Energy news April 2005

E N E R G Y & N AT U R A L R E S O U R C E S

Energy news is a publication of KPMG’s Oil & Gas Centre of Excellence in Australia.

KPMG sponsors APPEA 2005 in Perth KPMG's Oil & Gas Centre of Excellence has got right behind the 2005 APPEA Conference and Exhibition in Perth. As sponsor of the opening ceremony, KPMG will help launch what promises to be the highlight of the oil and gas industry calendar in Australia. “We are delighted to once again be involved in this conference and look forward to meeting many of our clients, colleagues and friends at the event this year,” said Brent Steedman, KPMG Partner and Leader of KPMG’s Oil & Gas Centre of Excellence in Australia, based in Perth. “During the conference we will be talking to delegates about some of the key issues facing the sector this year. These include the International Financial Reporting Standards, the changing landscape of corporate governance brought about by Sarbanes-Oxley in the US, the ASX Corporate Governance Guidelines here in Australia and some material changes to taxation in Australia that will impact oil and gas investments both in Australia and overseas.” If you are attending the conference we look forward to seeing you at booth 144. Just look for the KPMG logo in the exhibition centre.

Buying and selling petroleum interests - impact of tax reform The new tax consolidation system, together with a number of other recent tax reform measures, has led to a paradigm shift in the way in which the acquisition and sale of petroleum interests are treated for taxation purposes in Australia. STO RY C O N T I N U E S O N PAG E 3

Former US Secretary of State to speak at KPMG’s Energy Conference The Honorable James A. Baker III, Former US Secretary of State, will be the keynote speaker at KPMG’s 2005 Global Energy Conference - May 24-25, 2005 at the Inter-Continental Hotel, Houston, Texas. Join your fellow oil and gas executives from the US, Australia and around the world for this internationally recognised congress for CEOs, CFO’s and executives. Topics include Asia Pacific Energy issues, managing financial and tax risks of global acquisitions and lessons learned from Sarbanes-Oxley. For more information see back page or visit www.kpmgglobalenergyconference.com

KPMG’s Oil & Gas Centres of Excellence

Perth Beijing Calgary Houston Johannesburg London Moscow Muscat Paris Rio de Janeiro Rotterdam

KPMG’s Oil & Gas Centres of Excellence create a framework for delivering KPMG’s services in a consistent, high-quality manner around the world. The centres act as your point of access to KPMG’s international knowledge in the energy, oil and gas industries. The centres also draw on the broader skills of our power and utilities, mining groups and industrial markets to support vertically integrated companies in the sector. The centre in Perth was launched in late 2003 by the Global Chairman of KPMG’s Energy & Natural Resources practice, Roger Munnings. Since that time KPMG has worked closely with many major and emerging oil and gas companies in the region, supporting their business challenges and transactions. In addition to our audit, tax and advisory roles, the key assignments we have undertaken include: • guiding and resourcing the implementation of International Financial Reporting Standards • supporting international investors into the region from countries such as Japan, China, India and Korea

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• working with Australian companies expanding into international locations • taxation advice in relation to tax consolidations, FBT, structuring, PRRT support and R&D concessions • transaction advice on investments into the Australian oil and gas sector • migration and International Executive Services to support movement of staff and executives • global and local responses to Sarbanes Oxley, ASX Guidelines and other corporate governance developments. KPMG’s Global Oil & Gas Centres of Excellence are strategically located close to major producing regions around the globe. For more information on KPMG’s Oil & Gas Centre of Excellence, contact Australian Leader Brent Steedman on +61 8 9263 7184 or [email protected].

Buying and selling petroleum interests impact of tax reform In an industry where ownership interests in exploration and production fields regularly change hands, it is important that decision makers have a clear understanding of the impact of the new tax rules. So what is the commercial impact of these tax changes in the oil and gas industry? The new tax changes have the potential to materially affect the value of transactions. In certain instances, purchasers may find that the purchase price of a petroleum interest will be entirely deductible over a period of time. The new rules are not uniform, however, and there are a number of traps for the unwary. For example, depending on how an acquisition is structured, the purchase price of a production licence may be deductible to the purchaser entirely, or not at all. A significant change to the tax system has been the introduction of the tax consolidation system, which treats company groups as one taxpayer. When a company is acquired by a tax consolidated group, the purchaser treats the acquisition as akin to the direct acquisition of assets. This gives rise to a complex series of steps for taxation purposes, and will affect the tax values of the assets of the target company. The interaction of the tax consolidation system with the new uniform capital allowances (UCA) system creates a number of issues, which need to be understood. The UCA rules, which were introduced in 2001, also require examination in the context of buying and selling petroleum interests.

