Oil Insecurity – Current Trends & the Economic Impact

1. Oil Insecurity – Current Trends & the Economic Impact Simon WardellDirector – Global Oil Global Insight

2. Oil Insecurity • Oil Industry Trends: Fundamental Changes • Security & Oil Prices • Oil Prices and the Global Economy • Conclusion

3. 1. Oil Industry Trends: Fundamental Changes

4. Accelerating Global Demand Global Oil Demand by Region Oil Demand Growth (2005-25)

5. Supply Growth Lagging Behind ? Note: Assumes Iraqi production stays 2 MMBOPD through 2010 2006 includes 250 MBOPD of restored GOM production Data Sources: IEA, EIA, OPEC,Company Reports, Trade Press, ECG

6. Accelerating Declines? One reason for non-OPEC production’s struggle to grow has been the acceleration of decline rates • Acceleration can perhaps best be illustrated in areas with relatively little new field development • Aging fields, better technology and rate acceleration economics appear to be the culprits behind the acceleration of decline rates Source: EIA (USA lower 48 and Alaska), Canada Onshore-Light, Oman, Syria, Indonesia, Egypt, Australia),

7. The Upward Push of Costs on Prices Nominal Terms: F&D Costs, Steel Prices, & Brent Crude (Index 1990=100)

8. Full Costs & Required Oil Price to Achieve 13% ROCE

9. OPEC Spare Capacity Falls = Increased Market Sensitivity

10. Futures Markets – Chickens & Eggs NYMEX Crude Oil Non-Commercial Open Interest vs. WTI

11. Expected Net Oil Production Growth to 2020 (EIA) FSU35% Russia Western Europe- 16% North America6% +4mbpd - 1mbpd Middle East37% +0.92mbpd +11.38mbpd South & Central America65% Asia & Oceania6% +4.1mbpd +0.46m bpd Sub-Saharan Africa89% +5.3m bpd Source: EIA

12. Geographical Shift = Increased Political Risk • Global Insight Risk Ratings:OECD Risk = 1.50‘New’ oil territories = 3.42 (significant risk) • Concentration of supply in Middle East • Oil consumers incrementally more dependant on exports from more distant producers • Longer supply chain, more chokepoints =more risk of supply disruptions

13. 2. Security & Oil Prices

14. Changing Oil Industry More Vulnerable to Attack • Tight supply/demand balance = supply risks exaggerated • Shift in production = more opportunity for attack • Value of oil revenues = more damage caused by attack • Consequence: Insurgent/terrorist groups recognise vulnerability and target oil installations where possible. Success of insurgent groups leading to copy-cat attacks from criminal gangs

15. Oil Industry is a Target • 2001/02: Colombia – frequent guerrilla attacks on pipelines • 2003/04: Sudan – threatened attacks on oil facilities • 2002: Yemen – Limberg attack, kidnappings • 2003-Present: Iraq – pipelines specifically targeted to cause financial damage • 2004-Present: Nigeria – Southern Delta • 2001-Present: al-Qaida – Abqaiq attack, threats made to Saudi Oil • 2007: Mexico – Rebel groups attack pipelines

16. Nigeria • Ijaw community grievances: • Lack of employment • Environmental degradation • Lack of investment in social welfare (state revenue control) • Unhappiness spawns militant activists (MEND) • Oil industry is attacked through disruptive activities • System of “pay-offs” develops (political talks, social spending) • Ijaw community does have a stake in continued oil extraction (economic future) – maintains low-level violence • Stability of low level politically-motivated violence now changing • Political groups fractured – lacks unifying set of demands or organisation • Criminal gangs have taken over – ransoming workers and bunkering oil (guerrilla entrepreneurs) • Payment of ransoms/protection simply exacerbates the problem • Where IOCs could move on before, now they stay – and shut-ins result

17. Middle East • Threats to, and attacks on, domestic oil sector in MENA almost entirely politically motivated • Exceptions: Iraq (some bunkering), Yemen (kidnapping for financial gain) • Motivations are politico-religious: designed to put pressure on regional governments (Saudi Arabia, Algeria) • Clear link to wider international issues – Abqaiq attack took place on Saudi soil but true target was the global economy • Local governments have greater ability to counter threats • There are wider geo-political security threats in the region • Iran-Saudi tensions • Iraq fracturing • Iran-US • Oil installations are an obvious target in the event of any military clash (Kuwait, Iran-Iraq, Iraq war precedents) • The likelihood of attacks low, but the potential damage far greater

