1. ALGIERS AUSTIN DALLAS FORT WORTH HOUSTON MONTERREY PARIS RIO DE JANEIRO The American Experience in Oil and Gas Financing Rio de Janeiro – 9 June 2004 Presented By John W. Rain Thompson & Knight LLP 1700 Pacific, Dallas TX 75201 214.969.1644john.rain@tklaw.com NOT AN OFFICIAL UNCTAD RECORD

2. ALGIERS AUSTIN DALLAS FORT WORTH HOUSTON MONTERREY PARIS RIO DE JANEIRO 2 “The two contracts that are basic with the American oil and gas producer are the oil and gas lease and the promissory note, and practically all of the contracts that are peculiar to the oil industry are variations, refinements, elaborations and extensions of one or the other of these basic contracts.” “The oil and gas lease affords the oil producer something to work on, and the promissory note affords him something to work with.” Thomas A. Knight, Esq. circa 1945.

3. ALGIERS AUSTIN DALLAS FORT WORTH HOUSTON MONTERREY PARIS RIO DE JANEIRO 3 U.S. Oil and Gas Production Production began 150 years ago, mostly onshore. Production began 150 years ago, mostly onshore. Relevant laws and financing practices developed in relation to onshore production. Relevant laws and financing practices developed in relation to onshore production. Current law and financing practices stem from these origins and apply to both onshore and offshore production. Current law and financing practices stem from these origins and apply to both onshore and offshore production.

4. ALGIERS AUSTIN DALLAS FORT WORTH HOUSTON MONTERREY PARIS RIO DE JANEIRO 4 U.S. Oil and Gas Rights (“Something to Work On”) Rights to license exploration and production typically belong to individual landowners, not to the Nation. Rights to license exploration and production typically belong to individual landowners, not to the Nation. Diverse ownership by private farmers and ranchers means many small entrepreneurs can buy or lease rights to drill and produce. Diverse ownership by private farmers and ranchers means many small entrepreneurs can buy or lease rights to drill and produce.

5. ALGIERS AUSTIN DALLAS FORT WORTH HOUSTON MONTERREY PARIS RIO DE JANEIRO 5 Finance Capital (“Something to Work With”) The independent producers needed capital. The independent producers needed capital. Banks and private investors responded to this need. Banks and private investors responded to this need. Over time, some oil companies grew quite large and developed additional capital sources. But the larger companies never crowded out the smaller independent producers who own and operate many oil and gas properties today – both onshore and offshore – and who continue to need capital. Over time, some oil companies grew quite large and developed additional capital sources. But the larger companies never crowded out the smaller independent producers who own and operate many oil and gas properties today – both onshore and offshore – and who continue to need capital.

6. ALGIERS AUSTIN DALLAS FORT WORTH HOUSTON MONTERREY PARIS RIO DE JANEIRO 6 Historical Reserve-Based Lending Banks developed “reserve-based lending.” Banks developed “reserve-based lending.” ! One of the very first was Republic National Bank of Dallas, represented by Thompson & Knight. Based on the idea that oil and gas reserves have a “loan value.” Based on the idea that oil and gas reserves have a “loan value.” ! Usually 50% - 65% of ! the present value (at 10% discount rate) of ! future sales of oil and gas from proved, developed producing reserves. 35% - 50% discount is Bank’s safety factor. 35% - 50% discount is Bank’s safety factor.

7. ALGIERS AUSTIN DALLAS FORT WORTH HOUSTON MONTERREY PARIS RIO DE JANEIRO 7 Historical Reserve-Based Lending (cont’d.) Each bank develops its own “price deck” to use in calculating future sales proceeds. Each bank develops its own “price deck” to use in calculating future sales proceeds. ! Based on experience as well as economic forecasts. ! Less volatile than the futures markets. Estimates of future production are made by reserve engineers. Estimates of future production are made by reserve engineers. Bank uses this loan value to establish a “Borrowing Base,” which is Borrower’s line of credit with Bank. Bank uses this loan value to establish a “Borrowing Base,” which is Borrower’s line of credit with Bank.

8. ALGIERS AUSTIN DALLAS FORT WORTH HOUSTON MONTERREY PARIS RIO DE JANEIRO 8 Historical Reserve-Based Lending (cont’d.) A new reserve report is received every six months and Bank redetermines the Borrowing Base. A new reserve report is received every six months and Bank redetermines the Borrowing Base. Bank has discretion to consider other factors in setting the Borrowing Base. Bank has discretion to consider other factors in setting the Borrowing Base. ! Some future sales prices might be based on Borrower’s hedges, rather than on Bank’s price deck. ! PUD reserves might get partial value. ! Special credit problems might reduce Borrowing Base. Bank almost always receives a mortgage covering Borrower’s proved, developed producing reserves. Bank almost always receives a mortgage covering Borrower’s proved, developed producing reserves.

