Professional Documents
Culture Documents
With contributions by
Translated by
Bowne Global Solutions
Mr Jonathan PEARSE
2011
Editions TECHNIP
Translation of
Recherche et production du ptrole et du gaz.
Rserves, cots, contrats / 2e dition
N. BRET-ROUZAUT, J.P. FAVENNEC
2011, ditions Technip, Paris
for the second edition
Printed in France
We first had the idea for this book in early 1999, when we considered writing about all the
economic considerations associated with hydrocarbon exploration and production. It was then
that we laid out its aims and devised the plan.
The idea was consistent with one of the missions of the IFP Schools Centre for
Economics and Management: to convey information about all aspects of the hydrocarbon
economy. Thanks to encouragement from IFP nergies nouvelles and friends in the sector,
the project started to take shape and finally got under way.
This book sets out to tackle all aspects of hydrocarbon research and production concisely,
but also exhaustively. It does so by describing this activity an activity that is often seen
as somewhat mysterious by looking at all the major themes involved.
The first chapter contextualises the role played by oil in a world which is dependent on
it, and which shall continue to be dependent on it for a number of years to come. It looks
back over the history of this raw material, investigates the changes in its price over the years
and the changes in the way in which the whole oil industry has been structured. The second
chapter adopts a more technical approach and describes the expertise and technologies that
are used both in the search for hydrocarbons and in their production. The third chapter looks
at the concept of reserves and discusses it, along with the various classifications and modes
of assessment involved. The fourth chapter puts forward a detailed analysis of the investments and costs involved in this highly capital-intensive industry. The fifth chapter deals with
the legal, contractual and fiscal considerations which govern the ways in which income is
shared among the various stakeholders involved. The sixth chapter looks at the economic
criteria which are used when investment decisions are made in this sector. The seventh
chapter looks at specific accounting features and other useful indicators that are used for
analysing competition. The eighth and last chapter investigates problems to do with safety,
the environment and ethics problems which are fundamental nowadays.
If this book succeeds in providing readers with a better overview of this industry of which
Colonel Drake was the pioneer, then we will have succeeded in our aim.
We would like to extend our warmest thanks to all the people who were involved in the
first edition of this book. For the update, in addition to all those involved in the first edition
(including Denis Guirauden who has been ever present by our side), we called upon a
number of specialists who were tasked with looking out for errors and putting forward
recommendations for changes and improvements. Among them are Alain Auriault, Antoine
Couturier, Alain Doat, Jean-Luc Mari and Alain Mascle.
VII
Foreword
Finally, we would like to thank Total, Shell and BP who were kind enough to provide us
with the photographs without which such a book would not have been possible.
Nadine Bret-Rouzaut
Director of the Centre for Economics and Management
IFP School
Jean-Pierre Favennec
Consultant
Professor IFP School
September 2011
VIII
It has been a long time since a reference book on the exploration and production of oil and
gas was last published. This book therefore meets a genuine need: to explain to a wellinformed readership (teachers, students, researchers, journalists, engineers, industrial and
political decision-makers) the key activities of this sector so vital to the world economy both
now and in the future. It also provides essential information for the public at large on the
relationships between energy and the environment, which involve many complex issues and
stir public debate.
This book stresses the economic aspect of petroleum activities and provides a solid understanding of the technical and contractual issues which underpin relations between the
petroleum industry and the producing countries, a wise choice since the economics of the
sector cannot be understood without a solid grounding in the technical, legal and political
aspects.
I should like to pay tribute to the IFP and the IFP School for having taken the initiative
to compile this book, particularly valuable because of two features: it brought together, at
both conception and realisation stages, authors from both the IFP and the Total group,
thereby linking the visions of a large research institute and a commercial petroleum group,
and it features authors of varied backgrounds and ages, including young engineers as well
as recognised academic and industrial experts.
The book therefore sets a ne example in our rapidly changing world, and should be
instrumental in attracting new talents to a sector which will remain exciting and vital for at
least the next 50 years and probably longer.
I hope this book is rewarded with the success it deserves.
Thierry Desmarest
Chairman
Total
Table of contents
...................................................................
...............................................................
V
VII
...................................................
1
1
4
5
5
14
..................
17
1.2.4 After WWII: increasing oil consumption, new oil companies, creation and
1.2.5 Weakening of OPEC and fall in prices . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
1.2.6 The 1990s: market forces . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
1.2.7 The twenty first century: sustained high prices . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
20
31
36
37
44
44
45
51
1.4 Conclusion . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
60
61
2.1 How
2.1.1
2.1.2
2.1.3
61
61
63
65
development of OPEC
............................................................
IX
Table of contents
65
65
67
68
71
75
78
78
83
85
85
86
88
89
89
90
90
90
91
Hydrocarbon reserves . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
93
3.1 Definitions . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
3.1.1 Political and technico-economic constraints . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
3.1.2 Deterministic and probabilistic estimates . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
3.1.3 P90, P50, P10, etc. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
3.1.4 1P, 2P and 3P reserves . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
3.1.5 Proven, probable and possible reserves . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
3.1.6 Need for caution in using definitions . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
95
95
95
97
97
98
98
99
99
100
100
101
102
102
103
103
104
104
104
105
107
109
109
111
111
112
113
114
115
116
117
118
119
121
4.1 Introduction
...........................................................................
121
122
123
123
125
125
128
131
131
134
137
142
146
156
156
157
158
159
163
167
167
167
171
171
resources . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
Forms in which exploration and production can be undertaken . . . . . . . . . . . . . . .
Regulatory options . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
The content of petroleum legislation . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
The objectives of the parties involved . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
Reconciling objectives and sharing the economic rent . . . . . . . . . . . . . . . . . . . . . . . . .
Types of contract . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
Breakdown of petroleum contracts by type . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
171
174
175
175
177
178
178
178
178
178
182
188
191
192
5.1.2
5.1.3
5.1.4
5.1.5
5.1.6
5.1.7
5.1.8
XI
Table of contents
Europe . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
Africa . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
Middle East . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
Former USSR . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
AsiaOceania . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
3.5.3
3.5.4
3.5.5
3.5.6
3.5.7
Table of contents
193
193
194
199
199
199
202
202
activities
204
204
208
210
211
211
211
212
212
213
213
.......
214
............................................................
216
217
...............................................................................
..........................................................................
218
6.3.3 Evaluation criteria for investment projects: net present value (NPV)
and rate of return . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
Equivalent cost . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
Financing mix and the equity residual method . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
Acquiring participations, valuing a project . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
Another approach to calculating the return on exploration/production
projects: the Arditti method . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
6.3.8 A new approach: the generalized ATWACC method . . . . . . . . . . . . . . . . . . . . . . . . . . . .
6.3.9 A first step in dealing with uncertainty: sensitivity analysis . . . . . . . . . . . . . . . . . . . .
6.3.10 An empirical criterion: payback period (duration of financial exposure) . . . . . .
219
221
222
223
231
231
231
234
238
........................
243
245
245
248
250
6.3.4
6.3.5
6.3.6
6.3.7
XII
224
227
229
231
7.2.2 Indicators
.............................................................
........................................................................
Annexe to Chapter 7
Basic principles of financial accounting . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
7A.1
7A.2
7A.3
7A.4
254
254
258
265
266
268
271
272
........................................
277
277
278
278
278
279
...............................................
280
282
282
282
284
........................
285
286
288
288
291
Bibliography . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
295
Glossary . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
299
Index
307
.............................................................................................
XIII
Table of contents
Petroleum:
a strategic product
References to petroleum (literally oil from stone) or more precisely bitumen, asphalt or even
pitch, can be found in writings going back to earliest antiquity. These texts effectively
describe the heavy and viscous residue which remains when petroleum reaches the earths
surface and loses its lighter fractions as a result of natural evaporation. This residue has many
uses, in particular the caulking of ships. It is said that Mosescradle may have been tarred
to prevent it from sinking on its journey down the Nile.
Over the centuries up until the dawn of the modern era petroleum was used for two other
important purposes: as a medicine it was considered a panacea (see Box 1.1 and Fig. 1.1).
The ailments which it was supposed to cure were numerous: scurvy, gout, toothache,
rheumatism, even ingrowing toenails according to Morris and Goscinny, authors of the
cartoon Lucky Luke.
Petroleum is also combustible, and therefore an instrument of war: the Greeks knew it as
medical re, the Romans as incendiary oil, the Byzantines as Greek re, all forerunners of modern-day napalm.
But the modern development of petroleum is mainly attributable to the invention of the
oil lamp (Fig. 1.2) by the physicist Argand, later improved by Quinquet, a Parisian pharmacist. This lamp provided exceptional lighting, and caught on very quickly. From our
vantage point in the new millennium, these lamps, very varied in size and shape, testify
vividly to the daily life of our forefathers. Originally they often used whale oil. But apart
from endangering the survival of their prey, whalers were not able to meet the needs of
consumers. It was replaced by parafn, or kerosene, a petroleum product. However natural
seepage rapidly became insufcient to meet growing demand, prompting subsurface exploration to increase production. On 27 August 1859 Colonel Drake carried out the rst drilling
2
Figure 1.3 Delivery van in the 1920s (by kind permission of BP).
at Titusville, Pennsylvania. This was successful. At a depth of 23 metres the bottom of the
pit lled with precious petroleum (see Fig. 1.5, Section 1.2.1.1).
The methods used to manufacture kerosene from crude oil were rudimentary. The distillation techniques practised at that time allowed the heavy fractions to be separated and used
as lubricants, but part of the crude was deliberately discarded; environmental constraints were
not yet what they were to become a century later!
Increases in the consumption of kerosene led to a rapid growth in the demand for crude
oil. By the turn of the century oil lamps were being progressively replaced by the electric
light bulb, and the consumption of kerosene began to decline. But declining demand for
kerosene was offset by growing demand for petrol for cars, and later diesel. This was of
course the time when the automobile industry was expanding. Some time later the heavy fuel
oil market became an important outlet for the rening industry. Winston Churchill, rst Lord
of the Admiralty 1911-1915, urged the adoption of this fuel by the British eet whose
eventual agreement made an important contribution to the development of petroleum.
1.1.2
Finland
Yves Lacoste claimed that geography is used to make wars. We could paraphrase him by
adding that so does oil. It would be possible to do without metals or certain agricultural
products for a fairly long period. It would be unthinkable to do without petroleum products.
Indispensable in the transport sector, petrol is of vital national importance in times of peace,
but also in times of war.
During the Second World War the German army tried to take control of oilelds (Fig. 1.4).
The purpose of the 1941 offensive on the Eastern front was to gain control of the Russian
oilelds of the Volga. Berlin later directed its forces towards the Middle East where large
deposits of oil had been discovered in Saudi Arabia and Kuwait just before the onset of war.
Petroleum is therefore a strategic commodity, i.e. a commodity on which not only mans
prosperity but even his survival may depend. Georges Clemenceau declared at the end of
Nor
way
Swed
en
Until the Second World War, however, the consumption of petroleum remained limited
(Fig. 1.3): outside of the United States the consumption was small, and worldwide, coal was
still the dominant source of energy. It was only after the war ended in 1945 that oil was to
become the energy of reference. Consumption rose from 350 Mt in 1945 to over 1 Gt in
1960, over 2 Gt in 1970 and over 3 Gt in 1990. Now at the beginning of the 21st century
consumption is close to 3.5 Gt/y.
USSR
Moscow
Soviet
counter-offensive
Stalingrad
Turkey
Iran
Iraq
Morocco
El Alamein
Algeria
Libya
Egypt
British
counter-offensive
Figure 1.4 German army advances towards the Volga and the Middle East.
WW1 Petroleum is as necessary to the economy as blood to the human body. But the
examples of Japanese and Korean industrialisation show that it is control over the supply of
petrol rather than its possession as such which is really the issue.
Oil is likely to maintain its vital role in the future, particularly in the transport sector,
where its hegemony is virtually unchallenged. Alcohols and gas (LPG, compressed natural
gas and LNG) may make some inroads into the market for auto fuels, but the only serious
rival is electricity. However technological and economic problems mean that it is likely to
be many years or even several decades before electricity begins to make major headway in
the auto fuel market. It should also be noted that, even if electricity were to become a serious
contender, it would probably still be necessary to have recourse to petroleum or gas as energy
source in the fuel cells. For the moment there is no prospect of replacing oil products. Meanwhile another oil product is likely to continue to grow: the fractions which are used as feedstocks for petrochemicals. The demand for petroleum is likely to go on increasing in the
coming years to attain a level in excess of 4 Gt/y.
Figure 1.5 The rst oil drilling, as seen by Morris. The cartoonist was
carried away by his enthusiasm here, showing oil gushing forth from a
drillhole, whereas the oil actually only owed out slowly into the bottom
of the hole drilled by Colonel Drake. (From: lombre des derricks,
Lucky Comics, by Morris and Goscinny).
* and on 27 August 1859, having drilled to a depth of 23 metres, Drake
discovered oil, lots of it. This was the dawn of a new era for mankind
amongst its members; it received, in trust, the shares of all the companies in the group (14
were totally controlled and 26 partially controlled). The group continued to be run by a small
team led by Rockefeller.
Against a background of rapid growth in the demand for lighting, heating, lubricants and
greases, Standard Oil continued to grow, maintaining its rm grip on the rening, transport,
distribution and retail of petroleum. After 1880 it felt the need to increase its presence in oil
production in order to guarantee its supplies of crude. This strategy of developing its
production capacity proved particularly judicious when in 1888 a chemist employed by
Standard Oil perfected a rening process which permitted sulphur to be removed from oil
products, particularly kerosene. Hitherto kerosene with a high sulphur content had been
impossible to sell because of the odour produced when it burned. This invention meant that
new high-sulphur crudes could be used.
Having become a trust in 1882, Standard Oil was forced to transform itself after anti-trust
legislation was enacted (Sherman Act, 1890). In 1899 a new holding company, the Standard
Oil Company of New Jersey, was created, bringing under its umbrella all the companies then
constituting the group.
The new company continued to represent a great concentration of power, attracting
hostility not only from the authorities, who sought to promote competition, but also from
6
Box 1.2 The companies which emerged from the break-up of Standard Oil.
Of the 34 companies which made up the Standard Oil group, 5 ceased operations, 8
turned to other activities and 21 continued their development, in some cases buying out
their competitors. Amongst the companies still recently in existence were:
Standard Oil of New Jersey (now Exxon);
Standard Oil of New York (Mobil, after merger with Vacuum and until its merger
with Exxon);
Standard Oil of California (now Chevron);
Standard Oil of Indiana (Amoco until its merger with BP in 1998;
Atlantic Petroleum Company (Arco until its merger with BP);
Continental Oil Company (now Continental);
Ohio Oil Company (now Marathon Oil Company);
Standard Oil Company (Ohio) (bought by BP, and now BP USA);
Ashland Oil Company (now Ashland);
Pennzoil Company (now Pennzoil).
It should be noted that the mergers between Exxon and Mobil, and between BP,
Amoco and Arco further reduced by several companies the number of offspring
companies of Standard Oil.
The strategy adopted by Standard Oil illustrates the constant concern of industry to
control the entire chain of its activity. Furthermore this desire for control rapidly translated
itself into a nancial obligation, the demands of technological and industrial development
imposing investments on companies which only the largest could bear. This was conducive
to the emergence of a vertically integrated and oligopolistic industry. Although in the rst
twenty years of its existence the petroleum industry was American, and dominated by
Standard Oil, it rapidly became an international industry, even though the U.S. continued to
account for more than half of world production until 1950. The growth in the consumption
of kerosene, followed by gasoline, diesel-oil, and fuel oil was a worldwide phenomenon. Not
only Europe but also Russia and Asia became important markets. New oil companies were
created (e.g. Shell, Royal Dutch, Texaco, Gulf, Anglo-Persian, later to become BP).
Standard Oil of New Jersey (later Esso, then Exxon), Standard Oil of New York (Mobil),
Standard Oil of California (now Chevron), Texaco, Gulf, Royal Dutch Shell and BP became
the majors (also known as the seven sisters).
7
some journalists and writers who probed the mechanisms used by the group in its operations,
criticising its harmful aspects. A series of articles published at the turn of the century by the
journalist Ida Tarbell, subsequently compiled into a book, The history of Standard Oil, had
a tremendous impact. Eventually action was taken in the courts, and in 1909 the Federal
Court ordered the break-up of Standard Oil. Despite delaying tactics employed by the
company, the ruling was conrmed in 1911. The group divided up into 34 separate
companies (see Box 1.2).
The Nobels and the Rothschilds rapidly sought to sell their product to external markets:
Europe and the East. While the Nobel brothers controlled much of the Russian market, the
Rothschilds were much more dependent on foreign markets. The latter therefore turned to
Marcus Samuel (Fig. 1.7), a London businessman specialising in imports and exports, particularly the import of antiques and sea shells from the Far East, in regard to the transportation
of their products.
8
For many years there was erce competition between Standard Oil and the Caspian
producers. But there was a rapid deterioration in economic and social conditions in Russia,
the Tsarist administration proving weak and inept. A revolution in 1905 failed, but in 1917
the Bolsheviks took power and overthrew the Tsar. During this whole period the Baku region
was being shaken by a whole series of strikes and industrial unrest caused by the deplorable
working conditions. One of the leaders of these actions was a certain Jossef Djugashvili, later
to become the notorious Stalin. In the face of this situation, the Rothschilds decided in 1912
to sell most of their interests to Royal Dutch Shell, which had been set up in 1907. In 1918
the new Soviet regime nationalised the entire oil industry. Royal Dutch Shell lost 50% of its
oil supplies at a stroke. The last remaining Nobel was stripped of all his assets, which Standard
Oil of New Jersey nevertheless bought from him, doubtless convinced that it would one day
be able to resume operations on Russian territory. This hope was dashed, because despite the
adoption of a new and more liberal New Economic Policy in the 1920s, none of the companies
which had been nationalised ever managed to resume any signicant activity. Standard Oil
of New York, on the other hand, was later to contract to purchase Russian products.
By 1920, Russian oil production had fallen to 3 Mt/y, compared with 10 Mt/y at the turn
of the century. By 1930, however, it had regained the level it had enjoyed before the outbreak
of the 1914 1918 war, the government being in dire need of foreign currency earnings from
oil exports. These exports beneted from a small discount relative to the international price.
In order to nd new markets in the East the Rothschilds, seeking new transport possibilities, turned, as we saw, to Marcus Samuel. In 1892 Samuel turned his hand to the oil sector,
providing bulk transport of kerosene bought from Rothschild in Batum on the Black Sea to
Asia (Singapore and Bangkok via the Suez Canal (Fig. 1.8)). Marcus Samuel gradually built
up his oil interests, and in 1897 he created the Shell Transport and Trading Company
Limited to manage these activities. The company prospered, trading not only kerosene but
also, after 1885 when Karl Benz invented the internal combustion engine, gasoline.
Figure 1.8 One of the rst oil tankers, the Murex (by kind permission of
Shell).
In order to diversify his sources of supply, Marcus Samuel acquired concessions in the
Dutch East Indies (East of Borneo), where he produced crude which was rened in a factory
in the Balikpapan region. He also acquired interests in oil produced in Texas from the
Spindletop oileld, discovered in 1901. Shell therefore became the rst company with oil
sources throughout the world. Aware of the threat posed by its competitor, Standard Oil
attempted to buy Shell out, but was turned down by Marcus Samuel.
The company Royal Dutch was developing at the same time. It was created in 1890 by
Aeilko Gans Zijlker, a former head of the East Sumatra Tobacco Company who, on discovering traces of a parafn-rich petroleum on the island, decided to throw himself into oil
exploration.
After rst drilling a dry well (without oil), he was successful on his second drilling
attempt. In June 1885 there was a gusher from the Telaga Tunggal 1 well in Sumatra, which
had been drilled to a depth of 121 metres; the oilwell continued to produce oil for another
50 years. Supported by powerful allies (including the Dutch King Willem III, who granted
him a royal seal), Zijlker founded the Royal Dutch Company. When he died, several years
later, his mantle was taken on by Jean-Baptiste Auguste Kessler. A renery with a capacity
of 8000 bbl/d (400 000 t/y), about 50% of the production of which was kerosene, was
commissioned in the vicinity of the well (Fig. 1.9). Part of the production was exported,
putting Royal Dutch into direct competition with Standard Oil. From 1894, the latter made
10
Many attempts were made to combine Royal Dutch and Shell; and in 1902 a working relationship was established whereby. Marcus Samuel became the Chairman and Henry
Deterding, who had taken over from Kessler on the latters death in 1899, became Managing
Director. Deterding also took on the day-to-day management, which was his wish. The
Rothschilds became associated with this new organisation when the Asiatic Petroleum
Company was created also in 1902, bringing together these three interests who nevertheless
retained their autonomy. It was not until 1907 that a more comprehensive agreement was
signed between Royal Dutch and Shell. In fact this made Royal Dutch, based in the Netherlands, the senior partner, with 60% of the shares in the new company, Shell Transport and
Trading, based in the UK owning 40%. The formation of this new Anglo-Dutch group
ushered in a new chapter in the competition with Standard Oil. In order to avoid falling
victim to the power of the American company, Henry Deterding decided to gain a foothold
in the American market by buying the American Gasoline Company and the Roxane
Petroleum Company.
11
attempts to capture Asian markets. It introduced millions of oil lamps onto Asian markets
(particularly China) at derisory prices, or even gave them away. Competition was also
intense with Marcus Samuel who owned a renery virtually next door to that of the Royal
Dutch in Balikpapan.
production fell to a very low level (6 Mt/y) and never really recovered until the 1970s. It
was at that time that large new discoveries allowed Mexico to become one of the worlds
leading exporters.
Venezuela followed close behind Mexico, and in the 1920s became the second oil
producer in Latin America. The rst discovery was made in 1914, in Mene Grande.
Venezuela rapidly became the worlds second largest oil producer, in front of the USSR,
retaining this ranking until 1961. At the beginning, Royal Dutch, Shell, Gulf and a small
company, Pan American, were the main producers. After various incidents, Pan American
was bought out by Standard Oil of Indiana, and later by Standard Oil of New Jersey.
1.2.2
14
Until the Great War, French oil supplies depended on private, independent companies
linked to the major American, British, Russian and Romanian producers. Before the war,
France was one of the largest oil consumers in Europe. But the onset of war caught the
government by surprise. On the one hand the oil companies sought to maintain the regime
of competition characteristic of the sector. On the other hand, the international situation
meant that French supplies of Russian and Romanian oil were interrupted. The only source
was therefore American. Furthermore the attacks by the German navy on oil tankers in the
Atlantic were interfering with fuel supplies, to the point that in 1917 the private companies
were not able to meet French needs. Clemenceau had to make an appeal directly to Wilson
for the necessary shipments to be increased.
The war therefore demonstrated to France that the outcome of the war depended on the
large oil companies, mainly American and British: Standard Oil, Anglo-Persian, Royal
Dutch Shell. The French government realised that it was crucial to increase French independence in relation to energy supplies, in particular by ensuring that it participated in international oil concessions such as those in Mesopotamia, where the British were very active
and the Germans also had active interests.
Following new negotiations between Clemenceau and Lloyd George in December 1918,
agreement was reached about the transfer to France of the shares of the Deutsche Bank in
the Turkish Petroleum Company TPC (see Section 1.2.3.1).
The British were fairly favourably disposed to France participating in the TPC, as this
would act as a counterbalance to the inuence of the American companies. This agreement
proved particularly useful to Paris since the American companies decided after the war to
stop supplying France, based on the decision of the authorities to maintain control over oil
activities after the end of hostilities. During the war the efforts of these same companies, as
members of the Petroleum War Service Committee, had allowed France to satisfy its needs.
But once the war ended, the French government concentrated on trying to eliminate this
dependence. Apart from its efforts to gain direct access to crude oil, the French government
took other measures relating to the transport, rening and sale of products. Important decisions were also taken with regard to scientic research and training.
Figure 1.13 The Compagnie Franaise des Ptroles was created in 1924
(by kind permission of Total).
16
Laws enacted in 1928 provided for monopolies on rening and distribution to be granted
by the state. The state authorised companies, either private or public, French or foreign, to
import and rene crude for a term of ten years, and to import and distribute oil products for
a period of three years.
Protected in this way, the CFP created, in 1929, the Compagnie Franaise de Rafnage,
which built its rst two reneries in Gonfreville, near Le Havre, in 1933 (Figs. 1.14 and 1.15)
and in La Mde, close to Marseilles, in 1935. These two reneries, with a combined capacity
of 2 Mt/y, represented one-quarter of the total rening capacity in France at that time. Other
reneries were also built, in Port-Jrme by Esso, in Petit-Couronne by Shell, in Lavra by
BP and in Donges by Antar.
1.2.3
Near East Development Corporation (50% Standard Oil of New York, 50% Standard Oil
of New Jersey): 23.75%;
Participation and Investment (C. Gulbenkian): 5%.
Exploration got underway rapidly, and led to the discovery at Bala Gurgur, on 14 October
1927, of the very large Kirkuk oileld (Fig. 1.16). In 1928 the Turkish Petroleum Company
became the Iraq Petroleum Company (IPC), underlining its association with the newly
created independent kingdom of Iraq, which included the former Mesopotamia.
The Company ran rapidly into serious difculties. There proved to be a divergence of
interests between the CFP (for which the IPC was the only source of crude) and its American
partners in particular. The so-called Red Line agreement, which stipulated that the partners
in the IPC should act in concert in all the former Ottoman Empire territories, resolved these
difculties in 19282. However the problem resurfaced in 1948.
Figure 1.16 The discovery of oil at Kirkuk (Iraq) in 1927 (by kind
permission of Total).
2. The agreement is so named because, after long discussions, C.S. Gulbenkian grabbed a map and drew a
red line around the territories within which the partners in the TPC (later the IPC) would be obliged to act
in concert.
18
Around 1920 the geologist Frank Holmes published evidence pointing to the presence of oil
in the Bahrain region, and obtained concessions in that Emirate, as well as in Kuwait and
Saudi Arabia. However, short of money, he sold all these concessions to Gulf in 1927. In
Bahrain, Gulf sold these interests on to Standard Oil of California (Socal). The rst discovery
was made in 1932. This was fairly modest in size, and the production of the Emirate did not
exceed several million tonnes per year, but it conrmed the promise of this zone.
Kuwait was the only country situated outside the Red Line. Gulf and Anglo-Persian
jointly obtained a concession for 75 years. In 1938 the Burgan oileld was discovered. Its
initial reserves were estimated at 10 billion tonnes, making it at the time by far the largest
oileld yet discovered.
In Saudi Arabia IPC was competing with Socal. The new king, Sultan Ibn Saud preferred
to negotiate with the Americans and granted Socal a 60-year concession in 1933. In 1948
the Ghawar oileld was discovered, still the largest ever discovered.
At an early stage Socal formed a joint venture with Texaco in order to develop its
resources in Bahrain. The latter controlled major outlets in Europe and Asia, whereas Socal
Black Sea
USSR
ian
sp
Ca
a
Se
Turkey
Syria
Mediterranean
Sea
Palestine
Suez
Canal
Iraq
Iran
Transjordan
Kuwait
Egypt
Neutral Zone
Persian
Bahrain Gulf
Qatar
Red Sea
Saudi Arabia
Trucial
States
Oman
Figure 1.17 The Middle East in the 1930s. This region accounts for twothirds of the worlds oil reserves.
19
had an excess of crude. Socal and Texaco established two new companies: Casoc (California
Arabian Standard Oil Company), which looked after Socals production interests in Bahrain
and Saudi Arabia, and Caltex (California Texas Oil Company), which looked after the
Texaco distribution networks in Europe and the East.
The 1939-1945 war interrupted oil extraction activities in Saudi Arabia. The full potential
of the Arabian peninsula only became fully apparent after the war. But the investments
needed to develop the resources of the Wahhabite kingdom were considerable. Socal and
Texaco sought partners. After lengthy discussions, Esso and Mobil joined Socal and Texaco
to form Aramco (Arabian American Oil Company). The other IPC partners, who could have
demanded to participate in Aramco, obtained increased interests in Iraqi production.
1.2.4
After the Second World War, and particularly in the 1950s, oil consumption grew at a rate
of about 7% per year. Automobile transport was developing rapidly, and demand for
domestic and heavy fuel oil was increasing steeply. These two fuels were making major
inroads into the traditional markets of coal.
Supply remained abundant, however, thanks to large discoveries not only in the Middle
East (Fig. 1.18) but also in Africa (Algeria, Libya and Nigeria) and in Venezuela. Russian
exports were also increasing. However the entry of new producersthe American independentsonto a market hitherto controlled by the majors (current term used to designate
the large oil companies) increased and modied the nature of the competition. These new
companies sought to counter the declining protability of American operations by internationalising their operations and gaining a foothold in Libya, in particular.
European governments were also taking an increasing stake in oil and creating national
companies such as ENI (Ente Nazionale Idrocarburi), Elf and Fina, intended to increase
national energy-independence. These companies grew rapidly.
20
The Second World War changed the nature of the relationship between the producers and
the international oil companies: the producing countries were no longer content to grant
concessions in the traditional way. They wanted a greater share of the rewards arising from
the extraction of their oil wealth.
Negotiations in Iran in 1949 to revise the terms of the Anglo-Iranian concession got off
to a difcult start. The young Shah had to contend simultaneously with the very inuential
religious community and a powerful communist party. The rst proposals for modifying the
concession were rejected by the Iranian parliament, which demanded nationalisation. The
then Prime Minister announced to parliament that he rejected nationalisation, and urged
instead modication of the concession. He was assassinated several days later. The new
Prime Minister, Muhammad Mossadegh, had Parliament conrm nationalisation. After many
troubled months the Iranian authorities negotiated an agreement with the oil companies (led
by the American companies): the oil companies recognised the ownership by the Iranian state
of the Iranian land and mineral resources. The National Iranian Oil Company (NIOC) was
formed. It became the owner of the resources, with production being entrusted to a
consortium in which Anglo-Iranian would hold 40% of the shares, the ve American majors
(Standard Oil of New Jersey, Mobil, Standard Oil of California, Gulf and Texaco) 7% each,
Shell 14%, a group of American independents 5% and CFP 6%. Production, rose rapidly to
achieve 300 Mt in 1973.
Figure 1.19 Lacq: the major French gaseld (by kind permission of Total).
21
22
Figure 1.22 The rst ofces of the IFP (now IFP Energies nouvelles).
In 1956 the nationalisation of the Suez Canal resulted in its closure. As a gesture of support
for Egypt, Syria interrupted the shipment of IPC oil. While everything was restored to
normal within several months, and good cooperation between the consuming countries
limited the effects of the crisis, these events marked the emergence of third world countries
as a political force.
Two years later, in 1958, a military coup dtat in Iraq swept General Kassem to power.
In 1961 the new government decided to withdraw IPCs concessions except where there were
already productive wells. The following year the Iraqi government created the INOC (Iraq
National Oil Company) which replaced the IPC.
In 1967, during the Six Day War, the Arab countries imposed an embargo on oil deliveries to the U.S., the UK and Western Germany. While this embargo only lasted a few weeks,
it marked a new stage in the use by producing countries of oil as a weapon. Furthermore the
reclosure of the Suez Canal (see Fig. 1.27 and Section 1.2.4.10) led to an explosive growth
in the demand for transport, i.e. tankers, because Middle Eastern oil destined for Europe and
the U.S. henceforth had to be routed via the Cape of Good Hope. North African oil was
therefore at a premium because of its transport advantage, a factor which would become
signicant in the following years.
During the 1960s Algeria and Libya became important oil producers. In Libya, where not
only the majors (Exxon, Mobil, Gulf, BP, Shell) but also several independents (Occidental,
Oasis, etc.) were active, production reached almost 60 Mt in 1965 and almost 160 Mt in
1970. But in 1969 King Idris of Libya was replaced by Colonel Gadda, who became the
rst leader of a producing country to seek to cut production in order to conserve resources.
B. Economic climate
Oil consumption had increased (Figs. 1.23 and 1.24) to the point where liquid hydrocarbons
accounted for half the energy needs of Europe and three-quarters of those of Japan, two
regions virtually devoid of their own oil. There was another cause for disquiet: the worlds
oil reserves were equivalent to only 30 years production at current levels in 1970, compared
with 140 years production 20 years earlier (Fig. 1.25) 3. It was feared that oil resources might
be largely exhausted by 2000. This was the backdrop against which the famous report of the
Club of Rome entitled Limits to Growth was published in 1972. This report warned of the
dangers of the depletion of natural, non-renewable resources, as a result of economic development. The report called for economic growth to be slowed so as to save raw materials and
protect the environment. Of course there was no simpler way to limit consumption than to
increase prices.
At the same time, new air quality legislation in the U.S. made it more difcult to burn
coal, and encouraged the use of oil. But initiatives to open up new resources situated in
ecologically fragile areas (Alaska, California coast, Gulf of Mexico) were delayed following
actions taken by environmental protection groups. This led to a somewhat paradoxical situation, since it made the U.S. dependent on foreign oil. In order to protect the interests of
domestic producers, who were at a cost disadvantage compared with their foreign
competitors, quotas were introduced. But these proved difcult to administer. In 1969 President Johnson, who had been very close to Texan oil interests, was replaced by the Nixon
3. By 2000 the R/P ratio (reserves to annual production) was back to over 40, for conventional oil alone.
25
A. Political events
Figure 1.23 Service station in Senegal in the 1950s. Sales were increasing
and equipment was being modernised all over the world (by kind
permission of BP).
4 000
3 500
Billion tonnes
3 000
2 500
World production
2 000
1 500
1 000
500
0
1850
OPEC
1875
1900
1925
1950
1975
2000
Figure 1.24 Production and consumption of oil, showing the steep increase
in the 1960s.
26
150
125
100
75
50
25
0
1900
1910
1920
1930
1940
1950
1960
1970
1980
1990
2000
2010
$/b
140
Economic
crisis
130
Hurricanes
Katrina and
Rita
Attack on personnel
in Saudi Arabia,
trouble in Iraq
and Nigeria
120
110
100
90
80
50
40
11th September
OPEC
quota policy
70
60
Nationalisation
of oil fields
30
20
10
0
1970
Iran/Iraq
war
OPEC
domination
Netback
contracts
Iraq
war
Iraq/Kuwait
war
Oil
countershock
Cold winter
Second
oil shock
1980
Iranian
revolution
Agreement between
Mexico, Venezuela
and Saudi Arabia
OPEC quotas
Asian crisis
1990
New
OPEC
quotas
2000
2010
prices. The price of Arab light, the reference crude, rose from $2.989 to $5.119/bbl
(Fig. 1.26).
On 17 October all the member states of the OAPEC (Organisation of Arab Petroleum
Exporting Countries: Abu Dhabi, Algeria, Saudi Arabia, Bahrain, Dubai, Egypt, Iraq,
Libya, Kuwait, Qatar) except Iraq decided to reduce their exports by 5% per month until
Israel withdrew completely from occupied territories and the rights of the Palestinian
people had been restored. On 4 November this reduction was increased to 25%.
On 25 October the same OAPEC members imposed an embargo on the deliveries of oil
to the U.S., Portugal, the Netherlands, South Africa and Rhodesia, which were accused
of favouring Israel. The spectacle of Dutch motorways closed to trafc at weekends to
save fuel was a powerful image which remained engraved on European imaginations for
long thereafter.
Finally at a meeting in Teheran in December, OPEC took advantage of the turbulence to
again raise posted prices. The posted price of Arab Light rose to $11.651/bbl, the real price
was of the order of $7.
1.2.4.7 Nationalisations
Another consequence of the increasing power of OPEC, perhaps even more important than
the price rises, rock the oil world to its core: the main producing countries decided, one after
the other, to nationalise their oilelds (see Box 1.3).
During the 1970s a wave of nationalisations by OPEC member countries gathered
momentum. Over a few years most of these countries nationalised the assets of foreign
companies, and in most cases declared a state monopoly on all activities related to petroleum.
OPEC, by providing its members with the opportunity to take concerted action to strengthen
their negotiating position, acted as a catalyst to a movement which arose from age-old demands.
28
In producing countries petroleum has often been considered a natural resource which
belongs to the people, and must be used in their interests. This is sometimes actually written
into the national constitution. During the period between the Second World War and 1970
this concept reached its climax. Many countries became independent either after the war or
during the 1960s, and acquiring control over their natural resources, particularly oil,
symbolised national sovereignty.
Although several countries: Russia (1918), Mexico (1938), Iran (1952), India (1958)
nationalised their oil industry earlier, the great wave of nationalisations occurred between 1970
and 1980. In the Mediterranean countries nationalisations often occurred on a company-bycompany basis: in 1971 Algeria took control of 51% of the concessions of the French
companies. Starting in 1971 Libya successively nationalised BP and then ENI (50%) and the
other companies (51%), and Iraq nationalised the last IPC concessions. In 1972 negotiations
between the oil companies and OPEC led to the participation agreements (New York
Agreements), which envisaged the progressive acquisition of concessions by producing countries. The participation percentage, initially xed at 25%, was supposed to be increased to 51%
in 1983. Only some of the Gulf States signed this agreement, and the nationalisations in fact
occurred much faster than envisaged in the agreement: Kuwait and Qatar in 1975, Venezuela
in 1976 and Saudi Arabia in stages between 1974 and 1980.
One clear consequence of the concept of petroleum as the property of the people is that
the national public should have access to oil products at as low a price as possible. In
Venezuela, Nigeria and Saudi Arabia petrol prices are very low, often below the international
price excluding taxes and distribution costs. This encourages very high consumption, to the
detriment of exports, and therefore of vital foreign currency earnings. These concepts only
changed at the end of the 1980s, with the fall of the Berlin Wall and the collapse of
communism.
The oil shock of 1973 marked the start of an economic crisis in Western countries as well
as a major turning-point in the development of the petroleum market. Firstly, a new type of
actor in the oil market began to emerge beside the Western oil companies and the major
importing countries: the producing, exporting countries themselves. These countries acted
either individually or in some cases through OPEC. In 1973 these countries controlled over
50% of the worlds production of crude and more than 80% of its reserves. Secondly, a split
developed in the oil industry at the global level, with oil production, now under the control
of state companies, remaining separate from rening and distribution, most of which was
still in the hands of the Western oil companies.
Next Page
Figure 1.27 The Suez Canal was closed from 1967 to 1974, following the
Six Day War ( Ren Burri/Magnum photos).
Previous Page
maximise their stocks. By the end of 1979 spot prices (see Section 1.3.2.5) had risen above
$38/bbl. At the same time the OPEC countries began to pursue a policy of setting the
ofcial price close to the spot price.
In October 1980 the commencement of hostilities between Iraq and Iran led to a large
reduction in the output of these two countries, provoking a new, although brief, upsurge in
prices. In fact energy conservation measures taken by consumer countries were beginning
to show their effectiveness: world consumption fell from 3.1 Gt in 1979 to about 2.8 Gt a
few years later.
1.2.5
The attractiveness of OPEC oil (and particularly that from the Gulf states) was considerably reduced as a result of its policy of high prices. There were also doubts as to the reliability of OPEC supplies. Political instability in the region made Western countries
increasingly wary of Middle Eastern oil. Most oil-importing countries were pursuing a
policy of diversifying supplies. The sharp oil price rises greatly facilitated the emergence of
new producing regions. An oil price of $30/bbl enhanced petroleum-producing potential
throughout the world, beneting new producing countries, Western oil companies and
governments of importing countries. For new producers, any domestic production which
32
so vital to their rening activities on any single producer. They also sought to avoid losing
the benet of their production know-how, even though this meant redirecting investment
towards regions where production costs were higher than in the Arabian-Persian gulf.
Western states found in these developments a very effective means of revitalising competition between producers, thus exercising a downward pressure on prices and restoring a
balance of advantage in their dealings with exporting countries.
High prices and the fear of scarcity led to increased R&D efforts which allowed
production from elds with high exploitation costs, especially offshore. New production
facilities were established not only in Europe (the North Sea, see Fig. 1.31) but also in North
America (Fig. 1.32) and developing countries: Argentina, Brazil, Colombia, Ecuador,
Angola, Egypt, Gabon, Syria, India, Malaysia. All of these countries became middle-ranking
producers, between 20th and 30th in the world rankings. Only Mexico, Norway and the
United Kingdom joined the ranks of the major producers. During this time there was a significant fall-off in the production of the OPEC countries.
60%
First oil shock
1973
50%
40%
30%
Oil counter-shock
1986
20%
1960
1965
1970
1975
1980
1985
1990
1995
34
2000
2005
To cope with this weakness in demand, the OPEC countries decided to place limits, or
quotas, on their production. These quotas totalled 17.5 Mbbl/d (compared with a production
of 30 Mbbl/d two years earlier). They were only able to retard the fall in oil prices, which
fell from $34/bbl in 1981 to $29 in 1983 and $28 in 1985.
1.2.6
Since 1986 oil prices have been subject to rapid and large uctuations. Over the next
15 years it fell on several occasions to around $10/bbl, and rallied at other times to a
maximum of about $40. Remarkably small variations in the supply/demand balance can
produce very large price swings.
Between mid-1986 and mid-1991 prices remained within the range $10-20/bbl, depending
on the production quotas agreed by OPEC. The Iraqi invasion of Kuwait in 1990 resulted
in a sharp rise in prices. Supply was reduced by 4 Mbbl/d, and prices doubled in a few weeks.
Real shortages did not occur, however, as Saudi Arabia, Venezuela and the United Arab
Emirates were rapidly able to increase production to make good the shortfall in production
by Iraq and Kuwait.
Even more interesting is that throughout the occupation of Kuwait by the Iraqi forces, the
futures markets indicated a return to normal prices (i.e. around $20/bbl) within several
months. In fact, most observers were betting on the rapid intervention of the U.S. and her
allies and a normalisation of the situation within a reasonable period. Another lesson learned
in the Gulf was that when hostilities commenced on 17 January 1991 (Fig. 1.34), although
the experts expected a brief upsurge in the price of crude, it actually fell: the markets were
discounting a short, sharp military action, and the actual price aligned itself with price on
the futures market.
The oil price subsequently stabilised within the range $15 20/bbl. This was the result
either of modications in OPEC production levels or by actions such as that of American
pension funds in the spring of 1994: taking the view that the oil price was abnormally low
they purchased oil on the forward market.
The end of the century was marked by a further demonstration of the sensitivity of prices
to uctuations in the equilibrium between supply and demand and the importance of the role
of OPEC. Over the period 1995 to 1997 there was a signicant hardening of the oil price,
caused particularly by a series of cold winters in both the U.S. and Europe. On occasion,
stocks of oil products reached rock bottom levels, leading to spectacular price rises. It
became increasingly clear that the volumes of stocks of crude and of oil products were key
36
The other key factor is the volume of OPEC production. At the end of 1997 OPEC,
assuming continued economic growth in Asia, announced a 10% rise in its production
quotas (from 25 to 27.5 million barrels per day). This was equivalent to less than 4% of total
world production. Yet the Asian crisis of 1997, followed by a Russian crisis in 1998 and
subsequent problems in Latin America, dampened the increase in demand, so that the price
of crude fell to about $10/bbl, notwithstanding a progressive reduction in the OPEC quotas
which effectively wiped out the increase at the end of 1997.
1.2.7
1.2.7.1 Over the period 1999 to 2003 OPECs unity was re-established
A price of $10/bbl was a catastrophe for the oil-producing countries and it meant that they
could no longer meet their financial needs. OPEC countries debt was growing. A return to
discipline among the OPEC countries was needed to increase prices. How could it be
achieved?
The election of Hugo Chavez as President of Venezuela at the end of 1998 was the first
sign of change. While the previous governmental had favored maximizing production, the
new President favored a policy of solidarity with third-world countries in general and with
other oil-producing countries in particular. Aware of the importance of increasing oil prices,
he argued for an agreement between Venezuela, Saudi Arabia and Mexico (a non-OPEC
country) to limit production. This agreement would be strengthened by an improvement in
relations between Saudi Arabia and Iran, the main Arabian Gulf producing-countries. The
commitments to reduce OPEC production, supported by clear signs of solidarity from the
main non-OPEC producers, finally appeared credible to operators. In March 1999, the price
of oil started an upward trend that would lead it to a peak level in 2000. The OPEC countries then decided to set an objective for the average price of a basket of crude oil of $25
per barrel, and a range of $22 $28 within which the price should remain: if the price went
above $28, production would be increased by 0.5 Mb/d, and if the price fell below $22,
production would be decreased by 0.5 Mb/d. This objective was largely achieved: during the
first six months of 2001, the price of a barrel (OPEC basket) was $21.
The terrorist attacks of September 11, 2001 caused a collapse in prices, with Americans
greatly reducing their personal travel. But prices gradually recovered. Until 2003, $25/bbl
was generally agreed to be the normal price of crude oil, and this was OPECs objective.
But the threat of American intervention in Iraq caused uncertainty in the market and the
addition of a risk premium, which different experts estimated at $5, $10 or $15/bbl. This
theory was confirmed by the fall in the price of oil on March 20, 2003, the day on which
President George W. Bush announced that the US rejected Saddam Husseins response to
the US ultimatum, and that the US-led coalition would attack Iraq. In London, the price of
Brent crude fell from $35 to $25. Operators were not worried about the immediate consequences of the US action. Surplus capacity from countries neighboring Iraq (Saudi Arabia,
UAE, etc.) meant that lost Iraqi production could be made up and it was considered that,
with surplus production capacity at 5 to 10% of total capacity, there would be a return to
normal market supply within a few months. It was also expected that investment in Iraq
would once again become possible (plans were made to raise production capacity from 3 to
6 Mb/d), so a return to normal oil prices therefore seemed probable.
37
$/b
150
140
Weekly average
130
Annual average
120
110
100
90
80
65.1
70
60
50
54.5
40
28.4 24.5
38.1
30
19.1
17.7
28.8
20
24.5
10 20.7
12.7
0
1996
1999
2002
2005
97.6
79.6
72.5
61.1
2008
2011
Figure 1.35 Brent Oil Spot fob Price January 1996 to July 2011
(Source: US DOE, BP Statistical Review).
1.2.7.2 From March 20, 2003 to July 11, 2008, pressure on the market grew
The price of oil continued to increase, reaching $60 per barrel in 2005, and $75 in May 2006.
After a fall in the last months of 2006, it shot from $50 per barrel in January 2007 to $147
per barrel (Brent price) on July 11, 2008. There were many reasons for this. The situation
in Iraq and the Middle East was not as had been expected. Iraqi production remained
far below its level under Saddam Hussein.
Attacks in Saudi Arabia were worrying. Some countries could not stop their production
declining. Oil consumption rose strongly while the surplus production capacity that had
resulted from the fall in demand and increased non-OPEC production after the second oil
shock, had disappeared. There was no shortage of oil on the markets, but the balance of
supply and demand was precarious. Costs particularly capital costs were rising steeply.
Arguments regarding levels of oil reserves added to the concern. These arguments were
misdirected since the immediate problem was not the reserves underground, these were still
sufficient for several years. It was rather above the ground, particularly the lack of sufficient
capital investment for geopolitical reasons: producing-countries were reluctant to invest
massively to produce more oil for a market that did not seem guaranteed. Why invest to
supply Western consuming countries who wanted to reduce their oil consumption because
of their supply security concerns and to reduce greenhouse gas emissions? There was great
concern about forecasts of an oil production ceiling of 95-100 Mb/d, while the needs of China
and other emerging countries seemed unlimited. The market was preoccupied by its desperate
attempts to balance future supply and demand.
