The Goldman Sachs Group, Inc. Supply constraints drive resource realignment Oil shortages likely to re-appear with DM demand recovery January 2010 Jeffrey Currie Goldman Sachs International +44-(0)20-7774-6112 jeffrey.currie@gs.com The Goldman Sachs Group, Inc. does and seeks to do business with companies covered in its research reports. As a result, investors should be aware that the firm may have a conflict of interest that could affect the objectivity of this report. Investors should consider this report as only a single factor in making their investment decision. For important disclosures, see the text preceding the disclosures or go to www.gs.com/research/hedge.html.
The commodity crisis is an obvious imbalance like the financial crisis was Million b/d 90 Global production capacity 80 70 60 50 Global output By 2011 the market is back to capacity constraints 40 30 20 1965 1968 1971 1974 1977 1980 1983 1986 1989 1992 1995 1998 2001 2004 2007 2010 2013 Source: IEA, GS Global ECS Research Goldman Sachs Global Investment Research 2
However, the financial crisis created a collapse in company returns which has significantly interrupted the investment phase Average cash return among oil integrated companies 20% 18% 16% 14% 12% But policy constraints put a cap on further increases and on the ability to attract capital, regardless of price increases The revenge of the old economy creates a rise in returns, which attracts capital back to the sector 10% 8% 6% 4% 2% 0% 1965 1969 1973 1977 1981 1985 Poor returns in the 1990s caused capital to be redirected into the new economy Real cash return over cash invested 40-year average 5-year moving average 1989 1993 1997 2001 2005 2009E Source: Goldman Sachs Equity Research Goldman Sachs Global Investment Research 3
The collapse in commodity demand was driven by the decline in GDP, not higher prices, which suggest as the economy recovers, so will demand Percent change year over year GDP on left axis 6.00 5.00 5.00 4.00 3.00 2.00 1.00 0.00-1.00-2.00-3.00 4.00 3.00 2.00 1.00 0.00-1.00-2.00-3.00-4.00 1Q2000 1Q2001 1Q2002 1Q2003 1Q2004 1Q2005 1Q2006 1Q2007 1Q2008 1Q2009 1Q2010 1Q2011-4.00 World Real GDP growth Projected Real GDP growth World Oil Demand Growth Source: Goldman Sachs Global ECS Research. Goldman Sachs Global Investment Research 4
Two concepts that drive our views: 1. The adding up constraints Commodities are physical, not financial markets. So you cannot consume what you do not have, and you cannot store what you don t have space to store. 2. Don t begin an argument with price as it will only get you into trouble. Instead always start an argument with a fundamental event, i.e. inflation expectations and the impact of oil prices on economic growth. Goldman Sachs Global Investment Research 5
Commodities that are more difficult to store are more volatile Commodity Annualized volatility US Power (PJM West Hub - real time) 308.7 US Power (PJM West Hub - day ahead) 180.4 NYMEX Natural Gas 75.6 UK Natural Gas 74.8 WTI Crude Oil 64.2 NYMEX RBOB 54.9 LME Nickel 53.1 USGC Heating Oil 52.3 Brent Crude Oil 50.9 LME Zinc 43.8 LME Copper 43.6 CBOT Corn 42.0 CBOT Wheat 41.2 CME Lean Hog 39.9 London Silver 39.9 NYBOT Cocoa 38.4 NYBOT Sugar 37.9 CBOT Soybean 37.2 NYBOT Cotton 35.2 London Palladium 34.4 LME Aluminum 32.2 NYBOT Coffee 31.2 London Platinum 29.3 London Gold 22.9 CME Live Cattle 17.3 Source: Various exchanges and GS Global ECS Research. Goldman Sachs Global Investment Research 6
