Permian Reserves May Be Much Smaller Than You Think: Tight Oil and Long-Term Debt Cycle

Permian Reserves May Be Much Smaller Than You Think: Tight Oil and Long-Term Debt Cycle Arthur E. Berman September 11, 217 Slide 1

New Age of American Energy Dominance The U.S. is the 1th Largest Oil Reserve Holder in the World Venezuela Saudi Arabia Canada Iran Iraq Russia Kuwait UAE Libya US Nigeria Kazakhstan China Qatar Brazil Algeria Angola Ecuador Mexico Norway 13 12 12 8 8 8 48 48 37 3 26 25 98 12 11 153 158 172 266 31 5 1 15 2 25 3 35 Source: BP & Proved Reserves of Liquids (billions of barrels) We are entering a new age of American energy dominance: Rick Perry. we ve got underneath us more oil than anybody, and nobody knew it until five years ago. ---Donald Trump Trump referring to tight oil and today, that means the Permian basin. Global energy dominance by the U.S. is somewhere between aspirational and absurd. 9 mmb/d average 217 crude oil imports & 7 mmb/d net imports. U.S. is 1 th largest world reserve holder between Libya and Nigeria. Not bad but hardly in same class as Venezuela, Saudi Arabia, Canada, Iran, Iraq & Russia that have on average 4 times more proved reserves than the U.S. Slide 2

John Mauldin: An Energy Amateur Masquerading as an Energy Expert Rystad Energy Global Oil Recoverable Resource Estimate Saudi Arabia 276 U.S. 263 Russia 181 Canada 158 Iran 135 Iraq 11 Brazil 11 Venezuela 72 Mexico 68 5 1 15 2 25 3 Source: Rystad Energy & Labyrinth Consulting Servces, Inc. Billions of Barrels of Oil Perhaps the President & Secretary Perry read John Mauldin s recent work of magical realism, Shale Oil: Another Layer of U.S. Power. Mauldin features a chart showing U.S. is largest reserve holder in the world. So wrong that it defies explanation. Rystad Energy source reveals Maudlin mis-represented recoverable resources as reserves. Didn t even show Rystad s data correctly. Saudi Arabia not the U.S. is the largest holder of recoverable resources according to Rystad. What weight do recoverable resources have in a $5 per barrel world? Slide 3

EIA Reserve Estimates Table 2. Crude oil production and proved reserves from selected U.S. tight plays, 214-15 million barrels Basin Play 214 214 215 215 State(s) Production Reserves Production Reserves Williston Bakken ND, MT, SD 387 5,972 421 5,3 Western Gulf Eagle Ford TX 497 5,172 565 4,295 Permian Bone Spring, Wolfcamp NM, TX 53 722 66 782 Denver Niobrara* CO, KS, NE, WY 42 512 58 46 Appalachian Marcellus* PA, WV 13 232 16 143 Fort Worth Barnett TX 9 47 5 33 Sub-total 1,1 12,657 1,131 1,743 Other tight 56 78 83 859 U.S. tight oil 1,57 13,365 1,214 11,62 The more practical question is, What about the growth potential of the Permian basin? Pioneer CEO Scott Sheffield claims Permian production may exceed 16 billion bo! Even credible sources like Wood Mackenzie believe that Permian Wolfcamp growth alone will add 3 million barrels per day by 224. The EIA estimated that 215 Permian tight oil reserves were only 782 million barrels. Seems low and much less than the 5 billion and 4.3 billion barrels attributed to the Bakken and Eagle Ford plays, respectively. Slide 4

Reserve Estimate Using 216 1-K SEC Filings (Annual Reports) Permian 216 Proved Oil Reserves (kbo) 216 Tight Oil Production (kbo) PCT OF Total 216 Production CONCHO 321,26 37,315 9.3% PIONEER 283,647 45,538 11.3% ENERGEN 199,575 1,468 2.6% LAREDO 167,1 9,146 2.3% RSP PERMIAN 164,7 11,4 2.7% DIAMONDBACK 139,174 14,892 3.7% PARSLEY 136,536 11,763 2.9% EP 81,8 3,973 1.% DEVON 81, 16,211 4.% CIMAREX 74,3 17,92 4.5% CALLON 71,145 8,59 2.1% SUBTOTAL 1,72,3 186,776 47% TOTAL 3,696,999 41,459 1% I estimate that there are approximately 3.7 billion barrels of proved Permian tight oil reserves using 216 1-K SEC filings of leading operators in the plays. All the companies in the table differentiated Permian reserves from other company reserves. Those companies accounted for 47% of all tight oil production in 216. I used that as a scaling factor to estimate the contribution of companies such as Anadarko, Apache, EOG and OXY that did not separate Permian from other company reserves in their 1-K filings. The estimate is founded on a reliable base of 1.7 billion barrels from company filings. The assumption that undifferentiated company reserves will follow 216 production ratios is reasonable but uncertain. Slide 5

