Integrated Oil:Oil and Gas March Madness

Deutsche Bank Markets Research North America United States Industrials Integrated Oil Industry Integrated Oil Date 29 March 2016 Forecast Change Oil and Gas March Madness E&P Valuation Heat Check ________________________________________________________________________________________________________________ Deutsche Bank Securities Inc. Deutsche Bank does and seeks to do business with companies covered in its research reports. Thus, investors should be aware that the firm may have a conflict of interest that could affect the objectivity of this report. Investors should consider this report as only a single factor in making their investment decision. DISCLOSURES AND ANALYST CERTIFICATIONS ARE LOCATED IN APPENDIX 1. MCI (P) 124/04/2015. Ryan Todd Research Analyst (+1) 212 250-8342 ryan.todd@db.com Igor Grinman Research Analyst (+1) 212 250-4278 igor.grinman@db.com David Fernandez Research Associate (+1) 212 250-3191 david.fernandez@db.com Joe McKay Research Associate (+1) 212 250-5717 joseph.mckay@db.com Key Changes Company Target Price Rating APA.N 50.00 to 53.00(USD) - APC.N 60.00 to 58.00(USD) - CIE.N 14.00 to 11.00(USD) - COP.N 55.00 to 62.00(USD) - DVN.N 48.00 to 32.00(USD) - EOG.N 83.00 to 85.00(USD) - KOS.N 15.00 to 12.00(USD) - MRO.N 19.00 to 18.00(USD) - NBL.N 42.00 to 41.00(USD) - PXD.N 165.00 to 159.00(USD) - XOM.N 85.00 to 82.00(USD) - Source: Deutsche Bank Top picks Valero Energy (VLO.N),USD65.24 Buy Marathon Petroleum Corp (MPC.N),USD36.98 Buy HollyFrontier (HFC.N),USD35.71 Buy Source: Deutsche Bank Nearly six weeks into a rally that has seen crude rise ~50% and upstream equities increase by ~26%, investors are again wrestling with concerns regarding equity valuation, the pace and scope of further recovery, and the risk to the commodity of incentivizing increased activity levels "too soon". We take the opportunity to do a "heat check" of current valuations (relatively expensive, discounting ~$59/bbl), and although we expect quality to reassert itself in the near-term following recent weakness, we see attractive remaining upside at names with accelerating upside as the strip moves towards $60/bbl (MRO, DVN, PXD, COP). See details, within. Running the numbers: Positive crude, but is the move in stocks too far too fast? Post the bounce in the commodity and group since the February 11th lows, we estimate stocks are currently discounting a long-term WTI price of ~$59/bbl. We see higher discounted prices skewed toward operators with stronger balance sheets (OXY, HES, PXD), while highly levered beta oil names (MRO, MUR, DVN) imply a price closer to the mid 50's, nearly in line with the long-dated forward curve (~$52/bbl). After resetting our price deck assumptions (see below) we still see beta oil names showing significant upside from current levels. MRO remains the most levered way to play a recovery, where we see 2:1 upside/downside at $65/$50 long-term prices, though we note the 40% downside from current levels is among the highest in the group. A more tempered way to play could be DVN, with 3:2 upside/downside at $65/$50/bbl long-term. Cash flows improved by $6bn in 2016, but activity likely to remain disciplined Since setting budgets in the earlier part of 2016, the rise in the 2016 strip to ~$41/bbl has improved cash flows by 9% across our coverage group, reducing outspend (including dividends) by 23%, to an aggregate $19 Bn. We view the rise in price as constructive for balance sheets, though many areas of operation onshore US remain below breakeven at $40/bbl, limiting activity increase in the near-term. With the 2017 strip having risen only 14% since Feb 11 (vs. ~50% in the front month), a long-term recovery remains sluggish for now. Despite increasing concern regarding an increase in spend or cancellation of announced capital cuts, we expect that increased activity will remain fairly limited at $45/bbl crude (ie. PXD in our coverage, which will hedge up to 50% of 2017 volumes at that level, and could add 2-3 rigs). As we approach 1Q earnings, we look for signs of increased hedging and/or potential adjustments to earlier announced budget reductions. Updating the long-term view on pirce targets We have lowered our long-term price deck in our valuation framework to $65/$70/bbl (WTI/Brent) and $3.75/mcf Henry Hub, which we believe is more consistent with currently long-term fundamentals. Accordingly, we have adjusted price targets lower across the group by an average of 1%, with the largest reduction seen at DVN, although we make no change to current ratings - see details within (pages 4-6). . 29 March 2016 Integrated Oil Integrated Oil Page 2 Deutsche Bank Securities Inc. Stocks Discounting $55-$65 LT oil Despite Recent Run We estimate an average long-term im