Oil And Gas

J A N U A RY 2 0 0 7

OIL AND GAS

Untapped IN THIS EDITION... Page 1

Market Fundamentals

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How to Respond to the Threat of the Cost of Carbon

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Algeria - Land of Opportunity?

Page 4

EY OzOils

Page 6

EY OzOils Constituents

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Recent Thought Leadership

MARKET FUNDAMENTALS A THREAT OF OVERSUPPLY From a peak of US$77.03 per barrel on July 14, oil prices dropped sharply to a low of US$55.81 on November 17, the sharpest drop in oil prices since 1991. Oil prices fluctuated around US$62 in December 2006 before decreasing slightly in late December due to the mild winter in the US and Asia. The OPEC Reference Basket (ORB) has fallen by nearly US$18 per bbl as a result of easing geopolitical tensions in the Middle East, uncertainties about global economic prospects, slowing demand growth and the rebounding of non-OPEC supply. Adding to the oversupply is the return of some disrupted output from Nigeria and the Gulf of Mexico, with BP resuming full output at Prudhoe Bay. This in turn has supported healthy stock build-ups in the US and OECD countries, causing crude oil prices to fall amid signs of an oversupplied market. While the market has been focused on falling prices, OPEC has been discussing the need to discontinue the current stock build-up, resulting in a decision during October to cut global output by 1.2 million barrels per day, effective November 1st. At its December 14 meeting in Abuja, Nigeria, OPEC announced a further output cut of 500,000 barrels per day, to stem the decline in oil prices, the latest cut will take effect February 1. Weather conditions still remain a wild-card, as a colder-thannormal Northern Hemisphere winter could quickly erode the current bearish sentiment. At present, the 2007 winter has been forecasted to be a bad year for hurricanes which may increase demand for heating oil and increase oil prices, however the winter thus far has been fairly benign. Previous years have seen the oil market increase prices due to

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hurricane forecasts however the market currently appears to be far more focused on short term inventories and markets are taking a ‘wait and see’ approach to the hurricanes rather than react on expectations. The sharp decline in the oil price should also have an impact on headline rates of inflation. Whilst lower oil prices are not expected to have a major economic impact, headline inflation should fall further in the coming months as decreasing oil prices filter through to consumers. In Australia, the unwinding of earlier increases in petrol prices together with recent lifts in the official interest rate should see the headline rate of inflation decline sharply over the next year, before rising again by the first half of 2008.

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MARKET FUNDAMENTALS A THREAT OF OVERSUPPLY continued from Page 1

For additional information please contact Angus Walker on +61 (0) 8 9429 2493 or at [email protected]

Looking ahead, an optimistic assessment of the global economy, driven by an expectation of strong growth from the Middle East and China, has resulted in forecast global demand of 86 million barrels of oil per day during 2007. New supplies from non-OPEC countries will partially meet anticipated demand.

Moreover, projects in the Caspian Region, Africa and Brazil will add more than 900,000 barrels per day. This anticipated ramp-up in supply may cause oil prices to further soften in 2007, as growth in global demand may once again fall behind global production and supply.

HOW TO RESPOND TO THE THREAT OF THE COST OF CARBON Carbon risk is an emerging issue with the potential to have a significant impact on the energy sector. Pressures from public opinion and the introduction of climate change policy and regulations could affect the competitiveness of oil and gas resources. Conversely, incentives and subsidies for renewable sources or other lower-carbon fuel sources present a potential opportunity for companies looking to diversify their investments and asset portfolios. Australia has implemented a range of mandatory and voluntary schemes that encourage the reduction of greenhouse emissions. However, there is still significant uncertainty as to if, when and how the cost of carbon might be regulated in the future. Possible policy instruments include:

For additional information please contact either Talieh Williams on +61 (0) 3 9288 8985 or at [email protected] or Liza Maimone on +61 (0) 3 9288 7348 or at [email protected]

i) Voluntary schemes – such as voluntary reporting and reduction programs, voluntary offset schemes, voluntary commitments to reduction targets and public education programs; ii) Fiscal incentives – such as government funding in the form of soft loans, seed capital and/or tax concessions; iii) Carbon taxes – a tax charged to business based on the carbon emissions of energy use; iv) Emissions trading schemes – a mechanism for the trading of emissions allowances and abatement credits (eg, EU-ETS or the NSW GGAS);

