10thAfrican_Valicon.ppt

Merrrill Lynch

April 4th, 2006

Securing Revenues in a Volatile Crude Market

NOT AN OFFICIAL UNCTAD RECORD

Table of Contents

Securing Revenues in a Volatile Crude Market

1. Oil Market Outlook

2. Securing Oil Revenues

3. Securing Revenues from Energy Distribution

1. Oil Market Outlook

1

Oil Price Outlook: Short Term Support, Long Term Threat

Historical and Forward IPE Brent Curves

Global Market for Crude Oil

Oil Market Outlook

High Marginal Cost Oil Fields : Oil Sands (1)

Strong demand (particularly in Asia and South America) combined with bottlenecks in the refining sector (due to lack of investment) and a fundamental shift in oil production (from sweet/light to sour/heavy) have driven oil prices higher over the past 3 years

After 2007, forces driving oil prices lower might become dominant:

Upstream and downstream investments coming on-line in 2008

Chinese economic growth slow down

Risk of pandemics such as Avian Flu

Iraqi oil production recovering from current low levels

Development of a global gas market with the LNG production coming on-line

As seen during the oil shocks in the 1970’s, fear of a long term high oil price environment will stimulate

Development and production of high marginal cost oil fields (Venezuela, Canadian Oil sands) where majors are already making heavy investments

Investment in alternative technologies such as electric engines, fuel cells, hydrogen propulsion

10

20

30

40

50

60

70

$/b

bl

Spot shift in response to Supercycle

Forward shift in response to Supercycle

Current Mark et

ML Expectation

Historical

259

236

179

126 11597 92

6036 25

0

50

100

150

200

250

300

Saudi

Ara

bia

Venezu

ela

Canada

Iran

Iraq

Kuw

ait

Abu D

habi

Russia

Lib

ya

Nig

eria

Canada’s Reserves:

Oil Sands: 163 mmbblsConventional: 16 mmbbls

Conventional

Oil Sands

____________________(1) Source: Alberta Department of Energy and Oil and Gas Journal.

Boom and Bust of Commodity Markets: Cause, Effect & Remedies

2

Paying for Decades of Underinvestment

5-6 yearsNew Copper Mine

3-4 yearsCopper Smelter

7-10 yearsOil Field (new area)

2-3 yearsOil Field (existing area)

5-7 yearsOil Pipeline

5-7 yearsNew Refinery

2-3 yearsRefinery Upgrade

2 yearsShip (wet)

1-2 yearsShip (dry bulk)

Average Construction Lead-Times for Major Commodity Supply Infrastructure Projects(1)

Average Construction Lead-Times for Major Commodity Supply Infrastructure Projects(1)

____________________(1) Merrill Lynch Commodity Research

Low investment returns have led to a lack of capital flowing into the industry over the last decades (instead chasing more ‘desirable’ sectors, such as pharma, technology, telecoms)

As a result, we are looking at a chain of bottlenecks throughout the industry …

Exploration

Transportation

Refining

Labour

Etc …

… requiring high and sustained prices to justify investment

In any case many of these bottlenecks will take a long time to fix

Oil Market Outlook

Unconventional Low Margin Product Coming Online

3

The high forward oil price environment is stimulating production in unconventional oil which poses a threat to conventional producers

Unconventional Crude Production

The current high forward oil price environment encourages the production of low margin product

Canadian Oil Sands Venezuela Heavy Oil

Even at low margins, Unconventional Oil represents a clear threat to convention oil producing nations

The elevated forward curve allows low margin producers to lock in profit and potentially steal North American market share

High oil prices are stimulating increased investment in technology to efficiently extract unconventional oil

This flood of new crude will ultimately place downward pressure on commodity prices

0

500

1,000

1,500

2,000

2,500

3,000

3,500

4,000

4,500

5,000

2000 2001 2002 2003 2004 2005 2006 2007 2008 2009 2010 2011 2012 2013 2014 2015 2016 2017 2018 2019 2020

Synthetic Crude

Canadian Bitumen

Venezuelan Synthetic

Canada Venezuela

- Large resource base - Large resource base (similar potential to Canada)

