Annual Report and Accounts 2007

Risk factors

BG Group’s business, results, financial condition and reputation could be affected by various risks. Not all these risks are within the Group’s control and the Group may be adversely affected by other risks besides those listed below. Actions being taken by management to mitigate some of these risks are identified where appropriate. Investors should carefully consider these risks in conjunction with the Legal Notice.

FLUCTUATING MARKET CONDITIONS

Commodity prices

BG Group’s results are sensitive to crude oil and natural gas prices which are dependent on a number of factors impacting upon world supply and demand. The Group’s exposure to short‑term changes in commodity prices is mitigated by the predominance of gas in its portfolio and the use of long‑term gas contracts, which are not directly or immediately linked to short‑term changes in commodity prices.

The Group’s exposure to commodity prices also varies according to a number of factors, including the mix of production and sales. The Group estimates that, other factors being constant, a US$1.00 rise (or fall) in the Brent oil price would increase (or decrease) operating profit in 2008 by around £40 million to £50 million.

Over the medium term, commodity price increases can cause supply or capacity constraints in areas such as specialist staff, construction or operations. This can in turn create cost pressure on BG Group’s operating and capital costs, which affect ongoing financial performance.

The Group does not, as a matter of course, hedge all commodity prices, but may hedge certain LNG contracts and gas and oil revenue streams from time to time. In marketing its gas supply portfolio, the Group undertakes commodity hedging and trading activities including the use of natural gas futures contracts, financial and physical forward-based contracts and swap contracts. The potential exposure to fluctuations in natural gas sales prices is also mitigated within certain LNG purchase contracts where the gas suppliers share price risk with BG Group.

Fluctuations in exchange rates

The Group’s cash flow, income statement and balance sheet are reported in pounds Sterling and may be affected by fluctuations in exchange rates. A substantial proportion of the Group’s business activity is conducted in US Dollars and the Group holds substantial US Dollar-denominated assets. The Group mitigates its exposure to its holding of US Dollar-denominated assets by borrowing in, or swapping, the majority of its borrowing into US Dollars. In general, the Group does not hedge US Dollar-denominated transactions, although it may do so for specific transactions, as authorised by the Finance Committee. BG Group estimates that, in 2008, other factors being constant, a 10 cent strengthening (or weakening) in the US Dollar against pound Sterling, would increase (or decrease) operating profit by approximately £140 million to £160 million. The Group’s net balance sheet exposure to currencies other than the US Dollar or pound Sterling, primarily to the Brazilian Real, is managed on a case-by-case basis. The Group mitigates its exposure to transactions in currencies other than pound Sterling or US Dollars by hedging certain expected cash flows into pound Sterling or US Dollars. Subsidiary undertakings that borrow without recourse to the Group are generally required to borrow in, or swap borrowing into, their respective functional currency.

Competition

Across the world there is strong competition in the energy sector. As a global business, BG Group faces increasing competition both from the National Oil Companies (NOCs), which control a substantial percentage of the world’s reserves, and the International Oil Companies (IOCs). This competition could make securing access to acreage, reserves and resources more challenging.

The Group also competes with other forms of energy available to consumers. Policies and regulations at the international level to tackle climate change will increasingly affect the business environment, presenting new challenges. Changes in the usage of alternative sources of energy such as renewables, liquid bio-fuels, hydroelectric power and nuclear power may have an impact on the Group’s ability to maintain market position. Failure to adequately analyse, understand or respond to the competitive environment could have an impact on the Group’s financial position.

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RESERVES GROWTH AND PROJECT DELIVERY

Strategic balance of the BG Group portfolio

BG Group has a global portfolio of assets and opportunities across its business segments. Failure to manage this portfolio effectively could have a material impact on the Group’s business. The Group conducts regular reviews of its portfolio balance, as appropriate, looking at numerous factors including segmental weighting, geographical weighting, political risk, and gas/oil mix. Nevertheless, the Group may still be exposed to risk factors such as: shifts in the demand for different hydrocarbon products as sources of energy; adverse changes in the business environment; increased taxes; and governmental regulation. Inability to leverage its market position and skills to access upstream reserves can also have a material impact on the Group’s strategy in the long‑term.

LNG is an increasingly important element of the Group’s business, and growth in this area is dependent upon the level of success the Group achieves in connecting competitively priced gas to high value markets. This could be affected by factors such as: barriers to the purchase or development of LNG export projects; environmental, permitting or other planning restrictions; and the global demand for LNG.

