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ABERDEEN
MANUEL SUAREZ 1117655 WORD COUNT: 3,619 MODULE COORDINATOR: Ian Phillips
MAY 2012
EXECUTIVE SUMMARY Within the context of the Chevron-LNOC Production Sharing Contract for the development of an onshore gas field in Libya, this report provides an overview of the different contractual elements which should be included in the agreement and defines how to address some of the key issues related to them. For this purpose, a Base Case was defined taking in account the initial estimations obtained from the FEED programme, which have been adequately updated due to the current situation of the country and the perceived risks associated to the development of the project. After this, an assessment of the terms of the PSC has been realized to evaluate how their variation could affect to the feasibility of the project and therefore to be able to establish which are the drivers for the success of the project and to define priorities. Furthermore, trigger values defining acceptable variation limits have been calculated for the most sensible contractual terms, and several options have been included as possible solutions to be taken in account for planning a negotiation strategy. In addition, several proposals for the development of Local Content initiatives have been included in this report to enhance the attractiveness of the offer and to demonstrate commitment to the Libyan Government. In this regard, local workforce and supplier development, as well as community focused initiatives have been outlined and costs associated to them have been estimated. Finally, it has also been undertaken an options appraisal for the selection of the most suitable type of contract which could rule the construction of the pipeline from the gas field to the coast. In this regard, a weighted system has been created to evaluate the suitability of the different types of contracts with the final objective of balancing risks allocation between client and contractor.
MANUEL SUAREZ
TABLE OF CONTENTS: 1. 2. INTRODUCTION .......................................................................................................... 8 1.1. PROJECT BACKGROUND .................................................................................... 8 PSC PROPOSAL DEVELOPMENT METHODOLOGY .............................................. 10 2.1. KEY FEATURES OF A PSC ................................................................................ 10 2.2. METHODOLOGY ................................................................................................. 11 3. BASE CASE ............................................................................................................... 12 3.1. REVENUES .......................................................................................................... 13 3.1.1. Gas Price ....................................................................................................... 13 3.1.2. Gas Production .............................................................................................. 13 3.2. CAPITAL EXPENDITURE (CAPEX)..................................................................... 14 3.3. OPERATING COSTS (OPEX) .............................................................................. 14 3.4. PSC TERMS ........................................................................................................ 15 3.4.1. Bonus ............................................................................................................. 16 3.4.2. Royalties ........................................................................................................ 16 3.4.3. Cost Recovery ............................................................................................... 17 3.4.4. Profit Share/Profit Oil Split ............................................................................. 17 3.4.5. Profit Tax ....................................................................................................... 17 3.4.6. Accounting Standards .................................................................................... 17 3.4.7. Foreign Exchange .......................................................................................... 18 3.4.8. Export Rights ................................................................................................. 18 3.4.9. Duration of Contract ....................................................................................... 18 3.4.10. 3.4.11. 3.4.12. 4. Relinquishment ........................................................................................... 18 PSC Terms Resume Table ......................................................................... 19 Base Case Financial Results Resume........................................................ 19
SENSITIVITY ANALYSIS ........................................................................................... 23 4.1. NPV SENSITIVITY DIAGRAM.............................................................................. 24 4.2. IRR SENSITIVITY DIAGRAM ............................................................................... 27 4.3. PROFIT/INV RATIO SENSITIVITY DIAGRAM ..................................................... 30 4.4. RESULTS INTERPRETATION ............................................................................. 33 4.5. PSC NEGOTIATING POSITION DEFINITION ..................................................... 34 4.5.1. Gas Price ....................................................................................................... 34 4.5.2. Contractors Share Profit Oil .......................................................................... 34 4.5.3. CAPEX (OFC) ................................................................................................ 35
4.5.4. OPEX ( Platform) ........................................................................................... 35 4.5.5. Cost Recovery ............................................................................................... 35 5. ADDITIONAL OFFERINGS ........................................................................................ 36 5.1. LOCAL WORKFORCE DEVELOPMENT (LWD) .................................................. 37 5.1.1. LWD Estimated Investment ........................................................................... 37 5.2. SUPPLIER DEVELOPMENT ................................................................................ 37 5.2.1. Supplier Development Estimated Investment ................................................ 37 5.3. COMMUNITY DEVELOPMENT ........................................................................... 38 5.3.1. Community Development Estimated Investment ........................................... 38 6. PIPELINE CONTRACT SELECTION ......................................................................... 39 6.1. SCOPE OF THE CONTRACT .............................................................................. 39 6.1.1. Design, Procurement and Construction Contract ........................................... 39 6.1.2. Design, Procurement, Construction and Operation Contract ......................... 41 6.1.3. Scope Preferences: ....................................................................................... 42 6.2. TYPES OF CONTRACTS .................................................................................... 42 6.3. CONTRACTS COMPARATIVE ............................................................................ 43 6.3.1. Engineering & Design Phase ......................................................................... 44 6.3.2. Procurement .................................................................................................. 45 6.3.3. Construction ................................................................................................... 46 6.3.4. Operation ....................................................................................................... 47 6.4. CONTRACT TYPE RECOMMENDATION ........................................................... 48 6.4.1. Engineering & Design .................................................................................... 48 6.4.2. Procurement .................................................................................................. 48 6.4.3. Construction ................................................................................................... 49 6.4.4. Operation ....................................................................................................... 49 7. 8. 9. 10. 11. CONCLUSIONS ......................................................................................................... 50 RECOMENDATIONS ................................................................................................. 50 REFERENCES ........................................................................................................... 51 BIBLIOGRAFY ......................................................................................................... 52 APPENDICES.......................................................................................................... 53 APPENDIX 1: SENSITIVITY ANALYSIS CALCULATIONS .............................. 54 APPENDIX 2: LOCAL WORKFORCE DEVELOPMENT ................................... 56 APPENDIX 3: SUPPLIER DEVELOPMENT ..................................................... 57 APPENDIX 4: COMMUNITY DEVELOPMENT ................................................. 58 APPENDIX 2: CONTRACT TYPES .................................................................. 59 Fixed Price .................................................................................................. 59
11.5.1.
