in this edition

Executive interviews

IGass Gugen, Tethyss Robson and others questioned

An
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publication
+

On the spot

Burning question of fire sales

Expert insight

Volume 3 | Issue 3 | July 2012

Clifford Chance, Ernst & Young and more

Big fish or little fish? Get the shoal picture

M&A ISSUE
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Drillers Dealers
Official Publication of The Oil Council Bedford House 69-71 Fulham High Street London SW6 3JW UK Editor Drake Lawhead Senior vice-president, Americas drake.lawhead@oilcouncil.com T: +44 (0)20 7384 8061 Editor-at-Large and Media Enquiries 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 7384 8063 Partnership Enquires Vikash Magdani Executive vice-president, corporate development vikash.magdani@oilcouncil.com T: +1 212 813 2954 Advertising Enquires T: +44 (0)20 7384 8061
200 180 160 140 M&A spend ($bn)

July 2012 + MERGERS AND ACQUISITIONS

The Editor

4 10 12 14

EXECUTIVE Q&A
Francis Gugen, chairman, IGas Peter Veenhof, managing director, Dyas David Robson, CEO, Tethys Petroleum Somit Varma and Simon Eyres, Warburg Pincus

6-8 10-11 12-13 14-16 20-21

EXPERTS INSIGHT

Katy Foster and David Lewis, Clifford Chance Cross-border M&A perspectives

Zarko Arsov and Lydia Liu Supply and demand of Chinas natural gas

22-24

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100 80 60 40 20 0 2004 2005 2006 2007 2008 2009 2010 2011

Luke Parker Wood Mackenzie No shortage of deals to be done

26-28

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Jon Clark Ernst & Young National oil companies eye targets

30-31

ON THE SPOT

Will the shortage of debt in the market spark a series of fire sales?

35-38 41-47

In this issue, an avid Kishore da listener, a Stephen King reader, a football fan from the US and a rollerblader

MEET THE MEMBERS

THE EDITOR

Drake Lawhead

Remember when investing used to be fun?

ho would have thought so many engineers would be worried about Greece? Its hardly news that the interconnectedness of todays global economy now means that a budget crisis in a country that accounts for less than 2% of the eurozone GDP, has knock-on effects for the finances of a Calgary-based company drilling for oil in Peru, for example.

a long time in politics though one suspects not as long in Brussels. Many a time has the market predicted a rash of M&A that failed to materialise. Low asset prices do not always mean M&A after all, partly because, like a dog chasing a car wheel, you have to be able to do something with it when you catch it, and the technical complexities of operating an oil field mean that not all acquisitions are no-brainers even at cheap prices.

Yet the strength of the effect of the eurozone debt crisis still causes some head-scratching among the management of the junior/independent E&P firms, who have seen share prices decimated since the beginning of the year. According to one prominent banker in London, exploration is being priced at 0p per share as the global risk-off picks the flesh from stocks like a hungry piranha. Shares are at a historically cheap price in terms of P/E ratio valuations have scarcely ever been this low. But demand for oil is still robust as Goldman Sachs Jim ONeill pointed out, China currently creates a Greece-sized chunk of GDP every 80 days. Demand will keep oil near the $100 Brent mark, and on the supply side, the Saudis will hardly let it slip near the $90 mark, which is their break-even point for producing the stuff. And the fundamentals of finding and producing hydrocarbons have not changed on account of the turmoil in the eurozone.

Remember when investing used to be fun?

Weve gorged ourselves on a debt-fuelled smorgasbord of consumption, the bill has been presented, and someone has to pay for it. The food and drink was fine, but now comes the hangover.

As the global financial crisis enters its fifth year, a realisation is dawning at least on a certain part of the population in western economies that the party that started after World War II may be over. We might never see the kind of wealth creation that occurred from the 1950s until recently, let alone the kind of madness that made fortunes across America during the Clinton dot.com years back when investing was fun. Computer nerds flocked to Palo Alto in a virtual gold rush to pan for their fortunes in the streams of the world wide web, when investors grew fat off tech companies and blue chips alike, scoffing up their 200+ P/E ratios as if they were calories in an eclaire. Weve gorged ourselves on a debt-fuelled smorgasbord of consumption, the bill has been presented, and someone has to pay for it. The food and drink was fine, it made us happy and did us a lot of good in many ways, but now comes the hangover. As to the hangover cure, the left are suggesting hair of the dog and the right are suggesting a little less red meat and a little more tea. As Niall Ferguson said, if we knew what was good for us, wed all be members of the Tea Party, but everyone has their own opinion on the hangover cure. Its hard to imagine the hyper-liquid, eternally optimistic market conditions of the 1990-2000s returning to the west any time soon. But as is often said in these pages, for the right company with the right game plan, capital is always available as is a cash-rich bigger fish around the corner. Drake Lawhead, London, June 2012

The market can stay irrational longer than you can stay solvent

It beggars belief that a listed E&P firm is valued by the market at little more than its cash reserves when it is producing 20,000 barrels per day and has a balanced portfolio of attractive exploration prospects with commercial results, or that a 300m column of quality sweet crude discovery necessarily doesnt move the needle. The E&P companies I speak to, not to mention the broker-dealers, confess to a degree of perplexity about the mismatch between the fundamentals of their business and the level of risk appetite in the market its as if money managers have sworn off equities in favour of treasuries and the brown envelope under their mattress. Many view the markets inability to value E&P risk correctly as an opportunity to buy whether thats buying shares in undervalued companies, or (if youre an O&G company) buying assets and companies themselves. It all makes sense, but unfortunately John Maynard Keynes dictum that the market can remain irrational longer than you can remain solvent is correct. Many a company has gone bankrupt or been eaten up while waiting for the market to come to its senses. When talking to bankers and M&A specialists (On the spot, pXX), you hear phrases like blood on the streets come the third quarter. I wouldnt want to make a prediction, for the market is indeed irrational and a week is

Drillers & Dealers

July 2012

Confirmed Speakers:

NORTH AMERICA ASSEMBLY

OIL COUNCIL
At the Intersection of Energy, Finance and Investment

John Bookout Managing Director KKR

Janet Clark CFO, Marathon Oil

Alan Crain SVP and General Counsel, Baker Hughes

Jeffrey Currie Partner and Global Head Commodities Goldman Sachs Chuck Davidson Chairman and CEO Noble Energy

Mark Ellis Chairman and CEO, LINN Energy

October 9 10, 2012 Four Seasons Hotel, Houston, TX

Where North Americas oil & gas leaders meet international investors and financiers
The Oil Councils North America Assembly is a leading international conference and networking forum for senior oil and gas executives, and the finance and investment communities. We bring together thought leaders from the US and Canadian energy industries, international investors and financiers to discuss industry-critical issues in lively, interactive panel discussions: The future of North American O&G supply and demand Leadership and growth strategies for O&G firms US Energy policies after the election: The new regulatory environment The CFO wishlist: Needs & expectations NOCs and Forgein players The American opportunity M&A and A&D: Who, where, how? Independants abroad: International E&P strategies Investment insights: Debt vs equity financing Institutional investment Private equity

Bruce Laws President Maersk USA

John Manzoni President and CEO, Talisman Energy

Brian Maxted President and CEO, Kosmos Energy

Sam Oh Partner, Apollo Management

Irene Rummelhoff SVP, Strategy and Business Development Statoil USA

John Schiller Chairman and CEO Energy XXI

Lead partners:

Tom Ward Founder and CEO, SandRidge Energy

Tony Weber Managing Director and Chief Investment Coordinator Natural Gas Partners

www.oilcouncil.com/event/NorthAm

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EXECUTIVE Q&A I

KEEPING THE HOME FIRES BURNING

IGas chairman Francis Gugen discusses the current oil and gas landscape of the UK, North Sea and Norwegian Continental Shelf
Over the past 24 months weve witnessed rejuvenation of the North Sea and the Norwegian Continental Shelf in providing highly commercial finds. Is this a new beginning for the region or simply the last chapter in their ever-maturing lives?
Perhaps I am getting a bit long in the tooth but I cannot count the number of times the North Sea has been written off in my 35 years in the industry! In my view the North Sea still has much going for it: infrastructure, active acreage trading and a world-class HSEQ environment. However, of particular excitement at the moment is the potential being unleashed by new seismic technology such as GeoStreamer GS as provided by Petroleum Geo-Services ASA, where I must declare my chairmanship and the building of a more comprehensive understanding with mega surveys. It says something that the worlds largest oil discovery last year was made in the North Sea. The shale potential of the UK cannot be ignored either, and in my view has the potential to put this part of the world back on the map as a material producer. One of the reasons the North Sea and onshore the UK are so important is because of what they might do for the UKs security of supply in an ever more uncertain world. Of course the recent accord between the UK and Norwegian governments is also very helpful in this regard.

As regards the UK, there is no question that the recently announced changes were needed, certainly as regards small fields. One often overlooked effect of the earlier tax increases was that many of the smaller fields are being developed by entrepreneurial teams, whose financing arrangements usually mean they really only make money if certain demanding return thresholds are achieved. Better pretax profitability is, of course, good not just for the entrepreneurs but also for government. The effect of the earlier SPT increase did not just reduce the returns for such entrepreneurs proportionate to the tax increase, but in many cases wiped out a significant portion of their equity because of the disproportionate effect the SPT increase had on meeting return thresholds. This was evidently not conducive to the sort of entrepreneurial activity that the North Sea needs.

The recent 27th round in the UKs latest offshore licensing brought a record number of applications. The UK energy minister, Charles Hendry, commented: We have been working extremely hard with the oil and gas industry to ensure the UK remains an attractive place to invest. The recent budget was an important step to create a fiscal environment for North Sea development to flourish. Are these recent changes enough, in your opinion, to foster long-term investment and growth?

Reflecting on BPs recent asset sales to Perenco and Totals recent sales to Centrica, do you believe this signals a loss of interest from super-majors in investing heavily into the region?

This is evidently a question better posed to the super-majors. However, it is worth noting that many super-majors no doubt have most to offer where large and complex projects are involved. In the last few years, an unusually

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EXECUTIVE Q&A I

What needs to happen and by whom to ensure more long-term investment into the North Sea and NCS?

There are two essential ingredients to maximising the potential of the North Sea: appropriate fiscal and regulatory regimes, and the ability to effectively deploy resources against opportunities. The government is evidently in control of the former and shapes the latter to some degree, with its licensing and fallow acreage policies. I believe that government is generally aware of this and the last round of fiscal changes in the UK was perhaps a reminder of how mobile capital truly is in the oil industry. I would argue that there is no shortage of capital for the right management teams and companies and the right opportunities. However, one point that needs to be recognised is that ever more capital is having to be provided in the form equity. This is because debt, particularly project finance, is no longer such an attractive proposition for banks; particularly with Basel III coming. Since returns for equity, and particularly the sort of risk equity that is required in the North Sea, are considerably higher than for debt, policy makers will need to recognise that the environment they provide has to allow for this, if they do not want to risk a curtailment of activity.

What potential does onshore in the UK have and how is IGas positioned to take advantage of the opportunities there?

