Quarterly Energy Markets Analysis – Q.E.M.A., November 2019

Quarterly Energy Markets Analysis – Q.E.M.A., November 2019. ** Disclaimer: This market analysis is for informational purposes only, and is not intended to be construed as investment advice or to serve as the basis for any business decision. The views and opinions expressed herein are current only as of the date of publication, and are subject to change. Ascent Consultants does not undertake any obligation to update these views or opinions. Ascent Consultants neither paid nor received any compensation as part of this report. Contents:

  1. Q.E.M.A. – What, why?

  2. Introduction

  3. Markets Overview

  4. PolicyOverview

  5. Forecasts

  6. Analysis

  7. Conclusion

1. Q.E.M.A. – What, why First, thanks for taking the time to read through this market analysis. The Quarterly Energy Markets Analysis provided by Ascent Consultants collects news, data, insights and opinions covering the global energy industry, with a focus on US Shale, to create a broad analysis and forecasts for key variables. The goals of the Q.E.M.A. are to foster and facilitate positive discussion about energy policy across the industry’s many niche sectors, and from that discussion work toward a goal of maximizing the potential of all forms of US energy production, development, and innovation. Copyright Ascent Consultants. All rights reserved. 1

2. Introduction The last 12 months have been a bumpy ride for energy: Declining rig count; persistent oversupply conditions for oil, gas, and steel; a challenging trade environment; slowing global growth; reduced access to capital; and a growing focus on climate. In Q3 2019, US GDP grew at a meager 1.9% as businesses continue to deal with uncertainty about trade and tariff levels1. Growth for 2020 is forecast to be a mere 1.8%2, offering scant hope of movement from the current status quo. However, if trade tensions ease demonstrably, there is potential for a rapid turnaround, given the overall resilience and agility of the US economy. In specific sectors of oil, gas, and steel (both raw and finished products), the US and the world are in states of oversupply and soft demand. In the US in particular, we’re also seeing some dramatic shifts in the makeup, operations, and regulation of these industries. The good news, though, is that despite the current market conditions, all signs point to continued growth by the US as a global leader in all facets of energy production and innovation. 3. Markets Overview Steel On October 31, 2019, US Hot Rolled Coil closed at $498 / NT3, almost a 40% YOY drop from $831 / NT as global oversupply and declining business sentiment weigh further on manufacturing and steel demand. 1 https://www.nytimes.com/2019/11/01/business/wto-china-us-trade.html 2 OPEC Monthly Oil Market Report, October 2019 3 Investing.com historical data, US Midwest HRC Copyright Ascent Consultants. All rights reserved. 2

While numerous US mills announced price increases to try and reverse the trend, the market fundamentals do not support the price increases4. Scrap has remained effectively flat for nearly a year, as has iron ore5. Recent price increases at the recycling / scrap level appear to be due to a lack of activity. If scrap has indeed reached an economic bottom, that will boost forward- looking confidence for EAF’s even if the full price increases are unlikely to stick further up the supply chain until inventories have an opportunity to balance and/or demand recovers. Iron ore has trended flat for the quarter, bringing some pricing consistency to integrated producers. Looking out further though, steel faces a very challenging environment. The amount of new capacity scheduled to come online starting in 2021 creates a worsening structural oversupply outlook: “SteelmageddonTM” as described by Bank of America which has also trademarked the term6. One such example is JSW’s Sinton, TX facility with an estimated annual capacity of 3 million net tons, 30% of which is earmarked for energy tubulars. As one source put it, “what for?” 4 As of the date of publication, we’ve seen an increase of about $30 / NT, which represents a decent return for the mills back to back $40 / NT increases. 5 Investing.com historical data, 62% Fe ore, US scrap futures 6 https://www.cnbc.com/2019/03/19/steel-stock-investors-beware-price-crushing-steelmaggedon-is- coming.html Copyright Ascent Consultants. All rights reserved. 3

