The Philippines Leading Oil Company

Introduction

Petron Corporation was incorporated under the Corporation Code of the Philippines on December 15, 1966, as Esso Philippines, Inc. (“Esso Philippines”). On December 21, 1973, the Philippine National Oil Company (PNOC) acquired all of the shares in Esso Philippines and the Company was renamed Petrophil Corporation. On November 5, 1985, Petrophil Corporation and Bataan Refinery Corporation (formerly the Standard Vacuum Refining Corporation) were merged with Petrophil as the surviving corporation. Petrophil later changed its corporate name to Petron Corporation. On March 4, 1994, PNOC sold 40% of its shares in Petron to Aramco Overseas Company B.V., a wholly owned corporation of Saudi Arabian Oil Company (SAUDI ARAMCO). On September 7, 1994, 20% of Petron’s shares were listed with the Philippine Stock Exchange in the biggest Initial Public Offering (IPO) in the Philippines. Petron has their subsidiaries, which are as follows: New Ventures Realty Corporation (NVRC) is a realty firm established in 1995. It is authorized to acquire and develop lands but it does not engage in the subdivision business. Lands suitable for use as service station sites, bulk plants or sales offices are purchased by NVRC. These lands are leased to Petron for use in the latter’s operation. Petrogen Insurance Corporation is a wholly owned subsidiary of Petron Corporation incorporated in 1996. It serves the insurance requirements of Petron Corporation licensed by the Insurance Commission in November 1996. Petrogen has the authority to issue policies on fire, marine, casualty and surety. Accordingly, it issues bonds for haulers, bidders and contractors. Insurance provided excludes life insurance. In 2001, it was granted authority to cover insurance for accidental death and dismemberment, travel and directors’ and officers’ liability. Overseas Insurance Corporation or Ovincor was incorporated in 1997 under the laws of Bermuda for the purpose of expediting the reinsurance of Petron’s insurable interests as covered by Petrogen Insurance Corporation. Reinsurance includes the insurance cover for the Refinery, the bulk plants and service station properties, petroleum and cargo insurance and performance bonds for Petron contractors and haulers as well.

Petron Foundation, Inc. (PFI) was incorporated in July 1996. This company was created to function and operate as a charitable, humanitarian, and philanthropic and research foundation; to handle social, environmental, and music and arts development projects of Petron; to institutionalize and intensify Petron’s active involvement in corporate and social responsibility projects; to support scholarship programs for financially-handicapped but deserving students; and to participate in other social projects supported by Petron.

A. MARKET POSITION OF THE COMPANY

1. Relation of the company Sales to total industry and leading competitor

Coming from a record loss of 3.9 billion a year before, the company bounced back to profitability in 2009 with a net income of 4.3 billion. This strong performance was achieved despite cutthroat competition and continued economic lowdown experienced by the region.

The complete turnaround from last year’s loss to a positive bottom line was driven mainly by favorable margins as crude and fuel prices were more stable in 2009. Accordingly, earnings per share stood at 45 centavos from a loss of 42 centavos in 2008.

Total sales volume dropped by 11% from 49.77 million barrels to 44.22 million barrels. This was traced essentially to lower exports which slid by 5.1 million barrels specifically of low-value fuel oil products. On the other hand, Petron’s domestic sales performance was better than 2008 despite the economic downturn largely felt during the first half of the year and the devastations caused by typhoons “Ondoy and Pepeng” which hit the country in the fourth quarter of 2009. Volumes sold in the domestic market improved by 0.3 million barrels brought about by the acquisition of new accounts and the growth on toluene and mixed xylene petrochemical sales.

Despite a year-on-year (YoY) decline of 34% or 91.11 billion in revenues due essentially to lower selling prices of petroleum products, more high value products were sold with full operation of the Company ’s Petro Fluidized Catalytic Cracking Unit (PPFCCU).

Petron’s financial condition became healthier with improved financial ratios and well within loan covenant limits. Debt-to-equity indicator was less-leveraged at 2.0x at the close of 2009 from 2.4x at end-2008. Current ratio moved to a more liquid 1.3x from 1.1x the previous year. Debt service coverage ratio also improved significantly to 3.8x from .22x.

