2015 Market Outlook Workshop

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2015 Market Outlook

Workshop

Feeling the Squeeze

Deloitte Consulting LLP August 7, 2015

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Agenda

 Introduction to Deloitte

 Our View of the Oil & Gas and Oil Sands Market

 Trends in the Oil Patch – Cost Reduction

 Cost Reduction for Producers and what that means for Manufacturers (Cost Modeling)

 Cost Reduction for Manufactures (Direct Materials)

 Conclusion

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Introductions

Ted Brennan Senior Manager Deloitte Consulting LLP Martin Brotschul Principal Deloitte Consulting LLP Grant Poeter Specialist Leader Deloitte Consulting LLP

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4

9

Innovative Alliance Relationships Including Singularity University,

3D Systems and XPRIZE

=--54

Offices E&R consulting Global Consulting

Gartner, Kennedy, Forrester

#1

Centers for Energy Solutions

2

76%

Consulting services to E&R Companies

15

E&R studies and published articles In 2014 Supply Chain1,3_, Finance1,3_{, HR}3_, Customer Management1_, IT3_{Transformation}

#

1

Proprietary Tools and Methodologies Examples: Strategic Choice Cascade, The Visual Decision

Accelerator (VDXTM)

1_{As ranked by Gartner;}2_{Per International Association of Outsourcing Professionals®;}3_{As ranked by Kennedy}

2020 Global Procurement Outlook

About Deloitte Consulting LLP

Collaborative US/Bangalore Team

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The Market

Risk Profile of the Western Canadian Sedimentary Basin (WCSB) has Changed

• Structural shift away from natural gas drilling

• Full cycle dry gas has been uneconomic in Canada for several years – no indication that this will change • Liquids rich strategies can work but are challenged by

infrastructure constraints and depressed gas prices • Remain cautious on gas due to LNG uncertainty and

mountain of gas in the Marcellus

• The average cost per well drilled in the WCSB has risen dramatically as:

– new technologies are implemented (multi-stage fracturing) – deeper, more technically difficult reservoirs are targeted

(i.e. Duvernay)

• Risk for new entities has shifted from exploration to development

• Balance sheets need to adjust accordingly – hence larger initial capital raises

• Undercapitalization remains a risk

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The Market

West Texas Intermediate – The Challenging Market Continues

THEMES

• Recovery of WTI prices to US $70-80/bb • Longer than 12 months

• Many also commented on factors that have softened the impact of the price decline:

– The weakening of the CAD vs the USD – Hedging positions for the remainder of 2015

USD WTI CAD WTI

USD WTI prices

(FX rates per Bank of Canada)S

*from May, 2015

Weakening FX rate resulting in favourable CAD WTI

WTI pricing per www.eia.gov

June 2013 CAD WTI – $96 USD WTI – $93 April 2015 CAD WTI – $72 USD WTI – $60 Interview Period

Deloitte recently interviewed 20 CFOs to get a “pulse check” on the market. Their perspectives were quite similar.

28%

72%

Which of the following describes your outlook of when WTI prices will return to US $70 – 80/bbl?

>12

Months

<12

Months

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The Market

Global Crude Cost Breakeven Curve

Source: Spears

Even with low production costs, OPEC members rely on oil prices to be in the $80 - $100BBL range to fund their governments.

Prices will be further tested with the possibility of Iran production coming back into the world market as a result will likely stay soft for the foreseeable future.

Source: Reuters, “Oil prices below most OPEC producers' budget needs”, September 8, 2014;

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The Response

Global Oil and Bitumen Production Will Reduce as a Result of Cancelled Projects

Canada has been the hardest hit with a double whammy of lower oil prices and a weak Canadian Dollar. If sub $50 oil were to persist, this list would be pages long.

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The Response

Actions to sustain performance in the current environment

Proportion of participants (CFOs) considering or applying the following strategies to manage current and potential future prices

Companies are looking at a number of ways to mitigate both the immediate deflationary pressures and how to make structural changes to manage at a lower price per barrel range.