$1,000.00 $900.00 $800.00 $700.00 $600.00 $500.00 $400.00 $300.00 $200.00 $100.00 $0.00 HRC (US) $350.00 $300.00 $250.00 $200.00 $150.00 $100.00 $50.00 $0.00 Scrap Copyright Ascent Consultants. All rights reserved. 4 Aug-18 Sep-18 Jun-19 Jul-19 Oct-18 Nov-18 Aug-19 Sep-19 Dec-18 Jan-19 Oct-19 Feb-19 Mar-19 Apr-19 May-19 Aug-18 Sep-18 Jun-19 Jul-19 Oct-18 Nov-18 Aug-19 Sep-19 Dec-18 Jan-19 Oct-19 Feb-19 Mar-19 Apr-19 May-19

$140.00 $120.00 $100.00 $80.00 $60.00 $40.00 $20.00 $0.00 Iron Ore Oil West Texas Intermediate closed at $54.18 on October 31, just below the EIA’s forecast for average 2020 pricing of $54.43. Notwithstanding, US shale oil is forecast to grow in 2020 as pipeline constraints are alleviated7. With infrastructure a primary driver behind increased production, the economic benefits will likely accrue to specific players with pipeline access rather than the market as a whole. The OPEC Monthly Oil Market Report suggests more of the same for 2020, with 2.20 mbpd supply growth against only 1.08 mbpd demand growth for 20208. Projections for US shale growth have varied, but the overall prediction is for another supply glut on the horizon. 7 Growth figures for US shale have ranged between ~400,000 barrels / day, to over 1 million additional barrels per day 8 OPEC Monthly Oil Market Report, Oct. 2019 Copyright Ascent Consultants. All rights reserved. 5 Aug-18 Sep-18 Oct-18 Nov-18 Dec-18 Jan-19 Feb-19 Mar-19 Apr-19 May-19 Jun-19 Jul-19 Aug-19 Sep-19 Oct-19

DUC inventory has declined nominally for the year (makes sense with a declining rig count, relative “ease” of adding production versus a new well spud), but inventory still remains well above 7,000 wells due to stagnant pricing9. In the near-term, the primary drivers behind global oil price will be whether and to what extent OPEC continues its supply reduction strategy, and what external factors impact the global energy markets, such as the attacks on tankers in the Strait of Hormuz and the drone strikes on Saudi Arabia’s Abqaiq facility. With respect to those attacks, it is worth noting that the Abqaiq outage represented the single largest supply disruption ever; close to 6% of global capacity. If such an attack had occurred even 5-10 years ago, the impact would have been far more substantial in terms of price spikes and market disruption. While it is true that these attacks occurred during a period of oversupply, it is impossible to discount the impact of US shale production on the global energy markets. Two Baker Institute scholars provide an excellent analysis for further insight10. Finally, the long-awaited Saudi Aramco IPO has arrived. The listing is moving forward, and the Saudi’s have begun calls for more production cuts, ostensibly in an effort to reach (or get closer to) their desired $2 trillion valuation. Whether this influences the production management strategy at the December meeting of OPEC, or whether the Saudis cut deeper than the agreement (again) and sacrifice short-term production and market share in order to try and drive that valuation. As one source points out, the dollar value might ultimately be of less importance than the identity of the buyers of Aramco shares. With debt and equity markets tightening with respect to oil and gas, what is the appetite for shares of the world’s largest company? 9 https://www.eia.gov/petroleum/drilling/#tabs-summary-3 10 https://www.forbes.com/sites/thebakersinstitute/2019/09/16/attacks-on-saudi-oil-facilities-cast-a- huge-shadow-of-uncertainty-on-the-oil-market/#24980d3f50b3 Copyright Ascent Consultants. All rights reserved. 6

$80.00 $70.00 $60.00 $50.00 $40.00 $30.00 $20.00 $10.00 $0.00 WTI 1200 1000 800 600 400 200 0 Rig Count Copyright Ascent Consultants. All rights reserved. 7 Aug-18 Sep-18 Apr-19 May-19 Oct-18 Nov-18 Jun-19 Jul-19 Dec-18 Jan-19 Aug-19 Sep-19 Feb-19 Mar-19 Apr-19 May-19 Aug-18 Sep-18 Jun-19 Jul-19 Oct-18 Nov-18 Aug-19 Sep-19 Dec-18 Jan-19 Oct-19 Feb-19 Mar-19 Oct-19

