Economic Modeling Handbook June 17-1 PDF

Economic Modeling and
Risk Analysis Handbook
University of Dundee
ECONOMIC MODELING AND RISK ANALYSIS HANDBOOK
Copyright © 2002 Daniel Johnston and David Johnston
Daniel Johnston & Co. Inc. Daniel Johnston & Co. Inc.
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Hancock, New Hampshire Fairport, New York
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Printed in the United States of America.
Economic Modeling and Risk Analysis Handbook ii Daniel & David Johnston © 2002
Table of Contents
List of Tables ................................................................................................................................ vii
List of Figures ................................................................................................................................. x
List of Fiscal System Summaries................................................................................................. xiii
Foreword ....................................................................................................................................... xv
1. Economic Modeling.................................................................................................................... 1
Introduction............................................................................................................................... 2
Present value theory.................................................................................................................. 2
Future value ...................................................................................................................... 2
Present value..................................................................................................................... 3
Economic modeling/auditing – Art and science ....................................................................... 6
Risk Model................................................................................................................................ 7
Fiscal Terms.............................................................................................................................. 7
Cost recovery limit 50%................................................................................................ 7
Discussion ............................................................................................................................... 10
The model ............................................................................................................................... 10
Government total profit oil share (56%) ....................................................................... 12
Government take ............................................................................................................ 13
Effective Royalty Rate (ERR) ........................................................................................ 16
Savings Index ................................................................................................................. 18
Entitlement Index ........................................................................................................... 18
Spot Checks .................................................................................................................... 19
Price and cost assumptions ............................................................................................. 21
Initial oil price ................................................................................................................ 21
Capital cost per unit ($/BBL) ......................................................................................... 23
Capital costs per BOPD.................................................................................................. 23
Capital costs as a percentage of gross revenues ............................................................. 24
Total costs as a percentage of gross revenues ................................................................ 24
Operating costs (peak year)/total capital costs ............................................................... 24
Operating costs (early years) .......................................................................................... 25
Operating costs (full-cycle) ............................................................................................ 25
Technical aspects and assumptions......................................................................................... 26
Peak production/total reserves (P/R) ............................................................................. 26
Decline rate (12.5%)...................................................................................................... 26
Well spacing ................................................................................................................... 26
Initial production rate per well ....................................................................................... 27
BOPD per foot of pay..................................................................................................... 28
Development drilling success ratio ................................................................................ 29
Economic Modeling and Risk Analysis Handbook iii Daniel & David Johnston © 2002
Swanson’s Rule .............................................................................................................. 30
80/20 Rule - Pareto’s Law............................................................................................ 30
Cost of Capital ........................................................................................................................ 32
Cost of debt..................................................................................................................... 32
Cost of equity ................................................................................................................. 33
Capital budgeting and Investment theory ............................................................................... 36
Fundamentals of valuation ............................................................................................. 36
Fair market value............................................................................................................ 36
Probability criteria .......................................................................................................... 36
Payout ............................................................................................................................. 37
Cash Flow Multiple ........................................................................................................ 38
Profit-to-investment ratio ............................................................................................... 38
Competitive Bidding and the Winners Curse................................................................. 40
2. Risk Analysis ............................................................................................................................ 41
Expected Value theory............................................................................................................ 42
Reward............................................................................................................................ 44
Risk capital ..................................................................................................................... 44
Success probability......................................................................................................... 45
Decision tree analysis ..................................................................................................... 48
Estimating probabilities.................................................................................................. 50
Estimating probabilities.................................................................................................. 51
Common pitfalls in risk analysis .................................................................................... 54
Diversification of risk - Gambler’s ruin Theory............................................................. 56
Utility theory .................................................................................................................. 59
The Value-of-information concept ................................................................................. 61
Option Pricing Theory.................................................................................................... 62
The value of an option.................................................................................................... 63
Drill or Farm out?........................................................................................................... 65
The factored approach - A slight twist on the EV concept............................................. 69
Monte Carlo simulation .......................................................................................................... 70
Deterministic vs. Stochastic (probabilistic) approach .................................................... 70
Monte Carlo simulation audit checklist.......................................................................... 79
The competitive bidding dilemma .......................................................................................... 80
3. Fiscal System Analysis ............................................................................................................. 97
Variation on two themes ......................................................................................................... 98
Government take................................................................................................................... 100
Downside government take .......................................................................................... 101
Mid-range government take ......................................................................................... 101
Upside government take ............................................................................................... 101
Margin (marginal government take)............................................................................. 102
Effective royalty rate............................................................................................................. 104
Lifting (entitlement) ..................................................................................................... 104
Economic Modeling and Risk Analysis Handbook iv Daniel & David Johnston © 2002
Savings Index ............................................................................................................... 105
4. Exploration.............................................................................................................................. 128
5. Drilling and Production........................................................................................................... 144
6. Cost Data................................................................................................................................. 166
Tankers.................................................................................................................................. 190
7. Petrophysics ........................................................................................................................... 195
7. Petrophysics ............................................................................................................................ 196
Structural traps ...................................................................................................................... 207
Stratigraphic traps ................................................................................................................. 209
8. Fluid Properties....................................................................................................................... 212
9. Gas .......................................................................................................................................... 221
LPG Plants ............................................................................................................................ 226
Gas Cycling........................................................................................................................... 226
Gas Fired Power Generation ........................................................................................ 227
GTL....................................................................................................................................... 229
Gas to Liquids – Fischer-Tropsch ................................................................................ 229
GTL Products ............................................................................................................... 231
Qatar GTL Pioneer Plant ...................................................................................................... 235
Methanol....................................................................................................................... 236
Ammonia/Urea Fertilizer.............................................................................................. 236
Liquefied Natural Gas (LNG) ...................................................................................... 236
10. Refining and Marketing ........................................................................................................ 243
Industry overview ................................................................................................................. 244
Complexity index indicates refinery capability, value ......................................................... 254
The Nelson Complexity Index...................................................................................... 254
Offsite facilities ............................................................................................................ 254
Equivalent distillation capacity (EDC)......................................................................... 255
Changes in indices........................................................................................................ 256
Refinery cost and value ................................................................................................ 258
Product slate ................................................................................................................. 259
Future............................................................................................................................ 259
Economy of scale ......................................................................................................... 260
Service Stations..................................................................................................................... 270
Gas Stations and Marketing Outlets ..................................................................................... 270
Convenience stores ............................................................................................................... 271
11. Macro Economics ................................................................................................................. 279
Appendices.................................................................................................................................. 287
Economic Modeling and Risk Analysis Handbook v Daniel & David Johnston © 2002
A1 Present value of one-time payment........................................................................... 288
A2 Present value of an annuity ....................................................................................... 289
Glossary ...................................................................................................................................... 290
Fiscal System Summaries ........................................................................................................... 319
Abbreviations.............................................................................................................................. 344
Conversion Tables ...................................................................................................................... 348
Most common conversions and constants............................................................................. 348
Area....................................................................................................................................... 349
Energy work equivalents....................................................................................................... 350
Power .................................................................................................................................... 351
Fluids or fluid equivalents .................................................................................................... 352
Pressure equivalents.............................................................................................................. 353
Mass equivalents................................................................................................................... 354
Length equivalents ................................................................................................................ 355
Volume equivalents .............................................................................................................. 356
Velocity equivalents.............................................................................................................. 357
Pressure conversion .............................................................................................................. 358
Flow rate (mass) conversion ................................................................................................. 359
Flow rate (volume) conversion ............................................................................................. 359
Dynamic viscosity conversion .............................................................................................. 359
Bibliography ............................................................................................................................... 360
Index ........................................................................................................................................... 361
Economic Modeling and Risk Analysis Handbook vi Daniel & David Johnston © 2002
List of Tables
T 1.1 Comparison of discounting techniques ................................................................ 4
T 1.2 Case study parameters - assumptions ................................................................... 7
T 1.3 Cash flow model “Most Likely”........................................................................... 8
T 1.4 Contractor cash flow............................................................................................. 8
T 1.5 Cash flow review checklist................................................................................... 9
T 1.6 Government profit oil share estimate (full cycle) 1 ............................................. 11
T 1.7 Government profit oil share calculation ............................................................. 13
T 1.8 Government take back-of-the-envelope estimate............................................... 15
T 1.9 Government take calculation (from the cash flow model) ................................. 15
T 1.10 Effective Royalty Rate back-of-the-envelope estimate...................................... 17
T 1.11 Effective Royalty Rate cash flow calculation – year 4....................................... 17
T 1.12 Savings index estimate ....................................................................................... 18
T 1.13 Entitlement calculation....................................................................................... 19
T 1.14 Income tax and cash flow calculations – year 5 ................................................. 20
T 1.15 Reported international discoveries 1996 - 1998................................................. 28
T 1.16 Value Line – Betas ............................................................................................. 34
T 1.17 Weighted average cost of capital........................................................................ 35
T 1.18 Profitability criteria, abbreviations & synonyms................................................ 39
T 2.1 Expected value.................................................................................................... 46
T 2.2 Break-even success probability and success capacity ........................................ 47
T 2.3 Example calculations.......................................................................................... 53
T 2.4 Two-outcome Model without 3-D Seismic ....................................................... 61
T 2.5 Two-outcome Model with 3-D Seismic ............................................................ 61
T 2.6 EV decision analysis—step-by-step ................................................................... 68
T 2.7 Example valuation using factored approach....................................................... 69
T 2.8 Example reserve estimates ................................................................................. 70
T 2.9 Volumetric simulation ........................................................................................ 74
T 2.10 Variable dependency relationships..................................................................... 78
T 2.11 Examples of reserves prediction over-optimism ................................................ 84
T 2.12 Summary of assumptions ................................................................................... 94
T 3.1 Regional distribution of petroleum fiscal systems ............................................ 99
T 3.2 Government take .............................................................................................. 101
T 3.3 Example quick-look government take calculation ........................................... 103
T 3.4 Rule-of-thumb for production acquisitions ...................................................... 110
T 3.5 Example PSC cash flow projection .................................................................. 111
T 3.6 Example PSC cash flow projection .................................................................. 112
T 3.7 Cash flow model– summary and analysis ........................................................ 113
T 3.8 Different perspectives on the example PSC ..................................................... 114
T 3.9 World petroleum fiscal system statistics .......................................................... 115
T 3.10 Fiscal system statistics, the more prospective countries .................................. 115
T 3.11 Typical contract conditions .............................................................................. 117
T 3.12 Example ROR system cash flow model ........................................................... 122
T. 3.13 Example ROR system cash flow model ............................................................. 123
Economic Modeling and Risk Analysis Handbook vii Daniel & David Johnston © 2002
T.3.14 Example ROR system Trigger point calculation.............................................. 124
T 3.15 International oil & gas investment ................................................................... 126
T 4.1 Indonesian Production Profiles......................................................................... 134
T 4.2 West Africa....................................................................................................... 135
T 4.3 UK – Offshore .................................................................................................. 136
T 4.4 Range of oil well production rates.................................................................... 138
T 4.5 Type Well Productivity Statistics – Gulf of Mexico ........................................ 139
T 5.1 Drilling cost equation ....................................................................................... 146
T 5.2 Drilling costs late 1990s ................................................................................... 147
T 5.3 Drilling rigs ...................................................................................................... 149
T 5.4 Dayrates............................................................................................................ 157
T 6.1 Gulf of Mexico Deepwater 1997................................................................... 168
T 6.2 Southeast Asia Fields under Development – Aug., 1996................................. 169
T 6.3 UK Offshore Likely Developments.................................................................. 170
T 6.4 North Sea costs ................................................................................................. 171
T 6.5 Norwegian field developments......................................................................... 172
T 6.6 Three types of worldwide finding costs ........................................................... 174
T 6.7 Finding, development and production costs..................................................... 175
T 6.8 Cost of incremental production* ...................................................................... 176
T 6.9 Amoco Corporation – 1990 – 1992 .................................................................. 177
T 6.10 Offshore exploration/appraisal drilling ($MM)............................................... 178
T 6.11 Development drilling costs ($MM) .................................................................. 178
T 6.12 Drilling costs – Offshore Java Sea Indonesia – Early 1990s............................ 179
T 6.13 Platform costs – low cost environment ............................................................ 181
T 6.14 Facilities costs and operating costs................................................................... 182
T 6.15 3-D Seismic acquisition costs........................................................................... 183
T 6.16 Competitive price analysis ............................................................................... 183
T 6.17 2-D Seismic acquisition costs........................................................................... 184
T 6.18 Gas pipelines .................................................................................................... 185
T 6.19 Pipeline construction costs ............................................................................... 186
T 6.20 Oil pipelines...................................................................................................... 187
T 6.21 World crude oil................................................................................................. 189
T 6.22 Summary of tanker values ................................................................................ 190
T 7.1 Recovery factors............................................................................................... 203
T 8.1 Crude properties ............................................................................................... 216
T 8.2 Composition of a 35º API gravity crude oil ..................................................... 217
T 8.3 Physical constants – Light hydrocarbons ......................................................... 219
T 9.1 Vital Statistics—gas vs. oil .............................................................................. 222
T 9.2 Volumetric comparison of oil and gas.............................................................. 223
T 9.3 Gas development option ................................................................................... 225
T 9.4 Middle East power plants ................................................................................. 228
T 10.1 Nelson Complexity Multiplier.......................................................................... 255
T 10.2 Generalized refinery complexity indices 1998 +.............................................. 256
T 10.3 Thermal operations, categories, and distribution ............................................. 258
T 10.4 Kuwait Mina Abdulla Refinery (1/1/2002) ..................................................... 261
T 10.5 United States refinery capacity (1/1/2002)....................................................... 262
Economic Modeling and Risk Analysis Handbook viii Daniel & David Johnston © 2002
T 10.6 Worldwide refinery complexity 1995 .............................................................. 263
T 10.7 Refinery complexity ......................................................................................... 264
T 10.8 3 – 2 – 1 Cracked Spread example .................................................................. 265
T 10.9 Refinery Cash Margin Calculation................................................................... 266
T 10.10 Top 10 Convenience store companies.............................................................. 273
T 10.11 Marketing outlets-gas station valuation............................................................ 274
T 11.1 Recoverable oil and gas.................................................................................... 284
T 11.2 Oil and gas drilling ........................................................................................... 284
Economic Modeling and Risk Analysis Handbook ix Daniel & David Johnston © 2002
List of Figures
F 1.1 Future value diagram ............................................................................................ 3
F 1.2 Present value diagram........................................................................................... 4
F 1.3 Government profit oil share estimate (full cycle)............................................... 12
F 1.4 General oil price relationship.............................................................................. 22
F 1.5 Swanson’s rule.................................................................................................... 30
F 1.6 Two Perspectives on “Cash Flow” ..................................................................... 31
F 1.7 Capital asset pricing model (CAPM).................................................................. 34
F 1.8 Winners Curse .................................................................................................... 40
F 2.1 The Expected value (EV) formula...................................................................... 43
F 2.2 Decision tree ....................................................................................................... 44
F 2.3 Expected value graph.......................................................................................... 45
F 2.4 Multi outcome decision tree ............................................................................... 48
F 2.5 Two outcome decision tree................................................................................. 49
F 2.6 Two-outcome graph EV ..................................................................................... 50
F 2.7 Risk analysis building blocks - summary ........................................................... 55
F 2.8 Combined probability of success........................................................................ 57
F 2.9 Expected value and Utility theory ...................................................................... 60
F 2.10 Black-Scholes Formula....................................................................................... 64
F 2.11 Farm-out economics ........................................................................................... 66
F 2.12 Farm-in option – The partners perspective......................................................... 67
F 2.13 Monte Carlo simulation overview ...................................................................... 72
F 2.14 Monte Carlo simulation – The key steps ............................................................ 73
F 2.15 Cumulative frequency distribution ..................................................................... 75
F 2.16 Histogram distribution ........................................................................................ 76
F 2.17 Cumulative frequency distribution ..................................................................... 77
F 2.18 Historical oil price projections............................................................................ 82
F 2.19 Exploration strategy example ............................................................................. 86
F 2.20 Example #1 Two outcome – Expected value graph .......................................... 88
F 2.21 Using EV analysis............................................................................................... 91
F 3.1 Classification of petroleum fiscal regimes ......................................................... 98
F 3.2 Example analysis format and definitions.......................................................... 100
F 3.3 Government take vs. project profitability......................................................... 106
F 3.4 Production sharing contract flow diagram 1..................................................... 108
F 3.5 Production sharing contract flow diagram 2..................................................... 109
F 3.6 International Petroleum Exploration and Development Contracts................... 116
F 3.7 Maximum capital costs ..................................................................................... 118
F 3.8 Papua New Guinea rate of return system ......................................................... 121
F 3.9 “R” Factors vs. ROR systems......................................................................... 125
F 3.10 Royalty netback or tariff calculations............................................................... 127
F 4.1 World oil discoveries........................................................................................ 130
F 4.2 Western Canada field sizes............................................................................... 130
F 4.3 Major US gas field discoveries 1880 - 1990 .................................................... 131
Economic Modeling and Risk Analysis Handbook x Daniel & David Johnston © 2002
F 4.4 Gas & Oil discovery profiles ............................................................................ 132
F 4.5 Global large field discoveries ........................................................................... 133
F 4.6 Production rates ................................................................................................ 137
F 4.7 1996 Offshore atlas of world oil and gas theatres ............................................ 140
F 4.8 Gas reserve additions........................................................................................ 141
F 4.9 Crude oil reserve additions ............................................................................... 141
F 4.10 Crude oil reserves-to-production ratios ............................................................ 142
F 4.11 Wet natural gas reserves-to-production ratios .................................................. 142
F 4.12 U.S. total gas discoveries.................................................................................. 143
F 4.13 U.S. total crude oil discoveries ......................................................................... 143
F 5.1 Technological frontiers..................................................................................... 148
F 5.2 SPARs............................................................................................................... 150
F 5.3 FPSOs ............................................................................................................... 151
F 5.4 Fixed platforms................................................................................................. 152
F 5.5 Compliant towers.............................................................................................. 153
F 5.6 Semi-FPSs......................................................................................................... 153
F 5.6 Semi-FPSs......................................................................................................... 154
F 5.7 Tension leg platforms ....................................................................................... 155
F 5.8 Concrete structures ........................................................................................... 156
F 5.9 Well definitions ................................................................................................ 158
F 5.10 Mud costs per well............................................................................................ 159
F 5.11 Mud................................................................................................................... 160
F 5.12 Drilling and production..................................................................................... 161
F 5.13 Horizontal ......................................................................................................... 162
F 5.14 Vertical vs. horizontal drilling wells ................................................................ 163
F 5.15 Decline curve .................................................................................................... 164
F 6.1 Crude oil finding costs...................................................................................... 173
F 6.2 Offshore drilling cost estimates vs. total depth ................................................ 179
F 6.3 Cost estimates for development systems in various water depths.................... 181
F 6.4 Pipeline cost per inch calculations.................................................................... 188
F 6.5 Tanker freight rates........................................................................................... 191
F 6.6 Worldscale rates, 3 markets, 3 years ................................................................ 192
F 6.7 Tankers ............................................................................................................. 194
F 7.2 Porosity and permeability ................................................................................. 199
F 7.3 Reservoir porosity and fluid distribution.......................................................... 200
F 7.4 The Archie Equation......................................................................................... 201
F 7.5 Oil volumetric estimates ................................................................................... 202
F 7.6 Gas volumetric estimates.................................................................................. 204
F 7.7 Darcy’s radial flow formula.............................................................................. 205
F 7.8 Structure Map ................................................................................................... 206
F 7.9 Fault Trap.......................................................................................................... 207
F 7.10 Salt Dome ......................................................................................................... 208
F 7.11 Reefs ................................................................................................................. 209
F 7.12 Up dip pinchout ................................................................................................ 210
F 7.13 Combination trap – Angular unconformity ...................................................... 211
F 8.1 Hydrocarbons.................................................................................................... 213
Economic Modeling and Risk Analysis Handbook xi Daniel & David Johnston © 2002
F 8.2 General oil price relationship............................................................................ 214
F 8.3 Sulfur vs. API gravity ....................................................................................... 215
F 8.4 Barrels per metric ton per API gravity ............................................................. 217
F 8.5 Natural gas products ......................................................................................... 218
F 9.1 Oil and gas P/R ratio comparison ..................................................................... 224
F 9.2 Liquid yield....................................................................................................... 227
F 9.3 GTL Options..................................................................................................... 230
F 9.4 GTL vs. conventional fuel properties ............................................................... 231
F 9.5 GTL costs.......................................................................................................... 233
F 9.6 GTL lead times ................................................................................................. 233
F 9.7 GTL Sensitivity analysis—Tornado graph....................................................... 234
F 9.8 Qatar GTL Pioneer Plant Process ..................................................................... 235
F 9.9 Comparative costs; LNG, MeOH & GTL ........................................................ 237
F 9.10 Natural gas flow - 2000 .................................................................................... 238
F 10.1 The modern refinery ......................................................................................... 245
F 10.2 Gasoline refinery processes .............................................................................. 246
F 10.3 Distillation tower – atmospheric distillation..................................................... 248
F 10.4 Refinery cost/value ........................................................................................... 267
F 10.5 Gasoline yield as a function of NCI ................................................................. 268
F 10.6 United States petroleum flow, 2000 ................................................................. 269
F 10.7 C-Store sales mix.............................................................................................. 271
F 10.8 C-Store non fuel sales....................................................................................... 272
F 10.9 U.S. retail gasoline prices 1999 vs. 2000.......................................................... 275
F 10.10 World gasoline price comparisons.................................................................... 276
F 10.11 U.S. refineries ................................................................................................... 277
F 11.1 Vital statistics - 2 1995 ................................................................................... 280
F 11.2 Global oil production estimates ........................................................................ 281
F 11.3 Middle East reported reserves .......................................................................... 281
F 11.4 Vital statistics – 1 1995.................................................................................. 282
F 11.5 Lower 48 crude oil wellhead prices in three cases ........................................... 283
F 11.6 U.S. petroleum consumption - five cases ......................................................... 283
F 11.7 Deflated natural gas prices and operating cost indices..................................... 285
F 11.8 Deflated oil price and operating cost indices.................................................... 285
F 11.9 World oil prices ................................................................................................ 286
Economic Modeling and Risk Analysis Handbook xii Daniel & David Johnston © 2002
List of Fiscal System Summaries
Angola............................................................................................................................. 319
Argentina......................................................................................................................... 320
Azerbaijan 1994 .............................................................................................................. 321
China ............................................................................................................................... 322
Congo Br......................................................................................................................... 323
Ecuador ........................................................................................................................... 324
Gabon.............................................................................................................................. 325
India ................................................................................................................................ 326
Indonesia PSC................................................................................................................. 327
Indonesia post 1996 ........................................................................................................ 328
Indonesia 1994 frontier ................................................................................................... 329
Libya ............................................................................................................................... 330
Morocco .......................................................................................................................... 331
New Zealand ................................................................................................................... 332
Norway............................................................................................................................ 333
Pakistan PSC................................................................................................................... 334
The Philippines ............................................................................................................... 335
Syria ................................................................................................................................ 336
Trinidad & Tobago PSC ................................................................................................. 337
Tunisia............................................................................................................................. 338
Turkmenistan .................................................................................................................. 339
United States ................................................................................................................... 340
Venezuela PSC............................................................................................................... 341
Vietnam........................................................................................................................... 342
Yemen ............................................................................................................................. 343
Economic Modeling and Risk Analysis Handbook xiii Daniel & David Johnston © 2002
A Note from Daniel Johnston
For the past 20 years, in the normal course of my work, I have collected information, statistics,
and metrics for the petroleum industry from around the world. As a friend once said to me: “The
world’s shortest pencil is better than the world’s longest memory.” We have relied on both for
this handbook. And we have made every attempt to verify this information and maintain the
accuracy of the data. We make no representations beyond the fact that this information is simply
the best information we had available. The important exception of course is that confidential
information is not included.
A Note from David Johnston
Of all the industries in which I have worked, petroleum exploration has the greatest and most
dynamic combination of risk and reward. The problems of trying to quantify and characterize the
inherent uncertainty while they are not unique to this industry are more dramatic. I hope the
information in this book will provide a valuable source of reference for analysts and decision
makers throughout the industry.
How to use this book

