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March 2016

Issue 118

Americas
Oil and Gas
BMIs monthly market intelligence, trend analysis and forecasts for the oil and gas industry across the Americas
UNITED STATES

ISSN: 1750-7723

CONTENTS

Unconventional M&As Offer

Valuable Opportunities
BMI View: The potential acquisition by US independent Devon Energy
of Felix Energy points to a rising trend of M&A activity among smaller
E&Ps and supports our view that companies will be keen to bolt on
acreage within the major shale plays.

United States .................................................................................. 1

Unconventional M&As Offer Valuable Opportunities...............................................1
Demand For Refined Fuels Approaching A Peak....................................................... 2
Lifting The Crude Export Ban: Initial Implications.................................................... 3

Mexico ............................................................................................ 5
Onshore Round Solidifies Production Upside............................................................ 5
Downstream Improvements Will Alter Pemex's Portfolio........................................... 6

Canada ............................................................................................ 7
Husky Decision An Outlier, Producers To Delay Development......................................... 7

H215 Weakness Limiting Upstream Prospects

Front-Month WTI Price, USD/bbl

Colombia ......................................................................................... 8
Investment In Shale Will Yield Limited Success........................................................ 8

Venezuela ..................................................................................... 10
Petrocaribe Nearing Final Days..............................................................................10

Argentina ...................................................................................... 10
Lower Domestic Crude Prices Will Not Deter Investment.........................................10

Source: Bloomberg

On December 3, US independent Devon Energy reportedly made an offer for Felix Energy for a cash-plus-shares deal. While the amount of the
acquisition is unconfirmed at USD2bn, we believe this development is indicative of a wider trend that smaller, more leveraged companies are under
substantial pressure to offload assets amid consistently low crude prices.
We previously highlighted that a growing acceptance that benchmark
prices will remain weak for an extended period of time will drive mergers and acquisitions (M&A) activity into the new year (see 'Growing
Consensus Over Lower Oil Price Supports M&A Uptick', November 26
2015). With WTI crude prices consistently trading below USD55/bbl
since July 6, oil producers have been under tremendous financial strain
despite concerted efforts to cut production costs over the past year.
Continued downside pressure on WTI has resulted in greater assurance
regarding the value of upstream companies and their assets, thereby
facilitating M&A activity.
The proposed takeover by Devon also supports our view that there
is consistent communication between producers who are looking to
optimise their asset portfolios by bolting on adjoining acreage to boost
their competitiveness within the broader industry downturn.
We believe this particular deal is of interest given the acreage that is
on offer. While much attention within the unconventional space has been

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United States

Americas

Oil & Gas

directed toward the 'big three' plays the Permian, Eagle Ford, and
Bakken Felix's asset base is exclusively located in the Anadarko
Basin of Oklahoma, an area we previously highlighted as the top
emerging shale region in the country (see 'Oklahoma Countering
Shale Downtrend', June 22 2015).
Though production within the basin has declined in recent
months alongside the majority of other shale plays, the underlying
strength of the area makes this a valuable asset. Namely, the South
Central Oklahoma Oil Play and Sooner Trend, Anadarko Basin and
Canadian and Kingfisher counties (STACK) plays have attractive
breakeven structures, high recoverable liquids volumes and strong
initial production rates.
Devon's strength within the Anadarko basin makes it wellpositioned to link its portfolio with that of Felix, bolstering its
long-term prospects within the play. Namely, the strategic purchase
of Felix's 75,000 net sweet spot areas would complement Devon's
nearly 280,000 net risked acres where upstream developments are
continuing amid the price downturn. Devon has furthered its commitment to the STACK by leveraging enhanced completion designs
and reducing drilling time to achieve a reported 15% decrease in
total well costs this year, illustrating its understanding of the play
and making it an optimal fit with Felix's assets.

Lower prices at the pump reinvigorated US consumption in 2015,

reversing a long-term downtrend over the past decade. However,
following consumers' readjustment to new price levels, we believe
demand for refined fuels will become more tempered (see 'Lower
Oil Prices Boost Fuel Consumption', March 30 2015).

Demand For Refined Fuels

Approaching A Peak

Specifically, changing structural dynamics combined with a declining number of drivers in major urban centres and the emergence
of the electric vehicle segment will limit upside over the long run
(see 'Premium EV Brands Will Defy Low Fuel Prices', June 5 2015).

Demand Capped By Structural Changes

US Demand For Refined Fuels

f = BMI forecast. Source: EIA, BMI

BMI View: Changes in fuel standards will limit consumption growth

for refined fuel products in the US over the next decade. 2015 will
prove to be an outlier within a broader long-term downward trend.

Dip In Benchmark Incentivised Consumption

US WTI Front-Month Price, USD/bbl (LHS) & Primary Refined Fuels,
USD/Gallon (RHS)

Demand for refined petroleum goods in the US is nearing a peak as

structural changes within the market discourage higher consumption
levels. Namely, strict fuel economy targets being implemented in the
US along with higher blending mandates for biofuels will weaken
consumer demand for fuel over the next decade in spite of lower
prices at the pump.
Increased fuel economy standards will limit potential upside for
fuels consumption, with demand unlikely to return to levels seen in
the last decade. As such, we forecast total consumption of refined
fuels to rise by an average rate of 1.3% between 2015 and 2017
before falling to an average rate of 0.1% over the remainder of our
10-year forecast period at the time of writing.

