COMMODITIES REPORT ECONOMIC RESEARCH

6th January 2016 - N°01

Abhishek Deshpande, abhishek.deshpande@uk.natixis.com William Lapworth, William.lapworth@uk.natixis.com

Oil Outlook 2016 Demand to grow at 1.1mn b/d in 2016 with OECD, China and India the key drivers. Non-OPEC supply will contract by over 660,000b/d in 2016 as North American production retreats. OPEC will continue to add to the glut, despite Non-OPEC contraction which will put pressure on oil prices for most of 2016.

Global Demand

Demand growth was spectacular for most part of 2015, however, the growth rate seemed to slow in the last few months from the key demand drivers of the world. Chinese demand was up 3.6% yoy between Jan-Nov last year. The demand increase peaked in May15 at 9.7% yoy. The growth in Chinese demand has since slowed to -1.8% yoy in Sep15, +0.8% yoy in Oct15 and -1.1% yoy in Nov15. In the US, demand increased by 2.85% yoy in 2015. The demand increase peaked in Jun15 at 7.21% yoy. Since then, the growth in US demand has slowed to -1.58% in Nov15 and -0.07% in Dec15. Gasoline demand has started to show signs of weakness despite low gasoline prices in the US. In the EU, 2015 year-to-date demand was up 5.8% yoy. The demand increase peaked in 2015Q1 at 8.72% yoy. The growth in demand has since slowed to 0.11% yoy in Oct15. Indian demand for oil products is still strong. For India, year-to-date demand for major decontrolled products was up 7.4% in November. Demand in Nov15 was up 6.5% yoy. This was mainly driven by gasoline and naphtha. In the Middle East, demand for oil products was up 2.3% yoy in 2015Q2 and then slowed down to 1.9% yoy in 2015Q3. Initial estimates show demand in 2015Q4 to have risen by 2.3% yoy. In 2016 we expect demand to be driven by OECD economies, China and India due to price elasticity. Total demand should increase by 1.1mn b/d (as opposed to 1.7mn b/d in 2015). Additionally, a higher base effect and efficiency gains will put pressure on demand growth globally. However, there are several clouds on the horizon which may impact demand growth such as the potential slowdown in China and any other emerging markets.

Non-OPEC Supply

For non-OPEC production, the star performer of 2014, the US, has begun to struggle as we predicted early in 2015, although production is not declining aggressively yet and we

have considered a moderate decline in US production in our balances. The rig count has fallen dramatically to 536, the lowest level since May 2010. Production volumes, despite declining from the highs of May15 and Jun15 have remained resilient, averaging 9.18mn b/d in Dec15 vs 9.184mn b/d in Nov15. On an annual average basis, production in North America increased by 770,000b/d yoy in 2015. In 2016, we expect total North American supply to contract by over 500,000b/d and most of this contraction will be in the US. We believe around 1mn b/d of sub-investment grade production in the US is potentially under threat if companies were to begin succumbing to bankruptcy. South America is on course to boost production yoy with new projects in Brazil from the pre-salt, and greater stability in Colombia allowing output to be lifted. We expect 2016 supply of crude to increase by 100,000b/d. European production has also continued to demonstrate improvement, particularly North Sea production with the UK Continental Shelf producing its first production increase for the first time since 2000. Our figures indicate production for the year as a whole for BFOE (Brent, Forties, Oseberg and Ekofisk) was up 4.4% yoy for 2015 despite maintenance to several important platforms including Buzzard in the UKCS which feed these streams. BFOE loadings were up 6%yoy in Dec15 and are scheduled to be up 14%yoy in Jan16. We expect OECD Europe oil production to increase marginally by 40,000b/d due to past investments. Russian production is also up year on year and loading schedules for Dec15 were 26% higher yoy. For 2015 as a whole, loadings from East and West averaged 7.05% higher in comparison to the same period in 2014. CPC loadings for Nov15 were scheduled to be the highest on record, only to be surpassed by fixtures in Dec15 which themselves were the highest ever. In 2016, we expect Russian production to decline by 50,000b/d as the offsetting effect from condensates is expected to be limited to the decline in production from their brownfield projects. We also expect small yoy declines from Kazakhstan and Azerbaijan in 2016. That means total non-OPEC production will contract by over 660,000b/d in 2016.