As of December 31, 2009, total assets reached 113.2 billion, representing a modest growth of 1% over last year. The significant rise in receivables stemmed from higher claims from government agencies on tax refund as well as from trade accounts due to higher selling prices at year end. This was partly tapered down by the reduction in inventories due to lower volumes and the decline in property, plant and equipment as there were no major acquisitions during the year.

Lower purchases towards the end of 2009 in anticipation of the implementation of zero rate of duty for crude oil and finished products importations under the ATIGA (Asean Trade in Goods Agreement) mainly accounted for the combined 12.66 billion drop in suppliers ’ credit and short-term debts. On the other hand, long-term borrowings went up by 8.6 billion as the repayments during the year were fully offset by the issuance of the 10 billion five-year and seven-year FXCN. The net income for the year of 4.3 billion and the 375 million actuarial gains realized in 2009 beefed up total equity to 37.55 billion from 32.99 billion in 2008.

PETRON CORPORATION being one of the largest oil refining and marketing company in the Philippines supplied nearly 40% of the country’s oil requirements, with their world-class products and quality services fuel the lives of millions of Filipinos. They are dedicated and passionate about their vision to be the leading provider of total customer solutions in the energy sector and its derivative businesses.

2. Relative appeal of the Company Products

Petron operates in the context of a broader value cycle. They work with others to source materials; package, transport and sell our products; recover and reprocess blend components; collect and recycle the water we use. With their complex business cycle, managing sustainability in their daily operations poses great challenge.

By collaborating closely with their business partners, communities, and consumers, they aim to ensure environmental and social responsibility in every product that bears their name. They are working to close the loop associated with their products – from product innovation during the research and development stage, to efficient use of energy and materials during production and transport, to responsible product marketing and promotion.

As part of their continuing efforts to improve their existing product lines, they enhanced the quality level of their fully synthetic gasoline engine lubricant Ultron Race. The enhanced product now meets API SM—the highest and latest quality standard for gasoline engines licensed by the American Petroleum Institute. This suits high-performance engines, especially those fitted with turbochargers or operated under the most severe conditions. The enhanced technology is capable of extending the service life of Ultron Race by more than ten times of the current practice using conventional product. Thus, directionally used oil generation is significantly reduced.

They also re-launched Petron DieselMax with 2% coconut methyl ester (CME) to comply with the Biofuels Act of 2006. DieselMax is a premium quality fuel which also contains a multifunctional additive system for a cleaner engine, more efficient combustion, and fuel economy.

The technical support that their Marketing and Research and Development people have continuously provided helped strengthen customer loyalty and continue to build business for the company. One of these activities is the conduct of technical training programs aimed at informing these customers of the products that the company offers, as well as assist them in optimizing the use of these products in their chosen applications. These training programs are provided free to all our product users. Petron’s after-sales support is also unparalleled in the local petroleum industry. They provide after sales customer visits to our industrial and commercial clients and offer varied technical services to address technical difficulties, operational concerns, compliance to environmental regulations, efficiency enhancements, among others.

To further improve customer interaction, we launched our Petron Customer Interaction Center (PCIC) towards the end of 2009. As one of the initiatives under a comprehensive Customer Relationship Management (CRM) Master Plan, the PCIC will serve as the needed structure to deliver positive customer experience consistently.

PCIC will initially cater to the needs of our customers in Pandacan, Navotas and Pasig. However, we will expand PCIC to handle inquiries, feedback, and sales orders for the rest of Luzon and the Visayas and Mindanao regions. At present, customers can send their feedback via SMS, which are handled immediately by our Customer Interaction Specialists. Through our corporate website, customers can also touch base with Petron.

3. Strength of the Company in Major Markets

From January 2009 to January 2010, we opened 200 new Petron stations across the country. This brings their retail network count to 1,463, which remains the largest in the country. At the heart of their expansion program is the Micro Filling Station (MFS). In addition to offering small- and medium-scale entrepreneurs the opportunity to ride on the emerging growth of their local economies, the MFS also enables Petron to enrich communities touched by our business. By making these quality product accessible to rural areas, it helps in promoting livelihood and improving the quality of living standards.

As part of their efforts to reach more Filipino households, they also significantly increased the number of their Gasul branch stores by nearly 30% nationwide. This enables them to drive more branch store-to-home deliveries and makes our various LPG products more accessible to consumers. They also saw the continued success of our Tawag Lang Center, which is the main contact point of consumers for timely home deliveries in Metro Manila.