Stricter Rules Disincentivise Demand

The steep decline in crude benchmark prices since 2014 resulted in a
similar reduction in the price of refined fuels. This lowered average
retail prices for both gasoline and diesel by approximately 27.0%
y-o-y in 2015, falling below USD3.00/gallon for the entire year
compared to an average of nearly USD3.75/gallon for regular and
medium grade gasoline and USD3.80/gallon for diesel fuel in 2014.

Source: Bloomberg

A new chapter in US fuel efficiency standards will begin in 2017,

limiting consumption over the long run and proving the surge in
demand over 2015 will be short-lived. With motor gasoline and
diesel comprising two-thirds of domestic market demand, the US
government has increased its focus on creating a new generation of

FINAL RENEWABLE FUEL VOLUMES

2014

2015e

2016f

2017f

Cellulosic biofuel (mn gallon)

33.0

123.0

230.0

n/a

Biomass-based diesel (bn gallon)

1.63

1.73

1.90

2.00

Advanced biofuel (bn gallon)

2.67

2.88

3.61

n/a

16.28

16.93

18.11

n/a

Renewable fuel (bn gallon)

e/f = estimate/forecast. Source: EPA

www.oilandgasinsight.com

United States

Americas

cleaner vehicles to mitigate the effects of climate change and reduce

refined fuels consumption.
2015 Resurgence Will Not Reverse Long-Term
Downtrend
US Motor Gasoline & Diesel Consumption, 000b/d

Oil & Gas

This dynamic will provide modest support for WTI prices over the
next several years, particularly after 2018 when global supplies and
demand begin to balance. However, we believe structural changes
in the US market will outweigh market trends in the US, inhibiting
upward pressure over the long run as average yearly crude prices
remain below USD75/bbl through 2024 (see 'Demand Weakness
Will Restrain Prices', November 6 2015).

Lifting The Crude Export Ban:

Initial Implications
BMI View: The lifting of the US crude export ban will have a limited
impact on liquids production over the next year due to persistently
weak project economics. A tightening of the spread between Brent
and WTI will subdue demand for US cargoes overseas, with Canada
remaining the US's primary export market. Exports to Latin America
will also grow, given their demand for light sweet crude.
Source: EIA

Narrow Spread Decreases US Crude

Competitiveness

Namely, US passenger cars and light trucks model year 2017-2021

will be required to travel 40.3-41.0 miles per gallon (mpg) versus an
average of just under 30mpg over the past decade. Moreover, for cars
manufactured between 2022 and 2025, the mandated level increases
to an average of 48.7-49.7mpg. These rules will weaken demand in
both the motor gasoline and more nascent diesel fuel markets which
is already facing a setback following the VW scandal earlier this year
(see 'EPA Ruling Hits VW's US Advantage', September 21 2015).

WTI & Brent Front-Month Prices, USD/bbl (LHS) & WTI-Brent Spread,
USD/bbl (RHS)

Future Supplies Will Be Sold At A Lower Price

US WTI Front-Month Price, USD/bbl

Source: Bloomberg

The reversal of the 40-year ban on crude exports on December 18

will not revive the US's upstream industry. While a landmark change
in policy, this reform comes at a time when US oil producers have
little to benefit from the export market, given stuttering production
domestically and weak international demand growth for light sweet
crudes. We maintain our forecast for a contraction in output in 2016
with little prospect for strong production gains thereafter.
f = BMI forecast. Source: BMI, Bloomberg

US Supplies Entering Hotly-Contested Market

In addition, in November 2015, the Environmental Protection
Agency (EPA) released the volume requirements of biofuels in
the US gasoline supply in the Renewable Fuel Standard (RFS) for
2014 through 2016. The mandated blending volumes for all types
of renewable fuels increased markedly over the three-year period,
providing further downside for conventional refined fuels demand
over the long term.

Lower Demand Will Keep A Lid On Prices

In light of lower consumption trends, we expect benchmark crude
prices will find it challenging to realise a more pronounced recovery.
Producers will continue to scale back upstream developments as
sustained weakness in crude markets increases pressure to ensure
profitability by minimising costs.

www.oilandgasinsight.com

The introduction of US exports will allow producers to compete

freely in the global market. This will result in a further narrowing
of the spread between the WTI and Brent benchmarks which has
tightened significantly over the past year due to a slowdown in
output growth and continued infrastructural debottlenecking in the
US. As a result, US crude exports will be less competitive than
similar grades overseas when accounting for higher shipping costs
and longer transit times.
Given continued demand for heavy and medium sour crudes, the
US's light sweet supplies will become available for export. We caution, however, that these supplies are entering a highly-competitive,
oversupplied market. A number of the traditional suppliers of similar
light grades such as Nigeria and Angola have struggled to place
their own volumes in recent quarters. Discounted official selling

United States

prices for a number of West African grades are indicative of this

trend and highlight the competitiveness of the light sweet market
(see 'Exports To Pressure European Crudes', September 3 2015).