There is a lot of information in this book that could logically reside in more than one chapter and
in more than one format. Because of this we have provided a detailed index and an extensive
glossary. We felt that this would be essential for this handbook in order to ensure efficiency and
ease-of-use. The index though does not list glossary references.
Economic Modeling and Risk Analysis Handbook xiv Daniel & David Johnston © 2002
Foreword
The science of economic modeling and decision making is highly evolved yet there is still room
for the “art” of investment analysis. The capital intensity and space-age technology add to the
already dramatic importance of the industry. In exporting countries the petroleum sector
contributes the lion’s share of the nation’s budget. Furthermore, in many countries the mineral
resources are conisidered to be a gift from God. Consistent with that view then, is the prevailing
opinion of many government officials that to mis-manage or waste these resources would be a
sin.
The subject matter in this book was developed for all professionals in the industry as well as
those with a broad interest in all aspects of the petroleum exploration, development, production,
refining and marketing. This book was designed to provide discussion and explanation as well as
a source of reference.
Both tools and theory as well as practical application and examples to enable practitioners to
work with confidence in their understanding of industry standards and practices and to be able to
communicate efficiently with professionals from all sectors of the industry. Courage.
Economic Modeling and Risk Analysis Handbook xv Daniel & David Johnston © 2002
Economic Modeling
1. Economic Modeling
Economic Modeling and Risk Analysis Handbook 1 Daniel & David Johnston © 2002
Chapter 1 – Economic Modeling
Introduction
The focus of this book is on the micro-economics of exploration and development as well as
downstream operations. But we also cover various geotechnical aspects of the industry including
petrophysics and reservoir engineering. The upstream end of the industry is all about rocks.
However, the financial/economic end of the industry is all about the concept of present value.
Present value theory

The most fundamental financial concept is the time value of money. "A dollar today is worth
more than a dollar tomorrow." The difference between the value of a dollar today and a dollar
tomorrow depends on interest rates.
Most people are familiar with the future value concept. For example, $100 placed in a bank
account bearing 7% interest, would be worth $107 at the end of one year. Therefore, the future
value is $107. It is because of the potential to earn interest that money has a time value. If a
person can invest money at 7%, then the present value of $107 received one year from now is
$100.
Future value
The formula for the future value of a single payment P is:
F = P(1+ i)n
Where:
F = the future value of a payment
P = the principal, or present value of a sum
i = the rate of interest or discount rate
n = the number of time periods
For example, as depicted in figure F 1.1, $1,000 invested at 10% for five years would be equal
to:
F = $1,000 (1 + 0.10)5
F = $1,611
F 1.1 Future value diagram
The future value of $1,000 payment after five years at 10% interest
Year Year Year Year Year Future

Principal 1 2 3 4 5 value
$1,000 $1,611
Present value
The formula for present value is the inverse of the formula for future value. The formula for the
present value of a single payment P is:
P = F
(1+ i)n
Where:
P = the principal, or present value of a sum
i = the rate of interest or discount rate
1 = the discount factor

(1+ i)n
Part of this formula [1/(1 + i)n] is referred to as the discount factor. It is multiplied times the
future payment F to arrive at its present value. F is said to be discounted by that factor. This is
why the terms discount rate and interest rate are used interchangeably.
Assume that after five years a payment of $1,000 will be made. This is illustrated in figure F 1.2.
The present value of that payment discounted at 10% for five years is equal to:
P = $1,000
(1+ 0.10)5
P = $1,000
1.6105
P = $621
F 1.2 Present value diagram
The present value of $1,000 payment paid in five years
Year Year Year Year Year Future

Present
1 2 3 4 5 payment
value
$621 $1,000
The analysis of a stream of payments or cash flows (as opposed to a single payment like that
described above) is based on discounting each future payment F back to the present, hence
present value.
The financial analysis of an oil company, or even a single oil well, is based on the present value
of the expected stream of cash flow. These payments come in regularly, not just once a year.
Because it is easier to make estimates based on annual figures, midyear discounting is normally
used to emulate the nearly continuous income stream.
T 1.1 Comparison of discounting techniques
Monthly
End-of-year Mid-year mid-month
discounting discounting discounting
Formula for P = F/(1 + i)n F/(1 + i)n-0.5 F/(1 + i)n-0.5
i = 10% 10% .8333%
n = 3 3 25 - 36
F = $1,000,000 $1,000,000 $83,333
paid at paid 12 monthly
end-of-year 3 mid-year payments
in year 3 in year 3
Discount factor (rounded) .751 .788 .816 -.745

Present value $751,315 $787,986 $779,916
Where:
P = the principal, or the present value
i = the rate of interest
Assume for example, a five-year cash flow stream that starts at $10,000 the first year and is
expected to decline at a rate of 10% per year. The present value can be estimated by using the
discount factors from Appendix A 1. What would be the present value discounted at 15%? The
example below shows the calculated present value of the declining cash flow stream using a
midyear discount rate of 15%.
Declining Midyear
Cash Discount Present
Year Flow Factor* Value
(n) (F) (i = 15%) (P)
1 $10,000 .933 $9,330
2 9,000 .811 7,299
3 8,100 .705 5,710
4 7,290 .613 4,469
5 6,561 .533 3,497
$30,305
* From: Appendix A 1
The present value of the cash flow stream is $30,305.
Appendix A 2 shows the present value for a series of equal payments—an annuity. For example,
a five-year stream of cash flow, discounted at 15%, would have a present value of 3.329 times
the annual payment. Thus a cash flow stream of $10,000 per year for five years would have a
present value (discounted at a rate of 15%) of $33,290.
Economic modeling/auditing – Art and science

Discounted cash flow analysis and risk analysis are the workhorses of the upstream petroleum
industry. The characteristic features are the huge numbers involved and the enormous risks.
Unfortunately, the science of economic modeling and risk analysis do not provide all the
answers. The science typically outpaces the art. This is not good. It takes both.
The artistic aspect of the exercise of cash flow analysis begins with understanding all economic
models are flawed. Every model has its weaknesses—the challenge is to determine where the
weaknesses lie, whether or not they are material and/or if there are fatal flaws. Too many
managers make important big-dollar decisions based upon the results of economic models
without knowing where the weaknesses lie, nor how to locate them. Many problems are not
sufficiently material to justify all the effort required to re-run the economics, yet this can only be
determined if the problems are noted and understood. An economic model is used in this chapter
to show how problems can be detected.
Economic modeling requires estimates of production and timing (often called the “production
profile”), costs (operating expenses and capital costs) and product prices. These then are used to
calculate royalties, taxes and ultimately cash flow.
The example used in this chapter is for an exploration scenario, however, the techniques can be
used for evaluating farm-in/farm-out proposals, development feasibility studies, or production
economics for acquisition or sale etc. A cash flow review checklist, table T 1.5, provides
guidelines for reviewing the economic model. Estimates are made and compared with
calculations from the model to check various aspects of the model.
The Expected Value concept, often referred to as “risk analysis” uses the numbers/values
generated by cash flow analysis. It is discussed extensively in Chapter 2 – Risk Analysis.
T 1.2 Case study parameters - assumptions
The economic model discussed in this chapter and shown in tables T 1.3 and T 1.4
was based on the following assumptions.
Risk Model
Probability of success 15%
Risk capital $15 MM
“Most likely” discovery assumptions