Cost-Reimbursement Contracts ................................................................. 61 Incentive Contracts (Payment linked to results) .......................................... 62 Time and Materials and Labour-Hour Contracts ......................................... 63 Gainshare ................................................................................................... 63 Equity Investment ....................................................................................... 63 Economic Results Summary for Foreign Oil Company ............................... 66 Economic Results Summary for National Oil Company .............................. 67
FIGURES: Figure 1: Libya Map ............................................................................................................. 8 Figure 2: PSC Scope ........................................................................................................... 9 Figure 3: PSC Taxation Structure ...................................................................................... 10 Figure 4: PSC Development Methodology ........................................................................ 11 Figure 5: PSC Financial Elements ..................................................................................... 12 Figure 6: Gas Prices trends ............................................................................................... 13 Figure 7: Gas Price Estimations ........................................................................................ 13 Figure 8: Revenues Distribution ........................................................................................ 15 Figure 9: Royalty/Gas Production Relationship ................................................................. 16 Figure 10: Discounted Net Cash Flow Comparative .......................................................... 20 Figure 11: Cumulative Discounted Cash Flow Comparative.............................................. 20 Figure 12: Revenues Distribution ...................................................................................... 21 Figure 13: Revenues Distribution ...................................................................................... 22 Figure 14: NPV Spider Diagram ........................................................................................ 24 Figure 15: IRR Spider Diagram ......................................................................................... 27 Figure 16: PIR Spider Diagram.......................................................................................... 30 Figure 17: Elements Importance........................................................................................ 33 Figure 18: Local Content ................................................................................................... 36 Figure 19: Local Workforce Development.......................................................................... 37 Figure 20: Supplier Development ...................................................................................... 37 Figure 21:Community Development .................................................................................. 38 Figure 22: Contract Scope Comparative ........................................................................... 39 Figure 23: DPC Option Contract Value Comparative ........................................................ 40 Figure 24: DPC Option Profit Comparative ........................................................................ 40 Figure 25: DPCO Option Contract Value Comparative ...................................................... 41 Figure 26: DPCO Option Profit Comparative ..................................................................... 41 Figure 27: Contract Risk Allocation ................................................................................... 42 Figure 28: Contract Types Tree ......................................................................................... 68
TABLES: Table 1: Contract Requirements .......................................................................................... 8 Table 2: Operating Costs Estimations ................................................................................. 9 Table 3: Investor/Government Take .................................................................................. 10 Table 4: PSC Development Processes ............................................................................. 11 Table 5: Base Case ........................................................................................................... 12 Table 6: CAPEX ................................................................................................................ 14 Table 7: OPEX................................................................................................................... 14 Table 8: PSC Terms .......................................................................................................... 15 Table 9: Royalty Rate ........................................................................................................ 16 Table 10: Profit Oil Split ..................................................................................................... 17 Table 11: R- factor ............................................................................................................. 17 Table 12: Base Case PSC Terms ...................................................................................... 19 Table 13: Financial Results Resume ................................................................................. 19 Table 14: NPV Sensible Variables ..................................................................................... 25 Table 15: NPV Variation Limits .......................................................................................... 26 Table 16: IRR Sensible Variables ...................................................................................... 28 Table 17: IRR Variation Limits ........................................................................................... 29 Table 18: PIR Sensible Variables ...................................................................................... 31 Table 19: PIR Acceptance Rules ....................................................................................... 32 Table 20: PIR Variation Limits ........................................................................................... 32 Table 21: Variation Limits Resume .................................................................................... 33 Table 22: Strategy Options (Gas Price) ............................................................................. 34 Table 23: Strategy Options (Contractors SPO) ................................................................ 34 Table 24: Strategy Options (CAPEX) ................................................................................ 35 Table 25: Strategy Options (OPEX) ................................................................................... 35 Table 26: Strategy Options (CR) ....................................................................................... 35 Table 27: Local Content Activities ..................................................................................... 36 Table 28: DPC Option ....................................................................................................... 39 Table 29: DPCO Option ..................................................................................................... 41 Table 30: Type of Contracts .............................................................................................. 42 Table 31: Contract Selection Criteria ................................................................................. 43 Table 32: Contract Selection Matrix (Eng & Design) ......................................................... 44 Table 33: Contract Selection Matrix (Procurement) ........................................................... 45 Table 34: Contract Selection Matrix (Construction) ........................................................... 46 Table 35: Contract Selection Matrix (Operation)................................................................ 47 Table 36: Fixed Price Contracts ........................................................................................ 59 Table 37: Fixed Price Contracts Description...................................................................... 60 Table 38: Cost Reimbursable Contracts ............................................................................ 61 Table 39: Incentive Contracts ............................................................................................ 62 Table 40: Cost Reimbursable Contracts Comparative ....................................................... 64 Table 41: Fixed Price Contracts Comparative ................................................................... 65
It has been confirmed that the field development will include the tasks that have been reflected in Table 1.
Contract Requirements Drilling 150 wells Developing the field infrastructure Laying a 220 km pipeline Building a LNG terminal Building LNG vessels Investment Rate $ 500mill/year $ 1 billion/year Total Period Investment $ 2 billion $ 4 billion 4 years 4 years
$ 500mill/year
$ 2 billion
4 years
It has been estimated that the contract will have a duration of 25 years from the signature date, and once the production commences the field is expected to produce 2000 mmscfpd continuously for the remainder of the 25 years of the agreement.
On the other hand, the operating costs are estimated at US$ 200M/year. In this sense, a more detailed allocation of the cost has been included in Table 2.
Contract Requirements Operating Costs Onshore facilities LNG Terminal Ships Pipeline $ 180 million/year $ 20 mill/year
Total Costs
Period
$ 3.78 billion 21 years (Aprox.) (Aprox.) $ 420 million 21 years (Aprox.) (Aprox.)
Investor Take Government Take Cost Recovery Bonus Investor Profit Oil Split Royalty Net of Royalty Government Profit Oil Split Net of Taxes Investors Taxes
Table 3: Investor/Government Take
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2.2. METHODOLOGY
For the development of the PSC Proposal, several processes must be followed to allow Chevron to clearly define the contractual terms, and to maximise its expected benefits, as well as offering a stable and fair return to Libya Government. The main processes to be undertaken to define a PSC proposal have been reflected in Figure 4 and Table 4.
INITIAL FORECASTING
SENSITIVITY ANALYSIS
SPIDER DIAGRAM
NEGOTIATING POSITION
PROCESS
DESCRIPTION Initial forecasts for the project focused on: Production estimations Gas Price estimations Opex estimations Capex estimations Taxation estimations Development of the baseline for comparing the effects of the variation of different elements constituting the agreement on the feasibility of the project. To provide an understanding of how PSC components influence the economic outcomes of the project. Representing the results obtained from the sensitivity analysis. Interpretation of the results of the Spider Diagram to decide which are the key contract elements and to define strategies and alternatives. Based on the different alternatives a negotiation strategy may be developed by Chevron to succeed.
INITIAL FORECASTING
BASE CASE DEVELOPMENT SENSITIVITY ANALYSIS SPIDER DIAGRAM ACCEPTABLE/UNACCEPTABLE ALTERNATIVES NEGOTIATING POSITION
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3. BASE CASE
The Base case is the expected development of the project (from an economic perspective) using the assumptions that management deems most likely to occur. The financial results for the base case should be better than those for Chevrons conservative/pessimistic case but worse than those for its aggressive/upside case. The main reason for the Development of this Base Case is to define a baseline for comparing the effects of the variation of different elements constituting the agreement on the overall feasibility of the project. In this regard, this report will include an assessment of the key elements responsible for the financial feasibility of the project and it will be clearly defined the acceptable and unacceptable alternatives related to the negotiation of those elements.
REVENUES CAPITAL EXPENDITURE BASE CASE OPERATING COS PSC TERMS GAS PRICE GAS PRODUCTION LNG SYSTEM AND VESSEL COST WELLS DRILLING & WORKOVER ONSHORE FACILITIES CONSTRUCTION GAS PLATFORM OPERATING COSTS GAS TRANSPORTATION/PIPELINE TARIF PROFIT TAX ROYALTY BONUS
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3.1. REVENUES
3.1.1. Gas Price Initial estimations for this Project had considered that gas could be sold for an average of US$ 6.80 per thousand cubic feet. However, based on US Energy Information Administration (http://www.eia.gov), it is expected that imports price as liquefied natural gas for the next 25 years should follow the trend reflected on Figure 6.
Based on these data, gas price for sensitivity calculations will be set initially on 4$ plus and annual increase of 2% (See Figure 7).
7$ 6$ 5$ 4$ 3$ 2$ 1$ 0$
Year 1
Year 5
Year 9
Year 13
Year 17
Year 21
Year 25
3.1.2. Gas Production Based on the initial assessments, the field is expected to produce 2000 mmscfpd continuously for the remainder of the 25 years of the PSC.
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Table 6: CAPEX
Due to the actual situation of the country after a civil war, initial estimations have been updated in a pessimistic way. For this reason it will be considered the cost overruns an inflation rates reflected in Table 7.
Years 5-25 Cost Inflation ($ Mill.) Overruns Increase Gas transportation/pipeline tariff
Table 7: OPEX
$20 mm
10% 10%
5% 5%
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Depicts the distribution of how gross revenues are distributed from a barrel of oil under a PSC.
Figure 8: Revenues Distribution (Adapted from Center for Energy Economics, 2012)
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3.4.1. Bonus Bonus is a source of revenue for the host country. There are 3 main types: Signature (one-time payment upon execution of PSC) Production (recurring payment) Discovery (payable after commercial discovery) It has been considered that bonus payments could be a source of corruption, and because of this only a minimum amount of money will be paid as signature bonus. However an additional offer for developing local content will be included within the agreement to demonstrate commitment by Chevron.
Signature Bonus
US$ 5 Mill.
3.4.2. Royalties Royalties are taken right off the gross revenues. The royalty amount is subtracted from the gross revenues before the Cost Recovery Oil rate is applied. The Gross Profit Share is reduced by the amount of the Royalty. It has been established a Royalty scale directly related to the gas production rate as may be seen in Table 9.
Daily gas production rate (mmscf/d) 500 1000 1500 2.000 Over 5000 25% 20% 15% 10% 5% 0% OPTION 1 OPTION 2 OPTION 3 OPTION 4 OPTION 5 Royalty Rate 3.75% 7.5% 11.25% 15% 20% 5500 5000 4500 4000 3500 3000 2500 2000 1500 1000 500 0
ROYALTIE PRODUCTION
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3.4.3. Cost Recovery Before sharing of production, the contractor is allowed to recover costs out of net revenues. Cost recovery is the rate at which the contractor recovers its investment costs, and represents the percentage of revenues exempt from tax until costs have been recovered.
