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Canadian Oil and Gas. Sanjeev Gill | Mohammed Alshanakhnakh | Hans Melis | Alexandrine Austin. Overview. Introduction Industry Overview Risk Analysis Canadian Natural Resources Corporate Profile Risk Analysis Penn West Corporate Profile Risk Management

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slide1

Canadian Oil and Gas

Sanjeev Gill | Mohammed Alshanakhnakh | Hans Melis | Alexandrine Austin

slide2

Overview

  • Introduction
  • Industry OverviewRisk Analysis
  • Canadian Natural Resources
  • Corporate ProfileRisk Analysis
  • Penn West
  • Corporate ProfileRisk Management
  • Risk Overview of other Competitors
  • Conclusion: Recommendations
products
Products

Crude Oil

  • Gasoline
  • Heating Oil
  • Liquefied Petroleum Gas
  • Kerosene
  • Jet Fuel
  • Lubricants

Natural Gas

major substitutes
Major Substitutes
  • Coal
  • Nuclear energy
  • Biomass
  • Biogas
  • Solar power
  • Wind power
  • Geothermal
  • Tidal power
major costs incurred
Major Costs Incurred
  • Acquisition Costs
  • Exploration Costs
  • Developmental Costs
  • Production Costs
major canadian producers
Major Canadian Producers
  • EnCana Corporation
  • Canadian Natural Resources Limited
  • Husky Energy Inc.
  • Talisman Energy Inc.
  • Suncor Energy
  • CenovusEnergy
  • Penn West Energy Trust
  • Nexen
key economic events
Key Economic Events

2008 Financial Crisis

  • Reduced access to credit
  • Decreased demand
  • Decreased liquidity
  • Increased regulations
  • Increased supply
  • Decreased commodity price
global regulation
Global Regulation

Organization of the Petroleum Exporting Countries (OPEC)

  • Iran, Iraq, Kuwait, Saudi Arabia, Venezuela, Qatar, Libya, Algeria , Nigeria, Ecuador, Angola, and United Arab Emirates.
    • Unify Petroleum Policies
    • Secure stable prices for producers
canadian regulation
Canadian Regulation
  • National Energy Board (NEB)
  • Office of Energy Efficiency (OEE)
  • Environment Canada
  • Canadian Association of Petroleum Producers (CAPP)
  • Kyoto Protocol
    • Reduce carbon emissions
price volatility
Price Volatility
  • OPEC and domestic regulations
  • Geopolitical and Financial Events
  • Alternative energy sources
  • World Supply and Demand
  • Seasonality
risk exposure
Risk Exposure
  • Operational Risk
  • Economic and Political Risk
  • Commodity Risk
  • Financial Risk
    • Interest Rate Risk and FX Risk
  • Credit and Liquidity Risk
  • Regulatory Limitations
  • Exploration and Development
risk measurement
Risk Measurement
  • Sensitivity analysis
  • Simulation Analysis
  • Probability Estimation
  • Value at Risk (VaR)
risk management
Risk Management
  • Diversification and Insurance
  • OTC Forward Contracts
  • Exchange-Traded Energy Futures
  • Foreign Exchange Futures
  • Hedging through Options
hedging techniques for risk management
Hedging Techniques for Risk Management
  • Collar Hedge
  • Crack spread contracts and options
  • Interest rate swaps
  • FX swaps
risk management expense
Risk Management Expense
  • Increased Organizational Expense
  • Hedging Risks
    • Credit Risk
corporate overview
Corporate Overview
  • Calgary, Alberta based explorer, producer, and developer of oil and natural gas
  • Founded in 1973
    • Since then, has grown to become both the 2nd largest natural gas producer and the largest heavy oil producer in Canada
  • Energy products include: natural gas, light oil, heavy oil, in-situ oil sands production, oil sands mining and associated upgrading facilities
corporate overview1
Corporate Overview
  • Key factors of their business approach:
    • Lowest cost producer strategy
    • Exploitation focus using existing technologies, discoveries, and breakthroughs
    • Strategic acquisitions, often in existing core regions, to increase operational diversification
    • Avoid long-term drilling/supply contracts when possible to increase flexibility
    • Seek to own and operate 100% of their assets
    • Effective balance between heavy crude oil, light crude oil, and natural gas provides some protection against commodity price risk
    • Financial strength is of paramount importance
      • -Target strong debt ratings and manage liquidity “as a core asset”
      • -closely controlled hedging activities provide short-term cash flow certainty
stock details mar 9 2011
Stock Details (Mar. 9, 2011)
  • As of March 1, 2011, roughly 1.01 billion CNQ shares outstanding
  • Also trades on the NYSE
historical stock performance activity
Historical Stock Performance & Activity
  • 10 year price movement
  • Moving average highlights overall long-term upward trend
summary of operations
Summary of Operations
  • Canadian Natural relies on a North American foundation
  • Hold the largest undeveloped land base in the Western Canadian Sedimentary Basin
operations horizon oil sands
Operations – Horizon Oil Sands
  • Key oil sands asset located north of Fort McMurray, Alberta, with ongoing expansion
  • Supports 232,000 – 250,000 barrels per day of light, sweet, crude oil production for over 40 years, with no production declines (recoverable OOIP of 6 billion barrels estimated)
operations north american net oil gas reserves
Operations – North American Net Oil & Gas Reserves
  • Figures are net of royalties
  • Obvious uncertainty around the determination of “probable” reserves, which claim a 50% confidence level of recovery
operations international
Operations - International
  • Provide a strategic source of primarily crude oil (though in much lower quantities than North American operations)
  • Locations: the North Sea and Offshore West Africa (Espoir, Baobab, Olowi)
management
Management