Many specialists did not understand why the price increases did not reduce the increase
in demand. The explanation is simple. The income effect when revenues double, gasoline
consumption increases by 70% is more important than the price effect when prices
increase by 100%, gasoline consumption only decreases by 7%. Economic growth was
38
Although supply and demand has had a basic role in the oil price setting mechanism since
1986, at least until 2003 it was OPECs position that was decisive. Without OPEC, oil prices
would have been much lower probably of the order of $10 to $15 per barrel over the
period 1986-2003.
However, in periods of significant potential oversupply, OPEC cannot and does not wish
to assume the sole responsibility for supporting prices. Thus in 2001, OPEC reduced its
production by 5 million barrels per day, i.e. by nearly 20%, to prevent a sudden price fall.
But, at the end of 2001, the organization was faced with a dilemma: it could reduce its
production further and see its market share decline dramatically and non-OPEC producers
profit from higher prices without participating in the loss of production, or maintain its export
volume and inevitably experience a fall in the crude oil price. In fact, at the start of 2002, the
major non-OPEC producers (Mexico, Norway, and most importantly Russia) joined OPEC
in their efforts to maintain prices.
Between 2003 to mid-2006, there was no longer any need for this debate. Globally
production capacity was saturated and OPEC no longer needed to consider reducing its quotas.
In the autumn of 2006, with the commissioning of new production capacity, a quiet political
situation and mild weather, a tighter quota policy once again made sense. OPEC instigated
massive production cuts in reaction to prices collapsing by a third, which stopped the decrease
in prices and restored the organizations credibility. Angola and Ecuador joined OPEC in 2007
and, despite Indonesia leaving in 2008 (which was logical as Indonesia had become an oil
importer) OPEC increased its share of worldwide production to 44.8% in that year.
At the end of 2008, the worldwide recession and a further collapse in oil prices once again
made the cartels pricing policy a central issue. OPEC decided to reduce its quotas by 4 Mb/d
over several stages, starting in September. It also tried to persuade other producing-countries
(Russia, Mexico, Norway, etc.) to join in. Russia grudgingly agreed to a symbolic reduction
since, during winter, Russian exports are reduced anyway because weather conditions limit
tanker loading at the Novorossiysk and Primorsk terminals.
OPEC may decide to invite new members to join. Although countries like Brazil and Kazakhstan have envisaged joining, there are no guarantees that a larger OPEC could maintain its
unity. Would Brazil with its bio-fuels really be welcomed within the cartel? Would the
complexity of relationships between the states surrounding the Caspian Sea allow countries
such as Kazakhstan or Azerbaijan to join the cartel, without adversely affecting OPECs relationship with Russia? Would Russia be ready to compromise its foreign policy goals, particularly with respect to Iran, by participating in OPEC? Given their relations with Europe and
the US, is it conceivable that Norway and Mexico could join OPEC? Wouldnt the integration
of Sudan within OPEC carry the risk of dragging the organization into regional African
conflicts? A more reasonable solution to a massive and continuing fall in demand seems to
be OPEC working with associate members.
extremely strong (4% per year from 2003 to 2007), while the fuel price increases seen by
consumers were tempered by the significance of taxes in consuming countries and by price
controls in emerging countries.
A comment should be made on the impact of speculation. When it seems probable that
economic growth will continue and the needs of emerging countries will rapidly increase
e.g. automobiles in China an increase in oil prices appears inevitable. Commercial funds
will therefore invest in oil and other raw materials thinking that prices will continue to
increase. They of course make the trend in price increases more pronounced, but they do not
create the increase, they follow it.
39
of the energy bill is also less. France spent nearly 6% of its GDP on its oil at the beginning
of the 1980s but only slightly above 3% in 2007. More efficient use of oil, and an
increase in the service sectors share in the economy (services consume little energy)
explain this. However, although oil has less weight in developed economies, it remains
very significant for the poorest developing countries: in 2007 Senegal spent more than
8% of its GDP to purchase the oil it needed.
The proportion of taxes in the price of gasoline and diesel fuel lessens the impact of crude
oil price variations in a number of countries. Generally in Europe, if the price of crude
oil quadruples from $25 to $100 per barrel, the price of fuel at a service station only
increases by around F0.50 per liter, which is 30% of the consumer price.
The price of a liter of gasoline represented half an hours earnings at the French minimum
wage in 1981, but only less than 15 minutes in 2011 (when the price of oil is $100/b).
The weight of oil in the economy is less than it was 20 years ago and so the importance
more than $110 billion in profits every year from 2005 until 2008. In 2009 that total fell to
under $70 billion. Results in 2010 were distorted by BP taking a pre-tax charge of $32 billion
in relation to their Deep Water Horizon disaster, had it not been for that the total profit would
have shown a substantial increase over 2009. Over the total period some of these profits were
used to reduce their debt, which is now very low, and to reward shareholders. These companies
have announced significantly increased capital expenditure. But prudence is still necessary:
The most promising basins are often not accessible to major international companies.
OPEC member countries control 80% of reserves, and they are the lowest cost reserves
to exploit. However, since the nationalizations of the 1970s, and notwithstanding the few
exceptions which are discussed later, these countries overall remain reluctant to re-open
their oil and gas industries to major international companies. Saudi Arabia and Kuwait
are completely closed. Iran has opened itself to only a limited extent. Outside the Middle
East, Venezuela has only opened marginal fields and reserves of extra-heavy crude oil to
foreign companies. Outside OPEC, Mexico remains totally closed to non-Mexican
companies and Russia has shown that it wishes to keep tight control over its reserves. This
leads to the repeated refrain of international companies: We lack profitable projects.
Producing states adapt oil taxation levels to increase their share of the revenue when prices
increase, leaving the foreign companies portion broadly constant (in dollars per barrel).
This policy is consistent with a dominating political approach which sees mineral resources
as an asset belonging to the nation and its people whose benefits (and sometimes the
exploitation see the case of Mexico in particular) must be reserved for nationals.
State-owned companies (Saudi Aramco Saudi Arabia, NIOC Iran, PDVSA
Venezuela, Pemex Mexico, Sonatrach Algeria, NNPC Nigeria, etc.) have not had the
full benefit of the increase in crude oil prices. Their government only returns a portion of
the oil revenues to them and retains the rest to finance their budgets. Of course, the high
revenues of recent years have allowed major producing states to balance their budgets - or
even achieve surpluses in contrast to the difficult years of the 1990s. Nonetheless, in many
cases the amounts left for the national oil companies have been insufficient for them to
maintain and develop their oil production capacities. Since mid-2008, this position has been
even more pronounced.
A few figures will help put the significance of oil price movements into context. If the price
of oil were to remain at $75 for one year, the value of oil traded internationally would be
greater than $2 trillion. This is approximately the value of French GDP. It is significant, but
small when compared with 2007-2009 stock market losses amounting to $25 trillion, or the
amounts available in investment funds (these funds include in particular the pension funds
which receive contributions from American employees to fund their retirement), which
amount to tens of trillions of dollars.
Variations in the price of oil result in a significant shifts of resources from producing countries to consuming countries.
Impact of prices for the major consuming-countries: the price of oil was only $61/bbl in
2009 compared with an average of about $100 in 2008 ($97 to be precise). Frances oil bill
therefore fell from roughly $70 to $40 billion p.a. This decrease represented more than 1%
of GDP. The gas bill was also lower because gas prices are still linked to the price of oil.
The impact on inflation is also significant. The increase in oil prices was of great concern
to European authorities since it brought inflation to a level of nearly 4% While this was still
reasonable compared with the level of the 1980s (more than 10%), it was far above that of
more recent years. The decrease in the price of oil and of many raw materials at the end of
2008 decreased inflation to a level of nearly zero.
Impact of prices for poor countries: although emerging countries found it relatively easy
to tolerate a significantly higher energy bill, the same was not true for less-advanced countries for whom the increase in prices was stifling. Their oil bill, for example in West African
countries, frequently exceeded 10% of GDP, a level far greater than the few percentage
points of GDP covered by governmental and privately funded aid. The bill remains high with
current prices.
Impact of prices for producing-countries: a high price is desirable for producing countries,
since most depend almost exclusively on their oil and gas revenues to balance their budgets,
and the minimum oil price needed to achieve this varies considerably from one country to
another. It is the relatively low population Gulf countries that have accumulated significant
financial reserves and whose sovereign funds have access to hundreds of billions of dollars: $40
per barrel is sufficient for the UAE, Kuwait, etc. It is much higher in countries like Iran and
Venezuela, which have difficulties when the price drops below $80. Russia also depends significantly on its exports of oil and gas, since the price of gas is indexed to the price of oil. The
fall in the value of the ruble at the beginning of 2009 reflected the importance of oil for Russia.
capacity, which will probably result in a decrease or even collapse in prices, if demand
falls in several years time?
of the worlds population. In addition, reserves of oil although very large currently show
constraints that were not apparent in 1970 or 1980.
The oil market remains subject to basic economic laws: all periods of high prices carry
the potential for future prices to fall, since they tend to stimulate supply and moderate
demand. Nonetheless, it seems probable that future price movements will continue to be both
significant and unpredictable, while prices themselves will stay at a considerably higher level
than in the 1990s.
1.3.1
The most commonly quoted price for crude is the FOB (free on board) price. This is the price
of the crude on board the vessel which will transport it at the port of origin (Ras Tanura in
Saudi Arabia for Arab Light, Sullom Voe in the Shetland Islands for Brent, etc.). Prices are
also quoted as CIF (cost, insurance and freight) which is the price at the destination port
(New York, Rotterdam, Yokohama,). In principle there is only one FOB price for a given
crude at a particular time, but as many CIF prices as there are destination ports.
Two crudes of the same quality should have the same price when delivered to the rener,
otherwise the rener would choose the cheaper of the two. If two crudes of the same quality
are produced from different oil elds, the price differential between them should represent
the difference in transport costs. Suppose that two crude oils with the same characteristics
are produced, the rst in the North Sea (loading port: Sullom Voe), the second in Nigeria
(loading port Bonny). Assuming that the transport cost between Sullom Voe (North Sea) and
Rotterdam is $0.50/bbl, and that between Bonny (West Africa) and Rotterdam is $1.00/bbl,
then if the North Sea crude sells at $25/bbl FOB the West African crude would have to sell
at $24.50/bbl to compete.
1.3.2
1.3.1.2 Location
1
2
3
The fall in prices in the early 1930s provoked social unrest and riots. The authorities were
forced to intervene to control production. This meant putting a stop to anarchical oil
extraction activities, which proved to be hugely wasteful, and matching production to
demand. An inter-state committee was set up to distribute production quotas set by the
Bureau of Mines between the various states, and to set prices. This system of pro-rating
was established in Texas by the famous Texas Railroad Commission.
This formula was rst challenged during the war. The American and British navies
discovered that it increased their refuelling costs considerably. The oil companies therefore
accepted that a second point of reference for pricing should be established in the Arabian
Gulf. The FOB price there was aligned with the price in the Gulf of Mexico.
After the war the situation changed further. Europe was importing more and more crude
from the Middle East. The European Cooperation Administration (ECA), whose job it was
to manage the aid provided by the U.S. under the Marshall Plan, sought to reduce the cost
of oil imports, which was absorbing a large part of the American aid. Furthermore it was in
the interests of the oil companies to develop their production in the Middle East: per barrel
costs were low there and could be reduced even further if the volumes produced and exported
could be increased. After the war there was a growth in oil imports to the East coast of the
U.S. which involved the adoption of a new system of so-called posted prices (1949): the
FOB price of a crude was set at a level such that its price in New York would be the same
as a crude from Texas.
production, the system was based on the Gulf plus pricing agreement. All oil products
would be sold anywhere in the world at a price equivalent to the Gulf of Mexico FOB price,
to which would be added the transport cost from the Gulf of Mexico to the country of destination. After the major discoveries at the end of the 1930s, this system favoured and
continued to favour Middle Eastern oil because of the low production costs applying there.
Box 1.7 The legal and regulatory framework for oil production: the concession.
Mineral rights are the property of the state, except in the US where they belong to
landowners. An operator who suspects there is a deposit of oil on his land must seek
permission from the state, which owns the rights, to explore and if successful, produce.
There are several different types of contract (see chapter 5). The concession has long been
the most common. In exchange for the payment of a sum of money known as a bonus
and the acceptance of a number of obligations, the operator obtains the right to explore
for a certain number of years and, if he makes a discovery, to extract the hydrocarbons.
A company holding a concession must pay a royalty to the state (the owner of the mineral
rights) for each barrel produced. This royalty compensates the state for the removal of a
non-renewable resource. The amount varies considerably, but is frequently of the order
of 10-15% of the price of the crude. In addition, producing companies pay a tax on their
prots to the state. The cost of obtaining the crude is therefore the production costs plus
the royalty plus the tax. For example:
Example of cost of obtaining crude, Middle East, 1960s
Posted Price: $1.80/bbl
Production cost: $0.20/bbl
Royalty (12.5% of posted price): $0.225/bbl
Gross prot: $1.375/bbl
Tax (50%): $0.6875/bbl
Total cost of obtaining crude: $0.20 + 0.225 + 0.6875 = $1.1125/bbl
Receipts of the state: $0.225 + 0.6875 = $0.9125/bbl
Companys net prot: $0.6875/bbl
49
sold in Europe), WTI (for crudes sold in the U.S.) or Dubai (for crudes sold in the Far East).
Thus, the FOB price of Arab Light sold in Europe is indexed on the price of Brent, i.e. equal
to the price of Brent less a differential reecting both the difference in quality and the
difference in transport costs.
Spot markets developed relatively rapidly. Before 1973 when the producing countries took
control of their petroleum resources the international companies were highly integrated and
almost all trade took place within the framework of long-term contracts. Spot markets were
almost non-existent. In 1973 only 1% of transactions were effected on the spot markets, but
by 1980 spot transactions accounted for 20% and by the end of the 1990s the proportion was
about one-third. In most contracts for the delivery of crude oil or rened products, whether short
or long term, the prices are now indexed to spot prices or quotations on the futures markets.
Around 1980 forward and futures markets began to develop for some crudes and rened
products (see Box 1.8) to deal with the nancial risks associated with the volatility of prices
resulting from the development of spot prices. The new markets had a considerable impact
in making for a more exible market. The relatively low transport costs and the differences
in price between crudes of similar quality led traders to deal very rapidly for arbitrage4,
because market information is available in real time on computer terminals worldwide.
Many analysts ascribe the relative stability of prices (or more precisely the speed with
which prices regained their pre-war levels) at the outbreak of the Gulf war in 1990-1991 to
the existence of futures markets rather than the announcement by the IEA that strategic stocks
would be used. The ability to purchase oil forward has effectively made it pointless to accumulate stocks speculatively, a practice which is thought to have contributed to the second
oil shock. But speculative behaviour on these paper markets can also amplify the price
movements caused by uncertainties related to the weather, stock levels, etc. In general, a
small mismatch between supply and demand can strongly inuence price. The inuence
which market developments have on price volatility remains a matter of debate.
Box 1.9 The futures markets.
Spot and future price of gas oil in London
a. Spot price (in red) and future price (in blue) up to July 2008
$/b
140
120
100
80
60
40
20
0
1995
1997
1999
2001
2003
2005
2007
2009
2011
2013
2015
2013
2015
b. Spot price (in red) and future price (in blue) from July 2008
$/b
140
120
100
80
60
40
20
0
1995
1997
1999
2001
2003
2005
2007
2009
2011
Source: Total.
4. Arbitrage consists of exploiting differences between two markets for a given product. If, for example, the
price difference is greater than the transport and transaction costs then arbitrage consists of buying the
product at the lower price and selling it at the higher price.
50
51
1.3.3
0
200
Gulf of Mexico
USA
400
600
800
Water depth (m)
The situation has changed since then. The belief, up until 1985, in an ineluctable growth
in prices stimulated signicant research and development efforts. The resulting technological progress has led to the discovery of hard-to-nd deposits, to noticeable improvements
in rates of recovery, and to the development of non-OPEC oil, especially offshore. After
the 1986 price drop, these efforts were continued and led to a sharp decrease in exploration
and production costs in non-OPEC countries, especially for deep-sea oil. The frontier
between conventional and non-conventional oil (deep-sea oil, extra-heavy oil, tar sand) is
regularly being pushed back. Producers can now access offshore deposits at increasingly
greater depths using technologies that are constantly being improved. Figure 1.37 illustrates
the progress made in this eld. The difference between the production costs of offshore and
on-shore oil is decreasing. As indicated above, the extra-heavy oil in the Orinoco Basin in
Venezuela was, until the 1990s, considered to be practical to produce only at a relatively high
price per barrel of crude (at the time, $40 or more). This oil is now produced for a relatively
low price, and large-scale production has begun. Well discuss the technological costs in the
following section.
In fact, there is a continuum of hydrocarbon resources: deposits that are difcult to access,
traps that are more complex and harder to detect, deep and very-deep offshore sources, extraheavy oil, tar sand, oil shale, and so on. The traditional distinction between conventional and
non-conventional oil makes little sense today. Moreover, this continuum is not limited to oilbased hydrocarbons. Considerable research has been done on the development of technologies for producing liquid fuel from natural gas (gas-to-liquid, or GTL, technologies using
the Fischer-Tropsch process) and coal (coal-to-liquid, or CTL, technologies using direct
liquefaction or indirect liquefaction after gasication). These technologies will be discussed
below. This continuum extends to biomass fuels that make use of available products or
processes (ethanol, ETBE, vegetable oils, methyl esters of vegetable oils) or those that are
currently being researched (ligno-cellulose or biomass-to-liquid, BTL). In the more distant
future, we may be able to develop technologies for the carbonation of hydrogen produced
1000
Brazil (Petrobras)
Adriatic (Agip)
Brazil (Petrobras)
1027 m
Gabon
1200
1400
Congo
Brazil (Petrobras)
1709 m
1600
1800
Brazil (Petrobras)
1852 m
Mediterranea sea
2000
Gulf of Mexico
(Total) 2197 m
2200
2400
Gulf of Mexico
Texas 2370 m
2600
Gulf of Mexico
(Shell) 2307 m
Gulf of Mexico
Norway
(Chevron) 2400 m
(Statoilhydro) 2430 m
Gulf of Mexico
Gulf of Mexico
(ChevronTexaco) 3051 m
(Unocal) 2955 m
Brazil (Petrobras)
2777 m
2800
3000
1960 1964 1968 1972 1976 1980 1984 1988 1992 1996 2000 2004 2008 2012
52
140
Enhanced
recovery
120
100
Ultra
deepwater
Artic
CO2 injection
Coal
to
liquids
80
Gas
to
liquids
Other
conventional oil
60
40
Oil shales
Already
20 produced MENA*
0
0
1000
2000
Oil Sands
3000
8000
9000 10 000
53
from nuclear or renewable energy sources (Bauquis, 2004) or, to put it somewhat differently,
carbon hydrogenation (hydrogen-to-liquid, or HTL, technology).
Within several decades there will be no hydrocarbon (natural plus synthetic) resource limitation, but there is and will be a need to make use of more complex and more costly technologies (as currently perceived) as conventional deposits are exhausted.
C. Biofuels
The biofuels used today, so-called rst-generation fuels, consist primarily of ethanol for
gasoline engines and the methyl esters of vegetable oils for diesel engines. In 2010 worldwide
production of ethanol fuel was 70 million tons compared to 7 million tons for biodiesel.
Brazilian ethanol is produced from cane sugar at costs similar to, if not less than, those for
traditional gasoline. Outside Brazil, the cost of biofuels is higher than that (excluding taxes)
of oil-based fuels. Their contribution to the reduction of CO2 emissions is controversial. Their
substitution potential for oil-based fuels is limited to a few percent because of competition
with food production.
To go further it will be necessary to develop second-generation systems, which make
use of ligno-cellulose biomass (wood and straw). Optimistic estimates indicate a substitution
potential of 30% by 2030. Biomass-to-liquid (BTL) systems involve gasication of the
biomass followed by the production of kerosene and diesel fuel using the Fisher-Tropsch
process. The second method is comparable to the production of ethanol by fermentation.
These approaches are subject to considerable research in an attempt to reduce production
costs, which would be on the order of a euro per liter of oil equivalent at the present time.
D. The role of technological progress
What about future developments? The hydrocarbon resources constituting the continuum
mentioned above could be classied today by increasing cost. It is therefore likely that with
the exhaustion of deposits that are easy to access, costs and prices will increase. This is not
certain, however. Recall that in the early 1980s all the published scenarios for the development of oil prices pointed upward and technological progress played a determining role
in proving those assumptions wrong. But if there is one eld in which forecasting is an especially difcult art, it is that of technological change. There are many examples of this. In
the energy sector, aside from the spectacular drop in production costs for extra-heavy oil
already discussed, there have been improvements in the yield of combined cycle electrical
production plants. Progress is often faster than anticipated, although it does not always
occur when we expect it, as the case of nuclear fusion illustrates. Fifty years ago, it was
believed that it could be controlled for applications to produce electricity within 35 to 50
years. We are still talking about a fty-year horizon today, with little certainty about
commercial prospects.
7. Les pics mondiaux du ptrole et du gaz [Global Peaks in Oil and Gas], presentation to the Conseil
dAnalyse Stratgique, Paris, Oct. 28, 2006.
55
decisive effect on developments in this eld. Different projects are being studied but developments will probably remain limited to niche production activities. Another drawback: costs
do not include the cost of CO2 emissions, and GTL like CTL involves a signicant
consumption of energy. Additionally, opportunities could be limited by the appearance of the
global production peak for gas, which could follow the oil peak by ten to fteen years,
based on estimates by P. R. Bauquis7. Note, however, that according to other authors, the
uncertainties concerning peak gas are stronger than those for peak oil. In particular, in the
distant future shale gas reserves are large and we cannot exclude the development of
production technologies that make use of methane hydrates (clathrates). These resources are
poorly understood at present but could become highly signicant.
A. The cartel
Ever since the rst oil crisis, increases in crude oil prices have been considered the result of
behavior by the OPEC cartel8, with Saudi Arabia playing a dominant role. Outside periods
of sharply rising and falling prices, it has served as a price regulator, by agreeing to be the
(or the principal) swing producer. To meet demand, the country increased sales in 1977
78. In 1979 80, limited by its production capacity, it was unable to meet the increased
demand that was partly the result of speculative behavior (following the Iranian revolution)
and allowed prices to oat. To maintain them at their new level, it reduced production from
1981 to 1985. This situation is atypical, however. The Persian Gulf reserves, which are very
inexpensive, should be sold before those with a higher marginal cost, assuming the existence
of centralized global economic management or the presence of a competitive environment.
The result was just the opposite, however. When demand contracted following the introduction of alternative energy sources and energy saving policies, non-OPEC production, as
a result of the technological progress mentioned above, continued to grow while OPEC
production fell, especially in Saudi Arabia. In 1985 it hit bottom (2.5 mb/d compared with
11 in 1980). The decline in revenues led to tensions within the organization. Saudi Arabia
decided to regain its market share. This was the start of the counter shock and the drop in
oil prices (gure 1.26).
What is the role of the market when Saudi Arabia has the will and ability to regulate
activity? R. Mabro once quipped that Saudi Arabia and the market divide the work of determining crude oil prices: Saudi Arabia gets to determine the rst two gures before the
decimal point, while the market gets to determine the two gures following the decimal. Note
that Saudi Arabia assumed the bulk of production reduction efforts between 1980 and 1985,
but it refused to act alone in this role in 1998 99. The time needed to rally its OPEC partners
as well as non-OPEC producers (Norway, Mexico, Russia) explains the lag before prices
found a level that was considered satisfactory by the producing countries. In the interval, the
low price levels led some analysts to speak of a loss of power on the part of OPEC. However,
between 2000 and 2003, including during the American intervention in Iraq, OPEC demonstrated that it could exercise close control over the situation to hold prices within the range
($22 28 a barrel) it had established in March 2000, or at least could maintain the lower limit.
The possibilities for regulation disappear, however, when excess production capacity is inadequate, as was the case in 1979 and from 2004 to 2009.
8. More specically, it is a dominant oligopoly with a competing fringe. The Arab countries with small
populations and extensive reserves (Saudi Arabia, Kuwait, the Emirates), whose cash ow needs are less
pressing and can more easily limit production, constitute the core of the oligopoly (see, for example, P. N.
Giraud [1995]).
57
respectively, which are national companies. In Iran, foreign companies have limited access
to the market. The country has created an original type of contract known as the buy back
contract, which is a short-term risk-service contract. It is designed to adhere to the principles
embodied in the Iranian constitution, according to which the state has a monopoly on the
development of petroleum resources. Such complex contractual arrangements represent a
signicant limitation for the host country and for international rms. For the past several
years, we have seen how the Russian government has reasserted control over the oil and gas
sectors; and more recently Latin America (Venezuela, Bolivia) has followed suit.
9. Associate professor at the University of Grenoble, former Algerian Energy Minister, former president of
OPEC.
58
100
90
80
1980-1981*
Constants $
70
60
50
1982*
1983*
40
1984*
30
Real
20
10
0
1972
1976
1980
1984
1988
1992
1996
2000
2004
2008
followed the rst oil crisis. But signicant energy savings, the use of alternative energy
sources, research and development, and investments in the exploration and production of
difcult oil in non-OPEC regions occurred not simply because the price of crude was high
but because it was considered unlikely that prices would not continue their rise.
Expectation certainly played a role in the sequence of events leading to the saturation of
production and rening capacity in 2004. The rate of growth of demand, especially in China
since 2003, had not been anticipated. And, until the summer of 2003, nearly all analysts
assumed Iraq would again participate in the market, with the development of new production
capacities in the country, which would have resulted in signicant overcapacity for OPEC.
Increased Iraqi exports would have led to a necessary reduction in production from other
OPEC countries, primarily Saudi Arabia. Such a consensus was obviously unfavorable to
investment in those countries. Coupled with the slowdown in demand observed after the
events of September 11, 2001, this led to a reduction in worldwide exploration and development expenditures in 2002 and 2003, on top of that of 1998 1999. In short, the prevailing
consensus until mid-2003 on the existence of excess capacity contributed to the disappearance of that excess.
Following IFP Energies nouvelles studies on investments projects and production potential
region by region, Y. Mathieu proposed two scenarios regarding oil production (Fig. 1.40). It
is clear that hydrocarbon reserves are finite and therefore exhaustible. But little is known
regarding the level of ultimate (i.e. total existing) reserves. The Association for the Study of
Peak Oil represents a pessimistic view of the future production. However:
The work of ASPO mainly focuses on conventional crude oils, and does not sufficiently
take into account so-called unconventional reserves.
An increasing number of specialists put maximum production at less than 100 Mb/d (some
even speak of 95 Mb/d or less), more for geopolitical than physical reasons.
59
Production (Mb/d)
100
Conventional oil
Non-conventional oil
80
60
40
20
1260 Gb
Cumulated production
end 2010
1476 Gb
Proven reserves*
0
1950 1960 1970 1980 1990 2000 2010 2020 2030 2040 2050
Scenario 2: possible
120
Production (Mb/d)
Scenario 1: probable
120
100
Conventional oil
Non-conventional oil
80
60
40
20
1260 Gb
Cumulated production
end 2010
1476 Gb
Proven reserves*
0
1950 1960 1970 1980 1990 2000 2010 2020 2030 2040 2050
* including part of the oil sands of Canada and extra heavy oils of Venezuela
1.4 CONCLUSION
A future without oil crises is quite unlikely, even if we retain optimistic hypotheses of technological progress in the exploration and production sector, in the use of petroleum products,
and in the eld of alternative technologies. It is not enough that resources and technologies
are available, timely investments must be made in energy management and alternative fuel
technologies, and in the development of oil production capacity. This last point would
assume a continuous pro-active effort on the part of OPEC countries to make investments
with a certain amount of foresight. The investments in question are often considerable and
just-in-time management is not favorable to the existence of excess capacity. Moreover, it
is not clear that such behavior is in OPECs interest.
Finally, we must not forget that the question of the future of oil is only one of the
elements of a much larger problem the ability to ensure the sustainable development of
human societies. Water and agriculture are the major factors, along with health, and will
require increasingly greater amounts of energy. The real question is not about hydrocarbons
but about all energy sources. The twenty-rst century will only be able to resolve these
problems if we make a concerted effort to rid ourselves of our addiction to the use of
energy. We will also need to make use of synergistic effects in promoting the use of different
forms of energy: upstream and downstream cooperation between oil and nuclear energy,
cooperation between renewable energy and nuclear energy.
60
Sedimentary basins
61
180
UPPER
(MALM)
JURASSIC
154
MESOZOIC
LOWER
135
TRIAS
205
245
MIDDLE
(DOGGER)
HADRYNIAN
Birds;
Breakup of Pangea;
MIDDLE
LOWER
First dinausaurs
O2
First
microscopic algae
N2
Macroscopic
eukaryotes
Glaciation
Origin
of eukaryotes
Diversification
des prokaryotes
1,7
Glaciation
Conifers
295
21 %
Development
of sexual
reproduction
Formation of South
Atlantic;
UPPER
PERMIAN
1,0
Flowering plants;
First mammals;
Primates
Mammals
Fish
Disappearance of
dinausaurus and
ammonites; Primate;
Formation of North
Atlantic,
LOWER
(LIAS)
Atmo
-sphere
PALEOZOIC
0,6
HELIKIAN
UPPER
Main
events
Reptiles
0,20
APHEBIAN
96
PALEOCENE
MESOZOIC
ALGONKIAN
IVre
CRETACEOUS
65
EOCENE
CENOZOIC
0,06
PRECAMBIAN
53
OLIGOCENE
Period
PROTEROZOIC
34
MIOCENE
Homo sapiens;
Glaciations;
Proto-hominoids;
Formation of
the Red Sea;
Subduction of India
under Asia;
Anthropoids;
Separation
of Australia from
Antarctica;
Emergence of
mammals;
ARCHEOZOIC
23,5
CENOZOIC
5,3
PLIOCENE
PALEOGENE
0,01
1,65
Billions
years
PERIOD
HOLOCENE
PLEISTOCENE
NEOGENE
ERA
Aerobic
respiration
couche
O3
oxygenated
atmosphere
O2
Development of
aerobic
photosynthesis
CO2
Reptiles
N2
2,6
CARBONIFEROUS
LAURENTIAN
Insects
410
3,2
Bony fish
SILURIAN
Terrestrial flora
Firts
stromatolites
H 2O
Anaerobic
bacteria
NH3
CH4
HCN
KEEWATINIAN
fems
ARCHEAN
Amphibians
DEVONIAN
KATARCHEOZOIC
360
PALEOZOIC
My
First sedimentary
rocks
435
Glaciation
First known
igneous rocks
3,9
ORDOVICIAN
Armour-plated
fish
Formation
of oceans and
continents
500
4,6
H2
CAMBRIAN
molluscs
4,7
15
540
62
2.1.2
Petroleum geology
When animals and plants die, they leave an organic residue composed of carbon, hydrogen,
nitrogen and oxygen. Most of this material is broken down by bacteria. Some, however, is
deposited in aquatic environments low in oxygen on the beds of inland seas, lagoons, lakes
or deltas and is therefore protected from the action of aerobic bacteria. These residues are
mixed with sediments (sand, clay, salt, etc.), accumulate, are compressed, and undergo a rst
transformation under the action of anaerobic micro-organisms. This rst stage in the decomposition of the organic matter gives rise to kerogen, solid organic molecules entrapped
within a rock known as the source rock.
The mechanism of subsidence causes sediments to be entrained to great depths, where they
are exposed to high temperatures and pressures. The kerogen is then transformed into hydrocarbons by thermal cracking: the long molecular chains are broken down, expelling the
oxygen and nitrogen, leaving molecules made up only of carbon and hydrogen. When
temperatures exceed around 60C (140F), kerogen is transformed into petroleum (also
referred to as oil). From 90C (194F) the oil is itself subjected to cracking, to give wet gas,
then dry gas, as indicated in Fig. 2.3.
The higher the temperature and the longer it is maintained, the shorter are the resulting
molecules, and therefore the lighter the hydrocarbons. In some cases, all the hydrocarbons
are broken down into the lightest hydrocarbon component, methane (CH4).
During their primary migration, due mainly to the effect of pressure, the oil and gas
generated from the kerogen are expelled from the ne-grained source rock in which they
formed. Lighter than water, they tend to rise towards the earths surface, making their way
upwards along permeable conduits and fractures during secondary migration. Unless stopped
they escape and seep away at the surface or lose their volatile components and solidify into
bitumen. If on their path they encounter an impermeable layer, referred to as a seal, they
cannot migrate further. In order for a deposit to form, the hydrocarbons also need to be trapped
under this seal, in the pores and ssures of a rock reservoir where they can accumulate.
63
Immature
zone
Depth (km)
2
Oil
3
Wet
gas
Oil
Biochemical CH4
Gas
Dry
gas
Hydrocarbons formed
0
There are two main types of trap: structural traps and stratigraphic traps (Fig. 2.4). Structural traps are created by folds and fractures in the earths crust. The most common are anticlinal traps, which contain two-thirds of the worlds hydrocarbon reserves, and fault traps,
in which the accumulated hydrocarbons are retained by an impermeable rock formation lying
adjacent to the reservoir rock. A trap is referred to as stratigraphic, on the other hand, if at
least one of its boundaries comprises a change of physical properties, i.e. a signicant
change in porosity or permeability within the rock.
64
2.1.3
Petroleum system
The term petroleum system refers to the combination of the main geological attributes which
have led to the accumulation of hydrocarbons (Fig. 2.5). Firstly, there has to be a source rock
for hydrocarbons to be generated. A porous and permeable reservoir rock is needed to
contain the hydrocarbons and allow them to accumulate. The reservoir must be surmounted
by an impermeable cap which acts as a barrier to the natural upward movement of uids.
The system must be sealed by a trap in order to permit the hydrocarbons to accumulate. And
nally, the succession of geological events, referred to as the timing, must be favourable and,
in particular, it is crucial that the trap forms before the hydrocarbons migrate.
During the so-called phase of hydrocarbon exploration, prospectors try to assess the likelihood of occurrence of each of these events in order to estimate the chance of nding an
accumulation of hydrocarbons at a given subsurface location.
2.2.1
Prospecting
The exploration phase is subject to uncertainties more or less great according to the regions.
The purpose of exploration is to discover accumulations of hydrocarbons situated thousands
of metres below ground, so quite indiscernible visually or otherwise. Furthermore, these
accumulations themselves only occur under very precise and restrictive conjunctions of
geological circumstances. An exploration programme involves formulating a certain number
of hypotheses which are either more or less rapidly conrmed or have to be rejected given
the indicators commonly adopted. Chance plays a non-negligible role, even though spectacular advances in prospecting methodology have taken place since oil exploration began
150 years ago. At one time the most effective method of nding oil consisted of drilling close
to surface indicators. Hydrocarbon resources are now becoming increasingly difcult to
discover because they are found at depths of up to 5 000 or even 6 000 m (16 00020 000 ft),
increasingly frequently offshore, so that sophisticated tools are needed to locate them.
Even today, however, drilling is still the only way of denitely establishing the presence
or absence of hydrocarbons in a given subsurface formation. Furthermore it allows the
pressure of a reservoir to be measured and allows samples of rock to be brought to the surface
65
The capacity of the reservoir rock to contain hydrocarbons is determined by its porosity,
that is the ratio of the pore volume in a sample of the rock to its total volume. A reservoir
of fair quality has a porosity in the range 1020%. Moreover, it must be permeable, i.e. the
pores must be connected in such a manner that the uids can ow through the pores, so that
they can be extracted. Most reservoir rocks are composed of sandstone or carbonates. Sandstone reservoirs account for some 80% of all reservoirs and 60% of oil reserves. Within the
reservoirs the uids arrange themselves in layers from the lightest to the heaviest, the gas
lying above the oil, which itself lies above the water.
A eld comprises one or more reservoirs superposed over one another or in close lateral
proximity. Some formations may contain many tens or hundreds of reservoirs: they are then
described as being multilayered.
10 km
50-100 m
3
3
1 1
2
2
50-100 m
Rock pores
Oil
Salt water
for analysis. Because drilling is costly, however, it is essential that geological, geochemical
and geophysical studies are carried out beforehand.
In the rst place it is up to the geologists to identify general areas which, on the basis of
geological criteria, are likely to conceal accumulations of hydrocarbons. They work with
geophysicists who study the physical properties of the subsoil, in particular with the help of
seismic reection. For offshore exploration since general ground reconnaissance is simply
not feasible, seismic methods are used right from the outset.
At this stage the presence of a deposit is still uncertain, and the term prospect is used.
Using the rst set of data collected, a prospect is evaluated, and if appropriate, a decision is
66
If exploration drilling produces positive results, the next task is to delineate the reservoir
discovered and appraise it by drilling additional wells and making further measurements. At
this point, we can estimate the volumes of oil and gas in place, then the recoverable reserves.
2.2.2
Geology
There are four main branches of geology relevant in exploring for hydrocarbons:
Sedimentology, i.e. the study of sedimentary rocks;
Stratigraphy, i.e. the organisation in time and space of sedimentary rocks;
Structural geology, i.e. the study of deformations and fractures;
Organic geochemistry, i.e. the study of the potential of rocks to produce hydrocarbons.
The approach taken to prospecting in a particular sedimentary basin will depend on how
much is already known about the area. In hitherto unexplored territory the rst stage is to
narrow down the area of study and identify zones where more detailed exploration is appropriate. For onshore zones this involves studying satellite images, aerial photographs and radar
imagery in order to determine the main features of the sedimentary basin concerned. The next
stage is to conduct geographical studies of the surface in order to verify that the three
necessary components, i.e. source rock, reservoir rock and impermeable seal are present. If
they are, the next stage will be to try to identify possible traps.
Traces of hydrocarbons at the surface or in the subsoil can be a good indication of the
proximity of an accumulation. Geologists drill small boreholes which allow them to take core
samples for chemical analysis by a laboratory. The results provide useful information on
whether there are traces of hydrocarbons present. In a mature, more familiar region, existing
sources of information in libraries and company databases, public agencies, etc. can be
consulted. Particular efforts are made to gain a better understanding of the porosity and
permeability of potential reservoirs. Most large traps have already been discovered, so that
less obvious traps need to be identied.
Geologists synthesise the information obtained into subsurface maps on different scales,
which may be extended over an entire basin or represent just a single eld. The most
common geological maps comprise:
Contours of equal thickness (isopachs);
Contours of equal depths (isobaths);
Physical properties of rocks (lithofacies).
Every time a new well is drilled, additional data are obtained and added to the subsurface
maps. These successive elaborations require a stratigraphic correlation which involves identifying rocks of a similar age by comparing fossils and the electrical analysis from an exploration well or from an outcrop with the data from another well or outcrop in the light of the
seismic results. A major variation in thickness or in the type of rock may provide an interesting geological clue.
67
taken to drill an exploration well. Whether or not the drilling is successful, it provides the
geologist with valuable information in the form of core samples, cuttings and electrical
records from the wellbore. By examining, cross-correlating and interpreting these data,
prospectors are able to pinpoint subsurface structures which could contain economically
viable quantities of hydrocarbons. Exploration is an iterative process, each round of results
obtained permitting more targeted exploration to be conducted.
2.2.3
Geophysics
Gault
clays
AlboAptian
Barremian
Wealdean
Portlandian
Kimmeridgian
Sequanian
Rauracian
A
B
Figure 2.6 Principle of seismic exploration (A), 2D seismic image (B). 3D seismic image (C).
68
Seismic methods, which involve making an ultrasound image of the subsoil by studying
the way waves are propagated, thereby providing prospectors with information on the
subsurface structures and stratigraphy.
The rst two categories are in fact not used very often; seismic methods, and seismic
reection in particular, represent some 90% of geophysical operations, however.
Seismic reection involves transmitting sound waves into the subsoil which are propagated through the rock mass, undergoing reection and refraction at certain geological
discontinuities, referred to as reectors. Like echoes, the reected waves return to the surface
and are recorded by sensors which convert the vibrations in the ground into electrical
voltages (Fig. 2.6). There are two types of acquisition: two dimensional (2D) and three
dimensional (3D) seismic acquisition. Traditional 2D acquisition is used for extensive exploration and in zones where access is difcult, whereas 3D seismic methods are used for ner
prospecting and offshore programmes.
On land the seismic waves comprise tremors on the ground surface generated articially
by buried explosives or thumper trucks (Fig. 2.7). The receivers or geophones are
distributed at the surface in different possible congurations: in a straight line, along several
parallel lines, in a star or rectangular shape or any other geometric conguration. They are
connected to a recording truck which logs the data acquired.
69
Source
Hydrophones
Seabed
2.2.4
Exploration drilling
71
Seismic records collected by the geophysicists are then processed by powerful computers
which seek to increase the signal to noise ratio. Advances in data processing achieved in
recent years make it possible to discover new petroleum structures using old data using
higher-performance imaging techniques.
Once the seismic data have been acquired and processed, they have to be transformed into
utilisable data in the form of isobath or isopach maps and interpreted geological crosssections showing the faults and the main reservoir layers. In order to provide the most
accurate possible description of the subterranean structures the velocity of propagation of the
waves must be known everywhere so that the time-lapse can be converted into depths.
Preliminary assessments cannot be conrmed until a borehole has been drilled. The calibration of seismic reectors using the measurements made in the wells is therefore a key step.
The results of a seismic survey provide good indications of the subsurface structures, the
inclination of the strata, their continuity and folds, thereby indicating the presence of possible
traps which would be the target of drilling. They also allow gas reservoirs to be located in
certain cases, or oil-water or gas-water contacts (oil-water contact: OWC, gas-water contact:
GWC) to be identied.
Drilling an exploration well can take several (2 to 6) months, but the precise duration is
difcult to predict because of geological uncertainties at this level. Important doubts will
always remain about the depths, the hardness of the rocks and interstitial pressures in the
formation, which can only be swept away by drilling. On average one drilling in ve results
in the discovery of an economically feasible hydrocarbon reservoir. This falls to 1 in between
7 and 10 in relatively unexplored zones.
Crown
block
Drilling
cable
Travelling
block
Hook
Injection
head
Drill pipe
Rotary
table
Drilling
winch
Mud
pumps
72
In addition to cleaning the bottom of the well, drilling mud helps to cool and lubricate
the drilling bit, to consolidate the walls of the wellbore and exercise pressure such as to
contain the ow of oil, gas or water from a drilled formation.
Drilling starts with a large bit, for example of 26 in. (66 cm) in diameter attached to a
drill-collar and a drill-pipe. When drilling has reached a certain depth a new drill-pipe is
added to the drillstring. This procedure is repeated each time the increase in drilled depth
reaches the length of a drill-pipe, until a certain depth is reached, when the wellbore is cased.
Lengths of steel casing of diameter corresponding to that of the wellbore are lowered into
the wellbore one at a time, and cemented in place so as to protect the groundwater and control
uids emitted from the well. Several items of equipment are tted to the upper extremity of
the casing to insure suspension and seal the opening. Safety devices known as blow-out
preventers are also tted at the wellhead, tted with high pressure valves which allow the
well to be sealed rapidly using remotely controlled valves in the event of a sudden surge.
The casing and other equipment are subjected to a series of pressure tests, and if the
requisite safety requirements are all met the next drilling stage can begin. A new drilling bit
of smaller diameter is lowered into the hole inside the surface casing, and operations proceed
in the same manner as before. When a certain depth has been reached the hole is again cased
using smaller casing which matches the diameter of the new hole. The size of the drilling
bit is again reduced, the procedure is repeated, and so on. As drilling progresses, successively
smaller drill bits are used and the diameter of the cased hole decreases, as shown in Fig. 2.11.
Drilling proceeds at a rate of several metres per hour, the rate declining with increasing
depth, punctuated by difculties and the need to regularly replace the drilling bit, which
involves withdrawing the entire drillstring As drilling advances a drilling log is maintained
in which information is entered regarding the drilled depth, the nature of the rock and the
uids encountered, the drilling durations and any noteworthy events. This document is of
great value to geologists and geophysicists.
The drilling bit is attached to a drillstring made up of tubular elements which are screwed
on as the drilling advances: drill-pipes and drill-collars close to the bit. This assembly is
suspended and manipulated from a derrick (Fig. 2.10). Depending on the type of well the
rotary movement is generated either:
From the surface by means of a rotary table and a transmission pipe known as a kelly,
or by a power swivel connected directly to the last drill-pipe; or
At the bottom of the well only, by means of a drilling turbine or engine (turbodrilling).
Surface casing
250
750
12 1/4" (311 mm)
Technical casing 2
Depth (m)
Concrete
2 500
Production casing
Liner hanger
3 300
5 3/4" (146 mm)
5" (127 mm)
Liner
3 600
Jack-up
rig
Jack-up rig
semi-submersible
Dynamically positioned
drill vessel
500
1000
Water depth (m)
1500
2000
2500
3000
74
During drilling, prospectors keep records of a number of physical parameters of the rock and
the uids encountered, known as logs, which they represent graphically as a function of depth
or time.
The mud log comprises the various measurements provided by the mud circuit. These
include the penetration rate, the characteristics of the drilling mud and the cuttings and cores
description. The study of the cuttings brought up to the surface as the drilling progresses,
and particularly the cores obtained by replacing the drill bit by a hollow tool known as a
core barrel, provides information on the main characteristics of the formations encountered
(Fig. 2.13). These relate to the lithology, the fossils present in each stratum (which dates
them), porosity, permeability, and uids saturation.
Wireline logging, also commonly known as electrical logging, is carried out during interruptions to the drilling. It uses a tool known as a sonde lowered into the wellbore at the end
of an electric cable or wireline. Logging while drilling, on the other hand, is carried out with
the help of instruments included in the drillstring (Fig. 2.14).
2.2.5
Appraisal
2.2.4.4 Logging
55
30
GR
140 170
Logs
NPH
-5
RH08
270
2360
2370
2380
2390
Logs
2400
2410
2420
2430
2440
2450
2460
2470
2480
2490
76
When these tasks have been completed, a decision will be taken, based on the available
information, whether to develop the eld and put it into production or to shut it in until
economic prospects become more favourable or whether to abandon it.
The appraisal stage is a period of high economic risk. On one hand, a precise appraisal
programme needs to be undertaken and targeted studies need to be conducted so that sufcient information is obtained to take the right decision, which takes time and requires
investment. On the other hand it is important to know when to bring this phase to an end,
either to cut losses and entirely abandon the programme, or alternatively to proceed with the
development of the eld and production as quickly as possible in order to ensure the project
remains protable.
When the eld has been delineated, data are available on:
The thickness of the reservoir and its porosity at the location of the wells;
Oil and gas saturation rates;
The composition of the efuent;
The reservoir pressure.
So we know the volumes of oil and gas in place.
Several vital questions have to be answered at this stage: Is the eld commercial? Should
it be developed? If so, what should be the development scheme? Answering these questions
involves understanding the interplay of geology, geophysics and reservoir engineering. The
total recoverable resources will depend on how recovery is to be effected: the production
Box 2.1 The most common forms of wireline logging.
The spontaneous potential (SP) measures the electrical current which ows in the
formations adjacent to the hole resulting from differences in salinity between the drilling
mud and the water in the formation. The SP can be plotted on a graph against depth, and
interpreted visually in order to demarcate reservoirs and clay overlays.
Resistivity logging is essentially used to calculate saturation levels of water, oil and
gas. Depending on the type of mud used and the radius of investigation, different tools
are used to measure the resistivity of formations: induction, conventional resistivity or the
laterolog. High resistivities indicate the presence of oil and gas.
Radioactivity logging measures the natural and articial radioactivity of formations.
