Proposed changes to oil and gas taxation

Who is making the money here?

Fit for $50 oil: will the boom go bust?

Edition Thirty Six – March 2015

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Issue 35 – February 2015

OilVoice Acorn House 381 Midsummer Blvd Milton Keynes MK9 3HP Tel: +44 207 993 5991 Email: press@oilvoice.com Advertising/Sponsorship Mark Phillips Email: mark@oilvoice.com Tel: +44 207 993 5991 Social Network

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Adam Marmaras

Manager, Technical Director

Welcome to the March edition of the

OilVoice Magazine.

Although the bad news on the price of oil seems to have 'bottomed out', the effects on the industry certainly haven't. Everyone is reigning in their spending, and 'luxuries' are the first to go. But from chatting to an employer at APPEX yesterday it was interesting to learn that they are increasing their training budget as this is the best way to retain key staff. And during this 'reshuffle', retaining your very best is vital.

Take a look at our Training Courses and I'm sure you'll find one to suit. Our courses are located in a prestigious central London location, with lunch included. At the end of the day all students also receive a certificate signed by the trainer, complete with frame!

But enough about training - you have in your hands a digital copy of the OilVoice Magazine, jam packed full of the best content that February produced. Thanks for taking the time to read it.

See you next month!

Adam Marmaras

Managing Director OilVoice

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1

Table of Contents

Role of Wages of the Common Worker in Oil Prices, Collapse by Gail Tverberg

2

Capital Costs in a Low Oil Price World by Stephen A. Brown

4

The six shale states and why supply growth will soon stop by Stephen A. Brown

6

Three Men in a Boat and Hot Air Exhibition? by David Bamford

9

Who is making the money here? by David Bamford

10

Proposed changes to oil and gas taxation by Ronan Lowney

12

A climate of opinion! by David Bamford

14

Oil & Gas in 2015: A Seller's Market by Joshua Robbins

16

Here today, gone tomorrow! by David Bamford

18

Tech Talk: enjoy it while you can by David Summers

19

Fit for $50 oil: will the boom go bust? by Chris Bredenham

22

2

Role of Wages of the Common Worker in Oil Prices, Collapse

Written by Gail Tverberg from Our Finite World In their book Secular Cycles, Peter Turchin and Surgey Nefedof point out the

important role falling wages of the common workers played in early collapses. I got to

thinking that this might be an issue with our current situation as well, including the low

level of oil prices.

I explain this in two presentations. The first one is called 'Overview of a Networked

Economy'. The second one is called, 'Economic Growth and Diminishing Returns.'

A couple of (amateurish) slides that need explanation are the following ones:

The cloud above my representation of the economy is supposed to represent the

cloud of goods and services that the economy makes. Many people would like us to

believe that as long as this cloud is growing, everything is fine.

What Peter Turchin discovered is that there is a smaller cloud that really needs to be

growing, as well.

This cloud is the after-tax income of the common worker. If this isn't growing, then it is

hard to collect enough taxes. The ultimate downfall comes from government downfall,

because of the problems of the common worker.

3

The above slide is an attempt to show the after-tax income of common workrs as a

subset within the GDP cloud. (It probably should be much smaller.)

Common workers are ones who will tend to buy mostly goods and not too many

services. In fact, the goods that they buy are not necessarily even high tech goods. If

these workers cut back on goods that use a lot of commodities in their production, this

cutback could contribute to all of the other pressures we are now seeing toward lower

commodity prices, and make it much hater for oil prices to rise again.

If we want common workers to do better, it looks to me like we need an increasing

supply of cheap-to-extract oil (low priced would help as well).

To see the full story, you will need to click on the links above.

I will be leaving on March 13 to spend four weeks lecturing and traveling in China. (My

family will not be coming along, so I won't be leaving an empty house here.) Hopefully

I will have a chance to write a 'regular' post between now and then-the two

presentations are from this series. I don't expect to be able to write posts while I am in

China because China does not allow access to the WordPress site where I write my

posts.

View more quality content from

Our Finite World

4

Capital Costs in a Low Oil Price World

Written by Stephen A. Brown from The Steam Oil Production Company Ltd I wrote earlier about oil prices, or more specifically, about where oil prices might go in

the medium to long term; that was $80/bbl plus or minus $20/bbl if you want the nub of

the article. This piece is an analysis of how the upstream oil industry's cost base has

been, and might be, affected by changes in oil prices.

At oil prices of less than $50/bbl not many North Sea projects look very profitable,

especially when you evaluate the investments with the costs operators have become

accustomed to paying over the last three or four years. Rig rates, vessel rates,

engineering and construction costs have all been at historic highs. That has been

inevitable, all oil and gas contractors from drilling companies to heavy lift contractors

were at full stretch and, so, have been adding capacity; and adding capacity costs

money.

But in a low oil price environment demand for services will fall and when demand falls,

prices will fall too. But how far and how fast?