Americas

Oil & Gas

WTI and Brent narrows, refiners' costs will increase, thereby squeezing profits at affected facilities. This could, in turn, increase demand
for seaborne imports, depending on shipping costs and transit times.

US Supplies Already Under Pressure

Stocks Nearing A Peak

US Crude Exports To Canada*, 000 b/d

US Weekly Crude Stocks Ex. SPR, mn bbl

*Monthly data through September 2015. Source: EIA

We therefore believe that US exports will largely stay within the

Americas given their proximity to potential importers. We expect
Canada will remain the largest importer of US crudes in light of
favourable demand dynamics and existing transport infrastructure.
Namely, we expect Canadian economic growth will accelerate in
2016 from stronger manufacturing exports and higher household
consumption (see 'Strong Exports Will See Economic Growth Accelerate', December 4 2015).
This will increase crude demand at Canada's light-geared refineries which already import US supplies due to an exemption in the US's
previous export regulations. However, we caution that US exports
will still face significant competition within Canada as evidenced
by the recent decline in US shipments attributed to the narrower
WTI-Brent spread which displaced more costly rail imports with
seaborne supplies (see 'Narrower Spread Will Disincentivise Bakken
Crude Imports', September 9 2015).
Within Latin America, we expect Mexico will be the largest importer of US supplies given refiners' continued demand for ultra-light
crude to blend with heavier domestic grades. Mexican production
of light oil has fallen sharply in recent years due to national oil
company Pemex's underinvestment in these resources. While we
expect this trend will reverse in the wake of ongoing energy sector
reforms, we do not expect these volumes will be produced before
2018, maintaining demand for imported supplies over the next two
years. The crude swap arrangement which was approved earlier
this year will also support future trade agreements between the two
countries (see 'Crude Swap Will Support North American Market',
August 18 2015).

Source: EIA

Midstream Priorities Will Shift

Greater international demand for the US's land-locked crude will
incentivise utilisation of midstream infrastructure. Specifically, we
believe the lifting of the ban will strengthen demand for crude-byrail usage from the Bakken as pipeline takeaway capacity remains
at a deficit. We caution, however, that utilisation rates will be
limited by weaker incentives for US imports due to the narrower
price differential.
Also, first shipments will likely come from crude stocks, providing much-needed relief for theseoverly-supplied facilities. As
of the week ending December 11, total commercial crude storage
in the US had reached 74.3% utilisation, reflecting the contango
structure of the market as producers await a more profitable price.
A stagnation or potential draw down in storage will reduce demand
for corresponding infrastructure, particularly along the Gulf Coast.
Finally, we could see increased demand for pipelines over the
long term. We believe this would primarily impact the Bakken play
due to its continued reliance on more costly rail infrastructure. However, this will take several years to materially impact capacity given
regulatory and environmental constraints on project developments.

East Coast Refiners Will Lose Advantage

Exports will alter the dynamics of the downstream sector. Namely,
Gulf Coast refineries will likely import larger quantities of medium
and heavy sour grades for which they were designed as lighter supplies make their way out of the country. This will optimise refinery
feedstock and improve downstream efficiencies throughout the
USGC downstream hub.
Facilities on the East Coast, however, are likely to suffer from
this change in policy. These refineries have benefitted from strong
crack spreads as rail transport costs were offset by discounted rates
for WTI-linked Bakken feedstock. However, as the spread between

www.oilandgasinsight.com

Mexico

Americas

Oil & Gas

Development Supports Positive Outlook

MEXICO

Onshore Round Solidifies

Production Upside
BMI View: The success of Mexico's third license tender demonstrates
ongoing government efforts to improve the attractiveness of the upstream investment environment, strengthening momentum for future
rounds. The development of onshore deposits will increase demand for
OFS providers and supports our upbeat long-term production forecast.
On December 15, Mexico's National Hydrocarbon Agency (CNH)
held the third tender of Round One auctions, launched to maximise
investment into Mexico's underdeveloped gas and liquids sector.
Having assigned all 25 of the blocks on offer, the latest tender significantly outperformed the expectations of both the energy ministry
(Sener) and the CNH which had anticipated a 20% success rate. This
suggests that the most recent regulatory changes provided sufficient
incentives for private exploration and production firms (E&Ps) to
participate in the reform process, highlighting the importance of an
open and attractive regulatory regime (see 'Full Potential Rests On
Greater Government Support', May 12 2015).

With a total of approximately 1.8mn bbl of oil and 98.0mn cu m

of 3P reserves across the offerings, the onshore fields will support
production of both resources beginning in 2018. 19 of the areas
assigned are already actively producing, but have suffered from
chronic underinvestment in recent years by national oil company
Pemex. We believe the era of declining output in Mexico is nearing
its end as onshore development begins to ramp up.
As a main goal of the third tender, the CNH will ensure that these
onshore blocks remain active while promoting long-term development from all 25 areas. While winning bidders have up to two years
to formulate upstream plans as part of the 25-year concessions,
existing infrastructure within the blocks will facilitate and likely
expedite development plans. As such, we expect incremental output
from onshore plays to be the first new volumes to emerge from the
Round One process.