18. Security Trends • The oil industry is a more tempting target now than in the past because: • Oil resources much harder to access • IOCS more exposed to unstable regions • IOCS more resilient in face of attack – negative feedback loop • Attacks have wider significance – publicity for political causes or… • …Attacks designed to target wider economy • No reversal of this trend in immediate sight • The transformation from political to criminal violence the most worrying • But • Most important installations can be protected • It is still difficult to cause significant damage to the oil industry

19. Iraq Pipeline Attacks: Cumulative Increase Kirkuk-Ceyhan 1st major attack Kirkuk-Ceyhan 2nd major attack Kirkuk-Ceyhan 4th major attack Kirkuk-Ceyhan 3rd major attack

20. Price Spikes and Volatility Khobar Bombing • Oil market sensitivity to Saudi security is heightened due to reduced spare capacity Yanbu Shooting Foiled Attack on Abqaiq oil facility

21. Nigeria: Ongoing Attacks; Ongoing Volatility ENI declares ‘force majeure’ MEND hits Shell’s Forcados exports ENI pipeline hit by MEND Nigerian military attacks MEND

22. Quantifying Price Impact: “Risk Premium” • “Proportion of oil price not attributable to supply/demand fundamentals”

23. Security and Oil Prices • Ultimately it’s always a question of supply and demand • Security/geopolitical risks = future supply • ‘Risk premium’ exaggerated by lack of spare capacity • Difficult to isolate security threats within crude price • If quantified security ‘risk premium’ approximately 20-30% of oil price at present (best guess)

24. 3. Oil Prices and the Economy

25. Debate Over High Oil Prices and Economy Rages • 1970s & 80s: High oil = inflation, recession • 1990s & 00s: High oil = lower growth • Western economies less oil dependent now • Energy diversification • Growth in service sector has helped sever direct link But • Oil still underpins global economy • Transport industry heavily reliant on crude • Oil does still impact broader economy, but more lag

26. Demand Responding to Price?

27. Declining Oil Intensity of the Global Economy Fuel substitutionEfficiencyGrowth of service sector Annual decline averages around 2% since first oil price shock in 1973

28. Global Economy More Resilient to High Prices • Incremental oil demand/gdp nearly half the level of 10 years ago • For many OECD consumers, the price of crude oil is a small fraction of their fuels costs • In some major emerging markets, energy prices are subsidized and consumers do not ‘see’ higher prices • Petro dollars are being recycled more quickly through investments and financial flows • There has been an absence of inflationary pressures thanks to increased global and domestic competition • For US retail fuel prices to match European levels a $200/b price would be needed

29. How High Can Price Go Before There is a GDP Impact? • Global Insight sensitivity analysis of an oil price ‘shock’ on the global economy • WTI price over $100 for two months and over $70 for six months and over $50 for an additional year. • Slight negative impact on global GDP in the first year, no impact in the second and positive impacts in the following years. • Price impact shaves 0.3 – 0.4 percent off growth for China and India in year 1 and 2. • What price is too high?

30. Impact of $100 Oil Shock on World Growth

31. Conclusion: The Causal Chain • Security > oil prices > economic consequences • Psychological impact of ‘oil jitters’ on wider economy hard to quantify • Oil industry trends will only accentuate impact of supply threats, and the threats themselves • ‘Risk premium’ pales in comparison to impact of significant strike on oil infrastructure • Mitigates: • Big oil price movements require big actions – still rare • Economies less oil dependant than in the past • Government stocks can act as a buffer if expanded

32. Conclusion: Final Thought • Can we quantify the cost of oil insecurity? • Assuming: • World GDP 2007 = $55.0trn • $20/b average above trend = -0.85 GDP Growth • ‘Risk premium’ accounts for 30% of higher price... • ...and 50% of ‘risk premium’ is due to security fears • Then oil insecurity will cost the global economy... $233,750,000,000 per annum in lost growth

33. Thank you for listening Simon Wardell, Director – Global Oil, Global Insight simon.wardell@globalinsight.com