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Canadian Natural Resources
& Penn West Energy Trust
Agenda
1. Introduction
2. Industry Overview
3. Risk Management
4. Financial Statements
5. Summary
Industry Overview
Upstream Sector Mid-stream Sector Downstream Sector
Exploration and Oil and gas Refineries, gas
production pipeline distribution
companies systems that utilities, oil
connect product
producing and wholesalers,
consuming service stations
areas. and
petrochemical
companies.
Industry Overview cont.
Canada - A World Leader
High-tech exploration
Enhanced recovery production method
Development of oil sands and sour gas resources
Statistics
3rd largest producer of natural gas
8th largest producer of crude oil in the world.
The upstream sector is the largest single private sector
investor in Canada.
We produce 25% of North America’s crude oil and
natural gas
Crude Oil
Actively traded commodities
Oil prices change daily
Global Trend
Demand rising steadily over the past 20 years
60 million barrels per day to 84 million barrels per
day.
Emerging Economies
Commodity Volatility
Future Trend – Crude Oil
Market Supply
Next 20 Years Remanaged Constrained Cornucopia
A significant
Petroleum OPEC re- We enter an supply surplus
supply and emerges as the era where develops
demand are not market supply and (exceeding 5%
driven by “governor” demand of world
events in any and attempts to must balance demand),
one country or manage prices in on demand, causing
industry, but by the not supply. the price to drop
a host of mid-$40s per Prices spike to to the low-to-mid
industries, barrel. unprecedented $30s per
consumer levels beyond
trends, and
barrel range—
$100 per about the level of
government barrel. marginal
policies.
production costs.
Future Trend – Crude Oil
Light Sweet Crude Oil
Natural Gas
Price determined in an open market
Supply of natural gas versus the demand for the fuel
Price Sensitivity
Residential
Commercial
Industrial
Winter Season
Higher crude oil prices
Economic growth
Future Trend
Natural Gas
Regulation
Global
Organization of the Petroleum Exporting
Countries (OPEC)
Regulation cont.
Canadian
National Energy Board and Office of Energy
Efficiency of Natural Resources Canada
Environmental Regulations (Environment Canada)
Provincial Government and Federal Government
Self-regulation:
• Canadian Association of Petroleum Producers
(CAPP)
Risk Exposures
General
Business
Environmental/
Legal
Financial/Commodity
Operational
Credit/Liquidity
Industry Risk Management
• Objective
• Reduce the risk of adverse price changes in the
physical market
• Perhaps to make a profit
• How?
• Determines a hedge ratio
• Optimal hedge ratios should be time-varying
For example, a hedging program covering 50%–60% of total
production is far more common with trusts than in the
Exploration &Production sector
Industry Risk Management
• TransCanada Corp, Nexen Inc, Talisman
Energy Inc
- No clear hedging strategies
– Minor oil stake -> all hedged
• Encana Corp
- Mainly fixed price contracts, collars,
puts and calls
• Suncor Energy Inc ($9.7B in revenue)
– Hedged 36%, 16% and 9 % (2003-2005)
-> losses $550M
Industry Hedgers
• Husky Energy Inc ($10B in revenue)
– Hedging no more than 50% of production
(2003-2004) -> losses $670M
• CNRL ($7B in revenue)
– Horizon Oil Sands Project ($10.8B in 10 yrs)
– Largest hedge loser (close to $1B)
– Continues to hedge into 2007 (US
$50/barrel)
Industry Risk Management
Canadian Natural Resources
NYSE: CNQ
TSE: CNQ and CNQ.U
Corporate Profile
Incorporated November 7, 1973, in Alberta, Canada
Senior Oil and Natural Gas Exploration & Production
Common Shares: NYSE: CNQ and TSE: CNQ
Current Stock Price as of March 20, 2007: $60.90 (CAD)
Market Capitalization: 27.23B (USD)
Total Shares Outstanding: 537.90M
Profile
Canadian Natural Resources is the second-largest
natural-gas producer in Canada.
Their international properties in the North Sea and West
Africa has boosted oil production to 57% of the total.
In 2005, the firm produces 553,000 gross barrels of oil
equivalent per day and posted approximately 3.7 billion
barrels of gross proved reserves, including oil sands
resources.
