Bank of America, N. A. provides corporate banking and global markets products and services generally throughout the United States and offshore. Investment banking services and certain securities products, which may be referred to in the accompanying materials, may be provided through Banc of America Securities LLC in the United States or through certain other affiliates of Bank of America, N. A. Copyright 2007 Bank of America Corporation. Commodity Risk Management For ABC Producer June 2007 Jon Efken Global Commodities Tel: 312 -234 -3345 Fax: 312 -234 -3345 Jon. Efken@bankofamerica. com 1
Table of Contents u Overview u Historical Prices u Commodity Hedging Alternatives u Documentation Note: All pricing shown is for illustration only and not indicative of the current market 2
Overview 3
Energy Risk Management – Our Objective u To provide corporate risk management services and structured solutions that meet customers’ needs. We provide these services to users, producers and investors of commodities. 4
Commodities Hedging Our Mission and Clients u Investors/Relative Value Trading To provide corporate risk management services and structured solutions that meet customer needs u u Relative Value Traders u consumers, and being a leading market maker, Bank of America provides competitive bid and offer pricing in many Hedge Funds u By dealing with both producers and Directional and Arbitrage Desks markets Producers Consumers u u Industrial Consumers u Oil Refiners u Regulated Utilities u u Oil and Natural Gas Producers Energy Asset Investors u Transportation Industry We provide these services to commodity consumers, producers and investors in the areas of: Energy-Linked Finance l Natural Gas u Forward Sales l Petroleum u Electricity u l Metals (base & precious) Credit-Enhanced Reserve Financing u We have two trading centers (New York, London) as well as four coverage offices (New York, London, Charlotte and Chicago) Reserve Based Financing l u Inventory Monetizations 5
Global Commodities Capabilities ENERGY COMMODITIES CAPABILITIES u u Oil/Petroleum Products l Global platform – U. S. , International l Refined product capabilities l Comprehensive oil and refined product options Natural Gas l Consistently ranked “Top Tier” financial product provider l Comprehensive gas options capabilities Electricity l Dominant Northeast financial trading presence l Trading presence in West and Midwest Research l World-class oil and natural gas research OTHER COMMODITY CAPABILITIES u u u Liquefied Petroleum Gases l Propane l Ethane l Butane Base Metals l Aluminum l Copper l Zinc l Lead l Nickel l Tin l NASAAC Precious Metals l Gold l Silver l Platinum l Palladium BANK OF AMERICA RATINGS Bank of America, NA Credit Ratings Aaa AA+ Source: Bank of America, NA; Bloomberg; Energy & Power Risk Management Magazine 6
Energy Capabilities: Petroleum u Crude Oil (North America, Europe and Asia) u Refined Products (North America, Europe and Asia) Gas 20°c 40°c Naptha 70°c Crude Oil Gasoline 120°c Jet Fuel Distillation Column Gas Oil / Diesel Fuel 200°c Lubricating Oil 300°c Heavy Gas Oil Residual Fuel Boiler 600°c 7
Energy Capabilities: Natural Gas u Over 50 Natural Gas locations (Benchmarks include Inside FERC’s Gas Market Report, Natural Gas Intelligence, Canadian Gas Price Reporter) u Natural gas indexation in Europe (Indices include HEL, HSL, NBP as well as CSS, Unapace, CMP and PA Formulae) ROCKY MOUNTAINS/WEST COAST Colorado Interstate Gas - Rockies CIG Northwest Pipeline - Rockies NWPL Questar Pipeline - Rockies Kern River Gas Transmission – Wyoming PG&E Malin PG&E Citygate So. Cal Border MID-CONTINENT Panhandle Eastern Pipeline - TX, OK ANR Pipeline - OK Natural Gas Pipeline - Midcon NGPL Northern Natural Gas - Ventura, Iowa Northern Natural Gas - Demarcation Chicago Citygate Williams Natural Gas - TX/OK/KS Michigan Consolidated Gas Company - Mich. Con Centerpoint Energy Gas Transmission Co. East Natural Gas Pipeline –TX, OK Oneok Gas Transportation LLC - OK CANADA AECO - C/NIT Northwest Pipeline-Canadian Border (Sumas) NORTHEAST Dominion Transmission Inc. Appalachia Index Columbia Gas Transmission Appalachia TECO Transcontinental Gas Pipeline – Zone 6 (New York only) TRANSCO Texas Eastern Zone M-3 GULF COAST Columbia Gulf Transmission - LA Southern Natural Gas - LA SONAT Tennessee Gas Pipeline - LA & Offshore (zone 1) Texas Gas Transmission - Zone 1 Texas Gas Transmission - Zone SL Transcontinental Gas Pipeline - Zone 2 TRANSCO TEXAS Transcontinental Gas Pipeline - Zone 3 Houston Ship Channel TRANSCO Tennessee Gas Pipeline - TX (zone 0) Transcontinental Gas Pipeline - Zone 4 (Miss, Texas Eastern Transmission - S. TX TETCO STICKS AL) TRANSCO Transcontinental Gas Pipeline - Zone 1 TRANSCO ANR Pipeline - LA El Paso Natural Gas - San Juan Henry Hub El Paso Natural Gas – Permian Natural Gas Pipeline - LA NGPL Waha Texas Eastern Transmission - E. LA TETCO East Texas - Katy Texas Eastern Transmission - W. LA TETCO Trunkline Gas – LA Florida Gas – Zone 1 Florida Gas - Zone 2 Florida Gas - Zone 3 8
