Unconventional Resource Finance icon Donec vel nisl nec risus vulputate placerat in at ligula. Donec auctor magna nec lacus porttitor hendrerit. In pulvinar quam vitae NGI Annual Affiliates Meeting and Research Review November 9 th, 2017
Unconventional Resource Finance How Did We Get Here, Where Are We Going? The Opportunity Reservoir Driven Capital Pull Massive scale 800 600 400 200 0 Compelling economics 0 12 24 36 48 60 $1 trillion of N.A. unconventional capex from 2008-2017 $ Executive Driven Capital Pull Public markets view production growth as value adding Executive compensation becomes tied to production growth Funding Source Capital requirements exceed available internal cash flow, equity markets, and traditional debt instruments significant high yield debt is issued Production Growth & Price Response From 2010 to 2014, US shale oil production triples, and shale gas production doubles Supply / demand balance moves into surplus, driving commodity price declines Investor Returns High yield debt becomes an inefficient and costly capital structure Well economics decline and corporate level cash flow and returns fall Technology improvements and cost reduction allows producers to continue to drill Today: Investors are dissatisfied with the model of high growth with low returns and are limiting capital access Going Forward: Returns based capital discipline focused on only the top tier plays 1
Contents I. The Opportunity II. III. IV. Funding Source Production Growth & Price Response Investor Returns V. Where We Are Today VI. What This Means for Tomorrow 2
I. The Opportunity 3
I. The Opportunity North American Unconventional Development The nine basins illustrated represent the vast majority of drilling in North America. Within North America, Canada is attracting a fifth of total drilling and ~40% of gas directed drilling (1) In the following discussion, US unconventional development will be used as a proxy for broader North America as the relationships and trends are consistent. (2) Most Active North American Basins (1) WCSB 179 / 19% Oil 87 / 12% Gas 92 / 40% DJ-Niobrara 24 / 3% Oil 23 / 3% Gas 1 / 0% Williston 48 / 5% Oil 48 / 7% Western Canadian Sedimentary Basin Select US Plays Legend (Basin) Total Hz Rigs / % of N.A. Hz Rigs Oil Oil Hz Rigs / % of N.A. Oil Hz Rigs Gas Gas Hz Rigs / % of N.A. Gas Hz Rigs Marcellus/Utica 71 / 7% Gas 71 / 31% Permian 339 / 36% Oil 339 / 47% Barnett 4 / 0% Oil 1 / 0% Gas 3 / 1% Eagle Ford 62 / 7% Oil 57 / 8% Gas 5 / 2% Woodford/SCOOP-STACK 76 / 8% Oil 66 / 9% Gas 10 / 4% Haynesville 40 / 4% Oil 2 / 0% Gas 38 / 16% (1) Baker Hughes, October 2017. Data in graphic above includes horizontal drilling only. (2) Unconventional resource includes shale / tight oil and gas reservoirs developed through horizontal drilling and / or hydraulic fracturing. 4
I. The Opportunity Compelling Unconventional Scale and Economics US Unconventional Gas Proved Reserve Growth (1) North American Gas Play Economics (2) US Unconventional Natural Gas Proved Reserves (tcf) 250 200 150 100 50 0 Unconventional Reserves % of Total Reserves 2008 2009 2010 2011 2012 2013 2014 2015 60% 50% 40% 30% 20% 10% 0% Percentage of Total US Natural Gas Proved Reserves (%) Montney Haynesville Spirit River Duvernay Utica Marcellus Horn River United States Canada $0.00 $1.00 $2.00 $3.00 $4.00 $5.00 Breakeven Price (US$/mcf) US Unconventional Oil Proved Reserve Growth (1) North American Oil Play Economics (2) US Unconventional Oil Proved Reserves (mmbbls) 16 14 12 10 8 6 4 2 0 Unconventional Reserves % of Total Reserves 2011 2012 2013 2014 2015 (1) US Energy Information Administration, 2017. (2) Bank of Montreal Capital Markets, Global Cost Study, 2017. 40% 35% 30% 25% 20% 15% 10% 5% 0% Percentage of Total US Oil Proved Reserves (%) Bakken (US) Montney Oil Bakken (SK) Cardium Permian Viking Shaunavon Eagle Ford Niobrara Duvernay United States Canada $0.00 $15.00 $30.00 $45.00 $60.00 Breakeven Price (US$/bbl) 5
II. Funding Source 6