Ten years ago, when I first became involved with unconventional onshore, it really was considered somewhat eccentric, to put it politely! Even I had questions, particularly since the gas price then was a 10th of what it is today. Now things look very different. There is little doubt that unconventional production has, and is, transforming North America, not just the oil and gas industry but it is having a significant effect on the US economy as a whole. So where are we in the UK? We have both good coal bed methane (CBM) potential and a possibly even more exciting and game changing shale potential. At IGas we are in the early stages of CBM production operations, with three wells currently dewatering. As regards our shales, which are attracting very considerable attention from many well-informed sources, we need to recognise that the UKs journey has just started, with few well penetrations and fewer still production tests. This said, early results are encouraging. I can do no better than quote the results of IGass most recent penetration into its extensive shale holdings, which are approaching 400,000 net acres. After penetrating the top 1,000 ft of the shale section at Ince Marshes in Cheshire, IGas encountered a potentially highly prospective shale resource that benchmarks well with other successful shale regions including in the US with an average total organic content of 2.8%, leading to an at least doubling of the resource in place pre-drilling, leading to a revised potential of at least 9.2 tcf in place. IGas also benefits from being the operator of the largest number of production sites onshore the UK, since its acquisition last year of Star Energy. This gives IGas access to a wealth of successful, safe and environmentally responsible onshore production capability and history; where we have always worked very closely with our local communities. For these reasons I am very excited about the potential, not just for IGas, but what for what this could do for the UKs indigenous hydrocarbons production and its reliance on imported gas. >

large number of regions have yielded bigger, and in some cases more complex opportunities, such as in East Africa, Eastern Mediterranean, Brazil and the Arctic. It would be surprising if such regions did not attract the focus of the super-majors. It is also significant that many of these opportunities have been made possible by some of the latest seismic technology to which I have previously referred.

A swath of new private E&P companies have been launched to capitalise on exploiting these mature fields and unlocking pockets of new value. Is there enough business to go around?

As I have said I believe that there is much opportunity left in the North Sea and entrepreneurial companies will play a critical role realising the North Seas potential. Entrepreneurial companies will be vital since they are able to apply disproportionate talent and focus to opportunities that may not be immediately attractive to larger companies. I can perhaps best refer to practical examples of which I understand intimately because of my role as chairman. For example, CH4 Energys development of the previously somewhat moribund Markham and fallow Chiswick fields, and Chrysaors development of the previously fallow Solan field west of Shetland. This latter development will also be bringing much-needed fabrication activity to the UK, creating some 500 jobs on its own.

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EXECUTIVE Q&A I

Recently the UKs Department for Energy & Climate Change (DECC) released an independent expert report into the impacts of shale gas operations on seismic activity. Briefly, what were the findings of this report and how quickly will this hasten new investment into the UK shale plays?

First let me say that IGas, and I believe the industry as a whole, welcomed the independent report commissioned by the government and the recommendation for an effective monitoring system and a traffic light control regime. We fully support the governments approach that safety is of paramount importance and believe that the development of shale needs to be carried out in a way that engages with, and is supported by, other stakeholders in the area, particularly local communities. At IGas, in all of our operations to date, both from conventional and unconventional reservoirs, our relations with those around us are key. The principle finding of the independent report was: assuming agreement to use more sensitive fracture monitoring equipment and a DECC-agreed induced seismic protocol for future operations, the authors of the independent report see no reason why shale gas exploration activities should not proceed and recommend cautious continuation of hydraulic fracture operations. It is perhaps also worth noting that the prime minister David Cameron, in an interview given to the Lancashire Evening Post, also referred to the need for safety, but concluded by saying: But, I am fully alert to the potential and I am looking very closely at this industry with energy independence and security of vital importance to our country.

We should be proud of our contribution, since it is also difficult to conceive how 7 billion people could be kept alive on the planet, with the technology and economic challenges we currently face, without what we do. But the onus is on us to convey this to people in a language that is accessible and understandable. So my plea is for each and every one of us, in this industry, to start by exciting those around us of our relevance, expertise and passion for health safety and the environment, in language that our children and families can understand. I firmly believe that if we did this we would not be talking about recruitment in the coming decade. In addition to this self help, there is also a role for government the amount of investment required in energy and infrastructure over the course of the next 20 years is staggering, as is the amount of potential jobs this investment could create, but the government needs to start now to educate our children that industries like ours are worthwhile, sustainable and will provide long-term employment prospects to fill the skills gap we undoubtedly will have. We did it before and we can certainly do it again, but common threads across departmental boundaries need to be created.

What advice would you pass on to a recent graduate wishing to work in the oil and gas industry?

From my previous answer it should be clear I would say come and join us, be challenged, do some good, the world needs what you do each and every day and in more ways than you have probably ever imagined. Did you know you go running and wash your hair in North Sea oil?

How can technologies and practices from the US Shale Gale be best leveraged within the UK onshore shale plays? Are there enough comparatives or is UK onshore simply a different ball game all together?

All the indications are that the UK can learn from what has been done successfully elsewhere. But at the same time it is critical to recognise that the UK is a much more densely populated environment where, as I say, relations with those around us always have been, and will continue to be, key. At IGas we have already announced that we will be seeking a farm-in partner to help take forward our considerable shale holdings.

The government needs to start now to educate our children that industries like ours are worthwhile, sustainable and will provide long-term employment prospects

Looking across the horizon, what excites you most about the future of the UK energy industry and why?

Far from the UK industry being in its twilight years, there is plenty of opportunity remaining in geological horizons and traps, not previously considered or seen and, onshore, in production from what was called unconventional but is rapidly being seen as just mainstream.

This potential is sufficiently great that it will not just be interesting for a few isolated companies, but that it has the opportunity to make a contribution to the UKs security of supply and maybe even to help the UK economy more generally, and goodness knows that could do with all the help it can get. However, our attitude to these opportunities will be critical to how fully they are realised and how quickly. The old adage that oil is not found in the ground but is found in the minds of men was never more true! So let us set our minds to making shale happen in a manner that works both for the country as a whole and local communities.

Looking at how the UK is going to staff the companies extracting its hydrocarbon resources, the country is facing a major talent crunch with a lack of young professionals and graduates coming into the UK oil and gas industry. What actions need to be taken and by whom to try and reverse this worrying trend?
We seem to have been debating this question for at least the past two decades but the reality is what drives young professionals and graduates has always been the same. They want to feel they are making a valuable societal contribution and the oil and gas industry has not kept up with others in conveying this message. I, and most people in this industry, are passionate about the planet and the legacy we leave our children, but have we done enough to communicate this to the wider world?

Finally, a question we always ask, what three luxury items would you take to a desert island? (NB: You may NOT choose a boat, satellite phone, Practical Raft-building for Dummies, etc!)
A bottle of fine Burgundy, evidently red since I am assuming there will be no fridges on this desert island! A very fine straw hat, since I continue to be follicly challenged and a very good geological atlas, since there is shale everywhere and I am not good at sitting still for too long!

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Clients First, Always

Established in 1996, Evercore Partners is a premier global independent investment banking advisory rm, providing strategic advisory services on mergers, acquisitions, disposals, restructuring and capital market transactions. Today, our ofces in the U.S., the UK, Mexico, Brazil, and Hong Kong are complemented by strategic alliances with leading rms in China, Japan, India, Korea and Argentina. Evercore has over 800 employees, of which almost 400 are M&A and restructuring professionals, including one of the largest dedicated Energy advisory teams in the market comprising almost 50 bankers, based in Houston, London, New York and Aberdeen. In EMEA, we continue to build-out our practice rapidly across the entire region, working for clients in the UK, Europe, Russia, the Middle East and Africa.
US$47m 2012 Terms not disclosed 2012 US$90m 2012 US$7.2bn 2012 US$582m 2011

Advised TAQA on the acquisition of 13.5% interest in the North Cladhan area and farm-in of 12.5% to South Cladhan from Sterling

Advised TAQA on farm-in to three licences operated by Fairfield Energy in the North Sea including the Darwin oil discovery

Acquisition by EnQuest of 20% in Kraken Discovery from Canamens

Advised Kinder Morgan and El Paso on the sale of EP Energy to an investor group led by Apollo Management and Riverstone

Joint financial advisory on international marketing of 65% of Burrup Holdings acquired by Apache Corporation and Yara International

US$55m

2011

A$924m

2011

799m

2011

US$7.2bn

2011

US$1,800m

2010

Advised TAQA on the acquisition of EnCores interest in Cladhan from Premier Oil

Joint financial advisers to ESG on its acquisition by Santos via a scheme of arrangement

IPO of Ophir Energy on the London Stock Exchange

Advised Itochu on its acquisition of a 25% interest in the acquisition of Samson

Acquisition by TNK-BP of BP's assets in Venezuela and Vietnam

Energy Corporate Finance team contacts:

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EXECUTIVE Q&A II

Ross Campbell talks to Peter Veenhof, managing director of Dyas, about the Dutch companys joint ventures

NETHER
For those of our readers who might not know about Dyas, Peter, can you share with us briefly some information about your company?
Dyas is an active partner, as non-operator, in oil and gas exploration, development and production joint ventures with most assets in the UK and Dutch North Sea. We are owned by SHV, a multinational corporation and the largest privately owned company in the Netherlands.

BETTER
Our non-operating investment model has its origin almost 50 years ago. Dyas started partnering in Dutch gas exploration in 1963 because, at that time, gas from the giant Groningen field started to replace the coal supplied and sold by our shareholder for domestic use since 1896. The formula has worked well since and family owned companies often have a long-term view. No particular reasons have arisen to change this strategy.

With a small team we manage a portfolio with developed reserves well above 60 million boe. Daily production in the UK and Netherlands is in the 20,000-25,000 boed range, split 75%/25% between oil and gas. The Dyas strategy is to grow its reserves base through active participation in the joint ventures that were in, as well as acquire new assets through negotiated deals and auctions, preferably in the pre-development project stage. Dyas is opportunistic towards other business opportunities, and we recognise that we have to diversify our reserves base outside the North Sea.

Your equity investments range from between 2% and 50%. Is there a preferred equity stake that you are comfortable with and like to secure?

That really depends on the quality of the asset and build-up of our portfolio. With our current portfolio, we prefer interests to be in the 10%-30% range, depending on the risk and size of in the investment. We like our portfolio to have some degree of internal hedging, which means that subsurface risk as well as the dependency on a single operator, country or commodity should ideally be mitigating overall portfolio risk. Of course, commodity prices and currency risks remain important factors outside our control. We also realise that, as non-operating investors, we cant always get what we ideally want.

Your strategy on being an active partner but non-operator has proven very successful. Why did you opt for this strategy, what was and still is the thinking behind this decision?

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EXECUTIVE Q&A II

For us that is a key point. Of course technical capability and financial robustness are important. But again, I emphasise that an oil and gas investment always boils down to something in the ground with a bunch of people on top of it. Dyas, staffed with seasoned E&P professionals with 20-plus years operating experience each, shares the risk developing the something in the ground. However, the key to unlocking value is often in the personal relationship, where mutual core values of trust, integrity and transparency play a dominant role.

The key to unlocking value is often in the personal relationship, where mutual core values of trust, integrity and transparency play a dominant role

Looking at the North Sea and the Netherlands, how do you view the current investment landscape in these regions? Is there enough opportunity still around? Are you actively looking for more opportunities here and, if so, what are you looking for in new prospects?
Relative to the scale of Dyas, the North Sea continues to offer sufficient opportunities for the near future. However, we are actively looking for diversification outside the North Sea on an opportunistic basis.

Were now seeing, in the wake of global and financial uncertainty, a lot of public companies struggle with share price volatility and market confidence. What are the benefits of being a privately owned company and do you ever see that changing?

The list of companies you partner with is very impressive. Majors such as Chevron and Total, national energy companies like TAQA and independents like Nexen and Ithaca an enviable list indeed. Is there a preferred type of partner in terms of size and structure?
We strive to have a variety of operators ranging from big to small. The key criteria we look for, apart from the quality of the asset, is financial robustness, technical capability and project drive of the operator. At the end of the day it is really down to people, so we also look at the track record of the individuals involved. We spend a lot of time building an active, trusting relationship with the people involved because we tend to invest in the pre-development stage, i.e. the resource has been found but needs to be developed. Our industry is more and more constrained by non-availability of key people that stand out from the crowd. Hence this aspect receives more attention than before.

