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2015 Market Outlook

WorkshopFeeling the Squeeze

Deloitte Consulting LLP

August 7, 2015

Agenda

Introduction to Deloitte

Our View of the Oil & Gas and Oil Sands Market

Trends in the Oil Patch – Cost Reduction

Cost Reduction for Producers and what that means for Manufacturers (Cost Modeling)

Cost Reduction for Manufactures (Direct Materials)

Conclusion

Questions

Introductions

Ted Brennan

Senior Manager


Martin Brotschul

Principal


Grant Poeter

Specialist Leader


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About Deloitte Consulting LLP

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US/Bangalore Team

Unmatched Breadth and Depth


The Market

Risk Profile of the Western Canadian Sedimentary Basin (WCSB) has Changed

• Structural shift away from natural gas drilling

• Full cycle dry gas has been uneconomic in Canada for

several years – no indication that this will change

• Liquids rich strategies can work but are challenged by

infrastructure constraints and depressed gas prices

• Remain cautious on gas due to LNG uncertainty and

mountain of gas in the Marcellus

• The average cost per well drilled in the WCSB has risen

dramatically as:

– new technologies are implemented (multi-stage fracturing)

– deeper, more technically difficult reservoirs are targeted

(i.e. Duvernay)

• Risk for new entities has shifted from exploration to

development

• Balance sheets need to adjust accordingly – hence larger

initial capital raises

• Undercapitalization remains a risk

Source: Spears


The Market

West Texas Intermediate – The Challenging Market Continues

THEMES

• Recovery of WTI prices to US $70-80/bb

• Longer than 12 months

• Many also commented on factors that have softened the

impact of the price decline:

– The weakening of the CAD vs the USD

– Hedging positions for the remainder of 2015

USD WTI

CAD WTI

USD WTI prices (FX rates per Bank of Canada)S

*from May, 2015

Weakening FX rate resulting in favourable CAD WTI

WTI pricing per www.eia.gov

June 2013

CAD WTI – $96

USD WTI – $93

April 2015

CAD WTI – $72

USD WTI – $60

Interview

Period

Deloitte recently interviewed 20 CFOs to get a “pulse check” on the market. Their perspectives were

quite similar.

28%

72%

Which of the following describes your outlook of when

WTI prices will return to US $70 – 80/bbl?

>12 Months

<12 Months


The Market

Global Crude Cost Breakeven Curve

Source: Spears

Even with low production costs, OPEC members rely on oil prices to be in the $80 - $100BBL range to

fund their governments.

Prices will be further tested with the possibility of Iran production coming back into the world market as a

result will likely stay soft for the foreseeable future.

Source: Reuters, “Oil prices below most OPEC producers' budget needs”, September 8, 2014;- IMF, “Statistical Appendix, Regional Economic Outlook - Middle East and Central Asia Update”, May 2014 and Deloitte MarketPoint Analysis


The Response

Global Oil and Bitumen Production Will Reduce as a Result of Cancelled Projects

Canada has been the hardest hit with a double whammy of lower oil prices and a weak Canadian

Dollar. If sub $50 oil were to persist, this list would be pages long.

Source: Deloitte Canada Study


The Response

Actions to sustain performance in the current environment

Proportion of participants (CFOs) considering or applying the following strategies to manage current and potential future

prices

Companies are looking at a number of ways to mitigate both the immediate deflationary pressures and

how to make structural changes to manage at a lower price per barrel range.

REDUCING

COSTS

DEFER SPEND

STRATEGIC

ACQUISITIONS

DIVESTITURES TO

MONETIZE ASSETS

CUT DIVIDEND

SHORT-TERM CASH

FLOW

ALTERED PLANS

TO ACCESS

FINANCING

DEBT

MANAGEMENT


The Response

Cash Flow Management

67%

8%

17%

8%

Achieved 10% reduction




Percentage cost reduction achieved by CFOs,

shown proportionally

• Reducing contractor and employee headcount.

• Seeking cost reductions from suppliers. Most indicated

that achieving approximately 10% reduction is a realistic

“first step”

• Improving management of receivables from JV partners

while being strategic in vendor payments and realizing

discounts for early payment.

Most companies have engaged in Cost Reduction programs in 2015. If there is a continued softening,

there will be further contractions and negotiations.