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v) Direct regulations – such as mandatory efficiency standards for generators (eg, Australian Greenhouse Office’s Generator Efficiency Standards program); and vi) Renewable energy targets – such as mandated renewable energy percentages (eg, MRET). With such a range of options available and the high level of uncertainty in the future direction of Australian climate change policy, assessing the business risks of regulation can be extremely complex. Despite this uncertainty, companies should seek to understand the potential risks that climate change and the introduction of climate change policy poses to their business, as well as identifying opportunities for investing in renewable or lower-carbon fuel sources. A number of companies in industry sectors with significant climate change risks have already undertaken some form of risk assessment, based on the impacts of the changing face of Australian climate change policy and the direct effects of climate change on their business assets. Some of these companies have not only been able to leverage this work to reinforce their green credentials (eg, BP), but are also now in a better state of preparedness to react to changes in climate change policy.

ALGERIA – LAND OF OPPORTUNITY?

For additional information please contact either Colin Pearson on +44 (0) 1224 653128 or at [email protected] or Angus Walker on +61 (0) 8 9429 2493 or at [email protected]

We would like to focus on North Africa in this edition, specifically Algeria, which has increasingly emerged as a country with significant hydrocarbon reserves and an important role to play in world energy supplies. Oil production in Algeria began in1956 and over the past 50 years has grown to more than two million barrels per day with huge potential for further exploration. Oil reserves are currently estimated at a phenomenal 11.4 billion barrels (Oil & Gas Journal, January 2006 ). Some 90% of Algerian oil exports are channelled to Western Europe, with the largest importers being Italy, Germany and France. Thanks to its low sulphur content, Algerian oil can be easily exported. The three major national oil companies are Sonatrach, Naftal and Naftec. Sonatrach is a state-owned company specialising in the exploration, transport and marketing of petroleum, natural gas and related products. Until the Hydrocarbon Reform Bill was passed in 2005 by the Algerian Government, Sonatrach had the domestic monopoly on oil exploration, production and transportation. However, under the new hydrocarbon law, it is now a commercial entity like any other oil company and it is required to bid on domestic projects alongside foreign firms. Even on projects that Sonatrach does not win, it still retains the right to exercise an option of 20-30% of the equity of the project, allowing it to become a regular shareholder with the same responsibilities. As a subsidiary of Sonatrach, Naftal distributes petroleum products to the domestic market. Naftec is also a Sonatrach subsidiary and operates and manages all refineries. Since the implementation of the Hydrocarbon Reform Bill, foreign interest in Algeria has soared. Today there are about fifty foreign participants in the country’s oil sector, including Anadarko, currently the largest foreign oil producer in Algeria, Amerada Hess, which has been in country since 2000, and Australian oil company BHP Billiton. Gas production in Algeria started in 1961 and by 2003 the country was producing 2.9 trillion cu ft (TCF) , becoming the fifth largest natural gas producer in the world.

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With annual consumption of 0.75TCF, there is enormous scope for exports. With its proximity to the European market and an increasingly politically stable and open market, Algeria is an attractive market for the oil and gas community. The Algerian Government has encouraged the domestic use of natural gas and in 2003 gas consumption represented more than 64% of the country’s total energy consumption. As with oil, there are three major national gas companies: Sonatrach, which dominates natural gas production and wholesale distribution; Sonelgaz, specialising in transportation and supply of gas, and retail distribution; and Cogiz, a Sonatrach subsidiary, which packages, stocks, markets and transports industrial gas. Sonatrach has numerous partnerships with foreign companies, including Enel, Statoil, BP and BHP Billiton. The new hydrocarbon law has stipulated the separation of Sonatrach’s commercial role from its previous regulatory and procurement / contracting functions. To support the Bill, two new regulatory agencies have been established: ALNAFT, which defines the competitive environment in which energy companies, including Sonatrach, will operate; and ARH, the regulatory agency for hydrocarbons, which monitors compliance by foreign firms with various health, safety and environmental regulations, and the use of the pipeline transport system. Algeria’s huge hydrocarbon potential remains under explored which means substantial opportunities for foreign investors. But as new entrants into the Algerian market, it is important to structure the investment correctly from start-up. For example, tax exposure will depend on the branch or company status, and also whether a single purpose contract is being entered into. Tax legislation consists of a common tax regime and a withholding tax regime and there are a variety of international tax treaties in force. Investors also need to consider foreign exchange control regulations, specifically since Algerian dinars are not freely convertible and certain bank account types must be held in Algeria.

