EQUITY RESEARCH Jamie Kubik Dennis Fong

March 31, 2022 Industry Update

Camille Gordon Christopher Thompson

Energy Companies & Mid-cycle Profitability:

Benchmarking Industry Supply Costs Cheryl Wu Chris Lee

Maintenance-focused Spending Expected To Remain In 2022

Our Conclusion
Sector:
The energy industry’s shift towards maintenance versus growth naturally
requires less capital spending. Free cash flow generation and recycle ratios Energy
were meaningfully better in 2021 across the sector, and 2022 is poised to
demonstrate more of the same. While we should expect to see growth at
current pricing, capital discipline and a lack of excess takeaway capacity are
likely to stem outsized growth from Canadian producers, which should see
capital spending remain mostly focused on mid-cycle programs. We expect
supply costs will increase in 2022 through a combination of royalties and
higher cash taxes along with general cost inflation; however, strong
commodity pricing should still see average cash netbacks increase by more
than 50% relative to 2021. In reviewing 2021 supply costs, we saw select
names achieve proved developed producing (PDP) recycle ratios in excess
of 3x (which is very strong), and would not be surprised to see recycle ratios
reach new highs in 2022. Companies that screen well on a lookback basis
with positive future implications include ARX, BIR, BTE, NVA, TOU and
WCP.

Key Points
Stocks are pricing close to 1P values at $70/Bbl WTI and US$3.50/Mcf
NYMEX based on 2021 reserve values. Our risked NAVs also calculate
~15% average discount rates on strip pricing, which we would argue is high
considering the runway of low-cost resource in front of most enterprises, but
ultimately is a reflection of the higher cost of capital for the sector.
The concentration of PDP reserves in valuations is continuing to
increase as growth trajectories moderate. This should ultimately be
positive for valuations given the reduced capital intensity of these
businesses. The average producer PDP RLI is 6.0 years on 2021 reserves,
which compares to 5.2 years on 2018 reserves. This has not assisted trading
valuations, as the average valuation on forward cash flow has further
compressed to 2.8x 2022E EV/DACF versus 4.7x EV/DACF for 2019.
Average total cash costs tallied $36/Boe in 2021, which was modest
compared to revenues of $54/Boe. This was good enough for most
operators to generate a 1.5x recycle ratio on PDP FD&A costs. We expect
average revenues to increase to ~$77/Boe in 2022 (+43%), while average
corporate and field costs are expected to increase by 32%.
Cash netbacks averaged $25/Boe in 2021 and are expected to increase
by ~70% in 2022. Hedge losses will be an anchor on netbacks in 2022, with
an average loss of ~$5/Boe expected (similar to 2021 levels at $4/Boe).
Cash netbacks are expected to be $42/Boe in 2022E on strip pricing, which
should see average PDP recycle ratios exceed 2.0x.

All figures in Canadian dollars unless otherwise stated.

For required regulatory disclosures please refer to "Important Disclosures" beginning on page 9.
Energy Companies & Mid-cycle Profitability: Benchmarking Industry Supply Costs - March 31, 2022

Looking Ahead – Mid-cycle Profitability For 2022

Double-digit free cash flow yields through 2022 and 2023 are likely. The bar chart in
Exhibit 1 includes estimated free cash flow yields by company using recent strip pricing for
2022 and 2023. Free cash flow has been the focus for some time in this sector, but double-
digit free cash flow yields are becoming the norm. We expect the bulk of free cash will be
dedicated towards debt reduction, share repurchases or special dividends. We expect there
will continue to be upward pressure on capital spending and unit costs due to inflation as we
move through 2022, but commodity price tailwinds should continue to drive strong free cash
flow. Exhibit 1 highlights liquids-weighted producers as having the strongest free cash flow
yields, although gas producers such as BIR, PEY and SDE also screen well.

