Commodities

Special Report
Part I: A shale of a tale
This is the first in a series of three which explores shale hydrocarbons (natural gas and oil). This report serves as an introduction to the topic and provides a discussion of the US experience and specifically its impact on US and international energy markets. The next report (Part II) will give an overview of the potential for shale hydrocarbon production in the rest of the world (i.e. outside of the US), with the final report (Part III) providing a more detailed look at South Africas shale gas potential and the possible ramifications. A difference in geology gives rise to the unique production characteristics of shale plays. Chief among these unique production technologies employed are: horizontal wells, hydraulic fracturing (or fracking), and pad-drillingwithout which, shale hydrocarbon production would not be commercially viable, given the weak flow rates encountered when using conventional production methods. Other than requiring the use of more sophisticated (and more expensive) technologies, the unique geology of shale plays also adds other factors which have a direct bearing on the economics of extraction. These factors include: significantly more wells need to be drilled over a much larger area; ultimate recovery rates are much lower; and rapid production decline rates are the norm. As with any resource extraction process, consideration must be given to the environmental impact. For shale hydrocarbon production, this is largely centred around the use of hydraulic fracturing and the intense water usage and possibility of water contamination which this implies. Venting and flaring, seismic activity and surface impacts must also be considered. It is well known that the US can be considered the cradle of the shale hydrocarbon industry, and it remains the largest exploiter of this resource. We look at how the growth of this industry in the US has impacted on US energy markets and the wider domestic economy and, by extension, given the USs prominent position as a global energy consumer, the impact this has had on international energy markets and players. The outcomes of this shale revolution for US and global energy markets are essentially a reduced US reliance on imported natural gas and oil (more profound for the former than the latter), and substitution towards natural gas in electricity generation with a consequent rise in US coal exports. These changing global trade patterns have invariably meant that traditional exporters to the US have become more oriented towards China. Although difficult to measure, increased supply has also most likely contributed to lower energy prices, both in the US (more the case for natural gas) and globally (more the case for oil and coal).

29 April 2013
Research Strategist
Marc Ground, CFA* Marc.Ground@standardbank.co.za +27-11-3787215

Please refer to the disclaimer at the end of this document.

Commodities: Special Report 29 April 2013

This drill is for real

What makes shale plays different from conventional gas and oil plays? Essentially, the primary difference between shale plays and that of conventional hydrocarbon plays is that the hydrocarbon reservoir is found within a shale formation, as opposed to other rock formations. Most hydrocarbon deposits have their origin in the formation of shale rock. Shale rock is formed by the layering of fine sediments, usually at the bottom of seas or lakes, over millions of years. When significant amounts of organic matter form part of these sediments, the shale rock can contain kerogen (solid organic material). Should this rock be subjected to sufficient heating during its geological history, some of this kerogen can be transformed into oil and gas (or a mixture of both), depending on the specific temperature conditions. The increased temperature is usually accompanied by increased pressure within the rock, which generally results in part of the oil and/or gas being expelled from the shale into other more permeable rock formations, where it forms conventional hydrocarbon reservoirs. However, on occasion, some or all of the oil and gas formed within the shale remains trappedand this is a shale gas or tight oil reservoir (see Figure 1). This difference in geology gives rise to the unique production characteristics of shale plays, that have until this century limited the widespread exploitation of these hydrocarbon resources. A confusion of terms Oil shales (or kerogen shales) are sedimentary rock formations (not necessarily shale rock) that contain relatively large amounts of kerogen. This kerogen can be converted into liquid or gaseous hydrocarbons through a process that involves heating the oil shale to a sufficiently high temperature. The liberated hydrocarbons are termed shale oil and oil-shale gas. Shale oil is also know as kerogen oil or oil-shale oil. Therefore, unlike the formation of tight oil and other conventional oil, during which the required heating of the rock formation occurs naturally during the rocks underground history, shale oil is formed by human intervention. Both shale oil and tight oil are classified as unconventional oil. Tight gas is a general term referring to natural gas that is found in any low permeability formations, in which it would be impossible to obtain economically viable flow rates with conventional production techniques. As such the category tight gas could be considered to encompass shale gas, although the category and its boundaries remain poorly defined. Generally, tight gas and shale gas are treated as disparate categories. Both are classified as unconventional gas. There is a third type of unconventional gas, coalbed methane, which as the name implies is natural gas contained in coalbeds and also requires unconventional methods of extraction although these unconventional methods differ from those used in shale gas recovery.
Figure 1: Geology of natural gas resources*

Sources: EIA; USGS

* Although the figure specifically refers to natural gas resources, the concepts are generally analogous to unconventional oil resources.

Commodities

Commodities: Special Report 29 April 2013

Production characteristics of shale plays Compared to conventional hydrocarbon reservoirs, shale reservoirs are characterised by: Low permeability: the gas or oil does not flow easily out of the rock formation. Fairly low porosity: relatively few spaces within the rock formation for the gas or oil to be stored (most often found to be less than 10% of the total volume). Low recovery rates: this is due to the gas or oil being trapped in disconnected spaces within the rock or being stuck to the rocks surface. Low porosity and low recovery rates is the reason why the volume of recoverably hydrocarbons per square kilometre of area at the surface is usually considerably smaller than for conventional plays, ultimately having consequences for the economics of resource extraction. However, it is the low permeability of the reservoir that truly exemplifies shale gas or tight oil production, as it requires the use of specific technologies to achieve commercially viable flow ratesi.e. flow rates that adequately compensate for capital investment and operating costs. Chief among these technologies are horizontal wells, hydraulic fracturing, and pad-drilling. Horizontal wells: In order to maximise the surface contact with the reservoir rock and thereby increase flow rates, shale wells are often characterised by long horizontal sections (i.e. horizontal wells) as opposed to conventional wells which are purely vertical (see Figure 2). Horizontal wells require specific drilling techniques, in particular coil tube drilling, whereby the well is drilled by a flexible pipe using liquid nitrogen. These drilling units can be easily moved (unlike conventional drilling rigs) and can be used in an existing well while it is producing.
Figure 2: A typical hydraulic fracturing operation*

Source: ProPublica * While the figure specifically refers to shale gas production, the concepts also largely apply to tight oil production