100 MMBBL Field (Assumed recoverable reserves if a discovery is made)
26° API crude oil
GOR 800 cubic feet per barrel (gas/oil ratio)
Brent (North Sea) marker crude price at time of study = $22.00/BBL
600 feet of water
25 development wells drilled
3 development wells dry
110 feet of pay (Avg. reservoir thickness - productive section of the reservoir)
6,000 acres productive area
Fiscal Terms
Type of system Production Sharing Contract (PSC)
Royalty 10%
Cost recovery limit 50%
Profit oil split Government Contractor
BOPD Share Share
0 - 10,000 50% 50%
10,000 - 20,000 60 40
20,000 - 30,000 70 30
> 40,000 80 20
Income tax rate 40%
Depreciation Rate 20%/year [for both tax and cost recovery]
T 1.3 Cash flow model “Most Likely”

Cash Flow Model for assumed “Most Likely” 100 MMBBL Discovery
Annual Oil Oil Gross Net Capital Operating Deprec- Unrecovered Cost
Production Price Revenues 10% Revenue Costs Costs iation Costs C/F Recovery
Year (MBBLS) ($/BBL) ($M) Royalty ($M) ($M) ($M) ($M) ($M) ($M)
($M)
1 0 $20.00 30,000 0 0
2 0 $20.00 40,000 0 0
3 500 $20.00 10,000 1,000 9,000 100,000 3,000 34,000 0 5,000
4 5,900 $20.00 118,000 11,800 106,200 60,000 15,800 46,000 32,000 59,000
5 9,312 $20.00 186,240 18,624 167,616 70,000 22,624 60,000 34,800 93,120
6 12,050 $20.00 241,000 24,100 216,900 28,100 60,000 24,304 112,404
7 10,750 $20.00 215,000 21,500 193,500 25,500 60,000 85,500
8 9,406 $20.00 188,120 18,812 169,308 22,812 26,000 48,812
9 8,230 $20.00 164,600 16,460 148,140 20,460 14,000 34,460
10 7,202 $20.00 144,040 14,404 129,636 18,404 18,404
11 6,301 $20.00 126,020 12,602 113,418 16,602 16,602
12 5,514 $20.00 110,280 11,028 99,252 15,028 15,028
13 4,825 $20.00 96,500 9,650 86,850 13,650 13,650
14 4,221 $20.00 84,420 8,442 75,978 12,442 12,442
15 3,694 $20.00 73,880 7,388 66,492 11,388 11,388
16 3,232 $20.00 64,640 6,464 58,176 10,464 10,464
17 2,828 $20.00 56,560 5,656 50,904 9,656 9,656
18 2,475 $20.00 49,500 4,950 44,550 8,950 8,950
19 2,165 $20.00 43,300 4,330 38,970 8,330 8,330
20 1,395 $20.00 27,900 2,790 25,110 6,790 6,790
21 0
Total 100,000 2,000,000 200,000 1,800,000 300,000 270,000 300,000 570,000
T 1.4 Contractor cash flow

Total Gvt. Contractor Tax Loss Taxable Income Contractor Cash Flow ($M)
Profit Oil Profit Oil Profit Oil C/F Income Tax 40%
Year ($M) ($M) ($M) ($M) ($M) ($M) Undiscounted 12.5% DCF
1 0 0 0 0 0 0 (30,000) (28,284)
2 0 0 0 0 0 0 (40,000) (33,522)
3 4,000 2,000 2,000 0 (30,000) 0 (96,000) (71,514)
4 47,200 25,400 21,800 30,000 (11,000) 0 5,000 3,311
5 74,496 43,387 31,109 11,000 30,605 12,242 19,363 11,397
6 104,496 64,605 39,891 64,195 25,678 98,517 51,543
7 108,000 64,599 43,401 43,401 17,360 86,041 40,014
8 120,496 70,320 50,176 50,176 20,071 56,106 23,193
9 113,680 64,451 49,229 49,229 19,692 43,537 15,998
10 111,232 61,102 50,130 50,130 20,052 30,078 9,824
11 96,816 52,481 44,335 44,335 17,734 26,601 7,723
12 84,224 44,959 39,265 39,265 15,706 23,559 6,080
13 73,200 38,383 34,817 34,817 13,927 20,890 4,792
14 63,536 32,627 30,909 30,909 12,363 18,545 3,782
15 55,104 27,618 27,486 27,486 10,995 16,492 2,989
16 47,712 23,856 23,856 23,856 9,542 14,314 2,306
17 41,248 20,624 20,624 20,624 8,250 12,374 1,772
18 35,600 17,800 17,800 17,800 7,120 10,680 1,360
19 30,640 15,320 15,320 15,320 6,128 9,192 1,040
20 18,320 9,160 9,160 9,160 3,664 5,496 553
Total 1,230,000 678,692 551,308 220,523 330,785 54,357
T 1.5 Cash flow review checklist
Any checklist is better than none at all. Too many decision makers and managers
are uncomfortable reviewing models. But, all models have their weaknesses and a
checklist like this can quickly indicate biases or even “fatal flaws” in either the
modeling or the assumptions—there is only one way to know—check it out.
Checking the model The model World Average

1. Government total profit oil share
At peak production 62% N/A
Average full-cycle 56% N/A
2. Government take 77% 67% Oil (57% Gas)
Contractor take 23% 33% Oil (43% Gas)
3. Effective royalty rate 30-35% 20%
4. Savings index 26¢ 35¢
5. Entitlement 56% 50 – 60% for PSC
90% for R/T
6. Spot checks Various
[Such as checking the tax rate, follow all calculations for a specific year and for “Totals” etc]
Price and cost assumptions

7. Initial oil price $20.00/BBL
8. Capital cost per unit $3.00/BBL $3.50/BBL
9. Capital costs per BOPD $9,090/BOPD $10,000/BOPD
10. Capital costs as a % of gross revenues 15% 15%
11. Total costs as a % of gross revenues 28.5% 30 – 35%
12. Operating costs (peak year)/total CAPEX 9.4% 3-5 to 6-8%
13. Operating costs (early years) ($/BBL) $2.50± /BBL $3.50± /BBL
14. Operating costs (full cycle) ($/BBL $2.70/BBL >$3.50/BBL
Technical aspects
15. Peak production/total reserves 12% 10 - 12%
16. Decline rate 12.5% 10 - 12%
17. Well spacing 270 acres 160 – 200 Oil *
18. Initial production rate per well (BOPD) 1,500 N/A
19. BOPD per ft of pay 14 BOPD/ft 15 – 20 BOPD/ft
20. Development drilling success ratio 88%
* Typically more for gas
Discussion
Each metric in the cash flow review checklist (table T 1.5) provides it’s own particular insight
into the veracity of the model. Some measures take on greater meaning when viewed in the
context of others as well as an understanding of the area, region, or play. Some of these measures
are more useful and powerful than others. Some are rather obscure, yet in the context of other
measures and with increased usage, they take on added value.
The objective here is to provide guidelines and analytical tools to give analysts, auditors and
managers more confidence with and understanding of economic/cash flow models.
The model
With so many cash flow programs, spreadsheets, black-boxes and modeling techniques around
these days, it is somewhat dangerous to simply assume that contract terms have been modeled
correctly. There are a number of ways to check the veracity of a particular model. While many
things can be done to review/audit the modeling itself, some key techniques are shown here.
Because the PSC has a sliding scale this aspect needs to be inspected first (see table T 1.6).
T 1.6 Government profit oil share estimate (full cycle) 1
Quick evaluation of a sliding scale requires a 3-step process. And, it must be field-
size specific and consistent with the peak production rate. The process starts out
essentially with a “weighted average” calculation of the division of profit oil in the
peak year.
1st Step The peak year of production is 12,050 MBBLS in year 6 (table T 1.3).
This is equates to 33,000 BOPD.
Gvt.
P/O Split Gvt.
Tranch (%) Share
  
1st 10,000/33,000 * 50 = 15.15%
2nd 10,000/33,000 * 60 = 18.18
rd
3 10,000/33,000 * 70 = 21.21
4th 3,000/33,000 * 80 = 7.27

Government share peak year 61.81% [year 6]
2nd Step Towards the end of the life of the field when production drops below
10,000 BOPD government share of profit oil (P/O) will be at 50%.
Government share last year 50% [year 20]
3rd Step The third step is simply an average of steps #1 and 2.
61.81 + 50%
Average =  = 56% [Total full-cycle]
2
F 1.3 Government profit oil share estimate (full cycle)
Government total profit oil share (56%)

To estimate overall (full cycle) Gvt. profit oil
split with a sliding scale, take the average of the
highest (peak year) and lowest (last year). (See The example fiscal system (table T 1.2) has a
table T 1.6) sliding scale profit oil split similar to many
found in PSCs worldwide. Roughly 80% of
1st Step the PSCs have sliding scales and this type of
sliding scale is most common. In order to
Peak Production evaluate various other aspects of the model
Year 6: this must be evaluated first.
12.05 MMBBLS
33,000 BOPD A technique is illustrated here for making a
P/O Split ≈ 62%
Annual quick estimate of what the weighted average
Production profit oil split (or any other parameter for that
MMBBLS
matter) would be over the life of a field. It
3rd Step
15
requires three basic steps:
Average = 56%
1st step – Estimate what the split would be in
a peak year of production.
2nd Step
10 Near Abandonment In the cash flow model (tables T 1.3 and T
Last Year: 1.4) production peaks at 12,050 MBBLS in
1.395 MMBBLS year 6. This comes to approximately 33,000
<10,000 BOPD
P/O Split 50%
BOPD. At 33,000 BOPD the profit oil split is
roughly 62/38% in favor of the Government,
5
as shown in table T 1.6.
2nd step – Estimate the split at the end of the

life of the field, which in this case would be
0 down around 50% because production would
6 20 likely be below 10,000 BOPD.
Year
(in Cash Flow Model)
3rd step – Take the average of the two.
Thus the estimated full-cycle profit oil split is 56/44% in favor of the Government. This
technique of averaging the peak and ending splits (see figure 1.3) will usually provide an
excellent estimate. If the peak production had by far exceeded the highest tranche then the
estimate would likely have been low. For example the highest tranche is the > 40,000 BOPD
tranche and if production had reached say 80,000 BOPD the technique would typically
underestimate the government share of profit oil (full-cycle) and overestimate company share.
T 1.7 Government profit oil share calculation
If the economic model is working properly the estimates should be very close to the
cash flow results as they are here.
Year 6 (peak production) ($M)

Government profit oil $64,605
Total profit oil $104,496
$64,605
Gvt. share =  = 61.8% vs. 61.8% from the estimate
$104,496 (table T1.6 and F 1.3)
Full cycle
Government profit oil $678,692
Total profit oil $1,230,000
$678,692
Gvt. share =  = 55.18% vs. 56% estimate
$1,230,000 (table T1.6 and F 1.3)
Table T 1.7 compares the estimates with the actual results from the cash flow model showing
some modest differences. One reason for the differences is that profit oil splits are calculated on
the basis of gross production yet applied to profit oil only. Profit oil as a percentage of total
production in the early “saturated” years when cost recovery is at the limit, represents only 40%
of production in this fiscal system. These are typically the years during which the Government
share of profit oil is greatest. Later, after payout, when production rates are lower, profit oil may
represent over 70% of production. The suggested 3-step estimate does not take this into account.
However, the estimate will often closely mirror detailed year-by-year estimates (like those from
the cash flow model). It appears so far that the model is correct.
Government take
In many countries the fiscal/contract terms are so well known that this simple calculation of
Government take could indicate whether or not there might perhaps be a problem with the
economic model itself. For example if this project were in Malaysia under the late 1990s vintage
contracts the Government take would be expected to be 83% or so, not below 80%. [Note: until
this point we have discussed Government share of profit oil which is only a part of Government
take which includes all of the means by which Governments get a piece of the pie (not just the
profit oil split). This important subject is explained in further detail in Chapter 3 – Fiscal
Systems.]
The example here is a fairly common fiscal/contractual system and a “back-of-the-envelope” or

“quick-look” estimate indicates that the cash flow model is likely on track. It yields a
Government take of 77.4% in table T 1.8. Approximately 80% of all fiscal systems worldwide
can be quickly checked this way. Those fairly rare systems with depletion allowances, “R”
factors, price cap formulas, rate of return (ROR) features and excess cost oil provisions can get a
bit complicated.
Government take 77.4% [estimate] vs. 76.9% [ cash flow calculation]
So why was there a difference between the calculations from the model and the estimate? And is
this a significant difference? The back-of-the-envelope estimate, in table T 1.8, that yields a take
estimate of 77.4% is based on a slightly different cost assumption. The costs as a percentage of
gross revenues used in the estimate are 30% vs. 28.5% in the model. This would make only a
slight difference because the royalty is not that large. The biggest difference arises from the
profit oil split estimate of 56% (table T 1.6 and figure F 1.3) vs. the 55.18% profit oil split
calculation from the model. The cash flow model provides a more detailed year-by-year
estimate. However, the difference is quite small. Based upon the slight difference between the
cash flow “take” and the quick-look estimate it is likely that there are no big errors in the model.
There are other things to check of course.
T 1.8 Government take back-of-the-envelope estimate

100% Gross revenues (Full-cycle)
- 10 Royalty rate

90 Net revenues
- 30 Total costs

60 Total profit oil
- 33.6 Gvt. share profit oil (56% estimated)

26.4 Contractor share profit oil
- 10.6 Tax 40%

15.8 Company cash flow
Contractor take = 15.8/(100 – 30) = 22.6%
Government take = (10 + 33.6 + 10.6)/(100 – 30) = 77.4%
T 1.9 Government take calculation (from the cash flow model)
Total profits = Gross revenues - Total costs

Total profits = $2,000,000 M – $300,000 M – $270,000 M
= $1,430,000 M
Gvt. take = Gvt. share of profits/Total profits

Gvt. share = $200,000 M + 678,692 M + $220,523 M
= Royalties + profit oil + taxes
= $1,099,215 M
Government take = $1,099,215 M/$1,430,000 M = 76.9%

(see tables T 1.3 and 1.4)
Effective Royalty Rate (ERR)

With any production sharing contract with a cost recovery limit the Government will be
guaranteed a share of production in each accounting period by virtue of the combination of the
limit and the subsequent profit oil split. This creates much of the effect of a royalty. For PSCs
like the example system here, where there is also a royalty, the effect is magnified. The
combined effect of a royalty and a cost recovery limit is referred to as the “effective royalty rate”
or “revenue protection”. It represents the minimum share of revenues the government might
expect through royalty payments and profit oil in a given accounting period. With production-
based sliding scales this minimum guarantee will change from accounting period to accounting
period because production rates change.
An estimate of the ERR is provided in table T 1.10. Here it is assumed that the cost pool by far
outweighs the available revenues and the system is “saturated”, i.e. at the limit. Furthermore,
with sufficient deductions, the company would be in a no-tax-paying position. Thus the ERR will
range from 30 to 34.8% depending upon the profit oil split in any given accounting period
because of variations in production levels.
Notice in the early years of production in the cash flow model, there is a cost recovery carry
forward (C/F). Also there is no taxable income in the first two years of production. In these two
years the effective royalty rate can be taken from the cash flow model.
An example from year 4 is shown in table T 1.11 (figures are in $M).
[($11,800 + $25,400)/$118,000] = 31.5%
In year 4 the gross revenues are $118,000 M. Of this the Government receives $11,800 M in
royalties and $25,400 M in profit oil and no taxes. This kind of situation, where a company can
be in a no-tax-paying position, can happen under a variety of circumstances: in the early stages
of even a profitable field, in the latter stages of production for all fields, and during much of the
life of marginal and sub-marginal fields.
T 1.10 Effective Royalty Rate back-of-the-envelope estimate
Minimum * Maximum *
 
100% 100% Gross revenues
- 10 - 10% Royalty rate
 
90 90 Net revenues
- 50 - 50 Total cost recovery [“saturated”]
 
40 40 Total profit oil
- 20 24.8 Gvt. share profit oil (50% - 62%)
 
20 15.2 Contractor share profit oil
- 0 - 0 Tax (40%)
 