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COMMODITIES REPORT

CAPEX vs OPEX:

For non-OPEC producers, the CAPEX cuts announced at the beginning of this year have continued and for the companies we follow currently stand in excess of $176bn, an average cut of 37% vs 2014 budgets, although producers in the US are facing larger cuts on the whole, averaging 38%. According to Wood Mackenzie, the Capex cuts are over $200bn, based on a much larger set of companies that they monitor. We have also begun to look at OPEX cuts for a small number of the principal IOCs. OPEX cuts are less than average CAPEX cuts (with the exception of Petronas who have a CAPEX cut of 15% and an OPEX cut of 30%). Average OPEX cuts for the 14 large cap IOC average 12% compared with an average CAPEX cut for the same firms of 27%. Most of the CAPEX cuts will impact crude production outside of North America beyond 2017, whereas in North America, US in particular, we have already started seeing the impact of CAPEX reduction on crude oil production in 2015 and we can expect to see continued impact on production in 2016. CAPEX cuts are continuing into 2016 with large companies such as Shell, ConocoPhillips, and Chevron already announcing cuts to budgets. OPEC Production

At the 168th meeting on 4Dec15 OPEC decided to maintain production levels and failed to reach a consensus on output targets. OPEC said they will continue to monitor the market and call another meeting if necessary. The prospect of a ceilingless OPEC means countries such as Saudi Arabia and Iraq will continue producing at high volumes, leaving the market in surplus for months to come. (Refer to report 168

th

(N)OPEC Meeting)

OPEC production levels have continued to remain elevated in line with our expectations. OPEC produced 31.695mn b/d of crude in Nov15, an increase of 312,000b/d mom. Saudi Arabian crude output was close to 10.13mn b/d in Nov15. Saudi Arabia, Iraq, Iran, UAE and Angola have all increased output in 2015 with Iraq increasing production by more than 28% yoy in Nov15. Output increases in all these nations have been steady and relentless (with the exception of Angola which has experienced field level production issues) as these countries have begun to compete with each other following OPEC’s paradigm shift. This competition is not only evident through the increases in production volumes but also in aggressive pricing. The market share battle between OPEC and Russia also intensified as Saudi Arabia cut its OSP to Europe. According to Reuters, Swedish refiner Preem imported Saudi Arabian crude for the first time in 2 decades in December. Saudi Arabia is also taking steps to tackle the drop in oil prices and the collapse in its revenues by reducing subsides on fuels and other basic goods announced on 28Dec15. As part of a 5 year austerity programme the price of petrol was raised by 50% and the price of diesel by 2/3 overnight. Iran looks set to return to the market in the coming months with suggestions that sanctions will begin to be lifted in January. Iran began to reduce levels of crude in floating storage after Jul15, decreasing from 54mn bbl to 42mn bbl. On 5Jan16 Iran had 47mn bbl in floating storage. Based on the current fundamentals, we expect markets to remain in excess until at least the end of 2016, averaging well above 1.1mn b/d for the year as a whole. With this as the base of our analysis, we are looking at global crude stock builds of well over 800-900mn bbl by end of 2016.

