Drillers and Dealers May 2011

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Editors Remarks
The Student Becomes The Master

Pop quiz: in what city will you find more Michelin-star restaurants per inhabitant than any other in the world? Paris? London? Nope, the answer is Tokyo. That may come as a surprise until you start to think about it and realise that the Japanese are the masters of imitation. Whether its a wristwatch, a train, or French cuisine, the Japanese have built an economic empire on reverseengineering and then improving technology. I was prompted to think about that bit of trivia at the Oil Councils press conference held last Thursday in London. On that morning there was a fascinating discussion about two things: The nature of IOC/NOC partnerships, and the importance of innovation to success in an increasingly competitive and globalised world. It wasnt Japan that was on anyones mind however, but China. Right now there is an unprecedented transfer of knowledge flowing from IOCs to Asian NOCs technological, management, and organisational knowledge, and the Chinese, Koreans, and others are paying a premium for it. We see this in the inflated prices the Chinese have been paying for assets in strategic plays like shale in North America. The question was raised: will the Chinese continue to work with the IOCs in the future or will they, as it were, learn what they can in the next 5-10 years and slink away to go it alone? Telecommunications infrastructure circa 2002. There is a precedent for this. A decade ago, the market for telecommunications infrastructure gear was dominated by the likes of Ericsson, Nokia, Alcatel-Lucent, Nortel, and a dozen other European and Western firms. Two Chinese upstarts, Huawei and ZTE, were confined to their own domestic markets, but backed by central Government and hungry to expand. In the early 2000s, they began to form strategic alliances and partnerships with their Western counterparts with 3com, Siemens and the like at a time when their market was predominantly domestic-driven. Less than a decade on from those first tentative steps, the global market is dominated by the dynamic duo of Huawei and ZTE, who are not just eating the Europeans lunch, but their dinner and breakfast too, with only Ericsson able to stake a credible claim as a leader in telecommunications infrastructure. Cisco, Motorola, Intel, and some other niche players have cried uncle and given up trying to compete with the Chinese by exiting the market all together. Nortel, once Canadas biggest company, and a major player, is now defunct. The new resource nationalism of the Chinese in the hydrocarbon sphere reveals a similar pattern of behaviour; where she perceives a strategic priority, China acts singlemindedly in pursuit of its goal, backed by seemingly bottomless funds, and virtually impervious to external pressures. So how do the IOCs plan to compete with the deeply liquid NOCs over assets after theyre no longer sought for strategic partnerships? The new innovators Innovation is a good candidate as an answer to that question. And even here there are signs that China is not just learning from the West in the practical sense that implies technical mastery, but they are learning the importance of innovation; they are learning how to innovate. The knockout success of Huawei and ZTE wasnt merely about having lots of money. They recognized the importance of R&D and invested heavily in it so that they wouldnt have to form strategic partnerships to get their hands on intellectual property. Now, having crippled their opponents, they lead the way in cutting edge technology such as 5G. In the oil and gas industry, it is the West that holds the high cards in terms of innovation, you only have to look at the plethora of nimble, independent, tech-savvy, E&P firms listed on the TSX, AIM and ASX to see the spirit of entrepreneurialism is alive and well. But we shouldnt assume there is anything pre-ordained about this. Of course, there are major differences between oil and mobile masts that preclude a crude comparison. And more to the point, you might be thinking that theres no zerosum game here to be worried about. I dont care where the oil is being drilled and who is drilling it, you might say, as long as its being drilled, pumped, and piped to market. But as NOCs become IOCs and the distinction between the two becomes meaningless, the IOCs who have traditionally dominated the marketplace will find themselves increasingly in competition with the globalising NOCs for market share, and as Darwin would have it: survival is the prize not for the strongest, but for the one who adapts fastest. p.s. I hope you can join us on the night of Thursday 17th November for our Awards Dinner. Were proud to announce that Lord John Browne is our Guest Speaker.
Drillers and Dealers :::
::: May 2011 Edition
Welcome to Drillers and Dealers May 2011
Drillers & Dealers

Official Publication of The Oil Council 3rd Floor 86 Hatton Gardens London EC1V 8QQ, UK Editor Drake Lawhead Vice President, Content and Member Relations drake.lawhead@oilcouncil.com T: +44 (0) 20 7067 1873 Editor-at-Large and Media Enquires Iain Pitt COO iain.pitt@oilcouncil.com T: +27 (0) 21 700 3551 Publisher Ross Stewart Campbell CEO ross.campbell@oilcouncil.com T: +44 (0) 20 7067 1877 Partnership Enquires Vikash Magdani Executive Vice President, Corporate Development vikash.magdani@oilcouncil.com T: +44 (0) 20 7067 1872 Advertising Enquires Eric Anderson Vice President, Sales eric.anderson@oilcouncil.com T: +44 (0) 20 7067 1876 Laurent Lafont Vice President, Business Development laurent.lafont@oilcouncil.com T: +44 (0) 20 3287 3447 Ken Lovegrove Vice President, Business Development ken.lovegrove@oilcouncil.com T: +1 604 566 4949 North American Media Enquiries Jay Morakis Partner JMR Worldwide jmorakis@jmrworldwide.com T: +1 212 786 6037 To Be Added to Distribution List Email: info@oilcouncil.com More Information At www.oilcouncil.com
Contents
Sustainable Development in the Petroleum Industry
Dr. Abdul-Jaleel Al-Khalifa, CEO, Dragon Oil
Special Focus on M&A and A&D Executive Q&A

Paul Atherton, CFO, Heritage Oil
11 13
Upstream MA&D Activity through the Financial Crisis, Recovery & Beyond
Mark Llamas, Managing Director, Divestments, FirstEnergy Capital Acquisitions &
What is the Potential Impact of the Increase in the Supplementary Charge on M&A?
Mark Andrews, Partner, KPMG
16
Plenty of Heat, But Wheres the Light? Unlocking M&A Opportunities in Oil and Gas
Jon Clark, Director and Head, UK Oil & Gas Transactions, Ernst & Young
19
THE LEGAL CORNER What are the most common mistakes made by oil & gas companies buying and selling in today's M&A markets, and how can they be overcome?
Legal Perspectives from Across the Globe
23
OC Columnists Whats New Online? Meet The Member Insights from The Oil Councils NYC Press Briefing (April 2011) Industry Versus Equity Market: North Sea Asset Valuation Trends
Martin Copeland, Managing Director, Lexicon Partners
Copyright, Commentary and IP Disclaimer: *** Any content within this publication cannot be reproduced without the express permission of The Oil Council and the respective contributing authors. Permission can be sought by contacting the authors directly or by contacting Iain Pitt at the above contact details. All comments within this magazine are the views of the authors themselves unless otherwise attributed to their company / organisation. They are not associated with, or reflective of, any official capacity, or any other person in their company / organisation unless so attributed ***
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Special Feature
Sustainable Development in the Petroleum Industry

