oil & gas: necessity as the mother of invention: sector...

March 11, 2014

Oil & Gas Necessity as the Mother of Invention: Sector View to ‘Attractive’

We see potential for a period of outperformance for the majors, as the market starts to anticipate FCF recovery, driven by improving capital discipline, a slowdown of cost inflation and an oil price that appears increasingly well underpinned.

We raise our sector view to ‘Attractive’: A sharp deterioration in the FCF outlook of all European oil majors has driven underperformance of ~35% since the start of 2012. However, from currently depressed levels, we see potential for FCF recovery, for three reasons.

First, companies have started to address key issues. In 2013, the five European majors declared dividends of $35bn but generated negative organic FCF of $(5)bn. This gap is now so large that there is pressure on companies to arrest the trend. The reduction in capex plans recently announced by nearly all majors suggests this process has started.

Second, we see potential for certain upstream costs to moderate: Upstream capital costs are ~130% higher than in 2004, but in the last two years cost inflation has moderated substantially, and appears to be turning negative for certain categories of spending.

Third, oil prices appear increasingly well underpinned: The ‘oil glut’ we and others have been expecting has so far not materialised. Instead, demand has turned out surprisingly strong, supply has been much weaker and inventories have drawn. If oil prices remain stable at current levels, the FCF outlook of the majors is substantially better than at the forward curve.

Our new price targets imply 15-24% TSR; Total and Statoil are our top picks. We think the majors have strong incentives to improve FCF to at least 1x dividends, and are likely able to do so. We set our new price targets on this basis on average.

What's Changed: Industry View

Integrated Oil & Refining In-Line to Attractive

Our new price targets assume dividend cover ~1x

Previous New Implied TSR

Shell (EW) 2330p 2500p 16%

BP (EW) 490p 525p 15%

Total (OW) €50 €55 24%

Eni (EW) €17.4 €18.0 10%

Statoil (OW) NKr 175 NKr 190 24%

Example: Total is set to improve FCF to 110% of dividend, which should drive the shares to €55

Source: Thomson Reuters Datastream

0.4 0.6 0.8 1.0 1.2 1.4 1.6Dividend cover by FCF

1.0

1.1

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Rel

ativ

e di

vide

nd y

ield

Most recentpoint

Basis forprice target

If Total grows FCF to 110%of dividends...

...yield contraction will likelydrive the shares to €55

Note: Chart shows monthly data over the past seven years

Morgan Stanley does and seeks to do business with companies covered in Morgan Stanley Research. As a result, investors should be aware that the firm may have a conflict of interest that could affect the objectivity of Morgan Stanley Research. Investors should consider Morgan Stanley Research as only a single factor in making their investment decision.

For analyst certification and other important disclosures, refer to the Disclosure Section, located at the end of this report. += Analysts employed by non-U.S. affiliates are not registered with FINRA, may not be associated persons of the member and may not be subject to NASD/NYSE restrictions on communications with a subject company, public appearances and trading securities held by a research analyst account.

Morgan Stanley & Co. International plc+

Martijn Rats, CFA [email protected] +44 (0)20 7425 6618

Haythem Rashed, CFA [email protected] +44 (0)20 7425 9943

Sasikanth Chilukuru [email protected] +44 (0)20 7425 3016

M O R G A N S T A N L E Y R E S E A R C H

E U R O P E

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March 11, 2014 Oil & Gas

Necessity as the Mother of Invention: Sector View to ‘Attractive’

“Happiness is positive free cash flow” -- T-shirt slogan seen in Central Park

“Happiness is negative free cash flow so long as the returns are attractive” -- G. Bennett Stewart, III in ‘The Quest for Value’

It’s so bad, it’s good

In 2013, European oil & gas majors1 produced neither positive FCF nor satisfactory returns. In aggregate, Shell, BP, Total, Eni and Statoil generated negative organic FCF of $(5)bn last year – the first time organic FCF turned negative since the financial crisis. At the same time, they announced dividends of $35bn, leaving a ~$40bn gap, to be financed mostly through asset sales.

Return on Capital Employed (ROACE) fell to 10.3% in 2013, down from 15.0% in 2011. However, adjusted for the fact that reported depreciation is significantly less than maintenance capex, we estimate last year’s ‘economic’ ROACE to be 300-400bp lower, at around 6-7%.

If unaddressed, neither the declining trend nor the recent levels of FCF and ROACE generated by the majors appear commensurate with keeping these companies in good health. Arguably, the sector has arrived at an important point of

Exhibit 1

‘Big Oil’ has underperformed substantially but appears to be turning the corner Relative Return Index: Sectors vs Market (3 years ago = 100)

80

85

90

95

100

105

110

115

120

Mar-11 Jun-11 Sep-11 Dec-11 Mar-12 Jun-12 Sep-12 Dec-12 Mar-13 Jun-13 Sep-13 Dec-13 Mar-14

European majors vs MSCI Europe MSCI Europe Oil & Gas vs MSCI Europe

5 European majors only vs Market

Oil & Gas vs Market

Source: DataStream, Morgan Stanley Research

1 In this note, the term ‘majors’ refers to Shell, BP, Total, Eni and Statoil.

Exhibit 2

Both the trend in FCF, and its recent level, are not sustainable in the long run European majors: Organic FCF (rolling, last 4 quarters; $bn) and Dividend cover ratio (%)

-20

-10

10

20

30

40

50

1Q08 3Q08 1Q09 3Q09 1Q10 3Q10 1Q11 3Q11 1Q12 3Q12 1Q13 3Q13

-60%

-40%

-20%

0%

20%

40%

60%

80%

100%

120%

140%

Organic FCF Dividend cover by FCF (RHS) Source: Company Data, Morgan Stanley Research

inflection: if the companies can arrest these trends, and recapture some of the economic rent of the projects they undertake, there is significant upside for investors. Alternatively, they may need to supplement FCF by continued asset sales, thereby becoming smaller and leaner over time.

Recent FY13 results statements suggest the majors are now viewing the need to address the underlying pressures on FCF and ROACE as a clear priority. In our view, both can improve, and we see some encouraging signs that they will. In the rest of the note, we set out why we believe this is the case.

As the sector’s FCF and ROACE outlook improves, we expect the share prices of the majors to follow. Hence, following ~35% underperformance over the last two years, we see a more attractive equity outlook and raise our rating for Integrated Oil to ‘Attractive’.

We also raise price targets for the majors, by 7% on average. Including dividends, our new price targets suggest total return potential of ~17% over the next 12 months, which is well ahead of the ~10% our strategists forecast for the European market. Our top picks remain Total and Statoil, which we believe have the potential to generate total returns of 24% over the next 12 months.

It is worth stressing that our call applies to large cap, integrated oil & gas companies only, not to the wider energy sector. Steps taken by the majors to address the challenges that are facing them will create a headwind for the oilfield service sector, and as a second order effect, also for the

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independent E&P sector. For those sectors, our view remains ‘In Line’.

There are three reasons underpinning our more positive stance on the European majors, which we set out below.

1. The majors have started to address key challenges

FCF and ROACE have been declining for some time now, but over the past two years companies have highlighted both that it was a temporary phenomenon and the importance of investing with the long term in mind.

However, organic FCF turning negative over the last four quarters appears to have triggered a change: in recent weeks, all majors have announced plans to do one or more of the following:

Reduce capex, either in absolute terms or relative to previous plans

Improve allocation of the capital that will still be spent, by evaluating projects more critically

Accelerate disposals of underperforming, non-core assets

Reduce operating costs, through better procurement and greater efficiency

Shrink the non-producing assets base, which should boost return on capital

Total, for example, initially guided for capex in 2013 of $29bn, spent $28bn, and has indicated that capex will fall to $26bn in 2014, on its way to reaching $24-25bn in 2015. The company has also launched an operating cost savings program, and has indicated that there is upside to its planned $15-20bn asset sales program.

Statoil announced a $5bn reduction to its capex plans for 2014-16 and is now targeting $1.3bn of cost savings. The company also promised a stricter prioritization and optimization of projects, all in an effort to cover its dividend by organic FCF by 2016 and at least maintain its 2013 ROACE.

Setting our new price targets: What are the majors worth when dividends are covered?

We observe strong correlations for the majors between consensus expectations for dividend cover-by-FCF, and their dividend yield relative to the market (see pages 14-16). We use these relationships to set our new price targets.

There is a strong incentive for companies to improve organic FCF to at least 1x dividends. For the reasons discussed in this report, we see this as a likely outcome and set our price targetson this basis (with minor variations in assumed dividend cover for specific companies.)

On average, our targets imply total shareholder return of 17% across the majors, and 24% for OW rated stocks. Below we summarize our calculations and show sensitivities of our targets to different level of dividend cover.

Exhibit 3

Price targets Stock Dividend cover Target 2015e PT TSR

Consensus* For PT yield DPS

Shell 71% 100% 4.7% $1.92 2500p 16%

BP 70% 90% 4.7% $0.415 525p 15%

Total 77% 110% 4.6% €2.52 €55 24%

Eni 60% 80% 6.3% €1.14 €18 10%

Statoil 26% 100% 4.0% kr 7.50 kr 190 24%* for next 12 months ** upside plus dividends Source: IBES, DataStream, Morgan Stanley Research

Exhibit 4

Price target sensitivity to dividend cover Dividend cover by FCF

Share price 80% 100% 120%

Shell £23.2 £23.2 £25.0 £26.4

BP £4.80 £5.20 £5.40 £5.70

Total €46.1 €49.0 €53.0 €57.0

Eni €17.3 €18.0? €19.6 €21.3

Statoil kr 161 kr 181 kr 190 kr 200 Source: Morgan Stanley Research estimates . Exhibit 5

Implied total shareholder return

Dividend cover by FCF

80% 100% 120%

Shell 5% 16% 19%

BP 13% 18% 24%

Total 11% 20% 29%

Eni 10% 19% 29%

Statoil 18% 24% 31%Source: Morgan Stanley Research estimates

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‘Big Oil’ is increasingly aware of its predicament…

“What we are doing today is too expensive [...] We cannot continue to swallow this huge inflation [...] We have to go to thesub-subcontractors and say: ‘We know what’s going on. We can no longer be the deep pocket,’” - Christophe De Margerie, CEO Total (4 March 2014)

“The new reality for our industry is that costs have caught up torevenues. […] Essentially, for a company like mine and many others, $100 a barrel is becoming the new $20.” - John Watson – CEO Chevron (4 March 2014)

“The industry faces a very important point of inflection. If we can get our approach right, then there is opportunity to usher ina new phase of organic growth along with improving returns forinvestors. Get it wrong and we risk investing too much and delivering too little.”

- Bob Dudley – CEO BP (4 March 2014)

“If nothing happens to the cost structure, I think we’ll see stranded projects and mothballed projects over the next years.” - Jakob Thomasen, CEO Maersk (4 March 2014)

Eni pledged “strict capital discipline” at its recent investor presentation and cut its capex plans for 2014-17 by 5% compared to previous plans. It also increased its disposal target to €9bn over the next few years. This follows an earlier announcement that Eni will buyback 10% of its outstanding shares over the next few years.

