ANALYTICAL REPORT

2010

CORPORATE FINAN

CE MGT

3470Z

SUMMARY

This analytical report was conducted on Nexen Inc. Nexen was chosen for review as it is a Canadian

based organization. Being residents of the Province of Alberta, we felt it was important to have a

solid grasp of the energy industry and one of its major players to assist us in fully understanding how

fluctuations in this one particular sector can have a major ripple effect for the Canadian economy.

As part of the analysis, we will look at and discuss the following key performance indicators:

The corporate profile and history of the company

The industry and the major competitors

Discussion of the capital structure and efficiency

Weighted average cost of capital analysis

Dividend policy analysis

Investment risk management review

Conclusions and recommendations

1

TABLE OF CONTENTS

Corporate Profile and History 3

Major Competitors 5

Discussion of the Capital Structure and Efficiency 6

Weighted Average Cost of Capital (WAC C) Analysis 12

Dividend Policy Review 15

Risk Management Specific to Investments 18

Recommendations and Conclusions 22

Works Cited 23

2

CORPORATE PROFILE AND HISTORY

Nexen Inc.

Nexen Inc. is a Canadian based, independent global energy leader. Nexen’s suite of assets is unique

while its strategy is value-focused. It has a strong commitment to ethics, integrity and sustainable

business practices.

With a team of 4,000 individuals, strong board and management, and more than 30 years of

consistent profitability, Nexen is builds momentum by delivering solid value for customers, partners,

and shareholders.

Nexen was formed in Canada in 1971 as Canadian Occidental Petroleum Ltd (CanOxy) when

Occidental Petroleum Corporation combined its Canadian crude oil, natural gas, sulphur and

chemical operations into one company.

In the 1970s, Canadian Occidental Petroleum Ltd. broadened its western Canadian asset base and

entered the US Gulf of Mexico. In the 1980s, they grew their western Canadian and Gulf of Mexico

assets through acquisitions and captured an interest in Syncrude.

During the 1990s, Canadian Occidental Petroleum had two major defining events. First, a large

discovery was made at Masila in Yemen and production was commenced in 1993. Second, CanOxy

tripled its Canadian production in 1997 by purchasing Wascana Energy Inc. CanOxy leveraged its

success in Yemen and Western Canada to fund their growth internationally.

In 2001 the name was changed to Nexen Incorporated in recognition of the fact that Occidental no

longer held a significant portion of the company.

Core Business Activities

Explore for, develop, produce and market crude oil, natural gas and power.

Core Oil and Gas Business Locations3

UK - North Sea

Yemen

Gulf of Mexico

Canada

Long Lake

Syncrude

Energy Marketing

Nexen is one of Canada's largest energy marketing companies, selling proprietary and third-party

natural gas, crude oil, natural gas liquids, ethanol, and power in certain regional markets. Nexen has

built a strong, strategic presence within various North American regional markets and extended

their presence into certain global markets as well. They are also a specialized retail provider of

customized electricity and natural gas solutions including green energy and renewable energy

credits (REC’s).

Nexen Marketing

Nexen Marketing is also a specialized provider of customized retail electricity and natural gas

solutions for municipal, commercial and industrial markets in Alberta.

Nexen has been an active electricity and natural gas retailer in the Alberta market since 2003 and

currently provides retail services to more than 1000 commercial, industrial and municipal

customers. Nexen does not provide residential services.

Nexen Marketing is structured as a partnership under Alberta law. The partners are Nexen Inc.

(99.99%) and Wascana Energy 2001 Ltd. (0.01%).

