The Outlook for Oil Markets in 2007: Head Fakes From Demand & Supply

The Outlook for Oil Markets in 2007: Head Fakes From Demand & Supply David Knapp Energy Intelligence The New York Energy Forum New York - Jan. 30, 2007

Key Oil Market Developments • Short Term Factors • Weather, accidents, financial markets • Short-term demand responses • Inventory rebalancing • Geopolitics (demoted, but not gone) • Non-Opec’s Recovery • Opec expansion

Issues for Short-Term Oil Markets • First of All, Don’t Forget Geopolitics, Weather • Price Outlook for 2007 • 2007 Supply-Demand-Inventory Balances • Short-Term Demand Issues • Non-Opec Supply’s Final Last Hurrah • Opec’s Challenge • Some Conclusions

Sellers’ Markets Will Survive • Sellers’ markets in 1920s, 1940s, 1970s were sudden, brief, unstable and supply-led • Post-2000 market was demand-led, and emerged gradually and looks more durable • Late ‘06/early ‘07 not likely a reversal • Supply surge not apt to come to the rescue • Post-2007 Non-Opec unable • Opec unwilling

Oil Market Force Diamond Geopolitics, Weather, Accidents OECDDemand Elasticity vs. Non-OECD drivers “Peak Oil” vs. “Resource Nationalism” “China Thesis” and “Paper Oil” Q: What’s This Diamond Worth? A: Still $55-$65 per barrel

Geopolitics Stay in the Forefront • Nigeria • history is for sporadic not major outages • this disruption better organized, conditions ripe for generalized strife • new offshore fields help, but not safe either • Iran • leadership less pragmatic, threat could last • impact on oil market probably slow to come • Others • Venezuela, Russia, West Africa, Middle East

Weather • Past • No US Hurricanes, mild autumn, late No. Hemisphere winter, big hit on Nor. Am. gas • Present • El Nino vs. North Atlantic Oscillation • Asian cyclones, North Sea storms • Future • Severe 2007 Gulf of Mexico storms? • Global warming responses

Price Outlook • Range of $50-$60 for 2007 WTI • average $56-$57; high early, summer low • about $10.50 lower than 2006’s $67. • 2006 WTI up 17% after 38% jump in 2005 and 34% in 2004 • Fundamentals look weaker for 2007, with paper markets reflecting expected weakness • Up-shift in long-term oil band still being digested • For now, no return of late-2004 differentials explosion

Reasons for 2004/mid-06 Strength • Strong and unexpected demand surge • Storms & other non-Opec disruptions • Sporadic Iraqi exports • Tight Atlantic Basin sweet crude supplies • Supply threats in Nigeria, Iran, Venezuela • Growing long positions by traders and funds

Reasons for Post-July ’06 Weakening • Mild Northern Hemisphere summer/winter weather • Weaker OECD demand • Surging non-Opec supply • Credibility issues for Opec cuts • Market rotation out of commodities into equities • Diminished geopolitical concerns

2007 Outlook for Price Levels Source: Energy Intelligence Research.

Quarterly Oil Prices Outlook Source: Energy Intelligence Research.

Short-Term Demand • Weather dominates current Northern Hemisphere demand • Price impacts hit harder in OECD • Low North American natural gas prices hitting bottom of the barrel • US nuclear capacity utilization has been relatively high • Anti-oil policies, peer pressure may be having an effect • Economic, demographic drivers propel Non-OECD • Fewer options for substitution, less discretionary use

OECD Flat After 2006 Decline

Non-OECD Not Back On Fast Track

Short-Term Supply • 2004-2006 special factors inhibited supply • Hurricanes Ivan, Katrina & Rita plus several others • leaks at offshore fields in No. Sea, Canada, Mars • BP pipeline corrosion at Prudhoe Bay • 2007 non-Opec supply spurt, final last hurrah • Opec capacity adds, membership expansion • Saudi Arabia, Nigeria, Kuwait, Libya, Algeria • Angola + (who’s next?)

2007 -- A Final Last Hurrah?

2006 Supply-Demand Balances Source, Oil Market Intelligence, January 2007.

2007 Supply-Demand Balances Source, Oil Market Intelligence, February 2007, forthcoming.

“Observed” Stock Changes • Evidence of stock draws since September, despite supply-demand surplus • Oil at sea has been highly variable • Non-OECD SPRs beginning to suck up oil • Contango helping keep independent commercial storage high • Geopolitics out of the headlines but still in tanks • Opec focus still on OECD commercial stocks

2005 Global Stock Changes Source, Oil Market Intelligence, January 2007.

Opec’s Dilemma • Maintaining long term markets • Showing production discipline • Adding sufficient capacity to handle chronic geopolitical risks • Making reserve estimates credible • Dealing with global quality issues

Conclusions • 2007 is a transition year • non-Opec supply spurt is an illusion • demand reactions are temporary • Opec difficulties peak in 2007 • Sporadic physical market price bearish signals will continue in first half • Investors look to bullish 2008 and beyond by the second half of the year

SUPPLEMENT DETAILSon2007 Non-Opec Oil Supply

2007 North American Oil Supply new fields in Gulf of Mexico, PL repairs in Alaska growth from Canada synthetics, East Coast, in situ bitumen

2007 North Sea Oil Supply positive impact on UK of Buzzard, Tweedsmuir Norway’s Alvheim plus Snohvit, Ormen Lange late in the year

2007 FSU Oil Supply higher Russian upstream spending; nearly half of growth Sakhalin 1 better performance at Kazakh’s Karachaganak, Tengiz filling Azerbaijan’s BTC pipeline undoing Yukos damage in Russia; full-year Sakhalin 2 from 2007-08

2007 Non-Opec Africa Oil Supply Changes exclude Angola, which joined Opec as of Jan. 1, 2007 Sudan’s delayed pipeline expansion, new fields Equatorial Guinea bouncing back

2007 S. & C. America* Oil Supply * Excluding Venezuela. Brazil belatedly growing Campos Basin joined by Santos Ecuador dealing with protest to new pipeline Colombia, Argentina past their peaks

2007 Asian* Oil Supply * Excluding Indonesia. dominated by sharp drop for China small gains for Australia, Thailand, Vietnam, Malaysia

2007 Non-Opec Mideast Oil Supply Oman and Syria seeing accelerating declines some new fields in Yemen

2007 Other Europe Oil Supply

The Outlook for Oil Markets in 2007: Head Fakes From Demand & Supply