Source: Deloitte Canada CFO Study

The resounding feedback from CFOs is that there is

increased focus on “getting the most out of what

you’ve got”. In their view, relevant areas being

considered include:

• Field productivity

• Asset management

• Many highlighted recent or planned investments in

operations technology to do more with field data

available, as well.

Operational readiness was also highlighted as a priority by

those dealing with the transition of capital projects

to operations.

CFOs were asked what elements of operations excellence are

priorities in the next 3 to 12 months


The combination of weak oil prices and a strong US dollar have driven a shift in oil price fundamentals.

With no end in sight for either oil demand increasing or the dollar weakening, low oil prices are likely

here to stay.

Summary

The Market and Our Thoughts

We see some examples of trends to be more competitive in this market environment for both

customers and manufacturers

• Consensus of analysts and data point to no real improvement for 12 Months or more

• Upside is in the $70BBL - $80BBL range. No one is predicting $100 anytime soon

• All operators have conducted cost out programs with mixed results – more will likely follow

• Companies with strong balance sheets are seeing this as an opportunity to gain market share and scale,

ultimately meaning fewer, larger customers in the market

• Marginal programs/projects will be mothballed or abandoned

• Added uncertainty with Iran’s potential move back in to the mainstream will keep prices lower

• It’s not all bad for other industries, it is estimated that low oil prices is a $1.1Trillion stimulus in to the world

economy*

Source: Citi Group


Customer Response

Cost Model Example: Region A Seamless 7 in. 32# HCP110 Casing

There are two types of Cost models; one is used to estimate both the Total Cost of a Material or

Service to a company and the second estimates the cost for a supplier to produce a component/input

Total Cost of Ownership

Should Cost

$8.73 $0.98 $3.11

$9.90$2.58 $0.91

$26.21 $2.85 $29.06 $0.84 $1.16 $0.27 $31.33

$0$5

$10$15$20$25$30$35

$8.16

$24.50 $27.69 $29.07

-$5

$0

$5

$10

$15

$20

$25

$30

$35

Per

foo

tP

er

foo

t

With your customers driving to this level of information, it can enable you to have different

conversations on pricing, including indexing to some of your key cost drivers

Manufacturing Distribution and Freight Total

Manufacturing Distribution Fees and Freight Total


Customer Response

Cost Model Example: Region B Welded 7 in. 23# J55 Casing

The example pipe accounts for 40% of Region B’s OCTG spend. As modeled, Region B is paying 7%

under the Should Cost.

Total Cost of Ownership

Should Cost

$7.30 $0.43 $0.68$1.49

$1.69 $0.81 $12.39$1.63 $14.02 $0.72 $0.56 $15.30

$0$2$4$6$8

$10$12$14$16$18

$7.85

$13.33 $15.34 $16.13

-$2$0$2$4$6$8

$10$12$14$16$18

Per

foo

tP

er

foo

t

This type of analysis can also help to ferret out pricing anomalies in the market, such as this case

where a foreign company that recently had a 15.89% countervailing duty levied against it.

Source: International Trade Commission

Manufacturing Distribution and Freight Total

Manufacturing Distribution Taxes and Freight Total


A number of market trends in the manufacturing industry lead to increasing pressure on companies

Manufacturers Response

Overview

Globalization of

supply and

customer base

Appearance

of new competition

Typical company in the manufacturing

industry

Decreasing product

differentiation

Stronger end

customers

Increasingly sophisticated

procurement managers

Mature, slow-growing

markets

M&A among competitors

and customers


We are in the second cycle in the past 15 years


Volatility – here to stay

2004 2005 2006 2007 2008 2009 2010 2011 2012 2013 2014 2015

Aluminum Raw Materials Index Petroleum Maize

• Increasing sophistication in commodity management

• Commodity management as a competitive advantage

12

Commodity Prices Since 2004

Note: Raw Materials Index includes Timber, Cotton, Wool, Rubber, and Hides Price Indices, Aluminum based on LME price, Petroleum based on simple average of

three spot prices: Brent, West Texas Intermediate, and the Dubai Fateh, Maize (corn) based on U.S. No.2 Yellow

Index = 1.0


Purchase price timing and variation among suppliers indicates an opportunity for price reduction


