Corporates

www.fitchratings.com May 3, 2010

Energy (Oil & Gas) US and Canada Special Report

$150 per Barrel Crude Oil: Credit Implications

across the Corporate Sector

Overview Fitch’s outlook for the oil and gas sector in 2010 calls for $70 base case oil prices in 2010, driven by a
combination of weak but positive global economic growth, significant amounts of liquidity being injected into global
financial markets, and the use of energy as a separate financial class to protect against dollar depreciation. As highlighted in
that outlook, non-fundamental factors are a significant driver of crude prices in the current environment, given evidence of
still weak end-user demand in Organization for Economic Cooperation and Development (OECD) countries and ample
spare capacity. According to recent Energy Information Administration (EIA) data, U.S. gasoline demand has entered its
third year of decline in 2010, and has cumulatively dropped over 360,000 barrels per day relative to 2007 levels. In
OECD Europe, 2010 oil product demand across all categories declined 8.0% year over year, according to the latest
International Energy Agency (IEA) data, while OECD Pacific demand declined 0.9%, although growth in China does
provide an offset to these declines. Significant surplus capacity is also evident in low global refining capacity utilization
rates (<80%) and stillsizable spare OPEC capacity (5.1 million barrels per day).

Despite this evidence of lack of tightness in oil markets, the possibility of further increases in crude oil pricing based on
dollar weakness remains an ongoing risk for corporate issuers, given widespread investor concerns about the
unprecedented expansion of the U.S. money supply in the wake of the global recession and looming structural deficits.
While such a spike does not represent Fitch’s base case expectation, Fitch believes there is significant analytic value in
thinking through possible impacts that such a scenario could have on credit quality across a range of corporate sectors and
credits outside of exploration and production in the current still-fragile economic environment. A summary of these impacts
is laid out in the table on page 2. Note that while this report focuses solely on oil, a scenario of dollar weakness would also
affect other dollar-priced commodities which could exacerbate the pressures mentioned in this piece.

The impact of higher oil prices varies by sector but is generally significant. The sectors most vulnerable to a spike in crude
prices include airlines (due to high operating cost exposure to jet fuel and limited hedges); trucking (the relative fuel
inefficiency of moving goods by truck is magnified under higher diesel prices); commodity chemicals (sensitive to oil-
based feedstock pricing, but with cheap natural gas a partial mitigant to higher oil prices); and consumer goods (notable
exposure to resin-intensive business lines and inability to efficiently hedge energy inputs). By contrast, beneficiaries of a
crude oil spike include ethanol producers (due to its rising value as a gasoline blendstock during a crude spike), and
railroads (double benefit of fuel cost savings, and potential for higher traffic due to dollar depreciation-linked exports). An
important credit consideration for most sectors across the space is the degree to which companies have already performed
aggressive adjustments to maintain margins and financial flexibility in response to the last crude oil run-up and subsequent
recession. These actions include workforce reductions, general and administrative cuts, facility closures,

Analysts
Oil & Gas Mark C. Sadeghian, CFA +1 312 368-2090 mark.sadeghian@fitchratings.com

Sean T. Sexton, CFA +1 312 368-3130 sean.sexton@fitchratings.com

Transportation William Warlick +1 312 368-3141 bill.warlick@fitchratings.com

Stephen Brown +1 312 368-3139 stephen.brown@fitchratings.com

Chemicals Tom Dohrmann +1 212 908-0637 tom.dohrmann@fitchratings.com

Agribusiness Judi M. Rossetti, CFA, CPA +1 312 368-2077 judi.rossetti@fitchratings.com

Consumer Grace Barnett, CPA +1 212 908-0718 grace.barnett@fitchratings.com

Related Research

• Airline Credit Navigator, April 13, 2010. • 2010 Outlook for Refiners: Still

Waiting for the Turnaround,

March 23, 2010. • Oil and Gas 2010 Outlook: Exposure to Deflation Remains High, Dec. 15, 2009. • North American Chemicals Industry:

Outlook 2010, Dec. 15, 2009. • Turning up the Heat: Implications of GHG Legislation on Energy and

Related Sectors, Nov. 3, 2009. • Observations of High Commodity Costs on the U.S. and Household Personal Care Sector, Sept. 10, 2008. • 2007 Energy Bill:
Slower Downstream

Growth Ahead, Jan. 4, 2008.

Corporates

2 $150 per Barrel Crude Oil: Credit Implications across the Corporate Sector May 3, 2010

reductions in discretionary capital expenditures, lower dividends, and changes to healthcare and pension benefit programs,
among others. As a result, the ability to offset a future spike in energy input costs through further restructurings in other
parts

of the business is limited at this point in the cycle, as the low-hanging fruit have already been plucked.

The Risk of Dollar Depreciation As seen in the chart below, dollar depreciation accounted for a significant
portion of

Summary Impact of High Crude Oil Price Scenario

Industry Margin Impact Comments
Airlines High and

negative

Jet fuel prices were as much as 35%−40% of industry variable costs during the 2008 spike. Many carriers (Southwest, United, Delta) have more than 40% of
expected 2010 consumption hedged, but others (US Airways, Continental, and AMR) have put on fewer hedges and are more vulnerable to a rapid increase in oil.

Ethanol High and

positive

Ethanol's top line directly benefits from higher crude given its status as a gasoline blendstock. High pump prices are generally expected to increase discretionary
blending; however, oversupply of U.S. ethanol distillation capacity and blend wall issues associated with E-10 may limit market’s ability to participate in upswing.
Move to an E-15 standard (under review by the EPA) would ease blend wall concerns.

Trucking Medium and

negative

Trucking's relative fuel cost disadvantage to railroads (only one-third as fuel efficient as rails) is heightened under a high fuel price scenario. Lags in fuel cost
recoveries and the potential existence of fuel caps in existing contracts could add to credit pressure in a spike scenario.

Railroads Medium and

positive

Higher diesel prices would magnify relative fuel efficiency advantage of railroads over trucks. A dollar depreciation scenario is also likely to spur additional U.S.
exports, increasing railroad capacity utilization and pricing power for shipments to coastal ports.