A privately owned and well-funded company such as Dyas is much less dependent on the day-to-day ups and down in the market and can continue to take a long-term view. For example, during the 2008/2009 credit crunch, Dyas could undertake significant acquisitions of assets from Oranje-Nassau and Ithaca Energy. When oil prices climbed to their recent relatively stable level, we divested a number of assets that were better placed in other hands. We seek to invest again in the years to come.

You have worked for companies large, medium and small. What other oil and gas companies public and private do you admire most and why?

Without mentioning any of our operators, partners or competitors, I admire companies the same goes for people who actually do what they say. Thats difficult enough in our industry.

What interesting news and developments will we see coming from Dyas in 2012, what should our readers be looking out for?

We do not often sound our trumpet before us because we are privately owned. But I would say, after a period of portfolio realignment, we should see Dyas making fresh investments again.

Successful and dynamic partnerships are key to unlocking value in our industry. Is there a proven formula for making joint ventures work effectively for all parties concerned? Reflecting on the good, the bad and the ugly, what lessons have you learned that you would pass on to others?

Finally Peter, the question we ask all executives, a little off key but what three luxury items would you take to a desert island?
I guess I also cannot take my wife to whom Ive been married 27 years, she would turn the island into a place where one would not want to leave. I would take a supply of cigars, the New Testament in the translation of William Tyndale and a picture of my wife and five children. Boring, isnt it?

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EXECUTIVE Q&A III

CENTRAL REVELATION
Drake Lawhead talks to David Robson, CEO of Tethys Petroleum

EXECUTIVE Q&A III

Describe Tethys Petroleum briefly to those who may be unfamiliar with you what is the masterplan that Tethys is based on in terms of exploration and growth strategy?

Tethys CEO Robson meets Emomali Rahmon, president of jewel in the crown Tajikistan

We are the leading independent E&P company in central Asia. Our strategy, in simple terms, is to increase production at our producing assets and bring recent discoveries on stream, and use the cashflow developed to explore some potentially high-impact prospects. We are also looking to add additional projects within the general region.

How important are political and government relations to the conduct of your business in central Asia, and how have you developed and managed these over the years?

It is important but can be overstated. In the countries where we operate there have not seen the licence disputes that have impacted some E&Ps in recent years. We have developed good relations by being open and ensuring that we meet our work programme commitments and operate in a socially responsible manner employing local workforce. We are also well placed because we were one of the first to enter each country we operate in, and have a detailed knowledge of the region with more than 20 years operating there.

How is the infrastructure to bring gas and crude to market in central Asia is the regional midstream capability adequate or is there work to be done?

You are the only independent oil and gas company operating in Uzbekistan and the only one to operate in three central Asian countries. What has attracted you there but no one else?

There is a well developed infrastructure for both oil and gas, with new routes now available to provide off-take of oil and gas to China and shortly gas to India and Pakistan. The infrastructure is rapidly developing to supply these adjacent energy-hungry markets.

It is an area with substantial oil and gas potential, both in existing discovered deposits and in large upside exploration targets, where we felt that considerable benefit could be achieved by introducing Western technologies and management systems. Other companies are interested and operate there but we are the only one to have built up the relationships to operate in three of the republics.

Do you plan to tap the capital markets this year, and if so, for debt or for equity? What is your view of the capital markets currently for a company like yourself, and do you see a material difference between Toronto and London?
I think it is far to say that London investors are more comfortable with central Asia than is the case in Toronto. We have good and increasing cash flow and we keep our costs low by using our own fleet of drill rigs. So, we shouldnt need to raise additional funds in the market for the foreseeable future.

You refer to Tajikistan as your jewel in the crown. Can you explain what it is you see there and what youre hoping for?

Tajikistan is a largely underexplored country and offers excellent fiscal terms. Our assets there provide an opportunity to rehabilitate some existing oil fields but the jewel in the crown is the deeper sub-salt prospects that we have identified on the seismic and geophysical data. We hope to drill the first exploration well targeting these deeper horizons in 2013 but there is the potential for a game-changing billion-plus barrel discovery. A new reserve report is due out in the next month or so.

Whats the next big piece of news we should look out for from Tethys this year?

How easy or difficult is it to sell central Asia to investors in Toronto and London? Whats the main point of resistance you come across when explaining your vision to the market?

The next key milestone for Tethys is the drilling of the Doris AKD07 appraisal/exploration well in Kazakhstan, which we hope to spud in the next few months. Not only is this well a further appraisal well for the Doris discovery, but it is also an exploration of a deep sand fan play that we believe we have identified.

E&P investors are used to investing in countries operating in remote areas or those perceived as politically risky. Our biggest obstacle is lack of knowledge and understanding of the region. Investors who visit are quickly convinced of the potential.

Considering the global E&P industry, which other pioneering E&P firms outside your neighbourhood do you admire, and why?

I have always had a great admiration for Cairn Energy, going into India and finding big potential in areas previously overlooked. I wish them well in offshore Greenland, an area I think has good potential.

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EXECUTIVE Q&A IV

PRIVATE
Warburg Pincus has been strengthening its reputation with some sage investments in the energy sector and emerging markets. Can you briefly describe your investment portfolio in these sectors the funds you have, the companies involved and any future funds on the horizon?
Founded in 1966, Warburg Pincus is a leading global private equity firm focused on growth investing. The firm has more than $35bn in assets under management. Its active portfolio of more than 130 companies is highly diversified by stage, sector and geography. Warburg Pincus does not have a specific energy fund but makes energy investments from a global fund, to date we have invested over $40bn globally. Warburg Pincuss focus on energy investing began in 1987, and we have provided more than $6bn of equity capital to at least 45 companies. Even though we invest across the whole energy chain exploration and production, midstream, power generation, oilfield technology and relatedservices, and alternative energy development most of our portfolio companies have been in the E&P sector, where our investments range from deepwater exploration to unconventional assets and across geographies. As a global investor, in addition to North America and Europe, we have made investments in, for example, Brazil, China, Ghana and India. This breadth of experience allows us to be proactive and evaluate different kinds of opportunities in an effective manner. As to style, we are primarily a growth equity investor and we seek to work with exceptional management teams to build businesses of scale over a relatively long period of time five to 10 years.

Somit Varma and Simon Eyers from Warb private equity landscape

Youve been involved in more emerging market investments recently. Are you actively looking to grow your investment portfolio here, both generally and within energy? What are your remits within Warburg Pincus and what returns are you seeking on new investments?
Warburg Pincus is one of the pioneers in emerging markets investing and it is certainly an area on which we are focusing, however we invest in specific opportunities rather than pre-determined regions.

Energy is a global business, and although above the ground issues can vary from one place to another, the principle of backing world-class management teams to build durable businesses and create growth underpins our philosophy in whatever region we invest. The combination of deep-domain expertise and physical presence in the regions where we invest allows us to evaluate opportunities offering the right risk/reward profile with environmental, social and governance elements incorporated into our investments.

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EXECUTIVE Q&A IV

EYES
For a firm with as many investments as we have, it means we can share information across the portfolio for example comparing North American coal bed methane (CBM) well results with those of an investment in China, or applying valuable experience drilling offshore Ghana to investments in the North Sea and the Gulf of Mexico. We dont really think geography first: its quality of the management team, the investment thesis, and the potential to scale that we look for. In the case of Kosmos Energy, we backed the management team in 2004, and in 2007 Kosmos discovered one of the largest new oil discoveries in the past decade in the Jubilee Field. Since then, Kosmos has grown into a publicly listed, international E&P company of scale, and has succeeded in a basin where many others had failed. Another example of an investment in the emerging markets is Asian American Gas, in which we invested in 2010. AAGI is a China-based CBM producer which has since received the first ever Overall Development Plan approval in the Chinese CBM industry allowing it to continue commercialisation of the Panzhuang block in China.

burg Pincus talk about todays

Sticking with emerging markets, who is now co-investing with you on projects? Are you seeing the same old companies involved or are there new players coming into the fray? How sophisticated are these in particular emerging indigenous funds specifically relating to energy?
Warburg Pincus benefits from having energy specialists in London, Mumbai, Hong Kong and Sao Paolo as well as New York, all of whom have made and manage investments in their regions. This is something that makes us fairly unique and attractive to co-investors.

There has been a huge amount of private equity investment in E&P over the last couple of years according to public data the US alone has seen $20bn put to work since the beginning of 2011. We work with most of the names you would recognise. We frequently co-invest with our limited partners, several of whom have developed considerable experience of their own as co-investors in our deals and in energy broadly. So yes, there is meaningfully broader and deeper experience than there might have been five years ago. We are responding to that by emphasising the benefits of our global approach, and by investing at the forefront of technical and operational innovations where our experience can add the most value.

With the continuing financial uncertainty weve observed debt markets becoming closed off to many and the stuttering of public equity markets proving too volatile for some O&G companies to access new capital. Have you seen an uptake in the interest for private equity capital and what role do you believe it has to play in markets such as these? >

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EXECUTIVE Q&A IV
There has been a huge amount of private equity investment in E&P over the last couple of years according to public data the US alone has seen $20bn put to work since the beginning of 2011
There is really only one: alignment. Alignment applies to incentives, to objectives, to focus, and to a host of other things. Your use of the term partnership is exactly right, management teams bring a thesis and the human capital and operational experience necessary to put it into action, private equity contributes the financial resources with its own experience and relationships to the table. Recognising the contributions of both sides and making sure the interests are aligned is essential to creating value and de-risking the investment. Keeping it simple also helps there is no point in trying to predict and provide for every circumstance in which you might find yourself disagreeing with a management team. Incidentally, all this is just as true for the relationship between an emerging market venture and the host country. You need to be humble as a guest in the country, you need to structure a deal that is fair and not one-sided, and you need to focus on actual rather than perceived risks.

< Public markets come and go, and while the debt markets are virtually closed in Europe, reserve-based lending remains strong in North America. Ours is by its very nature a long-term business, and the lives of a fund and an investment tend to outweigh those cycles by a long way. Private equity appeals where management teams want an active investor, and put predictability of funding ahead of the possibility that the public markets may, in certain instances, provide it more cheaply. Our model usually involves so-called lines of equity (LoE) and is particularly well adapted to energy growth companies because it takes away the uncertainties related to volatile markets. In an LoE, we commit what can be quite a large a sum up front to a management team, which has access to the equity as the company expands. Since the beginning of 2011, we have led six LoEs, including a $1.125bn financing for Venari Resources, a start-up company focused in the Gulf of Mexico.

How well prepared are companies who are coming to you for capital, what do you think is the general quality of their advisers and what suggestions would you like to make to improve their chances of success in a workable timeframe?

We see all sorts the best have a robust thesis that is both different and demonstrable. In E&P they will have done a lot of ground work and have data to show and will have a management team that brings complementary strengths to make the business successful and scalable. We generally look for opportunities that can grow to scale. In services, they will have more than a good idea few industries are as reluctant to try something new as the energy industry, so demonstrable traction is key. Some advisers bring the best out of the team and help them showcase their strengths, others pitch only the dream, which is unhelpful.

With financial uncertainty adopted as the new status quo, are you finding the demands and needs of your portfolio companies changing and what advice and support do their management teams now seek from you?
The advice would be that in the current uncertain environment, liquidity is at a much greater premium than it was a few years ago. At the risk of stating the obvious, it allows management teams to respond more quickly to opportunities, and it keeps them out of trouble when the inevitable surprises occur. The stock market is not always a good place to find liquidity, nor are the banks, and so we are seeing a greater appreciation for the security of funding a private equity partner can bring.

