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Deepwater Economics: A Case Study of Nigeria

Emmanuel I. Onwuka, SPE, AUST; Omowumi O. Iledare, SPE, LSU Center for Energy Studies; Joseph C. Echendu, SPE,

AUST

This paper was prepared for presentation at the Nigeria Annual International Conference and Exhibition held in Abuja, Nigeria, 68 August 2012.

This paper was selected for presentation by an SPE program committee following review of information contained in an abstract submitted by the author(s). Contents of the paper have not been reviewed by the

Society of Petroleum Engineers and are subject to correction by the author(s). The material does not necessarily reflect any position of the Society of Petroleum Engineers, its officers, or members. Electronic

reproduction, distribution, or storage of any part of this paper without the written consent of the Society of Petroleum Engineers is prohibited. Permission to reproduce in print is restricted to an abstract of not more

than 300 words; illustrations may not be copied. The abstract must contain conspicuous acknowledgment of SPE copyright.

Upstream petroleum industry remains one of the most prolific in contractor-payout while the net present value is negatively

terms of technology and risk capital transfer and rewards. impacted by accelerated extraction.

Consequently, governments all over the world try to formulate

fiscal regimes that could favourably attract investments to Introduction

petroleum provinces in their jurisdiction. Fiscal systems that are

progressive tend to find a common ground for both government Exploration & Production business in Nigeria started in 1938

and the contractor by optimizing efforts and benefits. Nigeria when Shell DArcy was granted a prospecting licence. However, it

belongs to a region of low-risk hydrocarbon discovery relative to became prominent shortly after the company completed the first

the world average. Therefore, the government designs fiscal well, Oloibiri 1 in 1956. Since then, crude oil reserves have

regimes that would seemingly extract more economic rent from increased to 37.2 billion barrels, representing 2.7% of world total

the development of its petroleum resources. This paper reserves as of January 1, 2012. These reserves are found in

investigates the impact of some of the technical instruments in the offshore and onshore basins in Nigeria. Following the world trend,

Nigerian PSC on rewards from deepwater investments. the potential for offshore oil and gas production in Nigeria has

increased in comparison to onshore operations in recent years. But

Discounted economic models are developed for two petroleum investment in the deepwater requires huge risk capital. Therefore,

sharing contracts in Nigeria- the 2005 PSC and the interagency the investor is naturally attracted to a clime that guarantees him

team (IAT) redraft of the 2008 Petroleum Industry Bill (PIB)-with early return on investment as well as maximum economic benefit.

due consideration to the three Arps production decline profiles.

Different tangible CAPEX depreciation methods are imposed on According to Iledare (2010), the structure and conduct of the

the models and profitability indicators are estimated. Monte Carlo global E&P industry have changed significantly over the years; to

simulation analysis is applied to resolve the stochastic nature of the extent that the search for and development of petroleum

some model input variables. resources have become mostly driven by the attractiveness of

fiscal regimes rather than geological prospectivity only. The

Simulation results show that maximum reward is observed when petroleum fiscal system (PFS) contains the terms and conditions

Unit of Production (UOP) depreciation method is applied in the that govern E & P business, constituting an important factor that

redraft 2008 PIB; while straight line depreciation (SLD) gives influences investors project evaluation. It can only be said to be

better economic metrics for the 2005 PSC keeping all the terms of natural for petroleum provinces with low exploration and

the contractual arrangements constant. These results could be discovery risks to crave for more access to gross revenue.

applied in formulation of petroleum fiscal policies like the PIB by

making cost depreciation a form of incentive. It is found that for a For example, the government of Brazil on discovering large oil

specific fiscal contract, cost depreciation method influences reserves in the pre-salt areas of Santos Basin proposed to change

economic indices when used in project evaluation. Irrespective of the fiscal system from R/T to PSC because exploration risk in this

2 SPE 163007

basin is very low. Evidently, government wants larger share of oil and natural gas reserves are generally classified under two

Production (Lima et al, 2010). Similarly, Nigeria over the years categories or divisions:

has set up different series of PSCs with the more recent ones

attracting more revenue to government. And once again, in August Proved developed reserves

2008 government started a process of changing the terms of the Proved undeveloped reserves

current fiscal regime. This proposed fiscal system, popularly

called the Petroleum Industry Bill (PIB), is the work of the Oil and Generally speaking, proved reserves must be recoverable with a

Gas Implementation Committee (OGIC) sent to the National high degree of confidence if estimated by deterministic methods.

Assembly for passage into an Act. It must have at least a probability of 90 percent that the actual

recovery exceeds the estimated quantities, if probabilistic methods

The hitches surrounding the passage of this bill insinuate that risks are used. For the most part, probable and possible reserves cannot

and rewards in the E & P business have not been adequately be used for economic evaluation as they do not constitute

harmonized. Therefore, this calls for thorough and insightful bankable assets (Deloitte, 2003). Therefore, serious consideration

petroleum project re-evaluation that would bring about empirical is given mainly to proved reserves in petroleum project evaluation.

evidence that reflects reality and hence leads to informed decision

making. Estimating Reserves Volumes

Petroleum project evaluation involves determining the volume of Reserves estimating methods usually are categorized into three

reserves that is recoverable within prevailing economic and families:

technological realities. This is done for tax accounting, financing,

budgeting and unitization purposes as well as setting of 1. Analogy

depreciation and decline rates for future production predictions.