COST RECOVERY
90%
3.4.4. Profit Share/Profit Oil Split Revenues remaining after royalty and cost recovery are referred to as profit oil or profit gas. The contractor share of profit oil or gas is a specified percentage. In this sense, it has been established a Profit Share scale directly related to the R-factor as may be seen in Table 10.
R-factor less than 1,0 1,5 2,0 2,5 over 2.5 Local Company share 10% 10% 10% 10% 10%
Table 10: Profit Oil Split
R-factor R = Cumulative Receipts / Cumulative Costs Receipts = revenue from sale of gas/oil Costs = Capital Costs + interest + Operating Costs
Table 11: R- factor
3.4.5. Profit Tax The contractor's share of profit oil and gas is subject to taxation. This Profit tax has been charged at 25%, the same as for all other companies in Libya. 3.4.6. Accounting Standards The purpose of this is to further define the manner in which the costs and expenses of Petroleum Operations will be recorded, in this regard: Accounting Standards will be in accordance with generally accepted accounting procedures and standards of the international petroleum industry Metric units and barrels shall be employed for measurements and quantities under this Agreement. The Accounting Records, and all reports to the Designated Authority, will be in English. The Accounting Records, and all reports to the Designated Authority, will be in United States Dollars.
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3.4.7. Foreign Exchange Costs and revenues in another currency will be translated at the exchange rate set on the day the cost is incurred or the revenue realised at a time and by a financial institution designated by Chevron and approved by the Libya Government. 3.4.8. Export Rights Chevron will have right to export any Marketable Gas Natural produced in the contract area in the form of LNG. 3.4.9. Duration of Contract The PSC will have a 25 years duration from the signature date to the assets being handed over to LNOC. 3.4.10. Relinquishment Relinquishment of Development Area: The twenty fifth (25th) anniversary of the date on which the Development Plan in respect of the Development Area was approved by the Libya Government.
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ROYALTIES
GROSS REVENUE
COST RECOVERY
Investment Recovering
PROFIT OIL
R-Factor
PROFIT TAX
25%
3.4.12. Base Case Financial Results Resume See Appendix 6 for further details about the Base Case Financial Results.
Economic Results Summary for Foreign Oil Company Profit / Investment Ratio 1,63 NPV (Discounted at 15%) $687,878,476 16,31% IRR Economic Results Summary for National Oil Company NPV (Discounted at 15%) $2,799,050.571
Table 13: Financial Results Resume
19
2.000 $
0$
1
-2.000 $
9 10 11 12 13 14 15 16 17 18 19 20 21 22 23 24 25
-4.000 $
-6.000 $
-8.000 $
-10.000 $
20
Before Investment has been recovered, revenues distribution will follow pattern reflected in Figure 12.
21
After Investment has been recovered, revenues distribution will follow pattern reflected in Figure 13.
22
4. SENSITIVITY ANALYSIS
Decisions on the design of an appropriate PSC framework can be supported by an understanding of how its various components influence decision making and outcomes.
DECISION MAKING TOOLS Profit/Inv Ratio IRR NPV PSC COMPONENTS Gas Price CAPEX (Onshore Facilities Construction) CAPEX (Wells Drilling & Workover) CAPEX (LNG Systems & Vessels) OPEX(Oil transp./Pipeline Tariff) OPEX(Platform) Royalty Rate Cost Recovery Contractors Share Profit Oil Profit Tax Signature Bonus
To this end a simplified economic model including this components and decision making tools was developed to design a suitable PSC framework for the development of this project. In particular, simulations were conducted to show the effect on project economics of alternative PSC terms and their relative responsiveness to changes in economic conditions. (Rutledge, 2004). (See further details and calculations in Appendix1).
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5.000
4.000
3.000
2.000
1.000
-1.000
-2.000
-3.000
-4.000
-5.000
GAS PRICE NPV CAPEX (Wells Drilling & Workover) NPV OPEX(Oil transp./Pipeline Tariff) NPV ROYALTY RATE NPV CONTRACTOR S SHARE PROFIT OIL NPV
CAPEX (Onshore Facilities Construction) NPV CAPEX (LNG Systems & Vessels) NPV OPEX(Platform) NPV COST RECOVERY NPV PROFIT TAX NPV
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This spider diagram (See Figure 14) represents the different sensitivity scenarios that were developed to evaluate how the NPV under the PSC proposal varies with changes in the various economic parameters. This will also provide an in-depth understanding of the different variables that significantly affect the reported NPV of US$ 687.88M. Based on the diagram it may be concluded that variables which reflected the strongest relationship with the NPV are: Gas Price Contractors share profit oil Capex (Onshore Facilities construction) Cost Recovery
NPV Variation(%) 578,19% 452,38% 326,57% 267,51% 133,80% 0,00% -93,12% -234,52% -350,23% -541,99% -685,19% Gas Price Variation(%) 50% 40% 30% 20% 10% 0% -10% -20% -30% -40% -50% Contractor Share PO Variation(%) 10 0 -10 -20 -30 -40 -50
NPV 4.665.093.460,38 3.799.703.056,18 2.934.312.651,97 2.528.004.733,57 1.608.263.477,88 687.878.476,45 47.303.910,40 -925.343.275,56 -1.721.291.719,60 -3.040.321.725,95 -4.025.415.817,44
NPV Variation(%) -173,39% -129,16% -84,92% -40,68% -43,70% 0,00% 43,49% 86,97% 130,46% 173,95% 217,34%
NPV -504.860.180,55 -200.568.340,98 103.723.498,59 408.015.338,17 387.271.477,01 687.878.476,45 987.013.529,81 1.286.148.583,17 1.585.283.636,52 1.884.418.689,88 2.182.912.354,76
Capex (OFC) Variation(%) 50% 40% 30% 20% 10% 0% -10% -20% -30% -40% -50%
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It has also been calculated (for each variable) the maximum variation limit from which the NPV will be minor than zero and therefore the project will become unattractive for Chevron. The results have been reflected in Table 15.
Variation Limit Gas Price 10% Contractors Share Profit oil 12% Capex (OFC) 32% Cost Recovery 49% Contractual Element
Table 15: NPV Variation Limits
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17% 16% 15% 14% 13% 12% 11% 10% 9% 8% 7% 6% 5% 4% 3% 2% 1% 0% 50 40 30 20 10 0 -10 -20 -30 -40 -50
GAS PRICE IRR CAPEX (Wells Drilling & Workover) IRR OPEX(Oil transp./Pipeline Tariff) IRR ROYALTY RATE IRR CONTRACTORS SHARE PROFIT OIL IRR
CAPEX (Onshore Facilities Construction) IRR CAPEX (LNG Systems & Vessels) IRR OPEX(Platform) IRR COST RECOVERY IRR PROFIT TAX IRR
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The Internal Rate of Return is a widely used economic indicator that assesses the performance and attractiveness of a project. Projects that return higher IRR are normally preferred, thus a sensitivity analysis on the IRR with respect to this agreement was conducted and the results were reflected on different tables (See Appendix 1). The Spider diagram represents the different sensitivity scenarios that were developed (See Figure 15). Based on it, may be concluded that variables which reflected the strongest relationship with the NPV were: Gas Price Contractors share profit oil Capex (Onshore Facilities construction)
IRR Variation(%) 41,03% 32,67% 24,02% 20,11% 10,28% 0,00% -7,47% -19,38% -29,68% -47,89% -63,24% Gas Price Variation(%) 50% 40% 30% 20% 10% 0% -10% -20% -30% -40% -50% Contractors Share PO Variation(%) 10 0 -10 -20 -30 -40 -50
IRR 23,00% 21,64% 20,23% 19,59% 17,99% 16,31% 15,09% 13,15% 11,47% 8,50% 6,00%
IRR Variation(%) -13,08% -10,09% -6,94% -3,59% -3,65% 0,00% 3,87% 8,01% 12,46% 17,24% 22,40%
IRR 14,18% 14,66% 15,18% 15,72% 15,71% 16,31% 16,94% 17,62% 18,34% 19,12% 19,96%
Capex (OFC) Variation(%) 50% 40% 30% 20% 10% 0% -10% -20% -30% -40% -50% Table 16: IRR Sensible Variables
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It has also been calculated for each variable the maximum variation limit from which the IRR will be minor than 14% and therefore the project will be considered unattractive for Chevron. The results have been reflected in Table 17.
