Start Up Training For Project Engineers

OMV Exploration & Production
Economic Evaluation
Start up Training for
Project Engineers
Move & More.

Start up training for project engineers_07.ppt
2 |OMV Exploration & Production EC-E, December 30, 2011

Purpose of the Training

f Brief introduction into cash flow based project economics
f Understanding major economic decision criteria applied by OMV E&P
f Usage of the Easy Evaluation Tool

Contents
A.
Cash Flow Basics
B.
Economic Decision Criteria
C.
Sensitivities
D.
Easy Evaluation Excel Tool
E.
Project Example
F.
2 E&P Exercises
G.
Conclusion

A. Cash Flow Basics
Cash Flow Basics

f Definitions & Cash-flow Profile
f Revenue / Volume / Price
f Petroleum E&P Expenditure
-
Capital Expenditure (CAPEX)

Operational Expenditure (OPEX)

A. Cash Flow Basics
Cash Flow Profile of an E&P project

f Revenue
f CAPEX
f OPEX
mn EURO
Cash-Flow of an E&P-Project (entire life cycle view)

27.5
27.7%
20.6
19.8%
13.7
12.0%
6.9
4.2%
0.0
-3.6%
-6.9
-13.7
-11.4%
-20.6
-19.3%
-27.5
2012
2014
2016
2018
2020
2022
2024
2026
2028
2030
-27.1%

A. Cash Flow Basics
Revenue / Volume / Price

Revenue = sold Volume x Price
Differentiation:
f Produced Volume
f Sold Volume
The income portions of cash flows are known as Revenue

f Gross revenue is the product of oil and/or gas volume multiplied by
the unit price received for each volume of that product

A. Cash Flow Basics
Petroleum E&P Expenditure

Payment of cash or cash-equivalent for goods or services;
can be classified as:
f Capital Expenditure (CAPEX) and
f Operating Expenditure (OPEX)
Definition of typical E&P expenditures

f Finding Cost CAPEX
f Development Cost CAPEX
f Production Cost OPEX

Contents
A.
Cash Flow Basics
B.
C.
Sensitivities
D.
E.
Project Example
F.
2 E&P Exercises
G.
Conclusion

B. Economic Decision Criteria

f Fundamental bases of economic decision
- General introduction
- Time value of Money
f Economic Yardsticks
- Net Present Value (NPV)
- Expected Monetary Value (EMV)
- Internal Rate of Return (IRR)
- Payback Period
- Profitability Index

Financial & Economic Analysis

f Everything important to the decision should be included in the analysis
f Concerning the decision making process also qualitative factors have to
be taken under consideration (e.g. effects to the society)

f Financial analysis of investment alternatives requires that all
opportunities be appraised on the same basis, and the time value of

money be properly taken into account
f There is not only one single measure of profitability

Time Value of Money

f Decision-making in investment analysis requires anticipated revenues &
cost of investment alternatives to be placed on equivalent bases

6,209 / (1 + 0,1)
=
5,645
6,830 / (1 + 0,1)
= 6,209
7,513 / (1 + 0,1)
8,264 / (1 + 0,1)
= 6,830
= 7,513
9,091 / (1 + 0,1)
= 8,264
10,000 / (1 + 0,1)
= 9,091
10,000
+0.1)6
1
/(
0
0
,0
0
1
=
***id)
*PV = **FV / (1 +
6 = 5,645
1
7
.7
/1
0
0
,0
0
1
=
n
@10%
* PV
. Present value
** FV
. Future value
*** id . discount interest

rate
fCounterpart of discounting: compounding

fRelevant levers
f discount rate
f time
f value
Project Economics and Decision Analysis, Volume I, p. 23ff.
Discount rate
Discount rates at E&P:
f Standard rate (WACC)- Percentage rate at which future money is
discounted 10%
(WACC): Weighted-average cost of capital the marginal cost of
funding the next project; this is calculated as an weighted-average
cost of a mixture of equity and debt.
f Hurdle rate the minimum acceptable rate of return on investment
15% for incremental projects / 11% for acquisitions
Economics of worldwide PPC, R.D. Seba; page 185

Net Present Value (NPV) (1/4)

f For analyses of project cash flows the most common method is Net
Present Value (NPV)

f NPV = Total PV of future CFs + Initial Investment (negative)
f General:
f NPV uses cash flows
f NPV uses the cash flow pattern of the entire project
f NPV discounts the periodically (yearly) cash flows properly (
discounted cash flows)

f Base case model computes nominal NPV

Net Present Value (NPV) (2/4)

The formula for NPV calculation is*
CF n
n
n =1 (1 + i )
N
NPV = CF 0 +
where
CF0 = Todays cash flow

