LEHMAN BROTHERS Jane 22, 2004 North America il : Energy & Power Oil & Gas: E&P (Large Cap) Oi! & Gas: E&P (Large Cap) Industry Update Thomas R. Disel, CFA Pip R. Skonick 1.212.508.3857 1212528.5344 Notes From Syncrude Tour terisco@ietman com pskolnic@iehman.com Sector View: Now: 1-Positive Old: 1-Postive Investment conclusion 10 We toured Syncrude’s oll sands mining operation and the AE-1 (Stage 3) expansion site last week. Syncrude's production is expected to increase by roughly 40% to about 350 MBBIid (extracted via-mining) in mid-2006, ance Stage 3 expansionis complete. The recently incurred cost over-tundelay was a mein focus during the Q&A session; and below isan outline ofthe challenges and potential solutions discussed, Interest holders in Syncrude are Canadian Oil Sands Trust (35.49%), Imperial Oil (25%), Petro-Canada (12%), ‘ConocoPmilps (9.03%), Nexen Ine. (7.233), Murphy Oil (5%), and Mocal (5%). Talisman Energy also holds @ 1.25% economic interest in the project. ‘summary 1B Cost Over-Run/Delay: Syncrude incurred a C$2.1 billion cost over-run and 1 year delay on its Stage-3 expansion in March ofthis year. ‘The project, which wil increase Synerude's praduction by about 100 MB/d or 40% to 350 MB, is now expected to cost C$7.8 billion ‘and commence operations in mid-2008. According to Synccude’s management team, the cost over-tunidelay was the result of problems ‘encountered bath in the engineering and construction phases particulary inthe revamping of brownfield areas. 2 Challenge: Shortage of Skilad Engineors.-On the engineering side, a shortage of skilled engineers in North Americ, particularly yn Canada, forced Syncrude to outsource over-seas (India was cited), resulting in co-ordination problems and an almost doubling of man), ro hours during the engineering phase, This protracted engineering phase delayed module fabrication and the construction timetable, ee cour 1 Potential Solution: Train internally--Syncrude is starting to develop In-house cost engineers, etc. in an attempt to mitigate iskof bik another shortage, vse NEST 2 Challenge: Cost Estimates~-Management team feels costs were grossly underestimated particulary on the cost of revamping brownfield ‘areas due in part to underestimation of labor hours needed. ound ees 2 Potential Solution: Do More Upfront Engineering-While Synerude completed 80% of engineering prir to construction, itonly “completed 10% before implementing the AFE. Management boieves that it could have achieved greater cost certainty ift had complete ox} 20% of engineering prior to AFE. Syncrude feels that 20% completion prior to AFE is likely to become an industry standard Challenge: Revamping Existing Facilites--On the construction side, Syncrude encountered challenges of bulding within exist facies. The greanfeld portions ofthe projects, which included construction ofthe mining site, came within expectations. rie 57.00% eol? © Potential Solution: Build in Smaller Parcels--Management believes that it tried to do too much at ane time, particularly given the complexity of modifications and tie-ins within existing facitias. By breaking up these revamps into smell components, Syncrude fels it willbe able to reduce variabilty in costs andtiming. Saget Eups/ oN = Caperae his (Ty 70 CANE Stmaes NET MENT Te COSTER [Lehman Brothers does and seeks to do business with companies covered in its research reports. As a result, investors. [should be aware that the fiem may have a conflict of interest that could affect the objectivity ofthis report. Investors should consider this report as only a single factor in making thelr investment decision. PLEASE SEE ANALYST(S) CERTIFICATION(S) ON PAGE 1 AND IMPORTANT DISCLOSURES BEGINNING ON PAGE 4of LAR LEHMAN BROTHERS ER ly operations was cited as @ major @ Challenge: Lack of Centralized Mt flaw as it lacked focus and conto. 