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BHP's $15 Billion Lotto Ticket

Alan von Altendorf CWSX LLC

It is always the case in oil exploration that we have to make geological and economic estimates based on all of the scientific evidence which is available at the present time. Observe that I did not say guesswork. Geoscience is not supposed to be a crap shoot or leap of faith. See The Tragedy of 21 Darts. Valuation of merger/acquisition in the oil space is therefore a serious matter, requiring sober due diligence, technical assessment of reserves, and frank discussion of whether it will benefit or hurt shareholders. Announcement of a pending BHP deal was exciting news: Britain's Daily Mail newspaper reported yesterday that BHP was preparing a cash offer of $US90 a share, or $US44.6 billion for Anadarko. [Jan 2011, The Australian] Ooops, wrong story. Anadarko isn't for sale nor was Woodside Petroleum, nor Potash, nor arch-rival Rio Tinto. Determined to buy something, BHP Billiton hooked a US minnow that habitually loses money: Petrohawk
Net Income 12/2006 12/2007 12/2008 12/2009 12/2010 total 5 years 117 million 53 million -388 million -1,025 million 189 million -1,054 million USD

Yeah, But Look At All The Upside...


Anglo-Australian mining giant BHP Billiton unveiled a $12.1 billion takeover of Petrohawk Energy Corp. that will give it access to the lucrative US shale gas market. BHP will pay $38.75 a share, giving the deal a total value of $15.1 billion including Petrohawks debt. "The proposed acquisition of Petrohawk is consistent with our ... strategy and provides us with even greater exposure to the worlds largest energy market, while also broadening our geographic and customer spread," BHP chief executive Marius Kloppers said. [Saudi Gazette/AFP]

Shareholders of Petrohawk (82% institutional) got a nice payday


SHARES HELD AT BUYOUT

Insiders at Petrohawk had a nice payday, too

During the six months ended June 30, 2011, Petrohawk granted stock options covering 2.3 million shares of common stock to employees of the Company.
[August 10-K]

The BHP all-cash offer represents a 65% premium to the Houston-based company's closing share price. [Dow Jones]

The key strategy message was that BHP Billiton is a natural owner of large, long-life, high-margin shale assets. BHP Billiton will be able to bring lower cost and faster funding for the development of Petrohawk's shale gas assets in Texas and Louisiana. Exploration companies do not have the same cost of capital as a diversified resource company like BHP Billiton. 'The ability to deploy the capital is the opportunity that we're looking for here,' BHP Billiton's CEO said. [Ravi Madhavan]
MELBOURNE -(Dow Jones)- BHP Billiton Ltd's US$12.1 billion bid for Petrohawk Energy Corp. (HK) should be valued against the gas and oil assets in the ground rather than the U.S. shale gas company's share price, the chief executive of BHP said Friday. Exploration companies in the oil and gas space attract higher takeover multiples than established companies where "upside" is capped, Marius Kloppers said during a conference call. Kloppers said he is confident BHP can add value to Petrohawk due to the cost at which the AngloAustralian company can raise funding and the speed it can develop the assets. The offer price recognizes the value of Petrohawk's opportunities, and the deal is expected to be accretive to earnings per share in the first full year after completion, he said.

So, what's not to like?

BHP Acquired a Financial Trainwreck [Anand Chokkavelu, Motley Fool, Apr 8, 2011] Petrohawk has a P/E ratio of 39.3 and a negative EV/FCF [Enterprise Value to unlevered Free Cash Flow] ratio over the trailing 12 months. If we stretch and compare current valuations to the five-year averages for earnings and free cash flow, Petrohawk has negative P/E and EV/FCF ratios. A positive oneyear ratio under 10 for both metrics is ideal. For a five-year metric, under 20 is ideal. Petrohawk is zero for four on hitting the targets. [M&A Review] Charles Kernot, analyst at Evo Securities says: BHP Billiton would pay around $27 per boe for proved reserves, which is relatively expensive.

