Volumetric Production Payments An Effective Monetization Strategy

1. Volumetric Production PaymentsAn Effective Monetization Strategy IPAA Private Capital Conference 19 January 2006 Presented by:Paul RiddleManaging DirectorEnergy & Power Corporate FinanceWachovia Securities

2. Volumetric Production Payments – An Effective Monetization Strategy Topics for Discussion • What is a volumetric production payment (VPP) • How is the VPP upfront payment determined • VPP risk and responsibility allocation between purchaser and seller • Accounting and tax treatment • Rating agency views • Reasons to sell a VPP • Pioneer Natural Resources case study | Wachovia Securities

3. Volumetric Production Payments – An Effective Monetization Strategy What is a Volumetric Production Payment? • A Volumetric Production Payment or VPP is a limited term overriding royalty interest in oil and gas reserves. • A VPP is free and clear of all operating costs, capital expenditures and taxes • The VPP entitles the purchaser to receive scheduled production volumes from specific lease interests. • The VPP guarantees the purchaser a first priority on production from these specified lease interests. • The VPP is recourse only to these specified lease interests and not to the seller’s other assets • The Bankruptcy Code provides special protection to VPPs in the event of a seller’s bankruptcy. • The VPP is recognized as a separate property interest (not part of the seller’s bankruptcy estate). | Wachovia Securities

4. Volumetric Production Payments – An Effective Monetization Strategy Sample VPP PDP Cushion Volume serves to provide reliability of production volumes. Size of cushion is based on the production profile’s predictability. Reserve Tail reserves remaining at the end of the VPP term (will be owned by the VPP seller along with PDNP, PUD and all other upside potential). PDP Operating Cost Volume producer retains enough volumes to cover all operating costs, basis volatility and taxes. PDP VPP Volume volume purchased under the VPP. | Wachovia Securities

5. Volumetric Production Payments – An Effective Monetization Strategy How is the VPP Upfront Payment Determined? • Upfront Payment = Discounted present value of projected VPP cash flow • VPP Cash Flow = (VPP volumes) x (Projected realized sales price based on NYMEX forward curve less a hedgable basis) • Discount Rate = Weighted average of the forward LIBOR curve hedged over the term of the VPP plus a credit spread | Wachovia Securities

6. Volumetric Production Payments – An Effective Monetization Strategy How is the VPP Upfront Payment Determined? (Continued) | Wachovia Securities

7. Volumetric Production Payments – An Effective Monetization Strategy VPP Risk / Responsibility Allocation VPP Seller VPP Buyer Operations Pays Operating Costs and Taxes Subject Reserves Encumbered Until VPP Volumes Are Produced Reserve Risk Production Risk Price Risk Offtake Risk Hedge Exposure Interest Rate Exposure | Wachovia Securities

8. Volumetric Production Payments – An Effective Monetization Strategy GAAP Accounting Treatment • VPP Reserves • Removed from annual disclosure of proved reserves • Removed from “Standardized Measure of Discounted Future Net Cash Flows” • VPP transaction would be recorded as a sale of reserves in the analysis of reserve changes • VPP Production • Not included in the Company’s reported production volumes in the analysis of reserve changes • Can disclose production subject to a VPP in operating data, but the data would need to be footnoted to identify volumes subject to a VPP • Disclosure of VPP production would allow investors to calculate the Company’s true economics on a per unit of production basis | Wachovia Securities

9. Volumetric Production Payments – An Effective Monetization Strategy GAAP Accounting Treatment (Continued) • Balance Sheet • Credit “Deferred Revenue” which is a long-term liability • Income Statement • Company recognizes VPP production revenue as VPP production occurs. VPP production revenue is categorized as “Oil and Gas Sales Revenue.” • Value of VPP production revenue is determined by the average of the cash advanced per unit of production (provides a stable, predictable hedged revenue stream) • Company continues to recognize appropriate “Operating Expenses” and “Depletion” for VPP reserves | Wachovia Securities

10. Volumetric Production Payments – An Effective Monetization Strategy GAAP Accounting Treatment (Continued) • Cash Flow Statement • The initial proceeds received upon the sale of a VPP are generally reflected as “Cash Flow from Investing Activities” in the cash flow statement • As the reserves are produced and delivered under the VPP, “Cash Flow from Operations” is reduced in the cash flow statement • The reduction in “Deferred Revenue” is noted in the non-cash adjustments | Wachovia Securities

11. Volumetric Production Payments – An Effective Monetization Strategy Other Accounting Issues • FAS 133 Impact • The Company does not mark-to-market gains or losses on hedge contracts associated with the VPP • FIN 46 Impact (related to Special Purpose Entity) • The VPP purchaser consolidates the entity for accounting purposes • The entity purchasing the VPP must have multiple assets | Wachovia Securities

