Integrated Oil:The Times, They Are a Changing:Shifting Paradigm for the US E&Ps

18 December 2017Integrated OilIntegrated OilIndustrialsIntegrated OilFITT ResearchNorth AmericaUnited StatesIndustryIntegrated OilDate18 December 2017Deutsche BankMarkets ResearchThe Times, They Are a Changing:Shifting Paradigm for the US E&PsAdmit that the waters around you have grownLed by a fundamental shift in investors' long-term view on oil price, and a decadeof subpar returns and value creation by the E&P sector, there is increasingpressure on US E&Ps to show greater capital discipline, returns, and maybe evena path towards cash return to shareholders. Within, we examine both drivers andpotential forward looking scenarios, with the conclusion that: 1) over the next 5+years the sector can generate higher growth and FCF than the market suspects,even at $50/bbl, 2) there is precedent for similar transitions which have beenrewarded by investors, and 3) heavily discounted future FCF offers an attractivevalue relative to other industrial/cyclicals in the broader market. Positive: EOG,NBL (Upgrade to Buy), MRO.F.I.T.T. for investorsRyan ToddResearch Analyst+1-212-250-8342Joe McKayResearch Associate+1-212-250-5717David FernandezResearch Analyst+1-212-250-3191Cheryl KniattResearch Associate+1-212-250-4461Deutsche Bank Securities Inc.Deutsche Bank does and seeks to do business with companies covered in its research reports. Thus, investors should beaware that the firm may have a conflict of interest that could affect the objectivity of this report. Investors should considerthis report as only a single factor in making their investment decision. DISCLOSURES AND ANALYST CERTIFICATIONSARE LOCATED IN APPENDIX 1. MCI (P) 083/04/2017.Distributed on: 18/12/2017 11:33:14 GMT7T2se3r0Ot6kwoPa 18 December 2017Integrated OilIntegrated OilIndustrialsIntegrated OilFITT ResearchNorth AmericaUnited StatesIndustryIntegrated OilDate18 December 2017Deutsche BankMarkets ResearchThe Times, They Are a Changing:Shifting Paradigm for the US E&PsF.I.T.T. for investorsAdmit that the waters around you have grownLed by a fundamental shift in investors' long-term view on oil price, and a decadeof subpar returns and value creation by the E&P sector, there is increasingpressure on US E&Ps to show greater capital discipline, returns, and maybe evena path towards cash return to shareholders. Within, we examine both drivers andpotential forward looking scenarios, with the conclusion that: 1) over the next 5+years the sector can generate higher growth and FCF than the market suspects,even at $50/bbl, 2) there is precedent for similar transitions which have beenrewarded by investors, and 3) heavily discounted future FCF offers an attractivevalue relative to other industrial/cyclicals in the broader market. Positive: EOG,NBL (Upgrade to Buy), MRO.For he that gets hurt will be he that has stalledValuation and RisksCompanies in our integrated/large-capspace are valued on either a EV/DACFmultiple (CVX.N, XOM.N, COP.N, andOXY.N or on a blended NAV, EV/DACFmultiple methodology. NAVs assume $60/bbl, $57/bbl, and $3.25/mcf for Brent,WTI and Henry Hub pricing resp. Primarydownside risks include a decline in global oildemand and a decrease in the underlyingcommodity. Upside risks include increaseddemand and increased operator efficiency.Companies in our refining coverage aremostly valued under a 2018 multiple-based(EV/EBITDA) SOTP valuation. Upside risksinclude widening crude diffs, and gasolineinventory draws while key downside risksinclude tepid gasoline and distillate demand.Since the emergence of shale, the driving philosophy underpinning bothdevelopment strategy and investors has been maximizing resource value, ascaptured in the Net Asset Value (NAV) model. The right answer for use of anincremental dollar has ALWAYS been to drill faster. However, we see this shiftingas: 1) change in long-term view on oil price (lower for longer), 2) investors are tiredof waiting for the "eventual" prize, and want to share tangibly now (or at least aclear path/timetable), and 3) the realization that while INDIVIDUAL accelerationmay make sense, the COLLECTIVE acceleration of the industry can quickly ruinthe commodity. We expect pressure to continue on companies to throttle backspend/growth, and consider a path to return cash to shareholders.Don't stand in the doorway, don't block up the hallSo what does a "disciplined, returns-focused" E&P sector looks like? For starters,the group has the potential to generate more FCF than most would assume (ormore efficient cash-neutral growth), even at $50/bbl. We ran sensitivities acrossvarious scenarios, including "low, medium and high" growth cases, at $50/bbl and$60/bbl long-term, with current portfolios offering sufficient flexibility to generateattractive levels of growth, free cash flow, or a combination of the two. We seethe group able to generate attractive growth (8%-15%/yr), returns (a pathway todouble digit ROCE in 2020+) and free cash flow (average