[M&A Review] According to Robert Morris and his crew from Citigroup Global Markets, the cost to BHP for undrilled Haynesville acreage is about $5,000 per acre, which matches what BHP paid for Chesapeake's Fayetteville stake earlier this year. For Petrohawk's Permian acreage, Citigroup estimated the cost to BHP was about $6,200 per acre, which appears quite aggressive given that HK's average cost basis is $1,400 per acre. And for the Eagle Ford acreage, Citigroup estimated the price to be $22,000 per acre, which is arguably the high-end of any public transaction to date. BHP paid $27.00/boe for HK Reserves XTO paid $11.50/boe for HK Reserves [Eugene Kim, Drilling Info] Petrohawk Energy Corporation announced on December 23rd that it has completed the sale of its natural gas assets in the Fayetteville Shale to XTO Energy Inc. subsidiary of ExxonMobil for $575 million. The Company has estimated that its Fayetteville Shale assets have proved reserves of approximately 299 Bcf (50 million boe). HK had to sell Fayetteville (cheap) to raise Cash [David J. Phillips, 10Q Detective, Feb 2010] Petrohawk is nursing a mighty hangover after awaking from a 2-year buying binge $5 billion spent on acquiring leasehold interests in the Haynesville Shale, Fayetteville Shale, and Eagle Ford Shale plays. Petrohawk is like the U.S. Treasury in some respects, having funded its expansive appetite with paper common stock outstanding has almost doubled since 2006 to 300 million shares and deficit spending: At September 30, long-term debt stood at approximately $2.4 billion, roughly 73 percent of stockholder equity. Contractual obligations maturing on Petrohawks leveraged balance sheet climb from $663 million in the next 12 months to approximately $1.9 billion in 2011 2012. The company has never thrown-off positive free cash flow since being birthed by Wilson through a reverse merger of some long forgotten energy exploration shell back in 2003.

It will be several years before we know whether the Petrohawk deal was a strategic masterstroke or a costly blunder. [Ian Lyall]

Well, Petrohawk confidently affirms that everything will play out nicely, according to this financial presentation to BHP:

No idea what they mean by ROR. Two possibilities ROR (Return on Total Capital) measures the income return of an income producing property with the implicit assumption that there is no debt. ROR (Return On Revenue) calculated as net income divided by revenue; increasing ROR implies less expense for higher net income. neither of which pertains to Petrohawk and if I'm reading their chart correctly, it claims that Haynesville Shale is profitable at $4/mcf, which is most certainly not true and never was.

[Robert Hutchinson, May 9, 2011] Petrohawk Energy released its first quarter earnings report last week. As the company has been saying for the past year, it expects to have the vast majority of its leasehold held by production in the second quarter of this year. As a result, it will start reducing rig count in the next few months. The company has been averaging 16 Haynesville rigs, but that number will drop to six by the beginning of the third quarter and hold until the end of the year. When you step back to think about it, the company has produced 410 billion cubic feet of natural gas in three years and has yet to break even. Economists would describe that as irrational. Running that many rigs drilling $10 million wells in a crappy commodity price environment?

Petrohawk's reserve base is expensive to exploit, with average well costs in the vicinity of $10 million. [Stephen D. Simpson]

Nor is it simply a matter of drilling cost. Billions of dollars were spent to lease mineral rights or to buy them from others at a premium, to hire a professional engineering staff, and to build gathering infrastructure. [Arthur E. Berman] When capital expenditures are added, it costs most operators about $7.50/Mcf to find, develop and operate in the play. While some operators are currently hedged at higher prices, this is a short-term situation, and no one will take the other side of a hedge at more than $7.50/Mcf today or at any time in the foreseeable future. While shale play enthusiasts have claimed profitability at gas prices below $5/mcf in recent years, these half-cycle economics do not include significant fixed and sunk costs such as debt service and overhead. With the flight to liquids-rich plays in recent months, the truth about true cost is being revealed.

In a very real sense, it's inappropriate to pick on poor Petrohawk, who has an enviable track record in drilling and completing exceptionally productive Haynesville Shale wells.
[Berman & Pittinger, 2011] Petrohawk results average 4.0 Bcf/well and are substantially better than Chesapeake and Encana results, which average 2.4 and 2.6 Bcf/well respectively. The better results achieved by Petrohawk and Exco are probably because of their acreage positions in the core area of Desoto, Red River and Bossier parishes.

That's the good news. Now the bad news.