BP indicated last year that capex would not exceed $27bn in any given year to 2020, but recently reduced this further to $24-26bn for 2014-18. In addition, late last year the company announced an incremental $10bn of asset sales, plans to realize substantial savings on overhead costs as the firm has shrunk in size in recent years, and a substantial restructuring of the way its North American onshore business is organized.

Shell has been less specific to date, but at the FY13 results presentation new CEO Ben van Beurden talked about being “more selective on growth opportunities” and “improving capital efficiency”. Organic capex is targeted to come down from

$38bn in 2013 to $35bn in 2014. The company is also planning to address the poor performance of its North American and Downstream businesses, and aims to sell assets worth $15bn over the next two years.

We think the majors’ efforts to revive FCF and ROACE are likely to succeed

There are four main reasons for this.

1. There are encouraging signs that steps to date are yielding fruit: For example, in early 2013 Total shelved its Kaombo project in Block 32 offshore Angola as the development costs had become too high. Following a substantial delay, Total recently indicated that it has been able to save ~$4bn of the development costs, making the project attractive again. Total achieved this through optimizing purchasing (i.e. lower prices for oilfield services and equipment), a reduction in local content, and reducing the scope of the project.

This is not the only example: BP’s Mad Dog phase 2 project and Woodside/Shell’s Browse LNG project were initially put on hold, but both projects now appear to be going ahead again with substantial improvements/cost savings having been found.

The story is similar for Block 1, 2 and 3a in Uganda, where operators Total, Tullow and CNOOC recently reduced capex guidance for the project from $8-12bn to $8bn.

2. It is possible that cost efficiency has had limited focus in recent years: We suspect that, following the four-fold increase in oil prices between 2004 and 2011, companies have had less incentive to focus on cost control. It is therefore possible that material savings could be made, especially with the added incentive that negative FCF brings.

In this context, we are encouraged by the results of BP’s disposal program over the last few years. BP generated its highest-ever level of operating cash flow (excl. changes in working capital) in 2008, when it reached ~$33bn and the oil price averaged $97/bbl during the year. Since then, the company has sold assets worth ~$65bn in the wake of the Macondo incident. Yet, despite this massive disposal program, the company still says it is on track to generate $30-31bn in operating cash flow in 2014. To us, this highlights the extent to which a company like BP can have assets that command substantial market value but that generate little cash flow for the group.

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Exhibit 6

A number of upstream projects have already seen substantial cost reductions Project Location Operator Comment

Kaombo Angola Total Cost reduced by $4bn through lower contractor prices, reduced local content and a smaller project scope Mad Dog ph2 GoM BP Put on hold in April 2013 but BP now planning go-ahead based on smaller platform and fewer wells Browse LNG Australia Woodside Land-based development scrapped in April 2013; Woodside now planning a cheaper, floating LNG solution Uganda Blk 1,2 & 3a Uganda Total* Development costs revised down from $8-12bn to the bottom-end of that range following re-design/optimisation

Source: Bloomberg, Reuters, Upstream, Morgan Stanley Research *Shared with Tullow and CNOOC

We think this could apply to a greater or lesser extent to all the majors. This would suggest that either 1) large disposals are possible with limited impact on FCF and dividend capacity, or 2) substantial improvements in operating cash flow are achievable that are more commensurate with the external market value of these assets.

3. Closer scrutiny of projects could likely enable capex savings. After being relatively opportunity constrained in the early 2000s, in recent years large new investment opportunities have opened up for the IOCs in unconventional projects in OECD countries, where there was typically little competition from NOCs. Naturally, the majors were keen to participate in projects such as shale gas/tight oil in North America, CBM-to-LNG in Australia, offshore drilling in Alaska. Despite their initial promise, many of these projects now appear likely to generate poor returns, given some of the cost overruns and impairment charges that have been announced.

Inevitably, companies need to take risk, which means that with the benefit of hindsight a certain amount of capital will probably always appear misallocated. However, we would argue that in recent years this amount has been higher than normal, given the sharp rise in capex, which has not led to much earnings and production growth, and impairment charges announced already. If we are correct, it suggests there is room to reduce

…and contractors are now seeing pricing pressure

“I think we will see day rates also for new equipment coming down in this market. No one is immune.” - Rune Lundetrae, CFO Seadrill (4 March 2014)

“There is now enough capacity in the third-party vessel [market] to see our costs* plateauing, or in certain cases, particularly in the North Sea, even going down.” - Thierry Pilenko – CEO Technip (25 February 2014) * Low-end vessels are an input cost for Technip but source of revenue

for other contractors

capex. With FCF having turned negative (even before dividends), capital has now become much scarcer within the majors, and this is likely to force greater capital discipline.

4. We expect the sector to start enjoying some tailwinds. The high level of capex in recent years is starting to drive some growth in operating cash flow. To support this observation, we show the contribution to operating cash flow from known oil & gas fields within the European majors over the years 2013-17 in Exhibits 3 and 4. Both exhibits are based on Wood Mackenzie estimates and assume that the price for Brent crude oil remains stable in nominal terms throughout this period at $110/bbl – the median level of the last three years.

As shown, Wood Mackenzie estimates suggests that ‘start-ups’ and ‘ramp-ups’ are likely to add ~$35bn to operating cash flow over this period, net of decline in mature fields. This amount is broken down by project and by company in Exhibit 8.The figure of $35bn coincides with the amount of dividends that the European majors currently declare – also ~$35bn per year.

These are sizeable numbers in the context of the sector’s negative organic FCF of $(5)bn last year. Total and Shell alone aim to reduce capex by at least $4bn and $3bn respectively

Exhibit 7

Wood Mackenzie estimates suggest a $35bn increase in CFFO* from known fields during 2014-17 Contribution to operating cash flow from known oil & gas fields ($bn)

20

40

60

80

100

120

140

160

180

200

2013 2014 2015 2016 2017

Statoil BP Eni Shell Total

+$35bn

* if oil prices remain stable at ~$110/bbl Source: Wood Mackenzie, Morgan Stanley Research

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Exhibit 8

Incremental contribution to operating cash flow in 2013-17 from key upstream projects

Field Country ∆CFFO (2013-17e; $bn)

Shell BP Total Eni Statoil Sector

Kashagan Kazakhstan 1.7 1.7 1.7 5.1

Schiehallion UK 2.1 1.3 3.5

Clov Angola 0.6 1.5 0.9 3.0

Gorgon Australia 2.8 2.8

Martin Linge Norway 1.3 0.5 1.7

Gina Krog Norway 0.6 1.0 1.6

Thunder Horse US 1.3 1.3

Clair UK 0.6 0.6 1.3

Ekofisk Area II Norway 0.8 0.3 0.2 1.2

Mars US 0.9 0.3 1.2

Corrib Ireland 0.6 0.5 1.1

Mariner UK 1.1 1.1

Goliat Norway 0.7 0.4 1.1

GLNG Australia 1.0 1.0

Laggan UK 1.0 0.0 1.0

Kizomba Satellites Phase2 Angola 0.4 0.3 0.2 0.9

Bonga Fields (OML 118) Nigeria 0.6 0.1 0.1 0.9

Angola LNG Angola 0.3 0.3 0.3 0.9

Prelude FLNG Australia 0.9 0.9

Tempa Rossa Italy 0.3 0.6 0.8

Ivar Aasen Area Norway 0.8 0.8

Stones US 0.8 0.8

Block 31 PSVM Angola 0.5 0.3 0.8

Loyal UK 0.4 0.4 0.7

Block 1506 Western Hub Angola 0.6 0.1 0.7

Other (including natural decline) -0.3 -0.6 -1.3 0.0 1.0 -1.2

All fields 11.3 5.2 7.6 4.0 6.8 35.0

Source: Wood Mackenzie, Morgan Stanley Research

from their 2013 levels. If the sector can indeed deliver $35bn of incremental operating cash flow by 2017, those factors would account for a $42bn swing in FCF. That would be sufficient for the sector to cover its dividends by 2017, at least in aggregate.

2. Upstream cost inflation appear to be moderating, turning to deflation in certain areas

Recent weeks have shown increasing signs that the oil majors’ efforts to pass the pressure on returns and FCF down the value chain are having an effect. In certain pockets of the oilfield service market, there is evidence that prices are coming down.

Exhibit 9 shows IHS’ Upstream Capital Cost Index, which highlights that cost inflation in upstream projects more than doubled between 2004 and 2008. As the majors generally work on multi-year projects and lock in a lot of the costs at the start, it has taken several years for this step-change in cost to become

fully evident in the financials of the majors. Although prices have not risen materially in 2013, most companies still mentioned that they saw relatively high cost inflation in their results last year as a result of this lag effect.

Our suspicion is that this process of ‘catch-up’ is now complete, with current income statements broadly reflecting current industry cost levels across the board. As ‘leading edge’ costs have not meaningfully increased from the peak in 2008 (see Exhibit 9), there should be no latent effect from past cost inflation on 2014/15 financials.

In fact, we see potential for the opposite to start happening. Recent weeks have shown increased signs that various oilfield service costs are under pressure.

Drilling day rates appear to be softening. Transocean’s fixture of Dhirubhai KG-1 for $488k/d

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Exhibit 9

IHS’ Upstream Capital Cost Index has already flat-lined over the last 12 months … Upstream capital cost index (Jan 1999 = 100)

-

50

100

150

200

250

4Q99 1Q04 1Q06 1Q08 2Q09 2Q10 2Q11 2Q12 2Q13 Source: IHS, Morgan Stanley Research Exhibit 10

..and prices have started to fall in offshore seismic too PGS and CGG Veritas: Average revenue per day for 3D vessels ($k/d)

50

100

150

200

250

300

350

400

450

500

1Q07 1Q08 1Q09 1Q10 1Q11 1Q12 1Q13 Source: Company Data, Morgan Stanley Research

Exhibit 11

Drilling dayrates have peaked and are likely to fall over the next 12-18 months… Floating rigs: day rates ($k/d)

-

100

200

300

400

500

600

700

Jul-97 Jul-99 Jul-01 Jul-03 Jul-05 Jul-07 Jul-09 Jul-11 Jul-13 Jul-15

Average mid-water Average deepwater Average ultra-deepwater Note: dotted lines represent Morgan Stanley Research forecasts Source: ODS Petrodata, Morgan Stanley Research Exhibit 12

OCTG prices in the US have started to trend down, and are 10-15% lower than two years ago OCTG prices ($/tonne)

-

1,000

2,000

3,000

4,000

5,000

6,000

7,000

8,000

Jan-08 Jan-09 Jan-10 Jan-11 Jan-12 Jan-13 Jan-14

Welded Seamless Premium 2-3/8" Premium 2-7/8" Premium 7-5/8" Source: PipeLogix

for the next three years may be somewhat depressed by unusual factors, but nevertheless highlights the new trend. Exhibit 11 shows dayrates for mid- and deepwater floating rigs. Our colleagues covering the drilling sector have recently lowered their dayrate forecasts and now foresee a 20-30% reduction from recent levels (dotted line).