II. Funding Source Capital Spend Beyond Internal Cash Flow US Onshore E&P Reinvestment Rate (1) North American Onshore E&P Spending (2) Reinvestment Rate (Capex / Cash Flow From Operations) 200% 180% 160% 140% 120% 100% 80% 60% 40% 20% Free Cash Flow Externally Funded Capital Internally Funded Capital Capital Expenditures (US$bn) $300 $250 $200 $150 $100 $50 Unconventional Conventional % Unconventional 80% 70% 60% 50% 40% 30% 20% 10% Unconvnetional as a Percentage of Total Spending (%) 0% 2000 2002 2004 2006 2008 2010 2012 2014 2016 $0 2004 2006 2008 2010 2012 2014 2016 Prior to 2007, US exploration and production ( E&P ) capital spending was at or below internally generated cash flow levels. Post 2007, demand for unconventional growth led to spending that was well beyond internal cash flow, resulting in material increases in external capital raised. (1) Bank of Montreal Capital Markets, 2017. (2) IHS Markit, 2017. 0% 7
II. Funding Source Public Equity and Debt Markets Equity Issuances (US$bn) US E&P Equity Issuances (1) US E&P Debt Issuances (1) $50 $45 $40 $35 $30 $25 $20 $15 Secondary IPO Debt Issuances (US$bn) $50 $45 $40 $35 $30 $25 $20 $15 Investment Grade High Yield Not Rated $10 $10 $5 $5 $0 2000 2002 2004 2006 2008 2010 2012 2014 2016 00-04 05-09 10-14 15-16 $0 2000 2002 2004 2006 2008 2010 2012 2014 2016 00-04 05-09 10-14 15-16 Equity Issued (US$bn) $9 $29 $51 $44 HY Debt Issued (US$bn) $15 $40 $116 $56 % of Total Debt Issued 34% 44% 69% 67% Equity issuances have increased as unconventional development advances. Total debt issued has also increased, with high yield becoming the primary funding source. (1) Bank of Montreal Capital Markets, 2017. 8
II. Funding Source Energy Equity Raised Energy Equity Fundraising by Subsector (1) Equity Raised (US$bn) $80 $70 $60 $50 $40 $30 $20 $10 Energy Services Midstream Diversified Upstream Cumulative Upstream (Conventional & Unconventional) $180 $160 $140 $120 $100 $80 $60 $40 $20 Cumulative Upstream Equity Raised (US$bn) $0 2000 2001 2002 2003 2004 2005 2006 2007 2008 2009 2010 2011 2012 2013 2014 2015 2016 2017 Total Energy Equity Raised (US$bn) 2000-2004 2005-2009 2010-2014 2015-2017 Upstream $6 $29 $56 $68 Total $20 $109 $153 $136 $0 The amount of capital raised by private equity funds has trended upwards over the long term with 2017 expected to be a record year in terms of private equity energy fundraising. The number of private energy-related funds has also increased significantly over this time period. (1) Cambridge Associates, 2017. Fundraising for 2017 represents a forecast for the full year based on expected or reported fundraising targets for funds that are either open or expected to open in 2017, and is subject to change. 9
III. Production Growth & Price Response 10
III. Production Growth Aggressive Unconventional Growth Natural Gas Production (bcf/d) US Shale Dry Natural Gas Production (1) 70 Marcellus Utica 60 Permian Haynesville Eagle Ford 50 Other 40 30 20 Oil Production (mmbbl/d) US Shale Oil Production (1) 7 Permian Eagle Ford 6 Bakken Niobrara Other 5 4 3 2 10 1 0 2007 2009 2011 2013 2015 2017 0 2007 2009 2011 2013 2015 2017 Shale production has grown exponentially from 2010 onwards. Rates of growth of Canadian unconventional plays such as the Montney reflect similar growth profiles Natural gas production and pricing has been heavily influenced by the associated gas of oil-weighted plays such as the Permian, and the gas directed drilling driven by liquids economics in plays such as the Montney. This will likely continue to effect natural gas dynamics going forward (1) US Energy Information Administration, 2017. 11
III. Production Growth Executive Compensation Becomes Linked to Production Use of Key Factors for Annual Bonuses (1) Factor Weightings in Annual Incentive Plans (1) 120% 25% Percentage of Companies (%) 100% 80% 60% 40% 20% 100% 90% 90% 80% 50% 50% 20% 20% 15% 10% 5% 21% 16% 15% 11% 10% 10% 6% 6% 2% 2% 0% 0% 0% 0% Production Safety Opex Reserves Cash Flow TSR ROCE EPS Other Opex Production HSE Strategic Reserves Cash Flow TSR Projects Annual Incentive Plan Factors (%) ROCE EPS E&P executive compensation structures focus on production / reserves growth and largely neglect return metrics. This may help to explain why executives chose to accelerate development, even in the face of falling commodity prices. (1) Evercore ISI, 2017 data reflects 2016 reporting. TSR represents total shareholder return measured by stock price appreciation plus reinvested dividends. 12
