[jp morgan] oil & gas basics

O C T O B E R 2 0 0 6

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

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Katherine Spector(1-212) 834-2031

[email protected]

Scott Speaker(1-212) 834-3878

[email protected]

Kristi Jones(1-212) 834-2835

[email protected]

Sung Yoo(1-212) 834-7045

[email protected]

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, 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, 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.

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Volatility of Various MarketsVolatility of Various Markets

Energy is significantly more volatile than other markets

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Jan-01 Sep-01 Jun-02 Mar-03 Nov-03 Aug-04 May-05 Feb-06

Power EUR GLD CL NG HO SPX 10-yr T bills

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Agenda

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References, Websites and Data Releases to Watch

Natural Gas Specifics

What’s the Story This Year?

The Big Picture: Macro Oil Fundamentals

Oil Specifics

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From the well to the tank. . .

Source: JPMorgan Energy Strategy

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Market drivers to watch

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

Upstream investment – capacity additions? Cost? Location? Type of crude?

Natural decline rates – Field age, field maintenance, geological makeup

Geopolitics (e.g. Iran, Nigeria)

Field maintenance, unplanned outages

Weather (e.g. hurricanes)

OPEC decisions and politics – internal politics, spare capacity, relationships with consumer countries

Level relative to long term trend and normal seasonality

Level relative to demand

Regional distribution

Levels at transit points

Crude versus refined product levels

Oil DemandOil Demand Oil SupplyOil Supply Oil InventoriesOil Inventories

Deals associated with mergers/acquisitions

Speculative flows

Tanker supply/demand/rates

Seaborne disruptions – weather, traffic, accidents

Port capacity, availability

Pipeline capacity/nominations

Refinery capacity/investment

Planned outages, unplanned outages

Refining economics, run rates

Refined product yields

OtherOther DistributionDistribution Oil RefiningOil Refining


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Price relationships to watch. . .and what JPMorgan trades

Time spreads— e.g. Q1 vs. Q3; winter vs. summer, Cal 05

vs. Cal 06

Regional spreads— e.g. NYMEX West Texas Intermediate vs.

IPE Brent, NY Harbor gasoline vs. US Gulf gasoline

Crude vs. refined product spreads— ‘Cracks’ (e.g. crude-gasoline;

crude-heating oil)— Refinery margins

Crude grade differentials (physical trade only)— e.g. West Texas Intermediate vs.

West Texas Sour; Bonny Light vs. Brent

Product vs. product spreads— e.g. gasoline-heating oil

Interfuel spreads— e.g. natural gas-heating oil

OilCrude— WTI— Brent— Tapis— DubaiRefined productsUS market:— NYMEX heating oil— US Gulf Coast heating oil— US Gulf Coast jet fuel— NYMEX gasolineEuropean market:— IPE gasoil— Gasoil 0.2% CIF NWE— Jet fuel cargoes CIF NWE— EN590 cargoes CIF NWE— 1% and 3.5% fuel oil cargoes FOB NWEAsian market:— Singapore jet fuel

Natural Gas:NYMEX natural gasEuropean natural gas priced as oil-referenced formula

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How oil (gas) trades

Formal Exchanges

Int’l Petroleum Exchange(London)

Brent Crude

1 lot = 1,000 bbl

Gas Oil

1 lot = 100 tonnes = 750 bbl

NY Mercantile Exchange

West Texas Intermediate(‘Light, Sweet’) Crude

1 lot = 1,000 bbl

Heating Oil

1 lot = 42,000 gallons = 1,000 bbl

Unleaded Gasoline

1 lot = 42,000 gallons = 1,000 bbl

Henry Hub Natural Gas

1 lot = 10,000 MMBtu

Over-the-Counter

Swaps/Options

Variety Of RegionalBenchmark Crudes and Refined Products. . .

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Major global crude benchmarks and oil market centers

Dubai

London (IPE)Dated Brent

Urals

WTINew York (NYMEX)

TapisSingapore

Oman


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Risk exposure and management strategies

Production

Consumption


Exposure Type Risk Management Strategy

Price of crude

Cost of transportation, insurance, duty/tariff

Cost of carry (time value of money), time spread

Refinery margins

Refined product price

Locational/basis risk

Retail margins

Producer hedging: swaps or put options

Freight hedging

Hedging with time spreads

Hedging cracks (spread between crude and refined products) or full margins

Consumer hedging: swaps or call options

Hedging product — product risk, or regional risk

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Conventions of the oil market

