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Bruce E. Edgelow Vice President, Energy Group

Canadian Association of Petroleum Landmen (CAPL) CAPL Conference 2009 31 st Annual Conference and General Meeting Negotiating the Road Ahead – Banking & The Energy Sector September 30, 2009. Bruce E. Edgelow Vice President, Energy Group. Outline. ATB Corporate Financial Services

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Bruce E. Edgelow Vice President, Energy Group

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  1. Canadian Association of Petroleum Landmen (CAPL)CAPL Conference 2009 31st Annual Conference and General Meeting Negotiating the Road Ahead – Banking & The Energy SectorSeptember 30, 2009 Bruce E. Edgelow Vice President, Energy Group

  2. Outline • ATB Corporate Financial Services • Industry Check-up: • Commodity Prices • Natural Gas • Drilling / Completions • Land • M&A Activity • Upstream Equity Markets • Leverage Results • Cost of Capital

  3. Outline (continued) • Lending Best Practice • Commitment (size of market) • Due Diligence / Analysis • Portfolio Management • Security • Covenants • Monitoring • Advisory Role • What Can Go Wrong? • What the Future Holds

  4. ATB Corporate Financial ServicesEnergy Group • Industry specialization with a focus on Exploration & Production (E&P), Midstream, Drilling & Services, Pipelines and Utilities • Authorized loan book of $4.1 Billion (~ 240 borrowers) • Deposits under management over $1.7 Billion • (~ 450 deposit clients) • Staff of 30 professionals, including relationship managers, account managers, derivatives traders and engineering • Participation in 80 syndications • Hold limits range from $15MM (B equivalent rating – S&P) to over $100MM (A rating)

  5. Industry Check-upCommodity Prices - Crude 2008 average: $99.65 2009 YTD: $56.30 As of September 25 2010 WTI forecasts range from $70-$80 Source: Energy Information Administration

  6. Industry Check-upCommodity Prices - Crude As of September 25

  7. Industry Check-upCommodity Prices – Natural Gas 2008 average: $8.12/mcf YTD Price: $4.10/mcf As of September 25 2010 Average AECO forecasts range from $4.00 – $6.00. Source: Canadian Association of Petroleum Producers

  8. Industry Check-upCommodity Prices – Natural Gas As of September 25

  9. Industry Check-upNatural Gas – U.S. Production Shale gas production has contributed to increased total U.S. supply from 51 BCF/D to 56 BCF/D beginning in 2007 Demand is down 5% year over year as a result of the U.S. recession Source: Energy Information Administration

  10. Industry Check-upUS Natural Gas Storage Current Stock: 3,525 BCF Last Year: 3,016 BCF 5 Year Average: 3,040 BCF As of September 18 Source: Energy Information Administration

  11. Industry Check-upNatural Gas Correction – a matter of time • Massive decrease in capital spending • 190 Canadian E&P Companies spent $14 Billion in exploration and development in the first 6 months of 2009 versus $46 Billion in 2008 • Number of wells drilled / completed will not replace the production lost to decline • The estimated average decline for gas is 35% annually. The prolific shale zones is 40 – 60% in the first year • Offset by weaker demand, down ~ 2.5 BCF / day (5%) year over year Source: Canoils Database, Energy Information Administration

  12. Industry Check-upDrilling Activity 2009 Q1 drilling utilization was the lowest since 1992 Source: CAODC

  13. Industry Check-upDrilling Activity Source: CAODC, Baker Hughes

  14. Industry Check-upCompletion Activity Average over period: 19,200 wells Industry analysts expect 2009 drilling activity to decline a third year in a row. Source: CAODC

  15. Industry Check-upLand 2008 B.C. $2,662 SK $1,119 2009 B.C. $322 SK $51 Source: AB Dept of Energy, B.C Ministry of Energy, Mines and Petroleum Resources, Saskatchewan Energy and Resources

  16. Industry Check-upM&A Activity Suncor-Petro Canada merger valued at approximately $26.0 Billion in Q1 2009. Source: ATB Financial

  17. Industry Check-upM&A Activity There is approximately 37,000 BOE/D currently for sale or under review in the market according to Sayer Energy Advisors. Weighted average price: $17.72 Source: ATB Financial