IHS provide the industry with a very useful index of capital costs over the past fifteen

years. Their data is available here. They track the costs of equipment, facilities,

materials and people involved in the construction of a diversified portfolio of projects.

For the purpose of this analysis I have taken their data and deflated the index using

the Bureau of Labor Statistics CPI index and then added on to the chart below the oil

price in real terms. That way we can see how costs have really increased (or

decreased) and get a clue as to what might have been behind the changes.

5

IHS UCCI deflated by US BLS CPI & Brent oil prices, also inflated by US BLS CPI to

present oil price in 2014 dollars

Well, correlation doesn't prove there is causation, but it isn't hard to see that when oil

prices went up, the cost of doing business in the oil patch went up too. When the oil

price tripled from c. $40/bbl in 2000 to 2003, to $120/bbl in 2008, the UCCI (Upstream

Capital Cost Index) went up 80% in real terms.

This chart also gives us a clue as to what happens when oil prices fall. At the end of

2008 prices fell precipitously, just as they are doing today. It took about eighteen

months for the impact of the oil price drop to work its way through the system, but

eventually costs fell by about 13% even though the oil price had actually recovered

back to about $80/bbl. When, after that dip, the oil price climbed again and then

steadied at about $110/bbl the index stabilised, midway between the peak of 2008 and

the trough of 2010.

The uplift in the UCCI index over the last decade fits with the actual experience of oil

companies everywhere. Costs have been higher, a lot higher than we remembered. It

is that high cost base combined with current low oil prices that is making lots of North

Sea projects look marginal.

But we can already foresee what might happen to the cost base if prices stay low. It

doesn't seem unreasonable to speculate that If the oil price settles at $80/bbl in the

long run then capital costs will once again ease off by 10% to 15% over the next a

year or so. If the oil price stays as low as $50/bbl to $60/bbl for a couple of years then

I would expect the cost base to fall by around 30%, but perhaps it will take three years

for that to happen. Finally, it is pretty clear that it isn't really feasible to expect a bigger

reduction than 40%, no matter how low oil prices go.

As always, the pain being felt by the oil producers today will be felt by suppliers and

contractors tomorrow. Costs will come down, but it will take some time to show up in

bid tabs and budget quotes. Unfortunately for companies entering into major contracts

today, or who have just signed contracts, the benefits will be minor. The real

beneficiaries will be those companies with uncommitted projects on their books who

can wait until costs have actually fallen before spending their money.

View more quality content from

The Steam Oil Production Company Ltd

6

The six shale states and why supply growth will soon stop

Written by Stephen A. Brown from The Steam Oil Production Company Ltd Everyone knows it by now but the growth in domestic US oil production has

been truly astonishing. Spurred on by high oil prices and easy credit, oil

companies in Texas and North Dakota have been drilling like crazy and the

result has been an inexorable rise in US domestic production.

What is remarkable is that almost all of the growth in production has been

recorded in just six states, Texas, North Dakota, Oklahoma, New Mexico, Utah

and Colorado.

This chart shows US domestic production from 1981 to 2014 and the upturn in

production is striking. Even more dramatic when you focus in on just those six

states.

7

In 2008, just before the crash, there were almost as many rigs working in these

six states as have been working there over the past three years, but back then

the growth in supply was positively anaemic. Now, it seems as if the folk

running these crews have really got their eye in, and lately, with around 1500

rigs drilling, annual growth has averaged about 30%. That's astonishing. There

is obviously a correlation between rigs working and supply growth, but lately

that correlation has changed.

Back when shale wasn't even a gleam in Harold Hamm's eye, when about 600

rigs were working all the decent drilling locations were being snapped up.

Adding more rigs in the pre-shale era didn't do anything for production growth.

Nowadays though, growth and rig count are very strongly correlated. I would

guess that when the rig count falls to somewhere between 600 and 1,000 rigs

growth will grind to halt. So how long will that take.

Well I would say that the reduction in rig count is already baked in.

8

It turns out that the rig count in these states is very strongly correlated with the

oil price. That should be no surprise to anyone. The correlation works best with

a one hundred day delay between the rig count and the oil price. It is a very

simplistic model but I can use that equation to predict where the rig count in

these six states is going to go in the coming months. Based on January's

average price, I reckon by April we will be down to around about 700 operating

rigs.

It also turns out that the correlation between rig count and production growth

works best with a three month delay between the two curves. That means that

by July production growth in domestic US oil supply should quietly drop to

zero.

What happens in August and beyond will be very dependent on what happens

to oil prices between now and then, but the shale miracle will be over in the

summer. For how long, who knows, but for sure it will come back in time.

View more quality content from

The Steam Oil Production Company Ltd

9

Three Men in a Boat and Hot Air Exhibition?