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

BenchmarksBenchmarks

Barges: 1,000 - 5,000 MT (2 - 8 days loading)

Cargoes: 10,000 - 25,000 MT (15 days loading)

ParcelParcel

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

Delivery MethodsDelivery Methods

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

Main LocationsMain Locations


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


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Backwardation vs. contango

Backwardation vs. Contango CurvesBackwardation vs. Contango Curves

$4.70

$4.80

$4.90

$5.00

$5.10

$5.20

$5.30

M01 M05 M09 M13 M17 M21 M25 M29 M33

In US$/bbl

contango curve

backwardation curve


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More backwardation than contango

Contango vs. BackwardationContango vs. BackwardationThe oil curve shifts regularly between backwardation and contango

Historically, oil has spent more time in backwardation than contango

Backwardation has been steeper than periods of contango

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$(11) $(9) $(7) $(5) $(3) $(1) $1 $3 $5 $7 $9 $11

N ote: M02–M 13 in U S$/bblSource: JPM organ Energy Strategy

Contango Backwardation

Number of instances

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Agenda

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Oil Specifics

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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, 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 refiner makes by turning crude into products

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 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


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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 API gravity and a high sulfur content

In general, light/sweet crude tends to sell at a higher price than heavy/sour crude

In general, refiners can produce a higher yield of high quality refined products, such as gasoline, by running light/sweet crudes. Heavy/sour grades yield less gasoline, and more of the ‘dirty’ products such as fuel oil Source: JPMorgan Energy Strategy

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Where are most of the world’s oil reserves?

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

Proved Oil Reserves (end 2005)Proved Oil Reserves (end 2005)

40.2 59.5103.5 114.3

140.5

742.7

Asia Pacific North America Africa South & CentralAmerica

Europe & Eurasia Middle East

In thousand million barrels

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

Where are the world’s top consumers of oil?

FSU5%

Japan6%

China9%

United States25%

Other49%

India3%

Germany3%

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

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US Gasoline Demand & Exploration Based on Fuel EfficiencyUS Gasoline Demand & Exploration Based on Fuel Efficiency

US gasoline: 12% of global demand and growing

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1979 1981 1983 1985 1987 1989 1991 1993 1995 1997 1999 2001 2003 2005 2007 2009 2011 2013

In million b/d

Historical Gasoline DemandExtrapolation at today's MPGAt 22 MPGAt 24 MPGAt 26 MPGAt 28 MPGAt 30 MPGAt 30 MPG With Staggered Fleet Turnover

Source: JPMorgan Energy Strategy , EIA

270 kbd

1.4 mbd

2.2 mbd

2.8 mbd

3.4 mbd

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Who are the world’s top producers of crude oil?

The world’s biggest producers are not necessarily the same as the world’s biggest exporters. For example, the US and China produce a lot of oil, but export very little given high domestic demand

OPEC members Saudi Arabia and Iran are the world’s biggest exporters of crude oil

2005 Averages2005 Averages

Note: Bold = OPEC membersSource: JPMorgan Energy Strategy, IEA

Volume in kbd

Producer Volume Share of Global Production Russia 9,185 12.5% Saudi Arabia 9,063 12.4% United States 5,131 7.0% Iran 3,879 5.3% China 3,617 4.9% Mexico 3,334 4.6% Venezuela 2,706 3.7% Norway 2,506 3.4% UAE 2,458 3.4% Nigeria 2,405 3.3% Kuwait 2,133 2.9% Iraq 1,813 2.5% Canada 1,805 2.5% Libya 1,640 2.2% Brazil 1,634 2.2% UK-offshore 1,560 2.1% Algeria 1,345 1.8% Angola 1,245 1.7% Kazakhstan 1,025 1.4% Indonesia 942 1.3% Qatar 796 1.1% Malaysia 727 1.0% Oman 722 1.0% Argentina 665 0.9% India 663 0.9% Other 10,206 13.9%

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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?

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:

1. High oil prices could reduce economic growth and oil demand growth

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

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A little history. . .