CFn = Projects cash flow of period n
i = discount rate
n = Number of years elapsed
If NPV > 0, the project is accepted
(NPV represents present value cash worth in excess of realizing a rate of return
equal to i);
If NPV = 0, the project is marginal, i.e. neither adds or destroyed value.
(the project yields a rate of return equal to i);
If NPV <0, the project is not profitable on a time-adjusted basis;
The higher the NPV, the higher is the value added for the company.
* OMV standard: mid-year discounting
Net Present Value (NPV) (3/4) Example

Would you rather receive:
Option A: 10,000 as follows: 6,000 after 1 year and 4,000 after 2 years
or
f Option B: 12,000 as follows: 2,000 after 1 year followed by another 2,000
annually during over the next 5 years?
f
Cash Flow
Year
Discount rate
@ 10%
Option A
Option A
Option B
Option B
Undiscounted
Discounted
Undiscounted
Discounted
1.000
0.909
6,000
5,455
2,000
1,818
0.826
4,000
3,306
2,000
1,653
0.751
2,000
1,503
0.683
2,000
1,366
0.621
2,000
1,242
0.564
2,000
1,129
10,000
8,760
12,000
8,711
Total
In this example, it is preferable to receive 10,000 in 2 years as this has a present value of 8,760 as opposed to the
present value of de 8,711 based on in six payments of 2,000 each.
Net Present Value (NPV) (4/4) Example

f
Normally, when the discount rate (i) increases the NPV decreases.
10,000
9,000
8,711
Option B
8,000
6,651
NPV EUR
7,000
6,000
5,285
5,000
4,336
3,649
4,000
3,135
3,000
2,000
1,000
0
10%
20%
30%
40%
50%
60%
discount rate (i)

Expected Monetary Value (EMV)

f Expected Monetary Value can be calculated by risk adjusting the NPV
f expressed mathematically as the sum of the product of an events
probability of occurrence and the gain and loss that will result
Year
0
1
2
3
4
5
6
7
8
9
10
Total
Cash Flow Exploration Well (mn EUR)

undiscounted
discounted @10%
-2.50
-2.50
success
2.00
1.82
propability
3.50
2.89
15%
4.00
3.01
4.50
3.07
5.00
3.10
4.00
2.26
dry hole
3.00
1.54
propability
2.00
0.93
85%
1.00
0.42
0.30
0.12
26.80
16.66
chance of success
dry hole costs
gain (NPV)
16.66
2.50
+
x
loss (drilling costs)

-2.50
EMV = 0.37 mn EUR
-2.13
15%
2,5

Internal Rate of Return (IRR) (1/2)

f
f
Internal Rate of Return (IRR) is the discount rate for which the Net Present
Value equals 0
Excel formulae:
f IRR () English version
f IKV() German version
Effective rate of interest of the respectively bounded capital
If IRR the hurdle rate, the investment proposal shall be accepted.

If IRR < the hurdle rate, the investment proposal shall be rejected.

Internal Rate of Return (IRR) (2/2) Example

5.00
4.00
3.80
NPV mn EUR
3.00
2.45
2.00
IRR = 58% --> NPV = 0
1.42
1.00
0.63
0.00
0.00
-0.51
-1.00
-0.93
-1.28
-2.00
18%
28%
38%
48%
58%
68%
78%
88%
-1.58
98%
discount rate

Payback Period (1/3)

The focuses on recovering the initial investment
f time needed to recover the investment (payback or amortization period)
f Break-even point
Signifies time period of exposure to risk
f the shorter the payback the better
Problems with payback
f ignores benefits occurring after the payback period
f does not measure total income
The payback period is based on the discounted accumulated project cash
flow (main OMV discount rate of 10% has to be used)

Payback Period (2/3) Example Calculation

New Oil Company is considering to drill an additional development well on its
field. The well will cost mn EUR 2.5 to drill and will generate mn EUR 0.33
additional income for 20 years. The company requires that investments are
paid back within 10 years. Should the investment go ahead?
Year
0
1
2
..
7
8
..
13
14
15
..
20
0.909
0.826
Annual Cash
Flow
[mn EUR]
-2.50
0.33
0.33
Accumulative
Cash Flow
[mn EUR]
-2.50
-2.17
-1.84
Accumulative
discounted Cash
Flow
[mn EUR]
-2.50
-2.20
-1.93
0.513
0.467
0.33
0.33
-0.19
0.14
-0.89
-0.74
0.29
0.263
0.239
0.33
0.33
0.33
1.79
2.12
2.45
-0.16
-0.07
0.01
0.149
0.33
4.10
0.31
Discount
Factor
@ 10%
Solution: The payback period is 14,6 years, the investment is rejected