Written by David Bamford from PetroMall When I first saw this headline, I thought perhaps it was a slightly tongue in cheek

reference to the three leaders of the main UK political parties publishing a joint on the

UK's forward policy on emissions but, no, it was an article about attractions in the

Dundee area!

A pity!!

Anyway, to reprise...

Last weekend, David Cameron, Nick Clegg and the other guy issued a joint climate

commitment, pledging to work together to combat climate change, whatever the

election result. This was followed up in the Grauniad by the Energy Secretary lauding

the degree of togetherness shown by the Three Men.

Now personally I would have preferred it if this unison, this united view, had been

shown over the defence of the realm and delivering some sort of energy security,

given that Russia, the Middle East, North Africa are showing deeply worrying

tendencies at the moment.

Moving on....

However, when you dig into the commitment, this turns out to be about coal. Hmm,

aren't we blowing up lots of coal-fired power stations just now? Just in passing, you

might like to watch the video of three of the cooling towers at Didcot power station

suffering this fate some months ago.

But when you dig down, for example into the BBC article, what you actually find is:

'The leaders have gone so far as to promise to ban "unabated" coal-fired power

generation - meaning that, if it is to continue, the emissions will need to be captured

and stored in rock formations. This decision has been long debated and will send a

strong signal of intent to the power industry.'

10

So 'They' will be happy if we in the energy industry can develop and deploy effective,

economic, Carbon Capture&Storage technology. Whether this will keep the

'Renewables lobby' happy is another question. However, as I said in my last article...

Bless them, maybe our leaders speak the truth - the only way to square rising demand

for fossil fuels, the need for the UK (and NW Europe) to become more energy

independent, and do this with a greater proportion of gas in the mix, and live with the

environmental pressure on the fossil fuel industry, is for the industry to get on and roll

out full-scale carbon capture and storage technology rapidly at, I would add, a

marginal cost to current finding, development and operating costs.

For an industry whose efforts in working in deep water or the North Sea or Alaska

compare favourably with those of the USA/NASA in putting a man on the moon, this

should be easy-peasy.

View more quality content from

PetroMall

Who is making the money here?

Written by David Bamford from PetroMall Now here’s something interesting, as reported by RigZone.

“Schlumberger announced Friday full-year results for 2014 that the firm’s CEO

described as demonstrating the resiliency of its business portfolio.

Schlumberger reported that its revenue increased by seven per cent last year to $48

billion. The firm’s pre-tax operating income was 13-percent great at $10.6 billion.”

Wow, it’s worth reading those numbers again, just to get them clear! That’s

$48,000,000,000 and $10,600,000,000! Quite a few zeroes...

11

I wonder what they will look like for 2015...

That depends a lot on oil & gas prices and at the moment folk are trying to figure out

where these prices are headed: a really good example is in this talk by Stuart Amor of

RFC Ambrian at last week’s Finding Petroleum event.

Here’s my wacky idea!

Where the oil price goes from now – the price relative to this moment in time – is

determined by the supply/demand balance.

But what determines the absolute price?

My argument would be that the whole price curve moves up and down in response to

the cost of goods, people and services. And thus Schlumberger’s revenues are not an

outcome of high oil & gas prices but are the result of the prices Schlumberger (and of

course countless others) charge for goods, people and services.

And, as we all know, the prices paid in the ‘oil patch’ have been exponentiating over

the last two or three years.

A wacky, dodgy, half-baked, economic idea maybe but I think there is some kind of

support for it in a Daily Telegraph interview with Francis Egan, the CEO of Cuadrilla

Resources, who said:

“There’s no such thing as a break-even gas price. Cost of extraction is a function of

the cost of people and services. As prices in the market come down, the cost of

people and services come down - so the break-even price comes down.”

I await being shot down by petroleum economists!

View more quality content from

PetroMall

12

Proposed changes to oil and gas taxation

Written by Ronan Lowney from Bond Dickinson The UK government has announced three changes to oil and gas taxation which could

radically change the way the offshore oil and gas industry is taxed.

Announced by Chancellor George Osborne in the Autumn Statement on 3 December

2014, the changes cover the Supplementary Charge, ring fenced expenditure

supplement and a new cluster area. Draft clauses to outline these measures in the

2015 Finance Bill were published on 10 December 2014. Ronan Lowney, Managing

Associate at Bond Dickinson LLP considers the proposals.

The changes come in the wake of the review of the industry by Sir Ian Wood. The UK

government realises that the North Sea basin is at a stage of maturity which requires

greater investment in infrastructure and in the technical challenges required to

maximise UK energy security. The fiscal regime within which the industry operates

needs review and change in order to maintain competitiveness for such in investment

in what is a very international sector. The fall in oil prices is also a motivational factor.