Historical Pricing 9
NYMEX WTI Crude Oil Market Update u Prices have been supported lately by elevated geopolitical tensions worldwide. Continued disagreement over Iran’s nuclear capabilities, along with unrest following elections in Nigeria pose the greatest upside risk to crude oil. u Historically high levels of storage at Cushing, OK (delivery point for the benchmark WTI grade) have kept prices in check. As refineries resume normal levels of operation during the summer driving season, however, this downward pressure could be lost. u The IEA reported that oil stocks in industrialized nations experienced their largest first quarter decline since 1996, driven by OPEC’s successful production cuts. It also said that OPEC would need to increase production before the summer in order to prevent a sharp decline in OECD inventories. u Recent resource nationalization that has swept Venezuela, Bolivia, and Russia threatens supply stability in these countries as state control can lead to misappropriation of revenues that choke investment. NYMEX WTI Crude Oil Prices NYMEX WTI Crude Oil Forward Curves DOE Crude Oil Storage 10
Natural Gas Market Update u With La Niña now taking hold in the Pacific and weaker than average NYMEX Natural Gas Forward Price Curves ($/MMBtu) trade winds over the Atlantic, early season tropical activity have been bullish for prices. Tropical Storms Barbara and Barry, both forming before the official start to hurricane season, have given support to prices. u A record 2. 5 Bcf per day of Liquefied Natural Gas (LNG) was reportedly imported in the first four months of the year as sellers attempted to capture higher prices than those offered in Asia and Europe. It is expected that this rate will be sustained until August when Asian utilities begin purchasing gas for storage. u The natural gas rig count as reported by Baker Hughes stands near its all-time highs, pointing to the possibility of record high domestic production in the future. u Inventories are well above five-year averages, but are still at a healthy deficit year-over-year. Fuel switching away from residual fuel and into natural gas by utilities during a warm summer could keep gas from being injected into storage. NYMEX Natural Gas Prices ($/MMBtu) US Natural Gas Inventories Source: Bank of America NA; Bloomberg 11
OTC Hedging 12
Commodity Hedging Over-the-Counter Hedging - managing price risk off-exchange with a financial contract u Advantages l l Longer trading maturities are available in the OTC markets than are available on the futures market. l The financial benchmarks available include NYMEX crude oil (WTI) as well as Brent crude and for natural gas include NYMEX natural gas as well as more than 60 other indexes. l The OTC market may offer better liquidity in the medium and long term (beyond six months). l Confidentiality can be assured. l No additional commissions, fees, and potentially no initial/maintenance margining. l u OTC transactions are highly tailored (basis, volume, structure). Management of an OTC program can be much easier than an exchange-traded program. Disadvantages l You would be exposed to the credit quality of your counterparties Ø l Bank of America’s long term debt is rated Aaa/AA+ by Moody’s and Standard and Poor’s. There is little price transparency (no screen). 13
Basis Risk What is Basis Risk? Basis risk is the mismatch between the price you receive on your physical sales and the floating price you pay on your hedge. This is the reason benchmark selection is so important. You need to ensure that the price you receive on your physical sales is highly correlated with your hedge benchmark to minimize or eliminate your basis risk. 14
OTC Products u Swaps u Options (calls, puts) u Collars u Three-Ways u Extendables u Basis Swaps u Swaptions u Other (exotics, combinations) 15
Swap u NYMEX WTI Crude Oil Swap l This enables ABC Producer to lock in a price for oil. l There is no up-front premium. l ABC Producer is protected from prices below the swap price, however, the Producer will not benefit from prices above the swap price. l Physical sales price must be strongly correlated to the hedge benchmark. Floating Price Basis Risk is the degree to which these are not correlated. ABC Producer Refiner Physical Oil Floating NYMEX WTI crude oil $70. 00/bbl Bank of America Note: Prices used throughout this presentation are for illustrative purposes only and may not be indicative of current market pricing. 16
