OCTOBER 2006

OIL & GAS BASICS

C O N F I D E N T I A L

Katherine Spector
(1-212) 834-2031
katherine.b.spector@jpmorgan.com

Scott Speaker
(1-212) 834-3878
AN D

scott.c.speaker@jpmorgan.com
P R I V A T E

Sung Yoo
(1-212) 834-7045
sung.k.yoo@jpmorgan.com
S T R I C TL Y

Kristi Jones
(1-212) 834-2835
kristi.l.jones@jpmorgan.com
 Oil & Gas Basics_20061020_book

This presentation was prepared exclusively for the benefit and internal use of the client in order to indicate, on a preliminary basis, the feasibility of a
possible transaction or transactions and does not carry any right of publication or disclosure to any other party. This presentation is incomplete without
reference to, and should be viewed solely in conjunction with, the oral briefing provided by JPMorgan. Neither this presentation nor any of its contents
may be used for any other purpose without the prior written consent of JPMorgan.

The information in this presentation is based upon management forecasts and reflects prevailing conditions and our views as of this date, all of which are
subject to change. In preparing this presentation, we have relied upon and assumed, without independent verification, the accuracy and completeness of
all information available from public sources or which was provided to us by or on behalf of the client or which was otherwise reviewed by us. In addition,
B A S I C S

our analyses are not and do not purport to be appraisals of the assets, stock, or business of the client. The information in this presentation does not take
into account the effects of a possible transaction or transactions involving an actual or potential change of control, which may have significant valuation
and other effects.

JPMorgan is a marketing name for investment banking businesses of J.P. Morgan Chase & Co. and its subsidiaries worldwide. Securities, syndicated loan
arranging, financial advisory and other investment banking activities are performed by J.P. Morgan Securities Inc. and its securities affiliates, and lending,
G AS

derivatives and other commercial banking activities are performed by JPMorgan Chase Bank and its banking affiliates. JPMorgan deal team members may
be employees of any of the foregoing entities.
&
O I L
 Oil & Gas Basics_20061020_book

Energy is significantly more volatile than other markets

Volatility
Volatility of
of Various
Various Markets
Markets
200% Power EUR GLD CL NG HO SPX 10-yr T bills

180%

160%

140%

120%

100%

80%

60%

40%

20%
B A S I C S

0%
Jan-01 Sep-01 Jun-02 Mar-03 Nov-03 Aug-04 May-05 Feb-06
G AS
&
O I L

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 Oil & Gas Basics_20061020_book

Agenda

Page

Oil Specifics 2

The Big Picture: Macro Oil Fundamentals 13

What’s the Story This Year? 24

Natural Gas Specifics 54

References, Websites and Data Releases to Watch 62

B A S I C S
G AS
&
O I L

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From the well to the tank. . .

S P EC I F I C S

Source: JPMorgan Energy Strategy

O I L

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Market drivers to watch
Oil
Oil Demand
Demand
„ Macro economy
— Sectoral trends – are growth sector
energy intensive?
— Power generation trends what kind
of fuel does new generation use?
— Transportation trends – number and
type of cars sold?
— Tax and subsidy regimes – distort
price signals to consumers and
affect their consumption behavior…
„ Weather, seasonality – winter heating
demand, summer cooling demand,
holidays, vacation and travel trends
„ Non-oil fuel markets, substitution
(e.g. gas, coal, hydro, nuclear)
„ Misc events – e.g. SARS, Sep. 11
Other
Other
„ Deals associated with
mergers/acquisitions
S P EC I F I C S
„ Speculative flows
Source: JPMorgan Energy Strategy
O I L
Oil & Gas Basics_20061020_book
Oil
Oil Supply
Supply Oil
Oil Inventories
Inventories
„ Upstream investment – capacity „ Level relative to long term trend and
additions? Cost? Location? Type of normal seasonality
crude?
„ Level relative to demand
„ Natural decline rates – Field age, field
maintenance, geological makeup „ Regional distribution
„ Levels at transit points
„ Geopolitics (e.g. Iran, Nigeria)
„ Field maintenance, unplanned outages „ Crude versus refined product levels
„ Weather (e.g. hurricanes)
„ OPEC decisions and politics – internal
politics, spare capacity, relationships
with consumer countries
Distribution
Distribution Oil
Oil Refining
Refining
„ Tanker supply/demand/rates „ Refinery capacity/investment
„ Seaborne disruptions – weather, traffic, „ Planned outages, unplanned outages
accidents
„ Refining economics, run rates
„ Port capacity, availability
„ Refined product yields
„ Pipeline capacity/nominations
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Price relationships to watch. . .and what JPMorgan trades

„ Time spreads Oil

— e.g. Q1 vs. Q3; winter vs. summer, Cal 05 „ Crude
vs. Cal 06 — WTI
— Brent
„ Regional spreads
— Tapis
— e.g. NYMEX West Texas Intermediate vs.
— Dubai
IPE Brent, NY Harbor gasoline vs. US Gulf
gasoline „ Refined products
US market:
„ Crude vs. refined product spreads — NYMEX heating oil
— ‘Cracks’ (e.g. crude-gasoline; — US Gulf Coast heating oil
crude-heating oil) — US Gulf Coast jet fuel
— Refinery margins — NYMEX gasoline
European market:
„ Crude grade differentials (physical trade only) — IPE gasoil
— e.g. West Texas Intermediate vs. — Gasoil 0.2% CIF NWE
West Texas Sour; Bonny Light vs. Brent — Jet fuel cargoes CIF NWE
— EN590 cargoes CIF NWE
„ Product vs. product spreads — 1% and 3.5% fuel oil cargoes FOB NWE
— e.g. gasoline-heating oil Asian market:
— Singapore jet fuel
„ Interfuel spreads
S P EC I F I C S

— e.g. natural gas-heating oil Natural Gas:

„ NYMEX natural gas
„ European natural gas priced as oil-referenced
formula
O I L

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How oil (gas) trades

Formal Exchanges Over-the-Counter

Int’l Petroleum Exchange

NY Mercantile Exchange Swaps/Options
(London)

West Texas Intermediate Variety Of Regional

Brent Crude
(‘Light, Sweet’) Crude Benchmark Crudes and
1 lot = 1,000 bbl Refined Products. . .
1 lot = 1,000 bbl

Heating Oil Gas Oil

1 lot = 42,000 gallons = 1,000 bbl 1 lot = 100 tonnes = 750 bbl

Unleaded Gasoline
1 lot = 42,000 gallons = 1,000 bbl
S P EC I F I C S

Henry Hub Natural Gas

1 lot = 10,000 MMBtu

Source: JPMorgan Energy Strategy

O I L

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Major global crude benchmarks and oil market centers

Urals
Dated Brent
London (IPE)

New York
WTI
(NYMEX)
Dubai

Oman
Tapis
Singapore
S P EC I F I C S

Source: JPMorgan Energy Strategy

O I L

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Risk exposure and management strategies

Production Exposure Type Risk Management Strategy

Price of crude Producer hedging: swaps or put options

Cost of transportation, Freight hedging

insurance, duty/tariff

Cost of carry (time value Hedging with time spreads

of money), time spread

Refinery margins Hedging cracks (spread between crude

and refined products) or full margins

Refined product price Consumer hedging: swaps or call options

Locational/basis risk Hedging product — product risk,

or regional risk
S P EC I F I C S

Retail margins
Consumption
Source: JPMorgan Energy Strategy
O I L

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Conventions of the oil market

Benchmarks
Benchmarks
Commodity Lot Size Quote Unit
Crude (global) 1,000 barrels US$/barrel
Gasoline (US) 42,000 gallons cents/gallon
Heating oil (US) 42,000 gallons cents/gallon
Gas oil (Europe) 100 metric tons US$/metric ton
Jet fuel (Europe) 100 metric tons US$/metric ton
Natural gas (US) 10,000 MMBtu US$/MMBtu

Parcel
Parcel
„ Barges: 1,000 - 5,000 MT (2 - 8 days loading)
„ Cargoes: 10,000 - 25,000 MT (15 days loading)

Delivery
Delivery Methods
Methods
„ Delivery specifications are factored into the cost of products. For example
— Free on Board (“FOB”)
— Cost Insurance Freight (“CIF”)

„ In the US, products may be priced as “pipe”, “barge”, or “waterborne” based on delivery method

Main
Main Locations
Locations
S P EC I F I C S

„ Europe: Amsterdam-Rotterdam-Antwerp; Arab Gulf; Mediterranean; North West Europe; Rotterdam.