1800 1600 1400 1200 1000 800 600 400 200 0 TX Permit Submissions 4. Policy Overview As market fundamentals across multiple industry sectors point to oversupply and weakening demand, the policies behind the data become very important. The question of how, when, and to what extent we see progress on trade policies is anyone’s guess, despite broad agreement that new and updated agreements are overdue. Significant uncertainties remain around a US/China deal. The USMCA remains in limbo, and whether it or any other deal could be ratified in light of impeachment investigations and the 2020 elections appears to be a very, very long shot11. Adding to the challenge, most if not all trade policy since 2017 has been regressive, creating an added layer for negotiations, and also more severe gyrations as sectors are forced to (re)adjust to any tariff rollback. Recent stories covering Phase 1 of the US-China deal illustrate the issues quite well. 11 Notwithstanding, news broke on the USMCA today that suggests it could move forward Copyright Ascent Consultants. All rights reserved. 8 Aug-18 Sep-18 Oct-18 Nov-18 Dec-18 Jan-19 Feb-19 Mar-19 Apr-19 May-19 Jun-19 Jul-19 Aug-19 Sep-19 Oct-19

Tubing offers a more granular example of how has trade policy impacted one corner of the energy space. Rewinding the clock to mid/late 2018, forecasts were suggesting that an oil price spike was imminent. As sentiment became strategy, importers of API tubing naturally placed orders for future inventory. What happened? The oil price spike never came, and the market remains grossly oversupplied for tubing, with some Q3 estimates at over 50 million feet. While the oil forecast proved incorrect, trade policy also contributed to the oversupply problem. When S. Korea agreed to an annual quota for steel products, there was a major shift by API mills in S. Korea to tubing production. This was a market segment where S. Korean mills were highly competitive, and the lower weight-per-foot of tubing meant that more product could be shipped under the tonnage quota. As a result, it is not only possible, but likely that buyers overbought to get ahead of both quarterly and annual quotas. Similarly, quotas often produce with “use it or lose it” scenarios at both the macro and micro level12. If S. Korea’s total average tonnage drops, it creates an opportunity to revise down the overall quota. Similarly, at the micro level, any drop off by one company is likely to be very quickly absorbed by another, creating dilemmas for manufacturers as well and distorting market-based decision-making. Sources have indicated that S. Korean mills are bringing in unsold API casing in order to meet and maintain the tonnage quota. This bears a stunning resemblance to the tubing issue, although without any accompanying demand growth forecast. This will make destocking a longer and more costly process, while simultaneously blurring the supply chain as manufacturers compete with their distributors. Trade and economic policies vary among the Democratic candidates for 2020, but nearly every candidate has endorsed policies that would totally reshape the US energy industry, if not the entire economy. The two main proposals are the “Frac Ban” and the Green New Deal, or some facsimile thereof. 12 Anyone who has managed a departmental or government office budget will understand this. Why do we get new desk chairs every year? “Use it or lose it” disincentivizes fiscal discipline and sound decision-making. Copyright Ascent Consultants. All rights reserved. 9