Finding new reserves

BG Group’s future gas and oil production is dependent upon finding, acquiring and developing new reserves. In general, the rate of production from natural gas and oil reservoirs declines as reserves are depleted. The Group needs to replace these depleted reserves with new proved reserves cost-effectively and on a consistent basis. This could be affected by a number of factors including: barriers to gaining new exploration acreage; inaccurate interpretation of geological and engineering data; unexpected drilling conditions or equipment failure; inadequate resources including drilling rigs, skilled personnel, contractors, materials and supplies; and disruptions to the successful implementation of the drilling programme.

Developing Reserves

Following the creation of exploration or new venture opportunities, certain activities are performed before an investment decision or “sanction” is made by management. These activities include commercialisation, feasibility studies, concept selection and definition. There are a number of risks during the pre-sanction phases, including sub-surface, engineering, commercial and regulatory risks. The principal risk prior to sanction is failure to assess accurately the project schedule and cost. Failure to select the most suitable development concept based on full ‘life cycle’ understanding of the project can expose projects to additional risk and cost.

If the Group is not successful in securing appropriate long‑term commercial agreements, in particular related to gas and LNG sales and transportation, it may be unable to commercialise its reserves, thus adversely impacting the Group’s cash flow and income. If the Group fails to adopt an appropriate procurement and project management strategy, it may experience delays to project schedule and cost. Gas-related projects often require a chain of commercial agreements, frequently amongst different parties. Failure to complete this chain or to apportion risks appropriately prior to project sanction can leave projects exposed to commercial risks that could affect the project economics.

Principal regulatory risks during the pre-sanction phase are failure to negotiate appropriate agreements, where required, with host governments, lack of appreciation of the regulatory framework in the host country and failure to gain applicable permits, licences or approvals from the relevant local authorities to carry out or operate certain works.

There are numerous uncertainties inherent in estimating oil and gas reserves. Reserves are estimated using available geological, technical and economic information. The process involves informed judgements and therefore estimates of reserves are not exact measurements and can be subject to revision. Published reserves estimates may also be subject to correction in the application of published rules and guidance.

Commercial

E&P operations are typically conducted under licences granted to BG Group and its partners (collectively the Contractors) by the state or national government or by entry into a Production Sharing Contract (PSC) between the Contractors and the state or national government (generally represented by a state-owned company). The terms and conditions of the licences and PSCs vary from country to country.

Licences generally give the Contractors the right to explore for, and exploit a discovery of, hydrocarbon resources whilst bearing the risk of, and providing funding for, the exploration, development and production activities. Licences granted by a state generally require Contractors to be jointly and severally liable, which means that the Group may be at risk for liabilities to host states if its partners fail to perform their contractual obligations or deliver their share of the E&P operations.

A PSC is an enforceable contract setting out the rules governing the co-operation between the Contractors and the host state. The Contractors usually bear the risk of funding the exploration, development and production operations, although the state company may participate in the funding of the development. Under the terms set out in the PSC, the Contractors recover their approved costs from the future production revenues and, in exchange for the risk of the investment, enjoy a share of the excess production revenues.

Financial and reputational exposure exists for failure to perform under its commercial agreements and the Group continually reviews these arrangements to ensure a high level of confidence in its ability to perform and to mitigate against any such liabilities should they arise.

Project Delivery

BG Group’s future gas and oil production is to a significant extent dependent upon the successful completion of development projects within budget, cost and specifications. The delivery of these projects is subject to HSSE, technical, commercial, legal, contractor and economic risks. Development projects may be delayed or unsuccessful for many reasons, including: cost and time overruns of projects under construction; failure to comply with legal and regulatory requirements; equipment shortages; availability, competence and capability of human resources and contractors; unscheduled outages; mechanical and technical difficulties; and gas pipeline system constraints. Projects may also require the use of new and advanced technologies, which can be expensive to develop, purchase and implement and may not function as expected.

Efficient Operations

The integrity of the Group’s assets can be affected by a number of factors, including unplanned shutdowns and equipment failure. Failure to have common, robust systems and processes in place across the Group may adversely impact plant availability, production volumes and ultimately cash flow. Failure to have good asset integrity and process safety practices could result in a safety or environmental incident.

Business activities conducted by the Group are often conducted with joint venture partners and some assets are under the day-to-day management of these partners and may therefore be subject to risks that are outside the control of the Group. The location of some of the Group’s operations may expose them to natural hazards such as hurricanes, flooding and earthquakes, each of which could materially impact the Group’s ability to deliver its products or services.