The changes in themselves did not come as a surprise to the industry - they are

largely positive, however they are regarded as merely piecemeal. HM Treasury

launched a consultation in July focusing on the fiscal regime in the UK relating to the

oil and gas sector. Large-scale change at this point would not have been expected,

but there is more expected to come. Of particular future interest in 2015 will be

proposals for the Investment Allowance, which will be designed to enhance production

in existing fields and will therefore be of significant interest to current participants.

While each of the changes is significant, it is the cluster area allowance that will be the

most interesting development. Other changes, such as the extension of the ring fence

expenditure supplement and the supplementary charge reduction are welcome, but

the cluster allowance is the development which is more closely tied to the aim of

expanding exploration.

The intention of the new cluster area allowance is to encourage investment in the

more challenging areas of the central North Sea. Accessing further reserves there is

financially and technically more difficult. Therefore, the proposal of Cluster Area plans

13

is designed to consolidate investment in these areas. The way that the allowance will

work should also give a direct cash incentive, in that it effectively reduces the tax rate

(through reduction of the supplementary charge) and applies to all UKCS activity and

not just profits from the cluster area.

The Chancellor suggested that there could be further changes to upstream oil and gas

taxation in the near future.

There is currently a lot of complexity concerning allowances and it would be a

welcome move were this to be addressed. These allowances have been developed

over a number of years in response to particular objectives. A consolidation of these to

fit within a rational framework of economic and energy security objectives could be

interesting, and may be a better way to encourage investment than headline rate

reductions. HMT has stated that the underlying tax structure of ring fenced corporation

tax, supplementary charge and PRT shall remain (albeit subject to review) therefore

we should see objectives and competitiveness being achieved through allowances.

In the short period between the start of the fiscal regime consultation and now we

have seen how global economics can impact this sector heavily and suddenly, with a

reduction of 50% in crude prices. This in itself demonstrates the vulnerability of mature

basins when it comes to the economic viability of exploration. Any future fiscal regime

may need to have an element of flexibility within it (such as allowance enhancement or

rate reductions tied to prices). For example, the Chancellor had stated in 2011 that if

crude fell below £45 per barrel, supplementary charge rates should be examined. That

floor has been reached.

View more quality content from

Bond Dickinson

SUPPORTING THE DEVELOPMENT OF NATURAL RESOURCES

rpsgroup.com/energy energy@rpsgroup.com

Operations Support | Technical Studies | Advisory Services Project HSE & Risk Management | Training

14

A climate of opinion!

Written by David Bamford from PetroMall First of all I have to introduce four or five interesting threads....

The most recent one is from the (new) CEO of Shell, asserting that oil&gas companies

need to become more fully engaged in the debate about climate change; and I

introduce one quote which is:

"What can we as an industry do to help clear the way for a more informed debate? In

the past we thought it was better to keep a low profile on the issue. I understand that

tactic, but in the end it's not a good tactic."

And then there is this report on shareholders sizing up to BP (and Shell); again,

just one quote:

'Pension funds controlling hundreds of billions of pounds are among the 150 investors

demanding the company tests whether its business model is compatible with the

international community's pledge to limit global warming to 2C.

The 2C target means only a quarter of existing, exploitable fossil fuel reserves are

burnable, according to a series of recent analyses, implying that trillions of dollars of

oil, gas and coal held by investors could become worthless and that further exploration

for fossil fuels may be pointless.

The same shareholder resolution, which includes a ban on corporate bonuses for

climate-harming activities, has been tabled with Shell and both will be voted on at

forthcoming annual meetings.

'Climate change is a major business risk,' said James Thornton, chief executive of the

environmental law organisation ClientEarth, which helped coordinate the resolutions.

'BP and Shell hold our financial and environmental future in their hands. They must do

more to face the risks of climate change. Investors can help them by voting for these

shareholder resolutions.''

The 'only a quarter of....reserves are burnable' line is similar to that

expressed here; namely that:

'The IEA says that two-thirds of all fossil fuel reserves are rendered null and void if

15

there is a deal to limit CO2 levels to 450 particles per million (ppm), the target level

agreed by scientists to stop the planet rising more than two degrees centigrade above

pre-industrial levels.'

Interestingly, the self-same IEA is quoted as the oracle in this article:

'Just as the United States and China agreed on a landmark deal to curb greenhouse-

gas emissions, the world's leading energy think tank says that demand for fossil fuels

is likely to keep growing for at least another 20 years.'

Yes, the 'world's leading energy think tank' is the IEA!

And a final link and quote (Yes, I know it's boring and/or confusing but bear with

me!):

The UK Parliamentary Environmental Audit Committee said recently that:

'Shale fracking should be put on hold in the UK because it is incompatible with our

climate change targets and could pose significant localised environmental risks to

public health.'

And this extract ensured that their report captured a lot of headlines.

However, if you dig even a couple of inches below the surface, you find that Joan

Walley MP, chair of the Committee, said:

'Ultimately fracking cannot be compatible with our long-term commitments to cut

climate changing emissions unless full-scale carbon capture and storage technology is

rolled out rapidly, which currently looks unlikely."

