June 26, Oil and Gas Overview and Analysis

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1 June 26, Oil and Gas Overview and Analysis Market Update: On a YTD basis, Total Returns for Major Indices are as follows: TSX (+1.31%), US S&P 500 (in C$ terms+8.22%), Developed Europe Index (in C$ terms+15.33%). As generally expected, the Fed recently raised its policy rate by 25 bps, lifting the fed funds target range to %. Their economic assessment was neutral-upbeat despite softer readings on capex, retail/housing activity and core inflation. Yellen also stated that the Fed had taken note of recent weak inflation data, but with employment near its maximum sustainable level and the labor market continuing to strengthen, the Committee still expects inflation to move up and stabilize around 2% over the next couple of years. On Friday, the TSX rallied on strength from positive performance in large sectors such as energy and mining. The overall energy group was up 1.4% as crude prices rose slightly. Warren Buffet s Berkshire Hathaway also agreed to provide financing for Home Capital, easing some worries surrounding the Canadian housing market. US markets were relatively flat for the week. Oil fell for the fifth straight week, and officially entered a bear market, but negative market sentiments were balanced by positive Federal Reserve Board news that all 34 US banks tested passed the quantitative portion of the yearly stress test. Longer-term US treasury yields were also largely unchanged for the week. The developed Europe index ended the week lower (-0.27%), as downward movement in the oil and gas sector led stocks lower. Financials, consumer goods and healthcare stocks were also affected, as investors received mixed signals about the health of the Eurozone economy. Japanese stocks finished up and the Nikkei 225 now stands near a 17 yr. high in USD terms. Last Week, MSCI announced that starting in June 2018, it will include 222 largecap Chinese companies in its flagship emerging markets index for the first time. This should lead to an influx of billions of dollars in the Chinese stock market. 1 Oil & Gas Portfolio Recommendations: US companies have more flexibility We remain cautious on the oil price outlook in the short term due to US production levels continuing as a key risk factor. We see oil prices stuck within the $40-50 range over the next couple of years. Energy markets have been hammered this year, and certain companies are now reaching levels where they are deeply discounted to consensus price targets We like CNQ and Suncor for long term free cash flow growth even at high $40- $50/bbl oil price and strong capitalization. We like EOG + ECA for high cash flow growth, especially if oil prices recover. We like CPG for a short-term play on a rebound in oil prices, but wouldn t hold it longer term. Pecking order: CNQ, SU, EOG, ECA, CPG. Oil & Gas Sector Macro: It is important to note that any discussion of future price trends for oil is highly speculative given the complex nature of the demand/supply balance. Overall our view is for prices remain stuck in the $40-50 range over the next couple of years. Therefore, we like the defensive play of holding companies that are able to grow and generate free-cash-flow even in the high $40 environment. The main downside risk (apart from OPEC abandoning the agreement to cut production), is U.S. supply growing too quickly, or Libya ramping up production. This could cause oil prices to reach the $40/bbl price level. The main upside risk is political and social unrest in Venezuela escalating to the point where it disrupts oil production, and causes oil prices to rise rapidly. Under this scenario we could see oil prices rise to the $60 or $70 levels. The average annual WTI price in 2016 was $43.15, down from $48.66 in 2015, its lowest (nominal) average since So far, this year, prices have averaged about $53 as the OPEC cuts have started to take effect, albeit partially offset by the strong recovery in US shale oil. Rising US crude production has undermined OPEC efforts to reduce global inventories to the five-year average, evidenced by the fact that US crude production hit 9.34 million barrels-per-day (bpd) last week, its highest level since August 2015, and 9% higher than the recent trough last September. Most analysts believe that OPEC s decision to cut production will lead to a steady price increase, based on the view that over-production caused lower oil 1 BMO The Week That Was