„ United States: New York Harbour; Los Angeles; San Francisco; US Gulf Coast; Midcontinent; West Coast.
„ Singapore
Source: JPMorgan Energy Strategy
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For example. . .
What is the price of spot fuel oil relative to crude?

What region? Europe.

Rotterdam or Med? Med.

What sulphur content? 1%.

CIF or FOB? CIF.

Barge or cargo? Cargo. $239/tonne

Compare to what crude? Urals.

€36.60 x $1.34 - $239 x 1 tonne = $13.16/bbl

1 bbl Urals €1 1 tonne FO 6.66 bbl

Extensions of this idea?

S P EC I F I C S

Look at the forward spreads; look at the spread to the US or Asian fuel cracks

Source: JPMorgan Energy Strategy

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Backwardation vs. contango

Backwardation
Backwardation vs.
vs. Contango
Contango Curves
Curves
In US$/bbl
$5.30

contango curve
$5.20

$5.10

$5.00

backwardation curve
$4.90

$4.80

$4.70
S P EC I F I C S

M01 M05 M09 M13 M17 M21 M25 M29 M33

Source: JPM organ Energy Strategy

O I L

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More backwardation than contango

„ The oil curve shifts regularly Contango

Contango vs.
vs. Backwardation
Backwardation
between backwardation and Number of instances
contango 90

„ Historically, oil has spent 80

more time in backwardation
70
than contango
60
„ Backwardation has been Contango Backwardation
steeper than periods of 50

contango 40

30

20

10

0
$(11) $(9) $(7) $(5) $(3) $(1) $1 $3 $5 $7 $9 $11
S P EC I F I C S

N ote: M 02–M 13 in U S$/bbl

Source: JPM organ Energy Strategy
O I L

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 Oil & Gas Basics_20061020_book

Agenda

Page

Oil Specifics 2

The Big Picture: Macro Oil Fundamentals 13

What’s the Story This Year? 24

Natural Gas Specifics 54

References, Websites and Data Releases to Watch 62

B A S I C S
G AS
&
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How is crude oil related to other oils, like gasoline and heating oil?

„ Crude oil is what gets pumped out of the ground. Very

little crude oil is consumed directly — it is a raw
material that has to be refined into other products, such
as gasoline and heating oil

„ Other products that are derived from crude oil include:

Jet fuel, diesel, residual fuel oil, naphtha, kerosene,
lubricants, tar, asphalt, petrochemicals, fertilizers,
F U N D AM E N T AL S

and plastics

„ The difference between the price of a finished product,

such as gasoline, and the price of crude oil is often
referred to as the ‘crack spread.’ A crack spread is a
very simplistic representation of how much money a
OI L

refiner makes by turning crude into products

M AC R O

„ A refinery ‘netback’ is the crude price at which a refiner

breaks even, given the value of the finished product
slate minus other costs to the refiner such as transport
P I C T U R E :

costs, refinery fuel costs, etc.

„ A refinery ‘margin’ is essentially the refiner’s profit —

i.e. the value of the product slate, minus the cost of
crude inputs and other expenses
B I G

Source: JPMorgan Energy Strategy

T H E

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Is all crude oil the same?

„ There are many different grades of crude oil. All grades have different qualities, and sell for
different prices based on their qualities

„ When we talk about ‘light,

sweet’ crude, we mean grades
with a high API gravity number,
and a low sulfur content. A
‘heavy, sour’ crude has a low
F U N D AM E N T AL S

API gravity and a high sulfur

content

„ In general, light/sweet crude

tends to sell at a higher price
than heavy/sour crude
OI L

„ In general, refiners can produce

M AC R O

a higher yield of high quality

refined products, such as
gasoline, by running light/sweet
P I C T U R E :

crudes. Heavy/sour grades yield

less gasoline, and more of the
Source: JPMorgan Energy Strategy
‘dirty’ products such as fuel oil
B I G
T H E

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Where are most of the world’s oil reserves?

Proved
Proved Oil
Oil Reserves
Reserves (end
(end 2005)
2005)
In thousand million barrels
742.7
F U N D AM E N T AL S
OI L

140.5
M AC R O

103.5 114.3
59.5
40.2
P I C T U R E :

Asia Pacific North America Africa South & Central Europe & Eurasia Middle East
America
Source: JPMorgan Energy Strategy, BP Statistical Handbook (June 2006)
B I G
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Where are the world’s top consumers of oil?

Top
Top Oil
Oil Consumers
Consumers (2005)
(2005)

Other
49% United States
25%
F U N D AM E N T AL S
OI L

China
M AC R O

India Germany FSU Japan 9%

3% 3% 5% 6%
P I C T U R E :

Source: JPMorgan Energy Strategy, BP Statistical Handbook (June 2006)

B I G
T H E

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US gasoline: 12% of global demand and growing

US
US Gasoline
Gasoline Demand
Demand &
& Exploration
Exploration Based
Based on
on Fuel
Fuel Efficiency
Efficiency
In million b/d
12
Historical Gasoline Demand
Extrapolation at today's MPG

1.4 mbd
11
At 22 MPG

2.2 mbd
At 24 MPG

2.8 mbd
F U N D AM E N T AL S

3.4 mbd
10 At 26 MPG

270 kbd
At 28 MPG
At 30 MPG
9 At 30 MPG With Staggered Fleet Turnover
OI L

8
M AC R O

7
P I C T U R E :

6
1979 1981 1983 1985 1987 1989 1991 1993 1995 1997 1999 2001 2003 2005 2007 2009 2011 2013
Source: JPM organ Energy Strategy , EIA
B I G
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Who are the world’s top producers of crude oil?

2005
2005 Averages
Averages „ The world’s biggest producers are not
Volume in kbd necessarily the same as the world’s
Producer Volume Share of Global Production biggest exporters. For example, the US
Russia 9,185 12.5%
Saudi Arabia 9,063 12.4% and China produce a lot of oil, but
United States 5,131 7.0% export very little given high domestic
Iran 3,879 5.3%
China 3,617 4.9% demand
Mexico 3,334 4.6%
F U N D AM E N T AL S

Venezuela 2,706 3.7%

Norway 2,506 3.4% „ OPEC members Saudi Arabia and Iran
UAE 2,458 3.4%
Nigeria 2,405 3.3% are the world’s biggest exporters of
Kuwait 2,133 2.9% crude oil
Iraq 1,813 2.5%
Canada 1,805 2.5%
Libya 1,640 2.2%
Brazil 1,634 2.2%
OI L

UK-offshore 1,560 2.1%

Algeria 1,345 1.8%
M AC R O

Angola 1,245 1.7%

Kazakhstan 1,025 1.4%
Indonesia 942 1.3%
Qatar 796 1.1%
P I C T U R E :

Malaysia 727 1.0%

Oman 722 1.0%
Argentina 665 0.9%
India 663 0.9%
Other 10,206 13.9%
B I G

Note: Bold = OPEC members

Source: JPMorgan Energy Strategy, IEA
T H E

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What is OPEC’s role

OPEC does not set prices. OPEC sets production quotas. Currently 10 of the
cartel’s 11 members are subject to group quotas; Iraq is exempt. Saudi Arabia is
by far the group’s biggest and most influential member

What is OPEC’s ideal price?