NYMEX WTI Crude Oil Swap Fixed Price Payer: Bank of America Floating Price Payer: ABC Producer Fixed Price Payment: $70. 00 bbl x volume Floating Price Payment: The average over the calendar month of the official daily settlement price for the first listed crude oil futures contract as traded on the New York Mercantile Exchange times the Monthly Volume: 5, 000 bbls/month Term: July 2007 – June 2008 Payments: Five Business Days following each settlement period, if the Floating Price Payment exceeds the Fixed Price Payment, ABC Producer will pay Bank of America the net difference times the monthly volume. If the Fixed Price Payment exceeds the Floating Price Payment, Bank of America will pay ABC Producer the net difference times the monthly volume. 17
NYMEX Natural Gas Swap Fixed Price Payer: Bank of America Floating Price Payer: ABC Producer Fixed Price Payment: $8. 73 / MMBtu x volume Floating Price Payment: The last trading day’s official settlement price for the Henry Hub natural gas futures contract as traded on the New York Mercantile Exchange times the Monthly Volume (alternatively, the average over the last three trading days or penultimate day pricing can be used. ) Monthly Volume: 200, 000 MMBtus/month Term: July 2007 – June 2008 Payments: Five Business Days following each settlement period, if the Floating Price Payment exceeds the Fixed Price Payment, ABC Producer will pay Bank of America the net difference times the Monthly Volume. If the Fixed Price Payment exceeds the Floating Price Payment, Bank of America will pay ABC Producer the net difference times the Monthly Volume. 18
Put Option NYMEX WTI Crude Oil Put Option l If prices fall below the put strike price, payments are made to ABC Producer equal to the difference. l ABC Producer will make no more payments after the upfront premium is paid. l Unhedged Volume ABC Producer pays an upfront premium for protection from prices below the put strike price. l Price Protection Under a Put Option ABC Producer is able to retain 100% of the upside if market prices rise (minus premium paid for the put). Revenue u Hedged Volume with Floor (realized revenue includes premium paid upfront) Market Prices 1 Option premium paid upfront and not taken into account for the payments shown. 19
NYMEX WTI Crude Oil Put Option Floor Option Buyer: ABC Producer Floor Option Seller: Bank of America Floor Strike Price: $63. 00/bbl Premium: $2. 28/bbl Price Benchmark: The average over the calendar month of the official daily settlement price for the first listed crude oil futures contract as traded on the New York Mercantile Exchange times the Monthly Volume: 5, 000 bbl/month Term: July 2007 – June 2008 Payments: Five Business Days following each settlement period, if the Price Benchmark exceeds the Put Strike Price, no payments are made. If the Price Benchmark is less than the Put Strike Price, Bank of America makes payments to ABC Producer equal to the difference times the Monthly Volume. 20
Costless Collar u NYMEX WTI Crude Oil Costless Collar l Collars involve buying a put option and selling a call option. l ABC Producer receives the same protection as a put option provides. However, instead of paying an upfront premium, ABC Producer “pays” for this put option by selling a call option. l ABC Producer loses the benefit of rising prices above the call option strike price. l Most collars are costless, meaning the upfront premium owed for the put option is offset by the upfront premium received for the call option. 21
NYMEX WTI Crude Oil Costless Collar Cap Buyer/Floor Seller: Bank of America Cap Seller/Floor Buyer: ABC Producer Floor Strike Price: $63. 00/bbl Cap Strike Price: $77. 50/bbl Premium: $0/bbl Monthly Volume: 5, 000 bbl/month Term: July 2007 – June 2008 Price Benchmark: The average over the calendar month of the official daily settlement price for the first listed crude oil futures contract as traded on the New York Mercantile Exchange times the Monthly Volume. Payments: Five Business Days following the settlement period, if the Price Benchmark is below the Put Strike Price, Bank of America will pay ABC Producer the net difference times the Monthly Volume. If the Price Benchmark is between the Put Strike Price and the Call Strike Price, no payments are made. If the Price Benchmark is above the Call Strike Price, ABC Producer will pay Bank of America the net difference times the Monthly Volume. 22
Three-Way u NYMEX WTI Crude Oil Three-Way l Three-ways are essentially costless collars where ABC Producer buys a put and sells a call, but sells an additional put option below the first put strike price. l The sale of this second put raises additional premium and this premium can be used to enhance either the strike price of the sold call (to raise it), or to raise the first put strike. l In essence, zero premium at-the-money protection can be achieved by setting the higher put strike at the market level. This is not possible with a zero cost collar. l ABC Producer has price protection between the two put strike prices, and mitigated floating exposure below the lower put strike. l ABC Producer does not float above the sold call strike price, and will be locked in at the call strike if the market rises above this level. 23