Commodity inventory drives volatility WTI volatility increases as inventories approach exhaustion and as inventories approach capacity Percentage, vertical axis; million barrels, horizontal axis Copper volatility increases as inventories approach exhaustion, but remains steady as inventories rise given few storage capacity constraints for metal Percentage, vertical axis; Thousand mt, horizontal axis 70% 60% 1997-2009 60% 50% 1971-2008 1-month realized volatility 50% 40% 30% 1-month realized volatility 40% 30% 20% 20% 10% 10% -120-70 -20 30 80 Crude oil stocks deviation vs. 5-year average (ex SPR) 0% 0 100 200 300 400 500 600 700 800 900 1,000 LME Copper stock ('000) Source: NYMEX, LME and GS Global ECS Research. Goldman Sachs Global Investment Research 7
Three emerging themes that are likely to dominate in 2010 and beyond 1. Differentiation between commodities driven by the extent of supply constraints that will likely drive greater price dispersion across the commodity complex i.e. the end of Btu convergence 2. Resource realignment as emerging markets are forced to bid away scarce commodities from the developed economies, especially when supply constraints are more restrictive, which shifts the focus away from the sustainability of higher prices and towards the sustainability of higher growth; 3. Increasing macroeconomic correlations as resource realignment will likely increase the relevance of the commodity prices and supply to the broader macroeconomic environment. Goldman Sachs Global Investment Research 8
Commodities with more restrictive supply constraints and greater leverage to emerging market demand growth have more positive outlooks Capacity utilization as of November 2009, EM vs. DM consumption growth is annual based on 1999-2008 consumption, BRIC leverage is average of 2008 and 2009 100% Corn Wheat 95% Rice Crude Coal Copper Lead Soybeans Zinc Capacity utilization 90% -5% 0% 5% 10% Platinum 15% 20% 25% Natural gas Refining Nickel 85% 80% Bubble size = BRIC leverage Aluminum 75% EM vs. DM consumption growth * Leverage score = (mkt share)^2 + (imp share), Capacity utilization for metals has been normalized by the historical maximum utilization for each metal. Source: Goldman Sachs Global ECS Research.ce: DOE. Goldman Sachs Global Investment Research 9
Credit normalization drove the most recent rally, as we still await the economic recovery rally
Decomposition of a commodity forward curve $/bbl 140 120 100 In a cyclically tight market the spread is typically positive, reflecting a premium for prompt delivery The short-term, cyclical component of price 80 = MC 60 40 20 In a cyclically soft market the spread is negative reflecting the cost of carrying inventory The long-dated, secular component of price Price = MC + d, where d is a delivery premium in a tight market or a discount in a soft market 0 2008 2009 2010 2011 2012 2013 2014 Source: GS Global ECS Research Goldman Sachs Global Investment Research 11
Long-dated commodity prices have remained very stable during the credit crisis, with most of the volatility in prices being driven by term structure $/bbl 160 140 120 100 Long-dated Oil Prices (5-year Forward) 80 60 40 Spot Oil Prices 20 Jan-08 Mar-08 May-08 Jul-08 Sep-08 Nov-08 Jan-09 Mar-09 May-09 Jul-09 Sep-09 Nov-09 Jan-10 Source: NYMEX. Goldman Sachs Global Investment Research 12
In early May, oil market fundamentals looked terrible, but the oil market wasn t pricing oil fundamentals Million barrels 1120 1100 1080 1060 1040 1020 1000 980 960 940 920 Jan Feb Mar Apr May Jun Jul Aug Sep Oct Nov Dec 2009 2008 2007 2006 Source: DOE. Goldman Sachs Global Investment Research 13
