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1. Agcapita Energy Update
October 2009
1

2. 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.
Kind Regards
Stephen Johnston - Partner
1

3. 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.
2

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

5. Energy Update (continued)
cheaper, the evidence we have seen suggests the why it has taken time for the reduced rig count
opposite: the long-term upward trend in the cost to impact production, but current rig counts are
of gas continues. However, we now find ourselves clearly unsustainable over the long term. Cana-
in a severe cyclical downturn. We believe that the dian production has also been reduced by lower
cyclical recovery will be relatively quick and that, rig counts, and hence imports to the US have
as a result, pricing will approach and surpass the dropped materially.
marginal cost of $7.50/mcf in the early part of
2010. − We think that LNG will not pose a material threat
to a recovery in US gas prices. Imports to the US
− The secular upward trend is unchanged because have been just 1.3 Bcfd so far in 2009 and with
even though shale gas is clearly abundant, there projects being delayed the anticipated flood of
is little evidence that producing it is cheap. We LNG will be smaller than expected. More im-
expect that most shales will be like the Barnett portantly, the world continues to have an LNG
Shale – very strong initial results followed by years shortage relative to regassification capacity, and
of rising F&D as companies either drill further from we expect that demand for LNG will be much
the core or drill wells too close to each other. stronger internationally than in the US.
Furthermore, shale gas still accounts for only 11%
of the total market, meaning that other gas drilling − We believe that the recovery of gas prices will be
must continue as well. We also believe that much led by declining supply of gas, not by a surge in
of the improvement in initial-production rates demand. Reductions in supply on a year-over-
seen in the past two years has been due to E&Ps year basis will be over 5 Bcfd, which is much
spending more on expensive completion tech- larger than the reductions in industrial demand,
niques, not due to improving geologic prospects. which was never greater than 2.5 Bcfd year over
year. We continue to model relatively weak indus-
− In terms of the cycle, the long-anticipated reduc- trial demand going forward, with little recovery in
tions in onshore supply have begun, with onshore the coming years. We believe there will be some
production 1.5% lower in July of this year than in growth in the electric power segment but there
June. We expect these production trends to con- may be a brief reduction in gas demand for power
tinue and to accelerate, and we believe that gas of around 1 Bcfd once gas again becomes more
production may be down as much as 10% year- expensive than coal.”
over year by December. There are a few reasons
4

6. Energy Update (continued)
enerGy Consumption QuiCK FaCts
− US Foreign Oil Dependence: In 2002, net imports − World Oil Reserves: The US has 2.4 percent of
accounted for 53% of U.S. oil consumed and is the world’s “proven” oil reserves, meaning the
projected to rise to 70% by 2025. 50 percent oil that we know is there and can be pumped
of US oil comes from the Western hemisphere; using existing technology. But that’s a modest
Canada and Mexico are its top suppliers. But percentage considering the US consumes more
then completing the list are countries like Saudi of it than any other country – and also considering
Arabia, Venezuela and Nigeria – major players in the US is one of the largest oil producers. No
the global oil market with authoritarian regimes or other country that produces as much oil also
politically unstable governments. So consider the consumes so much. To put this numbers in
range of implications for US oil supply if one of a global perspective, the Middle East has 61
these nations were to undergo a transformation of percent of the world’s proven oil reserves. Iran
power, civil unrest or even a natural disaster. The alone accounts for 11.2 percent.
US certainly got a foreshadowing of this in 2008
when gas prices reached $4 a gallon. − 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
5

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

8. DisClaimer:
The information, opinions, estimates, projections and other materials
contained herein are provided as of the date hereof and are subject to
change without notice. Some of the information, opinions, estimates,
projections and other materials contained herein have been obtained from
numerous sources and Agcapita Partners LP (“AGCAPITA”) and its affiliates
make every effort to ensure that the contents hereof have been compiled or
derived from sources believed to be reliable and to contain information and
opinions which are accurate and complete. However, neither AGCAPITA
nor its affiliates have independently verified or make any representation or
warranty, express or implied, in respect thereof, take no responsibility for
any errors and omissions which maybe contained herein or accept any
liability whatsoever for any loss arising from any use of or reliance on the
information, opinions, estimates, projections and other materials contained
herein whether relied upon by the recipient or user or any other third
party (including, without limitation, any customer of the recipient or user).
Information may be available to AGCAPITA and/or its affiliates that is not
reflected herein. The information, opinions, estimates, projections and other
materials contained herein are not to be construed as an offer to sell, a
solicitation for or an offer to buy, any products or services referenced herein
(including, without limitation, any commodities, securities or other financial
instruments), nor shall such information, opinions, estimates, projections and
other materials be considered as investment advice or as a recommendation
to enter into any transaction. Additional information is available by contacting
AGCAPITA or its relevant affiliate directly.
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