3 Commodities

Commodities: Special Report 29 April 2013

Hydraulic fracturing (or fracking): Given the lack of permeability within shale rock, unlike conventional wells, the hydrocarbons do not naturally flow into the wells (horizontal or vertical) in order to reach the surface or at least not at a commercially viable flow rate. Hydraulic fracturing solves this problem. A fluid, known as fracturing fluid, is pumped at extremely high pressure into the reservoir rock via the well. This creates fissures or fractures within the shale mostly only a few millimetres wide but sometimes hundreds of metres distant from the well bore. These fractures greatly expand the contact surface area within the rock, allowing much larger quantities of the trapped hydrocarbons to flow into the well (see Figure 2). The fracturing fluid consists of a mixture of water, various chemicals and sand or ceramic beads. The latter, known as proppants, are there to prevent the fractures from closing up again once the pressure is released, i.e. they literally prop open the fractures. To further improve flow rates, multi-stage fracturing has become commonplace. This involves fracturing the rock at multiple (from 10 to 20) set intervals (about every 100 metres) along the horizontal well bore. In the past, it was sometimes deemed necessary to repeat the hydraulic fracturing process (re-fracturing) on a producing well. However, this practice, more common in vertical wells, has fallen out of favour with the increased use of horizontal wells. Multi-well pad-drilling: Low permeability and low porosity means that the hydrocarbon resources are spread over a much wider area than is the case for conventional plays. Consequently, a much greater number of wells need to be drilled to access the resources in shale plays. The situation is compounded by the rapid depletion rates of shale wells as compared to conventional wells. Pad drilling (see Figure 3) allows groups of horizontal wells (5 to 10) to be drilled in relative close proximity, at a much reduced cost. This allows producers to target an increased area of the resource, yet minimise the impact on the surface. The wellheads of these multiple horizontal wells can then also be accommodated by a single drilling pad. This concentration of wellheads reduces both the above-ground resource management costs as well as the costs associated with moving the produced hydrocarbons to market. While all shale plays are characterised by low permeability, low porosity and low recovery rates, the intensity of each of these factors often varies between plays due to unique geological characteristics. This obviously affects the economics of production and the production technologies that can or need to be employed. Different geological characteristics may even be encountered in different parts of a particular play as they generally cover a large area (see Figure 4 overleaf). Therefore, even though considerable experience has been amassed through the exploitation of several shale plays in the US, the extent to which these learnings can be effectively applied to other plays, both in and outside the US, is not certain. Even the US experience has already taught us that considerable adaption and experimentation of drillFigure 3: Multi-well pad drilling

Source: Statoil

4 Commodities

Commodities: Special Report 29 April 2013

ing and completion techniques is required, both within certain plays and across plays, to ensure economically viable resource extraction. The economics of shale plays Shale hydrocarbon reservoirs typically overlie developed conventional gas and oil reservoirs, so initial exploration costs are generally minimal since appraisal of the shale can be achieved using information from existing wells. This is not always the case though, with an example being the Karoo Basin in central and southern South Africa, which does not overlie any significant existing conventional oil and gas drilling operations. As mentioned in the preceding section, low porosity and low recovery rates imply that the volume of gas or oil that occurs per square kilometre at the surface is of an order of magnitude smaller for shale plays than it is for conventional hydrocarbon plays. North American shale gas plays have recoverable resources of between 0.4bcm/km 2 (billions of cubic metres per square kilometre) and 0.6bcm/km2, while the worlds largest conventional fields average 2.0bcm/km 2. This low concentration of resources necessitates the drilling of significantly more wells (at least ten times more) over a much large area to access sufficient quantities of the shale hydrocarbons. Not only are more wells required, but as we saw previously more expensive and sophisticated drilling techniques are necessary in shale plays (such as horizontal wells). Ultimate recovery rates for shale plays are significantly lower than for conventional plays. Shale gas recovery rates have varied between 8% to 30% of gas in place, while conventional gas rates are usually around 60% to 80%. The use of horizontal wells has greatly improved the recovery rates per well.

Figure 4: US shale playslower 48 states

Source: EIA

5 Commodities

Commodities: Special Report 29 April 2013

Not only are recovery rates lower, but productivity of shale wells within the same play differ remarkably, significantly more so than is the case for conventional wells. These differences in ultimate recovery rates per well are largely due to differences in a) the quantity of gas in place at the specific drilled location (reservoir quality), b) pressure gradients c) the lateral reach of the well, and d) the effectiveness of the completion process (the hydraulic fracturing) in expanding the contact surface area within the target rock. Despite disparities in volumes produced, shale wells exhibit a similar production profilean early peak of production followed by a rapid decline. These production decline rates are considerably higher than those for most conventional wells. According to research done by the International Energy Agency (IEA), on average, weighted by production, horizontal wells in the Barnett shale play (the most developed shale gas play in the world) have declined by 39% from the first to the second year of production, and around 50% from the first to the third year. After several years the decline rates slow, although they remain relatively high. Consequently, most of the recoverable gas is extracted after just a few years. This bring us to an important difference in the economics of shale plays as opposed to conventional plays in the relationship between initial investment and continued production . Given the extremely rapid decline of shale wells, most of the hydrocarbons are produced within the first two years. Consequently, unlike in conventional plays which have a much longer production profile, discount rates do not matter much when deciding on commercial viability. Essentially, the economic decision for shale production is whether the value of the recovered hydrocarbons per well exceeds the well construction costs. Capital costs of drilling and completing wells must by necessity be recovered within a few years. This implies that the decision to go ahead with greenfield shale projects or to maintain production of existing projects (to keep a shale play producing drilling of new wells must be consistently maintained) will be significantly less encumbered by long-term considerations of future costs and prices, making shale production relatively more responsive to short-term changes in the marketi.e. shale production can play the role of swing supply in the oil and natural gas markets. The IEA has estimated that for the current gas plays in the US and Canada, the threshold price (at the wellhead) needed to yield a 10% return on investment ranges from $3/MBtu (million British thermal units) to $7/MBtu. However, these threshold gas prices are greatly reduced in plays containing wet gas (natural gas with some liquid content), and even more where tight oil is produced. The price for natural gas liquids (NGLs) is linked to oil prices, consequently a gas play with feasible liquid content requires a much lower gas price to profitably produce gas. At average 2012 oil prices (implying an NGL basket price of roughly $50/bbl), with a liquid content of 30%, the threshold gas price is approximately $1/MBtu. This reduction in the threshold gas price is driven to the extreme in the case of tight oil wells. Here the shale gas is essentially recovered as a free by-product. Wet gas and tight oil projects explain the persistent increase in US shale gas production, despite many dry shale projects being uneconomical at current gas prices. Not unlike in conventional projects, and depending on the regulatory burden of the particular locale, shale hydrocarbon producers need to take care in limiting and managing the environmental impact of their projects. This of course has associated costs, but these environmental considerations also have broader implications relating to the feasibility and likelihood of the development of shale plays in other parts of the world, as well as the continued success of the industry in the US. As such, we will discuss these considerations separately in the next section. Environmental considerations As with any resource extraction (whether it be mining, drilling, conventional or shale), there are risks and costs to the environment that must be managed and weighed up against the ultimate benefits to the wider community. Experience in the US has shown that if proper care is taken, the environmental damage of shale hydrocarbon production can be reduced to acceptable levels, and where serious environmental incidents have occurred this has invariably been the
6 Commodities