Seismic costs have been falling in recent quarters, with vessel dayrates down on average ~20% for CGG Veritas and PGS in 4Q13, both compared with the preceding three quarters as well as 4Q12.

Oil Country Tubular Goods, i.e. seamless or welded pipe for casing, tubing or drilling pipe, are now 10-15% lower in the US than two years ago.

Mid- to low-end construction vessels in the North Sea have seen pressure on dayrates, according to Technip, as supply has become sufficient.

So far, the signs of price deflation are somewhat tentative and isolated to asset-intensive areas of the oilfield service markets. Nevertheless, these signs are getting stronger. By delaying some projects and slowing investment activity, the majors are starting to see some of their input costs come down and their share prices go up. In essence, they are gaining by doing less. In our view, when such a ‘virtuous circle’ (at least from the perspective of the oil companies) takes hold, it is likely to persist. If may even provide a positive feedback loop, encouraging companies to do more.

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Exhibit 13

Around 2-3 years ago, futures prices started to discount a large fall in Brent crude oil … Value axis definition

85

90

95

100

105

110

115

120

125

130

Feb-11 Feb-12 Feb-13 Feb-14 Feb-15 Jan-16 Jan-17 Jan-18

Current 1 year ago 2 years ago 3 years ago Source: DataStream, Morgan Stanley Research

Exhibit 14

… but spot prices have not followed this trajectory and have remained very resilient

Dated Brent ($/bbl)

0

20

40

60

80

100

120

140

Dec-10 Jun-11 Dec-11 Jun-12 Dec-12 Jun-13 Dec-13 Source: DataStream, Morgan Stanley Research

3. Oil prices appear increasingly well underpinned

The third reason for our more optimistic stance on the majors is that the probability of a large fall in oil prices would appear to have diminished, in our view.

Over the last two years, it was widely feared that strong growth in production from the US, Canada, Brazil and Iraq, combined with modest demand growth due to tepid economic growth, would lead to rising inventories and increasing spare capacity. That had the potential to cause a ‘glut’ that would put pressure on oil prices. The forward curve started to reflect this some time between two and three years ago, when the back-end of the curve fell considerably. This is a strong market signal that is still shaping investor consensus, which remains relatively bearish,

in our view. Yet, oil prices have remained remarkably resilient, trading in a range of $100-120/bbl over the last three years, with an average of $110/bbl.

History has not been kind to forecasts that oil prices are well supported, especially over short periods. Nevertheless, there are a few observations worth making.

a) The sector has often been ‘bailed-out’ by the oil price. In the last 40 years, there have been six major oil sector ‘bear markets’. On average the sector underperformed ~40% during these periods. The last five of those came to an end via a sharp rally in oil prices, of on average 60% y/y. At the moment, we are primarily focused on capex cuts as a way to improve FCF, and shares are clearly responding positively to this.

Exhibit 15

From mid-2013 onwards, the IEA has consistently revised demand estimates upward for 2013 History of IEA estimate of 2013 global oil demand (mmbpd)

90.0

90.2

90.4

90.6

90.8

91.0

91.2

91.4

Jul12

Aug12

Sep12

Oct12

Nov12

Dec12

Jan13

Feb13

Mar13

Apr13

May13

Jun13

Jul13

Aug13

Sep13

Oct13

Nov13

Dec13

Jan14

Feb14

Source: IEA, Morgan Stanley Research

Exhibit 16

Upward revisions to estimates have continued in 2014, with YoY growth now expected at 1.3 mb/d History of IEA estimate of 2014 global oil demand (mmbpd)

92.0 92.0 92.0 92.0

92.1 92.1

92.4

92.5

92.6

91.5

91.8

92.1

92.4

92.7

93.0

Jun 13 Jul 13 Aug 13 Sep 13 Oct 13 Nov 13 Dec 13 Jan 14 Feb 14 Source: IEA, Morgan Stanley Research

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Exhibit 17

A large amount of oil is currently ‘off the market’ due to geopolitical disruptions Unplanned liquid fuels production outages (kb/d)

0

500

1000

1500

2000

2500

3000

3500

Jan-12 Apr-12 Jul-12 Oct-12 Jan-13 Apr-13 Jul-13 Oct-13 Jan-14

Iran Libya Nigeria Iraq Non-OPEC Note: data on unplanned outages for non-OPEC countries is not available before March 2013 Source: EIA

Historically, however, large, sustained capex cuts are very rare, at least over the last 30 years. If history were to repeat itself, it would be the oil price that ‘bails out’ the sector.

b) Oil demand appears stronger than expected: At the end of 2012, the IEA estimated 2013 global oil demand at 90.5 mb/d. However, from mid-2013 onwards, a clear cycle of upwards revisions started (see Exhibit 15). The IEA now estimates that actual demand was 91.3 mb/d, i.e. an 800 kb/d increase. Estimates for 2014 appear to be going through a similar cycle, having been revised upwards already from 92.0 mb/d as at September 2013 to the current estimate of 92.6 mb/d. Despite oil prices that are high by historical standards and global GDP growth that is still below-trend, oil demand growth appears robust.

c) Supply disruptions are high, but these have a tendency to last for many years. At the moment, some 3 mb/d of crude oil production is ‘off the market’, not for technical reasons but because of geopolitical factors (see Exhibit 17). In principle, this is a risk to oil prices, as a substantial amount of production could come back to the market relatively quickly. However, BP’s chief economist Christof Ruhl presented an analysis in his Energy Outlook 2035 that indicated that “historical precedent suggests that supply disruptions take years to fully recover […] Revolutions in Libya and Iran, war and sanctions in Iraq, and the collapse of the Soviet Union all resulted in production declines that persisted for at least a decade following the disruptive event.” (See also Exhibit 18). Although technically much of the 3 mb/d that is currently out could come back quickly, the underlying reasons for this oil to be ‘off the market’ are likely to persist for some time and the disruption to supply will therefore likely have a longer-lasting effect.

Exhibit 18

…but disruptions have historically resulted in depressed production for many years

Source: BP World Energy Outlook 2035

d) Inventories have drawn to multi-year lows: The net result of rising output from North America, increasing supply disruptions in the Middle East/North Africa and stronger-than-expected demand is that inventories have actually drawn, against the earlier expectation of a glut. As Exhibit 19 shows, OECD inventories have fallen well below their five-year lows. Therefore, if oil supply were to outpace demand, the need to rebuild inventories would absorb some of this, providing a cushion to oil prices.

The forward curve for Brent falls to $100/bbl by Dec-2015 and to $93/bbl by end 2017. With the factors above in mind, this curve appears strikingly backwardated to us. With realized prices fluctuating around a seemingly firm $110/bbl, our base case is gravitating toward that level.

Exhibit 19

Oil inventories have been drawing sharply and are now at multi-year lows OECD Total oil stocks (mb)

2,500

2,600

2,700

2,800

2,900

Jan Feb Mar Apr May Jun Jul Aug Sep Oct Nov Dec

Range 2008-12 Avg 2008-12 2013 Source: IEA, Morgan Stanley Research

10



Exhibit 20

European majors: Aggregate consensus expectations for rolling, next 12 months

The majors’ FCF outlook at stable oil prices is materially better than at the forward curve …

The recent round of capex cuts appears to have had some positive effects. The share prices of companies that have announced these cuts have done relatively well, and a tailwind seems to be emerging from a reduction in oilfield service costs. If the benefits are clear, it is possible that companies will accelerate these cuts, rather than slow them down.

At the moment, consensus cash flow estimates suggests that the European majors will cover just 68% of their declared dividends with organic FCF. However, we see a plausible scenario in which capex comes down another 5-10% from our base case levels, and oil and gas prices stay stable at their median levels of the last three years (e.g. $110/bbl for Brent crude oil).

These two factors would have a dramatic impact on FCF and dividend covers: if oil & gas price were to remain stable rather than follow the path of the forward curve, our estimate of

dividend cover-by-FCF in 2015 would improve from 68% to 91%. If in addition capex were to fall by another 5-10%, our estimate of dividend cover would increase even further to 112%.

… which can have a material impact on valuations

If the market starts to gain confidence that dividends will be solidly underpinned again by organic FCF, it is likely to boost valuations meaningfully.

In previous research, we have written extensively about the strong correlation between the majors’ dividend yield relative to the market and consensus expectations for dividend cover by FCF. The strong co-movement between these two variables can be seen in the bottom-right chart in Exhibit 20. Here we show consensus expectations for organic FCF over the rolling next 12 months (blue line) as well at the majors’ average forward dividend yield, divided by the dividend yield of the MSCI Europe (organic line; note that this is measured against the right axis, which is inverted).

11



Exhibit 21

Dividend cover can improve rapidly with further moderation of capex, especially if oil stays stable 2015e Capex ($ bn) Dividend Cover - 2015e

Current Low case Base Case Stable Oil Low Capex

Total 24.9 24.0 108% 126% 137%

Shell 35.6 32.0 58% 79% 99%

BP 25.1 24.0 57% 92% 107%

Eni 18.1 16.5 41% 57% 86%

Statoil 19.8 18.0 73% 96% 142%Sector 123.4 114.5 68% 90% 112%Note: ‘Base case’ is based on a Brent crude oil price assumption for 2015 of $102/bbl; the ‘Stable oil’ scenario is based on a price of $110/bbl; the ‘Low capex’ scenario assumes the low case for capital expenditure on top of a stable oil price of $110/bbl Source: Morgan Stanley Research estimates

The dynamic is clear: when FCF expectations improve, dividends are perceived to be less risky and to have better growth potential. As a result, investors require a lower dividend yield. However, over the past two years, the opposite has happened: FCF has fallen relative to dividends, making the dividend stream look more risky and reducing its growth prospects. The dividend yield of the sector has consequently increased.

The co-movement of dividend cover-by FCF and dividend yield relative to the market suggests that for every 10 percentage point increase in expected dividend cover for the next 12 months (say, from 70% cover to 80% cover), dividend yields contract by ~17bp.

This suggests that if the market starts to have confidence again that dividends are ~100% covered by organic FCF, up from the consensus expectation of ~68% for the next 12 months, this could lead to a contraction in dividend yield for the majors of about 55bp (from the current 5.3% to ~4.75%). Assuming stable dividends, that would imply a ~11% increase in share prices. In addition, we expect dividends to grow another 3-4% next year. Taking the dividend into account adds ~5% for a total shareholder return approaching 20% for the European majors.