- Stable political environment - Unstable political environment

- Developed and stable fiscal regime - Currently more favourable fiscal regime but could be potential changes

- Higher extraction costs (energy intensity)

- Lower extraction costs than in Canada

- Some market access constraints for output (limited refinery capacity)

- Limited market access constraints for output (U.S. Gulf Coast, Caribbean refineries)

- Acquisition and greenfield opportunities

- Primarily greenfield opportunities (must deal with PDVSA)

- Industry participants: ExxonMobil, Shell, ConocoPhillips, ChevronTexaco, Total, Canadian Independents and Integrateds

- Industry Participants: PDVSA, ExxonMobil, Petro-Canada, ConocoPhillips, ChevronTexaco, Total, Statoil

High Forward Oil Price Environment as a Potential Threat

kboed

Oil Market Outlook

Current Inelasticity of Demand is not Sustainable in the Long Term

4

The current growth in oil demand despite rising prices is unsustainable in the long term

Fear of an extended period of high commodity prices will drive investment in alternative technology

To date, global demand has proven to be highly resilient to the steady growth in oil prices

However, the fact that demand has failed to slow down despite the high prices does not mean that demand is price-insensitive in the long-run

As seen during the oil shocks in the 1970’s, fear of a long term high oil price environment will stimulate conservation efforts and fuel investment in environmentally friendly technologies such as:

Gas / Electric hybrid engines

Fuel Cells

Hydrogen propulsion

Gas fired Vehicles

The ultimate effect will be long term price elasticity of demand as consumers look to return disposable income from fuel expense to their pockets

Long Term High Oil Prices Will Lead to a Softening in DemandOil Market Outlook

5

High Demand will Lead to Increased Efficiency and SubstitutionIncreasing Inelasticity of Gasoline

Demand(1)…

-0.25

-0.2

-0.15

-0.1

-0.05

0

77 79 81 83 85 87 89 91 93 95 97 99 01 03 05

% change in gasoline demand for 1% change in price

%

____________________(1) Rolling regression coefficient on a 100-month window where the latest data point signals current price elasticities of gasoline demand, as estimated

over the past 100 month

0

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20

30

40

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60

0

5

10

15

20

25Average mpg/km per litre of city and highway

mpg km per litre

…Leading to Higher Fuel Efficiencies

US gasoline demand has become more price inelastic over time

A shift from SUVs to hybrid vehicles in the US could result in phenomenal energy savings

Oil Market Outlook

Overlap in the End Use of Oil and Gas may Lead to Substitution

6

Though it may be unlikely that the oil and gas price divergence will persist into the long term, should it occur, a significant amount of switching out of oil and into gas would be expected

Long dated crude oil prices have nearly doubled over the past 12 months, but long dated gas prices have not kept up

The emerging LNG market which is poised to increase substantially on both sides of the Atlantic will likely lead to an LNG spot market and …

Environmental reforms will increase pressure to take advantage of the disconnect in oil and gas prices as high pollution industries such as the power generation sector seek cleaner burning fuels

Any further divergence in oil and gas prices will accelerate the pace of demand adjustment

Overlap in the End Use of Oil and Gas

Growth of Global LNG Fleet

0% 20% 40% 60% 80% 100%

Rail TransportationInternal Navigation

Domestic Air TransportInternational Civil Aviation

Road TransportationAgriculture Sector

Non-specified Transport Construction

Feedstock In Petchem. Ind.Mining and Quarrying SectorChemical and Petrochemical

Non-specified Other UsesWood and Products IndustryTextile and Leather Industry

Non-specified IndustryNon-Metallic Minerals

Commercial/Public ServiceFood and Tobacco Industry

Residential SectorTransport Equipment

Paper, Pulp and Printing Ind.Machinery Industry

Non-Ferrous Metals IndustryIron and Steel Industry

Pipeline Transport

Gas Oil

92 99 104 109 115127 128

138153

176

201

237

276 286

1996 1998 2000 2002 2004 2006E 2008E

Number of LNG ships

Fuel Substitution: Relative Value in Natural Gas vs. Crude OilOil Market Outlook

2. Securing Oil Revenues

Cost and Access to Capital Markets Highly Correlated to Oil Prices…

Oil Price and Borrowing Cost

7

$10

$20

$30

$40

$50

$60

1996 1998 2000 2002 2004

0

1000

2000

3000

4000

5000

6000

7000

Brent Crude

Mexico Credit Spread

Russia Credit Spread

Credit Spread of Russia and Borrower (bps) vs Oil Price (Brent $/bbL)