The Haynesville play is unique among the shale gas plays because it is highly over-pressured, ranging from 0.75-0.85 psi/ft. This overpressure results in much higher initial rates than in other shale gas plays... As pressures deplete, the pore pressure can no longer counteract the lithostatic gradient, hence fracture permeability is probably reduced as the wells are depleted and fractures close, potentially explaining the much steeper decline rates observed in this trend. [ibid]

Shale Economics One of the measures that Petrohawk has adopted, to grapple with very steep rate of Haynesville decline (85% in the first 12 months) is to choke the wells and produce more slowly, thereby extending the Estimated Ultimate Recovery (EUR) i.e., the total production of gas obtained over the life of a single well or a portfolio of Haynesville wells. Extending and pretending are related ideas. [David J. Phillips, 10Q Detective, Feb 2010] Petrohawk Energy confidently predicts that the $5 billion spent on leasehold acquisitions and drilling projects (in just the last two years) for promising U.S. shale plays will offer attractive long-term production and profit growth potential for many years to come. A bad bet, say outside observers, arguing that the natural gas producers estimated reserves-to-production ratio of almost 16 years is not only overstated, but that projected shale gas numbers, known as estimated ultimate recovery (EUR) rates, are rooted in untenable flow rates. Petrohawk is currently operating 17 horizontal rigs in the Haynesville Shale, principally in Northwest Louisiana and East Texas. Of the $1.45 billion drilling budget for 2010, $900 million is being set aside for Haynesville, with plans to spud between 110 and 120 wells. You will perhaps recall that Petrohawk changed their game plan and that drilling to hold leases by production has trimmed the number of HK Haynesville rigs from 17 to 6. But let's suppose they drill 120 wells, sooner or later. That's BHP's explicitly stated goal to deploy a pile of Australian cash and exploit Petrohawk's Haynesville asset. 120 wells + gas gathering infrastructure will cost $1.2 billion at today's prices, ignoring company overheads, interest, and wellsite accidents. 120 wells @ 4 bcf x $5/mcf net = $2.4 billion (100% profit)

Petrohawk's ROR chart predicted 100% Haynesville profit at $6.20/mcf taking into consideration overheads and an occasional blunder, but let's not quibble over a buck or two. The question is whether to spend $1.2 billion to earn $2.4 billion. Sounds pretty sensible until you consider the hurdle rate, sometimes called the opportunity cost of money. If those 120 wells suddenly sprang into existence tomorrow afternoon and produced 4 bcf instantly, you'd have 100% profit. But they can't. A dollar today is worth more than $1 tomorrow. A highly aggressive drilling program will take years to spud 120 wells. 20 rigs each drilling 3 wells per year = 120 wells in 2 years. The first well drilled and completed produces 4 bcf cumulatively in the 4th year. The last well drilled delivers a profit in year Six assuming that every well is equally productive (the manufacturing model). It doesn't make sense to undertake unless netback is > $5/mcf. Nor is it likely that all 120 wells will be mechanically sound. Petrohawk successfully completed only 38 out of its first 44 Haynesville wells.

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Supply and Demand Okay, let's suppose that the 120 new wells are 80% successful and produce an average of 4 bcf each over six years, without any mishaps, shortages of rigs or skilled drilling crews, changes in hydrofracking rules, or cost overruns. At $8/mcf the plan is bulletproof, right? Uh, no. Not quite. Petrohawk does not have a monopoly on natural gas production.
U.S. Natural Gas Production in million cubic feet per day (mmcfd) Jan.-June 2009 1. BP 2. Anadarko Petroleum 3. XTO Energy 4. Chesapeake Energy 5. Devon Energy 6. ConocoPhillips 7. Encana Corp 8. Chevron Corp 9. ExxonMobil Corp 10. Williams Cos Inc 2,337 2,325 2,290 2,210 2,130 2,108 1,663 1,387 1,243 1,202

No matter how much BHP boodle they burn, Petrohawk is destined to remain a minnow among hungry killer whales like Chesapeake, Devon, and XTO. Natural gas is a commodity supplied in ever-increasing glut from conventional reservoirs and shales across the country. The upside for everyone is growing demand, but... Natural gas price projections are significantly lower than past years due to an expanded shale gas resource base.
[Richard Newell, EIA]

Supply will continue to outpace demand, and America's domestic gas glut is a long-term death threat for high-cost shale operators.