In 2014, all five European majors have guided for higher dividends than in 2013. We would note that, in contrast to, say, production growth targets, the penalty for not delivering on dividend guidance is relatively high from a stock market perspective, and hence we view targets for higher dividends as a particularly reliable signal of confidence. Recent dividend increases across the majors have been unexpectedly strong indications that company managements still see FCF well ahead of current dividends in future. With FCF so weak in 2013, it would have been understandable if companies had not grown their dividends. However, they did so nonetheless.

If investors regain confidence that dividends are well covered by FCF, we think the shares can deliver attractive returns.

We are raising price targets for the majors by ~7%; our top picks remain Total and Statoil

Given the arguments above, we expect investors to regain this confidence and start to price European majors on the basis that FCF covers dividends. We set our new price targets on this basis, which are on average 7% higher than before and imply an average total return of 17% over the next 12 months. This compares to the total return expectation of ~10% that Morgan Stanley’s strategists have for the MSCI Europe.

To estimate where individual share prices could go when dividend cover is 100%, we show the correlation between dividend cover and dividend yield for each stock on pages 14-16. The charts on the right of each page show the same data as those on the left but presented slight differently. Exhibit 22 below shows an example for Total.

Current consensus expectations suggest that Total will cover ~77% of its dividends with organically generated FCF over the next 12 months, and its shares trade on a forward dividend yield of 1.51x the yield on the MSCI France. As shown by the marker ‘Most recent point’ in Exhibit 22, Total’s current position is in line with how it has historically been valued. However, we see a strong case for FCF to improve at Total, driven by upstream start-ups/ramp-ups, downstream restructuring and capex decline. By 2015, we expect that Total will cover 110% of its dividend with organic FCF. As per Exhibit 22, history suggests that when Total’s dividend cover reaches 110%, its dividend yields usually contracts to 1.3x the yield on the MSCI France.

Exhibit 22

Total: Dividend cover vs Dividend yield

Div

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I F

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e

Note: Monthly data over last seven years

12



Exhibit 23

Where could share prices go if dividends were covered? Setting our new price targets

Ref. market Market DY Target multiple Target DY DPS 2015e Target price Implied Upside DPS 2014e Target TSR

Shell MSCI Europe 3.6% 1.30 4.7% $ 1.92 £ 25.0 11% $ 1.88 16%

BP MSCI Europe 3.6% 1.33 4.8% $ 0.415 £ 5.25 8% $ 0.400 15%

Total MSCI France 3.5% 1.30 4.6% € 2.52 € 55.0 17% € 2.44 24%

Eni MSCI Italy 3.7% 1.70 6.3% € 1.14 € 18.0 3% € 1.12 10%

Statoil MSCI Europe 3.6% 1.10 4.0% kr 7.50 kr 190 17% kr 10.50 24%

Average 17%

Note: Target multiple’ is consistent with the historical relationship between expected dividend cover and dividend yield relative to the market (see pp14-16). Source: Morgan Stanley Research

As the moment, the forward yield on the MSCI France is 3.5%. Assuming this remains unchanged, we see Total’s forward yield contracting to 3.5% x 1.3 = 4.6%, down from 5.3% today. In 2015, we expect Total’s dividend to increase to €2.52 per share, continuing the 2 cent increase in the quarterly dividend that we have seen each year since 2011. Capitalised at 4.6%, that suggests a price target of €55. Including the dividend itself implies total return prospects of 24%.

In Exhibit 23, we show this calculation for all five majors. We set our price targets for Statoil and Shell assuming that the market will value them on the basis of ~100% dividend cover. However, we assume slightly lower figures for Eni (80%) and BP (90%) as on our forecasts it will take a few additional years for these companies to get this level of cover.

There are still important risks to our thesis, and our call may be premature

Our thesis calls for an inflection in recent trends, for which we believe there are encouraging signs, but a new, upwards trend is by no means clear yet. There are still risks to our call.

Our call may be too early. Although companies are intending to slow down investment activity and reduce cost, this is likely to be a multi-year process. Over the course of the next several quarters, little of this may yet be visible in reported financials. Although the sector’s narrative is improving, it may take a while before this becomes clear in their numbers. This may be a headwind to our call during 2014.

The slowdown in capex may start to impact production sooner than expected. Decline rates of mature oil and gas fields are relatively high. Therefore, a slowdown in investment could mean that production starts to fall relatively quickly. In our note Something Has to Give: Analysing the Scope for Capex Cuts (10 July 2013), we argued that capex can be reduced in a way that the impact on production, and hence operating cash flow, is relatively small. However, there is uncertainty about this, and the

impact may be greater than expected. If so, operating cash flows may start to disappoint at some point as well.

Unplanned disruptions and downstream headwinds may intensify. Unplanned disruptions in countries such as Nigeria and Libya, as well as pressure on refining margins, particularly in Europe, have been meaningful headwinds to FCF. Of course, these are not under companies’ control and may actually intensify. This could depress FCF further.

Oil prices could decline. As discussed, we see oil prices are relatively well underpinned. However, market conditions can change, potentially quickly. If economic growth slows down, supply disruptions normalize and the US allows crude oil exports, oil prices could fall below the levels reflected in our price targets.

Part of our thesis may already be ‘in the price’. In the last 2-3 weeks, some shares (notably BP and Shell) have shown a modest fall in dividend yield without any upgrades to consensus FCF estimates, suggesting the market may already have built in some of the anticipated improvement.

Exhibit 24

Price target methodology: DDM

Shell B BP Total Eni Statoil

Risk-free rate 1.8% 1.8% 1.8% 1.8% 1.8%

CDS spread 0.6% 0.7% 0.6% 1.2% 0.6%

Cost of debt 2.4% 2.5% 2.4% 3.0% 2.4%

ERP 3.3% 3.3% 3.3% 3.5% 3.0%

Cost of equity 5.7% 5.8% 5.7% 6.5% 5.4%

DPS 2015 $1.92 $0.415 € 2.52 € 1.14 kr 7.50

DPS 2016 $1.96 $0.435 € 2.60 € 1.16 kr 7.75

DPS 2017 $2.00 $0.445 € 2.68 € 1.18 kr 8.00

Terminal growth 1.0% 0.8% 1.0% 0.0% 1.3%

Exchange rate 1.65 1.65 1.00 1.00 1.00

NPV £25.0 £5.25 € 55.0 € 18.0 kr 190

Source: Morgan Stanley Research estimates

13



Dividend Cover vs Dividend Yield for Individual Stocks

Exhibit 25

Shell

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Dividend yield rela

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CI F

rance

Exhibit 26

BP

Div

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t 12

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Dividend yield rela

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CI F

rance

Exhibit 27

Total

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by F

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Dividend yield rela

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CI F

rance

Exhibit 28

Shell

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to M

SC

I E

urop

e

Note: Monthly data over last seven years; based on ‘B’ shares Exhibit 29

BP

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to M

SC

I E

urop

e

Note: Monthly data since Oct 2010 only (i.e. six months after the Macondo incident) Exhibit 30

Total

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Note: Monthly data over last seven years

14



Exhibit 31

Eni

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by F

CF

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t 12

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Dividend yield relative to M

SC

I Italy

Exhibit 32

Statoil – no meaningful correlation

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SC

I Europe

Exhibit 33

ExxonMobil

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Dividend yie

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CI W

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Exhibit 34

Eni

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I It

aly

Note: Monthly data over last five years Exhibit 35

Statoil – no meaningful correlation D

ivid

end

yiel

d re

lativ

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MS

CI

Eur

ope

Note: Monthly data over last seven years. Exhibit 36

ExxonMobil

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15



Exhibit 37

Chevron

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SC

I World

Exhibit 38

Chevron

Div

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to M

SC

I W

orld

Morgan Stanley is acting as financial advisor to China Southern Power Grid International (HK) Co., Limited ("CSG") in relation to the proposed acquisition with CLP Power Hong Kong Limited (“CLP”) of 60% of the equity interests in Castle Peak Power Company Limited from Exxonmobil Energy Limited as announced on 19 Nov 2013. The proposed transaction is subject to approval by CLP’s shareholders, regulatory approval and other customary closing conditions. This report and the information provided herein is not intended to (i) provide voting advice, (ii) serve as an endorsement of the proposed transaction, or (iii) result in the procurement, withholding or revocation of a proxy or any other action by a security holder. CSG has agreed to pay fees to Morgan Stanley for its financial services. Please refer to the notes at the end of the report.

16



European majors: Organic dividend cover – Base case forecasts

Across Morgan Stanley’s global energy team, our forecasts use oil price assumptions in line with forward curves for the next three years.

Over the last three years, oil prices have remained substantially stronger than forward curves have suggested. In this note, we argue that also going risks remained skewed to the upside, and we assume flat oil in setting our price targets.

However, to ensure global comparability of our estimates, our earnings and cash flow forecasts shown below remain based on the forward curve.

For Brent crude oil, we make the following assumptions in our forecasts: 2014: $109/bbl; 2015: $103/bbl; 2016: $97/bbl; 2017: $99/bbl

Exhibit 39

European majors: Base case forecasts for organic free cash flow and dividend cover, 2011-17e Assumes capex in line with guidance and Brent in line with the forward curve 2011 2012 2013 2014e 2015e 2016e 2017e

BP ($ million) Operating cash flow excl. ∆w/c 41,822 27,248 26,143 28,521 29,210 29,299 32,019 Organic capex 31,518 24,342 24,600 24,542 25,076 26,123 26,123 Organic free cash flow 10,304 2,906 1,543 3,979 4,134 3,176 5,896 Dividends 5,503 6,501 6,886 7,082 7,206 7,610 7,845 Cover 187% 45% 22% 56% 57% 42% 75% Eni (€ million) Operating cash flow excl. ∆w/c 16,608 15,811 10,560 13,606 15,044 16,718 16,575 Organic capex 13,438 13,517 12,750 12,780 13,397 13,543 14,033 Organic free cash flow 3,170 2,294 (2,190) 826 1,647 3,175 2,542 Dividends 3,768 3,913 3,985 4,011 4,067 4,138 4,209 Cover 84% 59% -55% 21% 41% 77% 60% Shell ($ million) Operating cash flow excl. ∆w/c 43,242 42,749 37,452 41,480 41,539 42,230 44,094 Organic capex 28,187 35,604 37,283 35,551 34,473 34,685 34,685 Organic free cash flow 15,055 7,145 169 5,929 7,067 7,545 9,409 Dividends 10,460 10,806 11,346 11,835 12,087 12,339 12,591 Cover 144% 66% 1% 50% 58% 61% 75% Statoil (NOK million) Operating cash flow excl ∆w/c 117,798 123,449 104,600 125,369 134,018 134,537 144,272 Organic capex 92,791 108,378 114,400 117,350 117,025 117,025 120,875 Organic free cash flow 25,007 15,071 (9,800) 8,019 16,993 17,512 23,397 Dividends 20,677 21,468 22,255 23,050 23,407 23,464 23,474 Cover 121% 70% -44% 35% 73% 75% 100% Total (€ million) Operating cash flow excl. ∆w/c 21,275 21,378 19,543 22,461 24,622 24,991 27,229 Organic capex 14,828 18,516 21,312 19,293 18,418 18,631 18,716 Organic free cash flow 6,447 2,862 (1,769) 3,168 6,204 6,360 8,513 Dividends 5,148 5,302 5,410 5,551 5,733 5,915 6,097 Cover 125% 54% -33% 57% 108% 108% 140%e = Morgan Stanley Research estimates Source: Company Data, Morgan Stanley Research

17



European majors: Organic dividend cover – Upside scenario

We believe the back-end of the forward curve remains strikingly backwardated, and it is possible that prices remain more robust than the curve currently suggests. In addition, we see potential for incremental capex cuts, as positive feedback loops from rising share prices and falling costs may lead managers to do more.