Variation Limit Gas Price 15% Contractors Share Profit oil 21% Capex (Onshore Facilities 49% construction) Contractual Element
Table 17: IRR Variation Limits
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2,50
1,50
1,00
0,50
0,00 50 40 30 20 10 0 -10 -20 -30 -40 -50 Sensitivity Range % GAS PRICE Profit/Inv Ratio CAPEX (Onshore Facilities Construction) Profit/Inv Ratio CAPEX (Wells Drilling & Workover) Profit/Inv Ratio CAPEX (LNG Systems & Vessels) Profit/Inv Ratio OPEX(Oil transp./Pipeline Tariff) Profit/Inv Ratio OPEX(Platform) Profit/Inv Ratio ROYALTY RATE Profit/Inv Ratio COST RECOVERY Profit/Inv Ratio CONTRACTOR S SHARE PROFIT OIL Profit/Inv Ratio PROFIT TAX Profit/Inv Ratio
Figure 16: PIR Spider Diagram
30
The Profit/Investment Ratio (PIR) is a useful tool for ranking projects because it allows quantifying the amount of value created per unit of investment. Projects that return higher PIR are normally preferred, thus a sensitivity analysis on the PIR with respect to the Chevron-LNOC Collaboration Project was conducted and the results were included in Appendix 1. The Spider diagram (Figure 16) represents the different sensitivity scenarios that were developed. Based on it, may be concluded that variables which reflected the strongest relationship with the PIR were: Gas Price Contractors share profit oil Opex (Platform)
Profit/Inv Ratio Variation(%) 67,26% 53,04% 38,82% 28,98% 14,11% 0,00% -11,43% -26,38% -38,68% -57,39% -71,82% Profit/Inv Ratio Variation(%) -23,81% -19,72% -15,34% -10,65% -5,62% 0,00% 5,67% 12,03% 18,94% 26,48% 34,74% Profit/Inv Ratio Variation(%) 11,88% 0,00% -12,26% -24,33% -36,39% -48,46% -60,53% Contractors Share PO Variation(%) 10 0 -10 -20 -30 -40 -50
Profit/Inv Ratio 2,73 2,49 2,26 2,10 1,86 1,63 1,44 1,20 1,00 0,69 0,46 Profit/Inv Ratio 1,24 1,31 1,38 1,46 1,54 1,63 1,72 1,83 1,94 2,06 2,20
Gas Price Variation(%) 50% 40% 30% 20% 10% 0% -10% -20% -30% -40% -50% OPEX (Platform) Variation(%) 50% 40% 30% 20% 10% 0% -10% -20% -30% -40% -50%
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It has also been calculated for each variable the maximum variation limit from which the PIR will be minor than 1.3 and therefore the project will be considered unattractive for Chevron. The results have been reflected in Table 19.
PIR Calculation Rules for selection/rejection of a project If PI > 1 then accept the project If PI < 1 then reject the project
Table 19: PIR Acceptance Rules
Variation Limit Gas Price 15% Contractors Share Profit oil 16% OPEX (Platform) 39% Contractual Element
Table 20: PIR Variation Limits
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Furthermore, it has also been calculated the variation limits for each one of those elements and it has been established a trigger value based on the effect over the financial tools used in the assessment. (See table 21)
Contractual Element Gas Price Contractors Share Profit oil Capex (OFC) OPEX (Platform) Cost Recovery Variation Limit IRR 15% 21% 49% Trigger value 10% 12% 32% 39% 49%
Gas Price
OPEX (Platform)
Cost Recovery
Capex (OFC)
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Clauses affecting the length of the contract: it could be increased by a period of 1-5 years to Length of the contract recover losses due to an unusual decrease of gas prices. Clauses giving the option to Chevron to operate Operate the pipeline the pipeline to recover losses due to an unusual decrease of gas prices.
Table 22: Strategy Options (Gas Price)
4.5.2. Contractors Share Profit Oil This element is also affecting enormously to the profitability of the project, in this regard it would be necessary to negotiate this contractual element taking in account that only compensatory measures could balance changes upper 12% in this element. See Table 23 for strategy options.
Limit Increase (%) Contractor SPO Contractual Elements Royalties 12% Profit Tax Strategy options Clauses linking reductions on the Contractor SPO to reductions on Royalties Rate. Clauses linking reductions on the Contractor SPO to reductions on Profit Tax Rate.
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4.5.3. CAPEX (OFC) Due to the current political situation in Libya it would be acceptable to include some clauses about extraordinary circumstances affecting to the normal construction and development of the facilities. In this regard Royalties and Profit tax could be included within this agreement. See Table 24 for strategy options.
Limit Increase (%) Contractual Elements Royalties Profit Tax CAPEX 32% Length of the contract Strategy options Clauses linking CAPEX extraordinary increases to reductions on Royalties Rate Clauses linking CAPEX extraordinary increases to reductions on Royalties Rate Clauses affecting the length of the contract (it could be increased by a period of 1-5 years to recover losses due to an extraordinary increase of CAPEX.
Clauses giving the option to Chevron to operate Operate the pipeline the pipeline to recover losses due to an extraordinary increase of CAPEX.
Table 24: Strategy Options (CAPEX)
4.5.4. OPEX ( Platform) Operational cost can also affect to the success of the project, in this regard it has been added some options to include clauses in the contract. (See Table 25)
Limit Increase (%) Contractual Elements Royalties OPEX 39% Profit Tax Strategy options Clauses linking OPEX extraordinary increases to reductions on Royalties Rate Clauses linking OPEX extraordinary increases to reductions on Royalties Rate
4.5.5. Cost Recovery In a lower level of importance, this element also affects to the viability of the project, in this sense it has been added some options to include clauses in the contract. (See Table 26)
Limit Increase (%) Cost Recovery Contractual Elements Royalties 49% Profit Tax Strategy options Clauses linking reductions on the Cost Recovery to reductions on Royalties Rate. Clauses linking reductions on the Cost Recovery to reductions on Profit Tax Rate.
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5. ADDITIONAL OFFERINGS
With the aim of improving Chevrons offer, some additional activities will be included as part of the agreement. These additional elements will consist of:
LOCAL CONTENT ACTIVITIES Workforce development: Investments in supplier development Community/Infrastructure development DETAILS Employment of national, regional & local workforce Training of national, regional & local workforce Developing supplies and services locally Procuring supplies and services locally Infrastructure development Supporting Education Health Programmes
Table 27: Local Content Activities (Source: www.ipieca.org)
LOCAL CONTENT
WORKFORCE DEVELOPMENT
SUPPLIER DEVELOPMENT
COMMUNITY DEVELOPMENT
36
37
38
DPB DPBO
For doing this, both scope options will be compared on terms of the amount of estimated profit associated to each one, as well as the percentage that this profit means to the total profit of the work. 6.1.1. Design, Procurement and Construction Contract
DPC CONTRACT VALUE
(US$ Mill.)
TYPICAL PROFIT
(US$ Mill.)
% TOTAL PROFIT
39
US $ Millions
25 20 US $ Millions 15 10 5 0
80% 70% 60% 50% 40% 30% 20% 10% ENGENIERING & DESIGN 1,125 4,00% 0% PROCUREMENT 6,75 24,00% CONSTRUCTION 20,25 72,00% % Total Profit 40
CONTRACT VALUE
(US$ Mill.)
% TOTAL PROFIT
US $ Millions
OPERATION 10 100
25 20 US $ Millions 15 10 5 0
60% 50% 40% %Total Profit 41 30% 20% 10% ENGENIERING & DESIGN 1,125 3 0% PROCUREMENT 6,75 18 CONSTRUCTION 20,25 53 OPERATION 10 26
6.1.3. Scope Preferences: Based on these figures it can be concluded that the key stage within the pipeline laying contract (from an economic perspective) is the pipeline construction. Even if the scope of the work includes the operation phase, the higher percentage of the total estimated profit is obtained from this phase. Furthermore it has also been noticed that adding an operation phase to the contract is not especially profitable. The undertaking of this operation phase means a huge increase on the investment for the project; however the perceptual profit increase is not at the same level. For this reason, adding to the contract this operations phase is a strategic decision which can be linked to the final negotiation of the contract.
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Associated to the level of suitability of the contract under conditions of lack of clear definition of the product/service to provide, abundance of modifications, or other external factors affecting to the scope of the work. Level of motivation to Based on the level of motivation for the contractor to control control cost cost under that type of contractual relationship. Financial benefits Based on the financial benefits associated to the type of (Contractors perspective) contract and related to the payment structure and therefore to the amount of financing necessary for the project. Commitment/Collaboration Based on the type of relationship associated to the contract in terms of length and collaboration necessities.