NYMEX WTI Crude Oil Three-Way Call Buyer/Put 2 Seller/Put 1 Buyer: Bank of America Call Seller/Put 2 Buyer/Put 1 Seller: ABC Producer Put 1 Strike Price: $55. 00/bbl Put 2 Strike Price: $65. 00/bbl Call Strike Price: $78. 50/bbl Premium: $0/bbl Monthly Volume: 5, 000 bbl/month Term: July 2007 – June 2008 Price Benchmark: The average over the calendar month of the official daily settlement price for the first listed crude oil futures contract as traded on the New York Mercantile Exchange times the Monthly Volume. Payments: Five Business Days following the settlement period, if the Price Benchmark is below the lower Put Strike Price, Bank of America will pay ABC Producer the net difference between the two Put Strike Prices times the Monthly Volume. If the Price Benchmark is between the two Put Strike Prices, Bank of America will pay ABC Producer the net difference times the Monthly Volume. If the Price Benchmark is between the Put Strike Price and the Call Strike Price, no payments are made. If the Price Benchmark is above the Call Strike Price, ABC Producer will pay Bank of America the net difference times the Monthly Volume. 24
Extendable u NYMEX WTI Crude Oil Extendables are essentially swaps where ABC Producer enters into a receive fixed swap, but sells Bank of America the right to extend the swap at the same price and volume. l The sale of this option raises additional premium which can be used to enhance the swap price. l ABC Producer is protected from prices below the swap price, however, the Producer will not benefit from prices above the swap price. l If prices are above the swap price at the time of the exercise date, Bank of America will extend the swap, effectively locking in ABC Producer in at a rate below market. 25
NYMEX WTI Crude Oil Extendable Fixed Price Payer/Right to Extend: Bank of America Fixed Price Receiver/Option Seller: ABC Producer Swap Price/Extendable Price: $74. 00/bbl Premium: $0/bbl Monthly Volume: 5, 000 bbl/month Term: July 2007 – June 2008 Extendable Term: July 2008 – June 2009 Exercise Date: June 30, 2008 Price Benchmark: The average over the calendar month of the official daily settlement price for the first listed crude oil futures contract as traded on the New York Mercantile Exchange times the Monthly Volume. Payments: Five Business Days following each settlement period, if the Floating Price Payment exceeds the Fixed Price Payment, ABC Producer will pay Bank of America the net difference times the Monthly Volume. If the Fixed Price Payment exceeds the Floating Price Payment, Bank of America will pay ABC Producer the net difference times the Monthly Volume. Exercise: At any point on, or up to, the exercise date, Bank of America has the right to extend the swap at the same price and volume. 26
Benefits and Risks Swap Risks • There is no upfront premium. • Benefits ABC Producer is protected from prices below the swap price • ABC Producer cannot benefit from prices above the swap price. Put Option • • • Once ABC Producer pays the up-front premium, there are no further payments. Costless Collar Extendable • ABC Producer pays no up-front premium • There is no up-front premium. • ABC Producer is able to retain upward price participation until the call strike is reached. ABC Producer is protected from prices below the put strike. • The put spread provides protection from downward price moves, but limits the maximum payout to the difference between the two put strikes. • ABC Producer is protected from prices below the swap price. • The sold option gives ABC Producer a swap price well over normal swap levels. ABC Producer cannot benefit from prices above the call strike and is not protected from prices down to the put strike. • There is no upside participation above the call strike. • ABC Producer cannot benefit from prices above the swap price. • The maximum payout is limited to the difference between the two put strikes. • ABC Producer cannot benefit from higher prices if they exist at the time of exercise. ABC Producer is able to retain 100% of the upside if market prices rise (minus the premium paid for the put). ABC Producer pays the up-front premium and prices stay above the put strike. Three-Way • 27
Floating Price Benchmarks u In summary, here are some of the more common floating price benchmarks against which an OTC hedge could settle: l Crude Oil Ø l The average over the calendar month of the daily settlement price for the first listed NYMEX WTI futures contract. Natural Gas Ø The average over the last three days of the daily settlement price for the NYMEX natural gas futures contract. (Alternatively, this could be the last day settlement or penultimate day settlement only. ) Ø The first published Index price of the month for (specific pipeline) as published by Inside FERC’s Gas Market Report. (Alternatively, we can reference prices in Natural Gas Intelligence, Canadian Gas Price Reporter and, in some instances, monthly average prices from Gas Daily. ) 28
