Hedging Lessons Learned and Impact on Current Strategies

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1 Hedging Lessons Learned and Impact on Current Strategies Louisiana Energy Conference June 1, 2017 Sean Levine, Director Research and Product Development Energy Capital Research Group

2 A Nightmare on Hedge Street 2

3 Addressing the Topic Our Panelists Grant Brady Morgan Stanley Commodities Managing Director of Risk Management team Advises producers, consumers, refiners; also RBL perspective Kevin Hulsey Shell Trading Risk Management Director of Risk Management Energy Commodities Developed Shell s Unsecured No-Margin credit program, markets range of solutions to customers hedging hydrocarbons Joe LeBlanc PerPetro Energy Co-Founder & CFO of private, shallow GOM legacy-asset focused E&P Directed Tulane s Masters of Energy program, hedging & trading at Energy Partners, Shell Sean Levine Energy Capital Research Group Co-Founder, Director of Research & Product Development ECRG tracks & projects near-term commodity price moves & upstream liquidity, solvency dynamics 3

4 Advantages of Hedging Stabilize Cash Flows & Promote Sound Corp. Governance via Effective Risk Mgmt. Maximize Shareholder Value by Shielding Revenues, Profits & Balance Sheet from Market Price Risk Insurance Against Price Risk Assist in Budget Forecasting by Locking in Cash Flows Potentially Reduce Tax Liabilities 4

5 Disadvantages of Hedging May Limit Cash Flow Upside if You re a Bullish Producer or Bearish Consumer Dodd-Frank has Increased Complexity for Onboarding Between Swap Counterparties. Can be Time Consuming to Establish, Maintain Trade Relationships If New to Hedging, May Turn of Price-Bullish Shareholders If a Producer & Market Backwardated, or a Consumer & Market in Contango, May Lock in Lower Prices than Current Spot 5

6 WTI Flat Compared to Year Ago Jan-12 Mar-12 May-12 Jul-12 Sep-12 Nov-12 Jan-13 Mar-13 May-13 Jul-13 Sep-13 Nov-13 Jan-14 Mar-14 May-14 Jul-14 Sep-14 Nov-14 Jan-15 Mar-15 May-15 Jul-15 Sep-15 Nov-15 Jan-16 Mar-16 May-16 Jul-16 Sep-16 Nov-16 Jan-17 Mar-17 May-17 Jul-17 Sep-17 Nov-17 Jan-18 Mar-18 May-18 Jul-18 Sep-18 Nov-18 Jan-19 Mar-19 US$/bbl Series1 Futures - Apr 2013 Futures - Feb 2014 Futures - Nov 2014 Source: ICE Futures - May 2015 Futures - Mar 2016 Futures - May

7 But Values Rise in Wake of OPEC 2 7

8 Swap Activity Jumped on April Bounce via Swap Dealer Repository Data Source: Morgan Stanley 8

9 Nat. Gas Backwardation Sep-18 Jan-12 Mar-12 May-12 Jul-12 Sep-12 Nov-12 Jan-13 Mar-13 May-13 Jul-13 Sep-13 Nov-13 Jan-14 Mar-14 May-14 Jul-14 Sep-14 Nov-14 Jan-15 Mar-15 May-15 Jul-15 Sep-15 Nov-15 Jan-16 Mar-16 May-16 Jul-16 Sep-16 Nov-16 Jan-17 Mar-17 May-17 Jul-17 Sep-17 Nov-17 Jan-18 Mar-18 May-18 Jul-18 $/mmbtu Nov-18 Jan-19 Mar-19 Henry Hub Futures - Apr 2012 Futures - Apr 2013 Futures - Feb 2014 Source: ICE Futures - Nov 2014 Futures - May 2015 Futures - Mar 2016 Futures - May 2017

10 Longer-Term Strip Static, Lower 10

11 Henry Hub SDR Activity Solid Support Starting Around $3.10 Source: Morgan Stanley 11

12 WTI Volatility Surface Front End of Curve More Bearish, Bearish Bias Also Runs Deeper OPEC 1-11/30/16 OPEC 2-5/25/17 Source: CME, Bloomberg 12

13 Henry Hub Volatility Surface Gas Volatility Lower YOY vs. Last May Pre-50% Run to $3/MMBtu 5/25/16 5/25/17 Source: ICE, Bloomberg 13

14 Options Still Quite Cheap Implied Volatility Near Multi-Year Lows Source: Morgan Stanley 14

15 US Oil Resilient Down to $35-$40/bbl Source: J.P. Morgan, Company Data 15

16 Most Shale Gas Viable at $3 or Less Source: J.P. Morgan, Company Data 16

17 30% Service Cost Inflation Scenario Half of US Shale Still Generating 15% IRRs Source: J.P. Morgan, Company Data 17

