rise in global oil production

caused the rout in oil prices.

There are some big winners and

losers. The USA was up 8.5%!

Other winners include Brazil up

7.9%, the UK up 13.4%, Saudi

Arabia up 4.6% and Iraq up

22.9%. The big losers are Peru

down 11.1%, Syria down 18.2%, Yemen down 67.8%, Libya down 13.4%, Sudan

down 12.3%, Tunisia down 14.1% and Australia down 10.9%. Embedded in these

figures is a story of total failure of US and NATO foreign policy.

13

Figure 2 Global gas production

continues its upwards march as it

becomes increasingly important

in the global energy mix. There

are a couple of noteworthy

statistics. Dutch gas production is

down 22.8% as the Dutch

authorities reduce production

from the Groningen gas field

owing to subsidence and

earthquakes that were causing

structural damage. This is one of Europe's major primary energy sources. Venezuela

was up 13.2%. Rumours of that country's undoing are perhaps premature.

Bangladesh was up 12.2% as that country continues to exploit its large gas reserves.

Figure 3 Coal production looks

as though it may have peaked,

at least in the near-term. It has

succumbed to two major forces.

The first is the ending of the

industrialisation phase of the

Chinese economy. The second

is international pressure to

phase out coal because of

concern over CO2 emissions.

Global coal production was

down 4%. There is one noteworthy winner in Russia where production was up 4.5%.

Elsewhere the USA, Canada, Spain, Turkey, Ukraine, The UK, Indonesia and

Thailand all posted double digit % losses. Production in China, the world's largest

producer by far, was down 2%.

14

Figure 4 Notably, global nuclear

power production is once again on

a rising trend. With 69 GWe of

new power stations under

construction this is a trend that

may continue. The big winners in

nuclear power production are

China up 28.9% and India up

9.5%. The big losers are Belgium,

Germany, Sweden and

Switzerland.

Figure 5 Global hydro production

was up 1% and the overall

upwards trend must clearly reflect

growing global capacity. But it is

more difficult to make sense of

the annual figures for individual

countries since these are heavily

impacted by rainfall patterns. The

only countries that appear to

have expanded capacity are

Turkey up 64.6%, Indonesia up

5.9% and China up 5%.

15

Figure 6 The other

renewables category includes

wind, solar, geothermal and

biofuels. The meteoric rise

continues though the +15.2%

rise in 2015 compares with

+20% in 2011. The absolute

gain of 48.3 Mtoe needs to be

compared with oil up 133.2

tonnes, gas up 69.3 Mtoe and

coal down 158.8 Mtoe.

Figure 7 The rate of growth in

CO2 emissions has slowed in

the last 5 years as gas and

renewables substitute for coal

in power generation and the

Chinese economy evolves.

Notable statistics include

Germany up 0.8%, Austria up

3.6%, Portugal up 7.6%,

Spain up 6.8%. Italy up 5.1%,

Ireland up 5.4% and China

down 0.1%.

16

Figure 8 The rate of growth in

global primary energy

production appears to be

slowing which most likely

reflects the changing face of

the Chinese economy.

Primary energy is still

overwhelmingly dominated by

fossil fuels that accounted for

86.1% of global energy

production in 2015. This

compares with 86.8% in 2000.

Figure 9 While the growth in

new renewables looks

spectacular (Figure 6) they

remain insignificant in the

global energy mix amounting

to 2.8% of the total in 2015

compared with 2.4% the year

before.

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17

North Sea Oil and Gas -

an industry averse to

change

Written by David Wilson from Refining Business

Professional services organisation, PricewaterhouseCoopers (PwC), published their

latest report, 'A Sea Change - The future of the North Sea Oil & Gas', which seeks to

define the state of the North Sea Oil and Gas industry and, through the contribution

of some 30+ anonymous 'senior industry stakeholders', give some guidance on how

the industry could change to secure a turnaround in fortunes within a 24-month

window of opportunity. Whilst full of positive sentiment, I can't help but worry that

fundamentally, the North Sea Oil and Gas industry is averse to change.

The strongest element of the report is the urgent need for disruptive thinking within

an industry that has always cyclically repeated the past and now, in a lower for

longer environment, expects and needs different results. It shouldn't take Einstein to

see the insanity of that as a strategy.

In theory, three of the most innovative or potentially most impactful ideas mooted

are: consortium funding; nationalisation of the supply infrastructure; and

standardisation of technologies. However, in heeding lessons from other large scale

industries that have been forced into significant change, these are sometimes not

without their problems when it comes to practical implementation.