0

250

500

750

1000

1250

1500

1750

$10 $20 $30 $40 $50 $60

$/bbl

bps Credit Spread of Borrower (bps) vs Oil Price (Brent $/bbL)

Source: Merrill Lynch

Securing Oil Revenues

Credit Spreads vs. Oil Price

Over the past 7 years, oil producing countries have faced both historically low and historically high oil price environments

The volatility creates challenges to policy makers and jeopardizes sustainable and stable economic growth

Currently oil producing countries are enjoying low credit spreads resulting from high oil prices, and this translates into cheap and ample access to Capital Markets

However, 7 years ago these same countries were facing capital outflows, limited access to capital markets, and high borrowing costs (wide credit spreads) mostly as a result of historically low oil prices…

Oil Price Swap

(optional)

8

Oil Linked Financing

Description

Client issue Oil Linked Notes (OLNs) and receive Issuance Proceeds from Investors

Investors may choose to keep indexation to oil price or swap out price exposure with Merrill Lynch

Investors may require security over the Producing Assets against the possibility of default by Client

Client continue to sell oil in the market as usual:

Merrill Lynch may act as an offtaker for the transaction in order to improve credit quality of offtakers and potentially transaction rating

Client make debt service payments to Investors fluctuate in conjunction with movements in oil prices:

Lower debt service when oil price is low

Higher debt service when oil price is high

– Greater ability to meet payments

1

2

3

4

5

Flows At Issuance

Client

OLNs

($)Issuance Proceeds

Security (optional)

Producing Assets

100%

Ownership

InvestorsMerrill Lynch

1

2 3

($) Payment for

Oil

Oil

Ongoing Transaction Flows

ClientProducing

Assets

($)Oil Linked Payments

ML/Customers

Investors

4

5

4

Oil


Coupon Linked to Oil Price

Coupon Linked to Oil Price

Illustration of Credit Spread vs. Oil Price

Indicative Terms and Conditions / Sample

Issuer: Client

Principal Amount: USD 300,000,000

Effective Date: March 2006

Maturity Date: X years after Effective Date

Interest Rate: 12M USD LIBOR - 50bppa + Oil Spread

Oil Spread 95bp p.a. × Max [Oil Price – USD 65/ bbl, 0]

capped above USD 70/bbl at 425bppa

Volume equivalent: 2,885,000 bbls per annual Coupon Period

Oil Price: Annual average of PLATTS mid prices for Dated Brent crude oil

* Assumes Client standard funding at 100 bppa

9

Oil P

rice ($/bbl)

Client issue USD bullet bond with 5-year maturity for which credit spread is indexed to oil price

Oil price indexation results in credit spread subsidy in low oil price environment

Investor will receive enhanced coupon payment in high oil price environment but this will be capped allowing Client to participate above this level

-1.0%

0.0%

1.0%

2.0%

3.0%

4.0%

5.0%

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77

Oil ($/bbl)

Coupon (%

)

$50

$55

$60

$65

$70

$75

$80

Oil Linked Spread Standard Funding Spread Oil Price


Client issues USD amortising bond with 5-year maturity for which amortisation payments are indexed to oil price

Credit spread over LIBOR will be reduced due to inherent credit mitigation of oil price risk

Amortisation payments will be reduced in low crude price environment

Principal Linked to Oil Price

Principal Linked to Oil Price

Illustration of Amortisation vs. Oil Price

Indicative Terms and Conditions / Sample

Issuer: Client

Principal Amount: USD 300,000,000

Effective Date: March 2006

Maturity Date: 5 years after Effective Date

Interest Rate: 3M USD LIBOR + 75 bppa

Tranches: XXX quarterly linear amortisation payments

Amortisation Payment: Standard Amortisation + Oil Amortisation

Standard Amortisation: USD 15,000,000

Oil Amortisation: Volume x { Max [Oil Price - $78/bbl, 0] - Max [Oil Price - $100/bbl, 0] - Max [$55/bbl – Oil Price, 0] + Max [$40/bbl – Oil Price, 0] }