Written by Dr. Abdul-Jaleel Al-Khalifa, CEO, Dragon Oil
The human journey moved very slowly through the hunter-gatherer societies for 90,000 years into the agricultural societies for 9,000 years and only accelerated into the Industrial Revolution during the past two hundred years. It was indeed the availability of cheap, portable and efficient sources of energy, such as oil and gas, which fuelled the engine of growth and prosperity. As the human population continues to rise and development expands into developing and under-developed nations, demand for oil/gas will continue to increase. The challenge for the Petroleum Industry is to continue supplying more energy with time. The Petroleum Industry was born in a free-market capitalism environment, and continued until the Seven Sisters dominated the global map. They held concessions and production rights across the world. Late in the twentieth century, some National Oil Companies started to operate their own oil reserve base. Today, many integrated and independent oil and gas companies are operating on the global landscape. The fundamental idea of capitalism, formally defined by Adam Smith in his famous book The Wealth of Nations, (1776), is to free and motivate individuals to own and amass wealth and prosperity. He stated that when an individual pursues his own interest, he or she frequently promotes that of the society. Adam Smith was not clear of how to align the drive of self-interest with the sympathy theory he had advocated in his previous book The Theory of Moral Sentiment, (1759), where he proposes that observing other people makes people aware of the morality of their own behaviour. In practice, self-interests combined with economic liberty have developed over the years into free-market capitalism. While capital includes tools, lands and material, money is the only liquid capital that can be readily cashed and transferred. Driven by self-interest, rich individuals created a lending environment where borrowers needing money had to pay the lenders a secure interest over time; that is a dollar now is worth a dollar plus the interest rate after one year. The abundance of money and wealth in Europe, at that time, had facilitated a surge of innovations and a business revolution. Europe and North America became the workshop of the world. The Petroleum Industry grew in this free-market capitalism environment, but can this economic model serve the industry in the future? Despite Adam Smiths call for people to be aware of the morality of their behaviours, Western powers moved to colonize countries outside Europe looking for cheap resources and new markets for their industrial products. The situation changed in the mid-twentieth century, when Europes supremacy retreated in favour of the two new superpowers namely the United States of America and the Soviet Union. With the fall of the Berlin Wall, only free-market capitalism survived, which was then preached as the recipe for global growth and development. Unfortunately, capitalism could not address the serious economic inequality, where one percent of the human population, mostly in rich countries, owns forty-three per cent of world assets; while fifty percent of world population, mostly in poor countries, owns only two percent of world assets. Many intellectuals are advocating means to align Adam Smiths sympathy theory with the drive of self-interest. They are attempting to manage selfish greed which seems to have abused the economic liberty given by the capitalist model. Some are even proposing the collective shared value approach for all stake holders in the long term, rather than the individuals selfish greed in the short term - something along the lines of enlightened self-interest. This remains a theoretical concept and awaits practical applications. Even the latest interventions involving fiscal and monetary policies by most of the developed Governments in response to the financial meltdown, have yet to show clear improvements, thus providing further proof of the shortcomings and risks of freemarket capitalism. In addition to these inherent issues within the free market capitalistic model, it is also being challenged on a much wider scale. Chinas rapid growth and development was actually achieved by regulating market capitalism with central long term planning. When considering any investment opportunity in a capitalistic environment, future cash flows are discounted to yield a net present value. The discount factor is a function of the interest rates, risk premiums and opportunity cost. A discount factor in the petroleum industry usually ranges between eight to fifteen per cent and indicates the minimum return that a company must earn on an existing asset to satisfy its creditors, owners, and other providers of capital. This is also used as a benchmark to value companies, prioritize projects and justify field development plans. The major issue with this model is the negligible net present value of oil and gas reserves recovered in the long term, i.e. beyond 15-20 years. Any major expenditure today, such as on enhanced oil recovery projects which attempt to recover more reserves in the longer term, may result in negative net present value. No wonder, the average industry reserve recovery factor is only thirty per cent (recoveries can range anywhere between five to sixty per cent), leaving seventy per cent of original oil in place unrecoverable. It is worth noting that recovering an additional one per cent of original oil in place worldwide is enough to meet global demand for one full year. In the Petroleum Industry, a production-operator is sometimes a publicly-listed company which has capital and know-how and is driven by creating value for all of its shareholders. The market holds a companys board of directors and senior management responsible for the creation of that value. Most of the time, this is a win-win endeavour for both the operating company and the host government.
Special Feature
However, in certain circumstances, the interests of the operator, who has a production sharing contract, may not be fully aligned with the interest of the host government. The contract is normally for a limited tenure (20 to 30 years), and requires work commitment towards developing the asset. Operators aim to recover most of the proven and probable (P2) reserves within the contract tenure to maximize value for the shareholders. This might entail draining the reservoir at high production rates, thus negatively impacting the ultimate recovery. The operator may also shy away of investing in the asset towards the end of the contract, knowing that his contract may not be extended. The dilemma is how to provide a model that will help maximize value for all stake holders including government and shareholders, and avoid any negative impact on ultimate hydrocarbon recovery. Another challenge to the industry is the short-term focus (Wall Street mentality), where industry leaders have to report results to their public shareholders quarterly (or semi-annually at best). Any major expenditure on long term projects such as research and development (R&D) can be seen as a burden and may be deferred indefinitely. This explains why R&D expenditure is considerably low in the Petroleum Industry when benchmarked against other industries. It is clear that the DNA of the petroleum industry is long term, and thus collapsing it into short term will impact ultimate oil and gas recovery, which in turn will shorten the life of the industry. The endowment of hydrocarbon is collective in nature and should be geared to support all humanity rather than answer to a pure individuals motivations. The industry needs a new economic model that will promote the greater good for all stakeholders over the long term rather than for the selfish greed of a few in the short term. This will definitely ensure sustainable development of the Petroleum Industry towards higher ultimate recoveries and a more prosperous future for all humanity. Editors side note: You can meet the author in November in London as Jaleel is part of The Oil Councils World Assembly speaking faculty talking on leadership challenges in todays markets
Dr. Abdul-Jaleel Al-Khalifa is currently Chief Executive Officer of Dragon Oil. He served as the 2007 President of the International Society of Petroleum Engineers. He served for twelve years as Manager of Reservoir and Exploration Departments in Saudi Aramco. He is a PhD graduate at Stanford University in Petroleum Engineering. Dragon Oil is an independent international oil and gas exploration, development and production company. Our principal asset is the Cheleken Contract Area, in the eastern section of the Caspian Sea, offshore Turkmenistan. The Groups headquarters are located in Dubai, UAE. Dragon Oil had proved and probable oil reserves as at 31 December 2010 of 639 million barrels of oil and condensate, 1.6 trillion cubic feet of gas reserves (corresponding to 260 million barrels of oil equivalent) and 1.4 trillion cubic feet of gas resources.
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HeritageOilPlcisanindependentoilandgasexplorationand productioncompanywithaPremiumListingontheLondon StockExchange(LSE)(symbolHOIL).TheCompany isamemberoftheFTSE250Index.TheCompanyhas ExchangeableShareslistedontheTorontoStockExchange (symbolHOC)andtheLSE(symbolHOX).TheCompany hascoreactivityareasfocusedonAfrica,theMiddleEastand Russia. Heritagewasoneofthefirstcompaniestobeawardeda ProductionSharingContractinKurdistaninOctober2007 andwasappointedoperatoroftheMiranBlock,whichcovers approximately1,015squarekilometres,inthesouthernpartof Kurdistan. InJanuary2011,Heritageannouncedthediscoveryofthe largestgasfieldtobediscoveredinIraqforthelast30years. ManagementestimatesthattheMiranfieldcouldhaveupto12.3 trillioncubicfeetofgasin-place.Heritagehasnowaccelerated theworkprogrammeonthisfieldandisconsideringvarious developmentoptionsincludingatie-intoplannedinfrastructure thatwillachievefirstproductionforbothoilandgasin2015. Thisdiscoveryhasthepotentialtogeneratesubstantialfurther valueforHeritageshareholdersandbenefitthepeopleof KurdistanandIraq.
www.heritageoilplc.com
Special M&A / A&D Feature
Executive Q&A with Paul Atherton, CFO, Heritage Oil