Gamma rays allow impermeable formations (such as clays and clayey sands with higher
natural radioactivity levels) and formations likely to comprise reservoirs to be detected.
Neutron and density logging provide data on the type of rock and on porosity, and allow
gas, oil and water zones to be distinguished.
Sonic logging provides another means of evaluating porosity. It makes use of the
differences in propagation time of a sound wave across the strata of a formation, this propagation being faster through dense than through porous rock. These data also allow the
geophysicist to establish a correspondence between the geological strata and seismic
markers.
77
Mapping (making a more accurate evaluation of the size and position of) reservoirs
using the seismic data and the information obtained from the exploration wells;
Reservoir simulation;
The drilling of additional wells several hundred or thousand metres away in order to
obtain additional data, like the limits of the eld.
rate, the drainage methods adopted, the number and positioning of the wells, etc. The overall
economic context (prices, taxes, etc.) and the circumstances of the company itself (nancial
resources) are of course also relevant. These circumstances are subject to change.
For this reason the results from the exploration and appraisal stages and other sources are
studied by multidisciplinary teams comprising geologists, geophysicists, petroleum architects,
drillers, producers and reservoir engineers. They also take account of the thinking of economists and nanciers. These teams build up a detailed picture of the size of the reservoir,
its characteristics and of the resources present. This allows various development scenarios
to be considered and tested with the help of simulation models, and their value in economic
terms evaluated.
2.3.1
Reservoir management
3
5
Gas cap
6
6
Oil
Water
Vertical cut
In the case of a single-phase gas eld, the wet gases will generate, at the surface, condensates and dry gases comprising light fractions such as methane and ethane. In gas elds
subject to retrograde condensation, liquid hydrocarbons will be deposited in the reservoir
during production, and the efuent will have a high liquids content at the surface.
Water is also associated with the hydrocarbons in the reservoirs. Most reservoirs were
formed from sediments which settled in or close to the sea. Part of the water will have been
displaced during the migration of the oil, but some remains in the form of interstitial water
adsorbed as a lm onto the rock around the pores. Water is also often found in reservoirs
below the oil or gas, forming an aquifer.
Geologists and geophysicists begin by evaluating the volume of rock impregnated by
hydrocarbons, the percentage of this volume effectively occupied by hydrocarbons and the
distribution between hydrocarbon types, in order to estimate the total tonnage. The reservoir
engineer then estimates the reserves. Capillary forces within the reservoir make it impossible
to recover all of the hydrocarbons from the eld. It is estimated that an average of 7590%
of the gas, but only 3040% of the oil, can be recovered.
79
The downhole thermodynamic conditions and the composition of the hydrocarbons present
allow the reservoir to be classied according to the way the uids will behave during
production. When brought to the surface, oil and gas often have quite different properties,
in terms of volume and quality, than while in the reservoir.
In an oileld the associated gas may be dissolved in the oil or may be present as free gas.
An oil reservoir is described as being undersaturated when the hydrocarbons are initially
single phase liquids: the natural gas present in solution is released at the surface when the
oil is produced. On the other hand if the oileld originally contains both liquid and gaseous
phases, the oil is described as being saturated and the free gas which is not dissolved in the
oil resides in a gas cap (Fig. 2.15).
Wellhead
pressure
(WHP)
Well bottom
pressure (WBP)
Reservoir
pressure
(RP)
81
Atmospheric
pressure
(AP)
OIL
PRODUCTION
Water
injection
Gas
injection
Gas
injection
Water
injection
Figure 2.17 Maintaining pressure by injecting water into the aquifer and
gas into the gas cap.
Fewer injection wells are needed for gas than for water injection, but heavy compression
equipment is required (Fig. 2.17).
The injection of water or immiscible gas into an oileld leads to recovery rates which are
higher (4060%) but still limited because the ushing of the cavities in the reservoir is
incomplete (macroscopic sweep efciency) and because residual oil is trapped by capillary
action in the ushed areas (microscopic sweep efciency).
Tertiary recovery processes, known as EOR (enhanced oil recovery), make use of
chemical and thermal techniques, and seek to enhance the spacial sweep efciency and to
reduce the capillary forces by making the uids miscible or improving their mobility. They
can improve recovery by a further 510% of the total oil resources in the oileld (Fig. 2.18).
82
After tertiary
recovery
(gas lift)
Gas
Oil
Oil
Oil
GOC
Gas
Oil-water
emulsion
Oil
Oil
Water
Water
WOC
Water
Percentage oil
recovered
R = 0%
R = 50%
R = 65%
The behaviour of the uids during the production phase is carefully observed and analysed
so as to ensure that production continues to be optimised.
Finally after a period of, typically, 1530 years, the limits of economic recovery are
reached. The production facility is then dismantled and the site is rehabilitated.
2.3.2
A reservoir simulation model starts by taking a geological model, i.e. a static representation,
of the oileld. The rst stage is to synthesise the information collected by the geologists,
geophysicists and the reservoir engineer from the appraisal wells. It is advisable to analyse
these data critically because of the large uncertainties attaching to the hypotheses in the
exploration phase. The modelling phase proper involves interpreting the data in order to
construct a system which replicates the behaviour of the actual oileld.
The reservoir is represented by a grid of discrete cells. This grid may be in two or three
dimensions, and may be rectilinear, polar (around a well, for example), or irregular (in
order to show up heterogeneities, etc.). The parameters which characterise the reservoir must
be dened for each cell (Fig. 2.19).
Equations are then added to this static model which describe the uid ows between
adjacent cells, and between cells and the well, in order to obtain a dynamic model. The nal
stage consists of simulating the behaviour of the reservoir in time and space according to
different production scenarios which are subjected to a range of economic calculations.
Economic optimisation, using various hypotheses linked to the environment allows the most
appropriate development programme to be chosen.
83
After secondary
recovery
(water injection)
Outset
Once the project has been approved, the site prepared, the production wells drilled and
completed, and the gas collection, production, processing, storage and dispatch equipment
have been installed and the living quarters built, production can begin.
Numerical simulation models are subject to continual improvement as production proceeds
and knowledge about the eld increases. Renements made in the course of production allow
more reliable studies to be made of the impact of drilling new wells, horizontal drain holes,
methods of assisted recovery, etc. This will make a signicant contribution to investment
decision-making during the different stages of the life of the eld.
84
2.4.1
The principles underlying development drilling are the same as those for exploration drilling,
but more specic use is made of directional and horizontal drilling, and multidrain systems.
Modern drilling can be controlled so accurately that wells can be drilled according to a
precisely predetermined prole so as to target a precise subsurface location.
Directional drilling can be carried out in a J or an S conguration. It is normally used:
When the drilling zone is inaccessible or urbanised;
To circumvent a subterranean obstacle such as a salt dome;
To reduce the number of surface drilling installations, for example to limit the number
of platforms when drilling offshore, or to obviate the need to move them;
To test several potential reservoirs;
To deal with a well in which there has been an accident.
Horizontal drilling is a special case of directional drilling in which the borehole is horizontal, parallel to the reservoir strata. As indicated in Fig. 2.20, it is used:
When the production zone is a long way from the drilling rig; this technique can even
be used to access resources under the sea bed from an onshore location, thus avoiding
the need for offshore equipment;
To enhance productivity, and therefore recovery; by draining a reservoir over a length
of, sometimes, more than a kilometre, the oil ow rate can be increased, making it
feasible to develop an oileld of small thickness or low permeability;
To prevent the local deformation of the oil-water or gas-oil contact close to a producing
well (known as coning) which occurs with traditional drilling, which results in an
excessive production of gas and water.
Multidrain wells allow production from different parts of a reservoir with a single well.
They can be used at any stage in the life of a eld.
In the exploration and appraisal stages, sidetracking provides a less risky and lower cost
means of delineating a eld in unknown areas. The protability of a production well is
assured by the main wellbore drilled into a known reservoir (Fig. 2.21).
Offshore
Drilling from
the coast
Inaccessible
site
Emergency
operations
Multiple zones
Sidetracking
85
During production, multidrain systems multiply the number of wellbores and therefore
increase production while reducing the development costs per barrel. Drilling multidrain
systems in existing wells in the depletion phase slows the rundown of mature elds by
tapping into secondary reservoirs and allows a programme of water or gas injection to be
carried out for optimal ushing of producing formations.
2.4.2
Completion
Completion involves making the well ready for production. It begins when the drilling
phase comes to an end, when the last piece of casing has been cemented into place in the
producing formation. First of all a connection has to be made between the wellbore and the
reservoir, by drilling into the reservoir, treating it, equipping the well and putting it into
production.
The equipment and methods used in well completion are quite varied, depending on the
type of efuent, the kind of reservoir, the requirements to be met by the well during its
lifetime and the economic circumstances at the time of drilling. The completion must at least
ensure the integrity of the walls of the hole and the selectivity of the uid or production level
while permitting the unhampered ow of the uid. It must ensure that the well is secure,
allow measurements to be made, facilitate maintenance, allow the ow rate to be regulated
and the well to be put back into production.
Wellbore-reservoir connection
There are two types of wellbore-reservoir connection: cased hole completion and open
hole completion.
Cased hole completion is the most common. After the reservoir formation has been
drilled the last piece of casing or liner is set and cemented in place. Perforations are then
made at the level of the production zone to reestablish a connection between the reservoir
and the well. These perforations must pass through the casing and the cement sheathing
before penetrating the formation, which may then be subjected to stimulation treatments.
86
Tubing
The conguration of the tubing mainly depends on the number of production levels and
the production selectivity sought.
In conventional completion, we generally use a tubing which is totally contained in the
casing string. Completion may be single or multiple. In the latter case production can take
place at several levels selectively, allowing the eld to be developed with fewer wells and
therefore more rapidly, but maintenance costs are higher.
It should be noted that that there is a type of completion where tubing is not used. This
involves cementing and perforating a small length of casing in place at the level of the
production zone. This is appropriate for small gas elds poor in associated liquids and at low
pressure.
Once the well has been completed, the wellhead is attached to the top so as to control the
ow of uids (Fig. 2.22). The wellhead is made of:
The casinghead to which the casing is attached;
The tubinghead which supports the tubing;
The Christmas tree which comprises various valves and gauges.
Christmas tree
Tubinghead
Casinghead
87
In open-hole completion the well is simply drilled into the reservoir, which produces in
an open hole. A variant of this involves placing a pre-perforated liner against the wall of the
formation, so as to maintain its general shape. This type of completion tends to be used when
there is a single zone only which is either highly consolidated or where sand control by gravel
packing is adopted. In practice this procedure is rare for oil wells, but is sometimes applied
on gas wells.
2.4.3
Well productivity
Well tests are carried out in order to evaluate the productivity or injectivity index of the well,
and any damage which may have occurred. These tests together with the results of further
laboratory testing will reveal whether any treatment is necessary. The well is then put into
service and evaluated. It will subsequently undergo measurements, maintenance, workover
or abandonment.
88
Sucker rod pump: a downhole volumetric pump assembly driven by a surface recipro-
2.4.4
Well interventions
There are two categories of interventions practised on a well in the production phase: well
servicing and workover. These are both intended to maintain or enhance output from
production wells.
Well servicing involves the partial replacement of equipment such as downhole pumps,
gas lift valves, production tubing and the sealing systems which may fail because of
corrosion, waxy hydrocarbons, etc. Well servicing also includes simple operations such as
cleaning and sand control.
Workover includes more major repairs such as removal of sand which has intruded into
the wellbore and recompleting the well for production from a different zone.
In the case of oil production, the wellhead efuent is often a three-phase mixture of oil,
gas and water. It may also contain sands, clays, mineral salts, the products of corrosion and
sometimes carbon dioxide, in varying proportions. The water from the well and other impurities must be removed before the hydrocarbons are stored, transported and sold. The function
of the processing plant is to bring the oil or gas up to the specications required for export.
2.5.1
Separation process
The rst stage in the processing of the efuent is to separate the three phases oil, water
and gas by passing it through multi-stage separators. These are cylindrical installations
under pressure which may lie either horizontally or vertically. Within each separator water,
which tends to be retained in the lower compartment, and gas, which accumulates in the
upper part of the separator, are extracted.
2.5.2
Oil treatment
The oil separated in this way still needs further treatment to bring it to a specication where
it can be marketed. Watery emulsions must rst of all be broken down with the help of a
de-emulsier which allows the water to coalesce into larger droplets which can be separated
more easily from the oil. Inhibitors, solvents or heat are used to prevent the waxy hydrocarbons from precipitating out. And nally the oil is desalted by washing it in soft water. It
will then be dispatched either by pipeline or tanker.
2.5.3
Water treatment
Production water is produced in quantities which are generally quite small initially but
become progressively greater as production proceeds. It is imperative, for reasons at once
technical, ecological and economic, that this water is puried before being released into the
90
2.5.4
The natural gas or associated gas from an oileld often contains carbon dioxide, hydrogen
sulphide (H2S) and water. Depending on how the gas is to be used and transported, more or
less processing is required, and it must be sweetened and dehydrated. Natural gas may be
transported to the area where it is to be consumed by pipeline or may be liqueed and transported in LNG tankers. The propane and butane fractions are known as liqueed petroleum
gases, and are transported in special tankers. The natural gas can either be burned to produce
electricity or heat, or it can be reinjected into the oileld as a means of effecting secondary
recovery or gas lift.
Hydrogen sulphide is very toxic. If the gas is to be used commercially the hydrogen
sulphide must be completely eliminated. If it is to be liqueed, the CO2 content needs to be
reduced, by chemical absorption, physical absorption or adsorption, in order to prevent
subsequent crystallisation. If the gas has to be transported by pipeline for processing at
another location, as this is the case for offshore production, small quantities of H2S and CO2
may be tolerated but the gas must be dehydrated using glycol, by passing it through a molecular sieve or by condensation. At high pressure and low temperature the traces of water
present in the gas can lead to the formation of hydrates which can accumulate and cause
obstructions in the pipelines. But the formation of hydrates can be avoided by injecting a
hydrate inhibitor such as methanol or diethylene glycol.
In offshore production these installation have to be located on platforms with a restricted
surface area (Fig. 2.25).
91
environment or used in the production process. Firstly, all traces of oil must be removed and
added to the oil stream. The solids must then be removed so that the injection wells do not
become plugged. The content of dissolved gases, particularly corrosive oxygen, must also
be lowered. And nally, the sulphate-reducing bacteria in the water must be removed.
Hydrocarbon reserves
The concept of hydrocarbon reserves, absolutely fundamental to the oil industry, is a complex
one. In broad terms, the reserves are the total resources available to meet present and future
needs. In order to anticipate demand, the size of these reserves needs to be known. Very
broadly the worlds ultimate reserves of oil (i.e. past, present and foreseeable future) amount,
at the beginning of the 21st century, can be estimated at around 3 000 billion barrels (Gbbl),
which can be broken down as follows:
1 000 Gbbl of reserves already used;
1 300 Gbbl proven reserves remaining (about 40 years production at the present rate);
between 300 and 900 Gbbl reserves remaining to be discovered (conventional and
unconventional oil like oil sands);
300 Gbbl to be added to reserves by virtue of enhanced recovery techniques.
1000 Gb
Consumed reserves
1300 Gb
300 - 900 Gb
300 Gb
Reserves to be discovered
Enhanced recovery
The proven reserves of gas remaining are 177 Tm3 (60 years of production at the present
rate), and the ultimate reserves can be assumed to be of the order of twice this gure.
Of these gures, the only gures known with certainty are the quantities already used.
Figures announced for the reserves are essentially speculative. In practice, we do not know
93
a great deal about the hydrocarbons still in the earths crust. And even where we know of
the existence of an oil- or gaseld, the reserves can rarely be recovered in their totality with
present technology or given the policy on exploration practised by the states which own the
mineral rights. Furthermore even where technical and political conditions permit production,
costs may be too high under present market conditions to permit their commercial
exploitation.
In order to dene what we really mean by reserves, three questions need to be answered:
What has already been discovered and what remains to be discovered?
What fraction of these quantities is it technically possible to recover?
And nally, are production costs low enough for the reserves to be commercially
viable?
These questions are in fact not mutually independent: the rst two are strongly affected
by the third. The price of crude greatly inuences both the level of exploration activity and
the rate of technological progress. A high price means that it is protable to recover hydrocarbons with higher production costs. A low price, on the other hand, excludes any possibility of investing in programmes whose economic viability is uncertain, such as high-risk
exploration programmes or fundamental research. The three questions above behave like
lters, narrowing down the concept from that of hydrocarbons present in the ground to that
of economically recoverable quantities. They illustrate the difculty of rigorously dening
the concept of reserves. In 1986, for example, the OPEC countries changed their denition
of reserves. Their estimates of proven remaining world reserves were increased articially
but considerably from 700 to 900 Gbbl without there being any real change in the global
stock of hydrocarbons.
In this chapter we shall begin (Section 3.1) by reviewing the denitions used by the
industry. We shall then go on, in Section 3.2, to specify the various types of hydrocarbons
extant and will look particularly at those referred to as non-conventional. Unlike so-called
conventional hydrocarbons (broadly, those that are easy to produce and market in todays
conditions) non-conventional hydrocarbons are at present unprotable to produce, but could
become protable in the future. This category includes, for example, ultra-deep offshore
resources, extra-heavy oils and synthetic petroleum. These resources, even though they may
be recoverable with present technologies, cannot strictly be classied as reserves at present,
but this situation could change in the shorter- or longer-term future. Non-conventional
hydrocarbons exist in quantities incomparably greater than the proven reserves of conventional hydrocarbons, and could therefore have a major impact on the oil industry in the future
providing technologies emerge which allow them to be produced protably.
We will then go on, in Section 3.3, to consider reserves in relation to production. We will
show that hydrocarbon production curves are linked to the reserves in the relevant
geographical zones and allow the impact of technological progress in terms of creating new
reserves to be shown. The study of production proles has led many writers to try to forecast
the ultimate reserves and production rates by simple extrapolation. These theories can in fact
lead to two radically opposed visions of the future of hydrocarbons, corresponding to an optimistic and a pessimistic view. Energy experts armed with the same data disagree about the
short-term future of the oil industry. This debate rages on, and will be considered in
Section 3.4 of this chapter.
And nally, in Section 3.5 we chart the main hydrocarbon-producing sedimentary basins
in the world, continent by continent, giving the reserves and production volumes for the main
producing countries.
94
There are many different denitions of hydrocarbon reserves. The rst point to note is that
the term reserves denotes a technico-economic rather than a geological concept. A distinction
is made between:
Reserves: the volumes of hydrocarbons which are or will be recoverable, and
Resources: the volumes of hydrocarbons which are present in an oil or gaseld,
without reference to constraints as to their accessibility and/or cost. This concept is
identical to that of the hydrocarbons in place, in common use.
McKelvey (1972) and Brobst and Pratt (1973) dened the reserves of fossil fuels as being
identied deposits which can be extracted protably using present-day techniques and
under present economic conditions. The widely used term recoverable reserves is
therefore a pleonasm because broadly speaking the term reserves refers to hydrocarbons
which are destined to be produced and are economically viable.
3.1.1
The term resources refers to all the hydrocarbons present in the Earths crust, whether they
have already been identied or not. The rst stage is the identication of these resources,
i.e. exploration, so that hydrocarbon resources can be discovered.
Exploration is limited by two factors. The rst factor is political: certain geographical
zones are only partially open to exploration by the states which control them. The second is
technical: there are zones where the geological or geophysical exploration methods described
in Chapter 2 are not yet sufcient (for example ultra-deep offshore).
But there is a third barrier to resources becoming reserves: a technico-economic constraint
on production. There are in fact many accumulations of hydrocarbons for which the technology simply is not available today to put them into production. These accumulations,
although fully identied, may lie in waters which are too deep, or may comprise crudes
which are difcult to recover because their viscosity is too high, for example.
Technology is not the only obstacle to transforming resources into reserves. There are
resources for which the extraction technology exists, but where the recovery cost would
exceed the proceeds from selling the hydrocarbons extracted. Or, which boils down to the
same thing, the energy required to produce the hydrocarbons exceeds the energy content of
the products. These resources would not be economically feasible, and would therefore not
be put into production.
Resources can therefore only become reserves by passing a number of successive tests,
illustrated in Table 3.1.
Reserves are of course of political and strategic importance both to the oil companies and
the producing countries. Estimates of reserves may be intended to have a certain impact, and
should be viewed with caution. In fact estimates are beset by a lack of precision which is
intrinsic in the quantitative denition of the term reserves.
3.1.2
As described above, the term reserves applies to hydrocarbons which will be put into
production within the short and medium term. Reserves are therefore hypothetical volumes
95
3.1 DEFINITIONS
Tableau 3.1 From resources to reserves (by kind permission of Jean-Nol Boulard).
R
E
S
O
U
R
C
E
S
Accessible
to exploration
Identified
Production
technically
feasible
Economically
RESERVES
viable
Not economically
viable
Production not
technically feasible
Not identified
Not accessible
to exploration
because they are prone to various uncertainties and depend on variables such as technological
change, the economic climate, etc. The only reserves known with certainty, i.e. deterministically, are the reserves already produced. It is often said that the reserves present in a eld
are not known until production nally ceases. A deterministic approach assumes that the
value of each parameter needed for the calculation is certain. It obtains an estimate which
is assumed to be totally reliable, not subject to an error margin. Any other approach to
measuring the reserves in which there are uncertain parameters is necessarily speculative. It
provides probabilistic estimates in the form of a range, or in statistical terms, condence
intervals or, more precisely, prediction intervals.
Chapter 2 described the different stages in exploring and appraising an oil- or gaseld and
the uncertainties to which the results are subject. This approach produces a probability that
a particular prospect does indeed contain hydrocarbons. This is a probability because the estimates of the uncertainties involved are themselves formulated by experts in the light of their
own experience, based on their own hypotheses. The probability estimates are therefore
described as subjective, or as a priori probabilities.
Once a formation has been declared to contain hydrocarbons, the total quantities of
hydrocarbons physically present (these gures are rarely published) are evaluated, and the
associated reserves are estimated. To do this it is necessary to evaluate the ratio of the recoverable hydrocarbons to the total quantity of hydrocarbons in the reservoir. This quantity is
known as the recovery ratio, and we will return to it shortly.
Modern geoscientic techniques (geology, geophysics, geochemistry and geostatistics)
allow the potential reserves in the eld to be described by means of a probability distribution function. Because of the uncertainties in the measured values it is meaningless to say
that the reserves in a eld are 100 million barrels (Mbbl). What can be said is that there is
a certain probability that its size exceeds 100 Mbbl. The size distribution of a particular eld
is generally reasonably well represented by a lognormal distribution (see Fig. 3.2)1. In
practice the reserves are represented by providing a number of the parameters of the
lognormal distribution (the mean or a number of percentiles: 10%, 50%, 90%, etc.) which
is supposed to represent the size of the eld.
1. There is however a debate on this matter. The main weakness of the lognormal distribution is that it does
not represent small elds well, and in some cases completely misrepresents them.
96
3.1.3
Px is dened as a number such that there is an x% likelihood that the true reserves exceed
Px. For example if the P10 of a eld is 100 Mbbl, there is a 10% probability that the actual
size of the eld exceeds 100 Mbbl. The P50 is also called the median of the distribution,
and there is an equal probability that the actual reserves are greater or less than P50.
The percentiles most frequently used when estimating the size of a eld are P95, P90, P50,
P10 and P5. Estimates are also sometimes given in the form [minimum, mode, maximum]
or [minimum, mean, maximum]. The minimum and the maximum here are actually P5 and
P95 respectively, or P10 and P90. These are misleading terms, because the true minimum
and maximum of the lognormal distribution are 0 and +. The mode is the theoretically most
likely value of the distribution. The mean (or expected value) would be the average value
observed for a large number of elds whose size is characterised by precisely the same a
priori probability distribution. Figure 3.2 shows a typical lognormal distribution for a eld
for which the P50 is 500 Mbbl. The curve shows, for any x, the size for which the probability that that size is exceeded is x%.
This way of describing the size of the reserves is one of the most rigorous there is.
However many other methods are described in the literature.
3.1.4
Also widely used are the three values referred to as 1P, 2P and 3P, derived from the
percentile approach, and which also provide a probabilistic evaluation of the reserves in a
eld. These values correspond with the Px in a manner depending on the company or writer
concerned:
1P is generally equal to the P90 or P95 described above;
97
3.1.5
The terms proven, probable and possible reserves most often correspond, although there are
many exceptions, to the values 1P, (2P 1P) and (3P 2P). Or putting this the other way
round:
1P = proven;
2P = proven + probable;
3P = proven + probable + possible.
It should be noted that these denitions were formulated and ofcially adopted in 1997
by the SPE (Society of Petroleum Engineers) and the WPC (World Petroleum Congress).
More precisely, proven reserves are those which are reasonably likely to be produced;
reasonably likely here actually generally means P90. However these denitions are by no
means universally accepted, and are contested by some in the oil community. When gures
are quoted, they usually refer to the proven reserves. However does that mean P95, P90 or
something else? It is almost impossible to answer this question properly, and often the
vagueness is intentional on the part of the users. Examples can still be found where gures
given for proven reserves may mean an unspecied value between P50 to P98. Caution
is therefore needed when using the gures variously given for the reserves.
3.1.6
The probabilistic approach to quantifying the reserves in a eld is tending to become more
widespread. The approach is not without risks, however.
For example it is not as easy as it might appear to add together a set of reserves to arrive
at the reserves for an entire basin or country. This is because the gure obtained by summing
together the Px (or the modes) of the reserves for a number of elds is not generally equal
to the Px (or the mode) of the sum of those reserves.
For the record, summing the reserves 1P (proven reserves) for the elds in a basin tends
to underestimate the reserves 1P of the entire basin, and summing the reserves 3P (proven
+ probable + possible reserves) for the elds in a basin tends to overestimate the reserves
3P of the entire basin. In the case of 2P the error can go either way. Furthermore whether
they are an overestimate or an underestimate is a random process.
The only estimates which can legitimately (in mathematical terms) be summed together
are the expected values, because the sum of the means is equal the mean of the sums.
Broadly speaking, the mean is the only simple and robust statistical tool which allows a
forecast to be made. However it is important to realise that the mean only proves to be
effective when used a large number of times: taking Fig. 3.2 as an example, the expected
value of the distribution will only be achieved in 15% of cases. In concrete terms this means
that if several elds have this distribution, only 15% of them will turn out to have reserves
greater than the mean of the distribution! But it should be noted that the sum of the actual
reserves of the elds will be close to the number of elds multiplied by the expected value
98
Great care therefore needs to be exercised when doing calculations involving reserves.
However estimates of reserves for individual elds have to be summed in order to obtain
order of magnitude estimates of the reserves at a more macro level (region, country, elds
owned by an oil company). Usually only the proven reserves are published. These therefore
provide the only data available for statistical studies. Although summing them arithmetically
may not be mathematically correct, there is usually no alternative.
3.2.1
In this area also there is not a clear and precise denition of which hydrocarbons are conventional and which are not. A qualitative description of petroleum was given in Chapter 1.
Natural gas is described less in terms of quality parameters (caloric value, content of
sulphur or inert gases such as CO2, etc.) than in terms of its origin. A distinction is made,
therefore, between gases associated with oil or condensates and so-called dry gases (which
account for two-thirds of present world gas reserves). Whether a particular gas deposit is
considered conventional or not depends on how difcult it is to extract and put into
production.
Colin Campbell, Alain Perrodon and Jean Laherrre (1998) regard conventional hydrocarbons as being hydrocarbons which can be produced in the technical and economic conditions of the present and the foreseeable future. This denition, which is very close to
McKelveys denition of proven reserves (see Section 3.1), allows however for technological
progress and future economic circumstances. Non-conventional hydrocarbons therefore
become, putting it somewhat simplistically, those which are difcult and costly to produce.
But it is extremely difcult to know what the technical and economic conditions will be
in the future. The impact of a new technology on the extraction of hydrocarbons can be
measured post hoc, but how can we predict where technology will be in 20 years?
This is well exemplied by the deep offshore sector. At the end of the 1970s all offshore
hydrocarbons situated in water at a depth greater than 200 metres were considered nonconventional (and therefore not included in estimates of proven reserves). The technology
of the time was simply not able to put these resources into production protably. Nowadays
99
of the distribution. This apparent paradox results from the law of large numbers, which states
that deviations from the mean will tend to cancel one another out, i.e. that the mean of the
deviations will tend to zero. It is therefore just as crucial to know the standard deviation (the
quadratic mean of deviations from the expected value). This information allows prediction
intervals to be constructed. But it should be borne in mind that the size distributions of hydrocarbon elds are characterised by large standard deviations, giving extremely wide prediction
intervals.
3.2.2
A distinction is generally made between deep offshore (between 400 meters and 1 500 meters
water depth) and ultra-deep offshore (up to 1 500 meters). The former can nowadays be easily
accessed, thanks to advances in data processing and their application to 3D seismic data.
Deep and ultra-deep offshore reserves are estimated between 160 Gboe and 300 Gboe
(IEA, 2005). More than 70% of these reserves are located in Brazil, Angola, Nigeria and
United States. Today, most of the production comes from the Gulf of Mexico but the growth
is expected from Angola and mainly Brazil with the pre-salt discoveries.
3.2.3
An oil is termed heavy if its API gravity is less than 22. Below the range 12 to 15API it
is referred to as extra-heavy. Many of these deposits are referred to as oil sands. These
100
3.2.4
Oil shales
Oil shales are not oils in the same way as the aforementioned hydrocarbons. They do not
originate from the migration of oil from source rock to a reservoir, but remain in the source
rock. The source rock is usually a clayey sedimentary rock which can produce oil after undergoing crushing and pyrolysis at a temperature of about 500C. The production of oil from
shale requires heavy industrial installations. Shale can claim a rst in petroleum history: at
the beginning of the 20th century there were numerous sites where shale was quarried
throughout the world. These shales produced surface outcrops which were of course
exploited. At a time when petroleum geology was virtually non-existent, no exploration was
needed to nd these deposits.
Shale can be found on all ve continents, as can be seen from Table 3.2, but the largest
deposits occur in the U.S.
Except in the U.S. and in Estonia, the oil produced from shales is currently condential.
The process produces large volumes of solid waste and CO2, and these will lead to additional
environmental protection costs. Furthermore, enormous quantities of water are required.
For example it has been calculated by the company Unocal that it would be necessary to use
the entire ow of the Colorado river in order to produce commercially from the Green River
Canyon shales.
US
South
America
Australia
2 200
800
(of which 20 of
Stuart shale oil)
Africa
Former USSR
Asia
(unofcial)
(unofcial)
200
Resources
101
115
1 400
2 800
substances are genuine petroleum, having passed through the entire cycle which characterises
the formation of petroleum. They originate from hydrocarbons expelled from a source rock
into a reservoir (generally sand), often very large in size. Long oxidation and the gradual
disappearance of the lighter fractions have resulted in extra-heavy and extremely viscous oils.
The two main examples of deposits of this kind are the oil sands of Athabasca in Western
Canada and the Orinoco belt in Venezuela.
The total resources of these oils are considerable: of the order of 4 700 Gbbl, i.e. four times
the proven reserves of conventional oils! More than one-third (1 700 Gbbl) of these resources
are found in Canada, with 870 Gbbl in Athabasca alone. Russia may have 1 500 Gbbl of
heavy oil resources, although the ofcial statistics do not indicate the densities involved,
which makes classication risky. After Russia, Venezuela possesses 1 200 Gbbl in the
Orinoco belt. The U.S. and Indonesia also have large resources.
Oil sands have so far remained within the domain of non-conventional oils, despite the
vast resources involved. Today, only 5% of these resources appear to be economically
viable. By 20252035 the recovery ratio may have reached a threshold of 1520%, whereby
oil sands could be regarded as a conventional hydrocarbon.
3.2.5
The Fischer-Tropsch process for converting gas or coal into synthetic oil was developed in
Germany during the second world war (see Chapter 1), where it was the only source of motor
fuel. The process remains a difcult one. The market for synthetic oil produced from gas could
grow. Until recently, there were only a few units which convert gas into oil a production
capacity of 100 kbbl/d from 30 Mm3/d of gas notably in Malaysia (Shell experiment) and
South Africa (a remnant from a boycott by producing countries provoked by the policy of
apartheid. Things have changed with the new market conditions based on a higher crude oil
price. New projects are now under consideration. In the Pearl Gas to Liquids project, Shell and
Qatar Petroleum are investing hugely to build two 70 kbbl/d trains dedicated to convert gas into
oil. China has turned its attention to coal liquefaction technology. In 2004, Shenhua Group, the
countrys largest coal producer, was assigned a project to build a coal liquefaction plant in
northern China. The rst phase is intented to bring on stream annual production capacity of 1
Mtoe output by 2008. A second phase could then raise the project to its full design capacity
(100kbbl/d of oil equivalent output). South African Sasol sees also coal to liquids potential in
China (feasibility studies are conducted for two 80 kboe/d plants) and in the US (in Montana,
Illinois and Wyoming).
3.2.6
Non-conventional gas
The resources of non-conventional gas are thought to be considerable, but are not yet well
charted. Reservoirs of non-conventional gas are characterised by low recovery rates: of the
order of 1020%, against about 80% for conventional gaselds. These are reservoirs in which
the entrapment mechanism is very different from that of conventional reservoirs.
The three main types of non-conventional gas originate from:
Coal deposits (coalbed methane);
Shales and formations with a low permeability (tight sands);
Gas in solution in aquifers and zones of geopressure.
Gas obtained from coal deposits in the U.S. are the best known. But estimates of US
resources vary between 2.8 and 9.8 Tm3. The other countries with large resources are China
(3035 Tm3), Russia (20100 Tm3) and Canada (575 Tm3). The gures tell their own story
102
3.2.7
Several fruitful exploration programmes have been carried out in the Arctic, and these have
identied some 10 basins with real potential. Most of these basins are in Alaska, Greenland
and Russia, the latter looking the most promising. In the Arctic as a whole, resources of
8 700 Gbbl of oil and up to 20 Tm3 of gas have been discovered. However the elds
concerned probably contain much more gas than has been announced. It should not be
forgotten when considering these gures that production of these resources will be particularly difcult given the very harsh climate, the ice cover, the lack of infrastructure and the
remoteness of the site from existing markets.
The Antarctic, on the other hand, looks very much like being the poor relation of its
Northern counterpart. The geology of Antarctica seems unpropitious for the discovery of
signicant deposits of oil. Furthermore, quite apart from the difculties associated with the
extreme climate and inaccessibility, all industrial activities on this continent have been
forbidden since 1991, in order to preserve its environment.
3.2.8
There are many other categories of non-conventional and other hydrocarbons, for example:
Very small elds (less than 10 Mboe) are classied as non-conventional. There are very
many such elds. But their small size makes them difcult to nd. Furthermore there
needs to be pre-existing infrastructure nearby. Development costs must be kept low if very
small elds are to be remotely protable.
Oils won by assisted recovery techniques are themselves sometimes treated as being
inconsistencies because the various record-keeping agencies do not use the same pressure
and temperature criteria (these vary around 700 bar and 150C) for classication. This
103
as to the uncertainty attaching to the estimates. Production remains limited but is growing
signicantly in the US where 45 Bcm were extracted in 2004 and in China where
10 Bcm could be produced in 2010.
Tight gas sand reserves gures remain unknown. Canada estimates vary in the range
2.542 Bcm. US ressources are estimated to 7 Bcm. Production is growing. In 2005,
100 Bcm of natural gas were extracted from tight gas sand reservoirs in the US.
As far as shale gas is concerned, gures of 100 Tm3 have been suggested, but 40 Tm3 is
probably a more realistic gure. In any case, production is mainly located in the US (17 Gm3
per year in 2005).
The solubility of methane in water depends greatly on pressure and temperature (for
example 17 m3 per m3 of water at a depth of 6 000 m and up to 170 m3 at 10 000 m). Because
of the sensitivity of the calculation to the conditions within the trap, estimating the resources
present can be a perilous undertaking, and the gures which follow are of a highly speculative nature. Russia has estimated that its resources are 1 000 Tm3, and U.S. estimates vary
in the range 30200 Tm3 (including 150 Tm3 for the Gulf of Mexico alone). In the early
1980s an estimate of 1 000 Tm3 were made for a single reservoir in the Gulf of Mexico!
The production of non-conventional gases is growing fast in North America and China.
In any case, production remains limited compared to conventional gas extraction..
means that elds with the same pressure and temperature characteristics may sometimes
be classied as conventional and sometimes as non-conventional.
Gas hydrates are very important potential sources, and some authors consider that these may
exceed in magnitude the total known reserves of hydrocarbons. These are gases in a solid
form which occur in the form of crystalline hydrates. It is impossible to say now whether
we will one day be able to transform these resources into reserves. Two hurdles will have
to be overcome to make the production of these substances viable: their low energy density
and the considerable input of energy needed to transform them from a solid into a gas.
A new discovery is not put into production unless there is a protable market for the hydrocarbons produced. This self-evident statement illustrates the extent to which the concept of
reserves is economic in nature.
However the circumstances for gas are rather different from those of oil. At present and
allowing for existing rates of consumption the reserves of gas will outlast those of oil (about
65 years, against 40 years for oil). Furthermore it is generally agreed that gas production will
peak (point at which production begins to decline) later than oil production. The demand for
gas, although real and considerable, is therefore less sustained than that for oil products, or
to put it another way, in consuming energy we tend to give priority to the most economic
option (at present oil), with their wide variation in energy content. It should be remembered
in this connection that gas is 5 times as costly to transport as oil. The oil market is rather
more demand-driven than that of gas, where supply is often waiting for demand.
This phenomenon is well known because it also applied (and still applies) to the coal
market. In practice there are very many extremely large known gaselds which will probably
never be put into production.
At the present rate of production, coal reserves will last more than 160 years. This statistic
is difcult to interpret, however, because it seems very likely that two centuries from now
coal will have all but disappeared as a source of energy. This means that some of these
reserves will deliberately not be exploited. This being the case, these latter should be classied as resources rather than reserves. The same applies, on a smaller scale, to natural gas.
In the past, large quantities of gas have been ared because there was effectively no market
for it.
In the two succeeding sections we will consider how reserves are estimated, and
production is forecast, using production proles at the level of the eld, basin or province.
3.3.2
Production proles
The production prole of a eld is a graph in which production (usually annual) is plotted
against time. A production prole can be prepared in the same way for a well, a eld or a
complete geographical zone by the same process as that applying to a petroleum system, a
basin or a country. The prole can be descriptive (i.e. historical data) or predictive. Predictive
proles are usually constructed for a well or a eld once the production tests have been
completed. Two theoretical examples are given below which are typical of production
proles for an oil or gaseld. The eld reserves are represented by the area under the curve
104
Mbbl
18
3.2
16
2.8
14
Mbbl
2.4
12
10
1.6
1.2
0.8
0.4
2
Years
Years
0 2 4 6 8 10 12 14 16 18 20 22 24 26 28 30 32 34 36 38 40 42 444648 50
12
16
20
24
28
32
36
40
44
48
50
which denes the production prole. The preparation of a predictive production prole
therefore also involves estimating reserves (equal to the area under the curve).
At the level of the eld, there are broadly two types of prole, corresponding to small
and large elds. Small elds (Fig. 3.4) exhibit a very steep rise in production and are rapidly
exhausted, so as to reduce the production costs by concentrating them over as short a period
as possible. Conversely, the production prole of a large eld (Fig. 3.5) tends to be more
spread out in time. After an initial testing period it climbs steeply to reach a production
plateau which is maintained for a number of years, depending on the size of the eld. The
decline in production as the eld becomes depleted is generally slow.
It can be seen that production proles tend to be very asymmetric around their production
peak (or maximum). When, however, production proles are summed to give estimates for
an entire basin or country, the aggregated curve is often symmetrical about its peak, with a
rather bell-like shape. This fact was rst applied by King Hubbert at the end of the 1950s
to forecast the peak and decline of oil production in the U.S. But is this forecasting method
of universal applicability?
3.3.3
3.5
Annual production of US
(48 states)
2.5
2
1.5
1
0.5
0
1850
1900
1950
2000
2050
105
Years
4
3.6
Around 1960, King Hubbert, then an engineer at Shell, forecast, by tting a normal curve
to the production prole of 48 American states, that production would reach its peak in 1969.
Production would then decline in a manner symmetrical to the growth phase. His forecast
of the peak proved correct to within a year. This success won its author great acclaim and
recognition from his peers. There are various Internet sites which promote the work of
Hubbert and his disciples. However the fact that his theory was vindicated for one particular
example does not mean that his model has been validated generally. An entire school of forecasting has been erected on this solecism.
The object of this section is not to refute Hubberts conclusions or methodology but rather
to point out that there has been no valid scientic proof of the effectiveness of this method,
and still less of its universality.
The model does however have the merit of comprising a particularly simple example of
a method of forecasting production (and therefore also the ultimate reserves). As we argue
in Box 3.1, it is legitimate to make some criticisms of the tendency to force everything into
a normal distribution; there are many regions in the world, including the U.S., where aggregated production proles are not distributed normally, or even symmetrically.
A model of this kind makes time the only explanatory variable for the production of a
region. This is a astonishing idea, implying an ineluctable decline mirroring the growth phase,
and does not allow the possibility of reserves being created as a result of technical progress.
Box 3.1 Hubbert and mathematics.
Even if, in several regions of the world, production proles are found to be distributed
normally, there is no reason to believe that all production proles will display this pattern.
However attempts have been made to explain or justify the Hubbert phenomenon mathematically. One such attempt, tenacious and false, appeals to one of the most celebrated
theorems of probability theory: the central limit theorem. This states that under certain
regularity hypotheses the sum of a large number of independent random phenomena
(even if highly asymmetric or multimodal) tends to produce a random variable with a
normal distribution, that is, symmetrical with a bell-shaped distribution, like that used in
the Hubbert approach: the distribution function of the sum of the processes is close to
being normally distributed. But the probability density of the sum is not equal to the sum
of the probability density (in this case the production proles of the elds). Furthermore
the Hubbert phenomenon does not fall within the scope of this theorem. In the rst place
the production proles summed are obviously not independent of one another, particularly when they relate to the same geographical zone, and secondly the theorem relates
to numerical distributions rather than temporal distributions, as in Hubberts model.
Temporal distributions are subject to a completely different tool of probability theory,
namely time series analysis.
Great care must therefore be taken not to misuse this method which, however appealing
it may seem on the basis of a few examples, has no scientic basis. If certain aggregated
proles exhibit the characteristics of the normal distribution, these are curiosities, the real
reason for which it would be very interesting to explore, rather than a phenomenon of
general applicability as claimed by Hubbert and his numerous followers. Hubbert himself
ended up by repudiating the normal curve in favour of the logistic curve which unfortunately is no more justied than the normal curve.
106
A prole is usually constructed when production commences, once the production tests have
been completed. Post mortem proles, i.e. those which can be drawn when production
comes to an end, are often very different from those initially envisaged, however. This
difference is usually caused by technological progress, which may increase the reserves
(Fig. 3.7) or permit their accelerated production (Fig. 3.8).
3.5
3.5
Mbbl
Mbbl
2.5
2.5
1.5
1.5
0.5
0
0.5
Years
Years
0
0 2 4 6 8 10 12 14 16 18 20 22 24 26 28 30 32 34 36 38 40
0 2 4 6 8 10 12 14 16 18 20 22 24 26 28 30 32 34 36 38 40
The two scenarios presented below show the impact of an assisted recovery technique put
into operation after 16 years of production.
In the rst case there is no change in the resources, but additional reserves are created
(the area under the curve rises from 50 to 60 Mbbl). There is said to have been an increase
in the recovery ratio (see Box 3.2). In the second case no new reserves have been created
(the dark shaded area is exactly equal in size to the blank area under the curve corresponding to the original production prole), but simply an acceleration in the extraction of
the existing reserves. Production comes to an end 10 years earlier, without any loss in the
total reserves extracted. Although there is no increase in the reserves, the acceleration is denitely economically advantageous for the producer as it allows him to avoid a long period
of run-down and to receive the revenues earlier.
There are many examples of both cases. The Alwyn eld in the North Sea is a textbook
example of the rst scenario. A variety of measures were taken resulting in a succession of
signicant increases in the reserves. A number of writers have identied numerous examples
of the second scenario.
The second model of technological progress takes a pessimistic view about reserves. In
relation to conventional oil, technology simply accelerates depletion and therefore hastens
the onset of scarcity.
As already mentioned earlier, there are two schools of thought in relation to ultimate
reserves. The object of the next section is to present both sets of arguments so that the debate
can be properly understood.
107
3.3.4
Oil
Gas
50
70
80
90
00
150
30
50
35
55
40
60
40
63
Since 1970, when it appeared that oil would be exhausted by 2000, the outstanding
life of the reserves has only increased.
These indices, shown above for the global level, can also be calculated by region,
company, etc. These ratios vary from 8 years (North Sea) to 80 years (Middle East),
according to region and are traditionally in the range 8 to 15 years for companies,
depending on their policy. These ratios have a certain strategic importance for the
companies, who try to keep to the value reasonably constant at approximately 10 years.
A ratio which falls too low indicates a company in poor health. It should be noted that
this ratio is very sensitive to the denition of reserves adopted. In 1986 the method used
in the Middle East to evaluate reserves changed, leading to a substantial rise in the R/P
ratio.
Success rate
This indicator, used by the upstream petroleum industry, is the ratio of non-dry wells
to the total number of wells drilled. It is therefore, at the company level, a measure of its
success in exploration. However this index must be interpreted cautiously. A non-dry well
which discovers reserves of 1 million barrels is obviously not equal in value to one
which discovers reserves of 1 billion barrels. The ratio should therefore reect the size
of the reserves involved; a high success rate in a region where the reservoirs are small is
of no great interest to the company. The success rate nevertheless provides a measure of
the effectiveness of exploration. Its value has climbed over the last 30 years, from 1/10
to 1/5 and even 1/3 nowadays.
Recovery factor
The recovery factor, dened for a eld, is the ratio of the reserves to the resources in
the eld. It varies with time, along with the estimates of reserves and resources. Average
recovery factors for conventional hydrocarbons are at the moment 3040% for oil and
80% for gas. One of the ways of increasing reserves the other being exploration is
to increase this percentage by taking advantage of technological advances. This is sometimes referred to as eld growth. The recovery factor is often used as a criterion to distinguish between conventional and non-conventional hydrocarbons, particularly for gas. As
far as heavy oils are concerned, recovery factors are of the order of 10% or less. There
is obviously great scope for improving these rates, and nowadays reserves are mainly
created by increasing the recovery factor from deposits of non-conventional hydrocarbons.
108
It was seen in the previous section that the forecasting of reserves is particularly important
for the petroleum industry. There are several theories in this area, and these lead to schools
of thought which are radically opposed to one another.
3.4.1
P
r
i
c
e
P
r
i
c
e
Time
109
There are several theories of exhaustible resources, particularly Hotellings theory, for
which the reader is referred to Chapter 1. The following comments appeal to the law of
supply and demand.
Let us assume that the oil market is a closed market, that is, we only have to consider the
resource itself; there are no interactions, for example substitutions with other types of
resource. The depletion of the resource due to its consumption will lead inexorably to
increases in its price (Fig. 3.9), in accordance with the law of supply and demand. Conversely
when a market is open, other types of resource which are potential substitutes offer competition. This competition ensures that as a resource is gradually depleted there will be a transition, over time, to new sources of energy. This progressive substitution serves to stabilise
or even reduce the market price over time (Fig. 3.10). This phenomenon is sometimes
referred to as economic reproduction. Resources are depleted in physical terms, but the
reserves reproduce themselves in an economic sense.