instead the oil market was pricing credit market fundamentals, as credit markets normalized so did oil market timespreads, which was worth $20/bbl $/bbl (left axis) ; % return (right axis) -13-0.45-15 -0.55-17 -19 Spot-5 year forward Brent (left axis) -0.65-0.75-21 -0.85-23 -0.95-25 -1.05-27 -29-31 02-Jan 09-Jan Source: ICE and US Federal reserve. 16-Jan 23-Jan 30-Jan 06-Feb 13-Feb 20-Feb 27-Feb TED Spread Inverted 06-Mar 13-Mar 20-Mar 27-Mar 03-Apr 10-Apr 17-Apr 24-Apr 01-May 08-May 15-May 22-May 29-May Goldman Sachs Global Investment Research 14-1.15-1.25-1.35
The discount of spot prices to forward prices was larger than inventory levels would have suggested owing to limited access to capital and surging funding costs Percent 1st vs. 60th month timespread (vertical); million barrels of US crude oil in storage (horizontal) 80% 60% 40% 10-year average 20% 0% Oct 3, 2008-20% Dec 25, 2009-40% -60% Darker observations are post- September 2008, during the credit dislocations May 5, 2009-80% 260 280 300 320 340 360 380 Source: NYMEX, Goldman Sachs Global ECS Research Goldman Sachs Global Investment Research 15
Normalizing the price action for credit, prices are just barely off their lows, suggesting more upside as the economic recovery takes hold $/bbl 150.0 130.0 110.0 90.0 70.0 50.0 30.0 Jan-08 Mar-08 May-08 Jul-08 Sep-08 Nov-08 Jan-09 Mar-09 May-09 Jul-09 Sep-09 Nov-09 Jan-10 Credit normalized price Actual front month Source: NYMEX and GS Global ECS Research. Goldman Sachs Global Investment Research 16
Still on the cyclical trough, awaiting the recovery
The end of an economic recession corresponds to the trough in economic activity, not a return to normal Stylized economic cycle Economic recession Economic expansion trend activity recession ends expansion begins Source: GS Global ECS Research. Goldman Sachs Global Investment Research 18
The leading indicators point to a strong rebound in 2010 New orders to inventory ratio (left); diffusion index (right) 2.00 1.80 1.60 1.40 1.20 1.00 0.80 0.60 0.40 Oct-07 Jan-08 Apr-08 Jul-08 Oct-08 Jan-09 Apr-09 Jul-09 Oct-09 0.70 0.65 0.60 0.55 0.50 0.45 0.40 0.35 0.30 0.25 0.20 Source: ISM. ISM New Orders to Inventory (left axis) ISM New Orders Index (right axis) Goldman Sachs Global Investment Research 19
that has only just begun in the coincidental indicators $ bn (left axis); industrial production index (right axis) 350 1.2 340 1.15 330 1.1 320 1.05 310 1 300 0.95 290 Oct-07 Dec-07 Feb-08 Apr-08 Jun-08 Aug-08 Oct-08 Dec-08 Feb-09 Apr-09 Jun-09 Aug-09 Oct-09 0.9 US Retail Sales (left axis) US Industrial Production (right axis) Source: GS Global ECS Research Goldman Sachs Global Investment Research 20
As a result, US distillate demand has lagged, leaving it as the focal point Products supplied, Mb/d 4,800 4,600 4,400 4,200 4,000 3,800 3,600 3,400 3,200 Jan Feb Mar Apr May Jun Jul Aug Sep Oct Nov Dec 2009 2008 2007 2006 Source: DOE, GS Global ECS Research. Goldman Sachs Global Investment Research 21
EM market demand has been strong, but in oil not enough to offset the DM weakness
This also represents a transition from EM to DM growth leadership Industrial Production index 100 as of Dec-07 105 100 95 90 85 80 Dec-07 Feb-08 Apr-08 Jun-08 Aug-08 Oct-08 Dec-08 Feb-09 Apr-09 Jun-09 Aug-09 Oct-09 DM EM (ex China) EM (inc China) World Source: GS Global ECS Research. Goldman Sachs Global Investment Research 23
China is beyond recovery, as Chinese oil demand remains above the pre-recession highs thousand b/d 8500 8000 7500 7000 6500 6000 5500 Jan Feb Mar Apr May Jun Jul Aug Sep Oct Nov Dec 2009 2008 2007 2006 Source: Chinese National Bureau of Statistics and GS Global ECS Research. Goldman Sachs Global Investment Research 24