US Refiner Acquisition Price of Imported CrudeUS Refiner Acquisition Price of Imported Crude

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$10

$20

$30

$40

$50

$60

$70

$80

$90

$100

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

In US$/bbl

Nominal Real

Source: JPMorgan Energy Strategy, EIA

Gulf War I

Iran-Iraq War

Netback Pricing

Non-OPEC competition grows, price war

Exxon Valdez spill

Soviet Union collapse Asian Crisis

9/11

Venezuela Crisis, Gulf War II, Nigeria strike

Hurricane Ivan

Nigerian strike, cold winter

Hurricane Katrina & Rita

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

Shifting Market ShareShifting Market Share

34%

35%

36%

37%

38%

39%

40%

41%

42%

'95 '96 '97 '98 '99 '00 '01 '02 '03 '04 '05 '065.5

6.5

7.5

8.5

9.5

10.5

11.5

12.5

OPEC Share of Global Production

Saudi Oil Production

FSU Oil Production

OPEC Share of Global Oil Production (%) FSU/Saudi Oil Production (mbd)

Source: JPMorgan Energy Strategy , IEA, OPEC

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Keeping the cartel together can be tough, too

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


Cut Production Cheat on Quotas

Cut

Pro

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ion

(6,6) (1,10)C

heat

on

Quo

tas

(10,1) (3,3)

OPEC MEMBER #1

OPE

C M

EMB

ER #

2

All members have an incentive to cheat, even though they

would all be better off sticking to quotas

The best outcome for

the group as a whole, but hard to achieve. . .

Given the chance that other members mightcheat, and the non-

cheater could end up in his worst case

scenario, all members have an incentive to

cheat themselves

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Oil Specifics

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Short- to medium-term drivers for the oil market

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

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

Reassessment of investors’ commodities allocations down the road as returns falter and interest rates rise?

Current JPMorgan Price ForecastsCurrent JPMorgan Price Forecasts

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, 2006Note: All values are period averages. WTI & Brent in $/bbl; natural gas in $/MMBtuSource: JPMorgan Energy Strategy

1Q06 2Q06 3Q06 4Q06 2005 2006 2007WTI Forecast … … … 65.00 … 67.39 64.05

WTI Actual* 63.48 70.72 70.60 59.90 56.70 … …

Brent Forecast … … … 64.00 … 67.05 63.05

Brent Actual* 62.71 70.43 71.00 59.78 55.25 … …

Natural Gas Forecast … … … 7.67 … 7.32 7.50

Natural Gas Actual 7.84 6.65 6.18 6.02 9.02 … …

Crude Oil Price History, Forwards & Forecast RangeCrude Oil Price History, Forwards & Forecast Range

US$/bbl

$0

$20

$40

$60

$80

$100

'95 '96 '97 '98 '99 '00 '01 '02 '03 '04 '05 '06 '07 '08 '09 '10 '11 '12 '13

JPM Probable RangeJPM Possible RangeHistoryForward CurveJPM Forecast


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The crude oil market today

Crude Oil Price History & ForwardsCrude Oil Price History & Forwards

$5

$15

$25

$35

$45

$55

$65

$75

1988 1990 1992 1994 1996 1998 2000 2002 2004 2006 2008 2010 2012

WTI Brent

In US$/bbl


$0

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This has been a refined products driven market

Heating Oil Crack + ForwardsHeating Oil Crack + Forwards Gasoline Crack + ForwardsGasoline Crack + Forwards

US$/bbl

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$2

$4

$6

$8

$10

$12

$14

$16

$18

$20

'95 '96 '97 '98 '99 '00 '01 '02 '03 '04 '05 '06 '07 '08 '09 '10

Heat Crack FwdsHeat Crack


US$/bbl

$0

$2

$4

$6

$8

$10

$12

$14

$16

$18

$20

'95 '96 '97 '98 '99 '00 '01 '02 '03 '04 '05 '06 '07 '08 '09 '10

Gasoline CrackGasoline Crack Fwds

Source: JPM organ Energy Strategy

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

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Commercial oil inventories — Crude levels remain healthy

Total OECD Commercial InventoriesTotal OECD Commercial Inventories A 7 million bbl build in refined product inventories offset a 7 mb draw from crude. The level of crude remains much more comfortable than the level of refined product stocks

Regionally in August, builds in the US and Japan offset draws in Europe and other areas

In days of demand cover

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50

52

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58

60

Jun-99 Jun-00 Jun-01 Jun-02 Jun-03 Jun-04 Jun-05 Jun-06

Winter Summer Linear Trend

Source: JPMorgan Energy Strategy , IEA, Gov n't & industry sources

0

Total OECD Crude InventoriesTotal OECD Crude Inventories Total OECD Product InventoriesTotal OECD Product Inventories

In billion bbl In billion bbl

0.90

0.95

1.00

1.05

1.10

Jan Feb Mar Apr May Jun Jul Aug Sep Oct Nov Dec

Five-Year RangeFive-Year Average20052006

Note: Latest month is to-date only , not full-month projectionSource: JPMorgan Energy Strategy , IEA, Gov n't & industry sources

