LNG Markets & Price Volatility

LNG Markets & Price Volatility

LNG Markets and Price Volatility • Price determination in gas markets • The portfolio approach • Management of price risks • Concluding remarks

Price determination • LNG markets are not isolated : LNG prices depend ultimately on regional gas markets • Long-term gas price drivers : • marginal cost of supplying markets • pattern of demand growth : generation, domestic, GDP • government policies : conservation, supply security... • Short-term gas price drivers : • day-to-day uncertainty on local supply/demand balance: gas production & transportation, weather, power generation… • availability of “tools” : storage, flexibility, fuel switching,... • positioning of each market participant

long-term trends seasonal short-term (days) 7.00 4,50 10 6.80 9 4,00 6.60 8 6.40 3,50 $/mmbtu 7 6.20 6 6.00 3,00 5 5.80 4 2,50 3 5.60 2 5.40 2,00 Henry Hub – 5 yrs 1 Henry Hub – 1 yr Prompt Month Nymex 5.20 0 1,50 5.00 déc-01 avr-02 août-02 déc-02 avr-99 avr-00 avr-01 avr-02 02/03/03 02/08/03 02/13/03 02/18/03 02/23/03 • gas supply options • economic growth • political / environment • weather / temperature • local market balance Price determination over time (US market) • weather / temperature • competing fuels / markets • storage / interconnections • industry confidence

Price formation in UK gas market • The National Transmission System (NTS) and the National Balancing Point (NBP) • any licensed shipper can buy and sell gas in the high pressure network (NTS) under the Network Code • within the NTS, natural gas is exchanged at a virtual trading hub (NBP) • capacity must be booked or purchased through auctions to enter into and exit from the NBP • NBP price is the immediately negotiable value for a given delivery period (day-, week-, month-ahead…) • Most UK gas is traded at fixed price at the NBP

Terminals Compressors • Supply: • Production fields • NBP purchases • Storage (off take) • Interconnector • Future LNG imports Regulators St. Fergus • Demand: • VLDMC (Very Large Daily Metered Customers) • DM (Daily Metered sites) • NDM (Non-daily metered sites) • NBP sales • Storage (injection) • Interconnector LNG Terminal Projects 6300 km Pipelines Local Distribution Zones Exit Points Capacity Booking Rough Teesside Entry Points Capacity Auctions Burton Point Barrow Easington LDZ Theddlethorpe NBP National Balancing Point LDZ Bacton Customers LDZ Milford Heaven Isle of Grain LDZ Capacity Trading Gas Trading Capacity Trading UK National Transmission System (NTS) and National Balancing Point (NBP)

Front Gas Year: GY2002-GY2004 SHORT DERIVATIVES, SHORT INCREASED DEMAND, DERIVS, 40- COLDEST OCT SINCE 92, INTERCONNECTOR 50P/th 26.00 OFFSHORE RELIABILITY IMPACT UNRELIABILITY prompt, inc. OF 9-11 & CONFUSION OIL PX WAR & 25.00 ENRON OIL COLLAPSES 24.00 TXU DEBACLE 23.00 22.00 21.00 20.00 POST 9-11 19.00 GLOBAL ENERGY SLUMP 18.00 17.00 2001 2002 2003 Recent price developments in the UK • Spot UK gas prices remain high and above 2001 highs • Gas Year 2004 is assessed at ~ 24.6 p/th (12.5 €/MWH ~ 4.5 $/MMBTU) • How do spot gas prices compare with long term contract prices ?

Price formation in Continental Europe • Over 90% of continental demand is imported from Russia, Algeria and Norway • long-term natural gas compete with LNG imports • crude oil and oil products indexation interact with spot gas • emergence of continental spot trading hubs (Zeebrugge) • Dynamic linkage UK / Europe (Interconnector) • Growing distortion between • long-term horizon of supplies, and • short-term horizon of demand : most customers make competitive supply tenders every year • Market players must constantly balance portfolio

5.00 4.50 GY03 4.00 3.50 CAL04 3.00 3 p/th ~ 1.5 €/MWh 0.5 $/MMBTU 2.50 2.00 GY04 P/TH 1.50 1.00 0.50 CAL05 0.00 -0.50 -1.00 -1.50 Jul-03 Oct-03 Nov-03 Jun-03 Sep-03 May-03 Aug-03 -2.00 How do spot prices compare with LT contract prices ? • Continental European gas prices remain oil driven • Spot prices are influenced by short term supply/demand distortions (UK switch to import) • Contrary to recent history today’s spot prices (NBP or ZHUB) are above Long Term oil indexed contract prices • LNG supply contracts must compete in this market

