Petrocapita Energy Update

October 2009

1
Summary

There has been considerable discussion recently about the

“paradox” of bonds and stocks and commodities going up together
- that the bond market is predicting a continuing recession via low
interest rates and the stock market is predicting a recovery via high
equity prices. Why is the bond market behaving so strangely in the
face of a huge recovery stocks and commodities – surely one of
these indicators must be wrong? Maybe, but perhaps there is an
alternative interpretation that fits the facts.

Markets always appear to act strangely to profit maximisers when

non-profit maximisers are involved.  I actually feel that the behavior
of the sovereign debt market makes sense.  Virtually every asset
class is exhibiting the short-term effects of a massive monetary
expansion.  Once again assets that are liquid and traded - including
LT sovereign debt – are rapidly “increasing” in price in nominal
terms.  Monetary authorities have expanded the global money
supply aggressively allowing speculative activities to re-ignite via CONTENTS
investment and commercial banking intermediaries and at the same 2 Global Oil Production -
time they are busy monetizing the rapidly expanding government UKERC
debts - hence low interest rates and rapidly recovering equity prices. 3 North American Natural Gas
Storage
When cross-correlations between assets classes are very high and
positive we should always be asking ourselves whether we are in a 3 Crude Natural Gas Ratio
period of liquidity/money printing induced euphoria. 3 Natural Gas – Supply
Demand Analysis
Ultimately monetary authorities can control exchange rates or
interest rates but not both.  If they decide to sacrifice exchange 5 Energy Consumption Quick
rates for low interest rates then, in my opinion, inflation is sure to Facts
follow.

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 Energy Update

The peak year for discoveries of giant oil fields GLOBAL OIL PRODUCTION - UKERC
(ultimate recovery of 500 mbbl oil or more) in the
U.S. was 1930—in the world, 1962. 80% of the oil Despite large uncertainties in the available data,
produced in 1995 was found before 1973. We now sufficient information is available to allow the status
find one barrel for every four we consume. and risk of global oil depletion to be adequately
assessed. But the available methodologies can
frequently lead to underestimates of resource size
and overly pessimistic forecasts of future supply. The
CHART 1: UKERC canvassed the existing research and came to
EXPLORATION - DISCOVERY - CONSUMPTION the following conclusions:
80 12
70 11 − The rate of decline of production is accelerat-
Exploratory drilling “wildcats” (thousands)

ing. The global average decline rate of post-peak

Annual oil discoveries minus annual

60 10
consumption (billions of barrels)

50 9 fields is at least 6.5%/year and the corresponding

40 8 decline rate of all currently producing fields is at
30 7 least 4%/year. This implies that approximately
20 6 3 mb/day of capacity be added each year just to
10 5
maintain production at current levels – equivalent
0 4
Discoveries greater than consumption to a new Saudi Arabia coming on-stream every 3
-10 3
-20
Consumption greater than discoveries
2
years. An additional 1 mb/day is required to meet
1950 1960 1970 1980 1990 2000 demand growth. From a different perspective,
Source: Association for the Study of Peak Oil, more than two thirds of existing capacity may
www.asponews.org need to be replaced by 2030 solely to prevent
production from falling.

In the last 20 years, only three fields (in Norway, − A peak in conventional oil production before 2030
Columbia and Brazil) have been found with more than appears likely and there is a significant risk of a
one billion barrels each. None produce more than peak before 2020.
200,000 barrels a day. From 1990 to 2000 a total of
42 billion barrels of new reserves were discovered.
In the same period the world consumed 250 billion
barrels.

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Energy Update (continued)

NORTH AMERICAN NATURAL GAS STORAGE CRUDE NATURAL GAS RATIO

Working gas in storage was 3,734 Bcf as of Friday,
October 16, 2009, according to EIA estimates. This
represents a net increase of 18 Bcf from the previous
week. Stocks were 397 Bcf higher than last year at
this time and 432 Bcf above the 5-year average of
3,302 Bcf. In the East Region, stocks were 114 Bcf
above the 5-year average following net injections of
11 Bcf. Stocks in the Producing Region were 252
Bcf above the 5-year average of 935 Bcf after a net
injection of 5 Bcf. Stocks in the West Region were 65
Bcf above the 5-year average after a net addition of
2 Bcf. At 3,734 Bcf, total working gas is above the
5-year historical range.
The oil/natural gas ratio has moved down sharply
from the extreme trading of just 4 weeks ago.
NATURAL GAS – SUPPLY DEMAND ANALYSIS
Highlights from the recent Bernstein Energy report
“Why $5 Gas Is Still Cheap: It’s Cyclical, Not Secular:
Highlights”
“− Gas investors are now faced with two controver-
sial questions: what is the marginal cost of supply
and where are we in the cycle? Although some
people believe that gas has become structurally