Volume: 100,000 bbl per quarterly Coupon Period

Oil Price: Quarterly average of PLATTS mid prices for Dated Brent crude oil

* Assumes Client standard funding at 100 bppa

10

Oil P

rice ($/bbl)

$12

$13

$14

$15

$16

$17

25 30 36 41 46 51 57 62 67 72 78 83 88

Oil ($/bbl)

Am

ort

isati

on

Paym

en

t ($

MM

)

25

35

45

55

65

75

85

95

Oil Amortisation Payments Standard Payment Oil Price


11

Protection Range and Opportunity Cost versus historical and forward

The strategy offers effective protection from falling oil price, limited to the difference between the Put Strikes

The opportunity cost of the strategy is limited to the Call Spread

____________________Source: BloombergProtection and Risk Range refer to an Asian Single Settlement Four-Way Strategy maturing 31st December 2009

Lower Amortisation Payment

Higher Amortisation Payment Call Spread

Put Spread

0

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100

1995 1996 1997 1998 1999 2000 2001 2002 2003 2004 2005 2006 2007 2008

$/bbl


Solving the Problem of Revenue Stability…

Stabilising Revenues

12

Traditional hedging by buying puts or selling forward can be a delicate decision if the market goes against the hedge

In retrospect, any put premium lost will often be seen as money wasted… putting the decision makers at “political risk”

AAA oil bonds achieve the same objectives as the puts, without incurring any political risk


Fiscal Policy and Stabilization Funds can be complementation do NOT solve the problem entirely

Risk Management via Oil Price Insurance (Put Option) is the most conservative

Protect against lower prices

Retain upside to higher prices

Risk Management via Oil Forward Sales does not benefit from upside

Risk management via Over-The-Counter (OTC) derivatives, such as buying put options, selling forwards, or selling call options, may not be an efficient nor suitable approach for governments

AAA oil bonds provide AAA insurance, better suited for governments

AAA Oil Bonds are highly conservative investments, that simultaneously combine the benefits of stabilization mechanisms and hedging of oil price risk

Current historically high oil forward prices provide a short term OPPORTUNITY to oil producing countries… but also a long term THREAT on how to manage falling revenues if oil price drops

The bullish outlook in the immediate-near term, should not blind policy makers of the opportunities and threats arising from current long-term prices

AAA Oil Bonds provide significant improvements versus traditional Over the Counter Derivatives or Money Markets

Investing in Oil Indexed Notes

13

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$/b

bl

Spot shift in response to Supercycle

Forward shift in response to Supercycle

Current Mark et

ML Expectation

Historical

0%

20%

40%

60%

80%

100%

120%

10 30 50 70 90

Oil Bond Coupon (% p.a.)

Fixed Income Coupon (% p.a.)

$/bbl

3 year Oil Bond vs Fixed Income

Current Crude oil Price

AAA Oil Bonds Optimise Revenue Management


Favourable Market – High Oil Forwards

AAA Oil Bonds

Indicative Termsheet

14

The PV of the interest available is around 13% of the notional, which given current put options prices allows to purchase 11 million barrels of $40/bbl puts spread over the next 3 years

The AAA bond will return 100% at maturity, and protects $440 Million of oil revenues over the next 5 years

Issuer: African Development Bank (AAA/Aaa)

Issue Size: [USD 1 Bio]

Maturity Date: [3 years] from Issue Date

Issue Price: 100% in USD

Redemption: 100% in USD

Coupon: An amount in USD, payable ANNUALLY, equal to the maximum of zero or the difference between the Floor Level and the Final Price, per the Oil Volume Protected

Max [ 0 , Oil Floor – Oil Final ] x Oil Volume Protected

Oil Floor: [40 USD/bbl]