Chinese oil demand was largely driven by demand for industrial related other products Year-over-year changes in thousand b/d 1500 1000 500 Other (incl. Naphtha) LPG Jet Fuel Fuel oil Diesel Gasoline Total products 0-500 -1000 Jan-09 Feb-09 Mar-09 Apr-09 May-09 Jun-09 Jul-09 Aug-09 Sep-09 Source: China Customs, National Bureau of Statistics of China, Goldman Sachs Global ECS Research. Goldman Sachs Global Investment Research 25
implying positive upside surprise to our forecast if demand for transportation fuel follows total product demand Thousand b/d 10500 10000 9500 9000 8500 8000 7500 7000 6500 6000 Jan-11 Feb-11 Mar-11 Apr-11 May-11 Jun-11 Jul-11 Aug-11 Sep-11 Oct-11 Nov-11 Dec-11 2011 2010 2009 2008 2007 Source: IEA, Goldman Sachs Global ECS Research. Goldman Sachs Global Investment Research 26
Chinese retail sales growth has more than offset US weakness Change in Real Retail Sales Since January 2007 - USD Billion January 2007 Bil$ 80 60 China U.S. 40 20 0-20 -40-60 Jan-07 Mar-07 May-07 Jul-07 Sep-07 Nov-07 Jan-08 Mar-08 May-08 Jul-08 Sep-08 Nov-08 Jan-09 Mar-09 May-09 Jul-09 Sep-09 Nov-09 Source: GS Global ECS Research Goldman Sachs Global Investment Research 27
The distillate market needs to rebalance to support a sustainable move higher
Distillate demand is not that out of line with IP growth that has been slow to rebound Yoy change in thousand b/d (lhs); yoy % change (rhs) 1000 10 800 600 5 400 200 0 0-200 -5-400 -600-10 -800-1000 Jan-00 Jan-01 Jan-02 Jan-03 Jan-04 Jan-05 Jan-06 Jan-07 Jan-08 Jan-09 Jan-10-15 US distillate demand (left axis) US Industrial Production (right axis) Source: US FRB, DOE, GS Global ECS Research Goldman Sachs Global Investment Research 29
Trucking has now shown signs of rebounding in the past month or so as destocking reverses Index, Jan-08=100 (lhs); thousand b/d (rhs) 105 100 Manufacturers' Shipments of Durable Goods Truck Tonnage Index Distillate Fuel Oil Demand 4-wk average (right axis) 4400 4200 95 4000 90 3800 85 3600 3400 80 3200 75 Jan-08 Mar-08 May-08 Jul-08 Sep-08 Nov-08 Jan-09 Mar-09 May-09 Jul-09 Sep-09 Nov-09 3000 Source: American Trucking Association, Census Bureau and DOE. Goldman Sachs Global Investment Research 30
A recovery in DM demand growth should push the market back towards effective production capacity by 2011
Oil and agriculture are running at the highest capacity utilization Commodity 2006 2007 2008 Most recent Reference period Corn 97% 97% 100% 97% 2008/2009 Copper 94% 91% 90% 96% 2Q2009E Petroleum 98% 97% 98% 95% Jun09 Wheat 90% 87% 89% 94% 2008/2009 Coal 99% 98% 99% 93% Jun09 Coffee 76% 91% 83% 93% 2008/2009 Zinc 88% 91% 89% 92% 2Q2009E Soybeans 99% 100% 93% 89% 2008/2009 Natural gas 99% 99% 99% 88% Jun09E Sugar 86% 92% 91% 86% 2008/2009 Cocoa 90% 79% 86% 85% 2008/2009 Nickel 96% 94% 83% 83% 2Q2009E Cotton 95% 97% 92% 83% 2008/2009 Platinum 100% 100% 92% 82% 2Q2009E Aluminum 90% 93% 89% 76% 2Q2009E * Capacity utilization for metals has been normalized by the historical maximum utilization for each metal. Source: GS Global ECS Research Goldman Sachs Global Investment Research 32
Change vs. 4Q2007, thousand b/d Declines in DM oil demand were accelerated by the recession, freeing up oil supply, which has allowed EM demand to grow unimpeded, likely returning global oil demand back to pre-recession levels by 3Q2010 8,000 historical demand forecasted demand 6,000 non-oecd demand 4,000 2,000 0-2,000-4,000-6,000 Global demand OECD demand -8,000 1Q2008 3Q2008 1Q2009 3Q2009 1Q2010 3Q2010 1Q2011 3Q2011 Source: GS Global ECS Research. Goldman Sachs Global Investment Research 33
The commodity crisis is a supply problem more than a demand problem
