2. Risk Factors

The major risks associated with the Company’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 of high petroleum potential. A country strategy has been
developed as an investment guideline for both the short and long term;
country risk is mitigated by portfolio diversification. PTTEP has taken
the business expansion opportunity by acquiring under-valued assets
during a low oil-price period. Such action allowed PTTEP to enjoy assets
growth in many countries, especially Australia, a strategic growth
country. 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, attractiveness of fiscal regime, contract
adherence, political stability, geographical conditions, and project
types and sizes. These risk factors are taken into account in
profitability analyses.

In the past year, the Board of Directors made it a prerequisite that all
new investments in all projects, including farming in and out, should
undergo the approval process by the Risk Management Committee first
before securing the Board’s approval. Before this step, a given new
project, which fall in any phase of Exploration or Development and
Producing, must undergo the screening process of ’Peer Review’. The Peer
Review groups would oversee multi-dimensions of investment
attractiveness i.e. corporate strategic alliances, resources/ reserves
evaluation, economics soundness, and risk associations, etc.

2.1.2 Exploration Risks

Exploration for new petroleum sources 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 costs – 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 set up a ‘Peer Review’ that comprises of
experienced and competent personnel to review and recommend exploration
projects to the CEO. PTTEP recognizes the value of balancing reserves
growth via exploration programs to risk tolerance; therefore, the
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, 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; law personnel need to ensure compliance with laws,
duties and responsibility of the parties, etc.

It is believed that prevailing risks for new projects tend to be in the
construction phase. Having learned from its experience and developed a
body of knowledge, the Company has set up a central unit called Project
Management Group to provide management 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.

2.1.4 Production Risks

Production disruption (Production risks) tends to result from ageing
production equipment and operation errors. Production risks can cause
unachievable production target.

To prevent such risks, the Company emphasizes in every details starting
from production platform designs, 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 instill 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.

2.1.5 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 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.

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 buyers 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

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

1) Develop personnel recruitment and development plans through
Competency Management System for many functions especially core
professionals; develop competency assessment to define development plan
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. It is expected that such schemes will attract technical
professionals from external and internal sources with high potential to
join PTTEP.

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.

2.1.7 Safety, Security, Health, and Environmental Risks

Since the Company and its subsidiaries engage in the E&P business, it is
inherently associated with assorted risks not caused by human beings,
including oil and gas leakage during operation or fires around operating
areas. Offshore operations face natural risks in the form of waves,
storms, and earthquakes, while onshore operations could also suffer from
earthquakes and flashfloods. Other potential threats arise from
sabotages and terrorist acts. Besides external factors, of course, human
beings could cause risky situations. All these need preventive and
mitigating measures.

In view of SSHE risks, PTTEP has drawn up a clear SSHE policy with a
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 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 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 outside agencies. For example, there was an
incident of oil and gas leakage during Montara H1 development well
drilling. A fire broke out at the contractor’s West Atlas drilling rig
and, later, at a PTTEP-owned wellhead platform. PTTEP has responded well
to such emergency and put the situation under control, stopping oil and
gas leakage in November 2009. The development well, Montara H1, was
successfully capped in early January 2010.

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

2.1.8 Financial Risks

There are two risk factors categorized as internal financial risk:
credit risk and liquidity risk. PTTEP ensures that products are sold to
customers with acceptable credit profiles, with the overwhelming
majority of sales currently being made to PTT Plc, which is PTTEP’s
parent company. Bank deposits, accounts receivable trading and
derivatives, counterparty credit risks are carefully assessed and
regularly reviewed. Credit checks are undertaken by the Company before
any contractual commitment is made.

Liquidity risk is the risk that arises from a lack of viable sources of
funding for the Company’s business activities. PTTEP Group’s liquidity
is managed via the forecasting of cash and currency requirements by
operating units, which is provided to the central treasury function. To
address its liquidity risk, PTTEP commands access to external funding
sources in capital markets, both domestic and abroad.

2.2 External Risk Factors

2.2.1 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 investing in high-potential petroleum areas in Asia
Pacific and Middle Eastern countries as well as countries regarded as
emerging markets, including northern African and western African
countries. Some of these bear substantial political risks, and therefore
PTTEP appointed a geopolitical risk team to monitor all these factors
and periodically analyze their developments in form of risk alerts and
scenarios for the consideration of Management and relevant units for
their decision making concerning project risks and security risks in
each of these countries. The 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 for each country and is in line with
Thailand’s energy policy.

2.2.2 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 employees 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.

2.2.3 Price Risks

In 2009, the world oil price was highly volatile, with less fluctuation
than the price movement of 2008. The world oil price started the year at
USD 41.2 per BBL and ended the year at USD 78 per BBL. 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 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 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 move
correspondingly to a certain degree.

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

In order to manage risk from oil price volatility and the effect of the
unsteady economy on the oil price, PTTEP conducted oil price hedging
programs for petroleum products involved in the PTTEP group, using the
Brent crude price as a reference. So far, PTTEP has made a commitment on
an oil price hedging contracts for the period of July - December 2009,
amounting to 3.6 million barrels at a guaranteed price range of USD
55-86 per BBL.

2.2.4 Exchange Rate Risks

In 2009, the Baht appreciated against the US dollar. The exchange rate
started the year at Baht 35.0824/USD and ended it at Baht 33.5168/USD.
(Reference: Bank of Thailand)

Although the vast majority of PTTEP’s domestic and international
revenues and expenses are tied to the USD, the Company’s functional
currency remains in Thai Baht. Therefore, foreign-exchange risk arises
when transactions are denominated in a currency other than the Baht.
Foreign-exchange gains or losses appear in Item 26 of the Notes to
Financial Statements.

PTTEP has in place a treasury policy designed to measure and manage its
foreign-currency exposures based upon the reporting currency, and
reports foreign exchange gains and losses. To manage foreign-exchange
risks, PTTEP employs forward foreign-exchange contracts.

2.2.5 Interest Rate Risks

The majority of PTTEP’s debts are currently under fixed interest rates.
However, to capture the benefits of falling interest rates, the Company
has converted via an interest rate swap of Baht 6,000 million in
long-term bonds to 6-month fixed-deposit, Thai Baht rate plus an agreed
spread, reflecting the Company’s aim to minimize the funding cost while
managing risk in tandem. As a result, the Company harbors limited
exposure to Thai Baht floating interest rates.

Furthermore, PTTEP’s short-term commercial papers outstanding (Bills of
Exchange), featuring tenors of approximately one month, are subject to
pricing based upon the latest comparable yield on Thai government
treasuries.