2 prices and therefore lower output should bring markets back into somewhat of a production-consumption balance. While this should be true, there are certain factors that could prevent oil prices from rising as much as predicted. According to the International Energy Agency (IEA), the most important factor for supply is US crude production. As the result of recent stronger performance from the US shale sector, the IEA revised upwards their expectation throughout 2017, and now expect total US crude production to exit the year 790,000 barrels/day higher than at the end of Source: International Energy Agency According to the International Energy Agency (IEA), total global oil consumption averaged million barrels/day in 2016, and global oil production averaged million barrels/day. The IEA predict global demand to outpace supply until 2Q17. For reference, the top three global oil producers are Russia, Saudi Arabia, and the United States, producing approx. 10.6, 10.5, and 8.9 million barrels/day in Canada produced an average of 3.9 million barrels/day, consumed an average of 1.8 million barrels/day and exported the rest. The three largest consumers of oil are the United States, China, and India, consuming approx. 19.4, 11.9, and 4.2 million barrels/day respectively. 3 In the natural gas market, weak 2016 oil prices also took their toll, and global production was essentially flat. This is the weakest growth in gas output in the last 34 years, not including the immediate aftermath of the financial crisis. World gas consumption grew by 1.5%, slower than the 10yr. avg. of 2.3%, and is predicted to remain at this level through Gas has begun to face competition from renewable energy and cheap coal, so the global market will most likely remain oversupplied in the next few years. Growth is expected to be mainly led by India, and China, as more coal-fired plants are replaced by gas. On the plus side, the increased supplies of natural gas will likely lead to integration of markets and more competitive trading and pricing mechanisms. This should be positive for the industry as consumption eventually picks up again further down the road. In 2016, Gas trade grew by 4.8%, helped by 6.2% growth in LNG imports/exports. 4 Oil and Gas Companies: Canada s energy industry is grappling with peak pessimism as a result of weak oil prices, and pushbacks against a couple of proposed pipeline expansions. There has also been some uncertainty surrounding US Speaker of the House Paul Ryan s proposed border tax, which would deny companies that rely on imported inputs the ability to deduct their costs when computing taxable income. However, Canada is currently the largest source of US oil imports, and it seems unlikely the US would impose this tax on Canadian oil & gas imports, as their other main sources of imports are Saudi Arabia and Venezuela. These factors have caused investors to turn negative, and the TSX s energy group has fallen ~17% since the start of the year. At this point, share prices for several Canadian Oil & Gas producers have reached levels where they are deeply discounted to consensus target prices, and are beginning to look interesting. In Canada, we are mainly interested in CNQ, SU, ECA and CPG. We like CNQ, SU, and ECA for longer term holds, and CPG for a trade on the rebound in oil price and a depressed valuation. 2 International Energy Agency 3 International Energy Agency 4 International Energy Agency

3 In the United States, we like EOG resources. Pecking order: CNQ, SU, EOG, ECA, CPG. Preference on those best able to grow and generate cash flow even in a high $40/bbl environment. Particularly like their low valuations and growing FCF. Canadian Natural Resources (CNQ): Despite slightly missing Q1 expectations due to a third-party gas plant outage, we remain bullish on CNQ. This is largely due to their shift towards long-life assets such as their Horizon oil sands project, and their recent acquisition of a 70% interest in the Athabasca oil sands project from Shell, positions which should help them to generate strong free cash flow growth going forward. While oil sands are initially very capital intensive to set up, they can then be operated for 40-80yrs, as opposed to conventional oil and shale reservoirs which typically only last 15-30yrs., and require additional well development capital. Canadian companies are strongly positioned in the competitive landscape of oil sands, as they strongly invested in becoming more cost efficient as opposed to their American counterparts, who have chosen to focus their resources elsewhere. US companies have also begun to write down large amounts of their oil sands holdings (nearly 8 billion barrels last year), mainly due to U.S Securities and Exchange Commission accounting practices which look at current commodity prices as opposed to future projections. This has allowed companies like CNQ to make key strategic acquisitions. CNQ is targeting a 15.6% production growth from , and their production mix is currently as follows: (30% natural gas, 29% oil sands mining & upgrading, 27% heavy crude oil, 14% light crude oil and NGLs). The company has also booked 17 consecutive years of dividend increases, and has recently seen a 17% increase to current annualized dividend per common share over Even more

