RRP Risk Assessment and Risk Management Plan

Shah Deniz Gas Field Expansion Project (RRP AZE 49451-002) RISK ASSESSMENT AND RISK MANAGEMENT PLAN Risk Risk Description Assessment Mitigation Measures or Risk Management Plan Project Construction and Low Operation Complex structure of The progress report by the operator, BP (through its contracts that involve many subsidiary, BP Exploration [Azerbaijan] Limited), shows subcontractors and joint that approximately 93% of the Shah Deniz-ll-related ventures leads to delays in procurement of goods and services and 72% of project implementation supplies and construction works have been completed and/or technical or safety as of 31 August 2016, ahead of the original schedule, problems during and with a 5% savings below the budgeted amount. construction, or interruptions of gas production and/or The lender’s independent engineer has not identified technical or safety problems any incidents of major contractual disputes; ongoing during operations. litigation processes; or any health, safety or safeguards incidents in relation to implementation of Shah Deniz-II. Unanticipated technical challenges arise during The project progress has been based on BP’s drilling of wells. extensive experience and expertise in oil and gas exploration and operation. It is anticipated that Shah Pipeline projects are not Deniz-II (and the downstream pipeline projects) will be completed as planned. completed well within budget and on time. It is also anticipated that BP will successfully operate Shah Deniz-II, having been the largest international operator in Azerbaijan since 1996 and having successfully operated Shah Deniz-l over the past 10 years. Procurement Low BP’s procurement practices Project procurement is conducted in accordance with are not in line with principles BP’s procurement practices as agreed among the under ADB’s procurement parties to the joint operating agreement.2 The lenders’ guidelines.1 technical advisor confirmed that BP Azerbaijan’s procurement strategy and supply chain management are well established. With approximately 93% procured and 72% completed, the project is ahead of schedule and actual costs are 5% under budget. The first gas is scheduled to be delivered in 2018. [CONFIDENTIAL INFORMATION DELETED]. ADB is providing a PCG protecting commercial lenders against nonpayment by SGC and MOF of loaned amounts. These amounts are applied to SGC's financial obligations resulting from BP's cash calls and AzSD’s progress payment notices for Shah Deniz- related capital and operational expenditures. ADB is satisfied that the project’s procurement has been conducted following normal commercial practices, with due attention to economy and efficiency as required for procurement in relation to loans guaranteed by ADB. 1 ADB. Procurement Guidelines. April 2015. Manila. 2 Shah Deniz Joint Operating Agreement dated 5 March 1997. 2 Risk Risk Description Assessment Mitigation Measures or Risk Management Plan Project Implementation Low Limited capacity and While SGC lacks internal technical expertise, its experience in project service agreement with SOCAR calls for providing implementation and technical expertise in the project monitoring process, management lead to delays which mitigates this risk. and non-compliance with ADB policies. Cash call and progress payment notices processes will be the major part of project implementation activities. SGC has well established and documented processes to handle the cash requirements from its projects. Financial management Medium Limited experience working SGC used its own funding to engage legal and with multilateral financing financial advisors to support its financial planning and institutions while relying funds procurement, which mitigates the risk. The substantially on such continued engagement of such advisors is a financing leads to a delay in requirement under the financial management action securing financing. plan. Financial Sustainability Medium Diversion of Shah Deniz The State Commission established a financing revenues or lack of sufficient mechanism to cover SGC’s financing needs through financing in a timely manner equity injections to SGC, taking into account revenues leads to SGC’s non- obtained by SGC from its participating shares in the compliance with Shah Deniz Southern Gas Corridor projects. It also obliges SOCAR agreements. to direct the revenues earned by SOCAR from AzSD’s 10% participating share in the project (to be transferred to SGCU under the DSPA in 2023) to any additional equity injection requirements. SOCAR equity injections into SGC are pro rata its 49% shareholding in SGC and supplemented by injections by the Ministry of Economy for its 51% shareholding to be sourced from SOFAZ. Disappointing Shah Deniz-II [CONFIDENTIAL INFORMATION DELETED] sales revenues due to weaker than projected oil- linked gas prices, or a drop in demand or take-off. Environmental protection Medium Construction activities fail to Shah Deniz-II has been classified as category “A” for meet the national potential environmental impacts. An Environmental environmental safeguards Management Plan (EMP) has been developed to standards and ADB’s mitigate impacts. EMPs are implemented by the Safeguard Policy contractors within the respective territories of their Statement (2009). responsibility; contractors assume obligations and penalties as well as reputational risk. BP is responsible Lack of leverage over Shah for monitoring each contractor’s implementation of the Deniz-II’s construction and EMP. To the extent permissible under the relevant operational activities due to project agreements, SGC will be required to exercise its minority shareholding in its powers to ensure prompt reporting of and remedying Shah Deniz-II (6.7% during of any non-compliance under the loan agreement. construction and 16.7% Risk Risk Description Assessment Mitigation Measures or Risk Management Plan during operations) BP also produces environmental and social monitoring reports based on international practices acceptable to ADB. Any deviations from such practices will be scrutinized by the participating investors, which are internationally reputable companies. While SGC’s own participating interest is limited, all investors have an interest in abiding by internationally acceptable environmental protection standards. Loan Market Risk Low A change in loan market Macroeconomic indicators and responses to conditions affects the commercial market soundings have been positive. The appetite for and costs of market for PCG-covered loans is relatively stable as funds of lenders participating lenders take limited credit exposure on the Government in the ADB PCG-covered of Azerbaijan. Lead arrangers are incentivized by an loan facility. all-in pricing grid based structuring fee to achieve lowest pricing to SGC. Overall Medium ADB = Asian Development Bank, AzSD = Azerbaijan (Shah Deniz) Limited, DSPA = deferred sale and purchase agreement, EMP = Environmental Management Plan, PCG = partial credit guarantee, Shah Deniz-I = Shah Deniz Stage 1, Shah Deniz-II = Shah Deniz Stage 2, SGC = Southern Gas Corridor CJSC, SGCU = SGC Upstream LLC, SOCAR = State Oil Company of Azerbaijan Republic, SOFAZ = State Oil Fund of the Republic of Azerbaijan, SPS (2009) = ADB Safeguard Policy Statement (2009). Source: Asian Development Bank. .

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