Strategic Alliances Between National and International Oil Companies Robert A. James Pillsbury Winthrop Shaw Pittman LLP

October 3, 2009 Lansdowne Energy Conference Overview

ƒ How NOCs and IOCs deal (and have dealt) with one another ƒ Problems with the current allocation of roles ƒ The NOC/IOC strategic alliance concept ƒ Potential structures for alliances ƒ Where is the “sweet spot”?

2 | NOC IOC JVs NOCs and IOCs in the oil industry roster

The National Oil Companies (NOCs) The International Resource owners, custodians or Oil Companies (IOCs) managers in their home countries International developers and financers abroad Majors and supermajors Arms of the government, with revenue, Independents hard currency, employment, infrastructure International trading and and social service roles investment companies Independent power centers

Other players ƒ Governments (civil service, ministries, legislators, judges), nations and regions, NGOs ƒ Central banks and international financial institutions ƒ Oilfield service, EPC and technology licensing companies ƒ Independent sources of capital (now including private equity and sovereign funds) ƒ Owners of downstream businesses (refining, marketing and transportation)

3 | NOC IOC JVs Contemporary models of oil asset control

Downstream (refining, Upstream marketing & transportation) (exploration & production) Refinery operating, throughput or Production sharing agreement (PSA) toll processing agreement or concession Pipeline operating or throughput & Production services agreement with deficiency (T&D) agreement in‐kind compensation Patterns of distribution systems Operating agreement for fee Patterns of trading (import and export) and marketing

Auxiliary businesses ƒ Minerals ƒ Shipping ƒ Transportation infrastructure ƒ Petrochemicals, LNG and biofuels ƒ Power, retail

4 | NOC IOC JVs IOC reserves and presence

Ernst & Young, 2009 The internationalization of NOCs

Ernst & Young, 2009 The internationalization of NOCs

Resource holders The internationalization of NOCs

Resource Resource seekers holders The internationalization of NOCs

Resource Resource seekers holders The financial resources of NOCs

ƒ Retained earnings à Saudi Aramco, Kuwait Petroleum Company, Abu Dhabi NOC, Sonangol ƒ Equity markets à CNOOC, Petrobras, KMG EP, PTT ƒ Debt markets à CNOOC, PDVSA, NIOC, Pemex, Petronas, CNPC/Petrochina ƒ Joint venturers à KMG, Petronas, Sonatrach, CNOOC, Petrobras ƒ Production sharing contracts à NIOC, NNPC, SOC/MOC (Iraq) Dr. Valérie Marcel, Foreign Policy & KPMG 2009 The financial resources of NOCs

ƒ Retained earnings à Saudi Aramco, Kuwait Petroleum Company, Abu Dhabi NOC, Sonangol ƒ Equity markets à CNOOC, Petrobras, KMG EP, PTT ƒ Debt markets à CNOOC, PDVSA, NIOC, Pemex, Petronas, CNPC/Petrochina ƒ Joint venturers à KMG, Petronas, Sonatrach, CNOOC, Petrobras ƒ Production sharing contracts à NIOC, NNPC, SOC/MOC (Iraq) Dr. Valérie Marcel, Foreign Policy & KPMG 2009 The historical record

Third Wave: expansion of operational and financial NOCs (1990s‐today) ƒ 2008: IOCs hold 6‐8% of world reserves (O&GJ 2/2/09) ƒ IOCs driven toward technology, project First Wave: prevalence of IOCs delivery, capital, downstream roles (1900s‐1960s) ƒ NOCs active operators at home and ƒ 1970: IOCs held 85% of world competing developers abroad reserves (O&GJ 2/2/09)

Second Wave: resource sovereignty of governments (1950s‐1980s) ƒ Government control of reserves and production ƒ IOCs driven toward production sharing roles ƒ NOCs given carry, production sharing in some fields, custodial roles in others

12 | NOC IOC JVs Problems with the current allocation of roles

ƒ Inefficient allocation of prospects ƒ Ad hoc allocation of asset control and investment decisions ƒ Formal tenders interfere with custom solutions ƒ Host governments not always focused on profit or production goals ƒ Underuse of NOC and IOC strengths ƒ NOCs: resource and production controls in national interest; development of national human resources and technology transfer ƒ IOCs: access to markets and capital, downstream assets, technology, international, HR development, project discipline, infrastructure capabilities

13 | NOC IOC JVs Potential for NOC/IOC alliances

Precedent with limited ventures for specific projects and areas of mutual interest (AMI) ƒ Examples—BP/Statoil 1990‐1999, Aramco in midlife, Motiva/Star Enterprise, LUKoil/ARCO and LUKoil/ConocoPhillips; TNK‐BP, Shell/Gazprom?

