Facing upstream - Is the crisis for oil & gas the new normal?

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Introduction of Imperial Oil (Canada)

Subsidiary of ExxonMobil Corp

Imperial Oil Limited, Canada, operates in three segments: Upstream (24%), Downstream (72%), and Chemicals (4%) with products across crude oil, natural gas, synthetic oil and bitumen. The Downstream segment is involved in the transportation, refining, blending, distribution, and marketing; holds interests in pipeline companies. The Chemical segment manufactures and markets various petrochemicals, including ethylene, benzene, aromatic and aliphatic solvents, plasticizer intermediates, and polyethylene resins. Imperial Oil Limited also serves agriculture, residential heating, and commercial markets.

Trends in the Industry

Demand Side:

Supply side:


To the increasingly tighter margins, the shale men have responded by squeezing suppliers (20-25% cost cuts), selecting new drill sites frugally (number of operating rigs fallen by half), capex cutting (by a third) and raising capital from Wall Street ($35 b since December).


In November 2014, OPEC decided to maintain production at 30 MMbbl/d to stifle competition from alternative suppliers. With Saudi Aramco, UAE’s ADNOC and Kuwait collectively expected to increase exploration and production spending by 14.9% in 2015, OPEC’s long term production is likely to stay up.


A $3-4/b of change can be expected over Brent crude, given the removal of trade embargo. A major question to look out for is the time it takes for Iran to restore production, if Iran can ramp up within 6 months like Venezuela did in 2002.

Scenarios Analysis

Putting trends into action

Scenario 1: (Worst Case)

The Iran production follows through by the next year beginning, pushing pricing down to $46-45. Prices below this are unlikely, as this happens to be the breakeven of the most economical shale rigs. Shale men prove to be resilient yet again, stabilizing prices near this region, in lieu of no step up in demand.

Scenario 2: (Best Case)

Iran production takes time to follow through, while shale men’s derivative hedges run out, pushing the cost of crude oil up to $60-65. All shale rigs are profitable above this price and given shale rigs’ small investment cycle of 3-6 months, shale industry will push down quickly any further increase in price.

Scenario 3: (Most likely Case)

Iran production responds by next year and prices fall to $43-44. Shale men see their derivatives run, pushing the price to $60-65.


Now each of these companies (Appendix 1) underwent “stress testing”, meaning they were exposed to the set of 3 scenarios created above. Flex valuation was then used to factor in these scenarios and a new warranted price was estimated (Appendix 2).

Revised Flex Valuation: Stress Testing

The 3 driver model based on sales, margins and turns was used.

Accounting for Upstream Segment

Sales growth estimates were revised based on the revised oil price estimates

Revision formula:            

Accounting for Downstream Segment:

Historic Performance

Historically, IMO has outperformed its North American integrated peers in CFROI. However, asset efficiency fell due to low sales growth over strong asset growth in 2013, resulting in lower CFROI and margin, though a quick reversal happened in 2014, resulting in price momentum to be negative. Holt Valuation expects 2015 CFROI to fall to 3%. However, since the market has priced in just 2% long-term CFROI levels, without asset growth, IMO has a potential upside of 114%. A 40% upside is expected, in case CFROI levels improve to 5% by 2019, with comparable downside in case of negative CFROI.

Imperial Oil LTD (CAN): Why it’s a great buy?

Holt Upside = 113%

Performance relative to peers

The peer relative performance chart shows that Imperial oil has constantly outperformed its sector peers, with current peer average gap at 12%.

This is due to the fall in price of WTI which has narrowed the discount to the US benchmark that Canadian producers had been facing; Western Canadian Select was trading at discount of US$17.2/b in November, up from a discount of US$40/b in 2013. This has resulted in Imperial Oil getting into the positive territory (about 0.25%) in CFROI revisions while most of its peers are still losing cash flow.

Opportunistic Business position

A Holt upside of 113% implies that the market has not yet awarded Imperial Oil with its potential in Canadian oil sands. The oil crash has led to big investment cuts in shale industry and behemoths like Exxon have abandoned ambitious projects like artic and deep-water projects. The ISIS rage has also led to fall in capex in Iraq. This will eventually result in price rebound, making high breakeven oil sands profitable.

With Imperial Oil Ltd pushing forward with multibillion-dollar Kearl and cold lake oil sand projects despite 36% profit plunge, it would be well positioned to capture this fantastic opportunity.

Besides, the company’s endeavours in LNG, with a 30 million t/y project in British Columbia which will result in a shorter supply chain to East Asia (than from US Gulf coast), will provide the much needed diversification from the American markets.

Threats to business

  • Growth opportunity at risk: Canadian oil sands have one of the world’s highest production costs, with average breakeven at $US74/b. Though oil sandmen base their decisions on long-term horizon, a sustained period of low prices could have a substantial impact on the exploitability of this reserve.
  • Lack of diversification: The oil exports have not grown as fast as production. Once the domestic market saturates, the company will need new markets. The poor infrastructure at the US-Canadian border, high cost of exporting beyond North America, and the delays in keystone pipeline could prove to be a major issue.
  • Competition: Imperial Oil faces severe competition from the BG, Chevron, PETRONAS and Shell in its LNG projects. With lack of experience beyond North American markets, the company could lag in finding new markets to compete against the behemoths.


Imperial Oil LTD (CAN) is undervalued with Holt warranted upside at 113% and revised Flex Valuation upside at 126%. This is because company has significant growth opportunity in Canadian Oil sands.




[1] Reuters: “A year after the crash, oil markets risk more trouble ahead


[2] BCG Perspectives: “The Impact of Low Oil Prices on Downstream Oil”


[3] OPEC Annual Statistical Bulletin, 50th Edition


[4] Deloitte: “Oil and Gas Reality Check, 2015”


[5] Financial Times: “Dragon Oil weathers the rough oil market”


[6] Financial Times: “Oil: Some crude numbers”


[7] Financial Times: “Futures markets have much to say about oil’s direction”


[8] Financial Times: “Global oil companies will welcome Iran deal”


[9] Bloomberg: “History Shows Iran Could Surprise the Oil Market”


[10] Bloomberg Market Info


[11] [12] McKinsey and Company, Energy Insights: “Impact of low crude prices on refining”; and “Profitability in a world of over capacity”


[13] BCG Perspectives: “The Future of Oil Refining Profit Margins”


[14] The Economist Intelligence Unit: “The Business of Cheaper Oil”


[15] The Economist: “There will be Blood”




[16] The Economist: “After OPEC”


[17] The Economist: “Fractured Finances”