F U N D AM E N T AL S

Contrary to popular believe, it is not to OPEC’s advantage to target as high an oil

price as possible. The cartel wants to maximize revenues, but needs consumers as
much as consumers need OPEC oil. At very high oil prices, OPEC faces two risks:
OI L

1. High oil prices could reduce economic growth and oil demand growth
M AC R O

2. High oil prices could encourage higher-cost non-OPEC producers to

make investments that would increase global oil supply, and reduce
OPEC’s market share
P I C T U R E :
B I G
T H E

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A little history. . .

US
US Refiner
Refiner Acquisition
Acquisition Price
Price of
of Imported
Imported Crude
Crude
In US$/bbl
$100
Nominal Real
$90

$80
F U N D AM E N T AL S

$70 Iran-Iraq Non-OPEC competition

Hurricane
War grows, price war
Katrina & Rita
$60
Gulf War I Hurricane Ivan
$50
Venezuela Crisis,
$40 Gulf War II,
Nigerian strike, Nigeria strike
OI L

cold winter
$30
M AC R O

$20
Soviet Union 9/11
$10 Netback Exxon Valdez
Pricing collapse Asian Crisis
spill
P I C T U R E :

$0
1980 1982 1984 1986 1988 1990 1992 1994 1996 1998 2000 2002 2004 2006

Source: JPMorgan Energy Strategy, EIA

B I G
T H E

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Until this bull run, loss of market share was a real concern for OPEC

Shifting
Shifting Market
Market Share
Share
OPEC Share of Global Oil Production (%) FSU/Saudi Oil Production (mbd)
42% 12.5

41%
11.5

40%
10.5
F U N D AM E N T AL S

39% Saudi Oil Production

9.5
38%
8.5
37%
OI L

7.5
36% FSU Oil Production
M AC R O

OPEC Share of Global Production

35% 6.5
P I C T U R E :

34% 5.5
'95 '96 '97 '98 '99 '00 '01 '02 '03 '04 '05 '06

Source: JPM organ Energy Strategy , IEA, OPEC

B I G
T H E

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Keeping the cartel together can be tough, too

The
The Prisoner’s
Prisoner’s (OPEC
(OPEC Member’s)
Member’s) Dilemma
Dilemma

The best OPEC MEMBER #1

outcome for Cut Production Cheat on Quotas Given the chance that
the group as a other members might
whole, but hard cheat, and the non-
to achieve. . . cheater could end up
Cut Production in his worst case
F U N D AM E N T AL S

(6,6) (1,10) scenario, all members

have an incentive to
cheat themselves
OPEC MEMBER #2
Cheat on Quotas
OI L
M AC R O

(10,1) (3,3) All members have an

incentive to cheat,
even though they
would all be better
P I C T U R E :

off sticking to quotas

Source: JPMorgan Energy Strategy

B I G
T H E

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Agenda

Page

Oil Specifics 2

The Big Picture: Macro Oil Fundamentals 13

What’s the Story This Year? 24

Natural Gas Specifics 54

References, Websites and Data Releases to Watch 62

B A S I C S
G AS
&
O I L

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Short- to medium-term drivers for the oil market

Current
Current JPMorgan
JPMorgan Price
Price Forecasts
Forecasts
1Q06 2Q06 3Q06 4Q06 2005 2006 2007
WTI Forecast … … … 65.00 … 67.39 64.05 „ Ongoing oil buying interest from consumers
and investors
WTI Actual* 63.48 70.72 70.60 59.90 56.70 … …
„ Iran noise; major Nigerian disruptions
Brent Forecast … … … 64.00 … 67.05 63.05
„ Call on OPEC crude still topping 30 million
Brent Actual* 62.71 70.43 71.00 59.78 55.25 … …
b/d in 2007
Natural Gas Forecast … … … 7.67 … 7.32 7.50
„ OPEC showing commitment to a $50-55
Natural Gas Actual 7.84 6.65 6.18 6.02 9.02 … … basket price
2006 crude forecasts as of May 2, 2006, 2007 crude forecasts as of Aug. 9, 2006.
Natural gas forecast as of March 2, 2006 *Actual to date prices as of October 6, 2006
Note: All values are period averages. WTI & Brent in $/bbl; natural gas in $/MMBtu
Source: JPMorgan Energy Strategy

Crude
Crude Oil
Oil Price
Price History,
History, Forwards
Forwards &
& Forecast
Forecast Range
Y EAR ?

Range „ Comfortable oil inventories

US$/bbl
$100 „ Hurricane season less eventful than expected?
JPM Probable Range
Warm weather this winter to follow?
THI S

JPM Possible Range

$80
History
Forward Curve „ Global oil demand growth moderating; slower
$60
S T O RY

JPM Forecast economic growth ahead

$40
„ Downstream investment should start to hit
$20
the market in 2007-08
TH E

$0
'95 '96 '97 '98 '99 '00 '01 '02 '03 '04 '05 '06 '07 '08 '09 '10 '11 '12 '13
„ Reassessment of investors’ commodities
allocations down the road as returns falter
WHAT’S

Source: JPM organ Energy Strategy

and interest rates rise?
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The crude oil market today

Crude
Crude Oil
Oil Price
Price History
History &
& Forwards
Forwards
In US$/bbl

$75 WTI Brent

$65

$55

$45

$35
Y EAR ?

$25
THI S

$15
S T O RY

$5
$0
1988 1990 1992 1994 1996 1998 2000 2002 2004 2006 2008 2010 2012
TH E

Source: JPMorgan Energy Strategy

WHAT’S

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This has been a refined products driven market

Heating
Heating Oil
Oil Crack
Crack +
+ Forwards
Forwards Gasoline
Gasoline Crack
Crack +
+ Forwards
Forwards
US$/bbl US$/bbl
$20 $20

$18 $18 Gasoline Crack

Heat Crack Fwds Gasoline Crack Fwds
$16 Heat Crack $16

$14 $14

$12 $12

$10 $10

$8 $8

$6 $6

$4 $4
Y EAR ?

$2 $2
$0 $0
THI S

'95 '96 '97 '98 '99 '00 '01 '02 '03 '04 '05 '06 '07 '08 '09 '10 '95 '96 '97 '98 '99 '00 '01 '02 '03 '04 '05 '06 '07 '08 '09 '10
Source: JPMorgan Energy Strategy Source: JPM organ Energy Strategy
S T O RY

Although demand growth has moderated, we don’t think the products story is ‘over’ yet. New
TH E

refinery capacity additions will pressure these markets by 2007—2008, but not yet this year. Spec
changes in the US will be supportive psychologically if not physically
WHAT’S

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Commercial oil inventories — Crude levels remain healthy

Total
Total OECD
OECD Commercial
Commercial Inventories
Inventories „ A 7 million bbl build in refined product
In days of demand cover inventories offset a 7 mb draw from crude.
60
Winter Summer Linear Trend
The level of crude remains much more
58
comfortable than the level of refined
56
product stocks
54

52 „ Regionally in August, builds in the US and

50 Japan offset draws in Europe and other
480 areas
Jun-99 Jun-00 Jun-01 Jun-02 Jun-03 Jun-04 Jun-05 Jun-06
Source: JPMorgan Energy Strategy , IEA, Gov n't & industry sources

Total
Total OECD
OECD Crude
Crude Inventories
Inventories Total
Total OECD
OECD Product
Product Inventories
Inventories
In billion bbl In billion bbl
Y EAR ?