2. Volumetric,

In the study of petroleum project evaluations, many researchers

including Lima et al. (2010), Vikas et al (1997), Iledare (2010) 3. Performance techniques.

and Oyekunle (2011), by assumption, built cash flow models

based on production forecasts that are predicated on exponential The performance technique methods usually are subdivided into

decline pattern, which is widely accepted as conservative and easy simulation studies, material-balance calculations, and decline

to compute. This evaluation assumption is oblivion to the fact that curve analyses.

production decline pattern is a natural phenomenon controlled by

complex petrophysical and fluid behavioural tendencies of the Reserves estimation by analogy is a way of characterizing

reservoir. Consequently, there is a need for a thorough re- reserves in a field by assuming production forecast in adjacent

evaluation of all petroleum production decline options including field with similar properties. Forrest (1985) stated that if little or

hyperbolic and harmonic decline patterns. However, irrespective no production from the target formation exists, then statistical data

of the decline pattern encountered, it is also necessary to consider from wells completed in formations having characteristics

investment costs in terms of all methods of depreciation not just anticipated for the target zone are used.

straight line spread method, as commonly assumed during

economic evaluations, especially when the fiscal system does not

Mian (2002) identified reserves estimation by volumetric

specify depreciation options.

analysis as a method used in the early life of a reservoir. He

recognized that reservoir heterogeneities are a commonly

This paper evaluates the effects the IAT redraft PIB and the

overlooked factor which makes the volumetric estimates often

existing 2005 PSC may have on the economic rewards of

different from those obtained by evaluating performance. The

deepwater investment with emphasis on the impact of production

data required for estimating the initial oil in place N, are formation

decline methods and the cost depreciation patterns on project

thickness (h, feet), drainage area (A, acres), porosity (!, fraction),

economics and government take statistics. To achieve this,

formation oil saturation (So, fraction) and oil formation volume

production and cost assumptions reflecting Niger-Delta offshore

factor (Bo, RB/STB). The following equation is used in estimating

basin are applied to formulate spreadsheet discounted cash flow

the initial oil in place.

models for these two production sharing contracts in Nigeria.

!!"#! ! ! !!" !"

Theoretical Background !! !!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!

!!"

The availability of petroleum resources drives the desire to

venture into oil and gas investment. Petroleum resources represent Where!!!" !!"!!"#!!"#$%&'"(!!"#$%!!"#$%"#&'(.

the stock of hydrocarbon deemed extractable in an undefined

future. The resources presumed recoverable under currently For gas reservoir, the initial gas in place, G is calculated by the

known technology and economic conditions are referred to as following equation.

proved reserves. Eggleston (1962) documented that proved crude

SPE 163007 3

!"#$%! ! ! !!" !" decline naturally in any of these three ways:

!! !!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!

!!"

Exponential

Where !!" !!"!!"#!!"#!!"#$%&'"(!!"#$%&!!"#$%&!!!"! !"#!

Hyperbolic

Reserves estimation by reservoir simulation requires that the

reservoir be divided into units called cells. For each cell, Harmonic

permeability, porosity, thickness, elevation, saturation (initial),

initial pressure, rock compressibility and other reservoir properties Fetkovich (1980) developed a comprehensive set of type curves to

are assigned. According to Ogbe (2011), petroleum reservoir enhance the application of decline curve analysis. These curves are

simulation is the planning, construction and operation of a model variants of a hyperbola. Poston (2009) recognized that in order to

whose behaviour approximates the behaviour of the actual locate a hyperbola in space one must know the following three

reservoir. It involves building of models. This means that for each variables.

reservoir, a unique model must be built. For reservoir simulation

to be successful there has to be sufficient data of very high quality, The starting point on the y axis. (qi ), initial rate.

which would be inputted into the model in order to have a good

history match. It has been observed that obtaining a good history (Di ).the initial decline rate

match is not easy. Consequently, performance prediction generally

depends on quality history match. It has the advantage of handling The degree of curvature of the line (b).

different rock and fluid properties in different areas of the

reservoir. It can also predict production from individual wells. Applying this Arps concepts, (b = 0) defines the exponential case,

Once history match is obtained, quality reserves estimation can be (0<b<1) for the hyperbolic case, and (b = 1) for the harmonic case.

guaranteed.

McCray (1975) expressed the general equation of a hyperbola as

Reserves estimation by material balance is a method of shown in equation 4 below.

petroleum evaluation in which the reservoir is considered to be

zero dimensional, hence evaluated using a tank model. It is based !

on volume to volume replacement of the reservoir fluid extracted. !

!" !"

It works on a very simple computational principle as presented in ! ! !!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!

!"

the equation below.

Setting the decline exponent b to 0, 0<b<1 and 1 and solving

Volume entering-Volume leaving=Net change in Volume (3) equation 4 would yield the Arps decline equations for

exponential, hyperbolic and harmonic production decline curves

As simple as it may look, much data is required to account for any respectively. This is summarized in Table 1. Exponential decline

change in fluid volume in the reservoir. In computation, there is easier to compute and presents conservative estimates of

must be an understanding of the drive mechanism prevailing in the production with respect to time. According to Lin et al (1982),

reservoir. This means it can be used later in the life of the hyperbolic decline is the most realistic but difficult to compute

reservoir, as drive mechanism can only be ascertained if there is due to two unknowns in its equation (Di and b) while the

on-going reservoir fluid flow. This is a very accurate method if harmonic is rarely encountered in natural reservoirs.

there are enough data for computation. Data required includes

pressure, production history, fluid properties and rock properties.