12. Volumetric Production Payments – An Effective Monetization Strategy Tax Treatment • The Internal Revenue Code treats a VPP as debt for federal income tax purposes (as if it were a mortgage loan on the property) • Federal Income Tax over the life of the transaction remains the same independent of commodity prices • Tax treatment of expenses (including DD&A) is unchanged • State taxes are typically due when production occurs • If VPP reserves have no upside potential and only a nominal tail, then transaction could be treated as a sale for tax purposes | Wachovia Securities

13. Volumetric Production Payments – An Effective Monetization Strategy Rating Agencies • Rating agencies generally treat VPPs as debt, but recognize the following benefits: • Locks-in current attractive production economics to ensure repayment • Self liquidates • Cannot be accelerated based on the seller’s financial condition • Only recourse to underlying property and not to the Company • When determining a VPPs impact on ratings, agencies are concerned about the shifting of risk and whether the use of funds is debt holder friendly: • High amount of risk shifted to the VPP purchaser? Positive • Repurchase senior or pari passu debt? Positive • Repurchase junior debt or stock or fund a dividend? Negative • Reinvest in activities that create asset value and/or add cash flow? Positive | Wachovia Securities

14. Volumetric Production Payments – An Effective Monetization Strategy Requirements to Sell a VPP • Must own domestic reserves – VPP treatment as separate property is based on U.S. law • PDP must have predictable production profile – provides confidence in scheduling VPP production • Reduces cushion requirements • Reduces production risk = reduces cost • Ability to hedge or otherwise lock-in components of basis • Must have use of funds… • Acquisitions and other investment opportunities • Refinance higher cost capital (retire debt or share repurchase) | Wachovia Securities

15. Volumetric Production Payments – An Effective Monetization Strategy Reasons to Sell a VPP – Summary • Efficient way to hedge large quantities of production for long durations • Selling a VPP locks-in current attractive production economics on “top line” of income statement • The sale of a VPP can change the production profile of declining assets to flat (or increasing) • The sale of a VPP has advantages to selling the asset outright • Because of its flexibility, a VPP can be very competitive versus debt instruments based on advance rate and cost-of-capital • The sale of a VPP has advantages to forming an MLP or royalty trust | Wachovia Securities

16. Volumetric Production Payments – An Effective Monetization Strategy Reasons to Sell a VPP – Hedging • Efficient way to hedge large quantities of production for long durations • No potential for margin deposits (losing liquidity when prices go up) • No FAS 133 mark-to-market impact on income statement • Effectively matches hedges to production profile of assets • Removes hedge counterparty credit risk • Does not use hedge counterparty credit (VPP purchaser is hedging its own volumes) • VPP purchaser with higher credit rating is able to obtain longer, more favorable hedges • Producers can assign underwater hedges to a VPP • Up front payment is net purchase price (net of impact of assigned hedge) • Frees up margin deposits or LC requirements • Hedge losses are not recognized until volumes are produced | Wachovia Securities

17. Volumetric Production Payments – An Effective Monetization Strategy Reasons to Sell a VPP – Removes Earnings Volatility • Selling a VPP locks-in current attractive production economics on “top line” of income statement • VPP production still recognized on income statement as “Oil & Gas Sales Revenue” as volumes are produced • Each unit of production receives the average price paid per UOP over the life of the VPP • No FAS 133 impact! • No changes to “Operating Costs” or “Depletion” necessary | Wachovia Securities

18. Volumetric Production Payments – An Effective Monetization Strategy Reasons to Sell a VPP – Ability to Change Production Profile of Asset • The sale of a VPP can change the production profile of declining assets to flat (or increasing) • VPP reserves and production are removed from public Company disclosures • Asset profile becomes more attractive to public market or in a sale VPP Sold | Wachovia Securities

19. Volumetric Production Payments – An Effective Monetization Strategy Reasons to Sell a VPP – Attractive Alternative to Asset Sale • The sale of a VPP has advantages to selling the asset outright • Keep 100% of asset’s upside potential (including upside from future technologies) • Sale of a VPP is not a taxable event • Maintain operational control (no disruption for field level employees) • Size VPP to amount of desired proceeds only | Wachovia Securities

20. Volumetric Production Payments – An Effective Monetization Strategy Reasons to Sell a VPP – Attractive Alternative to Asset Sale (Continued) • Anatomy of an asset… Upside probabilistic discounting reduces purchase price for timing risk and likelihood for success Operating Cost Volume No money for this Reserve Tail heavily discounted by PV discount rate VPP Volume Not risked; Banks (VPP) are most aggressive bidders with lowest rate-of-return hurdles and ability to hedge large volumes (strong balance sheet) | Wachovia Securities

