Achieving World Class Deal Flow Pre-Reading - Risk Workshop II March, 1999

1. Achieving World Class Deal Flow Pre-Reading - Risk Workshop II March, 1999

2. Best Practices Overview • What are Best Practices • Attributes and principles used by companies to achieve exceptional performance, while also establishing the foundation for continuous improvement • Techniques and rules-of-thumb for effective process performance that provide useful guidelines in redesigning processes for greater simplicity, productivity, quality, speed and adaptability • Complimentary process to both the problem-solving process and the quality improvement process • The admission that another company is capable of doing something better than you... Helps the company set targets and determine how to reach them…Achievement typically requires stretching and new levels of performance • Why Study Best Practices • Learn from the best of the best • Don't make the same mistakes others made • Change quicker than the competition • Generate creativity, encourage radical thinking and shift paradigms • Form a basis of comparison of our results, outputs, methods, processes or practices to those of other companies in a systematic way 2

3. Best Practices Overview Thinking "Out of the Box" Functional Best Practices-Any Company Industry Best Practices Internal Best Practices by Function Functional Best Practices-World Class Competitors Best Practices 3

4. Best Practices Overview Benefits • What are the Benefits • Focus on external standards instead of internal edicts • Provide performance perspective needed to motivate entrepreneurial behavior • Promote process improvement based on opportunity, not history • Seek to incorporate the best methods for meeting customer needs, not just process improvement • Establish internal goals based on a concerned view of external conditions • Determine true measures of productivity • Attain and maintain a competitive position • Value to Equiva Trading Company • Establish reference points for the development of stretch targets • Discover actions that can be integrated into process improvement plans to close the performance gap • Instill mechanisms that reinforce desired behaviors to ensure successful implementation of best practice concepts … use measurements and rewards to develop behavior 4

5. Best Practices Overview Mistakes to Avoid When Identifying • Failure to consider companies from other industries, where the practice is of strategic importance to the company. • Failure to consider practices from other areas of your organization. When Applying • Failure to understand the unique circumstances that made the best practice successful elsewhere. • Failure to adapt the best practice to your company’s unique circumstances. • Failure to overcome the ‘we’ve tried that before’ mentality, which may not account for design improvements, technology changes, etc., that will allow it to work this time. • Failure to extend and improve upon the best practice. When Implementing • Failure of the project team to obtain the executive backing and credibility needed to implement the best practice. • Failure to devote the resources necessary to implement the best practice. 5

6. Best Practices

7. Best Practices - Plan the Deal • Supply/Demand forecasts are maintained and accessed from a single source. • Planning analysts support commercial activities and strategy. • Traders in all locations covering a specific book utilize a common trading strategy. • Exchange balances are used as a trading tool, prioritizing every exchange partner. • A clear process exists for establishing hedge programs and their justification (how risk management adds value vs. benchmark). • An independent function outside trading evaluates models (e.g. forward curves) periodically for validity • A deal review (product development) committee enables: • Traders to have a measure of their profitability • Traders to know what was accomplished yesterday • Intelligent and well-communicated entry into new markets • Effective communication exists in strategy between trading books, analytics and risk management is facilitated through a central structuring desk. • A pre-approved counterparty list is maintained for traders, including access of available credit to specific counterparties for traders prior to making the transaction. 7

8. Best Practices - Make the Deal • The process prohibits transactions prior to credit approval of customer/counterparty and establishment and authorization of an appropriate credit line. • Best practice is to have infrastructure and process which allows deal entry to only be one time, excluding that done for analytic, strategy, etc. • Every trade should have an exit strategy before the deal is made • The rationale for each transaction is clearly documented at the time of execution (typically captured on the Deal sheet). Additionally loss limits are set on the trade if it is TPT. The Deal sheet is completed immediately if possible and required to be completed within 24 hours of an execution. • A documented process addresses the counterparty credit worthiness evaluation; establishment of limits; netting agreements and collateral requirements; & establishment of ISDA agreements. • Various market risk exposures associated with each trade (e.g. flat price, basis, index, optionality) are disaggregated into separate risk groups for risk management and reporting purposes. • Opportunities are evaluated by a combined team of traders and operations personnel. • Exchange transactions are evaluated as if spot purchases, and compared to market benchmarks. • Various functions are represented during trading meetings - across function (e.g. risk, trading, scheduling, refining) and across commodity (e.g. crude, products, risk) 8

