Corporate Governance

Overview

During 2006 Oil Search fulfilled its commitment to maintain and further improve its already high standard of governance. Oil Search has refined its governance practices and procedures while at the same time trying to preserve the moderate cost structure, flexibility and independence that have traditionally characterised Oil Search’s business.

Best Practice Recommendations

Oil Search followed all of the applicable ASX Corporate Governance Council’s Principles of Good Corporate Governance Best Practice Recommendations (“Best Practice Recommendations”) during the twelve months ended 31 December 2006.

Management and Oversight

Oil Search’s internal systems and procedures are designed to enable the Board to provide strategic guidance for the company and effective management oversight. There is a balance of authority inside Oil Search so that no individual has unfettered power.

Oil Search has formalised and defined the functions reserved to the Board and those delegated to management in a formal Board Charter to facilitate accountability to the Company and its shareholders. The Board adopted the Charter on 14 October 2004 and the Charter was in force for all of 2006.

In accordance with Oil Search’s constitution, Oil Search has delegated to committees responsibility for a number of key areas of governance. This delegation is concurrent with, rather than to the exclusion of, the powers of the Board. In December 2005 the Board revamped its committee structure. Up until that time the Oil Search Board had six committees – Audit Committee, Risk Committee, Remuneration Committee, Corporate Governance and Nominations Committee, Health Safety Environment and Social Committee and Technical Committee. Having six Committees made the holding of effective meetings diffi cult and there was also an overlap between the functions of several of the Committees. At its December 2005 meeting, the Board decided to reduce to three the number of Committees and to put in place new Committee Charters that remove the overlapping of responsibilities previously existing. The new Committee Charters were approved by the Board in February 2006 and operated for the balance of 2006. Effective 1 January 2006, the Board Committees became the Audit Committee, the Finance and Risk Committee and the Remuneration and Nominations Committee. Copies of the Board Charter and the Charters for each of the three Committees are posted on Oil Search’s website in the corporate governance section.

Structuring the Board to Add Value

Oil Search recognises that an effective Board facilitates the efficient discharge of the duties imposed by law on directors and adds value in the context of Oil Search’s evolving circumstances. Accordingly, Oil Search has structured its Board so that it:

• Has a proper understanding of, and competence to deal with, the current and emerging issues of Oil Search’s business.
• Can effectively review and challenge management’s performance and exercise independent judgment.

The size of the Board (10 directors) and its composition is conducive to making decisions expediently, with the benefi t of a variety of perspectives and skills and in the best interests of Oil Search as a whole. There were two additions to the Board in 2006. Mr Timothy Warren and Mr Gerea Aopi both joined the Board. Mr Warren joined the Board as a non-execuitve director. He has wide ranging experience in the oil and gas industry, having spent most of his professional career with Royal Dutch Shell. Mr Aopi joined the Board as an executive director. He is a Papua New Guinea citizen, Oil Search’s General Manager in Papua New Guinea and a well known and highly regarded figure in the Papua New Guinea business community.

The Board Charter provides that, subject to re-election in accordance with the Constitution, non-executive directors will not normally be recommended for re-appointment after completion of an aggregate of 12 years of service. In light of this policy, Oil Search’s long standing Deputy Chairman, Mr Noreo Beangke, decided not to seek re-election at the May 2006 Annual Meeting. The Board has discretion (likely to be exercised only rarely) to recommend that a director continue serving as a director after the end of the director’s 12 year term if the Board reasonably believes it is in the best interests of the Company for that director to continue office.

The skills, experience and expertise relevant to the position of director held by each director in offi ce at the date of the annual report is detailed in the Directors’ Report.

The Oil Search Board has adopted “independence” criteria against which the independence of directors can be assessed. The Board Charter provides that the independence of directors will be assessed regularly. Only non-executive directors (that is, a director who is not a member of management) are considered independent. The Board has adopted a formal written policy governing the appointment of new directors. Among other things, the policy outlines what qualities a new director is likely to possess and what is expected of a director following his appointment.

During 2006:

• All of Oil Search’s directors (other than the Managing Director, Peter Botten and, from June 2006, Gerea Aopi) were independent, as assessed in accordance with the Board Charter.
• The Chairman, Brian Horwood, was an independent director.
• The roles of Chairman and Chief Executive Offi cer were performed by different people.