There is no doubt that good management teams are critical to the success of any company, but what other important qualities and characteristics must an investment have in todays markets?

Probably the most overlooked success factor is the opportunity for growth and scale. In E&P it gives you the chance to create assets and intellectual capital that other industry players want to own. In services, it allows you to create a business that is in charge of its own destiny. This is particularly true in emerging markets, for all the obvious reasons.

What news and developments will we see from Warburg Pincus in 2012, what should our readers be looking out for?
We both joined the Warburg Pincus comparatively recently Somit to lead in emerging markets, Simon to lead the energy effort in Europe. This reflects an investment by the firm in further strengthening its global franchise, and so we both hope youll see Warburg Pincus investing in energy more often outside North America.

Public markets are becoming more important as private equity investors look for realising the value of some of their portfolio companies. What then is the best strategy to optimise access to todays public markets? Is London, Toronto, Hong Kong or New York the best place to list or do you see more regional exchanges offering better returns?
It is very difficult to generalise. No stock exchange and public market is similar and the key is to match the company to the right public market. At Warburg Pincus, we have listed more than 130 companies on 13 exchanges, so we draw upon our capital markets experience to develop an appropriate strategy to maximise returns and the long term future of our investments.

What excites you most about the future of the energy industry and why?

Continually evolving technology, the opening up of new frontiers and, as investors, the fact that although energy use is on the increase, supply continually needs to be replaced.

What are the vital ingredients to making a successful private equity partnership with a portfolio company?

Finally, something we always ask: what three things would you bring to a desert island? (NB: You are NOT allowed Practical Raft building for Dummies, a satellite phone, tickets for the ferry, etc!)

As in most things, we agree on this, wed take a library of good novels, a sunshade and a comfortable chair.

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EXPERTS INSIGHT

Katy Foster and David Lewis Clifford Chance

Cross-border M&A: perspectives on a changing world

here is optimism around oil and gas M&A, but behind the scenes, research commissioned by Clifford Chance indicates how concerns around resource nationalism, political volatility, post-acquisition integration, and regulatory risks are shaping deals. For example, it is clear from the recent Shell/Cove Energy transaction that navigating through the local political context in Mozambique, including the decision of the local government to impose a capital gains tax on the sale, and securing its endorsement, will ultimately be fundamental to the success of this transaction. In the first quarter of 2012, the Economist Intelligence Unit carried out a global survey on behalf of Clifford Chance to explore current perceptions of the key opportunities and risks in cross-border M&A. It looked at current and future plans for M&A activity, and key barriers to successful cross-border deals. There were 377 respondents from companies with annual revenues in excess of $1bn, including from the O&G sector. Around 58% of respondents from the O&G industry stated that the focus of their organisations growth strategies was emerging and high-growth markets, and with such deals can come significant country risk. Within the sector, moreover, the variance we have seen across regions indicates that whether the glass is half full or half empty depends very much on whether you are looking at things from Aberdeen or Angola. What is apparent, is that although the various risks and concerns are important factors that are taken into account in assessing potential targets, it does not appear that many of these are ultimately deterring potential bidders from seeking to secure highly attractive or strategic assets. The competitive public auction and last minute higher offer for Cove Energy illustrates the appetite for securing such assets.

Concerns around effective integration and cultural differences

Investors in cross-border deals are increasingly focused on bridging cultural divides between foreign shareholders and management, employees, local partners and/or government. This trend is manifesting itself in attention being paid to careful integration planning and management due diligence at the outset of transactions. The extent to which respondents perceived cultural differences as critical varied from region to region. Sixty-seven per cent of respondents from Asia-Pacific stated that cultural differences are a deterrent to pursuing cross-border deals, against 35% in Europe.

Resource nationalism: protectionism and foreign ownership restrictions

Respondents from the O&G industry expressed a greater concern regarding protectionism and obstacles to foreign ownership than their peers from other sectors. Approximately 38% of respondents from the sector placed protectionism and restrictions on foreign ownership within the top three legal risks they perceived in cross-border M&A. This was significantly more than in other industries for example, just 14.8% of respondents in the mining sector agreed. Concerns around protectionism and foreign ownership restrictions were even more pronounced among respondents from the Asia-Pacific region. More than half of those respondents placed these issues in the top three risks they identified in cross-border M&A.

Economic and political volatility in target markets

Top five risks and concerns

Argentinas renationalisation of YPF at the expense of Repsol offers more evidence that, in some countries, outright state expropriation of foreign-owned assets remains a risk that needs to be considered and managed from the outset by potential investors. Our dialogue with business leaders revealed variance from region to region as to the precise political and economic factors that they perceived as key risks. In the shadow of the eurozone crisis, respondents based in Europe suggested a particular sensitivity towards fluctuations in macro-economic conditions: 25% identified volatility in pricing or valuation as the main reason behind deal failures they had experienced in the previous two years. Not one respondent from the AsiaPacific region identified the same cause for deal failure.

Respondents from the O&G sector identified the following top five risks and concerns regarding M&A: Concerns around effective integration and cultural differences. Resource nationalism, manifested in protectionism and foreign ownership restrictions. Economic and political volatility in target markets. Environmental risks in the context of crossborder transactions. Concerns around bribery and corruption.

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Katy Foster and David Lewis Clifford Chance

EXPERTS INSIGHT

Environmental risks in the context of cross-border transactions

Following BPs 2010 Gulf of Mexico spill, an unsurprising inclusion among risk factors was the perception of environmental laws as presenting a challenge to cross-border M&A. Beyond disaster and spills, the expansion of the global shale gas industry has provoked considerable speculation over the environmental impact of such production, and the industry will be watching closely for how legislators outside North America react. Many market participants also suspect that environmental investigations have been used in some countries as a way of pursuing political goals, applying pressure on foreign investors to agree to make concessions to the host State. It was notable that 40% of O&G respondents from the Asia-Pacific region placed environmental laws as among their top three risk factors when conducting crossborder M&A, suggesting a comparative lack of comfort in addressing such issues as part of transactions. We anticipate that the trend of environmental due diligence forming a key part of deal strategy will only continue.

The O&G industry expressed a greater concern regarding protectionism and obstacles to foreign ownership than its peers from other sectors
Potential acquirers are paying closer attention than ever to bribery issues in their diligence, are seeking additional robust warranties and indemnities in relation to historical compliance, and are also focusing more acutely on putting in place anti-corruption practices. Anti-corruption legislation is increasingly reaching across jurisdictions, and is becoming more aggressively enforced. Failure to comply with such legislation can and does have serious consequences. Issues are likely to be all the more complex where deals involve underlying assets in developing countries, and joint venture arrangements with local partners both trends highlighted in our survey.

Bribery and anti-corruption

Risk mitigation

When considering which political factors give them greatest concern in the context of their organisations cross-border M&A activity over the next two years, 30.3% of respondents identified bribery and corruption within their top three concerns, rising to 40% in Asia-Pacific.

The trends outlined above are affecting the way investors focus their due diligence efforts. Our research also indicated that, in a time of economic and political uncertainty, acquirers are increasingly partnering with co-investors in order to share the burden of legal and economic risk. With an emphasis on joint ventures comes a focus on negotiating the terms of an ongoing relationship with an appropriate partner, be that a local player or a multinational. The well-publicised dispute between BP and TNK-BP in respect of the latters Arctic Ocean ambitions was a further illustration of the challenges of managing a joint venture relationship, and the importance of carefully planning for all eventualities. Potential acquirers are also looking to mitigate political risk by engaging with key stakeholders, including regulators and politicians, before announcing any deal. Investors are also looking beyond the terms of their immediate deal in order to seek protection. Foreign acquirers sometimes seek to structure their investments to take advantage of bilateral investment treaties. Another risk mitigation method has been to obtain political risk insurance. Clifford Chance is advising Royal Dutch Shell on its offer of 1.12bn for Africa-focused Cove Energy

Political issues in Mozambique is just one of the barriers Shell will have to deal with after buying Cove Energy

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CREDIT: CORDELIA_PERSEN

EXPERTS INSIGHT

Zarko Arsov and Lydia Liu Taylor DeJongh

Natural gas in China potential for long-term oversupply?

wo key elements of Chinas national energy strategy are energy security, driven by aggressive resource acquisition abroad and development at home, and pollution control, driven by a shift away from coal to cleaner fuels. For both elements, natural gas is set to play an increasing role. In China, natural gas currently produces less than 1% of the total power output, compared with 23% in the United States and 48% in Russia1. However, natural gas is expected to grow in significance over the next decade, fuelled by the expansion of global supply, as well as the domestic discoveries of potentially significant shale gas reserves. In recent years, the Chinese government and national oil companies have moved aggressively to increase access to natural gas supply. Their efforts have involved increasing Chinas LNG access, through the rapid expansion of LNG regasification infrastructure, the acquisition of ownership interest in LNG liquefaction projects, and the securing of offtake contracts. Additionally, China has signed pipeline agreements with Russia, Turkmenistan and Myanmar that will substantially increase the countrys import of natural gas through pipelines. It now looks possible that these efforts may have been too successful. Chinas determined approach seems to have tentatively secured the countrys access to such quantities of gas that it could result in an oversupply in the next decade. The potential oversupply could, in fact, be significant if Chinas shale gas reserves are as large as expected, and the country is able to fully exploit them. The purpose of this article is to explore the sources of the potential oversupply and review its implications.

Rapid anticipated demand growth

Projections of Chinas gas demand can vary greatly depending on the source. However, most authoritative sources predict a significant increase in demand. As stated in Chinas 12th five-year plan (FYP), the Chinese government anticipates gas usage to increase to 170 bcm in 2015 and 200-250 bcm in 2020 (figure 1, below), potentially more than double 2010s usage levels. Other projections are even more aggressive; for example, one China-based source expects domestic demand for gas to reach 450 bcm by 2020.

Domestic production growth of unconventional resources plays key role

At the same time, domestic production is set to expand. In 2010, China produced approximately 97 bcm of domestic gas2, mostly from conventional and tight reserves. The Chinese government expects gas production to reach 170 bcm in 20153 and 200 bcm in 20204 (figure 2, opposite), driven mainly by the development of unconventional gas.

Over the past five years, the discovery of unconventional resources, particularly shale gas, has resulted in optimistic revisions of reserve estimates, and ambitious unconventional gas production targets have been set in the 12th FYP5. China currently does not produce shale gas6 in commercial quantities, however, by 2015, shale gas output is expected to reach 6.5 bcm. Total unconventional gas production could contribute 30% or more of Chinas natural gas supply by 20207.

Domestic supply and demand comparison

Fig.1 Actual and projected gas consumption in China, 2010-2020

350 300 250 200 150 100 50 0

BP Statistical Review of World Energy 2011 Energy Information Administration International Energy Agency (World Energy Oulook New Policies Scenario) 12th Five-Year Plan

Source: BP, EIA, IEA, China 12th FYP

2010

2015

The US Energy Information Administration (EIA) estimates that China holds the worlds largest technically recoverable shale gas resource of 36 tcm8, almost twice as much as that of the US. Encouraged by the impact shale gas has made on the US. and global gas markets, Chinas leadership is eager to replicate this shale gas revolution at home. The country has been promoting its shale industry through international M&A and co-operation between NOCs and foreign companies, which has given the nascent domestic shale industry access to essential technologies such as horizontal 2020 drilling and hydraulic fracturing.

bcma

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Zarko Arsov and Lydia Liu Taylor DeJongh

EXPERTS INSIGHT

However, development of shale gas in China is still in its earliest stage 300 with many uncertainties. The industry in China lacks many of 250 the key elements that supported the rapid shale gas growth in the 200 US. For one, technologies utilised in the US may not be suitable for 150 Chinese shale gas production because of geological differences9. 100 Costs for shale drilling also remain high, at approximately 50 $6.3m-$7.8m per well or higher10, making shale uncompetitive with 0 imported gas. Other concerns include lack of pipeline infrastructure, absence of policy support such as tariff subsidies and tax benefits, regulatory uncertainty, and emerging environmental issues, especially concerning water usage related to hydraulic fracturing.
bcma

350

Fig.2
Domestic supply Demand

Chinese domestic supplyand-demand comparison

2010

2015

2020

Source: Wood Mackenzie M&A Service

Of the LNG imported by China, 90% is estimated to be imported under long-term contracts, with only 10% bought on the spot market14. Because of its long-term purchase obligations, it might be difficult for China to significantly reduce LNG imports.