Potential for expansion to broader alliances ƒ REGION—portions of the home country (e.g., neutral zone production) or of other regions (e.g., West African offshore) ƒ SEGMENT—subsectors of the industry (e.g., deep offshore exploration) ƒ FUNCTION—efficient organization with right people for each role ƒ OBJECTIVE—defined shared objective as maximization of profit, or production, over a given time period

14 | NOC IOC JVs The NOC’s take on alliances

ADVANTAGES DISADVANTAGES ƒ Foreign equity is contrary to traditional ƒ Diversification nationalist laws and popular sentiment ƒ Vertical downstream integration ƒ Blunt traditional “national resource” immunities ƒ Efficient development of national resource base ƒ Picking a winner precludes competition on home front (or IOC front) ƒ Reduction of administrative expenses ƒ Rationalize selection process for opportunities ƒ Efficient allocation of R&D roles ƒ Political cover for unpopular decisions

15 | NOC IOC JVs The IOC’s take on alliances

ADVANTAGES DISADVANTAGES

ƒ Reserves, reserves, reserves ƒ Loss of control of internal organization ƒ Access to frontier, large‐scale production within alliance ƒ Priority for new projects ƒ Putting too many eggs in one basket ƒ Economies of scale ƒ Possible increase of expropriation risk at end or threatened end of relationship ƒ Greater use of IOC’s technology, project management and downstream resources ƒ Political ramifications in home country, corruption issues ƒ Possible reduction of expropriation risk in ongoing venture ƒ Difficult to sell to investment community, disclosure issues ƒ Concerns with host country politics and unrest (e.g., Alien Tort Claims Act)

16 | NOC IOC JVs Potential structures for NOC/IOC alliances

Alternative 1: Broad Joint Venture between NOC and IOC FORMATION ƒ Broad functional scope (exclusive and non‐exclusive zones) ƒ Broad geographic scope (exclusive and non‐exclusive zones) ƒ IOC provides technology, capital, downstream business access ƒ NOC provides reserves, access to local projects, local assets, entitlements

OPERATION ƒ Ongoing contributions: IOC obtains recovery of capital, IOC and NOC allocate operating expenses ƒ Export, tax/regulatory and profit distribution policies ƒ Sole risk and non‐consent rights ƒ Management and staffing

CONTROL ƒ Votes, audits, disputes and deadlocks

EXIT ƒ Transfers, withdrawals and removals for default or otherwise

17 | NOC IOC JVs Potential structures for NOC/IOC alliances

PREFERRED STOCK IOC NOC International Oil National Oil Company Company

ASSETS AND PROJECTS Potential structures for NOC/IOC alliances

Alternative 2: IOC Equity for NOC Assets and Prospects ƒ New series of preferred stock in publicly traded IOC issued in exchange for existing property interests and prospective projects of the NOC or government à Earnings like common, but stated liquidation and dividend preference ƒ Class vote on fundamental changes ƒ Board representation, some approvals for executive and committeeplacements ƒ Restriction on resale of preferred stock for specified time period à conversion to common stock when sold to third party ƒ Restriction on acquisition of common shares; standstill agreement ƒ Automatic adjustment of voting and earning rights à downward if country is confiscatory à upward if expected earnings or host country investments not met

19 | NOC IOC JVs Challenges for NOC/IOC alliances

ƒ Shareholder vote for IOC (NYSE and other standards) ƒ Central bank, IMF and lender issues ƒ CFIUS and related national approvals for foreign investment ƒ FCPA and OECD anti‐corruption issues ƒ Antitrust and competition law issues ƒ Finesse auxiliary issues by using such alliances outside the borders of the NOC’s host country?

20 | NOC IOC JVs Challenges for NOC/IOC alliances Challenges for NOC/IOC alliances

ƒ Structuring the (inevitable?) exit à Put and call rights for NOC’s or IOC’s interest, on defined events or at stated intervals? à In sale of IOC, NOC has veto right or call on portion of company? à Or unscramble omelet by returning the NOC’s assets and prospects? à Change of control or merger of IOC still possible? à Impact of exit on reserves booked by IOC? Opportunities for NOC/IOC alliances

Goldilocks conditions ƒ Not too small—need economies of scale, alignment with success of other party ƒ Not too big—neither party should be controlled by the other or be overly dependent on one country or region

Where is the “sweet spot”? ƒ DEEPWATER OFFSHORE EXPLORATION—IOCs still have critical technology and project skills; NOCs have prospects? ƒ LNG—challenged economic environment for international movement of gas? ƒ HEAVY OIL—NOCs still need IOC technology and downstream abilities? ƒ ALTERNATIVE ENERGY and trading of carbon emission credits?

Despite all the challenges alliances face, what are the alternatives?

23 | NOC IOC JVs Opportunities for NOC/IOC alliances

“IOCs must learn to package the elements of their core value proposition—technology, financial resources, access to markets, project execution expertise, and vertically integrated offerings—in innovative ways that are customized to each market. … [T]hose who are willing to adapt … will maintain their competitiveness and viability.”

—Rob Jessen, Ernst & Young Oil & Gas Journal 2/2/09

24 | NOC IOC JVs Robert A. James [email protected] 1.415.983.7215 (San Francisco) 1.713.276.7689 (Houston)

Terry M. Kee [email protected] 1.415.983.1724 (San Francisco)