1. Risk Factors

The major risks associated with the Company’s petroleum exploration and
production result from internal and external factors.

1.1 Internal Risk Factors

1.1.1 New Project Investment Risks

PTTEP’s policy is to invest more, both domestically and internationally,
with a focus on promising projects and those aligning with its strategic
plan of increasing petroleum production and reserves. To achieve solid,
long-term growth, it therefore focuses on investments made in
territories of high petroleum potential. Since new investments carry
risks, the Company has instituted risk mitigation measures designed for
each investment as part of its screening process – taking into account
petroleum potential, operating risks, operators’ capability, conditions,
and clarity of benefit allocation, contract adherence, political
stability, geographical conditions, and project types and sizes. These
risk factors are taken into account in profitability analyses.

With these risks in mind, PTTEP has instituted a prudent process for new
projects, under which all new investment projects, including farming-in
and farming-out, must undergo an approval process by the Risk Management
Committee first before securing the Board’s approval. Before this step,
a given new project, namely an exploration project, a development
project, or an investment project, must undergo an in-house screening
process called ’Peer Review’, depending on where in the value chain the
project in question belongs.

1.1.2 Exploration Risks

Exploration for new petroleum reserves is vital to this business, by
itself a high-risk, high-return one. Exploration projects deal with
petroleum reserves potentially lying kilometers beneath the surface of
the earth. Given the current level of advanced technology, it is still
difficult to visualize and understand the petroleum geology at such
depths. Absolute geological confidence is therefore rare and
considerable geological uncertainty prevails. Still, the availability of
sufficient data and detailed geological analyses could reduce this
uncertainty and exploration risks to acceptable levels.

Here are the major risk factors and uncertainty often stressed in
PTTEP’s detailed investigation before making exploration decisions:

(1) Risk assessment or probability of success, which depends on the
likelihood of finding traps and reservoirs, as well as the volume of
petroleum generated

(2) Assessment of the sizes of resources or reserves in each target
area, which relies on drilling data, analytical findings, and
sufficiently detailed interpretation of geological, geophysical, and
petrophysical data

(3) Finding costs, in particular those of geophysical surveys and
drilling – typically the bulk of such costs – need to be controlled to
keep tabs on operating costs and raise drilling and exploration
efficiency. As a rule, the more data one commands, the more effective
one’s investigation and analysis.

To minimize the risks associated with these factors, PTTEP values
capability development of relevant personnel, such as through knowledge
management efforts and further E&P database development to store best
practices and lessons learned from projects for everyone’s reference and
applications. In addition, an expert directory has been prepared for
reference by everyone.

To achieve efficient decision-making in a timely manner as required by
industry practices, PTTEP has set up a ‘Peer Review’ in-house screening
process that comprises of experienced and competent personnel to review
and recommend exploration tasks, as well as key exploration projects, to
the CEO.

1.1.3 Project Development Risks

Recognizing potential project development delays and cost overruns,
PTTEP has drawn up the following risk mitigation measures to yield
successful and timely project completion.

(1) Project management: To ensure timely project implementation,
suitable production costs, and maximum benefit to all parties involved,
the Company focuses on related policy formulation, sound project
planning and engineering system designs, contract administration,
monitoring, and construction supervision management.

(2) Personnel and procedures: This is achieved through a development
focus on project management, application of knowledge management
procedures for data and experience sharing among projects, and
improvement of its procurement processes for greater flexibility.

(3) Commercial contract: There exist risks arising from contractual
matters, ranging from contract drafting, contract obligation, to
contract management. These risks are controllable, starting at the
negotiation stage, which calls for knowledgeable and competent personnel
attached to related units. For instance, in negotiating production
platform construction agreements, knowledge and competence of civil
engineering is required for technical detail perusal. In addition,
procurement people need to examine contractors’ qualifications and
compare prices; finance and accounting people need to consider tax and
insurance matters; finally, law personnel need to ensure compliance with
laws, duties and responsibility of the parties.