18

Consortium funding

The exit of many forms or scale of traditional funding from the industry has crippled

exploration and development activities. Consortium funding, where those Operators

(or Service companies) with deeper pockets club together to finance projects of

mutual benefit could well go some way to replacing some of the more risk-averse

sources that have withdrawn their support in recent times, scared off by unworkable

reserves or performance covenant based lending. The worry is that whilst this may

reduce the capital injection required, lenders will still take funding decisions or

guarantees based on the weakest link in any partnership. Recovering after the 2008

financial crash, lending institutions of all sizes, despite having billions made available

to inject back into the market, were more interested in rebuilding their own balance

sheets before providing much-needed market stimulation. Perhaps, in the North Sea,

those with the deepest pockets could provide more assurity than others, but then

with shareholder pressure, Operators and Service companies may take the same

approach in addressing their own needs first.

Nationalised infrastructure

One of the biggest threats to the sustainability of supply in the North Sea is the

integrity and long-term viability of the supply structure. Much of the efficiency savings

achieved in the last decades that have driven the North Sea production cost to be

amongst the most competitive in the world stem from collaborative use of the

offshore pipeline and tie-back infrastructure. As fields face decommissioning or

reduced investment in integrity, this advantage may literally erode. So, the industry

suggests passing the maintenance of the infrastructure onto the Government.

However, as an option, this has a familiar ring.

The nationalised National Rail inherited a poorly maintained infrastructure from the

private Rail Track group of companies. Several catastrophic failures,

mismanagement and massive losses led to this re-nationalisation where the bulk of

the ongoing cost for the upkeep falls to the tax payer. A similar deal with the UK

people, who perhaps would not hold the same fondness for bailing out the oil and

gas industry, may struggle to find far-reaching support.

19

Standardisation

A key collaborative initiative that will only work if there is true commitment to co-

operate from both Operators and Suppliers is standardisation. Macondo and other

milestones have necessarily driven the performance standards demanded of oilfield

equipment and operations higher and higher. However, raising the bar to a level

where all equipment must meet the same stringent specifications whatever the

working conditions is an expensive gold-plated option that led to spiralling industry

costs in recent times. Likewise, the pursuit of competitive advantage by technology

developers has baked in over-complexity and a lack of interoperability that similarly

impacts on costs. Lessons can be learned from the automotive industry that

introduced cross-manufacturer standardisation and many other technology and

supply chain collaborations that greatly contributed to reduced manufacturing costs.

An industry averse to change

Change management experts identify several common traits in individuals and

organisational cultures that lead to the lack of success or failure of change

programmes. I believe that industries as a whole, including the Oil and Gas industry,

can also be affected by these same factors leading to less than practical success

when compared to the vision or goals such as this one.

Fear of the unknown

The precipitous decline of the oil price came as a surprise to most. However, like a

blind-sided boxer left reeling from a stunning left hook, the industry has taken too

long to gather its wits and come back fighting.

As an industry, Oil and Gas displays an astonishing lack of flexibility in its

interpretation of and reaction to the information it has to hand. Just like the proverbial

oil tanker, even with all the signs of oversupply, spiralling costs and reduced global

demand, the industry failed to read the signs and change direction. And now, almost

two years later, we are still lamenting how the industry should change rather than

celebrating how it has changed.

20

Greater emphasis needs to be placed on reading the signs of the cycle and not

adding too much complexity on what is still essentially a supply and demand driven

market.

Mistrust

Much hope is placed on the UK Government's fiscal mechanisms to create a more

favourable market environment. Whilst the PwC report cites praise for some of the

changes that have been made, they make little difference currently in a market

without revenue. UK Energy Secretary, Amber Rudd, on a trip to open the new Total

Shetland gas plant, made no apologies for her lack of a visit to Aberdeen fully a year

after taking up the appointment that oversees the UK's energy policies - including

North Sea Oil and Gas. That is clearly not something that inspires trust within the

industry that the Westminster government has a clear plan. One could argue that

they do not even have a vested interest in the industry with the tax take moving into

negative figures for the first time in 2015-16, falling from over £2 billion the previous

year and down from £10 billion contribution just five years ago.

Loss of control

The perception that change will take away control has a crippling effect. The often

quoted story of the howling dog not moving from the nail it is sitting on because the

pain is not yet bad enough, exemplifies how the fear of what is on the other side of

change outweighs the imperative for action. But surely, the industry has endured a

deep enough pain that even the most thick-skinned or stubborn cannot ignore.

Bad timing

The longer the industry waits to make significant changes the less chance they will

be made. As the oil price appears to stabilise around $50, the industry is already

showing signs of drawing its breath in preparation to releasing a collective sigh of

relief. However, $50 as the new bottom is tenuous and there is still a long way to go

21

before significant spending returns. There will be many more companies and

individuals who do not retain their positions to see the benefits of a market recovery.

PwC's report suggests a 24-month window of opportunity. I would ask why more was

not done a year ago when the window was open even wider.