These are the two sets of ideas which oppose one another, corresponding to the views of
the pessimists and the optimists.
The pessimists
Given that the quantities of sub-surface hydrocarbons are nite, each quantum consumed
brings the exhaustion of reserves closer. In fact, production and consumption are growing
over time (in particular because of demographic growth). The pessimists regard this development as unsustainable, being liable to lead to shortages, and therefore sharp increases in
price.
Many scientists, industrialists and ecologists fervently espouse the pessimistic view, regularly predicting the peaking and decline in the production of hydrocarbons, because for a
number of years the new reserves discovered worldwide have been less than production.
The petroleum price shocks of 1973 and 1979 were caused in part by the fear of shortages
and an articial reduction in supply. During the 1970s the economies of the industrialised
countries were very dependent on oil. A reduction in the reserves therefore contributed to
the very large increase in the prices of hydrocarbons, in accordance with the law of supply
and demand (see Chapter 1 for a presentation of the associated geopolitical issues).
However this recurrent fear led the oil companies and governments to step up their R&D
efforts in order to devise new techniques which would render feasible certain activities
which had hitherto been marginal, such as nuclear energy or the extraction of certain nonconventional oils.
Despite these efforts, economies remain largely dependent on the production of existing
conventional hydrocarbons. The pessimists tell us that despite the technological advances
made we are heading for a third and nal price shock3.
The optimists
This school of thought began to develop in the mid-1980s, and is based on the failure of
the expected increase in prices to materialise. There is of course no denying the fact that the
reserves of conventional hydrocarbons, nite in quantity, are being consumed. However oil
prices remain stable over the long term. The vaunted price rises have not happened. This can
3. This only applies to conventional hydrocarbons. As far as non-conventional hydrocarbons are concerned,
technical progress is obviously creating new reserves because it leads us to go and explore for
hydrocarbons in hitherto unexploited zones in the world.
110
3.4.2
Naturalists or economists?
Whatever ones point of view, the conclusion for the long term remains the same: energy
policy for the future must focus on radically new types of energy (rst and foremost nuclear,
followed by solar, wind, biomass, etc.) or hydrocarbons which have so far not been exploited
because they were not economically feasible (e.g. non-conventional). In both cases there must
be energy substitution, economic reproduction. The vision of the pessimists differs from that
of the optimists, however, in that it assumes that a very active posture, and the building of
public awareness of the impending shortages and risk of sharp price rises, are needed to negotiate the transition to the new energies. The optimists, on the other hand, believe that the transition to the new energies will occur naturally (as implied by the concept of the fossil
carbon continuum) as a result of technological progress and market forces such as the
competition between the various energy types.
3.4.3
Concluding remarks
Our intention at the end of this chapter is not to arbitrate between these two points of view.
It has to be conceded that in the short term the pessimistic view of the petroleum industry
is supported by many concrete and incontrovertible examples. On the other hand the optimists can also produce evidence suggesting that the petroleum industry has been able to adapt
to change through revolutionary technologies which have made it possible to commercialise
hydrocarbons which were previously ignored or whose existence we were unaware of. This
has enabled it to increase reserves during the last 20 years.
Despite this major divergence of opinion there is consensus that the ultimate reserves,
available for consumption during the next 20 years (see introduction to this Chapter), are
close to 2 500 Gbbl. This gure is very different from the estimate of several tens of thousands of Gbbl of non-conventional resources mentioned in Section 3.2. Furthermore these
111
be interpreted as a refusal by the markets to accept that the shortages proclaimed by the
pessimists are imminent. As described in Section 3.2.1, there has been a gradual substitution
of conventional by non-conventional oils which can now be commercially produced, in
accordance with the concept of the fossil carbon continuum mentioned earlier (in
Section 3.2.1). Furthermore the two oil price shocks in the 1970s encouraged the emergence
of new energies (particularly nuclear energy) and new technologies which allowed certain
non-conventional oils to be made commercial. To the proponents of this view, petroleum
appears to be characterised by the open market model (Fig. 3.10) in which the process of
economic reproduction is taking place, rather than the closed market model. Furthermore this
model is in keeping with the present trend towards economic liberalism.
However economic reproduction will only occur if technology is successful in developing
new types of energy. We saw in Section 3.3.4 that technological progress can be an agent
for accelerating depletion rather than a catalyst for economic reproduction. But the risk of
depletion should be reected in a perceptible increase in prices, whereas no such increase
can yet be detected.
The argument between the two camps appears to reduce to a confrontation between a
common sense, naturalistic view that if an exhaustible resource is consumed it will become
scarcer, and the partisans of progress and economic liberalism, the openness of markets and
the theory of economic reproduction which stems from it. Does this mean that naturalists
are essentially pessimists, and economists optimists?
speculations may rage, but as we saw, in the medium to long term both camps ultimately
agree that a transition to new energies or new hydrocarbons is inevitable.
The debate therefore boils down in the end to a personal conviction as to how the transition will come about: through an abrupt increase in prices for the pessimists or as an orderly
and gradual shift for the optimists.
Oil
Gas
Oil
Gas
Oil
Gas
Oil
Gas
Oil
Gas
Oil
Gas
Oil
Gas
117.5
Oil
Gas
1 239.9
Annual
production
(Mbbl)
(Gm3)
3 766
14.6
R/P
(years)
31.2
190.4
755.3
9 190
73.2
76.6
82.2
355.0
40.8
2 886
14.5
> 99
14.1
391.5
16.3
1 893
5.7
36.9
8.6
274.9
129.5
4 783
52.7
20.8
27.1
781.9
69.3
4 988
8.0
67.4
13.9
775.8
111.2
2 421
7.8
10.3
45.9
150.8
29 925
176.4
2 920.3
112
51.5
41.3
60.4
North America
Table 3.4 Proven reserves and annual production, North America.
Proven
reserves
(Gbbl)
(Tm3)
United States
Canada
Mexico
Total
Oil
Gas
Oil
Gas
Oil
Gas
29.4
Oil
Gas
69.3
Annual
production
(Mbbl)
(Gm3)
2 511
6.0
27.7
(years)
11.7
545.9
1 208
1.6
12.2
R/P
11.0
22.9
183.7
1 269
0.4
8.9
9.6
46.2
4 988
8.0
8.0
13.9
775.8
10.3
C A N A D A
U N I T E D S TAT E S
Offshore sedimentary basin
Onshore sedimentary basin
MEXICO
113
3.5.1
3.5.2
South America
Table 3.5 Proven reserves and annual production, South America.
Proven
reserves
(Gbbl)
(Tm3)
Argentina
Brazil
Trinidad
& Tobago
Venezuela
Other
Total
Oil
Gas
Oil
Gas
Oil
Gas
Oil
Gas
Oil
Gas
Oil
Gas
2.6
Annual
production
(Mbbl)
(Gm3)
255
0.44
12.6
10.2
669
0.48
18.8
39.0
5.15
28.5
1.33
> 99
16.8
27.2
2 421
7.76
12.3
91.2
487
111.2
31.9
14.2
954
8.2
9.8
11.3
56
87.0
(years)
44.8
0.36
0.8
R/P
48.9
45.9
150.8
114
51.5
Europe
Table 3.6 Proven reserves and annual production, Europe.
Proven
reserves
(Gbbl) (Tm3)
Norway
Netherlands
United Kingdom
Other
Total
Oil
Gas
Oil
Gas
Oil
Gas
Oil
Gas
8.2
Oil
Gas
16.3
Annual
production
(Mbbl)
(Gm3)
933
3.0
1.2
8.8
33.0
64.5
597
0.4
4.5
(years)
89.7
3.6
R/P
19.4
6.0
72.4
363
1.1
5.7
12.4
48.3
1 893
5.7
22.6
8.6
274.9
NORWAY
UNITED
KINGDOM
Netherlands
115
20.8
3.5.3
3.5.4
Africa
Table 3.7 Proven reserves and annual production, Africa.
Proven
reserves
(Gbbl)
(Tm3)
Algeria
Angola
Egypt
Libya
Nigeria
Other
Total
Oil
Gas
Oil
Gas
Oil
Gas
Oil
Gas
Oil
Gas
Oil
Gas
12.3
Oil
Gas
117.5
Annual
production
(Mbbl)
(Gm3)
730
4.5
9.0
46.5
1.5
44.3
61.5
15.2
860
5.3
14.4
15.8
675
36.2
54.5
14.3
2.1
99
42.1
35.0
613
1.2
> 99
23.5
10.7
3 766
14.6
Algeria
16.8
259
41.5
(years)
83.0
629
4.1
R/P
> 99
31.2
190.4
Libya
Egypt
Nigeria
Angola
116
76.6
Middle East
Table 3.8 Proven reserves and annual production, Middle East.
Proven
reserves
(Gbbl)
(Tm3)
Iran
Iraq
Kuwait
Qatar
Saudi
Arabia
United Arab
Emirates
Other
Total
Oil
Gas
Oil
Gas
Oil
Gas
Oil
Gas
Oil
Gas
Oil
Gas
Oil
Gas
138.4
Oil
Gas
755.3
Annual
production
(Mbbl)
(Gm3)
1 606
27.8
R/P
(years)
86.2
111.9
115.0
783
3.2
> 99
> 99
101.5
958
1.8
> 99
> 99
12.6
27.4
437
25.6
> 99
62.7
59.8
264.2
3 801
7.2
> 99
69.5
75.9
97.8
1 064
6.1
94
92
49.2
11.0
540
1.6
> 99
20.4
45.6
9 190
78.2
35.1
82.2
355.0
> 99
I r a n
I r a q
Kuwait
Saudi
Arabia
Qatar
United Arab
Emirates
117
3.5.5
3.5.6
Former USSR
Table 3.9 Proven reserves and annual production, former USSR.
Proven
reserves
(Gbbl) (Tm3)
Azerbaijan
Kazakhstan
Russian
Federation
Turkmenistan
Uzbekistan
Others
Total
Oil
Gas
Oil
Gas
Oil
Gas
Oil
Gas
Oil
Gas
Oil
Gas
Oil
Gas
R U S S I A N
Annual
production
(Mbbl)
(Gm3)
7.0
317
1.3
22.1
544
1.9
124,3
73.2
27.3
3 642
44.6
69,6
21.8
607.4
0.6
72
2.7
73.5
8.3
67.4
0.6
42
1.7
39.6
14.4
58.5
2.1
166
0.4
129.5
(years)
10.3
39.8
79.4
R/P
29.7
12.6
11.0
4 783
52.7
39.1
27.1
781.9
F E D E R A T I O N
118
67.4
AsiaOceania
Table 3.10 Proven reserves and annual production, Asia-Oceania.
Proven
reserves
(Gbbl)
(Tm3)
Australia
China
India
Indonesia
Malaysia
Others
Total
Oil
Gas
Oil
Gas
Oil
Gas
Oil
Gas
Oil
Gas
Oil
Gas
Oil
Gas
Annual
production
(Mbbl)
(Gm3)
4.2
205
2.5
R/P
(years)
20.5
40.0
15.5
1 366
1.9
62.8
11.3
69.3
5.5
292
1.1
27.1
18.8
30.2
4.4
354
3.0
35.1
12.4
66.7
5.4
276
2.5
45.0
19.6
60.5
5.8
393
3.5
41.0
14.8
124.8
40.8
2 886
14.5
28.3
14.1
391.5
China
India
Malaysia
Indonesia
Australia
119
36.9
3.5.7
4.1 INTRODUCTION
Due to the role of energy in the global economy, oil is a crucial global commodity, with a
world market of more than $2.0 trillion per year. Investment in oil and gas exploration and
production is very high, amounting every year to more than $300 billion. The oil and gas
sector is the biggest consumer of steel through its oil and gas pipelines. The total eet of oil
tankers amounts to more than 10,000 vessels (with around 500 very large carriers of more
than 200 thousand tons) and 350 million tonnes of oil capacity.
Oil and gas production is a very dynamic sector. The growth of demand is around 2%
per year, which is not a very high rate of growth compared to dynamic activities like electronics or telecoms. However each oil and gas eld has a limited lifespan: around 15 to 20
years for an oil eld and 20 to 30 years for a gas eld. Furthermore, this is the conventional
view as some new elds, especially offshore in the North Sea, Gulf of Mexico and even
Africa have much shorter lifespans. Thus there is a strong rate of decline of production which
varies from less than 3% per year (putting the lifespan over 30 years) in some Middle East
countries, to more than 10% in mature zones for satellite projects.
Taking a mean value of 5% per year for the rate of decline, this means that in 10 years,
more than 50% of todays production must be replaced with new production. For an oil
company, to keep its market share, the annual rate of growth is over 7% per year, so there
is a real challenge for the industry to nd and put into production enough oil and gas to
provide for the next generation.
The oil and gas upstream sector is therefore a very capital intensive sector. Globally, the
ratio of investment to revenue is around 8% for the whole sector. For the upstream segment
of international oil companies, the ratio of capital expenditure to revenue is much higher,
around 17%. This can be compared to a global industrial ratio of around 6-7% in the US
and Europe.
Today more than 150 oil and gas projects with a capital expenditure over $1 billion are
in development. Deciding to develop new E&P projects is the main task of the executive
121
committee of major oil and gas companies and capital discipline is a necessity to balance
technological, geological, nancial and geopolitical risks.
The decision on capital is very important because of the uncertain nature of oil and gas
production. When oil or gas is discovered, analyses of the drainage mechanisms allow
reservoir engineers to determine the nature of investments required and to establish
production proles. Using cost estimates, oil and gas price assumptions and scal and
contractual terms, oil companies can develop a revenue model for the entire life of the eld.
Oil and gas exploration and production remains a risky business, despite technological
progress. Discovering and producing new resources is a very challenging process, with
physical, environmental, technological conditions becoming even more difcult. During
exploration activity, despite constant progress in our understanding of the subsurface, a
percentage of an oil and gas exploration investment will vanish in dry wells. Over the last
ten years, globally, the rate of success in exploration activity has been around 25% (success
is measured by the ratio of discoveries with respect to exploration wells drilled, and this indicator gives an optimistic view as it includes discoveries that are not yet commercial, under
todays price and technology).
When new oil is discovered, choosing the best development concept is a key decision for
an oil company, because re-engineering is very costly, as it often completely denes the operating conditions of the eld. Although the initial investment is of fundamental importance,
there is a very strong technological evolution which constantly brings marginal projects into
development. The frontiers of offshore depth, reservoir temperature, and pressure and
viscosity (i.e. heavy oils) are constantly being increased. In order to bring challenging new
resources into production, access to new technology (derived from research) is required,
while maintaining control of costs.
Between 1990 and 2003, technical costs were decreasing, accompanied by technological
improvements and strong competition in the service sector. Since 2004, with the strong surge
in oil demand, the pattern of costs has changed. With the higher oil prices, oil companies
have raced to develop new resources as quickly as possible leading to a tense situation in
the oil services sector. As demand has grown very quickly, resources like oil rigs, technical
capacities and skilled labour are in short supply. The long-term trend of decreasing costs has
been replaced by a strong increase in many of the service sectors. After a peak in 2008, the
economic crisis has provoked a small reduction. However costs will remain now much
higher than at the beginning of the century.
122
4.2.1
Types of costs
Normally speaking there are four types of costs involved in a project in the upstream
petroleum industry. These comprise:
The exploration costs incurred mainly before the discovery of a hydrocarbon deposit.
These include the seismic geophysics, the geological and geophysical interpretation,
exploration drilling including the well tests;
The investment costs incurred in the delineation and appraisal phase, necessary to gain
4.2.2
The relative weights of these different types of cost differ from project to project depending
on the environment, the nature of the reservoir and its uids, the export conditions and, in
a very different vein, any contractual constraints which may apply.
The exploration costs can vary enormously. They may be limited to a seismic programme
and a dry well, in the case of an unsuccessful exploration (generally between $5 and
$20 million, occasionally much more). They may represent a very small proportion of the
development cost when the discovery is clearly established and well dened. In other cases
these costs may make the economics of the project problematical when considerable appraisal
work is needed (for example several delineation wells) and the discovery is a marginal one.
Two actual examples of cost breakdowns, including delineation, are given in Figs. 4.1
and 4.2.
These examples show, and many projects exhibit a similar pattern, that the development
costs are fairly evenly divided between drilling operations, the production installations and
transport systems. Similar attention therefore needs to be devoted to each of these categories,
in terms of the technical denition and the control of implementation. The same of course
applies to the operating costs. The total operating costs over the life of a eld are of a similar
123
The relevant importance of these three elements can of course vary depending on the
project context.
In the evaluation process these three types of data have to be analysed independently of
one another, but also subjected to an overall optimisation cycle such as to maximise value
added. This optimisation process almost always leads to a choice being made between alternative development options in which the minimisation of capital and operating costs is a
fundamental and ongoing requirement. The companys protability and competitiveness
depend on this. This imperative applies at all stages of the project.
Choosing the right development architecture, accurate costing and controlling expenditure across the board are the keys to success.
17%
11%
24%
22%
20%
21%
Subsea installations
Gas export pipeline
44%
41%
30%
38%
32%
magnitude to the investments, although for the decision-maker their weight is lessened by
the effects of discounting over a long period1.
The object of this chapter is to give a general overview of the orders of magnitude of each
of the main items of expenditure, to present some of the methods currently used by estimators
and project managers and, nally, to suggest a number of routes by which costs can ultimately be reduced.
1. A decision-maker does not place the same value on a given receipt or expenditure in a number of years as
on the same sum now. Discounting consists of applying a given annual rate (this rate is specic to the
company) to future receipts and expenditures to estimate their present value. Discounting tends to reduce
the impact of future cash ows (see Chapter 6).
124
Exploration costs are generally less important than other items of expenditure (see Section
4.2.2). On the other hand they incur before the discovery of hydrocarbons, and will therefore
have a direct impact on the accounts of the company, the recovery of these costs being linked
to the likelihood of success of the exploration programme, in general between 10 and 30%.
4.3.1
Geophysics
125
B. Dominant factors
The costs of data acquisition offshore are dominated by the costs of the equipment needed
(a modern 3D seismic vessel costs around $100 million). Service providers eets are tending
to move towards larger vessels capable of sophisticated automated manoeuvring.
The movement of seismic equipment onshore cannot however yet be automated. This
means that personnel costs are signicant, and depend on the cost of local labour. When the
terrain is difcult, costs may be increased substantially by the need to use a helicopter or
specialised equipment such as thumper trucks where access allows, or oating machinery
for swampy terrain. Because of the major investments required to maintain seismic teams,
the 1980s saw the oil companies abandoning their own activities in this area, to the advantage
of specialised companies such as CGGVeritas and Schlumberger.
Cost
($ million/100 km2)
Marine seismic is the least costly by virtue of a technique known as 3D multiute, which
permits the acquisition of strips 500 m wide in a single pass at a speed of about 10 km/hr.
On land it is impossible to obtain this density of data economically, and the acquisition grid
needs to be reduced.
Figure 4.4 shows a comparison of the expected costs of 2D and 3D seismic exploration
in different environments.
It can be seen that offshore there is not a great difference in costs between a 2D seismic
500 500 grid and a 3D programme, so that the latter is being used increasingly frequently.
A striking feature is the low cost of seismic for offshore exploration (particularly deep
offshore) compared with drilling exploration wells: the exploration costs for an area of
100 km2 would be around $0.5 million for 3D seismic, whereas the cost of drilling an
offshore exploration well can be more than $100 million.
14
13
12
11
10
9
8
7
6
5
4
3
2
1
0
Offshore
3D
seismic mini
3D
seismic maxi
Jungle
Marshland
2D seismic
(500 x 500 m grid)
126
Mountainous
Cost of
drilling well
127
The data processing costs are lower than the data acquisition costs, being of the order of
$500/km2 for 3D seismic and $100/km for 2D. These are the costs of producing the standard
data (a 3D programme for deep offshore will involve several terabytes2 of data). When the
data require certain advanced or detailed processes which are time-consuming and labourintensive the processing costs may be considerably higher. This applies, for example, to a
depth migration before addition of 3D which allows three-dimensional subsurface images
to be obtained as close as possible to reality from series of images over time created from
the seismic records. This process can cost several thousand dollars per km2.
Furthermore in mature exploration zones (North Sea, U.S., etc.) the oil companies often
award contracts for off-the-shelf seismic surveys on a xed price basis. These speculative
programmes, which are the property of the contractors who bear the cost of the preinvestment, are often offered at a cost as low as one-tenth of the price which an operating
oil company would pay for an exclusive customised survey.
For these reasons the mean costs per km2 indicated above must be adjusted to allow for
temporal and geographic factors, which can produce variations of a factor of 5 or 10 relative
to the mean value.
4.3.2
Exploration drilling
Most of the costs of an exploration programme are accounted for by the drilling. Onshore
and offshore drilling each has its own technical peculiarities; they differ particularly in
terms of cost if not duration. An offshore well typically costs between $20 and $100 million
and takes 30 to 100 days to drill. The corresponding onshore costs are $5 and $20 million,
the duration being of the same order. When the conditions are particularly difcult the costs
may be much higher, occasionally exceeding $200 million.
The main components of the cost of drilling an onshore exploration well are indicated in
Fig. 4.5.
The duration of drilling is difcult to predict due to geological uncertainties regarding the
drillability of the rock, the interstitial pressures of the formation uids, the depths, etc.
Difculties and unanticipated setbacks such as mud loss, jamming of the drill bit, etc. can
cause delays of several days.
Some 7075% of the drilling costs are proportional to the duration of the drilling:
equipment hire costs paid to petroleum service companies and the costs of supervising the
works (operating company personnel or prime contractor). Only 2530% of the drilling costs
can therefore be estimated with a reasonable degree of precision. These are the costs which
depend on the depth drilled (essentially the casing), the cost of the wellhead, etc. For this
reason it is a difcult exercise for the technicians to set a budget for an exploration well.
Petroleum services
29.5%
Consumables
32.8%
Consumables
Logistics
Management
and supervision
Hire of
drilling rig
Petroleum services
Hire of
drilling rig
20.1%
Logistics
12.5%
Management
and supervision
5.1%
128
700
550
Number of platforms
450
Supply
400
350
500
300
Demand
250
400
200
Jack-up
Gulf of
Mexico
300
150
Semi-submersible
North Sea
100
50
200
80
82
84
86
88
90
92
94
96
98
00
02
04
06
08
500
600
0
10
Figure 4.6 Daily hire cost of offshore platforms expressed in thousands US$ per day.
3. Logging: The recording of various electrical, acoustic and radioactive characteristics of the formations
penetrated, as a function of depth.
129
The hire of the drilling rig alone can represent between 20% (for the above example) and
35% of the total drilling costs. The daily cost depends on its power, which in turn depends
on the depth of the well and, for offshore drilling, the water depth involved. It will also
depend on the current availability of drilling rigs on the market, that is the relationship
between the supply of the drilling companies and the demand of the oil companies.
Daily costs for offshore rigs are usually several 10 thousand dollars but can reach several
100 thousand dollars if the market is tight. For the drilling contractor, the capital cost
involved can be between $10 and $16 million for onshore equipment, between $120 and $180
million for a jackup platform and between $300 and $380 million for a semi-submersible or
drillship with deep water capability.
Figure 4.6 illustrates the evolution of daily hire cost of offshore platforms.
drilling, or LWD), or after drilling by means of sensors lowered into the wellbore at the end
of an electric cable (wire line logging).
Both of these techniques are usually necessary, and they produce complementary data.
Their costs are quite different, as we shall see below.
4.3.2.3 Logging
Whatever the actual contractual terms negotiated for logging, the effective costs of these
services comprise two components:
The direct costs, i.e. the sums actually billed by the service companies;
The indirect costs, arising from the enforced idleness of other services contracted for
the drilling of the well when the logging is being carried out (drilling rig, mud units,
cement units, mud logging equipment, etc.).
On average, logging operations account for about 57% of the total drilling time.
Logging costs depend on the level of activity and the type of well being drilled (exploration, appraisal or development), each of these different types of well requiring more or less
Analyser
Extractor
Well:ML-1
Data processing
Gas logs
Interpretation
130
4.4.1
The authorisation of a project is the culmination of a process of study and evaluation, each
phase of which is intended to dene more precisely the project and its associated investment
and operating costs. Starting with exploratory studies the work proceeds through preliminary
study, the conceptual study and ending up with the preliminary design, the nal stage before
the project is authorised. The process is illustrated in Fig. 4.8.
Studies
Preliminary
studies
Conceptual
studies
(screening,
feasibility)
Go-ahead for
more in-depth
studies
or exploration
Go-ahead
to start
preliminary
design
Project
Preliminary
design
Go-ahead
to proceed
with project
Basic
engineering
Engineering,
procurement,
construction
(EPC)
Selection
of contractor
Completion of
construction
and
commissioning
Operations
Start-up
Operation
Provisional
acceptance
of the
installation
Production
and final
acceptance of
the installation
sophisticated measurements. They are often expressed as a cost per metre drilled, which
allows trends over time to be evaluated and comparisons made between different zones.
Direct costs amount to around $100$120 per metre drilled, to which must be added the
indirect costs of $50$80 per metre drilled.
of available databases. Furthermore the usefulness of analogies may be limited when new
technologies are involved.
+ 40
+ 30
+ 20
+ 10
0
10
20
Preliminary
studies
Conceptual
studies
Preliminary
design
Basic
engineering
Detailed
engineering
3
40
Project
go-ahead
Objective
Exploratory
studies
Preliminary
studies
Conceptual
studies
Risk evaluation
Preliminary
design
These studies require the participation of many engineers and specialists, and are therefore
not without costs. There are no hard and fast rules for determining the costs but, as a
percentage of the total expected investment, they are of the following order of magnitude:
Preliminary studies: between 0.05 and 0.1%;
Conceptual studies: between 0.1 and 0.2%;
133
Year 1
Year 2
Year 3
Design
Supply
Construction
Installation/Hook up
% Investments
20%
60%
4.4.2
Development drilling
Unlike exploration drilling, development drilling involves repeated operations, so that the
lead times involved are easier to plan and the costs are often easier to control. The time
required for the actual drilling has to be increased to allow for the time needed for well
completion, which varies according to the complexity of the completion.
In any particular environment, the development wells are generally drilled more rapidly
than the exploration wells; this effect is illustrated in Fig. 4.11.
When a series of development wells need to be drilled in the same eld, it is possible for
the technological parameters to be optimised on successive wells so that the drilling time
can be reduced. Figure 4.12 illustrates this learning curve effect. In a recent offshore development the time taken to drill a development well (2 700 m in depth, with horizontal drains
of 1 000 m at the bottom) was reduced from 26 days for well no. 1 to 13 days for well no. 7.
134
geology completion
drilling
Drilling
Geology
drilling
geology
testing abandonment
Production Testing
Completion
10
20
30
40
50
60
70
Duration (days)
Abandonment
30
25
20
15
10
No. of wells
Installation
16 phase
12 1/4 phase
8 1/2 phase
Completion
Tables 4.2 and 4.3 and Fig. 4.13 illustrate a typical breakdown of offshore development
drilling costs.
Special conditions can heavily inuence the costs of a development well, as shown by
the following examples.
Although the great majority of exploration and appraisal wells are vertical, nowadays 50%
of development wells are substantially deviated (>60) or horizontal. The cost of a horizontal
well is 2030% higher than those of a vertical well (but their productivity may be 3 times
as great).
135
Development drilling
Table 4.2 Cost breakdown for offshore development well. Oil-producing well SouthEast Asia water depth 70 m.
Phase
% of total cost
34
Consumables
Wellhead, piping, drilling bits and core barrels, mud and cement products,
accessories, energy, water.
Logistics
Fixed price (trucks, aircraft, removal of drilling rig).
41
14
Petroleum services
Mud, cement, casing, tubing, supervision, electric logging, mudlogging,
miscellaneous services, miscellaneous completion, diving team and ROV,
insurance, miscellaneous equipment hire.
Total cost
100
% of total cost
100
Duration (days)
55
Table 4.3 Duration for drilling an offshore development well (same project as in Table 4.2).
Erection and removal
Drilling
Geology
Completion
Total
33
16
55
Duration (days)
Petroleum services
13.8%
Consumables
34.2%
Consumables
Logistics
Management
and supervision
Hire of
drilling rig
Petroleum services
Hire of
drilling rig
40.7%
Logistics
7.9%
Management
and supervision
3.4%
136
4.4.3
It would be a vain enterprise to seek to list exhaustively the costs of all the various items of
equipment currently used in development drilling. Instead we describe below some typical
onshore and offshore project congurations and review some of the methods traditionally
used to cost these installations. We then present a set of unit costs and ratios which can be
used for very preliminary evaluations. More detailed descriptions will then be given for two
specic cases: a deep offshore development programme and an example of an LNG project.
Whether onshore or offshore, the principles of production, gathering, separation, treatment
and transport of the products remain the same. The structures and equipment will vary
according to the composition of the efuents, the product specications applying to transport
and sale, but also, obviously, according to the characteristics of the environment.
137
Another example is a high pressure, high temperature (HP/HT) well: more sophisticated
well and completion equipment is required, so that the consumables required are more
costly, increasing the costs by up to 20%. The same applies to exploration wells where the
conditions are difcult. A well producing corrosive uids requires completion equipment
made of more sophisticated metallurgical materials, which can also increase costs by up to
20%.
Furthermore an oil producing well where subsea pumping is necessary will require
multiple workovers in order to maintain the pumps.
Environmental constraints can equally affect drilling costs. These are increased if drilling
waste such as rubble or liquid wastes have to be treated in order to comply with national
legislation. The additional costs are very variable ranging between 1 and 5% approximately.
These can be reduced if smaller diameter drilling is employed, for example in ecologically
sensitive zones such as the Paris basin; the reduction which can be achieved in this way is
of the order of 1015%.
The field:
well clusters and gathering system
Separation
Heating
Storage
Pumping
Power generation
The pipeline
Well cluster
stored, transported and handled by normal methods. Desalters and stabilisers are the most
common installations.
The gas is treated to remove the pollutants (CO2, H2S, water) and heavy hydrocarbon frac-
tions which can be condensed out. There are various processes for sweetening, drying and
condensing the heavy fractions: molecular sieves, adsorbent beds, chemical or physical
absorption, traps with cooling coils or self-refrigeration by expansion and recompression.
The gaseous fractions are compressed for transportation or reinjection into the reservoir
or, very occasionally, for storage.
The water treatment usually involves a treatment plant and pumping facilities which
services).
The efuents are transported to a terminal, factory, etc. by pipeline.
138
ACCOMMODATION
PLATFORM
UTILITIES/PROCESSING
PLATFORM
FLARE
Pipeline
32 - 82 km
WELL PLATFORMS
PROCESSING PLANT
139
Table 4.4 is an example of a typical summary made by the estimators, in this case for an
on-shore gas treatment plant. The methods used to prepare it will be explained later. The table
shows that the technical costs4, although important, are just one element in the overall
estimate. They are accompanied by a range of other costs related to the studies, surveys,
project management and insurance.
Ratio (%)
42%
11%
2%
3%
58%
1%
2%
3%
6%
64%
10%
74%
1%
7%
1%
1%
84%
16%
100%
Total costs
4. The technical costs are the sum of the direct costs (main equipment and bulk items such as pipework,
valves and ttings, electricity, instrumentation, prefabricated materials and on-site construction) and
indirect costs (equipment transport, temporary installations, etc.).
141
4.4.4
Our object is not to present a course in cost estimating to the reader, but to give him a rapid
overview of the principal methods used by estimators during the various study phases referred
to above. Before doing so we take this opportunity to dene a number of terms and abbreviations which are not always understood by non-specialists in the way intended by estimators.
costs ultimately prove lower because the competition between the suppliers and other
companies turns out to be keener than expected or because dumping is practised by some
suppliers, all well and good. But an estimator may not assume a favourable scenario of
this kind.
An estimate is an approximation rather than a precise forecast of costs: an installation
cannot be costed by referring to a price catalogue. Quantities such as the weights of structures or piping, dimensions, volumes of concrete, the length of cables, etc., are not yet
known at the preliminary, conceptual or even the preliminary design stage. This is quite
different from a contractor bidding for a job, who must begin by calculating the quantities
of materials involved, so that he can price the job with the help of unit costs or price lists.
Main equipment
Carbon steel pressure vessels (less than 5 t)
(between 5 and 20 t)
(over 20 t)
Multiplier for inox pressure vessels
1535
1820
5
3.0
$/kg
$/ kg
$/kg
Bulk materials
Carbon steel piping (including ttings)
Inox piping
Duplex steel piping (including ttings)
Steel for structure
Carbon steel pipeline
67
2022
2530
1.5
1.52.0
$/kg
$/kg
$/kg
$/kg
$/kg
2040
6
1012
6080
1030
$/inch/m
$/inch/m
$/inch/m
$/inch/m
$/inch/m
Transport costs
510% of the purchase price of above items
Pipelines
Equipment
Laying costs: onshore desert
plain
mountains
offshore
Labour ($/hr)
Region
Onshore construction
Engineering
60
70
80
30
50
100
100
120
50
80
France
UK ($1 = 0.5)
Norway ($1 = NOK 5.96)
Far East (Indonesia)
Gulf of Mexico
Marine vessels ($000s/day)
Region
North Sea
Middle East /
Far East
Gulf of Mexico
Supply
vessel
Derrick barge
< 2,500 t
Derrick barge
< 6,600 t
Lay barge
20
810
1,100
300
1,300
850
4001,100
500
510
300
850
400
Indirect costs
Pipeline project, onshore or offshore
Other project
143
Table 4.5 Production and transport installations: standard costs and ratios (base 1st
quarter 2007).
A. Direct costs
These consist of the cost of the main equipment (ME): columns, separators, rotary drives,
etc., required by the process plant and the utilities, and the cost of the secondary or bulk
equipment such as pipework, valves and ttings, electric cabling, instrumentation, cladding,
etc. Also included are the construction costs including the costs of onshore prefabrication
of the elements and modules of the offshore platforms, as well as the on-site construction
costs (installation and hookup).
B. Indirect costs
These include the costs of transporting the equipment, materials and the different structures,
as well as the mobilisation/demobilisation of the marine equipment where appropriate.
The general expenses, often referred to as EMS (Engineering, Management and Supervision) cover:
The engineering, i.e. the basic engineering and the detailed engineering, as well as
services such as audit and certication, often performed by external service-providers;
The commissioning of the structures;
The management and supervision of the team in charge of the project, mobilised at
different phases of the implementation;
The insurance of the structures during construction and installation as well as other
indirect costs such as customs duties incurred by the subsidiary company.
The term EPC (engineering, procurement and construction) cost is sometimes used. This
corresponds to the value of the contract for the construction of the infrastructure, that is, a
technical cost together with the general costs of the contractor responsible for carrying out
the work. In a contractual arrangement of this kind the EPC cost must be increased to allow
for the general costs of the prime contractor, or company costs, that is, the costs of the
basic engineering, site surveys, management, project supervision and insurance.
C. Contingencies
The accuracy of a costing will depend directly on the technical denition of the project and
on how much is known about the environment. Whatever the stage of a project, a provision
for contingencies is always included in an estimate, in order to allow for uncertainties which
cannot be identied or quantied at this stage.
Preliminary
studies
+25%
+20%
Preliminary
design
Conceptual
studies
20%
15%
+10%
Final
costing
10%
30%
Global methods
Factorisation methods
Detailed methods
B. Factoring methods
These methods are widely used, particularly for preliminary and conceptual studies, and
sometimes even preliminary designs. They are based on the observation that there is a fairly
constant relationship between the direct installed cost of an item of processing plant or a
utility, including auxiliary equipment and construction, and the costs of the main items of
equipment. The latter are generally evaluated using small computational programmes or an
equipment database. A multiplier specic to the type of equipment involved is then applied
to obtain the direct installed cost.
To these equipment costs have to be added the site preparation costs, ancillary or offsite
installations (storage and loading facilities, reghting and utility networks, pipe connections,
industrial buildings, amenities, etc.) and the costs of the necessary infrastructure (roads,
power cables, jetty or port, etc.).
Finally the indirect costs, general costs and provision for contingencies are usually estimated using percentages.
C. Detailed or semi-detailed methods
This method involves estimating each item analytically. Since the quantities of bulk materials cannot be calculated at this stage of the study, they are estimated as a proportion of the
main equipment. For example the tonnage of the supporting structure or piping associated
with a particular item of equipment is estimated by applying a specic ratio to the tonnage
of the equipment. The hours of labour spent on manufacture or construction on-site are also
145
+30%
evaluated using ratios. It is estimated, for example, that the labour required for the manufacture of substructures for xed platforms is between 60 and 80 h/t, or about 300 h/t for
ordinary steel piping. Finally these hours are converted into costs by using a labour cost per
hour and assumptions with regard to productivity.
The general costs will be estimated at the most detailed level possible by evaluating, for
example, the number of hours of engineering based on the numbers of items of equipment,
or the management and supervision costs from hypotheses regarding the future contractual
strategy and the organisation of the project team.
4.4.5
Examples of developments
Examples are given below for two different types of development project, i.e. a deep or ultradeep offshore development project and a LNG (liqueed natural gas) supply system (entire
cycle including liquefaction, transport and regasication).
146
147
These two examples will give readers a better understanding of the orders of magnitude
of the overall costs of projects in the petroleum industry and, in particular, the technical costs
expressed per barrel of oil or per unit caloric value of gas, as appropriate.
Parameters associated with the reservoir are usually obtained from a speculative seismic
exploration survey and by interpreting local geological phenomena. These parameters allow
the size of the target object to be estimated, that is the reserves and the extent of the
reservoir, as well as its potential, i.e. the density of the reserves, reservoir productivity and
the types of uids.
The second category of parameters includes physical data (distance from the coast,
water depth, depth of reservoir under the seabed) and data which describe the environment.
These latter data relate to the oceanographic and meteorological conditions, the existing
petroleum infrastructure and the extent to which it would be available, the market prospects
for the production, local regulations, tax regime, etc.
The values of these parameters will point the evaluator towards the most appropriate
development plan.
B. Example of estimation of capital costs
By way of illustration the investment costs are estimated for two prospects of contrasting
size and location, both situated in 1500 m of water.
a. Prospect in the Gulf of Guinea
This prospect is situated in 1 500 m of water in the Gulf of Guinea. The hydrocarbon
deposits, of centred morphology, extend over an area of 90 km2. They consist of multilayer
reservoirs lying at depths of between 900 and 1 700 m below the sea bed. The reserves are
estimated to be 750 Mbbl of oil, and the eld would have a life of about 2025 years. The
production will plateau at 200 000 bbl/d.
Because of the lack of a local petroleum infrastructure and the remoteness of the markets,
the development is based on a FPSO acting as a gathering station for a subsea production
network (Fig. 4.19).
Offloads to tanker
Cluster of
10 subsea wells
148
Production vessel
Subsea equipment & control system
Gathering lines
Company costs1
Provisions
Drilling Wells
Total capital cost ($M)
Capital cost ($/boe)
Case 1
48 wells
Case 2
63 wells
1 700
1 000
1 700
600
500
2 000
7 500
9.9
1 700
1 300
1 900
700
600
2 600
8 800
11.7
The FPSO, tethered in a xed position by 16 mooring lines, will comprise a hull 300 m
long and 60 m wide with the capacity to store 2 Mbbl of oil. The treatment plant and utilities will be situated in one or more independent modules on the upper deck. Their net weight
(empty) is estimated at 20 000 t.
The production wells will be connected to production manifolds which are joined to the
gathering lines. Each production line is made up of two pipes thermally insulated by means
of a layer of foam in a metallic case. The water injection wells are connected in twos to the
injection manifolds. Three water injection wells are connected to the FPSO by three independent lines.
The production lines, water and gas injection lines are connected to the FPSO by exible,
thermally insulated connections. A control and command umbilical is attached to each
production line and water and gas injection line from the wells and the manifolds.
The oil is pumped into tankers at a loading buoy anchored at a distance of 2 km from the
FPSO. The associated gas is re-injected into the top of the reservoir.
In order to determine the sensitivity of this development scheme to the size of the recoverable reserves per well, two cases are considered, in which there are 48 and 63 production
and water and gas injection wells respectively.
The capital costs were estimated by reference to projects similar to the one in question
in the Gulf of Guinea and Brazil (see Table 4.6).
comprises a oating structure with a circular cross-section at water surface level and along
the length of the otation tanks on which the production and drilling modules are placed.
The cylindrical shell is 37 m in diameter and 215 m in height, with a hollow square cavity
of 18 m square in the middle containing the risers. The spar is anchored by means of 12 semitaut catenary cables. The risers connecting the seabed to the wellhead at the surface are maintained under tension independently by means of otation modules inside the cavity in the
shell. The riser contains a special joint at the level of the spar keel in order to accommodate
movements of the riser relative to the platform.
The drilling and production module, including the living quarters for 110 persons, is made
up of 3 decks 55 m in length, providing a total surface area of the order of 9 000 m2. The
empty weight of this module is approximately 9 000 t. All the wells are pre-drilled as far as
the surface casing. Four of the wells are drilled into the target formation so that production
can commence shortly after the installations are erected and connected. The remaining wells
are drilled from the spar.
After separation, the products are exported to pre-existing installations situated in shallower water by means of two independent pipelines, i.e. a 10" line, 60 km in length for gas
and a 16", 70 km line for oil.
The capital costs were estimated from available data as indicated in Table 4.7.
150
900
100
180
120
300
1 600
8.9
1. Including the drilling function\equipment and the production and export risers.
2. Project management and supervision, studies, preliminary work, insurance.
These two examples of deep offshore prospects show that, depending on location, the unit
technical costs for elds of quite different sizes can be of a comparable order of magnitude.
LNG
plant
Feed
gas
Refrigeration
Preprocessing
Precooling
LGN
Losses:
2%
Liquefaction
Sales
gas
Regasification
LNG
Temperature = 160C
GPL
8%
2%
1%
13%
A. Description
The main characteristics of each component of the cycle are reviewed below.
a. Liquefaction (Fig. 4.22)
There are strict limits on contaminants in the LNG (CO2 between 50 and 100 ppmv, total
sulphur approximately 3 ppm moles). Gas treatment units upstream of the liquefaction are
151
Fuel gas
N2
Denitrification
MCR
LNG
Cryogenic
exchanger
(MHE)
Propane
Preprocessing
Sour gases (CO2, H2S, mercaptans)
Feed
gas
Reception
Amine
treatment
Dryer
Mercury
trap
Precooling
LPG
Liquids
removal
Fractionation
NGL
more expensive than traditional liquids removal units. Any mercury in the feed gas is treated
at this level; nally the gas is dried by means of molecular sieves before refrigeration.
Two refrigeration cycles are generally needed in order to produce the LNG. The rst
cycle, which usually produces pure propane, cools the feed gas (usually to 20/30C) and
the refrigerant for the second cycle. The second cycle, which uses a mixture of nitrogen and
light hydrocarbons, allows the gas to be condensed and cooled to 160C. These units make
use of large compressors driven by gas or steam turbines.
The natural gas is liqueed in an exchanger (just one per train) with a large heat exchange
surface. They are usually spiral tube exchangers 4 metres in diameter and some 60 metres
in height.
Depending on the nitrogen content of the feed gas, the liqueed gas will be passed to a
denitrication unit in order to reduce the nitrogen content to a level acceptable for its transport
(normally 1%). The nitrogen-rich off-gas from this unit is returned to the fuel gas stream.
The heavy hydrocarbons are separated in a fractionation unit. This unit produces a gas
rich in ethane which is routed back into the LNG stream. It also produces a propane/butane
stream which can be reinjected into the LNG or sold as a separate product and nally, a
heavier product with the characteristics of a light condensate.
The liqueed gas is then stored in cryogenic tanks at atmospheric pressure tted with
loading pumps. The gas resulting from the evaporation of the LNG (boil-off) is returned
to the fuel gas stream by means of dedicated compressors.
The LNG is transferred from the loading bay onto LNG tankers by means of cryogenic
loading arms. In view of the size and draft (approximately 14 m) of these vessels, and the
precautions which must be taken during product transfer, a dedicated jetty and associated
port facilities are needed. A large LNG factory may have several jetties. The LNG plant at
Bontang in Indonesia, for example, has three jetties.
152
b. Transport
The LNG market is characterised by long-term contracts, and a dedicated eet of LNG
tankers is normally used to transport the product. The number and size of the tankers forming
the eet is a function of annual volumes of LNG to be transported and the transport distance.
The most common size for a tanker is 135,000 m3 or 65,000 dwt, or in energy terms, 3 TBtu
per tanker-load. Much larger ships with a 250,000 m3 capacity now exist.
A LNG tanker sails typically at 1819 knots. The longest routes (from the Middle East
to Japan) are approximately 6,300 nautical miles and the shortest (Algeria to Spain) about
350 nautical miles.
c. Regasication
On arrival at the reception terminal the LNG is transferred to storage tanks, and subsequently
vaporised, after cryogenic pumping, and made available to the end-user. The gases which
form due to the natural evaporation of LNG in the terminal installations are reincorporated
into the liqueed gas before pumping. The vaporisation is effected either in trickle evaporators or in submerged ame vaporisers. If the caloric value of the gas is too high, nitrogen
or air is injected into the sales gas.
B. Size of the units
In order to estimate the capital costs it is essential to know the capacity of the plant and the
unit size of the liquefaction trains.
a. Capacity of the plant
There are 30 LNG plants throughout the world in 2011. Their capacities range from 1.1 Mt/y
(Camel, Algeria, commissioned in 1964) to several 10 Mt/y (Qatar). The capacity of a plant
depends on the size of the reserves which it will process and the market for which it will
produce.
Only one plant, in Kenai, Alaska, operates with a single liquefaction train; all the other
plants have multiple trains. The maximum number of trains is eight, in Bontang.
b. Size of the trains
The capacities of trains of recent design can reach 8 Mt/y, using more powerful mechanical
drives. The liquefaction trains are sized on the basis of the markets at which the plant is
aimed, but also on the optimum production rate associated with the power of the refrigeration machine (initially assumed to be 14 kW per tonne of LNG per day).
High-power industrial gas turbines come in only a limited number of sizes. The most
appropriate turbine with a power which meets the requirements is therefore chosen. When
choosing the rated capacity of the turbine, it should be borne in mind that the power actually
available depends on the temperature of the air (there is a 0.7% variation in output power
per C): the capacity of the train will therefore be a function of temperature.
153
The liquefaction plant requires the following facilities: a cooling circuit (generally sea
water), a heating system (steam, thermal oil or hot water) for the reboilers, fuel gas, power,
compressed air and nitrogen (for inerting), a system for gathering and treating the liquid
efuents and a system for aring and liquids burning.
Air-cooling is possible, but all the major plants (except North West Shelf in Australia)
use sea water as the coolant.
It should also be noted that most liquefaction plants have been debottlenecked at some
stage in their lifetime, leading to an increase compared with the initial (design or nameplate) capacity of 1040% or even more.
c. Storage capacity
As a rule of thumb, the storage capacity should be no less than the capacity of a tanker plus
a certain number of days production for the plant when operating at full capacity. This
number of days will depend on the particular circumstances of the case, particularly the availability of tanker capacity (which may be disrupted by weather conditions, for example). As
a rst approximation, 45 days should be taken.
The number and sizes of the tanks will depend on the chosen capacity, but also on the
unit cost, given that these are lower for a large than a small tank. LNG storage tanks are
large: up to 250 000 m3 for an above-ground tank.
d. Size of LNG tankers
The size of a LNG tanker can reach 250 000 m3, but smaller vessels might be chosen for short
routes depending on the limitations of the destination port.