Karl Rove provides some analysis on the “frac ban” and its impact on Texas13 where roughly 500,000 people are employed in or near the “oil patch”. In short, the economic effects would be devastating. Similarly, Morgan Stanley’s research shows that in 2018, 78% of US onshore wells were fracked. Thus, a frac ban (or similar regulation) could be crippling for the US energy sector, with concomitant negative effects on the economy broadly, not to mention national security. Some sources, and plenty of pundits, suggest that this is just campaign trail bluster, but at least one major E&P company is hedging its bets, with Concho resources accelerating its drilling on federal land in order to get ahead of any possible policy shifts14. Whether there is a further chilling effect as we get closer to the 2020 elections is to be seen, but policy differences are stark and the elections could have outsized impact on the US energy landscape, the economy, millions of jobs, and of course billions in revenue for both the states and federal government. Shifting focus to the state level, recall Colorado SB 181, which fundamentally reformed the mission and structure of the state’s oil and gas regulatory agency, the COGCC. The most recent update suggests that it will be well into 2020 before the final rules are completed, creating an environment of uncertainty and a compliance nightmare as the state and individual communities establish their own sets rules at different speeds. This regulatory uncertainty will be much more challenging for the smaller operators who lack the resources to spend heavily on compliance. Meanwhile, Colorado Rising has filed suit asking the courts to ban new permit approvals until all final rules are in place15. The COCGG continues to fight this, but the courts will have their say. At the state level, Colorado will continue to be the petri dish for aggressive oil and gas regulation16 as SB 181 backers push for more stringent rules and consider 13 https://www.wsj.com/articles/how-the-democrats-will-keep-texas-red-11571872390 14 https://www.worldoil.com/news/2019/10/30/talk-of-a-frac-ban-has-one-driller-tapping-federal- lands-in-advance 15 https://www.denverpost.com/2019/10/09/colorado-rising-complaint-oil-gas-development-sb-181/ 16 New York is a close second. https://www.coned.com/en/save-money/convert-to-natural- gas/westchester-natural-gas-moratorium/about-the-westchester-natural-gas-moratorium Copyright Ascent Consultants. All rights reserved. 10

additional legislation. Expect the courts to play a role in the final outcome, potentially delaying finality even further. The Heartland Institute’s interview with CO State Senator Cooke (who represents Greeley, one of the key O&G development areas in the state) provides some local perspective and commentary17. 5. Forecasts18 Rig Count: Drop to 700 in our future? Year over year, the US rig count has dropped roughly 25% from 1,081 to 81719. As if the trends didn’t already provide adequate evidence, data analysis also points to a continued downward trajectory. This will make OCTG destocking a slower process and potentially brings challenges to operators that need to meet midstream volume commitments. Distributors still holding high priced inventory will face a difficult decision as the US shale industry appears mired in the doldrums. Using the EIA’s 2020 oil forecast of $54.43, a linear regression of WTI and Rig Count suggests approximately 673 rigs at the forecast WTI price for 2020. As 2020 budgets and capital programs are unveiled, early numbers are flat / down, as companies seek out higher capital efficiency and attempt to work within free cash flow to meet investor demands for ROI, while access to debt and equity markets tightens. The SPDR XOP and XLE, and the Alerian AMZ are all down. Comparing October 2019 and 2018 YOY, these major energy indices are down 40%, 13% and 7% respectively. And https://www.reuters.com/article/us-consolidated-edi-natgas-new-york/no-new-natural-gas- hookups-in-new-yorks-westchester-county-con-ed-says-idUSKCN1QW2IS 17 https://www.heartland.org/news-opinion/news/legislative-pulse-colorado-legislature-overrides- voters-oil-and-gas-decision 18 Basic regression analyses in Excel, using data from Aug 2018 - Present 19 https://www.aogr.com/web-exclusives/us-rig-count/2019 Copyright Ascent Consultants. All rights reserved. 11

HRC: Bouncing along the bottom? Recent price increases followed the traditional script, despite numerous sources forecasting persistent market weakness well into 2020. However, as is often the case, part of the price increases stuck. As noted above, scrap has begun to trend upward with recyclers apparently happy to trade some margin for activity, but given the broad market conditions it is unlikely that buyers will be forced to fully absorb any more of the recent HRC increases. At the mill level, higher input costs mean at least short-term margin tightening for coil, pipe, tube, and similar finished and semi-finished products. This is consistent with some analyst forecasts reviewed for this report. Analyzing scrap as a function of HRC supports this theory, with scrap forecasts coming in around at around $250 / NT, or slightly under the current spot prices. The premium spot price over the forecast brings some credence to the theory that the price increase was meant to spur activity. Analyzing this Scrap price increase and HRC, we should see HRC at a far more palatable $540 / NT, so the mills will be hoping that HRC cooperates, but this illustrates the combined problem of oversupply and misguided trade policy. One caveat: as the US-World spread widens in any product, it allows domestic buyers the opportunity for purchasing arbitrage. Despite the current pricing environment, and another possible drag on HRC recovery, US capacity utilization remains oddly high. WARN notices issued for several domestic mills will see some capacity go offline in Q4, and should the Tenaris acquisition of TMK Ipsco’s assets close in Q4 as planned, perhaps some redundant capacity will be eliminated there as well bringing further relief. Ominously silent on this issue is whether US Steel will decommission any capacity (Granite City, for example) in light of its Big River investment. Reductions in capacity now would help mitigate further price erosion as new capacity comes online starting in 2021. Copyright Ascent Consultants. All rights reserved. 12

