WoodMac - Insight - 14 Dec 2016

Global trends: 6 things to look for in 2017

The next 12 months may resonate for decades

The world adjusts to President Trump. Attention first shifts to the strategic
priorities of the incoming administration. US energy is a potential winner, but
much remains unknown, and a fluid uncertainty may well turn out to be the tenor
of President Trump's time in office.

On carbon, which way will the world turn? The Paris Agreement came into
force on 4th November 2016, but only five days later was cast into doubt by the
results of the US presidential election. Will China seek to adopt the nebulous role
of 'climate leadership', and will the rest of the world follow?

Demand disruption is the big question. How soon is peak oil demand?
Renewables and electric vehicles are in the ascendant, but could political
changes in the US revitalise demand in the world's largest oil market?

Corporate strategies a muted recovery. The industrys balance sheet

starts 2017 weaker than 12 months ago. We expect the US Lower 48 to drive an
uptick in global investment, signalling the end of the downturn. Firmer oil prices
will encourage the strongest companies to look at growth opportunities.

The cartel formerly known as OPEC? OPEC has painted itself into a corner.
The group may still be able to control oil prices to a limited degree, but whatever
OPEC does in the future, the benefits of that control will accrue to parties
elsewhere.

Populism is the most potent risk for 2017. Sudden shocks can and should
be expected over the next 12 months. A fracturing EU could deliver a threat to the
global economy akin to that of the Great Financial Crisis. In Asia, populism will be
used to consolidate power rather than challenge it. 2017 could be a delicate year.

1. The world adjusts to President Trump

After an unpredictable campaign, the energy industry in the US and beyond has
been trying to determine the strategic priorities of the incoming Trump
administration. Critical areas are the US coal, oil and gas industries; the overall

direction of the economy, trade relationships and foreign policy; and the attitude to
the Paris Agreement on climate change, ratified by President Obama just prior to
the election.
There are potential winners in the US energy industry. Trump's campaign made an
issue of energy independence, further exploitation of domestic oil, gas and coal
reserves, encouraging gas demand, and job creation in the industry. Infrastructure
would get an easier ride; Keystone XL is likely to get the green light, and Trump is
said to be a supporter of the Dakota Access pipeline. Regulatory barriers that raise
costs or limit domestic production are in line to be dismantled.
But Trump's room for manoeuvre may be limited, and his agenda somewhat
contradictory. A more favourable upstream environment could see reduced fiscal
take (say GoM royalty rates); a more liberal approach to leasing, opening up access
to areas currently closed (such as Alaska); and encouraging tight oil production. On
the latter, oil prices will be the primary incentive rather than fiscal measures, with
most if not all plays breaking even around $55/bbl. Gas production is unlikely to be
materially affected; under President Obama, demand has been the limiting factor for
drilling activity, not drilling regulations. Over the last few years, the US coal market
has been subject to many structural changes outside the scope of government
policy, not least the emergence of cheap natural gas, which would make a return to
the past difficult.
Financial markets are betting a Trump presidency will boost spending and cut taxes.
The latter is classic Republican supply-side economics, but Congress may not be
tolerant of a ballooning deficit once increased spending is taken into account. It is
also as yet unclear if Trump's infrastructure investment plans would lead to a boost
in economic growth. For the moment, our short-term economic outlook for the US
remains unchanged.
From a foreign policy perspective, a perceived bias towards isolationism could
reshape key geopolitical relationships with Saudi Arabia and the other Gulf OPEC
states, including Iran. OPEC's 30th November decision to restrain production did not
include Iran, which has been allowed to increase output to pre-sanction levels (see
below). A re-assessment of US support for lifting Iranian sanctions could thus
materially impact oil markets. But the sanctions deal was a global one, and it is
doubtful a Trump administration will have the clout to kill it.
Trump's developing relationship with Asia will garner close attention, and the
dialogue with Taiwan late in 2016 indicates a non-traditional approach. Much has
been said about renegotiating trade deals in America's interest, or even abandoning
them altogether. But imposition of tariffs on China and other exporters of goods
could slow the global economy and offset the ongoing recovery in commodity
markets. Meanwhile, China has its own ambitions as a global power. Obama's 'pivot'