1.44

1.49

1.54

1.59

1.64

1.69

Jan Feb Mar Apr May Jun Jul Aug Sep Oct Nov Dec

Five-Year RangeFive-Year Average20052006

Note: Latest month is to-date only , not full-month projectionSource: JPMorgan Energy Strategy , IEA, Gov n't & industry sources

0.00 0.00

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Hurricanes hammer US Gulf refineries

Hurricane Impacts in PerspectiveHurricane Impacts in Perspective

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

Gulf of Mexico Crude Shut In (in mbd) In US$

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0.0

0.5

1.0

1.5

2.0

2.5

3.0

3.5

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$(5)

$-

$5

$10

$15

$20

$25

$30

$35

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

Actual Refinery Loss Minus Gulf of Mexico Crude Shut InProjected Refinery Loss Minus Gulf of Mexico Crude Shut In

Gasoline CrackHeating Oil Crack

Gasoline Crack FwdNYMEX Heating Oil Crack Fwd

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US refinery maintenance: Looking ahead to the fall

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 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 than 2 million b/d lost in October 2005

US Planned & Unplanned Refinery ShutdownsUS Planned & Unplanned Refinery Shutdowns

Average Offline Capacity Per Month (in million b/d)

0.0

0.3

0.6

0.9

1.2

1.5

1.8

2.1

2.4

2.7

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

UnplannedPADD I (East Coast)PADD II (Midwest)PADD III (Gulf)PADD IV (Rockies)PADD V (West Coast)

Source: JPMorgan Energy Strategy , IIR

Hurricane Katrina & Rita

Hurricane Ivan

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Gasoline: An easier problem to solve in the Atlantic Basin

Net Gasoline Balances By RegionNet Gasoline Balances By Region Net Gasoil Balances By RegionNet Gasoil Balances By Region

Regional production minus regional consumption (in kbd)

-600

-500

-400

-300

-200

-100

0

100

200

300

400

1995 1996 1997 1998 1999 2000 2001 2002 2003 2004 2005

AsiaEuropeNorth AmericaTotal OECD

Source: JPM organ Energy Strategy , IEA

Regional production minus regional consumption (in kbd)

-1,000

-800

-600

-400

-200

0

200

400

600

800

1,000

1995 1996 1997 1998 1999 2000 2001 2002 2003 2004 2005

OECD AsiaOECD EuropeOECD North AmericaTotal OECD

Source: JPM organ Energy Strategy , IEA

Europe has always been structurally long gasoline but has become more so as vehicle demand shifts to diesel. The Atlantic Basin is now long gasoline. . .but shorter and shorter distillate

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

Changes to Diesel Sulfur LimitsChanges to Diesel Sulfur Limits The US diesel sulfur limit drops by 97% this year to 15 ppm

US refiners were required to meet the new standard by June 1; pipeline operators must meet the 15 ppm limit by Sept. 1; retailers must offer 15 ppm by Oct. 15

Dramatic changes to diesel standards underscore the challenge of not only making the fuel but also distributing it to customers. While US refiners have successfully ramped up ULSD production and inventories of the new spec have climbed steadily, there are still logistical challenges associated with the storage and transport of the cleaner fuel

Ultra-low sulfur diesel is so much cleaner than others in the distillate family (heating oil, jet, kerosene) that operators will be challenged in how they batch/order the fuels in the pipe. Test flows have shown that the sulfur in ULSD will have to be far lower/cleaner in order to deliver fuel at the government-set limit to consumers. Separate storage tanks will also be required for distribution of ULSD

* 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 2010Source: JPMorgan Energy Strategy, government & press reports

In ppm 2003 2004 2005 2006 2007 2009 2010US 500 15

Europe 500 350 50 10

Canada 500 15

China* 500 350

India** 2,500 500 350 50

Brazil 5,000 2,000 500 50

Japan 50 10

S Korea 430 30 10

US Diesel Inventories By Sulfur ContentUS Diesel Inventories By Sulfur Content

Million bbl

0

20

40

60

80

Feb'05 Apr'05 Jun'05 Aug'05 Oct'05 Dec '05 Feb'06 Apr'06 Jun'06 Aug'06

<15 ppm sulphur diesel15-50 ppm sulphur diesel


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Changes to gasoline specs: Sulfur limits and oxygenate requirements

Changes to Gasoline Sulfur LimitsChanges to Gasoline Sulfur Limits

* 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 2010Source: JPMorgan Energy Strategy, government & press reports