Compensation (2009) & Background

 $10, 578, 701.00 (includes option awards)

 BSc in Chemical

Engineering

$10,009,651.00 (includes option awards)

 BSc in Mechanical

Engineering

financial performance
Financial Performance
  • Canadian Natural refers to “four metrics” that measure corporate success:

Horizon Oil Sands

adjusted net earnings from operations
Adjusted Net Earnings from Operations
  • Changes in the intrinsic value of outstanding vested options are recognized in net earnings (stock-based compensation expense)
  • Changes in fair value of non-designated hedges are recognized in net earnings
  • Unrealized foreign exchange gains and losses, offset by cross currency swaps, are recognized in net earnings
corporate approach to risk management
Corporate Approach to Risk Management
  • Hedge program aims to give the company certainty in their short-term cash flows
    • Ensures adequate financing for capital plans
  • Derivatives usage is solely aimed at managing the various types of risk exposure, not for speculative activity
  • Operational risks limited through a focused effort on large core areas and by operating key facilities
  • Product and operations diversity important
market risk
Market Risk

3 Primary Types:

commodity price risk
Commodity Price Risk
  • Fluctuations in commodity prices impact Canadian Natural’s cash flows associated with commodities that are sold and purchased
  • Sales to hedge:
    • Futures crude oil and natural gas production
  • Purchases to hedge:
    • Natural gas
interest rate risk
Interest Rate Risk
  • 2 sources of interest rate risk to be dealt with:
    • Interest rate price (fair value) risk on the company’s fixed rate long-term debt
    • Interest rate cash flow risk on the company’s floating rate long-term debt
foreign currency exchange rate risk
Foreign Currency Exchange Rate Risk
  • Primary source is the company’s US dollar denominated long-term debt and working capital
  • Also exposed because of:
    • transactions conducted in other currencies (in its subsidiaries)
    • Carrying value of self-sustaining foreign subsidiaries
commodity price risk management
Commodity Price Risk Management

Net derivative financial instruments outstanding (Dec. 31, 2010):

The Company’s outstanding commodity derivative financial instruments are expected to be settled monthly based on the applicable index pricing for the respective contract month.

interest rate risk management
Interest Rate Risk Management
  • Interest rate swap contracts outstanding (Dec. 31, 2010):
  • 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
foreign currency exchange rate risk management
Foreign Currency Exchange Rate Risk Management
  • Cross currency swap contracts outstanding (Dec. 31, 2010):
  • 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.
  • Canadian Natural also uses foreign currency forward contracts in response to currency exposure (at December 31, 2010, US$1.162 billion in foreign currency forward contracts were outstanding, with terms of roughly 30 days or less.)
credit risk
Credit Risk
  • Results from the failure of a party to a financial instrument to live up to contract obligations

Canadian Natural’s Counterparty Credit Risk Management:

  • Normal industry credit risk levels for accounts receivable
    • Canadian Natural regularly reviews risk exposure to individual companies
  • Risk of default by counterparties on derivative instruments expected
    • Canadian Natural only enters into agreements with investment grade counterparties in order to manage this risk
liquidity risk
Liquidity Risk
  • The risk that Canadian Natural will find it hard to cover financial liability obligations

Canadian Natural’s Liquidity Risk Management:

  • Canadian Natural maintains adequate cash & cash equivalents
  • Also maintains other sources of capital
    • Cash flow from operations
    • Available credit facilities
    • Access to debt markets
risk management overview
Risk Management Overview

