Session i mark gottfredson

Strategy in Uncertainty

A guide to anticipate and act in a time of uncertainty July 2016

CONFIDENTIAL

This information is confidential and was prepared by Bain & Company solely for the use of our client; it is not to be relied on by any 3rd party without Bain's prior written consent

Strategy in Uncertainty

“Prediction is very difficult – especially about the future” - Niels Bohr, quantum physicist and Nobel Prize Winner (1922)

This information is confidential and was prepared by Bain & Company solely for the use of our client; it is not to be relied on by any 3rd party without Bain's prior written consent

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Objectives of these materials

• Introduce a framework and methodology to anticipate and act in times of unprecedented uncertainty • Share some perspectives on what the signposts are indicating regarding the future energy landscape

This information is confidential and was prepared by Bain & Company solely for the use of our client; it is not to be relied on by any 3rd party without Bain's prior written consent

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There are many variables that can affect any business: Utility Example Market environment • U.S. economy • Canadian economy • Global GDP growth • Capital markets (yield curve, cost of capital, etc.)

• Consumer preferences, trends, and social media • Energy intensity (per capita, per $ GDP) • Energy spend as percent of income or revenue • Generation – utility and IPP • Transmission – electrical wires and gas pipeline • Global and North American petrochemical demand • Global development of potential shale plays • Competitive activity: new competitors, and asset builds/ expansions

Regulation and Policy

Technology

Energy costs and supply

• Licensing of new and existing nuclear plants

• Fracking techniques / technologies

Crude oil

• State and federal rules on fracking and disclosures

• PE cracking technological improvements, e.g. coal to olefins

• Energy independence

• EPA regulations on coalfired generation • Federal GHG regulation • Global compact on GHG • State and federal rules and incentives for renewables, energy efficiency, etc. (e.g.

RPS, ITC, PTC)

• Utility-scale renewable cost experience curve • Electricity storage and transmission technology • Next-gen nukes (incl. modular) • Coal and gas turbine

• Foreign imports Coal • Pricing and supply • Mining and emission regulations • Import / export dynamic Gas and NGLs • Pricing and production

• State and federal subsidies for alternatives to gasoline/diesel

• Distributed generation

• NGL prevalence and frac spread (oil, NGLs vs. gas) • Fracking constraints

• FERC, NERC, other regulatory body standards and rulings

• Energy efficiency, demand mgmt. / response • AMI / "smart meter" / Smart Grid evolution

• Import / export dynamics

• Public safety (pipeline and other), reserve margins, etc.

• New segments of demand, e.g. long-haul trucking and North American GTL

• Cyber-security, geopolitics, and policy

• Gas infrastructure Nuclear • Permitting process • Loan guarantees • Next-gen technology • Public opinion

Even if each bullet point represented one bimodal variable would be 2^45 possible outcomes This information is confidential and was prepared by Bain & Company solely for the use of our client; it is not to be relied on by any 3rd party without Bain's prior written consent

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Energy costs and supply: on just the production variable, projections vary widely CRUDE OIL

NATURAL GAS

COAL

GREEN POWER

Notes: North American production only Source: Analyst set includes EIA, IEA, Exxon, IHS, among others This information is confidential and was prepared by Bain & Company solely for the use of our client; it is not to be relied on by any 3rd party without Bain's prior written consent

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And future price forecasts are ‘unusable’…

WTI CRUDE OIL Implied price (95% confidence) $200/bbl

150

Upper confidence Lower confidence Futures price Historical price

HH NATURAL GAS Implied price (95% confidence) $10/MBtu 8

Upper confidence Lower confidence Futures price Historical price

6 100 4 50

0 2009 2010 2011 2012 2013 2014

2 0 2009 2010 2011 2012 2013 2014

Source: EIA June 2016; Bain analysis (Probability values created using NYMEX market data) This information is confidential and was prepared by Bain & Company solely for the use of our client; it is not to be relied on by any 3rd party without Bain's prior written consent

6

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‌As history teaches us these forecasts are often wrong

WTI CRUDE OIL

2009 2011 2012 2014 2016

HH NATURAL GAS

2009 2011 2012 2014 2016

Source: EIA June 2016; Bain analysis (Probability values created using NYMEX market data) This information is confidential and was prepared by Bain & Company solely for the use of our client; it is not to be relied on by any 3rd party without Bain's prior written consent

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Strategy, as traditionally designed, is about clarity and alignment from ambition to execution at the front line Bold, inspiring full potential ambition Ambition