4

MAJOR COMPETITORS

Nexen’s competition in the industry include Suncor, Exxon Mobil and British Petroleum (BP)

Nexen Exxon Mobil BPPE Ratio - LTM 26.8 17.3 11.3

Market Capitalisation 13,506.00 324,398.70185,589.4

0 mil

Latest Shares Outstanding 523.3 4,721.30 3,127.60 mil

Earnings pS (EPS) 0.96 3.98 5.25 $

Dividend pS (DPS) 0.18 1.66 3.36 ¢

Dividend Yield 0.7 2.4 5.7 %

Dividend Payout Ratio 18 42 64 %

Revenue per Employee 1,205,119 3,736,059 2,979,726 $

Effective Tax Rate 31.9 43.5 33.3 %

Float 522.5 4,796.90 0 mil

Float as % of Shares Outstanding 99.9 99.8 0 %

Foreign Sales 3,864 211,653 90,888 mil

Domestic Sales 378 89,847 155,290 milSelling, General & Adm/tive (SG&A) as % of Revenue 8.6 4.9 5.9 %Research & Devlopment (R&D) as % of Revenue 0 0 0 %

Gross Profit Margin 28 29.1 19.8 %

EBITDA Margin 19.4 12.7 14 %

Pre-Tax Profit Margin 14.1 11.5 10.5 %

Assets Turnover 0.3 1.3 1 %

Return on Assets (ROA) 2.3 8.3 7 %

Return on Equity (ROE) 7.1 17.4 16.3 %

Return on Capital Invested (ROCI) 3.6 16.4 13 %

Current Ratio 1.8 1.1 1.1

Leverage Ratio (Assets/Equity) 3 2.1 2.3

Interest Cover 3.6 63.8 23.5

Total Debt/Equity (Gearing Ratio) 0.96 0.09 0.34

LT Debt/Total Capital 49 6 20 %

Working Capital pS 4.37 0.67 2.66 $

Cash pS 3.1 2.26 2.67 $

Book-Value pS 13.82 23.42 32.49 $

Tangible Book-Value pS 13.2 21.87 26.04 $

Cash Flow pS 0.98 6.61 9.17 $

5

KEY FIGURES (LTM): Price info

Price/Book Ratio 1.87 2.93 1.83

Price/Tangible Book Ratio 1.95 3.14 2.28

Price/Cash Flow 26.4 10.4 6.5

Price/Free Cash Flow -9.7 -400 -64.8

P/E as % of Industry Group 137 89 58 %

P/E as % of Sector Segment 14 137 89 %

Financials found at www.advfn.com

DISCUSSION OF THE CAPITAL STRUCTURE AND EFFICIENCY

Nexen’s capital structure is unique when compared to other industry competitors. Management’s

objective is to maintain a capital structure that provides the financial capacity to support flexibility,

liquidity, positive net present value investments and day to day operations. Failing to consider the

financial constraints of the chosen structure can stunt growth and negatively affect the market value

and profitability of the firm. The importance of having a properly managed capital structure is

magnified in times of increased volatility, which is often present in commodity markets. A firm’s

capital structure is a blend of debt and equity used to finance assets and business operations. In

2009 Nexen’s short term debt was comprised of the following current liabilities (as a percentage of

total debt): accounts payable (19.9%), accrued interest payable (.5%), dividends payable (.2%).

Nexen’s long-term liabilities include: long-term debt (47.5%), future income tax liabilities (18.4%),

asset retirement obligations (6.7%), deferred credit and other liabilities (4.46%). Nexen’s debt

obligations account for 66.61% of their capital structure. Equity includes (as a percentage of total

equity), retained earnings (29.35%) and share holder’s equity (4.58%), this amounts to 33.39% of

Nexen’s capital structure. Their debt to equity ratio is 1.995 for 2009, a reduction in total debt when

compared with 2008 (D/E 2.08).

Competitor’s Capital Structure

6

When comparing some of Nexen’s larger competitors, it is apparent their capital structure

differs significantly. Nexen’s capital structure contains approximately twice as much debt to equity

than the selected competitors. Suncor, Exxon Mobile (EM) and British Petroleum (BP) all have debt

to equity ratios much closer to one (1.05, 1.02 and 1.31, respectively). Also, out of the selected

companies, all except EM took steps to either reduce overall firm leverage or increase their equity

position in 2009. Another significant difference in capital structure is that Nexen carries more cash,

on average, as a percentage of total assets. Although Nexen carries more debt than their major

competitors, they are more liquid. Accordingly Nexen has a ratio of 1.76, current assets to current

liabilities. Their competitors positions are less liquid: Suncor 1.06, EM 1.06, BP 1.14.