Mexican Dominance Will Shore Up Support

The result of the onshore round will foster the development of
Mexico's nascent private exploration and production (E&P) sector
(see 'Start-Ups Well Positioned In Onshore Bidding Round', December 14 2015). Of the 96 companies that demonstrated interest
in the onshore round, 64 paid to access the data room, including

RONDA UNO ONSHORE TENDER WINNERS

Block

Company

Country Of
Origin

Share Of Profits
Offered (%)

Tajn

Compaa Petrolera Perseus, S.A. de C.V.

Mexico

60.82

Servicios de Extraccin Petrolera Lifting de Mxico, S.A. de C.V.

Mexico

60.82

Canamex Dutch B.V. with Perfolat de Mxico, S.A. de C.V. and American Oil Tools S. de R.L. de C.V.

Holland/Mexico

85.69

CuichapaPoniente
Moloacn
Barcodn

Diavaz Offshore, S.A.P.I. de C.V.

Mexico

64.50

Renaissance Oil Corp S.A. de C.V.

Canada

80.69

Roma Energy Holdings, LLC with Tubular Technology S.A. de C.V. and Gx Geoscience Corporation, S.
de R.L. de C.V.

US/Mexico

35.99

Diavaz Offshore, S.A.P.I. de C.V.

Mexico

63.90

Renaissance Oil Corp S.A. de C.V.

Canada

78.79

Mundo Nuevo
Paraso
Catedral
Topn
Mayacaste
Malva
Pea Blanca

Grupo Diarqco, S.A. de C.V.

Mexico

60.36

Renaissance Oil Corp S.A. de C.V.

Canada

57.39

Strata Campos Maduros, S.A.P.I. de C.V.

Mexico

50.86

BenavidesPrimavera

Sistemas Integrales de Compresin, S.A. de C.V. with Nuvoil, S.A. de C.V. and Constructora Marusa,
S.A. de C.V.

Mexico

40.07

Fortuna Nacional

Compaa Petrolera Perseus, S.A. de C.V.

Mexico

36.88

Ricos
Maregrafo
Carretas

Strata Campos Maduros, S.A.P.I. de C.V.

Mexico

41.50

Consorcio Manufacturero Mexicano, S.A. de C.V.

Mexico

34.25

Strata Campos Maduros, S.A.P.I. de C.V.

Mexico

50.86

Geo Estratos, S.A. de C.V. with Geo Estratos Mxoil Exploracin y Produccin, S.A.P.I. de C.V.

Mexico

61.50

Tecolutla

Geo Estratos, S.A. de C.V. with Geo Estratos Mxoil Exploracin y Produccin, S.A.P.I. de C.V.

Mexico

68.40

Secadero

Grupo R Exploracin y Produccin, S.A. de C.V. with Constructora y Arrendadora Mxico, S.A. de
C.V.

Mexico

60.74

Construcciones y Servicios Industriales Globales, S.A. de C.V.

Mexico

20.08

Pontn

Duna
San Bernardo

Sarreal, S.A. de C.V.

Mexico

10.56

Consorcio Manufacturero Mexicano, S.A. de C.V.

Mexico

41.77

Geo Estratos, S.A. de C.V. witth Geo Estratos Mxoil Exploracin y Produccin, S.A.P.I. de C.V.

Mexico

66.30

Grupo Diarqco, S.A. de C.V

Mexico

81.36

Geo Estratos, S.A. de C.V. witth Geo Estratos Mxoil Exploracin y Produccin, S.A.P.I. de C.V.

Mexico

67.61

Calibrador
La Laja
Calicanto
Paso de Oro
Source: CNH

www.oilandgasinsight.com

Mexico

Americas

supermajors ExxonMobil and Total as well as Statoil and China

National Offshore Oil Corporation. However, 26 companies and
14 consortiums ultimately participated, the overwhelming majority
of which were newly-formed Mexican E&Ps including Perote E&P
and GPA Energy. Meanwhile, the larger integrated producers did
not present bids, suggesting these offerings were too small or too
unprofitable to justify investment.
The dominance of private Mexican companies will help alleviate one of the primary threats facing the reform movement, given
the importance of these resources to the citizens themselves. With
domestic E&Ps winning rights to operate or participate in 22 of the
25 contracts, we believe broader support for the privatisation of the
industry will strengthen, reducing the risk of demonstrations, which
have increased over the past two years.
Onshore Blocks Cement Upstream Momentum
Mexico Total Hydrocarbons Production