C. Energy losses
An estimate is made in this section of the mean energy efciency of the entire LNG supply
cycle; this parameter is indispensable for any technico-economic analysis.
The liquefaction plant requires around 1012% of the feed gas for its own use. The
precise gure depends on the pre-treatment necessary, the installations used to load the LNG
onto the tankers, the source of power (gas or steam turbine) and the intrinsic efciency of
the liquefaction process.
There is some evaporative loss of LNG during transportation, and this will be burned in the
vessels boilers. In addition, some LNG will be used to keep the storage areas cold for the return
journey. The loss of saleable product is estimated at between 1 and 3%, according to the distance
involved. In addition an average of about 1% of the LNG will be used during regasication.
The total energy loss over the entire LNG supply cycle is around 13% ( 2%) of the feed gas.
D. Technical costs
One of the measures of technical costs most commonly found in the literature is the specic
project costs (limited to the turnkey or contractors cost), expressed in $ per t/y capacity.
These specic costs vary in the range $500 to $800 per t/y, according to the technical denition, but also as a function of environmental factors such as the composition of the gas,
the cost of labour, the adequacy and preparation of the onshore or offshore site, the
remoteness of the site and the logistics. These costs also depend on the market conditions
at the time the construction contract is signed. For a preliminary estimate of the cost of the
LNG supply cycle it is suggested that the gures in Table 4.8 are used.
Consider a LNG project involving the transportation of 5 Mt/y over 6 000 nautical miles.
By applying the data in Table 4.8 and by making a few simplifying assumptions, we arrive
at a production cost CIF5 including regasication but excluding feedgas for LNG of approximately $3/MBtu. These costs are broken down in Fig. 4.23.
5. Cost, Insurance and Freight: the price including the cost of the merchandise, insurance and maritime
freight as far as the destination port.
154
Plant (capacity
5 Mt/y, 2 trains)
Site preparation
Processing
Liquefaction
Fractionation
Utilities
Storage
Transfer
Port
Wharf
Jetty
Water supply
Proposed cost
($M)
%
of total cost
150
250
900
50
450
300
50
100
200
50
50
6
10
34
2
18
12
2
4
8
2
2
2 550
100
Proposed cost
($M)
%
of total cost
Storage
Transfer
Port
Wharf
Jetty
Vaporisation
Utilities/other
300
80
100
50
30
200
160
33
9
11
5
3
22
17
TOTAL
920
100
TOTAL
Reception
terminal
LNG tankers
(capacity 135 000 m3)
Cost range
($M)
50200
100400
30100
20500
1550
Cost range
($M)
50100
5350
1550
Unit costs
($M)
150200
3.5
3
OPEX
0.5
2.5
LNG tanker
0.7
Terminal
0.5
1.5
1
Plant
1.4
0.5
0
Figure 4.23 Cost structure for the LNG cycle ($/MBtu feedgas excluded).
155
Table 4.8 Estimation of the cost of an LNG cycle using standard factors.
4.5.1
The operating costs can be classied either by their nature (personnel, services, supplies) or
by their purpose (production, maintenance, security, etc.).
Where items are classied by their nature, they should generally conform to the
accounting conventions, which may have a statutory character in the particular country
concerned. They will include, in particular:
Personnel costs, accommodation, subsistence, transport;
Consumables (fuels, energy, lubricants, chemicals, ofce supplies, technical equipment
such as piping, drill strings, joints, catalysts, molecular sieves, cladding, laboratory
supplies, individual items of security equipment, spare parts, household supplies, food);
Telecommunications costs, miscellaneous hire charges, service and maintenance
contracts.
The classication by purpose allows the costs to be analysed in a manner which corresponds more closely to the objectives of the operator. The following breakdown is an
example:
The direct costs comprise downhole (well services) and surface production, maintenance
of the wells and surface installations, new works (excluding Capex), inspection, logistics,
security, site management;
The transport costs are the costs related to the transmission pipelines and the terminals;
The indirect costs include technical assistance, operating company staff and head ofce staff.
These breakdowns must be made according to very precise rules so that costs can be monitored throughout the life of the eld, compared between installations, and so that the costs
of planned installations can be estimated.
Conditions and circumstances can vary enormously. We can only give orders of
magnitude here: operating costs are subject to a very wide spread, ranging from $0.5 and
$6/boe (1 boe = 6.119 GJ), depending on:
156
6
5
4
3
2
1
0
4.5.2
In order to maintain tight control over operating costs, a rigorous approach must be taken,
initiated during the conceptual studies when the development architecture and operating
philosophy are chosen. This is the stage at which the overall optimisation, and in particular
the trade-off between Capex and Opex is virtually xed. Optimisation is achieved through
the engineering studies (detailed installation design, choice of equipment) and the preparations made (policies on recruitment and subcontracting, organisation of logistics).
Particular consideration needs to be given to the operating philosophy, because this has
a direct impact on personnel costs, preponderant in the eld. It is vital to optimise the workforce when the units are being conceived. It would be illusory to think that savings can be
made through antiquated methods such as using operators for remote monitoring for example.
This would have the effect of inating the production workforce, decentralising maintenance
operations and ultimately straining budgets. A single operator costs in excess of $100 000/y,
not allowing for various extras, i.e. $1 million over 10 years, far in excess of the capital cost
needed to avoid this labour cost.
During the operating phase, the steps taken to control operating costs are as described
below:
157
The ease with which the gas, oil, heavy oil, etc. can be extracted;
4.5.2.1 Control
In order to enable the operating costs to be controlled, they are broken down into categories,
sub-categories, equipment, components and items. A system must be established for
recording expenditure, often using automated procedures, for the same elements in this hierarchical breakdown. By calculating costs at each hierarchical level, analyses and comparisons can be made.
4.5.2.2 Optimisation
An analysis of the expenditure, beginning with the largest items, will allow areas to be identied where economies are possible by reviewing current practices and technical specications. Examples of areas in which savings might be possible are:
Personnel costs (simplify organisation, mechanise, automate, sub-contract);
Consumption of chemical products (settings, change supplier, change process);
Use of spares (analyse parameters, carry out metallurgical analyses, change materials,
change supplier);
Storage costs (change supply and stock policy, standardisation);
Review maintenance policy.
At one site, for example, the frequency with which the 24 gas turbines present were reconditioned (unit cost between $200 000 and $800 000) was challenged. By considering the
history of these machines it proved possible to increase the interval between reconditioning
from 3 to 5 years on average. This led to a reduction of 5% in the total maintenance costs
for the site.
Account must also be taken of future production dynamics such as the run-down of the
reservoir, the need for assisted recovery, the bringing into production of new reservoirs, etc.
Regard must also be had to changes which will affect the installations over time (ageing
equipment, obsolescence, extensions) and changes in the economic climate.
The scope for optimising operations may be inhibited by poor development prospects or
when there is an economic downturn, or may conversely be enhanced by organisational
changes, or a modernisation of the installations when there is a major extension to the
project, for example.
158
20
18
Depreciation
Exploration costs
Operating costs
16
Dollars/barrel
14
12
10
8
6
4
2
0
1990
1992
1994
1996
2000
1998
2002
2004
2006
2008
20
18
Depreciation
Exploration costs
Operating costs
16
9.1
Dollars/barrel
14
8.1
12
7.0
10
8
6
4.4
0.8
2
0
1.9
6.0
4.7
0.8
1.7
5.2
1.2
0.9
0.9
3.4
3.5
3.9
4.7
2002
2003
2004
2005
5.6
2006
6.9
7.8
2007
2008
Since 2000, this trend has changed: technical costs are rising and they have increased by
more than 100% between 2000 and 2008. The increase nds its explanation rst in the
economic cycle, with higher price of commodities like steel and other metals. Second the
high level of investment drove to strong constraint in the oil services sector. Exploration
equipments like oil rigs, technical capacities, skilled labour are in short supply.
4.6.1
The cost decrease observed in the nineties is a tribute to the efforts made by the petroleum
industry to reduce its technical costs. A number of technological advances helped to make
this achievement possible.
159
Major strides forward have been made in geoscience as a result of the processing capabilities of modern information technology. The systematic use of 3D, for example, has made
it possible to reduce the number of exploration wells needed to uncover economically viable
deposits of hydrocarbons. It has also allowed the wells to be positioned optimally, thereby
limiting the need for further delineation.
Advances in drilling have also helped to cut costs: deviated wells, horizontal and even
multiple borehole drilling, to name but a few, have increased the number of objectives
which could be reached from a single site (a platform, for example), as well as allowing
multiple pay zone access from a single well. These techniques have had a radical impact on
the productivity of wells by reducing the number required and, in consequence, signicantly
simplifying the linking infrastructure needed.
Another notable advance has been the simplication in gathering systems made possible
not only by reductions in the numbers of wells, but also to a great extent by advances in
multiphase transport. Because the liquid and gas phases no longer have to be separated, it
has been possible in some cases to halve the number of pipelines. In addition, separation units
have been considerably simplied or even eliminated altogether, particularly in places where
these are undesirable, such as in the vicinity of the wellhead. Of course some of these
effects are offset by developments at the reception facilities, which have necessarily become
more complex. But the overall net effect is substantially positive, a saving of the order of
1015% of the total cost of a project.
Technological advances have also led to remarkable improvements in production
equipment (power generation, instrumentation, piping, rotary drives, etc.), in terms of reliability, availability, and ease-of-use. Other examples include the development and widespread use of digital process control systems, the advent of high-performance private
telecommunications networks, the emergence at last of really reliable, powerful, light gas
turbines, a spin-off from ongoing progress in the aero industry. Other important developments include the advent of the variable-speed electric drive, the contribution made by
powerful electronics and technological advances in rail transport.
It is difcult to quantify the effect on costs of all these improvements, but it is certainly
considerable.
We have got to the point where diminishing returns are beginning to set in. But further
progress is always possible, and there are still many opportunities for making savings in all
areas. Some of these opportunities are described below.
It is impossible to over-emphasise the fact that 90% of the costs are determined in the denition of the object to be built. This underscores the enormous importance of the conceptual
studies and the preliminary design, during which potential areas in which the costs can be
reduced should be identied (Fig. 4.26). Sufcient time and resources and the best possible
skills therefore need to be devoted to these studies to ensure an optimum project denition.
Traditional methods need to be constantly questioned and new ideas systematically
considered.
A second way of reducing capital costs is to seek to simplify and standardise the
equipment. This is not often possible because projects are usually different from one another.
But duplication pure and simple can sometimes achieve savings of the order of 40% for
structures and 25% for construction and supervision not counting savings in time, which
may be as much as 35 months. Even if two installations are not completely identical, it is
worth checking whether some of the units in the rst installation cannot also be used without
modication in the second.
A third way adopted by some companies is to put the contractual arrangements with
subcontractors on a different footing. The objective is to harness the skills of both
management and workforce as a whole towards common objectives in terms of costs, deadlines and even production. This approach has spawned alliances, the concept of the target
price, ventures involving prot-sharing. There is no doubt that service providers have taken
on a broader role, becoming in the process more partners than subcontractors. Many have
restructured, growing in the process, and with their technical competence considerably reinforced. The oil companies have relinquished entire areas which were hitherto very much their
preserve. This new modus operandi is undoubtedly acting as a mechanism for the dissemination, spread and acceleration of technological progress, and has led to a division of work
propitious to these advances, the service providers building expertise in new areas, and the
oil companies taking on the coordinating role in relation to the complex set of tasks requiring
inputs from a range of different specialities.
Cost reduction potential
Screening
studies
Conceptual
studies
Preliminary
design
Basic
engineering
Detailed engineering
Time
Figure 4.26 Cost reduction potential during the various study phases.
161
Quite separate from this antithesis between service providers and oil companies, it is clear
that the growing complexity of projects, together with the shortening of the development
cycle in the face of economic pressures means that there is an increasing interdependence
between the disciplines involved at an increasingly early stage. In other words, the need for
a cross-disciplinary approach is making itself keenly felt; this is certainly the case in the eld
of R&D, where efforts are being directed towards technological innovation which can be
used commercially, with attractive economics.
4.6.2
particularly where this leads to signicant rewards or where the technical parameters are such
that innovation is needed to reach new reserves. Innovation obviously involves risk of
greater or lesser magnitude, both nancial and in terms of image.
The wide use of multiphase pumps in place of the much heavier and more costly traditional system of compression pumping is an example of the industrial application of an innovation resulting from prolonged R&D.
Risk used to be essentially of a geoscientic or geopolitical nature, and if considerable
technical risks were sometimes taken, for example in the North Sea in the 1970s, these were
not seeking to establish or strengthen the position or competitiveness of a particular company
in a given context.
Times have greatly changed in this regard. The oil companies differentiate themselves and
promote themselves to the competent authorities in host countries in terms of their capacity
to take technological risks and to bear the nancial consequences which ensue. There are
many reasons for this. For example there is no doubt that the technological levelling
upwards requires the ability not only to realise an activity at a particular point in time but
also to be able to bet on future performance in the short or medium term so as to retain
competitiveness. Specically the willingness is required to take risks at the moment when
agreements or contracts are signed, i.e. well before the realisation stage, and to manage these
risks subsequently.
In other words, in the past when development opportunities were technology-limited, risktaking remained fairly low. At present the reverse applies, and technological risk-taking has
become a consequence of commercial decisions taken on the basis of considerations of a
different nature. The perils are increased further still by the sheer physical size and therefore
nancial implications of the stakes involved.
This contractual basis is appropriate to phases of the study in which the basis of the
project, and therefore the work required of the contractor (at this stage, consulting engineers),
is still subject to great variation. These phases are not the most costly part of the overall
project, and it is vital that the necessary resources are made available and that the work does
not suffer as a result of relentless cost-cutting. This is the time when the installations to be
constructed are being dened technically, and the quality of this work provides the best guarantee that the project will be completed within budget and on time. For large construction
projects, on the other hand, day-rate contracts should be avoided, as overruns on multimillion dollar projects can be extremely costly.
In a foot-rate contract the contractor is remunerated according to measurable quantities
of work carried out (volumes of earthworks, tons of piping installed, etc.) based on a unit
price schedule appended to the contract. This form of remuneration may be appropriate in
the initial phases of construction when the works have still not been fully dened and a xed
price cannot yet be set.
This form of contract only passes part of the nancial risk to the contractor. It also
presents similar risk of overruns to the day-rate contracts.
Unlike a day-rate contract, a turnkey contract remunerates the contractor for the supply
of a complete installation (where appropriate with performance guarantees) without reference
to the time spent and materials used. Only the result counts. The contractor has to estimate
the cost of the proposed works on the basis of a call for tenders prepared by the petroleum
company, and prepare a xed-price bid for carrying out all the work, including an element
which compensates him for his risk, and his prot.
For the oil company, this formula has the merit of constituting a formal commitment on
the part of the contractor to complete the work on time and at minimum cost. The fact that
the contractor has to bear the cost of an overrun gives him every incentive to keep to the
initial estimates.
The oil company needs to be aware of the fact that if a turnkey contract is to be effective
the work to be carried out must be dened in a precise, complete and denitive manner. Any
work not covered by the contract is likely to be billed at a rate which reects the fact the
contractor will be the only one able to carry out the work required.
Turnkey contracts are therefore suitable during the construction phase when the design
and technical studies have been completed and the project denition has been frozen. In
practice it is often necessary, in order to stick to the timetable, to award contracts before the
denitional studies have been fully completed. In such cases it is up to the oil company
managing the project to ensure that the timing is such as to ensure an optimum trade-off
between cost and time.
In the foregoing we have presented a simplied picture of the various contractual options
open to oil companies in implementing development projects. In reality it is up to them to
adapt, mix and coordinate these various possibilities depending on the realities of the situation, so as to optimise the overall economics. Particular attention is needed to ensuring that
the various contractual interfaces between the petroleum company managing the project and
its main subcontractors are clear and well coordinated. Special care needs to be taken that
responsibilities are well delineated, and that there are no overlaps or gaps.
The price of executing a project can vary signicantly (i.e. by 2030%) depending on
whether or not there is genuine competition between contractors or the price was imposed
by a contractor acting monopolistically. If it is not careful, such a situation may be of the
oil companys own making, as illustrated in the following examples.
a. Design of the modules of an offshore platform
The trend within the oil industry to design ever larger and heavier modules in order to
minimise the need to link up separate modules was in itself a good idea. However this idea
was taken to extreme lengths, so that modules became so large that there remained only one
contractor with the necessary equipment or a lifting barge of sufcient capacity, with the
result that prices became prohibitive.
b. LNG plants
Over the years petroleum companies have got into the habit, for reasons of technical
conformity, of using the same proprietary liquefaction process and the same contractors for
the construction of LNG plants. A quasi-monopoly has therefore arisen between a few
contractors, and this has pushed prices articially high. This situation has in turn tended to
reduce the number of new LNG projects which are economically viable. The entry of new,
or the return of existing, contractors into the market and the emergence of new proprietary
processes should lead to appreciable cost savings.
The petroleum services sector, or more fully the upstream oil and gas supply and service
industry, is not easy to dene as it embraces activities of a very heterogeneous nature. It
includes geophysical activities (the acquisition, processing and interpretation of seismic
data), drilling and associated services, engineering and design, subsea engineering (pipeline
laying) and the construction of platforms (shipyards). In addition there are hosts of manufacturers of tools (for geophysics and drilling), metal construction and mechanical engineering rms. What all these companies, whether large, medium-sized or small, have in
common is that they provide a service or services to the petroleum industry.
4.7.1
Historical background
The four major international poles of the petroleum services industry are the U.S., the UK,
Norway and France. These national industries developed alongside the efforts in each country
to develop national hydrocarbon resources. The U.S. has long set the pace for the petroleum
industry worldwide; it has developed a powerful petroleum services industry which includes
many companies which are global players.
In the United Kingdom, although drilling began in the 1960s, it was the rst oil shock in
1973 which really rendered exploration and production projects protable and permitted the
emergence of a national petroleum services industry which, on the back of its success in the
domestic market, rapidly took on an international dimension.
In Norway the rst seismic proles date back to the 1963. At that time the Norwegian
government decided it would control exploration and production on its continental shelf. The
petroleum services industry has developed in three stages: in the 1970s service companies
cooperated with other countries with petroleum experience. In the early 1980s, nurtured by
heavy protectionism and the publicly owned national oil companies (Norsk Hydro and
Statoil) the large petroleum industry players emerged. Since the late 1980s these companies
have been established themselves on the international market.
In France the state played a role in helping the home-grown petroleum services industry
to develop, despite the lack of a domestic market for these activities. But the French
companies, which cover almost the entire spectrum of activities in this sector, have become
major players in markets such as the North Sea and the Gulf of Guinea, and have thereby
succeeded in gaining access to the international market.
Apart from these main actors, China and South Korea, have signicant petroleum services
industries.
4.7.2
The market for equipment and services in the upstream petroleum industry is made up of
three components, as follows:
The rst and largest category comprises investment by the oil and gas companies in explo-
existing installations, only part of which benets the petroleum services industry. This
market is worth roughly $50 billion/y.
167
G US$
350
300
250
200
150
100
50
0
2007
2008
North America
South America
Europe
Rest of World
2009
CIS
Africa
Middle East
Asia
400
Onshore rest of World
Offshore non US
Onshore North America
Offshore North America
350
Number of teams
The balance comprises the sums invested by the petroleum services companies themselves
300
250
200
150
100
50
0
2004
2005
2006
2007
2008
2009
168
This decline directly affected companies in the oil and gas supply and service sector,
which is directly dependent on oil company investment. Small companies were hit first, but
even the biggest failed to emerge unscathed. Early in 2009 for example, Schlumberger and
Baker Hughes were obliged to implement extensive redundancy plans.
Depending on the sector concerned, this fall made itself felt in different ways.
120 000
World
100 000
80 000
60 000
North America
40 000
20 000
China
0
2004
2005
2006
2007
2008
2009
169
Over the last two decades the petroleum industry has undergone a transformation as a
result of factors which affect the level of investment in the upstream industry: oil shocks and
counter-shocks, major technological advances, large gains in productivity and radical restructuring.
In the rst half of the 1980s upstream investments by oil and gas companies were relatively high varying between $80 and $90 billion/y because of the high price of crude.
After the counter-shock of 1985/86, investment fell back sharply, settling into the range of
$45 to $52 billion/y. In the early 1990s the Gulf crisis produced a brief rebound in
investment, to $79 billion, followed by three years of retrenchment, down to a level of
$71 billion in 1994.
Between 1995 and 1998 this trend reversed and there was a sharp increase in the capital
ows in the upstream sector. In 1997 investments broke through the $100 billion barrier, an
all-time high in current dollars. During the period 19941997 there was therefore strong
growth in the upstream petroleum sector, which grew at an annual rate of 12%. In 1999,
however there was an overall fall in investment, due to weak crude prices.
From 2000, and up to 2008, the level of investment grew steadily, driven by rising oil
prices, but also, and especially, by increasing costs.
In 2009 the trend was reversed, with investments falling by an average of 16% (dropping
37% in North America but only 8% elsewhere in the world). The total of G$406 was G$80
less than in 2008, due to an economic environment that hardly encouraged companies to
invest in developing new production capacity.
4 000
3 500
3 000
World
2 500
2 000
Asia excluding China
1 500
1 000
North America
500
0
2004
2005
2006
2007
2008
2009
170
Two questions arise regarding the ownership of hydrocarbons. Firstly, who owns these
resources while they are in the ground, either before or after their discovery, but before their
extraction? And secondly, who owns them after their extraction from the subsoil, and at what
point in time and space is ownership transferred if these two are not the same.
As a general rule (except in the U.S. onshore), subsoil natural resources (and this includes
hydrocarbons) are the property of the State. The State monitors petroleum activities and intervenes as custodian of the public interest, in particular when it licences individuals or organisations to explore for and produce hydrocarbons.
B. Ownership by occupation
Under this regime, the mineral rights belong to the rst occupant of the land or to the
person rst applying for the right to occupy the land. This system was in force in some new
countries, but is no longer applied for hydrocarbons.
C. State discretion
In this system hydrocarbons are not owned until they are discovered. At this time the State
determines, by virtue of its power of patronage, the conditions under which the exploration
for and production of hydrocarbons, which constitute part of the national wealth, will take
place. The State grants mineral rights (leases or concessions) to the companies it chooses at
its discretion, a process which may involve competitive bidding. The companies chosen are
required to observe the conditions laid down by law, equal for all, without discrimination.
The ownership of the hydrocarbons and the rules governing the transfer of this ownership
are also laid down by the State. This is the system which applies in most industrialised countries.
D. State ownership
In this approach, which has its roots in the feudal system, hydrocarbon resources are owned
by the State (the sovereign) and form part of its estate. Hydrocarbon exploration and
production are governed by agreements or contracts made between the State and the company
it chooses. This was the system which applied in the Middle East and Latin America, and
involved applying application of the rule of the inalienable and imprescriptible property of
the State.
The principle of State ownership results in a State monopoly, companies acting as mere
contractors with the task of developing the assets of the State. This is exemplied by the
system of service contracts used in Latin America, Mexico, Brazil and Argentina until 1989.
E. Hybrid regime
In most countries today, the petroleum legislation lays down a regime which embodies the
principles of State discretion or State ownership, the State exercising its sovereign rights over
the natural resources.
B. State sovereignty
Developments in the way the international community interprets the concept of the sovereignty of the State are particularly important in practice. Since 1952 the United Nations
General Assembly (Resolution 626) and then the United Nations Conference for Trade and
Development (UNCTAD) have repeatedly reafrmed the inalienable right of all States to
dispose of their wealth and natural resources in accordance with their national interests and
based on respect for their economic independence (1960). Resolution 1803 of 1962, restated
in the third general principle adopted by UNCTAD at its rst session in 1964, calls on States
to exercise this sovereignty in the interests of national development and the well-being of
their peoples.
Subsequent declarations have been more radical, and the Resolutions adopted on 1 May
1974 by an extraordinary session of the UN General Assembly on raw materials introduced
the notion of permanent integral sovereignty under the New International Economic Order.
The principle was restated in the Charter of Economic Rights and Obligations of States,
adopted by the General Assembly in 1974: the declaration of permanent integral sovereignty
gives states the right to safeguard their mineral resources by exercising effective control over
them.
This principle was not to apply to mineral resources in the high seas. The United Nations
designated (Resolution 2749-XXV of 1970) these as a common patrimony of man under
the stewardship of sovereign states.
The State exercises sovereignty over its national territory, the continental shelf and the 200
mile exclusive economic zone in the case of coastal nations. The UN Convention on the Law
of the Sea (UNCLOS) of 1982, signed by 135 countries, sets forth the relevant principles in
this regard. The interpretation of these principles can sometimes pose severe difculties, as
in the case of the Caspian Sea, where the determination of sovereignty has been a matter of
dispute since the creation on its shores of new states formerly part of the Soviet Union.
C. Nationalisation
The right of states to nationalise companies or requisition them in the national interest is
acknowledged in UN resolutions as a corollary of their sovereignty over their natural resources.
Certain industrialised countries once resorted to this practice. But these resolutions also require
that a public interest is demonstrated and that fair and prior compensation is paid. Nationalisation without or with inadequate compensation discourages new petroleum exploration.
The basis on which compensation is determined remains a moot point. In equity it could
be argued that the compensation should be based on the market value of the company, i.e.
either the estimated or accounting value of the hydrocarbon resources and the installations
or the present value of future prots derived from producing the known reserves. Such a basis
is contested, however, because the reserves are the property of the State. The most common
criterion adopted is that of the accounting value of the installations, as determined by an
173
either into the States public domain (inalienable and imprescriptible) or its private domain.
Although there are issues of the common good involved, mines are not an asset held for the
benet of all citizens, but nor are mines subject to the rules of private property. Some
authors consider that mineral resources constitute a category sui generis of State assets,
referring to them as national property, intermediate between the two traditional forms of
State patrimony, or even, in the view of some South American jurists, as an eminent
domain or special domain of the State.
expert, with the possibility of resorting to international arbitration, although the latter is not
accepted by all countries.
It should be noted that problems of a similar order occur where the State, while stopping
short of full-blown nationalisation, takes a share, as a partner alongside the other investors,
in the lease or contract where this was not originally provided for, even though this is of
course more acceptable to the investors than nationalisation.
In contrast, the 1990s have seen a growing tendency in many countries towards the total
or partial privatisation of certain assets and certain activities of the State or State enterprises.
These transactions are usually effected by means of a call for tenders so that a purchaser can
be selected and a value can be put on the transaction.
Facing the new context of sustained high level of oil price since the early 2000s, some
countries have decided a partial re-nationalisation (Russia, Bolivia, Venezuela).
5.1.2
There are two options available to the owner of underground mineral resources: direct action
or indirect action.
5.1.3
Regulatory options
The foregoing shows that there are two opposite approaches to establishing a legal framework
for exploration and production activities, i.e. the legislative and the contractual approaches.
In the legislative approach, which is that adopted in Europe, the U.S., Canada, Australia
and Latin America, the legal framework is dened in detail and in a non-discriminatory
manner by legislation and regulations;
In the contractual approach the relations between the State and the companies are essentially dened contractually, and are often discretionary. This is the system applying in
many developing countries.
In practice there are variants which involve a combination of these two approaches,
particularly licence-based systems in which a detailed contract is made.
5.1.4
5.1.4.1 Purpose
The purpose of a law on petroleum exploration and production is mainly to dene:
The legal regime applying to exploration for, and the production and transport of
hydrocarbons (petroleum, natural gas and associated products), but excluding rening
and distribution, which are industrial activities of a different nature;
The objectives of petroleum policy;
The modalities of State intervention, the competent administrative authorities charged
with petroleum matters and, where applicable, the role of the national oil company;
The conditions under which petroleum contracts are approved and signed and licences
are granted;
The way in which activities are conducted and monitored;
The tax, customs and exchange regimes.
A petroleum law must be capable of continuing to apply for decades without major
amendment, although amendments may be needed in response to particular circumstances.
In a non-producing country, for example, the law needs to encourage exploration in the short
term and, in the medium term, protect the State if major discoveries are made. Modern legislation provides a exible framework, conning itself to laying down the principles, leaving
the details, modalities and economic parameters to be dealt with in implementing regulations
and contracts. The delicate balance which needs to be achieved is often the subject of major
discussions between the legislature and the executive.
175
of a discovery he has the exclusive right to develop and exploit the resources, and will receive
a remuneration equal to a proportion of the production (whence the name). The State receives
the remaining proportion of the production.
In either case, certain countries stipulate that, in addition, the State may participate
directly in the operations as a partner of the license holder or contractor, taking on the same
rights and obligations in proportion to its level of participation. Under such an arrangement,
the State is usually represented by the national oil company, and the arrangement can offer
the State a number of advantages. Until the late 1980s such arrangements were to be found
in many countries, the participation rate reaching 50% or more, but they are tending to be
reduced or even disappear completely. However since 2005, some producing countries have
re-introduced participation rates higher than 50% (Algeria, Venezuela).
However legislation can be more or less exible, depending on the constitution of the
country concerned, particularly in relation to taxes and to contracts. In some countries,
particularly developed countries such as the United Kingdom, Norway and France, tax is a
matter for the legislature, which means that taxes are set in the law without leaving any
margin for negotiation. Under this regime, petroleum taxes can be amended periodically by
nance acts, and apply equally to all operators.
Other countries adopt a more exible approach, and make use of contracts which leave
a considerable margin for negotiation.
specic regime for the taxation of the prots from petroleum exploration and production
activities.
The petroleum law only deals with certain tax matters (royalties, taxation of prots,
special petroleum tax), other taxes falling under general taxation law.
The petroleum sector is dealt with by a special chapter of the general tax law.
5.1.5
The main objectives of the State and of the oil companies can be summarised as follows:
The State
To promote petroleum-related activities at all levels:
to explore the countrys petroleum basins,
to develop and exploit the resources discovered,
to rehabilitate old elds or put into production discoveries as yet undeveloped for technical or economic reasons;
To maximise the revenues of the State while securing, if possible, returns to investors
to conditions as they evolve over the long term, thereby maintaining a satisfactory activity
level;
To supervise and monitor operations in consultation with the companies, while ensuring
Petroleum companies:
To obtain a return consistent with the companys objectives;
To recover the investment costs as rapidly as possible;
To gain access to oil and gas reserves;
To ensure that reserves are replaced;
To limit risk by diversifying their portfolio of exploration and production acreage.
The criteria adopted and the priorities set between these various objectives depend on
many factors, both for the State and for oil companies, and can also change over time in
response to circumstances, e.g. developments in international hydrocarbons markets, the
potential and position of the country (producer or not, exporter or not, etc.), the importance
of oil in the national economy and the companys own particular strategy.
177
trialised countries and older legislation inspired by the French model in Africa. An alternative
approach is to dene the broad principles, particularly in relation to taxation, by reference
to a model contract prepared by the competent authority. This is a more exible solution
which allows the regime to be established in the contract. This model contract, which does
not form part of the law, can be adapted to allow for the nature of the potential discoveries
of hydrocarbons and the petroleum context.
5.1.6
Clearly the objectives of the two parties are not always totally consistent. The legal, scal and
contractual framework should be designed to create a win-win situation for the two parties.
The core issue between States and oil companies is the way the economic rent is shared (this
notion has already been considered in Chapter 4). Depending on the parameters mentioned
above, this sharing may be more or less favourable for the State or for the companies,
depending on the parameters mentioned earlier. We shall consider below the mechanisms by
which this sharing is implemented and simple instruments by which it can be assessed.
5.1.7
Types of contract
It is important to be clear about the different types of contract used in the upstream oil
industry.
A contract for petroleum exploration or production deals with the relationship between
the State (or the national oil company representing the State) and the license holder or
contractor (which may comprise a consortium of companies formed exclusively for this
purpose). This is the type of contract considered further here.
When the license holder or contractor comprises a number of partners, the association
between these partners is formalised by means of a Joint Operating Agreement (JOA) which
spells out their relationship in regard to decisions and the conduct of operations, based on
their stake in the partnership, under the responsibility of an operator chosen from amongst
the partners.
5.1.8
Tables 5.1 and 5.2 show the incidence and breakdown of petroleum exploration and
production contracts according to:
The different countries;
Geographical region.
It should be noted that several regimes may coexist in the same country. An estimate
shows that most of the volume of hydrocarbon production is still governed by concession
regimes. This is due to the fact that this type of contract predated the production-sharing
arrangements introduced more recently, in the late 1960s.
A petroleum exploration and production contract (within the meaning dened in the previous
section, i.e. which confers exclusive rights on the beneciary) generally consists of a
document of, typically, about a hundred pages, with several sections: the preamble, the main
text, and appendices which form an integral part of the contract.
178
Type of contract
1. America
Concession
Exporting
countries
Producing
countries
Non-producing
countries
Colombia
Trinidad and Tobago
Production sharing
contract
Bolivia
Peru
Trinidad and Tobago
Argentina
Brazil
Barbados
Canada
US
Chile
Cuba
Guatemala
Surinam
Bahamas
Belize
Costa Rica
Paraguay
Antigua
Aruba
Dominican
Republic
Guyana
Haiti
179
Honduras
Jamaica
Panama
Puerto Rico
Salvador
Service
contract
Absolute
monopoly
Ecuador
Venezuela
Mexico
Table 5.1 Types of exploration and production contract and countries in which practised.
2. Western Europe
Concession regime in all countries (apart from production sharing contracts in Cyprus,
Greece, Malta).
Russia
Other CIS Republics:
Azerbaijan, Kazakhstan,
Uzbekistan,
Turkmenistan
Hungary
Poland
Slovakia
Czech Republic
Albania
Bulgaria
Croatia
Rumania
Exporting
countries
Producing
countries
Production
sharing contract
Service contract
or absolute monopoly
Most production is
presently carried out
by State enterprises
Non-producing
countries
4. Asia
Concession
Production
sharing contract
Bahrain
China
Indonesia
Iraq
Malaysia
Producing
countries
Australia
New Zealand
Pakistan
Thailand
Turkey
Bangladesh
Burma (Myanmar)
India
Philippines
Thailand
Non-producing
countries
Fiji
South Korea
Cambodia Nepal
Laos
Sri Lanka
Mongolia
Exporting
countries
180
Oman
Qatar
Syria
Yemen
Vietnam
Service
contract
Iran
Qatar
Absolute
(or partial)
monopoly
Saudi
Arabia
Iraq
Kuwait
Concession
Exporting
countries
Algeria
Angola
Cameroon
Chad
Congo
Gabon
Libya
Nigeria
Tunisia
Service
contract
Absolute
monopoly
Algeria
Angola
Egypt
Congo
Gabon
Equatorial Guinea
Libya
Mauritania
Nigeria
Sudan
Tunisia
Nigeria
Benin
Ivory Coast
Ghana
Democratic Republic
of Congo
Tanzania
Producing
countries
Non-producing
countries
Production
sharing contract
Burkina Faso
Niger
Central African
Republic
Guinea Bissau
Seychelles
Madagascar
Sierra Leone
Mali
Morocco
Somalia
Ethiopia
Guinea
Kenya
Liberia
Madagascar
Mozambique
Senegal
Togo
Zambia
The preamble enunciates a number of general statements (customarily beginning with the
word Whereas) whose purpose is to set the detailed provisions of the contract in their
broader context, both legal (for example references to existing legislation which provides for
the type of contract in question to be concluded) and political (for example references to the
role of the State, national policy on the development of natural resources).
The main text takes the form of a series of articles and subarticles numbered sequentially,
and often arranged in chapters. It states who the parties to the contract are, its purpose, term
of validity and the rights and obligations of the respective parties. Broadly speaking the
provisions fall into four categories:
Technical, operational and administrative provisions, which deal with practical aspects
related to the conduct of operations during the different phases;
181
5. Africa
Economic, taxation, nancial and commercial provisions, which deal with how the
prots will be split between the parties, how petroleum costs will be accounted for,
pricing and disposal of production;
Legal provisions, which deal with the application and modication of the contractual
relationships between the parties;
Miscellaneous provisions, which deal with any other matters.
Generally the appendices include:
a description of the contract zone in terms of its geographical coordinates including a
map, and its surface area;
the accounting procedure which provides for the methods and procedures to be used
for accounting for the petroleum operations covered by the contract;
the work commitments;
a guarantee by the parent company and/or a bank.
The following sections describe the main provisions to be found under each of the above
headings. Most of these are to be found in any petroleum contract, but some are specic to
certain types of contract only.
5.2.2
A. Term
In setting the term of the exploration phase should two conicting criteria need to be met:
It should be long enough give the contract holder the time he needs to conclude
successfully the activities needed to evaluate the petroleum or gas potential of the
exploration zone and to discover hydrocarbons;
It should be short enough discourage the contract holder from proceeding unduly
slowly, thereby occupying for too long a large area which might be of interest to other
companies.
In order to reconcile these two criteria, the normal practice is to provide for a relatively
long total exploration period (generally 510 years), but to subdivide this period up into a
number of subperiods. The contract holder therefore has an initial period, renewable for one
or two succeeding periods. At the end of each subperiod he may renew his entitlement for
a further subperiod provided he met his commitments for the period just ended.
At the end of the nal subperiod the contract expires for the entire area covered by the
contract except the zones containing commercial discoveries which will be developed.
However it is customary to provide for an optional extension (on average 36 months)
running from the expiry of the contract, to allow the contract holder to complete the exploration work still in progress.
Up until 1986 the general trend was for a reduction in the duration and the size of the
exploration area. Since then this trend has been reversed as a result of the changed petroleum
environment, particularly in deep offshore locations.
The initial exploration period begins when the contract takes effect. Because this is
generally the longest of the exploration sub-periods, and in order not to quarantine a large
area without any exploration taking place, it is normally stipulated that the contract holder
must begin work within a certain period (typically 36 months) from the effective date of
the contract.
B. Contract area and relinquishment
The initial area covered by the licence or the contract zone is specied by means of a map
showing the boundaries and indicating the coordinates of reference points. It is often dened
by the State before blocks are created, rather than by the applicant, particularly where there
is an international call for tenders. Sometimes the size of a licence or a zone available for
granting is limited by legislation. This area varies considerably depending on the particular
circumstances applying.
Although in some cases large areas are still granted to contract holders, authorities
generally tend to allocate zones of medium size (of the order of 1 000 to 5 000 km2). If the
area is too large there is a risk the holder will only explore a small part of it. The rest will
therefore be frozen, thereby excluding other companies which might want to invest in that
zone. It is important that the State adopts a policy which ensures the coherency of exploration programmes.
Usually the contract holder cannot hold on to the entire area indenitely. It is customary
for a minimum reduction to be made in the area of the contract zone when an application is
made to renew the exploration term. In most contracts which provide for an initial period
and two additional exploration periods, the rst and second renewals are accompanied by
183
the mandatory relinquishment of up to 2550% of the initial area, except where special
circumstances justify a smaller or no relinquishment.
The contract holder is usually free to choose the zones to be relinquished. To prevent him
from relinquishing a large number of fragmented pieces, constraints can be imposed on the
shape and the number of pieces relinquished.
C. Exploration work obligations or expenditure obligations
When the contract is signed, a minimum work programme is specied for each of the exploration sub-periods (initial period and additional periods) which the contract holder must carry
out if he wishes to renew his rights. This programme is normally subdivided by type of operation: geological studies, seismic surveys and exploratory drilling.
A minimum seismic programme is often only imposed for the initial period of exploration.
The programme is dened in terms of a minimum number of kilometres of 2D proles or
3D surfaces.
The minimum drilling programme is dened in terms of a minimum number of wells to
be drilled; this number will depend on the duration of the exploration period and on the area
covered by the contract. Minimum depths for the drilling (or specic objectives to be
attained) will also be specied. And nally the contract needs to state whether delineation
and appraisal wells will be considered as exploration wells for the purpose of this obligation.
The purpose of specifying minimum levels of activity is to satisfy the State that each
contract holder will undertake sufcient exploration work obligations to ensure that the
petroleum potential of the zones granted will be properly studied.
The contract usually provides that if during one of the exploration periods the contract
holder exceeds the specied minimum exploration work obligations for that period, the
additional work can be carried forward to the following period, thereby reducing the obligation in that period.
Sometimes the obligation imposed on the contract holder is dened in terms of the
minimum expenditure on exploration work, either as a total or broken down by the various
types of work.
The contract needs to specify whether the contract holder must comply with both work
and expenditure obligations or only one of these, and what the priority is. Usually work obligations take priority over expenditure obligations. In that case the only expenditure stipulated
in the contract relates to the penalties applying in the event of failure to complete the specied work.
In order to ensure that the contract holder can discharge his obligations to invest or carry
out exploration, the State can demand that the oil company provides nancial guarantees.
This guarantee can take the form of a bank guarantee or a performance bond of the company.
The contract holder may relinquish all or part of the area before the expiry of the exploration period. The contract provides that where there is a partial relinquishment of the area there
is no diminution of the obligations in the current period, and that of the area is totally relinquished, the contract holder will be subject to the same rules and penalties as described above.
D. Evaluation of a discovery
If the contract holder discovers hydrocarbons during his exploration activities, he is required
to notify the competent authority of this fact. If he considers that the discovery is worth an
184
appraisal, he must prepare an appraisal (or delineation) programme and a budget for the works.
Certain countries then create a specic appraisal zone so that the work can be carried out.
After this programme has been executed the contract holder informs the authorities of the
results obtained from the appraisal and his conclusions, and specically, whether he regards
the nd as commercial and whether he plans to develop it.
Where the contract holder concludes that the discovery is economically marginal or noncommercial, some contracts may provide that he can propose to the State modications to
some of the provisions of the contract so that the contract holder is able to exploit the
discovery. These proposals must be accompanied by economic studies performed by the
contract holder which demonstrate the effect of the proposed changes on the project
economics. The State is of course at liberty to accept or reject the modications proposed.
If it accepts them the contract holder is required to declare the discovery commercial and to
propose and implement a development programme.
Some contracts provide that if a discovery is considered non-commercial the contract
holder must hand the discovery over to the State if the authorities wish to exploit it before
the normal expiry of the contract. Special clauses may apply to gas discoveries (see
Section 5.2.5).
The grant of a production licence involves an obligation on the part of the contract holder
to develop the eld in question in accordance with the development plan. He is expected to
produce in accordance with best international practice, with optimal recovery of the reserves.
C. Area of production zones
When a contract holder declares that a discovery is commercial he is required to submit to
the authorities details of the precise conguration of the eld which emerges from the delineation. The production zone corresponds to the extent of the eld. Within a given exploration
zone there will be as many production zones as commercial discoveries.
The area of the production zone is determined at the time that the discovery is declared
commercial. It can occur that the improved knowledge gained after several years of
production means that the production zone needs to be enlarged.
To cater for this possibility, a provision can be included allowing the production zone to
be enlarged so that it corresponds with the new area of the zone which has now been found
to be exploitable, providing that the additional area lies within the area of the exploration
zone still held by the contract holder.
D. Unitisation
When an oileld is discovered which straddles several different exploration zones granted
to different contract holders, the contract needs to contain a clause which ensures that the
recoverable reserves are exploited in a coherent manner (for example by appointing a single
operator, adopting a joint development and production plan, etc.).
Such a clause, known as a unitisation clause, has to be common to all the agreements made
between the State and the contract holders, since in the event that such a clause has to be
invoked, the rules must be identical for all.
The special case of oil and gas elds which straddle national frontiers has to be dealt with
by means of international agreements, as in the North Sea between the British and Norwegian
sectors. When a dispute arises between several countries, this can be resolved by creating
joint development zones governed by ad hoc statutory and scal arrangements, as in the celebrated Neutral Zone between Saudi Arabia and Kuwait, the Timor Gap between Australia
and Indonesia, and the Joint Development Zone between Nigeria and Sao Tome and Principe.
E. Obligations when production is abandoned
When production from a eld is abandoned, the obligations of the operator need to be specied. These may involve transferring all installations to the State without charge or decommissioning the wells and the disposal of the installations at its own cost. Contracts
increasingly specify an abandonment plan, submitted to the authorities in advance, containing
special scal provisions if appropriate, and providing for cost allowances to be set aside in
advance to fund the abandonment costs. This may be a costly operation in offshore zones
subject to stringent regulations.
tives are also set, expressed as the percentage of the workforce at a given level of qualication which should be made up of local employees.
F. Priority for local products and services, and local development
As well as requirements regarding local employees, there will likewise be expectation that
local goods and services are used. Use is often made of international calls for tender in
awarding contracts, with local businesses being consulted.
Local development becomes a growing requirement in many producing countries. In
October 2009, Nigeria adopted the concept of Local Content Bill to develop the local
industry. Venezuela introduced the concept of Desarollo endogeno. In Canada, the oil
producing Provinces of Nova Scotia, Newfoundland and Labrador propose Benefit Plans
to measure employment and profits related to any oil producing project.
5.2.3
Depending on the detailed arrangements, the participation of the State can have a major
economic impact because the State does not share the initial exploration risk. And State
participation reduces the shares of the other investors in the production. The State share can
be 50% or even higher in some countries, but has generally declined considerably over the
1990s, in some cases to nil. As already mentioned, the opposite trend can be now observed
in some major producing countries (Algeria, Bolivia, Venezuela).
5.2.3.5 Marketing
The contract holder is responsible for the marketing of all the products extracted or of his
share of those products, depending on the type of contract applying, and is obliged to obtain
the best possible price. There is often a requirement that the domestic market should have
a rst call on national production. In this case the sale price is either the market price or a
reduced price, but the latter practice represents a hidden tax.
Some exporting countries have in the past obliged companies to reinvest part of the
prots in the country, in the petroleum or in other sectors. Very often the local tax legislation in a country which is already a hydrocarbon producer provides incentives for reinvesting, for example by making new exploration expenditure immediately tax deductible
through the consolidation of different activities or by allowing a depletion allowance.
5.2.4
Legal provisions
Sales revenues to be received directly in other countries free of any constraint (i.e.
without repatriation) except for that part necessary to cover the expenditure in the
country, i.e. the operating costs, taxes, etc.;
Foreign currencies to be converted and bought in the host country.
5.2.4.6 Responsibility
The contract holder is responsible, with or without limitation, for any damage (including
environmental damage) resulting from his petroleum operations, whether or not due to negligence or gross misconduct. The government and third parties have to be compensated for
such damage. Where a consortium of companies is involved, these companies bear joint and
several, rather than individual, liability. The contract holder is obliged to effect insurance.
5.2.5
Gas clause
Natural gas can be produced either in association with crude oil (associated gas) or in its own
right as dry or wet gas (non-associated gas).
The production of natural gas has a number of specic characteristics: considerable and
therefore costly infrastructure needed, the fact that it cannot be stored, special transport and
distribution requirements, the need for a long-term and stable market. Special provisions are
therefore included in contracts designed to facilitate gaseld development and production.
As far as associated gas from a commercial oileld is concerned, the usual procedure is
as follows:
The natural gas is rst used by the production facility for its own internal needs (as energy
authorities have been informed and, if necessary, have approved it. But aring is more
and more regulated to reduce the emission of greenhouse gases (GHG).
The State is entitled to use any natural gas destined for aring for its own purposes,
without payment.
Where a discovery of (non-associated) gas is made the following measures are usually
taken to develop and exploit the discovery:
The deadline for declaring a commercial discovery can be extended, provided that an engi-
neering study and a preliminary feasibility study on the development of the discovery and
the marketing of the production must be submitted to the authorities. These should demonstrate the commercial potential of the discovery. The deadline can often be extended by
3 to 5 years.
Either the authorities or the contract holder can decide at any time during this additional
period to develop the gaseld, the other party being free to participate in this development
if it so wishes.