The Company has set up a central unit called Project Management Group to
provide consultancy and advice to critical construction projects.
Prudent contract management lessens risks and damage potentially
resulting from delays, which could not only affect company plans and
performance at large, but result in potential litigation and disputes.
Therefore, departments charged with contract management must ensure that
PTTEP personnel master contractual terms and conditions and that they
consult the Legal Department.

1.1.4 Production Risks

Risks of production disruption tend to result from ageing production
equipment and operation errors. Production risks can cause unachievable
production targets.

To prevent such risks, the Company emphasizes in every detail, starting
from production platform design, production systems, and production
control and preventive maintenance. Automatic detection and emergency
shutdown systems are in place to prevent losses. Work procedures and
operation manuals, together with training programs to cultivate greater
understanding and efficiency of operation, are similarly in place. In
addition, stringent Opersafe assessment is conducted by external
agencies. And because of the prudent prevention and maintenance planning
systems, these risks are now minimized.

1.1.5 Commercial Risks

Since the Company’s main product is natural gas, which relies mainly on
the domestic market, its revenue could drop if the domestic demand
proved lower than projected. As a result, PTTEP has expanded its
investments in overseas E&P projects, in particular those with crude oil
potential, to increase its oil reserves and diversify any risk of
excessive dependence on natural gas. In addition, PTTEP signed a
memorandum of understanding with Golar LNG Limited in the joint
investigation of the feasibility of developing stranded gas fields
through the so-called FLNG (Floating Liquefied Natural Gas Production).
This implies the conversion of natural gas into a liquid, which is then
transported to market, thus adding commercial viability to medium-sized
and small gas fields. The milestone investment in the gas industry,
which provides a clean fuel from abundant sources worldwide, could
bolster energy security for Thailand through PTT’s future importation of
LNG.

Although PTT Plc is the sole customer of natural gas, PTTEP has
concluded long-term gas sales agreements (GSAs) with PTT to guarantee
income over 25-30 years, thus mitigating the risks if PTT should refuse
to take delivery of the gas. Under these GSAs, a take-or-pay clause is
included in case buyers cannot take delivery of at least the net annual
contract quantity (ACQ), which serves as a guarantee for PTTEP’s
revenue.

1.1.6 Organization Capability Risks

Personnel and business processes define any organization’s success. The
Company has taken the following actions to enhance its business process
and organizational capability:

(1) Develop personnel recruitment and development plans through
competency models for core professionals; develop competency management
systems for use in developing assorted professionals; and announce a
Technical Career Ladder (TCL) to foster growth for technical
professionals on par with line management. It is expected that TCL will
attract technical professionals from within and outside PTTEP to the
Company.

(2) Set up a talent management plan to develop high-potential personnel
to take on greater responsibility

  (3) Raise the efficiency for risk-prone processes:

1.  Procurement processes

2.  Project management processes

3.  Subsurface evaluation processes and knowledge management

4.  Investment decision-making and risk management processes.

  1.1.7 Safety, Security, Health, and Environmental Risks

In view of SSHE risks, PTTEP has drawn up a clear SSHE policy with
commitment to strict compliance with governing laws and regulations, or
even exceeding them. The Company pays attention to every step of
operations, including the design of rigs, production platforms,
production processes, production control, vigilance and monitoring, and
hazard control.

For efficient and effective policy implementation for PTTEP as a whole,
the Company has not only defined its operating procedures, but regularly
updated its data. Training is continually provided to enhance employees’
potential and educate them about accident prevention and safe work
practices, as well as emergency responses through drills, including
joint ones with relevant external agencies.

To achieve the Company’s objectives and sustainable business operation,
PTTEP has internally implemented the ISO 14001:2004 environmental
management system and the approach used by the International Association
of Oil and Gas Producers (OGP) in PTTEP’s safety management in support
of the SSHE policy, as well as risk prevention and remedy.

Since the Company and its subsidiaries engage in the E&P business, it is
inherently associated with assorted risks not caused by human beings.
For instance, offshore operations face natural risks in the form of
waves, storms, and earthquakes, while onshore operations could also
suffer from earthquakes and flashfloods. Other threats arise from acts
of sabotage and terrorism. Besides external factors, of course, human
beings could cause risky situations. All these need preventive and
mitigating measures.

