Annual Report 2011

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Description of risk OPERATIONAL RISK Increase in production costs Production costs are affected by the normal economic drivers of supply and demand as well as by various field operating conditions. Mitigation – Risk management Effective procurement and cost control management processes are essential in ensuring that reasonable cost levels are achieved relative to business plans. Diligent operations management and effective maintenance planning help to ensure efficiency during operations. Production delays and declines from normal field operating conditions cannot be eliminated and may adversely affect revenue and cash flow levels to varying degrees. Advanced planning of the Company’s operational programme includes ensuring that the contracting strategy and procurement process is in place. Regular engagement with contractors and suppliers as well as consideration for equipment as part of the licence application process mitigates the risk. Reserves and resource calculations undergo a comprehensive internal peer review process and adhere to industry standards. All reserves are independently audited by Gaffney, Cline & Associates as part of the annual reserves audit process unless otherwise stated. (See also pages 28–31 Reserves, Resources and Production for more information.) Availability of operational equipment Oil and gas exploration and development activities are dependent on the availability of drilling and related equipment. An inability to procure equipment on a timely basis may delay exploration and development activities. Reserve and resources estimates In general, estimates of economically recoverable oil and gas reserves and the future net cash flows therefrom are based upon a number of variable factors and assumptions. All such estimates are to some degree speculative, and classifications of reserves are only attempts to define the degree of speculation involved. Inability to replace and grow reserves The ability to increase reserves will depend not only on the ability to explore and develop the Company’s present portfolio of opportunities, but also on the ability to select and acquire suitable producing assets or prospects. Health, safety and environment (HSE) A major operational HSE event could have a negative impact on the people and environment in which the Company works. This in turn can have an adverse impact on valuation. Ineffective systems to prevent bribery and corruption Corruption can occur in any country of operation. Incidents of non-compliance with anti-bribery and anti-corruption laws could be damaging to Lundin Petroleum, its reputation and shareholder value. The use of effective peer review for subsurface analysis and well site selection together with a well-defined strategy for recruitment and retention of talented personnel mitigates the risk. (See also pages 28–31 Reserves, Resources and Production for more information.) Lundin Petroleum promotes active management of HSE issues throughout the Company. HSE policies, goals and objectives and an HSE management system in compliance with statutory requirements are an integral part of operations. (See also pages 32–39 Corporate Responsibility for more information.) A consistent application of Lundin Petroleum’s Code of Conduct, together with policies and procedures that clearly define levels of authority and internal control requirements help to mitigate risk. In 2010 Lundin Petroleum joined the UN Global Compact to further confirm the Company’s commitment to ethical business practice and the Board of Directors adopted in 2011 an anti-corruption policy and guidelines. (See also pages 32–39 Corporate Responsibility for more information.) FINANCIAL RISK 1 Fluctuation in the price of oil and gas The price of oil and gas are affected by the normal economic drivers of supply and demand as well as the financial investors and market uncertainty. Fluctuation in currency rates Crude oil prices are generally set in US dollars, whereas costs may be in a variety of currencies. Fluctuation in exchange rates can therefore give rise to foreign exchange exposures. Liquidity risk The risk that the Group may not be able to settle or meet its obligations on time or at a reasonable price, could lead to inability to fund exploration and development work programmes. Lundin Petroleum’s policy is to adopt a flexible approach towards oil price hedging based on an assessment of the benefits of the hedge contract in specific circumstances. Lundin Petroleum’s policy on currency rate hedging is, in case of currency exposure, to consider setting the rate of exchange for known costs in non-US Dollar currencies to US Dollars in advance so that future US Dollar cost levels can be forecasted with a reasonable degree of certainty. The functional currencies of the companies in the Group are reviewed annually. Lundin Petroleum monitors rolling forecasts of the Group’s liquidity requirements to ensure that it has sufficient cash to meet operational needs. The economics and planning department continuously monitors the macro and micro economic environment impacting the Group’s business so as to ensure that management is informed of developments impacting capital decision making. Liquidity and funding risks and related processes and policies are overseen by management who maintain a market awareness. Lundin Petroleum’s policy is to limit credit risk by limiting the customers and partners to major oil companies and only use major banks. If there is a credit risk for oil and gas sales, the policy is to require an irrevocable letter of credit for the full value of the sale. Lundin Petroleum regularly assesses the benefits of interest rate hedging on borrowings. Credit risk The risk arises from cash and cash equivalents, deposits with banks and financial institutions as well as credit exposure to customers. Interest rate risk The uncertainty in future interest rates could have an impact on the Company’s earnings. The Group’s interest rate risk arises from long-term borrowings. Financial reporting risk The risk that material misstatements in financial reporting and failure to accurately report financial data could lead to regulatory action, legal liability and damage to the Company’s reputation. EXTERNAL RISK Geopolitical Risk The Company is, and will be, actively engaged in oil and gas operations in various countries. Changes to laws within these countries may lead to negative consequences such as but not limited to the expropriation of property, cancellation of or modification of contract rights, and or increased taxation. 1 The internal control system for financial reporting is in place to ensure the Group’s objective for financial reporting is fulfilled (See also page 52–53). The Company reviews its portfolio of assets in relation to its financial performance on a regular basis. The consideration of political risk elements is a key component driving investment decisions for the Company as a whole. Local laws are monitored and the Company strives to ensure comprehensive interpretation and compliance with any changes that may impact the business. For more detailed information regarding financial risks see also Note 14 in notes to the financial statements, pages 89–90. More information on the internal control is found in the Corporate Governance Report, pages 40–56. 61

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