REDUCING COSTS DEFER SPEND STRATEGIC ACQUISITIONS DIVESTITURES TO MONETIZE ASSETS CUT DIVIDEND SHORT-TERM CASH FLOW ALTERED PLANS TO ACCESS FINANCING DEBT MANAGEMENT

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The Response

Cash Flow Management

67% 8% 17% 8% Achieved 10% reduction Achieved 15% reduction Achieved 20% reduction Achieved 40% reduction Percentage cost reduction achieved by CFOs,

shown proportionally

• Reducing contractor and employee headcount.

• Seeking cost reductions from suppliers. Most indicated that achieving approximately 10% reduction is a realistic “first step”

• Improving management of receivables from JV partners while being strategic in vendor payments and realizing discounts for early payment.

Most companies have engaged in Cost Reduction programs in 2015. If there is a continued softening, there will be further contractions and negotiations.

Source: Deloitte Canada CFO Study

The resounding feedback from CFOs is that there is increased focus on “getting the most out of what you’ve got”. In their view, relevant areas being considered include:

• Field productivity

• Asset management

• Many highlighted recent or planned investments in

operations technology to do more with field data available, as well.

Operational readiness was also highlighted as a priority by those dealing with the transition of capital projects

to operations.

CFOs were asked what elements of operations excellence are priorities in the next 3 to 12 months

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The combination of weak oil prices and a strong US dollar have driven a shift in oil price fundamentals. With no end in sight for either oil demand increasing or the dollar weakening, low oil prices are likely here to stay.

Summary

The Market and Our Thoughts

We see some examples of trends to be more competitive in this market environment for both customers and manufacturers

• Consensus of analysts and data point to no real improvement for 12 Months or more • Upside is in the $70BBL - $80BBL range. No one is predicting $100 anytime soon

• All operators have conducted cost out programs with mixed results – more will likely follow

• Companies with strong balance sheets are seeing this as an opportunity to gain market share and scale, ultimately meaning fewer, larger customers in the market

• Marginal programs/projects will be mothballed or abandoned

• Added uncertainty with Iran’s potential move back in to the mainstream will keep prices lower

• It’s not all bad for other industries, it is estimated that low oil prices is a $1.1Trillion stimulus in to the world economy*

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Customer Response

Cost Model Example: Region A Seamless 7 in. 32# HCP110 Casing

There are two types of Cost models; one is used to estimate both the Total Cost of a Material or Service to a company and the second estimates the cost for a supplier to produce a component/input

Total Cost of Ownership

Should Cost $8.73 $0.98 $3.11 $9.90 $2.58 $0.91 $26.21 $2.85 $29.06 $0.84 $1.16 $0.27 $31.33 $0 $5 $10 $15 $20 $25 $30 $35 $8.16 $24.50 $27.69 $29.07 -$5 $0 $5 $10 $15 $20 $25 $30 $35 P er f o o t P er f o o t

With your customers driving to this level of information, it can enable you to have different conversations on pricing, including indexing to some of your key cost drivers

Manufacturing Distribution and Freight Total

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Customer Response

Cost Model Example: Region B Welded 7 in. 23# J55 Casing

The example pipe accounts for 40% of Region B’s OCTG spend. As modeled, Region B is paying 7% under the Should Cost.

Total Cost of Ownership

Should Cost $7.30 $0.43 $0.68 $1.49 $1.69 $0.81 $12.39 $1.63 $14.02 $0.72 $0.56 $15.30 $0 $2 $4 $6 $8 $10 $12 $14 $16 $18 $7.85 $13.33 $15.34 $16.13 -$2 $0 $2 $4 $6 $8 $10 $12 $14 $16 $18 P er f o o t P er f o o t

This type of analysis can also help to ferret out pricing anomalies in the market, such as this case where a foreign company that recently had a 15.89% countervailing duty levied against it.