And, bless them, maybe our MPs speak the truth - the only way to square rising

demand for fossil fuels, the need for the UK (and NW Europe) to become more energy

independent, and do this with a greater proportion of gas in the mix, and live with the

environmental pressure on the fossil fuel industry, is for the industry to get on and roll

out full-scale carbon capture and storage technology rapidly at, I would add, a

marginal cost to current finding, development and operating costs.

16

Just my opinion, of course, but for an industry whose efforts in working in deep water

or the North Sea or Alaska compare favourably with those of the USA/NASA in putting

a man on the moon, this should be easy-peasy.

View more quality content from

PetroMall

Oil & Gas in 2015: A Seller's Market

Written by Joshua Robbins from Beachwood Marketing Group Since the start of the decline of oil in June, I have spoken with nearly two thousand oil

and gas firms.

Large oil companies, small mom and pop organizations, mid-size firms, guys that have

been in oil for 40 years, and someone who just broke ground on their first well in 2014.

I've spoken to investors, A & D groups and management teams.

And, out of all of these conversations, I have received one loud and surprising

chorus: this is a seller's market.

No one has any idea if oil is going to drop to $30.00 or jump to $80.00 in the next few

months. Emails from "experts" hit inboxes by the digital truckload. With all of these

conflicting opinions floating around about what will happen with WTI at the end of the

day, oil and gas producers are looking much further into the future.

Their production portfolios are becoming incredibly streamlined. This drop in price, in

many cases, is allowing producers the opportunity to increase specific well efficiencies

and productivity.

17

Each well is being classified into a new portfolio criteria, offering a unique perspective

of where a well fits within the operations of the whole organization. Because of

increased access via web or internal management based systems, new wells, land or

opportunities are easier to find and capitalize on.

And producers are finding that just because a well kicks out 100 barrels a day, doesn't

mean it fits within their core portfolio.

Many people will read this article and think "this is a buyer's market" because half

priced oil means half priced property. But that is just not the case in today's

environment.

This is not a "fire sale" environment, where people are selling their oil property and

throwing in their fishing boat.

Look, there will be cash available for oil. Forever. The market will always have buyers.

But this environment reflects that guarantee of capital. The market is filled with

companies that can hold their properties until the end of time. However, as a seller in

this market, you have a huge mass of people that are looking at your property for its

future value within their company.

Buyers are not basing their bids on the current price of oil. They are being based on

the criteria of their organization - what the property is worth to them - creating a

seller's market.

Within this seller's market, the property values based on new criteria can maximize the

selling price, while at the same time allowing buyers to purchase an otherwise

unavailable property that fits perfectly into their portfolio.

But even in a seller's market, there are pitfalls. So, I'll share with you what an oil man

once told me: "Remember, smart money will always find smart deals."

View more quality content from

Beachwood Marketing Group

18

Here today, gone tomorrow!

Written by David Bamford from PetroMall

To those of us 'of a certain age', the phrase 'here today, ... , gone tomorrow' is

redolent of an interview on the BBC in which Sir Robin Day quizzed Sir John Nott,

then UK Defence Secretary, immediately following the Falkland's crisis in the early

1980's. Sir Robin's use of this phrase to describe politicians led to the latter casting off

his microphone and leaving the studio...

It came to mind because, after one of our Finding Petroleum events, I was trying to

figure out why oil & gas companies, especially those with deep UK roots, do not enter

more into the debate on the longevity of the North Sea, on climate change, on

emissions, on the need to develop carbon capture and storage etc etc.

Putting aside the risk that after the UK General election in May, the next UK Prime

Minister could be someone who seems to be hostile towards business, or for that

matter that we have an Energy Secretary (Ed Davey) who is unsympathetic to oil &

gas companies: see this report on a letter from Malcolm Webb (Oil and Gas UK) to Ed

Davey, a reply, and notes of a meeting with Ed Davey and head of Shell UK: it was

private but released under a freedom of information request...

[Note my even-handedness here: links to the Telegraph and the Grauniad!]

and moving right along...

...the issue is that our oil & gas business is so long term that we seek as little

uncertainty and as little political volatility as we can muster.

However, you have to say that the UK seems to offer more of both uncertainty and

volatility than some other countries, for example, in the form of unpredictable tax

changes. And poorly thought through commitments on emissions. And as a poor

humble voter, I am sceptical about whether anything I hear between now and the

Election on May 5th will actually come to pass!

What's missing is, in my humble opinion, any sort of UK Energy Strategy. For a long

while I believed that this was probably yet another thing that we had handed over to

19

the European Commission in Brussels. But not so! Apparently it is one of the key

principles of the Lisbon Treaty that Energy Strategy is the preserve, the bailiwick, the

responsibility of each country.