Overall, China appears to possess significant domestic unconventional gas reserves. If these prove to be recoverable, Chinas gas demand could conceivably be met entirely by domestic production. However, the likelihood and extent of recoverability of these resources is uncertain at this time, and it could take at least five to 10 years for meaningful production levels to materialise.

Pipeline imports

Fig.3 Chinese LNG regasification terminals as of 15.05.12

China imported a modest 3.55 bcm of natural gas through pipelines in 2010, all through the Central Asia-China Pipeline from Turkmenistan. However, China is expanding its cross-border gas pipeline network. China and Turkmenistan have announced an increase in the planned capacity of their pipeline to up to 60 bcma, and the Myanmar-China Natural Gas Pipeline, currently under construction, is expected to add 12 bcma in 201315. Further, a planned pipeline from Russia is expected to provide up to 68 bcma of gas as early as 201516. There are substantial hurdles to these deals for example, China and Russia have yet to agree on the pricing regime. Nonetheless, it is almost certain that China will increase its pipeline gas imports over the near and medium term. Chinas total pipeline gas import capacity could reach 140 bcm per annum by 2020, assuming all three pipelines come on line at full capacity, supplying close to half of the estimated natural gas demand in China.

On stream Under construction Planned

bcma

LNG imports

Potential Oversupply

Chinas current LNG imports are modest, accounting for only about 11% of the countrys total natural gas usage, but are expected to grow rapidly over the next decade. LNG imports in 2011 were expected to reach more than 18 bcm11, and grow to 35 bcm in 201512 and 80 bcm13 in 2020. China currently has five LNG regasification terminals on stream, six under construction and another 13 planned (figure 3, above).

Comparing the projected demand with Chinas ambitious plan to increase domestic gas production, as well as gas imports, reveals a potential oversupply of gas for China in the 2015-2020 timeframe. To illustrate the potential oversupply, two supply scenarios are presented overleaf, for both 2015 and 2020 a conservative supply scenario and an aggressive supply scenario. The projected supply-and-demand values are outlined in the table (figure 4) overleaf. >

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EXPERTS INSIGHT

Zarko Arsov and Lydia Liu Taylor DeJongh

Fig.4

Estimated China natural gas supply and demand scenarios

(bcma) Conservative supply 2015 Supply Demand 222 260 (38) 2020 313 301 12 Aggressive supply 2015 287 260 27 2020 420 301 119

Source: IEA, China 12th FYP, TDJ Research

Oversupply/(supply gap)

Based on estimations from various sources, a range of supply volumes were determined for both 2015 and 2020, respectively. Conservative supply numbers take into consideration the uncertainties related to unconventional gas development, pipeline deals with Myanmar, Turkmenistan and Russia, and LNG imports. Conversely, aggressive supply numbers adopt a more optimistic view of the realisation of these developments. For estimated demand levels, the governments demand projections, as outlined in the 12th FYP, are used. Readers should note that the Chinese governments demand projections are relatively aggressive, with other sources, such as the EIA, projecting lower levels of natural gas use in both 2015 and 2020 and thus a higher potential oversupply than the scenarios presented above.

One of the most obvious potential implications of the oversupply is the reduction in Chinas pipeline and LNG imports. A substantial portion of Chinas future LNG imports is based on long-term contracts. However, China could reduce its participation in the spot market. Even more likely is the reduction of pipeline imports, such as the potential scrapping of the Russia pipeline. Another possible implication of the oversupply is for China to re-export natural gas to its neighbors, possibly Japan. Re-export could be an attractive option, as Japanese appetite has caused gas price to exceed those in China by almost 25% over the past few years. China could potentially become a regional supply hub, playing a role similar to that of Russia today. The Chinese government might pursue such a course of action even if shale gas commercialisation is achieved, as being a major regional gas re-exporter would be a valuable tool in the service of Chinas strategic and geopolitical interests. Yet another possibility is a more aggressive shift toward replacement of coal with gas in Chinas energy mix essentially growth in demand even beyond the governments ambitious targets. As Chinas population becomes richer, quality-of-life issues will grow in importance, and a reduction in pollution especially in the wealthier industrial hubs would be a significant improvement. Whether China ever faces a significant oversupply of natural gas, and how the country uses that position, is uncertain. However, it is certain that Chinas increased consumption and production of natural gas will have a profound impact on the global gas and overall energy markets over the next decade. Zarko Arsov is senior associate, and Yi-Chun (Lydia) Liu is marketing and research associate at Taylor DeJongh

Endnotes 1 Trailing Gas Demand Signals China Import Boom: Energy Markets. Ryan Woo. Bloomberg. December 13 2011. http://www.bloomberg.com/news/2011-12-13/ china-natural-gas-demand-to-surge-as-cleaner-fuelprized-energy-markets.html 2 Ibid. 3 China Energy News. December 9, 2011. http://www. cnenergy.org/_d272966177.htm 4 China National Radio Website. August 1 2011. http:// www.cnr.cn/jingji/yaowen/201108/t20110801_508311730. shtml 5 The Present Situation of Chinas Unconventional Gas. Che Changbo, Deputy Director, Oil and Gas Strategic Center, China Ministry of Land and Resources. Presentation to 11th US-China Oil & Gas Industry Forum. September 25 2011. 6 Sinopec News Website. December 7 2011. http:// www.sinopecnews.com.cn/news/content/2011-12/07/ content_1116820.shtml 7 The Shale Gas Energy Revolution. by Ronald Stoeferle. http://oilprice.com/Energy/Energy-General/The-ShaleGas-Energy-Revolution.html. April 5 2011. 8 World Shale Gas Resources: An Initial Assessment of 14 Regions Outside the United States. U.S. Energy information Administration (EIA). April 2011. 9 Shale gas reserve in US mostly lies in marine deposits, whereas shale gas reserve in China is located in various geological formations including marine deposits, continental deposits, and transitional areas in between. 10 Sinopec News Website. September 22 2011. http:// www.sinopecnews.com.cn/shnews/content/2011-09/22/ content_1074303.shtml 11 China LNG Imports to Rise 30% in 2012, Mirae Forecasts. John Adelman. Bloomberg Businessweek. December 15 2011. http://www.businessweek.com/ news/2011-12-15/china-lng-imports-to-rise-30-percentin-2012-mirae-forecasts.html 12 Unconventional Gas and Implications for the LNG Market. Facts Global Energy. February 2011. 13 Wall Street Journal. October 14 2010. 14 Commercial and Strategic Opportunities for LNG in China. Norwegian Embassy. http://www.norway.cn/ Global/SiteFolders/webbeij/DNV%20-%20China%20 LNG%20Final%20Report.pdf 15 CNPC Website. http://www.cnpc.com.cn/en/ cnpcworldwide/myanmar/# 16 Putin Says Russia Nears Deal on Supplying Natural Gas to China Bloomberg Business Week. October 11 2011. http://www.businessweek.com/news/2011-10-11/ putin-says-russia-nears-deal-on-supplying-natural-gasto-china.html

The projected supply-anddemand trends suggest that China could face a potentially significant oversupply of natural gas by 2020

The figures above show that in the conservative supply scenario, China faces a supply gap of approximately 38 bcm in 2015, and an oversupply of approximately 12 bcm by 2020. The aggressive supply scenario, however, suggests an oversupply of approximately 27 bcm in 2015, and 119 bcm in 2020, equivalent to 40% of the total demand for that year, and higher than the total gas demand in 2010.

Implications of oversupply and longterm trends

The recent reduction in global prices of gas, potentially significant shale finds at home, and greater focus on pollution control have contributed to the Chinese governments plan to increase the utilisation of natural gas. The projected supply-anddemand trends suggest that China could face a potentially significant oversupply of natural gas by 2020, especially if the country manages to achieve large-scale production of shale gas. Such a development could have a big impact on the regional and global energy markets.

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EXPERTS INSIGHT

Luke Parker Wood Mackenzie

Six good reasons to suggest deal decline is temporary

he oil and gas sector has been one of the bright lights of the global M&A market since the financial crash. More than $500bn of assets have changed hands since 2008. This year has been something of a disappointment deal numbers and values have slumped as transaction activity is hit by oil and gas price volatility. Yet international and national oil companies will need M&A as a key part of their resource-capture strategies to build their portfolios for the longer term. Here are six themes that suggest the current hiatus will be short lived.

The gap between the Brent curve and the ILTOP has been widening for more than a year, unsettling the M&A market (figure 1, below). Buyers are wary of overpaying in a rising oil price environment. Sellers can be seduced by the higher forward curve. Either the oil price needs to fall by $20-$30/bbl or planning assumptions need to rise. When the two come back into equilibrium, momentum in M&A activity will start to rebuild. The US gas market is also now affected by a similar disconnect between sellers and buyers. Sustained weakness in Henry Hub prices in 2011 prompted further disposals from gas-weighted players. Larger operators in a position to take a longer-term view were only too happy to get into the shale gas game. Our underlying analysis of 2011 shale gas deals suggests that buyers were factoring in long-term Henry Hub gas prices in the region of $5.50-$6.00/mcf (NPV10). US gas deal activity has slowed to a trickle this year so far and the forward curve is sitting well below 2011 implied prices. Yet financial pressures on producers are intensifying as past hedges unwind and earnings are marked to market. In North American gas, there could be bargains for buyers if and when the industry settles on a realistic Henry Hub price.

1 A good market needs commodity price stability

Shouldnt high oil prices be bullish for M&A activity? Oil prices surged to new highs early in 2012, but deal activity globally is sharply down. Regionally, North America has continued to see deals being done, but the market in the rest of the world has virtually ground to a halt in the first few months of this year. The key to any good market is a matching of buyers and sellers expectations, and oil and gas price assumptions are usually a big factor in energy M&A. Wood Mackenzies M&A service calculates a break-even oil price for every transaction the minimum long-term oil price that the buyer requires to make a positive return on a particular deal. We call it the implied long-term oil price (ILTOP), and it could be viewed as a proxy for industry planning assumptions.

Fig.1 Gap between Brent curve and ILTOP is widening

Brent / ILTOP ($/bbl) .

140

120

M&A is the quick way for a company to turn around a flagging production profile. The majors are often perceived as ex-growth, after half a decade of flat production and where several companies failed to meet over-ambitious targets. The outlook for the next few years is more promising. Wood Mackenzie estimates that all eight majors will be producing more in WoodMac implied long-term oil price Brent oil price 2020 than in 2011, based on current 2P reserves. Growth for large-cap independents is significantly higher. This all suggests that IOCs have no burning need for M&A to generate growth. We do expect the majors to continue to look for infill purchases to bolster portfolio weaknesses, but not a fresh wave of large-scale M&A. Instead, high-impact exploration is the focus of more investment, with the majors looking to establish new growth platforms for next decade.