III. Price Response Commodity Prices Decline Material unconventional production growth from 2009 to 2014 pushed supply / demand balances into surplus, causing price declines. With top tier plays having seemingly unlimited inventory, commodity prices will be dictated by the marginal barrel, which for the near term will be unconventional production. Henry Hub Natural Gas Price Response (1) $6 WTI Oil Price Response (1) $120 $5 $100 NYMEX Price (US$/mmbtu) $4 $3 WTI Price (US$/bbl) $80 $60 $2 $40 $1 2009 2010 2011 2012 2013 2014 2015 2016 2017 $20 2009 2010 2011 2012 2013 2014 2015 2016 2017 (1) Bloomberg, 2017. 13
III. Price Response Unconventional Economics Adjust For Commodity Price Decline Technology Advances Permian Illustration (1) Service Providers Cut Costs (2) Technology Advances (% of 2012) 300% 250% 200% 150% IP90 Oil Rates Proppant per Well Frac Stages Lateral Length 400 300 200 100 Delaware Basin IP90 Oil Rates (bbl/d) Oil Field Service EBITDA Margin (%) 35% 30% 25% 20% 15% 10% 5% 100% 2012 2013 2014 2015 2016 Technological advancements related to lateral length and completion intensity improved operational results. In addition, oil field service providers cut their prices materially to maintain market share. 0 0% 2008 2011 2014 2017 These two events resulted in unconventional production in top tier plays remaining economic even in a lower commodity price environment, resulting in continued drilling. (1) Goldman Sachs, 2017. Reflects Permian average technology advances and Permian Delaware Basin production response as a proxy for the broader unconventional industry trend. (2) Bloomberg, 2017. Reflects Philadelphia Oilfield Services Index quarterly results. 14
IV. Investor Returns 15
IV. Investor Returns A History of Production Growth and Value Destruction E&P Index Performance Relative to Production Growth (1) S&P 500 Oil and Gas E&P Index 900 800 700 600 500 400 300 S&P 500 Oil and Gas E&P Index Total Shale Production 18 16 14 12 10 8 6 Total US Shale Production (mmboe/d) 200 2007 2009 2011 2013 2015 2017 4 Since 2007, ~$1 trillion of capital has been spent on North American onshore unconventional development. (2) Average annual US E&P ROCE was below 10% from 2007 to 2014 and has been negative since. (3) Investors are becoming frustrated with returns to date and will no longer fund growth for growth s sake. (1) Bloomberg, 2017. (2) IHS Markit, 2017. (3) Bank of Montreal Capital Markets, 2017. 16
V. Where We Are Today 17
V. Where We Are Today Capital Access is Becoming Limited US and Canadian Public E&P Equity Issuances (1) Total Equity Raised (US$bn) $14 $12 $10 $8 $6 $4 $2 $0 Canada United States Q1 Q2 Q3 Q4 Q1 Q2 Q3 Q4 Q1 Q2 Q3 Q4 Q1 Q2 Q3 2014 2015 2016 2017 2014: US$22bn 2015: US$21bn 2016: US$41bn 2017: US$9bn Through 2017, the equity markets have been closed for North American E&P companies. The combination of aggressive growth forecasts at very low incremental returns has turned off institutional investors Institutional investor catch-22 If I write XYZ-co a big cheque for growth acceleration, then at the margin I m just worsening commodity fundamentals in a world of infinite inventory. (1) Bloomberg, Company Filings, October 2017. 18
V. Where We Are Today Producers Are Starting to React Producers Are Reacting to Investor Response Producers Are Adjusting Messaging Producer messaging is focusing more on returns as opposed to production growth. Capital budget expectations are declining. Select leading E&P companies are undertaking share buybacks for the first time in years. Select producers are announcing production volumes being removed as a performance compensation metric, to be replaced by efficiency metrics including ROCE. The capital program in 2018 is being designed to optimize returns, not production growth Devon Energy [we] expect to deliver a returns-focused program, while living within our means at a moderate oil price of around $50 WTI. Marathon Oil Our number one goal is getting ROCE back to our historical average EOG Pursuing growth without adequate returns is something we will avoid Anadarko Change in E&P Production Forecasts Since June (1) 0% Recently Announced Share Buybacks (2) % Change in Production Forecast -1% -2% -3% -4% -5% -6% -2.0% -5.0% US Small & Mid Cap -1.1% -2.5% 2017e 2018e US Large Cap US$2.5bn US$2.0bn US$1.6bn/yr US$3.0bn US$1.2bn US$1.0bn (1) BMO Equity Research, Comparables at strip pricing, October 2017. (2) Company disclosure, 2017. 19