Statement of Earnings

changing royalty regimes
Changing Royalty Regimes
  • Crude oil and NGLs royalties averaged approximately 19% of revenues in 2010, compared to 14% in 2009.
  • Natural gas royalties averaged approximately 5% of revenues in 2010, compared to 7% in 2009.
netback
Netback
  • Influenced by royalty figures (plus other factors)
stock based compensation
Stock-Based Compensation
  • Stock Option Plan gives employees choice to receive either:
    • Common shares
    • Direct cash payment in exchange for surrendered options
  • Changes in the intrinsic values of stock options recognized in each period (increased transparency)
  • Options have a term of 5-6 years until expiry, with exercise price based on closing price on the day prior to the grant (TSX)
  • stock option plan liability measured using the Black-Scholes-Merton option pricing model
  • Significant stock price changes lead to volatile earnings
corporate overview2
Corporate Overview
  • Based in Calgary, Alberta, the company operates throughout the Western Canadian Sedimentary Basin.
  • Largest producer of light and medium density oil in western Canada by volume.
  • Considerable interests in light/medium oil pools, an extensive in-situ oil sands project under early stages of development, and a large inventory of enhanced oil recovery opportunities.
  • In January 2011 Penn West converted from an income trust (Penn West Energy Trust) back into an independent corporation (Penn West Exploration).
financial profile
Financial Profile
  • Current Market Capitalization: $12.03 Billion CAD
  • Shares Outstanding (Dec. 31, 2010): 461 million
  • Stock Quote (Mar. 10, 2011): $26.10 CAD PWT.TSX
    • 52 Week Range: 17.09 – 26.25
    • PWE.NYSE
  • P/E: 50.41 EPS: $0.52 Dividend Yield: 4.14%
  • ROE: 3% (2010) [-2% (2009), 19% (2008)]
historical stock price volume
Historical Stock Price & Volume

10 Year PWT.TSX versus S&P/TSX Composite

operational profile
Operational Profile
  • Average Daily Production: 164,633 boe
  • Production Ratio: 60% oil and 40% natural gas
  • Proved Reserves (as at Dec. 31, 2010): 259 mmboe
management profile
Management Profile

William E. Andrew, Chief Executive Officer

  • Professional Engineer with 35 years of oil and natural gas industry experience, including over 18 years with Penn West.
  • Joined Penn West in 1992 as founding member.

Todd Takeyasu, Chief Financial Officer

  • A Chartered Accountant with more than 25 years of oil and natural gas industry and public accounting experience.
  • Joined Penn West in 1994, holding various positions including Financial Controller and Treasurer.

Keith Luft, General Counsel & Senior Vice President

  • A lawyer with more than 20 years of experience in private practice.
  • Joined Penn West in 2006 as Vice President responsible for land and legal matters.
  • In 2008 he was promoted to his current position, responsible for Legal, Regulatory, Corporate Resources, Insurance and Risk Management.
risk management statement
Risk Management Statement

“We 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 and environmental and climate change risk. We seek to mitigate these risks through various business processes and management controls and from time to time by using financial instruments.”

(4th Quarter Report, 2010)

risk management philosophy
Risk Management Philosophy

Increasing the insurance of budgeted

expected cash flows

Managing downside risk, while preserving exposure to commodity price upside

statement on hedging
Statement on Hedging

“Penn West considers price hedging of oil and natural gas production to be a useful tool of risk management. Its uses include protecting planned capital budgets, safeguarding the economics of acquisitions and providing downside cash flow protection to support planned distributions.”

“Penn West continues to employ derivative instruments on a portion of its production volumes spanning several quarters into the future. The company also secured hedges to fix the costs of electric power at its oilfield operations, improving its ability to project operating costs, netbacks and cash flows.”

“Penn West is careful and judicious in its hedging activities in order to preserve exposure to commodity price upside and avoid unreasonable opportunity costs.”

(www.pennwest.com)

risk factors
Risk Factors

Commodity Price Risk

Foreign Currency Exchange Risk

Interest Rate Risk

Credit Risk

commodity price risk1
Commodity Price Risk
  • Oil and natural gas price risk most significant exposure.
  • Active hedging program that uses swaps, collars and other financial instruments up to a maximum of 50% of forecasted short term sales volumes.
  • Secures hedges to fix the costs of electric power at its oilfield operation, improving its ability to project operating costs and cash flows.
foreign currency exchange risk
Foreign Currency Exchange Risk
  • Commodity prices referenced to US dollars, thus realized prices are impacted by CAD/USD exchange rates.
  • Debt capital is denominated in USD, thus principal and interest payments in CAD are also impacted by exchange rates.
  • Use forward contracts to fix or collar future exchange rates to fix the CAD equivalent of oil revenues or to fix USD denominated long-term debt principal repayments.