2 Growth IOCs have it, NOCs need it

100

80

60

40

11

10

11

20 10

09

10

11

20 0

20 0

20 1

20 1

20

20

20

20

Source: Wood Mackenzie M&A Service

20

20

4 Q

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20

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Luke Parker Wood Mackenzie

EXPERTS INSIGHT

Acquisition spend ($bn)

Asian NOCs are in a different position altogether rising dependence on imports means many NOCs will be active buyers of oil and gas assets for the foreseeable future. As a group, Asian NOCs face a decline in domestic production which will result in falling total production.

45 40 35 30 25 20 15

National oil companies Majors

Fig.2 Peer group acquisition spend

We expect oil production for a 10 group of 30 Asian companies to be 1 million b/d lower in 2020 5 than in 2011. These companies currently meet just 35% of Asias 0 2007 need for oil and gas, and falling production and rising demand will reduce the contribution to 20% by 2020. We expect the Asian NOCs to remain active buyers in the market, probably at the high levels seen in the last three years.

2008

2009

2010

2011

2012

Source: Wood Mackenzie M&A Service

4 Asian NOCs internationalisation just starting

3 NOCs are cash buyers, while IOCs are risk averse

NOCs are in a very strong position financially to fund further M&A. The balance sheets for several are net cash positive CNPC and Petronas each held net cash of more than $25bn at the start of 2012. We estimate that cumulative upstream asset cash generation for the 30 Asian NOCs will amount to $450bn over the next five years, before expenditure on exploration, dividends, interest, and other financial commitments and business segments. This source of cash, equivalent to 75% of the corresponding figure for the international majors but from half the production, should provide the Asian companies with the financial flexibility to continue their expansion efforts. IOC balance sheets are generally in good shape, gearing for most of the majors is below 20%. However, the IOCs, and majors in particular, have a very conservative approach to balance sheet management. Four years on from the financial crisis, investors too still have a low appetite for risk; driven home by Macondo (the Deepwater Horizon fire). The appetite for additional leverage among IOCs is modest, and this by and large rules out large-scale M&A. Polarised stock market ratings the majors trade at much larger discounts than pure upstream independents suggest that the arithmetic of equity funded acquisitions in most circumstances currently does not work (figure 2, above).

Asian companies need significant ongoing M&A if portfolios are to be transformed away from maturing domestic businesses and towards new international growth themes. CNPC, Petronas and ONGC stand out as the most likely large-scale acquirers each with strong balance sheets and relatively modest acquisition spend over the last decade. As a peer group, Asian NOCs need to address a lack of exposure to growth resource themes, notably deepwater resource development, liquefied natural gas (LNG), oil sands and unconventional/tight oil. Corporate as well as asset acquisitions could play a part for those companies seeking to develop technical and operating capability. Many of the Asian companies now appear willing to compete for assets by paying over and above our base case asset valuations. Optimistic views on oil prices, confidence in asset resource upside potential, lower discount rate assumptions and significant strategic incentives may all be factors in driving asset considerations upwards. That said, we do not view the Asian companies as consistently overpaying for assets. A win at all costs strategy is not generally apparent. For example, our analysis indicates the Chinese NOCs were valuing acquisitions in 2010 and 2011 at an ILTOP on a par with the global average for deals across the sector. NOC spend overseas dropped year on year in 2011, for the first time since 2007. Nonetheless, at $21bn (99.5% attributable to Asian NOCs), down from $34bn in 2010, this peer group still accounted for 14% of global M&A.

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EXPERTS INSIGHT

Luke Parker Wood Mackenzie

5 Majors get active on portfolio management

The increase in portfolio management by the majors has been a feature of the M&A market in the last two years. Traditionally, majors have been net buyers of assets. This changed in 2010 when BP needed to raise capital to fund the pending Macondo liabilities and put non-core upstream assets on the market. The speed in which the company sold these assets and the prices it achieved prompted other majors to follow the same course. Total, for example, more financially constrained than its peers, has a policy of sell to buy to fund its repositioning for the longer term. In all, the majors raised $40bn in 2010, and although the total fell to $10bn in 2011, this was in part a function of the weaker market dynamics. The majors also raised around $30bn in 2011 through sales from non-upstream assets mainly downstream and gas infrastructure. Portfolio high-grading is very much back on the agenda and we expect management to continue to challenge strategic commitment and returns across the business.

It is becoming increasingly clear that the scale of the tight oil resource is material even to the very largest of companies
first moves by majors to establish a material presence through M&A. The last quarter of 2011 was the first in which tight oil M&A spend exceeded shale gas and the gap widened in Q1 2012. The returns relative to gas are part of the story, but it is also becoming increasingly clear that the scale of the tight oil resource is material even to the very largest of companies. Wood Mackenzie expects US tight oil production to increase from 1 million b/d in 2011 to 4.1 million b/d in 2020. Tellingly, the very same buyers that transformed the M&A market for shale gas the majors, international large caps and Asian NOCs have started to make moves in tight oil. Cumulative spend in shale gas M&A now exceeds $170bn. Last years spend was broadly flat year-onyear, at $37bn, boosted by BHP Billitons $15bn acquisition of Petrohawk. However, shale gas M&A has arrived at a very different and more challenging stage in the cycle. Desperately weak gas prices in 2012 and the inexorable unwinding of higher-priced hedges have led to a financing crunch for some companies. Deals have slowed to a trickle and only around $1bn has been transacted so far in 2012. But shale gas too is a huge resource in which many big players are very underweight in portfolio terms. The flexible capital investment profile of these plays is highly attractive, and those with the financial capacity to take a longer-term view will be on the lookout for value. The nascent North American LNG export industry could be a nearterm catalyst. The deal between Encana and Mitsubishi early in 2012 in Canada implied a price of $6.50/Mcf more than double the near-term curve. More deals like this could materialise as the industry positions to sell cheap gas into high-priced Asian markets. Luke Parker is product manager for Wood Mackenzies M&A Service. For further information, click here.

6 Tight oil 2012s big play

Unconventionals are the number one resource theme in upstream M&A, accounting for 43% of the global market in 2011. Shale gas has been the focus of most of the capital so far, but this is changing spend on tight oil-focused deals trebled year on year, a trend that has continued into 2012. Tight oil began to boom in 2011 (figure 3, below), and $20bn of acquisitions pushed cumulative spend to $35bn. Activity broadened from the Bakken to include other, emerging plays such as the Utica, Niobrara, and Mississippian. Statoil and Total announced the biggest tight oil deals to date, in the

Fig.3 Tight oil began to boom last year

200 180 160 140 M&A spend ($bn) 120 100 80 60 40 20 0 2004 2005 2006 2007 2008 Tight oil 2009

2010

2011

Source: Wood Mackenzie M&A Service

Conventional

Shale gas

Other unconventional

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Analysis that helps you drill for the future

Wood Mackenzie has been a respected adviser to the energy industry for over 30 years. We combine experience with industry knowledge to provide clients with valuable analysis and unique insights that makes them stronger. Our expertise gives our clients confidence the confidence to define their strategy, identify new opportunities, evaluate the markets they operate in and improve their performance against peers.

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EXPERTS INSIGHT

Jon Clark Ernst & Young

National oil companies are on the acquisition trail again

n recent years, national oil companies (NOCs) have become increasingly international in their operations as they seek to secure supplies to satisfy domestic demand growth or new markets for equity production. Since 2007, NOCs have spent almost 300bn on asset and corporate acquisitions in the pursuit of their strategic mandate. In this article we examine some of the recent trends in NOC deal activity and consider the opportunity landscape for NOC acquirers in the remainder of 2012. Tightening credit markets are likely to result in an increase in transaction activity in the oil and gas sector as the largely wellcapitalised majors and NOCs exploit their balance sheet advantage. NOC upstream spending was down sharply in 2011 compared with the previous year, distorted by the significant internal investments made by Petrobras in 2010. Backed by robust cash reserves, however, NOC transaction activity started 2012 on a strong footing and this trend is likely to continue, as a broad opportunity set is available for NOC acquirers. In the first three months of 2012, NOCs were involved as buyers in 25 oil and gas transactions with a combined value of $12.4bn. All but one of these transactions focused on the upstream sector, reflecting NOCs appetite for access to reserves and technology. Since the beginning of 2011, more than 80% of NOC transaction spend has been directed upstream. NOCs were responsible for 8% of the volume and 19% of the value of all upstream deals in 2011, which has increased to 17% of volume and 29% of value in the first quarter of 2012. The most active deal-makers in the first quarter of 2012 were NOCs from Asia and Russia. Recent years have witnessed the Asian NOCs international pursuit of production and reserves to meet aggressive supply targets. Most deals announced by Russian NOCs focused on the acquisition of stakes in independent domestic oil and gas companies or regional partnerships to help develop domestic oil and gas reserves. The Russian government has signalled its intention to open up offshore areas to more foreign investment.

The most common method that NOCs are adopting in their pursuit of international targets is to partner with existing asset or company stakeholders. In 2011 and the first three months of 2012, 86% of all NOC acquisitions outside their home country involved partnerships in some shape or form. There have been very few outright corporate acquisitions by NOCs outside their home territory, and only 10 such deals have been completed since the beginning of 2011. However, these types of transactions are typically larger and so, although they represent just 13% of the total international deal count, they accounted for 32% of NOC spending in 2011. Chinese NOCs, which alone were responsible for half of NOC acquisition spend in 2011, were active acquirers of international assets in the first quarter of 2012, featuring as buyers in 10 transactions and acquiring interests in several unconventional resource plays around the world. The NOCs of China and Korea spent a combined $11.6bn on transactions outside their home country in Q1 2012, which represents almost two-thirds of the $18.1bn they spent on international acquisitions in the whole of 2011. The acquisitions covered a diverse asset range, including Australian liquefied natural gas (LNG), US shale plays, Canadian oil sands and deepwater concessions in Brazil. However, the primary focus has been on assets in the Americas, particularly unconventional assets in the US and Canada.

Globalisation ambitions

Investments outside the home country account for the vast majority of NOC transactions, representing more than 65% of NOC deal volume and almost 78% of total reported deal value in 2011. This globalisation trend continued into 2012 NOCs were responsible for 76% of all acquisitions and 93% of deal value relating to international transactions.

NOCs have been particularly interested in unconventional assets such as oil sands

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Jon Clark Ernst & Young

EXPERTS INSIGHT

Appetite for unconventional assets is undiminished

NOCs spent $14.5bn acquiring shale plays and tight gas, coal bed methane, oil sands and heavy oil assets in 2011 and most of this was invested in the Americas. NOCs appetite for assets in this region remains undiminished in 2012 more than 80% of the value of all NOC deals outside of their home country in the first quarter has been focused on acquisitions across the continent.

Russia hopes to attract up to500bn in investment through partenrships such as its recent deal with Eni

The transformative impact that shale gas has had on the outlook for US energy markets has led to speculation over the potential for this experience to be replicated in other parts of the world. The success in North American unconventional plays has driven the formation of several partnerships between NOCs and their international counterparts. Many of these agreements provide for the NOC to fund all or part of the drilling costs on shale projects with their new partners. One of the drivers of the Asian NOCs pursuit of unconventional assets in the Americas is to gain knowledge of the underlying technology in order to export expertise to other areas of the globe.