Drake Lawhead (DL) interviews Paul Atherton (PA)
DL: With assets in Russia, Kurdistan, and Tanzania, Heritage is involved in some very intriguing plays. How did the decision to focus on these areas come into being? PA: Heritages portfolio of international oil and gas assets has been based on a strategy of gaining a first mover advantage, supported by sound decision making and technical and operating expertise. DL: Youre also involved in some very frontier plays Mali, Pakistan, and Malta in particular. How important are these to your business, and what does it reveal about Heritages business strategy? PA: First mover advantage is key. Malta and Mali demonstrate that we are a wild cat explorer whose portfolio includes high impact exploration targets which have the ability to transform the company and generate substantial value for our shareholders. DL: What one line would best describe Heritgae to investors? PA: We are a proven, successful, cash rich international, high impact exploration oil and gas company that moves quickly to invest and operate in certain of the more challenging locations in the world to maximise returns to shareholders DL: In April last year you sold your Ugandan assets to Tullow for $1.45bn. Was the billion barrels of oil not enough to tempt you to develop or farm it out? PA: Heritage has had remarkable operational success in Uganda as a result of technical excellence and first mover advantage. In 1997, Heritage became the first oil and gas company in almost 60 years to undertake exploration in Uganda after being awarded a licence in the Albert Basin of western Uganda. We believed that the sale of the interests was the right time to monetise our investment since we estimate that the development of the fields and related infrastructure will costs in excess of $12 billion, which is beyond our current capability. DL: In January, you made Iraqs largest gas discovery in over 30 years and lost nearly 30% of your share value the same day. Can you describe your reaction to that at the time? PA: We estimate that the Miran West field has 9.1 TCF of gas as well as oil and condensate. Its vast size means that it is a commercial discovery that has the ability to generate billions of dollars of value to Heritage shareholders. Its only a matter of time before the market values this success. DL: What are your plans now in Iraq? PA: Following the discovery of the Miran field in January 2011, we have expanded and accelerated the work programme. The 3D seismic programme which we began acquiring in Q4 2010, has been increased from 550 to 730 sq km, we have contracted a rig to spud the Miran West-3 well in July and we will have brought a second rig into country before the end of this year, following completion of the seismic programme, to drill the Miran East-1 exploration well.
DL: From a CFO point of view, what have been the most important changes over the last few years to the way independent O&G companies are financed, manage their money and deploy their capital? PA: Heritage is unusual, in having a strong balance sheet with approximately $600 million of available cash and a further $400 million reserved for a tax dispute with the Government of Uganda. Heritage is therefore not cash constrained and has not experienced any issues with raising finance in the capital markets which has impacted many oil companies. DL: What trends in M&A and A&D do you see on the two-five year horizon for independent O&G companies? Do you believe independents can realistically compete with the growing presence of emerging market NOCs? PA: The question should be whether emerging market NOCs will be able to compete with entrepreneurial independent companies and the answer will continue to be no. A fast moving independent company has the ability to obtain licences and explore in the more remote and challenging parts of the world without challenge from the super majors or NOCs. Heritage will have acquired seismic and drilled a well before these parties have made a decision. DL: Where do you see most value in todays oil and gas markets? PA: International conventional oil plays. There are still a number of massive oil and gas fields to find. DL: What do you see as the greatest challenge O&G CFOs will face over the next 12 months? PA: The continued difficulties in raising debt and equity finance in the capital markets DL: What is the best piece of professional advice you received? PA: Fortune favours the bold. DL: Whats the one surprising fact about you that not everyone may know? PA: Now that would be telling! DL: Finally, something we always ask: What three things would you bring to a desert island? PA: Satellite phone, computer and solar power generator.
About Heritage Oil: Heritage Oil is an independent oil and gas production and exploration company listed on the London Stock Exchange, with a secondary listing on the Toronto Stock Exchange. The Company's immediate focus is on its operations in Africa, the Middle East and Russia. For more information please visit: http://www.heritageoilplc.com About Paul Atherton: Mr. Atherton is a qualified accountant, having qualified with Deloitte & Touche, and holds a degree in geology from Imperial College London. He has a corporate finance background with specific experience in the international mining and resource sectors. He joined Heritage in 2000 and subsequently joined the Board of Directors in 2005. You can meet Paul Atherton in November in London as he is part of The Oil Councils World Assembly speaking faculty talking on CFO leadership and financial challenges in todays markets
Upstream MA&D Activity through the Financial Crisis, Recovery & Beyond
Written by Mark Llamas, Managing Director, Acquisitions & Divestments, FirstEnergy Capital
After a period of relative stability and consistent deal flow from 2005 to 2007, the last three years have seen the Mergers, Acquisitions and Divestments (MA&D) market move through several distinct phases driven by changes in commodity prices, the appetite of equity and debt markets, the explosion of unconventional plays, the Macondo oil spill in the Gulf of Mexico, the acquisition strategy of Asian NOCs and more recently, social and political unrest in key producing regions.
2008 to 2010
During 2008, extreme price volatility resulted in a disconnect between price expectations of buyers and sellers which commenced with the steep ramp up of crude prices to levels in excess of US$140/bbl and continued through the precipitous fall which followed in mid 2008. Buyers and sellers continued to participate in MA&D activity, however many deals were stalled or withdrawn from the market as buyers and sellers failed to reach agreement on price. The rapid oil price rise in early 2008 presented a challenge to buyers who were reluctant to change long term price assumptions. The collapse in crude prices in the second half of 2008 presented the same issue for sellers however the environment for MA&D activity was further impacted by the financial crisis and the lack of capital available to those buyers dependent on the equity and debt markets which were effectively closed to E&P players. By the end of 2008 deal flow had almost ground to a halt. Exceptions included deals involving distressed sellers unable to wait for improved market conditions (e.g. the acquisition of Bow Valley Energy and Oilexco North Sea by Dana Petroleum and Premier Oil respectively) and the completion of deals negotiated prior to the financial crisis (e.g. the acquisition of Revus Energy ASA by Wintershall). 2009 started slowly, however, whilst industrial counterparties were slow to change long-term views on commodity prices, valuations in the capital markets were much more responsive to the prevailing conditions, leading to a favourable environment for corporate M&A. Deal flow gathered pace and the year was characterised by several very large corporate transactions. These deals helped the market return to historic levels measured by deal value despite the overall deal count remaining at relatively subdued levels. Significant corporate transactions included the acquisition of XTO Energy Inc. by Exxon Mobil Corp. (US$41 billion), the Suncor Energy Inc. merger with Petro-Canada (US$21 billion) and smaller multi-billion dollar deals such as the acquisition of Africa focussed Addax Petroleum by Sinopec (4.4 billion). Depressed market valuations also led to hostile corporate activity such as the acquisition by Centrica of Venture Production in the North Sea. Active international buyers during 2009 were the Asian NOCs (driven by security of supply), European Gas Utilities (seeking direct access to resources (including oil) as a way to hedge against higher energy prices) and Majors and Large Independents (exploiting the relative strength of their balance sheets to grow in resource plays).
In 2010 oil prices returned to industry consensus levels with buyers and sellers more closely aligned (particularly in oil weighted deals) which, coupled with supportive capital markets and improving balance sheets, helped propel deal flow to record levels. The year lacked the corporate mega-deals seen in 2009, however, many players took advantage by selling assets into a strong A&D market. Much of the activity was driven by the Majors rationalising portfolios by selling mature and declining assets and
using the proceeds to pursue new legacy assets in LNG, unconventional resources and in significant frontier exploration programmes including deepwater targets. Some companies were very aggressive such as Apache which was one of the main beneficiaries of the BP sell-off in the wake of the Macondo oil spill. Apache acquired almost US$12 billion worth of assets in 2010 equivalent to a third or more of its market capitalisation. In the last year or so high impact exploration has also been favoured by institutional investors leading to strong capital market valuations of exploration focussed companies particularly those exposed to pure plays in favoured regions/basins such as East and West Africa, Falklands, Kurdistan, Greenland etc. Despite the high market valuations, such companies have attracted interest from larger players and this trend has continued in to 2011 e.g. the recent acquisition of UNX Energy Corp. with exploration acreage in Namibia, by HRT, an oil and gas company with expertise on the conjugate plate margin in Brazil. Whilst confidence was returning to oil weighted deals, uncertainty in natural gas pricing, particularly in North America, pushed some to consider asset sales whilst others saw a longer term buying opportunity. Indeed buyers with a longer-term investment horizon chose to address organic growth challenges by acquiring significant volumes of unconventional gas with some US$40 billion worth of North American shale gas deals completed, representing over 20% of the global MA&D activity for the year. In the latter half of 2010, focus was also increasingly directed towards shale oil transactions particularly in the Bakken Play. North America remained by some distance the most active region in terms of deal count however in 2010 Latin America led in terms of transaction value driven by the massive deal between Petrobras and the Government of Brazil in which Petrobras transferred $42.5 billion of stock in exchange for the rights to 5 billion barrels of oil reserves in deepwater areas offshore Brazil and through a series of large deals by Chinese players in Brazil and Argentina including Sinopec and CNOOC.
2011 and Beyond