1 Potential Solution: Internalize Project Management—Syncrude is increasing internal management carol and decision making in an attempt to enhance co-ordination throughout construction. We feel the partnership structure of Syncrude, wit its seven partners, could also be a problem as there appears to be no true dominant decision maker at Syncrude. wee TMS 1 Future Cost Over-runiDelay Risk for the Industry: Mining vs. SAGD—Labor costs have been a large cause of cost over-runs Pistorically for ail sands producers. Oil sands projects that use mining for extraction are more labor intensive than ones that utlize insitu technology, such as steam assistad gravity drainage (SAGD), for extraction. AS a result, mining projects are more susceptible to labor cost overruns. However, competition for labor is expected ta decline, possibly reducing some of ths risk. In our coverage universe, ‘Canadian Naturals C$8 bilion Horizon oll sands project isa mining project, whereas Nexen's C$3.4 bilion (gross) Long Lake ol sands projects a SAGD project. Both companies, however, feel they have risk adjusted their Budgets enough for potential cost aver-uns basing ‘them on the results of other projects that have incurred cost over-runs. Analyst Certification: We, Thomas R. Driscoll, CFA and Philip R. Skolnic, hereby certify (1) that the views expresso in this research Industry Note accurately reflect our personal views about any ofall ofthe subject secures or issuers referred to in this Industry Note and (2) no part of our ‘compensation was, is or wil be directly or indirectly related tothe specc recommendations or views expressed in this Industry Note, Related Stocks: Disclosures Ticker Price (08/18) Rating ‘ConacoPhilips DJKLM cor. 76.89 2.Equal weight Murphy Oil J MUR 7134 2-Equal wight, Noxen Ine J Nxy 52.09 2-Equal woight Petro-Canada J PCA 58.53 2-Equal weight Talisman Eneray J T™ 28.81 1-OverweightLEHMAN BROTHERS Important Disclosures "EQUITY RESEARCH] Rating and Brice Target Chart COP ts it Date Closing Price | Rating Price Target Data Gioaing Price | Rating Price Targat PAGE| TSA 72.00 ares | 4788 Overnight ‘SD.Macoa | 69.37 76.00 Novo? | 4848 aon 1e-Jer-O4—| 65.80 52.00 (Os: Aug-02 | 46.50 Equal weigh Oan-03 | 54.03 Zequa wag Rating and Price Target Chart MOR MURPHY Ot. Data Closing Pree | Rating Price Target Date ‘Gising Bice | Rating Price Targat TTeSeG0S_| S745 6.00 Os.AUg.o2_| 37.50 ZEqualweght Be.nug-03 [5773 4.00 Treo? —[ 35.88 eau 3i-Octw [at 31 40.00LEHMAN BROTHERS EQUITY RESEARCH] Rating and Price Target Ghare_ WKY NexEN INC a FReconmencnion Cnange_ BropCaverese Dat ‘Giosing Pree | Rating Brice Target Date Closing Price | Rating Price Target OB ABOT [5.05 69.00 3.03 [39.07 0.00 Zociard8 | 49.00, 68.00 og-May-03_| 23.85 Ziqualvegt e-Mer4 | 49.30, 4800 Or-Ney-03 | 3048 0 Ws:Feb04_| 50.07 47.0 2e-Mar03 | 30.00 43.00 Te-bec.09 | 4567 24.00 2r-Feb-03 | 30.85 42.00 18-0803 | 4587 Sages 1g:Feb-03 | 31.00 38.00, DsDee-05aa7t a0 te-Now-02_[ 31.74 38.00 TeOotos | 38.75, 45.00 Fi.Oetid | 34.47 0.00 17-Sep-05 | 38.02 23.00 05-Aug-02 | 36.08 Tada TeuhOs | 35.10, 42.00 B0ukd2 [35.90 ‘S-Market Peron | Rating and Price Target Chart: PCA PETRO-CANADA toyLEHMAN BROTHERS EAM Date | Giosing Pree | Rating Price Taraot Date | Closing Pie | Rating rico Targot Tareena 5988 0 oeFeO | 172 00 inc [-88.20 35.0) OiOetIe | aa.5e B00 [ois o8 [aa Ema a BeAugt2 | a6 aaa Tein and Price Target Charo Tt “TaUSMAN ENERGY Date Ciosing res | Rating — Pica Target Taio —~|-Giosing Price [ Rating — Free Target eNacoa_| 2532 Bo cesants | 19.82 war Geniarot [25.00 3033 FiFeo-09 | 10.38 7633 Gbee03_] 23.25 id ZiFebis_[ 79.38 Zee tenorts 12129 2539 aiiar03 [79.51 BE abet | 22.9 257 W7Decsi2_| 1927 Teo wadetOo | 22a oe Brose [79.16 waar 7 Sep-05_| 218 Ta Gebers Ba Srend3 20.18 267 iSsepae | 209% TEquawegit Tashn-00 | 20.9 7a Teng | 2057 ‘-Oveigt 6-09 18.8 Bw Genia-02 | 2278 0 FOR EXPLANATION OF RATINGS REFER TO THE STOCK RATING KEYS LOCATED ON THE PAGE FOLLOWING THE LAST PRICE CHARTLEHMAN BROTHERS Important Disclosures: The analysts responsible for preparing this port have received compensation based upon various factors including the Firm's total revenues, a portion of which is generated by investment banking activites. D-Lehman Brothers ine. andlor an affiliate has received compensation for investment banking services from the subject company in the past ‘12 months, J Lehman Brothers Inc andlor an afflate trade regulary in he shares ofthe subject company. = Lehman Brothers inc. has received non-investment Banking elated compansation from the subject company within the last 12 months, LL= The subject company is or during the past 12 months has been an investment banking cient of Letiman Brothers Inc. IM--Tne subject company is or during the last 12 months has been a nor-investment banking client (secutties related services) of Lehman, Brothers inc. Risk Disclosure: COP: Our earnings estimates are based on Lehman Brothers’ current commodiy price assumption on ol & gas, refining and