The advantages include that there is no assumptions necessary for Petroleum Production Economics

areal extent, thickness or recovery factor. However, accurate

pressure data are not easy to come by. The previous section discussed estimation of reserves and

production performance as being the first step to an economic

analysis of a petroleum venture. Subsequently, the investor is

Reserves estimation by decline curve analysis is a procedure

interested in knowing the interplay between the hydrocarbon

used for analysing declining production rates, and forecasting

market price and the actual costs of extraction and handling. The

future performance of oil and gas wells. It involves curve-fitting

resultant economic metrics would determine whether the venture

the past production performance using rate time data and

adds value to the corporation.

extrapolating the curve to predict future performance. The

assumption is that the conditions surrounding past production

The price of crude oil and in some cases the price of natural gas to

remain the same in the future. Compared to other methods, decline

a large extent drive E & P activities and they are the most

curve analysis requires minimum amount of data.

uncertain economic items of interest in the economic evaluation

process. In addition, the cost of production varies from one

location to another. The fiscal regimes may stipulate how these

4 SPE 163007

costs are treated. For example, the 2005 PSC in clear terms ! !!!

stipulates that depreciation shall be by 5-year straight line, !"#$ ! !!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!! !

!

whereas, the IAT redraft PIB section 400 sub 4 states that the Where t, is the useful life of the asset.

contract shall determine the treatment of the recoverable costs, SOYD is then used in the calculation of the depreciation given

including whether costs shall be expensed or depreciated, the cost, C, the remaining useful life, !! and the salvage value of the

method of depreciation and the treatment of pre-production costs. asset, S. Thus

A recoverable cost can either be expensed or depreciated for cost

recovery and tax calculation purposes (IAT, 2009). !! ! !!!! !

!! ! !!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!

!"#$

CAPEX Depreciation Options

Unit of production depreciation (UOP): When an asset loses

For the purpose of this paper, depreciation is defined as a loss in value not because of time lapse but due to the service it renders,

the value of an asset over its useful life. It is a method of then its depreciation is best determined using UOP depreciation.

redistribution of tangible costs over a period of time, called useful The unit of comparison is not time but the total life time activity,

life, for income tax calculation purposes. The different methods of A of the depreciable asset. This is determined as ratio of the

depreciation applied for the purpose of this paper are: annual production, !! , to total production, !! , attained during

the useful life of the asset. Thus

Straight line depreciation (SLD)

Declining balance depreciation (DBD) !! ! !!!! !

Sum of years digit depreciation (SOY) !! ! !!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!

!!

Unit of production depreciation (UOP)

Nigerian Petroleum Fiscal System Overview

There are other variants of depreciation methods which could

involve switching from one method to the other. According to Johnston (2003), there are two major classifications

of petroleum fiscal system in the world. These are

Straight Line Depreciation (SLD): This method involves

distributing depreciable cost equally over the useful life of the Concessionary or Royalty & Tax (R/T) system

asset. Given depreciable cost, C, the useful life, t and the salvage

Contractual system

value, S, of the asset, Straight Line Depreciation (SLD) is given

by equation 5.

In Nigeria, Joint venture agreements (JVA) and PSC are mostly

!!! operational. JVA is basically R/T with government participation.

!! ! !!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!! Most deepwater operations are under PSC regimes. Nigeria has

! different sets of PSC used in the deepwater ventures. These are

Where !! is the depreciation factor.

1993, 2000 and 2005 PSCs. The petroleum industry bill when

passed into an Act will be listed alongside the existing PSC series.

Declining balance depreciation (DBD): This method is used

The summaries of terms and instruments in the 2005 PSC and the

when it is certain that the benefits derived from the asset decline

Proposed PIB 2009 are presented in Tables 2 and 3, respectively.

over time. As standalone, this method is an accelerated

depreciation method. A switch to straight line method is allowed.

There are different types of DBD: 200%, 175%, 150% and 125% Methodology

declining balance methods. In order to obtain a fixed percentage

depreciation rate, any of these methods could be divided by the The spreadsheet modelling approach similar to that adopted by

useful life of the asset. The initial value (cost) of the asset is then Mian (2002), Johnston (2003) and Iledare (2010) was used in this

multiplied by this factor. The result obtained is subtracted from study. Assumptions of a prolific deep offshore field with huge

the initial cost of the asset to determine the book value of the asset crude oil reserves, good recovery factor, reasonable peak

in the following year. This process is repeated until the useful life production capacity and decision-based decline patterns were

of the asset is complete. However, a constant comparison with made.

SLD is made each year and the greater between the two

depreciation deductions is taken. Production profile was first developed by transforming all the

Arps equations, as summarized in Table 1, into an automated

Sum of years digit depreciation (SOY): A declining charge is spreadsheet-based program. This program generates production

applied to the depreciable cost each year. The declining charge is forecasts under exponential, hyperbolic and harmonic decline

determined by dividing the remaining useful life of the asset by conditions, automatically. The profile reflecting the three phases

the sum of the years digits (SOYD) calculated as shown in of production is as shown in Figure 1.

equation 6.

