BUS419 Advanced Derivative Securities Canadian Oil and Gas Presented by: Amjodh Dhillon Qiyuan Ren Junheng Cai (Pat) Jiyuan Chen

BUS419 Advanced Derivative

Securities Canadian Oil and Gas

Presented by: Amjodh Dhillon Qiyuan Ren Junheng Cai (Pat) Jiyuan Chen

Intro Canadian Natural Resources Penn West Canadian Oil Sands Q&A

Agenda

o Introductiono Canadian Natural Resourceso Penn Westo Canadian Oil Sandso Q&A

Industry Overview


Canada •The oil and gas industry is a branch of the Energy Industry•Oil and Gas Industry components:

Upstream operation (Exploration) Midstream Operation (Refining) Downstream Operations (Distribution and sales)

Statistics•5th largest production of natural gas•5th largest production of crude oil in the world•5th largest energy producer in the world•Largest single private investor in Canada•20% of value on Toronto Stock Exchange

Industry (Forecasting) • Industry revenues down one third• WCSB capital investment down 33% ($23 billion)• Well drilling down 30% (3,150 wells) from 2014• Oil and gas share of TSX down from 20% in 2014 to

12% in January in 2015

Industry (Forecasting)

Industry Products-Crude Oil• Actively traded commodities

• 40% of Canada’s energy demand

• 17% of Canada’s merchandise exports

• 3rd crude oil reserves in the world, after Venezuela and Saudi

Arabia

• Reserves: 4,561 million barrels

• Production: 1.38 million barrels per day (Conventional oil,

2013)

Industry Products-Crude Oil• Products:

-Gasoline-Kerosene -Jet Fuel-Lubricants

• Substitutes-Nuclear

Power-

Hydrogen-

hydropower-Coal -Methane-Solar

energy

Industry Products-Crude Oil



Capital Investment-Crude Oil

Industry Products-Natural Gas• Natural gas accounts for 30% of Canada’s

energy demand. • Reserves: 69.3 trillion cubic feet• Production: 14.1 billion cubic feet per day

Industry Products-Natural Gas• Price determined in an open market• Supply of natural gas versus the demand for the fuel• Price Sensitivity – Residential– Commercial – Industrial – Winter Season – Higher crude oil prices– Economic growth

Industry Products-Natural Gas



Regulation on the Industry

Regulation on the Industry Canadian •Natural Resources Canada•National Energy Board•Environmental Regulations (Environment Canada)•Self-regulation:– Canadian Association of Petroleum Producers

(CAPP)

Risk Management

• Risk Exposures– General Business– Environmental/Legal– Operational– Credit/Liquidity– Financial/Commodity

Risk Management

• Objective– Reduce the risk of adverse price changes in the

physical market– Perhaps to make a profit

• How?• Determines a hedge ratio • Optimal hedge rations should be time-varying

Risk Management

• Sensitivity analysis:– On cash flows sensitive to:• Oil and gas prices• Interest rates• FX changesFurther Developed with:• Probability calculations for movements in prices

interest rates and FX

Risk Management

• Derivatives are at the center of risk management for these companies:

• Major Products for risk management: – Energy Futures traded din COMEX– FX futures traded in CME– OTX Forward contracts (oil, gas, etc.)– Interest rate and FX SWAPS– Options: Costless Collar

Risk Management

• Hazards from risk management activities– Decreased earnings– Liquidity pressure – Potential loses from hedging


Canadian Natural Resources


Overview

• Headquarters in Calgary, Alberta (1973)

• Operates in Western Canada, the North Sea off Scotland, and West Africa


Overview


Overview• Grown rapidly since 1989

• In 2013 CNQ produced 641000 BOE/d

• Bulk of production located in North America, with 25% in light crude oil, 35% in heavy oil bitumen, and 14% from the Horizon oil sands mining and upgrading project

• 9% market share of Canadian Oil production

• 8% market share of Canadian gas production

• Canada’s largest heavy oil producer

• Canada’s second largest natural gas producer


Overview


ManagementN. Murray Edwards:•Chairman•Launched Canadian Natural Resources•Bachelor of Commerce•Law Degree•Doctors of Law (Honorary)

Steve W. Laut:•President & Director•Bachelor of Science in Mechanical Engineering•Joined CNQ In 1991•President since April 2005•Compensation for 2013: $9,248,828