The new tax changes have the potential to materially affect the value of transactions. Another major area of change is the impact of tax consolidation on tax losses. When a company is sold by a tax consolidated group, the losses of that company remain with the vendor. The purchaser will not obtain the benefit of tax losses in a purchase transaction. This means that in many cases the value of tax losses can no longer be ‘sold’ to a purchaser. There are a number of areas where the new tax consolidation and tax reform measures will impact the way merger and acquisition transactions in the industry are negotiated, priced and implemented, including: • whether to acquire petroleum interests directly, or as held by a company • minimising exposure to the joint and several tax liabilities of the vendor’s group • performing tax due diligence in a new way • valuing the tax attributes of the purchaser in a new way • the consequences of tax consolidation on the financial model underpinning the deal • pricing impact on the acquisition, price negotiations and adjustments to the price • the impact of legal agreements including tax warranties and indemnities • other taxes, including PRRT, stamp duty, offshore registration fees and goods and services tax.

Decision makers should be alert to the impact of the new rules to ensure that they are properly factored into a deal prior to committing to a new sale or purchase transaction. These tax rules will also influence the structuring of the transaction. Now, more than ever, there is no substitute for obtaining detailed professional tax advice when contemplating the sale or acquisition of petroleum rights or interests. KPMG will present a paper at the APPEA conference on Buying and Selling Petroleum Interests-Impact of tax consolidation and other tax reform measures. For copies of the paper, contact KPMG Partner Rod Henderson on +61 2 9335 8787 or [email protected]. Rod Henderson KPMG Tax Partner Rod leads KPMG’s Energy & Natural Resources Taxation team in Australia and heads the Energy & Natural Resources group in NSW. Based in Sydney, Rod advises numerous Australian and overseas oil and gas players on taxation issues relevant to their Australian and overseas investments. Carlo Franchina KPMG Tax Partner Carlo is a Tax partner in Perth. He provides taxation support for several significant Australian and overseas investors in the oil and gas sector in Australia.

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How can governance initiatives deliver value to the oil and gas industry? What lessons have we learnt from the Sarbanes-Oxley legislation and the ASX Corporate Governance guidelines and what does it mean to us in Australia?

There have been different reactions and approaches to addressing the challenges of more robust corporate governance structures and the development of internal control environments throughout the world. In the US, there is the SarbanesOxley Act (SOX), with US-based companies issuing their first compliance reports under this legislation in the first quarter of 2005. Here in Australia, the ASX has outlined 10 corporate governance guiding principles that it expects listed corporations to follow and the long-awaited CLERP9 was enacted into law during the year. Whilst there is universal consternation at the cost, a number of corporations have seen benefit from their recent SOX implementations or their corporate governance reviews, and feel they could gain more payback in future years with the right approach.

We have seen an unprecedented amount of activity in improving internal control environments and strengthening corporate governance frameworks

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Does this investment have to be written off to the cause of compliance or can it deliver value to the organisation, and if so how? We believe that with the right focus, value can be obtained from governance initiatives. In the oil and gas industry, SOX is complicated further by some of the remote locations in which companies

need to develop control environments and understand the unique governance relationships at those sites. Other difficulties lie with addressing the responsibilities of Joint Venture Partners (JVPs). However, there are opportunities to be exploited in these areas through the exercises being currently conducted. US companies will spend at least $2M each (on average) complying with SOX, according to Gartner estimates. This kind of investment is forcing companies to think about how they can derive a return from this investment. We have seen an unprecedented amount of activity in improving internal control environments and strengthening corporate governance frameworks over the past year with many organisations in the process of learning more about control environments and how to add value though governance activities. Practical tips Controls are like brakes in a motor car – as brakes enable a car to go faster (with braking slowing the fast car down when a dangerous situation appears), controls can enable an organisation to take on riskier

situations profitably. Examples of where a focus on governance and controls can deliver value to oil and gas companies include the following: • Sharing costs - controls for an operator of a Joint Venture (JV) enable them to ensure they share all (appropriate) costs with JVPs. If costs incurred by the operator are not coded to the correct JV and/or not able to be substantiated, the operator may not be able to share that cost with JVPs. This has a direct bottom-line profit impact on the operator for the year. • Contract price benefits - long-term gas sales contracts can be very complex with a variable level of risk involved in the agreement contributing to the contract price. The higher the robustness of the control environment and governance capability, the lower the perceived level of risk will be, leading to a potential beneficial swing in the contract price. • Costly cleanups - inefficiency in JV cost controls can result in costly cleanups before JV non-operator audits, and/or costly resolution of JV audit findings and lack of confidence and trust in the operator.

• Project finance reductions developments that require external project finance may reduce their lender costs as lenders will apply some level of risk premium or discount depending on their perception or assessment of the borrowing party’s risk management capability. Demonstrably strong corporate governance would be a sound method of illustrating this.

outlined above. Non-financial controls are not always the focus of governance requirements.