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It is really very simple: how much did you spend, how much have you got out and how much are you getting out each day, using not gross amounts but net amounts. Projections are where all the falsehoods hide. Four 10% errors in a row give a 60% of projection result. [Doug Proctor]

Investors voted with their feet when BHP's acquistion of Petrohawk was announced. Paying a 65% premium for shale assets didn't make sense. Nor is Petrohawk's claim of 22 tcf risked resource a fair assessment. Petrohawk proved reserves are 3.4 tcfe all assets including Eagle Ford, Permian Basin and Haynesville Shale* Total Haynesville Shale basin EUR may be as low as 30 tcf and intrepid little Petrohawk owns a small fraction of that risked resource. Their Haynesville play has never yielded a profit in the past and might never return a profit in the future, no matter how many wells they operate. * HK proved reserves are ~80% proved undeveloped which are vapor in shale plays, so even the
Netherland Sewell certified 3.4 tcf is inflated. Petrohawk's proved producing number may be 0.7 tcf, most of which is SEC non-commercial and will have to be written off as impairments by BHP. The brilliance of the transaction from HK's perspective is that, under the revised SEC rules, PUDs must be drilled in 5 years to remain booked. HK doesn't have to deliver but got to count them as valuation.

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Will Eagle Ford Liquids Save BHP's Bacon?

(Petrohawk leaseholds are the 3 white dots) Every good story should have a happy ending. Unfortunately, Petrohawk is not one of those happy smilie kid adventures where everyone wins.
[Robert Hutchinson] In the beginning, Petrohawks focus was on natural gas in the Eagle Ford. Based on seismic surveys and well logs they began acquiring what appeared to be the best acreage prospective for natural gas. EOG Resources began to stealthily lease up all of the 'wet' Eagle Ford shale acreage that they could get their hands on, much of it at prices under $500 per acre. EOG Resources soon overtook Petrohawk as the largest leaseholder in the Eagle Ford shale and became the biggest liquids producer. EOG Resources has estimated over 900,000 barrels of recoverable oil (net after royalty) in the 550,000 acres they hold in the oil and condensate windows.

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Horizontal wells with long laterals are $10 million a pop in the Eagle Ford, and if you aren't within spitting distance of a pipeline, 'wet' gas containing small amounts of liquid condensate isn't worth drilling. Petrohawk is in the worst possible position: 90% dry gas.
Red Hawk field initial oil production averaging 375 barrels per day. The company claims EUR of 500-750 Mboe. "It is interesting to note that Petrohawk describes these liquids as condensate and not oil." [Drilling Info.com, Mar 2010]

Compare other Eagle Ford operators:


EOG Resources: 520,000 acres in mature oil window, 26,000 acres in wet gas window and 49,000 wet gas. Total: 590,000 acres. Chesapeake Energy: (partner CNOOC) 445,000 acres. Newfield Exploration: (85% working interest), 335,000 acres. Apache Corporation: 450,000 acres mixed oil and gas windows. Pioneer Natural Resources: 310,000 acres. Anadarko Petroleum: 300,000 acres. ConocoPhillips: 300,000 + acres. St. Marys Land And Exploration: 250,000 acres. Consists of 165,000 acres, 100% working interest in wet gas window and 85,000 acres in wet gas and oil windows, JV with Anadarko.

The Eagle Ford play is not a cake walk. I reproduce below professional assessment by petroleum geologists in The Oil Drum, August 2011 [Rockman] I've been tracking the Eagle Ford production. As you know
it takes 2 to 3 years to get enough decline rate to be able to make an accurate projection. There are just a small number (around 20) of Eagle Ford wells with enough history to make a valid argument at this time IMHO. But in the next year or two we'll have at lot more wells to analyze... (continued next page)

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In the meantime all I can do is point out some obvious BS companies put out. One company brought an Eagle Ford well on at 947 BOPD and produced 181,000 bo in the first 12 months. They bragged about this well and offered that it MIGHT recover 500,000 bo. But in their press release they neglected to mention that the well declined from 947 bopd to 86 bopd in that one year. Yes ... a 90% decline rate. So averaging around 500 bopd it made 181,000 bo and they say it MIGHT produce an another 320,000 in the future while averaging much less than 90 bopd. They are certainly free to express their OPINION. But opinions vary. [abundance concept] So, if they keep the thing active for another 30 years, that's 320,000 / 30 years / 365 days = 29.2 bpd average over 30 years. Why is that unreasonable? [Rockman] And if they keep producing 500 years they'll recover over 5 million bbls of oil? ...In the Eagle Ford shale it appears most of those wells will go on gas lift within the first 18 months of their life, then once solution gas is dissipated those wells will have to go on rod lift. Once you begin producing 9000 foot horizontal wells on rod lift, the patient has been diagnosed with cancer, it's just a matter of how long it's got to live. That rod lift well will reach economic limits for medium sized independents at around 12 BOPD, 8 BOPD net after royalty deducts, assuming $75 oil, if they don't make water. If they make water the net BOPD must be more lots more depending on how much water they make. So at some point in the decline those wells reach economic limits and they die a premature death, long before the ripe old age of 30. Add in a multitude of unknowns like lateral collapse and re-fracs, casing failure, falling oil prices, inflationary increases in the incremental lift cost per barrel, disposal costs, regulatory/environmental costs in the next 15 years, changes in tax laws; these shale wells down here in Texas won't live to be teenagers, much less young adults. The EUR's they are throwing at us in my opinion are bunk. [pittsburghsteelers] In general I would agree with you that the Eagle Ford is over-hyped. For instance, North Dimmit Co has some of the poorest well results, yet leases are going for $10,000/acre with wells IP'ing at <100 BOPD... Let's say I have an IRR hurdle of 25% in the company. Any revenue produced beyond year 5 is going to be so heavily discounted that it is negligible.