ManagementTim S. McKay•COO•Since January 2003•Salary: $4,053,568

Douglas A. Proll•Executive Vice-President•Previously served as CFO/Senior VP of Finance since 2001•Salary: $2,158,846

Corey B. Bieber•CFO (since 2013)•Senior Vice-President of Finance•Bachelor of Commerce•Salary: $2,000,010


Historical PriceTSX


Trading and Share Statistics


Future Development

Birch Mountain:•Currently at planning stage•Completion 2019•Oil sands thermal in situ project

Gregoire Lake:•Currently at planning stage•Completion 2018•Oil sands thermal in situ project

Grouse:•Currently at planning stage•Completion 2018•Oil sands thermal in situ project


Reserves


Risk ManagementRisks:•CNQ is exposed to various operational risks inherent in the exploration, development, production, marketing of crude oil, NGLs, natural gas, the mining, and upgrading of bitumen into SCO

•Market Risk

•Commodity Price Risk

•Interest Rate Risk

•Foreign Currency Exchange Risk

•Credit Risk

•Liquidity Risk


Risk Management

Managing Risk:•Derivative financial instruments are utilized to help ensure targets are met and to manage commodity price, foreign currency and interest rate exposures


Risk Management


Risk Management


Risk Management

Commodity Price Risk

• The Company periodically uses commodity derivative financial instruments to manage its exposure to commodity price risk associated with the sale of its future crude oil and natural gas production and with natural gas purchases. At December 31, 2013, the Company had the following derivative financial instruments outstanding to manage its commodity price risk:


Risk Management


• The Company’s commodity hedging program reduces the risk of volatility in commodity prices and supports the Company’s cash flow for its capital expenditures programs.


Risk Management

Interest Rate Risk

• CNQ is exposed to interest rate price risk on its fixed rate long-term debt and to interest rate cash flow risk on its floating rate long-term debt.

• CNQ periodically enters into interest rate swap contracts to manage its fixed to floating interest rate mix on long-term debt.

• The interest rate swap contracts require the periodic exchange of payments without the exchange of the notional principal amounts on which the payments are based.

• At December 31, 2013, the Company had no interest rate swap contracts outstanding.


Risk Management

Foreign Currency Exchange Risk

• CNQ is exposed to foreign currency exchange rate risk in Canada primarily related to its US dollar denominated long-term debt, commercial paper and working capital.

• CNQ is also exposed to foreign currency exchange rate risk on transactions conducted in other currencies and in the carrying value of its foreign subsidiaries.

• CNQ periodically enters into cross currency swap contracts and foreign currency forward contracts to manage known currency exposure on US dollar denominated long-term debt, commercial paper and working capital.

• The cross currency swap contracts require the periodic exchange of payments with the exchange at maturity of notional principal amounts on which the payments are based.


Risk Management

Foreign Currency Exchange Risk


Risk Management


Risk Management

• Credit risk is the risk that a party to a financial instrument will cause a financial loss to the Company by failing to discharge an obligation

• CNQ manages these risks by reviewing its exposure to individual companies on a regular basis and where appropriate, ensures that parental guarantees or letters of credit are in place to minimize the impact in the event of default. At December 31, 2013, substantially all of the Company’s accounts receivable were due within normal trade terms.

• CNQ is also exposed to possible losses in the event of non-performance by counterparties to derivative financial instruments; however, the Company manages this credit risk by entering into agreements with counterparties that are substantially all investment grade financial institutions and other entities. At December 31, 2013, the Company had no net risk management assets with specific counterparties related to derivative financial instruments

Credit Risk


Risk ManagementLiquidity Risk

• Liquidity risk is the risk that the Company will encounter difficulty in meeting obligations associated with financial liabilities

• Management of liquidity risk requires the Company to maintain sufficient cash and cash equivalents, along with other sources of capital, consisting primarily of cash flow from operating activities, available credit facilities, commercial paper and access to debt capital markets, to meet obligations as they become due.

• CNQ believes it has adequate bank credit facilities to provide liquidity to manage fluctuations in the timing of the receipt and/or disbursement of operating cash flows.