Oil price was applied to the production forecasts to generate gross

revenue. The price was made to be either real or nominal by

SPE 163007 5

applying the GDP price deflator as may be necessary in order to To measure the economic performance of a deep water venture,

account for inflation. profitability indicators were included in the model. These are

objective measures of the economic worth of the investment. They

Front loaded government payments, FLGT, were determined from include

the gross revenue and eligible technical costs based on the

stipulations of the two contractual contracts, which are: PSC 2005 Net present value (NPV)

and the IAT redraft PIB 2009. These payments include royalties, Payout Period (PP)

rentals, signature bonuses, NDDC and institutional levies where Growth Rate of Return (GRR)

applicable. Front Loading Index (FLI)

Total technical costs were treated in two ways: exploration

CAPEX and operating costs were expensed hence recovered in the Net Present Value (NPV): This is also known as present value of

year they were incurred; development CAPEX was depreciated cash surplus or present worth. It is obtained by subtracting the

hence they were spread beyond the year expended. Depreciation present value of periodic cash outflows from the present value of

method applied was an option between SLD, SOY, DBD or UOP the periodic cash inflows. It is normally calculated at a discount

in the model as described earlier. rate, id which should reflect the value of the alternative use of

funds. It is given as

Cost recovery specifications of the fiscal regimes were duly

imposed on the model. Eligible recoverable costs were determined !

!"#!

and removed from the cost oil which was obtained by removing !"# ! !!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!

the royalties from the gross revenue and multiplying by cost ! ! !! !

!!!

recovery limit factor. This was used to recover all eligible costs in

a production year. Costs not recovered were carried forward Where !"#! ! !"#!!"#!"#$%&'!!"#!!!"#$!!"!!"#!!"#$!!!

indefinitely until they were fully recovered. The difference

between the gross revenue and the cost oil gives the profit oil. This study adopted the year end discounting method to arrive at

Excess cost recovery, ECR, is the cost oil after all the eligible NPV. As a decision criterion, NPV is desired to be positive in

costs have been recovered. ECR and the profit oil were shared project ranking.

between the host government and the contractor based on

respective fiscal provisions presented in Tables 2 and 3. Payout Period (PP): This is also referred to as the breakeven

point. It is the expected number of years required for recovering

The before income tax (BIT) cash flow was developed in the the original investment. At this point, the receipt exactly equals

model by applying certain taxes and levies, which are not the the cash disbursements. On its own it cannot provide a yardstick

federal income taxes. These were strictly defined by the respective for meaningful decision making. Low payback is desirable in

fiscal systems, given that tax deductible items could vary from one decision making. It is calculated by the following equation.

fiscal system to another. For PIB 2009, the BIT is basically a cash

flow for Nigerian Hydrocarbon Tax (NHT) calculations. For the !!!!"!!"#!

!! ! !"#! !!"!!"# !"#$% ! ! !!!!!!!!!!!!!!!"!

2005 PSC, it is basically a cash flow for education tax !!"!!"# ! !!!"!!"#!

calculations. The host government BIT take, !"#!"# , was

obtained as the sum of FLGT, share of profit oil and the non- Growth Rate of Return (GRR): Since many managers believe IRR

federal income tax, while the contractor BIT take, !"!"# !!was is not a reliable profitability indicator, then GRR was introduced.

obtained by subtracting !"#!"# !and technical costs from gross It is also referred to as equity rate of return or modified IRR. GRR

revenue. resolves the shortcomings of IRR like trial-and-error calculations,

reinvestment rate assumptions etc. In terms of PI, it is thus

The after income tax (AIT) cash flow was calculated in the model calculated.

by applying the federal income tax to assessable profit, as defined

by the respective fiscal systems. In PIB 2009, the AIT cash flow !"" ! !"

!

! ! ! !! ! !!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!

includes calculations for corporate income tax (CITA) and

education tax. It was also observed in the model that NHT is not Equation 11 is based on annual compounding. A project is

deductible for CITA calculations. In 2005 PSC, it involves

desirable if GRR is greater than the hurdle rate, !! .

calculations for petroleum profit tax (PPT).

Front-end Loading Index (FLI): This throws more light on the

The host government AIT take, !"#!"# , for the PIB 2009 model

spread in the discounted and undiscounted takes. FLI of zero

was the sum of !"#!"# , CITA and education tax, while in 2005

indicates an ideal condition in which a fiscal system presents no

PSC, it was the sum of !"#!"# , host government share of profit front-end loading at all. The higher the FLI, the more front-end

oil (!"#!" ) and PPT. The contractor take in both fiscal regimes loaded the fiscal regime becomes. The fiscal conditions that

was the difference between gross revenue and the sum of the present very high FLI becomes less attractive to the contractor.

!"#!"# and technical costs. FLI is calculated from equation 12.

6 SPE 163007

!"# ! ! !!!!!!!!!!!!!!!!!!!!!!"!

!"#$%&'(")*#!!"#$%&'$&(!!"#$

Table 4 shows the summary of economic measures obtained using

These economic metric measures were used as outputs to perform the base inputs assumed. The best case contractor NPV of $557.63

sensitivity analysis on various input parameters using two methods million was obtained as the production was made to decline in

exponential manner while UOP CAPEX depreciation option was

Monte Carlo simulation via @RISK imposed on the cash flow model, whereas the worst case NPV of

Designed model manual variations. $26.11 million was obtained as the production declined in

harmonic manner given DBD CAPEX depreciation option.

Results and Discussions Similarly, the best case payout period of 7.72 years was obtained

as the production was made to decline in exponential manner

This section presents deterministic as well as stochastic results for while imposing the UOP CAPEX depreciation option on the

both 2005 PSC and PIB 2009 obtained by various input variations model. Harmonic DBD scenario presented the worst payout

in the models developed. period of 9.74 years. On the basis of FLI, similar pattern was

observed; the exponential UOP scenario presented the best case

Base case assumptions result of 0.055 while harmonic DBD scenario gave the worst

case performance of 0.207.