OMV discounted 10% - notice
Payback Period (3/3) Example Chart

5
(disc.)
Project CF (non-disc.)
Project Cash Flow, non-disc.,acc.
4.1
Project Cash Flow, disc., acc.
3.8
3.4
3.1
2.8
3
2.5
2.1
Payback after 14.6 years

1.8
mn EURO
1.5
1.1
0.8
1
0.5
0.3
0.3
0.2
0.2
0.2
0.2
0.2
0.1
0.1
0.1
0.1
-0.2
0
-0.5
-0.9
-1
-1.5
-1.6
-1.2
-1.4
-1.2
-1.0
-0.9
-0.7
-0.6
-0.5
0.1
-0.3
0.1
-0.2
0.1
-0.1
0.1
-0.1
0.0
0.1
0.1
0.1
0.1
0.1
0.2
0.1
0.2
0.3
0.1
0.0
-1.8
-2
-2.1
-2.2
-2.4
-2.5
-2.4
-3
2011
2013
2015
2017
2019
2021
2023
2025
2027
2029
2031

Profitability Index (1/2)

f Also known as Discounted Return of Investment (DROI)
f PI shows how many EURO cents is earned per 1 EURO of cash out (e.g.
CAPEX)
Profitability Index
PV Cash out
PV Cash in
PV Cash out
PV Cash out
Typically used within OMV E&P

NPV
PI
=
Present Value of CAPEX
NPV
PV of CF
PV of CAPEX
Also possible (normally not used within OMV E&P)

NPV
PV of CF
PI
=
=
Present Value of (CAPEX + OPEX)
PV of (CAPEX + OPEX)
Profitability Index (2/2) Example
Example:
f Project CAPEX = 100 MM EUR spent over 1 year.
f Operational CF = 20 MM EUR per year over 10 years.
f Discount rate = 10%, CF basis at the end of the year.
f NPV = 20,81 MM EUR, Present Value (PV) of CAPEX = 90,9 MM EUR
f PI = 0,23 which means this project will generate 23 EURO cents per each 1
EURO invested, both being in terms of Present Value.

Which yardsticks to use Decision

KPI
What is it
Major assessment criterion for
NPV
project economics
Absolute value in monetary
terms of discounted payment
surpluses indicating project
attractiveness
Useful for project rankings
Risk-adjusted (probability-
EMV
adjusted) NPV (cf. above)
Internal rate of return (in %) of a
IRR
Pay
Back
Period
cash flow profile

Indicates the discounting rate at
which the cash flow profile has
an NPV of 0
Is compared to a specific hurdle
rate (%)
Number of periods (years)
needed to recover the invested

capital
Useful for single investment of
choice decisions
Ratio indicating how many
What it means
Positive NPV project is profitable
Uncertainty of cash flows
Negative NPV project is not profitable
Reinvestment premise (at discounting rate)
For rankings: a project is preferred if the
For project comparisons: prerequisite of
Positive EMV project is profitable (given
Accuracy of probabilities
NPV is higher than that of an alternative

investment
its probabilities)
Negative EMV project is not profitable
(given its probabilities)
Higher than hurdle rate project is
profitable (with some restrictions)

Lower than hurdle rate project is not
profitable
For rankings: a project is preferred if the IRR
is higher than that of an alternative
investment
identical life time of all alternatives

Reinvestment premise (at IRR)

Cannot always be calculated (certain cases
of inconclusive IRR or no IRR at all)
Not additive
Does not consider (total) investment volume
The shorter the pay back period the better
A shorter payback period indicates a lower
Ignores occurrences after breakeven point
risk exposure
The higher the PI the more attractive a

monetary units is earned per 1
project appears
monetary unit of cash out (e.g.
CAPEX)
26 |OMV Exploration
& Production
December 30, 2011
Useful
for projectEC-E,
rankings
PI
Stumbling blocks
in time
Does not provide information about total
profit of the investment project
Reinvestment premise (cf. NPV)
There is different ways of calculation
(depending on denominator)
Not additive
Does not consider (total) investment volume
Contents
A.
Cash Flow Basics
B.
C.
Sensitivities
D.
E.
Project Example
F.
2 E&P Exercises
G.
Conclusion

C. Sensitivities
Spider Sensitivity graph (1/2)

f Differentiation between input variables/parameters and output results
f Ceteris paribus assumption (all other things held constant)
Spider chart illustrates the differences between

f the minimum and maximum values of the output result by drawing a
curve through all variations of the input variable tested (E&P standard
50%, 75%, 125%, 150%)
f Curves with steep slopes, positive or negative, indicate that those
variables have a large effect, while curves that are almost horizontal
show little or no effect on the forecast
f The slopes of the lines also indicate whether a positive change in the
variable has a positive or negative effect on the output result

