2. Risk Factors

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

2.1 Internal Risk Factors

2.1.1 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 with high petroleum potential. The Company revises its
investment expansion strategy through its deliberation of deposit
potential and investment opportunities in target countries, petroleum
production technology, and investment expansion with strategic partners.
In addition, it adjusts its strategic plans by growing aggressively in
core areas through more exploration and mergers and acquisitions (M&As),
with a focus on growth-platform investment base expansion or investment
in countries where PTTEP holds advantages due to investment already made
in these countries, which could leverage existing projects and command
growth potential. Yet, new investments contain risks. Therefore, PTTEP
has instituted risk mitigation measures designed for each investment as
part of its screening process – taking into account petroleum potential,
operating risks, operators’ capability, attractiveness of fiscal
regimes, contract adherence, political stability, economic and fiscal
stability, international relations, geographical conditions, and project
types and sizes. In addition, risk prevention measures must be
identified ahead of time. These risk factors are taken into account and
mitigated in profitability analyses.

In view of such risks, PTTEP has instituted a process to scrutinize
investment for each new project by running it through the Early
Opportunity Review Committee so that investment expansion may follow the
corporate investment direction and policy. The committee analyzes
assorted factors for both business investment and technological
investment—both conventional and unconventional development. Each new
investment, including farm-in and farm-out projects, must secure
endorsement from the above-mentioned committee and the Management
Committee before securing another endorsement from the Risk Management
Committee. Then, the Board provides the final approval.

2.1.2 Exploration Risks

Exploration for new petroleum sources is vital to this high-risk,
high-return business. 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 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 exploration decisions are made:

(1) Risk assessment or probability of success

(2) Assessment of the sizes of resources or reserves in each target area

(3) Finding costs.

To minimize the risks associated with these three factors, PTTEP values
capability development of relevant personnel, such as that 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.

For efficient decision-making as required by industry practices, PTTEP
set up a risk management mechanism for its technical consideration by
using a peer review through the New Venture Project Quality Assurance
Review Team (QART), which screens and assesses the quality of
exploration projects that encompass key technical issues and geological
uncertainty in keeping with PTTEP’s standards as well as processes.
PTTEP’s exploration portfolio has undergone stringent reviews during the
annual work program and budget formulation period. Such process ensures
efficient fund allocation based on risk profiles.

2.1.3 Project Development Risks

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

(1) Project management: To ensure timely project implementation,
suitable production costs, and maximum benefit to all parties involved,
PTTEP 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 personnel, application of knowledge
management procedures for data and experience-sharing among projects,
while constantly improving procedures under the Project Realization
Process (PREP) to enable project development to follow proper procedures
that are suitable, transparent, and conducive to goal achievement in
quality, budgetary, and time aspects, including 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 administration, violation of which could lead to litigation.
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 scrutiny. In addition, procurement personnel need
to examine contractors’ qualifications and compare prices; finance and
accounting personnel need to consider tax and insurance matters; law
personnel need to ensure compliance with laws, duties and responsibility
of the parties, etc. Prudent contract management lessens risks and
damage potentially resulting from delays, which could not only affect
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.

2.1.4 Production Risks

Production disruption tends to result from aging production equipment
and operation errors, which may make output targets unachievable.

To prevent such risks, PTTEP focuses on every detail, starting from
production platform designs, production systems, to production control
and preventive maintenance. Automatic detection and emergency shutdown
systems are in place to prevent losses, as are work procedures and
operation manuals, together with training programs to instill greater
understanding and efficiency of operation. PTTEP has implemented ARIMs
(Asset Reliability & Integrity Management System), which forms a part of
the Operation Excellence Project. ARIMS cuts production losses due to
worn-out equipment and regularly raises equipment efficiency, as well as
raising the management efficiency of preventive maintenance and
inspection. The ultimate goal is zero unplanned shutdowns.

To give its overall operation management even greater efficiency, PTTEP
has set up an Operations Risk Committee to analyze and assess risks,
impacts on project implementation plans, and provide recommendations on
action plans to ward off and mitigate potential impacts while monitoring
risks to ensure that they align with PTTEP’s risk management policy.

