BUS419 Advanced Derivative Securities Canadian Oil and Gas

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BUS419 Advanced Derivative Securities Canadian
Oil and Gas

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

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Agenda

• Introduction
• Canadian Natural Resources
• Penn West
• Canadian Oil Sands
• QA

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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

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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

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Industry (Forecasting)
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Industry Products-Crude Oil

• Actively traded commodities
• 40 of Canadas energy demand
• 17 of Canadas 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)

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Industry Products-Crude Oil

• Products
• -Gasoline
• -Kerosene
• -Jet Fuel
• -Lubricants

• Substitutes
• -Nuclear Power
• -Hydrogen
• -hydropower
• -Coal
• -Methane
• -Solar energy

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Industry Products-Crude Oil
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Industry Products-Crude Oil
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Industry Products-Crude Oil
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Capital Investment-Crude Oil
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Industry Products-Natural Gas

• Natural gas accounts for 30 of Canadas energy
  demand.
• Reserves 69.3 trillion cubic feet
• Production 14.1 billion cubic feet per day

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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

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Industry Products-Natural Gas
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Industry Products-Natural Gas
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Industry Products-Natural Gas
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Regulation on the Industry
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Regulation on the Industry

• Canadian
• Natural Resources Canada
• National Energy Board
• Environmental Regulations (Environment Canada)
• Self-regulation
• Canadian Association of Petroleum Producers (CAPP)

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Risk Management

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

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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

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Risk Management

• Sensitivity analysis
• On cash flows sensitive to
• Oil and gas prices
• Interest rates
• FX changes
• Further Developed with
• Probability calculations for movements in prices
  interest rates and FX

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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

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Risk Management

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

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Canadian Natural Resources
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Overview

• Headquarters in Calgary, Alberta (1973)
• Operates in Western Canada, the North Sea off
  Scotland, and West Africa

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Overview
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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
• Canadas largest heavy oil producer
• Canadas second largest natural gas producer

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Overview
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Management

• N. 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

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Management

• Tim 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

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Historical Price TSX
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Trading and Share Statistics
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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

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Reserves
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Risk Management

• Risks
• 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

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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

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Risk Management
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Risk Management
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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

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Risk Management
Commodity Price Risk

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

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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.

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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.

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Risk Management
Foreign Currency Exchange Risk
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Risk Management
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Risk Management
Credit Risk

• 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
  Companys 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

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Risk Management
Liquidity 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.

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Risk Management
Liquidity Risk
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Risk Management
Sensitivity Analysis

• The following table summarizes the annualized
  sensitivities of the Companys 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

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Risk Management
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Penn West Exploration
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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 VPs

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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

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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

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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

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Historical Price TSX
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Trading and Share Statistics
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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

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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.

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Reserves
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Reserves
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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

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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.

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Risk Management

• Commodity Price Risk
• 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 Boards approval, our hedging
  limits may be increased above the maximum limits

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Risk Management
Commodity Price Risk
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Risk Management
Commodity Price Risk
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Risk Management
Commodity Price Risk
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Risk Management
Foreign Exchange Risk

• Prices received for crude oil are referenced to
  US dollars, thus Penn Wests realized oil prices
  are impacted by Canadian dollar to US dollar
  exchange rates.
• A portion of the Companys debt capital is
  denominated in US dollars, thus the principal and
  interest payments in Canadian dollars are also
  impacted by exchange rates.

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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 oil revenues or to fix
US denominated long-term debt principal repayments
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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.
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Risk Management
Interest Rate Risk

• A portion of the Companys 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.

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Risk Management
Interest Rate Risk
As at December 31, 2013, none of the Companys
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.
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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.

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Risk Management
Liquidity Risk
The following table outlines estimated future
obligations for non-derivative financial
liabilities as at December 31, 2013
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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.

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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 impact
• and sufficient capital is allocated to
  reclamation and other activities to mitigate the
  impact on the areas in which we operate.

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Risk Management
Sensitivity Analysis
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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.
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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.

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Market for COS Production
Headquarters is located in Calgary, Alberta
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Board of Directors

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

• 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

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

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Highlights
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Historical Stock PriceGoogle Finance
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2015 Outlook
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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 EHS
  performance.

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Highlights
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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.

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Risk Management
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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

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Risk Management

• Operational Risk
• Operational Outages
• The shutdown of any part of Syncrudes operation
  could significantly impact production of SCO.
• water store
• geology and limestone base
• electrical power
• Solution maintaining appropriate levels of
  insurance, primarily business interruption (BI)
  and property insurance.

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Risk Management

• Operational Risk
• Project Execution
• Risks associated with the execution of Syncrudes
  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

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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

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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 Emissions
• Legislation significantly restricts or penalizes
  water use and/or emissions

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Risk Management

• Financial Market Risk
• Foreign Currency Risk
• Fluctuations 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

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Risk Management

• Financial Market Risk
• Interest Rate Risk
• Changes in market interest rates may affect the
  Corporations financial results and financial
  condition.
• Long-term Debt (variable-rate credit facilities)
• short-term investments
• - Employee future benefits
• - Accrued benefit liability
• - Asset retirement obligation

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Risk Management
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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 PPE.
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Risk Management

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

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Risk Management
Financial Market Risk
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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

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West Canadian Oil Sands QA
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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 Corporation
• Solution Manages its liquidity through cash,
  debt and equity management strategies

Intro Canadian Natural Resources Penn
West Canadian Oil Sands QA
107
Sensitivity Analysis
Intro Canadian Natural Resources Penn
West Canadian Oil Sands QA
108
Financial Report
Intro Canadian Natural Resources Penn
West Canadian Oil Sands QA
109
Financial Report
Intro Canadian Natural Resources Penn
West Canadian Oil Sands QA
110
Financial Report
Intro Canadian Natural Resources Penn
West Canadian Oil Sands QA
111
Oil and Natural Gas Industry
Any Question
112
Oil and Natural Gas Industry