Oil Final : Daily average of IPE Brent over year prior to each Settlement Date

Oil Volume Protected: [3.65] million bbl per annum (total 11 million bbl over 3 years)

Fees: None

Dealer/Underwriter: Merrill Lynch InternationalListing: UnlistedProgram: Global Debt Issuance FacilityFormat: Permanent Global Note

3 Year AAA Oil Bond, 40 $/bbl Floor, 100% Principal Protected

Basis: IPE Brent: 62.96 $/bbl, assuming 3 Year AAA Oil Bond, strike 35 $/bbl, 100% Principal Protection


15

Three-Way Zero Cost Strategy - Oil Derivatives

Benefits & ConsiderationsDescription

Graphical Illustration

The Three-Way Zero Cost strategy enables Producer to achieve price protection on crude oil while partially participating in rising oil prices. Producer can finance the purchase of a Put Option by selling a Call Spread. The structure limits the opportunity cost of the hedge to the difference between the Higher and Lower Call Strike

At maturity, assuming cash settlement:

If the oil price is less than the Put Strike, then Producer receives the difference between the Put Strike Price and the prevailing oil price

If the oil price is higher than the Put Strike and less than the Lower Call Strike, neither party makes a payment

If the oil price is greater than the Lower Call Strike and less than the Higher Call Strike, then Producer pays the difference between the prevailing oil price and the Lower Call Strike

If the oil price is greater than the Higher Call Strike, then Producer pays the difference between the Higher Call Strike and the Lower Call Strike

The Three-Way Strategy can be implemented in Asian and Quanto forms

Producer receives compensation when the oil price drops below the Put Strike

Producer’s payment occurs only if the oil price is above the Lower Call Strike and is limited to the difference between the Higher and Lower Call Strikes

Structure is zero premium

Producer has the flexibility of customising maturity, Put Strike and Call Strikes, as well as the notional

DownsideProtection

HigherCall Strike

LowerCall Strike

Put Strike

Realised Price

Oil Price

Forgone Appreciation


16

Three-Way Zero Cost Strategy – Potential Exposure

The Three-Way strategy offers effective protection from large market shocks

The risk is limited to the range of the Call Spread and is at much higher levels than both long-term oil prices and current analyst predictions

____________________Source: BloombergProtection and Risk Range refer to an Asian Single Settlement Three-Way Strategy maturing 31st December 2009

Call Spread

0

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30

40

50

60

70

80

90

100

1995 1996 1997 1998 1999 2000 2001 2002 2003 2004 2005 2006 2007 2008

$/bbl

Protection Range

Opportunity Cost

Put Strike


17

Indicative Prices

Fixed Price Swap on IPE Brent

Three-Way Zero Cost Strategy on IPE Brent

Swap Contract Period

Jan-07 to Dec-07 Jan-08 to Dec-08 Jan-09 to Dec-09 Jan-10 to Dec-10 Jan-11 to Dec-11 Jan-12 to Dec-12

Fixed Price $/Bbl 67.12 66.21 65.21 64.24 63.36 62.63

Period

Underlying Swap

Price $/Bbl Put Strike $/Bbl Lower Call Strike

$/Bbl

Upper Call Strike

$/Bbl

Jan-07 to Dec-12 65.35 55.00 65.00 84.18


3. Securing Revenues from Energy Distribution

Description Financial Hedge

The Power Plant is exposed to the risk of higher Fuel/Coal Market Prices as revenues from electricity sales are regulated

Increasing regulated electricity Tariff is a highly political decision

purchasing cost is directly driven by market price which have proved to be very volatile

Regulated electricity Tariff in most countries aim providing price stability to final consumers

Ideally, the Power Plant would like to stabilise its Fuel/Coal purchasing cost in line with the the regulated electricity Tariff

Merrill Lynch proposal is to secure cost of Fuel/Coal supply at a Fixed Price level through a financial swap or a fixed price physical delivery

Fixed Price Physical Delivery

Physical Transfer

Financial Transfer

Fuel/Coal Fired Power Plant with a Regulated Electricity Tariff

18

Basis Risk

Fuel Oil Supplier

Power Plant

Retail Market

Merrill Lynch

Floating Market Price

Floating Market Price Fixed Price

Regulated Tariff

Electricity Delivery

Physical Fuel Oil Delivery

Physical Transfer

Financial Transfer

Basis Risk

Power Plant

Retail Market

Merrill Lynch

Fixed Price Regulated Tariff

Electricity Delivery

Physical Coal Delivery

Securing Revenues from Energy Distribution

19

Structuring the HedgeBenefit and Considerations

Risk of a margin squeeze

By entering the proposed hedging strategy, the Power Plant can secure is purchasing cost over the future.