to Asia was never really followed through, and has allowed China to flex its military
muscle more than ever before. An antagonistic trans-Pacific relationship could
quickly spill out into the South China Sea, and beyond.
While much remains unknown, clarity should emerge as the Trump cabinet is
finalised and a strategy formed. But key policies have already been talked down.
Twitter-based diplomacy is an astonishing reality. A fluid uncertainty may well turn
out to be the tenor of Trump's time in office. From 2017, the world will be forced to
adjust.
2. On carbon, which way will the world turn?
The Paris Agreement implied a downside risk to hydrocarbon demand growth by
promising to cap global warming to no more than 2 degrees above pre-industrial
levels. Both China and the US non-signatories to previous climate treaties were
on board. But less than a week after it had come into force, the Paris Agreement
was thrown into doubt by the results of the US presidential election.
A Trump administration may seek to extricate itself from the Paris Agreement, but a
simpler and more likely course of action is that emissions targets will simply be
ignored, and then missed. The global emission trajectory implied by the current draft
of the Paris Agreement is thus out of reach, and the 2-degree target unachievable.
The Paris Agreement may be remembered as the fastest climate deal ever agreed,
and the fastest killed off.
But unfolding energy demand trends suggest greenhouse gas emissions growth will
continue to slow, even without the explicit driver of carbon policy. We believe coal
consumption in China has peaked and is in terminal decline, as growth shifts to
renewables, nuclear and gas. By 2030, China's greenhouse gas output will remain
below peak levels of 2013. China thus ratified the Paris Agreement from a position
of strength, and will deliver a 70% emissions intensity cut versus a 2005 base year
significantly beyond its Paris commitment.
If Paris falters, the blame for future global warming will be laid at the feet of the
incoming US administration. In the complex post-Trump world of fluid strategic
relationships, 'saving the climate' could be valuable geopolitical currency. If so, an
economy already trending towards lower-carbon growth gives China a tremendous
opportunity for leadership.
Whether other countries follow depends entirely on cost. Emerging markets need to
develop, and fossil fuels remain the cheapest and most abundant forms of energy.
Carbon targets have historically fallen by the wayside when economic growth is a
country's primary concern. But disruptive technology is a reality, and here too China
has a hand to play. A China focused on slowing emissions growth domestically and

facilitating change in the region and beyond exporting technology and expertise
and reaping the geostrategic benefits could be a far more potent force for
decarbonisation than the troubled Paris Agreement.
3. Demand disruption is the big question
'When is peak oil demand?' is the big question surfacing in the oil industry. Shell has
speculated on the risk of oil demand peaking within 5-15 years. Our own base case
outlook suggests demand growth continuing (albeit at a slower rate) until at least
2035, sustained in part by growth in petrochemicals. A definitive answer won't come
in 2017, but peak demand is a puzzle set to remain on the agenda as a complex
interplay of technology, politics and consumer attitudes evolves through the year.
Solar power has enjoyed a vibrant 2016, buoyed by a series of 'world record' low
prices for new projects, each more eye-catching than the last. In 2017, solar will
take something of a breather, as China modestly scales back its ambitions, Japan
dials back on feed-in tariffs, and the US suffers something of a hangover from
exceptional growth in installed capacity over the last 12 months.
But 2017 will be an anomaly in an unstoppable growth trend extending into the
foreseeable future. Projects that achieved record low prices in 2016 will begin to
come online across the world and demonstrate if they can be profitable without
subsidy. As the solar market expands, utility buyers will be increasingly joined by
corporate clients (tech companies, manufacturers) purchasing power direct to build
socially responsible credentials. The solar market will take time to survive entirely
without support, but 2017 will mark the beginning of a mature and sustained phase
of growth.
Alongside renewables, electric vehicles (EVs) are the disruptive threat to
hydrocarbon demand most often cited. 2016 was the year EVs arrived in the public
consciousness, driven predominantly by a slew of announcements of lower-cost
models. Chevrolet's Bolt (approximately US$38,000 and 240-mile range for the
base version) will roll out into early 2017. Tesla's Model 3 (US$35,000 and 215
miles) will be the blockbuster release at the end of the year, but many other
manufacturers will either take a first step into this market, or expand their current
ranges. These 'mass-market' offerings will be required to prove their worth to
consumers through 2017 if EVs are to stand a chance of displacing material
volumes of oil demand over the coming years.
If EVs take off, oil demand in transport could still grow. In the US, increased
efficiency of cars and light trucks is driven less by economic decisions of consumers
than the federally-mandated Corporate Average Fuel Efficiency (CAFE) standards.
But environmental regulation across the board is now in question; a rollback on
CAFE standards could mean a return to demand growth in the world's largest