Notable Changes to Capital Structures

Over the last two years, Nexen’s capital structure grew by 3.4%. The weighting of the structure also

changed, debt decreased by .94% while equity increased by .94%. Suncor grew 114% after merging

with Petro Canada, the weighting of their debt decreased 4.26% and their equity increased by

4.26%. BP continued this trend, growing their capital structure by 3.4% and increasing their equity

weighting by 2.91% and decreasing debt by 2.91%. EM’s structure grew by 2.3%, while increasing

their debt weighting 2.07% and decreasing their equity weighting by 2.07%. All firms issued shares

during 2008 and 2009. (Nexen issued 3,467,253 shares over this period.)

Capital Structure Efficiency and Performance

In order to evaluate Nexen’s Capital structure, it is important to compare it to industry competitors

using the same criteria. Nexen’s profit margin for 2009 was 9.24%, down 11.56 points from 2008

(20.8%). Over the same two years, competitor profit margins were as follows: Suncor 4.5% (down 3

points), EM 6.4% (down 3.4 points), BP (up 1 point). It is apparent that organizations with a lower

debt equity ratio are more stable. With greater leverage you assume more risk. More risk can lead

to profit volatility and less stability; nevertheless, Nexen still out performed competitors despite

7

economic and price conditions, based on their profit margins. Although this is by no means

conclusive, it does speak to the company’s efficiency and the ability to manage costs. Nexen`s return

on assets for 2009 was 2.3%, down 4.8 points compared to 2008 (7.1%). In 2009 both EM and BP out

performed Nexen, 8.3% and 7.1% respectively; however, both EM and BP`s asset returns were also

down when compared to 2008. Suncor`s asset return was surprisingly low at 1.64%, down from 6.6%

the previous year. Nexen`s return on equity (ROE) during 2009 was 7%, down 16.8 points from the

previous year (23.8%). All competitors ROE dropped during 2009, both EM and BP out performed

Nexen based on ROE; however, in 2008 only EM preformed better than Nexen. Another way to

evaluate capital structure is through a firm’s market value. In 2009 Nexen shareholders were willing

to pay $24.32 in share value per dollar earned, second only to EM whose investors paid $16.8 per

dollar of earnings. (Suncor $34.27 and BP $64.58)

Risk Management

Based on Nexen’s capital structure it is apparent that holding more debt exposes them to greater

risk. Nexen invests in capital intensive projects, purchases and sells commodities, issues short and

long term debt, while operating internationally. All of these undertakings result in more risk. When

oil prices fall it drastically affects cash flow and expected revenues. In order to reduce this risk,

management actively pursues “financial derivative contracts, including energy-related futures,

forwards, swaps and options” (Nexen Annual Report p.171). This helps to set a price floor, mitigating

some of the risk associated with commodity price fluctuations. However, management also

understands that prices pertaining to oil supply tend to fluctuate in a favourable direction. This is

why they prefer not to match their actions of offsetting risk too closely, remaining open to benefit

from potentially favourable volatility in short term contracts. [This strategy helps to explain the large

performance gaps between 2008 and 2009, caused by oil prices swings and economic uncertainty,

(specifically profit margin and return on equity)] This strategy augments the upside, while mitigating

8

down turns similar to those seen in 2009. Management also continually monitors volatility by

performing stress tests to assess abnormal changes in commodity price (best and worst case

scenarios). Nexen also faces fluctuation in foreign currencies. To reduce risk in this area Nexen

conducts most of their business in U.S. dollars to reduce currency costs, “we manage our exposure

to fluctuations between the US and Canadian dollar by maintaining our expected net cash flows and

borrowings in the same currency. Cash inflows generated by our foreign operations and borrowings

on our US-dollar debt facilities are generally used to fund US-dollar capital expenditures and debt

repayments” (Nexen Annual Report p.172). They also maintain “revolving” Canadian and US

borrowing facilities to help manage expected cash flows. This reduces the costs and risk associated

with continually swapping currencies. Nexen also actively engages in currency contracts and swaps,