30% 34.8% Effective Royalty Rate (ERR)
[Royalty + Profit oil]
T 1.11 Effective Royalty Rate cash flow calculation – year 4
($M)

$118,000 Gross revenues from the model
- 11,800 Royalty

106,200 Net revenues
- 59,000 Total cost recovery

47,200 Total profit oil
- 25,400 Gvt. share profit oil * (53.8%)

21,800 Contractor share profit oil
- 0 Tax

$37,200 Government share of revenues
[$11,800 + 25,400]
31.5 % Effective Royalty Rate *

[$11,800 + 25,400]/$118,000
* Year 4 “off peak” production rate is 16,160 BOPD.
Savings Index
There is much discussion these days about the “mutuality” or “alignment” of interests between
host governments and international oil companies as an important objective in fiscal/contract
design. Most of the context of this design concept deals with creating incentives for cost savings.
To a large extent this can be measured.
Typically for any given fiscal system, an oil company (and the Government) will benefit from a
reduction in costs—either capital or operating costs(as long as it does not delay or reduce
production or impair safety). And the degree to which the company will benefit depends upon
the profits-based fiscal elements. For example, in the example PSC, there is a profit oil split in
favor of the Government on the order of 56% and a tax of 40%. The combination of these two
(profits-based) levies will yield an effective tax rate of 73.6%.
T 1.12 Savings index estimate

In terms of present value, the full benefit of
$1.00 One dollar saved a dollar saved will be different than the
(yields an additional $1.00 of profit oil) index. From an exploration point of view,
.56 Gvt. Share of Profit Oil (56%) reducing capital expenditures (or costs) by a
 dollar will increase company cash flow
$0.44 Taxable income from $1.00 saved discounted at 12.5% by more than 26.4¢.
- 0.176 Tax (40%) The same is not true of operating expenses.
 Saving a dollar of operating expenses in the
= 0.264 Contractor share of $1.00 savings cash flow model, table T 1.12, might
improve contractor discounted cash flow by
26.4¢ on the dollar (undiscounted) only 10¢ or so. However, in any given year
during the producing years, if management
reduces operating expenses (also called
operating costs), the impact will be closer to
the index26.4¢.
Entitlement Index
Booking barrels is such a big thing these days—much more so than even 10 years ago. Under
most systems, companies will “book” the equivalent of their “entitlement” barrels net to their
working interest share of proved reserves only (UK public companies under London Stock
Exchange (LSE) regulations will book P50 or Proved + Probable). Under a PSC, contractor
“entitlement” consists of two components: cost oil and profit oil. Government entitlement also
consists of two components: royalty oil and profit oil. In a typical economic model, cost oil and
profit oil are converted to dollars so a simple calculation is required to convert this to
“percentage entitlement” and then to barrels as shown in table T 1.13. The table T 1.8 estimate of
Government take provides the components of contractor entitlement: Cost oil 30% and profit oil
26.4% which yields an entitlement of 56.4%.
This “lifting entitlement” would however not correspond to the reserves the company would be
able to “book” for Securities and Exchange Commission (SEC) purposes. Even if a 100
MMBBL discovery were made it is likely that it would be quite a long time before all 100
MMBBLS would qualify as “proved” reserves. Thus, depending upon the estimate of proved
reserves, the company would likely “book” roughly 56% of those barrels. With most PSCs
company entitlement is between 50 and 60%.
T 1.13 Entitlement calculation
($M)
$570,000 Company cost oil (from tables T 1.3 and T 1.4)

551,308 Company profit oil

$1,121,308 Company entitlement
56% Company entitlement

[$1,121,308/$2,000,000]
56,065 MBBLS Company entitlement (BBLS)
Spot Checks
There is already evidence to indicate that the model is working as it should based on the metrics
used so far. But these indicators are not sufficient. There are other methods of checking the
model, and some are shown here.
C/R Limit
A quick check in the early years of production will often show if the model is honoring the
contractual 50% cost recovery limit. It depends upon whether or not the system is “saturated”
and where the limit is tested. In this case in year 4 there are unrecovered costs carried forward
(C/F) so cost recovery is “saturated”. Gross revenues are $118,000 M and total cost recovery that
year is projected at half of that, $59,000 M as it should be.
40% Tax
The tax rate is supposed to be 40% and this can be checked in individual years against taxable
income. It can also be checked against contractor profit oil. In any given accounting period the
company share of profit oil will not be the tax base, but on the average, over the life of a field it
will average out (see table T 1.8). Therefore, to check the model, income tax paid comes to
$220,523 M. And indeed this is equal to 40% of the company share of profit oil: $551,308. An
additional check is provided in table T 1.14 with an inspection of the tax base calculation in year
5.
Company cash flow
Table T 1.14 provides a spot check (year 5) of the model by testing the calculation of company
cash flow. This provides additional assurance that the modeling has been constructed correctly.
Assuming the model is correct, the next step is to inspect various assumptions.
T 1.14 Income tax and cash flow calculations – year 5
($M)
Taxable income = Gross revenue

- Royalties
- Depreciation
- Operating costs (OPEX)
- Government profit oil
- Tax loss carry forward (TLCF)
Taxable income = $186,240

- 18,624
- 60,000
- 22,624
- 43,387
- 11,000

= $30,605 This “checks” with the model (see table T 1.3)

Net cash flow = Gross revenues
(after-tax) - Royalties
- Capital costs
- Operating costs
- Government profit oil
- Taxes
Net cash flow = $186,240

(after-tax) - 18,624
- 70,000
- 22,624
- 43,387
- 12,242 [.4 * $30,605 above]

= $19,363 This “checks” with the model (see table T 1.3)
Checking the assumptions

In the previous pages the integrity of the model and the algorithms were put to the test. And, it
appears that the model is working properly. In the following pages the assumptions that went
into the model are reviewed and tested for reasonableness.
Price and cost assumptions

It takes a lot of experience to have a feel for whether or not certain assumptions are reasonably
in-tune and balanced. But of course it also requires knowledge of how and where to check—that
is what this chapter is all about. This example review/audit exercise has purposely been generic,
and non site-specific. In practice this exercise would be conducted within the context of known
conditions, offset fields, experience in the region, basin, and play and so forth. This kind of
information in conjunction with the methodology outlined here provides powerful insight.
Initial oil price

It was assumed that at the time of the analysis, North Sea marker Brent Crude was trading at
$22.00/BBL (see table T 1.2). The oil price in the model is $2.00/BBL lower than the price of the
lighter Brent crude. Brent is a well known North Sea marker crude blended from the fields
producing into the Brent and Ninian pipelines. Because the mix of crudes has changed over the
years the API gravity has changed slightly upward but not dramatically. Brent crude is
approximately 39° API. The question of course is whether or not the price adjustment assumed
in the economic model is sufficient. Heavier crudes are not as valuable as lighter crudes like
Brent and the price adjustment can range from as low as 1.5% per degree API to as much as 3%.
Assuming a price adjustment of 1.5%/degree the 26° API crude should sell for $17.70/BBL.
Brent $22.00/BBL
Adjustment - 4.30/BBL [13° API * 1.5%/degree = 19.5% adjustment]
__________
Adjusted Price Estimate $17.70/BBL
The adjustment could have been greater of course. The generic relationship is shown in figure F
1.4.
F 1.4 General oil price relationship
This general relationship provides a point of reference in the absence of hard current
information. Price relationships vary from region to region and also fluctuate with
time and conditions. Furthermore this relationship does not capture directly the
effects of sulfur content.
← Slope: → ← Condensates
1.5 – 3.0% price
Oil adjustment
Price per ° API
$/BBL
Intermediate Condensates
Heavy Oil Light
10° 40° 50°
Crude Gravity ° API

Not to Scale
In Nigeria in 2001 the price adjustment for heavier crudes was 30¢/BBL for each ° API
difference. This kind of adjustment will work when oil prices are stable. However, with
fluctuating oil prices sometimes it helps to use percentages. During the year 2001 the 30¢/BBL
adjustment represented roughly 1.5% price adjustment for each ° API. For example if Nigerian
Bonny light (37° API) was selling for $20/BBL then a heavier crude, say 30° would sell for
around $2.10/BBL less (see Chapter 8 – Fluid Properties).
Capital cost per unit ($/BBL)

$300,000 M/100,000 MBBLS = $3.00/BBL
Capital costs are an extremely important aspect of project economics. The main categories of
cost associated with the upstream petroleum industry are: Exploration, development, operating,
abandonment, and financing costs (cost of capital).
As far as economic sensitivity is concerned, exploration risk capital is about 10 times more
important than development capital and development capital costs typically outweigh operating
costs by a wide margin.
Development costs typically consist of:

Drilling costs
Production/processing facilities
The transportation function
$3.00/BBL in this case could be a reasonable number. It is however, slightly low by world
standards, for 600 feet of water. There is not sufficient information in this exercise to make
comparisons. However, in the real world analysts would have a feel for whether or not this is a
reasonable number in a particular area.
Exploration well costs
The cost of drilling an exploratory well is a useful index. Exploration drilling costs often
constitute the lion’s share of the risk capital associated with an exploration venture. Knowing
how much it costs to drill an exploratory well will also provide some insight into subsequent
development drilling costs should there be a discovery.
Drilling costs typically can represent from 25-50% of the total costs associated with a
development. Production facilities of course become of greater and greater importance the more
remote the location and the deeper the water.
Capital costs per BOPD

$300,000 M/33,000 BOPD = $9,090/BOPD “Dollars per daily barrel”
This statistic is based on total capital costs divided by peak daily production. Peak production is
projected in year 6 when 12,050,000 barrels are modeled (around 33,000 BOPD). This is an
interesting statistic—perhaps more interesting than useful as far as this particular exercise is
concerned. However, it is a statistic used in a variety of circumstances and for that reason is
included here to show where these numbers originate.
Often, when macro-economists discuss capital cost requirements to meet world demand growth
(for crude oil) they will state that OPEC, particularly the big four Gulf states (Iran, Iraq, Kuwait
and Saudi Arabia) will need to add another 15 MMBOPD of capacity in the next 7-10 years.
Capital cost requirements are estimated to be on the order of $60 Billion. This equates to $7.5
Billion per year for the next 8 years for upstream capacity only. This is based upon the
assumption that capital cost requirements should be on the order of $4,000/BOPD of capacity.
Refining capacity expansion is often rated in terms of $12,000 per barrel per day of capacity for
a modern high-conversion refinery, and this would include both distillation capacity as well as
typical upgrading units such as cracking, reforming and such. (see Chapter 10)
Capital costs as a percentage of gross revenues

$300,000 M/$2,000,000 M = 15%
Total capital costs divided by gross revenues are 15%. By world standards with around $20/BBL
(for a Brent quality crude) this is a fairly normal percentage. It is no surprise that as capital costs
increase, project economics deteriorate. The point at which costs become too high is usually very
close to where capital costs as a percentage of gross revenues (15% in this case) approach the
Contractor take percentage.
Contractor take here is 23% so it is not surprising the NPV 12.5% is positive. Had Government
take been greater than 85% (Contractor take <15%) it is likely the economics would have been
marginal or worse. It depends on other things of course such as operating costs, timing etc.
Total costs as a percentage of gross revenues

($300,000 M + $270,000 M)/$2,000,000 M = 28.5%
Total costs including both Capex and Opex divided by total revenues under ordinary conditions
(if there is such a thing) are often around 30-35%. In this model the ratio was less than 30%. This
is not unusual but there should be a reason. Governments are extremely sensitive to costs. In
their view, if sufficient revenues are generated all costs borne by the oil companies are
reimbursed out of revenues generated from the government’s mineral resources (theoretically).
Every dollar of additional cost reduces Government profits. The same is true for oil companies.
Operating costs (peak year)/total capital costs

$28,100 M/$300,000 M = 9.4%
This is a fairly obscure but useful statistic for checking operating cost estimates relative to
capital costs. For conventional developments (with no substantial “floating” elements), the range
is often from 3 to 8%. In the Gulf of Mexico shelf (conventional water depths) the relationship
between annual operating costs and total Capex is often from 3 to 5%. In the UK North Sea the
range might be more like 6 to 8%. World average is probably close to 5%. However, for
deepwater non-conventional developments with substantial floating elements for production,
storage and off-loading, the ratio can approach 20% or more.
Operating costs (early years)

$15,800,000 M/5,900 MBBLS = $2.67/BBL [year 3]
$22,624,000 M/9,312 MBBLS = $2.43/BBL [year 4]
Operating costs in the early years of production are assumed to be roughly $2.50/BBL. This may
seem a bit low depending on the region and the particular situation. Average operating costs
worldwide are higher by about $1.00/BBL. It is certainly possible for costs to be this low, but
there is not enough information in this exercise to say one way or another. Analysts would likely
know for a particular area whether this number was high or low.
Operating costs (full-cycle)

$270,000 M/100,000 MBBLS = $2.70/BBL
In any given region or situation there is a likely level of operating costs that would be considered
realistic or reasonable under a given set of conditions. Full-cycle operating costs with most
models are typically higher than operating costs per unit in the early years of production.
Sometimes when analysts or management quote operating costs they include depreciation.
Furthermore, in many countries, intangible costs that are not required to be capitalized (i.e. these
costs are expensed not amortized), are defined as operating costs. In order to be comfortable with
operating costs on the order of $2.70/BBL there should be a good healthy economy-of-scale and
no cruel and unusual conditions that might require higher costs. A 100 MMBBL field is not
necessarily large, but it may be large enough to provide sufficient economies to justify lower-
than-average operating costs.
The key factors that influence both capital and operating costs include:
Water depths or terrain
Climate: Weather windows, wave conditions, spring break-up
Infrastructure: Roads, rail, port facilities, airports, communications
Distance from supply points for goods and services
Distance to market
Reservoir depth
Rock type/Petrophysical parameters
Reservoir pressure gradient
Fluid properties: Paraffin content (pour point), Gas oil ratio
Political conditions/risks
Technical aspects and assumptions

The basic unit of production in the upstream end of the industry can be viewed as either a well or
a field depending upon the situation. In this case both are considered. The petroleum industry is
highly technical. The measures here only scratch the surface but they do provide some insight
into the dynamics of the model. Furthermore, checking these aspects of the model provides quick
indications of particular areas for further inspection.
Peak production/total reserves (P/R)

12,050 MBBLS/100,000 MBBLS = 12.05%
In year 6 of the cash flow model production peaks at 12,050 MBBLS. This represents 12% of the
total reserves. This production/reserve (P/R) ratio is a useful and direct measure of the rate of
production. Typically, field developments are designed in such a way that roughly 10% or so of
the recoverable reserves are produced in a peak year of production. However, higher rates can be
found. Indonesia is fairly famous for high P/R ratios—on the order of 20 to 25%. Often the
production decline rate coming off plateau production will be close to or greater than the P/R
ratio (see figure F 4.6, Chapter 4).
The rate of production can have a huge impact on project economics. Therefore it is important to
ensure that if a production profile has a particularly high (or low) P/R ratio that there is adequate
justification.
Decline rate (12.5%)

Typically production decline rates will be equal to or greater than the P/R ratio. In this case there
is little information provided by this statistic but it was considered important to illustrate how
this can be observed fairly quickly. Take year 10 for example. Year 10 from the production
profile has 7,202 MBBLS of production. The previous year was 8,232. This represents a 12.5%
decline. The same rate is found in subsequent years.
7,202 MBBLS [year 10]