Economic and scal incentives may also be put in place in order to lower the commercial
threshold. Such measures have allowed small projects for supplying gas to local power
stations to get off the ground in developing countries.
In the case of associated gas, the purpose of such measures is ensure that the gas is only
ared in certain conditions dened clearly in the agreement, and where there is no prospect
of selling the gas.
In the case of non-associated gas, these measures seek to prolong the exploration period,
thus giving the contract holder more time to evaluate the commercial potential of the
discovery and identify potential markets.
General framework
Under a concession arrangement the State grants the contract holder exclusive exploration
rights (exploration licence), as well as an exclusive development and production right (lease
or concession) for each commercial discovery.
A contract established under a concession regime will contain the provisions described
above. This may involve an actual petroleum agreement or simply the application of general
and special conditions associated with the grant of an exploration licence or a lease within
the framework of current petroleum legislation and accompanied by a schedule of conditions
specic to the licence.
The features which distinguish a concession agreement are the ownership of the hydrocarbons produced, the ownership of the production installations and the items of revenue to
the State, and these three aspects are dealt with below.
It should also be borne in mind that even where a legislative approach as referred to in
Section 5.1.3 is taken, a concession comprises a contract in law, and this offers some
protection to the holder in the event of subsequent changes in the petroleum law.
193
If the gas cannot be used by the production facility or marketed it can be ared once the
5.3.2
following this procedure is analogous to a signature bonus, however. This procedure has been
adopted when licences were granted in Federal zones in the U.S.
Between 1986 and the end of the 90s, the practice of paying a signature bonus has been
declining, indeed has largely disappeared except in countries formerly closed to the direct
involvement of the international oil companies, but which are now opening their borders.
Representative examples are Venezuela, where very high bonuses were achieved in the rst
round of bidding for exploration blocks, organised in 1998, Brazil in 1999-2000, the JDZ
between Nigeria and Sao Tome and Principe in 2004, Libya after 2000.
B. Royalty rate
The royalty rate is usually different for crude than for natural gas, the latter being lower.
In order to ensure that the royalty is adapted to the characteristics of the eld, a sliding
scale is sometimes specied in the contract, depending on the production level. There are
various options, including:
A variable percentage which depends on the daily or annual production (per well, per
reservoir, per concession, etc.). In order to prevent abrupt changes in the calculated
amount for small changes in production, the percentages apply to incremental
production rather than the whole amount;
A variable percentage which depends on cumulative production since production
began;
A variable percentage which depends on economic criteria such as the R-ratio between
cumulative cash ow and cumulative investment.
C. Ring-fencing or consolidation
In cases where the holder produces from several concessions both resulting from the same
exploration licence, there are two ways in which production can be calculated:
For each concession separately: the holder pays a separate royalty for each concession,
and these are calculated separately;
For all the concessions together: the holder pays just one royalty, based on the total
production from all the concessions.
Where the percentage used to calculate royalties increases with increasing production it
is obviously more attractive for the State to aggregate the concessions for the purpose of the
royalty calculation, but the impact on the holder will be greater.
D. Payment procedure and frequency
The royalty can be paid in cash or in kind, as the State chooses. Payments are made quarterly or monthly. Where payment is made in cash, the calculated amount of the royalty will
depend on the value placed on production, on the point at which the royalty is calculated
and on the frequency of payment.
E. Point of calculation
Three points are possible: at the wellhead, at the point of departure from the eld, or at the
point of export or the point where it is made available for consumption in the host country.
F. Value of production
Production can be valued on the basis of:
The posted price or the price xed ofcially by the State, practised historically but now
rare;
The actual market price.
G. Tax treatment
The impact of the royalty for the holder will depend on the way it is treated for the purpose
of prot tax, i.e. whether as a tax credit (practised historically, but now rare), or as a charge
deductible from the holders taxable prot.
196
The royalty is independent of prot, and becomes increasingly onerous for the investor as
the technical costs rise or the oil price falls. The 1990s have seen a tendency for royalties
to be reduced or even dispensed with entirely in order to encourage new investment. The
percentage which was once typically 20% is nowadays more likely to be in the range 0 to
12%.
H. Recent trend
D. Tax rate
The tax rate may be that set by general tax law or a specic rate may apply for petroleum
activities. Historically, the rate was typically at least 50%, and could reach up to 85%. Over
the 1990s there has been a trend for the rate to fall to a gure of about 3040%. As already
mentioned this trend has been reverted in some countries, tipically the UK with a gure of
50%. Some countries have introduced in the past, and still retain, a special additional tax
which is levied over and above the normal tax.
Years
Royalty
Profit tax
Net profit to company
Depreciation
Operating costs
Development costs
Exploration costs
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5.4.1
General framework
The legal framework for the production sharing contract was devised by Indonesia in 1966,
in a contract made between the national oil company Pertamina and an American independent, and a similar contract was developed in Peru in 1971.
Since then very many countries have adopted this basis. Some are oil exporters: Indonesia
and Egypt, where more than 100 contracts of this kind have been signed, but also Malaysia,
Syria, Oman, Angola, Gabon, Libya, Qatar, China, Algeria and Tunisia. But the approach
has also been adopted in countries which export little or no oil, such as Tanzania, the Ivory
Cost, Mauritania, Kenya, Ethiopia and Jamaica. Several countries in Eastern Europe and the
CIS countries have also adopted this system (see Section 5.1.8).
The success of this formula in developing countries and the transition economies is due
to several original features. Of interest, for example, are the nature of the contractual relationship (the oil company is not a direct holder of mining titles) and the concept of the
sharing of production. Also noteworthy are the greater control that the State can in theory
exercise over the activities of the oil company, which acts merely as a service-provider or
contractor to the State.
We shall see, however, that in practice the State can exercise as much control through a
modern concession arrangement as in a production sharing contract. In both regimes the oil
company bears the nancial risk, and is generally responsible for running and performing
operations under the supervision of the State. Some concessions may even be considered
more restrictive than production sharing contracts, in terms both of operating the facility and
the economics.
5.4.2
5.4.2.1 Principles
In legal terms the role of the State in a production sharing contract is reinforced by the
following two principles:
The State retains all the mineral rights and title, and therefore also owns the production.
resources of the oil company (which lends or prenances the necessary capital), it retains
ownership of a large proportion of the production. The contractor may only receive the
lesser share of production to meet his costs and remunerate him for his services. It should
be noted that it is this share of the production which appears in the annual company reports
and not the total reserves.
This system is therefore based on the principle of production being shared between the
State or national oil company, which owns the mining title, and the oil company (or
consortium). The latter is the operator, responsible for funding and running operations, and
it is remunerated, in kind, only where a commercial discovery is developed.
199
case, for example, the contractor can recover 117% (rather than 100%) of his capital costs;
this is designed to compensate him for the effect of ination (recovery is in practice based
on nominal value, without indexation).
Spreading the recovery of development costs over time: equivalent to a system of straight
Whether or not bonuses and interest and nancial charges are excluded;
Priorities for recovery of different cost categories (exploration, development,
production, other);
Recovery of joint costs shared between the members of a consortium and the costs
incurred individually for each of these members;
Methods by which costs are split between development zones if successive discoveries
are developed.
Production sharing contracts do not generally provide for the payment of a royalty on
production, but where a royalty is paid, the cost oil is calculated on the production remaining
after the royalty.
Years
201
Later, progressive sliding scales were introduced which depended on the daily production
rate, for example progressive sharing rates increasing from 5050% for low production
rates to 8515% for the top tier of production. In 1979 Angola introduced a progressive scale
based on the accumulated production from an oileld. These scales depend on the characteristics of the discovery and in particular, the environment (onshore, shallow or deep
offshore).
Some countries have adopted adjustment mechanisms which allow for changes in the price
of crude (price capping). The government share for that part of the price which exceeds the
price cap, which is indexed, may be as high as 100% (for example Angola, Malaysia, Peru
and Indonesia before 1978).
In 1983 a number of countries introduced new production sharing mechanisms, based not
on the daily or accumulated production but on the rate of return (or some other measure of
protability) to the contractor on a given date. The countries involved were: Equatorial
Guinea, Liberia (sharing according to the rate of return), India, Libya, Tunisia, the Ivory
Coast and Azerbaijan (sharing according to the R-ratio, which seems to be a more acceptable
basis, see denition in Section 5.6).
There are quite large variations in the prot oil split between different countries and
contracts. These reect differences in the perceived petroleum potential and costs, the latter
being directly linked to the characteristics and the location of the discoveries.
The possibility of adapting the terms of a production sharing contract to the potential
exhibited by a discovery is one of the advantages, and therefore explains the success, of
production sharing contracts compared with concession, where there is less exibility during
negotiations.
Service contracts
These are contracts made by the national oil company in producing countries which allow oil
companies to carry out petroleum exploration, development and/or production on their behalf.
Service contracts are used mainly in the Middle East and Latin America, but their use is
not widespread. Two categories of service contract exist, depending on the degree of risk
borne by the oil company:
202
The terms and conditions of service contracts are very variable. The main provisions are
summarised below.
Risk service contracts (or agency contracts) in which the contractor only recovers his
investment costs where a project proceeds to production;
Technical assistance or cooperation contracts, which are non-risk-bearing, carrying out
works on the basis of an agreed remuneration.
comprising three representatives of each party, the National Iranian Oil Company (NIOC)
becoming the operator when operations start. A proportion of the expenditure must be allocated to local sub-contractors.
These contracts present investors with a number of specic constraints: they are short-term
contracts, fairly inexible during the development phase, in which the plan must be followed
very closely. The share devolving to the contractor is relatively small, and they do little to
bolster his reserves. In addition the fact that the remuneration and the cost of the investment
are xed at the moment the contract is signed introduces an element of risk which has to be
managed. It is why some investors have decided to refuse any new buyback contract.
Given that, modications may be made in the future by the governments.
These issues will be the main focus of attention in the negotiations and the decisions taken
by oil companies when entering into a contract or licensing arrangement.
Fiscal and contractual provisions designed for a particular zone or in particular market
conditions cannot simply be transplanted without modication to other zones. A contract,
and more generally a rent-sharing arrangement, must be suited to the context, and be sufciently exible to accommodate expected and unexpected changes.
Incentives can also be introduced to foster investment in special zones such as unexplored
basins, deep offshore, remote onshore locations, the Arctic, rain forest or the desert. Incentives may also facilitate the development and exploitation of natural gas elds.
existing infrastructure, level of costs, etc. These clauses will also have regard to the international oil market, both at the date of signature of the contract and in terms of anticipated
developments during future production. They relate to the following aspects:
The duration of the exploration programme, the area to which the licence applies and
the relinquishment terms;
Minimum exploration work or expenditure obligations;
The basis for sharing the economic rent between the State and the contract holder;
The conditions for the disposal of the production.
These can take the form of investment credits, depreciation uplifts or a variety of other
devices which reduce the tax burden falling on the companies. This category includes the
consolidation for tax purposes of all the exploration and production activities in a particular
country rather than ring fencing each concession. This allows the holder to offset his exploration costs at one location against his revenues arising from production at another. This
amounts to an indirect subsidy by the State, and the higher the tax rate the greater the value
of this tax relaxation.
C. Progressive prots tax rate
This mechanism is fairly rare. It was introduced in Tunisia in 1985, for example, where a
progressive tax rate applies depending on a protability ratio recalculated each year, like the
royalty. The complication lies in the fact that the scale is not the same as that established
for the royalty and, what is more, is different for oil and gas.
Another possible incentive is to allow a temporary exemption from prot tax during the
rst years of production.
D. Progressive rates of participation by the State
The rate of participation by the State can also be made progressive, depending on the same
types of parameter as those mentioned for royalties.
E. Excess prot tax
As already mentioned in Section 5.3.2.10, many countries introduced this tax in various
guises in the 1980s: the Special Tax in Norway, the Petroleum Revenue Tax in the
United Kingdom, the Windfall Prot Tax in the U.S. and the Exceptional Levy in
France. The adoption by OPEC countries of higher rates of taxes on prots up to 85% in
some countries can also be regarded as an excess prot tax.
These instruments have an impact on the protability of the holder, but experience shows
that they are not sufciently selective in achieving the necessary objectives. They are in fact
based either on the excess of the oil price over an indexed base price (in the case of the
windfall prot tax) or on a pseudo-protability criterion calculated on a purely accounting
approach (the petroleum revenue tax) rather than being based on the true economic profitability of the operations in question.
Because of these considerations, some countries Papua New Guinea (1976), Madagascar (1981), Somalia (1984), Guinea-Bissau (1984), Senegal (1986), Australia (1988) and
Namibia (1991) have introduced a resource rent tax, calculated directly from the
effective protability of an exploration and production project.
Most of these instruments ceased to operate after prices fell to levels well below those
applying in the 1980s. However with the increase in oil price, they may be automatically
reactivated.
As already mentioned, some countries have re-introduced this kind of excess prot tax
(UK, Alaska, Ecuador, Algeria).
B. Investment incentives
recovery mechanisms and dening a sliding scale for the prot oil split, because the parameters concerned are the result of a negotiation process rather than being enshrined in the law.
A. Modications in cost recovery mechanism
This can involve:
Adopting a variable cost stop;
Modifying the period over which investments are recovered;
Introducing an investment credit or uplift similar to that described in relation to the
concession system.
B. Modications in the prot oil split
A xed prot oil split is an overly rigid instrument which is only appropriate in zones where
operating costs remain practically constant. Using the same concept as mentioned earlier, this
parameter could be based on a sliding scale which increases with the annual production or
the cumulative production from an oileld. This mechanism would represent a worthwhile
improvement, provided a signicant relationship can be established between the production
level and the potential return to the contractor, which is not always possible. This system
does not allow changes in the price of oil to be taken into account directly.
The introduction of a price cap increases the share accruing to the State when the price
of oil rises beyond a certain threshold, indexed to allow for ination: this device is found in
certain contracts in Angola and Malaysia.
There are various types of mechanism which allow a linkage to be established between the
share accruing to the contractor and the effective protability of his operations, as follows:
The introduction of an excess prot tax (as described for concession) which the contractor
pays in cash on his share of the prot oil, the latter being determined using the same rules
as for a conventional shared production contract (Tanzania, Trinidad).
The prot oil split can be made a function of the effective rate of return. In the early years
all production with the exception of a small deduction for the State can go the contractor.
The State share then increases progressively in a manner similar to that described for
concession. This device has been adopted by two countries, i.e. Liberia and Equatorial
Guinea, but did not achieve the success hoped for because of difculties in putting into
effect the necessary calculations.
The prot oil split can be made a function of a protability ratio, or R-factor, calculated
each year as the ratio of the contractors cumulative net revenue to his cumulative investments. The amounts are calculated each year, and accumulated from the rst year of the
contract. The contractors share of the prot oil reduces as the R-factor increases according
to a scale set forth in the contract. Unlike the device described previously, and even if the
calculation and auditing procedures need to be dened precisely, the latter is far less difcult
to implement. This instrument has therefore enjoyed increasing success and has been
adopted, for example, in the following countries: India (1986), Egypt (1987), Ivory Coast
(1990), Algeria (1991), Libya (1991), Nicaragua (1998), Peru (1998) and Cameroon (2000).
5.6.2
Comparing different systems of sharing the economic rent is a delicate business, involving
several difculties. In particular, the economic calculations which underpin them are often
208
Between 30 and 50%: Argentina, Colombia, US (Gulf of Mexico), Ireland, Morocco, New
Yemen, Trinidad & Tobago, Venezuela. In this category, Iran (buyback contract), Libya
and Venezuela are around 90%.
Some countries appear in different categories because they offer different terms for
different zones. The countries in the rst category are largely industrialised countries which
are producers and consumers, and whose economies are not greatly dependent on their
upstream oil activities. The second category is the most numerous, and comprises a heterogeneous group of countries with modest or moderate production, with petroleum policies
which depend on their level of development. The countries in the third category are
producing, and in many cases exporting, countries whose economies are highly dependent
on these activities.
There is increasing competition between countries to attract investors and to offer
attractive conditions. A token of this is the periodic revisions which countries make in their
legislation, tax regimes and contractual arrangements. This was exemplied by Cameroon
and Morocco, which made major changes in their systems in 2000. Morocco introduced tax
incentives, and is hoping to be able to attract deep offshore activity to its shores. Cameroon
made sweeping changes to its systems, and also provided incentives to attract renewed
exploration so as to reverse the downward trend in its production.
209
made on a stand-alone basis, with no allowance for the possibility of consolidation with other
activities in the country or region. Furthermore the technical conditions prevailing in one
country may not be reproduced in another. And nally, the fact that the contracts tend to be
strictly condential does not make it any easier to get data; those obtained from indirect
sources may not be reliable.
While bearing in mind the reservations described in the foregoing, it is possible to rank
the relative severity (from the investors point-of-view) of the economic rent sharing systems
throughout the world by reference to the simple criteria of the total Government take. This
parameter is expressed as a percentage. The word Government is taken in its widest sense,
including any national petroleum companies with a participation in the petroleum operations.
The calculation is performed for the simulated total duration of exploration and production.
It should not be confused with the marginal Government take, calculated after all investment
costs have been written off or recovered, and which is higher.
A high value for this percentage corresponds to a basis which is favourable to the State
and harsh for the investors. Obviously whether or not a system is harsh depends on the
petroleum potential of the country. However activity levels are not necessarily inhibited by
a severe system as long as the country in question has a well demonstrated potential or is
very prospective. On the other hand countries with little or no production, or where
production is declining and which are not able to renew their reserves, have no choice in
the current very competitive environment but to try to entice inward investment into the
country by offering an attractive package.
To illustrate this, a number of countries with diverse backgrounds are classied below
according to the State take. The classication is approximate, and more careful analysis might
lead to some changes.
Conservely, producing countries with expected additional upsides, have recently introduced revisions aiming at increasing the State take.
5.6.3
Perspectives
In order to assess fully the upstream petroleum activities, it is vital to have knowledge of
the legislative, scal and contractual framework alongside the technical side and results of
appraisal of the petroleum potential. These aspects lie at the heart of the relationship between
petroleum-producing countries and investors, and play a crucial part in determining how the
economic rent is shared. The objective is to try to optimise the benets for both parties.
On the basis of a number of relatively simple principles, universally accepted by the international community and of a number of systems usually adopted by countries, this chapter
has outlined the huge diversity of instruments possible, both regulatory and economic.
The terms offered by countries have evolved in response to a whole range of technical,
economic and political parameters. Over the last twenty-ve years international exploration
and production have become quite competitive. New regions once closed to international
investors or inaccessible within the technological constraints then applying have been opened
up, thereby considerably increasing the choice of countries for possible investment. The oil
companies have then become more selective because of budgetary constraints when prices
are low, and there has at the same time been a reduction in the number of oil industry participants as a result of mergers and acquisitions. These large corporations apply different
criteria with regard to the required return on investment from those used by the smaller independent companies. One consequence of the increase of the prices is a trend followed by
the independent companies to invest in risky new areas when they made signicant discoveries like Tullow in Uganda, Kosmos Energy in Ghana and Noble Energy in Israel.
It seems likely that the trend towards increased competition between actual and potential
hydrocarbon-producing countries will continue, resulting in still more exible tax regimes
and contracts. This tendency is particularly discernible in regard to exploration and
production in more challenging environments. However competition also exists between oil
companies which need to secure and renew their reserves. In parallel, established producing
countries wish to benet from the sustained increase in oil price, so that they have introduced
new contractual and scal provisions to increase the global State take. Not all countries are
in the same boat, however, or carry the same weight on the international scene. It is to be
expected that a number of countries which still have enormous potential Saudi Arabia,
Iran, Iraq, Kuwait and Mexico will open up to the international industry.
210
Decision-making on
exploration and production
The petroleum sector is a capitalistic industry par excellence, and investment decisions in
the industry are absolutely crucial. This chapter therefore deals with the evaluation of capital
projects. Our object is not to provide the reader with a potted manual on project evaluation,
but rather to address a number of topics specic to the upstream petroleum industry, while
recalling a number of more general principles.
We shall begin by introducing the concept of strategic analysis which will help to establish
the main constraints within which the project evaluation will be performed. We shall then
touch briey on questions which arise in connection with short-term decision-making, before
turning to the techniques for estimating the return on capital. In this connection we shall rst
discuss deterministic methods before addressing, in the last section, the topic of risk analysis
and decision-making under conditions of uncertainty.
6.1.1
In order to dene the strategic options it is obviously necessary to have a good understanding
of the environment in which the company is operating. One of the missions of the department
211
in charge of strategy is therefore to monitor constantly and analyse the markets for crude
price behaviour, the relationships between the participants, the political risks, etc. These
elements were touched on in Chapter 1, and we will not dwell on them further here. Visions
of the medium and long-term future are often expressed in the form of scenarios. Shell has
established a reputation in this area which goes back many years. Where a comprehensive
scenario is not available, it is necessary to specify a number of reference hypotheses so as
to ensure the consistency of the analyses carried out by the different sectors of the company.
Particularly important amongst these assumptions are those relating to technological
development. While forecasts are difcult in this area, they have a major impact on a certain
number of options. A decision to develop interests in natural gas inevitably involves making
forecasts of future demand and the way the market will evolve. But it will also depend on
the anticipated reduction in the costs of liquefaction and transport. Similarly, companies
involved in producing extra-heavy oil in the Orinoco Belt were not simply betting on the
eventual scarcity of conventional oil. They were undoubtedly also banking on future
processing improvements, and therefore on better recovery rates and reduced production costs
for resources of this kind in the future.
6.1.2
Opportunities are usually identied by comparing the proposals of the operating companies
in the group with analyses of the external environment. A strengths and weakness analysis
is then carried out, both for the competitors and for the company itself. It is usually carried
out for each separate business, and relates to all the factors which affect competitiveness:
technology, nance, human resources, organizational aspects and political factors. In looking
at competitors, their intentions also have to be analyzed. While some are very clear to see,
others are only revealed by a closer scrutiny of their activities. The numbers of patents
applied for may be an indication of technological preoccupations, while acquisitions, divestments and changes in shareholdings may provide indications of orientations, a refocusing
on core activities or geographical diversication. Presentations made at road shows may also
be a source of information.
Know thyself enjoined Socrates. It is difcult to be objective about ones own strong
and weak points. A team which has proven its worth in one country may not necessarily be
the most effective in another country or environment. This notwithstanding, it is obviously
of crucial importance to assess critically ones own company.
6.1.3
The desire for a balanced portfolio is also based on considerations of risk, one of the
objectives being to reduce the overall risk associated with the portfolio through diversication. This is one of the reasons why oil companies have long collaborated with one another
on projects. Generally speaking it can be assumed that there is no correlation between the
technical/geological risks, or more generally the risks related to the size of the reserves, for
different projects. By increasing the number of projects we therefore reduce the risks for the
portfolio as a whole.
It should be noted, however, that increasing the number of projects does not entirely
reduce the risks associated with variations in the price of oil because nearly all oil projects
(that is, with the exception of projects governed by service contracts) are sensitive to price
uctuations. But this sensitivity can vary signicantly between zones, depending on the cushioning effect of the tax regimes in place.
The practice of sharing capital costs between competitors is characteristic of the upstream
oil industry, and is not common in other industries.
6.1.4
Alliances
Although risk reduction is the most common reason for the associations observed in most
large projects, political motivations should also be mentioned. The inclusion of certain
partners can sometimes provide an insurance policy, contributing decisively to the
successful realisation of the project. Totals choice of partners in Iran was probably not based
purely on economic considerations, but also on a desire to reduce the political risk. In
general terms, and quite apart from mergers and acquisitions, strategic alliances provide a
way of acquiring new skills and can provide an entry ticket into new activity sectors or countries. A particular focus in recent years has been the alliances between international corporations and national companies in producing countries.
6.1.5
The organisation of this department can vary greatly between one group and another, and
we conne ourselves to a number of observations.
Responsiveness is a very important attribute for success. A signicant proportion of the
opportunities in the upstream oil sector need to be grasped fairly quickly, either for political
or economic reasons. The organisation should therefore be geared up to take rapid decisions,
whether mainly at operating company or at group level. Most strategic projects are in new
zones or activity sectors. The latter are analyzed by a central group (which may, as in the
case of BP, be non-hierarchical), whose role is more than merely to coordinate.
A medium-term plan is usually constructed, bearing in mind that planning should not be
regarded as inconsistent with exibility. The plan for the group is obtained by aggregating
together and synthesizing the plans prepared by the different subsidiaries or operating units.
213
In this connection, the fact (actually self-evident) is that that it may be necessary to
venture beyond the connes of exploration and production activities to take full advantage
of foreseeable developments. The acquisition of rening and even distribution interests may
make it possible to gain a foothold in a producing country about to open up its upstream
activities to international companies. It was undoubtedly this desire ultimately to gain access
to the upstream oil industry that explained why so many companies expressed interest in the
gas projects announced by Mexico and Saudi Arabia in 2000 and 2001.
The preparation of these plans creates a channel of communication between head ofce and
the other companies in the group. The latter enter into commitments in some areas and, in
other areas, propose options for possible changes.
The selection criteria and project analysis tools are determined by the Strategy Department
in consultation with the Finance department: discount rate, techniques for analyzing risk,
project briefs, resource allocation when capital is rationed. There will be one or more sets
of macroeconomic hypotheses associated with these criteria and the way they are applied,
in order to ensure overall consistency.
A crucial tool in the evaluation of projects is the discount rate or rates, and determining
this rate for the company is therefore of particular importance. Its value cannot be derived
by mechanically calculating the cost of capital, which is in fact never dened very precisely.
The use of a relatively high discount rate tends to result in a creaming of projects. It
reduces the likelihood that projects will turn out post hoc to be unprotable, but leads to
opportunities being rejected which may be grasped by the competition. On the other hand
setting the discount rate to the lowest possible value consistent with the data on the cost of
capital will tend to foster development and increase market share. This can be compared with
the strategy adopted by Shell, which has grown more rapidly than Exxon in recent years.
The latter, on the other hand, has obtained a better return on its capital, preferring to buy
back its own shares rather than invest in projects not offering the desired return.
In setting its discount rate a company is therefore also expressing its own strategic orientations. This is true at the level of a single company, but also for each sector of activities
within a group. The petroleum sector therefore often uses different discount rates for different
categories of activity, even within the exploration/production sector. These discrepancies may
be due to differences in the nancial methods applying, to differences in the risk prole, but
may also be an expression of strategic decisions: setting a high discount rate acts to limit
investment budgets. On the other hand, setting a relatively low discount rate can be a way
of factoring other indirect benets into the equation. When oil companies were integrated,
for example, some companies used to use low discount rates for downstream projects in order
to promote the development of the rening sector and distribution networks. This was
justied not in terms of the protability of these activities but in terms of the access it gave
to outlets for crude production. More generally, adjustments in the discount rate can be used
as a means of balancing an oil companies portfolio of activities.
25
32
40
49
60
70
73
27.7
33.8
40.0
47.5
55.7
61.0
62.0
Cost ($ 000s/year)
383
500
585
660
745
840
880
CM ($/bbl)
13.8
14.8
14.6
13.9
12.9
13.8
14.2
Cm ($/bbl)
19.2
13.7
10
10.4
17.9
40
These data can be used to construct the graphs in Figure 6.1 which show how the total
cost, average cost and marginal cost of the crude produced by secondary recovery vary as
a function of the additional quantities recovered.
Marginal cost
Cm =
dC
dQ
Average cost
CM =
C
Q
215
many of the decisions which need to be taken correspond to modications which may be
made at the margin of a production programme. These decisions can be usefully analyzed
by a marginal analysis, a practice we all use, whether or not we realize it! This can be
exemplied by considering a problem of secondary recovery by polymer injection during the
last year or years of production of a reservoir. The problem is to decide on the quantity of
uid to be injected. Table 6.1 shows the quantity Q of crude oil which can be recovered as
a function of the quantity of uid injected, and therefore of the corresponding cost C during
the year studied. The operation involves a declining marginal yield and increasing marginal
costs.
There is no further increase in the production of crude once the quantity injected reaches
73 000 m3.
the sale price, so that injection is worthwhile. It should be noted, however, that this cost is
close to the sale price. It may be, therefore, that the decision will be taken on the basis of
other considerations and criteria: uncertainty as to the behaviour of the reservoir, a desire to
gain experience with injection, etc.
Box 6.1 Marginal analysis.
For a production facility which manufactures a single product, the optimum production
level is generally not that which minimises average costs.
Over a short period, and for a given set of equipment, the level which maximises prots
is that for which the marginal cost (cost of the last unit of production) is equal to the
marginal receipts (receipts procured for the last unit of production) (subject to appropriate assumptions regarding continuity, differentiability, increasing marginal cost being
satised).
If the sale price is independent of the level of production, production is optimised when
the marginal cost is equal to the sale price. This can readily be proved mathematically
by setting the derivative of the prot function Pr = PQ C equal to zero.
It can be seen that the curves in Fig. 6.1 have a U-form similar to that traditionally shown
in microeconomics textbooks. This is rarely the case in the rening and petrochemical
sectors, where the cost function is often best represented by considering the cost C as the
sum of a xed term and a term proportional to the volume processed, at least as long as the
capacity of the plant is not exceeded.
Annual cost
900
30
800
25
Cm
700
20
600
15
500
CM
10
400
300
20
Additional production
30
40
50
60
5
20
70
Additional production
30
40
50
60
70
Figure 6.1
6.3.1
217
probabilistic calculations and on risk analysis techniques, which cannot be carried out until
we have quantied the value created (or destroyed) for the various outcomes of the decision
being studied. It is this quantication, based on deterministic calculations specic to a
particular assumption, which is the subject of the present section. In Section 6.4 we shall
look at the effect of taking account of uncertainty and applying probabilistic methods.
After making a few observations regarding the discount rate we shall present methods for
evaluating investment projects. The basic principles will be reviewed in boxes incorporated
into the text.
In costing equity capital, the most commonly used approach is the Capital Asset Pricing
Model (CAPM), based on nancial theory (see Box 6.3). This was the method adopted by
Elf Aquitaine in 1998 when it revised its discount rate. The parameter is obtained by econometric methods. Various studies have obtained values of less than 1 for the oil industry: of
the order of 0.9. Where an oil company is active in a number of different sectors, the coefcient can vary signicantly between sectors. Moving downstream from traditional
petroleum activities, values for of between 0.4 and 0,5 are observed in the pharmaceuticals
and cosmetics industries.
Box 6.3 The Capital Assets Pricing Model (CAPM).
This model gives a method of quantifying the cost of equity capital as the return
expected by the shareholders, which can be considered to be equal to the return on riskfree investments, increased by a risk premium. This risk premium relates only to
systematic risks affecting the share market as a whole. In practice, non-systematic or
specic risk, that is risks related to individual companies, can be reduced (vanishingly)
by portfolio diversication.
Based on the model, the risk premium can be expressed in the form:
(rM ro)
where:
rM is the average return offered by all shares (market return),
ro is the return on risk-free investments,
is a parameter representing the ratio of the covariance between the companys
return on capital and the average return for the market as a whole to the variance of the
latter. It can be calculated from stock market statistics.
6.3.2
Economic evaluations involve determining the net cash ow in future years, i.e. cash inows
minus cash outows.
218
Fk
Fk =
(1+ d )
Although in practice calculations may be carried out either in real or nominal terms,
American companies generally advocate that calculations are made in nominal dollars, thus
ensuring that the monetary units used in economic evaluations and accounting and tax documents are the same.
In the rst place we shall conne ourselves to looking at operating cash ows; these
do not bring into the calculations any debt-related ows, corresponding to calculations of
the overall return on capital.
6.3.3
NPV =
1+ i
k =0
Fk
( )
where:
Fk : cash ows in nominal terms,
where 1 + i = (1 + i ) (1 + d ).
219
k =0
Fk
(1 + i)
The cash ows are dened relative to the situation in which the project is not implemented: only those future ows related to the decision being evaluated should be brought
into the calculation. A cash ow usually involves (with a few exceptions, such as the residual
value of an item of equipment remaining at the end of the period studied) a real movement
of funds, and not a mere accounting concept. An important difference between cash ows
and prot and loss accounting relates to the treatment of depreciation. Depreciation does not
involve the physical movement of funds in or out. Depreciation only has an indirect impact
on cash ow insofar as it affects tax payments: depreciation can be a deductible expense in
calculating taxable prot.
Forecast cash ows can be expressed either in nominal (current) or in real (constant)
terms. In nominal terms (current money), the receipts and expenditures in year n are entered
in terms of the money of the day. Real terms (constant money) are notional monetary units
in which the purchasing power remains constant and equal to that in a reference year. If year
0 is the reference year and we assume a constant annual rate of ination of d, the value Fk
in real terms for year 0 of a ow Fk in year k dened in nominal terms, is given by:
Present value
Discount rate
F0
This is equivalent to checking whether the rate of return on the project is greater than the
discount rate or whether its NPV is positive. In choosing between two exclusive projects A
and B, the project with the highest rate of return is not necessarily that with the highest NPV.
The project with the greater capital cost, B, will be preferred if the incremental rate of return
of B with respect to A is higher than the discount rate (the incremental rate of return is the
rate of return on the incremental investment involved in investing in B instead of A).
If the rate of ination d is stable during the study period, the rate of return in nominal
terms, r, and in real terms, r-, are related as follows:
1 + r = (1 + r-) (1 + d )
r r- + d
220
NPV
I (%)
10
20
30
40
50
60
70
230
6.3.4
Equivalent cost
When studying an investment project, the sale price of the hydrocarbons produced may be
subject to uncertainty. It can then be very useful to determine the minimum sale price
needed to ensure that the project is protable, or in other words to calculate the equivalent
cost of production.
Determining the equivalent cost allowing for tax and recalculated to a before tax basis is
simplied when calculating an equivalent cost after tax is relevant, particularly in cases where
the project accounts are consolidated with those of other activities, the total being in prot
because a known tax allowance can be associated with every item of deductible cost.
In exploration/production it is common, due to the practice of ring fencing, for this not
to be the case, with some projects giving rise to losses which are carried forward. These
221
losses engender tax savings only when the taxable prot (after carry forward of losses)
becomes positive, this depending on the price of crude. In order to calculate the precise
equivalent cost it is then necessary to proceed iteratively to arrive at the sale price such that
the present net value is equal to zero.
When the main uncertainties relate to the price of crude, the difference between this price
and the equivalent cost throws light on the acceptable degree of uctuation in the price of
crude, and is often more informative than the value of the NPV or the difference between
the rate of return and the discount rate.
6.3.5
When the early studies are being made for an investment project and particularly for the
discussions between the partners, the calculations are generally carried out using operating
cash ows as dened above, without bringing in elements related to the loans required to
nance the project. These calculations relate to the WACC method. The data relating to the
nance are implicit in the discount rate, the internal price at which the nance department
is willing to allocate funds. This allows nancing decisions to be kept separate from
investment decisions. For small projects this overall approach (WACC method) is generally
the only one used: projects are assumed to be nanced from a common pot of capital
available. For large projects this WACC method is also adopted when the debt ratio
dened by the company for all its projects is strictly xed. In such a case, if the debt ratio
exceeds on a particular project, the debt component on other projects needs to be reduced
to a lower level. It is then appropriate to maintain a separation between the sources of
funding and their application.
For large exploration/production projects a exible approach is often taken with regard
to debt. When the studies reach a sufciently advanced stage and the nancing arrangements
have been dened it may be desirable to look at their impact. To this effect, most companies
advocate supplementing the calculations of the overall return on capital (possibly making use
of the method of Arditti, which we shall look at presently) by a calculation of the return on
equity (see Box 6.6). This will in fact be the main criterion in a case where the project nance
222
6.3.6
When the purpose of a study is to decide whether or not to proceed with a given project,
and when the project nance is in line with the nancing of all the investments in the same
sector, the various different methods of evaluation overall return on capital, return on
equity but also Ardittis method all tend to indicate the same decision. In other words, the
NPV for the different methods all tend to have the same sign. But they will not have the
same value and indeed may diverge considerably. The problem of putting a value on a large
project crops up frequently in the upstream petroleum industry, where development often
involves consortia, and where companies seeking to optimize the return on their portfolios
may seek to buy into a project, or divest their interests, at any stage during development and
exploitation. Investors need to be able not just to know its net present value, but to be able
to calculate its value in any year. Based on the criterion of overall return on capital, the value
of the project in any year k in the future is the sum of the values of future cash ows
discounted to that year:
2. We only have to set the equation in the Box 6.6, assuming it holds precisely, with = , beside the
formula for the discount rate i = (1 t)b + (1 )ke, to realise that re ke if and only if ro i.
223
has no impact on the debt ratio applying to the companys other investments (in the case of
non-recourse nancing, for example). When the project is nanced on the same basis as the
overall portfolio of investments, the two approaches, i.e. WACC and equity residual should
lead to the same decision2.
Vk =
n = k +1
Fn
(1 + i)
nk
In particular, once an investment I has been made in year 0, the value of the project at
the end of year 0 is:
N
V0 =
1+ i
n =1
Fn
( )
= I + NPV
Before an investment is made the value of the project (i.e. of the right to invest) is equal
to the NPV.
But if the equity residual method produces a very different value, how can a company
determine the maximum price it is willing to pay for an interest in the project, or for that
matter, a minimum price at which it is willing to sell?
In order to address this question, we shall invoke a result which may appear theoretical,
but which can cast useful light on the question: The NPVs for the two methods are equal
not when the initial amount of the loan is equal to I0 but when it is equal to (I0 + NPV)
assuming that the debt ratio for the project remains stable for its entire duration.
To make this point clear, we observe that the capacity of a company to borrow is determined not by the capital cost of the investments but by the capacity of the company to service
the loan, that is, by its expected revenues. Suppose there is a third party with the same expectations as to return and the same nancial structure, and therefore the same discount rate, as
the company we are considering. He is considering purchasing the right to carry out the
project. The maximum sum he is prepared to pay is equal to the NPV of the project. If we
add the capital cost of the project, the total acquisition costs including the construction of
the plant amount to I + NPV, a fraction of which he can nance by debt. The company
itself would only be able to borrow I, so it would benet from a lower gearing than the
imaginary third party, and its return on equity is therefore lower.
Which is in fact the correct value? The answer is related to the question of how the project
is nanced. If debt is limited by considerations of risks specic to the project, if it has no
impact on the debt ratio for other projects, it is the NPV on equity which should be used. If
on the other hand taking a smaller loan in connection with this project would result in
increased capacity to borrow elsewhere, the objective of complying with the reference ratio
for the totality of investments means that the WACC method using the relevant discount rate
should be used: the assumption that the debt ratio remains stable, and is dened by reference
to the value of projects, is implicit. It is therefore the overall NPV on capital which is the
relevant indicator.
6.3.7
Furthermore the return on equity, a parameter very sensitive to the assumptions regarding
nancing, is usually only used in the nal study phases. These various considerations have
led the oil industry to make fairly widespread use of another method, known as the ArdittiLevy method.
The problem is that the operating companies involved in exploration and production are
not always in prot, for example when they commence operations in a new zone. In such
circumstances they are not able to deduct any accounting loss from prots associated with
other activities. These losses must be carried forward to future years. Furthermore the
practice adopted in some countries of ring fencing the exploration licence can prevent scal
consolidation, even within a given country. Tax regimes are often complex, and generally
vary between different licences. The tax rate may depend on the rate of production, etc. All
this means that it is not possible to express the taxation of petroleum revenues (and its impact
on nancing costs) in terms of a single parameter. It is therefore not generally possible to
determine by simple calculation the cost of debt after tax. This makes the standard WACC
method an inappropriate method of evaluating a project. Even assuming the average cost of
capital after tax can be calculated, the company would have to use as many different discount
rates as there are petroleum tax treatments to consider.
for the project is consistent with that for the rm as a whole3. In other words, there is a
convergence of the viewpoints for the different methods: between that of all the various
investors (Arditti), the shareholders (equity), the department responsible for investment
(requiring a return on invested capital equal to the average after tax cost of capital).
The Arditti-Levy method is widely used in the upstream petroleum industry. Care is
needed in its application, however. The pitfalls are known to the specialists, but they make
it difcult for decision-making to be decentralized. It is not enough to simply provide a user
with the value of the discount rate. The rst step must of course be to check that the
nancing assumptions made in determining the discount rate are compatible with the assumptions made in calculating the nancing costs and the corresponding tax savings. In practice
the method in its original version is only appropriate for the study of projects where the debt
component of the nancing is consistent with the overall debt ratio objective set by the
company. Even in such cases, however, the non-specialist may encounter some difculties.
These include:
Sensitivity to the rate of interest on debt: the higher the rate of interest on debt then, ceteris
paribus, the higher the internal rate of return on the project. This may come as a surprise
to an inexperienced analyst, who might be inclined to use the same discount rate.
Term of loan: This may be signicantly shorter than the life of the project. In this case
the assumption of a constant debt-to-capital ratio over the entire study period is clearly
not satised, and can lead to an underestimation, sometimes substantial, of the protability
of the project.
Economic value of a project: consider a project for which the debt-to-capital ratio is equal
to the debt ratio set by the company, i.e. B0 = I0. In this case the NPVs calculated by
the traditional method and the Arditti-Levy method (as well as the equity NPV) should
have the same sign, but be different in magnitude4. If the object is to decide whether or
not to proceed with the project, both (or all three) methods lead to the same conclusion.
But if the purpose is to determine an acceptable price at which the company can acquire
or dispose of an interest in the project, it is the economic value of the project (Vn in year
n) which should serve as the reference value. The fact that the two methods may give
different results can also give rise to the problem referred to in Section 6.3.5.
3. More precisely, convergence is ensured when the debt-to-capital ratio for the project remains constant
over its life and is equal to the debt ratio xed by the company for projects of this type. The
demonstration is similar to that for the convergence between return on capital and return on equity. The
A-L rate of return rs is a weighted average of the cost b of debt before tax (return to lenders) and the rate
of return on equity re (return to shareholders):
rs = b + (1 )re
Where the nancing arrangements are not such as to preserve a constant debt-to-capital ratio, the
formula becomes approximate rather than precisely correct. The A-L discount rate s is a weighted average
of the cost of debt (before tax) and the cost of equity ke:
s = b + (1 )ke
For a project which satises the given assumptions, i.e. = , rs is greater than s if and only if ro is
greater than ke.
4. The relationships between NPVs obtained in this case by the different methods are given by Babusiaux
[1990].
226
At the time of writing, a new method is being studied with a view to its possible use by the
Total group. It is described in detail by Babusiaux and Pierru [2001]. It is a generalization of
the classical return on capital method, and caters for the case where prots arising from the
project studied will be subject to a different tax rate from that considered in calculating the
discount rate. We will begin by presenting the method under a simplied set of assumptions.
analyzing the protability of a project in order to apply for a loan at a subsidized interest
rate.
There are, on the face of it, no particular difculties in adapting the method to cater for
contractual conditions specic to the upstream oil industry. In the case, for example, of
5. When for example local taxes are higher than taxes in the companys home country, where prots
worldwide can be consolidated.
227
6.3.8
a production-sharing contract, in which the nancial costs are recovered in the form of
cost oil, the cost oil simply reduces by an equivalent amount the quantity of prot oil
which would have been shared between the state and the company.
erations of the debt ratio to be observed for all the companys projects of the same type.
In most cases outside the upstream petroleum sector, the tax regime applying to the
revenues from a project are no different from that applying to the company as a whole.
In this case the proposed method is equivalent to the classical method. Using the proposed
method therefore allows a unied criterion to be adopted for all the activities of an oil
company, a traditional criterion which is easier to use and whose use is more widespread
than that adopted in the Arditti-Levy method.
The rst studies of the protability of a project, particularly in connection with discus-
sions between consortium partners, are usually performed without any allowance for
debt. In other words they are carried out on the basis of projected operating cash ows.
Furthermore, the ex post evaluation of the nancial results is often based on the return
on capital employed (ROCE). The accounting revenues used in this exercise exclude both
interest charges and the corresponding tax savings. The ROCE is therefore analogous to
a cost of capital after tax. Similarly, the economic value added (EVA) method denes the
value added in a year as the annual accounting revenues (excluding nancing items) less
the cost of servicing the capital. The latter therefore also requires an after tax average cost
of capital. In each of these different cases the explicit or implicit method of reference is
the classical cost of capital method rather than the Arditti-Levy method. One of the
advantages of the generalized ATWACC method is that it rests on a similar basis.
6.3.9
Sensitivity analyses are usually indispensable in economic evaluation. They involve analyzing
how the protability of a project varies in response to changes in the assumptions regarding
the different components of the cash ow calculation, such as, in the case of the development
of a hydrocarbon reservoir: the cost of capital, the price of crude and/or gas, the size of the
recoverable reserves, tax rules, etc.
229
main formula which lies at the heart of the method, because it provides additional justication for the proposed method and throws fresh and instructive light on it.
We shall conne ourselves in this section to considering a project nanced in part by debt,
the amount of which is determined by the reference debt ratio . This debt ratio, dened by
reference to the economic value of the project (see Section 6.3.7), is assumed to remain constant.
In particular, the capital borrowed in year 0 is B0 = (I0 + NPV). Under these assumptions, Axel Pierru6 demonstrated a theorem interesting in both theoretical and applied terms.
His theorem states that the net present value of a project, and more generally its economic
value in any year, calculated using the generalized ATWACC method, is equal to the value
calculated by discounting the operating cash ows at a rate equal to the average cost after
tax of nancing the project. This property is intuitive.
The theorem has a corollary: the NPV of the project is independent of the tax rate t in
the country of origin. The parameter t can therefore take any arbitrary value. Each of the
traditional methods (standard WACC, Arditti-Levy, equity residual) corresponds to a
particular value of t, providing a very simple proof of their consistency7.
ice
pr
e
ud
Cr
NPV
Ca
pita
l c
ost
s
Re
er
ve
Variation (%)
The same procedure can be used to consider the simultaneous variation of any number
of parameters, as long as they are independent. In the general case the curves are not necessarily straight lines, and the parallelograms to be constructed are therefore curvilinear. It
should also be noted that when the chosen criterion is the rate of return, the method can only
be approximate, but can provide order of magnitude estimates.
The graph makes it easier to characterize the set of favourable cases for which the net
present value is positive, and the set of unfavourable cases (corresponding to the shaded halfplane in Fig. 6.4, which could be regarded as the red zone for the project). If, for example,
it is considered that the investment budget could be exceeded by x%, the graph can be
quickly used to determine what change would be required in another variable (sale price, for
example) to lead to a negative NPV.
In the case of a project to develop a eld for production, the price of crude or the price
of gas is usually the parameter to which the protability of the project is particularly
sensitive. The equivalent cost, as we saw earlier, is the threshold price which determines
whether or not a project is economically viable. This criterion, which itself embodies information on sensitivity to price, is in its turn particularly well suited to be the subject of a sensitivity analysis relating to the other parameters.
A decision to invest can be taken if the unfavourable cases are regarded as being unlikely
(a subjective judgement, these probabilities not being quantied), and as long as the possible
losses do not comprise a major risk for the company. Very often the sensitivity analysis is
regarded as dealing sufciently with the question of uncertainty to present a rm proposal
to the relevant senior management.
However it also often happens that the sensitivity analysis throws up a mix of favourable
and unfavourable cases, each with their associated gains and losses, such that a decision
cannot be made. For projects of a certain size, the analysis can be carried further by
attaching probabilities to each of the various outcomes. This approach will be considered
in Section 6.4.