Recent large gas discoveries in Mozambique, Tanzania and Kenya are also likely to attract NOC interest. A number of players involved in these discoveries in East Africa are actively looking for partners to farm-in to their projects to share the substantial development costs. Smaller equity participants may also prove to be attractive corporate acquisition targets, as illustrated by the takeover tussle between state-owned Thai firm PTT Exploration and Production and Shell Exploration and Production for East Africa-focused Cove Energy. Elsewhere, Russia is hoping to attract up to $500bn in direct investment in its oil and gas sector. However, any foreign participation is likely to only take place in partnership with Russian companies. This could lead to further arrangements such as the wide-ranging strategic partnerships agreed in early 2012 between Rosneft and ExxonMobil and ENI, in which each will partner with Rosneft in certain licences to explore the Russian continental shelf and in exchange Rosneft will gain stakes in selected international projects led by these IOCs. There is a diverse range of international investment opportunities available for well-capitalised NOCs. With capital constraints acting as a catalyst for many potential sellers, 2012 looks set to be a busy year for NOC deal activity. Jon Clark is partner, M&A, at Ernst & Young

Opportunities for wellcapitalised NOCs

Continued interest in unconventional resources is one of the areas we see driving a higher level of NOC oil and gas M&A activity in 2012. As part of the current five-year economic plan, the Chinese government is looking to encourage cleaner energy use and reduce carbon emissions. As a result, natural gas is expected to play a more significant role in the countrys overall energy mix.

In the first three months of 2012, NOCs were involved as buyers in 25 oil and gas transactions with a combined value of $12.4bn. All but one of these was upstream

NOCs will also be negotiating to become off-takers or partners in proposed projects to export LNG from the US and Canada. There is likely to be strong interest in these developments from China, Korea and Japan, which would be benefactors of this new supply source.

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NOCs looking for access to low-cost gas supplies will continue to invest in US shale plays. High oil prices, meanwhile, have improved the project economics of Canadas oil sands, which will continue to receive interest from Asian NOCs.

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ON THE SPOT
Given the current economic uncertainties in Europe and the capital markets, and the number of small-cap companies struggling to fund their exploration and other work commitments, do you foresee a rash of fire sales and if so, where and who is buying? >

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ON THE SPOT

Richard Kent Managing director, Jeffries International

Your question if phrased in a negative way. Many companies, including exploration companies without any reserves, have successfully accessed the equity markets this year both in London and elsewhere. Equity capital is available for good companies with good opportunities. For example, Jefferies raised equity capital for Falkland Oil and Gas earlier this year. In addition, many companies are looking for exploration opportunities. In order to attract a farm-in partner the opportunity has to rank well against both other marketed opportunities and companies existing prospects. For example, Jefferies acted for Cairn Energy in the farmout of its Pitu block, offshore Greenland, to Statoil earlier this year. It is an indication of an efficient market that the best companies will attract equity capital and the best exploration prospects will attract partners.

Mark Bentley Managing director, Greenhill

Greg Hammond Partner, Akin Gump Strauss Hauer & Feld

It is true that development capital whether in the form of equity or debt is in become extremely fierce.

short supply and that competition for that capital among small-cap companies has

There has never been a better time to buy exploration assets than now. The discounts to RENAV (risked exploration net asset value) have never been higher, and for the larger players it is time to fill in portfolio gaps. For the smaller companies, with strategies predicated on continued repeated trips to the capital markets, supplemented by reserve based lending to fund development to production, they will have to think again. For privately held companies, it is a lousy time to go public. Risk is being aggressively repriced, without sentiment, across all asset classes, and the energy sector is no different. The key for smaller E&P companies is to ensure they can avoid fire sales, either through ensuring funding for multiple years, or looking to merge with other companies so that their shareholders can roll the dice again, and retain the chance of the upside. This requires a full and detailed and dispassionate consideration of strategic options, and not the usual default option which, historically, has been to raise more equity.

On the plus side, the oil price has so far remained relatively high, with the result that those assets that are of genuinely good quality seem to be able to access the capital which they need albeit on terms that are not as good as in the past. However, the story for borderline or low-quality assets is very different. There appears to be a real flight to quality and some regions, such as Kurdistan and East

Africa, have been repeatedly grabbing the headlines with some high-profile deals. Outside the current regional hotspots, one would expect that there will be a

shaking-out of the investor profile. For example, one can probably expect to see some rationalisation in central and eastern Europe among the first wave of E&P companies developing the shale deposits in that region. Although the shale in

these regions may yet still prove to be commercially viable, it is possible that the

cost of and delay in cracking the code in Europe will simply prove too much for the small players. As a result, assets could be transferred in the short to medium can afford to take a longer-term view. term to those companies with deeper pockets and broader shale experience which

Similarly, while I dont expect any fire sales, its not inconceivable that there may be consolidation of assets in remote and difficult regions such as the Falkland Islands, where it may be decided that there are simply too many small players incurring high costs chasing after the same elusive prize. As usual, one would and see the value where others cant.

expect those with good knowledge of that region to be able to understand the risks

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ON THE SPOT

Dana Novakovic Managing director, LB Capital

Financing outlook for E&P companies remains sub-optimal. However, any fire sales come about for idiosyncratic reasons, such as the specific situation behind the highly publicised Chesapeake case where the $16bn funding gap was compounded by company-specific corporate governance gaps that resulted in the share price decline of over 55% relative to its 52-week high. Activity in the UK North Sea remains to be driven by largely strategic reasons. Even divestitures by German utilities are idiosyncratic in nature and a result of Germanys cut in exposure to nuclear. Small E&Ps have indeed felt the pressures, however, many purchases of attractive exploration and development targets by an acquirer with a lower cost of capital or able to utilise the targets UK tax losses is expected to close above equity research targets. Overall, the North Sea transaction multiples remain strong and at a similar level to last years valuations. Our sell-side advisory mandate, which is about to commence in the UK North Sea, is in the UK Southern Gas Basin, a proven hydrocarbon area with a number of producing fields in the immediate vicinity that provide a range of alternatives for gas production and delivery to onshore gas plants. It is an opportunity for E&Ps with core competencies in the North Sea, and gives a chance to smaller committed North Sea participants as well.

Meb Somani Head of oil & gas investments, Barclays Natural Resource Investments
Listed companies without cashflow will struggle to access the markets if the current uncertainty continues. We therefore see opportunities for those with access to funding, such as larger companies with balance sheet strength, national oil companies and private equity-backed vehicles. However, the anticipated widespread mergers of juniors

did not materialise in 2008/9. Reaching agreement between the personalities involved may turn out to be just as hard in 2012, although relative oil price stability should facilitate reaching price agreement on deals.

Overall, we believe asset deals, particularly farm-ins,

remain more likely among smaller companies than full-scale M&A. Producing assets will continue to trade at a full price.

David Fassom Director, Stellar Energy Advisors

When capital markets are weak it is natural that more assets and opportunities will come on to the sales market, but this does not in itself herald fire sales. We know from the number of active buyers in Stellars network that buyers still far outstrip the supply of quality opportunities. When Stellars clients seek to raise funds, there is a judgement to be made between the use of capital markets versus a sale or divestment/farm-out to other E&P companies. In our experience, as long as the asset has sound fundamentals, companies can often obtain better terms via transactions with other E&P companies than with the capital markets. Stellar has numerous examples of this from our own sales experience over the last 12 years and we would be happy to discuss these with interested parties. When there are a number of similar assets for sale, it does mean that companies must present their assets

in the best light to get the attention of buyers. Time spent assessing and mitigating risk factors, reviewing investment plans and economics, as well as acquiring additional data, can add considerable value and ensure a more successful sale. With a few exceptions, most successful buyers tend to be in the region of the assets already, especially for areas like Europe and the North Sea. In regions such as Africa, Latin America, as well as the Middle East, there is a more diverse set of buyers pursuing opportunities, from onshore to offshore, oil to gas, exploration to production, each with their own particular strategy. Stellar knows that people do deals, not emails or virtual data rooms. Our team, therefore, interacts with this diverse buyer group on a personal level, so we can understand their strategies and encourage them to look at new regions that we know will fit their aspirations.

>

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ON THE SPOT

Roger Carvalho Managing partner, SPTEC Advisory

The current financial environment has put a significant pressure on listed small caps, as traditional financial market places became very risk adverse towards African countries and emerging markets. We have seen many equity raisings being postponed over the last months. Share prices are very much depreciated compared with asset values, implying large dilutions to shareholders, quite unacceptable to founding shareholders and managements that are incentivised with stock options. We may not see many takeovers or fire sales because of some resistance from founders and managements. We do see a different type of investor coming to the scene, more agile, less risk adverse politically and quite educated to the oil and gas industry: private equity funds for emerging markets and family offices. We also see many financial institutions from these emerging countries ready to take some equity risk in projects related to their countries or economic zone. All these could be the new fund providers to the oil and gas entrepreneurs in Africa and emerging markets.

Barri Mendelsohn Associate, SJ Berwin

The recent increase in M&A activity in the oil and gas sector is being driven by both buyers seeking to

expand their portfolios and

reserves, and also distressed reduced financing options

assets being created through and unstable markets. This especially for some small cap companies.

has proved a difficult period,

The inherent difficulties presented by trying to secure requisite both opportunities and challenges for directors and investors. There are signs that takeover speculation surrounding oil and

capital, while avoiding an unwelcome takeover approach, presents

gas companies is becoming a reality. Well capitalised national oil advantage, are the main buyers of oil and gas companies so far in 2012, as well as independent consolidators.

companies and majors, who are keen to exploit their balance sheet

Recent oil and gas discoveries by Ophir, Tullow and Cove Energy in East Africa appear to have helped to maintain positive sentiment among investors against a backdrop of uncertainty surrounding continue in the small-to-mid-cap markets for the foreseeable is more apparent. the financial markets. However, it is inevitable that fire sales will future where other options are out of reach and investor pressure

Katya Zotova Head of international A&D, energy investment banking, Citigroup

Every economic downturn provides challenges to some industry players and presents extraordinary opportunities to others. The next 12 months will be a real litmus test for the riskier industry players: those with high exposure to certain geographies or hydrocarbon markets (e.g. Henry Hub vs Asian LNG), imminent cap-ex commitments, balance sheet vulnerability or sub-par management track record. This will, in turn, provide ample opportunities for the savvy, lessexposed players looking to rebalance their portfolios in the long term. In the US, we should expect to see more M&A around gassier small-cap players affected by financing constrains as the gas hedges continue to roll off. It is also likely that well see consolidation around mid-cap highly-leveraged players, which are also tainted by poor delivery track record, weak management and high exposure to long-lead/high-risk exploration. The rest of the world should see an increase in A&D activity vis-a-vis M&A: continuing market volatility will force most industry players to focus on their core portfolios, thus creating a wave of farm-outs and asset divestments driven by imminent drilling commitments, license expiries and the drive to expedite discoveries to enable reserves-based-lending. We also expect a few small(er) players to refocus their efforts and financing towards imminent production and therefore shed the riskier assets, such as long-lead exploration portfolios and positions exposed to high risk geographies. Our Energy team works with a broad range of industry players helping them prepare and position themselves well in advance of having to make portfolio choices, whether these are growth or divestment focused. The next 12 months will provide extraordinary opportunities for a well-prepared buyer to reposition themselves strategically and whether it is a cash-rich mid-cap or an Asian national oil company, this is the time to pick the right chips to play for the long term.

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Major New oil Discovery iN KeNya

+251 (0) 11 618 8155 africaoilcorp@namdo.com africaoilcorp.com

Africa Oil concessions Hydrocarbon trends east African rift system

MADAgASCAR 24 BBoip

MEET THE MEMBERS

Anoop Poddar Partner, Energy Ventures

How did you come to be in the oil industry?
Once you are a petroleum engineer, the beaten-up path in front usually leads to the oil industry. I was in midteens when I was asked to choose an engineering subject. Petroleum promised to open a world full of opportunities. It was a leap of faith that worked out quite well.

What advice would you pass on to a recent graduate wishing to work in your line of business?

Keep dreaming because dreams do come true. Also, people run businesses, not machines. Learn to work with people.

What is your proudest work-related achievement to date?

Whats the one interesting fact about you that no one would suspect?
Does singing in the shower count?