The following assumptions were made to arrive at the

deterministic results presented in this section. These include The results indicate that no matter how the reservoir declines, if

unit of production CAPEX depreciation option is imposed on the

Real oil price of $80/STB cash flow evaluation, the investor receives the best possible

Price and cost escalation of 1% reward from his investment. This is supported by the fact that the

Hurdle rate of 12.5% PIB 2009 has royalties and profit sharing tied to production. Using

UOP CAPEX depreciation option in this fiscal regime can

All development and facilities costs were 100% depreciated

effectively cushion the effect of host governments high rent

Total CAPEX was taken to be 20% of the production worth of

extraction. This depreciation method ensures that at the peak of

the field size and operating cost was about 9.4% of annual

production, the proportion of cost to be recovered by the investor

production.

is maximum despite huge royalty imposition. It is only natural and

Field size of about 200MMSTB

fair to recover more cost when production is more and vice versa.

Percentage of production before decline was 32.7% of Contrarily, using other depreciation methods in this fiscal regime

ultimate recovery. would amount to more economic rent to the host government as

Peak capacity was fixed at 0.04% of field size per day and the cost recovery economics may not encourage the contractor in

lasted for two years terms of NPV, payout period, FLI and discounted takes.

Production build up lasted for three years from 1000 STB/D

till peak capacity. This paper indicates that host governments can imbed in fiscal

Economic limit was constrained at 100 STB/D systems of this nature, CAPEX depreciation options as forms of

The hyperbolic decline curve exponent, b was taken to be incentive to the contractor. This way, the front-end loading index

0.5194 of the fiscal regime could become more progressive.

Gas production was considered uneconomic.

1000 m of water depth fiscal terms and conditions were Deterministic Results for 2005 PSC

invoked.

Table 5 is the summary of the objective functions given the

Empirical Results assumed base inputs. The presentation pattern established above

would be followed in this section. The best case contractor NPV

Twelve input scenarios are created in the models by varying the of $540.95 million was obtained as the production was made to

four depreciation methods against the three production decline decline exponentially while SLD CAPEX depreciation option was

patterns for each fiscal system. For the purpose of this study, the imposed on the cash flow model, whereas the worst case NPV of

terms of the fiscal regimes are made constant, that is to say that $180.32 million was obtained as the production declined

terms such as royalty rates, tax rates and other levies are not in any harmonically given DBD CAPEX depreciation option. Unlike the

way varied but used as stipulated by the fiscal regimes. This NPV, the best case payout period of 7.66 years was obtained as

means that the economic performance presented in this paper is a the production was made to decline in exponential manner while

strict functional variation of the twelve decline-depreciation imposing the UOP CAPEX depreciation option on the model. Just

scenarios created. The results (profitability indicators) are like in the PIB 2009 fiscal system, the harmonic DBD scenario

discussed as either best case or the worst case on the basis of the presented the worst payout period of 9.09 years. Better FLI was

scenario variations. obtained in the 2005 PSC than in the PIB 2009. The exponential

SLD scenario presented the best case result of 0.020 while

SPE 163007 7

harmonic DBD scenario gave the worst case performance of estimate stochastic values for NPV, payout period, GRR and FLI

0.099. for each PSC under consideration.

If the reservoir declines either exponentially or harmonically, the The Stochastic Results for PIB 2009

SLD CAPEX depreciation option would present marginally, the

best NPV and FLI while hyperbolic decline production evaluated The stochastic results from the best case input scenario are in

by UOP CAPEX depreciation option would give the best NPV and consistent consonance with those obtained from the deterministic

FLI. However, irrespective of the production decline pattern approach. This was observed when production was made to

encountered, UOP depreciation would present the best payout decline exponentially as UOP CAPEX depreciation option was

period as most of the CAPEX invested would be recovered during employed in the cash flow analysis.

the assumed three-year peak production period. This cannot be This combination presented a maximum payout period of 8.06

said to be true for other depreciation options that are not sensitive years. The economic performance showed a minimum contractor

to variation in production levels. However, the NPV and FLI may NPV of $135.92 million and a maximum of $639.61 million.

not follow production trend as royalty and profit sharing are not There was a 50% confidence that FLI would be between 0.064 and

tied to production but to water depth and R-factor respectively. 0.077 with corresponding GRR range of between 14.44% to

15.25%. The summary of the results for the best case scenario is

The economic performance of other scenarios would lie between presented in Figure 2 to Figure 5.

the best and worst case results presented here. For example, if a

decline is hyperbolic, irrespective of the CAPEX depreciation The worst case scenario just like in the deterministic approach was

option chosen the NPV ranges from $26.11 million to $557.63 obtained when a production declined harmonically with cash flow

million for PIB 2009 and $180.32 million to $540.95 million for evaluation that employed DBD CAPEX depreciation option. The

2005 PSC. result showed a minimum NPV of -$304.28 million and a

maximum of $ 258.56 million. There was 50% chance that the FLI

The Stochastic Results would be between 0.21 and 0.28. The minimum period to recover

initial capital investment was 9.7 years.

In order to resolve the uncertainties inherent in some of the input

variables, Monte Carlo simulation method was applied using The best case scenario presents economic metrics that are highly

Palisade @RISK, an MS Excel add-in. Probability distributions favourable to the contractor as the minimum NPV is positive. Also

were imposed on the inputs to reflect their behaviour ( range of the front-end loading effect of the fiscal regime on the contractor

values) in a given probability domain. economics is very mild and acceptable. However, the worst case

scenario presents harsh economic conditions to the contractor who

Table 6 presents a summary of the inputs considered and their could lose immensely going by the negative minimum NPV

assumed distributions. results. If at all the initial cost can be recovered, it will take a very

long time as indicated by the payout period.