To service the ever-growing number of autoLPG users, especially those with taxi fleets, they nearly doubled their outlet count offering their own Xtend brand. The latter sales volumes recorded a 28% growth and they remain the leader in this niche segment with an estimated 31% of the total market. Over the past few years, autoLPG has become a favored alternative automotive fuel since it is cheaper relative to gasoline and produces lower emissions.

They also acquired several new industrial LPG accounts and installed additional LPG facilities in malls across the country. Overall,their Gasul brand remains the most preferred LPG product, with nearly 35% of the total market in 2009.

B. SUPPLY POSITION OF THE COMPANY

1. Comparative Access to Resources

Under the Far East Crude Oil Sales Agreement signed in 2008, Petron may purchase about 140 MBCD of various Saudi Aramco crudes including the premium-grade Arab Super Light. Payment for Saudi crude shipments is on open account basis secured by an irrevocable standby Letter of Credit consistent with standard practice for Far East customers. The risk of a supply disruption is likely to be low in view of the huge oil reserves and alternative terminating facilities of Saudi Aramco.

In order to achieve a balanced and optimized crude mix, Petron regularly renews its one-year contract with PETRONAS for Malaysian crude oil. The 2009 PETRONAS crude contract covers the period January to December.

Although the Refinery is configured to run light and sweet crudes, most of which are produced by Saudi Aramco, it can run other types of crude. In line with a diversification strategy, Petron has looked into various types of crudes, other than Saudi Aramco‘s and Petronas‘, that could provide additional value to the Company and reduce reliance on a single crude supplier. Other product supply contracts that are in effect include import contracts for LPG and aviation gas as well as contracts for the domestic supply of LPG. Spot imports, which included gasoline blending components, diesel, jet fuel and low-sulfur fuel oil, among others, are sometimes needed to balance production and demand. Petron Corporation search for more supplier of premium crude oil and other product so just in case that there is a shortage with their one supplier still they can get from other supplier to meet the demand of the people.

2. Unique Productivity Advantage

Petron is the market leader in the domestic oil industry with 36.4% share of the market as of year-to date July 2009. In the retail market, Petron has 1,349 service stations all over the country as of October 2009, representing about 29% of the industry‘s total gasoline station count of 4,629. About 57% of these stations are located in Luzon where demand is heaviest. Similarly, 41% of these stations are directly owned by Petron, with 12 being operated by the Company. The remaining stations are operated by independent dealers. The Company‘s leadership in the retail business is supported by a fleet card base of almost 69,000 cardholders. The point of sale system has already been installed in several service stations nationwide. It is designed to help provide customers with consistent and efficient customer service, standardized promotions, and build a database that can be used for market sales analysis. In order to improve traffic in the service stations and gain from the potential of the non-fuel business, 51 Treats convenience stores and 128 quick-serve restaurants (―QSRs‖) and service locators were established in strategic service stations in Luzon. The non-fuel businesses are either owned by Petron or are covered by contracts with third party operators. Petron also services 38% of the country‘s Industrial Civil sector, which includes major manufacturing, aviation, and marine accounts. In addition, the Company serves 57% of the fuel requirements of the National Power Corporation (―NAPOCOR‖). Sales to NAPOCOR comprised about 8.1% of Petron‘s year-to-date September 2009 domestic sales volume, the bulk of which was fuel oil. The supply for NAPOCOR‘s fuel requirements is allocated through an annual bidding process among industry players. Petron continues to be the single biggest player in the LPG market. The Company has set up more than 70 additional branch stores through its Gasul dealers as of September 2009. It has also gained headway in the field of alternative fuels through its auto-LPG program Petron Xtend, of which auto- LPG facilities are already installed in 20 service stations nationwide. After Petron‘s acquisition of the Chevron LPG retail business, Petron started to offer re-branded LPG as Fiesta Gas.

The number of fleet card and BPI MasterCard holders similarly increased. The Petron e-Fuel Card was launched in July 2008 initially as a promotional item. Total cards issued as of year-to-date September 2009 is almost 9,000.

Petron having the most number of outlets all over the country which leads to easy access of their product and being the first one to introduce the newest trading technique which is the use of fleet card and BPI MasterCard pave its way to the distinctiveness of their product.