9. Best Practices - Execute the Deal • Contract administration process efficiently and accurately creates contract, notifies affected parties and ensures all parties are in compliance with credit, tax, legal, regulatory (e.g. FAS 133) and customer guidelines to protect company’s interest in the event of a dispute. • All involved parties in contract’s deal flow are provided with on-line, real-time access to the same data • There is a structured and formalized distribution of deal information to appropriate personnel after initiation of the deal. • There is a standardized method for capturing complex contract terms and conditions. • Clear methodology and procedure exists for what, when & how an organization administers contracts and contract deal confirmations. • Coordinate Deal Process with Credit Dept to assure LC's are posted timely; Prepay's have verifiable receipts • Same day confirmations by phone. Outgoing confirmations for all financial o-t-c transactions prepared and issued within 24 hours. 9

10. Best Practices - Measure the Deal • Forecast or plan accuracy is measured and tracked as a basis for continuous improvement. • Commercial activities are organized into pools of similar exposures called ‘books’ to measure the profitability and risk related to these activities. All components of a deal (e.g. freight, demurrage) show up in the associated book. • All transactions are marked-to-market daily. Price information is taken from consistent and, wherever possible, independent sources. • Inventory data is received on a real time basis through automated feeds, classified by location, product and customer, and performance is measured against pre-set targets. • Exchanges are measured as spot transactions. This involves: (1) marking-to-market daily against market benchmarks and (2) measuring the operators’ ability to manage exchange balances to targets. • The price risks of physical and financial trading positions are continuously measured using analytical techniques, such as Value at Risk (VaR), simulation and stress testing. • Activity is measured and reported daily against multiple limit types (e.g. volumetric, regional, stop loss, value at risk, stress) by an independent function. Limit violations are reported to the appropriate management level as soon as they occur. • Trading groups are measured both on profitability and service provided to internal customers (e.g. refining, marketing). Within the group, relative compensation is determined by each function’s perceived contribution (e.g. analyst trader, scheduler) to the group performance and goals. • Trading performance measures incorporate price risk. This risk adjusted return measure is actively utilized to allocate risk capital to more successful traders by changing limits. • All of the following components of credit available to counterparties are measured against pre-set limit(s) and reported to management: • Current replacement value (the positive mark-to-market exposure to the customer, supplier or counterparty) • Additional potential exposure embedded in the transaction • Accounts receivables/payables • Preferential payments (those payments due to recapture in the event of bankruptcy) 10

11. Best Practices - Settle the Deal • Builds in capture of FAS 133 accounting information on a continuous basis rather than at back-end • Automated invoicing, cash transfers and collection. • Allows accurate and easy linking and reconciliation between physical and financial positions. • Promote quality and accountability at the source of accounting transactions by returning errors to originator for correction on a timely basis. • Settlement system should provide list of discrepancies every day to deal with on an exception basis • Utilize shared services for common processes – accounts payable, accounts receivable, collections and compliance reporting • Bulk transactions are actualized immediately and invoices issued to partners on the same day, usually within a day of actual movement. 11

12. IPO Analysis

13. IPO Analysis • IPO stands for Input, Process, Output. • There is one chart for each silo of the Equiva business model (plan, make, execute, measure, settle). • The following IPO charts include the inputs and outputs identified in the Crude and Products Envisioning Session. • We will have these IPO charts and their associated process maps in the Risk Envisioning Session as a reference. • Review these charts prior to our workshop. What is missing from a Risk Service prospective? 13

14. IPO - Plan the Deal Input: Output: Supply Information/Forecasts/Actuals Program Trading strategies (when/why) Deal Requirements Demand Information/Forecasts/Actuals 1.0 PLAN THE DEAL PURPOSE: Inventory Updates; Exchange Balances; MSI Hedge plans (ratable & fixed price) Run Month Pricing Plan (if different from above - e.g. P+, swaps, etc.) & other risk management plans Determine Program position and optimize Program support through execution of financial instruments (futures, EFPs, swaps) to manage risk in physical positions. Identify and capitalize on market opportunities for TPT. Refinery Forward Margin Position (e.g. long cracks 100% or 80%) Potential structured deals and products (from customers) Refinery Margin Forward Hedging Plan Price Feeds (current, forward & historical); Forward pricing models Market Outlook & Opportunities (e.g. arbs); Volatility & Correlation Info (current & hist.) Deals to be Offered TPT Strategies (Risk Services and groups which involve Risk Services) Position Limits; Limit Alerts (Market & Credit) Risk & Trade Protocol Policies; Compliance, Legal, Credit Requirements Designation of Potential Transaction (e.g. hedge) Fundamentals (e.g. API data, weather, turnarounds); Logistical constraints; asset utilization Avails and Prices By pre-set criteria (e.g. book, strategy, trader): Profitability goal, capital at risk, daily C@R measure Marine info; fixtures; rates; availability 14