Oil & Gas

Downstream Improvements
Will Alter Pemex's Portfolio
BMI View: Pemex's announced USD23bn downstream spending
plan will be mostly funded through the newly-formed Fibra E investment vehicle, boosting refining capacity over the next three years. We
caution that extensive asset divestment on the part of Pemex could
threaten its long-term profitability given our outlook for sustained
lower oil prices over the next decade.
Mexican national oil company (NOC) Pemex affirmed its plans to
modernise the country's downstream sector over the next three years
through a USD23bn spending plan. While lower oil prices called
into question the company's plans earlier in the year, we believe
the Fibra E investment vehicle launched in November will provide
a significant boost to the national oil company (NOC) (see 'Fibra
E To Advance Energy Sector Liberalisation', November 5 2015).
This will offset declines in government spending and supports our
positive outlook within the sector.
Fibra E Enables Further Sector Development
Fibra E Ownership Structure

f = BMI forecast. Source: EIA, BMI

OFS Opportunities Opening Up

Onshore developments will offer a critical new pool of demand
for the embattled oilfield services (OFS) sector. Having come under tremendous strain over the past year in the wake of falling oil
prices, OFS companies have been forced to cut costs and increase
efficiencies as E&Ps throughout the world continue to pull back
investments to protect positive free cash-flow (see ' Majors To Play
Role In Market Rebalancing', November 4).
Quicker ramp-up of upstream projects particularly in the 19
actively-producing blocks will require equipment that is currently in oversupply including wellhead and service capabilities
and downhole expertise. With lower global demand having eroded
costs for these services, smaller developers within Mexico will be
able to benefit from cost deflation in the industry, crucial within a
low commodity price environment.

Source: Secretara de Hacienda y Crdito Pblico

Investment Supports Downstream Plans

A stronger environmental mandate following the UN 2015 Paris
Climate Change Conference (UN COP21) will couple with the
new Fibra E investment tool to revive downstream development
in Mexico over the next three years. The government is hoping to
modernise its industrial facilities to increase production of ultralow
sulphur (ULS) fuels, resulting in a reduction of CO2 emissions by
7mn tonnes per annum.
The Fibra E programme offers an ideal mechanism to direct

PEMEX DOWNSTREAM STRATEGY

Amount Allocated (USDbn)

Strategy

Renovate Technological Museum

Plan

0.3

Create the National Energy Technology Museum

Build co-generation capacity

3.0

Capture steam from three refineries for power generation

Increase ULS petrol production

3.1

Upgrades at all six refineries, decrease emissions by 90%

Increase ULS diesel

3.9

Upgrades at all six refineries

Increase utilisation of residual products

12.3

Modernise Salina Cruz, Tula and Salamanca to reduce use of coke from 20 to 3%

Total

22. 6

Source: Pemex company data

www.oilandgasinsight.com

Canada

Americas

private capital into Mexico's energy infrastructure. An offshoot of

energy sector liberalisation, its creation illustrates the government's
continued commitment to the reform process while maintaining
Pemex's prominence within the market.
Fibra E regulations require a corporate sponsor such as Pemex
to contribute equity interests in developed infrastructure assets, for
which they can raise capital by selling shares via the Mexican Stock
Market (BMV). In this instance, Pemex would continue to operate
the assets while generated cash flows would be distributed among
stakeholders, according to their respective share of ownership.
Modernisation Supports Capacity Growth
Mexico Refining Capacity Growth

Oil & Gas

were supported by stronger refining margins and a higher volume

of domestic fuel sales.
Pemex is hopeful that liberalisation of the market will decrease
their reliance on downstream revenues as stronger output levels
and higher crude prices boost upstream profits activities which
are excluded from the Fibra E regime. However, we caution that
this upside could prove insufficient to outweigh the decline in
downstream revenues due to our more bearish oil price outlook
whereby prices will average below USD70/bbl through 2020. The
divestment of midstream and downstream facilities will therefore
offer a short-term capital infusion for the modernisation plan, but
could ultimately threaten the long-term profitability of the NOC.

CANADA

Husky Decision An Outlier,

Producers To Delay Development
BMI View: The decision by Husky to advance development of its
Rush Lake, Edam and Vawn heavy oil projects in Saskatchewan will
not boost Canada's oil sector over the next decade. The high-cost
nature of similar upstream developments will not be justified within
a low crude price environment.

e/f = BMI estimate/forecast. Source: EIA, BMI

This structure will open Mexico's downstream sector to a wider

pool of investors through the BMV and will incentivise participation through tax incentives. With only existing, positive cashflow
generating assets allowed in this programme, this will reduce overall
investor risk and ensure significant take up of Pemex's future offers,
providing much-needed capital for the NOC's downstream plans.
While we are optimistic with respect to international investor
interest, we maintain our more cautious outlook for refining capacity
growth at the time of writing, given the scope of the modernisation
plan. Specifically, Pemex hopes to spend USD19bn of the funds
exclusively on refinery upgrades, reducing refined fuel imports by
139,000b/d. To date, we can confirm agreements at the Minatitlan,
Salamanca, and Tula facilities, totalling 93,000b/d in additional
downstream capacity which we believe will materialise between
2018 and 2019 (see 'Downstream Prepping For Upstream Growth',
November 20 2015).

