Share incentive arrangements

Performance Share Plan (PSP)

Currently, under the PSP, senior executives are eligible to be granted conditional awards of rights over whole shares worth up to 150% of salary each year (200% in exceptional circumstances). Awards vest under the PSP subject to a TSR based performance condition under which the Company’s TSR performance is measured over a fixed three-year period commencing on 1 January in the financial year in which the award is granted (i.e. with no opportunity to re-test). Half of the awards made to date are subject to performance against the constituents of the FTSE 250 Index excluding Investment Trusts (as at the start of the performance period) and the other half are subject to performance against the following comparator group of international Oil & Gas companies:

Addax Petroleum	Nexen Inc.
ATP Oil & Gas	Noble Energy Inc.
Burren Energy	Pioneer Natural Resources
Cairn Energy	Pogo Producing Company
Dana Petroleum	Premier Oil
Forest Oil Corporation	Santos
Lundin Petroleum AB	Venture Production
Newfield Exploration Company

In line with best practice, a ‘common currency’ approach is adopted for calculating TSR in respect of the above international group of companies.

For each portion of the award, vesting is as follows:

Company’s ranking in comparator group	Vesting percentage
Below median	0%
Median	30%
Upper quartile	100%
Intermediate performance	Pro rata between 30% and 100%

In addition, no award will vest unless the Committee considers that both the Company’s underlying financial performance and its performance against other key factors (e.g. health and safety) over the relevant period is satisfactory.

Proposed changes to the PSP from 2008

As part of its review of the remuneration policy for the Executive Directors, and taking into account its overall objective that a significant proportion of the overall remuneration package should be based on the performance of the Company, the Remuneration Committee is seeking shareholder approval at the forthcoming AGM to increase the ‘normal’ maximum annual limit under the PSP from 150% to 200% of salary (with a revised ‘exceptional circumstances’ maximum limit of 300% of salary increased from 200%). Exceptional circumstances would include, for example, an award to attract a new Executive Director to the Company. In addition, the following changes are proposed to the operation of the PSP from 2008:

While conditional awards of rights over whole shares to the Executive Directors in 2008 are expected to be worth 200% of salary, in subsequent years, the Committee may elect to vary the allocation taking into account the circumstances which prevail at the time (subject always, in normal circumstances, to the 200% of salary limit);
The performance targets will continue to measure TSR relative to two comparator groups (with equal weightings). 30% of awards will continue to vest for median performance, an approach the Committee believes continues to be appropriate, given the below market salaries payable to the Executive Directors. However, the performance required for full vesting of awards to Executive Directors will be raised from upper quartile to upper quintile; and

The comparator groups will be amended to reflect Tullow’s current circumstances. Therefore, half of the award will be measured against the FTSE 100 (of which Tullow is now a member) excluding Investment Trusts, and the balance against the following Oil & Gas companies:

Addax Petroleum	Niko Resources
Anadarko	Noble Energy Inc.
Apache Corporation	Pioneer Natural Resources
Cairn Energy	Premier Oil
Dana Petroleum	Santos
Forest Oil Corporation	SOCO International
Lundin Petroleum AB	Talisman Energy Inc.
Nexen Inc.	Venture Production

The changes to the Oil & Gas comparator group reflect a selection of companies that the Committee believes most accurately mirrors Tullow’s current complexity and operations.

All the other key features of the PSP (including the ‘underpin’ relating to Tullow’s financial and other performance) will remain unchanged. The Committee continues to believe that a TSR performance condition is appropriate as it encourages the Executive Directors to generate returns to shareholders in excess of both the market generally and a group of sector peers, and is a robust reflection of management’s success in achieving the strategic targets required to ensure the Company’s continued growth.

Share Ownership Guidelines

From 2008, to further align their interests with shareholders, the Executive Directors will be required to retain at least 50% of the shares that vest under the PSP and DSBP (after selling sufficient shares to pay tax liabilities) until they have built up a shareholding worth at least 200% of base salary (with existing holdings taken into account). This has been increased from the 2007 level of 100% to reflect the increased rewards which will now be available in shares if performance targets are met.

Share Option Scheme

Before the introduction of the PSP in 2005, Executive Directors were eligible for grants of options under the 2000 Executive Share Option Scheme (the ‘2000 Scheme’). The Committee does not intend to grant further options to Executive Directors under the 2000 Scheme. During the year, options were granted to substantially all employees of the Group under the 2000 Scheme, other than those senior executives who were granted awards under the PSP.

All–employee Share Incentive Plans

Executive Directors may also participate, on the same terms as other employees, in the Tullow Oil UK and Irish Share Incentive Plans. These are all-employee plans that have been set up in both the UK and Ireland which enable employees to make contributions out of salary up to prescribed limits each month, which each quarter are used by the Plan trustees to acquire Tullow Oil shares (Partnership shares). The Company makes a matching contribution to the trustees to acquire a matching number of shares (Matching shares) on a one-for-one basis.

Sourcing of shares and dilution

Awards under all the Company’s share schemes may be satisfied using either newly issued shares or shares purchased in the market and held in the Tullow Oil Employee Trust. Awards under the Company’s discretionary schemes which may be satisfied by new issue shares must not exceed the ABI’s limits of 5% of the Company’s issued share capital in any rolling 10-year period, and the total of all awards satisfied via new issue shares under all plans must not exceed 10% of the Company’s issued share capital in any rolling 10-year period.

The Company’s current intention is to satisfy awards under the 2000 Scheme via new issue shares, and awards under the PSP, DSBP and all-employee Share Incentive Plans via market purchase shares.

As at 31 December 2007, the headroom under the Company’s 5% and 10% limits was 5.5 million and 41.5 million shares respectively, out of an issued share capital of 719.6 million shares.

As at 31 December 2007, the Tullow Oil Employee Trust held 2 million shares.