1.69
1.10
1.64
1.05
THI S

1.59
1.00
1.54 Five-Year Range
Five-Year Average
S T O RY

Five-Year Range
0.95 Five-Year Average 1.49 2005
2005 2006
2006
0.00
0.90 1.44
0.00
Jan Feb Mar Apr May Jun Jul Aug Sep Oct Nov Dec Jan Feb Mar Apr May Jun Jul Aug Sep Oct Nov Dec
TH E

Note: Latest month is to-date only , not full-month projection Note: Latest month is to-date only , not full-month projection
Source: JPMorgan Energy Strategy , IEA, Gov n't & industry sources Source: JPMorgan Energy Strategy , IEA, Gov n't & industry sources
WHAT’S

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Hurricanes hammer US Gulf refineries

Roughly a quarter of US refining capacity was offline at peak during last year’s unprecedented hurricane season.
Much of the hurricane-affected capacity had normalized by early 2006 with a few major exceptions

As of May 3, 325,000 b/d, or 22%, of Gulf of Mexico oil production remains offline, according to MMS reporting

Hurricane
Hurricane Impacts
Impacts in
in Perspective
Perspective
Gulf of Mexico Crude Shut In (in mbd) In US$
Actual Refinery Loss Minus Gulf of Mexico Crude Shut In Gasoline Crack
3.5 Projected Refinery Loss Minus Gulf of Mexico Crude Shut In Heating Oil Crack $35
Gasoline Crack Fwd
3.0 NYMEX Heating Oil Crack Fwd $30

2.5 $25
Y EAR ?

2.0 $20

1.5 $15
THI S

1.0 $10
S T O RY

0.5 $5

0.0 $-
TH E

-0.5 $(5)
28-Aug-05 27-Sep-05 27-Oct-05 26-Nov-05 26-Dec-05 25-Jan-06 24-Feb-06 26-Mar-06 25-Apr-06 25-May-06
WHAT’S

Source: JPMorgan Energy Strategy, EIA, government and country sources

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US refinery maintenance: Looking ahead to the fall

US
US Planned
Planned &
& Unplanned
Unplanned Refinery
Refinery Shutdowns
Shutdowns
Average Offline Capacity Per Month (in million b/d)
2.7
Unplanned
2.4
PADD I (East Coast) Hurricane
2.1 PADD II (Midwest) Katrina & Rita
1.8 PADD III (Gulf)
PADD IV (Rockies)
1.5 Hurricane
PADD V (West Coast)
Ivan
1.2

0.9

0.6
Y EAR ?

0.3

0.0
THI S

Mar-02 Jul-02 Nov-02 Mar-03 Jul-03 Nov-03 Mar-04 Jul-04 Nov-04 Mar-05 Jul-05 Nov-05 Mar-06 Jul-06 Nov-06

Source: JPM organ Energy Strategy , IIR

S T O RY

„ While the US planned refinery maintenance program for October looks to be heavier this year
than last year, unplanned outages are minimal compared to 2005. Planned maintenance is set
TH E

to average 798 kbd offline in October, compared to 527 kbd offline in October of last year.
Unplanned outages of several hundred thousand barrels for October 2006 compared to more
WHAT’S

than 2 million b/d lost in October 2005

30
 Oil & Gas Basics_20061020_book

Gasoline: An easier problem to solve in the Atlantic Basin

Net
Net Gasoline
Gasoline Balances
Balances By
By Region
Region Net
Net Gasoil
Gasoil Balances
Balances By
By Region
Region
Regional production minus regional consumption (in kbd) Regional production minus regional consumption (in kbd)
1,000 OECD Asia 400 Asia
OECD Europe Europe
800 OECD North America 300
North America
Total OECD
600 200 Total OECD

400 100

200 0

0 -100

-200 -200

-400 -300

-600 -400
Y EAR ?

-800 -500

-1,000 -600
THI S

1995 1996 1997 1998 1999 2000 2001 2002 2003 2004 2005 1995 1996 1997 1998 1999 2000 2001 2002 2003 2004 2005
Source: JPM organ Energy Strategy , IEA Source: JPM organ Energy Strategy , IEA
S T O RY

Europe has always been structurally long gasoline but has become more so as vehicle demand shifts
TH E

to diesel. The Atlantic Basin is now long gasoline. . .but shorter and shorter distillate
WHAT’S

31
 Oil & Gas Basics_20061020_book

Changes to diesel specs: Lower sulfur limits to challenge supply chain

Changes „ The US diesel sulfur limit drops by 97% this

Changes to
to Diesel
Diesel Sulfur
Sulfur Limits
Limits
year to 15 ppm
In ppm 2003 2004 2005 2006 2007 2009 2010
US 500 15 „ US refiners were required to meet the new
Europe 500 350 50 10 standard by June 1; pipeline operators must
Canada 500 15 meet the 15 ppm limit by Sept. 1; retailers
China* 500 350
must offer 15 ppm by Oct. 15
India** 2,500 500 350 50 „ Dramatic changes to diesel standards
Brazil 5,000 2,000 500 50 underscore the challenge of not only making
Japan 50 10 the fuel but also distributing it to customers.
S Korea 430 30 10 While US refiners have successfully ramped
up ULSD production and inventories of the
* Implemented in Beijing July 2005 ahead of 2008 Olympics; to be enforced nationwide 2010
** Implemented in major cities in 2005; to be enforced nationwide in 2010 new spec have climbed steadily, there are
Source: JPMorgan Energy Strategy, government & press reports
still logistical challenges associated with the
storage and transport of the cleaner fuel
Y EAR ?

US
US Diesel
Diesel Inventories
Inventories By
By Sulfur
Sulfur Content
Content
„ Ultra-low sulfur diesel is so much cleaner
Million bbl
than others in the distillate family (heating
80
THI S

oil, jet, kerosene) that operators will be

60 challenged in how they batch/order the fuels
in the pipe. Test flows have shown that the
S T O RY

40 <15 ppm sulphur diesel

sulfur in ULSD will have to be far
20 15-50 ppm sulphur diesel lower/cleaner in order to deliver fuel at the
government-set limit to consumers. Separate
TH E

0
storage tanks will also be required for
Feb'05 Apr'05 Jun'05 Aug'05 Oct'05 Dec'05 Feb'06 Apr'06 Jun'06 Aug'06 distribution of ULSD
WHAT’S

Source: JPM organ Energy Strategy , EIA

32
 Oil & Gas Basics_20061020_book

Changes to gasoline specs: Sulfur limits and oxygenate requirements

Changes
Changes to
to Gasoline
Gasoline Sulfur
Sulfur Limits
Limits RFG
RFG Inventories
Inventories vs.
vs. RBOB/Alcohol
RBOB/Alcohol Stocks
Stocks
In million bbl
In ppm 2004 2005 2006 2008 2009
35 Finished RFG RBOB w/ Alcohol
European Union 150 50 10
30
US 120 90 30
25
China* 500 150
20
India** 500 150
15
Japan 50 10 10
South Korea 130 50 5
Brazil** 400 80 Jul-04 Oct-04 Jan-05 Apr-05 Jul-05 Oct-05 Jan-06 Apr-06

* Implemented in Beijing July 2005 ahead of 2008 Olympics; to be enforced Source: JPM organ Energy Strategy , EIA
nationwide 2010
** Implemented in major cities in 2005; to be enforced nationwide in 2010
Source: JPMorgan Energy Strategy, government & press reports
Y EAR ?