2009 is about as good as it will get for the next three years as sanctioned projects peaked in 2006 25000 120 20000 100 80 15000 mn boe 60 10000 40 5000 20 0 2002 2003 2004 2005 2006 2007 2008 2009 2010 2011 2012 Source: Company data, Goldman Sachs Research estimates. Oil Gas Oil price (GS estimates post 2008) 0 Goldman Sachs Global Investment Research 35
Why are we not seeing investment and a supply response? The terra-concentration ratio is the lowest since 1650 under mercantilism Percentage of total global terrain controlled by superpowers 70% 60% 50% Chinese American French 40% Spanish 30% 20% Russian 10% Portuguese British 0% 1600-1650 1650-1700 1700-1750 1750-1800 1800-1850 1850-1900 1900-1950 1950-2000 2000 - date Source: GS Global ECS Research. Goldman Sachs Global Investment Research 36
The Last industry year represented has sanctioned the peak very in few new projects greenfield in the projects 2007 2009 period new start-ups boe addition by year in each region 1,600 1,400 1,200 1,000 800 600 400 200 0 2003 2004 2005 2006 2007 2008 2009E 2010E 2011E 2012E 2013E 2014E Latin America Russia Canada Australasia US Caspian Other regions Source: Company data, Goldman Sachs Research estimates, Top 230. Goldman Sachs Global Investment Research 37
Non-OPEC could decline by about 1 mn b/d in two realistic scenarios in 2011E 2014E Non-OPEC yoy production growth/decline kb/d 1,500 1,000 500 0-500 -1,000-1,500 2002 2003 2004 2005 2006 2007 2008 2009E 2010E 2011E 2012E 2013E 2014E Perfect delivery Delivery in line with history One percent more decline in the base Source: Company data, Goldman Sachs Research estimates, Top 230. Goldman Sachs Global Investment Research 38
DM demand will have to contract going forward to make room for EM demand due to supply constraints
We expect emerging market demand growth to crowd out developed market demand as supply growth will be limited Thousand b/d 3000 2000 EM Growth Rates +1200 1000 0-1000 -700-2000 -3000 DM Growth Rates 1Q2006 2Q2006 3Q2006 4Q2006 1Q2007 2Q2007 3Q2007 4Q2007 1Q2008 2Q2008 3Q2008 4Q2008 1Q2009 2Q2009 3Q2009 4Q2009 1Q2010 2Q2010 3Q2010 4Q2010 Source: IEA and GS Global ECS Research. Goldman Sachs Global Investment Research 40
Metals and agriculture are the most leveraged to China Average 2008 Figures China China China China Global Demand Net Import Leverage Commodity Units Consumption Production Net Imports Output % Global % Global Score* Cotton mmmt 10.7 8.2 2.5 26.3 40.6% 9.5% 0.2602 Soybeans mmmt 49.8 12.5 37.4 220.8 22.6% 16.9% 0.2201 Copper kmt 5014 3652 1362 18371 27.3% 7.4% 0.1486 Soybean Oil mmmt 9.7 7.1 2.6 37.6 25.8% 7.0% 0.1365 Zinc kmt 4018 3755 263 11509 34.9% 2.3% 0.1448 Lead kmt 3021 3024-3 8464 35.7% 0.0% 0.1271 Nickel kmt 280 168 112 1397 20.0% 8.0% 0.1201 Aluminum kmt 12854 13435-581 39594 32.5% -1.5% 0.0907 Rice mmmt 127.5 128.1-0.7 431.9 29.5% -0.2% 0.0855 Petroleum mmb/d 7.8 3.8 4.0 86.5 9.0% 4.6% 0.0544 Soybean Meal mmmt 30.8 31.3-0.4 158.5 19.5% -0.3% 0.0352 Corn mmmt 149.0 149.5-0.5 790.9 18.8% -0.1% 0.0348 Wheat mmmt 104.0 106.8-2.8 609.1 17.1% -0.5% 0.0246 Cocoa mmmt 0.1 0.0 0.1 3.6 1.7% 1.7% 0.0177 Sugar mmmt 14.9 14.0 0.8 166.6 8.9% 0.5% 0.0130 Coffee mmmt 0.0 0.0 0.0 7.3 0.2% 0.2% 0.0025 Natural Gas Bcf/d 7.1 6.6 0.4 301.4 2.3% 0.1% 0.0020 * Leverage score = (mkt share)^2 + (imp share) Source: GS Global ECS Research Goldman Sachs Global Investment Research 41
Due to a lack of copper supply, DM demand will likely be crowded out by BRIC demand Copper demand in kmt 25000 20000 15000 10000 5000 0 1985 1987 1989 1991 1993 1995 1997 1999 2001 2003 2005 2007 2009 2011 2013 2015 2017 2019 BRIC & Rest of World G-3 Source: Brook Hunt, GS Global ECS Research Goldman Sachs Global Investment Research 42