It helps to mitigate the risk of margin squeeze when purchasing costs increase more than the regulated Tariff

The Power Plant gives up potential benefit from lower purchasing cost

The basis risk between hedged purchasing costs and revenues from regulated tariff is low as long as price stability drives regulated electricity Tariff

When financing project or restructuring existing financing, Development Banks will value the hedging strategy as

– It provides improved visibility on future cash flows generated by the power plant

– it helps stabilising retail electricity prices avoiding political tension from Tariff increase

Following solutions facilitate the hedging execution

Guarantee from the State or from a Devlopment Bank

Pari-Passu with the financing banks

Collateral under the form of a partial pre-payment of future purchasing cost

Paying premium for an insurance against higher purchasing costs rather than fixing it

Fuel/Coal Fired Power Plant with a Regulated Electricity Tariff

0

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jan

v.-

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jan

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jan

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US

D/b

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IPE Brent

Regulated Tarif f

Securing Revenues from Energy Distribution

20

Disclaimer

Merrill Lynch prohibits (a) employees from, directly or indirectly, offering a favorable research rating or specific price target, or offering to change such rating or price target, as consideration or inducement for the receipt of business or for compensation, and (b) Research Analysts from being compensated for involvement in investment banking transactions except to the extent that such participation is intended to benefit investor clients.

This proposal is confidential, for your private use only, and may not be shared with others (other than your advisors) without Merrill Lynch's written permission, except that you (and each of your employees, representatives or other agents) may disclose to any and all persons, without limitation of any kind, the tax treatment and tax structure of the proposal and all materials of any kind (including opinions or other tax analyses) that are provided to you relating to such tax treatment and tax structure. For purposes of the preceding sentence, tax refers to U.S. federal and state tax. This proposal is for discussion purposes only. Merrill Lynch is not an expert on, and does not render opinions regarding, legal, accounting, regulatory or tax matters. You should consult with your advisors concerning these matters before undertaking the proposed transaction.

This information is for your private information and is for discussion purposes only. A variety of market factors and assumptions may affect this analysis, and this analysis does not reflect all possible loss scenarios. There is no certainty that the parameters and assumptions used in this analysis can be duplicated with actual trades. Any historical exchange rates, interest rates or other reference rates or prices which appear above are not necessarily indicative of future exchange rates, interest rates, or other reference rates or prices. Although the information is obtained from sources we consider reliable, we do not represent that it is accurate or complete.

We are acting solely in the capacity of an arm’s length counterparty and not in the capacity of your financial advisor or fiduciary.

Generally, all over-the-counter ("OTC") derivative transactions involve the risk of adverse or unanticipated market developments, risk of illiquidity and other risks. Unless specifically stated otherwise, any prices mentioned here are not bids or offers of Merrill Lynch to purchase or sell any securities or other financial instruments. We or persons involved in the preparation of issuance of this material, may from time to time have long or short positions in, and buy or sell, securities, futures, or options related to those mentioned herein.

Prior to undertaking any trade, you should consult with your own auditors and your professional tax advisers how such particular trade(s) affect you. Merrill Lynch accepts no liability for clients’ legal, regulatory, credit, tax and accounting aspects in relation to the proposed strategies. While Merrill Lynch may provide illustrations of trading strategies, this is on the understanding that Merrill Lynch is not giving any legal, regulatory, credit, tax or accounting advice to clients and no assurance or undertaking is given that the illustrated benefits can be achieved.

Merrill Lynch’s ability to execute the transactions described herein will be subject to approval of Merrill Lynch credit, risk and legal departments, respectively, and any associated due diligence undertaken by these groups.

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