(continued next page)

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[Bob DeLong] One of the advantages of owning small E&P is that occasionally a rich bunch of ignorant fat cats will pay a ridiculous premium for your stock. But shareholders lose, because they could have bought the stock themselves without paying the premium. And of course, there is no synergy. In fact, the opposite is true. If E&Ps are worth a huge premium, why arent cash rich integrated oils like COP, HESS, OXY (just to name a few) devouring the E&Ps? Certainly these firms are better able to value E&Ps than some miners from the other side of the world. Youve seen the maps. These integrated firms have acreage interspersed with that of the E&Ps. They have the best idea of what the E&Ps are worth. Announcement of the BHP-HK merger created a temporary bubble, thats all. Fools rushed into our industry.

Magical Thinking: Shale Gas = Oil BHP is not alone in fudging the value of shale gas assets. ExxonMobil's acquisition of XTO Energy inspired a 100 billion dollar scramble for US shale ventures and acquisitions by Reliance (India), CNOOC (China), Total (France), BG Group (UK), Statoil (Norway), Royal Dutch Shell (UK-NL), BP (UK), Talisman (Canada), Mitsui (Japan) and US stalwarts Chevron, Anadarko and ConocoPhillips. Why? reserves. [Berman] Reserve replacement has been a challenge for major oil companies for at least the last decade as opportunities in the international arena have contracted. North American shale gas plays offer a temporary solution. Whether big companies can find operational and technological ways to make these plays commercial is another question but, for the short term, shale plays provide a means to add reserves. SEC and IASB rules allow oil companies to book gas reserves as oil equivalent (boe) on the thermal basis of 6 mcf gas = 1 bbl of crude.

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That oil companies are unable to replace declining oil reserves with new oil reserves is a well-known, intractable problem.

That's why we are witnessing lunatic deals in Iraq ($1 per barrel fee for increased production), in Brazil ($300 billion to explore pre-salt), in Kazakhstan ($120 billion wasted at Kashagan), in Nigeria (Shell pulled out), and in Russia (too many deals blown up to name individually). Exxon's acquisition of XTO was a template. Shale's risked resources are huge. SEC revision of Rules S-K and S-X in 2009 allowed blue sky shale reserves to be reported by public companies as barrels of oil (boe) in a comingled portfolio of oil and gas assets. Equivalence of oil and gas is completely fake and everyone in the oil industry understands that boe (or worse: tcfe stating oil and NGL as gas volumes) is a game designed to flummox retail investors. Think about it. 6 mcf of natural gas fetches about $23 at the wellhead. A barrel of light sweet West Texas Intermediate is worth $85. A barrel of Brent is $105. Natural gas cannot power an airplane, a bulldozer, or hundreds of millions of cars, trucks and tractors that use liquid fuel.

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Less Government, More Creative Destruction