for use during more significant exposures. Nexen does “not have any material exposure to highly

inflationary foreign currencies” (Nexen Annual Report p.173). Liquidity risk refers to the risk

associated with not meeting current financial obligations. Nexen pays close attention to this

potential business risk. Many projects have lengthy capital intensive periods before they produce

cash flow from operations, for this reason liquidity is very important. Nexen also operates a capital

structure with more debt as a percentage of total structure than most of their larger competitors. So

maintaining sufficient liquidity is essential in covering maturing liabilities. For this reason, Nexen’s

management team maintains plenty of cash and unused credit facilities, amounting to over 3.3

billion. These measures help ensure liquidity.

9

Exhibits 1 & 2 (in Millions)

Capital Structure 22,900 69,746 235,968 233,323

Nexen SuncorExxon Mobile

(EM)British Petroleum

(BP)Key Ratios 2009 2008 2009 2008 2009 2008 2009 2008Profit Margin 0.0924 0.208 0.045 0.075 0.064 0.098 0.07 0.06Return on Assets 0.023 0.071 0.0164 0.066 0.083 0.198 0.071 0.095Return on equity 0.07 0.238 0.034 0.147 0.167 0.385 0.164 0.235Debt/Equity 1.995 2.08 1.05 1.24 1.022 0.94 1.31 1.48Total Debt 0.66 0.675 0.511 0.554 0.51 0.485 0.57 0.6Cash Ratio 0.54 0.59 0.06 0.19 0.205 0.64 0.14 0.12Current Ratio 1.76 1.73 1.06 0.91 1.06 1.47 1.14 0.95Capital StructureDEBT% 66 67.5 51.1 55.4 51 48.5 57 60EQUITY% 34 32.5 50.1 54.4 49 51.5 43 40Market ValuePrice/earnings* 24.32 34.27 16.8 64.58EPS (dollars) 1.03 3.26 0.96 2.29 3.99 8.7 0.88 1.12*Number of dollars paid for one dollar of earnings

10

NEXEN

11

COMMON SIZE BALANCE SHEETASSETS 2009 2008Current AssetsCash and Cash Equivalents 7.40% 9.04%Restricted Cash 0.86% 0.46%Accounts Receivable 12.17% 14.28%Inventories and Supplies 2.97% 2.20%Other 0.81% 0.76%Total Current Assets 24.24% 26.73%

Property, Plant and Equipment 67.65% 67.35%Goodwill 1.48% 1.76%Future Income Tax Assets 5.00% 1.58%Deferred Charges and other Assets 1.62% 2.57%Total Assets 100.00% 100.00%

LIABILITIESCurrent LiabilitiesAccounts Payable and Accrued Liabilities 13.27% 15.01%Accrued Interest Payable 0.39% 0.30%Dividends Payable 0.11% 0.12%Total Current Liabilities 13.77% 15.43%

Long-term Debt 31.66% 29.69%Future Income Tax Liabilities 12.28% 11.82%Asset Retirement Obligations 4.45% 4.62%Deferred Credits and Other Liabilities 4.46% 5.98%TOTAL LIABILITIES 66.61% 67.55%

EQUITYNexen Inc Shareholders Equity 4.58% 4.43%Contributed Surplus 0.00% 0.00%Retained Earnings 29.35% 28.39%Accumulated Other Comprehensive Loss -0.83% -0.60%Total Equity Nexen Inc 33.11% 32.22%Canexus Non-Controlling interest 0.28% 0.23%TOTAL EQUITY 33.39% 32.45%TOTAL LIABILITIES AND EQUITY 100.00% 100.00%

12

WEIGHTED AVERAGE COST OF CAPTIAL ANALYSIS

WACC = (E/V) x RE + (P/V) x RP + (D/V) x RD x (1- TC)E = Market value of the firm’s equityD = Market value of the firm’s debtV = Market value of the firm’s combined debt and equityRE = Cost of equityRP = Cost of preferred stockRD = Cost of debtTC = Corporate tax rate