Assessing the Growth Potential of the Permian Basin 8, Concho & Pioneer Proved Undeveloped Future Production Expected to Peak in 219 7, Proved Undeveloped Future Production (Barrels of Oil Equivalent Per Day) 6, 5, 4, 3, 2, 1, Pioneer Concho 4,97 22,6 1,373 53,132 13,299 9,538 6,93 61,515 7,128 57,47 Source: Company 216 1-K Filings & 217 218 219 22 221 Only 3.7 billion barrels may surprise those who buy into the vision of American energy dominance. Others may accept the estimate but argue that Permian plays have significant growth potential that the Bakken and Eagle Ford do not. Concho and Pioneer included tables in their 216 1-Ks that projected future production from proven undeveloped (PUD) reserves: peak PUD production in 219. PUDs only ~25% of their combined 216 daily production from the Permian basin. Future PUD production may only offset legacy production decline rates. Also, PUDs already included in proved reserves. Slide 6

Tank Theory 1.6 Permian Tight Oil Production Has Reached The Eagle Ford Peak & Is Still Increasing 1.4 Eagle Ford Permian 1.2 Bakken 1.8.6.4.2 Jan- Jun- Nov- Apr-1 Sep-1 Feb-2 Jul-2 Dec-2 May-3 Oct-3 Mar-4 Aug-4 Jan-5 Jun-5 Nov-5 Apr-6 Sep-6 Feb-7 Jul-7 Dec-7 May-8 Oct-8 Mar-9 Aug-9 Jan-1 Jun-1 Nov-1 Apr-11 Sep-11 Feb-12 Jul-12 Dec-12 May-13 Oct-13 Mar-14 Aug-14 Jan-15 Jun-15 Nov-15 Apr-16 Sep-16 Feb-17 Millions of Barrels of Oil Per Day Source: Drilling Info & Implied Permian tight oil reserves less than accepted estimates for the Bakken and Eagle Ford plays. Permian production, however, has already reached peak Eagle Ford levels and is still increasing. Doesn t this mean it will continue to increase & eclipse output from older plays? Without additional reserves from new plays or deeper layers, it may only reflect rate acceleration followed by steep decline once peak production is reached. Tank Theory you can drain the tank with the best technology at very high rates but ultimate production is limited by the size of the tank. Concho s and Pioneer s future production forecast suggests that peak production may occur sooner than later. Already, some operators are having problems with increasing gas production. Slide 7

Bakken EUR, Gas-Oil Ratios & Water Cut Trends 6 Oil Production Decline Rates For Recent Years Are Greater Than For Previous Years For Top 8 Bakken Producers Gas-Oil Ratio Increases Every Year For Top 8 Bakken Producers 6% Water Cut Increased In The Last 3 Years For Top 8 Bakken Producers 2,5 5 216 215 55% Oil Production (Barrels of Oil Per Day) 4 3 2 216 Declining Faster Than All Previous Years Despite Higher Initial Rates Gas-Oil Ratio (Cubic Feet Per Barrel) 2, 1,5 1, 216 214 213 212 Percent Water 5% 45% 4% 35% 216 215 214 212 213 3% 215 1 214 215 Declining Faster Than Previous Years 213 212 214 Declining Faster Than Previous Years 1 2 3 4 5 6 7 8 9 111121314151617181922122232425262728293313233343536373839441424344454647484955152535455565758596 Months of Production Source: Drilling Info & 5 Source: Drilling Info & 1 2 3 4 5 6 7 8 9 111121314151617181922122232425262728293313233343536373839441424344454647484955152535455565758596 Months of Production 25% Source: Drilling Info & 2% 1 2 3 4 5 6 7 8 9 111121314151617181922122232425262728293313233343536373839441424344454647484955152535455565758 Months of Production Pioneer's Permian Basin Gas-Oil Ratio Has Increased 28% Since November 216 2,5 2, 1,5 1, 5 Source: Drilling Info & 1/1/12 3/1/12 5/1/12 7/1/12 9/1/12 11/1/12 1/1/13 3/1/13 5/1/13 7/1/13 9/1/13 Gas-Oil Ratio (cubic feet/barrel) 11/1/13 1/1/14 3/1/14 5/1/14 7/1/14 9/1/14 11/1/14 1/1/15 3/1/15 5/1/15 7/1/15 9/1/15 11/1/15 1/1/16 3/1/16 5/1/16 7/1/16 9/1/16 11/1/16 1/1/17 3/1/17 5/1/17 7/1/17 EUR decreased & decline rates increased for wells with 1 st production after 213. Gas-oil ratios increased & then decreased. Water cuts increased for all wells with 1 st production after 213. These trends suggest depletion and that the play has been over-drilled not conclusive without pressure data. Pioneer s Permian basin GOR has increased 28% since November 216. Slide 8

