THE OXFORD INSTITUTE FOR ENERGY STUDIES A RECOGNIZED INDEPENDENT CENTRE OF THE UNIVERSITY OF OXFORD UNIVERSITY OF OXFORD Energy Value Chains James Henderson November 2018 The Oil & Gas Supply Chain Production Transportation Transmission Market Upstream Gas to Liquids Oil and Gas Field Life Cycle esource Assessment asin Evaluation oarse Seismic Distribution of Resource Potential Field Abandonment 1 Field Production Field life typically 5 to 25 years. Field will be in decline phase for last 30% to 50% of its life. I Access Rate at which prospective areas are made available by Host Governments for exploration activity by Oil & Gas companies Exploration Evaluation Mo Zoru .Iti ii '■■ i iff) _*_■ *_4)0 CDP% ptofb*inrr * Optional Step, depending upon me source and type ol gas stream. •Source. Energy Information Administration. Office of Ol and Gas. Natural Gas Division Natural Gas l.Kjulds (NGLsl □nunc Ryura Mmai SuoiM Extract valuable Condensate (light oil, propane, butane and some ethane. Remove water & nitrogen Remove C02 and H2S Must meet grid calorific value range and Wobbe index (calorific value divided by sqare root of density) - which determines flame stability. 7m Liquefaction -161°C GAS GAS Treatment and Purification z. • Removes condensate, C02/ Mercury, and H2S •Causes dehydration Refrigerant Loop Storage a J J L I Compression" Purified gas is cooled to minus 161 C at which temperature it becomes a liquid at atmospheric pressure. Volume reduced by a factor of 600 compared to gas atmospheric pressure. ^[f^ Source: Katherine D'Ambrosio The Gas into Power value chain Gas Components of Chain Gas Flow Production Transportation & Treatment I Pipeline Tariff I Distribution Price paid to Gas Producer Power Components of Chain _Electricity Flow_ Price paid to Gas Distributor Price paid to Gas Distributor Electricity Transmission & Distribution 17 Revenue Flow Electricity Price paid to Generators Electricity Consumers Electricity Price paid by Consumers 1 Gas Strategies 39 mm Gas Fired Generation Combined Cycle Gas Turbine Transporting Gas 7iK - From Production Source to Market - Summary As demand for gas has grown and in some cases nearby production sources have declined or not kept pace with consumption growth: • Long distance pipelines have been constructed; notably: • From Norway to the UK and North Europe. • From Russia to Northwest, Eastern and South East Europe. • From Algeria and Libya to Spain and Italy. • Throughout US, Canada and Mexico. Less prominently in: • South America • Asia • Africa • LNG was a key channel of gas supply in Asia (Japan, Korea, Taiwan & more recently India and China) and is becoming more widespread: • European periphery (UK, Spain, France, Italy, Turkey) • New markets for LNG are emerging with some frequency. • The growing volumes of LNG which are not constrained in terms of destination by contractual terms represent a powerful force for price arbitrage between regional markets. OP^ 7m WZ Investment Economics • Risk versus Reward - Geological - Political/Fiscal - Technological - Market (demand) and Price • Time value of money - High up-front (risk) investments, long field life, multi-year payback period. - Access to finance - cashflow, debt, equity • Competing Opportunities - Global portfolios - Oil.Gas, (Tarsands), (Gas to Liquids) ®K The DCF Calculation as a foundation - companies' must earn an adequate return on investment Time value of money Prvsvnt Vilue o I- + Future Value 3 -4- Years -1 ■■ 510,000 + interest Option B 510,000 - Interest -* Provided money can earn interest, any amount of money is worth more the sooner it is received Money available at the present time is worth more than the same amount at a future time because of its earning potential The DCF Calculation as a foundation - WACC concept Weighted average cost of capital is corporate "interest rate" Where; E = market value of equity D = market value of debt rt = CQ£tof equity rd = cost of debt t = corporate ta* rate WACC is the cost to a company of financing the capital for a project, including debt and equity Cost of debt = average interest rate for company Cost of equity is theoretical return