Commodities: Special Report 29 April 2013

result of improper practices which fall short of industry best practice. One of the most prominent environmental considerations in the exploitation of shale plays is the intense water usage of the techniques employed and the possibility of contaminating above ground and underground water resources. As already outlined, the fracturing fluid used in the process of hydraulic fracturing consists of water, proppants (together constituting about 98% of the fluid) and chemicals. Single-stage fracturing requires several hundred cubic metres of water per well. However, multi-stage fracturing (which is common practice now) can require from a few thousand to up to twenty thousand cubic metres (roughly eight Olympic size swimming pools or 20 million litres) of water per well. This obviously places strain on the availability of water for alternative uses and can affect aquatic environs1. However, of perhaps even greater concern is the possibility of contaminating water resources. There are several points in the production process where this might occur. During the drilling phase, a fluid known as mud (a base fluid, usually water or oil, mixed with salts, solids and chemicals) is circulated through the well bore as a lubricant, to control pressure in the well and to remove drill bit cuttings from the well. Several hundred tonnes of mud can be in use at any one time during the drilling process. Mud is stored in containers or in open pits lined with impermeable material and, once used, must either be recycled or disposed of safely. If not handled correctly, this fluid could potentially contaminate water resources. Fracturing fluid (in particular the chemicals used therein) also poses a potential hazard as it may come into contact with aquifers during the fracturing process, either via a breach of the well at the more permeable underground layers (wells must be constructed to withstand the extreme cycles of pressure in the fracking process), or through the fractures/fissures created in the targeted rock. Given the impermeable nature of shale, the latter should only be a problem if these fissures extend to more permeable layers of rock. After fracking is completed, some of the fracturing fluid flows back up the well as part of the produced stream (the rest remains trapped in the targeted rock). This flow-back must be treated and disposed of in an appropriate manner in order to avoid contamination 2. The flow-back period poses another potential environmental risk. During this period, the flowback of fracturing fluid declines, while the hydrocarbon content of the produced stream increases. The most environmentally sound policy is to separate (and then sell) these hydrocarbons from the fracturing fluid. However, this involves investing in separation and processing facilities. An alternative is venting of the flow-back gas to the atmosphere or flaring, essentially burning off the hydrocarbon content. Venting and flaring would invariably mean that greenhouse gas emissions during production will be higher (from 3.5% to 12% higher) than is the case for the production of conventional gas. According to data from the World Bank, the US flared around 2.4bcm of gas in 2008, rising to 71.1bcm in 2011 it is no surprise that this has coincided with the rapid development of tight oil plays. However, this concern is not unique to shale hydrocarbon production, with venting and flaring also an option in conventional projects. By its very nature (creating fractures in underground rock), hydraulic fracturing results in seismic events. However, these events are rarely discernible at the surface and in fact require specialised equipment to observe as petroleum engineers use this seismic activity to monitor the fracking process. Larger seismic events can occur if the fractures happen to intersect existing faults, although such instances have been rare. Best practice is to avoid areas where deep fault lines may exist, and constant monitoring, immediately suspending operations if there is a significant increase in seismic activity. As already mentioned, the surface impact of shale hydrocarbon production is significant since a large number of wells are required. Each of these well sites contains a drilling rig, storage
1

Salt water is being investigated as a possible alternative for use in hydraulic fracturing so as to ease the burden on fresh water resources. However, research into this is still at a relatively early stage.
2

In order to mitigate the potential for chemical contamination some oil and gas companies are experimenting with organic/food-based additives to fracturing fluid. Haliburton is apparently using such a fracturing fluid which the Governor of Colorado has famously admitted to drinking.

7 Commodities

Commodities: Special Report 29 April 2013

tanks, pits to store mud and flow-back fracking fluid, compressor stations and other equipment, occupying an area of around 10,000m 2 (this is roughly equivalent to around one and a half soccer fields). Delivery of the necessary equipment to set up drilling entails between 100 to 200 truck movements. After the set up, a constant stream of truck movements is required to bring in supplies during drilling and completion, for e.g. in remote areas the vast amounts of water used in the fracking process are often trucked in. The drilling process creates noise and air pollution (from diesel generators). Once started the process continues 24 hours a day (lights are required at night), taking from just a few days to several months, depending on the geology encountered and the required depth. Once drilling is completed and the well begins production, the disruption and visibility is greatly reduced.

8 Commodities

Commodities: Special Report 29 April 2013

An American revolution
It is well known that the US can be considered the cradle of the shale hydrocarbon industry, and it remains the largest exploiter of this resource. While shale gas has been produced in the US for over 100 years, in the Appalachian and Illinois Basins, it is the Barnett shale play (in North-Central Texas) that has seen the advent of large-scale shale gas productionand this has only really captured attention in the last six or so years. Currently, besides the Barnett Shale, the largest (by production) shale gas plays under production are the Marcellus, Haynesville and Fayetteville Shales (all in the US). Production of shale gas across the US has increased from around 3.8bcm (billion cubic metres) in 1990 to an estimated 227.8bcm in 2012 (see Figure 5)with the most dramatic increase seen since 2007, when production was only around 42.1bcm. As a percentage of total US gas production, shale gas now presents c.34%. The rise of tight oil production, starting largely in the Bakken shale play of North Dakota and Montana, has occurred just as dramatically and even more recently. In 2000, there was only about 0.15mbd (millions of barrels per day) of tight oil produced in the US, this has now grown more than tenfold to an estimated 2.0mbd in 2012representing around 32% of total US crude oil production (see Figure 6). The bulk of US tight oil production has occurred from the Bakken and Eagle-Ford plays, although there are several other plays also producing (for e.g. Spraberry, Niobrara and Bone Spring). The natural question to ask is how the growth of this industry in the US has impacted on US energy markets and the wider domestic economy and, by extension, given the USs prominent position as a global energy consumer, the impact this has had on international energy markets and players. These are the questions that we will concentrate on in the next sections of this report. However, given the marked differences between natural gas and oil markets, we will discuss the impact of each of their shale equivalents separately. Shale gas sparks an economic rejuvenation As discussed in the preceding section, the rise of US shale gas production has been quite remarkable. However, the impact on the overall US natural gas industry (and by extension the wider economy) has been particularly acute as this rise in shale gas production has occurred at the same time as a marked decline in conventional gas production, mostly due to resource exhaustion (see Figure 7 overleaf). It is also apparent that these supply changes have occurred against the backdrop of a long-term trend of growing consumption; however, this trend was temporarily reversed and somewhat more permanently slowed by the 2008 crisis. As a consequence, growth in US gas production (an average of 4.4% y/y over the past five years)
Figure 5: US shale gas production Figure 6: US tight oil production

