Integrated Oils and Refiners-1Q Preview:The Shift from Survival to Recovery

Deutsche Bank Markets Research North America United States Industrials Integrated Oil Industry Integrated Oils and Refiners Date 20 April 2016 Recommendation Change 1Q Preview: The Shift from Survival to Recovery 1Q16 Preview - Setting the stage for the recovery ________________________________________________________________________________________________________________ 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) 057/04/2016. 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 DVN.N 32.00 to 41.00(USD) - EOG.N 85.00 to 83.00(USD) Buy to Hold PXD.N 159.00 to 180.00(USD) - Source: Deutsche Bank Valuation and Risk Companies in our integrated/large-cap space are valued on either on a EV/DACF multiple (CVX, XOM, COP, and OXY) or on a blended NAV, EV/DACF multiple methodology. NAVs assume $70/bbl, $65/bbl, and $3.75/mcf for Brent, WTI and Henry Hub pricing respectively. Primary downside risks include a decline in global oil demand and a decrease in the underlying commodity. Upside risks include increased demand and increased operator efficiency. Major upside/downside risks to the refiners include an increase/ decrease in global product demand and a decrease/increase in feedstock costs. With crude oil balances likely to tighten through 2H16, and sentiment largely shifting constructive on both crude and the equities, we expect the market to look through what is likely to be a trough in qtrly results (high capex, low commodity), instead focusing on relative positioning into 2017 and the pace/magnitude of potentially increasing activity. Although we anticipate an emphasis on continued fiscal discipline, we expect signs of first-mover efforts by top-tier balance sheet/resource quality names (PXD) and an early road map into recovery for others. We favor quality multi-year outperformers (PXD, OXY), higher oil leverage plays (DVN, MRO, COP), and downgrade EOG to Hold. Closing funding gaps, the organic (and inorganic) way Since a 4Q15 results season that was largely focused on 2016 budgets and survival, the outlook for funding has significantly improved, with a projected $25 Bn funding gap reduced to $9 Bn through a combination of asset sales ($5 Bn), equity issuance ($6 Bn) and an $5/bbl increase in the 2016 forward curve ($5 Bn). While recent asset sales have shown some signs of encouragement, we expect the market to remain challenging, and look for updates on outstanding asset sale programs (DVN, APC, COP), as well as potential for increasing capital flexibility post successful divestitures and/or equity issuance (MRO, DVN, HES). From Flight to Fight: Framing the potential for the return of capital We expect conference calls to focus primarily on flexibility within current capital budgets, and the pace, magnitude and relative priority of a return to increased activity. Although we expect 2016 budgets to remain largely unchanged as yet, as companies emphasize capital discipline and balance sheet preservation, we expect increased discussion on hedging as a pre-cursor to a return of rigs (PXD now 45% oil hedged through much of 2017), DUC drawdown as a first step forward (EOG, APC), and the potential for the first rig/completion additions at $45/bbl crude from top-tier balance sheet/asset quality names (ie. PXD and other core Permian producers). While resource updates have garnered limited interest over the past 18 months, we expect potentially positive drilling/de-risking results from DVN, NBL, MRO. Within, see company by company details. Continued shift towards higher beta/crude leverage: Downgrade EOG to Hold Although we still see advantaged balance sheet/resource quality names as multi-year outperformers (PXD, OXY) in what is likely to be a choppy, volatile and relatively moderate pace of recovery, we continue to highlight the need for increasing exposure to higher beta names, DVN, MRO and COP, which in a move from $40/bbl to $55-$60/bbl offer increased exposure to a recovery via potential