Rf = credit-adjusted risk free rate = 5.9%β = 1.56D = $15,254,000,000Stock outstanding = 522,915,843Stock Price = $24.19Total Equity Value = 522,915,843 x $24.19 = $12,649,334,242.17RM = 8.20%Market Risk Premium = 2.3%RE = 5.9% + 1.56 x 2.3% = 9.488%V = 27,903,334,224.17RD Yield to Maturity = 3.09%TC = 29%

WACC = (12,649,334,242.17/27,903,334,224.17) x 9.488% + (15,254,000,000/27,903,334,224.17) x 3.09% x (1-.29)=.4533 x 9.488% + .5467 x 3.09% x (1-.29)=.05500 x 2= 11% = WACC

EnCana Weighted Average Cost of CapitalWACC = 9%Rf= 4.5%Cost of Debt = 6.7%Equity Risk Premium = 5.0%Beta (unlevered)

0.96

Industry D/E 35.5%

Tax Rate (5 yrs) 26.2%

Beta (relevered) 1.22

Cost of Debt (after-tax)

4.9%

Debt / Capital 26.2%

13

WAC (debt) 1.3%

Cost of Equity (capm)

10.6%

Equity / Capital 73.8%

WAC (equity) 7.8%

Cenovus Weighted Average Cost of CapitalRisk Free Rate

4.5%

Cost of Debt 6.7%Equity Risk Prem 5.0%Alpha 0.0%Country Risk Premium

0.0%

Industry WACC CalculationBeta (unlevered) 1.48Industry D/E 26.9

%Tax Rate (5 yrs) 24.0

%Beta (relevered) 1.78

Cost of Debt (after-tax)

5.1%

Debt / Capital 21.2%

WAC (debt) 1.1%

Cost of Equity (capm)

13.4%

Equity / Capital 78.8%

WAC (equity) 10.6%

WACC = 12%

WACC calculations found at www.wikiwealth.com/research

Corporate tax rate is taxable at 19% from the federal level and 10% on a provincial level.

Cost of equity is the credit-adjusted risk free rate of 5.9% plus their beta of 1.56 times the market

risk premium of 2.3%. Debt is strong for the company as it reduces the cost of capital so they can

14

accept projects with a lower NPV. With a lower weighted average cost of capital the firm will be able

accept projects with lower hurdle rates thus providing a competitive advantage for the firm.

Cost of Debt – Yield to Maturity

A) 233/7251 = 3.21% x Int Rate 2.2% =.0007062B) 1570/7251 = 21.65% x Int Rate 1% =.002165C) 52/7251 = .72% x Int Rate 6.57% ¼ -1.6425 =.0011826D) 523/7251 = 7.2% x IR 5.05% ½ - 2.525 =.001818E) 46/7251 = .63% x IR 8.00% ½ - 4.00 =.000252F) 262/7251 = 3.6% x IR 5.2% ½ - 2.6 =.000936G) 262/7251 = 3.6% x IR 5.65% ½ - 2.825 =.001017H) 314/7251 = 4.3% x IR 6.2% 1/2 – 3.1 =.001333I) 209/7251 = 2.9% x IR 7.4% ½ - 3.7 =.001073J) 523/7251 = 7.2% x IR 7.875% ½ - 3.9375 =.002835K) 827/7251 = 11.4% x IR 5.875% ½ - 2.9375 =.00334875L) 1308/7251 = 18.0% x IR 6.4% ½ - 3.2 =.00576M) 733/7251 = 10.1% x IR 7.5% ½ - 3.75 =.0037875N) 481/7251 = 6.6% x IR 7.35% ½ - 3.675 =.0024255

=.03090755 -> 3.090755%

DIVIDEND POLICY REVIEW

15

Nexen, similar to many other firms in the industry follows a compromise dividend policy. This policy

allows the company not only to focus on keeping enough money to cover capital budgeting projects

but also maximizes shareholder wealth by avoiding dividend cuts and maintaining stable dividend

payments.