Below we run a scenario where oil & gas prices remain stable at their median-levels of the last three years (i.e. Brent crude oil at $110/bbl throughout 2014-16; $112/bbl in 2017) and assume additional 5-10% capex cuts across the board. As shown, in this scenario, our estimates for dividend cover-by-FCF rapidly exceed to 100% for all companies.

We believe there are strong incentives for company managers to improve FCF to ~100% of dividends. (Beyond that, the focus on capital discipline may start to wane.) This analysis shows that this should be well within reach.

Therefore, we set our price targets on the basis of ~100% dividend cover across the group, with small variation for individual companies (also see Exhibit 23). This also means that the prices financials discounted in our price targets are broad in-between ‘base case’ scenario on page 17 and the ‘upside scenario’ shown above.

Exhibit 40

European majors: A plausible upside scenario for organic free cash flow and dividend cover, 2011-17e Assumes 5-10% additional capex cuts and Brent stable at $110/bbl 2011 2012 2013 2014e 2015e 2016e 2017e

BP ($ million) Operating cash flow excl. ∆w/c 41,822 27,248 26,143 28,670 31,726 33,668 36,453 Organic capex 31,518 24,342 24,600 24,542 24,000 24,000 24,000 Organic free cash flow 10,304 2,906 1,543 4,129 7,726 9,668 12,453 Dividends 5,503 6,501 6,886 7,082 7,206 7,610 7,845 Cover 187% 45% 22% 58% 107% 127% 159% Eni (€ million) Operating cash flow excl. ∆w/c 16,608 15,811 10,560 13,749 15,717 17,987 17,917 Organic capex 13,438 13,517 12,750 12,780 12,222 12,355 12,802 Organic free cash flow 3,170 2,294 (2,190) 969 3,495 5,632 5,115 Dividends 3,768 3,913 3,985 4,011 4,067 4,138 4,209 Cover 84% 59% -55% 24% 86% 136% 122% Shell ($ million) Operating cash flow excl. ∆w/c 43,242 42,749 37,452 41,734 44,016 46,698 49,063 Organic capex 28,187 35,604 37,283 35,551 32,000 32,197 32,197 Organic free cash flow 15,055 7,145 169 6,182 12,016 14,501 16,866 Dividends 10,460 10,806 11,346 11,835 12,087 12,339 12,591 Cover 144% 66% 1% 52% 99% 118% 134% Statoil (NOK million) Operating cash flow excl ∆w/c 117,798 123,449 104,600 126,335 139,500 144,233 154,675 Organic capex 92,791 108,378 114,400 117,350 106,200 106,200 109,694 Organic free cash flow 25,007 15,071 (9,800) 8,985 33,300 38,033 44,981 Dividends 20,677 21,468 22,255 23,050 23,407 23,464 23,474 Cover 121% 70% -44% 39% 142% 162% 192% Total (€ million) Operating cash flow excl. ∆w/c 21,275 21,378 19,543 22,793 25,648 27,058 29,866 Organic capex 14,828 18,516 21,312 19,293 17,778 17,984 18,066 Organic free cash flow 6,447 2,862 (1,769) 3,501 7,870 9,074 11,801 Dividends 5,148 5,302 5,410 5,551 5,733 5,915 6,097 Cover 125% 54% -33% 63% 137% 153% 194%e = Morgan Stanley Research estimates Source: Company Data, Morgan Stanley Research

18



Risk-Reward Snapshot: BP plc (BP.L, EW, PT 525p)

Limited upside compared to peers

WARNINGDONOTEDIT_RRS4RL~BP.L~

525p (+9%)480p

395p (-18%)

635p (+32%)

0

100

200

300

400

500

600

700

Mar-12 Sep-12 Mar-13 Sep-13 Mar-14 Sep-14 Mar-15

p

Price Target (Mar-15) Historical Stock Performance Current Stock Price

Source: Thomson Reuters (historical share price data), Morgan Stanley Research estimates

Price Target 525p Derived from base-case scenario (DDM). Key risks include oil prices, industry costs levels, project execution dividend decisions.

Bull Case 635p

6.2% DPS CAGR ‘13-17; LTG=1.5% ke=5.8%

Economic recovery creates more opportunity for accelerated dividend growth: Stronger oil demand supports higher oil prices. BP comfortably meets its capex requirements and is able to grow the dividend faster to 47¢ by 2017.

Base Case 525p

4.7% DPS CAGR ‘13-17; LTG=0.8% ke=5.8%

Oil prices stay flat and remain in line with the 3-year average: Flat oil prices till 2016 should enable BP’s dividend cover to broadly reach ~1.0x by 2015/16. As a result, the company raises the dividend by 4.7% p.a. in 2013-17e to reach 44.5¢ by 2017.

Bear Case 395p

0.7% DPS CAGR ‘13-17; LTG=0.0% ke=5.8%

Dividend growth lower for longer: Oil prices fall as macro-economic uncertainty persists and/or the civil fines and penalties related to the Macondo incident are high. The dividend stays unchanged at 38¢ until 2017.

BP: Key Metrics 2013 2014e 2015e 2016e

ModelWare EPS ($) 0.71 0.85 0.84 0.79 Production (kboe/d) 3,231 3,389 3,491 3,591 DPS ($) 0.37 0.40 0.42 0.44 Operating income ($bn) 22.8 26.0 25.4 23.8 Net income ($bn) 13.4 15.6 15.0 13.9 Net debt ($bn) 25.7 28.0 30.1 35.4 RNOA (ROIC) (%) 12.7 12.5 11.8 10.9 ROE (%) 10.8 11.9 11.2 10.1 Book value per share ($) 6.9 7.2 7.6 7.9 Source: Company data, Morgan Stanley Research e = Morgan Stanley Research estimates

Why Equal-weight?

Growth outlook appears weaker than peers: Production and operating cash flow growth appears to lag peers’ over the next 2-3 years due to BP’s relatively modest pipeline of start-ups. Also, several of the start-ups have relatively low IRRs, on Wood Mackenzie estimates, and are highly capital intensive.

Buybacks will still drive growth in cash flow per share … Management’s commitment to accelerate its disposal program and use the proceeds for share repurchases is still likely to shrink the share count faster than free cash flows. Despite the modest growth outlook, this is still set to increase cash flow growth on a per share basis and hence increase dividend capacity.

…which management is translating into dividend growth: We see BP’s recent dividend increase from 9¢ to 9.5¢ as a strong indication that management will use any improvement in dividend capacity to maximize distributions to shareholders.

With flat oil prices, the current dividend outlook supports a valuation of 525p: Flat oil prices till 2016 would enable BP’s dividend cover to broadly reach ~1.0x by 2015/16. In addition, the combination of share buybacks and disposals will likely mean that dividend growth from the current annualised level of 38¢ to 44.5¢ by 2017 is achievable. This is the basis of our 525p price target.

19



Risk-Reward Snapshot: Eni (ENI.MI, EW, PT €18.0)

Weak dividend cover compared to peers

WARNINGDONOTEDIT_RRS4RL~ENI.MI~

€18.00 (+4%)€ 17.34

€14.60 (-16%)

€22.80 (+31%)

0

5

10

15

20

25


€



Price Target €18.0 Derived from base-case scenario (DDM). Key risks include oil prices, industry costs levels, project execution dividend decisions

Bull Case €22.8

2.6% DPS CAGR 2013-17; LTG=1.3%; ke=6.5%

Dividend growth ahead of official policy: We assume the disposal of Snam and Galp, coupled with higher oil prices, results in rapid de-leveraging of Eni’s balance sheet. Concerns over Italiangovernment finances ease and, with all E&P projects on track, Eni accelerates dividend growth to 2.6% p.a.

Base Case €18.0

1.8% DPS CAGR 2013-17; LTG=0.0%; ke=6.5%

Oil prices stay flat and remain inline with the 3-year average: Despite flat oil prices, we estimate Eni is unlikely to cover dividendswith organic free cash flow in 2015. We assume operational cash flow to improve by only slowly as it takes some time for various headwinds to normalise. Medium term dividend growth is in line with inflation, as per policy and Eni starts its buy-back program in 2014.

Bear Case €14.6

0.5% DPS CAGR 2013-17; LTG=-1.0%; ke=6.8%

Sovereign crisis and capex hike combine: We assume that, to address accelerating decline rates in the latter half of the, Eni increases capex substantially and/or makes material acquisitions. At the same time, Italian bond yields increase, which drives up Eni’s cost of capital.

Eni: Key metrics, 2013-16e 2013 2014e 2015e 2016e

ModelWare EPS (€) 1.22 1.21 1.55 1.65 Production (kboe/d) 1,620 1,564 1,680 1,764 DPS (€) 1.10 1.12 1.14 1.16 Operating income (€bn) 12.6 13.2 15.1 15.2 Net income (€bn) 4.4 4.4 5.5 5.9 Net debt (€bn) 20.6 21.2 19.4 16.4 RNOA (ROIC) (%) 11.7 12.5 13.7 13.5 ROE (%) 7.5 7.5 9.5 9.8 Book value per share (€) 16.1 16.1 16.6 17.1 e = Morgan Stanley Research estimates Source: Company data, Morgan Stanley Research

Why Equal-weight?

Headwinds in 2013 have weighed on FCF and dividend cover … Disruptions in Libya and Nigeria as well as tougher trading conditions in European gas and refining markets led to a significant deterioration in earnings and cash flow in 2013. Dividend-cover-by-FCF in 2013 was negative (-0.55)% – in contrast to consensus expectations of 136% at the start of year.

… which has driven up dividend yield relative to market: As dividend cover by FCF has deteriorated, Eni’s dividend yield has expanded from 1.3x the yield on the MSCI Italy to 1.8x. Eni’s relative DY appears high in a historical context but is commensurate with its poor outlook for dividend cover, in our view.

Ultimately, we expect these headwinds to be temporary… At some point, we expect operating conditions in Libya and Nigeria to improve, the Kashagan project to re-start and profitability in European refining and Gas & Power to increase. When that happens, earnings and FCF are likely to increase, and Eni’s dividend yield ultimately has potential to contract again.