  18. Industry Check-upM&A Activity Weighted average price: $64,657 Source: ATB Financial

  19. Industry Check-upUpstream Equity Market Source: Sayer Energy Advisors / ARC Financial

  20. Industry Check-upLeverage Results – E&P Industry leverage has worsened given the sharp drop in commodity prices. Best positioned: > 20,000 BOED Leverage: 1.7x WTI Price Mid Cap: 1,000 - 20,000 BOED Leverage: 3.9x Most leveraged: < 1,000 BOE/D Leverage: 44.0x Data Source: Canoils Database

  21. Industry Check-upCost of Capital • Interest rates are at all time lows • Despite significant increases in spreads (premium over base rate), borrower’s cost is still very reasonable • Issuing equity may be necessary for survival but at depressed valuations it can be dilutive to shareholders • Mezzanine / Bridge financing is still available, albeit on a selective basis and at a much higher cost • Borrowing bases have been tested due to lower price deck, lack of reserve growth and reserve write-downs / reclassification

  22. Industry Check-upCost of Capital Recently priced investment grade deals (BA spread in bps) • Although spreads have increased significantly, the BA base rate has fallen from an average of 3.04% in 2008 to 0.58% in 2009 • In the single hold market, Prime spreads have increased from 0.25% - 1.00% to 1.25% - 2.00% (depending on credit quality) • Prime base rate has also fallen from an average of 4.73% in 2008 to 2.54% in 2009 • Bank of Canada has signalled they will keep rates at the current level for at least one year. However, the changing F/X environment may impact the Bank’s decision

  23. Lending Best PracticeCommitment • The Energy Lending Business in Canada has grown from $16 Billion in 2005 to $31 Billion in 2008 Bank Debt is a key source of capital to the oil and gas industry

  24. Lending Best PracticeDue Diligence • Counterparty analysis is required to establish a risk rating, which impacts: • Portfolio limits (How much can we lend to a sector?) • Hold limits (How much can we lend to a customer?) • Pricing / Fees (How much do we need to charge to make the sector threshold return?) • For E&P, we specifically focus on: • Operating costs / break even costs • Reserve replacement • Finding & Development Cost • Recycle Ratio • Funding Check

  25. Lending Best PracticePortfolio Management • General factors always considered, regardless of industry: • Management and Directors • Balance Sheet Composition • Asset Quality • Overall portfolio limits are in place to ensure banks are not overexposed to any particular sector and managed by: • Default insurance / Credit Default Swaps: banks can purchase insurance to protect against potential losses due to default • Smaller corporate entities – forward view (reserves / prices) • Larger corporate clients – Unsecured, for E&P at 50,000 BOE/D. Historical perspective (prior period debt and cash flow)

  26. Lending Best PracticeSecurity • Security provides lender with a legal means of recovering a loan in the event a borrower defaults on its debt obligations and a realization scenario follows formal demand • Small to midsize loans secured by company assets, general security agreement, or fixed/floating charge debenture • Larger corporate clients – Unsecured, typically rated externally by a third party (e.g. S&P or Moody’s). Historical perspective (prior period debt and cash flow) • For E&P, a Borrowing Base is determined from the Company’s reserves and is the major component of a bank’s security

  27. How Reserves Are Like Fish • Proved Developed - The fish is in your boat. You have weighed him. You can smell him and you will eat him • Proved Undeveloped - The fish is on your hook, in the water, by the boat and you are ready to net him. You can tell how big he is (They always look bigger in the water) • Probable - There are fish in the lake. You may have caught some yesterday. You may even be able to see them but you have not caught any today

  28. How Reserves Are Like Fish • Possible - There is water in the lake. Someone may have told you there are fish in the lake. You have your boat on the trailer but you may go play golf instead • Divested - You used to have a fish, but you traded it for magic beans. You also used to have cash flow, infrastructure and a job in exploration. Now all you have is beans