1.2 External Risk Factors

1.2.1 Political Risks in Other Countries

Under the Company’s foreign investment policy to supply the expanding
domestic energy market and sustain its own growth in the long term,
PTTEP has focused on investment in high-potential Middle Eastern
countries as well as countries regarded as emerging markets, including
Asia-Pacific, northern Africa, and western Africa. Some of these
countries bear high political risks; therefore, PTTEP has appointed a
geopolitical risk team to closely monitor all relevant factors and
periodically issue an analysis of their developments. In the case of
risk alerts, scenarios are developed for the consideration of the
Management and relevant units for their decision-making concerning
project risks and security risks of staff based in each of these
countries. This team periodically reports to the Risk Management
Committee its analysis of countries where PTTEP staff are based, where
it has invested significant amounts of capital, and where developments
could significantly impact the domestic energy situation, such as in
Myanmar and Iran. In addition, the Company liaises closely with the
Ministry of Foreign Affairs and Thai embassies in all these countries to
promote cordial ties while bolstering confidence that the Company’s
business secures support from each country and is in line with the
national policy.

1.2.2 Litigation Risks

Since non-compliance is illegal and directly causes all forms of damage
– monetary and otherwise – PTTEP strictly complies with all laws and
regulations relating to its operations.

All Directors, Management, and rank and file are responsible for audits,
control, and strict compliance with all related laws and regulations,
and for keeping all parties informed of new and upcoming regulations.

1.2.3 Price Risks

The Company’s product prices vary with those of world oil, which are
subjected to factors beyond its control, including market demand and
supply, political and economic stability of various countries, OPEC’s
output policy, oil reserves in individual countries, and the global
climate. Fluctuations in world oil prices affect revenue and investment
planning.

When oil prices drop, so do the prices of PTTEP’s oil and condensate.
However, because of built-in gas pricing mechanisms found in GSAs, which
cushion gas prices from oil price volatility (natural hedge), the
typical prices of natural gas, its main product, do not immediately
drop. Most of the Company’s contractual gas prices are adjusted every 6
or 12 months. A reference oil price is usually found in each gas price
formula, and should this price rise or fall, the gas price will – to a
certain degree – do the same.

PTTEP has realized potential price impacts on its revenue and profit;
therefore, the risk mitigation plan is routinely reviewed by Risk
Management Committee. The plan would be endorsed by the Board of
Directors for further action accordingly.

In 2008, the world oil price was highly volatile, as seen from the peak
price of July of nearly USD 150 per BBL, which then fell to less than
USD 40 per BBL in December as a result of the slowdown in the global
economy, which directly affected oil demand.

1.2.4 Exchange Rate Risks

In 2008, the Baht depreciated against the US dollar. The exchange rate
started at Baht 33.8850 per USD at the beginning of the year and ended
at Baht 35.0824 per USD at the end of the year (Reference: Bank of
Thailand).

In accordance with the accounting standard, the Company is to record its
USD assets and USD liabilities in Thai Baht. Exchange rate fluctuations
therefore affect the Company’s financial statements.

PTTEP has proved reserves, which can be produced and sold as its main
source of revenue. The pricing of PTTEP’s petroleum sales is linked to
the global oil price, denominated in USD. At the same time, part of the
Company’s capital and operating expenditures are also in USD. This tends
to curtail the impact of foreign exchange rate fluctuations on the
company’s revenue and expenditure structures (natural hedge).

1.2.5 Interest Rate Risks

Interest rate fluctuation affects both the interest revenue and the
interest expenses of PTTEP.

At present, approximately 72 percent of PTTEP’s long-term debts bear
fixed interest rates, which are not affected by market volatility.
However, approximately 28% of PTTEP’s debts are now subject to floating
interest rates as a result of the Interest Rate Swap (IRS) transaction
effective from 4 September 2007 for the Baht 6,000 million three-year
debentures.

For the deposits of surplus cash, interest rate fluctuations will affect
their interest income. The Company’s policy is to invest in short-term
deposits and instruments, with consideration of return and risks.
However, liquidity is considered a priority.