There is a procedure in place for directors to take independent professional advice at the Company’s expense. In particular, a director may obtain independent professional advice if reasonably required to assist the director in the proper exercise of powers and discharge of duties as a director of the company. The costs of such independent professional advice are borne by the Company provided that before engaging the independent professional adviser, the director obtains the approval of the Chairman, or, if the director is the Chairman, the approval of a majority of the non-executive directors of the Company.

The selection and appointment of new directors is key to an efficient, well managed company. During 2006 the responsibilities of the Remuneration and Nominations Committee included responsibility for the identifi cation of suitable candidates for appointment to the Board.

The members of the Remuneration and Nominations Committee and their attendance at meetings of the Committee during 2006 are detailed in the Directors Report.

The Remuneration and Nominations Committee has oversight of corporate governance issues and works closely with Oil Search’s General Counsel/Group Secretary in making sure that the Board is kept fully abreast of all developments affecting good governance.

The formal procedures for the selection and appointment of new directors to the Board are detailed in Oil Search’s Constitution.

Copies of Oil Search’s Constitution and the Board’s policy for the appointment of new Directors are available on Oil Search’s web site in the corporate governance section.

Promoting Ethical and Responsible Decision Making

Oil Search promotes ethical and responsible decision making. In particular, Oil Search has:

• Clarified the standard of ethical behaviour required of all directors, executives, other employees and contractors (“Oil Search Personnel”) and actively encourages the observance of those standards.
• Published its position regarding Oil Search Personnel trading in Oil Search shares.

Oil Search introduced a Code of Commercial Conduct in 1996. The Code was substantially updated in 2004 and renamed the “Code of Conduct”. A further review of the Code of Conduct was carried out in 2006 with a number of changes being made. The Code of Conduct details the Company’s requirements regarding monetary payments and gifts offered by third parties, and work place behaviour of Oil Search Personnel.

Oil Search has a separate “whistleblower” policy that details the responsibility and accountability of individuals for reporting and investigating unethical practices.

Trading in Oil Search securities by Oil Search Personnel is closely regulated and full details of the Company’s policy in this regard are contained in the Code of Conduct.

Oil Search is in the process of introducing a comprehensive trade practices compliance program. This will involve training for all relevant employees in the areas of anti-trust and consumer protection. Oil Search acknowledges that anti competitive behaviour is detrimental to the whole community and Oil Search is determined that such behaviour should have no part in Oil Search’s business strategy.

We are also currently reviewing the share trading policy and the rules and procedures pursuant to which Oil Search Personnel are permitted to purchase shares in Oil Search and shares in Oil Search’s business partners. We recognise that Oil Search Personnel should not have an unfair advantage over other investors in trading in those shares.

All donations by or on behalf of the Company require the approval of the Managing Director. Oil Search made charitable donations and undertook sponsorships totalling US2.3 million during the year ended 31 December 2006. Oil Search does not make donations to political parties or other donations designed to secure political favour.

The Code of Conduct (including details of Oil Search’s share trading policy) is available on Oil Search’s website in the corporate governance section.

Upfront Reporting

Oil Search recognises the importance of being able to independently verify and safeguard the integrity of the Company’s financial reporting.

The Chief Executive Officer and Chief Financial Officer are each required to state in writing to the Board that Oil Search’s financial reports present a true and fair view, in all material respects, of the Company’s financial condition and operational results and are in accordance with relevant accounting and legal standards.

The Board has established an Audit Committee. At all times during 2006 the Audit Committee consisted of:

• non-executive directors only;
• independent directors only;
• an independent chairman who was not chairman of the Board; and
• four members.

The Audit Committee has a formal charter that details its role and responsibilities, composition, structure and membership requirements.

The names and qualifi cations of the members of the Audit Committee and their attendance at meetings of the Committee during 2006 are detailed in the Directors’ Report.

As noted above, the functions and duties of the Audit Committee were reviewed and amended as part of the re-organisation of the Committee structure carried out in December 2005.