250

bcm

2.4

mbd

188

1.8

125

1.2

63

0.6

0.0

Source: EIA

Source: EIA

9 Commodities

Commodities: Special Report 29 April 2013

has far outstripped growth in domestic gas consumption (2.2% y/y). This has ultimately led to a dramatic fall in natural gas prices (see Figure 7)almost certainly in excess of what might have been the case had the 2008 recession occurred without the rise in gas production which in turn has had far-reaching implications for the US economy. To assess this impact, it is first necessary to understand the relative usage of total energy in general, and natural gas in particular, within the economy. Gas accounts for just over one quarter of total US primary energy consumption (see Figure 8), and as is evident from Figure 9, gas usage in terms of primary energy consumption is almost evenly distributed between the industrial, residential and commercial (primarily as a heating fuel), and electricity generation sectors. Electricity generation In electricity generation, an obvious implication of lower gas prices is cheaper electricitya factor which permeates positive benefits throughout the economy. While US electricity prices have not fallen (as gas is not the only factor of production in electricity generation, for e.g. labour input costs must also be considered, and also while this percentage is rising, currently only 30% of US electricity is produced using gas), electricity price inflation has slowed considerably. As is evident from Figure 10, annual electricity price inflation (across all sectors) since 2010 has fallen below the level of general consumer inflation, a reversal of the situation during
Figure 7: US natural gas consumption, production and price* Figure 8: US primary energy consumption by source (2012)

800 600

bcm

$/MBtu

12

9%
9

9%
37%

400
200

6
3

18%

Consumption

Production

27% Petroleum Natural gas Coal Renewable energy Nuclear

Production w/o shale gas

Sources: EIA; Standard Bank Research * Sectoral consumption-weighted price

Price

Sources: EIA; Standard Bank Research

Figure 9: US gas consumption by sector (2012)

Figure 10: US electricity price inflation

3% 16%

12.0
8.0 4.0

% y/y

36%

12%

0.0
-4.0

33%

Residential
Residential Electric power Commercial Transportation Industrial
All sectors

Commercial
CPI inflation

Industrial

Sources: EIA; Standard Bank Research

Sources: EIA; Bloomberg; Standard Bank Research

10 Commodities

Commodities: Special Report 29 April 2013

2005 to 2009 (2007 was the one exception, although the difference was marginal and was also preceded by a sharp, although temporary, dip in gas prices). Slower electricity price inflation has obvious positive consequences for households and firms, and ultimately the US economy. For households, disposable income is freed so that it can be used to purchase other goods and services3, thereby supporting other parts of the economy. For business and industry, there are essentially increased levels of productivity, as increases in production are gained with a lower increase in costs. Aside from electricity price implications, cheaper natural gas also has had an effect on the relative feedstock mix used in US electricity generation. Where possible, electricity producers have naturally turned to the cheaper alternative, with this substitution towards gas coming at the expense of coal, whose domestic price has remained relatively resilient amid the recession and subsequent anaemic recovery of the US economy. In 2007 the share of coal in US electricity generation was 49%, falling to c.38% in 2012. Over the same period, natural gas usage has risen from 22% to 30% (see Figure 11). This has put added pressure (other than the effects of post-2008) on the US coal industry, although after a dramatic drop in 2009, annual coal production has still grown modestly. The obvious outlet for this displaced coal has been exports to foreign markets, something we will deal with in greater detail later. Residential, Commercial and Industrial Aside from the benefit of cheaper electricity, lower natural gas prices have also meant reduced heating and cooling costs, and the consequent increased expenditure on other goods and services by households with attendant benefits to other sectors in the economy, and reduced costs and implied increases in productivity for commercial enterprises (natural gas accounts for 74% of residential and commercial sector primary energy consumption). In addition, for industry in particular, those energy and manufacturing sectors that use natural gas intensively in their production processes have benefited from reduced costs and productivity gains (natural gas constitutes around 42% of the energy usage of the industrial sector). Consequently, as they have attracted investment these sectors have grown, creating jobs and even new upstream/downstream industries. Of course, growth in one sector of the economy does not occur without impacting other sectors sometimes beneficially and sometimes adversely. The adverse effect is the crowding out of other sectors, for example as weve already mentioned the coal industry. However, given the size and diversity of the US economy, it is unlikely that these Dutch disease effects are detrimental to the overall economy.

Some of the income derived from savings on gas bills will also be used to buy more natural gas, although for most households there will be a limit to how much additional natural gas they would like to consume.

Figure 11: US electricity generation by fuel

Figure 12: US liquid fuel consumption, production and price

100%

22.0
16.5 11.0 5.5

mbd

US$/bbl

120
90 60 30

75%

50%

25%

0.0
0%

Coal

Oil and other liquids Nuclear Renewables Natural gas

Production Light tight oil production

Consumption WTI front-month price

Sources: EIA; Standard Bank Research

Sources: EIA; Bloomberg; Standard Bank Research

11 Commodities

Commodities: Special Report 29 April 2013

Tight oil loosens crudes constraint As was the case with shale gas production, the rise in production of tight oil in the US has coincided with a declining trend in the domestic production of conventional crude oil. However, the rise in production of tight oil has been even more impressive although not as long-lived as that for shale gas. As already pointed out, as a percentage of total US crude oil production, tight oil production constitutes around 32% (up from less than 5% three years ago). Similar to the gas industry, this lift to crude oil production coincided with a dramatic fall in domestic consumption as a result of the 2008 crisis, with negative implications for oil prices. Though there has been a difference between natural gas and oil markets, with oil/petroleum consumption not recovering as quickly (in fact it remains below 2007 levels, see Figure 12 on previous page), as was the case for natural gas consumption. These different reactions in consumption can in part be ascribed to the different usages of natural gas and oil. First, unlike natural gas, the use of oil in the US is dominated by one sector. Second, that sector is transportationaccounting for around 70% of petroleum used in the US and constituting only a minimal part of overall gas usage (3%). Demand for transportation is particularly sensitive to changes in income and economic activity, more so than for example demand for heating/cooling fuel and electricity. Part of reason why US oil consumption has not staged the rebound that weve seen in natural gas consumption is increased fuel efficiency (see Figure 13), brought into play by the precipitous rise in oil prices and legislation enacted before the 2008 crash, i.e. the demand destruction effects of high prices. Once such demand destruction occurs, it is not easily reversed, as fuel efficiency standards are legislated and consumer preferences become entrenched. Another reason for the different reactions between oil and natural gas markets is related to the international tradability of oil compared to gas. This has two aspects. First, domestic oil prices are dictated by a truly global competitive market, with international trade in oil occurring with minimal restrictions (both legal and physical). The gas market on the other hand is subject to export restrictions in the US, and global transportation of gas is not as easy and is more costly (requires gas-to-liquids processing at export centres and liquids-to-gas processing at the corresponding import location). This limits international trade, meaning that US natural gas prices are largely determined by domestic considerations. The second aspect is that the US is much more reliant on foreign oil (41% of liquid fuels consumed were imported in 2012) than it is on foreign gas, and as a consequence is much more of a price taker in the former market. So, by comparison, US natural gas prices (Henry Hub front-month), depressed by the glut of domestic supply, were on average 57% lower in 2012 than they were in 2008, while the US oil benchmark (WTI front-month) was only down 6%, supported by international supply and demand considerations. Naturally, the global crude oil benchmark (Brent front-month) reflects
Figure 13: Average fuel economy of light duty vehicles in the US Figure 14: Relative moves of Brent and WTI over 2012