3. Research and Development Strength

In their desire to bring Petron’s world-class products and services closer to their customers, they give so much importance to their research and development. They invest forcefully in the later that leads them to top. “The technical support that our Marketing and Research and Development people have continuously provided helped strengthen customer loyalty and continue to build business for the company”.

Petron conducted research that is centralized on how they can keep in top like building a market research on how they can develop their product to its maximum and how people will respond to it. Petron not only focuses on their main product but also to the things that are related to it like the company management, plant or depot, employees and on the customers. On company management, research and development helped in decision making like if they have a well coordinated management; on plant or depot, Petron must ensure that the operations are safe and there is a healthy environment; on customers, they should know what are the things that their customers looking for in terms of crude products and all of these could be done through research.

In business such as Petron that is changing fast, firms must continually revise their methods and range of products. This is necessary due to continuous change of technology and development as well as other competitors and the changing preference of customers. Research and development is nowadays of great importance in business as the level of competition, production processes and methods are rapidly increasing. It is of special importance in the field of marketing where companies keep an eagle eye on competitors and customers in order to keep pace with modern trends and analyze the needs, demands and desires of their customers.

C. SPECIAL COMPETITIVE CONSIDERATIONS

1. Relative Financial Strength

Petron’s key profit drivers during the year were the 30% YoY growth in sales revenue, the 7% reduction in selling and administrative expenses and the relatively moderate 10% increase in net interest expense and other charges. On the other hand, the improvement in profitability was tempered by a gross margin rate thinner by 0.54%-points, as well as by a higher effective tax rate. Still, the Company’s net profit margin for 2005 reached 3.16%, higher than the 2.78% achieved in 2004.Thus, net profit margin expansion leveraged on strong sales revenue growth resulted to a 48% YoY surge in their company’s earnings to a historic high of P — 6.05 billion.

The Company emerged from 2005 with a stronger balance sheet. Petron’s debt-to-equity profile moved to a less-leveraged position of 60/40 at end 2005 from 64/36 at end 2004. Current asset cover of current liabilities likewise improved to 129% from 124% at the prior year. Debt service coverage also improved to 1.8x from 1.6x.Total assets increased by P — 7.95 billion during the year to P — 71.08 billion. The bulk of this increase – P — 6.90 billion –was in inventory and receivables and mainly due to the increase in unit cost of crude oil and petroleum products. On the liability side, suppliers’ credit and

short-term debt increased in response to the higher level of working capital. However, these two accounts grew by only P — 4.71 billion during the year, less than the increase in inventory and receivable balances. Meanwhile, P — 1.89 billion of long-term debt was repaid during the year.Total liabilities increased by P — 2.65 billion. This increase funded a third of the P — 7.95 billion increase in assets. The balance was funded by a P — 5.29 billion improvement in stockholders’ equity on the back of the year’s P — 6.05 billion net income.Petron ’s selling and administrative expenses reached 5.8 billion, up 10% owing mainly to higher pension costs and increased cash expenses related o the expansion of retail network.Net financing costs, likewise, moved up by 2% or 71 million mainly on account of increased interest rates with the issuance of the 10 billion FXCN in June 2009. However, this was mitigated by foreign exchange gains as the peso strengthened vis-à-vis the US dollar reversing prior year ’s losses from foreign-denominated transactions. The favorable gross margin and lower net other charges boosted pre-tax income by almost 00% o 5.7 billion.Provision for income tax was 3.4 billion higher YoY with the pre-tax income in 2009 versus losses before income tax of 5.8 billion in 2008. Effective tax rate, however, was lower at 26% than the statutory 30% corporate tax rate with Petron ’s income tax holiday for its benzene and propylene sales as the main contributor.

2. Community and Government Relationship

Petron Corporation is not just a mere company which supplies nearly half of Filipinos with their demands on crude product, the former together with their partners, namely, the Department of Social Welfare and Development (DSWD), Department of Education (DepEd), World Vision and Land Bank of the Philippines, over 6,300 Petron Tulong Aral elementary and high school scholars continued to receive the gift of education. This project provides books, school supplies, uniforms, and daily meal allowances for their scholars. Of the 1,137 scholars that graduated from the program in 2008, around 140 students were given recognition for academic excellence.