The internal and external audit functions are separate and independent of each other. Oil Search rotates its external auditor from time to time. Deloitte Touche Tohmatsu was appointed the Company’s auditors in May 2002, succeeding Ernst & Young who had held that position for a number of years. Oil Search’s policy is to appoint an established international accounting firm with an office in Port Moresby as its external auditors. Deloitte Touche Tohmatsu attended all Audit Committee meetings during 2006, and the Committee had a closed session, without management present, with the external auditors at each meeting.

The internal auditing function is carried out by the Assurance and Compliance Manager using KPMG and other specialist consultants to deliver the internal audit plan. The Audit Committee reviews the annual plan, review scopes and internal audit reports at each meeting. The Audit Committee also approves the appointment and dismissal of the Assurance and Compliance Manager and regularly meets with the Assurance and Compliance Manager and his staff.

All Stakeholders Are Kept Informed

Oil Search practises timely and balanced disclosure of all material matters concerning the company.

All investors are given equal and timely access to material information concerning Oil Search’s financial situation, performance, ownership and governance.

Oil Search puts considerable effort into ensuring that its announcements are factual and presented in a clear and balanced way.

There is an External Communication and Disclosure Standard in place, designed to ensure compliance with the continuous disclosure requirements of the ASX Listing Rules and to ensure accountability at a senior management level for that compliance.

A copy of the External Communication and Disclosure Standard is available on Oil Search’s website in the corporate governance section.

Shareholders Deserve Respect

Oil Search respects the rights of all shareholders, irrespective of size, and facilitates the effective exercise of those rights in any way it reasonably can.

The Oil Search website is regularly updated so as to give all stakeholders ready access to balanced and understandable information about the Company and its business.

Oil Search liaises closely with a range of relevant institutions including the Australian Shareholders Association. Shareholder queries are answered promptly, comprehensively and courteously.

Being incorporated in Papua New Guinea, Oil Search’s Annual Meeting is always held in Port Moresby. The meeting is also web cast to shareholders outside Papua New Guinea. Oil Search’s Constitution requires the Chairman of the Annual Meeting to allow a reasonable time for shareholders at the meeting to question, discuss and comment on the management of the Company.

A representative of the external auditors attends Oil Search’s Annual Meeting. The representative is available at the Meeting to answer shareholder questions about the audit and the auditors’ report.

Oil Search's website details how investors may contact its investor relations team electronically. In addition, the website contains contact details for our external share registry, including a general enquiry line, fax and email details.

Risk Management is Crucial

Oil Search recognises that risk management is an integral part of the oil and gas business and has endeavoured to establish a sound system of risk identifi cation, assessment, mitigation and internal control.

The Board is responsible for establishing a framework of prudent and effective controls which enable risks to be assessed and managed. Oil Search has a comprehensive risk management framework operating across the business. The risk management framework has been developed with reference to the Australian Standard (AS/NZS 4360:2004) and leading oil and gas industry practices. The risk management framework ensures risks are evaluated in a consistent manner and reported through to the senior management team and applicable board committee. Oil Search continuously identifies, assesses and monitors key business and operational risks and ensures management plans and controls are operating effi ciently and effectively. The internal audit function undertakes an independent validation of controls as part of the risk-based audit plan and also reviews the adequacy the risk management framework.

A description of Oil Search’s risk profi le is available on Oil Search’s website in the corporate governance section.

At all times during 2006, Oil Search had a Board committee with responsibility for risk management. That committee met four times during the year and was tasked with establishing policies on risk oversight and management.

As noted above, Oil Search revamped its committee structure in December 2005. Effective 1 January 2006, the Risk Management Committee was disbanded and from that date the functions of that committee have been carried out by the Finance and Risk Management Committee.

The names of the members of the Finance and Risk Management Committee and their attendance at meetings of the committee are detailed in the Directors Report.

Oil Search’s Chief Executive Offi cer and Chief Financial Officer are required to state in writing to the Board that:

• their statements concerning the integrity of the Company’s fi nancial statements are founded on a sound system of risk management and internal compliance and control which in all material respects, implement the policies adopted by the Board of directors;
• the Company’s risk management and internal compliance and control system are operating effi ciently and effectively in all material respects; and
• material operational risks are assessed and reasonable mitigation opportunities are continuously acted upon. Material residual risks are understood with appropriate contingency plans in place.