15. IPO - Make the Deal Input: Output: Program Trading strategies (when/why) Deal Requirements Current Deal Sheet incl. total deal economics 2.0 MAKE THE DEAL Hedge plans (ratable & fixed price) PURPOSE: Changes to Deal Sheet Run Month Pricing Plan (if different from above - e.g. P+, swaps, etc.) & other exposure management plans Evaluate options Negotiate terms (buy/sell) Capture / Communicate deal information Hedging Requirements Types of Exposure (elements) Refinery Margin Forward Hedging Plan Deals to be Offered Confirms TPT Strategies (Risk Services and groups which involve Risk Services) Designation of Potential Transaction (e.g. hedge) Avails and Prices Buy / sell offers Market Information Customer credit position and rqmts. Real time exposure info. Clear policies and authorities (rules of engagement with / refineries) 15

16. IPO - Execute the Deal Input: Output: Deal Sheets (terms include internal/external elements) Contract 3.0 EXECUTE THE DEAL - CONTRACT ADMINISTRATION Contract Confirmation Terms Requirements, Authorities, & Policies Database/Information PURPOSE: Payables/receivables schedule Tolerances Accurate Contract Terms Create contract, notify affected parties, and ensure traders are in compliance with Credit, Tax, Legal, and customer guidelines. Notification of Non-compliance if applicable Rationale of deals Authorities & Policies Contracts and Confirmations Compliance Requirements 16

17. IPO - Measure the Deal Input: Output: 4.0 MEASURE THE DEAL TPT Gain/Loss TPT positions (Volumetric) TPT Mark-to-Market Report ( Inc.Exposure report vs. limits (volumetric, stop loss, VaR, realized & unrealized g/l) PURPOSE: Price data feeds & database ( current, forward and historical) Program Market-to-market report ( same as above) Identify / measure risk for prior and future activity and analysis effectiveness of individual deals and strategies. Provide support to traders to maximize profits / mitigate risk. Program Positions (Volumetric) Program Gain / loss Credit exposure report (with alerts): ( Inc.available credit vs. limits - system can measure by counterparty and aggregate: accnts r/p, current & potential exposure) Counterparty / customer information (ext. or internal rating & default prob., accounts p/r balance, position info (value), other inputs) Database accessible to plan & make, etc. (sliced aggregate & individual) & reported to management (VAR & MTM Daily, synergy capture reporting); Measure of Hedge Effectiveness (internal & compliance purposes) Need position data as soon as possible (disciplined & by categories) - Book Structure (carved out) demurrage, transportation, cost of money Approved customer list (to Trading) Designation of Derivative Trades Reports addressing Demurrage, interest costs, Pipeline losses etc. Authorities/Limits Capital at Risk (or other limit) strategic Reallocation based on performance? Volatility, Correlation, Models (other) 17

18. IPO - Settle the Deal Input: Output: 5.0 SETTLE THE DEAL Ticket data Accounts receivable /payable reports PURPOSE: Reconciliation (internal / external) Provide Equiva management with accurate timely financial information. Issue / collect payments. Contract Data Specifications, volume, pricing Invoices, payments, checks, wires Status of accounts reports Schedule information Financial reports Accounts receivable/ payable Outstanding accounts payables / receivables general ledger Margin calls / Disbursements Operating forecasted inventories (by system schedule) Actual vs. MTM (rationalization) “Roadmap” of accurate schedule information (what should be) Post Deal Analytics (Feedback to appropriate functions) Mark-to-Market Report (post-deal analytics) Measure of Hedge Effectiveness Accounting treatment for derivatives Schedules (Closing cycles etc.) 18