Review of Operations
Areas of Operation
Horizon Oil Sands Project
Future Growth
Key Executives
CNQ Management Team
Steve Laut
Current Position:
President and Chief Operating Officer
Education:
U. of Calgary - BSc – Mechanical Engineering
Previous Positions:
Vice President of Operations
Vice President of Engineering
Manager, Exploitation
Senior Exploitation Engineer
CNQ Stock Today
CNQ Price Chart (5 Year)
CNQ Financial Highlights
CNQ Financial Highlights
Slight decline in net earnings mainly due to funding
for the Horizon Oil Sand Project
Increase in dividend per common share indicates
confidence of properity in the long run
Consolidated Statement of Earnings
Consolidated Balance Sheets
Consolidated Statements of Cash Flows
Risks and Uncertainties
Hedging Philosophy
oThe derivative financial instruments are not intended for trading or speculative
purposes.
oThe purpose of using derivative financial instruments is to generate stable and
predictable cash flows.
oChanges in fair value of derivative financial instruments formally designated as hedges
are not recognized in net earnings until such time as the corresponding gains or losses
on the related hedged items are also recognized.
o Changes in the fair value of derivative financial instruments not formally designated
as hedges are recognized in the balance sheet each period with the offset reflected in
risk management activities in the consolidated statements of earnings.
Risk Management Activities
Commodity Price Risk
company enters into commodity price contracts to
o The
manage anticipated sales of crude oil and natural gas.
oRealized gains or losses on these contracts are included in risk
management activities.
oUnrealized gains or losses on commodity price contracts not
formally documented as hedges are also included in risk
management activities.
Currency Risk
oThe company’s operating results are affected by
fluctuations in the exchange rates between the Canadian
dollar, US dollar, and UK pound sterling.
oMajority of revenues are based on reference to US dollar
benchmark prices and therefore an increase in the value of
the CAD/USD results in decreased revenue from the sale
of production.
oProduction expenses are subject to fluctuations due to
changes in the exchange rate of the UK pound sterling to
the US dollar on North Sea operations.
Currency Risk
oCross-currency swap agreements are used to manage currency
exposure on US dollar denominated debt.
oGains or losses on the foreign exchange component of all
cross-currency swap contracts are included in risk management
activities.
oGains or losses on the interest component of cross-currency
swap contracts designated as hedges are included in interest
expense.
Interest Rate Risk
oThe company enters into interest rate swap agreements to
manage its fixed to floating interest rate mix on long-term
debt.
oThe contracts require the periodic exchange of payments
without the exchange of the notional principle amounts on
which the payments are based.
oGains or losses on interest rate swap contracts formally
designated as hedges are included in interest expense.
oGains or losses on non-designated interest rate contracts
are included in risk management activities.
Sensitivity Analysis (4Q ‘05)
Sensitivity Analysis (3Q ‘06)
Netback Analysis
Risk Management (Note 10)
Risk Management Tools
COMMODITY PRICE RISK
Crude Oil
Price Collars
Put Options
Brent Differential Swaps
Natural Gas
AECO Collars (NGX)
INTEREST RATE RISK
Swaps - Fixed to Floating
Swaps – Floating to Fixed
CURRENCY RISK
Swaps (US$/C$)
Commodity Price Risk
Interest Rate Risk
Foreign Currency Translation Adjustment
The company designated certain US dollar denominated debt as a hedge against its
net investment in US dollar-based self-sustaining foreign operations.
The gains and losses on this debt are included in the foreign currency translation
adjustment.
Other Financial Contracts
Employee Stock Options
The Company’s Stock Option Plan provides current employees with the right
to elect to receive common shares or a direct cash payment in exchange for
options surrendered.
Options are valued based on the difference between the exercise price of
the stock options and the market price of the Company’s common shares.
Stock options granted under the Option Plan have a maximum term of six
years to expiry and vest equally over a five-year period.
The exercise price of each stock option granted is determined at the closing
market price of the common shares on the Toronto Stock Exchange on the day
prior to the grant.
Each stock option granted permits the holder to purchase one common
share of the Company at the stated exercise price.
Employee Stock Options
The expense reflects the Company’s potential cash liability should
all the vested options be surrendered for a cash payout at the
market price on Dec. 31, 2005.
For the year ended Dec. 31, 2005, the Company paid $227 million
for stock options surrendered for cash settlement (Dec. 31, 2004 –
$80 million; 2003 – $31 million).
Employee Stock Options
Counterparty Credit Risk Management
Accounts receivable are mainly with customers in the crude oil and natural gas
industry and are subject to normal industry credit risks.
The company manages this risk by entering into sales contracts with only
highly rated entities.
The company ensures that parental guarantees or letters of credit are in
place to minimize the impact in the event of default.
The company is also exposed to possible losses in the event of non-
performance by counterparties to derivative financial instruments.
This risk is managed by entering into agreements with only highly rated
financial institutions and other entities.
Penn West Energy Trust
Background
• Based in Calgary, Alberta, Penn West is the largest conventional oil and
natural gas producing income trust in North America.
