Research Global Oil price to bottom when non-opec output rise halts déjà vu #2

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1 Investment Research General Market Conditions 18 December 2014 Oil price to bottom when non-opec output rise halts déjà vu #2 We expect the current slide in oil prices to continue until we see producers starting to adjust to the lower prices by lowering output around mid next year. Based on the difference in crude oil prices and production costs, producers of unconventional oil in, for example, the US, Canada and Brazil look more vulnerable. We see some probability of a cut in OPEC s output target in June. Pricing in the forward market and the experience of the 1986 oil glut indicates that the price of Brent crude oil will recover to USD85/bl in the medium term. The 1986 oil glut déjà vu This is the second paper in our series of papers under the title 1986 oil glut déjà vu see also: Research Commodities: The oil price plunge in perspective déjà vu #1, 12 December 2014 We have revised down our oil-price forecasts. We now expect the price of Brent crude oil to bottom in Q1 next year at around USD58/bl (revised down from USD87/bl) and average USD67/bl in 2015 and USD85/bl in 2016 respectively (revised down from USD93/bl and USD99/bl). The lesson from the 1986 oil glut As we wrote in Research Commodities: The oil price plunge in perspective déjà vu #1, 12 December 2014, the current plunge in oil prices is reminiscent of the collapse in oil prices in 1985 and In November 1985, oil prices started a sharp downturn, when OPEC, led by Saudi Arabia, initiated a price war to regain a larger share of the global oil market by flooding the market. Danske Bank s oil price forecasts Crude oil front month (US$/bbl) NYMEX WTI ICE Brent Oil products: front month (US$/t) NYMEX gasoline Euro-bob Oxy Jet fuel CIF cargo ULSD 10ppm CIF NWE cargo % Gasoil Barges FOB Rotterdam ICE Brent % fuel oil FOB NWE cargo % fuel oil FOB ARA barge (RHS) Source: Macrobond Financial and Danske Bank Markets The OPEC-led price war came to a halt three to four months later when the oil price had reached a level that led to the beginning of a decline in OECD oil production, most notably in the US. It marked the peak in OECD oil production and further started a gradual recovery in oil prices. In 1986 the oil price bottomed when OECD production peaked Source: Macrobond Financial Senior Analyst Jens Nærvig Pedersen jenpe@danskebank.dk Important disclosures and certifications are contained from page 5 of this report.

2 Who will be first to break? As OPEC continues to aggressively talk down oil prices, highlighted by recent comments from UAE energy minister, Suhail Al-Mazrouei that OPEC will not change its 27 November decision to keep its collective output target at 30mb/d even if prices drop as low as USD40/bl, the question is, which major oil producing country could be the first to lose in the 2014 oil glut? The answer to this question depends on the price of the country s crude oil and on the level of its production costs. Crude oil is found in different qualities around the world, which is reflected in the price the individual producer can get. Canadian and Latin- American crude oil tend to be of a lower quality and are thus priced lower relative to crude oil from the US, the Middle East, Africa and Europe. Producers in Africa and the Middle East are generally viewed as having the lowest production costs, while producers of so-called unconventional oil, e.g. producers of light tight oil in the US, Canadian producers of oil from tar sand and Brazilian producers of oil from ultra-deepwater drilling, probably have the highest production costs. The latter have been successful in increasing production in recent years. This suggests that OPEC producers, viewed from the perspective of profitability, are best equipped to endure a price war, while producers of unconventional oil in, for example the US, Canada and Brazil, may be first in line to scale back in production and investment. In particular, producers in Canada of oil from tar sand look vulnerable. Rising production in Americas Source: Macrobond Financial and Danske Bank Markets Cheap oil Canada first to lose in the price war? 70 USD/bbl Crude oil price benchmarks Source: Macrobond Financial and Danske Bank Markets 12/12/2014 USD85/bl the medium-term anchor for crude oil prices Drawing on the experience from the 1986 oil glut, crude oil prices may be heading lower over the next couple of months before significant adjustments on the supply side of the market start to take place. At that point though, which would be sometime during the first half of 2015, we expect prices to start gradually recovering. History further suggests that it might not be a particularly strong recovery in prices. In 1987, the price of Brent crude oil returned to around 70% of the level it had before the collapse. Hence, if prices follows the same pattern, the price of Brent crude oil should recover to around USD75/bl. The price fall has not reached a similar depth to 1986, so the anchor for an eventual recovery in prices may be higher than this level. Stable long end of forward curve Source: Macrobond Financial 2 18 December