to investors in the company Cost of Equity = Risk free rate +Beta*(Market return - Risk free rate) Essentially, how much return would an investor expect relative to putting his money with US Treasury stock, or in the stock market The DCF Calculation as a foundation - WACC Calculation Cost of Debt = 5% Cost of Equity Risk Free Rate - 4% Market Return - 8% Company Beta - 1.2 Calculation = 4%+(1.2*(8%-4%) Cost of Equity = 4%+4.8%=8.8% WACC Share of Equity - 50% Share of Debt - 50% Corporate tax rate - 20% Calculation = (8.8%*0.5)+[(5%*.5)*.8] WACC = 4.4%+(2.5%*.8)=6.4% Cashflow Analysis - Revenue Less Costs Cashflow = Revenue less: transport costs, royalty, state tax, federal tax, operating costs, capital costs, abandonment costs. 7m DCF - The Sum of Future Annual Discounted Cashflows DCF--L- +-...+-^ (1 + r)1 (1+r)2 (l + 0n CF = Cash Flow r = discount rate (WACC) A typical spreadsheet summary of a cashflow model OCF Valuation Protected Free Cash Flow Calendar Years ending Decern Der 31 Yearl Year 2 Year 3 Year 4 Year 5 Year 6 (S m thousands) EBITDA $8,954 $9898 $10,941 $12093 $13,367 $13,367 Less D&A 1,112 1222 1.343 1.476 1.623 1.623 EBfT 7.842 8.676 9.598 10.617 11.745 11.745 Less Cash Taxes (35%) (2.745) (3,037) (3.359) (3.716) (4.111) (4.111) Tax adjusted EBIT 5.097 5.639 6.239 6.901 7.634 7.634 Pluss D1A 1.112 1222 1.343 1.476 1623 1.623 Less Capital Expenditures (1750) (1.750) (1750) (1.750) (1.750) (1.750) Less Change in Net Working investment (318) (350) (384) (423) (465) (465) Unlevered Free Cash F low $4,141 $4,762 $5,447 $6,205 $7,042 $7,042 $19,845 - $4,141 $4,762 $5.44/ $6,205 / $7,042 + (1*.11)2 (1 • .11)* (1*11)4 (1 ♦ .11)* 7m Analysis to Support the Decision to drill an exploration well Geologists/Geophysicists: - Interpret Seismic data and assess reservoir size probability distribution. - Assess the probability of source, reservoir and trap. Reservoir Engineer: - Assess the recoverable reserves and reservoir properties for the 90%,50% and 10% cases. - Assess the number of production wells required. - Develop annual production profile for the life of the field. Facilities Engineer: - Creates conceptual design for min, mean and max cases with costing and cost phasing. Petroleum Economist: - Models the cashflow of the three reserve cases including tax or Production sharing effects. Derives the Net Present Value of Cashflows, the Internal rate of return and other metrics. - Integrates the NPVs over the reserve distribution range to derive the Expected Present value. - Performs decision tree analysis based on the probability of the exploration well being successful. - Presents the investment case to management. Create a theoretical cashflow based on assumptions known to date i'.icntfr Cer c reserve simulation: results ar.ci ji.jl;" parameter summary f. a £ w Volumetric parameters 0WC7GWC depth (m) thickness (w) Reservoir GRV area (km5) (10* m*) Petrophylslcal parameters Are» HfG PVT parameters Reservoir Pressure (MPa) Keswrvuir TtjrripyralLn fC) Factor Ht II (I evelopineiil Il.ll.llll.-1«: ■ r. Recovery factor Minimum 78.13 2M94J1 18.26 8.002 148.12 9.62 20.16 i.ii. til 1.00 46.08 97j00 322jM OjSM M11-1 Preliminary results 25.29 1. .IS .I'I. 0..0» 5000 GAS Simple M.i i im l Ml 338.45 2849.% W.tf 11.1r*1 412.92 14.09 39.70 /9.85 t.00 I'.'.f.m 9/.00 322.00 0.84li P90 124.80 P5o 166 48 P10 223.34 2804.86 2824.61 2844.6 21j5 2/.01 34.13 8.158 I 19322 8.947 245.14 10.192 316.0t 10.66 24.65 12.02 29.9/ 13.19 ! 35.48 64.52 /0.03 75.45 1.00 1.00 1.00 46.0S 46.08 46.0« 9r\00 9/.00 97.00 322.00 322.00 322.00 0.650 0.714 0790 350 in.., 250 700 t 150 2 E 3 z tun 50 -1*4- 124, 0 I I Most Likely iMoilei I Pi own (POOI I Probable iPbOi I PossMfrtPIOr T-^u^ÄOfTL^h-O'NÜ*. K. 01 N -» ^ 3> T- — _i r — •^o^-»«h-^l«*^ceiNÄT-AoiSs»?j*ÄiA« © —' — ,~ -i -I U"lt^ d d -~ » cc S: :> 50 4> 4r. 40 :«s 30 25 20 15 10 5 0 4- 78.0 i iniiiil.-iir.