Region OPEC IEA Natixis

Other Asia (Incl. India) +290 +450 +410

Source: Natixis, IEA, OPEC

Demand (yoy growth, 1000 b/d) - 2016

OECD +180 +50 +170

China +300 +320 +200

South America (excl. Chile) +130 +40 +50

Middle East +210 +180 +150

Net growth +1380 +1210 +1100

1.3

1.8571.465

1.715

-1.6-2

-1.5

-1

-0.5

0

0.5

1

1.5

2

2.5

3

1Q15 2Q15 3Q15 4Q15

Global physical balances for oil in 2015(mn b/d)

OPEC output-Call on OPEC

Potential Max SPR

yoy demand growth

yoy non opec supply growth

yoy opec supply growth

Source: IEA, Natixis

Region OPEC IEA Natixis

Africa -30 -70 -50

Source: Natixis, IEA, OPEC

Non-OPEC Supply (yoy growth, 1000 b/d) - 2016

North America -30 -400 -500

OECD Europe -20 -160 +40

South America (excl. Chile) +40 +90 +100

FSU -160 -110 -100

Net growth -130 -650 -660

1.7251.545

0.595 0.565

-1.5

-1

-0.5

0

0.5

1

1.5

2

1Q16 2Q16 3Q16 4Q16

Global physical balances for oil in 2016 (mn b/d)

OPEC output-Call on OPEC

yoy demand growth

yoy non opec supply growth

yoy opec supply growth

Source: IEA, Natixis

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COMMODITIES REPORT

Oil Price forecast

We continue with our bearish stand that we have maintained for most the part of 2015 due to oversupply. With minor changes to our forecasts, we expect Brent to remain under pressure in 2016Q1 at $38/bbl (-$3/bbl from last forecast update on 7Dec15) and then steadily rising to an average of $57/bbl (+$3/bbl from our last update) in 2016Q4. For the year as a whole, Brent should average $47.8/bbl (unchanged from last update) in 2016. The lifting of US export ban and the potential slowdown in US oil production in 2016 will continue to keep the spreads between Brent and WTI tight, with the spreads between the two staying as narrow as $1/bbl with momentarily WTI even staying at a premium to Brent. We however expect the Brent WTI spreads to eventually widen to over $2/bbl to reflect the cost of carrying crude from Midwest to the Gulf coast by pipeline and as US oil production increases thanks to price recovery. WTI to average $46.5/bbl (+2/bbl from the last update) in 2016. Given the amount of excess in the market, and the continued resilience shown by non-OPEC oil producers alongside the OPEC market share strategy, we could even see oil prices dipping well below $30/bbl for a brief period but then they are

unlikely to stay that low for long. Oil prices are also likely to take longer than 2008-09 crash to recover this time around. The ongoing tensions between Saudi Arabia and Iran could add a significant geopolitical risk premium but only if the tensions between the two oil rivals intensifies further to disrupt the supply in the region. Iran and Saudi Arabia both together contribute over 14mn b/d of crude supply. In our view both will be very careful in not disrupting these flows as they depend significantly on crude revenues. For now the excess supply and the possibility of more crude moving onto ships for floating storage will keep pressure on prices. Aside from our central scenario we have a high and low case scenarios. In our high case scenario we see Brent averaging $58/bbl in 2016 if non-OPEC (especially US) production declines aggressively. In our low case we see Brent averaging $41/bbl in 2016 if OPEC produces more than expected or increases production capacity, coupled with continued US shale resilience. In this case, oil could stay lower until 2017.

2014 2015

T1 T2 T3 T4 Annual

Crude prices ($/bbl)

- WTI (average) 93.6 48.8 37.0 45.0 49.0 55.0 46.5

t/t-1 (%) -5.2% -47.9% -12.1% 21.6% 8.9% 12.2% -4.7%

- BRENT (average) 99.8 53.5 38.0 46.0 50.0 57.0 47.8

t/t-1 (%) -7.2% -46.4% -15.0% 21.1% 8.7% 14.0% -10.7%

Base scenario2016

Forecasts ($/bbl) 31-Mar-16 30-Jun-16 30-Sep-16 31-Dec-16

Low Case Scenario WTI 30 24 42 44

Brent 32 38 46 48

Base Case Scenario WTI 37 45 49 55

Brent 38 46 50 57

High Case Scenario WTI 50 53 57 59

Brent 54 56 60 62

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COMMODITIES REPORT