Chemicals Significant and negative Exposure is higher for commodity chemicals producers (heavy users of oilderivative feedstocks) and lower for specialty
chemicals (more R&D driven

with feedstock a smaller percentage of COGS). Rising oil derivative prices also pressure liquidity through large working capital builds, although these are reversed
when the commodity cycle turns. Some offset for North American producers from cheap natural gas as well as feedstock flexibility.

Consumer Products

Variable and negative Resin-intensive companies (Clorox, Newell Rubbermaid) are among those with highest exposure, while personal care companies (Avon) have
relatively low

exposure. As a matter of policy, industry does not generally hedge commodity costs, increasing pressure on gross margins.

Source: Fitch.

50

100 150

200 250

300 350

400

1/7/05 4/7/05 7/7/05 10/7/05

1/7/06 4/7/06 7/7/06 10/7/06

1/7/07 4/7/07 7/7/07 10/7/07

1/7/08 4/7/08 7/7/08 10/7/08

1/7/09 4/7/09 7/7/09 10/7/09

1/7/10 4/7/10

Real/WTI CAD/WTI USD/WTI Euro/WTI

Source: Bloomberg, Fitch calculations.

WTI in Local Currency, 2005—2010 (Jan. 1, 2005 = 100%)

(%)

Corporates

$150 per Barrel Crude Oil: Credit Implications across the Corporate Sector May 3, 2010 3

the run-up in crude oil prices for U.S. consumers over the past several years, as compared to other better performing
currencies, including the Canadian dollar and Brazilian real. During the height of the crude run-up in the second quarter of
2008, West Texas Intermediate crude oil priced in U.S. dollars hit a high of $145/barrel, an increase of 320% from prices at
the beginning of 2005. However, when priced in Canadian dollars, the increase over the same period was just 265% in local
currency, while the increase priced in Brazilian reais was just 190%, as is seen in the variation in the currency-adjusted
prices of oil in the chart above. By contrast, the euro experienced even greater local currency inflation than the U.S. dollar
over the same period with a 385% local price increase. While market sentiment appears to have swung back in favor of the
dollar recently given rising concerns about sovereign debt in Greece and elsewhere, the volatility seen in foreign exchange
rates above and the large and ongoing U.S. structural deficit highlight the long-term risks of a dollar depreciation scenario.

Airlines Large movements in crude oil and jet fuel prices have had a dramatic impact on U.S. airline operating costs and
margins over the past decade, and the industry’s financial condition remains very sensitive to energy price changes. Even
after years of investment in more modern aircraft and engines with improved fuel efficiency, jet fuel costs still represented
on average between 25% and 30% of total operating expenses during 2009, and would be expected to rise significantly
higher in the event of another crude oil run-up. At the peak of the 2008 energy price spike, by comparison jet fuel
represented 35%−40% of industry operating costs.

Unlike many foreign carriers, U.S. airlines lack a fuel surcharging mechanism that would allow them to pass on higher jet
fuel costs to customers. Instead, as seen in the industry’s response to the sharp energy price spike in early 2008, airlines
must quickly adjust scheduled capacity to support higher fares during a period of extreme fuel price pressure. In addition,
airlines rely to varying degrees on fuel derivatives (in particular jet fuel and crude oil swaps, crude oil call options, and
heating oil-based costless collars) to guard against a scenario in which energy prices move dramatically higher in a short
period of time. Given the difficulties associated with near-term schedule and crew changes, U.S. airlines remain focused on
the need for close-in hedge protection, with the hedged portion of expected consumption generally trailing off to minimal

levels three to four quarters out.

Crude Oil and Jet Fuel Price Relationships Jet fuel prices generally move in lockstep with crude oil during
periods of relative stability in refining capacity. However, refined product supply disruption has at times led to a significant
widening of jet fuel crack spreads. This, in turn, has historically led to outsized movements in jet fuel prices. The most
obvious case of this kind occurred in the fall of 2005, when Gulf Coast refinery outages following Hurricanes Katrina and
Rita pushed distillate fuel crack spreads to historic highs. However, under a scenario of extended dollar weakness, Fitch
anticipates that the main driver for fuel price increases would be the rise in the cost of the underlying feedstock crude oil,
which would tend to push up all fuels in tandem and limit issues of fuel price divergence that could make underlying hedges
ineffective.

Hedging Strategies Diverge During the first half of 2008, as crude oil and jet fuel prices surged, U.S. airlines
generally adopted similar hedging strategies by layering on price caps via swap and costless collar transactions at
progressively higher strike prices. When energy prices reversed in the third quarter of 2008, most carriers quickly found
themselves in a

Corporates

4 $150 per Barrel Crude Oil: Credit Implications across the Corporate Sector May 3, 2010

liquidity squeeze when cash collateral flowed rapidly in the direction of counterparties as contracts were marked to market.
Some carriers (e.g. Southwest Airlines Co. [Southwest] and JetBlue Airways Corporation [JetBlue]) were able to stem
additional cash outflows by exiting long derivative positions. For most of the other airlines, the quick reversal of prices led
to persistent hedge-related losses through 2009 as carriers were effectively locked in at above-market prices.

With the 2008 hedging debacle still fresh in their minds, most airline management teams have trod carefully in their
approach to hedging in 2010. While many carriers (Southwest, United Airlines Corp., and Delta Air Lines, Inc.) have more
than 40% of expected 2010 consumption hedged, others (notably US Airways Group, Inc. [US Airways; Continental
Airlines, Inc.; and AMR Corporation [AMR]) have put on fewer hedges and are more vulnerable to a rapid crude spike.
US Airways, for example, would see annual fuel expense rise by $14 million for each $0.10 change in the price of jet fuel.
In a $150-per-barrel crude oil (approximately $4.00 per gallon of jet fuel) scenario, the carrier would face annualized fuel
cost increases of more than $2 billion. While this is a low-probability outcome, it is clearly a scenario that would threaten to
push US Airways and the entire industry into another deep liquidity crisis. Hedge positions by carrier are summarized in the
table below.