Rate of Change =  = 87.5%
8,232 MBBLS [year 9]
Decline Rate = (1 – 87.5%) = 12.5%
Well spacing
6,000 Acres/22 Wells = 270 Acres/Well
One of the important companion statistics to the P/R ratio is well spacing. An oil field can be
produced either slowly or very quickly and much of this will be reflected in the P/R ratio. It
depends primarily on the number of wells a company is willing to drill, or how many horizontal
wells are drilled. Up to a certain point there is an advantage to drilling more wells and beyond
that point there are diminishing returns. The objective is to maximize present value.
There is not sufficient information to determine if the spacing is appropriate, especially without
maps and other information. However, it is likely that it would be difficult to produce as much as
12% of the reserves in one year from a given reservoir on such a large spacing if all the wells are
vertical. In the early days of the North Sea, developments were typically initiated with 200 – 240
acre spacing. Later, additional in-fill wells were drilled. With these spacings P/R ratios were
typically around 10%.
Now, more horizontal wells are being drilled. Typically horizontal wells extend at least 3,000
feet horizontally through a reservoir. Much less than that is a waste and beyond that the relative
benefits typically diminish substantially. With a 3,000 foot horizontal leg a well will drain
approximately twice as much as a vertical well on a 200 acre spacing. If all the wells in this
100,000 MBBL development were horizontal then it could likely produce faster than the 12%
P/R in the model.
Initial production rate per well

33,000 BOPD/22 Wells = 1,500 BOPD/Well
The initial production rate per well is an extremely important parameter. From the limited
information provided with this model only an estimate can be made. Supposedly 22 wells are
assumed to be productive. However, from the model it cannot be determined just how many are
actually producing in the early years. Therefore, it will be assumed that by year 6 of the model
all wells are producing. Yet, by that time, some of the wells will already have been producing for
over 3 years. Thus this estimate will be somewhat low. However, this is an accuracy vs.
precision issue and a simple estimate is sufficient.
The field is projected to be producing at 33,000 BOPD by year 6 (year 4 of production). Divided
among 22 wells this yields an initial average rate of around 1,500 BOPD/well. The natural
question arises; “Is this reasonable?” It depends on many things, which are discussed in the next
section.
One common mistake is to use reported test rates from an area in an exploration or development
model. Or for development feasibility economics sometimes test rates from the discovery and
appraisal wells are used. This is often not appropriate. Reported test rates are usually the result of
“combined” flow rates that may include separate drill-stem test results from numerous reservoir
intervals up and down the hole.
Table T 1.15 shows reported discovery well test rates worldwide for the years 1996-1998. The
average test rate for an oil discovery during this period was around 5,000 BOPD. It is likely that
the average production rate per well, during the first full year of production for development
wells associated with these discoveries, would be half this much.
T 1.15 Reported international discoveries 1996 - 1998
Well Test Rates

In any given province the delivery rate per well is important but it is even more
important with deepwater developments.
Of these discoveries, approximately half were onshore and half offshore.
Reported Combined Flow Rate on Test (BOPD)

Oil Lower Upper
Year Discoveries Quartile Average Quartile
1996 46 940 4,600 9,900
1997 55 740 6,900 10,970
1998 84 350 4,015 11,070
    
185 613 5,018 10,750
Reported Combined Flow Rate on Test (MMCFD)

Gas Lower Upper
Year Discoveries Quartile Average Quartile
1996 57 4 22 50
1997 28 3 18 43
1998 53 2 22 62
    
138 3 21 53
Summarized from: AAPG Explorer Jan., 1997, 98 and 99. Major discoveries compiled by Petroconsultants.
BOPD per foot of pay

1,500 BOPD/110 feet = 14 BOPD/ft
This is an extremely rare statistical measure. It should be used with caution. For one thing, this
productivity index captures the effects of only one (pay thickness) of 4 main parameters that
influence oil well deliverability. Deliverability is also directly proportional to permeability and
drawdown (pressure differential in the well bore), and inversely proportional to fluid viscosity
(Darcy’s radial flow equation see Chapter 7 – Petrophysics).
However, for those familiar with both its strengths and weaknesses, it does provide insight. A
productivity index of 14 BOPD/ft is not high. In fact 20 might be closer to world average.
Anything above 40 is high. Some wells produce at rates on the order of 60 to 80 BOPD/ft but
these typically occur because of dramatically reduced bottom-hole pressure due to submersible
pumps.
Development drilling success ratio

22 Productive wells/25 Development wells drilled = 88%
Even development wells can come up dry. In some areas in fact the ratio can be quite high—on
the order of 20%. Furthermore there are worse things than a dry hole. A blowout of course would
qualify, but perhaps more common than that is the kind of drilling where a completed well yields
insufficient production to justify even the completion costs—let alone the dry hole costs.
Good Drilling results
Commercial success
Technical success
Dry hole – development
Technically successful development well with insufficient production to
justify even the completion costs
Dry hole – exploration (because typically exploration drilling costs more than
development drilling)
Remote gas discovery
Blow out
Bad
Swanson’s Rule
Swanson’s rule is a method of estimating the “mean” of a distribution, (shown below).
F 1.5 Swanson’s rule

Swanson’s Rule for finding the mean in low to medium-variance cases:
30% * P10 value Assume the field size distribution is as

+ 40% * P50 value follows, with an estimated chance of
+ 30% * P90 value success of 20%.
Swanson’s estimated mean:

30% * 40 MMBBLS = 12
40% * 75 MMBBLS = 30
30% * 135 MMBBLS = 40.5
 P10 P50 P90
Estimated mean: 82.5 MMBBLS 40 MMBBLS 75 MMBBLS 135 MMBBLS
(see Chapter 2 – Risk Analysis)
The focus on the mean is because it is the one single value that best represents the complete
distribution. And only the “means” from one distribution to another can be added.
For medium to high-variance (highly skewed) cases, a graphical solution is best for finding the
mean.
80/20 Rule - Pareto’s Law

Pareto’s law, the law of the trivial many and the critical few, is commonly known as the 80/20
rule. It has many applications and is an important analytical concept. It allows the analyst to
maximize efficiency by concentrating efforts on key elements.
For example, in a portfolio of producing wells, if there is a large enough (statistically significant)
sampling, 20 percent of the wells will likely produce 80% of the production. Twenty percent of
the wells will represent 80% of the value. In a given basin it is likely that 20% of the fields will
hold 80% of the reserves.
F 1.6 Two Perspectives on “Cash Flow”
Same thing, different perspectives! The typical petroleum industry

engineer/economist performing cash flow analysis needs this comparison handy
when talking to many of the wallstreet folks. They are used to taking net income
from the income statement and “adding back” DD&A to get “cash flow”.
Upstream Micro-Economic Modeling Accountants and Wall Street

Financial Statements
Gross Revenues
- Royalty

= Net Revenues → → → → → Revenues (or “Turnover”)
- Operating Costs - Operating Costs
- Capital Costs - Depreciation
 
= Pre-tax Cash Flow = Taxable Income
- Income Taxes - Income Taxes
 
= After-tax Cash Flow = Net Income
[Net Cash Flow] + Depreciation
Same - Capital Expenditures
thing 
= After-tax Cash Flow
[Net Cash Flow]
Cost of Capital
Cost of capital is the realm where corporate management establishes investment guidelines based on
how much it costs the company to finance its activities. The cost of capital depends on the cost of
debt, the cost of equity, and the corporate capitalization structure. The capitalization structure of a
company is essentially the corporate balance of equity (common stock) and debt financing. When
financial analysts talk about financial leverage they are referring to the amount of debt financing a
company uses. Theoretically there should be some ideal capital structure, say perhaps 40% debt, for a
particular company or even for a given industry.
Part of the determination of the financial structure deals with the cost of debt financing and the cost
of equity financing. A typical oil company may be paying 7% interest on its bonds, but only a 3%
dividend on common stock, i.e., the dividend yield = 3%.
Cost of debt
The cost of corporate debt is usually from 1.5 to 2.5 percentage points above long-term government
bond rates. Interest payments are deductible, so if a company is paying 35% tax for example, the
actual cost of debt financing (after tax) is 65% of the 7.0% interest rate or 4.55%.
Cost of preferred stock
There is no tax benefit for preferred dividends from the perspective of the issuing company. Preferred
dividends are not tax deductible like interest expenses for debt are. The cost of preferred stock is the
dividend per share divided by the price per share less the cost of issuing the stock. The costs of
issuing or floating preferred stock can range from 2 to 4%. For example, the dividend to price ratio
for most preferred stocks is around 9%. If the issuing or underwriting costs are 4%, the cost is
calculated at 9.37%. The cost of preferred stock capital is shown below:
Dividend
Cost of preferred stock =
Stock price - cost of issuing
4%
Cost of preferred stock = = 4.17%
100% - 4%
Cost of equity
Equity capital is usually more expensive than debt. In some over-leveraged companies, debt is
such a burden that the cost of debt approaches the cost of equity. This is particularly true of the
more subordinated layers of debt referred to as “junk bonds” with some very high interest rates.
Capital asset pricing model (CAPM)
The Capital Asset Pricing Model is the most accepted method for estimating the cost of equity. It
is also used to determine the discount rate that should be used to evaluate a stock. It is based on
the assumption that investors must aim for higher returns when dealing with the higher risks in
the stock market. The CAPM calculates the cost of equity based on a risk-free return such as a
U.S. government bond, plus a risk adjusted premium for the particular stock. The adjusted risk
premium is based on the market rate of interest and the beta of the stock.
Market rate of interest
Two basic elements make up the market rate of interest, or the market rate of return. The first is
the relatively risk free rate of interest of a U.S. government bond—about 5% which is composed
of a real interest rate component and an inflation component. The real rate of interest is
calculated by subtracting the inflation rate from the quoted nominal interest rate. The second is
the risk premium investors require to justify being involved with equity securities. Historically,
market premiums have ranged from 4% to 7%. The relationships are shown:
Real interest rate 3.0%

+ Inflation component 2.0%
= Government bond 5.0% Nominal rate (“risk free rate”)
+ Risk premium 5.0%
= Market rate of interest 10.0%
Beta
The beta of a stock measures its trading price volatility relative to either a stock market index or
an industry related index of stocks. If a stock's price tends to follow its industry group up or
down in synchronization, the stock will have a beta of 1. A stock that rises more than other
stocks in a bull market and falls faster in a bear market will have a beta greater than one. A high
beta stock will exhibit a more volatile performance during market fluctuations. If every time the
market went up 10% the stock of a particular company would go up 12%, the beta for that
company relative to the market would be 120% (or 1.2).
The beta, market rate of interest, and the risk-free rate of interest are used to calculate the cost of
equity capital for a company. An investor would use the same information to calculate his
required rate of return for investing in a stock with the same parameters. The Value Line betas
for several oil and gas companies are shown in table T 1.16.
T 1.16 Value Line – Betas
4/1988 4/1990 1/1993 3/1995 2002

Unocal 1.05 1.05 1.00 .95 .85
Mobil .90 .85 .75 .65 E/M .80
Oxy .95 .90 .95 .80 .80
Phillips .90 1.00 .90 .80 .75
Amoco .80 .80 .75 .65 BP/A .75
Arco .85 .85 .75 .70 BP/A
Chevron .95 1.00 .85 .70 C/T .75
Total .90 .95 - .60 TFE .75
Texaco .75 .75 .65 .65 C/T .75
RD Shell .80 .75 .70 .70 .80
Average .89 .89 .73 .72 .777
E/M = ExxonMobile, BP/A = BP Amoco (and Arco) , C/T = ChevronTexaco,

TFE = TotalFinaElf
The capital asset pricing model calculation of the required rate of return on common equity is shown
in figure F 1.7.
F 1.7 Capital asset pricing model (CAPM)
RRR = Rf + Bi(Rm - Rf)
Where:
RRR = Required rate of return from investor point of view, or cost of

equity capital
Rf = Risk free rate of return (U.S. government bond)
Rm = Market rate of return
Bi = Beta of the investment
Bi(Rm - Rf) = Risk premium for a particular stock with a Beta equal to Bi
RRR = 5.0% + 1.20 (10.0% - 5.0%)
= 5.0% + 6.00%
= 11.00%
Weighed average cost of capital
Many analysts prefer to determine discount rates, reinvestment rates and company cost of capital
by using the weighted average cost of capital. The cost of each component of corporate
financing is weighted according to its percentage of the capital structure.
The example here is a company with a beta of 1.20. The company has a capital structure that
consists of 30% debt and 10% preferred stock. The after-tax cost of debt is 4.55%, and the 10%
of capital provided by preferred stock has a cost of 4.17% and 5% deferred taxes at zero (0) cost.
The CAPM calculates the cost of equity at 11.0%. The overall cost of capital is summarized
below using the weighted average cost of capital (WACC) approach. Each form of corporate
financing is weighted according to its market value percentage relative to the total market
capitalization of the company. An example calculation is illustrated in table T 1.17.
T 1.17 Weighted average cost of capital
Cost Weight Weighted

Source of Capital % % %
Debt financing 4.55% 30% 1.37%
Preferred stock 4.17% 5% .21%
Deferred taxes 0% 5% 0%
Equity financing 11.00% 60% 6.60%
Weighted average 100% 8.18%
The weighted average of 8.18% represents the company cost of capital. The company would
theoretically not invest in any venture that yielded an after-tax internal rate of return (IRR) of
less than say 9%. There are other considerations of course, but this is the benchmark for
determining the boundary conditions for corporate financing and investment policy.
This is the common example used in presenting the concept of cost of capital, but determining
the cost of capital has elements of scientific procedure and art. Estimating the market rate of
interest, for example, can be quite subjective. Furthermore, the position held by deferred taxes in
the corporate capital structure can be fairly abstract. It is usually considered to be the equivalent
of an interest-free loan from the government. It normally does not amount to a substantial portion
of the total capitalization of a firm, but this is the most common treatment if it is factored in at
all.
Capital budgeting and Investment theory

The basic theories of economics and risk analysis are part of the fabric of our everyday lives and
the concepts are virtually timeless. However, with the computer age and the age of capital, the
sciences of economics and decision theory have evolved to a lofty position in the business world.
The language of risk analysis can be rather exotic and confusing at times. Understanding the
language and terminology of these theories allows professionals to communicate, yet sometimes
a number of terms are used for the same concept.
Even some of the more complicated sounding theories are really concepts that are familiar to
nearly everyone. Once the terminology is understood, an understanding of the theory is relatively
easy. Nearly every facet of economic or financial analysis deals with one or more aspects of
value. Value is the measure by which companies measure corporate wealth and whether or not
the organization is growing.
Fundamentals of valuation
The concept of value can be viewed many different ways. The perspectives are different for
bankers, accountant, shareholders, management regulatory agencies, and for buyers and sellers.
Most engineers, analysts and shareholders focus on two general concepts of value: market value
and fair market value. Understanding the true value associated with any investment option is
fundamental to the corporate decision-making process,
Fair market value

Fair market value (FMV) is the price at which an asset would pass from a willing seller to a
willing buyer after exposure to the market for a reasonable period of time. It is further assumed
that both buyer and seller are competent and have a reasonable knowledge of the relevant facts,
and that neither party is under any undue compunction to buy or sell.
FMV is not a valuation technique. It is a concept, based on value that can be derived by several
techniques. The relationship between value and price can be quite complex. The difference
between price and value often reflects an increase (or decrease) in corporate wealth.
Another relationship between value and price is called the “winner’s curse”. It is important to
keep this relationship in mind especially in competitive bidding situations. Figure F 1.8
illustrates this concept. Theoretically, the average estimate or bid would most closely
approximate the true value of an asset. However, it is not the average bid, but the highest bid
that succeeds in a competitive bidding situation. Some define winner's curse as the difference
between highest bid and the next highest bit. Others define it as the difference between highest
bid and the average bid.
Probability criteria
There are a number of criteria used in the industry to quantify and characterize the value of an
asset or a producing properly. Some are superior to others and some are a waste of time.
Sometimes management uses yardsticks that are virtually obsolete and misleading.
There is no single measure of profitability that can fully characterize the nature of the value of an
asset. Numerous criteria exist and regardless of their relative value, an analyst must understand
the process and its strengths and weakness. Some common measures used to quantify and
determine value of an asset are:
• Payout
• Capitalized cash flow or Cash flow multiple
• Accounting rate of return
• Profit-to-investment Ratio (P/I)
- Undiscounted
- Discounted P/I ratio
• Net present value (NPV)
• Internal rate of return (IRR)
Payout
Payout (also known as “payback”) is the length of time (usually expressed in years) it takes for a
company’s net cash flow to equal the initial capital investment. The concept of return of capital
or "cost recovery” is universal.
From a financial point of view, the quicker the payout the better. Payout typically refers to the
time in which the firm gets its initial investment back and is considered to some extent a measure
of risk. The longer the riskier.
The payout measure is used widely. In fact, it is often overused because it has some significant
weaknesses and there are better measures. However, in management presentations, if payout is
not explicitly addressed then someone will raise their hand and ask, 'When is payout?'
Cash flow multiple