EY OZOILS The Ernst & Young Australian Small to Mid Cap Oils Index (EY OzOils) will be published quarterly at the beginning of March, June, September and December.

The Ernst & Young Australian Small to Mid Cap Oils Index (EY OzOils) will be published quarterly at the beginning of March, June, September and December. The EY OzOils is created using data from Bloomberg and is constructed on the same basis as other major financial market indices with a nominal value of 100 assigned to the Index levels as at 1 March 2005.

the performance of individual company’s can result in a company entering or exiting the index from quarter to quarter. There have been changes in the composition of the EY OzOils Index since the June 2006 quarter with CH4 Gas, Sunshine Gas, Stuart Petroleum, Salinas Energy, Golden Gate Petroleum and Cooper Energy exiting the index and Baraka Petroleum, Methanol Australia, Oilex, Pan Pacific Petroleum, Eastern Star Gas and Aurora Oil & Gas joining the composition of the index.

The EY OzOils is created using data from Bloomberg and is constructed on the same basis as other major financial market indices with a nominal value of 100 assigned to the Index levels as at 1 March 2005. The companies included in the Index are the ASX-listed oil and gas small and mid cap independents, ranked by market capitalisation, making up collectively 90% of the total market capitalisation of all oil and gas exploration and production companies. To ensure the Index closely reflects the overall performance of the small and mid cap oil and gas sector, it excludes BHP Billiton, Origin Energy, Woodside Petroleum and Santos. The company make-up of the Index may vary as

As at 15 November 2006, the value of the OzOils index had increased by 29% since March 2005, which is on par with the performance of the S&P/ASX 200 Index over this period (Fig 1). In the last quarter, the EY OzOils Index decreased such that it was providing a return lower than the S&P/ ASX 200, which is the first time this has occurred since the inception of the index.

FIG 1: EY OzOils vs ASX / S&P 200 Indices 180

EY Oz Oils ASX200

170

ASX200 Energy

160

150

140

130

120

110

100 15-Nov-2005

15-Jan-2006

15-Mar-2006

15-May-2006

Figure 1 also indicates that the OzOils Index has diverged from the S&P/ASX 200 Energy Index. This is due to the strong performance of Paladin Resources, Energy Resources of Australia and Centennial

15-Jul-2006

15-Sep-2006

15-Nov-2006

Coal, which are constituents of the S&P/ ASX 200 Energy Index, and have caused the index to recover from the substantial decline that occurred in early September.

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EY OZOILS continued from Page 4 FIG 2: EY OzOils vs WTI 180 170

EY Oz Oils WTI

160 150 140 130 120 110

For more information on the EY OzOils please contact Chris Ryan on +61 (0) 8 9429 2393 or at [email protected]

100 90 80 15-Nov-05

15-Jan-06

15-Mar-06

Since Q3 2006, the EY OzOils Index has had a considerable fall which has coincided with a similar decrease in the price of West Texas Intermediate (WTI) crude oil (Fig 2).

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15-May-06

15-Jul-06

15-Sep-06

15-Nov-06

The WTI index has declined by 20% since August 2006.

EY OZOILS CONSTITUENTS November 2006 March 2006 Ranking Ranking 1 2 3 4 5 6 7 8 9 10 11 12 13 14 15 16 17 18 19 20 21 22 23 24 25 26 27 28 29 30 31 32 33 34 35 36

1 2 3 5 4 9 6 14 15 23 10 8 7 24 11 21 12 13 19 17 18 25 22 32 26 30 31 20 33 29 -

Code

Company Name

OSH HDR AWE BPT ROC QGC AZA NXS EWC AOE AED PSA ARQ TAP HZN AMU KAR NZO MAE OPL PVE NDO GBP SGL EPG IPM BKP AZZ MEO OEX LNG PPP CUE AUT MOS ESG

