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Jeffrey W. Robertson Senior Vice President, Lehman Brothers Exploration & Production Equity Research IPAA 2005 Annual Meeting October 26, 2005 Lehman Brothers.

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Presentation on theme: "Jeffrey W. Robertson Senior Vice President, Lehman Brothers Exploration & Production Equity Research IPAA 2005 Annual Meeting October 26, 2005 Lehman Brothers."— Presentation transcript:

1 Jeffrey W. Robertson Senior Vice President, Lehman Brothers Exploration & Production Equity Research IPAA 2005 Annual Meeting October 26, 2005 Lehman Brothers does and seeks to do business with companies covered in its research reports. As a result, investors should be aware that the Firm may have a conflict of interest that could affect the objectivity of this report. Customers of Lehman Brothers in the United States can receive independent, third-party research on the company or companies covered in this report, at no cost to them, where such research is available. Customers can access this independent research at or can call LEHMAN to request a copy of this research. Investors should consider this report as only a single factor in making their investment decisions. PLEASE SEE ANALYST(S) CERTIFICATION(S) AND IMPORTANT DISCLOSURES BEGINNING ON PAGE 18

2 Commodities Prices Commodity prices have reached record highs in the past few months Crude Oil and Natural Gas Prices ________________ Source: Gas Price--Natural Gas Week; Oil Postings--Koch Oil. 1

3 Domestic Natural Gas Production U.S. natural gas production declined approximately 6% from 1998 to 2004 U.S. Production ________________ Notes: data is from the EIA, data 2003-onwards is Lehman Brothers estimates. Previously, we had estimated 1999-onwards. Excluding the impact of Ivan, we estimate U.S. production was down about % in 2004, versus the 5% decline shown above. Source: EIA, DOE: Office of Fossil Energy, and Lehman Brothers estimates. Bcfe/d 6% 2

4 Creating Value for Shareholders Is value creation any easier in today’s high commodity price environment? First, how should value creation be measured?  Growth in assets –Reserves & production Cash flow  Absolute or per share growth? –We believe per share should matter most to equity owner Equity owner benefits if reserves and production per share grow faster than the balance sheet. 3

5 Working Rigs and Gas Prices Drilling activity follows commodity price. But, do higher activity levels translate into faster value creation? Working Gas Rigs vs. Composite Spot Wellhead Gas ________________ Source: Rigs--Baker Hughes; Gas Price--Natural Gas Week Working Gas Rigs Composite Spot Wellhead Gas ($/MMBtu) 4

6 Production Growth Higher prices have not necessarily meant faster per-share growth rates. Production Per Share Growth Rates vs. Avg. Commodity Prices ________________ Sources: Company reports and Lehman Brothers estimates. 5

7 Reserve Growth Reserve per share growth looks better. More undeveloped reserve bookings? Reserve Per Share Growth Rate vs. Avg. Commodity Prices ________________ Sources: Company reports and Lehman Brothers estimates. 6

8 Growth Rates vs. Stock Returns There is a notable correlation between debt-adjusted growth rates in reserves, production and cash flow versus stock price returns ________________ Note: For details on calculation methodology of per share growth rates and individual company footnotes please refer to our main report titled “What Drives E&P Share Prices?” dated June 8, Source: Company reports and Lehman Brothers estimates. Note: Stock Price Appreciation has been calculated for the period from Jan to December Debt Adjusted 5 year CAGR of Reserves, Production and Cash Flow per Share 5 Year CAGR of Stock Price Return 7

9 Cost of Doing Business is Going Up Rising costs are raising the price needed to generate reasonable returns ________________ 1. Assume 5% drilling F&D costs to develop proven undeveloped reserves. 2. Assume 10% pretax return for six years. 3. Rounded average cash costs of APC, APA, BR, and EOG. 4. Differential vs. commodity prices. 5. Commodity prices assuming 75% gas and 25% oil mix. Assume Henry Hub gas price per MMBtu is one seventh WTI price per bbl. Sources: Company reports and Lehman Brothers estimates. 8

10 Current Issues E&P share prices are being buffeted by a number of conflicting issues  Commodity price volatility –Supply/demand concerns  Upward cost pressure –Are economics deteriorating?  Finding new opportunities in a competitive market place –Build or buy?  Tale of two sisters—Katrina & Rita Main question seems to be what should the long-term price used for valuation be and where is the market now? 9

11 Recent Commodity Price Volatility Equity prices are moving with near-term commodity price Natural Gas 12-Month Strip Prices vs. % Returns on AMEX Natural Gas Index (XNG) ________________ Source: Bloomberg. 10

12 Production Revenue ↑ 52% Profitability Margins Rising commodity prices have outpaced cash cost increases… so far Cash Costs 2Q01 – 2Q05 $ / Mcfe ________________ Source: Company financial statements and Lehman Brothers estimates. Cash Cost ↑ 50% Production Revenue 2Q01 – 2Q05 $ / Mcfe 11

13 Acquisition vs. Finding & Development Costs From 2000 to 2004, finding and development costs per Mcfe of proved reserves outpaced the costs of acquiring the same reserves through transactions Reserve Acquisition Costs vs. Finding and Development Costs ________________ Source: Lehman Brothers estimates and John S. Herold, Inc. report. $ / Mcfe of Proved Reserves 12