2.1.5 Commercial Risks

Since PTTEP’s main product is natural gas, which relies heavily on the
domestic market, its revenue could drop if domestic demand proved lower
than projected. As a result, PTTEP has expanded its investments in
foreign E&P projects, in particular those with crude oil potential, to
increase its oil reserves. A case in point is its investment in the
Canada Oil Sands KKD Project, where the first oil has flowed from the
Leismer area since January this year. This is a way to diversify risks
of excessive dependence on natural gas. In addition, PTTEP has been
seeking opportunities to develop stranded gas fields by employing
Floating Liquefied Natural Gas Production (FLNG), a process of
liquefying gas for subsequent barge transport to the market. Such
technology will make stranded gas field projects commercially feasible.
A clean and abundant energy form in the world today, natural gas could
enhance Thailand’s national energy security and fits in well with PTT
Plc’s plan to import 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, thereby 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 the buyer cannot take delivery of at least
the net annual contract quantity (ACQ), which serves as a guarantee for
PTTEP’s revenue.

In response to the dynamics of energy demand, PTTEP closely monitors
petroleum demand in coordination with PTT and related government
agencies to collectively outline an optimal supply plan. PTTEP reviews
and adjusts its production as well as project development plans to match
energy requirements. This also included the development of
a holistic development master plan to optimize reserves and resources of
existing assets to match the country’s energy demand.

2.1.6 Organization Capability Risks

Because personnel and business processes dictate an organization’s
success, PTTEP has taken the following actions to enhance its business
process and organizational capability:

(1) Accelerate competency development in support of future growth
strategies, consisting of M&As, exploration, drilling and production
processing with the FLNG technology

(2) Develop personnel recruitment and development plans through the
Competency Management System for many functions, especially core
professionals; develop competency assessment to define development plans
so that PTTEP personnel can attain the desired capability. A Technical
Career Ladder (TCL) has been implemented to provide career growth
opportunities to technical personnel, who are now able to acquire
comparable job values as management by staying on the technical track.
An Accelerated Development Program (ADP) has been also implemented to
speed up staff competency development to be ready to perform on given
assignments. PTTEP has also devised plans to recruit and develop
personnel who should hold executive positions and equivalent to replace
retiring executives or add to executive positions to accommodate the
Company’s growth. This includes a choice of technical partners—or
business allies—that can educate its personnel further and thus add to
its own strengths for specific expertise like FLNG.

2.1.7 Safety, Security, Health, and Environmental Risks

Since PTTEP and its subsidiaries conduct the E&P business, they are
inherently faced with assorted risks, including safety, security,
occupational health, and the environmental ones (all of which come from
inside and outside) with various degrees of severity.

In view of SSHE risks, PTTEP has drawn up a clear SSHE policy and
constantly improved its SSHE performance to add security and efficiency
to its business. This year, the Step Change in SSHE Project was
initiated, with a primary goal of becoming an LTI-free (lost-time-
injury-free) organization by 2013 in addition to capability upgrading to
become a national E&P entity filled with credibility, safety, and
sustainable growth. Emphasis will be on continuous development of SSHE
management systems to define and improve work procedures to be always
timely while enriching the SSHE culture through the expressed desires of
executives, participation of personnel, and assessment of operation for
the sake of continuous improvement.

2.1.8 Financial Risks

Two risk factors are categorized as internal financial risk: credit and
liquidity. PTTEP ensures that products are sold to customers with
acceptable credit profiles, with the overwhelming majority of sales
currently being made to PTT Plc, PTTEP’s parent company. Bank deposits,
accounts receivable trading and derivatives, and counterparty credit
risks are carefully assessed and regularly reviewed.

Liquidity risk arises from a lack of viable sources of funding for
PTTEP’s business activities. PTTEP Group’s liquidity is managed via the
forecasting and continual updating of cash and currency requirements by
operating units, including the launch of short-term loan projects to
provide access to domestic capital. This is done by issuing short-term
debt instruments (bonds) and entering into credit lines with obligations
with commercial banks.

2.2 External Risk Factors

2.2.1 Political Risks in Other Countries

Under PTTEP’s foreign investment policy to supply the expanding domestic
energy market and sustain its own growth in the long term, it has
focused on growing aggressively in core areas. Some of these bear
substantial political risks, and therefore PTTEP appointed a
geopolitical risk team to monitor all these factors and periodically
analyze their development in the forms of risk alerts and scenarios for
the consideration of management and relevant units for their
decision-making on new investments and assess security risks in
countries of existing investments where PTTEP staff are based. PTTEP
bases its risk rating scores on such assessment before investing in new
projects. In addition, PTTEP liaises closely with the Ministry of
Foreign Affairs and Thai embassies in all these countries to promote
cordial relations and ensure that PTTEP’s execution is well-supported by
the public sector and aligns with the national policy.

