japan courts mauritania for its oil, page-21

re: announcement mauritania - 618 hedging Hi DF,

I'm not sure you are correct with your comment on capacity of HDR to hedge.

Probably not ;)

My view is that some hedging could be done now based on analogue oil quality with cash settlement of position if production does not start on time. What I mean is that if they want to hedge, the only risk is they need to produce or remain exposed to price movements in a cash sense without oil/cash flow to support movements in price.

My understanding is that hedging is always done based upon standard products...to the extent there is basis risk in delivering a very slightly different product to the market it doesn't matter because the financial contract is not settled with physical delivery. The hedging party just settles in cash base on price movement since the contract was entered.

As Rager pointed out, that's not entirely true. My belief is based on several detailed discussions with Hardman as well as others in the industry. If it is a new oil field coming online in an established province like Angola or Nigeria, then they probably would have hedged by now. However, Chinguetti is a new oil field in a new province, hence the quality of oil and stability of production rate remains unknown - that is until after a period of production. Once the quality as well as quantity of produced oil is established, then the buyers will be more willing to pay a price closer to the spot price. Until then, they tend to offer a price that is significantly discounted to the spot price as a protection against quality (eg. high sulphur content heavy crude) and quantity.

There is nothing stopping Hardman from hedging now. However, two issues....Firstly, are you really willing to sell your oil at a significant discount when the general consensus is the POO will stay up in the 60s for 2006? Or you can wait a couple of months and get more for them? Secondly, if there is a production hiccup and POO goes through the roof (assuming they did hedge at a significant discount to the appropriate forward sale price - depending on which monthly delivery contract they sell into), they could end up losing a lot of money - even insolvency (think Sons Of Gwalia!!). Having the assets is one thing, managing it and cashflow is another.

In any case, Hardman has stated their intention NOT to put a ceiling on their exposure to upside in the POO, but will be looking to provide downside protection to provide a floor price for our oil. That way, we have the certainty (and I love certainties) of knowing that Chinguetti will be worth x dollars to us at the bare minimum, with the potential of earning x extra dollars if POO stays above that price.

Good stratrgy IMHO. Floor protection will enable them to plan forward their growth strategies (capex & growth commitment, etc) by allowing them to manage/budget their cashflow over the next however many years.

HTH...

618

PS. So where is this qtr report?? :)