But we maintain a tactically cautious short-term stance. The process described above is unlikely to happen soon, however. Earnings expectations for 2014 and 2015 still appear too high. As consensus expectations adjust downwards, we expect the shares to trade poorly.

20



Risk-Reward Snapshot: Royal Dutch Shell (RDSb.L, EW, PT 2,500p)

Limited upside compared to peers

WARNINGDONOTEDIT_RRS4RL~RDSb.L~

2,500p (+8%)2,321p

2,050p (-12%)

3,110p (+34%)

0

500

1,000

1,500

2,000

2,500

3,000

3,500


p



Price Target 2,500p Derived from base-case scenario (DDM). Key risks include oil prices, industry costs levels, project execution dividend decisions

Bull Case 3,110p

3.7% DPS CAGR 2013-17; LTG=1.8% ke=5.7%

Higher oil prices, improved operations lead to a fully covered dividend: With smooth execution and sustained high oil and gas prices, free cash flow starts growing again. By 2015, Shell’s dividend is more than fully covered by organic FCF and management starts raising the dividend at a higher rate.

Base Case 2,500p

2.7% DPS CAGR 2013-17; LTG=1.0% ke=5.7%

Oil prices stay flat and remain inline with the 3-year average; some restructuring benefits kick in: Headwinds in Nigeria, the US and in refining slowly normalise and are partially offset by new field start-ups. With a more constrained capex budget and flat oil prices till 2016, organic FCF covers dividends again in 2015e. As a result Shell increases dividend to $2.0/sh in 2017

Bear Case 2,050p

1.1% DPS CAGR 2013-17; LTG=0.2% ke=5.7%

Headwinds persist, preventing dividend growth: Oil prices come under some pressure, offsetting any benefits from restructuring. Generating sufficient FCF remains a struggle and again this backdrop, the dividends stops growing.

Royal Dutch Shell: Key metrics, 2013-16e 2013 2014e 2015e 2016e

ModelWare EPS ($) 3.10 3.36 3.55 3.63 Production (kboe/d) 3,200 3,158 3,296 3,404 DPS ($) 1.80 1.88 1.92 1.96 Operating income ($bn) 38.4 49.4 52.5 53.6 Net income ($bn) 19.5 21.2 22.4 22.8 Net debt ($bn) 34.9 34.0 29.4 29.0 RNOA (ROIC) (%) 10.7 12.2 12.2 11.9 ROE (%) 10.6 11.4 11.4 10.9 Book value per share ($) 28.6 30.3 32.2 34.1 e = Morgan Stanley Research estimates Source: Company data, Morgan Stanley Research

Why Equal-weight?

Shell’s ROACE and FCF have deteriorated in recent year: Shell’s organic FCF fell to ~$0.2bn, in 2013, down from $15bn in 2011. This compares to dividends declared of close to $12bn per year. At the same time, ROACE has fallen from 12.8% to 9.1% over this period.

…but its new CEO may be a catalyst for change: Across the majors we have witnessed reductions in capex, an increase in disposals plans, and cost savings targets. Although Shell has been less specific so far, we expect the company to undertake similar actions given it is exposed to similar pressures. New CEO Ben van Beurden has pledged to be “more selective on growth opportunities” and “improve capital efficiency”.

If Shell restores FCF to 1x dividends, we see ~16% TSR: We believe there is strong incentive for Shell to improve FCF to at least 1x dividends, and suspect that this is possible through a combination of improved operating performance, disposal of underperforming assets and a moderation in capex. When consensus expects Shell to cover its dividend with organic FCF, the shares are typically valued at a dividend yield equal to 1.3x the market’s yield. At the moment, this implies average an average TSR of 16% across the ‘A’ and ‘B’ shares, in line with the average for the rest of the majors.

21



Risk-Reward Snapshot: Statoil (STL.OL, OW, PT NKr 190)

Management focus on balancing returns and growth to drive FCF higher

WARNINGDONOTEDIT_RRS4RL~STL.OL~

NKr190.00 (+18%)

NKr 161.30

NKr130.00 (-19%)

NKr227.00 (+41%)

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Price Target NKr 190 Derived from base-case scenario (DDM). Key risks include oil prices, industry costs levels, project execution dividend decisions

Bull Case NKr 227

5.0% DPS CAGR 2013-17; LTG=1.8%; ke=5.4%

Improved dividend capacity helped by larger than expected buyback program: This would help reduce the share count and boost FCF per share. With improved dividend capacity, we assume the dividend is able to grow closer at to 5% p.a. in 2013-17.

Base Case NKr 190

3.4% DPS CAGR 2013-17; LTG=1.3%; ke=5.4%

Oil prices stay flat and remain inline with the 3-year average; financial framework as per strategy update: Organic FCF should grow meaningfully in the coming years and allow the company to grow the dividend broadly inline with their recent track record. We forecast 3.4% annual DPS growth between 2013-17.

Bear Case NKr 130

0.0% DPS CAGR 2013-17; LTG=0.0%; ke=5.4%

Further significant eurozone weakness and a structurally lower oil price affect Statoil through lower European gas demand and lower oil price realisations. We assume this places pressure on FCF and, given Statoil’s current weak dividend coverage, this leads to no growth in the dividend both in the near term and long term.

Statoil: Key metrics, 2013-16e 2013 2014e 2015e 2016e

ModelWare EPS (NOK ) 14.64 17.23 18.53 17.42 Production (kboe/d) 1,756 1,738 1,880 1,891 DPS (NOK ) 7.00 7.25 7.50 7.75 Operating income (NOK bn) 163.1 185.6 196.1 179.2 Net income (NOK bn) 46.6 54.8 57.8 52.7 Net debt (NOK bn) 97.3 119.4 124.8 129.7 RNOA (ROIC) (%) 15.6 14.6 13.9 12.1 ROE (%) 13.8 15.0 15.0 13.2 Book value per share (NOK ) 111.8 118.4 126.0 133.7 e = Morgan Stanley Research estimates Source: Company data, Morgan Stanley Research

Why Overweight?

Statoil announced several measures at its strategy update that should improve organic FCF and maximise shareholder distributions. These include a dividend increase and additional 2014 distributions, an 8% cut to capex guidance, a more active buyback program and a focus on ROACE instead of volume growth.

Real change afoot: Presentations at the strategy update gave us the impression of genuine underlying change in the approach that management is taking towards cost efficiency and project prioritisation while balancing growth and returns.

Incorporating new guidance, we forecast ~50% average annual growth in Statoil’s organic FCF 2014-16…: This is the highest among the European majors.

… and dividend cover to improve from 35% in 2014 to 75% by 2016: We also see the dividend fully covered by organic FCF from 2017.

Our NKr 190 price target implies ~18% upside from current levels: An improved organic FCF outlook underpins our higher dividend forecasts.

Potential Catalysts

Key upstream project start-ups: Gudrun (1Q14); CLOV (2Q14).

Further clarity on potential timing and size of any buyback program.

22



Risk-Reward Snapshot: Total (TOTF.PA, OW, PT €55)

Strong dividend cover compared to peers

WARNINGDONOTEDIT_RRS4RL~TOTF.PA~

€55.00 (+19%)

€ 46.14

€40.50 (-12%)

€67.30 (+46%)

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Price Target €55 Derived from base-case scenario (DDM). Key risks include oil prices, industry costs levels, project execution dividend decisions

Bull Case €67.3

4.1% DPS CAGR 2013-17; LTG=1.8%; ke=5.8%

Economic recovery creates breathing room for higher dividend growth: Stronger oil demand supports higher oil priceswhilst a European recovery leads to better than expected downstream profitability. Upside to our FCF estimates leaves Total able to grow the dividend faster at 4.1% (2013-17e).

Base Case €55.0

3.0% DPS CAGR 2013-17; LTG=1.0%; ke=5.7%

Oil prices stay flat and remain in line with the 3-year average; upstream and downstream projects delivered; capex moderates post 2013: At flat oil prices, Total enjoys strongest dividend cover in the sector in 2015, which provides headroom to grow the dividend at 3.0% p.a. from 2013-17e.

Bear Case €40.5

0.6% DPS CAGR 2013-17; LTG=0.0%; ke=6.0%

‘Sticky’ capex and poor project execution: Stronger than expected cost inflation or a change in capital discipline resulting in higher capex for longer; and delays to start-ups of key upstream and downstream projects would reduce FCF growth meaningfully and reduce the scope for dividend growth. We forecast growth of 0.6% p.a. from 2013-17e.

Total: Key metrics 2013 2014e 2015e 2016e

ModelWare EPS (€) 4.72 4.75 5.09 4.74 Production (kboe/d) 2,299 2,261 2,490 2,579 DPS (€) 2.38 2.44 2.52 2.60 Operating income (€bn) 20.3 19.2 20.4 18.6 Net income (€bn) 10.7 10.8 11.6 10.8 Net debt (€bn) 18.5 23.9 23.0 22.1 RNOA (ROIC) (%) 12.6 11.3 10.6 9.3 ROE (%) 14.8 14.3 14.2 12.4 Book value per share (€) 31.9 34.4 37.1 39.4 e = Morgan Stanley Research estimates Source: Company data, Morgan Stanley Research

Why Overweight?

Total’s FCF is set to improve relative to peers…Total’s FCF doubles in each of the next two years, on our forecasts, which is the highest FCF growth rate among the European majors.

…driven by start-ups in the upstream and downstream… We estimate upstream start-ups will add up to $4.7bn to operating cash flow in 2013-15 while downstream ‘self-help’ plans and capacity expansion will add a further $2.5bn to operating cash flow over the period.

…and moderating capex beyond 2013: Management guided that organic capex will fall to $24-25bn p.a. in 2015-17, down from $28bn in 2013. This should further underpin improving FCF in the coming years.

Improving dividend cover to drive a contraction in dividend yield: FCF growth should improve dividend cover from -0.33x in 2013, to 0.57x in 2014 and ~1.1x by 2015. History suggests that improving dividend cover by FCF will drive a contraction in yield. On this basis, we estimate Total’s yield to contract to ~4.5% via a ~20% rally in the share price. Combined with the dividend yield of ~4.5% itself, this suggests total return potential of close to ~25% over the next 12-18 months.

