EFTA01385319.pdf

3 January 2018 HY Corporate Credit HY Multi Sector.Media. Cable & Satellite HY Energy Outlook Jared Weil, operational by 01 18. EIA currently estimates YoY production growth of 6.2 Bcf/d next year. EIA's On market rebalancing on solid footing. but potential forecast of a largely balanced market and >$3 gas retracement in the cards En early 2018 price is predicated on A) higher export demand (+1.65 After three consecutive years of oversupply, the global Bcf/d YoY) which is on track and B) a normal winter oil market will likely a see a deficit in 2017, although driving up heating demand by 1.42 Bcf/d YoY. If the slight (-0.18 mmbbls/d). The OPEC decision last month latter fails to materialize, we could see price to extend production quotas sets up for an ultimate floundering below $3. This was highlighted in first half rebalancing of the market - supply and demand is of December when 2018 gas strip went below $2.70 expected to be largely balanced in 2018 and 2019 after trading in the $2.9043.10 range for most of 2017 though that would mean little progress in addressing - though it has since bounced back close to the lower the sizeable inventory surplus. That will come in 2020 end of the range given a strong revival in winter, when the market will see a meaningful supply deficit (- especially in the Northeast and Midwest. 0.75 mmbbls/d) as demand grows, US onshore supply slows down and non-OPEC production declines. While H Y tied' approaching a 'Hormel' sector the current rally in oil prices is backed by an improving In the two years following the collapse in oil prices in fundamental outlook, there is potential for a pullback. 2H 14, E&P players were focused on structural The key near-term swing factor is US onshore supply changes to the business model which could fit into a and the outlook for that sector is turning positive - reshaped oil market. This included efforts to repair drilling activity has bottomed while completions should balance sheet (equity issue, asset sales) and large scale pick up pace as significant new frac capacity (0.5-1.0 overhaul of the asset portfolio (mainly a shift to million hhp) is coming. Production from US onshore in Permian). By early 2017, the revamped corporate Q1 18 should drive the market back to oversupply after strategies were largely in place. The HY Energy index two quarters of deficit. This could drive a modest is currently trading only modestly wide of the broader pullback in oil prices during 1H 18. Longer term, falling HY index (50 bps wider), a far cry from the >1,000 bps breakeven levels of major prospective projects (non- gap in early 2016. Meanwhile, oil markets in 2017, OPEC. non-shale), especially deepwater, will likely keep while volatile, had established a $40 floor (for WTI). a lid on oil prices. Between 04 16 and 03 17, With the oil market settling at the "new normal" range, breakeven Brent oil price (10% discounted) of major the exit of weak players from the market and major pre-FID projects have fallen from $53/bbl to $46/bbl. sector themes (like the Permian Premium) having For new Canadian oil sands projects, 365 (Brent) could played out, the HY E&P group has been transitioning be a threshold for additional supply kicking in. into a "normal" HY sector with standard credit themes US net gas normal winter key to absorb coming like operational performance, cash flow models, and production surge balance sheets allowing for greater differentiation. For most of this year, the outlook for the 2018 gas market had been largely supportive of a $3 price - We focus on the cash flow model - a good proxy for driven by two factors: first, the expectation that by the asset quality - as a key differentiator for E&P credits. 2017-18 withdrawal season, the sizeable working gas For the better quality names, our analysis focuses on inventory surplus would be whittled down, aided by identifying names with a superior FCF-growth flattish production and pop in exports, especially LNG. equation. For lower quality names, we tend to focus That has worked out with the inventory levels at a on the breakeven oil price needed to keep FCF neutral modest deficit (121 Bcf or 3% lower than 5-year in a maintenance mode, along with downside asset average) by mid-November compared to a 265 Bcf valuations. Based on the above, in the Mid Quality surplus (15% higher) at the start of the injection season. space, we are positive on WPX Energy (BUY-rated) and The second was the expectation of a normal winter Oasis Petroleum (HOLD-rated) as they otter after two consecutive years of very mild winters - significantly faster growth through FY 19E with lower warmer-than usual weather during first half of December has highlighted the downside risks to this cash burn when compared with their respective peers - thesis. Normal winter demand is crucial for QEP Resources (SELL-rated) and Whiting Petroleum maintaining S/D balance next year considering the (HOLD-rated). Among Lower Quality oily names, we market is set for an Appalachian-driven production note that most names (with the exception of EP surge in 2018 given significant progress made on Energy), are well positioned to deliver neutral FCF with takeaway capacity expansion in the Northeast. About flat production at WTI oil price close to $50. Many of 4 Bcf/d of takeaway capacity has been added in the these names have driven solid improvements to their region between July and mid-November and another opex/capex cost structure in recent years driving down -4 Bcf/d of new capacity is scheduled to become FCF breakeven oil price substantially. Page 44 Deutsche Bank Securities Inc. CONFIDENTIAL - PURSUANT TO FED. R. CRIM. P. 6(e) DB-SDNY-0086603 CONFIDENTIAL SDNY_GM_00232787 EFTA01385319