When the information is available, in some circumstances a multiple of cash flow provides a
rough estimate of the value of producing properties. The market for oil and gas production in the
U.S. will typically pay from four to six times (annual) cash flow for a mature portfolio of oil or
gas production.
This corresponds to payouts from five to seven years. Payout will typically be greater than the
cash flow multiple for a production acquisition because production and cash flow typically
decline.
Because of this, the cash flow multiple is not quite the same as the often-used term—payout. If a
producing property did not have a decline rate, the cash flow multiple and the payout could be
the same.
Profit-to-investment ratio
The profit-to-investment ratio (P/I) is an old and fundamental investment concept. It will
probably always be part of analysis and presentations. In a few cases the time value of money is
not considered; however, generally the discounted future cash inflows will be compared to cash
outflows. It is simply a comparison of the discounted cash flow that is ultimately received to the
investment that earned it. The P/I ratio provides a ranking index to be used when numerous
projects are considered in the capital budgeting process. Those with a higher index will take
preference over discretionary projects with a lower index. When present value discounting is
applied to the numerator this metric becomes slightly more sophisticated and is often referred to
as a “bang for the buck” index—present value profit to investment ratio (PVP/I).
T 1.18 Profitability criteria, abbreviations & synonyms
Abbreviations/Synonyms
Profitability Criteria Other Approaches
Payout Payback
Cost recovery period
Capitalized cash flow Cash flow multiple
Price/Cash flow ratio
Profit-to-investment ratio (P/I) Profit/Investment ratio
(P/I) (ROI) Return on Investment
(ROR) Rate of return
P/I ratio
Discounted ROI
Leverage
Percentage payout
(PI) Profitability index
(ROI) Cash-on-cash return
Net present value (PV) Present value
(NPV) (DCF-NPV) Discounted cash flow net present value
(PVP) Present value profit
(PW) Present worth
Present worth profit
(Discount rate should be specified, such as NPV 15%)
Expected value (EV) Also called “Risked value”
(EMV) Expected monetary value (“Risked value”)
Internal rate of return (ROR) Discounted rate of return
(IRR) DCF rate of return (DCFROR)
Internal yield
(PI) Profitability index
Marginal Efficiency of Capital
(DCFR) Discounted Cash Flow Return
Present value profit to investment (PVP/I) “Bang-for-the-buck” measures
(DPI) Discounted profit to investment ratio
(DCF-ROI) Discounted cash flow return on investment
Growth Rate of Return (MRR) Modified Rate of Return
Earning Power
Accounting Rate of Return The Baldwin method
Appreciation of Equity
Rate of Return
Simple Rate of Return
Unadjusted Rate of Return
Competitive Bidding and the Winners Curse
F 1.8 Winners Curse
The highly competitive exploration end of the industry is rich with terminology and
buzzwords dealing with competitive bidding, particularly, “Winners Curse”,
“Money-left-on-the-table”. And it is extremely common for the highest bid to be
twice as high as the next highest bid.
Frequency distribution of bids
4
Number of bidders
3
2
2
1 1 1
1
0 5 10 15 20 25 30 35
Estimated or bid value ($MM)
Number of Bidders = 5
Bids submitted = $31, 16, 12.5, 7.3, 6.1 MM
Average Bid = $14.58 MM = Fair Market Value?
Winning Bid = $31 MM = Market Value!
Winners Curse = $16.42 MM = (highest – average)
or $15 MM = (highest – next highest)
[people have different views on this one]
Money Left-on-the-Table = $15 MM = (highest – next highest)
Chapter 2 - Risk Analysis
2. Risk Analysis
VS.
“Risk vs. Uncertainty”
One of the most interesting and important aspects of investment theory is the subject of risk. The
definition of risk is slightly confusing because it is a bit difficult to define in such a way as to
make all people happy. Many analysts and authors equate risk and uncertainty, but there is a
difference. Risk analysis is the process of evaluating possible outcomes and uncertainties and
characterizing them in such a way that good business decisions can be made.
Expected Value theory

The decision-making process associated with risking money on a drilling location can range
from pure gut level experience to sophisticated analytical methodology. Regardless of the level
of sophistication, the experience factor and the gut level choices are of great importance. Even
for the relatively unsophisticated decision maker, the process is much the same. At the gut level,
investors either consciously or subconsciously weigh in their minds the “stakes”—the balance
between risk and reward. The only difference is that some people try to quantify the “odds” and
put a name to that approach. It is called the expected value (EV) approach.
The use of expected value theory-also referred to as the expected monetary value (EMV)
approach, became more common throughout the 1980s as a formal tool of decision makers. Prior
to that there were many who informally weighed the risks and rewards of a possible drilling deal
and then made their decision. The decision of whether or not to drill is one of the best examples
of the use of this tool. The EV approach weighs risk capital and the chance of losing it with the
potential reward and the probability of achieving that reward. The EV formula for evaluating
“the stakes vs. the odds” is defined in figure F 2.1. Figure F 2.2 shows where EV and other
analyses fit into the decision theory scenario.
F 2.1 The Expected value (EV) formula
This is the basic equation of modern day risk analysis. The rule is: If expected value is
positive then the reward outweighs the risk. Companies try to choose investment
opportunities that maximize expected value.
Expected value = Reward * SP - Risk capital * (1-SP)

Where:
Risk capital = Costs associated with testing a prospect. Typically consists of
dry hole costs , geological/geophysical costs, and possibly a
signature bonus.
Reward = Present value of possible successful exploration efforts based
upon discounted cash flow analysis of a hypothetical
discovery typically discounted at (or close to) corporate
cost of capital. [see tables T 1.3 and T 1.4]
SP = Probability of success (Likelihood of actually making a
discovery – Estimated by geotechnical personnel.)
1 – SP = Probability of failure (Likelihood of drilling a dry hole and
losing the risk capital).
This formula provides the cornerstone of risk analysis. The rule is that if EV is positive, then the
risk-weighted reward outweighs the risk-weighted cost of failure.
The expected value formula, whether it is used directly or indirectly (gut feel), provides the basis
for billions of dollars of exploration investments. It is normally more complex with the common
practice in the industry of using multiple outcomes (at least 3) on the “reward side” of the
equation. This is illustrated in the ‘Multiple outcome decision tree’ figure F 2.4. The focus of this
chapter is on how the “reward side” values are derived. The cash flow model, summarized in
table T 1.2, represents the “most likely” outcome (100 MMBBLS) if a discovery is made.
F 2.2 Decision tree
Reward
Drilling Field Size Estimates Probability of
Costs/Timing Deliverability success In an exploration project, the reward is
Estimates Estimates
Technical & represented by the discounted present value of
Geological Risks estimated successful drilling results—a
discovery. For example the 100 MMBBL
Monte Carlo
Simulation * discovery (discussed and modeled in Chapter
* 1) could have represented a value (“reward”)
Political Risk of $54 MM. The rate at which the cash flow
Analysis
projection is discounted should be a discount
rate that would represent an acceptable rate of
Discounted Cash Flow Analysis return to the company. Sometimes a hurdle
Threshold Field Size Analysis
rate is established by corporate financial
Sensitivity Analysis management for discounting purposes. The
Break-even Analysis
issue is based upon the corporate cost of
capital and/or the perceived market rate of
* interest for such investments. The decision to
go forward with a project therefore could be
Expected Value (EV)
Utility Theory made for a project that had a positive
expected value.
Whether or Not to
Invest Risk capital
Gamblers Ruin
Risk capital is usually the sum of costs
Theory
No Yes
associated with the drilling of an exploratory
How much to
invest? well, seismic data acquisition and processing,
site preparation, and dry hole costs, etc plus a
signature bonus if any. The importance of the
risk capital cannot be overemphasized. The
* Monte Carlo Simulation can be used in a number relationship between risk capital and the
of places or situations.
present value of a successful venture is a
function of success probability. In an area
where the probability of success is as high as 20%, the risk dollars must be offset by a factor of
at least 5 to 1. This is the essence of expected value theory.
Success probability
Estimation of the probability of occurrence of either a dry hole or some form of discovery is one
of the more difficult aspects of the evaluation process. Many people are very uncomfortable
making such estimates. There is perhaps more gut instinct required at this stage than any other.
Some analysts will run a cash flow to determine possible financial results to three decimal places
and then go pale at the thought of estimating success probability (SP). Sometimes it helps to
simply calculate a break-even success (also called chance factor). If break-even SP is around
20% in a region where success ratios are over 25%, then the matter becomes less complicated.
F 2.3 Expected value graph
Expected Expected Figure F 2.3 illustrates the relationship

Value Value between the key variables in EV theory. This
($MM) ($MM)
graphical approach is called the “two outcome
$120 2
$120 model”. A case is outlined in which dry hole
100 3 100 costs for a particular drilling deal are $30 MM.
80 80 If the well is dry, the investment is lost. If the
60 60 well turns out as hoped, then the present value
40
5 40 of the project discounted at 12.5% is estimated
20
12 at $110 MM.
0 0
1
-20
4 -20 If management believed that the probability of
-40 -40 success was greater for the project they may be
0% 20% 40% 60% 80% 100%
interested in investing. The EV approach is the
30%
formal method of weighing the possible
outcomes. Suppose management believed that
Success Probability
the probability of success was around 30%.
1 Estimated dry hole cost Table T 2.1 and figure F 2.3 show that the EV
2 Estimated value of a discovery (using DCF) would be $12 MM.
3 Break-even success probability 20%
4 The drilling would either result in a total loss
Estimated success probability (SP)
5 Expected Value (EV)
or a success, but on the average this kind of
prospect would enhance the corporate wealth
by around $12 MM if enough similar
opportunities were available, and assuming the estimated costs, reserves, probabilities and so
forth are correct.
T 2.1 Expected value
The Expected Value (EV) is the weighted value of a success less the weighted cost of a
dry hole—tabular format.
Expected
Present Monetary
Possible Value Probability Value
Outcome ($MM) (%) ($MM)
Success $110 30% $33
Dry Hole -30 70% -21
$12
With these monetary risks and that kind of potential reward, management would not go near the
project unless it estimated a probability of success for the well greater than 21%. This is the
break-even success ratio, which is determined either graphically or by setting EV equal to zero in
the expected value formula:
T 2.2 Break-even success probability and success capacity
0 = (Reward * SP) – [Risk capital * (1 – SP)]

Solving for SP, the above formula converts to:
SPbe = Risk capital ÷ (Reward + Risk capital)
Where:
EV = 0 (zero) by definition
Reward = $110 MM
Risk Capital = $30 MM
SPbe = Break-even Success Probability
SPbe = 21.4%
The break-even success ratio is related to a concept called success capacity. Success
capacity is the number of dry holes a successful well can carry. It is equal to the inverse
of the break-even success ratio minus 1:
Success capacity = (1/break-even success ratio) – 1
The success capacity in the example above is 3.7, (1/0.214) – 1. This represents the
number of dry holes a success can “carry” and still break even.
F 2.4 Multi outcome decision tree
Decision tree analysis

The decision tree is simply a graphical
representation of the Expected Value
Decision tree analysis is pure EV theory. The
formula. It tries to capture the uncertainty
regarding how big a discovery might be if a
previous examples are sometimes described as
discovery is made. two-outcome expected value models or two-
outcome decision trees. The EV approach can
be logically applied to a number of scenarios.
Expected The probabilities of occurrence for each
Possible SP Value
% $MM possible event must add up to 100%. An
Outcome
example is outlined in figure F 2.4 with four
$450 MM
150 MMBBLS
4.5% $20.25 possible events that could result from the
decision to drill. In this example, if the well is
a dry hole, the outcome will be a loss of $15
MM. A discovery could be worth from $20
MM to $450 MM in this model (figure F 2.4).
$180 MM 6% $10.8
80 MMBBLS
The multiple-outcome decision tree in figure
F 2.4 has been collapsed to a simple two-
outcome tree (figure F 2.5).
$20 MM 4.5% $0.9

20 MMBBLS
$31.95
Drill? Probability of success (SP) 15%

Yes
Probability of failure (1-SP) 85%

No
-$15 MM
85% $(12.75)
Dry hole
Chance node 100%
Expected Value ($MM) $ 19.20

Decision node
F 2.5 Two outcome decision tree
This two-outcome decision tree is a “collapsed” version of the tree found in

figure F 2.4 The three outcomes on the “reward” side have been collapsed into
a single representation of a possible discovery.
Expected
Possible SP Value
Outcome % $MM
$213 MM 15% $31.95

83.3 MMBBLS
Probability of success (SP) 15%

Drill?
Yes
Probability of failure (1-SP) 85%
No -$15 MM 85% $(12.75)

Dry Hole 100%
Expected Value ($MM) $ 19.20
F 2.6 Two-outcome graph EV
Expected Expected value/Probability of success Expected

Value Value
($MM) ($MM)
$300 Discovery: $213 MM $300

250 250
200 200
150 150
100 100
50 50
$19.2
0 0
-50 -50
Dry hole: -$15 MM
-100 -100
0% 20% 40% 60% 80% 100%

15%
Success probability
The figure F 2.6 “two outcome” graph represents the decision trees found in figures F
2.4 and F 2.5. From a graph like this the EV can be derived by estimating the success
probability and going from that point to the EV curve then over to the “Y axis” to get
the EV. The EV curve (which is a straight line) is defined by two points: (1) dry-hole
costs or the “risk capital” and (2) the potential value (to the Contractor) of a discovery
based on discounted cash flow analysis.
Estimating probabilities
With all of the expected value approaches, the cornerstones of the analytical process are founded
on the present value of the cash flow projections and the estimation of success probability.
Estimating the probability of success or failure is often part science and part “guestimation”.
Sometimes, regardless of the degree of sophistication involved, the whole process boils down to
a gut feel about a particular project. This approach is wonderful if the gut feeling is founded on
an understanding of the implications of EV theory, as well as years of experience. The concept
and use of success probability (SP) estimates is not as simple as one might hope.
When viewing the investment decision, the estimate of SP must be based upon experience and
available knowledge. Often in new frontiers and exploration plays, the available information can
be scarce. It helps to understand some of the things that influence SP and the first step along this
road is an understanding of the difference between commercial and technical success.
Commercial and technical success
When a well actually locates a measurable quantity of either oil or gas, the well is often classed
as a technical success. Whether or not the well will ever be worth the money invested, is a
measure of commercial success. In many places the conventional wisdom or the general
experience in the area will provide some indications of success rates for both exploratory and
development drilling. These rates unfortunately are often the technical success rates not the
commercial rates. Technical success rates are always higher than commercial success rates. The
investment decision really should be based upon an understanding of the difference.
Look at it this way. Technical success is the chance of finding hydrocarbons. Commercial
success is the chance of finding enough hydrocarbons to justify development. The difference,
therefore, between technical and commercial success is the development field size threshold (see
figure F 2.7).
Some areas or types of plays are strongly characterized by success rates and the difference
between commercial and technical success. In the Gulf of Mexico deepwater (not ultra-deep) by
the year 2000 a healthy success ratio of 33% had been established. Out of over 210 exploratory
wells, over 70 discoveries had been made. But, the average field size was only around 130
MMBBLS of oil equivalent (MMBOE). Over 70% of these discoveries were not economically
viable for development at that time and many of the others hovered on the margin. The
commercial success rate was less than 10%.
An example calculation of SP is shown in table T 2.3.
F 2.7 Technical vs. commercial success
The difference between technical success and commercial success is development

field size threshold.
Assume gas discovery is not economic.
Expected oil field size – frequency distribution histogram
23% 77%
Minimum Maximum
2 MMBBLS 100 MMBBLS
Threshold
field size
25 MMBBLS
Governed by costs, reservoir quality, fiscal terms, etc.
Technical success probability – assumed 20%