They are also actively involved in providing the infrastructure essential for learning. In partnership with USAID, they constructed 34 classrooms in 17 schools, mostly in the Mindanao region. Two USAID-Petron schools were inaugurated in early 2009: one in Paglat, Maguindanao and another in Malapatan, Sarangani, bringing to 44 their total school buildings nationwide.

Through this school-building program, they hope to make basic education more accessible and, thus, contribute to peace and development in the region. They forged a partnership with the Municipality of Limay and the Technical ducation and Skills Development Authority (TESDA) to help residents acquire more skills such as welding, pipefitting and instrumentation. Through these training programs, they create more opportunities for the local community, particularly for youth, to enter the workforce through the projects being implemented in their Bataan refinery. They also helped refurbish the existing TESDA Center at Limay to support the local skills training requirements. In the same municipality, they expanded their existing reforestation program by 30 hectares, bringing the total land area under their care to 330 hectares. The project has a livelihood component to benefit local farmers. Through this initiative, they also expect to restore and preserve the watershed supplying surrounding barangays. The reforestation of the Lamao watershed forms part of Petron’s efforts to contribute in the fight against climate change. They continued to have a lead role in the Bataan Integrated Coastal Management Program (BICMP). Through the Bataan Coastal Care Foundation, which is composed of 17 members of

the business community, they implemented the Bataan Coastal Land-and-Sea-Use Zoning plan. The BICMP has become a model for public-private partnerships in environmental management. In the City of Manila, they helped establish the Petron Health Community Center to provide specialized health services to indigent families. They also conducted nearly 50 soup kitchens in 2009, serving around 36,000 people in Pandacan. In a parallel effort, they worked with Caritas Manila on a six-month feeding program for 200 undernourished children. Their mariculture program in Guimaras, has been successful in providing a viable alternative livelihood to local fishermen and in improving their socioeconomic status. In partnership with the Southeast Asian Fisheries Development Center and Citi Philippines/ Citi Foundation, the second phase of the mariculture program was started. This allowed three other barangays to replicate this initiative and provide livelihood to 120 fishermen from their barangays. They also continued to support 47 Self-Employment Assistance Kaunlaran or Sea-K associations for seaweed farming. Based on a DSWD report, this has become a source of additional income for the beneficiaries.

“Our contract with society is anchored on the belief that we have an equal stake in and responsibility to ensuring the well being of those whose lives are touched by our business. Simply put: as we grow, so do our communities. Our company’s Vision, Mission, and Values serve as our guidepost in “caring for the community and environment.” At the same time, we align our efforts with the United Nations Millennium Development Goals, as well as with the national government’s poverty alleviation agenda.”

Through the Petron Foundation, they are able to bring CSR into the mainstream of their operations by integrating the social agenda into their business plans and programs. They are able to achieve this through the responsive delivery of relevant and effective programs and services, active employee engagement, strategic partnerships, organization effectiveness, and communications programs. All of these are under Fuel H.O.P.E. (Helping the Filipino children and youth Overcome Poverty through Education). Through their Human Resources Management Department, they are able to attract, retain, and reward a professional workforce committed to excellence and capable of sustaining and furthering the company’s business growth.

Also, with its partnership with San Miguel Corporation, the Company will maximize synergies with the SMC network, products and services this will raise more opportunity and soon will need more employees.

3. Abilities and Values of Company Managers

On August 12, 2009, a Board of Advisors was created to assist and advise the Board on matters relating to business strategies and directions aimed at improving shareholder value. At the heart of Petron’s success in its Corporate Social Responsibility endeavors is the active involvement of Petron employees. As much as 80% of the company’s workforce has contributed their time, talent, or treasure in almost every CSR activity. The management of Petron treats their employees as the heart of their business. They believe that they depend on their drive, passion, knowledge, and talents to make Petron a sustainable business entity. They place significant importance in creating working environments where our employees can professionally flourish, where their well-being and skills are nurtured, and where teamwork can thrive. They also ensure that their workforce mirrors “The Petron Way” in the communities where they operate.