In an effort to limit collateral-related liquidity pressure in a highly volatile energy market like that seen in 2008, airlines
generally have steered away from costless collar derivative structures where call premium costs were offset by proceeds
from the sale of put contracts at low strike prices. Instead, most big carriers are favoring a strategy focused on the use of
crude calls and jet fuel swaps. Although this is a more expensive strategy due to higher net premium outlays, it effectively
eliminates the risk of large cash flow swings in a whipsawing energy price scenario.

Likely Outcomes in a Crude Spike Scenario While some carriers like Southwest have layered on extensive
catastrophic protection at crude oil prices above $120 per barrel, most U.S. airlines lack extensive hedge coverage beyond
the first half of 2010, and would likely move to rapidly trim capacity in response to another jet fuel price shock. In the
aftermath of the huge capacity cuts made in 2008−2009, this would be a difficult task. With the bulk of older, high fuel cost
aircraft already retired, incremental cost reduction opportunities are limited. To offset much higher fuel costs, carriers would
instead be forced to drive fares substantially higher in order to maintain adequate liquidity. In light of the fragile nature of
the nascent recovery in business air travel demand, reliance on rising fares as the primary tool to fight higher fuel prices
would present problems for all U.S. carriers, but particularly those with weaker liquidity and hedge positions (US Airways)
and less fuel-

U.S. Airlines: 2010 Fuel Hedge Positions

Airline % of 2010 Consumption Hedged Avg. Crude or Jet Fuel Cap ($)

AMR/American 33 93/Bbl.

Continental 23 2.23/Gal.

Delta 40 76/Bbl

JetBlue 38 84 to 90/Bbl

Southwest 50 75 to 120/Bbl

UAL/United 54 79/Bbl

US Airways 0 N.A.

N.A. − Not applicable. Source: Company filings.

Corporates

$150 per Barrel Crude Oil: Credit Implications across the Corporate Sector May 3, 2010 5

efficient fleets (AMR). On the flip side, the clear winners in a more protracted highcrude oil scenario would be those with
better relative liquidity and hedge positions (Southwest and, to a lesser extent, JetBlue). Sustained pressure from jet fuel
prices above $3.00 per gallon for more than a few months would almost certainly lead to a renewal of extreme liquidity
pressure on the most vulnerable carriers, with bankruptcydriven cuts in industry capacity the most likely corrective
mechanism for margin stabilization among surviving airlines.

Freight Transportation Unlike the U.S. airline industry, which generally has been unable to pass along higher
fuel costs to passengers, fuel surcharge mechanisms are an established component of pricing among freight transportation
companies. These surcharges historically have shielded freight transportation issuers from the severe margin degradation
that would otherwise occur under a fuel price spike scenario. However, they do not protect against volume impacts linked to
higher fuel pricing, either through reduced overall demand or through volume shifts to other, more fuel-efficient modes of
transportation. A scenario of very high fuel prices amplifies the cost differential between various transportation modes, and
thus increases incentives for incremental switching where possible ⎯ in particular, from trucking to rail and barge modes.

Each of these modes of transportation has specific characteristics that make it more or less appropriate for certain types of
shipments. For instance, barge transportation works well for shipping bulk commodities like coal, grain, and aggregates to
and from port facilities along the inland waterway system when the timing of delivery can vary somewhat. Due to the
limited reach of the U.S. inland waterway system, barge transportation is limited geographically. Railroads are a better
option for bulk loads that require more certainty in the timing of delivery, or that must be transported in parts of the country
that are not served by the inland waterway system. However, they also are somewhat limited by the geographical reach of
the U.S. rail network. Trucks are most appropriate for relatively small shipment sizes or shipments that require more exact
delivery windows. Trucks also have virtually unfettered access to all points within the U.S. without any geographical
limitations, but generally have higher per unit costs than the other modes and are the most exposed to fuel costs. Due to the
limitations noted above, it is common for a shipment to be transported via more than one mode of transportation before
reaching its ultimate destination.
Fuel Consumption Differs by Transportation Mode Inland barge transportation is the most fuel-efficient
mode of freight surface transportation. According to the Texas Transportation Institute’s (TTI) Center for Ports and
Waterways, a single barge can transport the equivalent of 16 railcars or 70 truck trailers, and a single 10,500-

horsepower towboat can push up to 52 barges. Thus, one towboat can move the equivalent of 832 railcars or 3,640 trucks.
In terms of fuel

efficiency, the TTI estimates that barge tows can move a single ton of freight 576 miles on one gallon of fuel, as is seen in
the chart to the right.

155

457

576

100

200

300

400

500

600

Truck Train Barge

Source: Texas Transportation Institute’s Center for Ports and Waterways, the Association of American Railroads.

(Miles/Gallon)

Gallons per Ton-Mile by Transport Mode

Corporates

6 $150 per Barrel Crude Oil: Credit Implications across the Corporate Sector May 3, 2010

After barges, railroads are the second most fuel-efficient mode of freight transportation. According to the Association of
American Railroads (AAR), a single freight train can haul the equivalent of 280 or more trucks. The AAR reports that trains
can move one ton of freight 457 miles on one gallon of fuel, suggesting that trains are about 79% as fuel efficient as barges.
Trucks are the least fuel-efficient mode of freight transportation. Using TTI figures again, trucks can move one ton of
freight about 155 miles on a single gallon of fuel. Thus, trains are 2.9x and barges are 3.7x more fuel efficient than trucks,
respectively.

Fuel Surcharges Mitigate the Effect of Fuel Price Volatility As noted earlier, fuel surcharges are an
established component of freight transportation pricing. Regardless of the actual mode of transportation, all freight
transportation service providers adjust pricing as fuel prices rise and fall. Thus, over the long term, higher fuel prices
theoretically are offset by increased surcharges, limiting the effect that increased fuel costs have on operating margins.
However, in practice there is frequently a lag between when fuel prices rise and when the surcharges are adjusted. These
lags can vary from one week to several months, depending on the nature of the negotiated agreement with the shipper, and
can therefore result in lower margins and potential credit stresses in periods when fuel prices are rising rapidly. While most
Fitchrated entities in the transport space are investment grade and have the balance sheets to withstand the stresses that a
period of under-recovered fuel costs could create, this could become more of an issue in the case of an especially large or
prolonged fuel price increase, or in the case of lower credit quality firms. The flip side is that in periods of rapidly falling
fuel prices, companies can enjoy outsized margins as they over-recover on fuel charges relative to rapidly falling spot fuel
prices.