Where to Play

How to Win

Actions that Drive to Full Potential

Roadmap to Deliver Results

Clear choices on where to play and how to win

Initiatives and capabilities to repeat success

Plan and routines to align the front line

This information is confidential and was prepared by Bain & Company solely for the use of our client; it is not to be relied on by any 3rd party without Bain's prior written consent

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In periods of heightened uncertainty, however, strategy creation can fall into common traps UNDERCONFIDENCE

OVERCONFIDENCE

Treating uncertainty as “unknowable’”

“Rifle shot” views of the future

Focusing only on things that can be controlled “Wait and see” stance on market changes Doubling down to protect incumbency Few reinvention or innovation bets A bet on every square to manage risk

Ambition

Where to Play

How to Win

Actions that Drive to Full Potential

Lack of direction in front line execution

Roadmap to Deliver Results

Bold, but unrealistic or vague ambition Failure to anticipate competition Rigid pursuit of new business models Big and monolithic bets that create “lock-in” Little or no focus on risk management Heads down and rigid execution

Modified approach is needed This information is confidential and was prepared by Bain & Company solely for the use of our client; it is not to be relied on by any 3rd party without Bain's prior written consent

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Dealing with Future uncertainties

• The primary means of forecasting by most companies, analysts, and economists today consists of: - Development of a base case (usually based on significant analysis of 3-5 variables and building a “story” for why that is the most likely - Adjustment of variables to create a “high case” and a “low case”

• Shell created a different concept of “scenario analysis,” which takes 3-5 reasonably likely scenarios, and then builds potential strategies around each scenario, putting probabilities against them and using those to include into hurdle rates for investment decisions • We have developed a new approach that identifies the “extreme, but plausible corners” of an infinite cube of scenarios. This approach allows us to identify clearly the variables that matter most, set them as “signposts” and monitor for disruptive “tipping points”. There is tremendous economic value to be created if you can see a disruption coming 3-5 years ahead of competitors This information is confidential and was prepared by Bain & Company solely for the use of our client; it is not to be relied on by any 3rd party without Bain's prior written consent

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Among economic signposts, experience curves are important to monitor as they highlight “tipping points�

VHS tape becomes mainstream

Laserdisc offers alternative to VHS

DVD is introduced and laserdisc stops production 2 years later

Streaming technology disrupts music and video industry

Source: IC Insights; ICE Status; Electronic Design; Singularity University This information is confidential and was prepared by Bain & Company solely for the use of our client; it is not to be relied on by any 3rd party without Bain's prior written consent

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Consumers adopt new technology once its capability and price become more attractive than its predecessor MUSIC: ECOMMERCE PENETRATION Legend

VIDEOS & DVDS: ECOMMERCE PENETRATION Legend

Actual

Actual

Prediction using Forrester forecast

Prediction using Forrester forecast

The growth of iTunes, founded in 2001, contributed to the acceleration of ecommerce penetration in music.

Historical

Forecast

Historical

Forecast

Note: Videos and DVDs - DVDs and VHS. Includes digital downloads. Music CDs, digital downloads, and streaming services; Forrester ecommerce estimates based on any purchase paid for online (regardless of whether delivered or picked up in store); Source: Forrester; Bain analysis This information is confidential and was prepared by Bain & Company solely for the use of our client; it is not to be relied on by any 3rd party without Bain's prior written consent

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Unless there are substitution barriers which may slow penetration NORTH DAKOTA FLARING

North

FLARES VISIBLE FROM SPACE

Bakken formation

Eagle Ford

• Low Gas Prices caused rigs to rapidly shift to “wet” plays • However, midstream infrastructure was not in place…thereby creating a substitution barrier • As a result, gas was flared and WTI crude prices decoupled from Brent.

• Bakken flaring burns more than $100 million per month (~30% of production) • Bakken flares are being replicated in other shale regions, including Texas • As rail and other infrastructure has been put in place, the WTI/Brent spread has narrowed

Source: NASA, Financial Times This information is confidential and was prepared by Bain & Company solely for the use of our client; it is not to be relied on by any 3rd party without Bain's prior written consent

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We assess the strategic implications in order to understand potential actions to take, now and in the future

ENERGY EXAMPLE

This information is confidential and was prepared by Bain & Company solely for the use of our client; it is not to be relied on by any 3rd party without Bain's prior written consent

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As an example, we developed 8 “corner scenarios� for energy markets No imports

U.S. Energy consumption (Qbtu)

2030 EIA Reference

Hydrocarbon Starved

Gas Land

Oil Rebirth

Hydrocarbon World

Green Nirvana

Green Mandate

Green Power

Feuding Fuels

1

2

3

4

5

6

7

8

This information is confidential and was prepared by Bain & Company solely for the use of our client; it is not to be relied on by any 3rd party without Bain's prior written consent