market. This trend could persist for years and push global peak oil demand far into
the future, offsetting any demand destruction from the growth of EVs.
4. Corporate strategies a muted recovery
Strengthening finances through 2017 will again be a top priority. Persistent oil prices
below US$50/bbl would crank up the financial pressure, forcing companies to spend
another year in survival mode. If prices strengthen as we expect, its a much more
positive story. The industry turns cash flow positive at US$55/bbl, and growth
becomes an option once again.
We expect upstream investment to increase in 2017 by 3%, ending two successive
years of decline. US Lower 48 unconventional plays, tight oil and shale gas are
highly price sensitive. The nascent recovery underway in 2016 should accelerate.
Emboldened by a Trump administration committed to exploiting domestic oil and
gas resources, US operators have three core competitive advantages: access to
capital; cost-advantaged portfolios; and the flexibility to scale back spend sharply if
prices stay low.
More conventional projects should achieve final investment decision (FID) we
expect 20 to 25 FIDs in 2017, a marked step up from the single figures of both 2014
and 2015. However, much of the actual spend on these greenfield projects may not
come through until 2018. Many of the 2017 FIDs will be relatively small, short leadtime projects where costs have been significantly reduced in the downturn,
reflecting the industrys focus on value over volume. Big projects with long lead
times, marginal economics and substantial up-front spend will struggle to win
funding. There is a need for further cost reduction if investment in conventional
resource themes is to restart in earnest.
Portfolio adaptation will gather momentum as companies seek to position lower
down the cost curve and into new energy. Opportunities at the bottom of the curve
will be in demand, particularly short-cycle, factory-type investments such as tight oil.
Big, costly, high-risk volume plays will be out of favour.
Exploration success rates and full-cycle returns will continue to improve in 2017, as
the industry does more with less capital. The Majors should continue to re-establish
their exploration credentials after a long period of playing second fiddle to the
Independents. Financing M&A will again be a challenge for many E&P companies,
particularly outside North America. But a degree of optimism for oil markets after
OPECs u-turn may spur those looking to do deals into action while asset prices are
still relatively subdued.
5. The cartel formerly known as OPEC?

OPEC's 30th November decision to restrain production had an immediate impact on

oil markets. The plan to cede 3% market share for an asymmetric increase in prices
was welcomed, with Brent lifting to well above US$50/bbl. Whether prices can be
sustained above the 2016 average of around US$45/bbl depends on OPEC and its
non-OPEC partners, as well as the pace of underlying market tightening.
Our fundamental view is that oil markets would rebalance and prices recover in the
latter part of 2017 without production cuts. Demand is robust, whereas non-OPEC
supply, mainly US Lower 48, has been suppressed by a lack of investment post2014. Even with partial compliance, OPECs production cuts of 1.2 million b/d
(effective from January 2017), supplemented by 0.6 million b/d from non-OPEC
producers, will accelerate the tightening process. Reported production numbers for
OPEC and its partners will be closely watched through the early months of the year.
OPEC may choose to extend the deal for a further six months if need be. But by
then, the group may be questioning its entire reason for existence.
The uplift in prices after the deal is a boost for the upstream industry, and
particularly for tight oil producers. Drilling was already on the up, and is likely to
accelerate. We expect output to return to positive growth after Q1. If prices stabilise
above $55/bbl for a few months, anticipate a step change in production into 2018.
OPEC's decision is a gift to the very competitor it sought to kill off in 2014.
By abandoning the market share strategy, OPEC has painted itself into a corner.
The group may still be able to control oil prices to a limited degree, but whatever
OPEC does in the future, the benefits of that control will accrue to parties outside
the cartel. If OPEC remains a functional entity by the end of 2017, its greatest hits
will surely be in the past.
6. Populism is the most potent risk for 2017
The tide of populist sentiment that delivered Trump and Brexit will continue to rise
through 2017, colouring the year with an unpredictable and potentially dangerous
sentiment. There are major elections in France, Germany and possibly Italy. The
primary risk to energy markets is a chronic drag on economic growth as the
narrative plays itself out, but sudden shocks can and should be expected over the
next 12 months.
The UK government has promised to trigger Article 50 (to leave the EU) by March
2017, but is currently engaged in a Supreme Court battle over its right to do so
without Parliamentary approval. A verdict is expected in the new year. Should the
government win, Brexit will be assured by 2019. If the government loses the case,
an early general election is a possible outcome something that could become a
de-facto referendum on the 23rd June result.

In mainland Europe, surprise elections in Italy are possible following Prime Minister
Renzi's resignation in the wake of his own referendum defeat. All three main
opposition groups are anti-EU. France holds presidential elections through April and
May; here the contest will be between the right-wing Francois Fillon and the far-right
Marine Le Pen. Germany will vote in September, with Chancellor Merkel's popularity
under sustained pressure from the ongoing refugee crisis. A European Union that
fractures either by accident or design could pose a threat to the global economy
akin to that of the Great Financial Crisis.
The prevailing mood should suit President Putin well. With a kindred spirit in the
White House, Putin is likely to elevate Russia's standing with the US. This could
lead to a dynamic realignment of a raft of hitherto intractable US-Russia problems.
But what remains unclear is how this realignment could affect Russia's relations with
China.
President Xi's China looks increasingly authoritarian. Anti-foreign rhetoric to rally the
country behind the government means populism is being used to consolidate power,
rather than challenge it. This agenda also facilitates an increasingly muscular
foreign policy. China is unlikely to budge on its ambitions in the South China Sea,
and will seek to keep negotiations entirely bilateral, between itself and one
neighbour at a time. There is potential for increased friction between Japan and
China especially, which would suit each government well, as a distraction from
poorly performing economies.
For now, we remain cautiously optimistic the worst excesses of populist and
nationalist sentiment are reined in, as the protagonists succumb to realism and
pragmatism. But the risks are real, and 2017 could be a delicate year.