U.S. Reserves Must At Least Double To Become a Top-Tier Reserve Holder The U.S. Must Double Reserves To Become an Oil-Dominant Producer Even Doubling or Tripling Permian Reserves Not Nearly Enough 35 BP EIA 3 Billions of Barrels of Liquids 25 2 15 1 5 United States 48 35 Source: BP, EIA & Permian Basin Venezuela Saudi Arabia Canada Iran Iraq Russia Kuwait UAE Libya US Nigeria Kazakhstan China Qatar Brazil Algeria Angola Ecuador Mexico Norway Azerbaijan Oman India Vietnam Australia Malaysia South Sudan Egypt Permian This study represents one scenario that may provide context for the claims and expectations about future production potential for the Permian basin. Aside from weak growth in the offshore Gulf of Mexico, or some return to growth in the Bakken and Eagle Ford plays, it is the only current basis for the crude oil portion of emerging American energy dominance. For the U.S. to move into the top tier of oil producing countries, reserves must at least double from accepted estimates by BP, EIA and other credible organizations. In some upside scenario in which Permian reserves of 3.7 billion barrels somehow double or triple, that still will not be nearly enough for the U.S. to become energy dominant in oil. Slide 9

Low Oil Prices & The Long-Term Debt Cycle U.S. Govennment + Consumer + Non-Financial Corporate Debt (Trillions) $35 $3 $25 $2 $15 $1 $5 $ 196 1962 Oil Prices 2.4 times Higher After 24 Than 1986-24 In 216 Dollars Debt > GDP After 1974-1986 Oil Shocks $45/barrel 195-216 Avg Price $23 Avg Price 1964 1966 $5 $48 Source: U.S. Federal Reserve Bank, U.S. Bureau of Labor Statiistics, World Bank, EIA & $ 1968 197 1972 Oil Price 1974 Oil Shocks $69 Avg Price 1976 1978 198 1982 1984 1986 1988 $34 Avg Price Debt > GDP After 1986 199 1992 1994 1996 1998 2 22 24 $86 Avg Price 26 28 21 Debt 212 GDP 214 216 $12 $11 $1 $9 $8 $7 $6 $4 $3 $2 $1 WTI Price in 216 Dollars Per Barrel CPI-Adjusted Brent Price (December 216 $/barrel) $12 $1 $8 $6 $4 $2 $ 3.5 2.7 3.5 4.1 -.8 -.4 No Demand Destruction During The 212-216 Oil-Price Collapse Brent Price LHS (WTI before 1975) 3.4 2.2 2.9 1.1-1.3-1.9-1.5 -.4 1.2 -.2 1.7 1.4 1.8 1.1.4.5.6.1 1. 1.5 1.7 1.3.5 1.8 1.8.8.6 1.6 3.1 1.4 1. 1.5 Negative Demand Growth (RHS) Positive Demand Growth (RHS) 1.2 mmb/d 3-Year Avg Source: IEA, EIA, OPEC, BP, U.S. Bureau of Labor Statistics & -.6-1. 3.1.9 1.1 1. 1.2 1.9 1.3 1.5 1.4 197 1971 1972 1973 1974 1975 1976 1977 1978 1979 198 1981 1982 1983 1984 1985 1986 1987 1988 1989 199 1991 1992 1993 1994 1995 1996 1997 1998 1999 2 21 22 23 24 25 26 27 28 29 21 211 212 213 214 215 216 217E 218E 4.5 4.25 4 3.75 3.5 3.25 3 2.75 2.5 2.25 2 1.75 1.5 1.25 1.75.5.25 -.25 -.5 -.75-1 -1.25-1.5-1.75-2 -2.25 Annual Liquids Demand Growth (mmb/d) Petroleum Age after WWII produced unprecedented economic growth. Oil shocks of 1974-1986 threatened to end that party. Demand destruction & oil production bubble resulted in 18 years of cheap energy. Debt re-started economic growth & debt-based growth of China challenged oil supply after 24. Second oil shock made unconventional oil possible. Zero-interest rates led to 2 nd oil bubble. Longest period of high oil prices in history. That bubble burst in 214 and oil prices collapsed but without demand destruction. Now, we are near the end of long-term debt cycle but denying that the economic basics have fundamentally changed since the post-war era. Slide 1