Chance of making a discovery of from 2 to 100 MMBBLS.
Commercial success probability – assumed 15.4%

Chance of finding a field large enough to develop, i.e. > 25 MMBBLS.
T 2.3 Example calculations
Up to this point we have used success ratios without showing how they are estimated.
There are a number of variations on this theme, but this example is fairly typical and
has all the elements that go into the exercise. Geotechnical personnel usually make
these estimates based on experience in the area, geophysical and well data, etc.
Simple Example
A Source/Timing 70% Estimate
B Reservoir 90% Estimate
C Trap/Seal 60% Estimate
D Structure 80% Estimate
E Probability of Hydrocarbons 30% A*B*C*D sometimes
called geologic probability
More Complex Model

A Source 95% Estimate
B Trap 70% Estimate
C Ability to locate 60% Estimate
D Reservoir quality rock exists 90% Estimate
E Timely migration 75% Estimate
F Other 100%
G Probability of Hydrocarbons 27% A*B*C*D*E*F sometimes
called geologic probability
H Probability of oil 60% Estimate – Assuming
Hydrocarbons are found
I Oil SP 16% G*H
J Gas SP 11% G*(1-H)
K P of oil exceeding threshold size 80% Estimated probability of exceeding
minimum economic reserve given a
discovery.
L P of gas exceeding threshold size 30% Estimated probability of exceeding
minimum economic reserve given a
discovery.
M P of commercial oil discovery 12.8% I*K oil only
N P of commercial gas discovery 3.3% J*L gas only
O P of commercial discovery 16.3% M+N Oil and Gas
P = Probability SP = Success probability

(In these examples the variables are considered to be independent of each other)
Common pitfalls in risk analysis

Using discount rate to “risk” a project. One of the more common inappropriate techniques is
to use a high discount rate to “risk” projects. This is consistent with one aspect of modern
portfolio theory and the capital asset pricing model (CAPM) that dictates a higher targeted rate
of return for higher risk stocks or investments. However, it is seldom acceptable in petroleum
exploration. While the CAPM uses beta (a measure of a stock’s volatility relative to some market
index such as the DOW Jones Industrial averages) to quantify risk or uncertainty, expected value
theory uses estimates of the probability of success to characterize, quantify, and account for most
of the risk.
Use of inappropriate estimate of success probability. Too often this factor is over-exaggerated
in order to sell management on a particular play concept or prospect.
Overestimating prospect size. The industry has been consistently overoptimistic in this area.
Always assuming field size distributions are either normal or lognormal. Some plays and
reservoir types exhibit strong log normal reserve size distributions. Log normal distribution
requires close scrutiny and multi-outcome modeling. Usually the two-outcome EV approach is
sufficient for plays with an expected normal distribution. However, for log normal distributions
even a three-outcome model of a possible discovery may not be sufficient.
Assuming “development drilling” is risk free. In some areas development drilling is nearly as
risky as exploration drilling. This is an unusual case but to assume better than 90% chance of
success for a series of development wells would be a mistake in most provinces.
One example that provides a good yardstick is the Gulf of Mexico. This province is characterized
to a large extent by the fact that the seismic data quality is quite good. Furthermore, the province
is relatively mature and well understood by international standards with substantial drilling
activity and history. Wildcat drilling during the 1970s and 1980s was more than 200 wells per
year. The cumulative wildcat success ratio was around 15% during the 1970s. By 1990, it had
crept up to more than 20% due partially to the increased use of 3-D seismic data. Development
well success ratios are on the order of 70-75% in this province.
F 2.7 Risk analysis building blocks - summary
Estimated Field Size Distribution Probability of Success

From Monte Carlo Simulation
Parameter %
Source 80
Migration 60
Seal 70
20 80 150
Trap 70
P10 P50 P90 Reservoir 65
Recoverable Reserves (MMBBLS) SP 15
Cash Flow Analysis P50

P10 Most P90
Min Likely Max
Recoverable Reserves (MMBBLS) 20 80 150
Dry Hole Costs ($MM) $15 $15 $15
Oil Price (no escalation) $19.80 $20.00 $20.25
Capital Costs/BBL $3.25 $3.00 $2.70
Annual Operating Costs ($MM) $16± $20± $28±
Peak Production (BOPD) 8,000 26,000 43,000
Decline Rate 14% 12.5% 11%
Contractor Take 22% 23% 24%
NPV 12.5% ($MM) (“unrisked”) $20 $180 $450
IRR (%) 13% 17% 28%
Decision Tree Analysis EV

Unrisked Unrisked * Expected 12.5%
Reserves NPV Chance Reserves DCF
(MMBBLS) ($MM) % (MMBBLS) ($MM)
150 $450 4.5% 6.75 $20.25
80 $180 6% 4.8 $10.8
20 $20 4.5% 0.9 $0.9

12.45
0 ($15) 85% ($12.75)
Expected Monetary Value $19.2

* Swanson’s Rule
Diversification of risk - Gambler’s ruin Theory

Hand-in-hand with the decision to participate in a drilling venture or just about any investment,
is the question of how much exposure the company should incur. This is also known as the eggs-
in-the-basket branch of investment philosophy. The general rule is that there shouldn’t be too
many eggs in any particular basket. The difference between a gambler and an investment
strategist in many drilling deals lies in the degree of exposure.
Gambler’s Ruin occurs when a risk-taker with a limited amount of funds goes broke through a
continuous string of failures. With any kind of drilling budget there is such a risk, but
diversification can minimize this risk. The concept of Gambler’s Ruin flows from the same
estimates of risk used in expected value decision theory. The probability of success estimate is
used to help determine the maximum level of capital exposure under specific confidence level
criteria. The objective for management is to stay in the drilling game long enough for the odds to
work as they should.
Another way of looking at it would be to ask the question, “What would be a statistically
significant sampling size (at a confidence level of say 95%) given the nature of the play? The
concept of Gambler’s Ruin is used for this. To avoid a successive string of failures that would
exhaust a drilling budget, at least one success must be achieved. The Gambler’s Ruin algorithms
are outlined as follows:
The probability
of at least = 1 – The probability of all failures
one success
Assume that a confidence level of 95% is desired. How many wells (n) must be drilled to be 95%
confident of at least one success? Too often the assumption is made that a one-in-five chance of
success means with five wells at least one will be successful. There is a good chance this will not
happen.
.95 = 1 – (1 – SP)n
Where
.95 = Desired confidence level
SP = Success probability
(1 – SP) = Probability of failure
n = Number of trials (exploratory wells)
The results of this formula are shown in figure F 2.8. If five wells are drilled with probability of
success of 20%, there is only a 67.2% chance of at least one successful well—this is a
confidence level of only 67.2%.
F 2.8 Combined probability of success

110% For example, if a particular play has a
25% 20%SP 20% probability of success and a 6-well
100% program is planned, there is a 73.8%
30%
15% chance of drilling at least one successful
90%
well (but a 26.2% chance of a
successive string of failures).
Combined Probability of Success
80%
10%
70%
60%
50%
40%
30%
20%
5% SP
10%
0%
0 5 10 15 20
6
Number of Wells Drilled
Solving for n in the formula above yields:
Log (0.05) Log (0.05)

n = =  = 14.4
Log (1 – SP) Log (0.80)
Where
0.05 = 1 – desired confidence level (Probability of all failures)
0.20 = SP (Probability of success for an individual well)
n = 14.4 (Number of wells required)
Assuming a probability of success of 20% then over 14 wells must be drilled to be assured a 95%
chance that at least one of them will be successful.
Utility theory
Human and corporate behavior manage to carry on whether or not people know or care that an
exotic name is applied to their actions. Utility theory also known as preference theory, (and the
term risk aversion also often applies), describes to a large extent why people will happily stick a
quarter into a slot machine in Las Vegas even though the odds are squarely against them. The
expected value of that sort of action is always negative—always. This is called gambling.
But quarters have almost no utility. When it comes to risking a few million dollars on an
exploratory well, even expected value theory is not enough. Discounted cash flow analysis and
expected value theory explain what people should do and what the boundary conditions are. It
does not explain behavior. If the expected value of a potential investment opportunity is positive,
then it is worthy of consideration. But, just how positive must an expected value be? The
standard industry two-outcome EV model is used once again here in figure F 2.9, to illustrate the
essence of utility theory.
The risk capital is $15 MM. The possible reward in this two-outcome model has a value of just
over $100 MM. These points define the EV curve (straight line). Staying below the curve results
in positive expected values. For example, the expected value is equal to $20 MM with an
estimated probability of success of 30%. If management were bidding on this project, the bonus
bid would have to be less than $20 MM (in order to stay below the line).
F 2.9 Expected value and Utility theory
$120
The EV breakeven success ratio is close
$120
to 13%, but the utility break-even
110 110
success ratio is over 25%. Utility curves
100 100 and EV curves approach each other at
90 90
the end points. If management was
convinced that the $15 MM well had
80 80
zero percent chance of success, then it
Expected Value ($MM)
70 70 would be worth a negative $15 MM. No

60 60
company would drill such a well unless
EV Curve someone paid the company $15 MM to
50 50
do it. Drilling contractors do it all the
40 40 time. On the other hand, if management
30 30
were convinced that this drilling
opportunity had a 99% or 100% chance
20 20
Utility Curve
of success, the expected values and
10 10 utility values again converge. It would
0 0
be like buying production or proved
undeveloped reserves. It is in the middle
-10 Exploration -10
Expense ($15MM)
ground where the curves diverge.
-20 -20 Companies have different risk profiles or
0% 20% 40% 60% 80% 100% levels of risk aversion. Determining a
30%
company’s utility curve with a drilling
Success Probability venture like this is complicated and
becomes academic; consequently, it is
not done often. Sometimes the whole
subject is simply marked down as gut feel and left at that.
The endpoint values represent the result of discounted cash flow analysis, discounted at the
corporate cost of capital. The margin between the utility curve and the EV curve is sometimes
viewed as the minimum risk premium or “cushion”. This is one reason why negotiations get
sticky on the subject of profitability. For drilling ventures that are successful, the rewards are
spectacular. But only within the narrow context of the discovery well, which requires ignoring
any associated dry holes. Once a discovery is made it is hard to speak in terms of chance of
success and appropriate rate of return. This is particularly true from a government’s viewpoint
because they may not be aware or may not care that the company drilled five dry holes prior to
the discovery especially if these dry holes had been drilled in another country.
The Value-of-information concept

One of the smaller less frequently visited branches on the tree of risk analysis is the concept of
the value-of-information. A two-outcome model is used as an example to demonstrate how it can
look. The following tables, T 2.4 and T 2.5, summarize what the expected results would look like
depending upon whether or not a 3-D seismic survey was implemented. The example here
assumes that with 3-D seismic data the success ratios are better. Without 3-D in this example, the
success probability is 30%. But, suppose that where drilling locations have been identified with
3-D programs the success rates are better—in this example, 5 percentage points better. The
expected value improves by $9 MM. But notice in this example, the cost of the 3-D survey has
not yet been accounted for. This way, it is easy to see that the cost of the 3-D survey must be
kept below $9 MM or the drilling decision is better off without the value of that information.
T 2.4 Two-outcome Model without 3-D Seismic
Present Expected
Reward $150 30% $45.0
Dry Hole -30 70% -21.0
$24.0
T 2.5 Two-outcome Model with 3-D Seismic
Present Expected
Reward $150 35% $52.5
Dry Hole -30 65% -19.5
$33.0
Option Pricing Theory

That options have value is an undisputed fact illustrated by the active market for the purchase
and sale of stock options to buy (call) or sell (put) at a certain price at a specified future date.
Option theory as it applies to the microeconomics of petroleum exploration investment analysis

is a very involved process and is invariably accompanied by numerous arcane formulas that get
relegated to an appendix in most articles found in the literature. There are numerous views on the
validity and usefulness of Options theory:
“In most capital investment decisions, the simple option pricing models are
inadequate. The concept however, is valid and can be represented in a value
of information analysis (usually solved as a decision tree).
From personnal communication with John Schuyler, Aurora, Colorado author of various books including
“Decision Analysis for Petroleum Exploration” 2nd Edition with Paul Newendorp, Decision Precision, 2000.
“Assumptions encumbering option theory methods for valuation of oil and

gas assets, unlike purely financial assets, are shown to severely burden
getting servicable answers.”
Lohrenz, J., and Dickens R., “Option Theory for Evaluation of Oil and Gas Assets: The Upsides and
Downsides”, SPE 25837, Hydrocarbon Economics and Evaluations Symposium, Dallas, Texas March, 1993.
Commenting later on the statement made above Lohrenz stated:
“That was written 3 years ago. Today, I would not be so courteous. Grievous
misapplication of options theory methods for searchable, developable, and
producible in situ oil and gas assets continue to be espoused and, one can
presume consumated. The gateway seduces innocents to misapplication of
option theory. The gateway is the advertisment of higher estimates of value
of assets. ”
From personnal communication with John Lohrenz; “Draft” document dated 11-02-1995.
Option theory started in 1973 with the Black-Scholes (B-S) model (see figure F 2.10 Black-
Scholes formula). The basic assumptions required to evaluate an oil and gas property using the
B-S model or even variations on this theme include:
An ongoing active (liquid) market for the asset in question exists.

Fluctuations in the ongoing, active market for the asset in question can be
quantitatively, statistically described.
The quantitative, statistical description of fluctuations in the market for the asset will
continue throughout the timespan of the option to purchase the asset.
The value in the ongoing, active market for the asset in question never goes negative.
This summary (above) is paraphrased from personnal communication with John Lohrenz; “Draft”
document dated 11-02-1995.
Lohrenz considered this set of assumptions “that lie at the core of option theory”
as applied to oil and gas asset evaluation to be “impossible to hold”.
Lohrenz, J., Certain Uncertainties, Volume No. 3, January, 1997.
The value of an option

An example of the value of an option can be illustrated using the “value of information” example
above. In that example the EV of the drilling opportunity without 3-D seismic data was $24 MM.
The EV with 3-D data was $33 MM—a difference of $9 MM. If the 3-D data cost for each
prospect was $3 MM then the value of the “seismic option” would be $6 MM ($9 MM – $3
MM). The term “seismic option” in the industry typically implies that a company has the right to
shoot, process and interpret seismic data before it must decide whether or not to drill (it has an
“option). In the example above there would theoretically be a few prospects (5% of them) that
would be eliminated on the basis of the 3-D data (at $3 MM per prospect) instead of a more
costly well (at $30 MM per prospect).
F 2.10 Black-Scholes Formula
Black – Scholes formula for valuing a call option

This model was developed by Fischer Black of the U. of Chicago and Myron
Scholes of MIT and published in “The Pricing of Options and Corporate
Liabilities”, Journal of Political Economy, May/June 1973.
rt
C(t) = S (O) N(d1) – X/e N(d2)
Where:
C(t) = value of a call option
t = time until expiration date, decimal year
S(O) = current price of underlying stock
X = exercise price of option
e = 2.71828, base of natural logarithms
r = continuously compounded risk-free interest rate
N(d) = probability that a standardized, normally distributed random
variable will have a value less than or equal to d
½
d2 = d1 – st
s = the standard deviation of the continuously compounded annual
rate of return on the stock
½
d1 = (ln(S/X) + (r - .5s2)t)/st
Drill or Farm out?