Whilst it is difficult to predict political uncertainty and commodity pricing through the remainder of 2011 and beyond, one would anticipate deal flow remaining robust through this period. Despite high predicted deal liquidity, it is expected that quality assets, regardless of their position in the E&P life-cycle, will continue to command a premium via strong competition from buyers. Predicting the behaviour of the Asian NOCs is far easier and it is anticipated that the group will remain focussed on reserve and resource capture of a material and long-life nature. This will naturally push the peer group towards unconventional plays, large scale LNG projects, heavy oil projects and high-impact under-explored exploration plays such as those sub-salt and in deepwater and hence directly in to competition with the acquisition targets of the Majors. The trend of increasing transactions in unconventional plays is expected to continue in to 2011 with an increasing focus on liquids-rich shale acquisitions (e.g. KNOC acquisition from Anadarko in the Eagle Ford Shale play) in addition to continued large scale unconventional gas plays (e.g. Sasol partnering Talisman in Canada). Canadian Oil Sands will also come in to focus as long as oil prices remain robust. Tight oil plays in particular are likely to receive more interest as players balance the perceived technical risks against the high potential returns afforded by the current strong oil price environment.
Summary
In conclusion, the long term outlook by E&P players on factors such as commodity pricing and capital markets dynamics, opened up a gap between buyers and sellers during the periods of extreme price volatility in 2008 when actual prices fell outside consensus ranges. When the difference between buyer and seller expectations exceeded the gap which could be closed through deal structure and negotiation, asset deal flow was much reduced. In 2009 acquirers turned to corporate deals attracted by the lower equity valuations of potential corporate M&A targets before the return in 2010 to consensus pricing and increased overall activity. The outlook for 2011 and beyond is positive for transaction levels with confidence returning to the sector and robust capital markets providing access to deep pools of capital. However, buyers and sellers will again have to address the impact of events such as the current social and political unrest in the MENA region and its dramatic effects on commodity prices.
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What is the Potential Impact of the Increase in the Supplementary Charge on M&A?
Written by Mark Andrews, Partner KPMG LLP
The Chancellors recent move to increase the Supplementary Charge on oil and gas production in the North Sea from 20% to 32% has been met with opposition from both companies and stakeholders with material interests in the region. Indeed, many market commentators have gone so far as to suggest that instability in the tax regime could undermine the North Seas longterm prospects. The immediate impact of the rate rise in the North Sea has seen the scaling back of exploration and development activities and the recent announcement of the cancellation of a number of projects, such as Statoil placing on hold its US$10 billion plan to develop the Mariner and Bressay heavy oil fields1. Other companies have already begun to publicly disclose the adverse impact the change in tax has had on earnings. In their recent trading statement BG Group state that the higher tax has had an adverse impact of $265 million2 on their earnings for the first quarter of 2011. No knee jerk reaction in M&A Despite the obvious impact on North Sea operations, in the weeks since the Budget there has been no indication that there will be a knee jerk reaction to the rate increase, resulting in immediate M&A activity, or an intensive short-term upsurge in asset disposals. Many do not expect the increase in the Supplementary Charge to have much of a short-term impact on M&A activity for the Majors. Whilst underlying long-term strategies remain fundamentally unchanged and the risks associated with potentially significant decommissioning liabilities still exist, it is thought that a wholesale exit from the North Sea by the Majors is somewhat unlikely. In the short term, cash flows generated by many of the small cap explorers will not be heavily impacted by the increased rate as they continue to have substantial accumulated tax losses which can be used to shelter profits over the medium to longer-term to reduce cash tax outflows. Hence, for a number of players the cash flow impact of this change may not be felt for some time to come. The rise in Supplementary Charge could lead to downward pressure on deal values; however, the impact on transaction volumes is not clear The increase in Supplementary Charge could lead to downward pressure on asset value and prices, due to the decline in the present value of future cash flows from the fields. However there are a number of different factors at play which make it difficult to assess the overall longer term impact on transaction volumes in the region. Licence holders have been forced to undertake a fundamental economic reassessment of their portfolios on a project-byproject basis under the new tax system. A period of portfolio consolidation and asset rationalisation may well follow once operators have completed a full appraisal of their interests. A greater focus on asset performance and investment returns may well serve as a catalyst for identifying potential strategic acquisitions or divestments. In light of the increased tax rate, there will be licence holders seeking to divest interests in the region and those seeking to use this opportunity to grow acquisitively through the purchase of these assets. However, there is a risk that the expectation gap between buyers and sellers may have widened further as a result of the uncertainty surrounding the Chancellors move. This uncertainty has been further compounded by the lack of clarity in regards to the trigger price beneath which the supplementary charge would have a staged decrease back to 20%3. There will undoubtedly be some reluctance from sellers to recognise that they cannot achieve pre-Budget prices, meanwhile purchasers will argue that a decrease in future cash flows has driven prices downward. The net result is that the valuation of upstream companies and their assets are likely to be even more sensitive to downward volatility in the prevailing oil price and future oil price curve. Aggressive acquirers will seek to exploit this dynamic during pricing negotiations and will argue that risks arising due to potential fiscal instability have made it even more difficult to attract the necessary equity and debt to fund acquisitions. Pure play independents may benefit from internationally diversified operators seeking higher returns elsewhere The North Sea is characterised by the presence of a significant number of independent upstream companies which vary in scale of operations from large internationally diversified hydrocarbon producers to smaller North Sea centric operators.
Source: Bloomberg Businessweek 29 March 2011 (http://www.businessweek.com/news/2011-03-29/statoil-holds-10-billion-in-u-kexpansion-after-tax-jump.html) 2 Source: BG Group plc 2011 First Quarter results 3 The Government has stated that they believe a trigger price of US $75 per barrel to be appropriate, but will set a final level and mechanism only after seeking the views of oil and gas companies and motoring groups (www.hmrc.gov.uk/budget2011/tiin6133.pdf)
Operators with a diverse global portfolio of assets and limited presence and exposure to the North Sea would appear to be the most likely to divest their interests in the region as they seek to redirect their finite capital to higher investment returns in territories with potentially more favourable and/or stable fiscal regimes. Aligning sellers with potential purchasers is clearly critical and there is the question of which companies will be willing to increase their interest in the region under the new tax regime. Pure-play North Sea operators may provide a compelling answer. Strategic acquisitions within the North Sea will underpin their growth ambitions and the non-core assets of larger players may present attractive investment opportunities. These operators often carry lower fixed cost bases, have greater regional focus and may have less onerous return on capital requirements which, when combined, may result in these assets being more economically attractive to North Sea centric operators than their current owners. EnQuest, a producer with its licence portfolio wholly based in the North Sea, suffered a 14% fall in its share price in the immediate post Budget fall out. However, its Chief Executive has publicly stated that, although very disappointed 4, the increased Supplementary Charge may well ultimately benefit its acquisition plans by decreasing the value of others North Sea assets. EnQuests proven acquisitive appetite, having in 2010 increased its production licences from 16 to 26, and focused North Sea presence forms a compelling potential purchaser profile. Concern over potential future new investment may be eased through consideration of a change in the licensing structures The potential for new inward investment in the North Sea may have suffered from the increase in the Supplementary Charge; both in terms of possible reduced economics as well as increased uncertainty. Some industry commentators have therefore suggested a review of the licence structure in the UK may help to rejuvenate interest in the North Sea. One potential option being voiced to bolster investment in the North Sea is to fix the applicable tax rate upon a licence being granted, thereby creating a more certain and stable financial environment which will serve to provide greater certainty over future returns; it is uncertain, though whether such an alternative is achievable in practice. To conclude, whilst the North Sea landscape is unlikely to change in the short term, M&A activity could shape the future The increase in the Supplementary Charge on hydrocarbon production is likely to have an impact on the long-term health of the North Sea oil and gas sector. Lower investment returns coupled with instability in the fiscal regime could serve to reduce exploration activities and discourage new inward investment, especially in scenarios where capital can be employed more effectively and with greater certainty in other jurisdictions. Furthermore some areas of the North Sea may be left fallow due to some marginal fields being deemed uneconomic and sections of pipelines being shut off as they become prohibitively expensive for the remaining users. Fundamentally though the North Sea M&A landscape is unlikely to change in the short-term. Having weathered the initial reaction to the new higher tax regime and with little sign of quick exits, oil and gas companies are in the process of reassessing the economic value of their interests. The offshore upstream sector is typified by long mobilisation and drilling times due to the inherent operating environment and investment decisions are based on long-term financial forecasts and economic data. Market sentiment does not suggest that the increased Supplementary Charge will act as a catalyst for a mass exit from the region; rather, and somewhat conversely, it may actually create opportunities for strategic acquisitions and divestments. Brokering deals to align the interests of buyers and sellers, and the future availability of sufficient funding at the right price will become even more critical.
Mark Andrews, Partner KPMG LLP: Mark Andrews is a dedicated transaction advisory partner within KPMGs Energy & Natural Resources Practice. Marks primary focus is the Oil & Gas sector and his experience includes domestic and international mergers, acquisitions and disposals involving financial due diligence, de-mergers and IPOs. The KPMG Global Energy & Natural Resources (ENR) Practise is dedicated to assisting all organizations operating in the Oil & Gas, Power & Utilities, Mining and Forestry industries in dealing with industry trends and business issues. We believe our member firms have a distinct portfolio of service offerings which can be tailored to the needs of our clients, and can be delivered by our industry professionals.
Source: Mentor IMC Group (http://www.mentorimcgroup.com/oil-and-gas-news/significant-potential-for-enquest-despite-north-sea-oiltax-increases-20110407323.html)
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Plenty of Heat, But Wheres the Light? Unlocking M&A Opportunities in Oil and Gas
Written by Jon Clark, Head of UK Oil & Gas Transactions, Ernst & Young
The oil and gas world abounds with growing confidence and appetite for transactions in 2011. Ernst & Young research suggests that mergers and acquisitions (M&A) opportunities will consume increasing levels of boardroom time over the coming months. But while dealmakers are busy, not all of this activity is leading to success. To unlock the right opportunities, there is an increasing need to consider what is going on in the world beyond oil and gas. Ernst & Youngs Capital Confidence Barometer (CCB) shows growing optimism. And oil and gas leaders are leading the charge, as the following chart shows (Fig. 1). Based on this survey of 1,000 senior executives from large companies around the world (the Ernst & Young 1,000), conducted by the Economist Intelligence Unit, more than two-thirds of oil and gas leaders think the financial downturn will be over by the beginning of Q4 2011. Among these, 45% think it has already ended. But has anyone told their shareholders and their bankers? As well see, the outside world is tempering the rate at which this optimism translates into corporate development activity.
Figure 1
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Fig.1 How long does your organization expect the financial crisis and resultant downturn to persist in your industry? Fig.2 Respondents actively looking to take advantage of inorganic growth through M&A over the next six months
Nonetheless, the findings are an important gauge of corporate confidence in the economic outlook, and the CCB has a proven track record of identifying boardroom trends and practices in the way companies manage their capital agenda. There is certainly increased appetite to get back into the M&A game, with oil and gas leaders 50% more likely to contemplate acquisitions than the market as a whole, as the CCB reveals (Fig. 2). This is all the more notable considering that a year ago, energy leaders were less sanguine than the Ernst & Young 1,000 as a whole. So where are all the deals? At the start of the year, it seemed that, for dealmakers, big was back. A sustained period of oil price stability, and greater access to capital, was leading to a recovery in deal activity. Now the flurry of big announcements looks a little like a false start. For example, Cairn Energys US$9.6 billion sale of its Indian assets to Vedanta was originally announced in August of last year, but it continues to await approval. Similarly, BPs US$16 billion share-swap deal with Rosneft, announced in January, has yet to conclude. These deals serve to highlight the risks in M&A execution, and show that risks and hesitation are as likely to come from shareholders, funders or governmental sources, no matter how strategically valid the deal itself may be. There are three principal lessons for deal-hungry businesses. Firstly, any sustained upturn in M&A activity is likely to be determined by external factors, and todays winners will have planned to cope with the new twists and turns involved in cutting a value-adding deal in 2011. Secondly, the trickle-down effect of big deals now seems less likely to catalyze change in the mid-market. A year ago, the prospect of the return of big deals meant non-core disposals, momentum in the sector and increasing confidence among important stakeholders. The difficulties companies have encountered in executing major deals has had the opposite effect, potentially reducing non-core divestment activity.
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Thirdly, while conditions in the funding market have improved, providers of funding for acquisitions have become more discerning. Asked when they expected financing to be available to fund major acquisitions and capital projects for their organizations, oil and gas leaders in the Ernst & Young 1,000 are considerably more upbeat than one year ago, as the following chart shows (Fig. 3). But access to capital has not universally improved, with 20% of respondents stating that funding for such projects is still at least a year away (down from 32% in April 2010). So there are winners and losers in the new capital markets for oil and gas deals. Figure 3
Access to finance is not a problem for my organization Within 6 months 6 to 12 months Over 12 months
Fig.3 When do you expect financing to be available to fund major acquisitions and capital projects for your organization?
There is something approaching consensus that conditions in the oil and gas industry are improving. The industry now needs to make the case to stakeholders for its optimism, and remember that it is competing in a global and often sector-agnostic marketplace for capital whether that be of the funding or the political variety. Ernst & Young sees three factors as essential to success in the current M&A climate. 1. Proper planning, due diligence and anticipating issues will help increase deal prospects and avoid negotiating from a position of weakness. Ernst & Young is working with clients long in advance of a transaction to identify critical path items and iron out potential deal issues such as shareholder disagreement, price expectations, unforeseen tax complications and the route to differential value creation in assets under new ownership. Bridging the buyer-seller disconnect on price has become more difficult as volatility has returned to commodity prices. In particular, funders and asset owners are at times using very different pricing forecasts. By positioning assets correctly, uncovering hidden or untapped value and conducting a tailored approach to buyers with a strategic reason to invest, sellers can exploit their position in a market where appetite for M&A is increasing. Buyers who have properly planned for the process, can execute efficiently and have identified which buttons to push with sellers will put themselves in a strong competitive position. A broader view of the economy and potential deal issues is now essential. The dealmakers watch list should include planning for, among others, regulatory attention, rising inflation, conditions in the financial markets, political instability, austerity and tax regimes, and the impact of natural disasters on supply chains. A no surprises approach is needed to help increase the prospects of success. This is likely to mean investing significant resources to plan ahead of a transaction, monitoring external factors, contingency planning and retaining maximum flexibility in deal terms.
2.
3.
In 2011s capital-constrained environment of high commodity pricess, it is doubly difficult to execute transactions. Detailed planning and a broad view of the components needed to put together a successful deal will help convert todays optimism into future shareholder value. The views reflected in this article are the views of the author(s) and do not necessarily reflect the views of other members of the global Ernst & Young organization
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The Legal Corner
The Legal Corner