Canadian energy company Husky Energy announced it would

complete the 10,000b/d phase II of its Rush Lake heavy oil project,
its Edam East and Edam West thermal oil developments and its
10,000b/d Vawn project in Saskatchewan, all by 2021. This is a
significant departure from the vast majority of its oil producing peers
in Canada, who have suspended or cancelled numerous projects
over the past several months amid a weak oil price environment.
While notable, we caution that Husky's decision will do little
to stem the inevitable decline in Canadian heavy oil production,
beginning in 2018. With the fall in WTI prices precipitating substantial weakness in Western Canadian Select (WCS), the majority
of producers in Canada will forgo any pending or unconstructed
upstream projects, thereby putting an end to the multiyear project
pipeline which began in 2010.
Downturn Ahead
Canada Total Liquids Production

Divestments May Erode Pemex Balance Sheet

In order to secure adequate funding for the downstream modernisation
projects, Pemex will need to offer stakes in some of its most profitable
assets. In an increasingly risk-averse environment following the fall
in commodity prices, international investment will be incentivised
by facilities that ensure strong future cash flows such as those within
Pemex's downstream portfolio. In addition its six refineries, Pemex
operates nine gas processing centres, two petrochemical facilities and
more than 1,300km of pipelines and associated storage infrastructure,
all of which enjoy a strong domestic demand outlook.
As the sole operator in Mexico's USD49bn downstream market, these assets have helped support Pemex's balance sheet in a
time of declining upstream profits from steadily declining output
and sharply lower oil prices. Specifically, in Q315 Pemex posted
a USD9.5bn loss which was mainly attributed to a 39.1% decline
in the value of its crude exports. However, the company's finances

www.oilandgasinsight.com

f = BMI forecast. Source: EIA, BMI

We believe Husky decided to move forward with these developments due to the integration of these assets with its downstream
network. The company is keen to boost its ability to refine lower-cost
feedstocks at its 160,000b/d refinery in Lima, Ohio in an effort to

Colombia

Americas

improve margins in the downstream sector which have become an

important revenue generator as crude prices fall.
WTI's Fall Signalled Heavy Oil's Demise
WSC (Top) & WTI (Bottom) Front-Month Price, USD/bbl

Oil & Gas

production (see 'Prices Range-Bound As Glut Persists To 2018',

December 9 2015). The WCS benchmark has traded at a USD1315/bbl discount to WTI over the past year to account for its heavier
composition and higher shipping costs. Given our outlook for
WTI to average below USD55/bbl per year through 2018, WCS is
likely to trade below commercial breakeven costs for many heavy
crude projects, the bulk of which require a WTI price in excess
of USD50/bbl.
At the time of writing, we estimate total crude output in Canada
will reach 4.6mn b/d in 2015 and will increase to more than 5.0mn
b/d by 2017. We therefore believe the combined 34,500b/d from
the Rush Lake, Edam and Vawn developments pose little upside
to the overall health of Canada's upstream market through 2024,
supporting our long-term bearish production outlook.

COLOMBIA

Investment In Shale Will Yield

Limited Success
BMI View: Efforts by ConocoPhillips, ExxonMobil and CNE
within Colombia's shale sector will not revive development of these
resources over the next several years. These higher cost projects
will prove difficult to justify amid an environment of continued oil
price weakness.

Source: Bloomberg

With Canadian crude prices expected to remain below USD40/

bbl well into 2016, Husky and its peers in the heavy oil and bitumen
market will suffer from significant financial strain. Falling upstream
revenues will outweigh cost-cutting efforts, solidifying weaker operating margins and an eventual stagnation in heavy oil output (see
'Tough Times Ahead For Oil Sands Producers', August 14 2015).

We expect recent developments in Colombia's nascent shale sector

will fail to result in meaningful upstream development. On December
3 2015, US-based independent ConocoPhillips and CNE Oil and
Gas a subsidiary of Canacol announced they would extend their
exploration contracts within Colombia.
Unconventionals Not A Factor
Colombia Total Liquids Production

Canadian Crude Being Produced At A Loss

WTI Full-Cycle Breakeven Price For Selected Oil Sands Projects, USD/bbl

f = BMI forecast. Source: EIA, BMI

Note: Black line = BMI core oil sands profitability level; yellow line = current WCS spot
price. Source: BMI, BMO Capital Markets, Citi Research, Cenovus

This view is anchored in our oil price outlook whereby a continued oversupply in the market will sustain downside pressure on
benchmark prices until 2018 in spite of a pull back in US crude

The agreement will now include non-traditional oil resources in

the VMM-3 block, taking advantage of regulations passed by the national hydrocarbon agency in 2014 to incentivise shale development.
The following day, supermajor ExxonMobil filed an environmental
permit to explore for shale resources in the VMM-37 block. While
promising, we believe these efforts will not spur progress to an extent
that would result in growth of unconventional reserves or production,
in light of continued oil price weakness (see 'Unconventionals Will
Not Attract Capex', March 25 2015).
We therefore maintain our modest oil production growth forecast
in Colombia through 2024 whereby output will not exceed 2016

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Colombia

Americas

levels. We believe declining upstream investment by both public

and private partners will cause natural depletion to outweigh any
incremental gains (see 'Reduced Attacks Improve Short-Term Production Outlook', August 24 2015).
In The Red
ConocoPhillips Key Profit Metrics, Earnings (LHS) & EPS (RHS)