VI. What This Means for Tomorrow 20
VI. What This Means for Tomorrow North American Unconventional Development The development of North American unconventional resources has had and will continue to have a strong positive effect on the consumer, the overall economy and on natural gas usage as a primary energy source. Going forward, companies that prioritize return over growth will be rewarded over the long term. A reduction in growth for growths sake is a positive fundamental outcome and will likely result in an improvement of the global supply / demand balance Only the top tier plays will receive capital, and only to the extent a compelling shareholder return can be generated. Top tier plays receiving capital will most likely be financed via: Internal cash flow Conservative leverage, likely funded through more traditional secured structures Select equity for high quality names equity capital The development of global unconventional resources will also be influenced by North America s experience. 21
VI. What This Means for Tomorrow Global Unconventional Shale Resources Technically Recoverable Shale Gas and Shale Oil Resources (1)(2) Canada Gas 572.9 tcf Oil 8.8 bn bbl Russia Gas 1130.1 tcf Oil 103 bn bbl Poland Gas 145.8 tcf Oil 1.8 bn bbl Ukraine Gas 127.9 tcf Oil 1.1 bn bbl United States Gas 622.5 tcf Oil 78.2 bn bbl Mexico Gas 545.2 tcf Oil 13.1 bn bbl Venezuela Gas 167.3 tcf Oil 13.4 bn bbl Brazil Gas 244.9 tcf Oil 5.3 bn bbl France Gas 136.7 tcf Oil 4.7 bn bbl Algeria Gas 706.9 tcf Oil 5.7 bn bbl Libya Gas 121.6 tcf Oil 26.1 bn bbl Egypt Gas 100.0 tcf Oil 4.6 bn bbl Iran Gas 1200.7 tcf Oil 158.0 bn bbl Qatar Gas 865.2 tcf Oil 26.0 bn bbl Saudi Arabia Gas 600.3 tcf Oil n.a. UAE Gas 205.3 tcf Oil 22.6 bn bbl Pakistan Gas 105.2 tcf Oil 9.1 bn bbl China Gas 1115.2 tcf Oil 32.2 bn bbl Australia Gas 429.3 tcf Oil 15.6 bn bbl Argentina Gas 801.5 tcf Oil 27.0 bn bbl South Africa Gas 389.7 tcf Oil 0.0 bn bbl Legend Current Unconventional Gas Producers Potential New Frontier for Unconventional Gas Wet Shale Gas (trillion cubic feet) Tight Oil (billion barrels) (1) World Energy Council, February 2016. US Energy Information Administration, September 2015. (2) Potential New Frontier for Unconventional Gas includes countries with greater than 100 tcf of technically recoverable shale gas resources. 22
VI. What This Means for Tomorrow Unconventional Opportunity Assessment Technically Recoverable Shale Gas and Shale Oil Resources by Area (bn boe) (1) 0 200 400 600 800 Fiscal Regime Political Environment Infrastructure Resource / Land Access Investability / E&P Diversity Established Service Provider Environmental Leadership Middle East North America South America Africa Russia China Australia Eastern Europe Other Asia Western Europe Supportive of development Wet Shale Gas (solid bar represents current unconventional gas producers) Shale Oil (solid bar represents current unconventional gas producers) Outside of North America, each potential unconventional producer faces below and above ground challenges as they attempt to replicate North American unconventional development progress. Following the experience in North America, investors will be conservative in their desire to finance the development of riskier plays. North American technology and experience is transferable, but commodity prices will need to improve to exploit international unconventional resources in a meaningful way. (1) World Energy Council, February 2016. US Energy Information Administration, September 2015. (2) Classifications are subjective in nature and are based on J.P. Morgan and Azimuth estimates. These classifications can vary within each specified region. 23
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