Individual segments of the Group’s activities are subject to specific operational and production risks. In the E&P segment, failure to adopt the correct reservoir and well management strategy could adversely affect the ultimate reserves recovery from the field and, consequently, reduce long‑term Group profitability and cash flow. Failure to manage effectively the global LNG chain, including shipping capacity and movements, port schedules, lifting and delivery timetables and the related impact of weather conditions, may lead to market opportunities being missed, penalty payments or other factors adversely affecting the Group’s financial performance. The successful management of daily supply and demand across the Group’s T&D assets is critical to ensure consumers’ supplies are secure.

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Health, Safety, Security & Environment

A major HSSE incident could result in injury or loss of life, damage to the environment or destruction of facilities, each of which could have a material impact on BG Group.

BG Group recognises that the protection of the health and safety of its employees, and others affected by its operations, is an essential element in delivering business performance, as are the security of physical and intellectual assets and the protection of the natural environment.

Policies and measures at the international and national level to tackle climate change will increasingly affect business conditions, presenting environmental and regulatory risks. Similarly, measures to tackle loss of biodiversity may limit access to oil and gas resources in areas deemed to be biologically sensitive.

The increased threats from international terrorism and violent crime could also interrupt the Group’s operations to a material extent.

POLITICAL, REGULATORY AND STAKEHOLDER

Political context

The success of the Group depends in part on understanding and managing the political and other contextual issues in the many diverse countries in which it does business. Specific areas of country risk that could have an effect on BG Group’s business and reputation include: international disputes and conflict; the imposition of international sanctions; civil disorder; government instability; changes in government policy, laws, regulations, standards or fiscal terms; re-interpretation of existing tax laws; government intervention in licence awards; expropriation of assets; cancellation, variation or breach of contractual rights; and political obstacles to project approvals and delivery. Effective stakeholder engagement (see Stakeholder Engagement) is a key component of political and contextual risk management.

Regulation

BG Group’s business activities are conducted in many different countries and are therefore subject to a broad range of legislation and regulation. BG Group faces value erosion if the conditions attached to licences, which govern operations, are not properly managed or delivered. In addition, future growth of assets may be affected if required regulatory authorisations are not obtained.

The Group’s T&D companies mainly operate under a form of licence or concession agreement awarded by the state or national government. Normally, the tariff that gas customers are charged is determined by the regulator and reviewed periodically in line with licence terms and conditions. The Group may be at risk of unfavourable tariff reviews which may have an impact on T&D income and growth.

The Group’s LNG and gas marketing activities also operate within market rules set down by the respective regulator. Typically, these regulations evolve over time. The Group faces value erosion if it does not respond to changes in these market rules and ensure compliance.

Many of the countries in which the Group conducts, and expects to conduct business are developing new regulatory frameworks. These regulatory frameworks, and their interpretation and application by administrative agencies, may be specific to a given market and untested. BG Group may be offered the opportunity to help shape suitable regulations but with no guarantee that account will be taken of its representations. Regulatory frameworks will continue to evolve as markets mature and this will also affect the Group.

Stakeholder Engagement

A number of stakeholders (including employees, investors, media, governments, civil society groups, non-governmental organisations and those living in local communities affected by BG Group’s operations) have legitimate interests in the Group’s business. The Group’s reputation and/or share price could suffer due to inappropriate or inadequate engagement with stakeholders, including, for example: failure to develop proactive stakeholder engagement strategies, delivery of inconsistent messaging to key stakeholders on business objectives and strategy; failure to provide adequate explanations if performance targets are not met or if performance is perceived as poor against competitors; and inadequate responses to any crisis (including financial market challenges, such as a hostile bid) or a major HSSE incident.

Corporate Responsibility

BG Group defines corporate responsibility as the Business Principles in practice (see Corporate Responsibility for further information). BG Group’s failure to implement its Business Principles and/or any ongoing or damaging investigations of BG Group could impact the Group’s reputation and/or share price. Each of the following risks could affect the Group’s ability to deliver projects on time and within budget and damage BG Group’s reputation: failure to consider and manage environmental impacts, social consequences and human rights in investment decisions, project planning and operational management; failure to identify stakeholder expectations; and weak governance and internal controls, including the ineffective implementation of anti-corruption policies.