Exhibit 1: Energy – Free Cash Flow Yields, 2022E – 2023E

40%
2022E 2023E
30%

20%

10%

0%
CVE
SDE

BIR

ERF

CPG
OVV

TOU
AAV
CNQ

PSK

KEL
WCP

MEG

SU
PEY

NVA
ARX
IMO

POU
BTE

TVE

FRU

TPZ
Source: FactSet; Company reports and CIBC World Markets Inc.

Leveraged and liquids-weighted enterprises demonstrate the highest rate of change in

2022 cash netbacks. The bar chart in Exhibit 2 illustrates the forecasted percentage rate of
change in cash netbacks for our producers in 2022E compared to 2021A. Cash netbacks for
all companies are expected to grow over the course of the next year, with the average growth
rate coming in at ~70% Y/Y. Companies that have reduced hedge positions for 2022 screen
favorably.

Exhibit 2: Energy – Cash Netback Rate Of Change (%), 2021A-2022E

160%
140%
120%
100%
80%
60%
40%
20%
0%
CNQ
ERF
ARX
OVV
TOU

PSK
CPG

BIR
PEY
KEL
SDE
MEG

SU

AAV
NVA

CVE
FRU
TPZ

BTE

WCP

IMO
POU
TVE

Source: Company reports and CIBC World Markets Inc.

Momentum in 2022 netbacks is likely to drive meaningful debt reduction and

increasing shareholder returns. The bar chart in Exhibit 3 shows the 2022E costs and cash
netbacks by component for companies under coverage. Although netbacks are expected to
be dampened by hedge losses of ~$5/Boe for the group, our producer group is expected to
generate an average cashflow netback of ~$42/Boe in 2022E based on recent strip pricing,

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Energy Companies & Mid-cycle Profitability: Benchmarking Industry Supply Costs - March 31, 2022

which is a 68% improvement to 2021 levels. Even with hedge losses, average cash netbacks
in this range compare very well to PDP FD&A costs witnessed through 2021 of $15/Boe.

Exhibit 3: Energy - Netbacks Versus Cost Components ($/Boe), 2022E (futures strip pricing)
E&P's Oil Sands
$140 Cash Taxes G&A $140

$120 Interest Royalties $120

Transport Opex
$100 Cash Netback $100
Netbacks (C$/Boe)

$80 $80

$60 $60

$40 $40

$20 $20

$0 $0

MEG

IMO
SU
CVE

CNQ
BIR
WCP
TVE

BTE

TPZ
FRU
PSK

KEL

AAV
PEY
CPG

ERF

NVA

SDE
ARX
TOU
POU

OVV
Note: CVE, CNQ and MEG includes diluent purchases as part of transportation cost and realized pricing (revenue). IMO’s opex includes transportation cost. TPZ only reflects
GORR revenues and costs. IMO’s revenue includes intersegment sales. ERF & OVV shown in CAD. Source: Company reports and CIBC World Markets Inc.

Current share prices are generally reflecting 1P values at US$70/Bbl WTI and
Our risked NAV analysis US$3.40/Mcf. The bar chart in Exhibit 4 includes the current share price versus the stated
suggests most companies value of reserves at year-end 2021 (less net debt) assuming a 10% discount rate. The
are pricing in a discount rate average E&P is currently trading at a 6% premium to its 2021 proved reserve values.
of 15% or greater on recent Evaluator price decks are generally conservative versus current strip pricing, with GLJ,
strip pricing or <$60/Bbl
McDaniel, and Sproule assuming prices that are ~US$71/Bbl WTI and ~US$3.40/mcf
WTI.
NYMEX between 2022 to 2030. These are lean measures in our view, particularly when
considering FDC requirements for 1P development reflects 1.8 years of forward cash flow
under recent strip (Exhibit 5 bar chart).

Exhibit 4: Energy – Share Price Relative To Reserve Evaluator Values (pre-tax) - 2021
180%
Price to 1P and 2P Values (%)

160%
140%
120%
100%
80%
60%
40%
20%
0%
AAV ARX ERF KEL NVA POU SDE BTE BIR CPG PEY TOU TVE WCP

Px/2P Value Px/1P Value

Source: Company reports and CIBC World Markets Inc.

