Diversification and portfolio trends in upstream oil and

Diversification and portfolio trends in upstream oil and gas Paul Horak, Partner, Deloitte & Touche LLP August 29, 2018

Agenda • The portfolio predicament of O&G companies • Upstream portfolio characterization and assessment tools • Characteristics of a fit-for-the-future portfolio • Summary • Q&A The analysis and findings in this Dbrief are from Deloitte’s recently published whitepaper, “The Portfolio Predicament: How can upstream oil and gas companies build a fit-for-the-future portfolio ? ” Copyright © 2018 Deloitte Development LLC. All rights reserved. Diversification and portfolio trends in upstream oil and gas 2

Oil prices up, energy shares down Why do energy stocks appear to underperform relative to market fundamentals? • Despite oil prices rising 25%, upstream stocks underperformed between January 2017 and March 2018. • Global and US energy indices underperformed oil prices by 14– 36%, especially when there was strong upward momentum in equity markets. • Even companies in some of the most promising resources and markets—for instance, the Permian ―reported an average shareholder return of -14%. The March 2018 stock price of 18 upstream companies, with a combined market capitalization of $110 billion, is even below early 2016 levels when oil dropped to $26/bbl. Copyright © 2018 Deloitte Development LLC. All rights reserved. Diversification and portfolio trends in upstream oil and gas 3

Portfolios of O&G companies are fast-evolving New resources like shales, the changed oil price environment, and the need for both operational excellence and financial performance have reset the entire landscape Past Orientation • High prices, scarce resources • Find large reserves Emerging Orientation Assets/Projects Landscape 17, 163 Assets 9, 380 Projects 419 Basins • Play price and investment cycles • Evaluate each opportunity on its own merit • Low prices, plentiful resources • Deliver high and sustainable cash flows • Balance project and cash flow cycles 700 K+ US Wells 1, 862 Companies 6 Resources • Evaluate all opportunities in the context of the portfolio Sources: Rystad Energy, Marakon, Deloitte analysis Copyright © 2018 Deloitte Development LLC. All rights reserved. Diversification and portfolio trends in upstream oil and gas 4

What explains the disconnect? Myriad of portfolio narratives, a narrow view on what constitutes a “good” portfolio, and the lack of a common tool to judge its effectiveness • Before the shale boom, most companies and investors used traditional metrics such as RRR, F&D costs per boe, and ROCE for reporting and benchmarking performance. • These “traditional” metrics were often not connected – companies often chose whichever metric looked best at any particular time. • The emergence of shale plays has complicated this problem further by adding multiple breakeven nomenclatures and leading to selective disclosures from companies. Our study of top IOCs, E&Ps, and NOCs reveals a breakeven gap of $19– 33/bbl between their best assets and their overall portfolio (Source: Deloitte analysis). Copyright © 2018 Deloitte Development LLC. All rights reserved. Diversification and portfolio trends in upstream oil and gas 5

A two-pronged approach Tool 1: A standardized way to study the changes in the portfolios of E&Ps Tool 1: Upstream Diversification Index (UDI) Copyright © 2018 Deloitte Development LLC. All rights reserved. Diversification and portfolio trends in upstream oil and gas 6

Tool 1: The UDI trend Our yearly UDI analysis reveals significant changes in the portfolios of E&Ps, especially over the past few years where there is a visible change in the pace and scale of restructuring Divergent pathways Production-weighted UDI trend of company groups Shales has been an essential “add-in” to IOCs’ continued strategy of diversification North American E&Ps are prioritizing shales over other resources, explaining their increasing concentration Portfolios of NOCs and global E&Ps, on the other hand, haven’t changed significantly over the past 5 years Source: Rystad Energy, Deloitte analysis Copyright © 2018 Deloitte Development LLC. All rights reserved. Diversification and portfolio trends in upstream oil and gas 7

A two-pronged approach, continued Tool 2: A scenario-based methodology to assess the future readiness of portfolios across future market conditions Tool 2: Shield, Sustain, and Scale (3 S) The analysis was run on 32, 000 assets of top 230 global upstream oil and gas companies. Copyright © 2018 Deloitte Development LLC. All rights reserved. Diversification and portfolio trends in upstream oil and gas 8

Tool 2: Results from the 3 S model Our 3 S analysis suggests that 62– 80% of the industry’s portfolios have not yet adjusted sufficiently to navigate the uncertain future Portfolio assessment results (2018– 2022) Sources: Rystad Energy and Deloitte analysis Copyright © 2018 Deloitte Development LLC. All rights reserved. Diversification and portfolio trends in upstream oil and gas 9

The 3 S: Shielded for $40/bbl environment The majority of companies may struggle to reduce their capex without impacting their production—the problem of linearity. Average production and capex change, 2018– 22 (Shield: $40/bbl oil price scenario) Best About 5% of the companies may be able to grow both their production and capex Majority of the E&Ps still have a linear relationship between their capex and production, which is not ideal in a downturn About 15% of the industry could face a double whammy of higher pre-productive capital commitments and falling production Source: Deloitte analysis Copyright © 2018 Deloitte Development LLC. All rights reserved. Diversification and portfolio trends in upstream oil and gas 10

The 3 S: Sustainable at $55/boe About 70 percent of the companies (entire portfolio) could face challenges in sustaining their current production levels, funding new projects, and maintaining their payouts Breakeven analysis, producing vs non-producing assets (2018) It’s about both good projects across the lifecycle and a high proportion of good projects Best Share of low profitability projects Source: Deloitte analysis Copyright © 2018 Deloitte Development LLC. All rights reserved. Diversification and portfolio trends in upstream oil and gas 11

The 3 S: Readiness to Scale up at $65/bbl Companies will likely report higher cash flows in 2018 due to the recent surge in prices. But, sustaining and extending these gains in a timely manner would be a challenge for many. Total incremental free cash flows and 2018 growth ($65/bbl oil price scenario) Majority of the companies will likely realize one-time gains in 2018, but sustaining these gains would be a challenge later 28% companies will likely see both lower magnitude and delayed recovery of FCF gains Best A handful of companies will likely see higher gains per boe but with a lag of 2 -3 years from the price recovery Source: Deloitte analysis Copyright © 2018 Deloitte Development LLC. All rights reserved. Diversification and portfolio trends in upstream oil and gas 12

The power of two tools: Characteristics of a future-ready portfolio The top 30 portfolios in the 3 S model, when seen through the lens of the UDI, displayed five distinct traits—excellence is clearly not happening by accident! Characteristics of future-ready portfolios Patterns amid chaos: Following a consistent strategy and actively managing portfolio Through a different lens: Manage resources by focusing on investment cycles Not two sides of the same coin: Understanding that strong financials need not necessarily mean a futureready portfolio Copyright © 2018 Deloitte Development LLC. All rights reserved. The “how” before the “where”: Prioritizing operational excellence over location A balanced mix: Exposure to gas is important but not central yet Diversification and portfolio trends in upstream oil and gas 13

Summary Solving the portfolio predicament Copyright © 2018 Deloitte Development LLC. All rights reserved. Diversification and portfolio trends in upstream oil and gas 14

Question and answer

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