Oil market benchmarking December 2015 - blogs

Oil market benchmarkingDecember 2015

5 February 2016

www.pwc.com

Oil market benchmarking • December 2015 PwC • 2

Important notice

The following market benchmarking exercise has been performed as of 31 December2015.

Due care should be taken when using our conclusions and the market data points assome of our data points are more dated than others (i.e. data points spread betweenthe beginning of December 2015 and beginning of January 2016). Given the rapidlyevolving views by market participants, certain views can become quickly outdated.

Our market benchmarking data and conclusions should thus not be appliedmechanistically. Instead, careful consideration should be given to the purpose of thevaluation and to the price forecasts and sensitivity analysis used.

Oil market benchmarking • December 2015 PwC • 3PwC • 3

The oil market rout in the past 18 months shockedfinancial markets and caught many marketparticipants off-guard. Increased Brent oil pricevolatility hasn’t helped and makes forecasting futureoil prices fraught with difficulty.

There has thus been enhanced scrutiny inpredicting the oil price for potential merger &acquisitions, investment appraisals, impairmenttesting, stock price valuations and lending positions,amongst others.

The persisting question remains: how deep andsustained will the oil price decline be and to whatlevel will it recover?

The results of our latest 31 December 2015benchmarking exercise are clear: If we focus onBrent oil, the continued downward trajectory of theBrent oil price over the course of 2015 has shown thatthe decline has been more sustained and deepthan market participants thought this time last year.

Market participants have been revising downwardstheir expectations of the oil price recovery. In addition,they have extended out their views on when Brentoil prices are expected to recover compared to thistime last year. Interestingly, whilst short term priceforecasts have come down, as has the Brent oil futurescurve, we observe less divergence in the range ofanalyst views in the short-term.

Scraping the bottom of the barrel

Based on our benchmarking analysis of analysts in oursample, short-term Brent oil prices are expectedto average $53/bbl in 2016, representing a c.$26/bbldrop versus forecasts a year ago. The drop in the 2016Brent oil futures curve has been even morepronounced, falling by $29/bbl to be in the region of$40/bbl.

Longer-term analysts forecasts for 2022 havenow fallen by as much as $19/bbl to around $77/bblwhen compared to 12 months earlier. Based on oursample, all are above the liquid period of the futurescurve which indicates that there is a lag in marketviews or that they are placing less reliance on thisdata-point in their analysis.

However, the news is not entirely negative. Currentspot prices of ~$35/bbl seems incongruent with long-term marginal costs of production from a structuralindustry perspective. Whilst the industry, and indeedgovernments, are having to adjust to the current priceforecasts, long term floors (such as breakevenpoints for national budgets, upstream investmentcosts, prices to develop new projects) should helpunderpin prices.

The analyst views that we have benchmarked reflect anupward sloping price curve and the longawaited recovery. It is a matter of whom is bestplaced to survive this.

Jacqueline Chow

(Director, Natural Resources Valuations)


Section 1Brent Oil – Market commentary


0%10%20%30%40%50%60%70%80%90%

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Brent Crude – volatility

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Brent Crude – Spot Price

Brent Oil – increased uncertainty and downward revisions inforecasts and the futures curve

Price performance

Brent oil prices have fallen by 66% since 30th June 2014 from $112/bbl to $38/bbl as of 31stDecember 2015. The majority of this decline (c.48%) occurred in the 6 months to 31December 2014. Since then, 2015 has witnessed a further 35% decline with significantlyincreased volatility.

As measured by the annualised standard deviation (rolling 10 day average), we estimate thatthe volatility in oil price returns has increased significantly from 21% in the 6 months ended31 Dec 2014 to 36% during 2015.

Market expectations

Given the continued downward trajectory of the Brent oil price over the past 18 months andmarket drivers (refer to subsequent slides), we have observed market participants extendingtheir views on the Brent oil price recovery and revising their medium and long-termexpectations downwards.

According to consensus forecasts and the futures curve as at December 2015 versusDecember 2014, the market now expects Brent oil prices to be c.$25-$28/bbl lower between2016 and 2018. In the longer-term, consensus forecasts have fallen by c.$15/bbl.

Section 1 – Brent Oil – Market commentary

-66%

Source: Capital IQ, PwC analysis

Source: Capital IQ, PwC analysis

Source: Consensus Economics, Capital IQ, PwC analysis

-48%

Avg 36%Avg 21%

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Spot price 2015 2016 2017 2018 2019 2020

$/b

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December 2015 vs December 2014 forecasts

Consensus Economics (Dec'15) Consensus Economics (Dec'14)

Futures curve (Dec'15) Futures curve (Dec'14)


Brent Oil – fundamental drivers of price declines in 2H14

Key drivers – 6 months to 31 December 2014

In their ‘Global Economic Prospects’ report, the World Bank outlined the key drivers causingthe sharp drop off (-48%) in Brent oil prices in 2H14:

• Trends in supply: US crude production increased by 1.2 mb/d during 2014, the largestincrease (+16.2%) since records began. This increase in supply was additionally attributedto faster than expected recovery of Libyan oil production in September 2014 andcontinued unaffected Iraq production, despite conflict in these regions.