230
The pay-back or pay-out period is an empirical criterion used by the petroleum industry,
particularly in the face of major uncertainties: commercial risk, major political risk, technological risk (a technical advance may be of short duration), etc. It is dened in various
ways, and can be calculated from the start of exploitation or from when capital expenditure
starts (in the latter case we refer to the duration of nancial exposure). Payback time may
be dened in terms of discounted or non-discounted values. In any case this criterion is a
good way of formalizing the desire not to carry out projects whose protability depends on
cash ows beyond a date when it becomes difcult to make forecasts.
A drawback of this criterion is that it is rather arbitrary. To ignore project revenues
beyond the desired payback period is to assume that they will be nil, which is generally not
realistic. There are many projects of long duration in the petroleum industry (and in the
energy sector generally).
Despite these drawbacks, payback time is a criterion, albeit secondary, which many
decision-makers nd of interest. The maximum nancial exposure (accumulated expenditure) is another parameter to which they pay particular attention.
6.4.2
Expected value
6.4.2.1 Denition
The main criterion used to summarise a probabilistic future is the expected value of the net
present value, i.e. the weighted average of the possible values of the NPV, the weights corresponding to their probabilities. This is the value to which the average would tend if the
company were able to repeat the experience a large number of times.
Actually it is not necessary for an identical experiment to be repeated a large number of
times. The criterion of expected value is also justied by the law of large numbers if the
231
company carries out a sufcient number of similar, mutually independent projects. This is
therefore the basic criterion used for all the small projects.
Remark: It is possible to calculate the expected value of a revenue, a discounted cost or
an annual equivalent cost. It is not in general possible, on the other hand, to calculate the
expected value of a rate of return as a weighted average using probabilities.
Let us consider a very simplied example of a prospect A whose recoverable reserves may
be 250 Mbbl. This prospect could require a development with a NPV of $320 million. The
probability of nding an oileld of this size is 10%. There is also a 5% probability of
nding a larger oileld. The NPV in this case would be $400 million. The probability of
discovering a smaller oileld is 5% and the NPV in this case would be $200 million. The
probability of failure is estimated at 80%. The cost of drilling is estimated to be $50 million.
The expected value of the NPV is therefore the average of the possible values weighted by
the probabilities, i.e.:
50 + (0.10 320) + (0.05 400) + (0.05 200) = $12 million
Probability
Capital cost
232
6.4.2.3 Simulation
The technique most commonly used consists of performing a simulation using Monte Carlo
methods8, and computer processing is normally required. A sample is drawn at random for
each variable considered stochastic using the appropriate distribution function. These values
are then used to calculate the corresponding possible value of the net present value (or the
volume of the reserves, as the case may be). This operation is repeated a large number of
times (several hundred), a sample set of notional values of the NPV is obtained. Statistical
operations can then be carried out on this sample: construction of a histogram, calculation
of mean, standard deviation, etc. If the sample is large enough, the method allows a probability distribution function to be derived for the NPV. In particular, the mean of the sample
is an estimate of its expected value. This method has been in use by the oil industry since
the early 1960s.
One of the disadvantages of simulation methods is they behave like a black box. The
probability distribution function of the target criterion is derived from probabilistic data for
the different parameters. But, unlike what happens in a sensitivity analysis, the effect of individual factors is not apparent. In practice, the uncertainties attaching to the different parameters can be of different types. In the case of a development project for an oil or gas eld,
for example, the probability estimates for the physical and technical parameters repose on
a large number of cases studied by the company, and on the experience of specialists. It is
much more difcult, on the other hand, to obtain probabilistic data, even subjective, for the
economic parameters (price of crude, tax rules). This is one of the reasons why simulation
tends to be mainly used for evaluating the volume of the recoverable reserves. It allows the
impact of uncertainties of a technical nature to be represented, while those relating to the
price of crude are often better analyzed by means of scenarios.
More generally, it is often the case that estimates of the future prices of products are more
subjective in nature than the other parameters. Analogous to what was said in discussing
sensitivity analysis earlier, simulation can be used just to determine the equivalent cost. This
allows uncertainties related to the sale price to be kept distinct from all the other uncertainties
which affect the net present value.
Finally, the use of simulation, always a major exercise, can be avoided by using approximate formulae to determine the expected value and the variance of the net present value for
a project.
8. These methods were popularised by D.B. Hertz [1964], and are sometimes referred to as the Hertz method.
233
In the development of oil or gas elds, the parameters crucial to protability are the
volume of the reserves and the productivity of the wells. The latter depends on a number of
variables which can be considered random: the area of the reservoir, the thickness of the
reservoir bed, the porosity and permeability of the rock, the viscosity of the uids, etc. These
are the fundamental parameters which can be estimated and described in terms of probability
functions by the geologists and geophysicists. Often an estimate has already been made of
the minimum recoverable reserves required to make the development viable. The question
then reduces to ascribing a probability distribution function to the volume of the reserves.
Whether the object is to consider just the reserves or to determine a probability distribution function for the net present value (or equivalent cost), the problem is to derive this
function from assumptions about the probabilities of the fundamental parameters.
6.4.3
234
235
50
64
(0.2)
Explore
prospect A
Abandon
32 0
E
45
Develop A
310
Explore
prospect B
No discovery
Oil discovery
(0.8)
55
Small field
110
- 600
820
(0.6)
900
Favourable
conditions
(0.4)
700
450
650
(0.8)
Favourable
conditions
Unfavourable
conditions
610
(0.2)
Unfavourable
conditions
220
500
Develop
Develop
Abandon
Medium-sized field
Small field
Failure
Medium-sized field
(0.1)
Failure
(0.10)
(0.05)
(0.85)
(0.2)
(0.7)
27.5
Explore
prospect B
45
Abandon
The diagram does not show the lower part of the decision tree, corresponding to prospect
B if A is successful. The section after node H in the lower part of the tree will be identical
to the section in the upper part after node G. It should be noted that it is possible, instead
of duplicating this part of the graph, to simply connect node G directly to nodes I, J and K,
which means that we can formulate the problem considered as a stochastic dynamic
programming problem.
In order to determine the expected value of the NPV associated with a decision studied,
calculations are carried out starting in the future and proceeding back to the present. In
Fig. 6.6 we therefore move from right to left.
A value is associated with each node (value, score or potential) which corresponds
to the expected value of subsequent revenues. The evaluation starts at the nodes at the nal
stage (M and N). The score assigned to node M, for example, is the expected value of
revenues from the development of a small eld. The probabilities are indicated in brackets
on the decision tree. The expected value is therefore:
EM = 0.2 450 + 0.8 650 = 610
Having determined the values at the nodes of the last stage, we proceed to the nodes of
the penultimate stage, i.e. J and K. While the last stage was the outcome of a random process,
the preceding stage is a decision process. The decision is of course that which corresponds
to the highest expected value. At node J abandon has an expected value of 0 while development, which requires an investment of 500, has an expected value of 610 500 = 110.
The calculations proceed in the same manner, moving each time back to the preceding
stage until we arrive back at the initial node A.
In practice, the number of possible decisions is often large, and the number of possible
consequences is even greater. The size of decision trees can escalate rapidly, and this
imposes limits on the use of this method. Even if explicit calculations are not carried out,
the decision tree is a concept to which it is useful to refer, even if only mentally, as a means
of ensuring that consequences or possible actions are not forgotten.
A call option gives its owner the right to purchase an asset at a given date or for a predetermined period at a xed price (the call price). The standard method for evaluating an option
is the Black and Scholes model.
If we assume that the changes in the market price of the underlying share follow a
normal distribution, the value of a European call option (i.e. a call option exercised on a xed
date) is
S N (d1 ) Xe r0t N (d 2 )
where:
Log
d1 =
1
S
+ r0 + 2 t
2
X
t
d 2 = d1 t ,
S
X
t
r0
N(d)
Option valuation can be a useful tool in a situation combining exibility and uncertainty,
that is when a decision, which can be modied by changes in random factors, can be taken
in the future. Apart from opportunities to develop oilelds, there are in theory many situations in the upstream petroleum industry which meet these conditions: the acquisition of an
exploration licence, special contractual clauses, etc.
Options theory is well adapted to evaluating asset market values, and does not require
knowledge of a discount rate. It should be emphasized that models for valuing options
assume the existence of a liquid market in the underlying asset, and that there are no opportunities for arbitrage. This may be true for the price of oil, but is less so for petroleum
projects.
The value of a given asset is the sum of two components: the intrinsic value and the time
value. The intrinsic value is the value if the option were exercised immediately and can be
determined by traditional NPV methods. The time value corresponds to the potential for
appreciation in the present net value, and disappears when the option is exercised.
The value of an option is affected by a number of different parameters: the value of the
underlying asset, its volatility, the exercise price, the term and the risk-free interest rate. The
greater the variations in the value of the underlying asset the greater the value of the option.
As a result the value of undeveloped reserves will be greater ceteris paribus when the oil
price is more volatile. By holding back with the development of certain gaselds in the North
Sea, gas companies were able to change the nature of the competition in that area. As a result
prices became more volatile, which in turn increased the value of the licences held by these
companies.
237
Although tools originating from the real options theory have not, or not yet at any rate,
really caught on in the oil industry, occasional reference to them, even if only qualitatively,
can be useful in making decision-makers aware of the choices and parameters which affect
the value of certain assets which have similar characteristics to options.
6.4.4
Probability (%)
NPV ($ millions)
Small
100
Large
10
1 000
Very large
1 500
Probability
A
NPV
The risk is generally characterized by the standard deviation9 (or the variance) of the
discounted revenue.
If two projects have the same expected revenue, a risk-averse decision-maker would opt
for the project with the smaller standard deviation. A problem which can arise is that one
project has a higher expected value but also greater risk. The decision-maker is then faced
with making a choice based on two different criteria.
The problem is similar when the decision is between accepting and rejecting the project.
The fact that the expected value of the discounted revenues is positive is not enough. It is
also necessary that the risk should not be too high.
In practice both of these criteria (expected value and variance) are commonly used without
their being universal agreement about the trade-off. As indicated earlier, in the oil production
sector simulation methods are often used. These methods allow the expected value and
variance of the volume of recoverable reserves, or going further, of the NPV for the development project, to be calculated.
Nor do we necessarily rely on just the expected value and the variance, since the distribution function is also available. This allows us to calculated the probability, for example,
that the project will result in a loss.
A decision can often be taken on the basis of the information described above, possibly
supplemented by considerations of a more strategic nature, without having to seek to quantify
the weights to be attached to each element, in particular to the expected value and the
variance (mean value and risk).
9. The standard deviation of a variable is the root mean square of the deviations of the variable from its
mean. It is a measure of the dispersion of the variable. The variance is equal to the square of the standard
deviation.
239
Before examining possible responses to the question posed, let us take yet another
example. Let us look at two development projects whose NPVs can be considered to be
continuous random variables. Suppose the expected values of the NPVs for the two projects
are the same. A risk-averse decision-maker will prefer the project with the smaller dispersion
of NPVs, i.e., project A in Fig. 6.7, which presents the probability distribution functions for
these two projects.
Different approaches are used to deal specically with risk. One of these involves using
an expected value/variance criterion which uses weights derived from decision theory.
Before presenting this criterion we shall look at a method widely used by companies in which
a risk premium is included in the discount rate.
(1 + i0 ) (1 + pr )
n
A risk premium of 10%, for example, involves applying a factor of approximately 0.6 in
year 5. This is equivalent to assuming that there is a 60% probability that the given ow will
take place, and a 40% probability that it will be nil (e.g. complete expropriation without
compensation). This would be a very high assumed risk.
240
2
2P
where
m is the expected value of the NPV
2 is its variance
L is a parameter which characterizes the ability of the company to accept risk and which
represents the maximum acceptable loss which will not jeopardize the survival of the
company; this sum can be estimated (relatively) easily by general management.
1. Charreton R, Bourdaire JM (1985) La dcision conomique. Que sais-je ?, PUF, Paris, France.
241
When this method is adopted the safety margin used may vary between different divisions
within a company, as a function of the risks to which the different activities are subject. A
problem may occur if the same specic risk premium is applied to all the projects in a sector,
when risks may in fact even vary for the different projects within a single sector. A strict
application of the method may therefore lead to inconsistent decision-making.
The use of a specic risk premium has another disadvantage. We saw earlier that the
concept of the expected value is well suited to the study of small independent projects.
Account only needs to be taken of risk in the case of large projects (or when projects are
interdependent). Increasing the discount rate would lead to the same decision being taken,
whatever the multiplier which one might choose to apply to the various cash ows for the
project, on similar projects irrespective of their size.
As a result, when a discount rate is adopted which incorporates a specic risk premium,
the criteria which use this rate are never applied in a strict manner. Furthermore at present
the oil industry appears to be using this device less than it has in the past. Where it is still
being applied, lower risk premiums are being used (typically between one and a few percent).
In any case an analysis is always needed of the risks and uncertainties applying to any
project. In some cases a sensitivity analysis will sufce while in others, probabilistic calculations may be needed. There are techniques based on decision theory which permit the
analyst to go beyond the multicriterion approach mentioned earlier.
CONCLUSION
Economic evaluations of investment projects using discounted cash ow are the rule in oil
companies, as in other large corporations.
It is important that these evaluations are carried out in a rigorous manner because,
although the techniques are very simple, this very simplicity can lead the novice to forget
the snares awaiting the unwary practitioner. We have mentioned a number of these traps:
going, other things being equal, for the project with the highest rate of return when choosing
between projects; unreective use of a discount rate which includes a high risk premium;
mixing values in current and constant prices, etc.
Whether one sticks to a sensitivity analysis, always a must, or goes for more sophisticated
techniques for analyzing risk, capital budgeting techniques are intended to summarise in a
single or a small number of numerical values a large set of data. They are a tool for ensuring
coherence between the assumptions used by different sectors in the company. Of course the
economic evaluation is only one of the factors to be taken into account when making a
decision, because it is never possible to quantify all the consequences of a decision. But the
object should be for it to be used by all the different actors involved in investment projects:
technical, nancial and management specialists, etc.
In this regard economic evaluation can provide a means of communication between
specialists with different backgrounds: a genuine common language.
242
In this Chapter we shall examine the issue of information on exploration and production
activities, and how oil companies deal with this information in the context of their nancial
accounting.
Management in this sector, like any other, relies on an information system so that they
can steer the enterprise on a sound course, optimise its choice of projects and provide all
the information needed for:
Investors who monitor the fortunes of the companies they intend to invest in, and who
make use of competition analysis to benchmark performance;
Creditors and suppliers, who have to evaluate nancial strength and creditworthiness;
Financial analysts, who appraise company performance with a view to advising
potential investors;
Stock exchanges, when seeking a new stock market quotation;
Regulatory bodies, whose job it is to ensure that the company is in compliance with
current regulations.
These data are provided mainly in the form of a balance sheet, a prot and loss account,
a statement of changes in equity, a cash ow statement and disclosures. These documents,
mainly based on historical data, cannot claim to give a complete picture of the company, or,
on their own, permit its worth to be measured. They must be interpreted with caution (for
example a building bought several years ago appears in the balance sheet at its cost of acquisition rather its present value) and need to be supplemented with other information
including share price trends if the company is quoted on the stock exchange and by qualitative information regarding non-quantiable aspects.
There are specic accounting issues which arise in relation to the oil and gas exploration/production sector, and it is vital to understand these so that all the information provided
by petroleum companies can be used wisely.
These specic issues result from the following characteristics of the sector:
The relationship between expenditure and revenue, both in terms of amounts and timing can
be very loose. A company may have invested $1 500 million (historical costs) in an oileld
243
of 100 Mb, the value of which could collapse when production starts if the price of oil falls
to $50/barrel or, conversely, soar if the price rises to $ 150/barrel. Furthermore the costs
are incurred early on in the process, possibly extending over a period of 510 years, while
the receipts which follow may be spread over a period of 1020 years, or even more in some
cases. The oil company will be required to provide information both in the short term (quarterly, yearly) and the long term (throughout the productive life of the oileld).
The intrinsic value of a petroleum exploration/production company depends largely on the
size of its reserves. And yet when the company makes a discovery, this does not affect
the assets in the balance sheet.
The sale price of hydrocarbons does not depend in any way on the seller. It is therefore
difcult for him to estimate the value of an oil or gas eld, and yet he is required to carry
out such an exercise to comply with various legal obligations.
Oil companies conduct their activities in association with other oil companies, and the
contracts that bind them to the host country are often specic, imposing particular
constraints on data structures and the management of projects. This factor inuences the
way the company organises its internal accounting system.
These difculties make it an extremely complex matter for a nancial analyst to carry out
evaluations or comparative studies of the companies in the sector. However the history of
the oil industry shows what a major role has been played by American companies, whose
leading position is to reect in the hegemony of United States of America Generally
Accepted Accounting Standards ("US GAAP"') internationally.
This situation has evolved due to the introduction of International Financial Reporting
Standards ("IFRS") since 2005. Indeed, European listed companies have had to prepare their
nancial statements in compliance with IFRS since the beginning 2005. Many other countries are also choosing to adopt IFRS as their national regulatory bodies move to converge
with the standards. The IFRS are becoming widespread and the oil and gas companies in
Europe need to comply with these new standards.
Furthermore, the leading international oil companies are all quoted on the New York Stock
Exchange and are therefore bound by the requirements of the Securities and Exchange
Commission (SEC).
In this context, the knowledge of both US GAAP and IFRS is therefore essential, when
examining non American companies' fmancial statements.
We shall begin by analysing in detail the accounting principles governing investments,
costs and oil and gas reserves, as well as depreciation and provisions.
We shall then go on to look at information specic to the upstream petroleum sector which
allows comparative studies of oil companies to be carried out. We shall begin with the information provided by oil companies in annexes to their annual reports, and will then dene a
Box 7.1 SEC (Securities and Exchange Commission).
Companies quoted on the New York Stock Exchange have to submit a special form
(form 10-K for US companies, form 20-F for other companies) to the SEC giving the
balance sheet, prot and loss account and a statement of source and application of funds,
all consolidated.
Supplementary information is appended in annexes (analysis of xed industrial and
intangible assets, etc.) and, for oil companies, information prescribed by SFAS 69.
244
Oil and gas activities are dealt with by specic publications based on recommendations of the FASB. Their objective is to be able to measure the repercussions on the
nancial position of a company of the cost of exploration and development of oil and gas
resources, and of the revenues from their sale.
In 1977 the FASB published for the rst time a SFAS (no. 19) requiring the oil
industry to publish information about their oil and gas production activities. The term
production includes extraction, gathering , processing and in situ storage.
The following year a new concept known as Reserve Recognition Accounting
(RRA) was introduced, based on the specications of the SEC, published in the
Accounting Series Release (ASR). This document requires that reserve data are published
in the companys nancial statement, with an indication of forecast future production and
associated expenses, accompanied by a very detailed description of past performance.
This resulted in a nancial statement not subject to standards, which led the FASB to
propose a new standard in 1982, the SFAS 69, which denes the way in which the reserves
and associated costs should be presented in an annex to the annual nancial report.
The recommendations in the SFAS 69 were accepted by the SEC. The denition of
proven reserves in this document is largely based on the requirements of the U.S.
Department of Energy.
Box 7.3 IASB (International Accounting Standards Board).
The International Accounting Standards Board was formed in 2001 and is an
independent, private-sector body that develops and approves International Financial
Reporting Standards (IFRS). The IASB operates under the oversight of the International
Accounting Standards Committee Foundation.
Concerning the European Oil and Gas companies, the IASB did not have time to develop
a comprehensive standard on extractive industries in time for the entities converting to IFRS
in 2005. Therefore, the IASB issued IFRS 6 in December 2004 and provided an interim
solution by allowing entities to continue applying their accounting policy in respect of exploration and evaluation until a more comprehensive solution is developed. As a matter of fact,
European Oil and Gas Companies have maintained their previous accounting principles such
as SFAS No. 19 and SFAS No.69 as they did not conict with IFRS.
number of indicators which can be constructed from these data. And nally we shall describe
the many difculties involved in using these data.
For readers not familiar with accounting practices, an introduction to nancial accounting
is appended as an annex.
According to current usage, the term capital costs (or investment costs) is used during
the exploration and development phase and the term operating costs during the production
phase. These capital and operating costs relate to many different operations, as can be seen
in Table 7.1.
245
Development (offshore)
Development drilling
Construction/
installation platforms
Preliminary studies
Geological studies
Seismic operations
Enhanced recovery:
wells
pumping equipment
other
Exploration drilling
(Flowline connectors)
Appraisal drilling/
delineation of discoveries
Production installations:
separation/processing
discharge
storage facilities
Production
Transport costs
The distinction between an investment and an operating cost for the purpose of the accounts
may not correspond exactly with the way these terms are used in everyday language.
According to accounting principles (GAAP: General Accepted Accounting Principles),
capital costs appear in the balance sheet and operating costs in the prot and loss account.
While economists and accountants can agree on what constitutes a cost for the purpose of
the prot and loss account, accountants may have different views about capital costs,
depending on the method they apply.
The U.S. accounting standard SFAS 19 provides for two methods of treating the exploration and development costs: the successful efforts method and the full cost method.
Generally speaking the large integrated oil companies use the former method (at least for
their consolidated accounts) and other companies, for example the American independents,
prefer the latter. The two methods differ in their approach as to what is regarded as an
investment during the exploration phase.
Successful efforts
Full costs
Capitalised
Capitalised
Geology/geophysics costs
Expensed
Capitalised
Expensed
Capitalised
Capitalised
Capitalised
Development costs
(including dry development well)
Capitalised
Capitalised
Expensed
Expensed
Production costs
Apart from the purely accounting aspects, these two methods lead to differences in the overall
results in terms of the annual prot/loss and the return on capital. When the full costs method
is used, all the costs of an unsuccessful exploration are capitalised. As a result the book prot
will be higher than that obtained using the successful efforts method (in which dry wells are
treated as operating costs), but the return on capital employed will be lower.
The treatment of drilling costs depends on the outcome of the drilling: if the drilling is
unsuccessful (dry well) the costs are treated as operating costs. If the results are successful,
however, the drilling costs are capitalised. During the entire drilling period, the exploratory
drilling costs are temporarily capitalized pending determination of whether the well has found
proved reserves if both of the following conditions are met:
The well has found a sufcient volume of not yet proved reserves to justify, if
appropriate, its completion as a producing well, assuming that the required capital
expenditure is made in the course of the eld development;
The company makes sufcient progress assessing the reserves and the economic and
operating viability of the project.
The nal result of any exploration well is twofold:
The well will have added proved reserves : it will therefore be classied in the category
of capitalized exploration;
The well has not found any proved reserves: its entire cost must be expensed.
C. Development costs
Development costs are the costs necessary to put the reserves discovered into production. They
include seismic 3D analysis, which allows the eld to be monitored dynamically, the drilling
of production and injection wells, the installation of production and processing plant, gathering and storage systems and systems for transporting the product to the point of contractual
delivery. These costs are directly linked to the reserves discovered, and are capitalised.
Table 7.2 Comparison of the successful efforts and full costs methods.
7.1.2
Reserves
A distinction is made between reserves of liquids (oil plus natural gas liquids) and of gas.
The units are millions of barrels (Mbbl) for liquids and billions of cubic feet for gas. Conversions are based on energy equivalence, and every company uses its own ratio, depending on
the quality of its gas. The conversion rates vary between 5 300 and 6 000 ft3/bbl.
Variations in the amount of the reserves compared with the previous year must be allocated between six categories:
1. Changes resulting from an improved knowledge of the reserves (due to the drilling of
a new development well, for example), or a change in the economic environment;
2. Enhanced (secondary or tertiary) recovery (injection of water, associated gases, steam,
inert gas, etc.);
3. Enlargement and discoveries resulting from the exploration of an uninvaded or virgin
zone, or from delineation beyond the perimeter of the proven reserves;
4. Acquisition of proven reserves;
5. Sales of proven reserves;
6. Production during the year.
It is not always easy to make this allocation, and in practice there is a certain degree of
freedom in the choice of category. A further complication is that a distinction has to be made
between developed proven reserves (quantities which can be produced from existing installations and wells, without any further development) and those not developed.
It should be noted that the SFAS 69 advocates identifying separately those reserves
coming from subsidiary companies fully or proportionally consolidated (rst category), and
subsidiary companies consolidated by the equity method (second category).
The SEC denition of reserves based on the notion of reasonably certain recovery, may give
rise to problems of interpretation. Each company will have its own policy on accounting for
its reserves. A very cautious company will always retain the most conservative estimate of
its reserves as knowledge develops about the eld. Others will post a best estimate , subsequently correcting this gure as needs be.
production of the reserves in question in order to determine the amount of the reserves which
will be disclosed in the nancial statements. This means that a company operating under a lease
will not enter the same amount as one with a production-sharing agreement.
Historically, the rst system to be adopted by producer countries was the system of
leasing. The idea is only to take credit for the proportion of the reserves which it effectively
owns. A leaseholder therefore only takes account of its interest in the eld after deducting
the royalty, paid in kind as remuneration to the owner of the site. The reserves in this case
therefore correspond to proven reserves net of royalty.
In certain leasing systems royalties can be considered as a tax on production, and are therefore
not deducted from reserves. In this case the reserves are the gross gure. In this system, of
course, in addition to producing the reserves and paying the royalties, the leaseholder also pays
249
one or more petroleum taxes each year which are charged against income in the prot and
loss account; the reserves accounted for before these payments are therefore gross of tax.
The advent of new scal regimes has further complicated this system of accounting.
Production sharing contracts (PSCs) began to be developed with effect from 1966. In this
system the oil company is a contractor, and only owns part of the production; it can therefore
only bring that part of the reserves into its accounts, i.e. the cost oil (the repayment of all
its costs) and its share of the prot oil. The rest of the prot oil accrues to the State, and is
therefore not accounted for as the reserves of the oil company.
Some PSCs, however, regard the States share of the prot oil as a tax, and the company
can then include the total prot oil in its reserves. The reserves announced therefore correspond to access to hydrocarbons. In order to quantify them, nancial modelling of the
contract until the end of the eld life is required.
Finally, in the case of a service contract the contractor is reimbursed his expenses and
remunerated nancially rather than in kind. He never owns the reserves, and does not
therefore include them in his nancial statement.
Contracts of mixed type are becoming more and more common, and it is not always easy
to decide in which scal category a particular set of reserves fall. In order to decide, oil
companies refer to rules laid down by the SEC to guide them as to what should be accounted
for as reserves.
These rules reiterate the matters which need to be dealt with in an international agreement
or contract if proven reserves are to be identied and disclosed. These include the right to
extract oil or gas, the right to take payment in kind, exposure to risk (technical and economic)
through its activities and a clear mineral interest. In addition, the rules draw up a list of
specic elements which do not require to be identied and disclosed as proven reserves.
These include interests limited to the right to purchase certain volumes of hydrocarbons,
supply or factoring agreements, services or nancing which do not involve any risk or in
which a clear mining interest is not involved.
The main theme in the foregoing is related to risk and reward: the reward must be linked
to a risk (technical and economic) if the company is to disclose an item as reserves.
7.1.3
In this section we shall only deal with those aspects of depreciation and provisions specic
to the upstream petroleum sector. More general material on depreciation, and details of
straight-line and declining balance depreciation will be given in the Annex to Chapter 7.
We shall therefore deal with depreciation by the unit-of-production method recommended
by the SEC and the FASB for investments in the upstream petroleum industry in consolidated accounts. We shall then look at depreciation for projects still in the development phase
(slot ratio and reserve ratio) and will nally consider provisions for decommissioning and
site rehabilitation.
The depreciable balance or net capitalised assets are multiplied by this rate to nd the
amount of the depreciation.
Table 7.3 shows the depreciation prole obtained, based on an investment of $100 million
and initial developed proven reserves of 100 Mbbl. It is assumed that the reserves are not
re-evaluated during this time.
n+1 n+2 n+3 n+4 n+5 n+6 n+7 n+8 n+9 Total
Production (Mbbl)
10
20
20
15
10
7.5
90
70
50
35
25
17.5 10.5
3.5
5.5
10.0 22.2 28.6 30.0 28.6 30.0 40.0 47.6 63.6 100
100
Net capitalisation
at 31 Dec.1 ($ millions)
5.5
2.0
0.0
Depreciation
($ millions)
7.5
7.0
5.0
3.5
2.0
Depreciation
($/bbl)
1.0
1.0
1.0
1.0
1.0
1.0
1.0
1.0
1.0
1.0
100
100
1. The net capitalisation on 31 December in year n is equal to the net capitalisation on 31 December in year
n-1, plus new investment in the year minus depreciation in the year.
It can be seen in this example that that the depreciation in terms of its absolute value varies
tremendously over time, but is constant on a per barrel basis. In practice the exercise is
somewhat more complex because the estimated volume of the reserves is subject to constant
revision, and these changes have to be incorporated into the calculation. These variations
result not only from production but also from successive re-evaluations, due particularly to
improved knowledge of the eld as new investments are made. Some of the probable and
possible reserves, for example, will become proven reserves (there is a 90% likelihood that
actual production will exceed proven reserves).
251
n+1 n+2 n+3 n+4 n+5 n+6 n+7 n+8 n+9 Total
10
20
20
15
10
7.5
40
45
50
35
25
17.5 10.5
3.5
5.5
20.0 30.8 28.6 30.0 28.6 30.0 40.0 47.6 63.6 100
Investment ($ millions)
100
100
8.3
4.4
1.6
0.0
Depreciation
($ millions)
7.9
5.9
5.5
4.0
2.8
1.6
100
Depreciation
($/bbl)
2.0
0.8
0.8
0.8
0.8
0.8
0.8
1.0
1.2
0.8
0.8
These changes can also come about as a result of the impact of changes in the economic
environment on the protability of production, either forcing the company to cease
production earlier than anticipated or, conversely, allowing it to continue production. It
should not be forgotten that reserves are no more than the sum of the quantities produced
in each year from the rst year of production to the last.
Table 7.4 shows the depreciation prole obtained, based on an initial investment of
$100 million and initial developed proven reserves of 50 Mbbl. It is assumed that the estimated reserves are increased by 25 Mbbl in year n+1 and a further 25 Mbbl in year n+2.
It can be seen that these upward adjustments in the estimated reserves result in higher
depreciation in the early years.
Reserve ratio = developed proven reserves (end of the year n) + production year n
proven reserves (end of the year n) + production year n
These two denitions lead to different gures, as the following example shows:
An offshore production platform is constructed at a cost of $100 million;
An exploration well and two appraisal wells were drilled before development, at a total
cost of $20 million;
The number of development wells planned is 22;
The total proven reserves amount to 30 Mb;
On the 31st of December n, three development wells had been drilled;
Production began in year n, amounting to 500 000 barrels;
The developed reserves as at the 31st of December n amounted to 5 Mbbl, i.e. 5.5 Mbbl
originally, less production in year n.
The capital costs therefore amounted to $120 million (successful exploration well,
appraisal well and production platform), and have led to the discovery of oil and the
construction of production installations for the entire oileld. However since only part of the
reserves have been developed, only part of these investments will be amortised:
based on the number of wells drilled, the slot ratio is equal to:
wells drilled/wells planned = 3/22 = 13.6%, i.e. 13,6% 120 = $16.4 million.
based on the reserves, the reserve ratio is:
developed reserves/total reserves = 5.5/30 = 18.3%, i.e. 18.3% 120 = $22 million.
The capital costs adjusted by one of these two ratios are then depreciated by the unit-ofproduction method based on the developed proven reserves.
Or as the reserve ratio (beginning of the year), i.e. the estimated ratio of developed
proven reserves to the total proven reserves:
7.2.1
reserves.
6. Changes in the standardised measure of discounted future net cash ows.
7. Other information.
255
of the production prole. This calculation is carried out using the economic conditions at
the year-end, and assume that all the reserves will actually be produced.
The estimated discounted net future ows from the proven reserves are valued on the basis
of posted prices at year-end, except in cases where the existing contracts provide for xed
and determinable revaluations of the prices.
The estimated production costs (including, where appropriate, transport costs and taxes
on production), future development costs and decommissioning costs are deducted from
future ows. All estimates are based on year-end economic conditions.
The estimates of future taxes on prots are based on the legal tax rate in force locally at
the year-end.
A number of objections can be made to this calculation, for example, as follows.
The assumption regarding the price is questionable. Companies operating in seasonal gas
markets, for example particularly in the United States with prices which are higher in
winter, and therefore on 31 December, the reference date for prices will produce higher
present net values.
Only the proven reserves are allowed for. This is rather a pessimistic scenario, since the
eventual reserves are very likely to exceed the proven reserves only.
The future capital and operating costs are not those provided for in the basic scenarios used
by the oil companies. The latter allow for the development and production not only of the
proven reserves but also of a part of the probable and possible reserves, producing higher
values for production and costs.
The tax calculation is an estimate only; often the actual tax calculation is affected by activities beyond the connes of the eld being considered. The methods used for arriving at this
estimate vary between companies, which makes comparison difcult.
The use of a single discount rate does not take account of differences in the real cost of
capital to the companies holding the reserves. On the other hand the use of a standardised
value allows inter-company comparisons.
257
The most difcult aspect of this calculation is calculating tax. This is purely theoretical, and
does not correspond to the real tax situation of the company (no account taken of losses in
previous years brought forward to the current exercise, tax-allowable provisions different
from book provisions, etc.). The result obtained is therefore a notional value which allows
the results of different companies to be compared independently of their tax situation and
their nancing method.
7.2.2
Indicators
A number of indicators can be constructed from the supplemental information on oil and
gas producing activities in oil companies annual reports, so that their exploration and
production performance can be compared.
258
This indicator is the ratio of production in the year concerned to the amount of the reserves
at the beginning of the year. These reserves are calculated by adding the production in the
year to the reserves at the year-end.
production in year n
production in year n + reserves on 31 Dec. of year n
This parameter represents the rate at which the company is producing its developed
resources. In terms of equipment, this ratio comprises the depletion coefcient used in
calculating depreciation by the unit-of-production method.
mentary basin?
The source information, i.e. the six categories of supplemental information on oil and
gas producing activities, was not intended for this calculation. Every company, depending
on its accounting methods or the image it wishes to project, and every nancial analyst
(depending on the information he possesses) will use a different denition of nding cost.
259
Barrel-based ratio
Mean revenue per barrel
Production cost per barrel
Depreciation per barrel
261
1 600
Net profit /
Company profit oil
1 400
1 200
Taxes on profit
1 000
Royalties
Depreciation
800
Production costs
600
1: Lease
400
2: Standard PSC
3: PSC (tax oil)
200
0
1
Figure 7.1
Under each of the four contractual bases the companys net prot is the same. But the operating prot and all the per-barrel ratios are totally different. This means that comparisons
of these parameters will not be relevant unless the analyst has a detailed knowledge of the
contractual and tax systems used in the calculations.
100 Mbbl
$15/bbl
CONCLUSION
All these indicators are useful in giving an appreciation of the value of a company, but they
give greater insight into the past than the future. Furthermore they are calculated on the very
conservative basis of proven reserves only.
The most appropriate method would be to calculate expected future cash ows, extended
to include all reserves, that is, allowing for:
The portfolio of elds currently under development or in production;
The portfolio of elds not yet developed;
Expected discoveries related to the companys exploration activities.
An analysis as described above needs to be complemented by a study of market-related
factors, such as the market capitalisation of the company, the market value of its reserves
262
No. 1
Lease
No. 2
Standard
PSC
No. 3
PSC
(tax oil)
No. 4
PSC
+ tax
Mb
Mb
100
801
463
46
1005
100
527
52
Gross turnover
Royalties
Production costs
Depreciation
Operating prot
Tax (and/or tax oil)
Net prot
$M
$M
$M
$M
$M
$M
$M
1 500
300
200
400
600
5102
90
6904
1 500
7804
200
400
90
90
200
400
900
8106
90
200
400
180
908
90
2.5
5.0
7.5
1.1
4.3
8.7
2.0
2.0
2.0
4.0
9.0
0.9
3.8
7.7
3.5
1.7
Production costs/bbl
Depreciation/bbl
Operating prot/bbl
Net prot/bbl
$/bbl
$/bbl
$/bbl
$/bbl
as reserves if there is an active market serving as a reference, and indeed the analysis of information from other sources such as:
Press releases of the companies circulated by press agencies such as AFP or Reuters,
and which are available on the companies Internet sites. These releases may give quarterly results or information on the strategies of the company;
Specialised publications produced by consulting rms or nancial analysts, in the
form of inter-company comparisons;
Computerised databases offered by consulting companies, for example giving the
reserves held by the companies.
263
Annexe
to Chapter 7
Basic principles of nancial accounting
Financial accounting collects and organises information needed by a business and compiles
it according to certain principles, as follows:
Historical costs: accounting documents are maintained in actual historical costs (current
265
7A.1.1 Assets
Investment involves creating the means of production. These may be tangible, such as
purchased or constructed equipment, whether replacement, expansion or diversication; or
they may be intangible, such as know-how, patents, etc.
There are two major types of assets:
Durable assets of the company whether goods, rights or claims: land, buildings, indus-
trial equipment, vehicles, patents, mineral rights, etc. These are called xed assets. These
xed assets appear in the balance sheet at their book value, that is, their cost of acquisition less depreciation (see prot and loss account). They may include securities, such
as shares in other companies, and goodwill. Goodwill is the excess of an enterprises fair
value over its book value at the date of acquisition.
Capital used in the companys operating activities or in short term operations. These are
known as the current assets. They meet various needs (a) to have a certain quantity of raw
materials, energy and services in hand in order to initiate operating activities, (b) to fund
the requirements resulting from the delay between the time when expenditure is incurred
in connection with an operation and the receipt of the corresponding revenue (working
capital) and (c) the need for liquid funds. These assets fall into the following three categories:
Stocks (non-capitalised), including raw materials, work in progress and nished
products. Stocks are generally either merchandise destined for sale or products which
will be used to manufacture this merchandise;
Accounts receivable: these are invoices issued and credited but still unpaid at the date
of the balance sheet. This amount can be considered a credit extended to customers
which needs to be nanced (trade debtors);
Liquid assets comprising cash balances or equivalent, such as cash accounts, bank
deposits and short-term investments which can be realized rapidly.
All these investments are included as assets in the balance sheet. They represent the total
assets which need to be nanced.
7A.1.2 Liabilities
Liabilities refer to all the sources of nance. There are effectively three forms of nance.
Equity capital i.e. the nancial resources provided by the shareholders. These are the funds
subscribed by investors when the shares were issued and retained earnings, i.e. earnings
which have not been distributed in the form of dividends (reserves). These funds have to
be remunerated, either by dividends or an increase in the value of the shares. Equity capital
is made up of shareholders equity and minority interests.
Long-term debt, made up of loans from banks, nancial markets and other companies, as
well as all the bonds and debentures of the company with a term greater than one year.
They include nancial debts (loans and bank overdrafts), provisions for the payment of
266
than one year, also referred to as current liabilities. These are partly operating debts.
Accounts payable arise in the same way as accounts receivable from clients, but in
relation to purchases from suppliers, and therefore comprise a source of nance. Other
operating debts refer to all non-nancial debts of the company such as taxes payable to
the inland revenue authorities, salaries payable, social security outstanding, etc. There are
also short-term debts, including bank overdrafts, those long-term debts which fall due
within a year, use of credit lines, etc.
The liabilities therefore represent all the funding available on the date at which the
balance sheet applies, and the assets represent the way these funds were applied.
LIABILITIES
Equity capital
Long-term debt
Working capital
Capital employed
Fixed assets
ASSETS
Current
liabilities
Operating debt
Short-term debt
Working capital (WC): the amount by which the permanent funds exceed net xed assets. It is therefore that part of the medium
and long term nancial resources which can be used to nance the operating activities.
Working capital requirement (WCR): amount of capital needed to allow the capital to nance its operating activities.
Net liquid assets (NLA): Short-term assets less short-term liabilities.
We therefore have: WC = WCR + NLA
267
Short-term nance, made up of all the companys debt with an outstanding term of less
Annexe to Chapter 7
pensions, provisions for restructuring, provisions for site rehabilitation and deferred taxes
(see 7A.4).
The balance sheet can also be presented with operating items separated from items related
to the nancing (Fig. 7A.2). We then have:
net debt: long- and short-term nancial debt minus the liquid assets;
operating liabilities: long-term provisions and deferred taxation.
Assets
Liabilities
Shareholders capital
Annexe to Chapter 7
Minority interests
Fixed assets
Net debt
Operating liabilities
7A.2
The prot and loss account is a synthesis of the accounting events during an accounting
period which increase (prot) or decrease (loss) the overall wealth of the owners. It incorporates all the revenues and costs during the period, the difference corresponding to the
prot/loss for the period.
The revenues are the events which add to the wealth of the owners. In the case of oil
companies these arise mainly from the sale of oil and gas. The costs, on the other hand, are
the items which deplete this wealth. The prot and loss account includes cash outows
resulting from the companys operations corresponding to the direct use of materials,
consumables and labour.
However the prot and loss account must also allow for the calculated costs associated
with the consumption, that is the wear and tear to the equipment and installations. These
installations are designed to last for a certain period. There is therefore a lag between the
time when their capital cost has to be disbursed, and therefore accounted for (this is done
in the ow of funds statement) and the times at which these capital assets are actually used.
The latter results in wear and tear which extends over time: this is depreciation, a non-cash
cost.
Depreciation
Net profit / loss
Financial income
The net prot provides the company with resources to pay a dividend to shareholders and
increase their equity.
Operating
costs
Depreciation
Operating
revenue
Gross operating
surplus
Taxation
Operating
profit / loss
Operating
profit / loss
after tax
The operating prot/loss represents the contribution to prot of each operating unit. It may
the effect of taxation on operating revenue. This tax is before taking credit for reliefs
relating to the servicing of debt. These reliefs are accounted for in the item cost of net
debt.
The net cost of debt is made up of costs and nancial credits directly attributable to the
items which make up the net debt (including the effect on taxation of these items).
The net prot/loss is therefore the operating prot/loss after tax less the net cost of debt.
269
Financial costs
Taxes
Sales
Annexe to Chapter 7
COSTS
REVENUE
Operating costs
7A.2.3 Depreciation
Wear and tear on the working equipment since its commissioning is reected in the balance
sheet item net xed assets, i.e. the value of the all investments less depreciation. The wear and
tear for a given year, on the other hand, appears in the prot and loss account in the form of
a debit: the allowance for depreciation. The term depreciation (instead of allowance for depreciation) is often used for convenience to designate this item in the prot and loss account.
The rules for calculating depreciation are imposed from outside the company. Three
separate practices can be distinguished:
Equipment wear and tear is assumed to be occur uniformly over its life. It is easy to see that
this does not apply to an oil or gas eld, since production declines over time.
Year
1
2
3
4
5
6
7
8
Investment
100
Net value
31.12
(1)
100
75.0
56.3
42.2
31.6
27.3
15.8
7.9
0.0
Depreciation
(2)
Straight-line over
remaining life
(3)
DDB
depreciation
(4)
Straightline
8 years
25.0
18.8
14.1
10.5
7.9
7.9
7.9
7.9
12.5
12.5
12.5
12.5
12.5
12.5
12.5
12.5
1. Net value at 31.12 in preceding year (1) less depreciation for the year (4).
2. 25% of net value at 31.12 in preceding year.
3. Net value at 31.12 in preceding year divided by remaining life.
4. Once the result in column (3) exceeds the result in column (2), it is taken until the end-of-life.
Annexe to Chapter 7
This recommendation complies with IFRS (IAS 16 Property, Plant, and Equipement).
Investments shared by several elds (treatment facilities, export pipelines) are amortised on
the basis of developed and undeveloped proven reserves, or even by straight-line depreciation (usually over 20 years).
Tax account
TAXABLE REVENUES
+ sales
+ nancial revenues
ALLOWABLE COSTS
royalties
operating costs
nancial costs
tax depreciation
= Taxable prot
= Adjustedtaxable prot
rate = TAX
+ accounting depreciation
COSTS
= cash ow
operating costs
accounting depreciation
= operating cash ow
investment
= available cash ow
+ change in debt
+ change in capital
dividends
= NET PROFIT
Full integration
Control on company
Yes
No
Jointly owned company
Oil/gas company held jointly
with other shareholders in
the common interest
Proportional integration
Yes
No
Equity method
Significant influence on company
273
The method chosen depends on the level of control, essentially given by the percentage of
the voting rights owned (Fig. 7A.6).
As dened in IAS 27 Consolidated and separate nancial statements, control is dened
as the power to direct the nancial and operational policies of an entity in order to obtain
economic benets from its activities.
The parent company is presumed to have control when it holds more than 50% of the
voting rights (exclusive control) or when, if it holds 50% or less than 50% of the voting
rights, it benets from:
Control of more than half the voting rights by virtue of an agreement with other
investors;
The power to direct the fmancial and operational policies of the entity under a statute
or an agreement;
The power to appoint or remove the majority of the members of the management
bodies;
The power to cast the majority of the votes at meetings of the Board of Directors or
the equivalent administrative body.
Joint control, as defmed in IAS 31 Interests in joint ventures, is the sharing of control of
an economic activity under a contractual agreement. This only exists if strategic nancial
and operational decisions in connection with that activity require the unanimous consent of
the parties who share control (co-venturers). Such a requirement ensures that no single
venturer is in a position to control the activity unilaterally.
Signicant inuence, as defmed in IAS 28 Investments in afliated companies, is the
power to participate in the nancial and operational policy decisions of the company without,
however, exercising control over these policies. This is assumed when the investor holds
directly or indirectly through subsidiaries 20% or more of the voting rights in the company
held (including potential voting rights).
The accounts of foreign subsidiaries are drawn up in the most important currency in the
particular economic environment concerned, described as the functional currency. In most
cases the functional currency is the local currency, except for a large number of subsidiaries
in the upstream petroleum sector for which the U.S. dollar is the most important currency.
The accounts are converted to the currency of the parent company at the rate applying on
the day the balance sheet is made, and at the mean annual rate for the prot and loss
accounts, conversion errors resulting being included in the equity capital.
Investments are usually depreciated in consolidated accounts by the straight-line method
over their life, with the notable exception of oil- and gas-producing assets, which are depreciated by the unit-of-production method, that is as a function of the production prole of the
eld.
The fact that different depreciation bases are used for the tax calculations and in the
consolidated accounts leads to the establishment in the consolidated balance sheet of an item
for deferred taxation (with variations in this item appearing in the prot and loss account:
provision for deferred taxation). These are equal, at any particular time, to the difference
between the value for tax purposes and the book value of an asset or liability, multiplied by
the most recent tax rate. Of course this difference is one of timing rather than in the total
amount, so that the deferred taxes reduce to nil by the time an asset reaches the end of its
life.
Table 7A.2 Balance sheet and prot and loss account of parent P and subsidiary S.
Balance sheet parent P
ASSETS
Net xed assets
Shares in S
Other assets
LIABILITIES
COSTS
12 000 Capital
900 Reserves
4 900 Prot for year
Debt
10 000
2 000
800
5 000
17 800
17 800
Operating costs
Financial costs
Taxes
Net prot
900
Other assets
900
Total
1 800
Capital
Reserves
Prot for year
Debt
10 000
10 000
LIABILITIES
Sales
10 000
REVENUES
8 000
500
700
800
COSTS
1 000
100
700
Operating costs
Financial costs
Taxes
Net prot
1 800
REVENUES
3 600
100
200
100
4 000
274
Sales
4 000
4 000
LIABILITIES
COSTS
Other assets
12 900 Capital
Reserves
5 800 Prot for year
Minority holdings
Debt
10 000
2 000
890
110
5 700
Total
18 700
18 700
Operating costs
Financial costs
Taxes
Net prot (P)
Net prot
(minority shareholder)
REVENUES
11 600
600
900
890
Sales
14 000
10
14 000
14 000
The consolidated balance sheet and prot and loss account are therefore as follows
(Table 7A.3):
Extract from balance sheet of company C:
Capital........................................................................................................