RFG Inventories vs. RBOB/Alcohol StocksRFG Inventories vs. RBOB/Alcohol Stocks

Major US gasoline spec changes slated for 2006: lower sulfur content limit and the 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 dramatic, these worries are overdone. We are experiencing some hiccups along the supply chain during the present transition period, but these should work themselves out as the US has proven itself to be quite capable of blending components up to standard

In ppm 2004 2005 2006 2008 2009European Union 150 50 10US 120 90 30China* 500 150India** 500 150Japan 50 10South Korea 130 50Brazil** 400 80

In million bbl

5

10

15

20

25

30

35

Jul-04 Oct-04 Jan-05 Apr-05 Jul-05 Oct-05 Jan-06 Apr-06

Finished RFG RBOB w/ Alcohol

Source: JPM organ Energy Strategy , EIA

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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

⎯Reformulated gasoline for oxygenate blending (RBOB) is blended with ethanol in the tank, after it has been transported separately by pipe

⎯States such as New York and California have already successfully phased out MTBE in favor of ethanol

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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

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

Reassessment of investors’ commodities allocations down the road as returns falter and interest rates rise?

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

Front-month NYMEX West Texas Intermediate with ‘Snapshot in Time’ Future StripsFront-month NYMEX West Texas Intermediate with ‘Snapshot in Time’ Future Strips

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

In US$/bbl

$-

$10

$20

$30

$40

$50

$60

$70

$80

'94 '95 '96 '97 '98 '99 '00 '01 '02 '03 '04 '05 '06 '07


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

West Texas Intermediate CurveWest Texas Intermediate Curve

In US$/bbl

$56

$58

$60

$62

$64

$66

$68

$70

Nov06 May07 Nov07 May08 Nov08 May09 Nov09 May10 Nov10 May11 Nov11 May12 Nov12


$0

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A new paradigm — contango at $70!

WTI Flat Price vs. Backwardation (in US$/bbl)WTI Flat Price vs. Backwardation (in US$/bbl)

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

$(2)

$(1)

$-

$1

$2

$3

$4

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

$5

$15

$25

$35

$45

$55

$65

$75


M01-M02 NYMEX WTI M01 NYMEX WTI

Backwardation

Contango

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WTI backwardation vs. flat price

WTI Backwardation vs. Flat PriceWTI Backwardation vs. Flat Price


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

M01 NYMEX WTI (in US$/bbl)

$-

$10

$20

$30

$40

$50

$60

$70

$80

$90

$(8) $(6) $(4) $(2) $- $2 $4 $6 $8 $10 $12M02-M24 NYMEX WTI (US$/bbl)

1996-2002 2004-present 10/13/2006

$0

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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

Up significantly — Major inflow of money and interest in commodities as an asset class that really did not exist in a meaningful way 3 years ago

Buyers — Institutionals enter the market almost exclusively from the long side via products like Commodities Indices and oil-linked notes

Passive — Take long-term, generally directional views. Tend not to enter or exit positions on short-term price fluctuations

New — Institutional investors have really only started to participate in the energy space in the past ~3 years

Institutional Investors

(Pension funds, mutual funds, retail investors)

Up — Generally more dollars in energy, but also more sophisticated and varied involvement in full range of energy products

Buyers or Sellers — Depending on view of the market. On average in recent years, hedge funds more long than short given price trend.Funds may participate in any part of the curve and have shown particular interest in owning deferred price and volatility, adding liquidity and price clarity to that part of the curve

Active — Take proprietary risk daily. May have long or short term views, and take directional or relative value positions in the full range of energy products

Old and New — Not new to energy per se but more professional and putting more money towards this space in the last ~3 years

Macro Hedge Funds

No significant changeBuyers or Sellers — Depending on market trend

Active — Fast moving, directional, tend to enter and exit positions quickly

Old — CTAs have traded energy for years

Trend Players

(Commodity Trading Advisors)

No significant change, though interest has arguably increased with price

Buyers or Sellers — Depending on customer business and view of the market. Depending on customer business, banks may make markets as far as 10+ years into the future

Active — Trade daily making markets (flow and structured business) and/or taking risk (proprietary trading). May have long or short term prop views

Old — Although the mix of banks in energy changes, banks have been market-makers and risk takers in energy since the inception of these markets

Financial institutions

(Banks)

Up — If anything consumers have hedged more actively as prices have risen, though options rather than swaps have been the preferred vehicle for upside protection with downside participation

