Credit FAQ:

What Is The Significance Of The Shale Phenomenon For Gulf Oil And Gas Producers?
Primary Credit Analysts: Karim Nassif, Dubai (971) 4-372-7152; karim.nassif@standardandpoors.com Carin Dehne-Kiley, CFA, New York (1) 212-438-1092; carin.dehne-kiley@standardandpoors.com Secondary Contacts: Oliver Kroemker, Frankfurt (49) 69-33-999-160; oliver.kroemker@standardandpoors.com Tommy J Trask, Dubai (971) 4-372-7151; tommy.trask@standardandpoors.com Cynthia M Werneth, CFA, New York (1) 212-438-7819; cindy.werneth@standardandpoors.com

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Frequently Asked Questions Related Criteria And Research

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Credit FAQ:

What Is The Significance Of The Shale Phenomenon For Gulf Oil And Gas Producers?
The extraction of shale oil and gas reserves in North America is proving a significant game-changer for global energy markets. As production levels have surged, the prices of North American natural gas and natural gas liquids (NGLs) have collapsed and U.S. natural gas and oil imports have fallen. What's more, liquefied natural gas (LNG) and petrochemicals exports to U.S. markets from major commodity producers such as the Gulf Cooperation Council (GCC) countries have started to decline. The Middle East Economic Digest (MEED) reports that the U.S. is set to cut its petrochemicals imports by 50% over the coming years. Notwithstanding the impact of shale oil production in North America on the level of light oil imports, Standard & Poor's Ratings Services considers there to be limited effect on rated GCC-based oil producers in the near term. This, in part, reflects the producers' ability to redirect their oil exports, as well as the fact that many of them export heavier crudes that are not currently being displaced by shale volumes. Most U.S. shale oil production is light, sweet oil, meaning it has low density and low sulphur, and is easier to refine. Consequently, the immediate effects of U.S. shale production, in our view, center on GCC-based natural gas producers. GCC member states--including Saudi Arabia, Kuwait, Qatar, and the United Arab Emirates--have begun to reposition their hydrocarbon strategies in response to the shale phenomenon. For example, market estimates put Saudi Arabian shale gas reserves at about 600 trillion cubic feet, and we understand that national oil and gas company Saudi Aramco is in talks to secure 40 extra rigs to cover shale gas operations, indicating that the company expects large-scale production over the medium term. In the medium to longer term, we believe material additional oil supplies could have implications for all oil and gas producers, although for now the cost of oil production from shale is materially higher than for conventional oil. In this FAQ, we address some of the likely questions from investors regarding the significance of the shale phenomenon for GCC countries and our rated issuers, and how the region is facing the competition posed by shale oil and gas. Our focus is on near-term trends, particularly in gas markets.

Frequently Asked Questions

How could the shale boom affect the creditworthiness of GCC oil and gas companies over the short, medium, and long term, in Standard & Poor's opinion?
One of the important effects of the shale boom is the potential decoupling of gas contracts away from being oil index-based to gas index-based. We see the effect of this shift on our ratings on GCC oil and gas companies as minimal in the short term. Over the medium to long term, the rating impact would depend on gas prices rather than whether or not they were linked to oil (see "Do Recent Rulings Herald The Divorce Of Oil And Natural Gas Prices, And Who Will Benefit?," published Feb. 4, 2013). We consider Gulf downstream companies to have sufficient diversification away from European and North American

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markets and strong competitive positions to maintain their credit profiles despite the shale gas boom in North America. Nevertheless, we will closely monitor the degree of exposure of these companies to Europe (due to its weakening competitive position as a result of the shale boom) and to the U.S., and to competition from alternative export products supplied from the U.S. over the medium to long term. We will also track how the potential global oversupply of certain petrochemical products affects GCC-based downstream businesses over the same time horizon. The shale boom could impact the oil price in a medium- to long-term scenario where shale oil supplies increase substantially from the U.S., and potentially other countries, and where sufficient infrastructure is put in place to render shale oil exports competitive with GCC oil exports. That said, U.S. law currently prohibits the export of crude oil, although exports of refined products are allowed. We consider that in an extreme scenario, GCC hydrocarbon-exporting sovereigns could withstand a 15%-20% fall in global oil prices due to the significant production of shale oil. Indeed, oil prices would have to drop to below $80 per barrel (Brent) before the likes of Qatar and Saudi Arabia would record any financial deficits (see "How Do Middle Eastern Sovereigns' Fiscal Breakeven Oil Prices Affect Credit Ratings and Oil Prices?," published Feb. 1, 2013).