• Trends in demand: Future expectations of global oil demand were revised downwards onmany occasions in 2014 as global economic growth in Europe and Emerging Markets(specifically, China) disappointed.

• Changes in OPEC objectives: Many market commentators regard OPEC’s November 2014decision to maintain production at 30 mb/d as pivotal in cementing price declines.Traditionally seen as the ‘swing’ producer with the ability to stabilise prices, the decisionnot to reduce supply to maintain market share contributed to a perceived ‘glut’ in oilsupply.

• USD appreciation: In trade-weighted nominal terms, the US dollar appreciated by 10%against major currencies in 2H14. As oil is priced in USD, this caused the relativepurchasing power of oil importers to fall, thus contributing to lower demand for oil.

The combined effect of the above demand and supply factors led to materially lower shortand long-term oil forecasts in 2H14.

Source: Energy Information Administration

0.900.951.001.051.101.151.201.251.301.351.40

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=1.0

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USD/EUR USD/GBP USD/AUD

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0.40

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1.20

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1Q13 2Q13 3Q13 4Q13 1Q14 2Q14 3Q14 4Q14 1Q15 2Q15 3Q15 4Q15

IEA Forecasts of World Oil Demand Growth (year-over-year changein million barrels a day)

Jul-14 Sep-14 Nov-14

Source: IEA, PwC analysis

-0.80

-0.60

-0.40

-0.20

0.00

0.20

0.40

0.60

0.80

1.00

1.20

1.40

1983

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Annual change is US field production of crude oil (1983 – 2015),million barrels per day


Source: Oanda, PwC analysis


Brent oil – what’s changed in 2015?

Key drivers – YTD December 2015

Brent Oil prices have declined by a further 35% for the 12 months to 31 December 2015, withincreased volatility. The market remains oversupplied against continuing weak demandwhich has led to oil forecasts being further revised downward by market participants in 2015:

• “China shock”: The extent of China’s economic slowdown and manufacturing contractiontook the market by surprise in 2015. Although growth expectations have been falling forsome time, the level of downgrades was most pronounced in 2015 with economic datacontinuing to disappoint. China’s growth rate now sits at a six-year low of c.6.5% despiteinterest rate cuts, devaluation of the currency and other stimulus measures. Thesemacroeconomic uncertainties were reflected in the local stock market with the SSEComposite Index down c.17% in 2H15.

In April 2015, China surpassed the US as the largest importer of oil in the world withimports of c.7.4 mb/d. As such, the slowdown in the Chinese economy is expected to havea material impact on long-term demand expectations.

• Resilience of supply: Whilst production is expected to contract in 2016, the market hasbeen surprised by the efficiency of US shale producers. As illustrated in the graph, US oilproduction has remained steady at c. 9.3m b/d in 2015 despite large falls in rig count.Furthermore, the lifting of the ban on US crude oil exports is expected to add to supply onthe global market, potentially lowering the spread between Brent and WTI oil pricesgoing forward.

Outside of the US, global supply has continued to increase with the world’s oil supplyrising by 2.5m b/d to a total of 96 mb/d, outpacing global demand growth which grew by1.6m b/d. Markets such as Russia have experienced record production levels, whilstOPEC has remained committed to producing at least 30 mb/d.

continued on next page…

5%

6%

7%

8%

9%

10%

11%

2011 2012 2013 2014 2015 2016 2017 2018 2019 2020

IMF Revised China Growth Forecasts

Oct-11 Oct-12 Oct-13 Oct-14 Oct-15

Source: IMF, PwC analysis

500

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1,000

1,250

1,500

1,750

5,000

6,000

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10,000

Feb-11 Nov-11 Aug-12 May-13 Feb-14 Nov-14 Aug-15

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U.S. oil rig count (monthly average) and crude production (inthousands of barrels a day)

Daily Production Rig Count

Source: EIA, PwC analysis



Brent oil – what’s changed in 2015?

• OPEC developments: In December 2015, OPEC confirmed that it would not be cutting itsoil production, preferring to maintain market share amidst US shale competition andexpectations of Iranian production in 2016 with the lifting of sanctions. Moreover, noagreement was made on production ceilings. In 4Q15, OPEC produced c.32 mb/d of oil,the highest in 3 years. This continued supply in the market has contributed to falling oilprices.

Moreover, since oil sales accounts for c.90% of government revenues in Saudi Arabia, theKingdom was forced to announce a series of reforms to tackle their worsening budgetdeficit, which stood at 15% in 2015. The announcement served as a further reminder ofOPEC’s strategic goal of maintaining market share, potentially to the detriment of the oilprice.

• Global growth expectations: Expectations of global growth have also experienceddownward revisions in 2015. Global growth forecasts have been reduced by approximatelya third since 2010. Furthermore, emerging market economies such as Brazil and Russiahave been adversely affected by the low commodity price environment and FX declines(amongst other country-specific issues), whereas growth in developed economies such asEurope and the USA have been less robust than expected.