Low Oil Prices Created A Capital Bubble For The Permian Basin $16 Lower Oil Prices Correspond With Higher Interest Rates & End of QE 3 in Late 214 7% 1 Rig Count Weekly Change Suggests Permian Break-Even Price Is $55-$6/Barrel Rig Count Rises & Falls Based on Expectation of $55-$6 Prices $11 $15 CPI-Adjusted WTI Price (216 Dollars Per Barrel) $14 $12 $1 $8 $6 $4 $2 $ Source: U.S. Federal Reserve Bank, U.S. Bureau of Labor Statistics, EIA & Jan- Jul- Jan-1 Jul-1 Jan-2 Jul-2 Jan-3 Jul-3 Jan-4 Jul-4 Interest Rates Jan-5 Jul-5 Jan-6 Jul-6 Jan-7 Jul-7 Jan-8 Jul-8 Jan-9 Jul-9 Jan-1 Jul-1 WTI Price (July 217 Dollars) Jan-11 Jul-11 Interest Rate Inc. From.9% to.12% Jan-12 Jul-12 Jan-13 Jul-13 Jan-14 Jul-14 Jan-15 End QE 3 Jul-15 Jan-16 Jul-16 Jan-17 Jul-17 6% 5% 4% 3% 2% 1% % Federal Funds Effective Interest Rate (Percent) Weekly Rig Count Change 5-5 -1-15 -2-25 1/1/14 3/1/14 5/1/14 7/1/14 9/1/14 11/1/14 1/1/15 3/1/15 5/1/15 $6 Source: Baker Hughes, EIA & 7/1/15 9/1/15 Weekly Rig Count Change 11/1/15 WTI Price Change In Permian Tight Oil Rig Count Lags Price By About 6 Weeks Weeks 1/1/16 3/1/16 5/1/16 7/1/16 9/1/16 11/1/16 1/1/17 $55 3/1/17 5/1/17 7/1/17 $1 $95 $9 $85 $8 $75 $7 $65 $6 $55 $5 $45 WTI Price ($/barrel) $4 $35 $3 $25 $2 $15 $1 $5 $ Slide 14 The oil-price collapse coincided with the end of QE 3 and the beginning of U.S. interest rate increases. Continued low interest rates caused margin hunters to focus on the Permian basin. $3 oil prices brought large capital flows to a select group of producers seen as winners. Tight oil and Permian rig counts have more than doubled since August 216. Increased rig count and fear of ongoing over-supply is a major drag on oil prices. Failure of OPEC production cuts to quickly balance oil markets has tightened capital flows since March. Slide 11

Energy Stocks Have Suffered in 217, Permian Stocks More Recently Estimated net flows into and out of U.S. energy stock funds $1.billion Vanguard 8 11 6 6 15 1 55 5 4 95 45 2 9 85 4 35 8 3-2 -4 212 13 14 15 16 17 Note: All data are full-year except 217, which is through July. Source: Morningstar THE WALL STREET JOURNAL Concho Pioneer 15 145 14 135 13 125 12 115 11 15 1 6 55 5 45 4 35 3 21 2 19 18 17 16 15 14 13 12 6 55 5 45 4 35 3 12-Sep-16 12-Oct-16 12-Nov-16 12-Dec-16 12-Jan-17 12-Feb-17 12-Mar-17 12-Apr-17 12-May-17 12-Jun-17 12-Jul-17 12-Aug-17 12-Sep-16 12-Oct-16 12-Nov-16 12-Dec-16 12-Jan-17 12-Feb-17 12-Mar-17 12-Apr-17 12-May-17 12-Jun-17 12-Jul-17 12-Aug-17 12-Sep-16 12-Oct-16 12-Nov-16 12-Dec-16 12-Jan-17 12-Feb-17 12-Mar-17 12-Apr-17 12-May-17 12-Jun-17 12-Jul-17 12-Aug-17 Close WTI Close WTI Close WTI Slide 12