American economist Joseph Schumpeter, champion of innovation and free market creative destruction would be appalled at our lack of progress in the 21st century energy industry. Instead of going forward, we're going backward with deployment of capital and value for money. By allowing oil companies to book shale gas reserves as oil equivalent and paying a premium for shale operators who cannot make a profit, we're sustaining Business As Usual in the oil patch. I use that term advisedly to denote the corrupt practice of milking investors, inflating the value of recoverable reserves, and masquerading as advocates of Politically Correct, hopelessly inefficient green technologies. The cost of such self-serving, callow PR is measured in hundreds of billions of dollars wasted on net energy negative Corn Ethanol subsidy and inherently silly Gas-To-Liquids and Blue Green Algae projects. I don't know which is worse: BP executives, an Offshore Installation Manager, and a Senior Toolpusher who were patting themselves on the back with safety awards and playing video games on the evening when Macondo exploded, killing all 11 men on the drilling floor or Obama's knee-jerk response that penalized Exxon, Chevron, Marathon, Shell, and thousands of offshore service workers who had absolutely nothing to do with Deepwater Horizon. If it wasn't for the heroism of a service boat crew, the number of Macondo survivors would have been zero. If the oil industry is to survive and thrive, the mind numbing delusions of safety-by-paperwork and see-no-evil reserves valuation must end. A free market does not reward failures like Petrohawk, absent a hysterical government sponsored climate change meme to mandate destruction of coal-fired electric power generation and diesel road transport.

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Concluding Remarks

No one is suggesting that shale oil and gas are unnecessary or unwise investments. Bakken structural traps were commercially successful. It is less clear whether big operators like Chesapeake will ever make a profit in uneconomic (Barnett) or conjectural plays (Bossier, Utica). At $4/mcf, Petrohawk is a dead enterprise. Artificially lifting the price of natural gas by government subsidy (The Pickens Plan) or mandating closure of US coal-fired power plants is what leveraged investment banks and Big Oil are praying for. Insiders can cash out and retire wealthy consumer prices, energy security, and spiraling government deficit spending be damned. America is best served by a free market with minimal regulation and more transparency on the balance sheets of oil companies. 6 mcf does not equal 1 boe and resources base is precisely what BHP Billiton called them in the attached pages of the Appendix not proved, not probable, not possible, and strictly forbidden by SEC rules.

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Disclosure: No position long or short in energy or any of the companies discussed. Content taken from public websites is "fair use" for critical and educational purposes. No financial, legal or accounting advice is offered in this article, nor any representation that the information presented is accurate, timely, or complete. The opinions expressed here are solely those of the author and do not reflect the views of CWSX LLC or its professional staff or directors.

Appendix
July 14 merger PowerPoint disclaimer BHP Billiton uses the term non-proved resources base" in this presentation to refer to reserves other than proved, probable or possible reserves, which the SEC's guidelines strictly prohibit us from including in filings with the SEC... This term includes estimates which are not yet classified as proved, probable or possible reserves. These estimates are by their nature more speculative than estimates of proved, probable and possible reserves and accordingly are subject to substantially greater risk of being actually realized. (In other words, complete monkey crap.)

August 2011 Petrohawk 10Q Stockholders' equity: $304,000 Net increase in cash: $64,000 Long Term Debt: $3,766,380,000
(continued next page)

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Petrohawk merger disclaimer ...actual results to differ from those anticipated in the forward-looking statements, including, but not limited to, the following factors: our ability to successfully develop our large inventory of undeveloped acreage in our resource plays such as the Haynesville, Lower Bossier, and Eagle Ford Shales; volatility in commodity prices for oil and natural gas; the possibility that our industry may be subject to future regulatory or legislative actions (including any additional taxes and changes in environmental regulation); the presence or recoverability of estimated oil and natural gas reserves and the actual future production rates and associated costs; the potential for production decline rates for our wells to be greater than we expect; our ability to generate sufficient cash flow from operations, borrowings or other sources to enable us to fully develop our undeveloped acreage positions; our ability to replace oil and natural gas reserves; environmental risks; drilling and operating risks; exploration and development risks; competition, including competition for acreage in resource play areas;
(continued next page)

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Petrohawk merger disclaimer cont'd management's ability to execute our plans to meet our goals; our ability to retain key members of senior management and key technical employees especially given the pending merger with affiliates of BHP Billiton Limited; the cost and availability of goods and services, such as drilling rigs, fracture stimulation services and tubulars; access to and availability of water and other treatment materials to carry out planned fracture stimulations in our resource plays; access to adequate gathering systems and transportation take-away capacity, necessary to fully execute our capital program; business, operations and financial results; general economic conditions, whether internationally, nationally or in the regional and local market areas in which we do business, may be less favorable than expected, including the possibility that the economic conditions in the United States will worsen and that capital markets are disrupted, which could adversely affect demand for oil and natural gas and make it difficult to access financial markets; social unrest, political instability, armed conflict, or acts of terrorism or sabotage in oil and natural gas producing regions... other economic, competitive, governmental, legislative, regulatory, geopolitical and technological factors that may negatively impact our business, operations or pricing. (In other words, ignore everything we said about assets, opportunities, co-operation with BHP and our competence to run an oil company.)