Buyers — The natural buyers in the energy markets. Consumers typically hedge 1-3 years into the future, but increasingly more sophisticated hedgers may go out as far as 5-7 years in products with sufficient liquidity

Active — May trade anywhere from daily to annually depending on hedging program

Old — Energy consumers have been actively hedging with derivatives since the early-1990s

Energy Consumers

(Utilities, airlines, railroads, industrials)

Down — Significantly less day-to-day tactical hedging at high prices. Remaining deals large, occasional, one-off M&A related strategic hedges. Options strategies generally preferred over swaps, for downside protection with upside exposure

Sellers — The natural sellers in the energy markets. Producers typically hedge 2-3 years out but can now find sufficient liquidity to hedge as much as 7 years out

Active — May trade anywhere from daily to annually depending on hedging program

Old — Energy producers have been actively hedging with derivatives since the early-1990sEnergy Producers

(E&P companies)

Activity vs. 3 Years Ago?Buyers or Sellers? Where on the Curve?Active or Passive?Old or New?Participant

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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

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 capacity constraints down the road

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

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Is the demand story over?

Historical Oil Demand GrowthHistorical Oil Demand Growth


Demand growth has moderated relative to 2004. We see this trend continuing for the balance of the year

%yoy, 3 month rolling average

-5%

0%

5%

10%

15%

20%

25%

30%

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

OECD Demand Growth/Contraction Non-OECD Demand Growth/Contraction OECD ProjectNon-OECD Project Global Demand Growth Historical Average Rate of Global GrowthWorld Project

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Light-end products dominate global oil demand growth

Global Oil Demand Growth by Major ProductGlobal Oil Demand Growth by Major Product

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

In kbd

-500

250

1,000

1,750

2,500

3,250

2000 2001 2002 2003 2004 2005

Gasoline Distillate Jet/Kero Fuel Oil Heavy Light

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

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Energy intensity in emerging economic powers moderates as they grow

Energy Intensity/GDP — China & JapanEnergy Intensity/GDP — China & Japan

Oil bbl consumed per US$1,000 GDP

0

1

2

3

4

5

6

7

8

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

GDP (in billion current US$)

Japan China

Source: JPM organ Energy Strategy , BP Statistical H andbook

Find from same publication (above)

Energy Intensity Declines As GDP IncreasesEnergy Intensity Declines As GDP Increases

0

1

2

3

4

5

6

7

8

9

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

OECD Non-OECD

Oil bbl consumed per US$1,000 GDP

Source: JPM organ Energy Strategy , BP Statistical H andbook

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 countries get richer

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The cycle of investment

OECD Oil Demand vs. Refinery CapacityOECD Oil Demand vs. Refinery Capacity

In million b/d

20

25

30

35

40

45

50

55

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

Refined Products Import GapRefinery CapacityOil Demand

Source: JPM Energy Strategy , IEA, EIA

Downstream investment, or lack thereof, is cyclical and tends to over-shoot in both directions

There’s no reason to think that this investment cycle won’t — eventually —be the same

OECD demand exceeds OECD refinery capacity. That means that, increasingly, ‘spare’ refinery capacity is in the non-OECD. That means that — just like crude production — most of the world’s refined products production is geographically far away from most of the world’s consumption

0

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Energy infrastructure/distribution capacity is still a constraint

Global Oil Demand Supplied By International TradeGlobal Oil Demand Supplied By International Trade

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?

Oil Trade:Oil Demand

30%

35%

40%

45%

50%

55%

60%

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

1985-89: 44%

1990-94: 51%

1995-99: 55%2000-04: 58%

Source: JPMorgan Energy Strategy, BP Statistical Handbook

Crude Refined Products 1987-1995 3.6% 1.8% 1996-2005 2.5% 3.8% 2001-2005 1.7% 5.4%

Growth In Waterborne Crude & Products Transport

Source: Clarkson's Shipping Review

0%

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Non-OPEC production has disappointed in recent years

Historical Oil Supply GrowthHistorical Oil Supply Growth

%yoy, 3 month rolling average

-10%

-5%

0%

5%

10%

15%

20%

25%

Mar-98 Jul-99 Nov-00 Mar-02 Jul-03 Nov-04 Mar-06 Jul-07

OPEC Supply Growth/Contraction Non-OPEC Supply Growth/ContractionGlobal Supply Growth Historical Average Rate of Global Growth

Source: JPMorgan Energy Strategy, IEA

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OPEC sails through three bull years

OPEC Crude Production & Group QuotaOPEC Crude Production & Group Quota

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

In million b/d

20

21

22

23

24

25

26

27

28

29

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

OPEC-10 Wellhead Production of Crude

Quota

Source: JPMorgan Energy Strategy , IEA

0

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Sliding OPEC spare capacity, but capacity additions in the pipeline

OPEC Spare Capacity vs. PriceOPEC Spare Capacity vs. PriceExpected Additions to OPEC Capacity* (in kbd)Expected Additions to OPEC Capacity* (in kbd)

* Excluding declinesNote: This is not a complete list and is subject to changeSource: JPMorgan Energy Strategy, government

reports, media reports

In kbd

0

1,000

2,000

3,000

4,000

5,000

6,000

7,000

8,000

Aug-97 Feb-99 Aug-00 Feb-02 Aug-03 Feb-05 Aug-06$-

$10

$20

$30

$40

$50

$60

$70

$80Spare Capacity Nymex WTI Price


US$/bbl 2006Saudi Arabia 300Iran 160Nigeria 265Algeria 50Venezuela 75Libya 150UAE 200

2007Saudi Arabia 500Nigeria 220Algeria 140

2008Saudi Arabia 300Nigeria 1,130Indonesia 180

2009-2010Saudi Arabia 1,200Algeria 100Qatar 525

2006 1,2002007 8602008 1,6102009-2010 1,8252006-2010 Total 5,495

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Top geopolitical hotspots: No strangers to disruptions

In million b/d

0

1

2

3

4

5

6

'67 '69 '71 '73 '75 '77 '79 '81 '83 '85 '87 '89 '91 '93 '95 '97 '99 '01 '03 '05Source: JPMorgan Energy Strategy , BP Statistical Handbook

Iranian Revolution

In million b/d

0

1

2

3

4


Iran-Iraq War

Gulf War I

Gulf War II

In million b/d

0

1

2

3

'79 '81 '83 '85 '87 '89 '91 '93 '95 '97 '99 '01 '03 '05Source: JPMorgan Energy Strategy , BP Statistical Handbook

Strike cripples production

NigeriaNigeria

IranIran

VenezuelaVenezuela

IraqIraq

In million b/d

0

1

2

3

4


Strike cripples production

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Oil production: An inherently risky business

OECD Reserves as % of GlobalOECD Reserves as % of Global

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

OECD Reserves: Global Reserves

0%

5%

10%

15%

20%

25%

'81 '83 '85 '87 '89 '91 '93 '95 '97 '99 '01 '03 '05

Source: JPM organ Energy Strategy , BP Statistical Handbook

Oil Reserves by Risk of LocationOil Reserves by Risk of Location

050

100150200250300350400450500

0-1 1-2 2-3 3-4 4-5 5-6 6-7 7-8 8-9 9-10

Average of Country Risk Rating & Corruptionion Perception Index (0 = highest risk/most corrupt)

Total Reserves (in '000 billion bbl)

Source: JPMorgan Energy Strategy , BP Statistical Handbook, Transparency International, UNCTAD

<5 = 1,062>5 = 329

More corrupt/risky Less corrupt/risky

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US oil dependency — on the rise

US Oil Demand as % of Total US Energy DemandUS Oil Demand as % of Total US Energy Demand

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

US Oil Demand by Source (2004)US Oil Demand by Source (2004)

35%

37%

39%

41%

43%

45%

47%

49%

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


Coal, 23% Nuclear, 8%

Petroleum, 40%

Natural Gas, 23%

Renewable, 6%


0%

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US reliance on oil imports also on the rise

US Net Oil Imports As % Of Total US Oil DemandUS Net Oil Imports As % Of Total US Oil Demand

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%

US Net Oil Imports By SourceUS Net Oil Imports By Source

0%

10%

20%

30%

40%

50%

60%

70%

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

Total Oil Imports, All SourcesFrom Mideast GulfFrom OPEC Members


Other Non-Opec, 28%

Other Opec, 4%

Mexico, 12%Canada,

16%

UK, 3%

Venezuela, 11%

Nigeria, 8%

Mideast Gulf, 17%


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Agenda

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Oil Specifics

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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

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 market look more like the oil market

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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

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

Some of the most frequently quoted basis markets are: the Rocky Mountain region, the Houston Ship Channel Hub, AECO (Canada), and the Panhandle Hub

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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 gas conversions:Useful gas conversions:

1 MMbtu = 1 million Btu’s

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

1 MMcf = 1,000 MMBtu

10 MMcf = 10,000 MMBtu = 1 NYMEX contract

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

1 Tcf = 1 trillion cubic feet

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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