Predisposition toward change

Finally, a person's attitude to change plays a large part in how actively they engage

with it. We all know and understand that the Oil and Gas industry operates on a

cycle of boom and bust. If so, then as an industry why change at all? Let's just wait

for the next upcycle to swing by.

Even if there is sufficient oil under the North Sea for another 20+ years, there is the

clear and present danger that without decisive change, the UK's ability to extract it

profitably will be severely damaged. Lack of investment in exploration and

production, the supply infrastructure or retaining the skilled workforce within the

North Sea basin will all impact negatively and, again, drive costs up and

competitiveness down.

Leading change

It is likely that seeking salvation from outside the industry at a Government level will

not bear much fruit. Instead, change should be led from the inside out. Our industry

leaders, therefore, bring the greatest chance of change within the Oil and Gas

industry.

Organisations that want to have a long-term future in the North Sea, need to embed

change within their organisations from the top down. Executive teams need to

consider change at the forefront of their strategy and decision making, ensuring that

it is a core competency of management and a key skill throughout the organisation.

Through championing change, great leaders create an environment that nurtures the

most innovative and creative thinking from their people. Openness, transparency and

22

availability of information for improved decision-making build the integrity and trust

needed to drive difficult changes throughout the workforce and the whole industry.

Developing a wider sense of trust will also bring greater collaboration between

industry players.

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Refining Business

$50 Oil Doesn't Work

Written by Gail Tverberg from Our Finite World

$50 per barrel oil is clearly less impossible to live with than $30 per barrel oil,

because most businesses cannot make a profit with $30 per barrel oil. But is $50 per

barrel oil helpful?

I would argue that it really is not.

When oil was over $100 per barrel, human beings in many countries were

getting the benefit of most of that high oil price:

Some of the $100 per barrel goes as wages to the employees of the oil

company who extracted the oil.

Often, the oil company contracts with another company to do part of the oil

extraction. Part of the $100 per barrel is paid as wages to employees of the

subcontracting companies.

An oil company buys many goods, such as steel pipe, which are made by

others. Part of the $100 per barrel goes to employees of the companies

making the goods that the oil company buys.

23

An oil company pays taxes. These taxes are used to fund many programs,

including new roads, schools, and transfer payments to the elderly and

unemployed. Again, these funds go to actual people, as wages, or as transfer

payments to people who cannot work.

An oil company pays dividends to stockholders. Some of the stockholders are

individuals; others are pension funds, insurance companies, and other

companies. Pension funds use the dividends to make pension payments to

individuals. Insurance companies use the dividends to make insurance

premiums affordable. One way or another, these dividends act to create

benefits for individuals.

Interest payments on debt go to bondholders or to the bank making the loan.

Pension plans and insurance companies often own the bonds. These interest

payments go to pay pension payments of individuals or to help make

insurance premiums more affordable.

A company may have accumulated profits that are not paid out in dividends

and taxes. Typically, they are reinvested in the company, allowing more

people to have jobs. In some cases, the value of the stock may rise as well.

When the price falls from $100 per barrel to $50 per barrel, the incomes of

many people are adversely affected. This is a huge negative with respect to

world economic growth.

If the price of oil drops from $100 per barrel to $50 per barrel, this change adversely

affects the income of a large share of people who formerly benefited from the high

price. Thus, the drop in oil prices affects the incomes of many of the people listed in

the previous section.

Furthermore, this drop in income tends to radiate outward to the rest of the economy

because each worker who is laid off is forced to purchase fewer discretionary items.

These workers are also less able to take on new debt, such as to buy a new car or

house. In some cases, they may even default on existing debt.

24

A drop in oil prices from $100+ per barrel to $50 per barrel leads to job layoffs by oil

companies and their subcontractors. Oil companies and their subcontractors may

even reduce dividends to shareholders.

While oil prices have recently been as low as $30 per barrel, the subsequent rise in

prices to $50 per barrel is not enough to start adding new production. Prices are still

far too low to encourage new development.

In 2016, other commodities besides oil have a problem with price below the

cost of production.

Many commodities, including coal and natural gas, are currently affected by low

prices. So are many kinds of metals, and some kinds of food commodities. Thus,

there is pressure in a wide range of industries to lay off workers. There are many

parts of the world now feeling recessionary forces.

As prices fall, the pressure is for high-cost producers to drop out. As this happens,

the world's ability to make goods and services falls. The size of the world economy

tends to shrink. This shrinkage is clearly not good for a world economy that needs to

grow in order for investors to earn a profit, and in order for debtors to repay debt with

interest.

Growing demand comes from a combination of increasing wages and

increasing debt.

The recent drop in oil prices from the $100+ level seems to come from inadequate

demand for oil. This is equivalent to saying that oil at such a high price has not been

affordable for a significant share of buyers. We can understand what might have

gone wrong, by thinking about how demand for oil might be increased.