Risk ManagementLiquidity Risk


Risk ManagementSensitivity Analysis

• The following table summarizes the annualized sensitivities of the Company’s 2013 net earnings and other comprehensive income to changes in the fair value of financial instruments outstanding as at December 31, 2013, resulting from changes in the specified variable, with all other variables held constant


Risk Management




Penn West Exploration

Overview

• Founded in Calgary, Alberta (1979)

• One of the largest conventional oil and natural gas producers in Canada

• Operates a significant portfolio of opportunities with a dominant position in light oil in Canada

• Operations are currently focused on light-oil development.

• Approximately 1415 employees, which is 25% less than the previous year

• Streamlined its management structure in July, 2013 by replacing its CEO and two Senior VPsIntro Canadian Natural Resources Penn West Canadian Oil Sands Q&A

Overview


• In 2013, approximately 50 percent was light and medium oil, 30 percent was natural gas, 13 percent was conventional heavy oil and 7 percent was NGLs

• Operates throughout western Canada on a land base encompassing approximately five million acres

Management


David E. Roberts•President and CEO•Joined in June, 2013•More than 30 years of operational experience in the upstream oil and gas business •Former Executive VP and COO of Marathon Oil Corporation

Richard L. George•Chairman, joined in May, 2013•Served as a director and the President and Chief Executive Officer of Suncor from 1991 to 2012•A director of the Royal Bank of Canada and Anadarko Petroleum Corporation and a partner of Novo Investment Group•A Bachelor of Science degree in engineering from Colorado State University•A law degree from the University of Houston Law School •A graduate of the Harvard Business School Program for Management Development

Management


Todd H. Takeyasu•Executive VP and CFO•Joined in 1994•Charted Accountant•Over 25 years of experience in oil and natural gas industry and public accounting experience

Mark P. Fitzgerald•Senior VP, Development•Joined in Nov, 2008•Professional Engineer•25 years of experience in field operations, production, development, business in the oil and gas industry

Historical PriceTSX


Trading and ShareStatistics


Future Development


Cardium Play:•Expanding waterflood programs in the core areas•Increasing development activities, primarily in the Lodgepole and Crimson Lake areas•$270 million capital budget in 2014

Slave Point:•Continuing waterflood program in Otter•Initial a new pilot in Sawn Lake•$150 million capital budget in 2014

Viking Play:•Further develop the Dodsland area•Assessing potential for down spacing with implementation of a waterflood program in the Avon Hills area•$150 million capital budget in 2014

Future Development


Enhanced Oil Recovery

• “Penn West believes that recent results in its key plays and continuing advancements in drilling, completions and other technologies will enable it to pursue various enhanced recovery techniques aimed at increasing oil recovery rates in several of its large plays”

• “During 2013, Penn West continued to expand its enhanced recovery programs primarily through the use of waterflood techniques as outlined above”

• “In 2014, Penn West plans to continue to build on these results and expand on existing waterflood projects and initiate others in most of its key areas.”

Reserves


Reserves


Risk Management


Company is are exposed to normal market risks inherent in the oil and natural gas business, including, but not limited to:

•Commodity price risk

•Foreign currency risk

•Credit risk

•Interest rate risk

•Liquidity risk

•Environmental and climate change risk

Risk Management


The Company seeks to mitigate these risks through:

•Business processes•Management controls

from time to time by using financial instruments.

“As at December 31, 2013 and 2012, the only asset or liability measured at fair value on a recurring basis was the risk management asset and liability, which was valued based on “Level 2 inputs” being quoted prices in markets that are not active or based on prices that are observable for the asset or liability.”

Risk Management



•The most important risk to hedge

•The risk is managend by using swaps, collars and other financial instruments

•“Commodity price risk may be hedged upto a maximum of 50 percent of forecast sales volumes, net of royalties, for the balance of any current year and one year following and up to 25 percent of forecast sales volumes, net of royalties, for one additional year thereafter”

• “Subject to the Board’s approval, our hedging limits may be increased above the maximum limits”


Risk Management



Risk Management



Risk Management



Risk Management


Foreign Exchange Risk

• Prices received for crude oil are referenced to US dollars, thus Penn West’s realized oil prices are impacted by Canadian dollar to US dollar exchange rates.

• A portion of the Company’s debt capital is denominated in US dollars, thus the principal and interest payments in Canadian dollars are also impacted by exchange rates.