• No Board surprises - there is a reduction in the level of surprises for the Board and CEO where the right controls are focussed on, for example, reserves, provisioning, and other areas of strategic focus. Likewise this provides JVP confidence and ultimately increases investor confidence.

Mark Puzey

• Efficiency in JVP management this can be obtained via increased focus on the right controls. For example, if operators provide dayto-day operational data via the Internet to JVPs (that take their share of output), this enables timely planning of information whilst relieving the operator of communication effort. An increase in operational controls as well as financial controls (such as SOX focus) provides the advantages

KPMG is presenting a paper at the APPEA conference on Can Governance initiatives deliver value to the oil and gas industry? For copies of the paper contact KPMG Partner Mark Puzey on +61 8 9263 7135 or [email protected]. Mark is the IT Governance ASPAC leader and a Risk Advisory Services partner. His oil and gas focus has included work on the complexities of JV arrangements, governance, shared services and capex/ IT projects. Simon Benson A senior manager within our Risk Advisory Services division. Simon’s main focus is on clients in the energy and natural resources sector, primarily, oil and gas producers. Simon, based in Perth, is a member of our global team responsible for developing KPMG’s approach to advising clients on good practice internal control environments.

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Energy outlook for China The energy needs of the People’s Republic of China are a major factor in the complex global energy demand and supply equation. Their importance will increase as China’s economy continues to expand and each year larger percentages of its population seek higher living standards.

alternative energy services. It highlights the roadblocks faced by China in meeting its energy demands including dealing with the complexities of no national grid and poor transmission, an overstretched transport network and significant consolidation needed in the coal sector.

The issues and challenges of efficient energy supply to a demanding economy are complex. An eager population in China will continue to be an underlying component of international political relationships and the world’s capital market systems with their need for long-term energy investment requirements and their aspirations to sustain and improve living conditions.

China’s oil majors are also introduced in the paper, as are the international partnerships China is forging as it moves to develop a secure and diversified global energy strategy.

KPMG has produced a paper Energy Outlook for China outlining these issues and challenges. The paper summarises China’s energy demands and resources, and looks at the Chinese government’s plans to develop

China and the environment is also reviewed with the anticipated release of renewable energy law in mid-2005 seen to spur growth in renewables. For copies of China Energy Outlook, contact Australian General Manager of KPMG’s Energy & Natural Resources group, Helen Cook at [email protected] or call Duncan Calder, Australian Leader of KPMG’s China desk in Australia on +61 8 9263 7388 or [email protected].

KPMG and RISC supporting the industry KPMG and Resource Investment Strategy Consultants (RISC) have formed a non-exclusive alliance to bring additional benefits to our clients in the oil and gas industry throughout the world. The KPMG and RISC alliance, including the key role of RISC Chairman and KPMG Adviser, the Hon. Richard Court AC, is focussed on supporting the following key business challenges in the oil and gas sector: Hon. Richard Court AC

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• support for acquisitions and divestments • assistance with the development of tailored financial models for decision making and audit and review of models built internally • resource development planning and execution including reserves certification and optimisation • enhancing the value of JVs • independent assessments.

The alliance offers the combination of highly experienced teams and a competitive alternative to managing separate teams on asset transactions, valuations and projects. For more information on the KPMG and RISC Alliance, contact: Brent Steedman +61 8 9263 7184 [email protected] or John Boardman +61 8 9420 6660 [email protected].

Analysts sound warning on IFRS KPMG has recently released a survey of financial analysts on the readiness of Australian capital markets for the introduction of reporting under the Australian equivalents of the new International Financial Reporting Standards (AIFRS). The survey Perceptions and Realities raised some critical issues for companies who must comply with AIFRS for financial years commencing on or after 1 January 2005. AIFRS is likely to affect a company’s financial reporting in a number of areas and may lead to greater volatility in reported earnings. Although the adoption of AIFRS will not of itself change the underlying reality of a company’s financial position, it has the potential to change the look of a company’s financial position and performance. Investor perceptions of company performance could change when financial results are first reported under AIFRS and in some cases the move to AIFRS may impact a company’s ability to pay dividends or meet debt covenant requirements. Key findings The survey found that there is a real risk of market turmoil when results under AIFRS are released. • Forty-nine percent of the analysts surveyed expect AIFRS to cause at least some market dislocation. Almost as many (40 percent) believe there are stock market valuation issues with reporting under AIFRS, and that the market has not yet factored in these issues. • A majority of analysts (62 percent) say they are likely to mark down a company’s shares if they do not