Clearly, one way of increasing demand is through increased productivity of workers.

If this increased productivity allows wages to rise, this increased productivity can

cycle back through the economy as increased demand for goods and services. We

25

can think of the process as an 'economic growth pump' that allows continued

economic growth.

Generally, increased productivity of workers reflects the use of more capital goods,

such as machines, vehicles, and buildings. These capital goods are made using

energy products, and operate using energy products. Thus, energy consumption is

an important part of the economic growth pump. These capital goods are frequently

financed using debt, so debt is another important part of the economic growth pump.

Even apart from the debt necessary for financing capital goods, another way of

increasing demand is by adding more debt. If a company adds more debt, it can

often hire more workers and can add to its holdings of property. These also help

raise the output of the company. As long as the output that is added is sufficiently

productive that it can repay the added debt with interest, adding more debt tends to

enhance the workings of the economic growth pump.

The way governments have attempted to encourage the use of increased debt in

recent years is by decreasing interest rates. The reason this approach is used is

because with a lower interest rate, a broader range of investments can seem to be

profitable, after repaying debt with interest. Even very 'iffy' investments, such as

extraction of tight oil from the Bakken, can appear to be profitable.

The extent of the decrease in interest rates since 1981 has been amazingly large.

Figure 1. Ten year treasury interest rates, based on St. Louis Fed data.

26

Since 2008, additional steps have been taken to decrease interest rates even

further. One of these is the use of Quantitative Easing. Another is the recent use of

negative interest rates in Europe and Japan.

Falling demand would seem to suggest that the world's economic growth pump is no

longer working properly. This is happening, even with all of the post-1981

manipulations of interest rates to reduce the cost of borrowed capital, and thus

reduce the required threshold for profitability of new investments.

What could cause the economic growth pump to stop working?

One possibility is that accumulated debt reaches too high a level, based on historical

parameters. This seems to be happening now in many parts of the world.

Another thing that could go wrong is that the price of oil rises so high that capital

goods based on oil are no longer cost effective for leveraging human labor. If this

happens, manufacturing is likely to move to countries that use a cheaper mix of

fuels, typically including more coal. The shift of manufacturing to China seems to

reflect such a change.

A third thing that could go wrong is that pollution becomes too great a problem,

forcing a country to slow down economic growth. This seems to be at least part of

China's current problem.

If oil prices drop from $100 to $50 per barrel, this has an adverse impact on

debt levels.

With lower oil prices, workers are laid off, both from oil companies and from

companies that provide goods and services to oil companies. These workers, in turn,

are less able to take on new debt. In some cases, they may also default on their

debt.

Oil companies with reduced cash flow are also less able to repay their debt. In some

cases, companies may file for bankruptcy. The result is generally that existing debt is

27

'written down.' Even if an oil company does not file for bankruptcy, it is likely to have

difficulty adding new debt. The trend in the amount of debt outstanding is likely to

change fromincreasing to decreasing.

As the amount of debt shifts from increasing to decreasing, the economy tends to

shift from increasing to shrinking. Instead of adding more employees, companies

tend to reduce the number of employees. If many commodities are affected, the

impact can be very large.

We need oil prices to rise to $120 per barrel or more.

The current price of $50 per barrel is still way too low. A post I published in February

2014 was called Beginning of the End? Oil Companies Cut Back on Spending. In it, I

talked about an analysis by Steve Kopits of Douglas-Westwood. In this analysis,

Kopits points out that even at that time-which was before oil prices began dropping in

mid-2014-major oil companies were beginning to cut back on spending for new

production. Their cost of production was at that time typically at least $120 or $130

per barrel, if prices were to be high enough so that companies could fund new

development without adding huge amounts of new debt. Oil prices could perhaps be

lower if oil companies could fund their operations using large increases in debt.

Company management recognized that such a funding approach would not be

prudent-it could lead to unmanageable debt levels.

Today's cost of oil production is likely to be even higher than it was when Kopits'

analysis was performed in early 2014. If we expect oil production to continue to rise,

we probably need oil prices in the $120 to $150 per barrel range for several years.

Prices at such a level are likely to be way too high for consumers, because wages do

not rise at the same time as oil prices. Consumers find that they need to cut back on

discretionary expenditures. These spending cutbacks tend to lead to recession and

falling oil prices.

28

We can think of our economy as being like a big ball, which can be pumped up

to greater and greater size with either rising productivity or rising debt.

This process can continue to work, only as long as the debt added is sufficiently

productive that it is possible to repay the debt with interest. We seem to be reaching

the end of the line on this process. Returns keep falling lower and lower,

necessitating ever-lower interest rates.