  29. Technical Reserve Definitions

  30. Lending Best PracticeCovenants • General covenants impose restrictions - for example, a negative pledge prevents granting security to another party • Covenants are tighter for smaller, higher risk borrowers: • Borrowing Base Test, Working Capital • Large Corporate: • Debt to Cash Flow, Debt to Capitalization • Financial ratio covenants outline lenders expectation of financial health on a “going concern” basis • Early warning signals often get created to monitor performance based on forecasts and budgets and allow both Lender and Borrower to monitor progress prior to triggering formal default • Pricing grid mechanics can tie into covenant threshold

  31. Lending Best PracticeMonitoring • Borrowers have to comply with certain reporting requirements including: • Annual reserve report (third party prepared in most cases) • Annual and quarterly financial statements • Compliance Certificate • Monthly production reports • Annual cash flow budget • Financial covenants are followed to ensure the Borrower is a going concern

  32. Lending Best PracticeAdvisory Role • Lenders’ broad view of the market can assist Borrowers with: • Understanding market changes in lending policy or credit availability • What borrowing rates are in the single hold versus syndicated market • Who is actively buying / selling assets or interested in merging • What other forms of capital are available, such as sub debt, equity, convertible debentures

  33. What Can Go Wrong? Portfolio Rebalancing • A Bank’s sector and industry limits are subject to change. • Negative external events in a sector (for example, weak commodity prices) can reduce the amount of capital available. • Exposures are reduced by one of the following strategies: • Borrowing Bases are “low balled” • Borrower requests are delayed or ignored • Borrowers are de-marketed directly through non-renewal

  34. What Can Go Wrong? Client Exposure • During robust times in the market there is a tendency towards relaxing lending best practices: • Stretch financing • Loose terms, no financial covenants • A bet on Management • It takes the income from many “good” loans to replace losses from 1 or 2 “bad” loans • Over $300MM in drawn loans would be required at today’s rates and fees to replace a $10MM loss

  35. What Can Go Wrong? Troubles in Head Office • There is an abundance of capital when times are good • Negative events in head office impact the ability of local Lenders to participate in deals and limit local management practices • Foreign Banks: problems in the home country can cause international offices to contract • Borrowers must be aware of the concentration of foreign banks in their syndicate

  36. What Can Go Wrong? Working Capital • Poor working capital management is the biggest cause of company defaults • High debt utilization (inclusive of working capital) leaves little or no margin for error if: • Cash flow is lower due to a drop in commodity prices or production is offline (plant turnaround) • Borrowing Base is reduced due to poor reserve replacement or low price deck • At ATB we require Borrowers to maintain a 1:1 adjusted ratio

  37. What Can Go Wrong? Management Issues • Lack of formal due diligence on asset or corporate purchases prior to completion (financial versus operational focus) • Management Entrenchment: • Inability to sell assets or transact • Building estate • Personal concern with respect to re-starting or obtaining employment • Discord among Managers, Board Members and Major Shareholders

  38. What Can Go Wrong? Reporting / Communication • Late reports (financial compliance, production, etc). • Poor quality reports • Phone calls or e-mails not returned. • Relevant information not disclosed. • Lender discovers problem, is not advised by Borrower. Absence of trust means relationship is breaking down!

  39. What Does The Future Hold? • Gas focused producers, especially small juniors, will struggle to survive if gas prices do not recover this winter • Consolidation of smaller players needs to continue • Management entrenchment is still an issue • Optimism in the market due to the very recent oil price recovery and resurgence of a few mega oil sands projects • Equity market opening up ($5.4 Billion year to date) • Reverse takeovers by successful management teams. • Business combinations on a share deal basis and asset purchases funded by equity

  40. What Does The Future Hold? • Rationalization of expenses (Operating and Capital) • Ongoing Borrower / Lender due diligence – who is left, at what level can deals still be done (bank holds), who can join syndicate • Need to protect balance sheet when stretching to grow – derivatives / equity / sub debt / form of vendor take back • Should last quarter of 2009 not see a rebound in gas prices, 2010 borrowing base reviews could be more challenging than this year • Lack of reserve replacement • Diminished value of reserves in place • Fully drawn bank lines / lack of capital • Pressure on working capital • Lending community resolves to support this industry through tough times

  41. Thank You Bruce E. Edgelow Vice President, Energy Group 403.974.5736 bedgelow@atb.com

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