C. Sensitivities
Spider Sensitivity graph (2/2)

800
C A P EX
O PE X
Pr ice
Q u a nt it y
BA SE CA SE
600
54 9
450
400
38 1
352
33 6
2 91
mn EURO
33 8
200
2 65
200
2 53
2 45
30 1
15 4
15
2 28
191
56
-43
-1 4 2
-2 0 0
-2 4 0
-339
-4 0 0
54 9
450
3 52
2 53
1 09
15 4
1 17
63
81
56
18
44
-28
7
-43
-1 42
-24 0
-33 9
5 0 .0 %
6 0 .0 %
7 0 .0 %
8 0 .0 %
9 0 .0 %
1 0 0 .0 %
110. 0%
% of B as e Cas e
1 2 0 .0 %
1 3 0 .0 %
1 4 0 .0 %

Contents
A.
Cash Flow Basics
B.
C.
Sensitivities
D.
E.
Project Example
F.
2 E&P Exercises
G.
Conclusion

D. Easy Evaluation Excel Tool

f General
- Pre tax calculation (no royalties and taxes are considered)
- All volumes have to be inputted in mn boe
- All cash values have to be inputted in mn
f Purpose of the tool

- Quick project evaluation
- Creation and comparison of project scenarios
- Optimization of the cash flow concerning the best economical
output
- Not a tool to create final economic calculations

- Final economics have to be calculated in Palantir Cash

Contents
A.
Cash Flow Basics
B.
C.
Sensitivities
D.
E.
Project Example
F.
2 E&P Exercises
G.
Conclusion

F. 2 E&P Exercises
Team Exercises
f 2 E&P exercises
f Project input
f Making the right decisions
- Output of calculations and graphics
f Change Input variables (scenarios)
- New output of calculations and graphics
f Close loop Learning by doing
f Short presentation of findings
f Presentation of the results and interpretations


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OMV Exploration & Production

Move & More.

2 |OMV Exploration & Production EC-E, December 30, 2011

Purpose of the Training

3 |OMV Exploration & Production EC-E, December 30, 2011

Cash Flow Basics

Economic Decision Criteria

Easy Evaluation Excel Tool

4 |OMV Exploration & Production EC-E, December 30, 2011

A. Cash Flow Basics

Cash Flow Basics

Capital Expenditure (CAPEX)

5 |OMV Exploration & Production EC-E, December 30, 2011

A. Cash Flow Basics

Cash Flow Profile of an E&P project

Cash-Flow of an E&P-Project (entire life cycle view)

6 |OMV Exploration & Production EC-E, December 30, 2011

A. Cash Flow Basics

Revenue / Volume / Price

The income portions of cash flows are known as Revenue

7 |OMV Exploration & Production EC-E, December 30, 2011

A. Cash Flow Basics

Petroleum E&P Expenditure

Definition of typical E&P expenditures

8 |OMV Exploration & Production EC-E, December 30, 2011

Cash Flow Basics

Economic Decision Criteria

Easy Evaluation Excel Tool

9 |OMV Exploration & Production EC-E, December 30, 2011

B. Economic Decision Criteria

Economic Decision Criteria

10 |OMV Exploration & Production EC-E, December 30, 2011

B. Economic Decision Criteria

Financial & Economic Analysis

be taken under consideration (e.g. effects to the society)

opportunities be appraised on the same basis, and the time value of

11 |OMV Exploration & Production EC-E, December 30, 2011

B. Economic Decision Criteria

Time Value of Money

cost of investment alternatives to be placed on equivalent bases

*** id . discount interest

fCounterpart of discounting: compounding

B. Economic Decision Criteria

15% for incremental projects / 11% for acquisitions

Economics of worldwide PPC, R.D. Seba; page 185

B. Economic Decision Criteria

Net Present Value (NPV) (1/4)

Present Value (NPV)

discounted cash flows)

14 |OMV Exploration & Production EC-E, December 30, 2011

B. Economic Decision Criteria

Net Present Value (NPV) (2/4)

CF0 = Todays cash flow

If NPV > 0, the project is accepted

B. Economic Decision Criteria

Net Present Value (NPV) (3/4) Example

B. Economic Decision Criteria

Net Present Value (NPV) (4/4) Example

discount rate (i)

17 |OMV Exploration & Production EC-E, December 30, 2011

B. Economic Decision Criteria

Expected Monetary Value (EMV)

Cash Flow Exploration Well (mn EUR)