• Foreign currency movements: The US dollar retained its strength in 2015 (refer to slide 3)as expectations of a Federal Reserve interest rate hike materialised in December 2015,reflecting the US economy’s relative strength and position in the economic cycle. At thesame time, emerging market currencies have depreciated. This has had the effect ofreinforcing declines in demand for oil which is USD-denominated.

Source: Bloomberg; Press; PwC analysis.

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2010 2011 2012 2013 2014 2015 2016

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IMF Forecasts for Global Growth

Oct-10 Oct-11 Oct-12 Oct-13 Oct-14 Oct-15

Source: IMF, PwC analysis


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OPEC total production (Jan 2014 – Nov 2015)

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32,500

Official productionceiling since 2011


Brent oil – longer-term considerations

Long-term considerations

Recent spot prices for oil at the c.$38/bbl level are considered to be unsustainable in thelonger-term, when compared to the marginal cost of production. The graph on the rightshows the approximate marginal cost curve for oil by region of production. The figuresuggests that more than half of current production is unprofitable at current prices which willlikely result in a cut-back in future supply.

Key factors to consider

The outlook for future oil prices will depend on the following demand and supplyconsiderations which could cause price expectations to increase:

• The resilience of US shale oil production to the current low pricing environment

• Spillover effects of conflicts in the Middle East affecting key supply routes

• Increase in geo-political risk due to the escalating conflict between Iran and Saudi Arabia

• Iran boosting production once sanctions are lifted in early 2016

• Potential change in Russian output following negotiations with OPEC/non-OPECmembers

• Current account/fiscal position of OPEC countries

• A faster than expected recovery in emerging market growth, specifically demand fromChina and India

• A faster than expected recovery in developed market growth, specifically Europe, Japanand the USA

• The outlook for the US dollar versus currencies of key importing nations

• The introduction of new technologies and approaches (e.g. hydraulic fracturing, enhancedoil recovery techniques etc.)


Note: Unless otherwise indicated, all material in figures and tables derives from IEA data andanalysis. “Other conventional oil” includes deepwater. No carbon pricing included. Synfuel resourcesare difficult to assess due to competition with other natural gas and coal uses. Biofuels are renewableand, in theory, not resource constrained

Source: IEA Resources to Reserves 2013

Long Term Oil Supply Cost Curve 2013 IEA Update


Section 2Brent Oil benchmarking

PwC • 10


Broker and consultant Brent oil price forecasts(31 December 2015)

Benchmarking using broker/consultant forecasts

• We have collated 23 recent Brent crude oil price forecasts of a group of brokers andconsultants.

• The graph on the right illustrates the low, median, high and inter-quartile views againstthe Capital IQ Brent Crude (ICE) futures curve as at 31 December 2015. The values shownare in nominal terms.

• Market participant forecasts are, in all instances, higher than the liquid period of thefutures curve.

Source: Various broker reports, Capital IQ

Section 2 – Brent Oil benchmarking

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2016 2017 2018 2019 2020 2021 2022

US

$/b

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Brent price forecasts - Nominal

Broker 50% interquartile range Brokers Median CapIQ Forward curve


Section 3WTI benchmarking


Broker and third party WTI oil price forecasts(31 December 2015)

Benchmarking using market participant forecasts

• We have collated 16 recent WTI oil price forecasts of a group of brokers and consultants.

• The graph on the right illustrates the low, median, high and inter-quartile views againstthe Capital IQ WTI Oil (ICE) futures curve as at 31 December 2015. The values shown arein nominal terms.

• Market participant forecasts are, in all instances, higher than the liquid period of thefutures curve.

Source: Various broker forecasts, Capital IQ

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2016 2017 2018 2019 2020 2021 2022

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WTI price forecasts – Nominal

Broker 50% interquartile range Brokers Median CapIQ Futures curve

Section 3 – WTI benchmarking

This publication has been prepared for general guidance on matters of interest only, and does not constitute professionaladvice. You should not act upon the information contained in this publication without obtaining specific professional advice.No representation or warranty (express or implied) is given as to the accuracy or completeness of the information containedin this publication, and, to the extent permitted by law, PricewaterhouseCoopers LLP, its members, employees and agents donot accept or assume any liability, responsibility or duty of care for any consequences of you or anyone else acting, orrefraining to act, in reliance on the information contained in this publication or for any decision based on it.

© 2016 PricewaterhouseCoopers LLP. All rights reserved. “PricewaterhouseCoopers” refers to PricewaterhouseCoopers LLP(a limited liability partnership in the United Kingdom) or, as the context requires, the PricewaterhouseCoopers globalnetwork or other member firms of the network, each of which is a separate and independent legal entity.

160122-124810-FI-UK

Jacqueline ChowDirector – ValuationsEnergy, Utilities, Mining & Infrastructure+44 7818 427 [email protected]

Faisal IslamManager – ValuationsEnergy, Utilities, Mining & Infrastructure+44 7808 091 [email protected]

Thomas RombergPartner – ValuationsEnergy, Utilities, Mining & Infrastructure+44 7730 733 [email protected]

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