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Collectively, these scenarios covered a wide range of volumes and prices CRUDE OIL

NATURAL GAS

$4/MMbtu Gas Land

$60/bbl Oil Rebirth

$120/bbl

$10/MMbtu

Green Nirvana

This information is confidential and was prepared by Bain & Company solely for the use of our client; it is not to be relied on by any 3rd party without Bain's prior written consent

Green Nirvana

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Signposts (the variables most important for identifying disruption) were set to “extend the headlights” Global Oil Signposts Production Growth • Iraq production

OPEC’s Influence • OPEC production levels and spare capacity

• Brazil deepwater production • Other conventional production

Demand Growth • Oil consumption in developed nations • Economic growth in emerging markets

• North America Production North America Production Metrics Basin Productivity

Supply Chain Capacity

Access & Regulations

Available Resources • Current and forecasted EUR

• Initial production rates

• Monthly rig count

• Current and proposed fracking restrictions

• Drilling days / frack stages

• Dry vs. wet rig deployment

• Federal acreage open/leased

• Planned E&P capital investment

• Well depletion rates

• Rig costs (day rates & breakeven)

• Drilling applications & permits

• Price differentials (basin vs market)

• Number of wells

This information is confidential and was prepared by Bain & Company solely for the use of our client; it is not to be relied on by any 3rd party without Bain's prior written consent

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Watching the signposts on cost of tight gas allowed us to see the explosion three years before everyone else E-CURVES SHOWED THE COMING DISRUPTION OF SHALE

ANALYSTS DID NOT PAY ATTENTION TO FRACKING UNTIL IT WAS DISRUPTIVE

SWN Fayetteville shale gas well costs ($/Mcf) 100

Slope = 72%

50

The world began to notice shale gas’ disruption

2004 2005

20

2006

10

2007

2007 price

2008 2009 2010 2011 2013 2012 2014 2015

5

2

Signposts indicated viability

10,000

Cumulative # of wells drilled

5,000

2,000

1,000

500

200

100

50

20

10

1

Note: 2013-15 $/Mcf costs based on % improvement in break-even oil costs over the same period Source: Argonne National Lab, EIA, Google Trends, The Atlantic, SWN company financials; EIA; Rystad; Company websites and press releases; Bain analysis This information is confidential and was prepared by Bain & Company solely for the use of our client; it is not to be relied on by any 3rd party without Bain's prior written consent

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We saw the same pattern in tight oil…

Eagle Ford breakeven oil prices ($/bbl)

~15% cost decline (’14-’15)

Note: Well cost is weighted average well cost, pads and single wells Source: Rystad; Continental Resources; EIA; Company websites and press releases This information is confidential and was prepared by Bain & Company solely for the use of our client; it is not to be relied on by any 3rd party without Bain's prior written consent

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And suggested in 2012 that low cost supply was likely to exceed demand, affecting global clearing prices Cost of production/import (2012 $/bbl)

2030

2012 average oil price

0

10

20

30

40

50

60

Crude production (MBD)

70

80 2016 crude demand

90 Estimated 2030 crude demand

Source: Rystad, IEA, Advanced Resources Int’l, BP Energy Outlook 2030, Bain Analysis This information is confidential and was prepared by Bain & Company solely for the use of our client; it is not to be relied on by any 3rd party without Bain's prior written consent

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And noted throughout 2014 that over-supply situations led to price declines between 30% and 70% 1986

1991

1998

2001

2008 Change in production Change in consumption

Source: EIA, IEA This information is confidential and was prepared by Bain & Company solely for the use of our client; it is not to be relied on by any 3rd party without Bain's prior written consent

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Strategies using this approach have a number of advantages • Strategies are developed that are robust under multiple scenarios -Clear “no regrets” moves

• Strategies have built-out element of optionality • Improved capability to monitor the environment provides visibility 3-5 years out into the future further than today’s strategies -Experience curves -Substitution barriers -Key Technological developments

• Clear decisions are triggered when signposts flash “red” prior to imminent change in the environment • Signposts accord greater time to execute and adjust

This information is confidential and was prepared by Bain & Company solely for the use of our client; it is not to be relied on by any 3rd party without Bain's prior written consent

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Objectives of these materials

• Introduce a framework and methodology to anticipate and act in times of unprecedented uncertainty • Share some perspectives on what the signposts are indicating regarding the future energy landscape

This information is confidential and was prepared by Bain & Company solely for the use of our client; it is not to be relied on by any 3rd party without Bain's prior written consent

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Some key questions to consider for the future mix and pricing of energy:

• We have seen why prices have dropped dramatically for both gas and oil, but why have they nearly doubled from their lows over the past few months? What does that imply for the future?