Table 31: Contract Selection Criteria
0.2
43
6.3.1. Engineering & Design Phase Basing on the selection criteria included in Table 31, an assessment has been undertaken to determine which type of contract would fit better for this stage. The results of the assessment have been reflected in Table 32.
TYPE OF CONTRACT
Financial Benefits
External Factors
Weight 20% 15% 10% 10% 20% 10% 10% 5% FFP FPE FPRP FPRR FFPLOE FPIF FPAF CR/CS CPFF CPAF CPIF Time & Materials Gainsharing Equity Investment 1 2 3 3 3 3 2 7 7 7 6 7 5 5 10 8 6 6 6 7 6 1 2 2 3 4 5 5 8 8 6 6 6 6 6 3 4 4 5 7 6 5 10 7 7 7 6 6 6 1 2 2 2 4 3 3 2 4 5 5 3 3 3 8 7 6 6 5 6 6 10 9 9 9 9 9 9 2 4 5 5 5 5 5 1 2 2 2 2 3 3 7 7 7 7 5 5 6 5,15 5,15 5,10 5,10 4,65 4,90 4,50 4,60 4,95 4,90 5,00 5,30 5,15 5,15
Based on the results of the assessment, it has been concluded the most suitable type of contract would be a T&M contract; table 32 also reflects that a FP contract could be also an appropriate selection depending on the circumstances.
WEIGHTED TOTAL
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6.3.2. Procurement Taking in account the different criteria included in Table 31, an assessment has been undertaken to determine which type of contract would fit better for the procurement phase of the pipeline execution project. The results of the assessment have been reflected in Table 33.
TYPE OF CONTRACT
Financial Benefits
External Factors
Weight 20% 15% 10% 10% 20% 10% 10% 5% FFP FPE FPRP FPRR FFPLOE FPIF FPAF CR/CS CPFF CPAF CPIF Time & Materials Gainsharing Equity Investment 1 2 3 3 3 3 2 8 8 8 7 7 5 5 10 8 6 6 6 7 6 1 2 2 3 4 5 5 8 8 6 6 6 6 6 3 4 4 5 7 7 5 10 7 7 7 6 6 6 1 2 2 2 4 3 3 2 4 5 5 3 3 3 8 7 6 6 5 6 6 10 9 9 9 9 9 9 2 4 5 5 5 5 5 3 3 3 3 3 3 3 7 7 7 7 5 5 6 5,35 5,25 5,20 5,20 4,75 4,90 4,50 4,80 5,15 5,10 5,20 5,30 5,25 5,15
Based on the results included in table 33, it has been concluded that the most suitable type of contract would be a FFP. Furthermore, this table also reflects that a T&M contract could also be an appropriate contract option and therefore could be considered as an alternative just in case the client disagrees to the first option.
WEIGHTED TOTAL
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6.3.3. Construction Basing on the criteria included in Table 31, an assessment has been undertaken to determine which type of contract would fit better for the construction phase of the pipeline execution project. The results of the assessment have been reflected in Table 34.
TYPE OF CONTRACT
Financial Benefits
External Factors
Weight 20% 15% 10% 10% 20% 10% 10% 5% FFP FPE FPRP FPRR FFPLOE FPIF FPAF CR/CS CPFF CPAF CPIF Time & Materials Gainsharing Equity Investment 1 2 3 3 3 3 2 8 8 8 7 7 7 5 9 8 6 6 6 7 6 1 2 2 3 4 5 5 7 8 6 6 6 6 6 3 4 4 5 7 7 5 9 7 7 7 6 6 6 1 2 2 2 4 4 3 2 4 5 5 3 3 3 8 7 6 6 5 6 6 9 8 8 8 8 8 9 2 4 5 5 5 5 5 2 2 2 2 2 3 3 7 7 7 7 5 6 6 4,80 5,05 5,00 5,00 4,55 4,80 4,50 4,80 5,15 5,10 5,20 5,30 5,85 5,15
Based on the results included in table 34, it has been concluded that the most suitable type of contract would be a Gainsharing. Furthermore, this table also reflects that a T&M contract could also be an appropriate contract option and therefore could be considered as an alternative just in case the client disagrees to the first option.
WEIGHTED TOTAL
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6.3.4. Operation Basing on the criteria included in Table 31, an assessment has been undertaken to determine which type of contract would fit better for the operation phase of the pipeline execution project. The results of the assessment have been reflected in Table 35.
TYPE OF CONTRACT
Financial Benefits
External Factors
Weight 20% 15% 10% 10% 20% 10% 10% 5% FFP FPE FPRP FPRR FFPLOE FPIF FPAF CR/CS CPFF CPAF CPIF Time & Materials Gainsharing Equity Investment 1 2 3 3 3 3 2 8 8 8 7 7 7 8 9 8 6 6 6 7 6 1 2 2 3 4 5 6 6 8 6 6 6 6 6 3 4 4 5 7 7 6 8 7 7 7 6 6 6 1 2 2 2 4 4 4 2 4 5 5 3 3 3 8 7 6 6 5 6 6 8 8 8 8 8 8 9 2 4 5 5 5 5 5 2 2 2 2 2 3 3 7 7 7 7 5 6 6 4,50 5,05 5,00 5,00 4,55 4,80 4,50 4,80 5,15 5,10 5,20 5,30 5,85 6,10
Based on the results included in table 35, it has been concluded that the most suitable type of contract would be an Equity Investment Agreement. Furthermore, this table also reflects that a Gainsharing agreement could also be an appropriate contract option and therefore could be considered as an alternative just in case the client disagrees to the first option.
WEIGHTED TOTAL
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The client might prefer a fixed price contract for this phase. However, a fixed price contract could be an issue when the contractor and client do not come JUSTIFICATION to a detailed agreement on what the work will include. PIPECO might be FOR PROPOSSAL asked to put in many more hours of work without compensation, or the client might feel that he has overpaid for the work. For these reasons, in this case a T&M contract should fit for purpose. The disadvantages could come if PIPECO charge too many hours and DISADVANTAGES exceeds the client's budget. This could cause friction between the two if the budget runs out before the contract is completed. EXPECTED ADVANTAGES With this type of contract, PIPECO is ensured of being paid for his time, regardless of how long the Engineering & Design phase takes. The client has the freedom to change the specifications of the project, or to add new components, as it is understood that such changes will incur more time on the project, and hence a higher invoice.
JUSTIFICATION There are reasonably definite specifications, and fair and reasonable prices FOR PROPOSSAL can be established at the outset. DISADVANTAGES PIPECO must absorb the costs of labour or materials increase during performance of the contract. Usually the purchaser pays only for completed or delivered work This element of the contract is probably the less risky for PIPECO, due to uncertainties are much lower than in the other stages, and for that reason a Firm Fixed Priced contract would be suitable from a PIPECOs perspective. On the other hand this type of contract should be positively valued from Chevrons perspective because it is simpler to administer and ensures cost overruns avoidance.
EXPECTED ADVANTAGES
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TYPE OF CONTRACT
JUSTIFICATION The parties cannot accurately or estimate the costs of the contract, at the FOR PROPOSSAL time of contracting. DISADVANTAGES If the initial estimations for the budget are not accurate, it could mean losses. Sharing of the risks Enhance involvement and collaboration of Chevron during the construction of the pipeline. This could mean technical support, but also external stakeholders (government) management support. There is a good possibility to increase benefits by reducing the estimated budged.
EXPECTED ADVANTAGES
Operation of the Pipeline requires a huge annual investment effort, furthermore operate pipelines is not usually included within PIPECOs core JUSTIFICATION businesses and lack of expertise managing this phase could be other FOR PROPOSSAL significant issue. For these reasons collaboration with Chevron under a Equity Investment Agreement would be the best solution to undertake this stage. DISADVANTAGES Sharing ownership and control over the development of the contract. EXPECTED ADVANTAGES Reduce Investment Effort Risk sharing Gain Chevron Collaboration and expertise
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7. CONCLUSIONS
After the analysis of the different terms included within the PSC, it has been concluded that Gas price and Contractor Share Profit Oil are the most sensible components included in it, and therefore need to be properly addressed in order to ensure the feasibility of the project. In this regard, Gas price is a variable which cannot be controlled exclusively from an internal perspective, because international markets and energy trends will influence its evolution; however it should be considered within the negotiation process as an element that should be related to the taxation of the revenues to minimize exposures. In the same way it should be managed the Contractor SPO, maximising Chevrons take of the revenues till recovering of the investment. Furthermore, it has been also noticed that the Payback Period of the project (under the conditions of the Base Case) is much longer that it would be desirable (almost 18 years). For this reason measures to decrease this period should be envisaged within the contractual terms of the PSC. In addition, it can be concluded that Local Content Initiatives may be an important way of increasing attractiveness of chevrons offer, demonstrating commitment to the Government and increasing Chevrons reputation. Finally, it is considered that PIPECOs pipeline contract should seek to balance the risks allocation between the contractor and the client, providing the most suitable contractual relationship during each one of the stages of the project and in this regard it is believed that a combination of contracts would be the best option for the success of the project.