Source: ConocoPhillips

Economics Do Not Favour Development

While each of the aforementioned companies have experience
with unconventional resources, we do not believe project economics in Colombia will incentivise their development over the
next several years. Given a lack of infrastructure and equipment
to support shale operations, the cost of development in Colombia
will prove too high to justify the necessary investment within a
low oil price environment.
Moreover, continued weakness in benchmark prices will maintain substantial financial pressure on exploration and production
companies, forcing them to reduce capital expenditures in an effort
to match spending with revenues by 2016 or 2017. We now expect
companies will prioritise investment on finishing major projects,
rather than expanding into new, high cost markets (see 'Majors To
Play Role In Market Rebalancing', November 4 2015).

Oil & Gas

Permian plays as well as the Duvernay and Montney in Canada.

However, a sharp decline in revenues over the past year has led to
a pullback in various regions including the US Gulf of Mexico and
unconventional development in China.
In addition, Conoco's previous joint venture with Canacol
to explore for shale oil which was announced in February of
2013 suffered repeated delays, ultimately failing to yield any
success. Though Canacol is already exploring for unconventionals in seven blocks within the Middle Magdalena Basin (MMB),
we do not believe it has sufficient financial firepower to progress
with these projects.
Finally, with respect to ExxonMobil, the company has yet todevelop its own existing shale assets within the MMB, suggesting a
prioritisation of their spending elsewhere. As recent as February
of 2015, the supermajor deferred its shale exploration plans in
Colombia owning to the fall in crude prices. While the company is
in a better financial position to advance its unconventional plans,
we believe it will ultimately chose to invest in proven, less risky
upstream opportunities.

Regulations Incentivise Extensions

We believe the extension of the exploration contracts underscores
the investor-friendly nature of Colombia's energy framework rather
than the potential of its resource base. This is illustrated by its first
place rank in our upstream industry risk component within our Latin
American Risk/Reward Index (RRI), scoring 85.0 out of a possible
100.0 points.
Colombia Leading The Pack
Latin America Upstream Industry Risk Index, Out Of 100

Middle Magdalena Shale Will Remain In Place

Map Of Colombian Hydrocarbon Basins

Source: BMI Oil & Gas Risk/Reward Index

We believe Colombia's favourable investment dynamics encouraged ConocoPhillips, CNE and ExxonMobil to secure their positions
within this widely undeveloped unconventional market in the event
of a market recovery. However, in light of our below-consensus
oil price forecasts whereby Brent will average below USD70/bbl
through the end of the decade, we do not believe such an opportunity
will present itself for the foreseeable future.
Source: BMI

In the case of ConocoPhillips, we do not believe it is wellpositioned to increase investment into Colombia's unconventional
resources by the required minimum of USD85mn. The company
has extensive experience developing shale in the US's Niobara and

www.oilandgasinsight.com

Venezuela

Americas

VENEZUELA

Petrocaribe Nearing Final Days

BMI View: Continued deterioration of the Venezuelan economy
and its upstream sector will exacerbate downside pressure on
the Petrocaribe programme in 2016. The inauguration of the
opposition-led National Assembly will further undermine the
Petrocaribe alliance given its reformist agenda.

Oil & Gas

The Venezuelan government has already taken steps to phase out

the Petrocaribe programme by increasing the interest rate it charges
on its oil loans for several members, as well securitising and selling
Petrocaribe debt abroad over the past year. However, we expect the
new parliament will take further steps to dismantle it. While we
acknowledge the potential threat of policymaking gridlock in the
coming months, we maintain that the underlying weakness of the
country's extractive sector will ultimately deem this programme
unsustainable in the near term (see 'Key Risks For 2016', January 6).
No Recovery In Sight

The continued slide in crude prices will wreak havoc on Venezuela's

already tenuous economic situation and undercut any efforts to
support upstream development in 2016. This will bring an end to
the 20-year-old Petrocaribe oil alliance as Venezuelan national oil
company (NOC) Petrleos de Venezuela (PdVSA) will prove unable to supply member countries.

Venezuela Total Liquids Production

An Unhealthy Relationship
Map Of Petrocaribe Members

e/f = BMI estimate/forecast. Source: EIA, BMI

Source: D-Maps, BMI

Not Enough To Go Around

Oil production in Venezuela will decline over the next several years
owning to chronic underinvestment into the sector which will be exacerbated by the global industry slowdown. Reduced profitability from
sustained lower oil prices, coupled with continued resource management, will make it difficult for the government to fund its expansive
social development programmes, particularly as Petrocaribe members
struggle to repay their own debts to Venezuela (see 'External Account
Dynamics To Weaken On Venezuelan Instability', February 26 2015).
We expect total output will continue to decline over the next
several years, averaging -2.1% y-o-y through 2020. While Venezuela
will remain one of the largest crude producers in the region, consistent declines do not support a continuation of the oil alliance given
elevated domestic demand due to subsidised fuel prices coupled
with committed volumes of approximately 300,000b/d to China
through oil-for-loans arrangements. As such, we do not believe
PdVSA will be able to maintain exports of nearly 200,000b/d to
Petrocaribe member countries over the next year.