9. ALGIERS AUSTIN DALLAS FORT WORTH HOUSTON MONTERREY PARIS RIO DE JANEIRO 9 What Happens When a Loan is in Default? If Borrowing Base is redetermined and falls short of the outstanding loan balance, Borrower is in default unless it quickly pays back the shortfall. If Borrowing Base is redetermined and falls short of the outstanding loan balance, Borrower is in default unless it quickly pays back the shortfall. Loan documents also contain other defaults customary for bank loans. Loan documents also contain other defaults customary for bank loans. If a default occurs, Bank and Borrower typically engage in “workout” negotiations: If a default occurs, Bank and Borrower typically engage in “workout” negotiations: ! Bank gives Borrower more time to pay. ! Borrower agrees to raise the money to repay by cutting costs or selling assets.

10. ALGIERS AUSTIN DALLAS FORT WORTH HOUSTON MONTERREY PARIS RIO DE JANEIRO 10 What Happens When a Loan is in Default? (cont’d.) If Borrower is unable to cure the default within a reasonable time, Bank will attempt to foreclose its mortgage. If Borrower is unable to cure the default within a reasonable time, Bank will attempt to foreclose its mortgage. Borrower will either allow foreclosure or commence a bankruptcy case. Borrower will either allow foreclosure or commence a bankruptcy case. If Bank forecloses, U.S. law allows it to own the reserves for up to 5 years while it seeks a buyer. If Bank forecloses, U.S. law allows it to own the reserves for up to 5 years while it seeks a buyer. In a bankruptcy, Borrower will have more time to put its affairs in order. But ultimately, it must either repay Bank, or refinance, or sell its properties. In a bankruptcy, Borrower will have more time to put its affairs in order. But ultimately, it must either repay Bank, or refinance, or sell its properties.

11. ALGIERS AUSTIN DALLAS FORT WORTH HOUSTON MONTERREY PARIS RIO DE JANEIRO 11 Key “Infrastructure” for Reserve-Based Finance Borrower owning proved, developed producing reserves. Borrower owning proved, developed producing reserves. Professional reserve engineers who estimate future production. Professional reserve engineers who estimate future production. An established market to sell this production. An established market to sell this production. An enforceable mortgage from Borrower to Bank. An enforceable mortgage from Borrower to Bank. An insolvency system that allows Bank’s mortgage to give it priority over most other creditors, especially other lenders. An insolvency system that allows Bank’s mortgage to give it priority over most other creditors, especially other lenders. Reserve-based lending is based on:

12. ALGIERS AUSTIN DALLAS FORT WORTH HOUSTON MONTERREY PARIS RIO DE JANEIRO 12 Who Provides Oil and Gas Financing in the U.S. Today? In addition to internal cash flow from operations and reserve-based lending, capital comes from: In addition to internal cash flow from operations and reserve-based lending, capital comes from: ! Equity investors, including mutual funds, hedge funds, and endowments ! Corporate lenders (generally to investment grade companies) ! Project partners ! Proceeds from asset sales

13. ALGIERS AUSTIN DALLAS FORT WORTH HOUSTON MONTERREY PARIS RIO DE JANEIRO 13 What Do All Investors Require in Order to Provide Financing? Satisfactory projected returns Satisfactory projected returns Satisfactory probability of achieving projected returns Satisfactory probability of achieving projected returns Liquidity Liquidity Legal certainty about rights and remedies in case of default Legal certainty about rights and remedies in case of default

14. ALGIERS AUSTIN DALLAS FORT WORTH HOUSTON MONTERREY PARIS RIO DE JANEIRO 14 Why Does Finance Still Matter to the Oil and Gas Industry? Multiple financing sources provide multiple ways for more individuals and organizations to acquire and operate oil and gas reserves. Multiple financing sources provide multiple ways for more individuals and organizations to acquire and operate oil and gas reserves. When there are more potential owners, there is a greater probability that the best owner for the properties will become the actual owner. When there are more potential owners, there is a greater probability that the best owner for the properties will become the actual owner.

15. ALGIERS AUSTIN DALLAS FORT WORTH HOUSTON MONTERREY PARIS RIO DE JANEIRO 15 Who is the “Best Owner” for a Particular Property? Oil and gas properties have a life cycle: Oil and gas properties have a life cycle: ! Geological concept ! Exploration project ! Development project ! Operating asset ! Mature field to be nurtured

16. ALGIERS AUSTIN DALLAS FORT WORTH HOUSTON MONTERREY PARIS RIO DE JANEIRO 16 Who is the “Best Owner” for a Particular Property? (cont’d.) The “best owner” for a property is the owner who can maximize its value. Different owners can: The “best owner” for a property is the owner who can maximize its value. Different owners can: ! Manage each stage of the life cycle better than others. ! Manage each stage more economically than others. ! Find new applications for technology to specific basins and fields. ! Keep fields producing longer than others. Shared, partial ownership of properties diversifies risks and encourages investment. Shared, partial ownership of properties diversifies risks and encourages investment.