In 2008, when crude oil prices rose above $140 per barrel and diesel costs reached record levels, another feature of some
shipping agreements became visible. Some contractual agreements, particularly in the trucking industry, contained fuel
surcharge caps that defined a maximum surcharge which would be levied on the customer. As a result of the very high fuel
prices realized in that period, some fuel surcharges hit their caps. As fuel prices rose beyond those points, transportation
providers were unable to increase surcharges further on these shipments, resulting in margin compression. Looking ahead, it
is unclear what percentage of contracts might contain this type of restriction, but to the extent these limitations continue to
exist in certain shipping agreements, there is a risk that higher fuel prices could hit capped levels again in the future.

Fuel Price Spike to Benefit Railroads and Barges From the shipper’s perspective, higher fuel surcharges result
in increased transportation costs. Therefore, when fuel prices rise, the relative fuel efficiency of each mode of transportation
can become more important. Thus, there can be an incentive to move certain types of shipments from railroads to barges,
or from trucks to railroads, in periods of high fuel prices. As mentioned earlier, this cannot be done for all shipments
because of geographical constraints, load sizes, or timing requirements. However, for certain types of shipments, customers
may seek to move to a lower cost mode, if possible, when fuel costs rise. In terms of shipments that could shift from rail to
barge transportation, the most likely candidates would be bulk items, such as coal, grain, aggregates, and liquids.
Particularly good candidates are shipments destined for export that can be transported by barge to ports along the inland
waterway system, such as those along the Gulf of Mexico. Under a scenario of a fuel price spike driven by dollar
depreciation, Fitch believes that inland barges and railroads could enjoy a double upside benefit, as they would not only
benefit from the previously mentioned fuel price differentials, but the weakness of the dollar would also likely spur
additional U.S. exports by making U.S. products cheaper abroad, in the process increasing railroads’

Corporates

$150 per Barrel Crude Oil: Credit Implications across the Corporate Sector May 3, 2010 7

capacity utilization and pricing power. Shipment timing remains a factor, however, so even many bulk commodities
destined for export may remain on the rails if there is a relatively limited time requirement for when the shipment must
reach the port.

With fewer geographical limitations than barges and significant spare capacity at this point in the recovery, the greatest
impact of fuel price-driven substitution is likely to be between trucks and trains. This effect is most pronounced with
intermodal shipments ⎯ those shipments of raw materials or finished goods that are shipped via two or more modes of
transportation before reaching their final destination. Although intermodal shipments likely will still be transported some
distance by truck even in a high fuel price environment, shippers generally have the flexibility to choose to transport these
loads over longer distances by train in order to save costs. In addition, with improvements in rail networks over the past
decade, many railroads now have the ability to compete with trucks directly for short-haul loads traveling less than 1,000
miles. Interestingly, the trucking companies themselves, especially those in the lessthan-truckload (LTL) segment, are large
customers of the railroads, particularly when fuel prices rise. In a high fuel cost environment, LTL truckers likely will
increase their use of railroads for long-distance line haul movements, as hiring a railroad to move the shipment is less
expensive than hiring a truckload operator to move it or even transporting the shipment themselves using their own
equipment.

Chemicals The chemicals industry is one of the largest consumers of energy, as both a feedstock in the production
process and indirectly through fuel and power use. As a result, production costs tend to be highly correlated to the price of
crude oil and natural gas, although individual company exposure is driven by feedstock mix, production technology, and
end-product slate.

Crude Oil as Production Cost Driver Feedstock costs tend to be the largest cost component of chemicals
production, as many chemical products are direct or indirect derivatives of crude oil-based feedstock and raw materials.
Ethylene and polyethylene, the largest basic plastics by volume, are produced using either heavier crude oil-based
feedstocks (naphtha, gas oils) or natural gas-based feedstocks (natural gas liquids, ethane, propane, or butane). The
aromatics benzene, toluene, and xylene, which are generally pulled directly from the catalytic reformer within a refining
stream, are used as building blocks and intermediates in many fibers and resins production chains, including styrenics,
polyurethane, and epoxy. Surfactants, the basic cleaning agent in detergents, household and industrial cleaners, and personal
care staples, can be either petroleum- or plant-based. Energy used in the production process (heat, steam, or electricity) is
also a significant factor in many chemicals operations; however, most energy used in North America tends to be derived
directly or indirectly from natural gas or coal rather than from the oil complex.

Across all uses, energy, used as feedstock as well as fuel and power, accounts for an estimated 60%−80% of total chemicals
production costs. However, the actual exposure varies by end product and subsector. Commodity chemicals including
petrochemicals and basic plastics typically have the highest energy costs, given the large volumes produced and high
feedstock requirements, while specialty chemicals tend to be more R&D driven, and feedstock costs usually rank closer to
the lower end of the range. For example, on the high end, raw material derived from petrochemicals accounted for 85% of
purchases made within Lubrizol Corporation’s Additives segment in 2009. On the low end, expenditures for hydrocarbon
feedstock and energy were just 35% of The Dow Chemical Company’s (Dow Chemical) production costs and operating
expenses over the same time frame.

Corporates

8 $150 per Barrel Crude Oil: Credit Implications across the Corporate Sector May 3, 2010

Competitive Advantage in a Crude Oil Spike Fast-rising rising raw material and energy prices will not affect
all producers and production regions equally, as some regions or segments are structurally better positioned to absorb rising
crude oil costs than others. In a crude oil price spike scenario, North American chemicals would benefit from its large
exposure to natural gas and natural gas liquids. Both sources combined accounted for approximately 54% of all energy
consumed by U.S. chemicals producers, while the share of petroleum use was limited to 23%. In contrast, the use of oil-
based energy sources by the European chemicals industry is estimated to exceed 50%.
Approximately two-thirds of North American ethylene crackers use light natural gas-based feedstock, 15% can switch
between light and heavy feedstock, and only 20% require crude-based heavy feedstock. In contrast, approximately 80% of
European cracker capacity uses heavy feedstock, and very little capacity is flex feed. In a scenario where crude oil prices
spiked but natural gas was flat, European industry production would be at a cost disadvantage, which would be exacerbated
by the significant low cost chemicals

capacity expected online in the Middle East over the next three years.