Oil Price: As noted above, the EIA is forecasting WTI to remain essentially flat for 2020, with an average price of $54.43 per barrel. Despite calls for greater OPEC+ cuts, a declining rig count, and flat-to-down capex spending forecasts for 2020, there is no short-term fundamentals-based recovery in sight. Analyst reports across the energy and steel sectors paint a bearish case for US shale in 2020 even as production growth forecasts are revised down due to the global oversupply situation20. As the Baker Institute scholars pointed out (see above), even the largest single outage in history wasn’t enough to meaningfully move prices for more than a few days, so flat pricing appears here to stay. Outlier – The Tenaris & TMK Ipsco Deal: Important in the discussion about steel, but even more important to the energy supply chain, will be the final closing of Tenaris’ acquisition of TMK Ipsco’s North American assets. In their Q3 earnings call21, Tenaris executives noted that they still expect the deal to close in Q4 2019. Analysts inquired about a change in the price, as well as DOJ issues, to which Tenaris executives responded that a) the contract is in place, and they expect the deal to close on those terms, and b) DOJ / anti-trust work is proceeding and they are confident in closing the deal in Q422. Rig Direct currently represents approximately 75% of Tenaris’ US OCTG shipments, which they expect to continue to grow. The acquisition of TMK assets provides immediate bolt on synergies to expand the Rig Direct model into Northeastern US basins as well as feedstock for existing assets. 20 US crude stocks remain toward the high end of the 5-year average as well. Suggesting a longer- term recovery for pricing https://www.eia.gov/petroleum/weekly/crude.php 21 http://ir.tenaris.com/events-and-presentations 22 Consider though that the contract may contain price adjustment clauses, and commentary on any DOJ investigation is bound to be vague at best. Copyright Ascent Consultants. All rights reserved. 13

The three main issues to follow on this deal will be: The outcome of the DOJ investigation, whether any surplus / redundant capacity is closed, and how Tenaris handles the existing TMK distributorships and licensees outside of the context of the DOJ’s investigation23. As Tenaris works to eliminate distribution from its supply chain entirely, this will effectively “shrink the pie” for the rest of the distribution space and alter the competitive landscape, especially for the smaller and mid-size operator market. These factors, plus slowing E&P activity and potential supply chain adjustments are likely to put more pressure on pipe and tube pricing in the short term. 6. Analysis First and foremost, it is worth highlighting Deloitte’s recent contributions to research on the US shale market24. With many industry heavyweights noting the difficulties presented by the current landscape, Deloitte’s research identifies opportunities for the industry to simultaneously increase efficiency and decrease its sensitivity to oil prices. While Deloitte’s reports highlight opportunities for everything from engineering to operations and strategy, the primary drivers of the global markets for oil and steel will remain external. Helima Croft of RBC Capital Markets pointed out earlier this year that geopolitics, trade, and Iran would be critical variables for oil price direction in 2020, and she reiterated those sentiments again this week25. Steel’s main driver is likely to be trade policy. If we see tariff escalation that creates more/new volatility, steel is likely to suffer. On the other hand, new trade agreements that return stability to markets and create conditions conducive to business investment should dramatically improve the outlook for steel as macroeconomic 23 On this third element, it appears that the distributors and licensees have already started seeking out new supply. Tenaris’ earnings call sounded very reminiscent of Rig Direct’s US roll out. Distribution is not in their plans. 24 https://www2.deloitte.com/us/en/insights/industry/oil-and-gas/us-shale-revolution- playbook.html?id=us:2el:3pr:4di6417:5awa:6di:102319:&pkid=1006754 25 https://www.cnbc.com/2019/11/11/rbcs-helima-croft-on-crude-oil-supply-demand.html Copyright Ascent Consultants. All rights reserved. 14