17. ALGIERS AUSTIN DALLAS FORT WORTH HOUSTON MONTERREY PARIS RIO DE JANEIRO 17 Why Does Transferability of Oil and Gas Assets Facilitate Financing? Transfers of properties to the “best owners” maximize the value of the properties. Transfers of properties to the “best owners” maximize the value of the properties. ! When a property matures and the present owner can no longer maximize its value, it is time to sell to a new owner who can maximize value. ! When a property’s probability of success becomes better known, it is time to find lower cost financing.

18. ALGIERS AUSTIN DALLAS FORT WORTH HOUSTON MONTERREY PARIS RIO DE JANEIRO 18 Why Does Transferability of Oil and Gas Assets Facilitate Financing? (cont’d.) Transferability of properties provides liquidity for investors, and liquid investments are safer. Transferability of properties provides liquidity for investors, and liquid investments are safer. ! If a borrower can sell a property to pay its lenders, the lenders are more willing to lend. ! If a lender can foreclose its mortgage in an emergency, the lender is more willing to risk an emergency. ! If a project equity investor knows the project can be sold once it is fully developed, the investor is more willing to make a medium term investment at a lower rate of return.

19. ALGIERS AUSTIN DALLAS FORT WORTH HOUSTON MONTERREY PARIS RIO DE JANEIRO 19 Transferability of Oil and Gas Rights in the U.S. Today Allows capital for new projects to be generated by sales of older projects Allows capital for new projects to be generated by sales of older projects Encourages equity investors who have medium-term horizons Encourages equity investors who have medium-term horizons Allows secured lending for higher risk companies Allows secured lending for higher risk companies Allows companies to find project partners both before and after a project has begun Allows companies to find project partners both before and after a project has begun

20. ALGIERS AUSTIN DALLAS FORT WORTH HOUSTON MONTERREY PARIS RIO DE JANEIRO 20 Should Governmental Authorities Outside the U.S. Consider Allowing Concessions to be More Easily Transferred? There are many kinds of qualified operators, including: There are many kinds of qualified operators, including: ! Huge companies with the capital to finance exploration and development. ! Smaller companies with operating expertise who need access to capital from lenders and investors. ! Service companies who operate for hire. ! Start-up companies formed by the individuals who previously worked for the huge companies, the small companies or the service companies. All of these can be competent, responsible operators, regardless of whether their capital is generated internally or comes from lenders. All of these can be competent, responsible operators, regardless of whether their capital is generated internally or comes from lenders.

21. ALGIERS AUSTIN DALLAS FORT WORTH HOUSTON MONTERREY PARIS RIO DE JANEIRO 21 Proposals to Encourage Oil and Gas Financing for Medium and Smaller Companies Develop an official list of qualified concession holders. Develop an official list of qualified concession holders. ! Include all companies with adequate operating experience, both large and small. ! Include service companies willing to act as contract operators for lenders, investors, and others.

22. ALGIERS AUSTIN DALLAS FORT WORTH HOUSTON MONTERREY PARIS RIO DE JANEIRO 22 Proposals to Encourage Oil and Gas Financing for Medium and Smaller Companies (cont’d.) Allow free transferability of concessions among qualified concession holders. Allow free transferability of concessions among qualified concession holders. ! Allow investors and lenders to take mortgages on concessions and to foreclose and own the concessions for a limited number of years. ! Make Agency approvals of assignments as fast and easy as possible, so lenders know they will be able to resell foreclosed properties and investors know the concessions are liquid investments. ! Do not provide for concessions to terminate upon foreclosure or “change of control.”

23. ALGIERS AUSTIN DALLAS FORT WORTH HOUSTON MONTERREY PARIS RIO DE JANEIRO 23 Summary Banks and investors have learned how to evaluate the risks of investing in oil and gas reserves. Banks and investors have learned how to evaluate the risks of investing in oil and gas reserves. These risks are reduced as oil and gas concessions become more and more liquid. These risks are reduced as oil and gas concessions become more and more liquid. ! Property values increase when concessions are transferred to new “best owners.” ! Investors provide more capital for liquid investments and will spend more for concessions if the concessions are liquid. ! Banks lend more capital when they receive mortgages.

24. ALGIERS AUSTIN DALLAS FORT WORTH HOUSTON MONTERREY PARIS RIO DE JANEIRO 24 John W. Rain Thompson & Knight LLP 1700 Pacific, Dallas TX 75201 Tel:214-969-1644 Fax:214-969-1751 Email:John.Rain@tklaw.com John W. Rain Thompson & Knight LLP 1700 Pacific, Dallas TX 75201 Tel:214-969-1644 Fax:214-969-1751 Email:John.Rain@tklaw.com