The global market • LNG is the only physical link between world gas markets • LNG participates in the global equilibrium of gas prices • direct influence is however difficult to demonstrate • conversely flows of LNG are directly influenced by variations in regional gas prices, leading to arbitrage opportunities • Aspiring leading market players will need to • balance the right mix of gas and LNG supplies • secure access to logistics assets (regas terminals, pipes, ships) • access end-user markets • be active in most gas and LNG markets • develop sophisticated risk management expertise (hedging)

Integrated Oil Companies as LNG buyers • IOCs have been traditional players in upstream markets and LNG liquefaction • IOCs are becoming purchasers of LNG • leverage their gas reserves and allow for faster launch of upstream project by securing outlets • IOCs are developing a strong marketing base, with direct access to end-user markets • credit worthiness • expertise in technical, commercial and financial matters, as well as risk management (Oil, Gas, Power, FOREX)

Why developing a portfolio ? • In today’s complex environment, back-to-back deals will become exceptional • Market players hold a set of purchase and sale commitments that cannot fully match • Portfolio • manage sum of purchase and sale commitments, and adjust base load and swing supplies to demand • manage time horizon discrepancies • aggregate risks using a unique “rule book” • take advantage of correlations between price formulas • minimize cost of commercial operations and logistics

Production UK Marketing UK Trading Production Norway Marketing FRANCE Marketing SPAIN LNG & Gas contracts Spot accrual accounting FAS 133 compliance mark to market accounting accrual accounting • LT absolute price risk • production performance issues • short to medium term price risk • transportation & capacity risk • supply / demand adequation • oil vs. natural gas • FOREX exposure • market share • commercial margin • credit worthiness issues • balancing risk How TOTAL portfolio aggregates flows & risks in Europe • LNG is a long term business (15 yrs +) • Trading is perceived as a short term activity (1 day +) • Retail & Marketing are medium term businesses (1 yr +) • Portfolio management conciliates these different time horizons

TOTAL European Gas Marketing Assets Leading supplier to I&C market UK 6.7 BCM 20% I&C As of 2004, TOTAL end-user European demand amounts to 17 BCM/y NWE 1 BCM Cross-border pipeline project FRANCE 8 BCM 17% market share SPAIN 1.3 BCM 6% market share 1/3 Equity in FOS 2 terminal 4th marketer in Spain

Norway LNG supply UK Gas supply Norway Gas supply Netherlands Gas supply UK Gas marketing France & NWE Gas marketing France Gas supply US Gas marketing Spain Gas marketing LNG arbitrage US Gas supply Algeria LNG supply Mid East LNG supply Algeria Gas supply Mexico Gas marketing Nigeria LNG supply The Gas & LNG portfolio of TOTAL in the Atlantic basin The building blocks of a worldwide portfolio are progressively put in place

The best hedge ? The right formula ! • A right price formula initially • LNG price formula must be representative of the fair value of gas in the target market • versus alternative competing supplies (gas or LNG) • A right price formula during contract’s life • long term take-or-pay and price reviews are linked • price review mechanism is of utmost importance to guarantee that the contract will remain balanced • LNG price formula must remain representative of gas prices

The representation of risks • Mark-to-market • flows & risks are recorded when commitment is taken • exposure can then be evaluated and categorized against set of references, driven by market standards • contracts are said to be “marked to the market” • examples of such references: Henry Hub in the US, NBP in the UK, oil-indexed prices in Continental Europe • At portfolio level, mark-to-market exposure of all contracts, LNG as well as pipeline gas, can be aggregated • identification of overall risk • implementation of appropriate hedging strategy

Risk management in LNG markets • Risk management over long-term horizon • the “right” formula • price review mechanism • Risk management over mid-term horizon • adequation between expected import flow and market • market risks are evaluated when the annual delivery programme is known • buyer can decide to take hedging and corrective action for exchange rates, oil vs. gas, crude vs. products • Risk-management over short-term horizon • day-to-day adjustment to schedules and actual physical flows

LNG vs. LT Natural Gas high crack 1 BCM/y ~ 15,000 bl/d refining margin risk + (LNG < LT gas) market CRACK high crack - (LNG > LT gas) low crack low crack 15 20 25 30 35 40 BRENT ($/bl) $/MMBTU Pipe gas in North Zone $/MMBTU (high crack spread) LNG delivered in North Zone $/MMBTU Pipe gas in North Zone $/MMBTU (base case) Pipe gas in North Zone $/MMBTU (low crack spread) Brent $/bbl LNG competition (LNG vs. LT gas - FRANCE Zone North)

Concluding remarks • LNG markets have achieved a maturity comparable to gas markets in North West Europe and North America • For IOCs acting as buyers, LNG purchases are now an integral part of their global gas portfolio supplying their marketing affiliates • Mastering the technicalities of markets is a key part of the commercial expertise required to be a successful player in LNG markets

LNG Markets & Price Volatility