Through VOLUNTEERISM IN ACTION or VIA, Petron is able to exhibit the kind of corporate leadership where promises are fulfilled, commitments are honored and pronouncements are lived up to. With VIA, the company has been able to do so with programs that engage the employees, the earliest going back to 1988. Quite fittingly, the acronym VIA also best describes how the volunteerism program appeals to employees: VIA is a way, a path or an opportunity by which employees can get directly involved in doing good for society in whatever way they can. 

By taking part in the various CSR programs, Petron employees are able to go beyond their professional chores and be involved in making a difference in society, be it planting trees, distributing relief goods, building houses, telling stories to grade school children, sharing time with street kids or cleaning the coast. It is during these instances that the employees get a deeper sense of fulfillment in what they do for others, and galvanizes their commitment to serve beyond their duties.

To underscore the company’s commitment to human resource management excellence in pursuit of our business goals, Petron was named “2008 EMPLOYEER OF THE YEAR” by the prestigious People Management Association of the Philippines (PMAP). In 2009, the company was also named as one of the “BEST GOVERNED PUBLICLY-LISTED COMPANY IN THE PHILIPPINES” by the Institute of Corporate Directors (ICD).

As of 2009, Petron employs 1,347 people covering our corporate office, Refinery, depots, and terminals. Full-time permanent employees represent 93% of our workforce while probationary employees make up the balance.Males account for 75% of our workforce, while the remaining 25% is composed of females. Being a highly technical organization (i.e., Refinery and Operations require engineering graduates, who are usually males) means that the job requirements in Petron fit males more than females. We view this as a challenge in enhancing diversity in our workplace.

D. CONCLUSION

STRENGTH

Petron believes that its competitive strengths will enable it to protect and build on its leadership position in the domestic oil industry, its core business. At the same time, leveraging on its existing assets and expertise, Petron will pursue opportunities that will complement its core business and capture higher-value products and markets.

1. Philippine’s largest oil refining and marketing company: Petron has the biggest refining capacity, most extensive distribution network and most number of service stations.

2. Leadership in a strategic industry: Petron is the market leader in the domestic oil industry with an overall market share of 36.4% as of year-to-date July 2009.

3. Sound financial condition: Petron has consistently improved on its income performance through the years, except in 2008 which is considered an uncharacteristic year.

4. Dynamic and experienced management: Petron management and employees, having long years of experience in the Company, have demonstrated the ability to overcome various challenges.

5. Strong growth potential: Petron is pursuing key strategic business imperatives that would support sustainable growth.

WEAKNESSES

Petron has so many branch that sometimes there is a need in an increase in capital requirements to sustain the need of the consumer.

Petron Corporation depends on so many suppliers that tend to increase their expenses and in some way it causes to the delay of production.

OPPORTUNITIES

As the company grows bigger and bigger there is more opportunities that could exist like the could earn more profits and somehow if the investor finds out that the company are liquid in terms of financial sense it would somehow convince more investor to invest with your company. Petron being the most leading company of crude products has now the ability to dominate the industry.

THREATS

Risks Related to the PhilippinesThe growth and profitability of Petron will be influenced by the general situation in, and

the state of the economy of, the Philippines. Any political or economic instability in the future may have a negative effect on the financial results of the Company.

Political ConsiderationsThe Philippines has from time to time experienced political, social, economic and

military instability. For example, in 2005, following allegations of fraud and disenfranchisement of votes in relation to the 2004 presidential elections, several members of the Arroyo administration resigned their posts and, along with certain government officials, various opposition groups and individuals, began to call for the resignation or impeachment of President Gloria Macapagal-Arroyo.

No assurance can be given that the future political or social environment in the Philippines will be stable or that current or future governments will adopt economic policies conducive to sustaining economic growth. Political or social instability in the Philippines could negatively affect the general economic conditions and operation environment in the Philippines, which could have a material impact on the Company‘s business, financial position and result of operations.

Economic ConsiderationsHistorically, oil demand and results of operations have been influenced to a significant

degree by the general state of the Philippine economy. In the past, the Philippines has experienced periods of slow or negative growth, high inflation, significant devaluation of the peso and the imposition of exchange controls. From mid-1997 to 1999, the economic crisis in Asia adversely affected the Philippine economy, causing a significant depreciation of the peso, increases in interest rates, increased volatility and the downgrading of the Philippine local currency rating and the ratings outlook for the Philippine banking sector. These factors had a

material adverse impact on the ability of many Philippine companies to meet their debt-servicing obligations.