To some extent, the pumping up of oil prices that occurs in this process represents a

lie, because the energy content of a barrel of oil remains unchanged, regardless of

price. In fact, the energy of coal and of natural gas per unit of production remains

unchanged as well. The value of energy products to society is determined by their

physical ability to leverage human labor-for example, how far diesel oil can move a

truck. This ability is unchanged, regardless of how expensive that oil is to produce.

This is why, at some point, we find that high-priced energy products simply don't

work in the economy. If we spend the huge amount of resources required for the

production of energy products, we don't have enough resources left over for the rest

of the economy to grow.

Low oil prices, plus low commodity prices of other kinds, seem to indicate that we

are reaching the end of the line in the 'pump up the economy with debt' approach.

We have been using this approach since 1981. At this point, we have no idea what

economy growth would look like, without the stimulus of falling interest rates.

The drop in oil prices and other commodity prices since mid-2014 seems to

represent a 'shrinking back' of our ability to use debt to raise prices to a level

sufficient to cover the cost of extraction, plus associated overhead costs, including

taxes. This drop in prices should be an alarm bell that something is seriously wrong.

Without continuously rising prices, to keep up with ever-rising extraction costs, fossil

fuel production will at some point come to a halt. Renewables will not work well

either, because prices will not be high enough for them to be competitive.

29

Of course, once the economy stops growing, the huge amount of debt we have

amassed becomes un-payable. The whole system we have built will begin to look

more and more like a Ponzi Scheme.

We are blind to the possibility that oil prices of $50 per barrel may indicate that

we are reaching 'the end of the line.'

The popular belief is that everything will work out fine. Oil prices will rise a bit, and

somehow the economy will get along with less fossil fuel. Somehow, we will make it

through this bottleneck.

If we would study history, we would discover that there have been many situations of

overshoot and collapse. In fact, those situations tend to look quite a bit like the

situation we are seeing today:

Falling resources per capita, because of rising population or exhaustion of

resources

Falling wages of non-elite workers; greater wage disparity

Governments finding it increasingly difficult to fund needed programs

There is a popular belief that oil prices will rise, if there is a shortage of energy

products. In prior collapses, it is not at all clear that prices have risen. We know that

when ancient Babylon collapsed, demand for all products, even slaves, fell. If we are

reaching collapse now, we should not be surprised if the prices of commodities,

including oil, stay low. Alternatively, they might spike, but only briefly—not enough to

really fix our current situation.

Too many wrong theories

Part of our problem is too much confidence that the 'magic hand' of supply and

demand will fix the economy. We don't really understand how demand is tied into

affordability, and how affordability is tied into wages and debt. We don't realize that

30

the view that oil prices can rise endlessly is more or less equivalent to the view that

economic growth can continue indefinitely in a finite world.

Another part of our problem is failure to understand how the economic pump that

keeps the economy operating works. Once debt rises too high, or the cost of energy

extraction rises too high, we can no longer keep the system going. Price tends to fall

below the cost of energy extraction. The quantity of energy products consumed

cannot rise fast enough to keep the economic growth pump operating.

Clearly neoclassical economics doesn't properly model how the economy really

works. But the Energy Returned on Energy Invested (EROEI) theory of Biophysical

Economics does not model the current situation well, either. EROEI theory is

generally focused on the ratio of Energy Returned by some alternative energy device

to Fossil Fuel Energy Used by the same alternative energy device. This focus

misses several important points:

1. The quantity of energy consumed by the economy needs to keep rising, if

human productivity is to keep growing, and thus allow the economy to avoid

collapsing. EROEI calculations normally have little to say about the quantity of

energy products.

2. The quantity of debt required to produce a given amount of energy by an

alternative energy device is very important. The more debt that is added, the

worse the alternative energy device is for the economy.

3. In order for the economic growth pump to keep working, the return on human

labor needs to keep rising. This is equivalent to a need for the wages of non-

elite workers to keep rising. This is a requirement relating to a different kind of

EROEI—energy return on human labor, leveraged with various types of

supplemental energy. Today's EROEI theorists tend to overlook this type of

EROEI.

EROEI theory is a simplification that misses several important parts of the story.

While a high fossil fuel EROEI is necessary for an alternative to substitute for fossil

fuels, it is not sufficient. Thus, EROEI analysis tends to produce 'false favorable'

results.

31

Lining up resources in order by their EROEIs seems to be a useful exercise, but, in

fact, the cut-off likely needs to be higher than most have supposed, in order to keep

total costs low enough so that the economy can really afford a given energy source.

In addition, resources that add heavily to debt requirements are probably unhelpful,

regardless of their calculated EROEIs.

Conclusion

We are certainly at a worrying point in history. Our networked economy is more

complex than most researchers have considered possible. We seem to be headed

for collapse because of low prices, rather than high. The base scenario of the 1972

book 'The Limits to Growth,' by Donella Meadows and others, seems to indicate that

the world will likely reach limits about the current decade.