Can anybody tell me what the UK's Energy Strategy is? And what HM Leader of the

Opposition says his would be (N.B. this isn't the same as saying they would cap prices

to the consumer!) if they won in May?

View more quality content from

PetroMall

Tech Talk: enjoy it while you can

Written by David Summers from Bit Tooth Energy

It is perhaps an odd time to be writing about oil shortages. The price of gas in

our town has just moved above $2 a gallon up significantly from the $1.64 it

was at its recent lowest point, but still very reasonable. Debate still rages as

to whether the global price of a barrel of oil has found a bottom, although

there are signs that the price is beginning to increase, in part due to other

issues than overall availability of crude. So why be concerned?

There are several issues, and perhaps the first is that of industrial inertia.

Despite the daily fluctuations in oil price, many of the events that occur

between the time that oil is found in a layer of rock underground and the time

that some of it is poured into your gas tank take a long time to initiate, and

similarly can't be turned off overnight. It takes, for example, roughly 47

days for a tanker to travel from Ras Tanura in Saudi Arabia to Houston.

One response to the drop in oil prices has been to reduce the number of rigs

drilling for oil in the United States. Again this is not an immediate response,

20

but rather one that grows with time. This is particularly true with the number of

oil rigs that are used to gain access to the oil reservoirs. As the price for this

oil falls, so rigs are idled and the potential for additional oil production also

declines. This drop is particularly significant in fields that are horizontally

drilled and fracked because of the very rapid decline in production with time in

existing wells and the need for continued drilling to develop and produce new

wells to sustain and grow production. The most recent figures show a fall of

98 rigs in the week from the 6th to the 13th of February, with the overall count

now standing at 1,358. This rate of decline has held at nearly 100 rigs a week

now for the past three with no indication of any immediate change in the

slope of the curve. At the same time the number of well completions in the

Bakken is falling, as producers hold back on the costs for producing oil

that would be sold at a loss.

The impact from this will take time to appear, North Dakota has reached a

production rate of 1.2 mbd in December and the DMR estimates that it will

need around 140 rigs to sustain that production level this year, with the most

recent rig count being 137. This number is likely to continue to fall through the

first six months of the year.

The impact is not just in the immediate loss of production. Rather, once the

rigs are idled it will take time, even after the markets recover, for the

companies to adjust their planning and finances, and to re-activate the rigs.

What this effectively does is to shift the production increment into later years,

when the production base from existing wells will have declined beyond

current levels. This means that the peak level of production will likely also be

lower than would otherwise be the case, and the period over which this peak

production is sustained will also be shorter.

The problem that this all presages is that lower levels of production against

an increasing world demand will induce a faster rise in price than many now

anticipate. There is a complacent feeling that oil prices won't reach $100 a

barrel for some considerable time - perhaps even years. If the current

difference between available oil supply and demand is below 2 mbd, Euan

Mearns has suggested that roughly half of this might be eaten up by

increased demand, while the other half would disappear as production levels

drop, although he doesn't see this bringing the two volumes into rough

balance until the end of 2016.

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I rather think that it will happen faster than that, and that the price trough will

steepen faster than currently anticipated, and likely before the end of this

year. The problem (if you want to call it that) with the perceptions of the ability

of global production to meet demand is that it is all tied to the production of

the United States and Canada. I have noted, over the past two years, how

future projections of increasing global oil demand have been met, in models,

by increased production from the United States, and that this was anticipated

to continue. (Increased production from Iraq, if sustained, is more likely to be

needed just to balance declines in production from other countries).

Yet the US industry is going into a relatively rapid decline because of the way

that it is structured that is going to be hard to stop, and much slower to

reverse than anticipated. (In a way it is similar to the intermittent traffic

congestion one finds on roads which result because we brake a lot faster

than we then accelerate). This will not only stop the growth in production that

is currently anticipated, but will go further and before the end of the year will

lead to a drop in overall volumes produced. Yet demand is expected to

increase. Where will the supply come from, if not the United States?

While Saudi Arabia can produce more, one gets the sense that they are quite

comfortable where they are, thank you and won't be increasing their

contribution, and while Russia may bemoan the price they are getting for their

oil, if the price goes up they are not going to be able to meet an increased

demand, nor are there likely to be others with spare capacity that they can

bring to the table. And because of the inertia in the system the United States

will still be in a mode of declining production.

So I rather suspect that what we can anticipate is that prices will start to

recover through the summer, and then, as the full impact of the rebalanced

situation starts to become evident, will move higher at an increasing rate.

Because if, in fact, we are reaching the period of a tighter balance between

demand and available supply, then the market will change its perceptions

quite quickly and be driven by a totally different metric.

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22

Fit for $50 oil: will the boom go bust?

Written by Chris Bredenham from PwC

Africa has seen enormous successes in the exploration for hydrocarbons over the last

decade, which has seen the entry of new country players in East Africa joining the

ranks of their West African neighbours. In 2013 alone, six of the top 10 global

discoveries by size were made in Africa - including some of the largest reserves

discovered in the last decade in East Africa!