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 become increasingly important as the market develops. LNG will make the gas market more global

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The US needs LNG to meet growing gas demand

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

The declining domestic production scenario makes LNG vital to satisfying projected US demand growth. . . or price will have to ration demand

In Tcf

500

700

900

1,100

1,300

1,500

1,700

1,900

2,100

2,300

2,500

1997 1998 1999 2000 2001 2002 2003 2004 2005 2006 2007 2008 2009 2010 2011 2012 2013 2014 2015

Lower-48 Production Canadian/Alaska Production Demand


In Bcf/day

0

The growing US LNG supply ‘gap’The growing US LNG supply ‘gap’

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US LNG terminal capacity

Imports by Terminal (Monthly)Imports by Terminal (Monthly)

In Bcf

0.0

0.5

1.0

1.5

2.0

2.5

3.0

3.5

4.0

4.5

5.0

Jan Feb Mar Apr May Jun Jul Aug Sep Oct Nov Dec Jan Feb Mar Apr May Jun Jul Aug Sep

Everett (MA) Lake Charles (LA) Cove Point (MD) Elba Island (GA) Gulf Gateway (Offshore)

Source: JPM organ Energy Strategy , Waterborne LN G Report

Sustainable Capacity

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

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Winter natural gas storage trajectories

Winter Gas Storage TrajectoriesWinter Gas Storage Trajectories

In Bcf

500

1,000

1,500

2,000

2,500

3,000

3,500

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

2000–01 2001–02 2002–03 2003–04 2004–05 2005–06


0

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Agenda

Page






Oil Specifics

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Important data releases

EIA Weekly Petroleum Status Report (Wednesdays 10:30 AM)EIA Weekly Natural Gas Storage Report (Thursday 10:30 AM)

EIA Petroleum Supply Monthly Report (end of month)EIA Short Term Energy Outlooks (beginning of month)

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

Euroilstock inventory report (~10th of the month)

CFTC Commitment of Traders report (Fridays)

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Key websites

US Department of Energy, Energy information Administration

www.eia.doe.gov

Organization of Petroleum Exporting Countries

www.opec.org

BP’s Statistical Review of World Energy

www.bp.com

New York Mercantile Exchange

www.nymex.com

Commodity Futures Trading Commission

www.cftc.gov

International Energy Agency

www.iea.org

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Bloomberg codes

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

Main energy page NRG <enter>

EIA inventory data DOE <enter>

Global crude oil prices CRUD <enter>

Exchange menu CEM <enter>

Nymex WTI crude CL1 [cmdty]

Nymex heating oil HO1 [cmdty]

Nymex gasoline HU1 [cmdty]

Nymex natural gas NG1 [cmdty]

IPE Brent crude CO1 [cmdty]

IPE gasoil QS1 [cmdty]

Cash values for refined products USPD <enter>

EUPD <enter>

FEPD <enter>

Top energy pages OTOP

ETOP

TGAS

All energy news NI NRG

Oil news NI OIL

Gas news NI GAS

Power news NI ELC

Refinery news NI REF

OPEC NI OPEC

Energy glossary REFG <enter>

Keeping time IC <enter>

Calendars CDR <enter>

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LE

AS

ES

TO

WA

TC

H


Reuters codes

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

Main energy page Q: ENERGY

EIA inventory data Q: EIAA

Nymex WTI crude Q: CLc1

Nymex heating oil Q: HOc1

Nymex gasoline Q: HUc1

Nymex natural gas Q: NGc1

IPE Brent crude Q: LCOc1

IPE gasoil Q: LGOc1

Cash values for Q: PRODUCT/1 refined products

Energy highlights Q: nTOPO or TOP/O

Link to energy codes O/CODES

All energy news O

Oil news OIL

Gas news NGS

OPEC news OPEC

EIA inventory report EIA/S

US refinery news REF/US

Energy glossary ENERGY/3

66RE

FE

RE

NC

ES

,W

EB

SI

TE

SA

ND

DA

TA

RE

LE

AS

ES

TO

WA

TC

H


Basic oil conversions

42 gallons = 1 barrel

159 liters = 1 barrel

7.33 barrels of crude = 1 ton

67RE

FE

RE

NC

ES

,W

EB

SI

TE

SA

ND

DA

TA

RE

LE

AS

ES

TO

WA

TC

H

[jp morgan] oil & gas basics

Documents

bp statistical handbook

worlds biggest exporters

west texas intermediate

jpmorgan energy strategy

proved oil reserves

mexico crude shut

refiner acquisition price

high oil prices