WTI Probably Stuck in High $4 to Mid $5 Range Through December 217 Ivnetories of Crude Oil + Products (mmb) 1,2 1,15 1,1 1,5 1, 95 9 85 Inventories Are Somewhat Down From Record Levels--The Difference Between Inventories & The 5-Year Average (C.I.) Is Also Near Record Levels 99 mmb Gap WTI Price (RHS) Record Inventory Level Inventories (LHS) 5-Year Inventory Average (LHS) Source: EIA & 8 1/1/1 1/1/11 1/1/12 1/1/13 1/1/14 1/1/15 1/1/16 1/1/17 $12 $1 $8 1 mmb Gap $6 $4 $2 $ WTI Price ($/barrel) Source: EIA & 214-217 Data WTI Price ($/barrel) $115 $11 $15 $1 $95 $9 $85 $8 $75 $7 $65 $6 $55 $5 $45 $4 $35 $3 $25 $2 $15 $1 Most Likely December 217 C.I. Range 4-75 mmb $5-$56/barrel Demand For Refined Products Is The Key Mid-cycle price Most-Likely Dec. 217 C.I. Range 4-75 mmb $5-$56/barrel Sept 1 Mar-June 215 Optimism End August OPEC Production Cut Optimism Mid-Feb $5 Comparative Inventory (C.I.) Millions of Barrels $ -5-4 -3-2 -1 1 2 3 4 5 6 7 8 9 1 11 12 13 14 15 16 17 18 19 2 21 22 23 24 25 $55 $4 Late 215-Early 216 Pessimisim (Cushing > 8% Capacity) Comparative inventory (C.I.) is the key to understanding oil prices and potential future trends. The oil price collapse resulted in the largest increase in inventories and C.I. on record. C.I. has fallen 112 mmb since mid-february but the gap between inventories & the 5-year average is still very large. Flat yield curve of WTI vs C.I. large decreases in C.I. do not create meaningful price increases. Most-likely range of C.I. indicates possible year-end WTI price range of $5 to $56/barrel. Slide 13

Closing Thoughts Billions of Barrels of Liquids 35 3 25 2 15 1 5 An appropriate context for the Permian basin & U.S. tight oil plays is necessary. Reserves are relatively small & costs are relatively high but the plays provide a just-in-time supply that has disrupted traditional markets. The global leverage of tight oil plays is almost entirely negative and they are wholly dependent on managed money for their survival. Capital supply may not continue to be as available as it has been. Most production forecasts assume business-as-usual, not a global economy near the end of a long-term debt cycle. It is unlikely that proven Permian reserves can deliver forecasted production. This will require adding reserves from new plays or pools. Those who celebrate tight oil play innovation should consider the desirability of more years of depressed oil prices. Venezuela BP Saudi Arabia EIA Canada Iran The U.S. Must Double Reserves To Become an Oil-Dominant Producer Even Doubling or Tripling Permian Reserves Not Nearly Enough Iraq Russia Kuwait UAE Libya United States 48 35 US Nigeria Kazakhstan China Qatar Brazil Algeria Angola Ecuador Mexico Norway Azerbaijan Oman India Vietnam Australia Malaysia South Sudan Egypt Permian Source: BP, EIA & Permian Basin Market Balance (Supply Minus Demand mmb;d) 2.5 2 1.5 1.5 -.5-1 -1.5-2 -2.5.5.4 World Market Balance Suggests Increasing Over-Supply Going Forward...4.5.3.. Brent Price (RHS) 1.3.8 Supply-Demand Surplus (LHS).87.92 1.6 1.86 2.9 1.26 2.11 1.28.46 1.42.2.45.29.31 1Q6 2Q6 3Q6 4Q6 1Q7 2Q7 3Q7 4Q7 1Q8 2Q8 3Q8 4Q8 1Q9 2Q9 3Q9 4Q9 1Q1 2Q1 3Q1 4Q1 1Q11 2Q11 3Q11 4Q11 1Q12 2Q12 3Q12 4Q12 1Q13 2Q13 3Q13 4Q13 1Q14 2Q14 3Q14 4Q14 1Q15 2Q15 3Q15 4Q15 1Q16 2Q16 3Q16 4Q16 Q117 Q217 Q317 Q417 Q118 Q218 Q318 Q418 Source: IEA, EIA, OPEC, BP & Supply-Demand Deficit (LHS) Q2 217 Q2 218.82 1.37.38.28 $16 $14 $12 $1 $8 $6 $4 $2 $ Brent Price (December 216 Dollars Per Barrel) Slide 14