What does Standard & Poor's consider to be the most significant effects for Gulf states arising from shale oil and gas extraction in North America?
To date, we believe that U.S. shale production has had a greater impact on GCC-based natural gas producers than on oil producers. Rising shale gas production in North America has led to a sharp decline in the Henry Hub gas price to just over $3.50 per million BTU (mmBTU) at end-October, from more than $10 per mmBTU in mid-2008. This drop in price has resulted in a significant reduction in U.S. LNG imports, to less than 0.5 billion cubic feet per day (bcf/d) in 2012 from more than 2.1 bcf/d in 2007. Qatar, the most significant GCC gas exporter and the only country in the GCC region experiencing a natural gas surplus, was the first to respond to the contraction in the Henry Hub price. Although the state had projected an increasing supply of LNG exports to the U.S. via its national oil company-backed facilities, these volumes are being diverted to other markets. Indeed, Qatar has exported no LNG to the U.S. from April this year. In 2011, it was exporting 0.25 bcf/d. To date, the financial performance of downstream gas companies in the Gulf has not really been affected by North American shale gas, for several reasons: Although North American natural gas prices have declined (see chart), most international natural gas contracts are priced off crude oil. Gulf downstream company sales are well diversified. So although the shale boom in the U.S. has affected the performance of European buyers who purchase downstream end products from Gulf companies, this is a small component of the latter's downstream EBITDA. A number of downstream companies in the Gulf have established businesses in the U.S. that continue to use feedstock from the Gulf.

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That said, IHS, a chemical consulting firm, has highlighted the possibility of global oversupply of certain petrochemicals later this decade, when significant new capacity is slated to come online. This additional capacity is occurring as North American markets become more self-sufficient in natural gas and are in a position to increase their exports of petrochemicals such as ethylene and vinyl, and as European markets are increasingly priced out in terms of feedstock price relative to the U.S. According to MEED, U.S. ethylene production, which is crucial to commodity plastics production, will increase by 37% by the end of the decade. These shale gas-derived developments will continue to present challenges for Gulf companies in terms of their downstream market position. However, we believe the GCC region will retain its low-cost status over the next five years at least.

How are GCC countries and their national oil companies countering the challenge of the shale boom in the U.S.?
While North America has become more self-sufficient in energy, other markets such as Asia and the Far East have continued to source upstream oil and gas from worldwide suppliers such as those in the GCC region. And we understand that some GCC-based producers have diverted LNG originally destined for North America to the Far East. However, while diverting exports has proved effective in the short term, GCC-based oil and gas producers recognize that more substantive and innovative strategic plans are needed over the longer term. As a consequence, some national oil companies have acquired equity stakes in downstream refineries operating in the U.S. Others have

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established joint ventures and service partnership arrangements with North American firms that have shale know-how. Qatar Petroleum International, for instance, has acquired 40% of Suncor, a Canadian gas producer, while Saudi Aramco is working with U.S. oilfield services firms to gain the technological expertise to develop its shale resources. In addition, GCC-based companies with midsize exploration and production (E&P) operations are beginning to allocate a share of their capital expenditures to shale activities such as horizontal drilling and fracking. One example is Abu Dhabi National Energy Co. PJSC (TAQA), which is looking to enhance recoveries from its Canadian fields. In our view, Saudi Arabia is at the forefront of shale gas development in the Gulf. The government recently invited overseas companies to express their interest in a front-end engineering and design contract for shale gas that, according to MEED, was to be released in the third quarter of 2013. The technology used to extract shale gas is improving each year and this should result in cheaper costs in the Middle East. However, according to MEED, the technology will remain expensive in the short term, at $8-$9 per mmBTU, to extract and process the resources in Saudi Arabia. This compares with our estimate of all-in finding, development, and production costs for more established shale plays of $3-$4 per mmBTU in the U.S. Additionally, Saudi Arabia is preparing to be among the first countries outside North America to use shale gas for power generation and thereby save more of its crude oil for export. Separately, Saudi Aramco announced recently that it was looking to commit shale gas for the development of a 1,000 megawatt power plant that will feed its phosphate mining and manufacturing sector. What's more, there have been signs that GCC sovereigns are looking to reduce energy subsidies. Kuwait recently set up a committee to review all forms of state subsidies. Meanwhile, Oman, Qatar, and Bahrain have all raised the price of gas supplied to downstream industries and utilities. This may place pressure on GCC downstream industries, although these adjustments will in our view not materially affect the competitive position of GCC downstream industries from a global perspective. Aside from the aforementioned initiatives, GCC countries are creating downstream energy clusters with the aim of generating an "internal use" of oil that is, to an extent, insensitive to the market price. Saudi Arabia, for example, has developed such clusters in Jubail and Yanbu, where refineries and petrochemical plants are built side-by-side. In the event of a downward oil price shock in the medium to long term due to significant shale oil production, Saudi Arabia's own oil would continue to supply the refineries that fuel the operations of the petrochemical plants that produce the enriched end products. This not only guarantees a usage value for the oil at a time of potentially depressed prices, but also generates jobs and leads to greater end product diversification. We understand that several other GCC countries may emulate the Saudi model in coming years. The advantages of shale expansion in GCC countries include energy diversification and security of supply (in as far as it relates to gas). It should also enable GCC oil and gas companies to gain a foothold in a market that's evolving rapidly and where costs at some point could become low enough to make shale impossible to ignore.