Production facilities that use lower cost fuels in North America could also benefit in a runaway crude oil

scenario, including Eastman Chemical Company (Eastman; coal gasification at its main Kingsport, TN, facility), and Nova
Chemicals Corporation, whose “Alberta Advantage” (the cash cost advantage of Western Canadian natural gas over U.S.
Gulf Coast ethane feedstocks) would be

expected to rise in a high crude oil scenario. During a period of rising crude oil prices in 2007 and 2008, the Alberta
Advantage increased to $0.17 per pound of produced ethylene, compared to a range of $0.04−$0.11 in the years before.

Ability to Pass on Price Increases to Customers? The cash flow generation of chemicals companies depends in
part on their ability to pass through higher raw material, energy, and transportation costs to customers in a timely manner.
This in turn depends on a variety of factors, including seller and buyer concentration, the degree of product differentiation,
the financial health of buyers, the frequency with which industry prices are trued up to market levels, and industry stock
levels heading into a large price increase. During the 2008 spike in crude oil pricing,

10 20

30

40 50

60 70

80 90

100

North America Europe

Light Feed Flex Feed Heavy Feed

Ethylene Feed

Source: Dow Chemical.

(%)

Other 9%

Natural Gas Liquids 22%

Natural Gas 32%

Coal 5%

Electricity 9%

Petroleum 23%
U.S. Chemical Industry: Energy Consumption by Source

Source: American Chemistry Council.

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$150 per Barrel Crude Oil: Credit Implications across the Corporate Sector May 3, 2010 9

firms implemented multiple price rounds in order to preserve margins. However, in most cases, these increases lagged
expenses as incurred, and were not able to fully recoup margins.

Those chemical companies with exposure to end-user markets decoupled from the economic cycles would tend to be also
favorably positioned. These end-user markets tend to follow different growth drivers, and as such are largely insulated
from the cyclicality of crude oil prices. Examples include agrochemicals, packaging for food and beverages, and ingredients
for personal care and consumer staples. For example, E.I. duPont de Nemours and Company had 29% of its 2008 sales in
the agricultural and food end markets, including ingredients, refrigeration, and packaging. Dow Chemical had 23% of its
pro forma 2008 sales in consumer and institutional goods end markets, besides 9% in agrochemicals and 8% in food.
Diversey’s institutional and industrial cleaners business held up steady during the recession, with an organic sales decline
limited to only 0.2% in 2009. Eastman’s stable end-user markets include packaging with 28% of 2009 sales and tobacco
with 18%. Chemicals companies with meaningful exposure to renewables would also benefit in a sharply higher crude oil
environment. Beneficiaries include materials supporting renewable energies such as photovoltaics or wind, and organically
derived or plant-based materials as a replacement for crude oilbased products.

Working Capital Pressure As is seen in the chart below, the large run-up in crude oil pricing had a sizable
negative impact on working capital during the 2008 crude oil run-up. While this was eventually reversed, rising crude oil
and derivatives prices did have a material impact on cash flow from operations and cash generation over a four-quarter
period beginning in the fourth quarter of 2007 and ending in the third quarter of 2008. Fitch anticipates that similar
pressures would hit the chemicals sector in the event of another run-up in crude oil prices, particularly one which was
sustained over multiple quarters without reversal.

How Well Prepared is the Sector Today for Another Run-Up? North American investment grade
chemicals issuers are reasonably well prepared for another spike in crude oil prices. As a group, producers have
aggressively managed their cost structures in response to the deteriorating demand environment. These actions have
included cutting fixed costs, slashing contractor staff, eliminating discretionary capital expenditures, and managing to
lower inventory levels to improve cash generation. An

4.40 226.60

1,293.00

(902.20) (1,572.50) (1,994.90) (1,437.60)

1,628.20 2,329.50 2,470.80 1,044.60

(2,500)

(1,500)
(500)

500

1,500

2,500

3,500

3/31/07 6/30/07 9/30/07 12/31/07 3/31/08 6/30/08 9/30/08 12/31/08 3/31/09 6/30/09 9/30/09

50

100

150

Change in Working Capital Across Peer Group WTI Crude Oil, Spot

Quarterly Change in Working Capital Vs. West Texas Intermediate Price,

2007—3Q09a

a Peer group comprised of Dow, Dupont, Eastman, and Lubrizol. Source: Company reports, Bloomberg.

($ Mil.) ($/Barrel WTI Price)

Corporates

10 $150 per Barrel Crude Oil: Credit Implications across the Corporate Sector May 3, 2010

exception to this would be those credits whose balance sheets were already weakened from external events heading into
the last downturn. These include credits weighted down by debt-financed acquisitions (LyondellBasell Industries and
Chemtura Corp., both of which filed for Chapter 11 bankruptcy in 2009), or credits burdened with other large liabilities that
could not be financed in the downturn (Tronox Inc., which filed for Chapter 11 as a result of substantial environmental and
other contingent liabilities resulting from its spinoff from Kerr-McGee Corporation in 2006).

However, while flexibility in the sector is reasonable, there are a few key differences between conditions today and during
the run-up in 2008 which could make a crude price spike scenario more challenging for the sector. In general, very high
unemployment (9.7% versus 5.8% seen in 2008), and the lingering softness in key end user markets (automotive,
construction, consumer) would make quick pass-through price increases likely to be much more challenging, putting the
industry under margin pressure. As previously mentioned, issuers with high exposure to commodity chemicals would likely
see meaningful liquidity pressure due to elevated working capital requirements from higher feedstocks. In addition, given
the significant cuts that have been made to date in cost structures, there is likely less fat to remove from the system today if
another retrenchment were called for, making it harder for companies to make up for shortfalls elsewhere by squeezing
additional costs out of their systems.