CHART 2: WTI CRUDE VERSUS NATURAL CHART 3: WTI CRUDE VERSUS NATURAL
GAS RATIO (SEPTEMBER 2009) GAS RATIO (OCTOBER 2009)

(CL V9 / NG V9) 9/1/2009 (CL Z9 / NG X9) 10/1/2009

23.50
23.00
22.50 17.50
22.00 17.00
21.50 16.50
21.00 16.29
16.00
20.50
20.00 15.50
19.50 15.00
19.00 14.50
18.50 14.00
18.00
17.50 13.50
17.00 13.00
16.50 12.50
16.00 12.00
15.50
15.00 11.50
14.50 11.00
14.00 10.50
13.50 10.00
13.00
12.50 9.50
12.00 9.00
11.50 8.50
11.00 8.00
10.50
10.00 7.50
9.50 7.00
9.00 6.50
8.50 6.00

2004 2005 2006 2007 2008 2009 Monthly 2004 2005 2006 2007 2008 2009 Monthly

3
Energy Update (continued)
cheaper, the evidence we have seen suggests the
opposite: the long-term upward trend in the cost
of gas continues. However, we now find ourselves
in a severe cyclical downturn. We believe that the
cyclical recovery will be relatively quick and that,
as a result, pricing will approach and surpass the
marginal cost of $7.50/mcf in the early part of
2010.
− The secular upward trend is unchanged because
even though shale gas is clearly abundant, there
is little evidence that producing it is cheap. We
expect that most shales will be like the Barnett
Shale – very strong initial results followed by years
of rising F&D as companies either drill further from
the core or drill wells too close to each other.
Furthermore, shale gas still accounts for only 11%
of the total market, meaning that other gas drilling
must continue as well. We also believe that much
of the improvement in initial-production rates
seen in the past two years has been due to E&Ps
spending more on expensive completion tech-
niques, not due to improving geologic prospects.
− In terms of the cycle, the long-anticipated reduc-
tions in onshore supply have begun, with onshore
production 1.5% lower in July of this year than in
June. We expect these production trends to con-
tinue and to accelerate, and we believe that gas
production may be down as much as 10% year-
over year by December. There are a few reasons
why it has taken time for the reduced rig count
to impact production, but current rig counts are
clearly unsustainable over the long term. Cana-
dian production has also been reduced by lower
rig counts, and hence imports to the US have
dropped materially.
− We think that LNG will not pose a material threat
to a recovery in US gas prices. Imports to the US
have been just 1.3 Bcfd so far in 2009 and with
projects being delayed the anticipated flood of
LNG will be smaller than expected. More im-
portantly, the world continues to have an LNG
shortage relative to regassification capacity, and
we expect that demand for LNG will be much
stronger internationally than in the US.
− We believe that the recovery of gas prices will be
led by declining supply of gas, not by a surge in
demand. Reductions in supply on a year-over-
year basis will be over 5 Bcfd, which is much
larger than the reductions in industrial demand,
which was never greater than 2.5 Bcfd year over
year. We continue to model relatively weak indus-
trial demand going forward, with little recovery in
the coming years. We believe there will be some
growth in the electric power segment but there
may be a brief reduction in gas demand for power
of around 1 Bcfd once gas again becomes more
expensive than coal.”
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Energy Update (continued)

ENERGY CONSUMPTION QUICK FACTS

− US Foreign Oil Dependence: In 2002, net imports
accounted for 53% of U.S. oil consumed and is
projected to rise to 70% by 2025. 50 percent
of US oil comes from the Western hemisphere;
Canada and Mexico are its top suppliers. But
then completing the list are countries like Saudi
Arabia, Venezuela and Nigeria – major players in
the global oil market with authoritarian regimes or
politically unstable governments. So consider the
range of implications for US oil supply if one of
these nations were to undergo a transformation of
power, civil unrest or even a natural disaster. The
US certainly got a foreshadowing of this in 2008
when gas prices reached $4 a gallon.
− World Oil Reserves: The US has 2.4 percent of
the world’s “proven” oil reserves, meaning the
oil that we know is there and can be pumped
using existing technology. But that’s a modest
percentage considering the US consumes more
of it than any other country – and also considering
the US is one of the largest oil producers. No
other country that produces as much oil also
consumes so much. To put this numbers in
a global perspective, the Middle East has 61
percent of the world’s proven oil reserves. Iran
alone accounts for 11.2 percent.
− Transportation: Transportation is one of the larg-
est consumers of energy in the world, accounting