Recovery factor was assumed to have a normal distribution with

35% of original oil in place as mean value. It can be easily observed that the stochastic results confirm those

presented in the deterministic approach.

The field size was given lognormal distribution with values

ranging from 2475 acres to positive infinity. The Stochastic Results for the 2005 PSC

Initial production rate was assumed to have normal distribution The results for the 2005 PSC model revealed that on the average,

with 1000stb/d as mean value. exponentially declining production evaluated by SLD method

yielded the best economic metrics for the contractor when

The peak capacity was given a lognormal distribution with 0.04% compared with other decline depreciation scenarios examined.

of field size as minimum value. This combination gave a maximum payout period of 8.53years

with a minimum contractor NPV of $130.93 million and

Total CAPEX and crude oil price were given triangular maximum of $765.71 million. The maximum FLI observed was

distribution in which minimum, most likely and maximum values 0.091 with a 50% confidence that the GRR would go between

were as defined in Table 6. 14.47% and 15.22%. However, for quicker investment payout, the

UOP depreciation represented the best option irrespective of the

Finally, cumulative production before decline is assigned a decline pattern undertaken by the production. The summary of the

lognormal distribution whose value ranged from 20% to 50% of best case is presented in Figures 6 to 9.

the ultimate recovery.

The worst case scenario is similar to that observed in the

For each of the twelve scenarios established, 5000 iterations of the deterministic analysis. The harmonic decline-DBD CAPEX

statistical inputs were carried out in two simulation runs to depreciation presented minimum contractor NPV of -$50.78

million and a maximum of $412.62 million. The observed

8 SPE 163007

maximum FLI was 0.36 while there was a 50% chance that payout Stream. All opinions, errors, findings and recommendations

period would go between 9.11 years and 9.41 years. expressed in this paper are those of the authors.

The best case results present a highly favourable economic metrics Nomenclature

to the contractor considering the profitability indicators used in

this research. If production declines in a way that is not AIT After Income Tax

exponential there are possibilities of making losses no matter what BIT Before Income Tax

depreciation method is employed. This risk may increase as CAPEX Capital Expenditure

decline goes from exponential to hyperbolic and finally to CITA Corporate Income Tax

harmonic. It can only make sense to use depreciation methods that CPI Consumer Price Index

can mitigate any economic regressiveness or uncertainty that may CT Contractor Take

arise from any production decline pattern presented by natural CUM. Cumulative

phenomena taking place in the reservoir. DBD Declining Balance Depreciation

DCT Discounted Contractor Take

Generally, stochastic results show that the contractor has slightly ECR Excess Cost Recovery

more favourable economic metric measures under 2005 PSC than FLGT Front Loaded Government Take

in the PIB 2009 cash flow model. It is also noted that considering G Original Gas in Place, scf

the NPV sensitivities, very high cumulative production before GDP Gross Domestic Product

decline, impacts negatively on NPV of the contractor as shown in GRR Growth Rate of Returns

Tornado charts of Figures 4 and 8. This means that depleting the HGT Host Government Take

reservoir at a very high production rate will lead to more crude oil HC Hydrocarbon

being bypassed in the reservoir. Consequently, secondary recovery IRR Internal Rate of Returns

measures become imminent early in the life of the reservoir and JVA Joint Venture Agreement

hence more cost implications. This may lower the net cash flow of N Original Oil in Place, stb

the venture and subsequently the NPV. NCF Net Cash Flow

NHT Nigerian Hydrocarbon Tax

Summary and Conclusions NPV Net Present Value

PFS Petroleum Fiscal System

Discounted cash flow models have been successfully developed PI Profitability Index

for 2005 PSC and PIB 2009 fiscal systems. PIB Petroleum Industry Bill

PO Profit Oil

Production decline patterns and tangible CAPEX depreciation are PPT Petroleum Production Tax

successfully integrated into the models. These have tremendous PROD. Production

impact on rewards of investment. PSC Production Sharing Contract

R/T Royalty and Tax

Both deterministic and probabilistic results can be obtained from SLD Straight Line Depreciation

the models developed. SOY Sum of Years Digit Depreciation

TC Technical Cost

The deterministic results under PIB 2009 show that applying UOP UOP Unit of Production Depreciation

method of depreciation to a reservoir declining exponentially ai Initial Decline Rate, per time

offers the most favourable economic metric measures to the qi Initial Prod. Rate, stb/time

contractor, while SLD method is the most favourable under 2005 qt Prod. Rate at any time t, stb/time

PSC, given the same production decline pattern. Np Cum. Prod., stb

b Hyperbolic exponent.

The stochastic results also give similar trends as the deterministic

results. However, it becomes clearer that 2005 PSC would allow

the contractor a higher maximum discounted take.

of reserves produced before production decline commences.

Acknowledgments

The authors would like to acknowledge the support of Petroleum

Technology Development Fund and the management of African

University of Science and Technology, Petroleum Engineering

SPE 163007 9

2011.

1. Arps J.J. Analysis of Decline Curves. TRANS AIME Vol. 23. Oyekunle A.A, Impact of the Petroleum Industry Bill on

160, 228 247, 1945 deepwater Economics, SPE 150774, 2011.