3 The three-year and four-year generic point on the Brent crude oil forward curve has been quite stable around a level of USD90/bl over the period since It overshot this level during the Arab spring in 2011 and is currently undershooting it, which may be indicative of the medium-term anchor. Based on this analysis we view USD85/bl to be the medium-term anchor for an eventual recovery in the price of Brent crude oil. It is roughly USD20/bl lower than the average level over the past couple of years and probably low enough for OPEC to succeed in its agenda to slow the pace of expansion in non-opec oil production. Oil prices to start recovering in Q2 next year Our previous oil-price forecasts did not take into account the significant market reaction to the decision from OPEC to keep its output target unchanged the price of Brent crude oil has dropped around USD20/bl over the three weeks since we published them Commodity Forecast Update: Recovery in 2015, stabilising in 2016, 24 November Consequently, we have revised our short-term forecast lower. We see a risk that oil prices could fall further in the near term before reaching the bottom in Q1 next year. We expect a recovery to begin in Q2 supported by higher demand for oil on the back of stronger global economic growth and the start of adjustments on the supply side. First we are looking for a slowdown of the expansion in non-opec oil production, but we also see some probability of OPEC cutting its output target at the June meeting. A prerequisite for OPEC to cut its target would be a prior reaction in non-opec production. We expect the price of Brent crude oil to average USD58/bl in Q1 next year (revised down from USD87/bl), USD62/bl in Q (revised down from USD91/bl), USD70/bl in Q (revised down from USD95/bl) and USD78/bl in Q revised down from USD97/bl). For the whole of 2015 we expect the price of Brent crude to average USD67/bl (revised down from USD93/bl). In 2016 we expect prices to recover further to an average level of USD85/bl (revised down from USD99/bl). Our forecasts are above prices in the forward market Source: Macrobond Financial and Danske Bank Markets estimates We expect prices of oil products to track this path and thus see the price of Jet Fuel averaging USD669/MT in 2015 (revised down from USD869/MT) and USD804/MT in 2016 (revised down from USD924/MT), the price of ULSD to average USD609/MT in 2015 (revised down from USD812/MT) and USD744/MT in 2016 (revised down from USD864/MT), the price of 0.1% Gasoil to average USD604/MT in 2015 (revised down from USD804/MT) and USD739/MT in 2016 (revised down from USD854/MT) and the price of 3.5% fuel oil to average USD331/MT in 2015 (revised down from USD492/MT) and USD442/MT (revised down from USD492/MT) and USD442/MT in 2016 (revised down from USD529/MT) December

4 Danske Bank s oil-price forecasts AVERAGE 18/12/14 14Q1 14Q2 14Q3 14Q4 15Q1 15Q2 15Q3 15Q4 16Q1 16Q2 16Q3 16Q Energy: front month (US$/bbl) NYMEX WTI ICE Brent Oil products: front month (US$/t) NYMEX gasoline Euro-bob Oxy (USD/MT) , Jet fuel CIF cargo (USD/MT) ULSD 10ppm CIF NWE cargo (USD/MT) % Gasoil Barges FOB Rotterdam (USD/MT) ICE Brent (USD/MT) % fuel oil FOB NWE cargo % fuel oil FOB ARA barge (RHS) Crack spread: front month (US$/t) NYMEX gasoline Euro-bob Oxy (USD/MT) Jet fuel CIF cargo (USD/MT) ULSD 10ppm CIF NWE cargo (USD/MT) % Gasoil Barges FOB Rotterdam (USD/MT) % fuel oil FOB NWE cargo % fuel oil FOB ARA barge (RHS) Source: Macrobond Financial and Danske Bank Markets estimates 4 18 December

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