The modeling done in 1972 laid out the basic situation, but could not be expected to

explain precisely how collapse would occur. Now that we are reaching the expected

timeframe, we can see more clearly what seems to be happening. We need to be

examining what is really happening, rather than tying ourselves to outdated ideas of

how the economic system works, and thus, what symptoms we should expect as we

approach limits. It may be that $50 per barrel oil is one of the signs that collapse is

not far away.

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32

The Biggest Winner

and Loser in the Last

Oil Cycle

Written by Keith Schaefer from Oil & Gas Investments Bulletin

Oil went from $8-$147 per barrel between 1998-2008. Then it crashed to $32. Then

it rocketed to $105 for five years. Then it crashed to $27.

Notice a pattern at all?

Ever wonder why management of senior oil companies don't notice this same

pattern? How can that be so when the long history of this business is nothing but

booms and busts?

In a moment I'm going to compare for you two companies of a similar size. One is

another typical victim of this crash. The other is going to come out the other side

stronger because of it.

Why more companies weren't in a position to do the latter....I do not fully understand.

The fact that oil crashed shouldn't have been a surprise to anyone. We have 150

plus years of oil production history that tells us that this is a highly cyclical business.

33

Source: Goldman Sachs

The fact that we were five plus years into a bullish oil run should have had every

energy executive worth his salt preparing for the next instance of the bottom falling

out.

I'm no rocket scientist, but even my teenagers think I have a bit of common sense.

In July 2014 I told my subscribers that with oil over $100 per barrel I didn't see a lot

of upside under many scenarios. With oil at $100 per barrel I really wasn't thinking

outside the box there.

Also at that time I told my subscribers that with oil at $100 per barrel I certainly could

envision a lot of downside.

So I greatly reduced my oil exposure and found other ways to make money from

energy.

34

My decision was based simply on common sense. That simple common sense

allowed my Oil and Gas Investments Bulletin portfolio continue climbing through

2014, 2015 and this year despite the complete carnage all around me.

If a simple thinker like myself could figure out that the time to build an ark is before it

rains.....why couldn't the majority of the people running oil producers?

For investors, the very cyclical nature of this industry isn't something to fear-it's

something to embrace.

Rather than be a victim of the cyclicality I don't understand why more companies

don't do what I do which is try to exploit it.

How It Should Be Done (Suncor), and How It Shouldn't (Marathon)

Source: Yahoo Finance

A picture tells a thousand words and the stock chart above definitely does too.

Since the middle of 2015 when it became clear that the oil crash wasn't going to be a

short one Suncor's (TSX/NYSE:SU) share price has held strong, while Marathon

35

Oil's (NYSE:MRO) has taken a beating.

Both companies are very large independent producers, virtually mini-majors.

Suncor produces 695,000 boe/day while Marathon produces 430,000 boe/day.

Suncor has distinguished itself in the eyes of investors over the past year while

Marathon has been forced into an ultra-defensive position where it is just trying to

survive.

Dividend Policy

Marathon hasn't completely eliminated its dividend but it isn't far off. From paying

$0.21 per quarter as a dividend leading up to the oil price crash Marathon has

dropped its dividend to only $0.05 per quarter.

At this point Marathon is paying a dividend more for the sake of saying that it is

paying a dividend than because it wants to pay a dividend. Marathon shareholders

have had the double whammy of both the share price and dividend collapsing.

There have been no dividend cuts from Suncor despite oil prices at one point losing

almost 75% from the 2014 peak. In fact these cheeky monkeys at Suncor actually

increased their dividend by a penny per quarter in September 2015.

36

Doing that while oil has fallen as far as it has is a tremendous accomplishment.

Acquisition and Dispositions

We are now 18 months plus into this oil crash. Cash flows are crimped, balance

sheets strained and the bankers no longer willing to lend.

To say that this is a buyer's market for oil and gas properties is an understatement of

epic proportions.

You can likely imagine which side of buying and selling these two companies are on.

Marathon's balance sheet is in rough shape. Over the past year the company has

sold $1.3 billion of assets into this buyer's market.

In the largest transaction Marathon sold all of its Wyoming assets for $870 million.

The properties consisted only of very low waterflood developments in the Big Horn

and Wind River basins which averaged 16,500 barrels per day in first quarter 2016.

That is only $52,727 per flowing barrel which is likely less than half what those

assets would have gone for in 2014.

37

Marathon is selling at the worst possible time. The company is a victim of low oil

prices. It is too bad they don't have the $1.5 billion in cash that they spent buying

back shares at $35 when oil prices are higher.

Suncor on the other hand is not a victim. The management group of Suncor has

positioned the company to take advantage this opportunity.

And Suncor has.