Foreign Currency Forward Contracts Outstanding as of Dec. 31, 2010

interest rate risk1
Interest Rate Risk
  • Currently maintain a portion of debt capital 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.
  • May increase the certainty of future interest rates by entering fixed interest rate debt instruments or by using financial instruments to swap floating interest rates for fixed rates or to collar interest rates
credit risk1
Credit Risk
  • Credit risk is the risk of loss if purchasers or counterparties do not fulfill their contractual obligations.
  • Oil and natural gas sales: follow a counterparty risk procedure whereby each counterparty is reviewed on a regular basis for the purpose of assigning a credit limit and may be requested to provide security.
  • Financial derivatives: transact with counterparties who are members of their banking syndicate or other counterparties that have investment grade bond ratings.
financial statement analysis
Financial Statement Analysis

Balance Sheet

Income Statement

Cash Flow Statement

As of Dec. 31, 2010

trust unit compensation
Trust Unit Compensation
  • Trust Unit Rights Incentive Plan
  • Compensation expense for the plan is based on the fair value of rights granted, amortized over the vesting periods.
  • A binomial option pricing model is used to determine the fair value of rights when granted.
risk factors1
Risk Factors
  •  Common Risk Factors:
    • Substantial decline in oil and gas prices
    • Increased environmental regulations
    • Counterparty Risk
  • EnCana:
    • Hedging activates could result in losses
  • Nexen:
    • Exploration and development loss
    • Reliance on few highly productive wells
    • Operations in unstable countries
hedging philosophy
Hedging Philosophy
  • partially mitigates its exposure to financial risks through the use of various financial instruments and physical contracts.
  • Use of derivative financial instruments is governed under formal policies and is subject to limits established by the Board of Directors.
financial risks
Financial Risks
  • Natural gas price risk (Commodity price risk)
  • Credit risk
  • Liquidity risk
  • Foreign exchange rates risk
  • Interest rates risk
financial risk management
Financial Risk Management
  • Natural Gas Price Risk:
    • Mitigates natural gas price risk by swaps that fix the NYMEX prices.
    • Manages price deferential between production areas and sales points by swaps
financial risk management2
Financial Risk Management
  • Foreign Exchange Risk:
    • Foreign exchange contracts
    • Natural hedge
    • Cross currency swaps
  • Interest Risk:
    • Holding a mix of fixed and floating rate debt
    • Interest rate swaps
  • Counterparty and Credit Risk:
    • Board approved credit policies
  • Liquidity Risk:
    • Cash and debt management programs
hedging philosophy1
Hedging Philosophy

Recognize market risks and manage them to the extent that it’s practical using derivatives for trading and non-trading purposes as part of an overall risk management policy.

financial risks1
Financial Risks
  • Commodity Price Risk
  • Foreign Exchange Risk
  • Interest Rate Risk
  • Credit Risk
financial risk management5
Financial Risk Management
  • Commodity Price Risk:
    • Futures
    • Forwards
    • Swaps
    • Options
financial risk management6
Financial Risk Management
  • Foreign Exchange Risk:
    • Matching expected cash flows and borrowings in the same currency
  • Credit Risk:
    • Assessing financial strength of counterparties
    • Limiting exposure to individual parties
financial risk management8
Financial Risk Management

Note 2. Accounts Receivables

financial risk management9
Financial Risk Management

Note 6. Derivative contracts related to trading activates:

hedging philosophy2
Hedging Philosophy

The company may use derivatives to manage financial risks

financial risks2
Financial Risks
  • Commodity Price Risk
  • Interest Rates Risk
  • Foreign exchange Risks (C$;US$,UK£, NOK)
  • Credit Risk
financial risk management10
Financial Risk Management
  • Commodity price risk:
financial risk management11
Financial Risk Management
  • Foreign Exchange Risk:
    • Denominating most borrowings in US$ to reduce exposure.
    • Managing currency translation with subsidiaries by matching internal borrowings with the functional currency of the subsidiaries
    • Cross currency interest rates swaps
  • Interest Rate Risk
    • Interest rate swaps to manage the fixed-float rates debts.
recommendations
Recommendations
  • Risk Management Committees
  • Sensitivity Analysis
  • Value at Risk (VaR)