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From: O'Neill, Jim [IMD]Sent: Friday, February 24, 2012 2:26 PMSubject: Oil. Liquid Gold or Troublesome Irritant?

Oil. Liquid Gold or Troublesome Irritant?

Given my generally optimistic stance on things coming into 2012 and what has transpired so far, I have spent moretime this week wondering what may go wrong. Given the ongoing impressive trend in US weekly job claims, March 2

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US payroll data is shaping up to be even more of a biggie than usual. S&P futures are hovering close to 1370, 2-yearnotes are threatening a break up, and the $/Yen relationship is threatening to finally reverse significantly. If thatproduces another drop in unemployment, then we might be really off to the races.

In the meantime, on top of the never-ending nonsense about Greece, something else that could go wrong mightinclude a continued rise in crude oil prices. When I reflect back on why the world economy suddenly had more issueslast year than I had expected, I think the rise in food and energy prices probably had the biggest role to play thanvirtually any of the other stories bandied around.

Many decades ago, I was awarded a PhD for researching oil prices and their consequences. As I am occasionally fondof saying, I am not sure I learnt much in the nearly 3 years it took me to complete the research. Perhaps two things,one, doing an economics PhD in those days was basically a test of ones sanity. Two, forecasting oil prices makesforecasting foreign exchange markets seem relatively easy (I learnt that later on really).

With this in mind, I am devoting most of my weekly Viewpoint to this topic.

Why the title? Well amongst the liquid gold aspects, supporters of a couple of well-known Premier League footballclubs owe their largesse to its strength over the past decade. Those fans will be amongst those that believe high andrising oil prices are a good thing. Many others will also, including the leaders and prominent policymakers of countriesthat can use the revenues to finance whatever it is that takes their fancy. It is also true in my judgment that a rise inrelative energy prices is a major positive in encouraging conservation, efficiencies and the search for alternatives, sothere are a number of good aspects of strong oil prices. Many others, especially those that have to queue up at petrolstations and squirm at the seemingly endless price increases, will not quite think the same. Im tempted to also addthat a number of other Premier League football supporters may wish that, just as with a number of commodity-richnations, those couple of clubs also suffer the consequences of and develop symptoms of the well-known DutchDisease of waste and missed opportunity from what temporary terms of trade improvements can offer. But you neverquite know is around the corner, so I shant.

Anyhow, what level of oil prices will start to cause renewed damage in terms of inflation and depressing real incomes?Unfortunately none of us know. And, in reality, I am of the school that quite strongly believes it is probably best seenin terms of oil-price-adjusted financial conditions to observe how strong or not any real economic damage can be. Inthis regard, so far, and especially because many leading nations continue to undertake steps to ease financialconditions China and Japan being the two most important recently it is probably not yet much of an issue. At somestage, though, it could become one.

Spot versus Big Picture?

One aspect to all of this that increasingly fascinates me is the difference between spot prices and longer term prices.For many years, I have wasted time trying to think of the Holy Grail of the equilibrium oil price and, in this search, I

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settled on using the 5-year price as a simple broad guide. The attached chart shows the path of the 5-year pricealongside that of the spot price. In my judgment, the 5-year price is probably a better guide of the true underlyingsupply and demand forces. In this regard, the chart shows an increasing divergence between the two as contrary tothe 2000-08 and immediate post 2008 meltdown, the long term price appears to have stabilized in an $80-100 perbarrel range.

Given what I said at the start about my PhD, this may not be as interesting as I suggest or could be temporary, but Isuspect not. It might be occurring due to some powerful reasons on both the demand and supply side of the equation.Certainly reported and anecdotal evidence is rising on both sides. Data shows that OECD oil demand actually declinedin 2011 and, as I have remarked before, China is falling in love with a softer future GDP growth path as well asalternative energies (and nuclear still) as part of its latest stage of development. On the supply side, there is evidence

that some alternatives are starting to come on stream. Natural gas in the United States is a particularly importantexample, and one that is still far from appreciated by the financial markets. Having observed the beginnings of thestabilization of the longer term price since late 2009, I find it a lot more difficult to be as bullish as many others, andindeed as I used to be for most of the last decade. (To suggest a parallel, it is not unlike being bullish for the Euro/$above 1.50 or bearish below 1.00 if its equilibrium is close to 1.20.)