Risk Management


Foreign Exchange Risk

Company may use financial instruments to fix or collar future exchange rates to fix the Canadian dollar equivalent of crude oilrevenues or to fix US denominated long-term debt principal repayments

Risk Management


Credit Risk

Credit risk is the risk of loss if purchasers or counterparties do not fulfill their contractual obligations.

To hedge credit risk:•each counterparty is reviewed on a regular basis for the purpose of assigning a credit limit and may be requested to provide security if determined to be prudent (oil and natural gas sales and financial derivatives)•transacts with counterparties who are members of its banking syndicate or other counterparties that have investment grade bond ratings (financial derivatives)•Credit events related to all counterparties are monitored and credit exposures are reassessed on a regular basis

“In 2013, the maximum exposure to credit risk was $265 million (2012 - $364 million) being the carrying value of the accounts receivable.”

Risk Management


Interest Rate Risk

“A portion of the Company’s debt capital is held in floating-rate bank facilities, which results in exposure to fluctuations in short-term interest rates, which remain at lower levels than longer-term rates.”

To mitigate interest rate risk:

•increasing the certainty of our future interest rates by entering fixed interest rate debt instruments

•using financial instruments to swap floating interest rates for fixed rates or to collar interest rates.

Risk Management


Interest Rate Risk

“As at December 31, 2013, none of the Company’s long-term debt instruments were exposed to changes in short-term interest rates (2012 – four percent).”

“As at December 31, 2013, a total of $2.1 billion (2012 – $1.9 billion) of fixed interest rate debt instruments was outstanding with an average remaining term of 4.5 years (2012 – 5.5 years) and an average interest rate of 5.8 percent (2012 – 5.8 percent), including the effects of interest rate swaps.”

Risk Management


Liquidity Risk

Liquidity risk is the risk that the Company will be unable to meet its financial liabilities as they come due

To mitigate liquidity risk:•Using short and long-term financial and capital forecasting programs to ensure credit facilities are sufficient relative to forecast debt levels, dividend and capital program levels are appropriate, and that financial covenants will be met•Regularly reviews capital markets to identify opportunities to optimize the debt capital structure on a cost effective basis•In the short term, liquidity is managed through daily cash management activities, short-term financing strategies and the use of collars and other financial instruments to increase the predictability of cash flow from operating activities.

Risk Management


Liquidity Risk

The following table outlines estimated future obligations for non-derivative financial liabilities as at December 31, 2013:

Risk Management


Environmental and Climate Change Risk

The oil and gas industry has a number of environmental risks and hazards and is subject to regulation by all levels of government.

Environmental legislation includes, but is not limited to:•Operational controls•Site restoration requirements•Restrictions on emissions of various substances produced in association with oil and natural gas operations

Compliance with such legislation could require additional expenditures and a failure to comply may result in fines and penalties which could, in the aggregate and under certain assumptions, become material.

Risk Management


Environmental and Climate Change Risk

To reducing the environmental impact from our operations through:•Resource conservation•CO2 sequestration•Water management•Site abandonment/reclamation

Operations are continuously monitored to minimize the environmental impactand sufficient capital is allocated to reclamation and other activities to mitigate the impact on the areas in which we operate.

Risk Management


Sensitivity Analysis

Risk Management


Financial Instruments

Financial instruments included in the balance sheets consist of accounts receivable, fair values of derivative financial instruments, accounts payable and accrued liabilities, dividends payable and long-term debt.




Overview

Canadian Oil Sands (COS):• A limited liability, publicly traded

Canadian corporation • Generate income from its oil sands

investment in the Syncrude Joint Venture.

• A major producer of high quality, low sulphur, light, synthetic crude oil (“SCO”)

• COS hold 36.74% interest in Syncrude since 2007.


Market for COS ProductionHeadquarters is located in Calgary, Alberta


Board of Directors


Donald J. Lowry•Chairman of the Board•Joined the COS in 2007•Bachelor of Commerce (Hons) degree & MBA•Harvard Advanced Management Program

Ryan M. Kubik •President and CEO•Bachelor of Commerce degree•Chartered Accountant &Chartered Financial Analyst designations•ICD.D designation

Gerald W. Grandey

•Corporate Director• Saskatoon, SK •Joined the COS board in 2011•Degree in geophysical engineering•Law degree

Lan A. Bourne •Corporate Director •Calgary, Alberta •Joined the COS board in 2007•Bachelor of Commerce degree•Director Education Program

Highlights


Historical Stock PriceGoogle Finance


2015 Outlook


Risk Management• Risks are categorized based on their probability of occurrence and their potential impact on

Canadian Oil Sands’ financial results, financial condition, corporate reputation and EH&S performance.


