Asset Evaluation

Reference: Adapted from HWU MSc P.E Materials

LEARNING OUTCOMES

• Definition an asset and list different types

• Identify and explain the three important asset valuation concepts
• List several business situations where evaluation is required
• Define the concepts of “depreciation”
• Calculate depreciation using the following methods: Straight line Declining
balance and Units of production
• List the factors which contribute to the quality of a market valuation
• Define “cash flow” and “incremental cash flow”
• List and explain the characteristics of a cash flow
• List different types of cash flow; differentiate between “capex” and “opex”
What are Assets?
“Assets” are items or entities, which bring benefit or positive value to an owner,
and, therefore require careful and appropriate measurement.

• Represents the wealth of an individual or organization and may be used as a

parameter of performance.
• Asset valuation also forms the basis of many business decisions, on which may depend
the long-term performance of the company.
• Recently, the petroleum industry focused more on managing assets and asset value, to
emphasize the importance of economic objectives.

Useful, Valuable and Beneficial Possessions

 What Comprises A Petroleum Asset?

Choke  Reservoir (reserves)

P4 P5
 Wells (production, injection)
DP4
P4  Surface facilities
Treatment
DP5
Plant
 People
P6
Petroleum Engineering
Sales Delivery Point Geosciences

Reservoir

DP3 Operations Facilities Engineering

P3 P1 Petroleum Engineering Wells Facilities Operations
Wellbore Engineering
P2
DP1
DP2
P3
Asset Managers must look after and
“optimise” all these components
 Asset Types

Land Surface Minerals – Productive Resources

Man made facilities, Factory
Equipment
Machine
Self-contained or
Project
Incremental to existing activities
Company Independent or subsidiaries
Long term investment
Financial
Short term investment
Intangible Knowledge & Reputation
Employees
Human
Organization
Evaluation Situations

Companies face many different situations which require the evaluation of assets :-
1. Purchase or hire of equipment
2. Developing an oil field
3. Buying or selling production facilities
4. Project abandonment
5. License acquisition
6. Borrowing money
7. Company takeover
8. Informing shareholders
9. Tax assessment
Asset Evaluation Methods

There are three fundamental methods of asset evaluation:-

• Book Value
Considers the history of the asset in terms of original cost and deterioration
• Market Value
Considers the value in the context of present day acquisition or disposal
• Cash Flow
Considers the future performance of the asset in terms of expenditure and revenue
Book Value Method

Also known as:

• Historical Cost Method
• Accountants’ Method
The value of a single asset after time period "n“ equals Original Cost [A0] less
Depreciation [d]

An = A0 -[ d1 + d2 +… + dn ]
Book Value Method

Depreciation Schemes
• Depreciation is the accountants' method of writing down the value of an asset over time
• It attempts to match our perception that the value of an asset does diminish over time.
• Depreciation schemes are to some extent a compromise between economic realism and
mathematical simplicity.
•Important to calculate taxable income or cost recovery.

The following are some of the more commonly used schemes:

• Straight Line
• Declining Balance
• Double Declining Balance
• Unit of Production
 Straight line depreciation
$ 100 MM
Depreciation occurs at end of
the year

$ 75 MM
Annual depreciation =
$ 25 MM

$ 50 MM

Depreciation
spread over the
$ 25 MM year

$0 MM
Yr 1 Yr 2 Yr 3 Yr 4
 Declining balance depreciation
$ 100 MM

$ 75 MM 75
Declining balance
56.3

$ 50 MM 42.2

31.6
$ 25 MM

Straight line
$0 MM
Yr 1 Yr 2 Yr 3 Yr 4
 Double declining balance
$ 100 MM depreciation
$ 75 MM
Declining balance
56.3
50
$ 50 MM 42.2

Double
declining 25 31.6
$ 25 MM
balance Straight line

12.5 6.25
$0 MM
Yr 1 Yr 2 Yr 3 Yr 4
 Depletion/unit of Production Method

Example : Capex to be depreciated based on the ratio of the annual production to the
reserves at the beginning of the year times the non-depreciated balance, First
Production in Year 2

Year 1 Year 2 Year 3 Year 4 Year 5 Year 6 Total

Annual Production 4 10 10 9 7 40
Reserves @ 1st January 40 36 26 16 7
Annual/Reserves 10% 28% 38% 56% 100%
Capex 100
Capex to be Depreciated 100 90 65 40 18
Capital Allowance 10 25 25 22 18 100
Balance Undepreciated 90 65 40 18 0
Market Value

Valuation is based on comparison with similar asset transactions

Important Factors:
• Asset definition: To make a valid comparison, it is important to be able to
compare like with like. The more precisely we are able to define the asset, the better.
• Transaction Statistics: Comparison is more reliable, if it is with an average, rather
than a single value. A large number of transactions will balance out the unusual
circumstances, which might distort a single or small number.
• Market Knowledge : “Fair market price” implies full knowledge of relevant
market conditions and freedom of choice.
Price is a function of market conditions:
• Demand, Supply
• Structure / Competition
 Market Model
D1 is the primary Demand Function.
It represents the behaviour of consumers.

S1 represents the primary Supply Function.

It represents the behaviour of supply companies
or manufacturers.

S1 and D1 intersect at P*Q*.

This is the market clearing, or equilibrium price
and quantity.

D2 is a secondary Demand Function.

It represents a shift in consumer behaviour.

S2 is a secondary Supply Function.

It represents a shift in supplier behaviour.
 Monopoly

• The opposite of competition is

monopoly,

• One or a few have sufficient size or

influence to set price or quantity in the
market.

• Monopoly supplier can set Price or

Quantity in a market, but not both.

• Quantity supplied is independent of

price.
Cash Flow Method

• Valuation of an asset is based on its future cost and revenue implications

• Impact of the asset on the company is represented by a series of positive and negative cash
flows
• The value or profit associated with the asset can be represented by a mathematical
function
of a series of cash flows:
Value or Profit equals

ƒ[ C1+ C2+ C3+… + Cn]

Cash Flow Method

Cash Flow Types

Most projects include the following types of cash flows:
• Revenue
Income from sale of goods and services
• Capital Expenditure (Capex)
Expenditure relating to the creation of production facilities
• Operating Expenditure (Opex)
Expenditure relating to the running of production facilities
• Taxation
Payments made to government
Cash Flow Method

Cash Flow Model

Models are used to represent the
cash flows associated with a project.
The complexity of a model will
normally reflect :
• Availability of data
• Application of the model
Economic Evaluation Basis

Elements of a Production Profile

Economic Evaluation Basis

Project Capital Expenditure (Capex)

Petroleum development projects involve several stages of expenditure:

• Exploration
Pre-discovery
Geophysics & drilling
• Appraisal
Pre-commercial decision
More geophysics & drilling
• Field Development
Wells, Structures & facilities
Export
• Modifications
Workovers
New topsides
• Abandonment
Removal of facilities
Economic Evaluation Basis

Project Operation Expenditure (Opex)

Normally specified as an annual amount, during productive years
• Lease of facilities
• Platform:- Operation
Transport
Maintenance
• Export:-Tankers, Pipeline
Terminal
Tariff
• Workovers
• Insurance & Administration