Future development capital within reserves screens conservative versus near-term

cash flow potential. We have generally found investors are relying less on reserve-based
metrics than in the past, but we do see the industry shift towards more conservative booking
practices as a positive transition. The bar chart in Exhibit 5 compares the future development

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Energy Companies & Mid-cycle Profitability: Benchmarking Industry Supply Costs - March 31, 2022

capital embedded in company reserves versus 2022 expected cash flow generation on recent
strip pricing. The median amount of proved plus probable future development capital
embedded within reserves represents less than three years of 2022 cash flow generation.

Exhibit 5: Energy – Future Development Capital Versus Strip Cash Flows, 2022E
5.0x
4.5x
4.0x

FDC / Cash Flow (2022E)

3.5x
3.0x
2.5x
2.0x
1.5x
1.0x
0.5x
0.0x
BIR AAV PEY SDE KEL POU BTE NVA TOU WCP CPG ARX ERF TVE

1P FDC/CF Ratio 2P FDC/CF Ratio 2P FDC/CF Ratio Median

Source: Company reports and CIBC World Markets Inc.

Looking Back - Benchmarking 2021 Supply Costs

The margin gap in Exhibit 6 Profitability in 2021 was robust with the improvement in commodity pricing and
demonstrates profitable maintenance-focused capital programs. The bar chart in Exhibit 6 illustrates 2021 total
programs through 2021, cash costs and revenues on a per unit of production basis for energy companies. We are
with most companies using PDP finding development and acquisition (FD&A) costs in Exhibit 6 to capture the cost
achieving recycle ratios in
of acquisitions during the year. Field costs include operating costs, transportation, and
excess of 1.5x.
royalties, while corporate costs include G&A, interest and cash taxes. The average total cost
of supply for gas producers in 2021 was ~$25/Boe, and $40/Boe for oil weighted producers.
This compares well to 2021 average revenues of ~$40/Boe for gas producers, and $57/Boe
for oil producers.

Exhibit 6: Energy – Total Cash Costs Vs. Revenues ($/Boe), 2021A

E&P's Oil Sands
$70 $140
PDP FD&A
$60 Field Costs $120
Corporate Costs
21A Revenue (Ex. Hedge)
$50 $100
Revenue & Costs ($/Boe)

$40 $80

$30 $60

$20 $40

$10 $20

$0 $0
SU

CNQ
CVE
IMO
MEG
PEY

AAV

TOU

BIR

KEL

NVA

SDE

ARX

PSK
OVV

POU

ERF

CPG
BTE

FRU

WCP

TVE

Note: Excludes SU, TPZ and VET. Oilsands companies include downstream revenues. ERF & OVV shown in CAD. IMO’s revenue includes intersegment sales and CVE includes
diluent blending in sales. Source: Company reports and CIBC World Markets Inc.

Cash netbacks averaged $24/Boe in 2021, which compares favorably versus an

average PDP FD&A of $15/Boe. The bar chart in Exhibit 7 details the 2021 average
company cash flow netbacks and unit costs. Hedge losses were an anchor on netbacks, with
an average loss of ~$4/Boe in 2021 (shown within cash netbacks), and if excluded would

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Energy Companies & Mid-cycle Profitability: Benchmarking Industry Supply Costs - March 31, 2022

have seen PDP recycle ratios closer to 2.0x for the group. Gas producers fared the best, with
PDP recycle ratios greater than >2.0x on average, with cash flow netbacks of ~$17/Boe
screening above PDP FD&A costs of ~$8/Boe. The average oil-weighted recycle ratio
computed to 1.7x, with cash flow netbacks of $26/Boe, versus $15/Boe PDP FD&A costs.