Source: International Trade Commission

Manufacturing Distribution and Freight Total

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A number of market trends in the manufacturing industry lead to increasing pressure on companies

Manufacturers Response

Overview

Globalization of supply and customer base Appearance of new competition Typical company in the manufacturing industry Decreasing product differentiation Stronger end customers Increasingly sophisticated procurement managers Mature, slow-growing markets

M&A among competitors and customers

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We are in the second cycle in the past 15 years

Manufacturers Response

Volatility

– here to stay

2004 2005 2006 2007 2008 2009 2010 2011 2012 2013 2014 2015

Aluminum Raw Materials Index Petroleum Maize

• Increasing sophistication in commodity management

• Commodity management as a competitive advantage

1

2

Commodity Prices Since 2004

Note: Raw Materials Index includes Timber, Cotton, Wool, Rubber, and Hides Price Indices, Aluminum based on LME price, Petroleum based on simple average of three spot prices: Brent, West Texas Intermediate, and the Dubai Fateh, Maize (corn) based on U.S. No.2 Yellow

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Purchase price timing and variation among suppliers indicates an opportunity for price reduction

Manufacturers Response

Supplier pricing – cat and mouse

75 80 85 90 95 100 105

2008

2009

2010

2011

2012

Pric

e I

n

d

ex

All Hydraulic Cylinder Cylinder Steel Index

1 Year Delay 1 Year Delay

6 Month Delay

• Steel price increases are

met with more rapid

purchase price increases

than steel price reductions

• Decline in steel prices over

the past two years has not

seen a commensurate

purchase price reduction

• There is an opportunity for

purchase price reduction

due to steel price decline

over last 18 months

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Continuous cost reduction efforts are crucial for lasting success

Another approach

Reacting to immediate cost pressure Improving product competitiveness Reaching strategic targets

PRIMARY TARGET SECONDARY TARGET

Product Cost reduction • Operational effectiveness – Reduction of complexity – Process efficiency – Reduced cycle time • Product optimization – Increase of product margin – Increase of competitiveness – Improved product quality

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Margin focused cost take out focuses on value to the business

Manufacturers Response

Cost take out at the product level

Engi-neering Procure-ment Manu-facturing Quality Logis-tics Product 1 Product 2 Product 3 Functional Engi-neering Procure-ment Manu- factu-ring Quality Logis-tics

Cost perspective Collaboration Value Chain

TRA DITIO N A L PRODUCT FOCUSED A PPRO A CH 1 2 3

Organization driven Isolated focus

Cross-functional

Product driven Integration of suppliers/sub-suppliers

RAW MATERIA SUPPLIER

Tier 1 OEM Cus-tomer OEM Procure-ment Manufac-turing Sales Cost reduction Personnel cost Material Manufac-turing Sales & Marketing Finance/ Admin … … … … 1,3

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Overall Methodology To Calculate Manufacturing Cost of Hydraulic Cylinders

Raw Material Operation Cost Finishing Cost Assembly & Testing

Purchased Parts Manufactured Parts Volumes (cm^3) Material Type - Density (Kg/ cm^3) Weight (Kg) Material Cost (€ / Kg)

Raw Material Cost (€)

Castings & Forgings

Tubes, Rods, Plates

Geometric Features Define Operations - Turn, Grind, et. al.

Setup Times (min) Cycle Times (min)

Fully Loaded Labor Rate (€ / hr)

X X

Operation Cost (€)

Chrome, Nitrite Plating Surface Area (mm^2) X Cost (€ / mm^2) = Plating Cost (€ ) Painting Surface Area (mm^2) X Cost (€ / mm^2) = Painting Cost (€ ) Welding Setup, Pre-heat, Handling, Cleaning (min) +

Weld [Length / Speed] (min)

=

Welding Time (min) X

Fully Loaded Labor Rate (€ / hr) = Welding Cost (€) Assembly Consider: Part Weight Torque Need Forced Fit Need Total Time (min) X

Fully Loaded Labor Rate (€ / hr) =

Assembly Cost (€)

Testing

Standard Testing Time (min)

X

Fully Loaded Labor Rate (€ / hr) =

Testing Cost (€)

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Conclusion and Questions

• Dynamic market will continue for the foreseeable future • Crude Supply – Demand Balance

• USD Strength

• Geopolitical uncertainty

• New entrants will further erode the balance • Companies are struggling to get costs in line • Different Thinking is Required

• Cost Modelling and Supply Chain Analytics will become more mainstream • Restructured relationships with key suppliers to align incentives will continue

• Managing Risks and Relationships will become more important to Sourcing & Procurement groups

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