„ Major US gasoline spec changes slated for 2006: lower sulfur content limit and the
THI S

elimination of the oxygen content standard, which will impact MTBE use
„ While market concern, over the what is in effect an MTBE phase-out, has been
S T O RY

dramatic, these worries are overdone. We are experiencing some hiccups along
the supply chain during the present transition period, but these should work
TH E

themselves out as the US has proven itself to be quite capable of blending

components up to standard
WHAT’S

33
 Oil & Gas Basics_20061020_book

Phasing out MTBE. . . phasing in ethanol

„ 2005 US Energy Policy Act eliminated the national oxygen content standard in
gasoline — while not explicitly banning MTBE — it effectively phases out the
gasoline additive MTBE and phases in the use of renewable fuels
⎯ MTBE has been found to contaminate groundwater, opening up MTBE-makers
up to lawsuits

„ Most of the industry are using ethanol because it replaces octane and clean-
burning properties of MTBE and it is in compliance with renewable fuel standard

„ Because of ethanol’s affinity to water, it cannot be transported by pipeline

after mixing with gasoline
Y EAR ?

⎯ Reformulated gasoline for oxygenate blending (RBOB) is blended with ethanol

in the tank, after it has been transported separately by pipe
THI S

⎯ States such as New York and California have already successfully phased out
MTBE in favor of ethanol
S T O RY
TH E
WHAT’S

34
 Oil & Gas Basics_20061020_book

Short- to medium-term drivers for the oil market

Bullish
„ Ongoing oil buying interest from
consumers and investors
„ Iran noise; major Nigerian disruptions
„ Call on OPEC crude still topping 30
million b/d in 2007
„ OPEC showing commitment to a
$50-55 basket price
Y EAR ?
Bearish
„ Comfortable oil inventories
„ Hurricane season less eventful than
expected. Warm weather this winter
to follow?
„ Global oil demand growth
moderating; slower economic growth
ahead

„ Downstream investment should start

to hit the market in 2007-08
THI S

„ Reassessment of investors’
S T O RY

commodities allocations down the

road as returns falter and interest
rates rise?
TH E
WHAT’S

35
 Oil & Gas Basics_20061020_book

Mean reversion (at least to the $20) is out the window

We are now assuming a new long-term average of $40

Front-month
Front-month NYMEX
NYMEX West
West Texas
Texas Intermediate
Intermediate with
with ‘Snapshot
‘Snapshot in
in Time’
Time’ Future
Future Strips
Strips
In US$/bbl
$80

$70

$60

$50

$40
Y EAR ?

$30

$20
THI S

$10
S T O RY

$-
'94 '95 '96 '97 '98 '99 '00 '01 '02 '03 '04 '05 '06 '07
TH E

Source: JPM organ Energy Strategy

WHAT’S

36
 Oil & Gas Basics_20061020_book

Today’s crude curve: Contango in the front, backwardation further out

West
West Texas
Texas Intermediate
Intermediate Curve
Curve
In US$/bbl
$70

$68

$66

$64

$62
Y EAR ?

$60
THI S

$58
S T O RY

$56
$0
Nov06 May07 Nov07 May08 Nov08 May09 Nov09 May10 Nov10 May11 Nov11 May12 Nov12
TH E

Source: JPM organ Energy Strategy

WHAT’S

37
 Oil & Gas Basics_20061020_book

A new paradigm — contango at $70!

WTI
WTI Flat
Flat Price
Price vs.
vs. Backwardation
Backwardation (in
(in US$/bbl)
US$/bbl)
M01-M02 NYMEX WTI M01 NYMEX WTI
$4 $75

$65
$3

$55

$2 Backwardation
$45

$1 $35

$25
Y EAR ?

$-

$15
THI S

$(1)
Contango $5
S T O RY

$(2) $(5)
'86 '87 '88 '89 '90 '91 '92 '93 '94 '95 '96 '96 '97 '98 '99 '00 '01 '02 '03 '04 '05 '06
TH E

Source: JPM organ Energy Strategy

We see contango as sustainable at these price levels. However, a compelling move lower (sub $50)
WHAT’S

could see backwardation return

38
 Oil & Gas Basics_20061020_book

WTI backwardation vs. flat price

WTI
WTI Backwardation
Backwardation vs.
vs. Flat
Flat Price
Price
M01 NYMEX WTI (in US$/bbl)
$90
1996-2002 2004-present 10/13/2006
$80

$70

$60

$50

$40

$30

$20

$10
Y EAR ?

$0$-
$(8) $(6) $(4) $(2) $- $2 $4 $6 $8 $10 $12
THI S

M02-M24 NYMEX WTI (US$/bbl)

Source: JPMorgan Energy Strategy
S T O RY

We see contango as sustainable at these price levels. However, a compelling move lower (sub $50)
could see backwardation return
TH E
WHAT’S

39
 Oil & Gas Basics_20061020_book

Change in the balance of energy market participation

„ At the end of the day, supply and demand determine price. Past 2 yeas had a good fundamentals story
„ But if there has a been a ‘paradigm shift’ in this market, it is a shift in the balance of participation

Participant Old or New? Active or Passive? Buyers or Sellers? Where on the Curve? Activity vs. 3 Years Ago?
Old — Energy producers have Active — May trade anywhere Sellers — The natural sellers in the energyDown — Significantly less day-to-
been actively hedging with from daily to annually markets. Producers typically hedge 2-3 day tactical hedging at high prices.
Energy Producers derivatives since the early-1990s depending on hedging program years out but can now find sufficient Remaining deals large, occasional,
liquidity to hedge as much as 7 years out one-off M&A related strategic
(E&P companies) hedges. Options strategies generally
preferred over swaps, for downside
protection with upside exposure
Old — Energy consumers have Active — May trade anywhere Buyers — The natural buyers in the energy Up — If anything consumers have
Energy Consumers been actively hedging with from daily to annually markets. Consumers typically hedge 1-3 hedged more actively as prices have
derivatives since the early-1990s depending on hedging program years into the future, but increasingly more risen, though options rather than
(Utilities, airlines, sophisticated hedgers may go out as far as swaps have been the preferred
railroads, industrials) 5-7 years in products with sufficient vehicle for upside protection with
liquidity downside participation
Old — Although the mix of banks Active — Trade daily making Buyers or Sellers — Depending on customer No significant change, though
Financial institutions in energy changes, banks have markets (flow and structured business and view of the market. Depending interest has arguably increased with
been market-makers and risk business) and/or taking risk on customer business, banks may make price
(Banks) takers in energy since the (proprietary trading). May have markets as far as 10+ years into the future
Y EAR ?

inception of these markets long or short term prop views

Trend Players Old — CTAs have traded energy Active — Fast moving, Buyers or Sellers — Depending on market No significant change
for years directional, tend to enter and trend
(Commodity Trading
exit positions quickly
Advisors)
THI S

Old and New — Not new to Active — Take proprietary risk Buyers or Sellers — Depending on view of Up — Generally more dollars in
energy per se but more daily. May have long or short the market. On average in recent years, energy, but also more sophisticated
professional and putting more term views, and take hedge funds more long than short given and varied involvement in full range
S T O RY

money towards this space in the directional or relative value price trend.Funds may participate in any of energy products
Macro Hedge Funds
last ~3 years positions in the full range of part of the curve and have shown particular
energy products interest in owning deferred price and
volatility, adding liquidity and price clarity
to that part of the curve
TH E

New — Institutional investors Passive — Take long-term, Buyers — Institutionals enter the market Up significantly — Major inflow of
Institutional Investors have really only started to generally directional views. almost exclusively from the long side via money and interest in commodities
(Pension funds, mutual participate in the energy space Tend not to enter or exit products like Commodities Indices and oil- as an asset class that really did not
WHAT’S

funds, retail investors) in the past ~3 years positions on short-term price linked notes exist in a meaningful way 3 years
fluctuations ago

40
 Oil & Gas Basics_20061020_book

Medium-term drivers of oil price have not gone away — yet

Key fundamental drivers have supported oil prices in recent years that are
still with us today
„ For the past several years, we have seen a refined products-led market.
In other words, as much as crude oil prices have increased, prices for refined
products such as gasoline and diesel have gone up even more

„ This had been in large part a demand story. Demand growth has been strong —
particularly in 2004, and particularly in the US and non-OECD Asia. Importantly,
demand growth is disproportionately for ‘light-end’ products, notably diesel, which
is a type of distillate
Y EAR ?