What are the most common mistakes made by oil & gas companies buying and selling in today's M&A markets, and how can they be overcome?
In the M&A context, most mistakes, whether they be loss of an opportunity, loss of value or risk related, have their origin in a failure to plan and execute the deal in an optimal manner. The two most common failures we see are in relation to team organisation and decision making. Whether you are on the buy-side or the sell-side, it is imperative you commit appropriate resource and use the available time to plan and evaluate. 'Back-ending' crucial aspects of a deal in order to save costs can prove to be a false economy. Once you have determined your commercial objectives, the next step is to organise your team in a way which facilitates those objectives, ensuring you have clear reporting lines and an effective means of keeping the whole team 'in the loop' this way team members know what is important and don't lose sight of the commercial objectives. Decision makers need to remain closely involved with their teams and involved in negotiations. Otherwise, much time, expense and goodwill can be wasted with the ensuing lack of focus and the elevation of particular issues beyond their importance in the broader commercial context. A well informed and involved decision maker will understand the risks and be able to communicate a coherent message both internally and to his or her negotiating counterparty. Inability to communicate a clear and consistent message has on more than one occasion led to unsatisfactory outcomes.
John Geraghty, Partner, Allen & Overy
One of the issues that we have seen become more important given recent events, are the conditions precedent to closing. When negotiating the closing conditions, some parties to the transaction would take the view that, if the host country wasnt experiencing any civil unrest, then closing conditions like material adverse change could be left out. Given the recent global events, more buyers will be insisting on MAC conditions in transactions with long delays between signing and closing, rather than hoping to rely on another condition precedent that may not be suitable or an argument based on force majeure or frustration. From the opposite perspective, sellers will resist these clauses more firmly and will likely press the buyers to factor those risks into the price offered.
Sean Korney, Partner, Baker Botts
Oil & gas assets are increasingly sold in auctions. From the seller perspective, it is key to know the warts in the business (not just the good selling points) before putting the relevant assets up for auction. Giving prior consideration to issues in the assets, and trying to consider potential ways in which those issues could be mitigated will help ensure a better auction process (and increase seller credibility). If a bidder consortium discovers something in due diligence which the seller isn't fully on top of, this puts the seller on the back foot, reduces credibility and can impact price. It is important therefore to carry out a thorough vendor diligence/risk assessment before putting assets up for auction. Another key area for sellers is how to handle any partners who have pre-emption or matching rights. These can give rise to tricky issues (both commercial and legal), and advisers should be brought in early to assist with this workstream. From a buyer perspective, one of the key things is deliverability (are any consents required on the buyer's side to do the deal? Is the financing properly committed and available?). Also, it is important to consider upfront a clear basis on which any consideration will be contingent. The devil is in the detail, but it can have a material impact on what the buyer ends up paying, and therefore needs careful analysis upfront.
Nick Williamson, Partner, Ashurst
There is strong competition for good oil assets at the moment and, given that notwithstanding last weeks price falls, the price of crude oil is still on average 40% more than last years average and 50% higher than 2009s, this is likely to continue. The consequence has been a pattern of abuse by sellers of buyers and risk taking by buyers wanting to get into the game. In view of the level of fees and technical and managerial effort required for due diligence, we always recommend that, in a private deal, an exclusivity period is granted. In a contested or tendered bid, a seller can, and will, abuse its right to waive the rules to override a fair bidding process unless that right is clear and limited. Buyer beware at this time in the cycle these are difficult to negotiate, but important. Another feature that has been concerning us is the general lack of awareness of exposure to the anti-bribery legislation, whether US, UK or third country. With the US concept of successor liability, this is particularly dangerous for companies with connections to the US.
Stephen Beharrell, Partner, Fasken Martineau
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Online Columnists This Month Include...
Make no mistake, despite the widespread civil unrest across the North of Africa from Tunisia to Egypt and the on-going mess in Libya during the quarter, the rest of the continent remained open for business, with $5 billion worth of upstream deals getting done. Read the rest of Kevins columns here...
On the other side of the Atlantic, WTI has also reacted with a vengeance reflecting impressive price increases. We continue to foresee WTI trading in a $95 to $100 per barrel range barring any additional unforeseen events. Mississippi River flooding does have the potential to break WTI out of that trading range if significant refineries and crude transport are disrupted. Read the rest of Giannas column here...
Spare a thought for the gas producers, hit by the tax increase but not enjoying the same uplift in commodity price as the oil producers. A foretaste of how this might pan out came at the end of April, when Centrica closed in Britains biggest natural gas field, Morecambe Bay, for maintenance, but claimed it may decide not to restart production because of the tax hikes. Read the rest of Elaines column here...
Meet The Members
Committee Member
Suleman Raji General Manager, Cost Engineering (Upstream), NNPC
Member
Sam Oh, Partner, Apollo Management
How did you come to be in the oil industry? After graduating cum laude in Chemical Engineering at the University of Pennsylvania, my wish was to work in the Nigerian oil industry. Apart from the attractive salary package and prestige that comes with working in the oil industry, I had always thought the job would be challenging and that one would be contributing positively to the national economy since the petroleum sector is, by far, the largest contributor of foreign exchange to the economy. In response to newspaper advertisement, I applied for employment at the NNPC and was among the lucky ones to be offered employment in 1979. It has been a very fulfilling and rewarding experience ever since. What is your proudest work-related achievement to date? Nigeria generates less than 4000 MW of electricity for a population of 150 million. This is grossly inadequate and results in frequent power outages which are detrimental to the rapid growth of the Nigerian economy. I used to work as the head of the Gas Projects Department of the National Petroleum Investments Management Services (NAPIMS), a strategic business unit of NNPC that oversees the activities of the IOCs in Nigeria. Being the NAPIMS Project Manager that successfully and cost-effectively oversaw the construction of the 650 MW Afam IPP Project, a joint venture project between NNPC and Shell takes the biscuit as my proudest work-related achievement to date. The completion and operation of that power plant has contributed to making Nigeria less energy-poor. Where do you see the greatest opportunity in todays oil and gas markets? In the aftermath of the recent tragic earthquake and nuclear disaster in Japan, I see the greatest opportunity in gas development projects globally, especially LNG, as public sentiments harden against the construction of new nuclear power plants.
How did you come to be in the oil industry? I was an investment banker at Morgan Stanley and I got a lucky break in 2000 to work on the formation of Intercontinental Exchange, which the commodities groups of Morgan Stanley and Goldman Sachs created. During that deal, I got to know the people in commodities and quickly moved over into the group. I have been involved in the oil and gas industry ever since.
What is your proudest work-related achievement to date? In 2002 I led the launch of an oil and gas production fund that in many ways was the precursor to the current MLP model. We raised $200 million of third-party capital for the fund called Helios Energy Partners, the only fund with third-party capital at Morgan Stanley that was in the brokerdealer. It was an extremely difficult fund raise, but in the end was a tremendous success and was one of Morgan Stanleys best performing private funds.
Where do you see the greatest opportunity in todays oil and gas markets? In the migration and proliferation of recovery technologies applied globally. The advent of the modern day shale is a great example, where the US has been a global leader in development of these resources through the use of new technologies and techniques. Applying even small slivers of these technologies and techniques across the world will go a long way in allowing many other nations to increase their natural resource potential.
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Where do you see the greatest challenge? Developing the cutting edge technology and securing easier access to the funding that will make for the exploration and production of oil and gas from deepwater and other difficult frontier regions at a substantially lower unit cost and in a safe, environmentally-friendly and sustainable manner.
Where do you see the greatest challenge? Trying to get countries to become energy selfsufficient is an incredible challenge. It requires an interesting cooperation between the private and public sectors, as well as intimate participation by producers and consumers. Sadly, much of the progress and developments towards this objective often comes too little too late with politics and special interests often being an impediment. Having said that, theres still time to achieve this objective but it requires a thoughtful and concise approach and will require patience.too often we are looking for the quick fix.
What was the wisest advice you ever received from a mentor? Even though I admire quite a number of personalities for their achievements and courage, I have never had a mentor per se. The nearest to a mentor for me was my late mum who always advised that I should believe and put God first in everything I do and all other things will fall in place nicely.
What was the wisest advice you ever received from a mentor? Be selfish with your time and look for opportunities that are sustainable. People talk about having balance in their lives, but it wasnt until I met Richard Kauffman, who ran global ECM at the time, did I truly understand how it all works. By being selfish with your time, I interpret it to mean that you have to be proactive about making time for things that you care about, so it becomes not only about how you allocate your time, but to your pursuits. This applies to the professional world as much as the personal. The second piece of advice comes from a great investor whom I had a chance to work for, who to this day still helps me think about investing. Larry Hite, one of the original CTA gurus, was always looking for situations, opportunities and investments that presented unique abilities to generate alpha on a sustainable basis. Looking back, Larrys pedigree in commodities and his approach to investing was in some ways a foreshadowing of what was to become of my career i.e. value investing in the commodities sectors.
What advice would you pass on to a graduate wishing to work in your line of business? There will always be need for some form of energy for the world to function. Hence, if you work hard and apply yourself positively, the sky is the limit in your chosen profession as your services will always be in demand in an energy-hungry world.
What advice would you pass on to a graduate wishing to work in your line of business? Keep an open mind. When I entered the commodities industry back in 2000, it was not a glamorous place to be, in fact just before I joined the internet was all the rage and everyone wanted to be in Menlo Park, CA. But I joined the group because I liked the people and I thought the types of opportunities that they were seeing were interesting and I saw a real edge that one could develop by having a deep understanding of the physicality of the business. The bottom line is that you have to be a bit of a contrarian in life and avoid the typical traps that often present itself like getting caught up in the latest craze/mania.