It also raises the possibility that if policymakers wanted to do something to try and get the spot oil price back down, itmight be easier than in previous years. Certainly if I were a policymaker, it would be something I would contemplate.Anyhow, by coincidence, I am off down to the Gulf for a few days at the weekend and I look forward to hearing viewsdown there about the topic.

The alternatives are appearing all over the place, and just as I was going to hit the send button , Anna Stupnytskapointed out an article to me suggesting that Ukraine has now found huge shale gas reserves putting them up their withPoland in terms of a major energy source.

While I am on that part of the world, I had a very interesting discussion with some Georgian policymakers this week,who were telling me about their desires to become a hub economy and in the process, downplayed any particularlinks to commodities and commodity producing countries. Most interesting.

Europe is Still Not the World.

Another week goes by with market participants and media in some sort of obsessive mindset about Greece. I am notat all sure what to make of the deal that was finally hammered out. What I do think is that so long as the rest of EMU,especially Italy and Spain, are ring fenced, it doesnt really matter. I shall repeat from a couple of weeks ago; China

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today creates the economic equivalent of a new Greece every 11 and weeks. One person I came across this weekremarked back when I said this that perhaps China will end up being a much bigger Greece, which could possibly beultimately true. But, as I suggested back, that isnt something worth spending endless hours thinking about. I alsoadded that the Chinese stock market is showing growing signs of being a bit happier with life, so I would also spendsome time thinking about more positive outcomes for China if I were him.

There were mixed signals from the latest European economic data this week, with the flash February PMIsdisappointing slightly, with the composite moving back down to 49.7, partly because of some giveback in Germany.While this was after two months of notable improvement, it was a bit disappointing. In contrast, the Belgian monthlyconfidence survey and the German IFO, both statistically pretty good European leading indicators, showed notable

improvements. Here in the UK, the very latest CBI business survey had some rather encouraging details, and thereare strengthening signs of improving exports. In addition, some leading figures in the UK retail industry are makingnoises about sourcing domestically for the first time in a generation.

Africa Continues to be Interesting.

I came across a number of interesting things about Africa this week, partly due to meetings planned with a couple ofprominent people in the African investment space, and it seems to me that the universe of investors looking at thecontinent is continuing to rise. Many often ask why we dont think about opening an African fund, and the answer isthat I spend a lot of time thinking about it, but amongst the current reasons why we dont, is that we have otherproducts that provide exposure to the African market and its investment opportunities. In the broader sense, it wasinteresting to see the news about Shell trying to expand their presence in Africa this week. Jonathon Bayliss whopointed this out to me, also highlighted that there is now competition for this bid from a Thai source, At the otherextreme, it was disheartening to read a story about evidence of rising inequality in Nigeria, despite that country's

chronic past and its more recent strong growth rate. I admire the efforts of their policymakers to keep focused toimprove all their citizens fortunes, and I hope they keep trying because, as I have mentioned before, with 20 pct of thecontinents population, it is a big issue for the entire continent not just Nigeria.

Anyhow, I shall leave things at that for this week, and I look forward to my return from the Gulf in time to see payrollsand then a big weekend of British football . Have fun.

Jim ONeillChairman, Goldman Sachs Asset Management.

Viewpoints are also available on our public website:www.gsam.com/jimoneill. Monthly Insights and Strategy Series are available onwww.goldman360.com. If you do not have access, please contact your Goldman Sachs relationship manager.

Jim ONeill is the Chairman of GSAM, which is a separate operating division and not part of the Global Investment Research (GIR)Department. The views expressed herein by Mr. ONeill do not constitute research, investment advice or trade recommendations and maynot represent the views and/or opinions of GSAMs portfolio management teams and/or the GIR Department. Copyright 2012 GoldmanSachs. All rights reserved. Please visit ourwebsitefor additional disclosures.

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