Ethanol A scenario of sustained higher crude prices should result in higher ethanol profits for ethanol producers given
the pass-through impact of higher crude oil costs on gasoline prices at the pump. While margins would be expected to
improve under such a scenario, the industry’s ability to take advantage of these differentials is constrained by an excess of
U.S. ethanol distillation capacity and an inability to blend ethanol beyond mandated levels (the “blend wall”), currently
capped by the E-10 standard (a maximum 10% blend of allowable ethanol in the gasoline pool). An increase in the
allowed maximum ethanol standard in the gasoline pool from E-10 to E-15 would raise the blend wall and increase allowed
blending volumes in the industry. While such an increase has not yet been approved by the Environmental Protection
Agency (EPA), it is under consideration, with a ruling possible by midsummer.

According to the EIA, crude oil costs comprise the largest single component of gasoline pricing. As a result, all else equal, a
spike in crude oil should boost ethanol revenue and profitability, given ethanol’s direct use as an octane-boosting
blendstock in North American gasoline. Several factors other than the price of crude oil also influence whether ethanol is
profitable for producers, including corn costs, other energy costs used in the distillation process, and co-product prices. One
bushel of corn makes about 2.8 gallons of ethanol. The independent dynamics of corn are a key driver of ethanol
profitability. In addition to using corn, ethanol dry mills produce the co-product distillers dried grains, which is sold to the
protein industry as a feed component. The hypothetical scenario underpinning this report ⎯ a very steep run-up in crude oil
prices based on dollar depreciation, without a similar run-up in other commodity prices ⎯ would be expected to produce an
additional tailwind for ethanol margins, as crude oil would be expected to outpace increases in other commodities, as
opposed to a scenario where a basket of commodities ran up in tandem. Note that the subdued current outlook for both
natural gas and corn also tends to support this view. Forward natural gas pricing remains low due to ample supplies and still
weak U.S. demand. On the corn side, the U.S. Department of Agriculture currently projects corn prices to average $3.50−
$3.70 per bushel for the 2009/2010 marketing year, amid a record North American corn crop of 13.1 billion bushels, which
should provide ample corn supply at the E-10 (10% ethanol) blend level.

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$150 per Barrel Crude Oil: Credit Implications across the Corporate Sector May 3, 2010 11

Impediments to Higher Ethanol Profitability The biggest impediment to higher ethanol profitability is the fact
that U.S. ethanol production is approaching its maximum at the E-10 blend rate. This has been exacerbated by recent
reductions in nationwide gasoline demand, which have effectively lowered the volume of ethanol needed to meet the E-10
standard in the U.S. As mentioned on page 1, U.S. gasoline demand appears to have entered its third year of decline in
2010, and is down approximately 360,000 barrels per day relative to peak levels in 2007. According to the Renewable Fuels
Association, there was approximately 12.6 billion gallons of U.S. operating capacity as of April 27, 2010, with
approximately 0.9 billion gallons of idle capacity and another 1.3 billion gallons under construction. This compares with the
2010 mandate from the Energy Independence and Security Act of 2007 (EISA) of 12.0 billion gallons of conventional
biofuel, mostly from corn, up 14.3% from 10.5 billion gallons in 2009. Thus, current overcapacity will be exacerbated if
more capacity comes on line. As the U.S. ethanol industry approaches the 10% blend wall, higher blend rates or more
vigorous growth in gasoline demand will be needed to achieve the industry growth outlined by EISA. Year-over-year
growth from conventional biofuel is expected to slow significantly as the industry levels off at 15 billion gallons per year in
2015 through 2022, and advanced biofuels (defined as biofuels derived from cellulosic and other non-corn-starch feedstock)
are expected to attain the incremental amounts to reach a total of 36 billion gallons of biofuels annually by 2022 (see chart
on page 12). However, advanced biofuel technologies are at early stages of development and are not currently economically
viable for commercial scale implementation.

While volume expansions in the industry appear to be capped for now, there are several factors worth mentioning which
could provide additional support for ethanol in the future: first, a scenario of very high gasoline prices could increase
political pressure on politicians to “do something,” and could help provide support for increased ethanol usage on a
permanent or seasonal basis. On a similar note, if the advanced biofuel portion of the EISA requirement has not scaled up
yet in significant commercial quantities by 2016, it remains possible that some of the growth earmarked for this category
could be siphoned off to traditional ethanol, again as way of easing fuel pricing pressures on consumers.

The EPA has determined that further testing is necessary to examine the long-term vehicle emission impacts of higher
ethanol blends. Preliminary testing revealed that higher blends may only be allowed for cars built after 2000. The EPA plans
to provide gasoline pump labels to prevent consumers from inadvertently using the wrong fuel. It is also plausible that
lawsuits filed by opponents of higher ethanol blend rates could delay implementation. If approved, higher blend rates in the
near term are also expected to result in increased use of corn, higher committed acreage, and upward pressure on crop
prices. Another factor that needs to be considered is the $0.45 per gallon tax credit for ethanol blenders, also known as the
Volumetric Ethanol Excise Tax Credit, which expires at the end of 2010. The $0.54 per gallon ethanol import tariff also
faces expiration at the end of December 2010. A House of Representatives bill was unveiled in March 2010 that would
extend both the blender credit and import tariff for five years. Without extensions, ethanol profitability is likely to suffer,
leading to facility closures, industry consolidation, and job losses. Given the U.S. commitment to renewable fuels and
growing energy independence, there is a high likelihood that the incentives will be extended. However, allowing the
biodiesel tax credit to lapse at the end of 2009 shows that timely extensions are not guaranteed.

Corporates

12 $150 per Barrel Crude Oil: Credit Implications across the Corporate Sector May 3, 2010

A Comparison to the 2008 Crude Oil Spike ⎯ Corn Prices Spiked Too Mid-2008 incurred a record run-
up in crude oil to $145/barrel but was also accompanied by a record run-up in corn prices to more than $7/bushel. Corn
prices were extremely volatile in 2008, rising approximately 65% from January through early July, and then falling roughly
50% from the July peak through December 2008. The escalation in corn prices was due to several converging factors,
including flooding in the Midwest which led to speculation that a large portion of corn crop would be unsalvageable; strong
demand; and increased investor interest in the sector. Weak ethanol margins led to plant closures and delayed construction
projects. High corn costs and extreme price volatility in mid-to-late 2008 also contributed to bankruptcies of ethanol
companies, most notably one of the largest ethanol producers at the time, VeraSun Energy Corporation. Even large, well
diversified ethanol producers felt the impact of the corn price volatility and soaring crude oil costs. Archer Daniels
Midland Company (ADM) reported that its bioproducts (primarily ethanol) segment profit fell steeply during the quarter
ended Sept. 30, 2008 due to sharply higher net corn costs, as well as higher natural gas cost for manufacturing. High costs
ate into profitability even though ethanol sales prices and volumes were up. However, diversification and strong liquidity
allowed ADM to successfully navigate that challenging period.