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BHP Investor and Analyst Briefing Monday 24 May 2010


J. Michael (Mike) Yeager, CEO, BHP Billiton Petroleum. Centralized management Everything that were going to do, everything that we - of what were going to do, all of our planning, all of our financial analyses, all the things that involve what were going to do tomorrow are centralised probably deeper than most companies... Worldwide BHP standards, no exceptions Its all built on functional excellence at being very, very strong down the different aspects of our business. In our countries, and you can see the places around the world that we operate, we have large stand alone strong operating units.... Theyre not out there writing their own policies. Theyre not out there deciding what the metrics are going to be for this year.. They accept and receive services from the centre in a common way, and they adhere to world wide standards... Extremely proud to be 73% in liquids ...weve had volume growth with liquids. We have volume growth in US gas right now. Youre getting about $4 per MMBTU. You convert that to a barrel by multiplying that times six, so your revenue in the US right now if youre in the gas business would be around $25 a barrel. Youre in the liquids business, its $70 or $80 a barrel, as you can see. So ours are primarily liquids growth... combined with low cash and low operating costs, gives us the margin that Ive described that were extremely proud of... $2 billion for Western Australia Our proven reserves, which are listed on the left-hand side there, about 1.4 billion barrels, or around eight to 10 years of future production, we have in the proved category. But that pales, as you can see, in comparison to about two and a half billion barrels that are already discovered, already there, not speculative, but just do not have funding behind them yet... In FY11 we will start spending on that in a capital nature, and as you can see, raise those expenditures by 2015 to over two to two and a half billion dollars a year. So these are large projects that are enormous, and clearly now moving into our longer-range view... Q: Merger or acquisition prospects? We do have some people that would explore that and it brings us back, of course, to the most valuable thing that I feel we have; not only being part of a great corporation, but the balance sheet we have... Having said that, our primary mission will always be through the drill bit, through the drill bit, through the drill bit. Thats how you get those low costs. Thats how you get those great returns...
(continued next page)

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Q: (Stuart Baker, Morgan Stanley) Just a question on strategy regarding gas. Some years ago, BHP was the reasonably active unconventional stuff here, coal steam and I think also in China, and didnt take that forward, and now weve seen the unconventional gas in quite a few countries, such as the US, fundamentally shift the dynamics in the gas industry... So just wondering what BHPs thinking is, in terms of unconventional gas? It doesnt seem to be featuring much at this point. A: 'We have our hands full with larger things' Well, Stuart, thanks for bringing that up. As most of you are familiar, you know, in the last five or so years, particularly in North America, the idea of the unconventional gas in the shales has now taken a big technological leap. Where the wells can now be drilled down and drilled horizontally, they can be fractured and we can get commercial amounts of gas from rock that for the entire previous history, the oil and gas business was too tight and too trashy to give you commercial discoveries. This phenomenon has advanced so much that now, literally, North America is selfsufficient in natural gas, so much so that theres gas-on-gas competition, and the consumer is now enjoying the lowest prices of natural gas that theyve had in quite some time, down around US$4 per million BTU... So I will say this, Stuart: you know, were not in that right now. Weve had our hands full in the larger things... We do want to diversify by geography. We do want to have a safer set of cash flows going forward, but were also a conservative company, if you will, in the discipline side, and we dont jump into things that we dont understand... But were open minded, and its because of the diversification part of our strategy. Its just how we do that and how we make sure the business is strong and healthy. And right now, for the next several years, that US gas business could be a bit soft, because of the oversupplied nature of it and the low prices that are being realised. It gives me a chance to make the comparison, guys I hope you can see at $4 per million BTU, if youre exclusively in that US gas business, to convert that to a barrel you multiply it by six. So youre talking about a $24 or $25 dollar revenue barrel... A lot of those companies have low revenues, have higher debt. Q: (Mark Busuttil, UBS) Real simple question: can you give us an idea of what your capex and exploration budgets are for this year and next? A: 'Not more than $2 billion a year capex" Sure, Mark. As I mentioned, this year well spend about $800 million in exploration, and a little over $2 billion in major project capital on all the things weve described. Next year, I would say that, although its not released and the board has not endorsed that, I dont think you could expect big movements from those numbers...

(shorter version: $4/mcf sucks, no plan to enter shale business.)


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