13.00

km/litre

135

$/bbl

$/bbl

26

12.00

21 115
16

11.00
95 11

10.00
75 Jan-12 Apr-12 Jun-12 Sep-12 6 Dec-12 Spread (rhs)

9.00 1980 1984 1988 1992 1996 2000 2004 2008 2012
Source: EIA

Brent front-month

WTI front-month

Sources: Bloomberg; Standard Bank Research

12 Commodities

Commodities: Special Report 29 April 2013

these global concerns to an even greater extent, and was therefore up 13% in 2012 from 2008, which implies that the import-weighted crude oil price the US faces was about 2% higher in 2012 than the 2008 average. This muted response in oil prices has of course dampened the positive effects of increasing crude oil production on the US economy. Looking at transportation, this is particularly evident in US motor gasoline prices which have proved exceedingly resilient. Consequently, the benefits to households (increased disposable income) and business (improved productivity) have not occurred to the same extent as was the case for gas. Industrial users, that use oil in their production processes (oil accounts for 40% of the energy usage of the industrial sector), have also not benefited as much as those that use gas extensively. Nevertheless, there have been unobservable benefits, as crude oil prices might have been considerably higher without the emergence of tight oil production. An indication of this is the widening discount at which WTI traded to Brent during 2012 (see Figure 14 on previous page). While many factors contributed to this widening spread, without this increased US production, the WTI price would most certainly not have moved so far away from the Brent price. The Brent-WTI spread While there were a number of factors that contributed to the persistent widening of this spread over 2012 (such as Middle East tensions, production problems in the North Sea, unplanned US refinery outages), the increase in inventories at Cushing during that year (see Figure 15 overleaf) was of particular importance, as this serves as the delivery point for the WTI contract. This remarkable jump in inventories was the result of the increased tight oil production from the Bakken (and also increased flows from Canadian oil sands) coupled with a lack of pipeline capacity that would allow oil to flow out of Cushing, or even by-pass it entirely, to reach refineries along the Gulf Coast. There appears to be no end in sight to ever-increasing tight oil production, so it is largely left to improved pipeline capacity to alleviate the problem. To this end, one of the major projects completed earlier this year was the expansion of the Seaway pipeline from 150kbd (thousands of barrels per day) to 400kbdtaking oil from Cushing to the Gulf Coast. This was not only expected to ease the build of Cushing stockpiles which would ease the downward pressure on WTI prices, but would also have a negative effect on the price of imported oil (largely priced in line with Brent)in anticipation of this the spread began to narrow from about mid-December last year. While the spread has narrowed substantially since then, the work down of Cushing inventories has been somewhat disappointing so far averaging only 250k bbls per week since the expanded pipeline was opened. In addition, total US crude oil inventories have continued to climb. Although there should be some work-down over the coming quarter as refineries ramp up production in preparation for the US driving season, while we feel that there is room for increased distillate production (stockpiles are currently extremely low), gasoline inventories are largely in line with their seasonal five-year average. In addition, Bakken tight oil and Canadian oil sands production continues to escalate, especially as we move into the northern hemisphere spring (as a number of wells have been idled over the winter), which could keep upward momentum in crude oil inventories in place. Taken together with a slowdown in US growth momentum evidenced in recent data flow and the ever-present threat that upcoming fiscal hurdles pose to US economic confidence, this leads us to conclude that perhaps the narrowing has been overdone. In addition, we have new planned pipeline projects (with total capacity of 215kbd) delivering crude oil into Cushing coming online from mid-year to fall (northern hemisphere). Consequently, where we now stand we view a spread of $10-$15/bbl as more in line with the two benchmarks underlying fundamentals. Of course, as we move towards the end of the year, room for narrowing will once again emerge. The TransCanada Gulf Coast and the Seaway twin pipeline projects are scheduled to come online in Q4:13 and Q1:14, respectivelywith respective planned capacities of 700kbd and 450kbd.
13 Commodities

Commodities: Special Report 29 April 2013

Global thermal coal markets fractured After having looked at the domestic impact, we will now turn our attention to the ramifications of the US shale hydrocarbon revolution on international commodity markets. Once again, we will treat gas and oil separately, given the differences between these markets and the ultimate differing impacts that US production of these shale hydrocarbons has had on global energy markets. Starting with the impact of US shale gas production, we have already mentioned that the US natural gas market is largely domestic, constrained by regulations on exports and higher transportation costs, when compared to crude oil. Another aspect that distinguishes the US gas market is that while the US is a net importer, its reliance on foreign gas has never been to the same extent as its reliance on foreign oil (net imports of natural gas account for roughly 6% of domestic consumption, while net crude oil and products imports make up just over 40% of domestic crude oil and products consumption). These two features have limited the impact that the growth of the US shale gas industry has had on the global natural gas market. The most obvious result, exacerbated by the 2008 crisis, has been that the US has curbed its imports of natural gas which peaked in 2007 (see Figure 16). Due to the previously mentioned physical and legal barriers which make transporting natural gas overseas difficult and costly, neighbouring Canada, via pipeline, is by far the largest source of US gas imports (currently accounting for more than 90% of gross imports, and over the past decade consistently more than 80%). Declining exports to, and increasing imports from 4 the US have been absorbed by increased Canadian natural gas consumption (due to lower gas prices, as has been the case in the US) and decreasing Canadian production. Consequently, gross exports of Canadian natural gas have shrunk which has helped confine the greatest impact of increasing US gas production to the North American market for natural gas (Mexican exports to the US have also fallen dramatically, although Mexico was never a major exporter to the US given that it is itself a net importer of natural gas). US imports of liquefied natural gas (LNG) has been the biggest loser, since this served as the avenue of marginal supply as US natural gas imports grew ever higher before 2007. The countries most affected by this (as well as the growing US preference for sourcing LNG imports from Qatar) have been Algeria, Egypt, Nigeria and Trinidad and Tobago. However, since even at its peak in 2007, LNG imports into the US accounted for less than 3% of total world natural gas exports, these countries have found it relatively easy to find new markets for their LNG exports, making the direct effect on
4

Due to considerations of geographic accessibility, despite the US being a net importer of natural gas from Canada, the US also exports natural gas to Canada (and an increasing quantity due to shale gas production). Canada by far receives the largest portion of US natural gas exports (around 98% in 2012).

