US Integrated Oils and Refiners:3Q Upstream Preview,Rigging the Outlook for Growth

3Q16 Preview: Slowly building momentum.

With OPEC (potentially) reducing some of the downside risk to crude, we (aswell as corporates and the market) remain broadly positive heading into 3Qresults, with crude, natgas and activity/production offering the potential ofpositive revisions in 2017. 2H16 acceleration plans across our group havelargely set the stage for 2017, with a likely focus into results on potential '17activity ramps/budget outlooks, continued resource expansion (downspacingand horizon tests) in Permian and STACK, and portfolio management (bothbuying and selling). We favor DVN and APC into the quarter.

Portfolio management (ie. Do you have enough Permian?).

One of the more notable aspects of the explosion in Permian transactions(other than valuations) has been who has been completely absent: Integratedsand large-cap E&Ps. With attention shifting to the long-term outlook forgrowth, large-cap portfolios are under increasing pressure to addressperceived imbalances, both as a seller and a buyer. We expect updates fromPXD/APC/APA/DVN on the outlook for monetization of non-core assets and/orinventory “tails” (eg. PXD’s selling 15k-30k+ non core Midland acres ~YE/16),both highlighting value and funding future core acceleration. In contrast, wesee increasing focus on others (NBL, HES, etc.) to address perceived holes inthe portfolio, but with current valuations proving challenging.

Resource expansion (Permian, STACK) a steady tailwind.

The Delaware and STACK basins have commandeered headlines in 2016 asdownspacing pilots lent support to resource expansion, and land grabs in theDelaware have reheated a once frosty M&A market. In the Delaware we lookfor updated/improving drilling results (APC, DVN, NBL, OXY, APA), deriskingplans (APC – 2nd BS, Avalon; DVN – Wolfcamp), and newdiscoveries/purchases (APA, EOG). In the STACK, we look for well results tocontinue outpacing type curves, and resource expansion on downspacing andas activity moves to the north and west (DVN, MRO). Not to be left behind,initial results from MUR in the Duvernay and Austin Chalk/Upper EF activity inEF should improve long-term outlooks. We provide a full rundown of onshoreactivity on page 6.

Oil growth inflecting, and time to dust off the natgas sensitivities.

With a stabilization in crude offering support for ongoing acceleration plans,we estimate an increase in rig count of 8%/30% by YE16 vs. 1H16/2Q exit,with another 36% increase expected for 2017, helping to drive an inflection incrude volumes into 1Q17. We estimate 3Q oil vols down 1.3% vs. 2Q, but see11% growth by 4Q17 (vs. 3Q16), and look for additional color on 2017 budgetsand medium-term growth outlooks (a la APC/EOG). Likely stillunderappreciated, we see the recovery in natgas (2017 strip now at $3.39/mcfvs. DBe $3.13/mcf) as a material tailwind to operating cash flow for exposednames (APC, DVN highest leverage), with a potential impact on incrementalcapital allocation in “combo” plays, such as DVN’s Cana Woodford. Incontrast, weak international gas pricing and refining margins is likely to weighon Majors’ results (CVX, XOM).

Updating Price Targets.