Oil Search Limited Hardman Resources Ltd Australian Worldwide Exploration Ltd Beach Petroleum Ltd Roc Oil Co Ltd Queensland Gas Co Ltd Anzon Australia Ltd Nexus Energy Ltd Energy World Corporation Ltd Arrow Energy NL AED Oil Ltd Petsec Energy Ltd ARC Energy Ltd Tap Oil Ltd Horizon Oil Ltd Amadeus Energy Ltd Karoon Gas Australia Ltd New Zealand Oil & Gas Ltd Marion Energy Ltd Orchard Petroleum Limited Po Valley Energy Ltd Nido Petroleum Ltd Global Petroleum Limited Sydney Gas Ltd European Gas Ltd Incremental Petroleum Limited Baraka Petroleum Ltd Antares Energy Ltd Methanol AustralIa Limited Oilex NL Liquefied Natural Gas Limited Pan Pacific Petroleum NL Cue Energy Resources Limited Aurora Oil And Gas Limited Mosaic Oil NL Eastern Star Gas Limited

Mkt Cap 15 November 2006

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3,829 1,498 1,282 1,142 953 689 611 546 530 473 394 333 328 233 229 192 187 183 164 158 154 141 136 117 112 104 95 94 93 92 89 87 85 82 77 76

Mkt Cap 1 March 2006 4,118 1,229 1,073 545 689 327 400 136 25 135 92 255 341 344 90 181 97 166 144 109 127 122 85 92 67 80 74 69 31 27 38 48 107 62 77 51

$ Change

% Change

(289) 269 209 597 264 362 211 410 505 338 301 78 (13) (111) 1401 11 90 17 20 49 27 19 51 25 44 24 22 25 62 65 51 39 (23) 20 0 25

-7% 22% 19% 109% 38% 111% 53% 302% 2002% 250% 327% 31% -4% -32% 56% 6% 92% 10% 14% 45% 21% 16% 60% 27% 66% 30% 29% 36% 200% 242% 136% 82% -21% 33% 0% 50%

RECENT THOUGHT LEADERSHIP BY ERNST & YOUNG Attracting Workers to the Oil Patch This report explores company responses to the continuing lack of supply of, and increase in demand for, workers in the energy industry. Strategies discussed for worker retention and attraction are:

High Risk, High RewardIntellectual Property Management at Energy Companies This paper discusses intellectual property management (IPM), which is of paramount importance to services companies which rely on IP for current and future cash flow. A non existent or poorly managed IPM can not only mean opportunities are missed, but can also lead to significant risk.

increasing financial incentives, increasing education in relevant age groups, looking to smaller companies or other industries, moving company location, flexible work structure, employing from other global locations, and outsourcing non core business.

IP is no longer managed by only the legal function, but also by R&D and sales and marketing. The integration of these three functions into the IPM program can help maximise benefits. Also discussed is the importance of IPM to Mergers & Acquisitions.

REGULAR UPDATES Ernst & Young’s Oil & Gas EYe This paper monitors the performance of the AIM oil & gas companies on a quarterly basis. As well as reporting the index, Oil & Gas EYe provides regular analysis and commentary on activity driving the AIM market

If you would like a copy of any of these papers, please contact Louise Higgins on +61 (0) 2 9248 4180 or at [email protected]

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www.ey.com/au

ERNST & YOUNG

Contacts NATIONAL & WA Leader of Oil and Gas Advisory Group Angus Walker T: 08 9429 2493 E: [email protected]

NSW Mike Elliott T: 02 9248 4588 E: [email protected]

SA David Powell T: 08 8233 7127 E: [email protected]

QLD Mike Meintjes T: 07 3011 3389 E: [email protected]

VIC Rodney Piltz T: 03 9288 8618 E: [email protected]

© Ernst & Young Australia 2007. This communication provides general information, current as at the time of production. The information contained in this communication does not constitute advice and should not be relied on as such. Professional advice should be sought prior to actions being taken on any of the information. Ernst & Young disclaims all responsibility and liability (including, without limitation, for any direct or indirect or consequential costs, loss or damage or loss of profits) arising from anything done or omitted to be done by any party in reliance, whether wholly or partially, on any of the information. Any party that relies on the information does so at its own risk.

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