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Canadian Crude Oil Futures Developing a Benchmark

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  1. Canadian Crude Oil FuturesDeveloping a Benchmark July 5, 2012

  2. Net Energy at a Glance • Highlights • First brokerage business for Canadian crude oil • Internet-based trading platform connecting over 220 traders to a centralized marketplace • First technology platform to launch and transact financial futures in Canadian crude oil • Business Model and Services • Voice-broking and electronic order matching operation focused on the Canadian crude oil market • Hybrid model with central order book combining broker-entry and client-entry via Ne2 trading platform • Physical and financial products available for trading • Clearing linkages to CME Group and Natural Gas Exchange • Market data dissemination platform for news, market data, settlement prices, indices through the Net Energy News Aggregator service (NENA) • Development of trade data warehouse and repository via Direct Deal ticket entry system • Development of RFQ and energy auction platforms to facilitate transactions in emerging markets • Corporate • Local Alberta ownership • Headquartered in Calgary, Alberta, Canada

  3. Alberta – History of Marketplace Innovation Launched First electronic Canadian Natural Gas futures First electronic marketplace for Canadian crude oil First hybrid brokerage/screen for Canadian crude oil Launch of Canadian crude oil financial futures marketplace • Why Develop Markets in Alberta? • Access to energy traders and principals, customization for Canadian products • Accessible regulatory and corporate regime for developing ventures • Many local trading pioneers have been involved in developing marketplaces such as Energy Exchange Inc., Natural Gas Exchange, Alberta Watt Exchange, Digital Outcry, KEFI Exchange, Netthruput, Auspice Capital, Net Energy and numerous others Launched first trading platform for Canadian electricity futures, followed by ancillary services First electronic Canadian CO2 trade First Canadian natural gas Exchange-Traded-Fund developed

  4. Canadian Crude Oil • Canada has 3rd largest oil reserves globally • 6th largest global producer of crude oil • Canadian crude oil production is forecast to increase from 3.0 million barrels per day in 2011 to 6.2 million barrels per day in 2030 • Numerous projects planned and/or under development to increase export capacity to U.S. and other foreign markets • Canadian crude oil market is a large, strategic and reliable source of supply Source: CAPP

  5. US and Canadian Crude Futures

  6. Canadian Crude Oil Marketplace • Early Stages of Development • The Canadian crude oil marketplace is currently primarily a physical, near-term, voice-brokered market with liquidity fragmented amongst a complex suite of grades and counter parties • Market in Transition • The introduction of standardized streams such as WCS in 2004, combined with global events increasing the demand for Canadian crude, have introduced more risk-takers into the marketplace and the result has been growth in price discovery and market liquidity • The introduction of the first widely traded financial contract (WCC) by Net Energy in 2010 increases the ability to hedge exposures without direct ownership of physical assets • Transaction Services • With the growth in traded volumes many new transaction service providers have entered the market in recent years, primarily those headquartered outside of Alberta in other parts of Canada or the United States • Benchmarking Western Canadian Crude Grades • Market hedges using predominantly sweet crude grades such as West Texas Intermediate • Volatility of the differential between WTI and Western Canadian crude is very high • Transportation logistics and supply/demand balance makes the value of Canadian crude oil fluctuate in extremes

  7. Volatility of the WCS Differential

  8. A Canadian Benchmark • Market Need Exists Locally • A large volume of production in Canada exists today, huge growth over the next 20 years • Transportation logistics make pricing very unstable, high volatility and unpredictable swings • Very difficult to hedge directly with the U.S. and European financial markets due to the volatility of the differential • However, a Global Need Exists • 60% of global crude oil is sour and exhibits market characteristics closer to Canadian crude than to the sweet grades commonly used as benchmarks today • Canadian markets are open for asset acquisition and trading, versus the South American and Middle Eastern markets that see a higher degree of government intervention • Asian buyers are increasingly involved in the Canadian market and need to hedge supplies • Why is a Canadian Benchmark Important? • Canadian crude oil exhibits its own characteristics and risks, requires hedging instruments that reflect those unique trading dynamics • A benchmark based in Canada attracts investment, trade and brings new market participants to Alberta • Liquidity in benchmark grades attracts capital into alternative products and market segments, including ETF’s and securities

  9. WCC Contract WCC Financial Futures Traded Differential Buyer Seller Net Energy CDI Index Price for the Contract Month • Contract is settled financially as the net difference between the two cash flows, no physical delivery is required • Current year plus four full years forward are available to be traded • 1 contract = 1000 barrels • Transactions are cleared via CME Clearport

  10. Hedging with WCC Short Hedge Example Hedge Price DELIVERY MONTH Market Price Hedge Price WCC Expiry/CDI Price Price Hedge Loss Hedge Loss Hedge Gain Final WCC Settlement Price = CDI Index Price Hedge Gain Time • At expiry of WCC the futures buyer/seller has hedged to CDI and has received any gains or paid any losses • Delivery exposure requires hedging with a physical transaction, either priced at a fixed differential or against index and is paid 25 days following the end of the delivery month

  11. WCC Contract Number of Contracts

  12. What Needs to Happen? • Canadian Crude Futures Trading Demographics and Market Dynamics • Volume and open interest in Canadian crude oil are growing • More market participants need to enter the marketplace, addition of financial players • Short-term and long-term trading has to develop, currently long-term heavy • Transportation and Logistics • Transportation and logistics of moving Canadian crude oil to markets constrains Canadian market growth • New pipelines and delivery mechanisms will increase activity on the long curve while the markets determine timing for supply/demand shifts • Differential Versus Flat Pricing • Canadian crude oil currently prices as a differential to WTI • A recognizable benchmark should be a flat or “delivered” price for Canadian crude oil • Flat pricing is much easier to understand and represents the actual price of crude oil as its bought and sold in the market • Flat pricing removes an obstacle to attracting new investment and generally increases global exposure • Flat pricing should be quoted and eventually traded directly

  13. Creating a Canadian Flat Price Canadian Crude Oil Flat Price

  14. The Goal • Healthy Canadian Crude Oil Futures Market • Based in Alberta to ensure product is developed near to the traders in an energy focused market • Providing short and long-term liquidity to the market to maximize exposure of Canadian crude oil and to attract/support new investment • Introduction of new financial market participants and risk capital • Increased use of Canadian financial products such as options and ETF’s tied to Canadian futures • Development of futures contracts for other key Canadian grades, such as sweet synthetic oil • Canadian Crude Benchmark • Canadian crude oil futures become a benchmark by which many global sour crudes are priced and risk is managed • A Canadian flat price for crude oil that is quoted as one of the key global benchmarks for trade recognizing Canada’s position as a global crude oil leader • Infrastructure Development • Development of infrastructure to relieve supply/demand imbalances • Use of Canadian crude oil futures to hedge the risk of in-service dates for new transportation services • Increased competition for Canadian crude production from West, East and South

  15. Contact Us Net Energy Inc. Suite 203, 440 – 2nd Avenue SW Calgary, Alberta, Canada, T2P 5E9 Dan Zastawny, Vice-President Business Development (403) 216-8349