marketing margins 28 well 25 chemical praduct margins, Thus, rs lls could be subject to changes due to fluctuations in the macro commedity market environment MUR: Our earnings estimates are based on Lehman Brothers’ current commadity price assumption on oil & gas, refining and marketing margins as well as chemical product margins. Thus, results could be subject to changes due to fluctuations in the macro commodity market environment. NXY: Our price targets derived using a multiple of 04 pre-interest cash flow (PICF) estimates. Our ests. for NXY's "05 PICF is predicated fon a benchmark Henry Hub natural gas price forecast of USS4.7SiMMBtu and a WTT oil price forecast of US$28/BbI. Should commodity prices, prod’ levels, or leverage difer matarally from aur ests, our price target would be affected. NXY's prod'n lovels are impacted by a ‘variety of factors including éiling success, reservoir performarice & future acquisitions. PCA: Our earnings estimates are based on Lehman Brothers’ current commodity pre assumption on ol & gas, refining and marketing margins as well as chemical product margins, Thus, results could be subject to changes due to fluctuations n the macro commodity market environment. ‘TLM: Our price target is derived using @ multiple to our 2004 pre-inteest cashflow (PICF) estimate, Our est. for Talsman's 2005 PICF is predicated on a benchmark Henry Hub natural gas price forecast of USS4.75/MMBtu and 2 WTI oll pice forecast of US$2@/Bbl. Should ‘commodity prices, prod'n levels, o leverage difer materially from our ests, our price target would be affected. Talsman’s prog’ levels are impacted by a varity of factors including driling success, reservoir performance & future acquisitions. Key to Investment Opinions: ‘Stock Rating ‘Overweight - The stock is expected to outperform the unweighted expected total retum ofthe industry sector over a *2.month investment horizon. 2-Equal weight - The slock is expected to perform in ine with the unweighted expected total return ofthe industry sector over a 12-month investment narizon, ‘3-Underweight - The stock is expected to underperform the unweighted expected total retum ofthe industry sector over a t2-month investment norizon, RS-Rating Suspended- The rating and target price have been suspended temporarlly to comply with applicable regulations andlor firm policies in certain circumstances including when Lehman Brothers is acting in an advisory capacity on a merger or strategic transaction involving the company. +LPositive - sector fundamentalsvaluations are improving, 2-Neutral- sector fundamentalsivaluations are steady, nether improving nor deteriorating, S-Negative - sector fundamentals/valuations are deteriorating, ‘Stock Ratings From February 2001 to August §, 2002 (sector view did not exist); “This isa guide fo expactad total return (price performance plus dividend) celatve tothe total relumn of the stock's local market over the next 12 months. 4-Strong Buy - expacted to outperform the market by 16 or more percentage points 2-Buy - expected to outperform the market by 5-15 percentage points. 3-Market Perform -expacted fo perform in Ine withthe market, plus or minus § percentage points ‘4-Market Underperform - expected to underperform the market by 5-15 percentage points ‘Sell - expected to underperform the market by 15 or more percentage points, Distribution of Ratings Lehman Brothers Equity Research has 1572 companies under coverage,LEHMAN BROTHERS 142% have been assigned a 1-Overweight rating which, fo purposes of mandatory regulatory disclosures, is classified as Buy rating, 40% of ‘companies with this rating ae investment banking clients ofthe Fir, 419% nave been assigned a 2-Equsl weight rating which, foc purposes of mandatory regulatory disclosures, i classified as Hold rating, 9% of ‘companies with this rating are investment banking clients ofthe Frm. {Punave been assigned a 2-Underwaignt rating which, for purposes of mandatory regulatory disclosures, is classified as Sell rating, 77% of ‘companies with this rating ae investment banking clients ofthe Firm, ‘This materal nas been prepared andlor sued by Lehman Brothers Inc, member SIPC, andor one of safes (Lehman Brothers") and hasbeen approved by Lehman Brater nteatonl (Europe), authorised and regulated by the Francial Sevices Autry, in connection with its dstbuton nthe Etropean Economic Area. 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