1 000 000 O
Reserves .....................................................................................................
200 000 O
Net prot....................................................................................................
40 000 O
The example below shows how the equity method of consolidation works. Company P
has acquired a 25% interest in company C for O 200 000.
The initial value of the shares included in the assets of P is replaced by the share of equity
capital (capital + reserves + net prot) which they represent in company C. The difference
relative to the original value of the holding is broken down between the items consolidated
Extract from balance sheet of company P:
ASSETS:
Equity interest in C ...................................................................................... 310 000 O
LIABILITIES:
Consolidation surplus (in consolidated reserves) ......................................... 100 000 O
Share of prots of afliates .........................................................................
10 000 O
275
10 000 O
Annexe to Chapter 7
An example of full integration is shown in Table 7A.2. Parent company P has a 90% stake
in a subsidiary S.
Corresponding items on the balance sheets and prot and loss accounts are rst summed.
Then:
The reference to holding of parent P in subsidiary S is removed;
The minority shareholders share in the net prot of S is entered into the prot and loss
account: Net prot (minority shareholder) = 10% 100 = 10;
The minority shareholders share in the capital and in the net prot is entered on the
liability side of the balance sheet: Minority holdings = (10% 100) + (10% 1 000)
= 110.
Health, safety,
the environment, ethics
277
The accident which befell the oil and gas production platform Piper Alpha in the North Sea
in 1988 called into question established offshore safety practices. This platform, situated
110 miles North-East of Aberdeen in Scotland, was destroyed in several hours following a
series of explosions, killing 167 persons. It led to production being stopped immediately, for
several months, at ve other elds, with a total loss of production of 300 000 bbl/d, representing 12% of the production of the North Sea. It was estimated at the time that the loss of
exports amounted to 550 million in 1988 and 800 million in 1989, with a loss of tax
revenue to the British government of 250 million in 19881989 and 520 million in
19891990.
The ndings of the enquiry conducted by Lord Cullen had a very major impact, leading
to a complete overhaul of the complex and sometimes conicting British supervisory system,
safety thereafter being overseen by a single administrative body, the Offshore Safety Division
of the HSE. The report also led to changes in the law, with greater emphasis on objectives
to be met. And nally it made clear the need for the development and application of a safety
management system (SMS) by all companies, a practise now regarded as standard in the
offshore industry.
This system is based on making a safety case demonstrating that the design, construction
and operation of every offshore installation is completely safe. It involves setting up training
and safety awareness-building programmes for both contracted personnel and others. It also
established a requirement for external safety audits. The safety case must be updated regularly and submitted to the HSE, which has to assess whether the document has identied,
assessed and controlled the main risks to an acceptable degree. This notwithstanding, the
operator retains full responsibility for the safety of operations.
Legislation varies between countries, but many of the companies operating in the North
Sea have applied the new approach to safety at other elds all over the world, and these practices have been disseminated throughout the entire oil industry.
8.2.2
Reducing risk
The central production facility must be designed in a manner such as to limit risk by reducing
the frequency of malfunctions and minimising their consequences. More specically this
means:
Minimising the likelihood of a loss of control of production and particularly of escapes;
Reducing the probability of ignition/explosion where there is an escape;
Containing the consequences of any re, explosion or escape of toxic substance;
As a last resort, ensuring that there are means of evacuation for all contingencies.
In order to bring this about, safety imperatives are integrated right from the preliminary
design stage into the overall layout, ensuring safe separations are respected, and systematically separating the oil and gas treatment plant from ignition sources. The organisation of
each project therefore draws on traditional risk management methods such as quality control,
risk assessment, safety reviews and audits.
The treatment plant is equipped with specic safety facilities, most commonly reghting
systems. It is always equipped with an integrated process control system and an emergency
278
8.2.3
Having looked at matters related to the design of installations, we shall now turn to safety
issues associated with operations.
shutdown (ESD) system. Detectors continuously monitor pressure, temperature, liquid levels,
etc. As an anti-re precaution, gas detectors automatically shut down production and dispatch
the contents of processing units to the are. If a re breaks out, re detectors automatically
trigger sprinklers in the zone where re was detected. Reliability calculations are carried out
for all safety systems which depend on sensors and automatic mechanisms (safety integrity
levels or SIL).
Other systems not directly related to oil processing have an essential safety function. The
ventilation of certain conned areas, for example, ensures that the concentrations of ammable gases will be kept below the lower ammable limit in the event of a leak.
Finally, safety precautions are put into effect on equipment whose main function is not
safety. The accommodation quarters in dangerous areas are designed to withstand explosion
and re, and an overpressure is maintained in order to prevent gas, smoke or toxic substances
from penetrating. The gangways and means of escape must be able to maintain their integrity
for a minimum period following re or an explosion. At each stage of a project safety
reviews are conducted which are intended to ensure that processes in the treatment plant are
robust. They identify the main hazardous events which threaten the installation: blowout, res
and explosions, escapes of hydrocarbons, ship collision, helicopter crash, etc. Estimates are
made of the probability of occurrence of such events. They describe the measures taken to
minimise the risks of accidents and identify their impacts: rewalls, re-extinguishing
systems, additional ventilation or the installation of walls able to withstand explosions,
training and simulation exercises, protected shelters for personnel in the event of a serious
accident. The consequences of every potential failure are evaluated in terms of human casualties, pollution and economic loss.
Safety is monitored and controlled throughout the entire lifetime of installations. Safety
systems and emergency procedures are developed by the operators. In the control room all
installations are continuously monitored; at the same time, rigorous maintenance is carried
out to prevent accidents and pollution. Those working in installations which process toxic
gases, for example hydrogen sulphide, are equipped with gas masks ready for immediate use
should there be a release. Gases no longer in their normal operating ranges are immediately
ared. Finally, all personnel must ensure, particularly offshore, that they are ready for an
emergency evacuation, a procedure practised regularly.
The EU Seveso II Directive, which took effect on 3 February 1999 and relates to the
prevention of major accidents, states clearly that it is the responsibility of all operating enterprises to practise a policy of prevention.
Management therefore has a clear responsibility to formulate a safety policy and make
organisational arrangements for safety. This legal requirement alone is sufcient argument
for the company to ensure that it has in place an effective safety management system.
281
diversity and cleaning up the legacy of historical contamination. The companies are highly
aware of the very severe nancial consequences of accidents and pollution in terms of nes,
compensation payments and the negative impact on their image. They fully appreciate the
need for their operations to be clean and safe.
The companies have a duty to minimise the risk of oilspills, the economic, ecological
and, for many, psychological consequences of which can be enormously damaging to the
industry. Over the last 20 years, and particularly since the Exxon Valdez catastrophe in 1989
and the high-prole hearing which followed leading to the award of massive compensation
payments, a battery of regulations and a whole range of technical measures have been put
in place internationally to contain possible disasters. Since the Kyoto Protocol in 1996
greenhouse gases, and combustion gases in particular, are under scrutiny. In response to
concerns about global warming, and driven also by states desirous of making the most of
their natural resources, the practice of aring associated gases is declining, these gases
instead being reinjected into the reservoir, used for secondary recovery or, when possible,
marketed.
A global initiative led by the World Bank the Global Gas Flaring reduction has the
aim to reduce signicantly the emissions of CO2 due to aring. According to this organisation, natural gas aring represents around 150 billion cubic meters every year, which is
more than the annual gas consumption of France and Germany and around 15% of
committed emission reduction by developed countries under the Kyoto protocol for 20082012. Flaring takes place all over the world, rstly in Africa (30%), Middle East (25%) and
the Former Soviet Union (20%) but also in the Americas (10%), Asia (10%) and Europe
(3%). Reducing aring is not a simple task as it means limiting the emissions of associated
gas in the process where the use or reinjection is not easy. The major international oil
companies are members of this initiative and some of them have indicated that in new
projects they will study and limit, as far as possible, aring of gas (for security reasons,
some aring during installation or closure is to be maintained). For many international
companies this Global gas aring reduction initiative will mean a very signicant
reduction of GHG emissions in the next 5 to 10 years. There is surely a need to associate
better national companies in areas like the Former Soviet Union and Middle East where
there is also an important aring of natural gas. It is still difcult to measure globally the
situation but there is a strong commitment of many actors to improve the impact of exploration and production in this area.
The main pollutants generated by exploration and production activities are sulphurous
gases. Nowadays measures are taken to purify these gases so that they comply with appropriate standards.
Liquid efuent poses a particular problem. Water is a by-product of oil production, and
the water naturally contains hydrocarbon emulsions. It is vital that the efuent is cleaned up
before being discharged. Efuent containing up to 40 ppm oil is presently tolerated, but oil
companies are seeking to impose a more stringent standard of 15 ppm. Production from
depleted reservoirs present difculties, because large quantities of water are used in the
production process.
Site rehabilitation at the end of eld life and in particular, the decommissioning of
offshore installations, are currently the focus of considerable attention. About a hundred platforms are dismantled every year in the Gulf of Mexico. International regulations, which are
only indicative, are generally implemented by host governments. They are currently being
toughened in order to increase the protection offered to the environment.
8.4.1
8.4.2
The approach depends on the type of operation involved, but it will any case be broadly
structured as follows.
It should be remembered that the baseline study and the impact assessment comprise initial
studies of the environmental risks.
Impact and risk assessments for modications or extensions of activities and installations;
Up-to-date operating procedures (management of waste and chemical products, procedures for dealing with incidents);
Emergency response plans (anti-pollution plan);
A programme of self-surveillance and monitoring involving the reporting of signicant
environmental indicators;
A programme of audits and environmental reviews.
8.4.3
Abandonment and decommissioning are dealt with by regulations. The rules governing
impact statements also often provide for account to be taken of site rehabilitation after
production has nished.
As far as onshore exploration and production are concerned, there are specic regulations
in most countries: a mining code, an oil and gas law or, as in France, an environmental law
for ICPE classied facilities or a police des mines(specic mining regulations). Offshore,
the disposal of platforms is dealt with by various international treaties and rules, including
UNCLOS (United Nations Convention on the Law of the Sea), the London Dumping
Convention, the IMO (International Maritime Organisation) and various UNEP conventions.
removed.
Platforms which are larger or located in deeper waters can be partially dismantled as long
dismantled.
For the North Sea and North Atlantic sectors, decommissioning is governed by Decision
Some major rehabilitation exercises and, in some cases, site redevelopments, have been
carried out recently, for example:
The reforestation of the site of an exploration well in the Madidi National Park in
Bolivia;
The restoration, re-vegetation and implementation of anti-erosion measures along a
pipeline route in South-East Asia (Burma);
The decontamination of groundwater at a eld in Argentina by means of vacuum
pumping together with a biological process (bioslurping);
The decommissioning of old platforms in the North Sea.
At all three of these sites the contamination/disturbance predated the acquisition. It is
therefore impossible to stress too strongly the importance of baseline audits, which allow the
division of responsibilities to be determined when contamination is an issue.
In conclusion, in implementing an environmental management system, identication and
prioritisation of the risks is a crucial rst step. But the dynamic element in the system which
ensures that the approach will be perpetuated and improvement implemented, is the audit.
By adhering to this approach the operating companies should have no difculty in
obtaining certication under ISO 1400 or EMAS.
But apart from the quest for recognition, the environmental management system, like
the safety system, must form a permanent part of an integrated approach to the management
of the entire exploration/production activity.
of which is to build awareness amongst managers and analyse the companys activity, not
only in economic terms but also in terms of safety, personnel satisfaction, environmental
results and relations with government. The system adopted by American companies, on the
other hand, emphasises the importance of motivating the personnel, cultural diversity, cost
control and the putting into practice, by management, of all the key elements.
Globalisation and technological progress have transformed the oil business, and nowadays
the public expects more of the multinationals. At present the oil industry has to operate on
the basis of three inseparable imperatives: economic development, social responsibility and
environmental protection.
The way in which the industry addresses safety and the environment has changed beyond
all recognition in the last 20 years. Safety, once considered the exclusive domain of the safety
department, has now become a concern of the company as a whole. Investment decisions
have to be based not only on economic feasibility but also have to factor in environmental
and social issues. Safety and environmental management have become an integral part of
the business. These matters become even more important when companies are operating in
harsh and sensitive environments such as deep offshore, tropical forests or the Arctic tundra,
and coming into contact with remote communities. The most apparent change in the
management of safety and the environment is probably the fact that commitments made by
the company are now publicised externally. The overall strategy and the objectives to be met
in these areas are communicated internally as well as to external partners and contractors,
who are expected to fall into line.
In many cases, oil companies try to take into account a price for CO2 in their evaluation
to measure the effects in terms of emissions. This leads to a limitation of these emissions
with regard to technical and economic conditions.
The term ethical is one which everyone seeks to appropriate: both politicians and those
who make it their job to monitor the behaviour of politicians, both businesses and their
critics. Amongst the most important stakeholders are the organisations referred to as NGOs,
i.e. non-governmental organisations, so as to highlight their separateness from the state and
supranational bodies whose function it is to make and uphold the law.
We will not ourselves attempt to dene the term ethical. Larousse denes it as the
science of morality; it derives from the Greek , or moral. Knowing what is moral
and what is not, is one of the earliest questions to preoccupy man. Aristotle wrote three books
on the subject, which remain reference works to the present day. It should perhaps be
remembered that moral codes are not universal, and can change over time. One of the most
variable areas in this regard, also in terms of its practical consequences, is probably that of
the relative importance of individual rights over those of the community as a whole.
A book on oil is not an appropriate arena for philosophical reection, and we shall try to
approach the problem of ethics by looking in practical terms at some real problems encountered by oil companies. We shall therefore attempt to tackle the most important of these
problems at the conuence between law, morality, commerce, technology and politics. In this
brief review we shall try to look at the expectations of public opinion and political leaders
as a means of shedding light on the difculties and contradictions which questions of ethics
pose for the oil industry.
In fact the oil industry has achieved an almost unique feat: it manages to project a
negative image both in the wealthy, developed or consuming countries (home countries)
and in the often poor and undeveloped oil-producing (host) countries. This doubly
unfavourable image is due to the fact that, for their part, consumers hold the oil industry
responsible for the prices, often considered excessive, of the fuels they use. People in
producing countries, on the other hand, often perceive oil companies as veritable states
within a state exploiting their natural wealth, causing pollution and economic and social
imbalances, or even political destabilisation, in their country.
In drawing up a list of the main ethical problems faced by the oil companies, it has been
possible to refer in recent years to documents which most of them have in their possession:
ethical charters and guidelines for conduct. These documents serve to complement more
traditional texts dealing with problems of health, safety and the environment (HSE).
Health, safety and the environment have already been dealt with in this book (Sections
8.1 to 8.4), and we shall only refer to them again where, because of their social and political
consequences, they have a genuinely ethical dimension which transcends purely technical
issues of prevention, or the rehabilitation of environmental degradation.
These problems are of three kinds:
1. Ethical issues which arise relating to the oil industry and direct stakeholders: the oil
companies, their employees, customers, suppliers, shareholders and partners.
2. Ethical issues relating to the relationships between the oil companies and the countries
where they pursue their exploration and production activities.
287
The vital economic role of oil and gas has a whole series of consequences which make for
a complex and potentially difcult relationship with society. Public acceptability is of course
one of the prerequisites for the harmonious development of any economic sector. An industry
can only nd and retain shareholders, employees, scientists and high-calibre managers if the
public understands its contribution to development, and believes that contribution to be
valuable, well managed, and acceptable on what might be called an ethical level.
8.6.1
These are the questions which weigh least heavily on public opinion, because they are
regarded as too specialised and of secondary importance compared with the fundamental
ethical issues, or the relations between the oil companies and host countries. Furthermore
they are not generally issues which are specic to the oil industry.
However this category includes quite a few important issues, which are indeed crucial to
the effective functioning of liberal and market economies. We shall consider a number of
examples.
First of all what should be the rights and duties of the companies in relation to the privacy
of their employees? Is it permissible, and to what extent, for a company to control how its
employees use their working time, their access to the Internet? Has it the right to limit their
political activity if this is judged potentially detrimental to or in conict with the activities of
the company? How can it be sure that none of its employees will get involved in insider dealing
on the stock exchange, or that they will not be tempted to accept some personal advantage if
their duties include procurement or the award of contracts? Will a company be able to guarantee that career progression and promotion to management will be purely merit-based, without
any form of discrimination based on gender, national or ethnic origin, religion or political afliation? These are well and truly ethical issues, as is the issue of equity in dealings with partners
and suppliers. Clear conicts of interest can arise between practical expediency and ethics. Is
it legitimate to favour one particular supplier of goods or services at the expense of others if
relations with that supplier accord with the logic of industrial strategy, partnership or regional
development? The oil industry has a symbiotic relationship with the service industries which
supply it and a number of special factors apply in consequence.
Many more examples could be mentioned, and we see that often there are different viewpoints, each in their way equally ethical, which can in practice conict with one another,
since they lead to different responses depending on which particular ethical aspect is regarded
as paramount. Consider, for example, the issue of ethical conduct towards shareholders. On
one hand there is a duty to ensure that information is transparent. On the other hand, there
is a duty to conduct commercial and industrial activities as efciently as possible. The latter
imperative, by its nature, tends to limit the transparency of information. Striking the right
balance between two ethical but conicting considerations is not a matter for detailed and
prescriptive rules. It has to be achieved by a combination of detailed knowledge and a good
understanding of the problem, a good dose of common sense and, ultimately, the moral qualities of those who will make the necessary choices.
There is a strong commitment to achieve a better balance between these two objectives.
And some of the Sarbanne-Oxley rules try to avoid the excesses found in the behaviour of
some companies like Enron.
8.6.2
This subject is one which nds a much more ready response amongst the general public, and
which involves a number of risks for oil companies, sometimes difcult to deal with.
288
In the face of these problems the foreign investor has to manage its own interests, not
having any real inuence over the political choices of the host country. Such an inuence
would in any case be unethical, since interference in the political problems of the country
would lack legitimacy. There would be no legality or morality supporting such interference.
Is the company qualied to decide what is desirable for the development of the country and
what is not?
Some individuals and NGOs in both producing and consuming countries consider,
however, that oil companies have a duty to intervene in these debates and decisions, i.e. to
get involved in local politics, in such situations.
Faced with dilemmas of this kind, the logical attitude on the part of the oil companies
would be to refrain from interfering in local political affairs. But they then run the risk of
being held jointly responsible for the injustices and even crimes perpetrated in the name of
the State or other authorities in the country. Such problems are not new: ethical debates still
continue today about the degree of culpability of Pontius Pilate!
289
Central to this issue is the nature of the contracts which dene the terms under which a
foreign company often powerful and usually from a developed country will invest in a
country which is often relatively undeveloped, and will be rewarded, if successful, for the
risks it has taken.
The terms of these contracts reect the characteristics of oil and gas exploration and
production, activities in which chance plays a large part, which are highly capitalistic in
nature, and which, when successful, have a major impact on the host country. These contracts
dene how the proceeds from the production will be split between the investors and the host
country. The appropriation and use of these proceeds, often large in amount, are a major
political issue. They rapidly become central to the economic and political life of the host
country, and are the root cause of a host of ethical problems which arise. These problems
usually lead to resentment on the part of the public in that country, or of external observers.
This resentment is not without foundation. Petroleum exploration activities generate large
nancial ows, and can lead to or exacerbate factionalism, or even fuel armed banditry. It
is not always possible to make a clear distinction between these two types of destabilisation
and violent disorder.
There have been many oil-producing countries in recent years where attempts have been
or are being made to seize power: examples include Angola, Burma, the Congo, Colombia,
Sudan, Algeria, while armed banditry in various forms is rife in Nigeria and now in Algeria.
In countries where the authority of the State is being violently challenged, the oil
companies are considered by the insurgents as natural enemies in so far as they pay taxes
to the State, and are often the largest contributors to their budgets. It is of course these
budgets which provide the State with the funding needed to maintain law and order or
exercise repression, the vocabulary used depending on the point-of-view of the speaker, i.e.
pro- or anti-government.
It is possible to draw up a list of problems created in practice by the management of oil
revenues. We only mention the most common ones, which are faced both by host countries
and oil companies. For the former the problems which crop up most frequently are:
Whether to use the revenues for development or for other purposes (prestige, arms, etc.);
Division of revenues between State and producing provinces or regions;
National or local development;
Risk of appropriation or misappropriation of a part of revenues for benet of individuals or clans.
Only someone completely ignorant of the distribution of oil and gas resources throughout
the world would subscribe to the idealistic argument that oil companies should only invest
in countries with acceptable regimes. Could useable criteria of acceptability be devised?
We might doubt that. In the absence of reasonably solid criteria, could we delegate to
particular authorities, and if so which ones, the task of deciding either to boycott new
investment or to discontinue activities in countries where investments have already been
made? It is clear that such authorities would need to have considerable legitimacy and
powers if their action is to be effective:
Economic powers to provide for compensation mechanisms should activities be
stopped;
Powers of inspection and sanctions to deal with non-compliance.
In other words, the authority would have to be a powerful supranational body.
In looking at questions of ethics which arise in relations between oil companies and host
countries, we conclude that oil does not necessarily, in itself, lead to economic and social
development, nor is it necessarily a democratising factor. However it will be appreciated that
the adverse effects will be less severe where the political system is perceived by its citizens
to be legitimate, and that these systems will permit the oil revenues to be distributed in an
equitable and balanced way.
Regimes of this kind would not necessarily have to conform to the model of parliamentary
democracy, although that is probably the model best able to reconcile oil and socio-economic
development or oil and ethics.
Some recent initiatives have to be mentioned:
Chad. In order to export the crude oil produced in the Doba Basin elds, the construction
of a more than 1,000 kilometres long oil pipeline between Doba and Kribi (Cameroon)
had to be built. However the construction of such a pipe line was costly and faced a large
number of environmental problems. To make it possible, it was necessary to bring the
World Bank into the project.
In 1999 the World Bank Chad agreement introduced an innovative scheme designed to
maximize the social use of oil revenues. With this system, all direct oil revenues (royalties
and dividends) are paid into a sequestered account in the name of the Chad Government
in London. After deduction of payments relating to the debts owed to the World Bank,
the remainder of the revenues is divided up as follows:
10% is paid into a fund for Future Generations, for the period after Chad's oil reserves
are exhausted,
72% goes toward capital investment in ve "priority sectors" in the ght against
poverty: education, health and social services, rural development, infrastructure and the
environment and water supplies.
4.5% is paid over to the oil-producing region of the Southern Chad, as additional
reserve nancing;
13.5% is paid into the Chad Treasury to nance current public expenditure.
But, the rise in the crude price put a new face on the situation. In January 2006, it led the
government to denounce the agreement with the World Bank. Clearly making such a
system sustainable over time is not easy. Nevertheless, this kind of agreements present
promising solutions to provide a better use of the energy revenues.
The Extractive industries transparency initiative (EITI) has the objective to provide for a
8.6.3
Quite apart from ethical questions, the activities of the oil companies mean that they are
involved in a whole range of issues of a general nature.
It should be remembered that oil products and gas are produced in order to meet societys
needs for energy. Approximately 50% of this energy is generated by the oxidation of the
carbon contained in hydrocarbons (40% or more for natural gas and more than 60% for oil
products). This results in the formation of carbon dioxide. This is in the nature of the
process, and technological progress cannot change it. On the other hand technology can help
us to reduce the amount of energy we consume to achieve a certain result, or perhaps even
to sequester some of the carbon dioxide produced. However this is not in itself what the
ethical debate is about. The debate arises from the fact that there is a correlation between
the temperature in the lower atmosphere and its carbon dioxide content. This carbon dioxide
content has been rising ever since the industrial revolution, and the question is to know
whether increasing consumption of fossil energy could lead to major climate change. Such
changes could be benecial to some (Siberia, Canada, Nordic countries) but disastrous to
others (countries with semi-arid climates and low-lying coastal regions in particular). These
debates of course go far beyond the connes of the petroleum industry, but the latter
inevitably occupies centre stage in relation both to the problems and the solutions or remedial
measures which will need to be taken.
This vast problem, known as the greenhouse effect, is not the only global or local environmental problem in which the oil industry is directly implicated. The climatic effect
caused by airborne particulate matter and the health effects of urban pollution are due in large
measure to the consumption of hydrocarbons. A number of ethical questions arise here
where political leaders have to make trade-offs, of their nature difcult to justify, between
short- and long-term effects, between public health and the economy. Although the oil
industry does not itself have to make these trade-offs, it is directly involved, at very least in
compiling technical reports which allow the facts to be established and understood before
deciding how to try to limit the impacts.
The oil industry is in particular heavily involved in transport-related problems. It has to
provide for the transport of large volumes of oil and gas by land and sea. A number of environmental questions arise in this connection also, both local (oil spills, etc.) and global (emissions of methane from urban gas distribution networks). These questions also involve
trade-offs between costs arising from the demands for ever greater safety and the implicit
and explicit costs of pollution, either local or global. This again gives rise to questions of
an ethical nature: what value should we attach, what priority should we give, to the survival
of a particular plant or animal species threatened with extinction, what value to the conservation of biodiversity? What value should we attach to a human life? There are so many
questions to which there are no natural and simple answers, whatever moral or philosophical
frame of reference we adopt.
291
better use of these revenues. This initiative is supported by more than 30 countries and
25 big oil, gas and mining companies. It is very interesting in that among the countries
there are some of the more important oil producers in Africa or Central Asia, such as
Nigeria, Gabon, Chad, Azerbaijan and Kazakhstan, Trinidad and Tobago. All the major
international oil companies either American or European are involved in this initiative.
A dynamic process has been initiated and it should provide for a better knowledge of
commodity revenues.
It is when major failures occur that these questions resurface: failures such as the wreck
of the Erika off the coast of Brittany in the last days of 1999. A detailed analysis of this
accident and its direct and indirect causes reminded all involved that only constant
improvement in international regulations will allow risks of this kind to be diminished. This
in no way means an abdication or absence of powers for national states. The latter have a
double task: to put their full weight behind ensuring that the international rules are the best
possible, and to ensure that the regulations are properly applied on their own territory as well
as by the companies under their jurisdiction.
A further point is that the objective of the oil companies is to produce fossil fuels, the
reserves of which are considerable but nite. This is not the least of the ethical problems.
To ensure that their activities are pursued within a framework of sustainable development,
the oil companies must involve themselves in developing techniques and policies for
reducing consumption so as to extend the era of oil and gas. Furthermore if they wish to
extend their role as energy suppliers into the very long term they will have to get involved
in the development of all forms of sustainable energy, whether renewable (solar, wind,
biomass, etc.) or simply durable, such as nuclear energy. This last category also poses its
own specic ethical problems.
No discussion, however brief, of the major ethical problems in which the oil industry nds
itself a participant can be complete without mentioning the question of human rights. We
have already observed, in looking at the relationships with producing countries, that although
the oil industry represents a source of wealth for these countries and therefore, potentially,
of development, it can also be associated with major breakdowns in the political and social
fabric, sometimes with tragic consequences. The oil industry therefore nds itself placed in
the dock, or even declared guilty, by public opinion when dictatorial political regimes
prosper, when civil war breaks out, or when cycles of violence and repression develop. In
situations of this kind the oil industry serves as a scapegoat, and has to face a range of consequences. In such cases, as for the environmental problems discussed earlier, there are unfortunately no simple rules or clear answers as to what constitutes ethical behaviour by oil
companies.
But there are areas where progress is being made, and these must be explored, in particular
through codes of conduct evolved between the governments of the countries of origin of the
large oil companies and the companies themselves. The U.S. Department of State, for
example, published an agreement of this type on 20 December, 2000, signed by the U.S. and
the UK as well as a number of oil and mining companies from these two countries. Agreements of this kind cannot in themselves resolve problems of political instability or violence,
but they have the merit of recognising that these situations exist, and of trying to articulate
explicit rules of conduct for the companies in such contexts. Agreements of this kind
comprise the rst steps towards wider agreements which will also ultimately involve the
governments of producing countries. We may be about to write a new chapter in international law, which recognises the right on the part of developed countries to interfere in the
way large international companies conduct themselves in other countries.
There is a clear movement from the oil industry to take into account the specic situation
of the host countries as they are long-term partners in extraction activity. The international
companies try increasingly to bring their contribution towards a sustainable development,
whether it is about the direct consequences of oil and gas extraction, or about the consequences of economic development. It has to be a balance between the need for direct intervention and the need not to interference with the central and local government of host
countries.
292
293
It may be only a modest start, but is a token of a growing awareness of global problems.
A global village needs global rules. In future the oil industry will not only have to comply
with the rules but also to assume an important responsibility in ensuring that these rules are
realistic, effective and ethical. If the oil industry succeeds in setting behavioural standards
for the rest of industry, it will have fully accepted the responsibilities conferred on it by its
economic weight and by the technical and human resources which it possesses.
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298
Chapter 1
Chapter 2
Chapter 3
Chapter 4
Chapter 5
Chapter 6
Chapter 7
Chapter 8
Glossary
Piping cemented into the internal wall of a well in order to maintain it.
CIF (Cost, insurance, freight) Cost of crude oil or product which includes insurance and
sea freight to the destination port.
Club of Rome Think tank in the 1970s renowned for publicising the risks of depletion of
natural resources due to over rapid economic growth.
Commercial discovery A discovery of hydrocarbons the commercial potential of which
has been demonstrated by an operator based on technical, economic, contractual and scal
parameters. A discovery cannot be developed and exploited until it has been declared
commercial.
Completion The operation of deploying production equipment in an oil well.
Concession An arrangement by which the state grants the exploration and production
rights within a given zone to the concessionaire who, in the case of commercial production,
becomes the benecial owner of the entire production in exchange for payment of the appropriate taxes (essentially a royalty on production and a tax on prots). The term also means,
in some countries, the legal title to mineral hydrocarbons authorising exploitation, or in some
countries, the contract associated with this mineral title.
299
Glossary
Consolidated prot Accumulated net prot/loss, both national and international, of the
parent company and all its branches and subsidiaries in which it holds a signicant share of
the voting rights.
Constant money
a reference year.
Dubai
Economic rent The difference between the value of production (gross revenue) and the
technical costs (capital and operating costs), before tax.
Equivalent cost
time, we have:
When the equivalent cost (annual or unit) can be assumed stable over
Equivalent annual cost: the annuity equivalent to the discounted capital and operating
expenditure.
Equivalent unit cost: the ratio of the total discounted expenditure to the total discounted
production.
Exploration costs Costs incurred before the discovery of a eld, including costs related
to the seismic/geophysical programme, the geological and geophysical interpretation, the
exploration drilling including the test wells.
Extra heavy crude Very heavy crude (specic gravity greater than 1, so API less than
10), found particularly in Venezuela in the Orinoco basin. The Orinoco crude is a non
conventional one since, before use, it needs a special treatment to make it suitable for
processing in a traditional renery
Field A eld can be dened as a receptacle comprising a permeable rock reservoir sealed by
a cap made of impermeable rock and a favourable subsoil conguration referred to as a trap.
There are different types of trap, including structural traps, stratigraphic traps and mixed traps.
Fiscal regime or Taxation system The totality of scal and contractual conditions which
determine how the oil prots are shared between the state and the holder of exploration and
production rights
FOB (free on board) The FOB price is the price of a crude oil or of a product when loaded
onto a ship at the port of embarkation. In principle at any given time there is only one FOB
price for a port (Ras Tanura for Arabian Light, Sullom Voe for Brent, Bonny for the Nigerian
crude of that name) whereas there are as many CIF see CIF prices as there are destination ports.
Foot rate contract Type of contract signed between a petroleum industry service
company and an oil company where the latter controls the operations and the former is remunerated according to some measurable unit of activity (for example per metre drilled in the
case of a drilling company).
Full cost method Accounting method dened by SFAS 19 and applying to exploration
and production expenditure. All expenditures (exploration and development) are capitalised.
Futures markets Financial markets on which normalised contracts for crude or petroleum
products are exchanged. They meet the needs of operators to protect themselves or exploit price
uctuations using hedging, arbitrage and speculation. Physical deliveries account for only a
small part of the transactions effected on futures markets. Orders are transmitted by a broker
and the security of operations is guaranteed by means of deposits to a clearing house. The main
markets are the NYMEX (New York) the ICE (London) and the SIMEX (Singapore).
Gas cap Gas already separated from the oil in an oileld, most often situated close to the
top of the structure.
301
Glossary
annual rate (this rate is specic to the company) to future receipts and expenditures to
estimate their present value. Discounting tends to reduce the importance of future cash ows.
Glossary
Gas lift Production process involving gas injection which serves to emulsify and lighten
the oil column.
Gas oil A petroleum cut which can be used for diesel oil or heating oil manufacturing
Gearing Ratio of debt to equity.
Geneva Agreements Agreements (signed in 1972) between OPEC and the oil companies
which provided for an increase in oil prices to allow for the devaluation of the dollar.
GOSP (government ofcial selling price) Between the rst oil shock (1973) and the
beginning of the eighties, the prices of the various crude oils GOSP were xed by the
OPEC governments. These prices replaced posted prices.
Government take The total revenues accruing to the government including the earnings
of the national oil company. It can be expressed as a percentage of the economic rent, and
measures the severity (from the investors point of view) of the scal regime.
Heating oil
buildings.
Hydrocarbon tenement Legal document, often in the form of a decree, which assigns
exploration rights (exploration licence) or production rights (production licence or
concession) to a party.
IFP (now IFP Energies nouvelles) French Petroleum Institute, a scientic institute devoted
to research, training and documentation, founded in 1944, from which has emerged an
extensive structure of companies and consultancy services.
Internal rate of return (IRR) Discount rate at which the net present value of a project is
nil. When unique, this is the maximum rate for which the project revenues allow the invested
capital to be remunerated without the project going into decit. In this case a project for
which the IRR is greater than the discount rate has a positive net present value. On the other
hand in choosing between several competing projects, it is not necessarily that with the
highest IRR which is the best (highest net present value is a better criterion).
Jet fuel
Kerosene Petroleum product from distillation which can be used for lighting or as jet fuel.
Logging while drilling (LWD) Technique consisting of recording, at the bottom of the well
during drilling, by means of sensors deployed in the drilling equipment, physical parameters
which allow the nature of the formations, their pressure regimes and the uids of which they
are composed to be characterised.
Logging The recording of certain electrical, acoustic and radioactive characteristics of
geological formations.
Migration
reservoir.
Monte Carlo Simulation method used, in particular, to determine the probability distribution function of a variable (e.g. net present value) which is a function of other variables
with given probability distribution functions.
302
National oil company Oil company fully owned by the state or in which the state has a
majority holding, to which the government delegates the role of supervising oil operations
and managing that part of the production accruing to the state where applicable.
Net present value (NPV) The sum of the present values of the cash ows associated with
a project. An investment project with a positive NPV will repay the investment giving a
return equal to the discount rate and produce a surplus whose present value is equal to the
NPV.
Netback The netback value of a crude is equal to the value of the products obtained from
its processing less rening and transport costs. The netback value of a crude can be compared
with its FOB price. If the netback value exceeds the FOB price the rener will make a prot,
otherwise he will make a loss.
Nominal value Value expressed in current money.
Non conventional hydrocarbons These are hydrocarbons which, unlike conventional
hydrocarbons, are difcult and costly to produce, and whose physical characteristics and
geographical situation are exceptional. Non conventional oils include extra heavy oil (from
Orinoco) and tar sands (from Athabasca Canada) which both need a special processing
before treatment in traditional reneries. Non conventional oil includes also ultra deep
offshore elds.
Offshore Refers to any exploration or production activity at sea, in contrast with onshore
activities. The term ultradeep offshore refers to petroleum activities carried out at great depth.
Oil quotas In 1982 the OPEC countries established quotas, or production ceilings, as a
means of regulating prices. Since that date, each OPEC member state has had to remain
within a production ceiling, adjusted periodically in the light of market conditions.
Oil sands Very heavy crude oil of specic gravity around 1 (or 10 API), close to tar, in
sand reservoirs. There are very large deposits of tar sands in Athabasca, Canada. The
production of oil from these sands is currently being developed.
OPEC Organisation of petroleum exporting countries, created on 14 September 1960 by
Saudi Arabia, Iraq, Iran, Kuwait and Venezuela.
Opening up Many producing countries nationalised their oilelds in the 1970s. Now
certain countries are reopening their doors, allowing foreign companies to operate in their
territory.
Operating cash ow
project.
Options Financial instrument giving the holder the option to buy (call) or sell (put) a
contract at a given price until a given date. If the option is not exercised before it expires,
the holders loss is limited to the price paid, whereas there is no limit to his possible gain.
The price of the option represents the market value of the option.
Parafn Petroleum product used for lighting (also known as kerosene).
303
Glossary
Mud logging A technique which involves the acquisition and interpretation at the surface
of samples, data and information, making use of the mud circuit.
Glossary
Petrol (gasolineUS)
Petroleum price shock Term used to describe a large increase in oil prices, particularly
the rst price shock of 1973 and the second price shock of 1979 1981.
Petroleum system Designates the interplay of the geochemical, geological and physical
parameters, the processes and the genetically related hydrocarbons which lead to seepage and
accumulations of hydrocarbons originating from a given source rock.
Production plateau
Production prole The way the production level of an oil or gaseld varies over time.
Early in the production phase there is a steep build up in production, after which there is
usually a period of stable production (plateau) followed by a progressive decline.
Production Sharing Contract Arrangement by which exploration and production rights
in a given zone are granted by the state to a contractor who, in the event of commercial
production, can recover his costs from a part of the production (cost oil) and obtain a return
on part of the remaining production (prot oil), the balance accruing to the state.
Prot oil In a Production Sharing Contract, that part of production remaining after the cost
oil. This part is shared between the contractor and the state on the terms agreed in the
contract.
R/P
Real value
Recovery rate Ratio of reserves to resources. Recovery rate is between 5 and 80 % for
crude oil depending upon eld and oil characteristics. Average value (for crude oil) is
around 35 %. For natural gas recovery rate is around 80 %.
Red line Line drawn on the map of the Middle East in 1928 in discussions between the
partners in the Iraq Petroleum Company. This line marked a region within which the partner
companies in the IPC were obliged to act in concert.
Reserves There are many denitions of hydrocarbon reserves. The reader is referred to the
index, which cross references these various denitions. In general when the term reserves
is used as such, it is synonymous with the term proven reserves.
Resources Total quantity of hydrocarbons physically present in the ground.
Riser Pipe connecting the seaoor with the surface during submarine drilling.
Royalties Under a concession system, the owner of land mineral rights (generally the state)
grants an operator the right to produce oil in exchange for the payment of royalties equal to
a percentage of the crude price. This royalty, often xed at 12.5% of the crude price, can
vary depending on the price of the crude and the characteristics of the eld.
SEC
Spot market A market in which deals are struck on the day itself, with prices being xed
at the time. The products traded are physical cargoes of crude and rened products. There
is no ofcial record of transactions effected between operators, but estimates are published
by specialised journals such as Platts. There are spot price estimates for both crudes and
for the principal products for the main consuming and rening regions: Rotterdam or North
West Europe, the Mediterranean, the Gulf, Singapore, the Caribbean, the U.S. The spot price
of the main crudes (Brent, WTI, Duba) act as indicators of crude prices and as reference
price in certain indexation clauses. There is also a spot market for vessel charter.
Spot
State participation Contractual provision by which the state has the option to participate
in the contract in partnership with the contractor, to the extent of its participation.
Success rate Ratio of nondry wells drilled to the total number drilled.
Successful efforts method The accounting method dened in SFAS 19 applying to the
expenditure associated with exploration and production. The costs of the geology geophysics
and unsuccessful exploration are expensed.
Swaps A type of paper contract in which the difference is bought between its values
quoted on the spot and forward markets. This instrument allows oil companies to make sales
to their customers for delivery several months hence (up to one year) at a guaranteed xed
price.
Tax In a concessionary system, the operator pays the owner of the eld not only royalties
but also a tax on prots.
Technical cost Total costs : exploration + development + production costs
Teheran Agreements Agreements (signed in 1971) between OPEC and the oil companies
which provided for programmed increases in oil prices for the Gulf producers.
Traders Persons who buy and sell commodities, currencies or nancial instruments. Unlike
a broker, whose function is merely to act as an intermediary between a buyer and a seller,
traders buy and sell cargoes on their own account and therefore are exposed to signicant
risk. A petroleum trader may be attached to a producing country, belong to an oil company
or a nancial group or be an independent. See also Broker.
Trading Buying and selling.
Tripoli Agreements Agreements (signed in 1971) between OPEC and the oil companies
which provided for programmed increases in the price of oil available in the Mediterranean.
Turnkey contract, rm price contract Type of contract made between an oil company
and a petroleum industry service company. Unlike a cost reimbursement contract or a contract
based on a work specication, the contractor is responsible for the operations and is paid for
services rendered (a drilling project, for example) at a contractually agreed overall price.
Unitisation Contractual clause providing for the unied operations for a eld extending
over several contractual zones exploited by different operators.
Uplift Device equivalent to an investment credit authorising the holder of production
rights to write off (in the case of a concession) or recover (in the case of shared production)
a sum in excess of the actual investments.
305
Glossary
SFAS
Glossary
Wire line logging A technique which involves using sensors lowered on the end of an
electric cable to record physical parameters such that the nature of the formations, their
pressure regimes, the uids of which they are composed can be characterised.
WTI (West Texas Intermediate) Reference crude in the U.S., on both the spot and NYMEX
markets.
306
=
=
=
=
=
=
=
=
=
Petroleum units
Gas units
1 Tm3 = 35.3 T cu ft (1 T cu ft = 28 G m3)
1 boe = 5.35 k cu ft (1 k cu ft = 0.18 boe)
XIV
INDEX
Index Terms
Links
A
Abandonment
186
Achnacarry Agreement
18
AGIP
23
Agreements
302
geneva
302
teheran
305
tripoli
305
197
305
Alaska
25
Anglo-Iranian
12
21
Anglo-Persian
12
14
15
17
19
46
Arab Light
30
44
Aramco
20
Arbitrage
50
Arbitration
191
Azerbaijan
B
Bahrain
19
Baku
Balance sheet
266
Balikpapan
10
Barges
73
Benchmarking
Between Iraq and Iran
9
11
254
31
Index Terms
Links
Bonus
194
Brent
48
Brent blend
44
12
Buyback contracts
195
203
C
C.S. Gulbenkian
Cash flow statement
18
271
Casing
73
Caspian
Caspian Sea
CFP
15
9
16
17
18
Churchill
12
CIF
45
Clemenceau
15
Club of Rome
25
Commerciality
185
Compaction
61
15
Competent authority
17
176
Completion
86
Concession
174
179
193
206
Consolidated accounts
272
Contract
164
day-rate
164
foot-rate
164
turnkey
164
Conventional hydrocarbons
99
180
Index Terms
Cost
Links
221
equivalent cost
221
Cost oil
200
Costs
125
127
131
156
158
255
270
271
256
capitalised
255
development
131
exploration
125
incurred
256
operating
156
trends
127
Counter-shock
35
D
Decision trees
234
Decommissioning
284
Deep offshore
100
Depletion rate
259
Depreciation
250
declining balance
271
straight-line
271
UOP
250
Derivatives
49
Derrick
73
Deutsche Bank
17
Diesel
Diesel oil
44
Diesel-oil
Discordance
61
Discount rate
217
Dubai
44
49
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Index Terms
Links
E
Economic reproduction
109
Ekofisk
44
Elf
15
EMS
144
ENI
15
EPC
144
Expected value
231
Exploration
Extra-heavy oils
Exxon
110
20
20
65
100
7
F
FASB (Financial Accounting Standards Board)
Fina
245
20
Finding cost
259
FOB
45
Forward
49
100
111
247
Futures
49
Futures markets
48
50
G
Gas cap
79
Gas clause
192
Gas hydrates
104
Gasoline
Geneva
27
111
44
23
Index Terms
Geology
Links
67
organic geochemistry
67
sedimentology
67
stratigraphy
67
structural geology
67
Geophysics
68
Ghawar
44
47
Government take
209
Gulf
12
Gulf of Mexico
25
12
Gulf plus
47
H
Heavy fuel
Heavy oils
100
Henry Deterding
11
Horizontal drilling
85
Hubbert theory
Hydrocarbons in place
recoverable
46
105
95
95
I
IEA
Incentives
INOC
29
50
193
204
25
Installations
137
production
137
transport
137
23
207
Index Terms
Links
Intensity of
259
220
Investment
259
Investment credit
197
200
208
10
J
Jackup
73
Jet-fuel
44
John D. Rockefeller
Jossef Djugashvili
K
Kerosene
Kirkuk
18
Kuwait
19
Lacq
21
22
Law
175
Legislation
175
LNG cycle
151
Logging
176
75
75
mud log
75
wireline logging
75
Lognormal distribution
96
M
Majors
Marcus
10
20
36
Index Terms
Links
Marcus Samuel
10
Marne taxis
14
Mesopotamia
15
Mexico
13
Mining title
174
N
Nationalisations
28
219
Netback
35
Nobel
Non-conventional gas
Non-conventional hydrocarbons
Norsk Hydro
102
99
167
O
OAPEC
28
Oil shales
101
Oil shock
27
Oklahoma
45
OPEC
Optimists
Options
28
30
24
28
30
31
32
33
109
110
49
Ownership
171
172
P
Participation
207
Permeable
65
Pessimists
109
Petrol
110
3
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194
Index Terms
Links
Petroleum system
65
Platforms
73
Polar zones
Porosity
103
65
Production profiles
104
Production sharing
174
179
180
207
Profit and loss account
268
Profit oil
200
208
Q
Quotas
34
R
R/P
108
Ras Tanura
45
Recovery
80
enhanced
80
primary
80
Recovery factor
108
Recovery ratio
96
Red Line
18
Regulations
177
Relinquishment
183
Rent
178
Reserve
258
261
replacement cost
260
replacement rate
258
Reserve ratio
19
260
252
199
Index Terms
Reserves
Links
93
1P, 2P and 3P
97
conventional
94
non-conventional
94
97
possible
98
probable
98
proven
98
SFAS 69 definition
ultimate
95
248
45
248
93
Resources
95
Rigs
73
Ring-fencing
196
179
Rockefeller
Rothschild
15
194
195
206
Samuel
11
Saudi
202
203
Royalty
Saudi Arabia
SEC
19
244
Sedimentary basins
61
Seismic
69
reflection
Semi-submersibles
Service contract
Seven sisters
69
73
180
23
245
Index Terms
Links
Shell
Sherman Act
25
Slot ratio
10
11
252
Socal
19
Sovereignty
171
Spar
149
Spindletop in 1900
12
Spot markets
48
173
Stalin
Standard Oil
10
15
18
194
205
State participation
188
State take
209
Statoil
167
Subsidence
61
Success rate
108
246
Suez Canal
25
Swaps
49
Synthetic oils
102
T
Tax
176
207
Tax incentives
190
Taxation
197
202
Teheran Agreement
27
Texaco
12
19
Texas
12
45
46
Title
199
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Index Terms
Links
Traders
50
Trap
64
stratigraphic
64
structural
64
Tripoli Agreement
27
Tubing
87
17
U
Ultra-deep offshore
100
Unitisation
186
Uplift
197
Uplifts
207
208
V
Venezuela
Volga
13
4
W
Walter Teagle
46
Well capping
284
Wellhead
87
William dArcy
12
Winston Churchill
Work programme
184
Work programmes
187
Workover
89
WTI
49