Exhibit 7: Energy – Netback Components ($/Boe), 2021A

E&P's Oil Sands
$100 $100
Cash Taxes G&A
$90 Interest Royalties $90
$80 Transport Opex $80
Cash Netback
$70 $70
Netbacks (C$/Boe)

$60 $60
$50 $50
$40 $40
$30 $30
$20 $20
$10 $10
$0 $0
BIR
WCP
BTE

TVE
TPZ
FRU
PSK

KEL

PEY
AAV
CPG

ERF

ARX

TOU
SDE
NVA
OVV

POU

MEG

IMO
SU
CVE
CNQ
Note: TPZ netbacks only incorporate production related revenues. ERF & OVV shown in CAD. IMO's opex includes transportation expense. Source: Company reports and CIBC
World Markets Inc.

PDP recycle ratios were strong overall for the industry in 2021. The bar chart in Exhibit 8
highlights the PDP recycle ratio by company using FD&A costs relative to cash flow
netbacks. Most companies that were focused on organic programs in 2021 drove recycle
ratios in excess of 2.0x, with the strongest recycle ratios demonstrated by BIR, BTE, CNQ,
MEG and NVA during the year. Companies that demonstrated weaker recycle ratios can
attribute this primarily to acquisitions that impacted the cost of reserve additions during the
year, include ARX, FRU, PSK, SDE, and TVE. Acquisitions aside, we would expect operators
to show stronger recycle ratios in 2022.

Exhibit 8: Energy – Industry PDP Recycle Ratios, 2021

5.0x
4.5x
4.0x
3.5x
3.0x
2.5x
2.0x
1.5x
1.0x
0.5x
0.0x
NVA
CVE

BIR
CNQ
CPG
AAV
TOU
PEY
KEL
ERF

ARX

SDE

PSK
IMO

MEG

POU
BTE

WCP
OVV

FRU

TVE

Note: PDP recycle ratio calculated as using 2021 cash netback divided by PDP FD&A. Source: Company reports and CIBC World
Markets Inc.

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Energy Companies & Mid-cycle Profitability: Benchmarking Industry Supply Costs - March 31, 2022

Valuations on PDP reserves demonstrate an improvement versus FD&A costs

compared to prior years. The scatter plot in Exhibit 9 highlights the three-year PDP FD&A
cost of reserve additions in comparison to company values on per barrel of PDP reserves.
Given the improvement in underlying cash flows for the sector, the valuation relative to PDP
reserves has drifted higher than previous years. This could be taken as a more positive view
on valuations, but we believe it also clearly demonstrates an industry shift towards more
profitable prospects and programs that are focused on maintenance versus growth (lower
PDP FD&A). This is also one of many screens for share repurchases, and valuations on BIR,
ERF, PEY and WCP clearly demonstrate very lean valuations relative to PDP supply costs.

Exhibit 9: Energy – PDP Reserves Valuation Vs. PDP Reserve Replacement Costs,
2019A-2021A
$40 TVE
$35
POU BTE
$30 KEL
ARX
EV/PDP ($/Boe)

$25 NVA

$20 WCP
TOU ERF
$15
$10 AAV
$5 PEY
BIR
$0
$0 $5 $10 $15 $20 $25 $30 $35 $40
PDP FD&A (3 yr; $/Boe)
Note: Excludes CPG, FRU, PSK, TPZ, CNQ, CVE, OVV, IMO, MEG, SU. Source: Company reports and CIBC World Markets Inc.

PDP reserve life index relative to trading valuations demonstrates increased

concentration of lower risk reserves as growth objectives have moderated. The scatter
plot in Exhibit 10 includes the PDP reserve life index (RLI) versus EV/DACF for SMID Cap
E&Ps under coverage. The average PDP RLI for companies in Exhibit 10 computes to six
years, versus the average trading value at 2.8x EV/DACF on 2022 strip. This remains a lean
valuation in our view as PDP reserves offer lower risk. We have seen a general shift towards
higher PDP RLIs from producers following the reduced growth trajectory of businesses, and
the PDP RLI has increased versus 2018 levels of 5.2 years. Forward trading valuations have
continued to compress though, as our work three years ago demonstrated average
valuations at 4.7x EV/DACF on forward cash flows for 2019E.