This can be observed through the dividend payments Nexen has issued over the last five years:

Table obtained from: www.nexeninc.com

16

Dividend Increase (Board of Directors July 1, 2008)

Stock Split 2 for 1

Stock Split 2 for 1

Declared Record Payable Amount Type

10/28/2009 12/10/2009 01/01/2010 Cdn$0.050 Cash

07/16/2009 09/10/2009 10/01/2009 Cdn$0.050 Cash

02/12/2009 03/10/2009 04/01/2009 Cdn$0.050 Cash

10/29/2008 12/10/2008 01/01/2009 Cdn$0.050 Cash

07/17/2008 09/10/2008 10/01/2008 Cdn$0.050 Cash

07/04/2008 06/10/2008 07/01/2008 Cdn$0.050 Cash

02/14/2008 03/10/2008 04/01/2008 Cdn$0.025 Cash

10/24/2007 12/10/2007 01/01/2008 Cdn$0.025 Cash

07/12/2007 09/10/2007 10/01/2007 Cdn$0.025 Cash

05/26/2007 06/10/2007 07/01/2007 Cdn$0.025 Cash

02/15/2007 03/10/2007 04/01/2007 Cdn$0.050 Cash

10/25/2006 12/11/2006 01/01/2007 Cdn$0.050 Cash

07/13/2006 09/10/2006 10/01/2006 Cdn$0.050 Cash

04/27/2006 06/10/2006 07/01/2006 Cdn$0.050 Cash

02/17/2006 03/10/2006 04/01/2006 Cdn$0.050 Cash

10/13/2005 12/9/2005 01/01/2006 Cdn$0.050 Cash

07/14/2005 09/09/2005 10/03/2005 Cdn$0.050 Cash

05/27/2005 06/10/2005 07/01/2005 Cdn$0.050 Cash

02/10/2005 03/10/2005 04/01/2005 Cdn$0.100 Cash

10/14/2004 12/10/2004 01/01/2005 Cdn$0.100 Cash

Maintaining a target debt to equity ratio is one key element of a compromise dividend policy.

Although Nexen D/E ratio fluctuates (1.995 in 2009 and 2.08 in 2008) they still meet this

requirement since their “debt/equity ratios are viewed as a long-range goal” (Fundamentals of

Corporate Finance/ Stephen A. Ross…[et al.] P.533) Nexen has also been able to maintain a stable

and consistent dividend payment, which has only changed whenever there has been a stock split

(splits occurred on May 2005 and May 2007, [Nexeninc.com]), and increases only occur when future

earnings are sufficient to maintain it. (Nexen’s divided increased to 0.050 as per Board of directors

meeting held on July 1, 2008 [nexeninc.com]).

Stock splits do not affect the underlying value of the company. Typically, a corporation will initiate

stock splits to increase the number of shares outstanding, reducing the price of each share to make

it more affordable to smaller investors. This also provides a signal to the market, indicating that the

company’s share price has been increasing and it will continue to grow in the future. As of

December 31, 2008 Nexen had 1,624 registered shareholders and 519,448,590 common shares

outstanding. (nexeninc.com)

Nexen has performed five stock splits since they became a publicly traded company:

Declared Record

May 2007 2 for 1

May 2005 2 for 1

May 1996 2 for 1

September 1987 2 for 1

December 1979 3 for 1

17

Shareholders approved a two-for-one share split at the Annual Meeting on April 26, 2007. Common

shares began trading on a dividend basis on May 8, 2007 on the TSX and on May 16, 2007 on the

NYSE. *** Table obtained from Nexen website: nexeninc.com

The benefit of maintaining a stable dividend and following a compromise divided policy rather than

following the residual divided policy is that it instill confidence it the investors the that the company

will perform well; even if there is a drop in earnings the constant divided payment lets investors

know that the decline is only temporary. A fluctuating payment policy leads to uncertainty, investors

are often left wondering whether they will receive a higher or lower divided payment due to lower

earnings or because the company may be having difficulties.

Another reason to follow a stable dividend policy is that many investors use dividends for current

consumption. Having a stable dividend can attract investors who are looking for a “steady” regular

income.