Investing into and building READ Well Services, including the spin-off, Meta, is definitely the proudest achievement. Joining the fabulous Energy Ventures team and successful investment into Novadrill both come a close second.

How do you prefer to spend your spare time?

Talking to my wife Tanuja building castles in the air. Also, playing badminton and squash and reading loads of books.

Where do you see the greatest opportunity in todays oil and gas markets?

Favourite holiday destination?

Well integrity assurance is going to be important for all, not least because as an industry we do care about the world around us. Similarly, real-time monitoring of well and critical surface assets for performance and environmental purposes will be quite important. The greatest opportunity, however, will be in the global exploitation of unconventional gas and oil in a costeffective manner. Positioning yourself at the right place at the right time with the right technology will be the key.

I love to explore new places, however, a recent trip to Rome (pictured) remains etched in memory.

All-time favourite book?

Hard to choose an all-time favourite. From the recent collections, I liked Chetan Bhagats Five-Point-Someone, Tipping Point by Malcolm Gladwell and the whole series of George RR Martins A Song of Ice and Fire. I could not stop laughing while watching the first the God Must Be Crazy. It remains my favourite film. Anand (in Hindi) is another film that left deep impressions.

All-time favourite film?

Where do you see the greatest challenge?

Finding, producing and using oil and gas in cost-effective and environmentally friendly manner remain the main goals for the industry. The biggest challenge the industry faces is the slow adoption of innovative or evolutionary technologies that can help achieve these goals. We need a culture that enables innovation rather than stifles it.

What three luxury items would you take to a desert island?

What was the wisest advice you ever received from a mentor?

Lots of Indian snacks (savouries) and drinking water; Kindle full of unread books; a good collection of my favourite Hindi songs, especially those sung by Kishore da (pictured) and Lata ji. Then I will just chill out and hope that the return trip is a while later so that I can get through my reading.

One of my much-loved colleagues, Bob Schwartz, used to say: It is very hard to think with your mouth open. A very wise advice but Bob forgot to mention that I needed a brain too. My mother believes that everything we do has some grand purpose. This has been great advice, especially when ones chin is down.

CREDITS: TRAVELING OTTER

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Insight changes everything

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MEET THE MEMBERS

Matt Lofgren CEO, Nostra Terra Oil & Gas

How did you come to be in the oil industry?
I was developing real estate, masterplanned communities, working for a large landowner in the south-west of the US.He branched out into Texas and got mineral rights along withhis first acquisition.Turns out they were sitting on top of what became the Barnett Shale play. He considered it the best accident that ever happened to him and wanted to set about getting into the business on purpose.I was tasked as his dealmaker to get it started.Eventually the opportunity came about to lead Nostra Terra.

What advice would you pass on to a recent graduate wishing to work in your line of business?
Find a niche that you really enjoy, dive in andabsorb all you can from others, especially the veterans.Its an aging industry and were quickly losing quality talent along with their vast knowledge.

Whats the one interesting fact about you that no one would suspect?
Im an Eagle Scout (Boy Scouts).

What is your proudest work-related achievement to date?

Ive never stopped to think about it. Ive enjoyed most of my career thus far and wake up every day excited about what the future holds.

How do you prefer to spend your spare time?

I love cycling and soccer proper football as I like to call it. I couldnt tell you a single starting quarterback in American football, but I surprise my English friends withcurrent knowledge of the Premier League.

Where do you see the greatest opportunity in todays oil and gas markets?

Favourite holiday destination?

Chamonix, France.

I see great opportunity in applying new technologies to old fields.Weve seen old fields have more production than they ever did originally.The Bakken, Eagle Ford, Permian Basin, these are only a few among many that are helping the US go through a renaissance, as they move rapidly towards energy independence.Even more exciting is seeing this spread across the world as the technology transfer takes place.

All-time favourite book?

From Beirut to Jerusalem by Thomas Friedman. Great depth and perspective from both sides. I find it most interesting hearing the various ways human beings cope with life in conflict areas.

All-time favourite film?

Where do you see the greatest challenge?

Dealing with the uncertainty of the European sovereign debt crisis.Weve been fortunate to keep exploration risk and overheads low so we can weather quite a bit.Small E&P companies, however ...

Lawrence of Arabia, however when I need a good laugh Dirty Rotten Scoundrels always does the trick.

What was the wisest advice you ever received from a mentor?

What three luxury items would you take to a desert island?

CREDITS: ALI ELAN

I was discussing the new year with a couple great mentors whom each shared fun, yet practical sayings. First: Every morning in Africa, a gazelle wakes up. It knows it must outrun the fastest lion or it will be killed.Every morning in Africa, a lion wakes up.It knows it must run faster than the slowest gazelle, or it will starve.It doesnt matterwhether youre or a lion or a gazelle, when the sun comes up youd better be running. Second: Never approach a bull from the front, a horse from the rear, or a fool from any direction.

Ruby heels no, I dont cross-dress on the weekends, I just cant stand being on an island.A hammock seems like a practical item.

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Integrated Energy Services from Petrofac

With a backlog of US$10.8 billion in 2011, Petrofac is one of the largest EPC contractors working out of the UK. Around 25% of UK oil production is operated by Petrofac and last year some 60,000 people went through Petrofac Training. Through its Engineering, Construction, Operations & Maintenance (ECOM) division, Petrofac will bid for service contracts globally. Through Integrated Energy Services (IES), Petrofac will invest in new or mature field development under innovative (service) contracts, leaving control of the assets and oil/gas reserves with the asset owner.
To learn more visit www.petrofac.com call +44 207 811 4758 or email investment@petrofac.com

PETROFAC IS DELIGHTED TO BE A PARTNER OF THE OIL COUNCIL

MEET THE MEMBERS

Anders Marvik Vice-president, corporate strategy, Statoil

How did you come to be in the oil industry?
I was interested in a career in an international and global industry, and coming from Stavanger in Norway, the oil industry came naturally. I grew up watching platforms being built in my local community, so it became part of my DNA very early. I also had a great interest in the industry as it is so important for the rest of society, creating economic growth, and the technological application is on a scale beyond most other industries.

What advice would you pass on to a recent graduate wishing to work in your line of business?
Get as broad an experience and business understanding as possible. If you are an engineer get to understand the commercial side of the business, if you are from the commercial side you have to understand the technical aspects. Only then can you emerge as a true oil and gas business leader.

What is your proudest work-related achievement to date?

Whats the one interesting fact about you that no-one would suspect?
Before university I competed in world rowing championships.

Building a global intelligence team up from scratch that has become recognised as top quality both inside and outside of the company.

How do you prefer to spend your spare time?

As quietly as possible.

Where do you see the greatest opportunity in todays oil and gas markets?

I truly believe there are many opportunities in this market. For green field projects we still have many frontier exploration areas the Arctic, for example and a global reach of unconventional oil and gas. Equally important are brown field projects such as increased oil and gas recovery, better reservoir management, and better seismic.

Favourite holiday destination?

Isla de Margarita in the Caribbean (pictured).

All-time favourite book?

The Long Walk, by Stephen King.

All-time favourite film?

Where do you see the greatest challenge?

Wild at Heart, a David Lynch film.

Capacity constraints on several levels: human resources in general; local hotspots being choked Brazil, Angola, Australia, Iraq; constant geopolitical events unfolding and financial capacity issues due to both large and complex projects and the economic crisis.

What three luxury items would you take to a desert island?

Sun-lotion, my Kindle and a hammock with my gorgeous wife included!

What was the wisest advice you ever received from a mentor?
Whenever possible, always choose your own boss, and never be afraid to hire anyone smarter than you.

CREDITS: HOMBERTHO, KEVIN H.

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Offering solutions 2 value

S2V Consulting provides technical and strategic advice to the oil and gas industry, We specialise in helping customers find integrated and valued solutions to challenging issues.
We have positioned our capabilities to meet the needs of our clients across the world by drawing on the technical expertise and knowledge base across three divisions. Our combined capabilities provide our clients with Solutions 2 Value for assets in any stage of the lifecycle.

Providing independent strategic advice on corporate, operational and investment matters in three portfolio areas: + Management Consulting + Developments + Assurance

Our full range of Technical Consulting services operates across the entire asset lifecycle to provide value adding solutions to our clients. Portfolios are: + Process + Facilities + Technical Safety + Risk + Environment + Emerging Technology

Providing value adding subsea and pipeline system solutions from concept identification through final field decommissioning. We have the experience to know how technical challenges need to be addressed. Portfolios include: + Subsea Systems + Pipelines + Flowlines + Flexibles + Risers + Materials

Solutions 2 Value - its in our name and everything we do

Offices: Perth, Australia London, United Kingdom Contact E info@s2vconsulting. com www.s2vconsulting.com

MEET THE MEMBERS

Paul Welch CEO, Chariot Oil & Gas

How did you come to be in the oil industry?
Growing up in Miami my next-door neighbour worked for Exxon and loved it. He travelled throughout Latin America doing deals, meeting different types of people and winding up in some interesting situations. It intrigued me, so I pursued it from the start of my studies at university.

Whats the one interesting fact about you that no one would suspect?

What is your proudest work-related achievement to date?

Up until very recently I didnt own a car. Living in central London I didnt really need one and it was only when a friend moved back to the US that I bought a car from him. Its a 2008 model that has less than 1,000 miles on it. Ive only purchased one tank of petrol since Ive owned it.

Probably some work that I did in China many years ago. It was my first management position and also my first nonoperated role. I took an asset that was on the disposal list and made it core by both reducing costs and increasing production substantially. My bosses were very happy as both were partners in the project. It was really satisfying because it was all down to trust and co-operation between parties. It also gave me confidence to contribute in areas that werent purely technical, which I hadnt done before.

How do you prefer to spend your spare time?

Rollerblading with my daughter in Regents Park.

Favourite holiday destination?

Skiing in the mountains of Colorado (pictured).

All-time favourite book?

Fear and Loathing in Las Vegas, by Hunter S Thompson.

Where do you see the greatest opportunity in todays oil and gas markets?

All-time favourite film?

Wag the Dog.

Africa, thats why we are so focused on it at Chariot.

Where do you see the greatest challenge?

What three luxury items would you take to a desert island?

Staffing availability industry wide and, uniquely for us, deepwater rig availability. Weve had issues with both recently and I dont see either improving in the short term.

An iPod loaded with music, photos etc; durable solar charger; spear gun with spares have to eat somehow!

What was the wisest advice you ever received from a mentor?
Answer a question with confidence! Dont be wishy-washy, tell them what you think and why you think it. This wisdom was expressed to me on the rig floor in the rain one night. I never forgot it.

What advice would you pass on to a recent graduate wishing to work in your line of business?
CREDITS: KA-HO PANG, FRANTS

Get the best education possible and then follow up with a lot of good-quality experience. Dont shy away from a challenge and dont be afraid to fail. You need a foundation to build from and then you need to grow that foundation. The only way to do that, in my view, is to challenge yourself. Failing, on occasion, is an important part of that process.

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Oil & Gas Spoken Globally

The unique vocabulary of the oil and gas industry requires fluent lawyers. K&L Gates offers clients innovative and reliable counsel on the most challenging legal issues affecting the oil and gas industry across the world. Our lawyers span more than 40 fully integrated offices in the U.S., Europe, the Middle East, Asia and South America. Our clients operate in every sector of the oil and gas industry, from capital markets participants to exploration and production to midstream transmission and storage to refining and transportation. From the routine to the complex, from equity funding to project development to mergers and acquisitions and all points in between; the oil and gas lawyers of K&L Gates draw on decades of experience in the worlds main oil and natural gas-producing regions. At K&L Gates, we are fluent in the language of the oil and gas business. K&L Gates LLP. Global legal counsel on four continents. Learn more at klgates.com.