understand why its results look different under AIFRS. • The market appears to be confused about whether or not the move to AIFRS will yield more or less insight into company performance. Fortyseven percent of analysts think AIFRS will provide more meaningful information about performance. However, exactly the same percentage disagrees, feeling that AIFRS will either make no difference or actually provide less insight into company performance. • Overall, analysts appear sceptical about the benefits of AIFRS. Fortythree percent feel there will be no benefit from the move to AIFRS, or could not answer the question. More than half (56 percent) felt that confusion, the potential for misinterpretation of company results, and increased market volatility were the most significant disadvantages of moving to AIFRS. Implications The critical message from the survey is that companies face a real risk that their financial performance as reported under AIFRS will be misunderstood or misinterpreted by the market. How should companies deal with this threat? KPMG believes companies must give a high priority to market communication. This includes: • explaining the AIFRS-related changes in financial statements

and distinguishing them from those that reflect changes in underlying business performance • providing more detailed insights into company readiness for reporting under AIFRS • clarifying and simplifying the complexity. AIFRS introduces new and complex concepts that need to be communicated clearly and simply. Even if the net bottom line effect of an AIFRS change is negligible, it is important to explain why. Finally, companies can use the transition to AIFRS to enhance ongoing market communication. In other words, use AIFRS as an opportunity to review and improve the organisation’s overall approach to market communication. How can KPMG help? KPMG can support companies with key aspects of AIFRS including transition project management and assistance, valuation assistance, specialist technical assistance, such as IAS 39 implementation, tax support, training and communications strategy. The survey Perceptions and Realities is available by contacting KPMG’s Energy & Natural Resources National Chairman, and Energy & Natural Resources IFRS Representative, Alison Kitchen at [email protected] + 61 3 9288 5345 Energy news 7

kpmg.com.au

KPMG responds to CERA study on oil and gas reserves Cambridge Energy Research Associates (CERA) recently released their six month study on disclosure of oil and gas reserves, bringing together many of the major international oil and gas companies and their advisors to look at the SEC guidelines. Entitled In Search of Reasonable Certainty: Oil and Gas Reserves Disclosure, the study sought to address some of the questions around how reliable disclosed reserves figures are and whether the current system of disclosure meets the needs of investors. KPMG, one of the professional services firms involved in the study, considers that the current reserve disclosure system does not go far enough towards meeting the needs of the wide constituency of investors in the industry. Brent Steedman, Oil & Gas Centre of Excellence leader in Australia, commented, “We support the findings of the study, but also take the view that reporting for oil and gas companies could benefit not only from better and more consistent reporting of oil and gas reserves, but also more relevant coverage of the way value is generated.” “Value in an upstream oil and gas company or the upstream operations of an oil and gas company depends on the ability to find oil and the ability to produce cash flow out of identified reserves. A reporting system which shows the performance of management in exploration spending and how they take prospects and discoveries through to production,

could provide investors with a better basis for assessment than the current specific requirements of the U.S. SEC.” KPMG also considers that, as part of a broad system, oil and gas companies need to do a better job of explaining the nature of reserves estimates and the high degree of complexity and inherent uncertainty underlying the estimation process. Estimating reserves is far from a precise science so reserves estimate data needs to be understood in that context. The disclosure of only proved reserves presents a very narrow picture of a company’s total oil and gas resources. KPMG believes that extending the disclosure requirements to include other reserve and resources categories, while helping to insure that investors fully understand the different risks associated with each category, could substantially increase the usefulness of disclosures to investors. For a copy of the KPMG’s full response to the CERA Report or a copy of the report contact Helen Cook, Australian General Manager, KPMG Energy & Natural Resources on +61 8 9263 7342 or [email protected]

The information contained is of a general nature and is not intended to address the circumstances of any particular individual or entity. Although we endeavour to provide accurate and timely information, there can be no guarantee that such information is accurate as of the date it is received or that it will continue to be accurate in the future. No one should act on such information without appropriate professional advice after a thorough examination of the particular situation.

KPMG looks to further support the vital oil and gas service industry KPMG has been a long-time adviser to the oil and gas services sector, with its unique financial and operational issues. During 2005 we will be further developing our audit, tax and advisory services for this growing and vital industry in Australia. KPMG supports the services industry with international migration issues for contractors and staff, accounting and tax advice, transactions and acquisition advice, taxation issues including R&D employee taxation and tax compliance. If you would like more information on KPMG’s services to the oil and gas services industry in Australia contact Brent Steedman on +61 8 9263 7184.

For more information on the activities of KPMG’s Oil & Gas Centre’s of Excellence contact Helen Cook, Australian General Manager, KPMG Energy & Natural Resources on +61 8 9263 7342 or [email protected].

© 2005 KPMG, an Australian partnership, is part of the KPMG International network. KPMG International is a Swiss cooperative. All rights reserved. Printed in Australia. The KPMG logo and name are trademarks of KPMG. April 2005. WA0532ENR