Overall Nexen meets all the requirements of a compromise dividend policy (avoids cutting back

positive NPV projects to pay a dividend, avoids dividend cuts, avoid the need to sell equity, maintain

a target debt/equity ratio, maintains a target dividend payout ratio [Fundamentals of Corporate

Finance/ Stephen A. Ross…[et al.].—6th Canadian Edition. P.533]).This policy seems appropriate for

this type of business, providing a stable return for investors.

If Nexen were to follow a residual dividend policy it could lead to high dividend payment volatility

and would likely be attractive to investors who are indifferent to fluctuating dividends. This constant

fluctuation will affect share prices since it increases on the announcement of dividend increases and

dramatic (share-price) decrease when firms reduce dividends.

RISK MANAGEMENT SPECIFIC TO INVESTMENTS

18

Nexen invests in significant capital projects; they purchase and sell commodities, issue short-term

borrowings and long-term debt and invest in foreign operations. These activities expose them to

market risks from changes in commodity prices, foreign currency rates and interest rates, which

could ultimately affect their earnings and the value of the financial instruments they hold. Nexen

uses derivatives for trading and non-trading purposes as part of their overall risk management policy

to manage these market risk exposures. The following market risk discussion relates primarily to

commodity price risk and foreign currency risk related to their financial instruments as their

exposure to interest rate risk is immaterial given that the majority of Nexen’s debt is fixed rate.

Commodity Price Risk

As Nexen is an oil and gas company, they are constantly exposed to changes in Oil and Natural Gas

prices specifically. There are many worldwide variables which are outside of Nexen’s control which

can affect the daily and contracted prices for these commodities.

Demand drivers such as season, short and long term weather forecasts and general economic

conditions can substantially change the prices but can be reasonably forecasted.

Supply drivers, such as coal generation outages, wind generation, West Texas Intermediaries price

influence on natural gas, and reserve margins can be fundamental factors in price swings for these

commodities.

Fundamental Factor Effect CommentsDemand

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Weather Outlook Bearish Return to normal summer conditions

Economic Outlook Bearish - Neutral

Economic contraction for the world economy, recovery in 2010

SupplyCoal Unit Outages Neutral Outages forecasted as per typical seasonal levels.Wind Generation Bearish Wind generation typically increases in winter months

WTI Bullish – Neutral

West Texas Intermediaries (benchmark in oil pricing) forecast is for oil prices to increase slightly as a result of decreased supply.

Natural Gas Prices BearishLower gas costs = Lower cost to produce electricalenergy from gas fired generators.

Reserve Margin BearishNew generation projects will increase spare capacitywithin the system.

Environmental Regulations NeutralNo major changes coming to Alberta’s GHG regulations in the next 3-months

Liquified Natural Gas (LNG)Reserves Bullish – NeutralLNG supplies being sold offshore for higher prices continue to drive down supply in North America

In order to manage the commodity and foreign exchange price risks that come from the physical

business, Nexen uses financial derivative contracts, including energy-related futures, forwards,

swaps and options, as well as currency swaps or forwards. However, the majority of their oil and gas

production is sold under short term contracts giving additional exposure to short term price

fluctuations.

Foreign Currency Risk

Foreign currency risk is created by fluctuations in the fair values or cash flows of financial

instruments due to changes in foreign exchange rates.

A substantial portion of Nexen’s activities are transacted in or referenced to US dollars, including:

Sales of crude oil, natural gas and certain chemicals products; Capital spending and expenses for our oil and gas and chemicals operations; Commodity derivative contracts used primarily by our energy marketing group; and short-

term borrowings and long-term debt.

20

Nexen also have exposures to currencies other than the US dollar, including a portion of their UK

operating expenses, capital spending and future asset retirement obligations, which are

denominated in British pounds and Euros. Nexen does not have any material exposure to highly

inflationary foreign currencies. In the energy marketing group, transactions are entered into in

various currencies, including Canadian and US dollars, British pounds and Euros.

Credit Risk

Credit risk is the risk that one party to a financial instrument will fail to discharge an obligation and

cause the other party to incur a financial loss.