Highlights


Risk Management

Crude Oil Price Risk:•The financial results and financial condition of Canadian Oil Sands are significantly impacted by crude oil prices.•Price is subject to large fluctuations in response to changes in the global and regional supply and demand for oil•A prolonged period of low crude oil prices could affect the value of our interest in the Syncrude Project, and result in the impairment of Canadian Oil Sands’ assets•Solution: Maintaining a strong balance sheet and ensuring adequate sources of financing are available.


Risk Management


Responding to Low Oil Price

• Syncrude cost reductions -Recent oil price decline intensified efforts already underway to achieve a lower

cost structure -Potential cost reductions, net to COS of $260 million to $400 million in 2015 -Reductions of $294 million have been incorporated into 2015 Outlook

• Reduced dividend On January 29, reduced the quarterly dividend from $0.35/share to $0.05/share to

align better with crude oil prices and to preserve balance sheet strength and liquidity


Risk Management

Operational Risk:•Operational Outages:The shutdown of any part of Syncrude’s operation could significantly impact production of SCO. water storegeology and limestone baseelectrical powerSolution: maintaining appropriate levels of insurance, primarily business interruption (“BI”) and property insurance.


Risk Management

Operational Risk:•Project Execution:Risks associated with the execution of Syncrude’s major projects and future growth and development projects

Solution (strategic planning function): Identification and evaluation of capital projects, helps manage these risks with support from Imperial Oil/ExxonMobil


Risk Management

Competition Risk:•Skilled labors Solution: Competitive industry compensation A socially and environmentally responsible company •Other competitions: longer procurement lead times, distribution and marketing of petroleum products Solution: Cost Analysis and Strategy Taskforce in 2014


Risk Management

Environmental Risk:•Tailings Management While Syncrude continues to develop tailings and fluid fine tailings reclamation technologies, there is a risk of increased costs to develop and implement various measures

•Water Access and EmissionsLegislation significantly restricts or penalizes water use and/or emissions


Risk Management

Financial Market Risk:•Foreign Currency RiskFluctuations in the U.S./Canadian currency exchange rates.Sales are based in part on a WTI benchmark price in U.S. dollars, while operating expenses and capital expenditures are primarily in Canadian dollars.No any foreign currency hedges in place in 2014 or 2013 COS may hedge foreign currency rates in the future


Risk Management

Financial Market Risk:•Interest Rate Risk:Changes in market interest rates may affect the Corporation’s financial results and financial

condition.Long-term Debt (variable-rate credit facilities)short-term investments - Employee future benefits

- Accrued benefit liability - Asset retirement obligation


Risk Management


Risk Management


The changes in the asset retirement obligation due to increases and decreases in the risk-free interest rate (2.25 per cent at Dec 31, 2014 VS 3.25 per cent at Dec 31, 2013)and increases in estimated reclamation and closure expenditures were recorded as changes in PP&E.

Risk Management

Financial Market Risk:•Credit Risk:Customer accounts receivable balances, financial counterpartiesSolution: - Credit policy that limits exposure based on credit ratings. - Credit insuranceAt present, there are no financial assets that are past their maturity or impaired due to credit risk-related defaults.


Risk Management


Financial Market Risk

Risk Management

Financial Market Risk:•Liquidity Risk:Liquidity risk is the risk that Canadian Oil Sands will not be able to meet its financial obligations- The amount and timing of operating commitments,- Future capital expenditure requirements- Debt repayments-Adequacy of financing available-Downgrade in the Corporation's credit ratings


Risk Management

Financial Market Risk:•Liquidity Risk:The ability to make scheduled payments on or to refinance debt obligations depends on the financial condition and operating performance of the CorporationSolution: Manages its liquidity through cash, debt and equity management strategies


Sensitivity Analysis


Financial Report


Financial Report


Financial Report


Oil and Natural Gas Industry

Any Question

Oil and Natural Gas Industry

Documents

BUS419 Advanced Derivative Securities Canadian Oil and Gas Presented by: Amjodh Dhillon Qiyuan Ren Junheng Cai (Pat) Jiyuan Chen