This sounds like a true success story for low-income African countries, some of which

have been highly dependent on agricultural exports up to now. The drastic drop in the

global oil price means that we may need to re-think the oil boom on the African

continent.

Oil price volatility is part of the industry

Oil price volatility results from complex interactions between supply and demand and

reacts significantly to word and economic events.

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For countries in West Africa, which are already highly dependent on oil exports, it

means potential austerity measures and budget reviews, but what is the potential

impact that a $50 (or less) per barrel oil price could have on fledging new oil producers

like those in East Africa?

Oil&gas explorers will be scrutinising (and likely reducing) their budgets and deciding

where to allocate their limited capital spend given the new price environment. This

may include rationalisation of portfolios in addition to general cost-cutting on

discretionary capex.

London-based Tullow Oil, for example, has reduced its global 2015 exploration budget

to $200 million, an 80% reduction in what it spent in 2014. We also expect an uptake

in M&A activity as players with strong balance sheets secure resources from those

with less liquidity, many of which could be smaller players with a strong presence on

the continent. In addition to gobbling up the weak, other assets may be put up for sale

as strategies are revised and implemented.

Companies across the globe that until recently enjoyed an economic environment in

which being a 'jack-of-all-trades' was a feasible proposition will now have to focus their

efforts to weather not only this storm but also those associated with volatility in other

commodity prices.

Players in the African market must act now to plan for the upturn to ensure that the

potential boom does not go bust. The reality is that this is a chance to review strategy,

reduce costs, optimise portfolios, assess talent and improve access to capital.

Many oil companies today are too rigid. They have a very linear and inflexible

approach similar to a train on a railway in which they move ahead with little ability to

adjust to what's happening on the ground. The players who make the most of this

situation will take the opportunity to become agile, flexible machines with dynamic

strategies that can adapt as sailors do in response to changes in the prevailing wind.

Sail, not rail, is the new approach which gives them the greatest chances of winning!

A challenging and uncertain environment

Oil companies with stakes in Africa are not strangers to risky environments. From

unclear legislation to corruption, the continent has always been challenging. In

addition, Africa has one of the highest average finding costs in the world at a massive

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$35.01 per barrel in 2009 - surpassed only by the US offshore fields which came in at

$41.51 per barrel.

Combine these forces with a drastically reduced and heavily uncertain oil price, and

it's a sure recipe for re-evaluation of prospects. Africa holds a number of technically

challenging (and therefore expensive) hydrocarbon prospects. Examples include

deepwater sub-salt exploration activity in West Africa, waxy oil in Uganda as well as

offshore exploration leases in South Africa.

Oilfield service (OFS) companies are also operating in unchartered waters, and worse,

they have very little control over the circumstances. Our view is that while OFS

companies will venture to cut back on spending, they will also be under extreme

pressure by oil companies to drop their prices. The cost of contracting to conduct data

acquisition, such as 2D and 3D seismic surveys, already dropped by 65% between

2013 and 2014. Some predict that the cost of hiring offshore rigs may fall by nearly

40%.

Another critical stakeholder that must be considered in the African landscape is the

host government. In many of the countries that have recently become burgeoning

hydrocarbon provinces, unclear legislation and regulation have inhibited development

in the sector.

In other cases, potential investors regard the fiscal terms to be overly onerous and

unattractive. In these countries, decision-makers have largely kept sight of the boom

of the last half-decade and forgotten the bust of 2009. For governments, we see the

current price environment as a reality check reminding them that commodity prices are

cyclical.

Governments would do well to recognise this time as an opportunity to sort out

regulatory, legislative and fiscal policies so that they are poised as attractive regimes

when the price recovers. Many operators have also vowed to renegotiate their

exploration licence terms, further raising governments' awareness of the issues.

25

In this challenging and uncertain environment, the question that needs to be answered

is 'Who is facing the greatest risks?' Historically, oil&gas production costs in Africa

have been on par with the world average, at $10.31 per barrel.2 This suggests that the

areas impacted most in Africa will be similar to those in the rest of the world, with a

few specific noteworthy caveats. Overall, global production growth is expected to slow

but not reverse. Our view is that the players in the following categories on the

continent are likely to be most at risk:

Frontier areas;

Major gas projects;

Host governments;

OFS companies.

Frontier areas around the world will potentially suffer from delayed development in the

near term. These include technically difficult projects that require more spend than

conventional production, such as deepwater, sub-salt, shale gas and enhanced oil

recovery ventures.

26

Countries that may see frontier project delays include offshore South Africa, sub-salt

Congo and Angola, offshore Tanzania and shale gas in South Africa. Shale gas, in

particular, could move forward if the gas price were not 100% linked to oil.