Documentation 29
Early Termination OTC Trades may be unwound prior to maturity of the transaction. The value of the transaction is determined as the current market value for the remaining term of the transaction multiplied by the remaining notional volume. For a receive fixed swap transaction, for example, the current market value of the swap is calculated by comparing the original fixed rate with the current market rate for the remaining term of the swap multiplied by the remaining volume. If the current market rate is greater than the original swap rate, the customer would make a payment to Bank of America for the difference times the remaining notional volume. If the current market rate is less than the original swap rate, Bank of America would make a payment to the customer for the difference times the remaining notional volume. 30
Accounting Considerations u FAS 133 Accounting Standards l FAS 133 requires all derivatives to be shown on the balance sheet at fair value. Ø Ø Companies must document hedge strategies and “test” the effectiveness of hedges to qualify for “hedge” accounting. Ø l Changes in fair value will go through earnings unless the transaction qualifies for special “hedge” accounting. Even with “hedge” accounting, any ineffective portion of the hedge will be charged to earnings immediately. The two types of hedges qualifying for special accounting are Cash Flow hedges and Fair Value hedges. Ø With respect to interest rate risk management, a cash flow hedge converts a floating rate exposure on an existing asset or liability to a fixed rate. Hedges of anticipated issuance are also cash flow hedges. An example is a pay-fixed swap used to convert a LIBOR-based bank loan to a fixed-rate liability. Ø A fair value hedge converts a fixed-rate exposure to a floating-rate basis. An example is a receive-fixed swap used to convert a fixed-rate bond to a floating-rate LIBOR-indexed liability. Note – BAC is not an accounting or tax advisor. Please consult with your auditors to determine the appropriate treatment for your company. 31
Documentation u Energy hedging transactions are principally documented under the International Swap Dealer’s Association (“ISDA”) Master Agreement and Schedule. The documentation associated with most energy hedging transactions consists of the following: u ISDA Master Agreement: The ISDA Master Agreement is an industry standard document which governs all energy hedging transactions. The Master Agreement addresses the following: l Netting benefits: exposure, payments, multiple transaction termination l Events of Default: termination mechanics l Bilateral provisions: industry standard document l Evergreen document u Schedule to the ISDA Master Agreement: The Schedule is utilized to tailor the standard documentation in order to address the individual Company. The schedule will include the specifics on credit support and structure. u Confirmation: The Confirmation presents all the details of the transaction including prices, volume and time period covered. u Combination of Master Agreement, Schedule and Confirmations form a single agreement. Negotiation and execution of Master Agreements is the responsibility of the Bank of America’s Derivatives Documentation Unit. 32
Disclaimer u Each prospective counterparty should conduct a thorough and independent review (either itself or with such advisers as it deems appropriate) of the legal, tax and accounting aspects of any proposed transaction in light of its particular circumstances. u Although the information set forth herein is indicative of the terms, as of the specified date, under which Bank of America believes a transaction might be structured, no assurance can be given that such a transaction will in fact be executed. u Information contained in this presentation has been obtained from sources believed to be reliable, but its accuracy or completeness is not guaranteed by Bank of America. u This presentation is for informational purposes only and is intended solely for your use. It does not constitute an offer to buy or sell or a solicitation of an offer to buy or sell a security or any financial instrument, or to execute a derivative transaction, of the type generally described herein. u The information contained herein, and any other communications or information provided by Bank of America, are not intended to be, and shall not be regarded or construed as, recommendations for transactions or investment advice, and Bank of America shall not be relied upon for the same without a specific, written agreement between us. 33
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