„ The oil industry cycles through periods of over- and under-investment. Refining
and distribution (e.g. pipelines, tankers, terminals) are particularly pronounced
examples of how years of under-investment due to poor margins can lead to
THI S

capacity constraints down the road

S T O RY

„ While under-investment in refining and distribution is not a permanent market

feature, it is also not a driver that can be reversed overnight. We see tight
TH E

downstream capacity influencing price until at least 2007—08, unless demand

growth falters significantly
WHAT’S

41
 Oil & Gas Basics_20061020_book

Is the demand story over?

Historical
Historical Oil
Oil Demand
Demand Growth
Growth
%yoy, 3 month rolling average
30% OECD Demand Growth/Contraction Non-OECD Demand Growth/Contraction OECD Project
Non-OECD Project Global Demand Growth Historical Average Rate of Global Growth
25% World Project

20%

15%

10%

5%
Y EAR ?

0%

-5%
THI S

Apr-98 Mar-99 Feb-00 Jan-01 Dec-01 Nov-02 Oct-03 Sep-04 Aug-05 Jul-06 Jun-07

Source: JPMorgan Energy Strategy

S T O RY

Demand growth has moderated relative to 2004. We see this trend continuing for the
balance of the year
TH E
WHAT’S

42
 Oil & Gas Basics_20061020_book

Light-end products dominate global oil demand growth

Dieselization and tightening global fuel specs will continue to dictate the global oil demand
growth profile — we see this trend continuing even as total demand growth eases
Global
Global Oil
Oil Demand
Demand Growth
Growth by
by Major
Major Product
Product
In kbd
3,250

Gasoline Distillate Jet/Kero Fuel Oil Heavy Light

2,500

1,750
Y EAR ?

1,000
THI S

250
S T O RY

-500
2000 2001 2002 2003 2004 2005
TH E

Source: JPM organ Energy Strategy , IEA, gov ernment & industry sources
WHAT’S

43
 Oil & Gas Basics_20061020_book

Energy intensity in emerging economic powers moderates as they grow

Energy
Energy Intensity/GDP
Intensity/GDP —
— China
China &
& Japan
Japan Energy
Energy Intensity
Intensity Declines
Declines As
As GDP
GDP Increases
Increases
Oil bbl consumed per US$1,000 GDP Oil bbl consumed per US$1,000 GDP
8 9
7 Japan China 8 OECD Non-OECD
6 7
Find from same publication (above)
5 6
5
4
4
3
3
2
2
1
1
0
0
Y EAR ?

0 1,000 2,000 3,000 4,000 5,000

250 5,250 10,250 15,250 20,250 25,250
GDP (in billion current US$)
GDP (in billion current US$)
THI S

Source: JPM organ Energy Strategy , BP Statistical H andbook Source: JPM organ Energy Strategy , BP Statistical H andbook
S T O RY

Chinese oil demand growth will continue to be significant to the global balance, especially in the
lead-up to the Beijing Olympics. But the energy intensity to growth ratio does moderate as
TH E

countries get richer

WHAT’S

44
 Oil & Gas Basics_20061020_book

The cycle of investment

OECD
OECD Oil
Oil Demand
Demand vs.
vs. Refinery
Refinery Capacity
Capacity „ Downstream investment, or lack
In million b/d thereof, is cyclical and tends to over-
55 shoot in both directions
Refined Products Import Gap
Refinery Capacity „ There’s no reason to think that this
50 Oil Demand
investment cycle won’t — eventually —
be the same
45

„ OECD demand exceeds OECD refinery

40 capacity. That means that, increasingly,
‘spare’ refinery capacity is in the non-
35
OECD. That means that — just like
Y EAR ?

crude production — most of the world’s

30
refined products production is
geographically far away from most of
THI S

25
the world’s consumption
S T O RY

200
'83 '85 '87 '89 '91 '93 '95 '97 '99 '01 '03 '05
TH E

Source: JPM Energy Strategy , IEA, EIA

WHAT’S

45
 Oil & Gas Basics_20061020_book

Energy infrastructure/distribution capacity is still a constraint

Global
Global Oil
Oil Demand
Demand Supplied
Supplied By
By International
International Trade
Trade
Oil Trade:Oil Demand
2000-04: 58%
60%
1995-99: 55%

55% 1990-94: 51%

50%
1985-89: 44%
45% Growth In Waterborne
Crude & Products Transport
Crude Refined Products
40%
1987-1995 3.6% 1.8%
1996-2005 2.5% 3.8%
35% 2001-2005 1.7% 5.4%
Y EAR ?

Source: Clarkson's Shipping Review

30%
0%
THI S

1985 1986 1987 1988 1989 1990 1991 1992 1993 1994 1995 1996 1997 1998 1999 2000 2001 2002 2003 2004

Source: JPMorgan Energy Strategy, BP Statistical Handbook

S T O RY

More refined products, in particular, have to travel greater distances to their end user. Ports,
pipes, tankers, etc. are all an issue — will they see the investment boom that refining is seeing?
TH E
WHAT’S

46
 Oil & Gas Basics_20061020_book

Non-OPEC production has disappointed in recent years

Historical
Historical Oil
Oil Supply
Supply Growth
Growth
%yoy, 3 month rolling average
25%
OPEC Supply Growth/Contraction Non-OPEC Supply Growth/Contraction
Global Supply Growth Historical Average Rate of Global Growth
20%

15%

10%

5%
Y EAR ?

0%
THI S

-5%
S T O RY

-10%
Mar-98 Jul-99 Nov-00 Mar-02 Jul-03 Nov-04 Mar-06 Jul-07
TH E

Source: JPMorgan Energy Strategy, IEA

WHAT’S

47
 Oil & Gas Basics_20061020_book

OPEC sails through three bull years

OPEC
OPEC Crude
Crude Production
Production &
& Group
Group Quota
Quota
In million b/d
29

28

27

26

25 Quota
24

23
OPEC-10 Wellhead
22 Production of Crude
Y EAR ?

21

200
THI S

Oct-02 Mar-03 Aug-03 Jan-04 Jun-04 Nov-04 Apr-05 Sep-05 Feb-06 Jul-06
S T O RY

Source: JPM organ Energy Strategy , IEA

OPEC’s market relevance has waned. The group hasn’t had to cut production — or show any
discipline — since March 2004
TH E
WHAT’S

48
 Oil & Gas Basics_20061020_book

Sliding OPEC spare capacity, but capacity additions in the pipeline

Expected
Expected Additions
Additions to
to
OPEC
OPEC Spare
Spare Capacity
Capacity vs.
vs. Price
Price OPEC Capacity* (in kbd)
OPEC Capacity* (in kbd)
In kbd US$/bbl 2006
Saudi Arabia 300
8,000 Spare Capacity Nymex WTI Price $80 Iran 160
Nigeria 265
Algeria 50
7,000 $70 Venezuela 75
Libya 150
UAE 200
6,000 $60
2007
Saudi Arabia 500
5,000 $50
Nigeria 220
Algeria 140
4,000 $40
2008
Saudi Arabia 300
3,000 $30 Nigeria 1,130
Y EAR ?