Oil Price Fluctuation RiskImported crude oil accounts for approximately 90% of Petron‘s total product cost and

thus, changes in the price of crude oil can be a significant risk factor for the Company. Crude oil price was on a rising trend during the second half of 2004 and into 2005 up to early 2006. The initial increase was caused by an upsurge in global oil demand, driven by the economies of the US, China and India. The soaring global demand took place amidst smaller escalations in crude oil supply and refining capacity, as well as several episodes of oil supply disruptions caused by weather, war and other events.

Higher oil prices could result to increased working capital requirements, resulting to higher financing costs for the Company.Oil price risk is primarily mitigated by the Company‘s ability to pass on the effects of crude oil price changes to the market in a timely manner, given that Petron operates in a fully deregulated industry. As an additional mitigating measure, the Company undertakes commodity hedging activities as a policy to protect profit margins against inventory loss and against rising crude prices. To minimize the impact of severe oil price volatility, commodity hedging management has been strengthened with the expansion of hedging authorities to include: a) authority to lock-in product and refinery margins to protect company profits; b) authority to address inventory losses brought about by abrupt and significant downward price swings; and c) authority to hedge against rising crude and refined product prices in instances wherein increased costs are not fully recovered through price adjustments. Moreover, the authority also grants flexibility to hedge up to 100% of crude and product volumes using a variety of instruments.

Furthermore, Petron routinely monitors its current and projected cash flows with the use of SAP, its enterprise resource planning software platform, and maintains access to credit lines in excess of typical requirements.

Foreign Currency Exchange Rate Risk

Foreign exchange risk is a major risk factor for Petron since a substantial portion of its revenues is denominated in Philippine pesos while the bulk of its costs are in U.S. dollars. Changes in the foreign exchange rate could adversely affect the Company in two ways. First, a drop in the value of the peso directly increases the cost of purchased crude oil, thus heightening oil price risk. As previously discussed, this is mitigated by the Company‘s ability to pass on the effects of price changes to its customers. Secondly, changes in the foreign exchange rate would result to the revaluation of key current assets and liabilities, and could subsequently lead to financial losses for the Company.

Risk of Operational Disruptions

Accidents, process or machinery failure, human error or adverse events outside of human control may cause substantial disruptions in the Company‘s operations. These disruptions may result to injury or loss of life, as well as financial losses should these disruptions lead to product run-outs, facility shutdown, equipment repair or replacement, insurance cost escalation and/or unplanned inventory build-up. This risk is most relevant to Petron‘s refining facilities since disruptions in the Refinery can have substantial ripple effects throughout the Company‘s supply chain. In order to mitigate this risk, the Refinery has been implementing programs designed to directly address the avoidance of operational disruptions through effective maintenance practices and the inculcation of a culture of continuous improvement.

Sales Concentration RiskSales to NAPOCOR comprised about 8.1% of Petron‘s year-to-date September 2009

domestic sales volume, the bulk of which was fuel oil. Loss of the Company‘s NAPOCOR volumes could impact the Company‘s revenues. However, lost sales to NAPOCOR could be re-directed to the export market.

Product Substitution RiskIn a scenario of high oil prices, as well as environmental concerns, the use of alternative

fuels such as natural gas and ethanol and coco-methyl ester (―CME‖) fuel blends become attractive. In the event that alternative fuels become more affordable and available than petroleum products, customers may shift to these alternative fuels not offered by the Company, hence, affecting its sales volume.

Regulatory RisksRegulatory risks arise from possible changes in government policies and regulations that

may adversely affect the operations and financial viability of the Company, either directly or indirectly. These policies and regulations include, but are not limited to, those relating to taxes and duties, environmental laws such as the Clean Air Act, the Clean Water Act and the Solid Waste Management Act, the Oil Industry Deregulation Law (Republic Act No. 8479) and various ordinances of local government units in places where Petron has facilities.

Petron Risk Management Framework and ProcessPetron Corporation follows an enterprise-wide risk management framework for

identifying, mapping, and addressing the risk factors that affect or may affect its businesses. The company’s risk management process is a bottom-up approach, with each risk owner mandated to conduct regular assessment of its risk profile and formulate action plans for managing identified risks