What factors have triggered the shale boom in North America?

Both external and market-specific factors have contributed to the shale boom in North America, including: High natural gas prices. The development of shale gas in the U.S. accelerated in the early 2000s, when there were

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concerns about natural gas shortages in the U.S. and prices exceeded $5 per mmBTU. However, the success of shale gas production in subsequent years led to a dramatic increase in production and a fall in Henry Hub natural gas prices. However, despite the initial fall in price, operators continued to drill for shale gas due to i) lease requirements, and ii) the existence of significant hedges that maintained profitability. This led to further increases in natural gas supply and continued natural gas price weakness. High oil prices. Due to the wide discrepancy between oil and natural gas prices (oil has traded at 20x-30x the price of natural gas on an energy-equivalent basis since the beginning of 2009), operators began transferring shale gas technology to oil shale, with positive results. High oil prices also allowed several small to midsize E&P companies to generate sufficient cash flows from conventional operations to invest in unconventional shale. Geology that is conducive to shale development. Shale research commenced in the U.S. in the 1980s, and a large number of independent small to midsize E&P companies have at various times since looked at employing various drilling techniques with the aim of exploiting U.S. and Canadian shale resources. This, combined with exploration activities involving a high level of trial and error, ultimately produced the significant discoveries. The commitment of E&P companies and oilfield services companies to development of new technology, such as horizontal drilling and fracture stimulation (fracking). The commitment of E&P companies and midstream entities, in tandem with support from governments and municipalities, to build the necessary infrastructure. This infrastructure includes gathering systems, processing facilities, pipelines to market, roads, and (in some cases) rail terminals. Infrastructure requirements represent a significant upfront capital cost for E&P companies, resulting in shale developments typically taking between three and five years to break even (assuming no drop in commodity prices). Access to large amounts of fresh water for the fracking process. Clearly established property and mineral rights. Large parcels of land are required for shale development programs, some of which cover highly populated regions. Supportive environmental regulations. Water usage and disposal activities that are supported by appropriate regulation have been hugely beneficial for North American shale activities, in particular in ensuring viable community relations. Nevertheless, regulation has not been supportive in every region. New York State, for example, has banned fracking. The availability of financing. It's important to distinguish between the two phases associated with shale activities: i) exploration and testing; and ii) development. During the exploration and testing phase, a significant amount of risk is involved, particularly where there are new fields with no track record of successful production. Typically, this phase has been funded through the E&P companies' own balance sheets, including revolving credit facilities backed by existing reserves and production. In a few cases, though, international or major oil companies have been willing to invest in this phase. Expanding sources of funding. Now that many gas and oil shale projects have moved into the less risky development phase, funding sources have expanded to include private equity groups and even master limited partnership (MLP) structures that require a steady stream of cash flows. Tax breaks for E&P companies. Tax credits are available for unconventional production, together with tax breaks for intangible drilling costs. We understand that similar incentives are under consideration in the U.K. to support its shale industry.

Do similar factors apply to shale development in GCC countries, in Standard & Poor's opinion?
Yes, to a degree. We note, for example, high natural gas and oil prices, along with the commitment of sponsors to technology and supportive environmental regulations, as factors that can influence shale developments in the GCC region. Some aspects highlighted above are not so applicable to GCC countries, because governments control all mineral rights and water is a scarce resource. Other aspects such as access to financing are less material in the Gulf

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because national oil companies are cash-rich and we would not anticipate that they would need to rely on external financing to fund shale exploration activities of a certain scale. We believe that in GCC member states, national oil and gas companies would develop the shale market. There are few private independent E&P companies with a balance sheet that would attract funding for high-risk exploration activities, in our view. There are also few private equity players or hedge funds looking for an equity return that would be capable of playing the role that their peers performed in support of the shale market in North America. On a positive note, the national oil and gas majors in the GCC have already started to take the lead, as we note above. Also, we anticipate that regulation may be less of an issue in GCC countries than it can be elsewhere due to the scarcity of population in areas where shale activities are likely to take place. However, we anticipate that political will and support for shale will be required to encourage the national oil and gas incumbents to invest seriously in the sector. We note, however, the higher cost of shale development in the GCC compared with conventional production. Narrowing this differential would be an important incentive for shale to take off in the GCC region in a meaningful way.