Exhibit 10: Energy – PDP RLI Vs. EV/DACF, 2022E

6.0x
5.5x
5.0x
2022E EV/DACF (x)

4.5x
4.0x TOU
ARX AAV
3.5x
TVE
3.0x KEL CPG PEY
ERF
2.5x
POU NVA BTE WCP
2.0x SDE BIR
3.0x 4.0x 5.0x 6.0x 7.0x 8.0x 9.0x 10.0x
Proved Developed Producing RLI
Note: Excludes CPG, FRU, PSK, TPZ, CNQ, CVE, OVV, IMO, MEG, SU. Source: Company reports and CIBC World Markets Inc.

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Energy Companies & Mid-cycle Profitability: Benchmarking Industry Supply Costs - March 31, 2022

Despite lean capital programs, growth in PDP reserves was significant in 2021, but the
most significant growth was M&A driven. The scatterplot in Exhibit 11 illustrates total
payout ratios versus PDP growth rates for SMID-cap E&P companies. Included within the
total payout calculation are dividends and A&D (cash and non-cash) to reflect PDP reserves
both acquired and/or disposed of during the year. The total payouts for 2021 averaged close
to ~150%, but this was primarily influenced by M&A spending. The average PDP growth rate
was ~32% for companies included in Exhibit 11. Organic development was the sole
contributor to the meaningful PDP growth demonstrated by KEL. What is notable in Exhibit 11
is that most companies that grew PDP reserves organically in 2021 typically spent ~75% of
cash flow. We see this as a relatively lean reinvestment rate as historical periods would have
typically seen industry spend greater than 100% of cash flows.

Exhibit 11: Energy – Total Payout Vs. PDP Growth, 2021A

400% SDE

350% PSK
300% TVE
2021A Total Payout (%)

250%

200% FRU WCP ARX

150%
TOU KEL
ERF
100% POU
PEY CPG
50% BIR AAV
NVA
0% BTE
(10%) 0% 10% 20% 30% 40% 50% 60% 70% 80% 90% 100%
2021A PDP Growth (%)

Note: Excludes TPZ, CNQ, CVE, OVV, IMO, MEG, SU. Source: Company reports and CIBC World Markets Inc.

Maintenance-focused spending is also moderating decline rates, which is helping

reduce the capital intensity of business models. Netbacks, decline rates and capital
efficiencies are three key variables for estimating cash flows and maintenance capital
requirements for energy businesses. While these variables are often looked at in isolation,
the scatter plot in Exhibit 12 attempts to plot all three of these variables on the same chart.
Exhibit 12 includes organic capital efficiency calculated through 2020 and 2021 expressed
over an entire year versus the netback that each barrel generated during 2021 relative to the
estimated underlying decline rate across 2020 and 2021. Under this framework, ARX, TOU
and WCP screen very well, and these businesses are underpinned by modest decline rates,
strong organic capital efficiencies, and robust netback generation.

7
Energy Companies & Mid-cycle Profitability: Benchmarking Industry Supply Costs - March 31, 2022

Exhibit 12: Energy – Decline Rate Vs. Organic Capital Efficiency/Cash Netback, 2021

40%
ERF AAV
35% ARX TVE KEL
TOU NVA

Ave. Decline (20 & 21 - %)

30%
BTE CPG
25%
POU PEY
20% WCP BIR
15%

10%

5%

0%
0.0x 0.5x 1.0x 1.5x 2.0x 2.5x
Capital Efficiency / Cash Netback (x)
Note: Excludes FRU, PSK, TPZ, CNQ, CVE, OVV, IMO, MEG, SU. Source: Company reports and CIBC World Markets Inc.

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Energy Companies & Mid-cycle Profitability: Benchmarking Industry Supply Costs - March 31, 2022

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Energy Companies & Mid-cycle Profitability: Benchmarking Industry Supply Costs - March 31, 2022

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Energy Companies & Mid-cycle Profitability: Benchmarking Industry Supply Costs - March 31, 2022

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