Germany and Japan have the lowest willingness to pay for commodities Regional willingness to pay for oil $1,800 $1,600 Australia Russia Willingness to pay ($ per barrel) $1,400 $1,200 $1,000 $800 $600 $400 Japan France Spain Canada Brazil United States Mexico India China Saudi Arabia Argentina $200 Germany South Africa Source: GS Global ECS Research $- 0% 20% 40% 60% 80% 100% 120% Oil Intensity Goldman Sachs Global Investment Research 43
Accordingly, they have seen the largest reductions in demand already Total Petroleum consumption (rebased to 100 in 2000) 110 United States 105 100 France 95 Germany 90 85 Japan 80 2000 2001 2002 2003 2004 2005 2006 2007 2008 Source: IEA, GS Global ECS Research Germany Japan United States France Goldman Sachs Global Investment Research 44
Rising prices over the past 6 years have already reduced demand over 5.0 million b/d Thousand b/d 95000 90000 Had price remained at $20/bbl, we would likely see global demand over 92.2 mmb/d 10000 9000 8000 85000 7000 80000 75000 70000 Over 5 mmb/d of demand is being held out of market by higher prices 6000 5000 4000 3000 65000 2000 1000 60000 0 1986 1988 1990 1992 1994 1996 1998 2000 2002 2004 2006 2008 Source: IEA and GS Global ECS Research. Goldman Sachs Global Investment Research 45
The macroeconomic linkages
The oil price and USD were highly correlated in the 1970s as the causality is oil to FX, not vice versa Oil in $/bbl (let axis); EUR/USD (right axis) 160 1.8 140 120 100 80 60 40 20 Both periods experienced a high level of oil-to-fx correlation EUR/USD (right axis) Crude Oil Price - $/bbl (left axis) 1.6 1.4 1.2 1 0.8 0.6 0.4 0.2 0 0 1972 1974 1976 1978 1980 1982 1984 1986 1988 1990 1992 1994 1996 1998 2000 2002 2004 2006 2008 2010 Source: Oil & Gas journal and Goldman Sachs Commodities Research. Goldman Sachs Global Investment Research 47
Oil as a share of US imports is rising back towards 1970 levels Percent 35% 30% 25% 20% 15% 10% 5% 0% 1978 1980 1982 1984 1986 1988 1990 1992 1994 1996 1998 2000 2002 2004 2006 2008 Source: Haver Analystics Goldman Sachs Global Investment Research 48
Relative to the barrels of oil that oil companies could hedge, index investors are holding a relatively small amount of oil price risk million barrels (end of 2007) Company Proven Reserves (million barrels) Exxon Mobil 11,075 Petrobras 9,613 Chevron 7,087 ConocoPhillips 6,320 Suncor Energy 2,515 Occidental Petroleum 2,224 Canadian Natural Resources 1,358 Apache Corporation 1,134 Marathon Oil 1,071 Hess Corporation 885 Index Investors 855 Nexen 835 Talisman Energy 648 Petro-Canada 597 Murphy Oil 307 Source: Goldman Sachs Equity Research and Goldman Sachs Commodity Research. Goldman Sachs Global Investment Research 49
Crude Oil Speculators vs Index Investors Crude oil prices move with speculators percentage (vertical axis), million barrels(horizontal axis) but not with index investors percentage (vertical axis), million barrels (horizontal axis) 15.00 15.00 10.00 10.00 5.00 5.00 0.00 0.00-5.00-10.00-5.00-15.00-20.00 y = 0.13x + 0.00 R 2 = 0.59-100 -80-60 -40-20 0 20 40 60 80 100-10.00-15.00 y = 0.00x - 0.00 R 2 = 0.00-100 -80-60 -40-20 0 20 40 60 80 100 120 Source: NYMEX, CFTC, and Goldman Sachs Commodities Research. Goldman Sachs Global Investment Research 50
RegAC I, Jeffrey Currie, hereby certify that all of the views expressed in this report accurately reflect my personal views, which have not been influenced by considerations of the firm's business or client relationships. Goldman Sachs Global Investment Research 51
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