4 impressive is the company s ability to generate FCF even at oil prices as low as mid-$30/bbl. The company also recently announced a share buyback program that will permit it to repurchase 27,930,000 shares over the next 12 months. This is typically a sign the management believes the company s stock is undervalued. 5 Suncor (SU) is an oil-sands focused company with strong production and FCF growth potential. They are a fully integrated company doing oil sands mining, exploration & production, and refining & marketing (operating retail gas stations). On a cash flow provided by operating activities basis, the mix of the aforementioned business divisions (excluding Corporate) is Oil Sands 32%, Non-Oil Sands Production 20%, and Refining & Marketing 48%. Their 1Q earnings beat consensus estimates, and the company has recently announced a $2B share buyback program for the next 12 months. BMO analysts believe their current financial position will allow them to sustain this buyback program even in the $45-50/bbl range, while allowing them to continue to grow their dividend and production. This growth should be supported by their large Fort Hills (oil-sands) and Hebron (offshore oil) projects coming online in Suncor has had >190% five year dividend growth from Q1/12-Q1/17, as well as 15 years of consecutive annual dividend increases across a wide variety of price and business operating environments. The company currently has $10.6B of liquidity, made up of 3.6B cash and $7B available in lines of credit, and is aggressively dedicated to consistent cost-cutting initiatives. Company operating, selling and general expenses are now below 2014 levels, despite production increasing 30%. Oil sands cash operating costs have also decreased from $C39.05/bbl. in 2011, to $C22.55 in Q1/17. 6 Encana (ECA) is focused on conventional and shale oil, as well as natural gas, with a production mix pretty much equally balanced between the two. Their main production facilities are located in Texas (Permian, Eagle Ford (both oil), British Columbia (Motney, wet gas), and Alberta (Duvernay,wet gas), largely considered some of the best locations in the game. Encana beat consensus estimates in both operating cash flow, and operating earnings, and remained in line with consensus on production. That being said, the cash flow and earnings beats are mostly attributed to a sizeable current tax recovery. In a $55/bbl WTI world, the company is targeting a 5-year plan of 60% production growth, and 300% cash flow growth. The company expects production to remain relatively flat in Q2, but expects growth to really ramp up in the second half of the year and into 2018, as more projects come online. Some analysts believe that Encana could also come close to achieving their goals in a $50/bbl WTI environment, but the story in a high $40/bbl environment is a little more unclear. The company is also good at cost management and believes drilling and completion costs will remain flat for the year, as 60-70% of their input costs are either self-sourced or contracted. Most likely more of a story in our opinion as more clarity will be needed on oil prices moving forward before knowing whether Encana can remain on track to successfully deliver their 5-year goals. 7 Crescent Point (CPG) is another interesting company, which is currently very inexpensive on a P/CF basis when compared to its peers (3x vs. an avg of 5.4x for the other three Canadian names). Their share price has fallen off since last year s equity financing as investors questioned the motives of this financing, and were unsure if CPG had a hidden agenda. The company was instead seeking to provide additional protection to their balance sheet, as they expected oil to enter the $40 range. This has proven to be the right decision for the company. CPG has zero oil sands assets, and instead focuses on conventional light and medium crude. At $55/bbl WTI prices, the company expects to deliver a 7% CAGR on average production, plus a 3.3% dividend yield over a 5 year period. The company also has good balance sheet strength with no material near-term debt maturities, and a significant unutilized credit capacity of $1.5 billion. However, CPG has lower projected CF/share and FCF/share than our compared peers, and has traded very closely with oil prices in the past. It has been battered recently, falling almost 50% since January of this year, but could offer good short-term upside if oil prices return to their projected range in the low-mid $50s. CPG is less positioned for growth if oil stays in the high $40 range, so probably a lower return opportunity than CNQ and SU. 8 EOG Resources (EOG) has 97% of their proven reserves located in the United States. Their 2016 production mix was 56% oil, 27% gas, and 17% NGLs (natural gas liquids), but they plan to increase oil s share