Household and Personal Care Consumer Products The consumer products sector is a moderate
overall user of refined products and other oil-related derivatives. Because firms in the space have limited means to negotiate
or offset rising prices being passed on by their suppliers, the impact of a spike in crude oil on gross margins is relatively
high. Within the space, the Clorox Company (Clorox) and Newell Rubbermaid Inc. (Newell Rubbermaid) are known to
have relatively high resin exposure with the Glad and Rubbermaid brands. However, even for those companies not viewed
as oil-derivative intensive, such as Kimberly-Clark Corporation (KimberlyClark; ‘A’/Stable Rating Outlook) and Colgate-
Palmolive Co. (Colgate; ‘AA−’/Stable Rating Outlook), there is a reasonable amount of leverage to energy price
movements.

• During 2008, Kimberly-Clark issued an earnings warning due to pressure on profitability stemming from rising
commodity costs, particularly oil-derived polymers. Kimberly-Clark is typically viewed as a large user of pulp in its tissue
and diaper segments. However, it also has leverage to oil through the manufacturing process as well as for derivatives such
as polymer, purchasing approximately 650 million pounds in 2008. Every $1/barrel increase in crude oil per adds $5
million−$6 million in overhead costs annually in the manufacturing process alone. Increases in polymer costs add to the
company’s burden.

0.0 5.0

10.0 15.0

20.0 25.0

30.0 35.0

40.0

2008 2009 2010 2011 2012 2013 2014 2015 2016 2017 2018 2019 2020 2021 2022

Conventional Biofuel Advanced Biofuel

Energy Independence and Security Act of 2007

Source: Renewable Fuels Association.

(Billion Gallons)

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$150 per Barrel Crude Oil: Credit Implications across the Corporate Sector May 3, 2010 13

• Colgate disappointed equity investors when it announced lower than expected earnings in early 2008, as the magnitude of
the negative impact of commodities on margins was surprising. Raw materials and packaging (input costs) comprise 75% of
Colgate’s cost of goods sold (COGS). While only one-third of the company’s commodity inputs relate to oil (much of the
remainder is to agricultural products in the pet food business), exposure to crude prices remains significant, with every $15
increase in oil resulting in total input cost increases of approximately 1.2%.

The impact of higher commodity prices on margins and cash flow is rapid in the household and personal care sector.
Hedging markets for oil derivatives like resins are generally limited and illiquid, and the correlations between crude oil
prices and oil derivatives pricing such as resins is generally not high enough to allow companies to qualify for hedge
treatment under Financial Accounting Standard 133. As a result of these factors, as well as a relatively short manufacturing-
to-sale cycle (three to five months), consumer products companies do not hedge these inputs, and changes in costs and
inventories related to crude price movements flow through the company’s financial results fairly quickly.
The table on page 14 provides a historical view of what happened to margins for two household products manufacturers
over the 10-quarter period which encompassed the last oil spike in mid-2008. Colgate was chosen because it had relatively
less exposure to oil price movements, in contrast to Clorox, which has higher exposure within the sector. Clorox chose to
absorb much more of the commodity pressure through 2007, in part because some of its segments (trash bags and bleach)
have a high proportion of privatelabel products, which serves to moderate pricing movements as the players manage pricing
parity. As a result its margins suffered to a greater degree and much earlier than Colgate’s. However, both companies
experienced at least a 600-basis-point compression in gross margins during the second half of calendar 2008, although there
were some differences in drivers for the two companies. Clorox’s gross margins were immediately affected by oil spiking in
2008 but then rebounded quickly as oil prices began to fall. For Colgate, as mentioned earlier, only one-third of its inputs
relate to oil prices, with the remainder relating to specialized agricultural materials which are used in its pet food business.
Because these costs were up 18%−20% in the aggregate in the first quarter of 2009, the company continued to experience
higher levels of commodity pressure than Clorox in quarters beyond the crude oil spike.

Corporates

14 $150 per Barrel Crude Oil: Credit Implications across the Corporate Sector May 3, 2010

The sector’s reaction to escalating commodity prices was first to reduce their cost structure via several large-scale
restructuring programs; second to increase prices on their products; and third to exit specific product lines. As polyethylene
and various polymer prices increased during 2008, Clorox took two price increases on Glad trash bags in 2008, as did its
competitor on Hefty trash bags. Clorox later exited the resinintensive private-label trash bag business. Additionally, Newell
Rubbermaid set out a program to exit a selective portion of its North American consumer product portfolio in order to
reduce its consumption of resins from 750 million pounds to 300 million pounds. As can be seen in the table above, these
actions did not entirely offset the tremendous run-up in commodity prices during 2008.

The table above looks at the two highest and two lowest rated Fitch Household and Personal Care companies and how they
performed before, during, and after the 2008 spike. Overall, the Household Products and Personal Care sector has
tremendous liquidity, stable operations, and typically solid investment grade ratings. Despite the intense commodity
headwinds in 2008, the sector remained free cash flow positive with credit metrics commensurate with their ratings.
However, credit metrics did weaken for several companies such as Kimberly-Clark, Clorox, and Newell Rubbermaid. It is
important to note that the weakness in Clorox’s metrics was caused by factors unique to the company, including the $925
million Burt’s Bees acquisition and $750 million accelerated share repurchase program, which was largely funded with
debt. However,

Credit Metrics ($ Mil.)

Free Cash Flow Interest Coverage (x) Leverage (x)

2007 2008 2009 2007 2008 2009 2007 2008 2009

Colgate (‘AA−’) 871 730 1,751 19.2 32.2 40 1.1 1 0.8

Kimberly-Clark (‘A’) 507 660 1,647 12.5 10.7 12.9 1.8 2 1.7

Clorox (‘BBB’) 379 332 334 9.4 6.5 8.8 1.9 3.2 2.3
Newell Rubbermaid (‘BBB’) 263 63 378 7.6 5.5 5.8 2 3.3 2.7

Source: SEC filings.