• The disruptive nature of tight oil and gas experience curves is now well known. Are there other disrupters or major tipping points that are likely to come over the next few years?

• Will the history of past boom and bust cycles in the oil industry hold for the future, or are other forces going to change the dynamics?

This information is confidential and was prepared by Bain & Company solely for the use of our client; it is not to be relied on by any 3rd party without Bain's prior written consent

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Dropping NA supply, and disruptions to supply, have been a primary driver of price increases the past few months

1,000

Italy’s Val d’Agri shutdown

Columbia’s Caño Limon Pipeline disruptions due to rebel

Ekofisk maintenance

Export blockage In Libya

San Pablo Bay Pipeline leak

Kuwait strike

US PRODUCTION

9,900 9,700 Buzzard maintenance

1,500

Canada wildfire

Nigeria’s interruptions Due to leaks and NDA attacks

2,000

Fire at Brazil’s Barracuda-Caratinga

2,500

Kirkuk-Ceyhan sabotage

Thousand barrels per day

3,000

Maintenance in Murban

SUPPLY DISRUPTIONS

9,300 9,100 8,900 8,700 8,500 8,300 8,100

500 0

9,500

Baghdad’s decision to halt pumping oil from Kirkuk into Turkey

Kuwait Canada North Sea Nigeria US Argentina Ghana Italy Columbia Libya Brazil Abu Dhabi Iraq/Kurdistan

7,900 7,700

Weekly Monthly Weekly production plus balancing term

US rig counts have now started to move up Source: Goldman Sachs This information is confidential and was prepared by Bain & Company solely for the use of our client; it is not to be relied on by any 3rd party without Bain's prior written consent

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Another potential disruptor is change in energy sources for demand applications (power and transport) SUPPLY

INTERMEDIARY Percent of sources

•

Transport

•

Conversion

•

Storage

DEMAND Percent of sectors 9

100 9 24 14 53 <1 9

1 76 15 11 7 44 39

91

28 33 3

5 3 92

35

4 23 72 1

22 13 37 26 1

Source: US Energy Information Administration, Bain analysis This information is confidential and was prepared by Bain & Company solely for the use of our client; it is not to be relied on by any 3rd party without Bain's prior written consent

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Li-ion batteries will likely be one of these disruptors as costs continue to trend down the experience curve RECENT TRENDS SUGGEST ~25% REDUCTION IN COST FOR EVERY DOUBLING OF PRODUCTION Li-ion battery/cell cost ($/kWh) [Log Scale] $2,000

Slope: = 75%

1,000 '12

'13

'14

500

'15

200 100 50 25 10

20

50

Cumulated produced capacity (GWh) [Log Scale] Note: This only includes cell cost; Cost in $2015 Source: Bloomberg New Energy Finance, Deutsche Bank, Bain DER analysis; CEMAC; FS-UNEP Global Trends in Renewable Energy Investment 2016 This information is confidential and was prepared by Bain & Company solely for the use of our client; it is not to be relied on by any 3rd party without Bain's prior written consent

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These trends suggest price parity for electric vehicles in the near-term TCO PRICE PARITY FOR EV EXPECTED BY 2020 MSRP + 5 year TCO ($US)

PURCHASE PRICE PARITY FOR EV EXPECTED BY 2022 MSPR ($US)

50,000

50,000

40,000

40,000

30,000

30,000

20,000

20,000

10,000

0 15'

Toyota Camry 200 mile EV 16'

17'

18'

19'

20'

21'

22'

10,000

0 2013

Toyota Camry 200 mile EV 2016

2019

2022

Source: Ark Investment Management This information is confidential and was prepared by Bain & Company solely for the use of our client; it is not to be relied on by any 3rd party without Bain's prior written consent

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As electric vehicle prices reach parity, consumers will increasingly adopt electric vehicles

Brazilâ&#x20AC;&#x2122;s adoption of flex-fuel vehicles was much more rapid, reaching 94% of new car sales in 2013

Purchase price parity TCO parity

Source: Bloomberg New Energy Finance; Ecowatch; ICCT This information is confidential and was prepared by Bain & Company solely for the use of our client; it is not to be relied on by any 3rd party without Bain's prior written consent

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Battery enhancements will also enable increased energy storage for alternative energy AS BATTERY PRICES FALL, ALTERNATIVE ENERGY WILL INCREASINGLY BE PAIRED WITH BATTERIES…