-i- ili'ii'.B', Most Likely ■ m■ ■ iel PrOVWI|PP.0> Pillll.llll- •(■' III issihli- iPln. 128.0 178.0 228.0 278.0 Recoverable Hydrocarbon ibct MMbbli U':j.n TOR At exploration stage add risk to calculate an Expected Present Value (integration over range of reserves uncertainty) NPVvs Reserves Probability 3,500 3,000 E E ^ 2,500 ro c 2,000 o 5 1,500 o % 1,000 > Q_ 500 0 EPV = $1,870 mm @10% Discount rate 1-^ -1 0 10 20 30 40 50 60 70 80 90 100 % Probability Reserves are less than I\Lb_If thp fiplH is viahlp n\/pr thp pntirp rangp thpn assiimft thp NPV nf thp 50% case equals the EPV Decision Tree Analysis Cost of Exploration Well =$50mm Probability of finding hydrocarbon = 20% 0.2 *(1870-50)< = 364 Probability of oil case =100% EPV $1,870m Probability of gas case = 0% Oil Case Min NPV $800mm MeanNPV $1,870mm Max NPV $2,900mm EPV $1,870mm Gas Case (not evaluated) 0.8 *(- 50) = -40 $324 mm Probability of not finding hydrocarbon = 80% Dry Well This is called the Expected Monetary Value (EMV) at the discount rate used. 7m Risked Rate of Return EMVvs Discount rate 3,000 2,500 2,000 1 1,500 ■CO- I 1,000 LU 500 0 -500 EMV @ 10% Discount Rate = $ 324 mm ^ / Risked Rate of F (eturn = 15% ^^^^^^^^^^^^^^^^^ i i i i i i i i i i i i i i i 0 5 10 15 20 Discount Rate % Exploration Proposal 'It is recommend that the company drill an exploration well on the prospect at a cost of $50mm. The probability of discovering oil is 20% (in in 5). The mean discovery case has a recoverable reserves level of 900 million barrels of oil and a NPV @ 10% discount rate of $ 1,900mm. Risked exploration economics indicate an Expected Monetary value of $324mm @ 10% discount rate and a Risked Rate of Return of 15%/

< OPEC meeting fails to reach agreement in Doha OPEC and non-OPEC renew agreement for 2018 Signs of US production decline Oil price collapses to $27- calls for OPEC meeting OPEC agrees to cut output and co-operate with non-OPEC LOLOLOLniutotouD oo oo oo I 13 U O ro 9-—> < ■ i o I Q. < i 3 U O c TO Q. =5 O c CD i i s_ — < ^ The rise of US shale has raised questions about the continuing relevance of OPEC Saudi Arabia decided to compete for market share, to force out higher-cost producers However, the strategy was not very successful - OPEC + Russia have been forced to curb production to encourage an oil price recovery Falling oil price = lower cashflow = lower investment Capital expenditure declines slowed and cash from operations increased from the second quarter of 2016 as crude oil prices stabilized cash flow items and Brent price billion 2016S; Brent in 2016 $/b 180 160 140 120 100 80 60 40 20 C cash from operations Q1 Q2 Q3 Q4 Q1 Q2 Q3 Q4 Q1 Q2 Q3 Q4 Q1 Q2 Q3 Q4 Q1 Q2 Q3 Q4 Q1 Q2 Q3 Q4 201J 2012 2013 2014 2015 2016 Source. U.S. Energy Information Administration, Evaluate Energy, Bloomberg Note: b-barrel Companies dramatically cut back investment in oil exploration and development during the period of low oil prices This inevitably led to a slowdown in supply - a classic commodity cycle The key question now is whether there will be a supply crunch and a price spike, and what impact this might have for the longer term Oil products and refining capacity are also important Figure 4.1 Changes in regional demand and refining capacity 3.0 2.5 2.0 1.5 1.0 0.5 0.0 -0.5 -1.0 (Change 2015-21) Demand Capacity OECD Arnikas OECD Europe OECD Asia FSU Oceania China Other Asia Mon-OECD Middle East Africa Americas • Lower oil prices encourage higher refining margins as well as demand growth • Refining capacity expansion is focused on developing markets in Asia and the Middle East • Oil product prices move in tandem with crude prices, but tend to provide extfja. profit when oil prices are low 7tt& Downstream Oil Value Chain GASOLINE Dl5.THEJ.miT« SYSTEM AND WLUAT10N FLOWS CRUDE OIL Futurri Price CRUDE 0«4tD«Jw The downstream oil business Refining margins (US$/bbl) USGC Medium Sour Coking ■ NWE Light Sweet Cracking Singapore Medium Sour Hydrocracking D7 OS 09 10 11 12 13 14 15 16 17 -5 Refining utilisation (% capacity 100 Refinery utilisation is a critical factor in oil economics -below 80% is a bad sign The Gas Commercial Chain - Pricing & Risks Regulated/ Market Price Production Contract Price Physical Flow - Volume Risk ■^nys Revenue Flow - Price Risk Quality / Credit / Contract Risks 1 Gas Strategies 74 7m Gas Market Evolution - Away from long-term contracts to market-based pricing ü c CD UJ H—' CD CO c C/D CO CD o Non-competitive market Merchant pipes "Strategic" relationships No consumer choice Supply security Competitive market Mature market Stage of market development Intensive growth Initial growth Competitive supply Regulated transport Consumer choice Security from portfolios & futures markets Basis-priced transportation Storage, load balancing & services competitive © Long-term contracts © Time Short-term contracts Spot/forward deals Pricing mechanism's development stages: Futures trading (T) - cost-plus or market related based on alternative fuel prices (2) - escalation formulas, based on either alternative fuel prices or gas markets (?) - based on traded prices and futures prices (commodities markets) 1 Gas Strategies Source: Gas Strategies 75 mm Historically regional pricing has been prevalent US Henry Hub Average German Import Price UK NBP Netherlands TTF Index Japan LNG CIF Japan Korea Marker (JKM) 00 01 For many years prices in different regions were close, despite limited interconnectivity A supply-demand imbalance from 2010 saw a huge disparity emerge, with Asia paying a significant premium TOR Global gas prices since 2012 Jan 12 Jul 12 Jan 13 Jul 13 Jan 14 Jul 14 Jan 15 Jul 15 Jan 16 Jul 16 Jan 17 Jul 17 Jan 18 'UK NBP 'US HH ►Japan Global gas prices have started to converge for four key reasons: - Supply and demand have been more balanced than expected - Increasing prevalence of LNG, which connects markets - Europe and Asia competing for gas, especially in winter - The availability of US LNG exports, which has introduced a new market-based pricing mechanism mm Global LNG Supply 2008 - 2030 Existing, Under Construction & FID'd 600 500 400 to R 300 u CO 200 100 2008 2010 Source: Author's Assumptions 2015 2020 2025 2030 > □ Asian LNG Demand - Large uncertainties but High Case now looks more likely_ 700 600 500 400 Low Case u CO 300 200 100 Indi aiwan Korea Japan 0 2C8BD5 2010 2015 2020 2025 2030 2035 Source: Platts, Author's Calculations Philippines I Vietnam I Bangladesh I Pakistan I Singapore I Thailand I Malaysia I Indonesia I India Ch in a I Taiwan IS Ko rea I Japan 700 600 500 400 High Case ^^Philippines Vietnam A Bangladesh Pakistan Singapore Thailand Malaysia Indonesia u CO 300 200 100 0 202BD5 2010 2015 2020 2025 2030 2035 mm ©[^European Balance - Low and High Asian LNG & European 'MK Gas Demand Case 2015 - 2030 Low Asian LNG Demand Case High Asian LNG Demand Case u CD 700 600 500 400 300 200 100 FID Onstream 1 2015 2016 2017 2018 2019 2020 2021 2022 2023 2024 2025 U CD 700 600 500 400 300 200 100 LNG Available Storage Withdrawal Russian Pipeline Imports Other Pipeline Imports Domestic Production >European Demand 2015 2016 2017 2018 2019 2020 2021 2022 2023 Sources: IEA, Platts, Author's Analysis Indicative Price Paths -Low Asian Demand Scenarios 12 Brent 2 0 2015 2016 2017 2018 2019 2020 2021 2022 2023 2024 2025 Europe does not need Russian Gas above 150 bcma until 2023. System needs new LNG beyond current supply under development in 2027, so prices rise to LRMC by then. Gazprom's pipeline supplies to Europe are a significant competitive threat to LNG producers Queflwenlwf.glBcncHixhcrehen AUTIV • Gazprom has surplus production potential in West Siberia • It has a very low delivered cost in Europe • Russia is essentially the Saudi Arabia of the gas market - its actions can determine price and volume for competitors Coal prices (US$/t) show what happens when a fuel is in decline Northwest Europe marker price US Central Appalachian coal spot price index Japan stearn spot CIF price China Qinhuangdao spot price Coal prices fell sharply in the face of increasing environmental challenges In particular US coal producers have been put under pressure by shale gas Elsewhere, countries are questioning how much coal they can afford to burn. Unfortunately, a lower prices also stimulated demand, but a price rebound is likely to undermine demand again 7m The Gas versus Coal dilemma in Europe 14.00 12.00 3 10.00 "I 8.00 I 6.00 to => 4.00 2.00 0.00 rN rN m m m m LT) LT) ~ Q. c >~ Q. C >~ Q. C >~ Q. C >~ Q. C >~ Q. rc rc CD rc rc CD rc rc CD rc rc CD rc rc CD rc rc CD 00