Indonesia 180

2,000 $20 2009-2010

Saudi Arabia 1,200
THI S

Algeria 100
1,000 $10 Qatar 525
S T O RY

2006 1,200
0 $- 2007 860
2008 1,610
Aug-97 Feb-99 Aug-00 Feb-02 Aug-03 Feb-05 Aug-06
2009-2010 1,825
TH E

2006-2010 Total 5,495

Source: JPMorgan Energy Strategy * Excluding declines
Note: This is not a complete list and is subject to change
WHAT’S

Source: JPMorgan Energy Strategy, government

reports, media reports

49
 Oil & Gas Basics_20061020_book

Top geopolitical hotspots: No strangers to disruptions

Iran
Iran Iraq
Iraq
In million b/d In million b/d
6 4 Iran-Iraq Gulf War II
Iranian
5 War
Revolution 3 Gulf War I
4
3 2
2
1
1
0 0
'67 '69 '71 '73 '75 '77 '79 '81 '83 '85 '87 '89 '91 '93 '95 '97 '99 '01 '03 '05 '67 '69 '71 '73 '75 '77 '79 '81 '83 '85 '87 '89 '91 '93 '95 '97 '99 '01 '03 '05
Source: JPMorgan Energy Strategy , BP Statistical Handbook Source: JPMorgan Energy Strategy , BP Statistical Handbook

Nigeria
Nigeria Venezuela
Venezuela
In million b/d
Y EAR ?

In million b/d Strike cripples

3 Strike cripples 4 production
production
3
2
THI S

2
1
S T O RY

0 0
'79 '81 '83 '85 '87 '89 '91 '93 '95 '97 '99 '01 '03 '05 '67 '69 '71 '73 '75 '77 '79 '81 '83 '85 '87 '89 '91 '93 '95 '97 '99 '01 '03 '05
TH E

Source: JPMorgan Energy Strategy , BP Statistical Handbook Source: JPMorgan Energy Strategy , BP Statistical Handbook
WHAT’S

50
 Oil & Gas Basics_20061020_book

Oil production: An inherently risky business

OECD
OECD Reserves
Reserves as
as %
% of
of Global
Global Oil
Oil Reserves
Reserves by
by Risk
Risk of
of Location
Location
OECD Reserves: Global Reserves Total Reserves (in '000 billion bbl)
25% 500 More corrupt/risky Less corrupt/risky
450

20% 400
350 <5 = 1,062
300 >5 = 329
15%
250
200
10% 150
100
50
5%
0
Y EAR ?

0-1 1-2 2-3 3-4 4-5 5-6 6-7 7-8 8-9 9-10
0%
'81 '83 '85 '87 '89 '91 '93 '95 '97 '99 '01 '03 '05 Average of Country Risk Rating & Corruptionion Perception Index
THI S

(0 = highest risk/most corrupt)

Source: JPM organ Energy Strategy , BP Statistical H andbook Source: JPMorgan Energy Strategy , BP Statistical Handbook, Transparency International, UNCTAD
S T O RY

More and more of the world’s remaining oil reserves are in geopolitically ‘risky’ parts of the world,
and that’s not going to change
TH E
WHAT’S

51
 Oil & Gas Basics_20061020_book

US oil dependency — on the rise

US
US Oil
Oil Demand
Demand as
as %
% of
of Total
Total US
US Energy
Energy Demand
Demand US
US Oil
Oil Demand
Demand by
by Source
Source (2004)
(2004)
49%

47%
Renewable,
45% 6%
Nuclear, 8% Coal, 23%
43%

41%

39% Petroleum, Natural Gas,

40% 23%
37%
Y EAR ?

35%
0%
THI S

'50 '55 '60 '65 '70 '75 '80 '85 '90 '95 '00 '05

Source: JPM organ Energy Strategy , EIA Source: JPM organ Energy Strategy , EIA
S T O RY

Political rhetoric aside, oil’s share of US energy consumption is rising, the share of renewables has
fallen slightly in each of the past 2 decades
TH E
WHAT’S

52
 Oil & Gas Basics_20061020_book

US reliance on oil imports also on the rise

US
US Net
Net Oil
Oil Imports
Imports As
As %
% Of
Of Total
Total US
US Oil
Oil Demand
Demand US
US Net
Net Oil
Oil Imports
Imports By
By Source
Source
70%
Total Oil Imports, All Sources
From Mideast Gulf
60%
From OPEC Members Venezuela, Canada,
11% 16% Mexico, 12%
50%
Nigeria, 8%
40% UK, 3%

30% Mideast Gulf,

17% Other Opec, Other Non-
20% 4% Opec, 28%

10%
Y EAR ?

0%
'60 '63 '66 '69 '72 '75 '78 '81 '84 '87 '90 '93 '96 '99 '02 '05
THI S

Source: JPMorgan Energy Strategy, EIA

Source: JPMorgan Energy Strategy, EIA

S T O RY

Foreign oil supplies are an ever growing percent of US demand. OPEC members supply just less
than half of total US net oil imports and Middle East Gulf produces supply 20%
TH E
WHAT’S

53
 Oil & Gas Basics_20061020_book

Agenda

Page

Oil Specifics 2

The Big Picture: Macro Oil Fundamentals 13

What’s the Story This Year? 24

Natural Gas Specifics 54

References, Websites and Data Releases to Watch 62

B A S I C S
G AS
&
O I L

54
 Oil & Gas Basics_20061020_book

How is gas different from oil?

„ Natural gas is a regional commodity, whereas oil is a global commodity

„ In other words, oil is fungible in a way that gas is not

„ Why? The physical properties of natural gas make it harder to transport,

particularly inter-continentally. Most natural gas is transported in gaseous
form via pipeline. This means that the US gas market is effectively a
closed system

„ For this reason, regional gas markets are unrelated. For example, the UK
gas market has no relationship to the US gas market. In fact, European
natural gas is priced using an oil-referenced formula
S P E C I F I C S

„ The widespread adoption of liquefied natural gas (LNG) — when and if it

happens — will change the gas market from a regional market to a global
market. In other words, the development of LNG will make the gas
GA S

market look more like the oil market

N A T U R A L

55
 Oil & Gas Basics_20061020_book

The US natural gas market

„ Natural gas is transported in the U.S. through pipelines to different locations called Hubs

„ Hubs are market places where the physical commodity can be bought and sold. Different
market places have different prices due to different supply and demand factors

„ Henry Hub is the most liquid physical natural gas market, because Henry Hub is where
futures contracts are settled for the physical commodity. It is the market which is most
closely represented by the NYMEX futures curve

„ Producers and consumers of natural gas have incentives to not only hedge their physical
commodity exposure using futures contracts, but also to hedge the location (basis) risk
associated with dealing in different markets across United States, Canada and Mexico

„ The basis market provides this added hedging ability

„ In the basis market hub locations trade at a differential to NYMEX futures contracts on a
forward basis
S P E C I F I C S

„ Hence leading to the ability to buy the NYMEX +/— the appropriate basis differential
forward to hedge a future sale of the physical commodity
GA S

„ Some of the most frequently quoted basis markets are: the Rocky Mountain region, the
Houston Ship Channel Hub, AECO (Canada), and the Panhandle Hub
N A T U R A L

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 Oil & Gas Basics_20061020_book

Natural gas: How is it measured?