8. RECOMENDATIONS
Values considered for the Base Case could be more exactly calculated by using a 3 points estimating methodology which would provide better estimations by adding pessimistic and optimistic considerations to the expected scenario. Options outlined to link the evolution of some of the contractual elements included within the PSC to the taxation should be deeply assessed to clearly define the effects on both Chevron and Libyan Government before using them in the negotiation process.
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9. REFERENCES
1. Center for Energy Economics. (2012). Fiscal Terms for Upstream Projects. Available: http://www.beg.utexas.edu/energyecon/. Last accessed 12th March 2012. 2. Silvana Tordo (2007). Fiscal Systems for Hydrocarbons. Washington (USA): The World Bank. 23-78. 3. Manuel, K. M. & Maskell, J. (2012). Insourcing functions performed by federal contractors: An overview of the legal issues. Washington, DC: Congressional Research Service. 13-72 4. U.S Energy Information Administration (2011). Annual Energy Outlook 2011. USA: U.S Energy Information Administration. 12-86. 5. U.S Energy Information Administration. (2011). Natural Gas Prices. Available: http://www.eia.gov/dnav/ng/ng_pri_sum_dcu_nus_m.htm. Last accessed 12th May 2012. 6. Kirsten Binderman (1999). Production-Sharing Agreement: An Economic Analysis. UK: Oxford Institute for Energy Studies. 14-63. 7. Dr Ian Rutledge (2004). The Sakhalin II PSA. UK: Sheffield Energy & Resources Information Services (SERIS). 7-33. 8. Marathon Oil. (2012). Social Responsibility. Available: 3. http://www.marathonoil.com/Social_Responsibility/. Last accessed 19th April 2012. 9. Total. (2010). 2010 CSR Report. Available: http://www.uk.total.com/environment/documents/FinalPDF-2010CSRReport.pdf. Last accessed 3th March 2012. 10. Shell. (2012). Shell in the society/social investment. Available: http://www.shell.co.uk/home/content/gbr/environment_society/shell_in_the_society/soci al_investment/. Last accessed 4th April 2012. 11. ExxonMobil. (2011). 2010 Corporate Citizenship Report. Available: http://www.exxonmobil.com/Corporate/Imports/ccr2010/community_ccr.aspx. Last accessed 20th Nov 2011. 12. ITWORLD. (2012). Making Gain-sharing work. Available: http://www.itworld.com/itmanagementstrategy/107881/making-gain-sharing-work. Last accessed 3th March 2012. 13. EHOW. (2012). Equity Investor Agreement. Available: http://www.ehow.com/facts_7685525_equity-investor-agreement.html. Last accessed 17th April 2012.
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14. Lt Colonel Stephen B. Leisenring (2004). Department of Defence Contracting: Considerations for Selecting Contract Type. Pennsylvania: U.S Army War College. 235. 15. Peter W. G. Morris, Jeffrey K. Pinto (2007). The Wiley Guide to Project Management, Supply Chain and Procurement Management. New Jersey (USA): John Wiley & Sons. 317-344. 16. The global oil and gas industry association for environmental and social issues. (2012). Social responsibility. Available: http://www.ipieca.org/focus-area/social-responsibility. Last accessed 19th April 2012.
10. BIBLIOGRAFY
1. R.K. Corrie (1991). Project Evaluation. London: Thomas Telford Ltd. 21-47. 2. Ernst & Young (2011). Turn risks and opportunities into results. USA: EYGM limited. 846. 3. Ernst & young (2011). Capital project life cycle management for oil and gas. USA: EYGM Limited. 1-16. 4. International Energy Agency (2010). Natural gas information 2010. Paris: CORLET. 11194. 5. Ernst & Young (2011). Navigating joint ventures in the oil and gas industry. USA: EYGM limited. 1-20. 6. Natural Resources Canada. (2011). Long Term Outlook: Crude Oil Prices 2030. Available: http://www.nrcan.gc.ca/energy/publications/sources/crude/issuesprices/1329. Last accessed 23th Sept 2011. 7. Al-Subhi Al-Harbi, K. M. 1998. Sharing fractions in cost-plus-incentive-fee contracts, International Journal of Project Management 5(4):231236. 8. The Office of Government Commerce (OGC). (2006). Risk Allocation Model for Project Strategy and Procurement. Available: http://webarchive.nationalarchives.gov.uk/20110822131357/http://www.ogc.gov.uk. Last accessed 5th April 2012.
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11. APPENDICES
APPENDIX 1: SENSITIVITY ANALYSIS CALCULATIONS APPENDIX 2: LOCAL WORKFORCE DEVELOPMENT APPENDIX 3: SUPPLIER DEVELOPMENT APPENDIX 4: COMMUNITY DEVELOPMENT APPENDIX 5: CONTRACT TYPES APPENDIX 6: BASE CASE FINANCIAL RESULTS RESUME APPENDIX 7: CONTRACT TYPES TREE
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23,00% 4.665.093.460,38 21,64% 3.799.703.056,18 20,23% 2.934.312.651,97 19,59% 2.528.004.733,57 17,99% 1.608.263.477,88 16,31% 687.878.476,45 15,09% 47.303.910,40 13,15% -925.343.275,56 11,47% -1.721.291.719,60 8,50% -3.040.321.725,95 6,00% -4.025.415.817,44
14,18% -504.860.180,55 14,66% -200.568.340,98 15,18% 103.723.498,59 15,72% 408.015.338,17 15,71% 387.271.477,01 16,31% 687.878.476,45 16,94% 987.013.529,81 17,62% 1.286.148.583,17 18,34% 1.585.283.636,52 19,12% 1.884.418.689,88 19,96% 2.182.912.354,76
CAPEX (Wells Drilling & Workover) Profit/Inv Ratio 1,56 1,59 1,61 1,58 1,60 1,63 1,65 1,68 1,71 1,73 1,76 IRR NPV Sensitivity Range (%) 50 40 30 20 10 0 -10 -20 -30 -40 -50
CAPEX (LNG Systems & Vessels) Profit/Inv Ratio 1,56 1,59 1,61 1,58 1,60 1,63 1,65 1,68 1,71 1,73 1,76 IRR NPV Sensitivity Range (%) 50 40 30 20 10 0 -10 -20 -30 -40 -50
15,45% 255.869.418,38 15,72% 408.015.338,17 16,01% 560.161.257,95 15,71% 387.271.477,01 16,01% 538.218.144,18 16,31% 687.878.476,45 16,62% 837.446.003,13 16,94% 987.013.529,81 17,27% 1.136.581.056,49 17,62% 1.286.148.583,17 17,97% 1.435.716.109,84
15,45% 255.869.418,38 15,72% 408.015.338,17 16,01% 560.161.257,95 15,71% 387.271.477,01 16,01% 538.218.144,18 16,31% 687.878.476,45 16,62% 837.446.003,13 16,94% 987.013.529,81 17,27% 1.136.581.056,49 17,62% 1.286.148.583,17 17,97% 1.435.716.109,84 OPEX(Platform)
OPEX(Oil transp./Pipeline Tariff) Profit/Inv Ratio 1,58 1,59 1,60 1,61 1,62 1,63 1,64 1,65 1,66 1,67 1,68 IRR NPV Sensitivity Range (%) 50 40 30 20 10 0 -10 -20 -30 -40 -50 Profit/Inv Ratio 1,24 1,31 1,38 1,46 1,54 1,63 1,72 1,83 1,94 2,06 2,20
IRR
NPV
16,22% 637.513.424,58 16,23% 647.586.434,96 16,25% 657.659.445,33 16,27% 667.732.455,70 16,29% 677.805.466,08 16,31% 687.878.476,45 16,33% 697.951.486,83 16,35% 708.024.497,20 16,36% 718.097.507,57 16,38% 728.170.517,95 16,40% 738.243.528,32
15,45% 229.194.193,97 15,62% 321.188.317,45 15,80% 413.182.440,93 15,97% 505.176.564,41 16,14% 597.170.687,88 16,31% 687.878.476,45 16,48% 778.535.569,82 16,64% 869.192.663,18 16,80% 959.849.756,55 16,97% 1.050.506.849,91 17,13% 1.141.163.943,28
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ROYALTY RATE Profit/Inv Ratio 1,45 1,49 1,52 1,56 1,59 1,63 1,66 1,70 1,73 1,77 1,80 IRR NPV Sensitivity Range (%) 50 40 30 20 10 0 -10 -20 -30 -40 -50 Profit/Inv Ratio 1,65 1,63 1,61 1,59 1,57 1,55 1,53
COST RECOVERY IRR NPV Sensitivity Range (%) 50 40 30 20 10 0 -10 -20 -30 -40 -50
15,40% 203.125.525,41 15,59% 300.333.382,60 15,77% 397.541.239,79 15,95% 494.749.096,98 16,13% 591.956.954,17 16,31% 687.878.476,45 16,48% 783.570.534,78 16,65% 879.262.593,11 16,82% 974.954.651,44 16,98% 1.070.646.709,77 17,15% 1.166.338.768,10
16,56% 817.965.836,76 16,31% 687.878.476,45 16,05% 554.567.389,07 15,80% 421.256.301,70 15,55% 287.604.227,76 15,28% 149.106.569,11 15,02% 10.608.910,46 PROFIT TAX
CONTRACTORS SHARE PROFIT OIL Profit/Inv Ratio 1,82 1,63 1,43 1,23 1,04 0,84 0,64 IRR NPV Sensitivity Range (%) 50 40 30 20 10 0 -10 -20 -30 -40 -50 Profit/Inv Ratio 1,42 1,46 1,51 1,55 1,59 1,63 1,67 1,71 1,75 1,79 1,83 IRR
NPV