Over the past several months Suncor has been able to turn its 12% interest in

Syncrude into a majority 53.74% interest by acquiring all of Syncrude pure-play

Canadian Oil Sands as well as Murphy Oil's small piece of Syncrude.

On top of that Suncor has tucked in another 10% interest in its Fort Hills oil sands

project.

Comparing these Syncrude transactions by Suncor looks like a major steal

compared to what Sinopec (NYSE:SHI) paid for Conoco Phillips (NYSE:COP)

Syncrude interest in 2010.

38

Sinopec's price was $4.65 billion for a 9.03% interest in Syncrude. Suncor's price for

41.74% of Syncrude was only $7.8 billion. (The consideration being $4.3 billion in

equity plus $2.6 billion of assumed debt for Canadian Oil Sands and $937 million for

Murphy Oil's stake.)

If Suncor paid the same price per percentage of Syncrude as Sinopec did the price

would have been $21.5 billion. Suncor paid one-third the price that Sinopec did.

You might think that Suncor being in a financial position that allows it to be an

acquirer is luck. I doubt it considering that the last time Suncor pounced on a major

asset was when oil prices last crashed. In 2009 Suncor made a major acquisition

acquiring Petro-Canada.

Equity Issuance

When commodity prices crash, commodity producer cash flows are going to do the

same. It makes a lot of sense to adjust dividend policy accordingly.

As a shareholder I can handle that.

But it gets worse when following Marathon Oil.

In 2013 and 2014 Marathon's stock price spent most of the time above $35 and

during this time the company repurchased $1.5 billion worth of shares. In total

Marathon repurchased roughly 43 million shares.

That is $1.5 billion dollars spent at share prices that are three times the current level.

In 2015 Marathon shut down its share repurchase plan entirely. Then came the

brutal kick in the stomach for shareholders.

On February 29, 2016 Marathon announced that it would be issuing 145 million

shares at a price of $7.65.

39

Let me recap those numbers...

In 2013/2014 Marathon spent $1.5 billion to repurchase 43 million shares at

$35

In 2016 Marathon issued 145 million shares at $7.65 to raise $1.1 billion

The net impact of this is that Marathon is out of pocket $400 million and has

increased its share count by 102 million (on a 770 million outstanding share base).

That' s just brutal.

Suncor meanwhile has reduced its share repurchasing since oil dropped to match its

reduced cash flows. It hasn't had any sort of a share issuance to raise cash so

Suncor shareholders haven't experienced the ugly dilution that Marathon

shareholders have seen.

Build the Ark Before It Rains

You have to wonder what so many of the management teams in this industry were

thinking when oil was at $100 per barrel.

Yes, everything is easy with the benefit of hindsight but the fact that oil prices would

crash again was never a matter of if. It was just a matter of when.

Instead of hitting the accelerator on spending when oil prices were high companies

should have been making their balance sheets bulletproof. Instead so many of them

go to work on their balance sheets after the crash has happened when selling assets

and issuing equity is painfully dilutive.

EDITORS NOTE-There's one junior producer out there who has made an amazing

deal at the bottom of the market-access to most of the ground surrounding an 850

million barrel field-near-virgin territory, with no work done on this prolific ground for

50 years...I think it will The Play of The Year...CLICK HERE for the details...

40

This Wipes Out Any

Spare Capacity OPEC

Has

Written by Keith Schaefer from Oil & Gas Investments Bulletin

The Offshore Oil Business Is Crippled And It May Never Recover

How badly do oil producers want to transition out of the deepwater and focus on

shale? And guess what that means for the global oil price?

Exxon Mobil (NYSE:XOM) just paid Seadrill (NYSE:SDRL) $125 million in cash to

get out of its commitment to use the West Capella drillship.

Don't you wish someone would just pay you $125 million to pack up your things and

just go home?

The contract that Exxon had on the Seadrill had an expiry date of April 2017. Exxon

couldn't wait that long and instead elected to pay the equivalent of $370,000 per day

to just get out of the deal.

Had Exxon used the West Capella it would have been paying $627,500 per day.

This is not a decision that is unique to Exxon. The theme of shifting away from

offshore projects is a consistent way across oil and gas producers.

Conoco Phillips - Last year the company said it is done with deepwater exploration

forever.

41

Marathon Oil - Announced that all of its budget in 2016 will be directed to its onshore

resource plays with only $30 million that was previously committed to going to

offshore work.

Chevron - Is pivoting in a major way away from big ticket offshore projects and is

hoping to ramp shale output up to 25% of the company's production by the middle of

the next decade.

This list goes on and on. And this, dear reader, will almost single-handedly move the

oil price higher in the coming two years.

Last August the U.S. federal government held an auction for offshore oil fields in the

Gulf of Mexico. Just five companies submitted bids and only 33 leases were sold.