„ In the United States, natural gas derives its value from its British thermal unit (Btu)
content, or heating capability

„ British thermal unit: a unit of heat equal to about 252 calories; quantity of heat required
to rise the temperature of one pound of water one degree Fahrenheit

„ Volumetrically natural gas is measured in cubic feet (cf) on a 24-hour flowing basis, and
consequently a standard conversion was adopted whereby 1 cf = 1,000 Btus, which allows
for natural gas to be bought and sold in terms of its Btu value

Useful
Useful gas
gas conversions:
conversions:
„ 1 MMbtu = 1 million Btu’s

„ 1 Mcf ≈ 1 MMBtu, depending upon the purity of the gas

S P E C I F I C S

„ 1 MMcf = 1,000 MMBtu

„ 10 MMcf = 10,000 MMBtu = 1 NYMEX contract

„ 1 Bcf = 1 billion cubic feet = 1,000,000 MMBtu

GA S

„ 1 Tcf = 1 trillion cubic feet

N A T U R A L

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 Oil & Gas Basics_20061020_book

Major market drivers

„ Weather is both a demand and supply factor

„ Summer storage injection season (April—October) is influenced by cooling demand

„ Winter storage withdrawal season (November—March) is influenced by heating

demand

„ Shoulder Months (March, April, May and September, October, November) are less
weather sensitive

„ But hurricane disruptions — most typically in the late-summer to fall — can affect
the supply side of the balance

„ Drought conditions in areas that depend on hydropower for electricity generation

can also boost gas demand
S P E C I F I C S

„ Oil price is also a driver of gas price, because there is some degree of
substitutability between the two fuels

„ Liquefied Natural Gas (LNG) is a minor factor in the gas market now, but will
GA S

become increasingly important as the market develops. LNG will make the gas
market more global
N A T U R A L

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 Oil & Gas Basics_20061020_book

The US needs LNG to meet growing gas demand

The
The growing US LNG supply ‘gap’
In Tcf growing US LNG supply ‘gap’
In Bcf/day
2,500 Lower-48 Production Canadian/Alaska Production Demand
2,300
2,100
1,900
1,700
1,500
1,300
1,100
900
700
5000
1997 1998 1999 2000 2001 2002 2003 2004 2005 2006 2007 2008 2009 2010 2011 2012 2013 2014 2015
S P E C I F I C S

Source: JPM organ Energy Strategy , EIA

The long-term gas price will depend heavily on LNG to fill the growing disconnect between demand
from residential, commercial, industrial and power generation consumers and North American
sources of supply
GA S

The declining domestic production scenario makes LNG vital to satisfying projected US demand
N A T U R A L

growth. . . or price will have to ration demand

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 Oil & Gas Basics_20061020_book

US LNG terminal capacity

Imports
Imports by
by Terminal
Terminal (Monthly)
(Monthly)
In Bcf
5.0
Sustainable Capacity
4.5
4.0
3.5
3.0 Everett (MA) Lake Charles (LA) Cove Point (MD) Elba Island (GA) Gulf Gateway (Offshore)

2.5
2.0
1.5
1.0
0.5
0.0
S P E C I F I C S

Jan Feb Mar Apr May Jun Jul Aug Sep Oct Nov Dec Jan Feb Mar Apr May Jun Jul Aug Sep
Source: JPM organ Energy Strategy , Waterborne LN G Report

Right now, LNG supply is the limiting factor for the US, not spare terminal capacity.
GA S

LNG imports to the US should ramp up from late 2007 when new supplies from Trinidad
and the Middle East come online contracted to meet US demand, likely to pressure US
N A T U R A L

gas prices

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 Oil & Gas Basics_20061020_book

Winter natural gas storage trajectories

Winter
Winter Gas
Gas Storage
Storage Trajectories
Trajectories
In Bcf
3,500 2000–01 2001–02 2002–03 2003–04 2004–05 2005–06

3,000

2,500

2,000

1,500

1,000

5000
7-Oct 1-Nov 26-Nov 21-Dec 15-Jan 9-Feb 6-Mar 31-Mar 25-Apr 20-May 14-Jun 9-Jul 3-Aug 28-Aug 22-Sep
S P E C I F I C S

Source: JPM organ Energy Strategy , EIA

GA S
N A T U R A L

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 Oil & Gas Basics_20061020_book

Agenda

Page

Oil Specifics 2

The Big Picture: Macro Oil Fundamentals 13

What’s the Story This Year? 24

Natural Gas Specifics 54

References, Websites and Data Releases to Watch 62

B A S I C S
G AS
&
O I L

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 Oil & Gas Basics_20061020_book

Important data releases

„ EIA Weekly Petroleum Status Report (Wednesdays 10:30 AM)

EIA Weekly Natural Gas Storage Report (Thursday 10:30 AM)
W ATC H

„ EIA Petroleum Supply Monthly Report (end of month)

EIA Short Term Energy Outlooks (beginning of month)
T O
R EL EA S E S

„ IEA monthly Oil Market Report (~10th of the month)

„ Euroilstock inventory report (~10th of the month)

D A TA

„ CFTC Commitment of Traders report (Fridays)

A N D
W E B SI T E S
R E F E R EN C E S,

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Key websites

US Department of Energy, Energy information Administration

www.eia.doe.gov
W ATC H

Organization of Petroleum Exporting Countries

www.opec.org
T O
R EL EA S E S

BP’s Statistical Review of World Energy

www.bp.com

New York Mercantile Exchange

D A TA

www.nymex.com
A N D

Commodity Futures Trading Commission

W E B SI T E S

www.cftc.gov

International Energy Agency

R E F E R EN C E S,

www.iea.org

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 Oil & Gas Basics_20061020_book

Bloomberg codes

Prices:
Prices: News
News &
& Info:
Info:

Main energy page NRG <enter> Top energy pages OTOP

EIA inventory data DOE <enter> ETOP

W ATC H

Global crude oil prices CRUD <enter> TGAS

Exchange menu CEM <enter> All energy news NI NRG

T O

Nymex WTI crude CL1 [cmdty] Oil news NI OIL

R EL EA S E S

Nymex heating oil HO1 [cmdty] Gas news NI GAS

Nymex gasoline HU1 [cmdty] Power news NI ELC

D A TA

Nymex natural gas NG1 [cmdty] Refinery news NI REF

IPE Brent crude CO1 [cmdty] OPEC NI OPEC

A N D

IPE gasoil QS1 [cmdty] Energy glossary REFG <enter>

W E B SI T E S

Cash values for refined products USPD <enter> Keeping time IC <enter>

EUPD <enter> Calendars CDR <enter>

FEPD <enter>
R E F E R EN C E S,

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Reuters codes

Prices:
Prices: News
News &
& Info:
Info:

Main energy page Q: ENERGY Energy highlights Q: nTOPO or TOP/O

W ATC H

EIA inventory data Q: EIAA Link to energy codes O/CODES

Nymex WTI crude Q: CLc1 All energy news O

T O

Oil news OIL

Nymex heating oil Q: HOc1
R EL EA S E S

Gas news NGS

Nymex gasoline Q: HUc1
OPEC news OPEC
Nymex natural gas Q: NGc1
D A TA

EIA inventory report EIA/S

IPE Brent crude Q: LCOc1
A N D

US refinery news REF/US

IPE gasoil Q: LGOc1
W E B SI T E S

Energy glossary ENERGY/3

Cash values for Q: PRODUCT/1
refined products
R E F E R EN C E S,

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Basic oil conversions

42 gallons = 1 barrel

159 liters = 1 barrel

W ATC H

7.33 barrels of crude = 1 ton

T O
R EL EA S E S
D A TA
A N D
W E B SI T E S
R E F E R EN C E S,

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