New Leaders Will Not Support Old Policies

As the new opposition-led National Assembly takes its place over
the next several months, we expect Petrocaribe will be increasingly
scrutinised. A sweeping electoral victory on December 6, where
the opposition coalition won a veto-proof two-thirds majority, will
open the door to their progressive agenda which is broadly against
the oil alliance.

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This will leave importing member countries at risk of supply

shocks and threaten their external accounts as Petrocaribe provides
both subsidised oil as well as financial assistance. The risk of a balance of payments crisis will therefore remain elevated for several
importers over the next year, including Nicaragua and Belize (see
'External Position Highly Vulnerable To End Petrocaribe', August
10 2015). As such, we believe those reliant upon Venezuelan crude
exports will be forced to seek alternative suppliers of crude, develop
their own upstream resources, or diversify their power sectors away
from oil-fired thermal capacity (see 'Renewables Opportunities Amid
Challenging Environment', August 27 2014).

ARGENTINA

Lower Domestic Crude Prices

Will Not Deter Investment
BMI View: The reduction in Argentina's domestic crude prices is a
positive signal for upstream investors as the country comes increasingly in line with international market standards. Continued reforms
within the sector will boost investment into unconventional projects
given Argentina's vast resource potential.
On January 5, the newly inaugurated administration of Argentina
announced a reduction in the country's mandated domestic crude
prices, continuing the presidents' ambitious reform strategy. Specifically, prices for both Medanito and Escalante crudes were reduced
by 10-12% in response to continued weakness in global benchmark
prices. This has created a significant premium for both grades, decreasing their international competitiveness.
We believe the reduction of domestic prices will not deter investment into Argentina's underdeveloped resources over the next
year. The country's crude prices will remain at a premium, offering

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Argentina

Americas

some insulation from the broader industry downtrend. This policy,

combined with the lifting of capital controls and domestic currency
weakness reducing foreign companies' development costs will
render the country's vast resources highly attractive, forming a bright
spot in an otherwise bleak global market (see 'Domestic Policy Pivot
Will Drive Investment', December 2 2015).

Oil & Gas

approximately USD14bn in developing the Vaca Muerta over the

next several years.
Devaluation Will Support Foreign Investors
Argentina Average Exchange Rate, ARS/USD

Former Pricing Policy Deemed Unsustainable

Front-Month Brent Price Versus Domestic Crude Prices, USD/bbl

e/f = BMI estimate/forecast. Source: Bloomberg, BMI

Source: Bloomberg, YPF

Vaca Muerta's Prospects On The Rise

Holding an estimated 16.2bn bbl of oil resources and 8.7trn cu m of
natural gas, the Vaca Muerta shale play is nearing a crucial turning
point. We expect upstream developers will scale back investments
further in 2016, turning their focus toward finishing major projects.
However, producers remain watchful for low-risk opportunities that
will offer long-term rewards. Given improving above ground prospects in Argentina, we expect developers will position themselves
to take advantage of this unique opportunity.
Crucially, Argentina's domestic crude prices will not be reduced
enough to render shale developments unprofitable. According to
company reports, drilling costs at the Chevron-YPF joint venture
the country's largest upstream project have fallen substantially
over the past several years, from USD11mn in 2011 to approximately
USD6.5mn in 2015. This, alongside continued improvements in
hydraulic fracturing, will bring commercial breakevens closer to
USD50/bbl, below the elevated domestic prices (see 'Vaca Muerta
To Drive Production Growth', June 9 2015).
Investor interest in the Vaca Muerta has already begun to
strengthen this year, supporting our upbeat production forecast.
Specifically, on January 7, Germany-based Wintershall signed a
new exploration contract with plans to invest USD110mn in six
oil wells through 2017. On the same day, junior operator President
Energy announced it would expand its five-well workover program
and may drill new wells in 2016. These followed supermajor ExxonMobil's announcement in December 2015 that it would invest

While President Mauricio Macri has initiated an aggressive pace

of market-friendly reforms, we do not believe his administration
will do away with the crude price-setting regime in the near future.
Originally enacted to boost energy output and protect jobs within
the country's hydrocarbon industry, this policy has largely helped
support development of Argentina's largely untapped shale resources
amid the downturn, particularly by state-owned YPF (see 'High
Domestic Oil Price Insulates Shale', January 13 2015).
On The Upswing
Argentina Oil & Natural Gas Production

e/f = BMI estimate/forecast. Source: EIA, BMI

Unconventional development in Argentina remains in a nascent

stage with approximately 400 wells having been drilled throughout
the Vaca Muerta to date. As such, production costs remain elevated
relative to similar shale projects in the US, rendering this pricing
strategy highly valuable.

Analysts: Marina Petroleka, Christopher Haines, E mma

2016 Business Monitor International Ltd. All rights reserved.

Richards, Mara Roberts, Peter Lee, Charles Swabey

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