of the mix. EOG is primarily a shale producer, with its biggest production centers located in Texas (Eagle Ford), the Delaware Basin, and the Rocky Mountains (Bakken, Williston Basin). EOG has begun a shift towards premium drilling, which are wells that provide oil with a higher rate of return (minimum 30%), even at $40/bbl oil. The rate of return from these wells rises to 60% at $50/bbl oil. These premium wells made up 50% of their operations in 2016, with that percentage expected to rise to over 90% by They also have a net debt to total capitalization lower than the peer average, and are planning asset sales to 5 BMO Research, CNQ Company Investor Presentation 6 BMO Research, SU Company Investor Presentation 7 BMO Research, ECA Company Investor Presentation 8 BMO Research, CPG Company Investor Presentation

5 further strengthen their balance sheet. EOG spends roughly 20% of their capital budget on infrastructure each year, and often develops projects well in advance of operation, therefore helping to lower front end costs. They project being able to balance capex and dividend with discretionary cash flow even at $47 oil, so we believe EOG to be a good defensive play if US production continues to offset OPEC cuts. EOG has also had 20% dividend growth since 1999, and have increased their dividend 16 times in the last 17 years, while remaining highly committed to controlling costs. 9 Cecil Hayhoe Gwyneth Pryse-Phillips Matt Ciprietti Investment Advisor Investment Advisor Investment Representative (416) (416) (416) cecil.hayhoe@nbpcd.com gwyneth.pryse-phillips@nbpcd.com matt.ciprietti@nbpcd.com Sources: Bloomberg, JP Morgan, Thomson, Moody s & BMO Nesbitt Burns Capital Markets research We deliver a full complement of thoughtful, customized wealth solutions for private clients and institutions, drawing upon global resources, top ranked research and the collective wisdom of BMO Nesbitt Burns and our internal and external partners. For more information on our team we invite you to contact us. BMO Nesbitt Burns 1 First Canadian Place 38th Floor Toronto, ON M5X 1H3 Member of the Investment Industry Regulatory Organization of Canada. *Disclaimers: BMO Wealth Management is the brand name for a business group consisting of Bank of Montreal and certain of its affiliates in providing wealth management products and services "BMO (M-bar roundel symbol)" is a registered trade-mark of Bank of Montreal, used under licence. "Nesbitt Burns" is a registered trade-mark of BMO Nesbitt Burns Inc. BMO Nesbitt Burns Inc. is a wholly-owned subsidiary of Bank of Montreal. The opinions, estimates and projections contained herein are those of the author as of the date hereof and are subject to change without notice and may not reflect those of BMO Nesbitt Burns Inc. ( BMO NBI ). Every effort has been made to ensure that the contents have been compiled or derived from sources believed to be reliable and contain information and opinions that are accurate and complete. Information may be available to BMO Nesbitt Burns or its affiliates that is not reflected herein. However, neither the author nor BMO NBI makes any representation or warranty, express or implied, in respect thereof, takes any responsibility for any errors or omissions which may be contained herein or accepts any liability whatsoever for any loss arising from any use of or reliance on this report or its contents. This report is not to be construed as an offer to sell or a solicitation for or an offer to buy any securities. BMO NBI, its affiliates and/or their respective officers, directors or employees may from time to time acquire, hold or sell securities mentioned herein as principal or agent. BMO Nesbitt Burns Inc. and BMO Nesbitt Burns Ltee/Ltd. ("BMO Nesbitt Burns") will buy from or sell to customers securities of issuers mentioned herein on a principal basis. BMO Nesbitt Burns, its affiliates, officers, directors or employees may have a long or short position in the securities discussed herein, related securities or in options, futures or other derivative instruments based thereon. BMO Nesbitt Burns or its affiliates may act as financial advisor and/or underwriter for the issuers mentioned herein and may receive remuneration for same. A significant lending relationship may exist between Bank of Montreal, or its affiliates, and certain of the issuers mentioned herein. BMO NBI is a wholly owned subsidiary of BMO Nesbitt Burns Corporation Limited which is a majority-owned subsidiary of Bank of Montreal. Any U.S. person wishing to effect transactions in any security discussed herein should do so through BMO Nesbitt Burns Corp. and/or BMO Nesbitt Burns Securities Ltd. Member-Canadian Investor Protection Fund. If you are already a client of BMO Nesbitt Burns, please contact your Investment Advisor for more information. 9 BMO Research, EOG Company Investor Presentation