14 Key Investor Themes  Unconventional gas –Shale, coalbed methane, tight gas sands –Risk—What if one doesn’t work?  Consolidation –Corporate vs. property –Capture drilling opportunities  Capital allocation  Is it really different this time? 13

15 Long Lived Assets In Vogue  Inventory… –Acreage is king Sample investor math: Step 1: acreage ÷ spacing = well locations Step 2: well locations × reserves/well × ownership = reserve potential Step 3: valuing the potential is trickier Valuation considerations -Risk, timing, capital Expectations of a longer commodity price cycle have put spotlight on long-lived asset bases 14

16 Commodities Price Sensitivity Estimated free cash flow for our Mid-cap universe varies depending on realized oil and gas price expectations Estimated 2006 Free Cash Flow 1 ________________ 1) Free cash flow estimates are totals for ATPG, BBG, CHK, CRK, DNR, FST, KWK, PXP, SFY, SGY, THX, WLL, WTI, XEC, and XTO. Source: Lehman Brothers estimates. Oil Price ($/bbl) Gas Price ($/MMBtu) $ millions 15

17 Actual vs. Implied Commodity Prices We estimate company share prices are discounting oil and gas prices which are significantly below current actual levels Actual Commodity Prices vs. Implied Commodity Prices ________________ Note: Price is an average of WTI oil and Henry Hub natural gas prices. Source: Lehman Brothers estimates and Reuters. 16

18 Not To Be Forgotten… This is still a hard business! 17

19 Disclosures I, Jeffrey W. Robertson hereby certify with respect to each security or issuer that we cover and covered herein (1) that the views expressed in this research report accurately reflect our personal views about any or all of the subject securities or issuers referred to in this report and (2) no part of our compensation was, is or will be directly or indirectly related to the specific recommendations or views expressed in this report. This material has been prepared and/or issued by Lehman Brothers Inc., member SIPC, and/or one of its affiliates ("Lehman Brothers") and has been approved by Lehman Brothers International (Europe), authorized and regulated by the Financial Services Authority, in connection with its distribution in the European Economic Area. This material is distributed in Japan by Lehman Brothers Japan Inc., and in Hong Kong by Lehman Brothers Asia Limited. This material is distributed in Australia by Lehman Brothers Australia Pty Limited, and in Singapore by Lehman Brothers Inc., Singapore Branch ("LBIS"). Where this material is distributed by LBIS, please note that it is intended for general circulation only and the recommendations contained herein does not take into account the specific investment objectives, financial situation or particular needs of any particular person. An investor should consult his Lehman Brothers’ representative regarding the suitability of the product and take into account his specific investment objectives, financial situation or particular needs before he makes a commitment to purchase the investment product. This material is distributed in Korea by Lehman Brothers International (Europe) Seoul Branch. This document is for information purposes only and it should not be regarded as an offer to sell or as a solicitation of an offer to buy the securities or other instruments mentioned in it. No part of this document may be reproduced in any manner without the written permission of Lehman Brothers. With the exception of disclosures relating to Lehman Brothers, this research report is based on current public information that Lehman Brothers considers reliable, but we make no representation that it is accurate or complete, and it should not be relied on as such. In the case of any disclosure to the effect that Lehman Brothers Inc. or its affiliates beneficially own 1% or more of any class of common equity securities of the subject company, the computation of beneficial ownership of securities is based upon the methodology used to compute ownership under Section 13(d) of the United States' Securities Exchange Act of In the case of any disclosure to the effect that Lehman Brothers Inc. and/or its affiliates hold a short position of at least 1% of the outstanding share capital of a particular company, such disclosure relates solely to the ordinary share capital of the company. Accordingly, while such calculation represents Lehman Brothers’ holdings net of any long position in the ordinary share capital of the company, such calculation excludes any rights or obligations that Lehman Brothers may otherwise have, or which may accrue in the future, with respect to such ordinary share capital. Similarly such calculation does not include any shares held or owned by Lehman Brothers where such shares are held under a wider agreement or arrangement (be it with a client or a counterparty) concerning the shares of such company (e.g. prime broking and/or stock lending activity). Any such disclosure represents the position of Lehman Brothers as of the last business day of the calendar month preceding the date of this report. This material is provided with the understanding that Lehman Brothers is not acting in a fiduciary capacity. Opinions expressed herein reflect the opinion of Lehman Brothers and are subject to change without notice. The products mentioned in this document may not be eligible for sale in some states or countries, and they may not be suitable for all types of investors. If an investor has any doubts about product suitability, he should consult his Lehman Brothers representative. The value of and the income produced by products may fluctuate, so that an investor may get back less than he invested. Value and income may be adversely affected by exchange rates, interest rates, or other factors. Past performance is not necessarily indicative of future results. If a product is income producing, part of the capital invested may be used to pay that income. © 2005 Lehman Brothers. All rights reserved. Additional information is available on request. Please contact a Lehman Brothers entity in your home jurisdiction. Lehman Brothers policy for managing conflicts of interest in connection with investment research is available at Ratings, earnings per share forecasts and price targets contained in the Firm's equity research reports covering U.S. companies are available at Complete disclosure information on companies covered by Lehman Brothers Equity Research is available at 18


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