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Brindisi LNG terminal criminal and other proceedings

The Court of Brindisi is pursuing a criminal investigation in connection with alleged improper conduct associated with the authorisation process for the planned Brindisi LNG regasification terminal. Further details of the criminal proceedings are provided in note 27. As part of the criminal investigation, the Brindisi LNG terminal site was seized by the Italian authorities in February 2007. It is not possible at this time to predict with any certainty when the seizure order will be lifted or the outcome of the criminal proceedings. It is also not possible to predict whether there might be additional investigations by the Italian authorities resulting from the circumstances surrounding the current investigations.

If the allegations of improper conduct are proven to be well-founded, BG Group entities could face a wide range of sanctions that could be imposed by the competent authorities, including criminal and civil fines, penalties, the revocation of authorisations and injunctive sanctions. Moreover, detecting, investigating and resolving such matters could be expensive and consume significant time, attention and resources of BG Group management.

There are various other legal proceedings ongoing relating to the Brindisi LNG regasification terminal, for example relating to the suspension of the original ‘Article 8’ approval (See operating review), consents necessary for the construction work and environmental procedures. The impact of these proceedings cannot yet be quantified but could delay or deny BG Group access to the Brindisi LNG terminal site.

HUMAN RESOURCE AND ORGANISATION

BG Group’s performance and its ability to mitigate significant risks within its control depend on the skills and efforts of its employees and management teams. Future success will depend to a large extent on the Group’s continued ability to attract, retain, motivate and organise its highly skilled and qualified personnel. This in turn will be impacted by competition for human resources. If the Group loses the services of key people or is unable to attract and retain employees with the right capabilities and experience, it could have an effect on the Group’s business and operations.

Effective organisation of the Group’s human resources relies upon the development and delivery of an organisational design aligned to the Group’s business objectives. Failure to effectively implement organisational design, or to adapt the organisation as the Group grows, could have a material adverse effect on the delivery of business objectives. The Group regularly reviews its organisational design to align it to the Group’s business objectives and a new three region structure and new Senior Vice President roles reporting to the Group Executive Committee have been implemented with effect from 1 January 2008.

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TREASURY, CREDIT AND INSURANCE

Interest rate and liquidity risk

The Group’s financing costs may be significantly affected by interest rate volatility. The Group is also exposed to liquidity risks, including risks associated with refinancing borrowings as they mature, the risk that borrowing facilities are not available to meet cash requirements, and the risk that financial assets cannot readily be converted to cash without loss of value. Failure to manage financing risks could have a material impact on the Group’s cash flow, balance sheet and financial position.

The Group’s interest rate management policy requires that the interest rate obligations of BGEH Borrowers be substantially floating, and sets limits on the maximum amount of fixed rate exposure from time to time.

The Group manages liquidity risk by maintaining adequate committed borrowing facilities and holding its financial assets primarily in short-term, highly liquid investments that are readily convertible to known amounts of cash. Refinancing risk is managed by limiting the amount of borrowing that matures within any specific period.

Credit

BG Group is exposed to credit risks, being the loss that would be recognised if counterparties failed to, or were unable to, meet their payment obligations. These risks may arise in certain agreements in relation to amounts owed for physical product sales, the use of derivative instruments and the investment of surplus cash balances. The Group is also exposed to political and economic risk events, which may cause non-payment of foreign currency obligations to BG Group.

The Group considers each counterparty’s financial condition prior to entering into commercial contracts, trading sales agreements, swaps, futures and options contracts. Credit exposures are monitored for individual transaction and concentration risk. Where multiple transactions are undertaken with a single counterparty, or group of related counterparties, the Group may enter into a netting arrangement to reduce the Group’s exposure to credit risk. Currently, the Group makes wide use of standard International Swaps and Derivative Association (ISDA) documentation for financial transactions. This provides netting of transactions covered by the specific ISDA documentation. For physical commodity trading, BG Group seeks to put in place bespoke master netting agreements or European Federation of Energy Traders (EFET), North American Energy Standards Board (NAESB) and National Balancing Point (NBP) agreements, as appropriate.

Insurance

A comprehensive insurance programme is maintained to mitigate significant losses, which, as is consistent with good industry practice, includes cover for physical damage, removal of debris, control of wells, re-drill, pollution and employer’s and third-party liabilities. Nevertheless, some of the major risks involved in BG Group’s activities cannot, or may not, reasonably and economically be insured.

The programme is subject to certain limits, deductibles, and terms and conditions. In addition, insurance premium costs are subject to changes based on the overall loss experience of the insurance markets accessed.

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