23



Valuation Table – European Integrated Oil

Valuation 2012 2013 2014e 2015e 2016e 2012 2013 2014e 2015e 2016e 2012 2013 2014e 2015e 2016eFCF yield 2.2% 1.0% 2.7% 2.9% 2.2% 3.2% 0.1% 2.4% 2.9% 3.1% -0.3% -5.1% 3.0% 5.9% 6.0%Dividend yield 4.9% 4.6% 4.9% 5.2% 5.4% 4.9% 4.8% 4.8% 4.9% 5.0% 6.0% 5.3% 5.2% 5.4% 5.6%P/E 7.5 11.5 9.5 9.5 10.2 8.8 12.2 11.6 11.0 10.8 7.2 9.4 9.8 9.1 9.8 EV/NOPAT 7.5 10.5 8.8 8.8 9.7 8.4 12.8 10.3 9.8 9.7 8.1 11.7 13.4 12.3 13.1 EV/EBITDA 3.9 5.0 4.4 4.1 4.2 3.5 4.5 4.2 3.9 3.8 2.6 3.5 3.8 3.3 3.3 EV/DACF 5.2 6.7 5.8 5.5 5.6 6.8 8.8 8.1 7.6 7.5 6.1 8.3 8.9 7.9 7.9 EV/Net operating assets 1.1 1.1 1.1 1.0 1.0 1.2 1.2 1.2 1.2 1.1 1.2 1.4 1.3 1.3 1.2 P/BV 1.1 1.2 1.1 1.1 1.0 1.2 1.3 1.3 1.2 1.1 1.2 1.4 1.4 1.3 1.2 Key metricsModelware EPS 0.92 0.71 0.85 0.84 0.79 4.01 3.10 3.36 3.55 3.63 5.44 4.72 4.75 5.09 4.74 Production (kboe/d) 3,331 3,231 3,389 3,491 3,591 3,262 3,200 3,158 3,296 3,404 2,300 2,299 2,261 2,490 2,579 DPS 0.34 0.37 0.40 0.42 0.44 1.72 1.80 1.88 1.92 1.96 2.34 2.38 2.44 2.52 2.60 Operating income (bn) 26.4 22.8 26.0 25.4 23.8 50.6 38.4 49.4 52.5 53.6 24.4 20.3 19.2 20.4 18.6 Net income (bn) 17.6 13.4 15.6 15.0 13.9 25.1 19.5 21.2 22.4 22.8 12.4 10.7 10.8 11.6 10.8 Net debt (bn) 29.2 25.7 28.0 30.1 35.4 19.2 34.9 34.0 29.4 29.0 17.8 18.5 23.9 23.0 22.1 ND/ND+E 19.6% 16.4% 17.3% 18.1% 20.1% 9.2% 16.1% 15.1% 12.6% 11.8% 19.4% 19.8% 22.9% 21.0% 19.4%RNOA (ROIC) (%) 14.3 12.7 12.5 11.8 10.9 14.8 10.7 12.2 12.2 11.9 15.7 12.6 11.3 10.6 9.3 ROE (%) 15.3 10.8 11.9 11.2 10.1 14.0 10.6 11.4 11.4 10.9 17.5 14.8 14.3 14.2 12.4 Book value per share 6.2 6.9 7.2 7.6 7.9 29.9 28.6 30.3 32.2 34.1 32.1 31.9 34.4 37.1 39.4

Valuation 2012 2013 2014e 2015e 2016e 2012 2013 2014e 2015e 2016e 2012 2013 2014e 2015e 2016eFCF yield 3.5% -3.5% 1.3% 2.7% 5.1% 3.4% -2.1% 1.6% 3.4% 3.6% 3.4% -2.2% -7.2% -0.9% 1.1%Dividend yield 5.9% 6.3% 6.4% 6.5% 6.7% 4.9% 4.8% 4.5% 4.6% 4.8% 1.6% 1.3% 1.7% 1.9% 2.1%P/E 9.3 14.3 14.4 11.2 10.6 8.0 10.0 9.4 8.7 9.3 12.3 16.8 16.7 13.9 11.8 EV/NOPAT 6.0 9.1 8.9 7.8 7.7 7.5 10.0 10.0 9.3 9.9 10.8 15.1 15.3 13.3 12.0 EV/EBITDA 2.2 2.9 3.3 3.0 2.9 1.7 2.1 2.2 2.0 2.1 6.1 8.0 7.8 6.7 6.0 EV/DACF 3.6 4.7 5.3 4.8 4.7 5.7 6.9 7.3 6.7 6.8 8.3 10.9 10.6 9.2 8.3 EV/Net operating assets 1.1 1.1 1.1 1.0 1.0 1.4 1.3 1.3 1.2 1.2 1.5 2.0 1.5 1.4 1.3 P/BV 1.1 1.1 1.1 1.1 1.0 1.4 1.3 1.4 1.3 1.2 1.7 2.3 1.8 1.6 1.5 Key metricsModelware EPS 1.97 1.22 1.21 1.55 1.65 17.48 14.64 17.23 18.53 17.42 1.33 1.28 1.08 1.30 1.53 Production (kboe/d) 1,701 1,620 1,564 1,680 1,764 1,805 1,756 1,738 1,880 1,891 657 634 608 710 811 DPS 1.08 1.10 1.12 1.14 1.16 6.75 7.00 7.25 7.50 7.75 0.26 0.29 0.32 0.35 0.38 Operating income (bn) 19.8 12.6 13.2 15.1 15.2 193.3 163.1 185.6 196.1 179.2 8.5 7.6 7.0 8.3 9.3 Net income (bn) 7.1 4.4 4.4 5.5 5.9 55.6 46.6 54.8 57.8 52.7 4.6 4.4 3.7 4.5 5.2 Net debt (bn) 16.6 20.6 21.2 19.4 16.4 54.2 97.3 119.4 124.8 129.7 11.1 11.3 17.0 18.8 19.5 ND/ND+E 21.0% 25.2% 25.9% 23.7% 20.2% 14.5% 21.5% 24.1% 24.1% 24.2% 25.1% 26.2% 32.9% 33.1% 31.7%RNOA (ROIC) (%) 15.3 11.7 12.5 13.7 13.5 17.9 15.6 14.6 13.9 12.1 14.6 12.7 11.9 11.8 12.0 ROE (%) 12.4 7.5 7.5 9.5 9.8 18.6 13.8 15.0 15.0 13.2 14.6 13.5 11.1 12.3 13.1 Book value per share 16.3 16.1 16.1 16.6 17.1 100.3 111.8 118.4 126.0 133.7 9.7 9.3 10.1 11.1 12.3

Valuation 2012 2013e 2014e 2015e 2016e 2012 2013 2014e 2015e 2016e 2012 2013 2014e 2015e 2016eFCF yield 33.7% 8.9% 0.5% 2.8% 3.0% -16.5% 0.0% -8.2% -7.2% -5.9% 10.9% 7.8% -3.2% -0.5% 3.8%Dividend yield 6.5% 5.3% 5.4% 5.5% 5.6% 2.0% 2.4% 2.8% 3.4% 4.1% 4.4% 3.6% 4.0% 4.1% 4.2%P/E 9.2 13.0 13.8 11.8 11.8 27.1 32.4 34.8 27.5 20.4 5.8 10.1 9.2 7.5 7.3 EV/NOPAT 11.6 13.4 14.0 12.4 12.2 30.5 31.3 32.4 26.4 19.4 5.2 8.2 7.4 6.7 6.7 EV/EBITDA 4.0 4.6 4.6 4.2 4.0 12.5 11.2 12.4 11.3 9.2 2.7 3.6 3.4 3.1 3.0 EV/DACF 7.3 7.9 8.1 7.4 7.0 17.6 15.7 17.4 15.9 12.9 3.5 4.7 4.6 4.2 4.0 EV/Net operating assets 0.8 0.9 0.8 0.8 0.8 1.5 1.6 1.5 1.5 1.4 0.8 1.0 0.9 0.8 0.8 P/BV 0.7 0.9 0.8 0.8 0.8 1.8 1.9 1.9 1.9 1.9 0.8 1.0 0.8 0.7 0.7 Key metricsModelware EPS 1.61 1.41 1.31 1.53 1.53 0.43 0.37 0.35 0.45 0.60 4.72 3.43 3.51 4.31 4.40 Production (kboe/d) 336 348 375 432 473 18 21 24 35 56 304 287 332 375 402 DPS 0.96 0.97 0.98 1.00 1.01 0.24 0.29 0.35 0.41 0.50 1.20 1.25 1.30 1.32 1.35 Operating income (bn) 4.3 3.7 3.7 4.2 4.3 0.6 0.6 0.6 0.8 1.2 3.4 2.6 3.0 3.5 3.5 Net income (bn) 2.0 1.8 1.8 2.1 2.2 0.4 0.3 0.3 0.4 0.5 1.5 1.1 1.1 1.4 1.4 Net debt (bn) 12.8 10.2 10.7 10.7 10.6 1.7 2.2 3.2 4.3 5.2 3.6 4.2 5.5 6.1 6.2 ND/ND+E 31.7% 26.4% 26.5% 25.5% 24.4% 20.2% 25.3% 33.4% 39.4% 43.7% 19.7% 22.4% 25.8% 26.2% 25.1%RNOA (ROIC) (%) 5.5 6.3 6.3 6.8 6.7 6.3 5.0 5.3 6.2 8.0 15.7 12.2 13.7 13.6 12.4 ROE (%) 7.8 6.8 6.2 7.1 6.9 8.7 5.8 5.6 7.0 9.3 13.5 9.4 9.3 10.3 9.5 Book value per share 20.8 21.3 21.7 22.2 22.7 6.5 6.2 6.3 6.4 6.6 36.4 35.9 39.6 44.1 48.5

BP Royal Dutch Shell Total

BG GroupEni Statoil

Repsol Galp OMV

Note: All financials above are in reported currency. Reporting currency for BP, Shell and BG is US dollar; for Statoil it is Norwegian kroner; and for the others, it is euro. e = Morgan Stanley Research estimates

24



Disclosure Section Morgan Stanley & Co. International plc, authorized by the Prudential Regulatory Authority and regulated by the Financial Conduct Authority and the Prudential Regulatory Authority, disseminates in the UK research that it has prepared, and approves solely for the purposes of section 21 of the Financial Services and Markets Act 2000, research which has been prepared by any of its affiliates. As used in this disclosure section, Morgan Stanley includes RMB Morgan Stanley (Proprietary) Limited, Morgan Stanley & Co International plc and its affiliates. For important disclosures, stock price charts and equity rating histories regarding companies that are the subject of this report, please see the Morgan Stanley Research Disclosure Website at www.morganstanley.com/researchdisclosures, or contact your investment representative or Morgan Stanley Research at 1585 Broadway, (Attention: Research Management), New York, NY, 10036 USA. For valuation methodology and risks associated with any price targets referenced in this research report, please contact the Client Support Team as follows: US/Canada +1 800 303-2495; Hong Kong +852 2848-5999; Latin America +1 718 754-5444 (U.S.); London +44 (0)20-7425-8169; Singapore +65 6834-6860; Sydney +61 (0)2-9770-1505; Tokyo +81 (0)3-6836-9000. Alternatively you may contact your investment representative or Morgan Stanley Research at 1585 Broadway, (Attention: Research Management), New York, NY 10036 USA.

Analyst Certification The following analysts hereby certify that their views about the companies and their securities discussed in this report are accurately expressed and that they have not received and will not receive direct or indirect compensation in exchange for expressing specific recommendations or views in this report: Martijn Rats. Unless otherwise stated, the individuals listed on the cover page of this report are research analysts.