Figure 15: Crude oil inventories at Cushing

Figure 16: US gross imports of natural gas

51,000 41,000

k bbl

140

bcm

105

31,000
21,000

70

35

11,000 Jan Feb Mar Apr May Jun Jul Aug Sep Oct Nov Dec 5-yr range
2012

2010
5-yr average

2011

Total
Source: EIA

from Canada

Sources: DOE; Standard Bank Research

14 Commodities

Commodities: Special Report 29 April 2013

the global market of reduced US natural gas imports, largely negligible. Of course, lost opportunity is another factor to consider, as many plans to export LNG to the US have now been shelved, with many investments in expanded LNG capacity already redundant. As a case in point, US regasification capacity is now dramatically underutilised, as the expected need to import increasing amounts of foreign natural gas has not materialised. In fact, the opposite has happened which is seeing plans now turn to expansion of domestic liquefaction capacity to support possible future exports from the US. While US shale gas production has had a limited impact on the international natural gas market, it has had a more significant bearing on the global coal market , a relatively easily traded commodity. As pointed out previously, cheap natural gas has seen it eat away at coals pre-eminence as a feedstock in US electricity generation. US coal production has not fallen off to the same extent, so naturally this displaced demand (more than 90% of US coal consumption is for electricity generation) has found its way onto international markets, particularly those of Europe, China and Japan (which are among the largest coal importers in the world), as marked by a dramatic rise in US coal exports (see Figure 17). This has put added pressure on a global market that was already reeling from the 2008 crisis, and continues to suffer due to reduced demand from an ailing European economy. Consequently, downward pressure on coal prices has been particularly acute, especially in the Atlantic Basin market affecting the other dominant net exporters in the region, such as Russia, Colombia and South Africa. However, exports from these countries have remained relatively resilient as new destinations, mostly in Asia, have been found. Given the shorter freight distance, the US has now displaced South Africa as the Atlantic Basin markets swing producer. Consequently, South Africa is no longer the swing-supplier between the Atlantic and Pacific markets, but is now firmly in the Pacific market. So, for global coal markets, the effect of the shale gas revolution has been i) reduced revenue for net exporters due to a dampened coal price, and ii) a shifting of global coal trade. Since the increase in coal exports is due to a substituting away in electricity generation, it is the global steam/thermal coal market that has been mostly affected. African oil producers turn to China The US is by far the worlds largest consumer and importer of crude oil, and consequently its growing tight oil production has had a significant impact (and will potentially have an even larger impact) on the global oil market. The main conduit of this has been through reduced US importsa two-decade-long increasing trend (with some minor dips) in crude oil net imports was halted in 2005 (see Figure 18)seeing net imports share of US crude oil consumption fall from 66% in 2005 to 57% in 2012. Although other factors, such as a fall in demand post-2008 and an increase in conventional oil production played their part, it is also no coincidence that this fall in imports has coincided with the dramatic increase in tight oil production (since 2005 net imports fell 1.7mbd, while tight oil production has grown 1.8mbd).
Figure 17: US coal production, consumption and exports Figure 18: US crude oil production and net imports

1,200 900 600 300 0

million tonnes

million tonnes

120 90 60 30 0

11.0
8.3 5.5 2.8

mbd

0.0

Exports (rhs) Total consumption

Sources: EIA; Standard Bank Research

Production Power sector consumption

Total production Net imports

Sources: EIA; Standard Bank Research

Tight oil production

15 Commodities

Commodities: Special Report 29 April 2013

The global impact of these reduced US imports of crude oil and petroleum products has been widespread, affecting imports from non-OPEC and OPEC producers equally (both groups losing around 0.8mbd of exports each to the US from 2005 to 2012). Among the OPEC members, the hardest hit have been Nigeria (0.67mbd), Venezuela (0.34mbd), and Angola (0.24mbd). The loss to non-OPEC members has been fairly widespread, although Mexico and the United Kingdom have suffered the most, having lost 0.58mbd and 0.21mbd of net exports to the US over 2005 to 2012, respectively. For the OPEC producers, most of these lost exports to the US have been redirected to China. This is particularly true for Angola which has seen growing production; while Venezuelan production has been in decline and Nigerian production has been volatile, in both instances due to varying degrees of natural resource exhaustion, maintenance issues and lack of investment. Of all these countries, Mexican oil exports have the largest exposure to the US, although the drop in exports to the US has also coincided with a slowdown in production (largely due to a lack of investment), so there hasn't been the need for a reorientation to other export destinations. Arguably, weaker demand from the US does not help the case for increased investment in Mexicos oil production capability, but other factors have been largely responsible for the current situation. Like Mexico, UK oil production has been in terminal decline, although unlike Mexico this has been mostly due to resource exhaustion, and so here too there has been little need to source new export destinations. Interestingly, over the same period, Canadian net exports to the US grew 0.78mb, as Canadian oil sands production grew and gained access (via pipelines) to the US market. Quantifying the price impact of this reduced US reliance on foreign oil, is near impossible, due to the myriad other concurrent and interlinked factors that played a role in forming the evolution of global oil prices over the same period. However, it goes without saying that in the absence of other factors, this reduced upward pressure on global oil demand would have a dampening effect on prices. So, it is safe to say that holding other factors constant, global oil prices would have been higher without the dampening effect of increasing US tight oil production and the consequent reduction in US oil imports. One should also note that the effect on international oil markets has been inhibited by the lack of access that this increasing US production has had to Gulf Coast refineries (see The Brent-WTI spread on page 13). Without this access new crude oil production has been building up in mid-West inventory centres. Plans are already underfoot to improve this access via increased pipeline infrastructure, however, had this capacity already been in place, the reliance of Gulf Coast refineries on imported oil would already be a lot lower. Consequently, the effect on global oil trade and prices wouldve most likely been greater. The frack heard round the world Turning to the future for the US shale hydrocarbon industry and its effect on US and global energy markets, the most talked about notion is that of possible US energy independence. Once again though, we feel that it is important to distinguish between natural gas and oil when it comes to the energy independence debate. US energy independence In terms of natural gas, the Energy Information Administration (EIA) predicts that the US will become a net exporter by the year 2019, the culmination of a trend of declining imports begun at the start of the century when shale gas production started to really ramp up (see Figure 19 overleaf). Clearly, from a natural gas point of view, US energy independence appears promising. However, as already mentioned, natural gas forms only part of the US energy equation, accounting for approximately 27% of total energy consumption. While this makes it the second-largest source of US energy, it trails oil and petroleum liquids which currently constitute around 37% of total energy consumption. It is in terms of oil and petroleum liquids that the move towards energy independence for the US is highly unlikely. As weve mentioned before, the US is and has always been far more dependent on foreign oil than it has on foreign natural gas. At its height in 2005, natural