This was the worst showing in three decades for the Western Gulf of Mexico.

Offshore Oil Production By The Numbers

Offshore production accounts for 30% of total global oil production. The percentage

of global production has remained the same since the early 2000s but the absolute

amount of production has grown.

42

Today nearly 22 million barrels of oil per day is produced offshore; the figure in the

chart above includes all liquids.

Offshore production has lower decline rates than shale does, but considerably higher

decline rates than onshore vertical developments.

It is hard to pinpoint these decline rates exactly since each field is unique unto itself.

What the industry generally believes is that offshore production declines at twice the

rateof conventional onshore.

That would put the offshore decline rate somewhere between 15-20% per year.

These higher decline rates mean that the sudden halt to offshore development will

result in BIG offshore production declines.

Off a 22 million barrel per day production base—15-20%= 3.3-4.4 million barrels a

day—gone. That is substantially more than the spare capacity of OPEC right now.

That means that in just one year, the world oil supply could be put into deep

undersupply (pardon the pun) as offshore exploration and development stagnate.

Short Lead Time, No Exploration Risk

Shale/tight oil has beat offshore production in every way. Onshore costs are down

dramatically. The time it takes to drill onshore wells is down. Onshore flow rates

have improved.

43

But is isn't just about breakeven-costs. There are other considerations.

Going offshore involves taking exploration risk. With shale, companies know they'll

get a producing well every time they drill. You can imagine how many companies

can afford to throw money down dry holes these days.

Even if an offshore exploration well is successful there are drawbacks.

44

Once a discovery is made offshore companies need to sink huge sums of money

(often billions) over an extended time period (years) before any production can

happen. That leaves companies without any revenue from the money being spent for

long stretches and also exposes them to commodity price swings.

Just imagine giving the thumbs up to a billion dollar offshore project that needs $70

per barrel oil and then having to watch oil crash just as production comes on stream.

Shale oil wells can be drilled in weeks meaning that there is very little time between

investment and cash flow. A shale well also costs under $10 million and can't ruin a

company like a billion dollar offshore project.

The location of shale within the continental United States is also far superior than

being in the middle of the ocean. Pipelines are already in place onshore, employees

can go home to their families every night and the worst case accident scenario is

much lessened.

Shale is simply a better option than deepwater development. It is lower risk and has

become higher return.

What Would It Take To Get The Industry Interested In The Deepwater Again

The majority of the oil and gas sector is in serious financial difficulty. It will take a

long stretch of sustained high oil prices before anyone gets bullish on deepwater

exploration again.

Existing discoveries will be developed. Investing money in those situations provides

a guaranteed return on investment through cash flow. Wildcat deepwater exploration

is not a business that is coming back for a long time, if ever.

Saudi Arabia's decision to open the taps has changed this business for everyone.

The idea that sustained high oil prices were the norm for the future is gone. Volatility

is back and it isn't going away.

45

There is no safety valve for oil prices. It is everyone for themselves from this point

forward.

Shale oil offers a predictable, manufacturing-like business model around which

companies can plan. And it can be stopped and started on a dime depending on oil

prices.

Ten years ago shale oil wasn't even on the radar. Now it is has displaced the

deepwater which was once thought to be our only savior from peak oil.

Now....about those electric cars.

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Has the Shale Oil Rig

Count Finally Hit

Bottom?

Written by Matt Loffman from DW Monday

As an indicator of the turmoil that has hit the US oil & gas services sector the Baker

Hughes rig count is hard to beat. From 1,931 rigs drilling in September 2014 the

count has declined to a total of 408, dramatically reducing activity and jobs for

drillers, service companies and suppliers alike.

46

Unconventional activity has been hit hard. Higher horsepower rigs, ever-longer

laterals and costly stimulation services increased well costs by millions of dollars

compared with conventional, vertical wellbores. Despite impressive cost savings

across the US, non-core unconventional assets have been among the main

casualties of the current energy crisis. Even core areas of the prolific Eagle Ford and

Williston Basins saw market declines in active rigs.

Those declines may have finally hit bottom. The last four Baker Hughes rig count

updates have horizontal rigs targeting oil at 248, 249, 249 and 257 units. Larger

unconventional drillers have stated that $50/bbl WTI will be enough for them to add

rigs to the fleet, albeit in modest numbers, a price now within reach. While vertical

rigs continue to decline slightly, the US service sector has now reached, or very

nearly reached, what appears to be the trough. This is good news for oilfield

employment with data suggesting up to 200 workers are employed for each active

rig, either directly or indirectly.

While the unconventional oilfield services and new equipment sectors appear to

have finally hit the lowest point in the cycle, their path to profitability remains distant.

The balance of 2016 is set to remain testing as the unconventional rig count grinds

upward.

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