• Penn West’s production averaged 129,915 boe per day at December 31,
2006, of which just under half was natural gas
• In May 2005 Penn West converted from a senior independent exploration
and production company into an income trust.
• The opening June 2005 cash distribution rate to unitholders was $0.26 CDN
per unit monthly, and was payable in July.
• In November 2005, the Trust increased the monthly distribution rate to
$0.31 CDN per unit and again in February, 2006 to $0.34 CDN per unit.
Financial Profile
• Market Cap. 6.77 Bil
• Market Capitalization as at Feb. 9, 2007:C $8.3 Billion / US $7.1 Billion
• Current Units Outstanding as at Dec. 31, 2006:237.4 Million
• Trading Symbols (TSX / NYSE):PWT.UN / PWE
• Current Annualized Yield as at Feb. 9, 2007:12.0%
• Estimated 2006 Cash Flow (Proforma Annualized):$1.3 -$1.4 Billion
• Current Debt as at Jan. 3, 2007:$1.3 Billion
Operational Profile
• Proved + Probable Reserve Life Index: 10.5 years
• Proved Reserves (as at Dec. 31, 2005): 414 mmboe
• Current Average Daily Production: 129,000 –133,000 boe/
Production Base
Operational Profit
Management Team
William E. Andrew
President and CEO
• Petroleum Engineer with more than 30 years of oil and natural gas industry
experience, including 14 years with Penn West.
• Engineering diploma from the University of Prince Edward Island in 1973 and
a bachelor degree in engineering from Nova Scotia Technical College in
1975.
• He previously held senior positions at Gulf Canada, Shell Canada, Canadian
Occidental Petroleum, Ocelot Industries and served as a Vice President at
Opinac Exploration.
• Joined Penn West in 1992 as a director and a key member of the.
• He was named President of Penn West in 1995 and President and Chief
Executive Officer in June 2005.
• On the Board of Governors of the Canadian Association of Petroleum
Producers and is the Chancellor of the University of Prince Edward Island.
Management Team
David Middleton
Executive Vice President and Chief Operating Officer
• Professional Engineer with more than 25 years of oil and natural gas
industry experience since graduating from the University of Toronto with a
degree in Engineering.
• He has been with Penn West since 1999 holding the Vice President, then
Senior Vice President, Production positions between 2001and 2005.
• In 2005, Mr. Middleton assumed overall day-to-day responsibility for Penn
West’s oil and natural gas operations as its Chief Operating Officer.
Management Team
Todd Takeyasu
Senior Vice President, and Chief Financial Officer
• Chartered Accountant and a Certified Internal Auditor with more than 23
years of oil and natural gas industry and public accounting experience.
• He has been with Penn West since 1994 in various positions including
Financial Controller, Treasurer from 2001 to 2005 and Vice President,
Finance until 2006 when he was promoted to Chief Financial Officer.
• He is a 1983 business school graduate of the University of Lethbridge.
Property Overview
Consolidated Balance Sheet
Consolidated Income Statement
Statements of Cash Flow
Sensitivity Analysis
Market Risk Management
• Credit Risk
– the Trust transacts only with financial institutions with high credit ratings and
obtains security in certain circumstances.
• Commodity Price Risk
– Using “Active Hedging Program” collars or other financial instruments up to a
maximum of 50 percent of sales volumes
• Interest Rate Risk
– using financial instruments to swap floating interest rates for fixed rates or to
collar interest rates
• Foreign Currency Rate Risk
– financial instruments to fix or collar future exchange rates
Hedging Philosophy
i. Increasing the insurance of Future Cash Flow
ii. Managing downside risk
Hedging
Risk Management Affecting Cash Flow
and Net Income
Production and Netbacks
Foreign Exchange
• During Q1 2005, the Trust converted US$205 million of its US denominated
borrowings to Canadian dollars at an average exchange rate of $0.829 CAD/USD
resulting in a realized foreign exchange gain of $63 million.