Meet The Members
Whats the one interesting fact about you that no one would suspect? I am a prospective author as I am currently writing a 6-volume series of mathematics textbooks for secondary schools in Africa, one for each year of secondary (3 years of Junior, 3 years of Senior).
Whats the one interesting fact about you that no one would suspect? Despite having an undergraduate business from Wharton, I actually started college as a fine arts major hoping to become an architectbut then transferred to the business school because I thought the world was not going to build any more interesting structures. boy did I get that wrong! How do you prefer to spend your spare time? With my three girls, aged 9, 6, and 4. But who has spare time?
How do you prefer to spend your spare time? I have very little spare time at my disposal giving my writing activities. However, the little spare time I have I prefer to engage and interact with my 6 y.o son, especially football. The expression of satisfaction and joy and on his face when we play is priceless. Favourite holiday destination? Cancun, Miami and Dubai but I will settle for Dubai.
Favourite holiday destination? I have been skiing Whistler mountain since the early 80s when it opened, so I drag the entire family out there at least two times per year. I think I am the only one in the family that would call it a favourite holiday destination Im sure someday soon I will get out-voted.
All time favourite book? The Quran, an amazing and profound book that relies on logic and reasoning, and not dogma, to convince its readers about the existence of One God and the essence of life. All time favourite film? An Officer and a Gentleman.
All time favourite book? Hmmthats a tough one, there are so many. Moneyball by Michael Lewis, Built to Last by Jim Collins & Jerry Porras.
All time favourite film? Another tough one. Breaking Away was a great favourite. Something more current is Tron: Legacy a real visual feast with great shots of my hometown of Vancouver.
What 3 things would you take to a desert island? A tent, a big sack full of assorted & easy-to-open can food and an iPad.
What 3 things would you take to a desert island? I would have to at least bring my wife and perhaps leave the kids with the sitter. In addition to that, I suppose some PV solar panels, my Macbook + charger, satellite dish..if these are not allowed, then I guess it would be like a big Rambo knife, water filter and the stack of books by my bed which I have yet to read. [Editor: Macbook and charger not allowed! You can have the Rambo knife, filter and books]