In addition, areas where limited infrastructure is currently in place are also likely to

suffer. This is because external investment is needed to develop the requisite

infrastructure - investment that will be difficult to procure to produce a commodity that

is currently losing in value. In these areas, development of existing discoveries may

end up on ice unless there is a domestic need for the resource.

The good news is that large international oil&gas players will likely look more to the

future (and beyond current prices) when deciding whether or not to continue proposed

drilling programmes due to the long-term nature of these prospects.

Major African gas projects will also be under increased scrutiny, as oil-linked LNG

prices have also dropped significantly. We don't envision that the major LNG projects

in Mozambique and Tanzania will be cancelled outright, but costs are a major concern

for investors.

Total capex needed to build a 2-train LNG project in Mozambique is a massive $2.14

million per bcf of net gas volume. That's a total investment of USD$26.1 billion.3 With

such high stakes, it's no wonder that investors may wait for some rebound in the

oil/gas price. Another other option would be to modify contract prices for LNG to de-

link them from oil, but we don't see this as probable in the short to medium term,

though the direct indexation that we see today may be modified.

Host governments in Africa could also see a major impact on their bottom lines caused

by the suppressed price environment. Those whose economies are not well

diversified, such as the Republic of Congo, Gabon and Angola, will be hardest hit and

may have to consider austerity measures and a revision of the government's budget.

Oil revenues make up a large portion of the GDP for many African countries and if the

current price environment persists, this could result in slowed development.

27

OFS companies will be hit hard globally, but Africa may be an especially vulnerable

portion of their portfolios. Overall, there will be extreme pressure on them from

upstream operators to reduce costs.

Africa could pose further complication due to difficult logistics and lack of infrastructure

to respond quickly to demand. Those who can predict movements in the market ahead

of time will perform best in this environment. Overall exploration costs have already

decreased significantly due to cost pressures, specifically seismic surveying and

drilling. This will likely lead to idle rigs as well as delayed and potentially cancelled

projects.

Rigs counts on the continent have already dropped as Baker Hughes has reported a

10% drop since 2013 figures. For those operators obligated to drill by lease terms,

service costs will be lower, but OFS company margins will be suffering. Schlumberger

came to this realisation early, which is what prompted its announcement of 9 000 lay-

offs globally.

28

What are the opportunities?

Despite bleak prospects, there are still viable opportunities to invest in the industry

within Africa - even from an exploration point of view. The greatest opportunity at the

moment seems to be within onshore, conventional plays. In contrast to offshore finds,

onshore prospects are technically much easier to discover due to well-tested

geotechnical approaches.

There are still risks, but onshore exploration is also significantly cheaper. Tullow Oil

has certainly taken note of this opportunity as it has announced that it plans to drill six

basin openers in onshore Kenya during 2015. Four of them are scheduled in the first

quarter. That's a large portion of its $200 million exploration budget. Kenya, in

particular, is also seen to be a relatively stable and fast-growing economy, with its

proximity to the markets of India and China being an added benefit.

Aside from exploration, some players are moving ahead with development

programmes, albeit with commitments not to expand exploration drilling. Where

production is already ongoing, these plays are viable at almost any oil price. This is

because most of the costs are already sunk.

We also see that there could be significant potential for firms that are strong in

research&development. Schlumberger usually sinks $1 billion annually into R&D. This

investment could pay off if efforts are made to reduce the cost of drilling and

production in a low oil price scenario.

Lastly, there is a big opportunity for new players with strong balance sheets to enter

the African market, potentially at a low cost. For those who are 'Fit for $50,' this poses

a potentially once-in-a-generation chance to pick up valuable assets at a bargain

price.

How to become more fit for $50

The key to surviving the ups and downs of the cyclical oil&gas market is to learn how

to adapt quickly - be more agile! A number of issues must, therefore, be addressed.

This can be done by starting with an organisational stress test.

29

The PwC Stress Test is a framework for developing relevant indicators to determine

the level of 'stress', or exposure and sensitivity of a company to weak hydrocarbon

pricing environments. It includes strategic, financial, operational and commercial

elements. Drawing on the results of the stress test, actions that could be taken include

cost reduction, portfolio optimisation, strategy review, improving access to capital and

people management. More detail on these potential actions are outlined in the

diagram below.

In situations of low commodity prices, many companies respond with knee-jerk cost

reduction programmes. This could be much more effective if they took the time to

understand what specific costs are, how they compare to peers and what reductions

are truly possible. Cost reduction programmes need to be targeted and realistic.

30

Health check scorecard

A health check scorecard is a useful tool that companies can utilise to determine how

to optimise their portfolios in a new price environment. As their margins erode,

companies must move from a growth strategy to a flexible position that will support the

return to a growth strategy or enable them to endure a downturn. Companies need

visibility into their assets across each element of the stress test to understand how to

optimise their portfolio in a new price regime.

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