Global Research Conflict Management Policy Morgan Stanley Research has been published in accordance with our conflict management policy, which is available at www.morganstanley.com/institutional/research/conflictpolicies.

Important US Regulatory Disclosures on Subject Companies As of February 28, 2014, Morgan Stanley beneficially owned 1% or more of a class of common equity securities of the following companies covered in Morgan Stanley Research: Afren, AMEC, Cairn Energy, Eni SpA, Genel Energy Plc, OMV AG, Premier Oil, Repsol, Saipem, Salamander Energy PLC, Subsea 7, Technip, TOTAL, Vallourec, Wood Group. Within the last 12 months, Morgan Stanley managed or co-managed a public offering (or 144A offering) of securities of BP plc, Eni SpA, Repsol, Royal Dutch Shell, SBM Offshore, Statoil, Technip. Within the last 12 months, Morgan Stanley has received compensation for investment banking services from BG Group, BP plc, Cairn Energy, Eni SpA, Repsol, Royal Dutch Shell, SBM Offshore, Statoil, Technip, TOTAL. In the next 3 months, Morgan Stanley expects to receive or intends to seek compensation for investment banking services from Afren, AMEC, BG Group, BP plc, Cairn Energy, CGG Veritas, Eni SpA, EnQuest PLC, Galp Energia, Genel Energy Plc, Lundin Petroleum AB, OMV AG, Ophir Energy plc, Petrofac, Petroleum Geo Services, Premier Oil, Repsol, Royal Dutch Shell, Saipem, Salamander Energy PLC, Sasol, SBM Offshore, Statoil, Technip, Tecnicas Reunidas, TGS-NOPEC Geophysical Company ASA, TOTAL, Tullow Oil, Vallourec, Wood Group, Xcite Energy Ltd. Within the last 12 months, Morgan Stanley has received compensation for products and services other than investment banking services from BP plc, Eni SpA, Galp Energia, OMV AG, Repsol, Royal Dutch Shell, Sasol, Statoil, Technip, TOTAL, Tullow Oil, Vallourec. Within the last 12 months, Morgan Stanley has provided or is providing investment banking services to, or has an investment banking client relationship with, the following company: Afren, AMEC, BG Group, BP plc, Cairn Energy, CGG Veritas, Eni SpA, EnQuest PLC, Galp Energia, Genel Energy Plc, Lundin Petroleum AB, OMV AG, Ophir Energy plc, Petrofac, Petroleum Geo Services, Premier Oil, Repsol, Royal Dutch Shell, Saipem, Salamander Energy PLC, Sasol, SBM Offshore, Statoil, Technip, Tecnicas Reunidas, TGS-NOPEC Geophysical Company ASA, TOTAL, Tullow Oil, Vallourec, Wood Group, Xcite Energy Ltd. Within the last 12 months, Morgan Stanley has either provided or is providing non-investment banking, securities-related services to and/or in the past has entered into an agreement to provide services or has a client relationship with the following company: Afren, AMEC, BG Group, BP plc, Cairn Energy, Eni SpA, Galp Energia, OMV AG, Petrofac, Premier Oil, Repsol, Royal Dutch Shell, Sasol, Statoil, Technip, TOTAL, Tullow Oil, Vallourec. Morgan Stanley & Co. LLC makes a market in the securities of BP plc, Eni SpA, Royal Dutch Shell, Sasol, Statoil, TOTAL. Morgan Stanley & Co. International plc is a corporate broker to Afren, BG Group, Cairn Energy, Tullow Oil, Xcite Energy Ltd. The equity research analysts or strategists principally responsible for the preparation of Morgan Stanley Research have received compensation based upon various factors, including quality of research, investor client feedback, stock picking, competitive factors, firm revenues and overall investment banking revenues. Morgan Stanley and its affiliates do business that relates to companies/instruments covered in Morgan Stanley Research, including market making, providing liquidity and specialized trading, risk arbitrage and other proprietary trading, fund management, commercial banking, extension of credit, investment services and investment banking. Morgan Stanley sells to and buys from customers the securities/instruments of companies covered in Morgan Stanley Research on a principal basis. Morgan Stanley may have a position in the debt of the Company or instruments discussed in this report. Certain disclosures listed above are also for compliance with applicable regulations in non-US jurisdictions.

STOCK RATINGS Morgan Stanley uses a relative rating system using terms such as Overweight, Equal-weight, Not-Rated or Underweight (see definitions below). Morgan Stanley does not assign ratings of Buy, Hold or Sell to the stocks we cover. Overweight, Equal-weight, Not-Rated and Underweight are not the equivalent of buy, hold and sell. Investors should carefully read the definitions of all ratings used in Morgan Stanley Research. In addition, since Morgan Stanley Research contains more complete information concerning the analyst's views, investors should carefully read Morgan Stanley Research, in its entirety, and not infer the contents from the rating alone. In any case, ratings (or research) should not be used or relied upon as investment advice. An investor's decision to buy or sell a stock should depend on individual circumstances (such as the investor's existing holdings) and other considerations.

Global Stock Ratings Distribution (as of February 28, 2014)

For disclosure purposes only (in accordance with NASD and NYSE requirements), we include the category headings of Buy, Hold, and Sell alongside our ratings of Overweight, Equal-weight, Not-Rated and Underweight. Morgan Stanley does not assign ratings of Buy, Hold or Sell to the stocks we cover. Overweight, Equal-weight, Not-Rated and Underweight are not the equivalent of buy, hold, and sell but represent recommended relative weightings (see definitions below). To satisfy regulatory requirements, we correspond Overweight, our most positive stock rating, with a buy recommendation; we correspond Equal-weight and Not-Rated to hold and Underweight to sell recommendations, respectively.

25



Coverage Universe Investment Banking Clients (IBC)

Stock Rating Category Count % of Total Count

% of Total IBC

% of Rating Category

Overweight/Buy 1015 34% 303 37% 30%Equal-weight/Hold 1307 44% 392 48% 30%Not-Rated/Hold 100 3% 24 3% 24%Underweight/Sell 538 18% 90 11% 17%Total 2,960 809 Data include common stock and ADRs currently assigned ratings. Investment Banking Clients are companies from whom Morgan Stanley received investment banking compensation in the last 12 months.

Analyst Stock Ratings Overweight (O). The stock's total return is expected to exceed the average total return of the analyst's industry (or industry team's) coverage universe, on a risk-adjusted basis, over the next 12-18 months. Equal-weight (E). The stock's total return is expected to be in line with the average total return of the analyst's industry (or industry team's) coverage universe, on a risk-adjusted basis, over the next 12-18 months. Not-Rated (NR). Currently the analyst does not have adequate conviction about the stock's total return relative to the average total return of the analyst's industry (or industry team's) coverage universe, on a risk-adjusted basis, over the next 12-18 months. Underweight (U). The stock's total return is expected to be below the average total return of the analyst's industry (or industry team's) coverage universe, on a risk-adjusted basis, over the next 12-18 months. Unless otherwise specified, the time frame for price targets included in Morgan Stanley Research is 12 to 18 months.

Analyst Industry Views Attractive (A): The analyst expects the performance of his or her industry coverage universe over the next 12-18 months to be attractive vs. the relevant broad market benchmark, as indicated below. In-Line (I): The analyst expects the performance of his or her industry coverage universe over the next 12-18 months to be in line with the relevant broad market benchmark, as indicated below. Cautious (C): The analyst views the performance of his or her industry coverage universe over the next 12-18 months with caution vs. the relevant broad market benchmark, as indicated below. Benchmarks for each region are as follows: North America - S&P 500; Latin America - relevant MSCI country index or MSCI Latin America Index; Europe - MSCI Europe; Japan - TOPIX; Asia - relevant MSCI country index or MSCI sub-regional index or MSCI AC Asia Pacific ex Japan Index. .

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Industry Coverage:E&P

Company (Ticker) Rating (as of)Price* (03/10/2014)

Jamie Maddock, PhD Afren (AFRE.L) O (01/10/2011) 159pAfrica Oil Corp (AOIC.ST) E (01/23/2014) SKr50.75Cairn Energy (CNE.L) O (08/24/2012) 201pDet Norske Oljeselskap ASA (DETNOR.OL)

E (11/13/2012) NKr65.75

EnQuest PLC (ENQ.L) U (01/05/2012) 147pFaroe Petroleum PLC (FPM.L) U (09/04/2013) 119pGenel Energy Plc (GENL.L) E (12/07/2011) 1,075pLundin Petroleum AB (LUPE.ST) E (11/07/2013) SKr125.6Ophir Energy plc (OPHR.L) O (01/10/2013) 310pPremier Oil (PMO.L) E (08/17/2012) 312pSOCO International (SIA.L) U (01/05/2012) 428pSalamander Energy PLC (SMDR.L) E (09/04/2013) 100pTullow Oil (TLW.L) O (01/10/2011) 804pXcite Energy Ltd (XELL.L) O (06/16/2011) 92p

Stock Ratings are subject to change. Please see latest research for each company. * Historical prices are not split adjusted.

Industry Coverage:Oil Services


Robert Pulleyn AMEC (AMEC.L) U (02/15/2011) 1,089pCGG Veritas (GEPH.PA) U (05/30/2013) €11.4Petrofac (PFC.L) O (10/12/2010) 1,357pPetroleum Geo Services (PGS.OL) E (06/14/2013) NKr65.25SBM Offshore (SBMO.AS) O (10/03/2013) €10.67Saipem (SPMI.MI) E (02/13/2014) €17.41Subsea 7 (SUBC.OL) E (05/30/2013) NKr107.1TGS-NOPEC Geophysical Company ASA (TGS.OL)

U (05/30/2013) NKr181.3

Technip (TECF.PA) O (11/23/2011) €70.31Tecnicas Reunidas (TRE.MC) U (11/23/2011) €38.69Vallourec (VLLP.PA) E (05/30/2013) €37.54Wood Group (WG.L) O (05/30/2013) 749p


Industry Coverage:Integrated Oil & Refining


Leigh Bregman Sasol (SOLJ.J) E (05/03/2013) ZAc57,800Haythem Rashed, CFA Galp Energia (GALP.LS) O (10/10/2012) €12.23OMV AG (OMVV.VI) U (09/12/2013) €32.31Repsol (REP.MC) U (11/28/2012) €18.1Statoil (STL.OL) O (02/10/2014) NKr161.7Martijn Rats, CFA BG Group (BG.L) E (02/10/2014) 1,088pBP plc (BP.L) E (11/01/2013) 484pEni SpA (ENI.MI) E (11/01/2013) €17.35Royal Dutch Shell (RDSa.L) E (08/13/2013) 2,193pRoyal Dutch Shell (RDSb.L) E (08/08/2013) 2,343pTOTAL (TOTF.PA) O (08/08/2013) €46.5


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oil & gas: necessity as the mother of invention: sector...

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