STELLAR ENERGY ADVISORS LIMITED

Stellar Energy Advisors is a leading advisory consultancy supporting international upstream oil and gas companies. The business has been growing steadily since 1999 and is well established and highly regarded in the upstream industry. Stellar provides a range of services which include asset and company sales, acquisition mandates, strategic advice and valuation of company portfolios in areas ranging from the Middle East, Africa, Europe and South America.
Recently completed mandates

Fyne Area UK North Sea Perth Field UK North Sea Bridge North Sea Ltd Blocks SM-1035, SM-1036 & SM-1100
Santos Basin, Brazil
Sale to Premier Oil UK Ltd
Sale to Deo Petroleum
Sale of company to Perenco UK Ltd
Farm-out to Vanco
Blocks SM-1035, SM-1036 & SM-1100 Santos Basin, Brazil
Aurelian Oil & Gas (Romania) SRL
Keta Block Ghana
Block 29/1c Orchid UK North Sea
Farm-out to Vanco
Sale of company to Raffles Energy
Farm-out to Eni Ghana E&P Ltd
Farm-out of interest to Atlantic Pet. P/F, Trap Oil Ltd & Valiant Petroleum Plc
In the last 6 months Stellar Energy Advisors has raised over USD 500m for our clients. Stellar is currently managing upstream mandates in South America, Africa and Europe interacting with a worldwide network of companies.
For further information contact us at Duke Street House, 50 Duke Street, Mayfair, London W1K 6JL or email: info@stellarlimited.com www.stellarlimited.com
Special Feature
Notes from The Oil Councils Press Briefing, New York, April 21
Written by John Kingston, Director of News, Platts
The Oil Council, as it did last October, brought together a panel of executives in New York April 21 to meet with the media and talk about pretty much everything. There wasn't one overriding theme, but when industry executives get together in the US these days, shale gas and its impact on so many parts of the business is never far from their minds. Here are some of the main points that the panelists discussed. These are a summation of their main thoughts, with direct quotes marked as such: Michael McMahon, Partner at Pine Brook Road Partners, a private equity firm in New York: There's a tremendous amount of investment interest through private equity. He cited large investors like CIC, which is the Chinese sovereign wealth fund, and the California pension giant Calpers. (CIC's minimum investment is $200 million). They are all ramping up their exposure to energy. But there may be a bit too much money chasing not enough good deals: "We're not quite back to the levels of the doctors and the dentists (investing in the business), but we're one step removed." But still, "access to capital is not an issue." Shale gas is a game-changer in many ways, including the capital game, but the industry needs to be more proactive on the issue of fracing and its environmental impacts. Claiming that the secret formula of fracing fluids must remain that way is the "stupidest" response, because with industry personnel jumping jobs all the time, "whatever secrets are out there last a week." He expressed confidence that the wastewater industry will be able to solve the issue of treating the fracing fluid that brings up plenty of undesirable materials from down the well. With the explosion of shale gas and the liquids that go with it, "What is the incremental US oil production in the next three to five years" from those shale plays? 1 million b/d? "Certainly." 2 million b/d? "Probably." 3 million b/d. "Maybe." The impacts from that and the entire shale gas revolution will be enormous, from petrochemical industries returning to the US, to the US balance of payments, to increased taxes at the state and federal level. "The outlook for North American energy is not all that bleak." Francisco Blanch, Global Head of Commodities Research, Bank of America Merrill Lynch: In a world where central banks are not willing to tighten, naturally we've seen inflation rates head above interest rates, so real interest rates have turned negative. When that's combined with the tremendous rate in oil demand growth from 2010, and the loss of Libyan crude, and the fact that OPEC output barely budget from April of last year through the end of the year, it's a formula for higher prices. Referring to the Saudi statement over the weekend that it had reduced production in reaction to no demand for its higher level of output, undertaken because of the loss of Libyan crude: "If the demand is not there, then why is Brent in backwardation? The demand is clearly there." The market is looking at an average Brent price of $140 over the next three months. But in the second half of the year, there are risks like Greece and Europe in general. Brent should average $102 in the second half of 2011. Spending on energy as a percentage of the global economy is getting in the danger zone. The world passed the "critical" 9% level in 1980, and again in 2008, helping to send economies into recession. "We just crossed it again." Steven Tredennick, Partner at Bracewell & Guiliani: The Securities & Exchange Commission rule on disclosing payments to foreign countries raises big risks to oil and gas companies. If other companies know what you paid for a lease, particularly if they are non-US companies battling for acreage around the world, "it could have significant anti-competitive effects...other companies would know what you paid." This rule could also be a boost for private companies who would not need to disclose the information. Private equity supporting these companies could be key to their development. One solution might be to enable companies to disclose aggregate payments rather than breaking it out into such specific information. On fracing: technology is proceeding apace so that it could be fracing fluid ultimately may not need to use any toxic materials. The elements in the fracing fluid just won't be the big issue it is now. But for now, it is a big issue, "first and foremost," and the industry is going to need to "spend a little more money, and going to have to do (its) homework." Laurent Lavigne Du Cadet, Deputy CEO, from investment bankers Taylor-DeJongh: The price of proved and probable reserves rose from $12.90/b in 2009 to $15.50 in 2010. The reason it didn't go higher is that the price of oil services rose substantially, so it gets more expensive to develop those reserves. Asset sales in the oil and gas business worldwide last year totaled $211 billion, the highest in the last 20 years. Commercial banks are not as key in funding asset sales as they were previously. Scott Bernstein, Executive Vice President of Corporate Finance at Buccaneer Energy, an independent E&P company Major oil companies are continuing to pull out of places and giving independents an opportunity to get in. He cited the North Sea, Alaska's Cook Inlet, Trinidad & Tobago, and the Philippines. The strength of independent oil companies is in their role as first mover, i.e., they need to get into shale plays before others, and then "upsell" to other companies seeking to get in. This article first appeared in John Kingstons blog The Barrel
Mergers & Acquisitions Advisory divestiture & sAle trAnsAction Advisory BoArd & MAnAgeMent teAM consultAncy
International Energy M&A Expertise Upstream Oil & Gas Oil Field Services For the Partners at Odin Advisors, the deal is not the ultimate goal. It is often the byproduct of the ultimate goal, which is to provide the absolute best advice and execution skill to clients as they work through their most important challenges. The skill, experience and personal commitment that we bring to those challenges is the essence of our firm. It is why we are here and how we define success.
Ian H. Fay, Founding Partner Odin Advisors LLC

ian.fay@odinadvisors.com t : +1 212 513 1174 www.odinadvisors.com
Industry Versus Equity Market: North Sea Asset Valuation Trends