…INCREASING ALTERNATIVE ENERGY APPEAL AS THESE TECHNOLOGIES RAPIDLY COME DOWN THE LEARNING CURVE

Total GW capacity

1,400 1,200

LCOE ($/MWH) 300

Solar paired with batteries Solar without batteries Cumulative small-scale solar

1,000

Solar Wind

200

800 600

100

400 200 0

2015

2020

2025

2030

2035

2040

0 09'

10'

11'

12'

13'

14'

15'

Source: Cleantechnica; Lazard Levelized Cost of Energy Analysis 9.0; GWEC This information is confidential and was prepared by Bain & Company solely for the use of our client; it is not to be relied on by any 3rd party without Bain's prior written consent

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All this will decrease demand for fossil fuels and impact oil/gas prices moving forward EVS EXPECTED TO REDUCE OIL DEMAND CONSIDERABLY…

…BUT CURRENT DEMAND FORECASTS MAY NOT TAKE S-CURVE INTO ACCOUNT Global oil and liquids demand

Expected Mb/d oil offset by EVs 0

150 0

-1

125 -3 -5

IEA expects relatively flat line growth in oil demand

100

75

-7 -10

50 -11

-15

Decreasing demand for oil should maintain lower oil prices

2015

2020

2025

25 -13 2030

2035

2040

0

2015

2020

2025

2030

2035

2040

Potential for Peak Oil Demand in mid 2020’s Source: Bloomberg New Energy Finance; Ecowatch; IEA This information is confidential and was prepared by Bain & Company solely for the use of our client; it is not to be relied on by any 3rd party without Bain's prior written consent

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Additionally, fuel cells could further disrupt the oil and gas marketplace ADVANTAGES OF FUEL CELLS • Higher efficiency than diesel or gas engines

FUEL CELL ADVANCEMENTS • Toyota has spent an estimated $8.8B and 20 years developing fuel cell technology

• Zero pollution • Faster refueling than EVs • Greater range than EVs • Potential weight advantages

• In 2015 Toyota released the Mirai, one of the first commercial fuel cell vehicles

• Toyota also announced royalty-free use of approximately 5,680 fuel-cell-related patents to encourage innovation

As fuel cell costs come down, fuel cell vehicles could further disrupt oil prices and overall mix of energy sources Source: Toyota; SeekingAlpha This information is confidential and was prepared by Bain & Company solely for the use of our client; it is not to be relied on by any 3rd party without Bain's prior written consent

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Given the emergence of these signposts, what does this mean for the energy market?

• Short term uncertainty will remain within the energy market - Typical approaches to forecasting will provide false accuracy

• Comparative changes in costs of alternative technologies will provide guidance around future trends. Tracking experience curves for key technologies can highlight when “tipping points” will be reached.

• More specifically, Li-ion batteries will continue to become more cost efficient, allowing EV’s to displace traditional gas powered vehicles • Solar/Wind energy will increasingly use these batteries to improve alternative energy storage while they become more cost efficient • These newer technologies will offset demand for traditional fossil fuels, putting continual pressure on prices and margins (assuming no major supply disruptions) • Trends in other emerging technologies (such as fuel cells) will need to be monitored to spot disruption before it happens

This information is confidential and was prepared by Bain & Company solely for the use of our client; it is not to be relied on by any 3rd party without Bain's prior written consent

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This information is confidential and was prepared by Bain & Company solely for the use of our client; it is not to be relied on by any 3rd party without Bain's prior written consent

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Appendix

This information is confidential and was prepared by Bain & Company solely for the use of our client; it is not to be relied on by any 3rd party without Bain's prior written consent

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Real breakthrough in storage will come with next generation batteries (not expected until ~2030) BY 2020, BATTERIES STILL NOT COST COMPETITIVE WITH PEAKERS FOR LARGE-SCALE PLACEMENT

NEW LI-ION TECHNOLOGIES PROMISE HIGHER POWER DENSITIES, BUT THE TRUE BREAKTHROUGH WILL BE LI-AIR Li-Air ~4000

Li-ion w/ Si Nanowire 400

Experience curve effect

Lithium Ion 110-140

LeadAcid 25-45

1860

NickelIron 30-40

NickelCadmium 35-60

1910

NickelMetal Hybride 50-75

1960

2010

2020

2030

Source: DOE Electricity Advisory Committee, BCC Research, Electrical Power and Research Institute (2010) Notes: “Other” includes flow batteries, lead acid, and thermal peak shaving (i.e., ice storage) This information is confidential and was prepared by Bain & Company solely for the use of our client; it is not to be relied on by any 3rd party without Bain's prior written consent

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