The following table illustrates the composition of Nexen’s credit exposure by credit rating:

Credit Rating 2009 2008A or higher 67% 65%BBB 26% 29%Non-Investment Grade 7% 6%Total 100% 100%

It would appear that very little has changed to Nexen’s credit exposure from 2008 to 2009. The

holdings for A (R-1) rated securities increased slightly but were offset by a decrease in BBB bonds

and other non-investment grade securities. Nexen has a relatively strict investment policy which

specifically sets out risk management techniques in order to mitigate their credit risk exposure.

Much of the credit analysis is done by in house expertise rather than relying on rating agencies, they

diversify their exposure across numerous organizations while receiving letters of credit or collateral

and constantly reviewing the counterparty credit limits.

Liquidity Risk

21

Liquidity risk is the risk that an organization will not be able to meet their financial obligations as

they fall due. Nexen generally relies on operating cash flows to provide liquidity. They also maintain

significant unused credit lines. At December 31, 2009, Nexen had about $3.3 billion of cash and

available undrawn committed lines of credit. This includes $1.7 billion of cash and cash equivalents

on hand and undrawn term credit facilities of $1.6 billion of which $407 million was supporting

letters of credit at December 31, 2009. The committed term credit facilities are available until 2012

unless extended. Nexen also has $492 million of undrawn, uncommitted credit facilities, of which

$86 million was supporting letters of credit at year-end. (Nexen Annual Report, pg .173)

Nexen’s quick ratio is currently 1.4 which shows that there is $1.40 of current assets, exclusive of

inventories, to meet each $1 of current liabilities. In the energy sector, there is no absolute standard

for this ratio; however, by comparison to its industry peers, this suggests a good liquid position.

This ultimately shows that Nexen has capacity to service their debt in a timely manner.

RECOMMENDATIONS AND CONCLUSIONS

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Nexen is a large company in among giants. One significant difference between Nexen and their

competitors is they use more debt to finance operations. They support this capital structure by

having an ample supply of liquid assets and credit facilities to support fluctuating cash flows (caused

by capitally intensive projects) with over $3 Billion in cash to demonstrate solid financial capacity. In

2009, Nexen’s profit margin dropped more than their competitors (down 11.56 percentage points);

however, they still out performed Exxon Mobile, British Petroleum and Suncor. Nexen’s profit

margin is strong when compared to their competitors. This is partly due to the notion that the

earnings of leveraged companies increase faster during an upswing in the business cycle than the

earnings of companies without or with less leverage. Conversely, the earnings of a leveraged

company typically collapse more quickly in response to deteriorating economic conditions. This is

not always so with Nexen. Nexen’s ability to manage operational costs and cash flows could be

considered one of their core competencies. Nexen also posted competitive returns on assets and

equity. Financially, Nexen seems to be managed to maximize shareholder’s wealth.

From an investment perspective, Nexen’s earnings fluctuated significantly over 2008 and 2009;

however, their lows were not too low and their highs are impressive. Nexen’s share price was less

than both Suncor and British Petroleum when compared to earnings, second only to Exxon Mobile.

Nexen also pays a steady, recently increased dividend and has a good credit rating, making capital

cheap and readily available. Considering their global presence, project diversity and strong risk

management, Nexen would be of good investment quality. As a strong performer with potential,

Nexen could be an excellent portfolio alternative to some of the larger more mature oil companies.

WORKS CITED

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British Petroleum. 2009 Annual Report,. Retrieved from: http://www.bp.com/extendedsectiongenericarticle.do?

categoryId=9021605&contentId=704094

Exxon Mobile. 2009 Annual Report,. Retrieved from: http://thomson.mobular.net/thomson/7/2946/4183/document_0/XOM_2009F&O.pdf

Nexen. 2009 Annual Report,. Retrieved from: http://www.nexeninc.com/~/media/Files/AnnualReports/2009/Nexen_2009_AR.ashx

Suncor. 2009 Annual Report,. Retrieved from: http://www.suncor.com/pdf/suncor_annual_report_2009_en.pdf

www.nexeninc.com

Ross et. Al., Fundamentals of Corporate Finance. Sixth Canadian Edition. McGraw- Hill Ryerson, 2007

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