16 Commodities

Commodities: Special Report 29 April 2013

gas imports accounted for only around 18% of domestic natural gas consumption in the US (it currently accounts for 6%), while foreign oil currently constitutes approximately 40% of US domestic crude oil and products consumption (granted this has fallen from the 60% high of 2005). This greater reliance on imported oil obviously means that it would take a much greater effort to achieve energy independence on this front. So coming off a comparatively low base, with US oil production expected to grow (according to EIA forecasts) only slightly faster than natural gas production over the next 10 years (on average 1.6% y/y for oil, compared to 1.4% y/y for natural gas), the incremental reduction in foreign oil reliance will not be enough to wean the US completely off imported oil. Compounding the effect of weaker domestic oil supply growth, is that domestic oil consumption is expected to grow slightly more (0.6% y/y on average over the next ten years, despite projections of increased energy efficiency) than natural gas consumption (0.3% y/y). By 2019 the EIA estimates that oil and petroleum liquid imports as a percentage of domestic consumption will reach a low point of 34.1%, after which it will begin to modestly rise again (see Figure 20), due to a projected decline in tight oil production. Looking at the overall energy picture for the US, it is clear that while significant strides will be made towards energy independence (the EIA predicts that by 2022 the US will only be importing 11% of its energy needs compared to 17% today, see Figure 21 overleaf), this is still a way off from complete self-reliance. Nevertheless, the main impetus for this reduced reliance is through increasing US shale hydrocarbon production (increasing energy production from renewable and nuclear is expected to play a small supporting role). Natural gas As already mentioned, the effect of the shale gas revolution on international markets has been fairly isolated, largely due to the US being less reliant on foreign natural gas, other than from Canada. However, as the US increases its shale gas production, its shift to a net exporter is imminent (although this does hinge on regulatory approval), which would have potentially wider ramifications for the global natural gas market as already mentioned, the EIA expects this turning point to be in 2019 (see Figure 19). This could be a step towards a truly global natural gas market , with a consequent global price for natural gas across disparate geographic locations. It raises the possibility of a delinking of natural gas and oil prices as consumers, faced with a wider range of competing suppliers can avoid the traditional oil-indexation of natural gas prices found in many supply agreements outside the US. However, even if the US were to become a natural gas exporter within this decade, according to current projections, its contribution to total natural gas trade would still be relatively small (at the turning point in 2019, US natural gas exports as estimated would be less than 1% of current total global exports). Consequently, we see the greatest potential
Figure 19: US natural gas consumption and production Figure 20: US oil & products production and consumption

800
600 400 200 0

bcm

22.0
16.5

mbd

11.0
5.5 0.0

Total production
Consumption
Sources: EIA; Standard Bank Research

Shale gas production

Total production

Light tight oil production

Consumption
Sources: EIA; Standard Bank Research

17 Commodities

Commodities: Special Report 29 April 2013

for a more competitive international market in the future coming from the exploitation of shale plays in other parts of the world (see Parts II and III for a more detailed discussion of these shale plays outside the US). Oil Despite the prospect of oil independence in the US being unlikely, given its current standing as the worlds largest oil importer, as the US grows increasingly less reliant on imported oil, the effect will no doubt be felt in the global oil market. Of course, as has already been seen, the greatest effect will be on those exporting oil to the US. However, this loss of the US market will not affect all exporters to the US uniformly, another aspect that is apparent from the trends over the past five years. Over the medium term, to the extent that refineries cannot adjust there processing and new refineries take time to build, those countries exporting crude oil to the US with characteristics that more closely resemble that of the oil extracted from US shale formations stand to lose the most. At present, these include Brent, Bonny Light and Cabinda crude oils from the UK, Nigeria and Angola, respectively (see Figure 22). Consequently, the trend of weaker US imports from these countries is expected to continue. This impact will be less felt in the UK, with its production already in decline due to resource exhaustion. For Nigeria and Angola, which both still have many years of viable and potentially increasing production, the loss of the US market has a potentially greater impact. As per their 2012 exports to the US, Nigeria could have to find a new destination for 405kbd (20% of total exports) and Angola 221kbd (14%). However, as has been the experience so far, it appears as if China would be ready to absorb these displaced exports, with the ultimate effect that these countries exports are not adversely impacted, but rather that they just become more dependent on Chinese demand. As weve already mentioned, the full effect of this has been hampered by the lack of pipeline capacity allowing new tight oil production to flow freely to Gulf Coast refineries. However, this situation is changing (see The Brent-WTI spread on page 13) and it is expected that the US will become increasingly less dependent on imports of sweet crudes. Another potential impact of the US being less reliant on imported oil, is that it perhaps loosens the grip of OPEC to some extent. We believe that claims of this nature are overdone. As long as the US remains a net importer of oil (i.e. without a significant oversupply of domestic production), Saudi Arabia remains firmly rooted as the worlds swing oil producer (as it has a significant oversupply of domestic production), managing to curb or ramp up supply as and when global demand conditions warrant itthe very essence of OPECs oligopolistic power. However, one cannot deny that the dynamic of global oil trade is changing. Global oil exports are becoming increasingly directed towards China, and this trend has and will continue to be accelerated by reduced US demand for foreign oil, as its domestic supply grows.
Figure 21: US total energy production and consumption Figure 22: Grades of selected US crude oil imports/production

120 90 60 30

quadrillion Btu

quadrillion Btu

4.0

30
24 18

Mexico - Maya

Sulpur content (%)

3.0

Saudi- Arab Heavy

Iraq - Basrah Light

2.0 Venezuela - Merey

1.0

Saudi- Arab Light

12
6

0.0

Nigeria - Bonny Light Angola - Cabinda

North Sea - Brent US - WTI 50

10
Net imports (rhs)
Sources: EIA; Standard Bank Research

Production

Consumption

30 40 API gravity US - Bakken US- Eagle-Ford

20

Sources: EIA; BP; Standard Bank Research

18 Commodities

Commodities: Special Report 29 April 2013

Coal In the commodity space, thermal coal has already emerged as the biggest loser in the wake of the US shale gas revolution, due to rising exports of US coal. Increasing US coal exports are expected to continue, as cheap natural gas and intensifying carbon emissions legislation provides little or no incentive for the building of new coal-fired electricity generation capacity (except for that already under construction). However, putting the brakes on this trend could be a slowing down in the growth of US coal production . The lowest breakeven costs for US coal miners are in the region of $90/tonne, which, given the dim outlook for future prices, provides little incentive for investment in greenfield projects and, at current price levels, might even see some marginal miners go out of business. Also, given that the US is a relatively high-cost producer in the global setting, this takes away the threat that US exports could significantly undercut other global producers, thereby placing their supply under threat. In addition, coals pre-eminence as a global energy feedstock is hardly threatened by these developments in the US. In fact, it could be argued that increased exports from the US, in that it puts downward pressure on coal prices (to the extent that it still supports the marginal producer in the US), serves only to heighten the appeal of coal-fired electricity generation. In the absence of similar shale gas exploitation in the other parts of the world (something we will discuss in Parts II and III), it seems unlikely that coal will be displaced by natural gas on the international stage, to the same extent that it has and will continue to be in the US.