Does Standard & Poor's rate any companies that participate in shale development?
Yes. We rate more than 100 hybrid shale/conventional E&P companies worldwide (primarily in North America), a number of 100% shale-related E&P companies (also primarily in North America). We do not currently rate any project financings or structured financings associated with the shale sector, although we have a number of project finance ratings associated with the conventional upstream oil and gas sector globally, including RasGas in the GCC region.

What does Standard & Poor's consider to be the likely sources of funding for GCC shale projects?
Cash-rich national oil companies dominate the GCC oil and gas market. Therefore access to funding at attractive prices for a certain scale of shale development should not present these companies with any material issues. We anticipate that corporate funding based on the balance-sheet strength of the issuing entity will be the primary means of financing GCC shale activities, particularly during the early phases that require exploration work and involve significant resource risk. We would therefore incorporate such funding in our normal analysis of E&P companies that encompasses the level of proven reserves and production, profitability based on unhedged EBIT per barrel of production, debt to EBITDA, and funds from operations to debt, among other measures. That said, we cannot rule out that if a level of success is achieved in isolating shale oil and/or gas from specific fields in the GCC region, some production-based, contract-driven project financing structures might evolve. We would expect these financings to be created with sufficient subsidy from the parent entity/sponsor and/or government to cover any exploratory activities connected with them. In our view, the most likely point at which a shale-related project or structured financing might emerge would be when oil or natural gas becomes economically viable to produce, and the program enters the development phase. In certain fields, shale production can span up to 30 years. Although initial flow rates from a shale well can be lower, and initial decline rates faster, than from conventional wells, shale development programs are typically more predictable than

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conventional well programs because of the relatively homogenous nature of the rock strata. Once the extent of shale resources has been determined and optimal drilling and completion procedures developed, the production phase becomes more akin to a manufacturing process, with operators drilling similar wells over and over again. This feature is in our view potentially supportive of 10- to 20-year project funding. While master limited partnerships (MLPs; limited partnerships that are publicly traded on a securities exchange) have entered the shale industry in the U.S., it's possible that volumetric production payment (VPP) models, also employed in North America, may be used in GCC countries to monetize future hydrocarbon production for shale financings. Such models would require reliable and predictable production profiles, and long (over 20 years) reserve lives. Outside of oil and gas, we rate a number of project financings in the alternative energy sector, primarily involving wind and solar power. Here, the similarities to shale include relatively new technologies for energy production and resource risk. Such financings also take account of supportive regulation, particularly in the nascent (exploration and testing) stage of project development. We believe renewable asset financings (also in their infancy in the Gulf; see "Q&A: Shams 1 Solar Power Project Financing Shines A Light On Renewable Energy In The Gulf," published March 29, 2011, on RatingsDirect) could be used as a proxy in the future for structuring shale projects.

Related Criteria And Research

The articles listed below are available on RatingsDirect. Low-Cost Shale Gas Gives North American Petrochemical Producers Advantages Over Europe, April 23, 2013 Do Recent Rulings Herald The Divorce Of Oil And Natural Gas Prices, And Who Will Benefit?, Feb. 4, 2013 How Do Middle Eastern Sovereigns' Fiscal Breakeven Oil Prices Affect Credit Ratings and Oil Prices?, Feb. 1, 2013 Has Foreign Investment Helped North American Oil And Gas Companies' Credit? Well, It Hasn't Hurt So Far, Oct. 19, 2012 Assessing Credit Quality And Trends For Master Limited Partnerships (MLP), Aug. 10, 2011 Q&A: Shams 1 Solar Power Project Financing Shines A Light On Renewable Energy In The Gulf, March 29, 2011
Additional Contacts: Trevor Cullinan, Dubai (971) 4372-7113; trevor.cullinan@standardandpoors.com Simon Redmond, London (44) 20-7176-3683; simon.redmond@standardandpoors.com Infrastructure Finance Ratings Europe; InfrastructureEurope@standardandpoors.com

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