15,70% 348.069.029,90 15,82% 416.030.919,21 15,95% 483.992.808,52 16,07% 551.954.697,83 16,19% 619.916.587,14 16,31% 687.878.476,45 16,42% 755.840.365,76 16,54% 823.802.255,07 16,65% 891.764.144,38 16,76% 959.726.033,69 16,87% 1.027.687.923,00
17,25% 1.230.133.473,66 16,31% 687.878.476,45 15,27% 138.320.287,28 14,14% -416.531.070,12 12,86% -980.316.337,29 11,41% -1.556.128.920,87 9,70% -2.150.402.430,51
SIGNATURE BONUS Profit/Inv Ratio 1,63 1,63 1,63 1,63 1,63 1,63 1,63 1,63 1,63 1,63 1,63 IRR NPV Sensitivity Range (%) 50 40 30 20 10 0 -10 -20 -30 -40 -50
16,30% 685.704.563,41 16,31% 686.139.346,02 16,31% 686.574.128,63 16,31% 687.008.911,24 16,31% 687.443.693,84 16,31% 687.878.476,45 16,31% 688.748.041,67 16,31% 689.182.824,28 16,31% 689.617.606,89 16,31% 690.052.389,50 16,31% 690.487.172,10
55
Estimated cost
56
Maximizing opportunities for achieving higher levels of reliability and quality through local supplier proximity. Maximizing opportunities for lower costs on some locally-procured goods and Attractiveness services (mainly in the longer term). Increased local and national commitment to the project. Closer business alignment with government goals for development and local capacity building. It can also reduce project risk and enhance a companys reputation with local stakeholders.(Shell, 2012) Period Year 1 to 4 Year 5 to 10 Year 11-25 Investment US$ 150;000/year US$ 100;000/year US$ 25;000/year Total Sub total US$ 600,000 US$ 600;000 US$ 375;000 US$ 1,575;000
Estimated cost
57
Infrastructure Repair infrastructures damaged by the war with special attention to improve Development roads conditions in the areas of our operations. Government relationship: Contributing to the stability of the business environment; Meeting legislative requirements; Meeting expectations of host governments (driven in many instances by the expectations of local communities and business) for local economic and social benefits of oil and gas developments. Attractiveness Increasing the likelihood of competitive differentiation in bidding rounds/negotiations with host governments and government authorities Reputation: Delivering sustainability and corporate responsibility objectives, maximizing the impact of community investment resources. Period Year 1 to 4 Year 5 to 10 Year 11-25 Investment US$ 100;000/year US$ 100;000/year US$ 25;000/year Sub total US$ 400,000 US$ 600;000 US$ 375;000 US$ 1,375,000 US$ 400,000 US$ 600;000 US$ 375;000 US$ 1,375,000 US$ 2,000,000 US$ 1,200;000 US$ 375;000 US$ 3,575,000 US$ 6,275;000 and
Supporting Education
Estimated cost
Health Programmes
Year 1 to 4 US$ 100;000/year Year 5 to 10 US$ 100;000/year Year 11-25 US$ 25;000/year
Year 1 to 4 US$ 500;000/year Infrastructure Year 5 to 10 US$ 200;000/year Development Year 11-25 US$ 25;000/year Total
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Fixed-price contracts are generally favored by purchasers because the contractor assumes the risk of increases in performance costs. Purchasers liability is typically limited to the contract price, so long as the contract does not have a price adjustment clause and the purchaser has not actually or constructively modified the contract. Additionally, the purchaser can generally rely on the contractor to finance performance under a fixed-price contract. Unless the purchaser agrees to provide financing in the form of progress payments, it pays only for completed or delivered work. (Morris & Pinto, 2007) Further, fixed-price contracts are generally simpler for the purchaser to administer because there is typically no need to audit the contactors books or determine whether particular costs are allowable under the contract. (Kate M. Manuel, 2010)
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DESCRIPTION Contractor agrees to provide supplies or services to the procuring activity for a specified price
Fixed-price contracts with Contractor agrees to provide supplies or services to the procuring economic price adjustments activity for a specified price that could be adjusted if certain economic conditions change during performance of the contract (FPE) Fixed-price contract with prospective price redetermination (FPRP) Fixed-ceilingprice contracts with retroactive price redetermination (FPRR) Firm-fixed-price, level-ofeffort term contracts (FFPLOE) Contractor receives a firm fixed price for a specified initial period of performance, with the price for later periods revised in an equitable manner based on variables agreed upon by the partiesb Contractor receives no more than a fixed ceiling price that was agreed upon when the contract was formed; determination of actual price occurs after the contract is performed based on variables previously agreed upon Contractor receives a fixed amount for providing a certain level of effort over a certain period of time on work that can only be stated in general terms
Table 37: Fixed Price Contracts Description (Source:U.S Army War College)
Regardless of the type of fixed-price contract used, the purchaser runs the risk of overpaying for goods and services, especially if it overestimates its requirements. With firm-fixed-price contracts, in particular, the purchaser could also: Pay higher prices than would have been paid under cost-reimbursement contracts. Have to convert the contract to another type to obtain completion of performance. Defend lawsuits filed by contractors attempting to recover increases in performance costs by alleging that the purchaser constructively modified the contract. Similarly, with fixed-price contracts with economic price adjustment clauses, the purchaser could be vulnerable to significant and unanticipated price increases, especially if the clauses do not adequately protect the purchasers interests. However, refusal to use economic price adjustment clauses where significant economic fluctuations are possible could result in the purchaser paying higher prices because fewer contractors will compete for such contracts. (Leisenring, 2004)
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11.5.2. Cost-Reimbursement Contracts The various cost-reimbursement contracts, described in Table 38, provide for the purchaser to pay the contractor, at a minimum, allowable costs incurred in performing the contract up to a total cost specified in the contract. As used here, costs do not necessarily include all expenses that the contractor incurred in performing the contract. Rather, costs are expenses that are allocable to the contract and reimbursable by the purchaser under the terms of the contract. (Morris & Pinto, 2007) The types of cost-reimbursement contracts differ in whether the contractor recovers only costs (e.g., cost contracts, cost-sharing contracts) or whether there is some allowance for profit (e.g., cost-plus fixed- fee contracts, cost-plus-a-percentage-of-cost contracts). Some contracts are with vendors that are nonprofits (e.g., cost contracts) or that at least are not expecting to profit from the contract (e.g., cost-sharing contracts). Others are with contractors who anticipate making a profit (cost-plus-fixed-fee contracts). Cost (CR) Cost-sharing (CS) Cost-plus-fixed-fee (CPFF) Cost-plus-award-fee (CPAF) Cost-plus-incentive-fee (CPIF)
TYPE Cost contracts (CR) Cost-sharing contracts (CS) DESCRIPTION Contractor reimbursed for allowable costs up to a specified total cost; no allowance for profit Contractor is reimbursed for some allowable costs; pays the other costs itself
Contractor is reimbursed for Cost-plus-fixed fee allowable costs up to the specified contracts (CPFF) total cost and receives a negotiated fixed fee for its efforts Cost-plus-a percentageof cost contracts Contractor is reimbursed for its costs and receives a certain percentage of these costs as an allowance for profit.