Better Performance Depends On Education

Oil Search believes that directors and senior management must be equipped with the knowledge they need to discharge their responsibilities effectively and that individual and collective performance should be regularly and fairly reviewed.

Directors and all employees have access to continuing education to update and enhance their skills and knowledge.

Each director is expected to undertake relevant training or continuing education each year. Oil Search will meet the cost of such training and education provided that directors obtain the Chairman’s prior approval.

The Board Charter guarantees all directors reasonable access to the Company Secretary and to the Company’s other senior managers at all times. This is generally for information purposes only and directors are not encouraged to participate in the day to day management of the Company.

Management supplies the Board with information in a form, timeframe and quality that enables the Board to discharge its duties effectively. Directors are entitled to and sometimes do request additional information if they consider that the information supplied by management is insufficient to support informed decision making.

The Oil Search Board has adopted a formal annual review process for the Board and individual directors and this process was implemented in 2006. In particular, during December 2006 each director was asked to complete a detailed questionnaire covering the performance of the Board as a whole, the individual director’s own performance and the performance of the Chairman. The Chairman will meet with each director to review the director’s responses to the questionnaire and to give the director the Chairman’s own views on how the director had performed during 2006.

A more detailed explanation of Oil Search’s annual review process for the Board and individual directors is available on Oil Search’s website in the corporate governance section.

Sufficient and Reasonable Remuneration

As detailed in the Remuneration Report on pages 70-76 of the 2006 Annual Report, Oil Search’s policy is to ensure that remuneration for directors and senior management is suffi cient and reasonable and that its relationship to corporate and individual performance is defined.

Oil Search's remuneration policies are designed to attract and maintain talented and motivated directors and employees so as to encourage enhanced performance of the company.

Oil Search clearly distinguishes the structure of non-executive director remuneration from that of executives.

The payment of any equity based remuneration is made in accordance with plans approved by shareholders. Oil Search has an employee share option plan and a performance rights plan. Non-executive Directors do not participate in these plans.

Within the aggregate amount approved by shareholders, the fees of the Chairman and non-executive directors are set at levels which represent the responsibilities of and the time commitments provided by those directors in discharging their duties. In setting fees, regard is also had to the level of fees paid to directors of similar companies.

Remuneration packages of senior executives include long term performance based components through the performance rights plan. Rights granted under this plan to senior executives are linked to the long term performance of the company and only vest following satisfaction of performance hurdles that are designed to maximise shareholder wealth.

Currently, there is no separate retirement benefi ts plan for Oil Search’s non-executive directors.

At all times during 2006, Oil Search had a Board committee with responsibility for remuneration issues. That committee has its own charter detailing the roles and responsibilities, composition, structure and membership requirements of the committee.

As noted above, the Oil Search Board revamped its committee structure in December 2005. Effective 1 January 2006, the Remuneration Committee was disbanded and since that date, the functions of that Committee have been carried out by the new Remuneration and Nominations Committee.

The names of the members of the Remuneration and Nominations Committee and their attendance at meetings of the committee are detailed in the Directors Report.

Full details of Oil Search’s remuneration policies and practices are set out in the Remuneration Report, including the key components of the remuneration paid to directors and key management personnel.

The Legitimate Interests of All Stakeholders Are Considered

Oil Search recognises that it has obligations to all legitimate stakeholders including shareholders, employees, contractors and the community as a whole.

Oil Search acknowledges that it can create value by better managing and working more closely with all its stakeholders. Oil Search has demonstrated its commitment to appropriate corporate practices by adopting the Code of Conduct. As noted above, the Code of Conduct guides Oil Search Personnel in complying with their legal and other obligations to legitimate stakeholders.

An Ongoing Commitment to Good Governance

Good corporate governance depends on a company’s policies, standards and procedures being continually reviewed and updated. What is good governance this year may not necessarily be good governance next year.

There is always room for improvement which is the reason why, in early 2007, Oil Search participated in the ASX public consultation of the proposed changes to the Principles of Good Corporate Governance and Best Practice Recommendations. Oil Search will use its best endeavours to maintain and improve upon the high standards of governance that it achieved in 2006 and meet additional requirements that may arise.