conditions improve. However, as noted above unwinding these policies presents an additional set of difficulties at every stage of trade policy updates26. While some positive developments in trade have occurred in recent weeks, the situation with Iran is deteriorating further on the heels proxy attacks and enhanced nuclear research. This should keep roughly 2 million barrels of Iranian crude off the global markets (at least explicitly). A reduction in sanctions allowing some or all of that crude back into the market would be devastating for oil prices in the current supply/demand environment. Economic indicators like PMI and the Transportation index appear to be flashing signs of improvement (or at least signs they are at or near bottom). Similarly, the Morgan Stanley Business Conditions Index shows substantial improvement from October to November (after hitting lows not seen since 2008-2009), suggesting that recession risks are fading, and hopefully improved economic conditions will follow in 2020. Manufacturing still appears to be lagging compared with the services sector, but better statistics can at least help improve sentiment. 7. Conclusion As the industry matures, a more holistic approach may be needed to continue shale’s upward trajectory, and its critical role in transitioning toward a zero-carbon future. Deloitte’s research points to additional efficiencies and untapped synergies throughout the supply chain, while Rig Direct provides an example of the paradigms which are starting to shift throughout niche sectors. The US energy industry has proven without a doubt its resiliency and innovative spirit. Both of those will need to be tapped again to weather another period of lower pricing and policy uncertainty, but as with every market dip, there are opportunities to be had. One of the most glaring examples is our aging and inadequate energy infrastructure. New pipelines are needed and there are hundreds of thousands of miles of aging 26 For example, elimination of steel tariffs or quotas would potentially see large amounts of S. Korean and Brazilian material re-entering the market Copyright Ascent Consultants. All rights reserved. 15

lines long past the need for replacement27. Yet in many ways the industry is hamstrung as projects face political opposition (some of which is highly illogical), costly delays due to litigation and more, resulting in numerous inefficiencies and opportunity costs. With opinion toward fossil fuels becoming more disparate, the industry will need to coalesce and stand up for the many benefits it brings in the way of jobs, reduced dependence on foreign oil, innovation, and security. Now more than ever, a carefully crafted, fact- and logic-based energy policy is critical to maintain the benefits shale has brought in terms of jobs, innovation, and security. So, in closing, as BP’s Bob Dudley said at CERA Week – it’s time to get off the sidelines and get involved. Thanks for reading. ADDITIONAL READING: Recent news stories that didn’t quite make it into the final edition, but are worth a read. Governance and Policy in Louisiana & the Impact on Energy in the State https://www.wsj.com/articles/louisiana-the-trial-lawyer-state-11573256661 Charting US production growth, along with import/export data. Look at how far we’ve come since 2010!! https://www.wsj.com/articles/u-s-oils-growth-challenges-investors- 11573387200?mod=hp_lead_pos9 27 https://www.phmsa.dot.gov/data-and-statistics/pipeline-replacement/decade-inventory Copyright Ascent Consultants. All rights reserved. 16

Shale pullback. A “New Normal” yet again? https://www.wsj.com/articles/frackers-prepare-to-pull-back-exacerbating-a- slowdown-in-u-s-oil-growth-11573478550?mod=hp_lead_pos6 CNBC “Fueling Change” Stories https://www.cnbc.com/2019/11/11/energy-ceos-defend-carbon-efforts-call-for- realism-from-campaigners.html https://www.cnbc.com/2019/11/11/us-shale-oil-revolution-will-continue-despite- headwinds-experts-say.html https://www.cnbc.com/2019/11/11/yergin-against-elizabeth-warrens-fracking-ban- pledge-adipec-2019.html Other: https://www.cnbc.com/2019/11/13/trumps-china-trade-war-losses-will-never-be- recovered-shipping-data-tells-us.html https://www.cnbc.com/2019/11/13/opecs-barkindo-us-shale-oil-producers-are- concerned-about-slowdown.html

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