19 Commodities

Commodities: Special Report 29 April 2013

References
Chatham House (2010), The Shale Gas Revolution: Hype and Reality, A Chatham House Report EIA (Energy Information Administration) (2013), Key Drivers for EIAs Short-Term US Crude Oil Production Outlook, Short-Term Energy Outlook Supplement EIA (2012), Annual Energy Outlook 2013 Early Release Overview EIA (2012), Pad Drilling and Rig Mobility Lead To More Efficient Drilling, Today in Energy 11 September 2012 EIA (2012), What is Shale Gas and Why Is It Important?, Energy in Brief EIA (2011), Review of Emerging Resources: US Shale Gas and Shale Oil Plays IEA (International Energy Agency) (2013), Monthly Oil Market ReportJanuary IEA (2012), World Energy Outlook 2012 IEA (2012), Golden Rules for a Golden Age of Gas, World Energy Outlook 2012 Special Report IEA (2011), World Energy Outlook 2011 IEA (2009), World Energy Outlook 2009 OPEC (Organisation of Petroleum Exporting Countries) (2012), World Oil Outlook 2012

20 Commodities

Commodities: Special Report 29 April 2013

Disclaimer
THIS COMMUNICATION MAY CONTAIN RESEARCH. SUCH RESEARCH IS A MARKETING COMMUNICATION: It is not investment research as it is not the result of financial analysis and has not been prepared in accordance with legal requirements designed to promote investment research independence. Additional information with respect to any security referred to herein may be made available on request. This material is for the general information of institutional and market professionals clients of Standard Bank Group ( SBG ) only. Recipients who are not market professionals or institutional investor customers of SBG should seek advice of their independent financial advisor prior to taking any investment decision based on this communication or for any necessary explanation of its content. It does not take into account the particular investment objectives, financial situation or needs of individual clients. Before acting on any advice or recommendations in this material, clients should consider whether it is suitable for their particular circumstances and, if necessary, seek professional advice. The information, tools and material presented in this marketing communication are provided to you for information purposes only and are not to be used or considered as an offer or the solicitation of an offer to sell or to buy or subscribe for securities or other financial instruments, nor shall it, or the fact of its distribution, form the basis of, or be relied upon in connection with, any contract relating to such action. This material is based on information that we consider reliable, but SBG does not warrant or represent ( expressly or impliedly ) that it is accurate, complete, not misleading or as to its fitness for the purpose intended and it should not be relied upon as such. The information and opinions contained in this document were produced by SBG as per the date stated and may be subject to change without prior notification Opinions expressed are our current opinions as of the date appearing on this material only. We endeavour to update the material in this report on a timely basis, but regulatory compliance or other reasons may prevent us from doing so. SBG or its employees may from time to time have long or short positions in securities, warrants, futures, options, derivatives or other financial instruments referred to in this material. Where SBG designates research material to be a marketing communication , that term is used in SBG s Research Policy. This policy is available from the Research Compliance Office at SBG. SBG does and seeks to do business with companies covered in its research reports including Research Communications. 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. SBG has published a Conflicts of Interest Policy that is available upon request which describes the organisational and administrative arrangements for the prevention and avoidance of conflicts of interest. Further disclosures required under the FSA Conduct of Business Sourcebook 12.4 and other regulatory bodies are available on request from the Research Compliance Department and or Global Conflicts Control Room, unless otherwise stated, share prices provided within this material are as at the close of business on the day prior to the date of the material. None of the material, nor its content, nor any copy of it, may be altered in any way, transmitted to, copied or distributed to any other party, without the prior express written permission of SBG. All trademarks, service marks and logos used in this report are trademarks or service marks or registered trademarks or service marks of SBG or its affiliates. SBG believes the information and opinions in the Disclosure Appendix of this report are accurate and complete. Information and opinions presented in the other sections of this communication were obtained or derived from sources SBG believes are reliable, but SBG makes no representations as to their accuracy or completeness. Additional information is available upon request. SBG accepts no liability for loss arising from the use of the material presented in this report, except that this exclusion of liability does not apply to the extent that liability arises under specific statutes or regulations applicable to SBG. The services, securities and investments discussed in this material may not be available to nor suitable for all investors. Investors should make their own investment decisions based upon their own financial objectives and financial resources and it should be noted that investment involves risk, including the risk of capital loss. Past performance is no guide to future performance. In relation to securities denominated in foreign currency, movements in exchange rates will have an effect on the value, either favourable or unfavourable. Some investments discussed in this marketing communication have a high level of volatility. High volatility investments may experience sudden and large falls in their value causing losses when that investment is realised. Those losses may equal your original investment. Indeed, in the case of some investments the potential losses may exceed the amount of initial investment, in such circumstances you may be required to pay more money to support those losses. Income yields from investments may fluctuate and, in consequence, initial capital paid to make the investment may be used as part of that income yield. Some investments may not be readily realisable and it may be difficult to sell or realise

21 Commodities

Commodities: Special Report 29 April 2013

those investments, similarly it may prove difficult for you to obtain reliable information about the value, or risks, to which such an investment is exposed. This report is issued and distributed in Europe Standard Bank PLC. 20 Gresham Street, London EC2V 7JE which is regulated in the United Kingdom by Prudential Regulation Authority ( P RA ) . This report is being distributed in the United States by Standard New Yor k Securities ( USA ) LLC; in Kenya by CfC Stanbic Financial Services Ltd; in Nigeria by Stanbic IBTC; in Angola by Standard Bank de Angola S.A.; in Brazil by Banco Standard de Investimentos S.A.; in China by Standard Resources ( China ) Limited; in Australia by Standard Bank Plc Sydney branch; in Botswana by Stanbic Bank Botswana Limited; in Democratic Republic of Congo by Stanbic Bank Congo s.a.r.l.; in Ghana by Stanbic Bank Ghana Limited; in Iran by Standard Bank Plc representative office; in Isle of Man by Standard Bank Isle of Man Limited; in Jersey by Standard Bank Jersey Limited; in Mexico by Standard Bank Plc representative office; in Madagascar by Union Commercial Bank S.A.; in Mozambique by Standard Bank s.a.r.l.; in Malawi by Standard Bank Limited; in Namibia by Standard Bank Namibia Limited; in Mauritius by Standard Bank ( Mauritius) Limited; in Peru by Standard Bank Plc representative Office; in Taiwan by The Standard Bank of South Africa; in Tanzania by Stanbic Bank Tanzania Limited; in Singapore by Standard Merchant Bank ( Asia ) Limited; in Swaziland by Standard Bank Swaziland Limited; in Zambia by Stanbic Bank Zambia Limited; in Zimbabwe by Stanbic Bank Zimbabwe Limited; in UAE by Standard Bank Plc Dubai branch. In jurisdictions where SBG is not already registered or licensed to trade in securities, transactions will only be effected in accordance with applicable securities legislation, which will vary from jurisdiction to jurisdiction and may require that the trade be made in accordance with applicable exemptions from registration or licensing requirements. Standard Bank Group Ltd Reg.No.1962/000738/06 ) is listed on the JSE Limited. It is an Authorised Financial Services Provider and it also regulated by the South African Reserve Bank. Copyright 2013 SBG. All rights reserved. This report or any portion hereof may not be reprinted, sold or redistributed without the written consent of Standard Bank Group Ltd.

22 Commodities