2. BP world energy statistics, 2011 24. Poston S., A two-day lecture on Decline Curves sponsored by

3. Center for Energy Economics, Fiscal Terms for Upstream Hamilton Group Company, 2009.

Projects An Overview, University of Texas at Austin. 25. Vikas S., Eppink J., Godec M. Application of a

4. Department of Petroleum Resources, Business Opportunities Decision-Making Model for Economic Evaluation of

in Nigeria and the E&P Environment, A Paper Presented at Production-Sharing Contracts in India, SPE PAPER 38780,

International Oil and Gas Business Days Conference, Norway, 1997.

August 26 -28, 2003.

5. Egbon F., Offshore Technology, AUST-Total lecture manual,

2011.

6. Eggleston W. S., AIME, What are Petroleum Reserves? SPE

Paper 255, 1962.

7. Fetkovich M. J., Decline Curve Analysis using Type Curves,

SPE 4629, 1980.

8. Financial Reporting in the Global Mining Industry, Deloitte

Toche Tohmastu Publication, 2003.

9. Forrest A. G., Oil and Gas Reserves Classification, Estimation

and Evaluation, SPE Distinguished Author Series, 1985.

10. Iledare O. O., Evaluating the Impact of Fiscal Provisions in

the Draft Petroleum Industry Bill on offshore E&P Economics

and Take Statistics in Nigeria. SPE 136972, 2010.

11. Iledare O.O, Advanced Petroleum Economics lecture notes.

African University of Science and Technology, Abuja, 2011.

12. Inter- Agency Team, Petroleum Industry Bill (PIB) redraft,

2009.

13. Johnston D., International Exploration Economics, Risk and

Contract analysis, PennWell Books, 2003.

14. Lima G.A.C., Ravagnani A.T.F.S.G., Schiozer D.J.,

Proposed Brazilian Fiscal System for Pre-Salt Production

Projects: A Comparative Study of Gain and Loss of

Government and Companies, SPE PAPER 139311, 2010.

15. Lin C., Rowland D. A., Determining the Constants of

Hyperbolic Production Decline by Linear Graphical Method,

unsolicited issue, 1982.

16. McCray A. W., Petroleum Evaluations and Economic

Decisions, Prentice-Hall Inc. publications, 1975.

17. Mian M.A., Project Economics and decision Analysis,

volumes 1, PennWell Corporation, 2002.

18. Mian M.A., Project Economics and decision Analysis,

volumes 2, PennWell Corporation, 2002.

19. Muscolino R., Rizzo C.A., Mirabelli G., The Cost Recovery

Oil in a Production Sharing Agreement, SPE 25844, 1993.

20. NNPC Annual Statistic Bulletin, 2010.

21. Nwonodi C., Eluozo B. A., Kwelle S. O., A Stochastic

Approach to Offshore Stranded Gas Project Investment

Analysis in Nigeria, OWA conference and exhibition, 2008.

10 SPE 16300

DECLINE !! ! !! !! ! !!

!! !! !! !!

RATE,(!!! ) !! !! !! !! !!!!! !!

! !! ! !"

!" !! !! ! !! !! ! !! ! !!

PROD.RATE, !! !"#!!!!! !! !! !!

!

(!! ) ! ! !!! ! ! ! ! !! !

CUM.PROD, !! ! !! !! !! !!!!! !! !!

!! !"

(!! ) !! !!! !! ! !! !! !! !!

Table 2: Typical 2005 PSC Fiscal Terms and Instruments (source: Nwonodi et al, 2008)

SPE 163007 11

A=EF?GE-DE-^=?J/C

=>? TFGJAF?-IF6

!"#$%&'($)*( !" #$%!&" $!" !" #$%!&"

'()*'+, &-.-$/012 $-.-!-/012 3!/012 &-.-#&&//4512 3#&&//4512

6*788'9-97:,+ &-.-!/012 !-.-$&/012 3$&/012 &-.-$&&//4512 3$&&//4512

;,,<-97:,+ &-.-!&/012 !&-.-#&&/012 3#&&/012 &-.-!&&//4512 3!&&//4512

A=EF?GE-DE-^F?JC

=>?-@A>BC-@CA- IF6-@A>BC-

DD? A=EF?GEH-" @CA-//DGJ A=EF?GEH-"

K&-.-KL& & K&-.K$ &

KL&-.-K#&& &%M1K K$-.KL &%$1#&4,(:)

K#&&-.-K#M& #$N&%$1K KL-.-K#O #&N&%#!1#&4,(:)

K#M&-.-K#P& $&N&%#1K K#O-.-K#P #PN&%#&1#&4,(:)

6@CB>F?-@A=;JBG>=T-F??=QFTBC6

FACF- F??=QFTBC BJ/%-@A=;%-U//D08V

_X(UKO&1D08H-O&"-'5-@+X4,V #&

=T6[=AC

_X(UK#$1D08H-O&"-'5-@+X4,V aL!

_X(UKO&1D08H-O&"-'5-@+X4,V $&

6[F??=Q-QFGCA

_X(UK#$1D08H-O&"-'5-@+X4,V a#!&

;CC@-QFGCA _X(U-K-L1D08H-O&"-'5-@+X4,V 788-<+'2%-?,`,8)

;C;JBG>D?C-Z=ACS@ R&"

CS@CT;>GJAC BF@CS =@CS

FBGJF?-Z=AC>IT-CS@ L!" !&"

F??=QFD?C-Z=AC>IT-CS@ R!" P&"

@A=;JBG>=T-F??=QFTBC-@CA-6GD K-----------------L%&&

F??=QFD?C-@A>BC-?>/>G O&"

T>I%-[B-GFS-UT[GV O&"

B>GF O&"

C;JBFG>=T-GFS $"

;>6B=JTG-AFGC #O"

A>ZG-K1D08 &%!