18 Oil & Gas Hedge Book Averages Both Over 50% covered in 2017, Gas With Longer-Dated Coverage Average % of Oil Production Hedged Per Year. Average % of Gas Production Hedged Per Year Source: Morgan Stanley 18

19 YOY Upstream Hedging Comps Both Oil & Gas Improve YOY, but Signs of Deceleration in Q Source: Morgan Stanley 19

20 Hedging by Derivative Type Swaps Predominant, Other Structures Have Role to Play for Oil Source: Morgan Stanley 20

21 Type of Hedge by Production Volume Particular Emphasis on Swaps by Smaller Independents 21

22 Because No Oil Presentation is Complete Without Saying Permania Low B/Es Help Permian Out-Hedge Peers Northeast, AECO Basis Dominant in Long-Dated Gas Source: Morgan Stanley 22

23 Regional Basis Differentials Cal18 vs. Henry Hub, May 26, 2017 Henry Hub NYMEX $3.11 NoCal (-$0.31) N. Rockies (-$0.38) Chicago (-$0.14) D. South (-$0.43) SoCal Border (-$0.20) Permian (-$0.50) Source: Energy Capital Research Group, Morgan Stanley HSC (-$0.02) Henry Hub (-$0.00) 23

24 Financing Dynamics Lender Confidence Important to Survival, Growth Leverage Ratios Driving Hedging Activity Strong Hedging Pairs With Capex Hikes Source: Bloomberg, RBN Energy, Company Data 24

Transaction-Specific Trends Deal-Contingent Hedging Buying or selling an asset exposes parties to market-related risks that cannot be contracted out or which one of the parties may be unwilling to

25 Transaction-Specific Trends Deal-Contingent Hedging Buying or selling an asset exposes parties to market-related risks that cannot be contracted out or which one of the parties may be unwilling to accept. A Deal Contingent Hedge provides a hedge prior to closing without any costs if the deal fails to close, and without any upfront premium The Deal contingent hedge mitigates the traditional risk to the buyer of remaining unhedged (risk: adverse price movements); hedging using swaps (risk: breakage costs if the deal does not close) and buying swaptions (isssue: large cash outlay) 25

Transaction-Specific Trends Price-Contingent Premiums A Commodity Price Based Contingent Premium Agreement can allow asset Buyers and Sellers to bridge the gap in their respective valuation

26 Transaction-Specific Trends Price-Contingent Premiums A Commodity Price Based Contingent Premium Agreement can allow asset Buyers and Sellers to bridge the gap in their respective valuation objectives. Under a Contingent Premium Agreement: 1) Buyer and Seller agree to a cash sale price that is aligned to current market conditions and prices, and 2) The Buyer grants the Seller the right to receive additional future cash payments that are contingent on the underlying oil or natural gas price moving to higher levels in the future. However, Contingent Premiums Agreements create potentially significant future cash liabilities for Buyers. Asset Buyers should consider actively mitigating their future contingent liabilities by working with the counterparties that can help them manage that risk Sellers may consider monetizing the value of the future contingent liability 26

27 Transaction-Specific Trends Recent Contingent Premium Transactions 27

28 Panelist Contact Information Grant Brady Morgan Stanley Commodities Kevin Hulsey Shell Trading Risk Management Joe LeBlanc PerPetro Energy Sean Levine Energy Capital Research Group

29 This report has been prepared for the Louisiana Energy Conference by Energy Capital Research Group, LLC (ECRG). The report is intended solely for the benefit of those present and its contents and conclusions are confidential and may not be disclosed to any other persons or companies without ECRG s prior written permission. The information upon which this report is based has either been supplied to us by third parties or comes from our own experience, knowledge and databases. The opinions expressed in this report are those of ECRG. Although we believe the information presented by ECRG in our published resources, at our meetings and during seminars is the best and most useful available to global professionals and investors today, it is subject to change at any time and we cannot guarantee its accuracy. ECRG does not act as an investment advisor or advocate the purchase or sale of any security or investment. The descriptions of commodities, industries, companies or assets provided by ECRG do not constitute recommendations to buy, sell, subscribe to or underwrite any security or financial investment of any kind. The information is not intended to form the basis of any specific investment or other decisions, and ECRG does not advise whether or not commodities as a whole are suitable investments. Should you still choose to incorporate this information in any decision to invest, you do so at your own risk, and should only invest after consulting with your investment advisor and performing your own due diligence. ECRG is not liable for any losses, damages, costs or expenses resulting from your investment decisions based on using all or any portion of our advice. Copyright 2015-Present Money Map Press 16 W. Madison Street Baltimore, MD or

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