21. Volumetric Production Payments – An Effective Monetization Strategy Reasons to Sell a VPP – Flexible Source of Leverage • Because of its flexibility, a VPP can be very competitive versus debt instruments based on advance rate and cost-of-capital Structural Flexibility (General) Highest Advance Rate (Stretch Collateral) Lowest Cost-of-Capital (Increase Collateral) • Borrowings are non-recourse to seller • VPP purchaser cannot accelerate repayment based on financial condition of the VPP seller • No financial covenants • Lower up front costs • Able to raise significantly more leverage on PDP reserves on a senior secured basis than bank debt • Allows for acquisition of reserves without significant equity component (and favorable accounting treatment if VPP is in place before the acquisition) • Able to raise capital at a tighter spread-to-LIBOR than senior secured bank debt (and usually more capital as well) • Credit quality is improved due to bankruptcy remoteness from the seller’s bankruptcy estate | Wachovia Securities

22. Volumetric Production Payments – An Effective Monetization Strategy Reasons to Sell a VPP – Attractive Monetization Strategy Versus MLP/Royalty Trust • The sale of a VPP has advantages to forming an MLP or royalty trust • Does not trigger a taxable event • Does not create significant overhead/reporting responsibilities • Lower up front costs • Banks likely buy at lower discount rate than public MLP/royalty trust markets • Ease/speed/certainty of execution with one counterparty | Wachovia Securities

23. Volumetric Production Payments – An Effective Monetization Strategy Wachovia VPPs — Pioneer Natural Resources Company Close Date: January 26, 2005 WS Role: Wachovia provided or arranged all capital and derivative contracts. Product: Aggregate VPPs of $593 million • $317 million 8-year VPP on Pioneer’s Spraberry field crude oil production • $276 million 5-year VPP on Pioneer’s Hugoton field natural gas production • After analyzing strategic alternatives to unlock the value of its reserves (royalty trust, MLP, outright sale), Pioneer chose to monetize its reserves through a VPP structure. • The transactions were a coordinated effort of Wachovia’s Energy & Power Corporate Finance Group, in-house technical staff, Structured Asset Finance Group and Derivatives Group. • By monetizing reserves through the VPP structure, Pioneer was able to lock in commodity prices (with no mark-to-market exposure) and accelerate the return of cash at a low discount rate while retaining control and all upside. • The VPPs monetized approximately 2% (20.5 MMBOE) of Pioneer’s total worldwide reserves for approximately 8% of its enterprise value • The VPPs monetized Pioneer’s reserves for over $29.00 / BOE ($23.00/ BOE net of operating expenses) as compared to a market valuation of $7.16 / BOE at the time • Monetizing the reserves allowed Pioneer to complete its targeted debt reduction and stock repurchase programs. | Wachovia Securities

24. Volumetric Production Payments – An Effective Monetization Strategy Public Equity Market Reaction to the Pioneer VPPs • Pioneer’s stock price closed up 6.17% the day of the announcement (versus a gain of 0.04% for the S&P 500), representing an increase in market capitalization of approximately $325 million. PXD Stock Price at $38.52 after 1st Trading Day PXD Stock Price at $36.28 at VPP Announcement | Wachovia Securities

25. Volumetric Production Payments – An Effective Monetization Strategy Public Equity Market Reaction to the Pioneer VPPs (Continued) • Research analysts reacted positively to the VPP transactions: • Moody’s Investors Service: • “We view the VPP’s as a monetization of 20.5 MMBOE of future production, with certain contingent obligations, but at very attractive up-cycle forward five-year and seven-year prices” • “Viewed another way, they nicely hedge the comparatively higher Spraberry and Hugoton production costs underlying the VPP volumes and arbitrage the gap between spot and long-dated forward prices” • Raymond James: • “By selling reserves through these VPPs, the company is capturing the value of its long-lived assets using current robust commodity prices” • “The VPPs and buybacks (stock buyback) show Pioneer's commitment to boosting shareholder value, and we view them very favorably” • Merrill Lynch: • “Pioneer is taking advantage of high commodity prices to monetize a very stable, low risk asset” • “We think it makes sense given that Pioneer’s reserves are currently valued under $7.00/BOE” (VPP was effectively sold for $23.00/BOE) | Wachovia Securities

26. $275,500,000 Volumetric Production Payment in Hugoton Natural Gas Field ¸ Sole Arranger January 2005 $317,400,000 Volumetric Production Payment in Spraberry Oil Field ¸ Sole Arranger January 2005 $143,400,000 Investment in Volumetric Production Payment ¸ Sole Senior & Preferred Capital Provider August 2004 Irish Ocean L.P. Volumetric Production Payments – An Effective Monetization Strategy Selected Structured Transactions $548,700,000 Oil / Gas Volumetric Production Payment Securitization ¸ Sole Arranger December 2005 | Wachovia Securities

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