T;;B O"

@A=Z>G-6[FA>TI

T<-U//D08V L!& #&&& $&&& 3$&&&

"-6*7+, &%$ &%O &%M (,W':X708,

ACTGF?6

?>BCT6C-UK1)\]/V

ECFA @C? @@? @/?

# #& #&& #&&&&

$ #& #&& #&&&&

O #& O&& #&&&&

M #& O&& #&&&&

! #& !&& #&&&&

YN #& !&& #&&&&

12 SPE 163007

)#)&A/+/A&(03+/A")%(A)B+!0C+>669

)3A,"(0$ 2A!(7 2A350,A+&#!A !"#$%&'#()*+ ,!-'.//* 0(( !0 1(( 23& 450

+.*%&+&/'"-0

8 )52 :78: ;6:7<< >;796D 87=8 8<7;D 8@766D 676?:

!)*+#,%-'(

!"#$%&'(

)#)&C/+/C&(03+/C")%(C)D+!)3+:66@

)3C,"(0$ 2C!(7 2C350,C+&#!C !"#$%&'#()*+ ,!-'.//* 0(( !0 1(( 23& 450

+.*%&+&/'"-0

!)*+#,%-'(

!"#$%&'(

SPE 163007 13

RiskNormal(0.35,0.035,RiskTruncate(0.1,0.

STOIIP

Recovery factor F10 6),RiskStatic(0.35),RiskName("Recovery 10% 35% 60%

INPUT

factor"))

STOIIP RiskLognorm(247.5,247.5,RiskShift(2475),R

FIELD SIZE H9 2475 2722.5 +!

INPUT iskStatic(2475),RiskName("FIELD SIZE"))

INPUT RiskNormal(1000,100,RiskStatic(1000),Risk

Initial Prod.rate C8 -! 1,000 +!

PROD. Name("Initial Prod.rate"))

RiskLognorm(0.00004,0.00004,RiskShift(0.

INPUT

Peak capacity G7 0004),RiskStatic(0.0004),RiskName("Peak 0.040% 0.044% +!

PROD.

capacity"))

COST

TOTAL CAPEX C1 RiskTriang(0.2,0.25,0.3,RiskStatic(0.2)) 20% 25% 30%

OUTLAY

FISCAL

OIL PRICE, $/STB / NOMINAL C6 RiskTriang(60,80,100,RiskStatic(80)) 60 80 100

TERMS

E15 20.0% 26.0% 50.0%

= INPUT .2,0.5),RiskStatic(0.327))

*+,-4567-)&%"8-)

+!"

*!"

)!"

!"#$%&'#()*+,-.)/0,12$)

(!"

'!"

&!"

%!"

$!"

#!"

!"

$!#!" $!#$" $!#&" $!#(" $!#*" $!$!" $!$$" $!$&" $!$(" $!$*"

!"#$%&'#()3-+")

14 SPE 163007

224 286 14.44%15.25%

0.010 70

0.009

60

0.008

0.007 50

0.006

40

0.005

30

0.004

0.003 20

0.002

10

0.001

0.000 0

12%

14%

16%

18%

20%

22%

24%

26%

100

200

300

400

500

600

700

CONTRACTOR($MM) CONTRACTOR

Figure 2: NPV @ 12.5% for PIB 2009 Exponential UOP Figure 3: GRR for PIB 2009 Exponential UOP

24.8% 50.1% 25.1%

7.682 7.826

TOTAL CAPEX -0.57 4.0

2.5

Peak capacity 0.37

Production before decline / 2.0

-0.05

Ur=N*Er = <0.=>"

1.5

Initial Prod.rate 0.03 ?198=44"

OIL PRICE, $/STB / 1.0

-0.03

NOMINAL

0.5

0.2

0.4

0.6

-0.6

-0.4

-0.2

-1E-15

0.0

7.2

7.3

7.4

7.5

7.6

7.7

7.8

7.9

8.0

8.1

NET PRESENT VALUE @ 12.5% Regression Fit Comparison for Payout Period,

Chart Years

Figure 4: Typical Tornado chart for PIB 2009 NPV Figure 5: Payout period for PIB 2009 Exponential UOP

SPE 163007 15

238 317 14.47% 15.22%

0.007 80

0.006 70

0.005 60

50

0.004

40

0.003

30

0.002

20

0.001

10

0.000 0

100

200

300

400

500

600

700

800

13%

14%

15%

16%

17%

18%

19%

20%

21%

22%

NET PRESENT VALUE @ 12.5%/ GROWTH RATE OF RETURN /

CONTRACTOR ($MM) CONTRACTOR

Figure 6: NPV for 2005 PSC Exponential SLD Figure 7: GRR for 2005 PSC Exponential SLD

OIL PRICE, $/STB / 7.925 8.212

0.49 2.5

NOMINAL

2.0

Recovery factor 0.43

1.0

Initial Prod.rate 0.06

Production before decline / 0.5

-0.03

Ur=N*Er =

0.0

-0.4

-0.3

-0.2

0

0.1

0.2

0.3

0.4

0.5

-0.1

7.4

7.6

7.8

8.0

8.2

8.4

8.6

NET PRESENT VALUE @ 12.5% Regression chart PAYOUT PERIOD, years

Figure 8: Typical Tornado chart for 2005 PSC NPV Figure 9: Payout period for 2005 PSC Exponential SLD

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