CHART 4: TOP SUPPLIERS OF OIL TO THE US CHART 5: WORLD OIL RESERVES

Thousand barrels per day, 2007
Proved oil reserves as a percentage of world total, at end of 2007
Canada 2,455
Mexico 1,532 100%
1,485 90%
Saudia Arabia
80%
Venezuela 1,361
70% 61.0%
Nigeria 1,134 60%
Algeria 670 50%
Angola 508 40%
Iraq 484 30%
Russia 414 20% 11.6%
9.0% 9.5%
10% 3.3%
U.S. Virgin Isl. 346 3.2%
0%
0 1,000 2,000 3,000 North South and Europe, Middle East Africa Asia Pacific
America Central Eurasia
America
Source: “Monthly Imports Report,” January 2009, Energy
Information Administration Source: “BP Statistical Review of World Energy,” June
2008, BP

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Energy Update (continued)
for 58 percent of liquid fuel consumption in OECD
countries in 2004.
− Coal: Coal is the most abundant fossil fuel pro-
duced in the US and is used to generate nearly
half of all electricity in the United States. The
United States has the world’s largest known coal
reserves, 263.8 billion short tons, which are pro-
jected to sustain the US demand for electricity for
225 years. The consumption of coal is expected
to increase at an average annual rate of 2 percent
from 2005 to 2030. Countries such as China,
India and the US have vast reserves of coal and
can extract coal relatively cheaply, making it an
economically attractive source of energy.
− Renewable Energy: Renewable energy is the
fastest growing source of energy, with projected
consumption increasing by 2.1 percent annually
from 2005 to 2030. Renewable energy is gener-
ally more expensive to produce than energy from
fossil fuels and current projections show that it is
not a realistic substitute for traditional fossil fuel
supply in the foreseeable future.
CHART 6: WORLD ENERGY DEMAND
Total Energy Non-Fossil
60
300 Non-Fossil Wind & Solar
} }
150 Developing
Fossil Nuclear, Hydro
& Biomass
Fuels
Industrialized
1980 2020 1980 2020
(Million Barrels/Day Oil Equivalent)
Source: Global Energy Network
− China: Oil consumption in China has increased
8% annually since 2002, doubling from 1996-
2006. China is capable of overtaking the U.S.
as the world’s largest energy consumer by 2010
according to the EIA. In March 2009, the Chinese
government agreed to finance oil-field develop-
ments with Brazilian and Russian oil companies
in exchange for guaranteed supplies of crude oil.
China will loan the Brazilian oil company Petro-
bras (PBR) $10 billion for the development of its
pre-salt fields. In return, Brazil will supply China
with 100,000 to 160,000 barrels of crude oil per
day. Petrobras (PBR) has reached similar agree-
ments with Unipec, a subsidiary of China Petro-
leum and Chemical Corporation. Petrobras (PBR)
will sell between 60,000 and 100,000 barrels
of crude per day to Unipec in exchange for $10
billion in loans from Unipec and the China Devel-
opment Bank. In March 2009, the China Devel-
opment Bank signed a $15 billion financing deal
with Russia’s government-controlled oil company
Rosneftand a $10 billion deal with Transneft in ex-
change for future oil supplies. In exchange for the
loans to Russian oil companies, China will receive
oil supplies and a new pipeline spur to China.
For China, the deals secure 15 million tons of oil
(300,000 bpd) every year for the next 20 years.
China has also agreed to loan Venezuela $12 bil-
Wind & Solar lion in order to develop oil projects that have the
1.2 potential to increase Venezuelan exports to China
from 330,000 bpd to 1 million bpd by 2015.
China’s financing contracts with Petrobras (PBR)
Wind and Rosneft are part of the country’s strategy of
securing future energy contracts in order to meet
the country’s rising demand for energy.
Solar
1980 2020
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