Cost-reimbursement contracts can be high risk for the purchaser because the contractor has little incentive to keep the performance costs down given that the purchaser will ultimately pay these costs. These risks are even greater when the contractor is assured of not only recovery of its costs, but also profit based on a percentage of the costs (i.e., costplus-a-percentage-of-cost contracts). Further, cost reimbursement contracts can give rise to disputes between the parties over whether particular costs are allowable under or allocable to the contract.
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11.5.3. Incentive Contracts (Payment linked to results) The various types of incentive contracts (fixed-price incentive contracts, cost-plusincentive-fee contracts, and cost-plus-award-fee contracts) are often characterized as occupying a middle ground between fixed-price and cost-reimbursement contracts because the parties share the risk by basing the contractors profits, in part, on the cost or quality of its performance. (Morris & Pinto, 2007)
INCENTIVE CONTRACTS TYPES fixed-price incentive contracts: Fixed-price award-fee (FPAF) Fixed-price Incentive Firm (FPIF) Fixed-price incentive with successive targets (FPIS) cost-plus-incentive-fee contracts cost-plus-award-fee contracts
Table 39: Incentive Contracts
The various types of incentive contracts are alike in that they provide for the contractor to get: 1 A specified base fee. 2 The opportunity to earn additional fees (i.e., incentive or award fees) based upon its performance in meeting cost, schedule, or technical goals under the contract. They differ in the basis upon which the additional fee is determined and, in the case of incentive-fee contracts, the circumstances in which they can be used. Cost plus-award fee contracts With this type of contracts the award fee is entirely separate from the base fee and is determined based on the procuring activitys subjective evaluation of the contractors performance. Fixed-price/Cost-plus incentive contracts With fixed-price incentive contracts and cost-plus-incentive-fee contracts, in contrast, the incentive fee is determined based upon formulaic adjustments of the base fee. The formula for fixed-price incentive contracts focuses upon the relationship of total final negotiated cost to total target cost. The formula for cost-plus-incentive-fee contracts focuses upon the relationship of total allowable costs to total target cost and includes the target cost, the target fee, the minimum fee, and the maximum fee as components.
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11.5.4. Time and Materials and Labour-Hour Contracts In a T&M contract, the contractor is paid a fixed hourly rate for direct labour expended during the contracts performance (e.g., wages, overhead, general and administrative expenses, profit), as well as the actual cost of materials. The materials covered by a timeand materials contract can include direct materials, subcontracts for supplies or incidental services, other direct costs, and applicable indirect costs. A labour-hour contract is similar to a time-and-materials contract, except the contractor supplies only direct labour, not materials. Suitability: The parties cannot accurately estimate the extent or duration of the contracts work, or reasonably estimate the costs of the contract, at the time of contracting The contracting officer prepares a determination and findings (D&F) that no other contract is suitable The contract includes a ceiling price that the contractor exceeds at its own risk. 11.5.5. Gainshare Gain sharing is a contractual structure where the organization and its service provider agree to share financial gains and losses under predefined conditions: If the project cost meets the agreed target, the contractor makes an agreed level of profit. If the project cost is lower than the agreed target, then the contractor receives some of the savings as a reward. Conversely, if the project cost is higher than the agreed target, then the contractor shares some of the cost over-run as a penalty. (ITWORLD, 2012) 11.5.6. Equity Investment Equity finance enables an organization to attract investment in exchange for an ownership stake in the business. For example, the investment can be made in exchange for shares in a company. Equity investor agreements facilitate these transactions. An organization can finance its operations in two principal ways: equity finance and debt finance. In equity finance, the organization sells equity in return for investment. In debt finance, the organization obtains funds through loans and the issuance of bonds. Advantages: Debt finance, such as loans, imposes extra costs on the organization such as interest and penalty fees. However, equity agreements enable the organization to attract investment without any obligation to repay the investor. Depending on the organization's success, an investor usually makes a return in his investment by way of dividends. (EHOW, 2012)
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CPIF
CPAF
CPFF
CR or CS
LH or T&M
Use
Objective relationship can be Objective relationship between Relating fee to measures of Contractor expects substantial No other type of contract is established between the fee and fee and measures of contract performance is compensating benefits for suitable due to contract measures of contract performance are not feasible. unworkable or of marginal absorbing part of the cost delivery requirements or performance Subjective standards can be utility and/or foregoing fee; non-profit other factors fairly applied contactor
Principal Risk Purchaser assumes the majority of the risk inherent in the contract due to highly uncertain and speculative labour, materiel and other requirements Purchaser necessary to perform the contract. perspective Required contract elements Target cost; minimum, Target cost; Standards for Target cost; fixed fee maximum and target fee; evaluating performance; Base formula for adjusting fee based and maximum fee; procedures on actual costs and/or for adjusting fee based on performance performance against standards Research and development of Large scale research study the prototype for a major system Research study Target cost; If CS, an Ceiling price; per hour labour agreement on the DOD share rate that includes overhead of the cost; no fee and profit; provisions for reimbursing direct material costs Joint research with non-profit institutions Emergency procurement of repairs Make a good faith effort to meet the contract requirements within the ceiling price
Make a good faith effort to meet the contract requirements within the estimated cost and schedule
Contractor incentive
Realize a higher fee by Realize a higher fee by Realize a higher rate of If CS, shares in providing a None Completing work at a lower cost meeting subjective return (fee divided by total deliverable of mutual benefit and/or by meeting other performance standards cost) as total cost objective performance decreases targets
Table 40: Cost Reimbursable Contracts Comparative
(Adapted from U.S Department of Defence Contracting Considerations for Selecting Contract Type)
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FFP
Requirement is well defined; contractor is experienced; stable market; insignificant financial risks
FPEPA
Significant risk to market prices due to industry wide factors beyond the contractor's control; Dollars at risk outweigh administrative burden Unstable market prices for labour or materiel over period of contract Fixed-price; ceiling for upward adjustment; formula for price adjustment for market conditions Commercial materiel and services during periods of market instability Provide acceptable deliverable at specified time, place and adjusted price
FPIF
Ceiling price can be established that covers the risks inherent in the work effort; profit sharing formula motivates contractor to control costs Moderately uncertain contract labour or materiel requirement Ceiling price; target cost; target profit; delivery and quality targets; profit sharing formula Production of a major system based on a prototype
FPAF
Acceptance criteria can be fairly evaluated; fee will provide meaningful incentives and justify related administration burden Contractor may acceptance criteria not meet
FPRP
DOD requires firm commitment for materiel or services during subsequent years; dollars at risk outweigh administrative burden Costs of performance after first year cannot be accurately estimated Fixed-price for first period; Proposed subsequent periods; Timetable for pricing next periods. Lon-term production of spare parts Provide acceptable deliverable at specified time, place and at price established for each period Additional profit for reduction in performance costs for performance periods
Use
Principal Risk to Purchaser Required contract elements Typical uses Contractor obligation Contractor incentive
Commercial materiel and services Provide acceptable deliverable at specified time, place and price Additional profit for reduction in performance costs
Firm fixed-price; performance evaluation standards; procedures for calculating fee based on performance standards Performance based contracts for materiel and services Perform at the time, place, and price fixed in the contract Additional profit for reduction in Performance costs; additional fee for meeting performance standards
Provide acceptable deliverable at specified time, place and at or below ceiling price Additional profit for reduction in Higher profit for completing performance costs work below ceiling price and/or meeting objective performance targets Table 41: Fixed Price Contracts Comparative
(Adapted from U.S Department of Defence Contracting Considerations for Selecting Contract Type)
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Economic Results Summary for Foreign Oil Company Profit / Investment Ratio 1,63 NPV (Discounted at 15%) $687,878,476 IRR 16,31%
MANUEL ANGEL GONZALEZ SUAREZ 1117655
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Economic Results Summary for National Oil Company NPV (Discounted at 15%) $2,799,050.571
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