• In May 2005, the Trust converted its remaining US$85 million of US denominated
borrowings to Canadian dollars at an average exchange rate of $0.803 CAD/USD
and realized an additional $23 million foreign exchange gain
Commodity Risk Tools
As at December 31,2005, the Trust had the following financial instruments outstanding:
Market
Notional Volume Remaining Term Pricing Value($millions)
Crude Oil
WTI Costless Collars 20,000bbls/d Jan/06 - Dec/06 $US 47.5 to $67.86/bbl ($22.10)
Natural Gas
AECO Costless Collars 46,300 mcf/d Jan/06 - Mar/06 $8.64 to $16.69/mcf 0.2
AECO Costless Collars 46,300 mcf/d Jan/06 - Oct/06 $8.64 to $16.25/mcf 2.1
AECO Costless Collars 18,500 mcf/d Jan/06 - Oct/06 $9.72 to $17.28/mcf 3.3
AECO Costless Collars 23,100 mcf/d Apr/06 - Sept/06 $9.07 to $15.12/mcf 0.7
AECO Costless Collars 9,300 mcf/d Apr/06 - Sept/06 $9.18 to $15.39/mcf 0.8
AECO Costless Collars 13,400 mcf/d Oct/06 -Dec/06 $9.18 to $17.39/mcf 0.2
Electricity
Alberta Power Pool Swaps 60MW 2006 $42.25 to $43.15/MWh 16.6
Alberta Power Pool Swaps 35MW 2007 $46.00/MWh 6.7
Collar
Stock Option Plan –before May 31, 2005
Before May 31, 2005 Stock Option Plan
• Stock option plan for the benefits of employees and
directors
• Stock options vested over a five-year period, and if
unexercised, expired six years from the date of grant.
• Cash settlement alternatives or unit shares
• Stock compensation costs were recorded based on changes
to the share price at the end of each quarter and any changes
to the number of outstanding options
• Pursuant to the plan of arrangement, all stock options
outstanding on the date of conversion were settled for cash of
$84.77 per share or by issuing shares.
Stock Option Plan –before May 31, 2005
Jan 1,2005 - May 31,2005 stock option plan
2005 2004
Liability, January 1, 91.90 27.90
Compensation expense provision 71.70 84.10
Cash payments on exercise of stock options (141.60) (15.60)
Liability settlements on stock options exercised for shares (22.00) (4.50)
Liability, December 31, - 91.90
Current portion - 71.00
Long-term portion - 20.90
- 91.90
Penn Number of stock Weighted
West options Average Exercise
Outstanding , Jan 1, 2005 3,728,980 39.00
Granted 82,600 79.51
Exercised for common shares (488,399) 34.72
Settled for cash (3,212,931) 40.51
Forfeited (110,250) 44.26
Outstanding , May31, 2005 - -
Stock Option Plan- after May 31, 2005
• After May 2005, Replace old plan with Trust unit rights incentive plan
• The number of trust units reserved for issuance shall not at any time
exceed 10 percent of the aggregate number of issued and outstanding
trust units of the Trust
• Unit right exercise prices are equal to the market price for the trust
units based on the five-day weighted average market price prior to the
date the unit rights are granted
• If certain conditions are met, the exercise price per unit is reduced by
deducting from the grant price the aggregate of all distributions, on a
per unit basis, paid by the Trust after the grant date
• Rights granted under the plan vested over a five year period and
expire six year after the date of the grant
• The compensation expense is based on the fair value of rights issued
and is amortized over the remaining vesting periods on a straight line
basis
Stock Option Plan –After May 31,2005
June 01, 2005 – Dec 31, 2005 option statement
Weighted
Trust unit Number of Unit Average Exercise
rights Rights Price
Granted 10,045,325 29.73
Forfeited (597,700) 28.46
Balance before reduction of exercise price 9,447,625 29.81
Reduction of exercise price for distributions paid - (1.36)
Outstanding, December 31, 2005 9,447,625 28.45
Exercisable, December 31, 2005 - -
The Trust recorded compensation expense of $5.5 million for the
period from implementation to December 31,2005
Black-Scholes Option Pricing
Black-Scholes option pricing model assumptions:
Seven months ended December 31 2005
Average fair value of trust unit rights granted(per unit)
Directors and officers $6.50
Other employees $6.13
Expected life of trust unit rights (years)
Directors and officers 5
Other employees 4.5
Expected volatility(average) 16%
Risk-free rate of return (average) 3.40%
Expected distribtuion rate nil
Employee Trust Unit Savings Plan
• Employees may elect to contribute up to
10 percent of their salary and contributions
are used to fund the acquisition of trust
unit
• The Trust matches employee contributions
at a rate of $1.5 for each $1.0 contributed
• Trust units may be issued from treasury at
the five-day weighted average month-end
market price or purchased in the open
market
Employee Trust Unit Savings Plan
• During 2005, 20,355 employer contribution
shares (equivalent to 61,065 trust units)
were purchased in the open market at an
average price of $81.48 per share ($27.16
per equivalent trust unit) and a total cost of
1.7 million and 21,905 shares (equivalent
to 65,715 trust units ) were issued from
treasury.
• Potential dilution of unit holder’s value
open market at an
average price of $81.48 per share ($27.16
per equivalent trust unit) and a total cost of
1.7 million and 21,905 shares (equivalent
to 65,715 trust units ) were issued from
treasury.
• Potential dilution of unit holder’s value