2.2.2 Litigation Risks

These risks result from violation or non-conformance to relevant laws,
requirements, or standards, leading to disputes or potential revocation
of licenses. An instance is violation of laws or requirements dealing
with safety and the environment, which directly causes losses of revenue
and immeasurable losses, such as PTTEP’s reputation.

To date, PTTEP has applied measures for risk prevention concerning
compliance with regulations of the Australian government for the Montara
Project, under which action plans were formulated to closely monitor
project operation, while an ad hoc oversight panel was also set up. In
addition, PTTEP is preparing to study rules and environmental & safety
standards of the Australian and Canadian governments to accommodate and
address changes in a timely way.

2.2.3 Price Risks

In 2011, the price of oil faced rather high volatility, with Brent crude
in the USD 94.49-127.71 per barrel range. PTTEP’s product prices vary
with those of the world oil market, which are subjected to factors
beyond its control, including market demand and supply, political and
economic stability of various countries, OPEC’s production 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 of 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 PTTEP’s contractual gas prices are adjusted every six or
twelve months.
A reference oil price is usually found in each gas price formula. Should
this price rise or fall, the gas price will do the same to a certain
degree.

PTTEP has realized the impact of prices on its revenue and profits.
Therefore, the risk mitigation plan is routinely reviewed by the Risk
Management Committee and endorsed by the Board for further action.

2.2.4 Exchange Rate Risks

Effective from January 1 this year, PTTEP has opted for the US dollar as
its functional currency, since it is the main denomination referred to
in petroleum product transactions involving its core products (oil and
gas). PTTEP’s cash flow is also subjected to risks concerning the baht
currency in comparison with the dollar, since the bulk of its cash flow
receivables are in baht based on the dollar. That is to say, the sales
prices of its crude, a key product, are based on the world oil price,
traditionally set in dollars. But because PTTEP’s key customers are
those registered domestically, they pay for such crude in baht
equivalent of the dollar, which is in turn derived from sales formulas
based on the world oil price. Conversely, PTTEP’s operation
payments—including key investment items—are in dollars. To make matters
worse, periods for payments and receipts of payments for goods and
services do not coincide, resulting in risks associated with cash flow
and volatility of the baht in relation to the dollar. To solve this
problem, PTTEP manages such risks by engaging itself in forward and
option contracts for foreign currencies, by basing them on currency
exchange rates for the receipt of payments for its goods in baht.

Such choice of functional currency also resulted in PTTEP’s exposure to
volatility in the baht currency in relation to the dollar due to the
conversion of asset values, including cash in hand and loans, in baht to
the dollar in every accounting period. To handle this, PTTEP exercise
risk management by choosing proper ratios between its assets and
baht-denominated liabilities. Besides, it is engaged in cross-currency
swaps for baht-denominated loans or debt instruments to convert and
decide interest rate payments and principals due in the dollar
denomination so as to ease potential impacts of the changing baht-dollar
exchange rate.

In addition, the performance of PTTEP and its subsidiaries are subjected
to risks resulting from changes in the US dollar-Canadian dollar
exchange rate. This is because PTTEP CA, its subsidiary partner in the
Canada Oil Sands KKD Project, had opted for the Canadian dollar as its
functional currency, while all loans are in US dollars. As a result,
PTTEP CA’s profits or losses are unrealized due to the conversion of
liabilities and changes in the US dollar-Canadian dollar exchange rate.
To solve this problem, PTTEP manages such risks by adjusting the ratio
between liabilities and capital, together with changing the denomination
of liabilities through its engagement in cross-currency swaps and
securing of new loans, taking into account costs, market situations, and
acceptable risks.

2.2.5 Interest Rate Risks

PTTEP and its subsidiaries are subjected to interest rate risks due to
changes in the interest rates affecting future cash flow and fair values
of financial instruments. The majority of PTTEP’s debts are long-term
under fixed interest rates, giving it constant cashflow expenses; yet,
there are risks of paying higher interests than market interest rates
during periods of declining interest rates. To cope with this, PTTEP’s
policy is to maintain a balance of its proportion of liabilities with
fixed interest rates and those with floating interest rates suitable to
PTTEP’s business. It favors borrowing funds at fixed and floating
interest rates and applies financial instruments to ward off
interest-rate risks, including interest-rate swap agreements,
to convert floating into fixed rates, and vice versa. In so doing, PTTEP
takes into consideration costs, market conditions, and acceptable risks.