Written by Martin Copeland, Managing Director, Lexicon Partners
The concept of perfect or efficient market theory holds that the value of a particular equity in the market is informed by all publically available information relevant to that company and therefore fairly reflects the true value of the company. Although there is much debate about the merits of this hypothesis in general, the valuation of E&P companies is one area in which the scope for discrepancy in valuations is probably at its most extreme. Often this is explained by the asymmetry of information, and in particular the highly technical information in the form of seismic interpretations, well logs and the like, which particularly impacts the valuation of earlier stage exploration or appraisal assets. However, in our view, there is also a clear discrepancy between the way in which industry and equity markets value assets. This article aims to explore some of the trends that we at Lexicon Partners have observed in practice on transactions in recent months, as well as highlighting some of the potential implications for capital markets and M&A activity in the sector. We have focused our discussion on the UK North Sea asset market and quoted E&P sector, but the trends and implications are equally applicable in other geographies. Equity markets are fickle One of the key challenges of the equity markets is that sentiment, and hence corresponding valuations, are notoriously fickle towards smaller E&Ps. An index comprised of UK weighted E&P companies is up nearly 50% in the last 12 months, as compared to the broader FTSE 250 up only 16%. This relative out-performance is explained by the combined impact of a number of high profile successes with the drill-bit and strongly rising oil prices. The mood of investor confidence that has driven this strong share price performance was however not present as little as 18-24 months ago in the immediate aftermath of the financial crisis. The combined market capitalisation of Encore, Sterling Resources, Xcite and Nautical Petroleum was a mere US$250 million two years ago on May 1st 2009. The same companies, in possession of the same assets, but with one or two positive well results apiece had an aggregate market value of some US$3.4 billion taken at the peak value of each company in the last 12 months. The fickle nature of equity markets can also be illustrated by the tendency of investors to extrapolate a particular run of newsflow and hence to fall into or out of love with a particular company. While this tendency is natural, and indeed may be deserved if for instance a run of poor well results is symptomatic of a poor quality technical team in the company, the result is often to over-react in either direction. This can result either in companies being over hyped on the basis that everything they touch will turn to gold, or conversely being consigned to the scrap heap with valuations that fail to recognise even core value or, at the extreme, cash resources. Unfortunately it is all too easy to fall off the pedestal, but very challenging to recover from the scrap heap treatment. and tend to over-value exploration The illustration above of the shift in value of the 4 E&Ps serves to highlight the tendency of equity markets (when they are in the mood to seek alpha and not retreating from risk as a herd) to over-value exploration relative to the industry norms. On paper the 4 North Sea exploration companies in my example created over US$3 billion of value. However, looked at from the perspective of an industry participant, the well results that they each announced on Catcher, Cladhan, Bentley and Kraken had in fact only marginally de-risked the assets concerned. Industry participants will farm into exploration or appraisal assets on the basis of proportionate well costs and a degree of promote and/or back cost recovery. The level of promote achievable also varies with market conditions and specific asset attributes, but is typically running at a 2:1 basis in the North Sea today. This industry approach to valuing early stage assets effectively implies that, for assets where the significant spend is still to come, the decision to invest or not by the farminee is binary they either like the risk or they dont. The value generated by a success case is shared broadly proportionately among the well participants save for the promote element. This industry convention therefore tends to give appropriate weight to the value of capital. The exploration focused E&P minnow is rewarded for the intellectual capital (and potentially historic cost) invested in maturing the asset to the point of farm-in, but the intrinsic net asset value is not explicitly paid to the seller. Equity markets, or more specifically sellside research analysts will, by contrast, typically apply asset by asset discounted cashflow valuations (or the shorthand proxy of a $/boe metric) to all of a companys assets. They will then weight the resultant net asset values (NAVs) by a range of somewhat arbitrary risk factors to arrive at an overall core (or essentially 2P) NAV and a total risked NAV (i.e. including value for 3P, contingent resource and even prospective
resource). This methodology by its very nature presupposes that the funding required to bring the asset through to first hydrocarbons will in fact be available. Indeed, rarely is it the case that the analyst community make explicit assumptions as to the sources of funding for specific exploration or appraisal assets either by factoring in the implied dilution of a required equity raise or indeed the NAV dilution of an industry farm-out. Strategic anomalies of the differing valuation approaches This approach to valuing earlier stage assets within listed E&Ps raises some anomalies which can have important implications for the strategic direction and consequently the corporate actions that companies take. The first such anomaly is the Big Company Conundrum. This phenomenon holds that were the same portfolio of assets to exist within an oil major, the appraisal and exploration assets that may constitute 40-70% of a typical mid to small cap E&P, would essentially have zero value. The illogicality of this is all the more stark when you consider that, in comparison to a poorly funded small-cap E&P with only a handful of assets in total, the oil majors scale of portfolio (and ideally higher quality management) and hence scope to high-grade, should in fact mean that the exploration assets that they choose to pursue are likely to be of higher quality than the smaller E&P. Nowhere is this conundrum more tellingly illustrated than in BPs actions since Macondo. The BP Shrink to Grow strategy is effectively an opportunity afforded by the crisis of Macondo for BP to seek to escape the tyranny of scale. When BP sold its Permian Basin, Canadian gas and Egyptian assets to Apache last summer for $7 billion it indicated that the assets represented 2% of BPs total upstream assets. This would imply that the full E&P business of BP should be worth some $350 billion and yet today the whole company is valued at an enterprise value of only circa $161 billion. Other factors aside, it seems that BP would have to shrink quite a bit more to achieve fair value for its assets. The second anomaly, the Victim of Success Conundrum is effectively the reverse of the Big Company Conundrum. That is that smaller E&Ps which have had a measure of success with the drill-bit and are the beneficiaries of the equity markets potentially inflated valuation of their assets, will have difficulty in selling those same assets to industry participants precisely because of the differential approaches to valuation. This phenomenon is perhaps best illustrated at the point where an exploration-led company has matured its key assets to a point where they are heading towards development. At this point the E&P will have realised all the value from the discovery and will be facing future newsflow which is likely to be all negative as the realities of funding, and the practical challenges of major project management, are appreciated by equity markets. Recognition of this phenomenon is, in our view, the real driver to the announcement by EnCore Oil to separate its exploration assets into XEO. As Cladhan and Catcher move through the stagegates towards FDP, their natural owners are larger, better capitalised oil companies and yet, for the reasons discussed in this article, industry participants are unlikely to value the assets as highly as the equity markets do today. The separation of the EnCore pixie dust into XEO, coupled with continuing appraisal related newsflow, should at least give a chance for the two valuation approaches to come closer to alignment. Conclusion In conclusion, while the differential valuation approaches between industry and equity markets highlighted in this article may create strategic challenges for company management and financial investors alike, the room for difference of views on the value of assets also creates opportunities for the nimble or astute to exploit. Lexicon Partners is an independent corporate finance advisory firm headquartered in London, with offices in New York, Hong Kong and Aberdeen. Some recent energy transactions are below. Martin Copeland is a Managing Director with Prior experience as Managing Director, EMEA Energy, UBS Investment Bank and Director, Natural Resources and Oil & Gas, Deutsche Bank. Martin has a BA (Modern History), Oxford University: http://www.lexiconpartners.com/about_business.aspx
Graves & Co. supports buyside finance, merger, acquisition, and divestiture activities with specialized energy transaction insight, due diligence, audits and the evaluation of assets, throughout the entire deal lifecycle for upstream, midstream, E&P and oilfield services. With a combined 100+ years of experienced investment analysis, accounting/auditing services, and auction / negotiation advice, we mitigate risk by identifying challenges up front and help guide the entire acquisition process, from preliminary data room evaluation through closing and beyond.
Whether we are conducting due diligence on assets valued in the billions, closing transactions in the hundred of millions, or assisting global firms entering the often confusing world of U.S. domestic E&P operations, we answer our clients' needs with results. We provide timely information so our clients make good decisions. We effectively audit lease operating expenditures for nonoperators, and conduct multiproperty audits for mezzanine lenders, banks and funds. Graves & Co. evaluates subtleties ... analyzes the details of the transaction ... adds value to the deal ... and ensures your success.

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