Supplier pricing – cat and mouse

75

80

85

90

95

100

105

2008 2009 2010 2011 2012

Pri

ce In

dex

All Hydraulic Cylinder

Cylinder Steel Index

1 Year Delay 1 Year Delay

6 Month

Delay

• Steel price increases are

met with more rapid

purchase price increases

than steel price reductions

• Decline in steel prices over

the past two years has not

seen a commensurate

purchase price reduction

• There is an opportunity for

purchase price reduction

due to steel price decline

over last 18 months

Timing


Continuous cost reduction efforts are crucial for lasting success


Another approach

Reacting to immediate

cost pressure

Improving product

competitiveness

Reaching strategic

targets

PRIMARY TARGET SECONDARY TARGET

Product

Cost

reduction

• Operational

effectiveness

– Reduction of

complexity

– Process efficiency

– Reduced cycle time

• Product optimization

– Increase of product

margin

– Increase of

competitiveness

– Improved product

qualityCOGS Old COGS New


Margin focused cost take out focuses on value to the business


Cost take out at the product level

Engi-

neering

Procure-

ment

Manu-

facturing

Quality Logis-

tics

Product 1

Product 2

Product 3

Functional

Engi-

neering

Procure-

ment

Manu-

factu-

ring

Quality Logis-

tics

Cost perspective Collaboration Value Chain

TR

AD

ITIO

NA

LP

RO

DU

CT

FO

CU

SE

D

AP

PR

OA

CH

1 2 3

Organization driven Isolated focus

Cross-functionalProduct driven Integration of suppliers/sub-suppliers

RAW

MATERIA

SUPPLIER

Tier 1 OEM Cus-

tomer

OEM

Procure-

ment

Manufac-

turingSales

Cost reduction

Personnel

costMaterial

Manufac-

turing

Sales &

Marketing

Finance/

Admin

…

…

…

…

1,3



Overall Methodology To Calculate Manufacturing Cost of Hydraulic Cylinders

Raw Material Operation Cost Finishing Cost Assembly & Testing

Purchased Parts

Manufactured Parts

Volumes (cm^3)

Material Type

- Density (Kg/ cm^3)

Weight (Kg)

Material Cost (€ / Kg)

Raw Material Cost (€)

Castings & Forgings

Tubes, Rods, Plates

Geometric Features

Define Operations

- Turn, Grind, et. al.

Setup Times (min)

Cycle Times (min)

Fully Loaded Labor

Rate (€ / hr)

X X

Operation Cost (€)

Chrome, Nitrite Plating

Surface Area (mm^2)

X

Cost (€ / mm^2)

=

Plating Cost (€ )

Painting

Surface Area (mm^2)

X

Cost (€ / mm^2)

=

Painting Cost (€ )

Welding

Setup, Pre-heat,

Handling, Cleaning

(min)

+

Weld [Length / Speed]

(min)

=

Welding Time (min)

X

Fully Loaded Labor

Rate (€ / hr)

=

Welding Cost (€)

Assembly

Consider:

Part Weight

Torque Need

Forced Fit Need

Total Time (min)

X

Fully Loaded Labor

Rate (€ / hr)

=

Assembly Cost (€)

Testing

Standard Testing Time

(min)

X

Fully Loaded Labor

Rate (€ / hr)

=

Testing Cost (€)

Fixed Cost (€) Cost(€) / Weight(Kg)


Conclusion and Questions

• Dynamic market will continue for the foreseeable future

• Crude Supply – Demand Balance

• USD Strength

• Geopolitical uncertainty

• New entrants will further erode the balance

• Companies are struggling to get costs in line

• Different Thinking is Required

• Cost Modelling and Supply Chain Analytics will become more mainstream

• Restructured relationships with key suppliers to align incentives will continue

• Managing Risks and Relationships will become more important to Sourcing & Procurement

groups

As used in this document, "Deloitte" means Deloitte Consulting LLP, a subsidiary of Deloitte LLP. Please see www.deloitte.com/us/about for a detailed description of the legal

structure of Deloitte LLP and its subsidiaries. Certain services may not be available to attest clients under the rules and regulations of public accounting.

This communication contains general information only, and none of Deloitte Touche Tohmatsu Limited, its member firms, or their related entities (collectively, the “Deloitte

network”) is, by means of this communication, rendering professional advice or services. No entity in the Deloitte network shall be responsible for any loss whatsoever

sustained by any person who relies on this communication.

Copyright © 2015 Deloitte Development LLC. All rights reserved.

Member of Deloitte Touche Tohmatsu Limited.

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