Gross Margin (Bps)

3Q07 4Q07 1Q08 2Q08 3Q08 4Q08 1Q09 2Q09 3Q09 4Q09

WTI Price End of Quarter ($) 82 96 106 140 107 32 52 69 66 79

Colgate-Palmolive (‘AA−’)

Cost Savings 200 210 170 200 190 170 90 180 220 220

Pricing and Mix 90 110 140 210 270 310 280 310 210 140

Commodities and Other (210) (230) (320) (430) (550) (600) (350) (290) (160) (50)

Gross Margin Change vs. Prior Year in Bps 80 90 (10) (20) (90) (120) 20 200 270 310

The Clorox Company (‘BBB’)

Cost Savings 180 170 150 180 200 210 240 230 170 160

Pricing and Mix 50 40 80 150 230 350 310 250 170 80

Commodities and Other (260) (370) (580) (540) (630) (600) 0 (110) 110 150

Gross Margin Change vs. Prior Year in Bps (30) (160) (350) (210) (200) (40) 550 370 450 390

WTI − West Texas Intermediate. Bps − Basis points. Source: Company reports.

Corporates

$150 per Barrel Crude Oil: Credit Implications across the Corporate Sector May 3, 2010 15

during 2008, a large and sustained increase in commodity pricing was cited as a catalyst for a potential downgrade of
Clorox and Kimberly-Clark. Kimberly-Clark’s margins had declined for a number of years and by mid-2008 leverage had
increased to 2.1x.

As can be seen in the 2009 results, the industry’s margins and metrics bounced back very quickly once commodity prices
declined. Furthermore, many companies in the sector generated record free cash flow and had above-average cash
balances. Of note, several large restructuring programs announced in 2004/2005, such as Colgate’s $1.1 billion program
designed to save $475 million−
$500 million in costs and Kimberly-Clark’s $880 million program to generate pre-tax savings of at least $350 million, both
ended in 2008. While the sector continues to have ongoing cost-saving programs, the ability to effect further large cost-
reduction programs would likely prove more challenging, as the low-hanging fruit have already been plucked. As a result,
companies in the sector are first likely to reduce promotional activities such as coupons and trade support if costs increase
beyond an acceptable level. Some companies could also decrease product sizes to compensate, without the change being
directly perceptible to the consumer. Sustained price increases are likely to result in prices being increased at the retail level.
Fitch anticipates that the sector would likely increase prices in the face of higher commodity pressures to preserve
margins. Recently Kimberly-Clark raised prices in its tissue segment due to higher pulp prices. If there is another spike to
$150 per barrel, Fitch’s focus would be on the following companies, depending on the price of oil/oil derivatives; Fitch’s
expectation of those prices being sustained or increased; as well as recent history that shows covenants, leverage, and
other credit metrics can sometimes approach being out of line with ratings at least briefly.

• Kimberly-Clark ⎯ Leverage has been reduced to pre-2008 spike levels. Several actions were taken to further reduce the
company’s overhead during 2009. Fitch would expect that, barring unexpected management activities such as leveraged
acquisitions or share repurchases, the company would remain at its current outlook and rating unless oil derivative prices
exceed and are sustained above those levels seen in the 2008 run-up.

• Clorox ⎯ The company has a public goal to operate with leverage between 2.0x and 2.5x. For the LTM ending Dec. 31,
2009 the metric was 2.3x. Fitch’s November 2009 Rating Outlook revision to Positive was predicated on the company
continuing to operate within its public leverage goals. During its June 2009 Investor Day, Clorox stated that its 2010
outlook cannot accommodate, “… a run-up in oil [to] the $85, $90, $100 range.” Clorox should not have an issue in fiscal
2010 with the average being below $85, but going forward it does not appear that there is a lot of cushion in the target for
the fiscal year ending June 30, 2011. A modest spike in oil derivative prices might require stronger actions from
management or risk a change in the outlook or rating. However, Clorox still has a number of options to maintain financial
flexibility, such as price increases, a strong history of regularly reducing costs, asset dispositions, or other actions to reduce
debt to remain within its public target, and these also will be considered as part of any rating action.

• Newell-Rubbermaid ⎯ The company has done a lot to reduce its resin exposure. Fitch notes that the cushion in the
company’s most sensitive covenant (debt/capital) became much thinner in the first quarter of 2009 as the high mid2008
prices passed into COGS. However, the company remained in compliance. Since that time, Newell-Rubbermaid has
reduced its resin exposure and cost structure, as well as cut its dividend to preserve cash flow. The debt/capital cushion
has also seen considerable expansion. Oil derivative prices correlated with oil at $150 might affect the rating or outlook.

Corporates

16 $150 per Barrel Crude Oil: Credit Implications across the Corporate Sector May 3, 2010

Conclusion Unsustainably high oil prices, by definition, tend to sow the seeds of their own destruction as consumers
respond to high end-user prices by cutting back on demand. The scenario of a U.S. dollar depreciation based on a run-up in
oil prices would likely create a tailored version of this event, as the spike in pricing and accompanying demand response
would be expected to be largely concentrated in the U.S and dollarpegged currencies. However, even with the rapid growth
of oil demand in emerging markets, the U.S. remains a large enough oil consumer (approximately 22% of 2009 global
demand) that a significant U.S. demand response would be expected to be sufficient to eventually push global pricing back
down. Similar to the aftermath of the 2008 run-up and collapse in crude pricing, Fitch anticipates that a crude oil spike
could create a period of wrenching adjustment for a number of corporate issuers, including airlines, trucking, chemicals, and
consumer products industries. From a credit perspective, however, a key difference between a future crude oil spike and the
most recent run-up lies in the reduced ability of many corporate issuers to offset the impact of higher energy costs through
adjustments and restructurings in other parts of their business, given the aggressive actions most have already taken to
preserve margins and maintain credit quality. As a result, under this scenario, Fitch anticipates that the potential for
negative ratings actions could be higher than previously experienced.

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