One of the most common examples of the use of the graphical representation of a two outcome
EV analysis is the comparison of whether or not to drill or to farm out. Suppose there were an
opportunity to farm out this prospect.
Assuming that a partner would be willing to incur the cost of the exploratory well, for 50%
working interest. This is a referred to as a "drill-to-earn" type of deal and it is fairly common
with numerous variations. The company farming-in performs the work (or pays for it) and after
that both companies are “heads up” i.e. they each then pay for everything according to their
respective working interest share.
The farm-out option requires no risk dollars from the perspective of the license holder in this
example, but the present value of a potential discovery is half of what it would have been without
farming out 50% of the working interest.
The results depicted in figure F 2-11 illustrate that if management believed the probability of
success is less than about 15% then the best strategy would be to farm-out the prospect. Below
15% SP the expected value is always higher with the farm-out strategy. Above that point the
strategy to farm-out has a lower EV.
F 2.11 Farm-out economics

Value Value
($MM) ($MM)
$300 Discovery: $213 MM $300

250 250
200 200
150 No Partner 150
100 100
50 50
$19.2
0 0
-50 With Partner -50
Dry hole: -$15 MM
-100 -100
0% 20% 40% 60% 80% 100%

15%
Success Probability
F 2.12 Farm-in option – The partners perspective

Value Value
($MM) ($MM)
$300 $300
250 250
200 200
Discovery: $106 MM
150 150
100 100
50 50
0 0
-50 -50
Dry hole: -$15 MM
-100 -100
0% 20% 40% 60% 80% 100%

Success Probability
Figure F 2.12 shows the perspective of the potential partner. At an assumed probability of
success of 15% the project is very close to “breakeven”. Actual breakeven SP is 12.4% [$15
MM/($15 MM + $106 MM].
T 2.6 EV decision analysis—step-by-step
Expected value decision analysis

Step-by-step
(1) Define possible outcomes or events and decision alternatives.

(2) Estimate probability of occurrence of each outcome or event.
(3) Calculate monetary value for each possible outcome.
(4) Multiply probability of occurrence with monetary value of each
possible outcome.
(5) Calculate algebraic sum of the expected values of all possible
outcomes.
(6) Select alternatives which maximize EV.
The factored approach - A slight twist on the EV concept

The expected value approach is similar to a concept used in financial analysis called the factored
approach.
With this approach, a weight factor is applied to different estimates of value to arrive at a
weighted value. This approach is used in many different ways and for different reasons.
Regulatory bodies favor this approach for due diligence and fairness opinion work where third-
party estimates of value are required to protect independent shareholders. It is assumed that the
analyst will use common sense, experience, and sound business judgment in deciding how to
assign weight factors.
In the following table T 2.7, the value of Company A is based on three separate valuations. Each
technique gives a different value and a weight factor was applied to each. Here there are 3
different estimates of value but the weighted average is $246 MM.
T 2.7 Example valuation using factored approach

Estimated
Company A Weighted
Valuation Value Weighting Value
Technique $MM Factor $MM
Discounted
Cash Flow 230 60% 138
Capitalized
Earnings 180 10% 18
Adjusted
Book Value 300 30% 90
Total 100% $246
Monte Carlo simulation

Monte Carlo simulation (MCS) holds an interesting and lately an exalted place in risk analysis.
In some respects it captures the essence of quantifying uncertainty. And, like many new tools, it
has changed the language of risk analysis and it has altered the landscape of oil and gas reserve
definitions. In the early days, which were not so long ago, MCS was often mis-used or mis-
understood by both those using the tool and those confronted with the results. Some of the old
timers would disparagingly refer to the program as “Monte Cristo Simulation”.
Deterministic vs. Stochastic (probabilistic) approach

In the language of risk analysis the essence of characterizing uncertainty is to preserve the
uncertainty all the way through to the "answer". The first attempts to characterize the range of
possible outcomes of a discovery are the age-old minimum, most likely, and maximum reserve
estimates—the deterministic approach. However, with the deterministic approach the calculation
of the "minimum" estimate is typically based upon the minimum value for each possible variable
(pay thickness, porosity, water saturation, etc – see Chapter 7 - Petrophysics). This provides what
might be considered absolute minimum and maximum values. These absolute extremes have
little analytical value from a management perspective because they are too far-out.
Mother Nature does not behave like this. The likelihood that a possible outcome could result
from every variable being at it's minimum or maximum value is remote at best. What are needed
are reasonable minimums and maximums. This would provide management with better tools.
Simulation is one answer to this problem. The following tables compare ranges of reserve
estimates.
T 2.8 Example reserve estimates
Deterministic Recoverable Oil (MMBBLS)

Approach
Most
Minimum likely Maximum
22 48 79
Probabilistic Recoverable Oil (MMBBLS)

Approach
10th 50th 90th
Percentile Percentile Percentile
37 46 55
Monte Carlo simulation uses a different approach. Instead of calculating 3 separate estimates
(minimum, most likely and maximum) numerous calculations are made using a random number
generator. Flow diagrams of the MCS process are outlined in figures F 2.13 and F 2.14.
Estimates are made of the distribution of outcomes for each reservoir parameter and these
distributions are converted into a cumulative density function. The MCS model uses a random
number generator to “select” various parameters (randomly of course) for a single calculation of
reserves. Then it does it again and again and again. Users of these programs will typically
specify how many “iterations” are appropriate and a range of outcomes is generated. The
program will easily generate specific values consistent with the 10th, 50th and 90th percentiles (or
others if desired).
F 2.13 Monte Carlo simulation overview
Example
Oil reserve volumetrics example Name
Frequency
Distribution (Input Requirements)
1 Estimate distributions Triangular

(Min, ML, Max)
for each variable.
Net Pay
Uniform or
Rectangular
(Min, Max)
2 Random number Porosity
generator selects variables
from each respective Normal
distribution. (Mean, Std Dev)
Water Saturation
3 Calculate oil reserve Histogram

from randomly selected
A B C A B A (A,B,C,A,B,A)
variables. Productive Area
Log Normal
(Mode, Median, Mean)
Oil Volume Factor
4 Iterate!
Repeat steps 2 and 3
200 to 500 times or so. Truncated Normal
(Mean, Std Dev, Min, Max)
Recovery Factor
5 Evaluate results
Plot recoverable reserve
distribution and compute
statistics 10th 50th 90th
Frequency distribution Percentile Percentile Percentile
Range
Standard deviation
Kurtosis
Skewness
F 2.14 Monte Carlo simulation – The key steps
1 Estimate distributions Frequency Triangular

for each variable. (Min, ML, Max)
5 9 19
Net Pay
1a The frequency distribution is converted

into a cumulative density function.
100
Cumulative
frequency
2 Random number 0
generator selects a number 5 19
between 0 & 100. Assume Net Pay
the number is 68.
2a The randomly selected number (68) is

converted into a random variable. In this case
it is net pay thickness of 14 feet. The resulting
value comes from the cumulative frequency
curve.
100
3 Oil reserves are 68

Cumulative
calculated using the frequency
“randomly selected” 0
5 14 19
variables.
Net Pay
Each variable is randomly selected in this
4 Iterate! fashion.
Repeat steps 2 and 3 until
sufficient number of trials
have been completed.
T 2.9 Volumetric simulation
Deterministic Results Monte Carlo
Min ML Max Single Iteration

Drainage area (acres) 2,000 2,300 2,500 2,201
Zone Thickness (ft) 36 42 44 41.6
Porosity average 32.0% 32.0% 32.0% 32.0%
Water Saturation 35% 30% 25% 27.4%
Formation volume factor 1.05 1.04 1.03 1.038
Initial oil in place (MBBLS) 110,651 161,414 198,846 158,901
Recovery factor 20% 30% 40% 26.7%
Recoverable oil (MBBLS/acre–ft) 307 501 723 463
Recoverable oil (MBBLS) 22,130 48,424 79,538 42,395
Probabilistic results
Percentile 10th (P10) 50th (P50) 90th (P90)
Recoverable oil (MBBLS) 36,902 46,138 55,271
Iterations 200
Range 35,700 Skewness 0.187
Standard deviation 7,021 Kurtosis 2.61
F 2.15 Cumulative frequency distribution
100
P90
80
Probability (%)
60
P50
40
20
P10
0
0 30 37 40 46 50 55 60 70
MMBBLS Recoverable Oil
Characterizing variable distribution
The characterization of variables can be complex. It is important to remember that the object of
the exercise is to try to “preserve the uncertainty” so that the simulation results will as accurately
as possible characterize the dispersion of possible outcomes.
Suppose an estimate of porosity is being made and the estimate is going to be based upon
historical data from 10 wells in a particular reservoir.
Example 1 Historical data (see figure F 2.16)

Porosity (%) 12 14 14 14 14 14 18 20 20 24
Average (%) 16.4
Example 2 Historical data (see figure F 2.16)

Porosity (%) 12 12 12 14 14 14 14 18 20 24
Average (%) 16.4
Using a triangular distribution, both of these would be Min ML Max

characterized by:
12% 14% 24%
This example is used to illustrate the kind of things to look for. Both distributions would
probably be more accurately characterized by using a histogram distribution. Most modern
simulation packages will allow this type of distribution input.
F 2.16 Histogram distribution
With a typical triangular distribution the two data sets below would be characterized
the same way: (Min, ML, Max) = (.12, .14, .24).
Example 1 Example 2
40% 40%
30% 30%
20% 20%
10% 10%
12 14 16 18 20 22 24 12 14 16 18 20 22 24
Porosity Distribution (%) Porosity Distribution (%)
F 2.17 Cumulative frequency distribution
100%
90%
80%
Probability
value is equal
to or less than
40%
30%
20%
10%
12 14 16 18 20 22 24
Porosity Distribution (%)
Variable Dependency Relationships

The example of a recoverable oil reserve estimate with a Monte Carlo Simulation (MCS) model
provides a perfect example of a critical aspect of this kind of numerical simulation. There is a
relationship between porosity and water saturation. Generally, the better the porosity the lower
the water saturation. In the language of MCS there is a dependency relationship between these
two variables. Water saturation is partially dependent on porosity. It is not an independent
variable. Therefore the model should account for this relationship.
There are numerous dependency relationships and partial dependency relationships. Examples
are illustrated in table T 2.10.
T 2.10 Variable dependency relationships
Variable Dependent - - Partially Dependent

Volumetrics
Water saturation Porosity
Recovery factor Porosity Net pay thickness
Area May be partially dependent on net pay
Cash flow analysis
Capital costs Recoverable reserves
Operating costs Deliverability
Deliverability Net pay Porosity Water saturation
Royalty/Taxes Deliverability
Latin Hypercube sampling
Some programs offer optional sampling techniques than what is ordinarily used and referred to
as Monte Carlo sampling. The Latin Hypercube technique is the most common and is touted as
having the ability to yield statistically significant samples and similar results with fewer
iterations—hence less computer time, quicker results and less expense. The Latin Hypercube
technique is a stratified sampling technique. It effectively forces the random number generating
mechanism of the MCS program to select numbers from specific strata on the cumulative
frequency distributions so that a sufficiently broad spectrum of random variables is obtained
using the least effort (fewer iterations).
Monte Carlo arithmetic
1+1=3
One drawback to oil and gas reserves analysis with Monte Carlo Simulation stems from the
definition of proved reserves. The conventional approach these days is to assign the lowest 10th
percentile (or first decile) as proved (P), the 50th percentile as proved + probable (P+P), and the
upper 10th percentile (top decile) as proved + probable + possible (P+P+P). For example, in
the Monte Carlo sample above, the various confidence intervals would correspond as follows:
P10 37 MMBBLS
P50 46 MMBBLS (see figure F 2.15)
P90 55 MMBBLS
If a company had two similar fields as part of their portfolio then the P10, P50 and P90 reserves for
the two fields would not be twice as much. Only the means can be added unless the reserve
distribution is “normal” and then the P50 reserves should equal the mean and then these can be
added.
It may be best to use an example to illustrate the problem. If we roll a six sided die the
probability of getting a value of 2 or more is 83% (5/6) . We would be 83% confident that with
each roll of the die the value would be equal to or greater than 2.
This approach is similar to that of estimating proved reserves by using a 90% confidence level
that there is a 90% chance that the reserves will be equal to or greater than the proved estimate.
If we roll 2 dice each with an 83% chance of yielding a value of 2 or more, is there an 83%
chance the combined value will be 4 or greater? No!
The probability that the sum of 2 dice thrown being equal to 4 or more is closer to 92% (33/36).
Much more conservative than 83%. This same thing happens when adding probabilistic reserves
estimates. Adding probabilistic reserves estimates only works when adding the means.
Monte Carlo simulation audit checklist

1. Are the variable distributions realistic?
Is the Minimum value a value below which there is zero probability of occurrence?
If not, has the Minimum value been defined appropriately?
Is the Maximum value a value above which there is zero probability of occurrence?
2. Are triangular distributions over-used? Are all triangular distributions equilateral?
3. Are variable dependency and partial dependency relationships handled appropriately?
4. Can you identify the dependency relationships?
5. Is the answer realistic?
i.e. Is standard deviation ÷ mean > or < 10%?
> 10% implies greater uncertainty (exploration scenario?)
< 10% implies greater certainty (perhaps a development scenario)
6. Is the answer strongly skewed? This may determine how to evaluate the results.
The competitive bidding dilemma

International petroleum exploration is extremely challenging these days. While the amount of
exploration acreage available worldwide has more than tripled in the past 15 years, there are also
more companies seeking opportunities than ever before. From the point of view of most
governments this is a healthy environment, but it has not been healthy for most companies. For
the past two decades the exploration end of the business has been notoriously unprofitable. Part
of the reason is that fiscal terms are so onerous in most countries. This is because the industry
has been plagued by chronic over-bidding that has shaped the market for exploration acreage and
projects. Bid rounds and negotiations in the industry have been strongly influenced by both
increased competition and over-optimistic estimates of: oil prices, costs, prospect sizes, and
success ratios.
This cannot help but result in over-bidding and ultimately, loss of value.
“All in all, such exploration for new giant fields destroyed value rather than
creating it in the 1980s and early 1990s.
Exploration, as a corporate function, lost credibility.”
(Rose, 1999).
A McKinsey & Company report estimated for the petroleum industry:
“$400 billion value destruction over the 1980s”

(Conn and White, 1994)
Most of this $ 400 billion loss (over $100 MM per day for 10 years) was from the exploration
end of the industry. Similar conclusions exist for the bonus bidding in the US Federal Offshore
outer continental shelf (OCS).
“In 1970 after about a decade and a half playing this gambling game, the
estimate was that bidders were over $4 billion in “deficit”. After about three
decades, our estimate is that bidders are about $48 billion behind.”
(Lohrenz and Dougherty 1983)
This $48 billion estimated deficit is interesting considering cumulative bonuses for the U.S. OCS
were only $47 billion by 1983. The statement by Lohrenz and Dougherty would imply that any
bonus was an overbid. And this conclusion is shared by others.
“U. S. OCS Operators in the hole by $70-80 billion.”

(Warren, 1989)
Cumulative bonuses for the U.S. OCS were only $55 billion in 1989 so even a “zero” bid would
presumably have been too high—losses exceeded cumulative bonuses by $15-25 billion.
Additional analysis of the Gulf of Mexico—studies done through 1982 (before the U.S. Minerals
Management Service went “area-wide”) indicated that:
“The average block had three bidders and the average winning bid was $8
MM. The second highest bid averaged 3.2 MM and the lowest bid was $1.4
MM.”
(Warren, 1989)
It is extremely common in bonus bidding situations that the highest bid is about two times
greater than the next highest bid. Almost all the literature dealing with bidding performance like
that outlined above will refer to the highest bid as an over-bid. Typically too, the amount of over-
bidding quoted in the literature will correspond to the difference between the highest bid and the
next highest bid (the money left-on-the-table). In my opinion it is more likely that, in situations
where there are multiple bids, the highest bid is not the only over-bid.
A classic example would be a single bid of $5 MM. This is considered an over-bid of $ 5 MM

relative to zero. Why zero? What is the magic in that? The real value, considering prospectivity,
oil prices and fiscal terms could have been less than zero. Let’s face it, if royalties and taxes are
too high relative to the geopotential of a province, then even “no bonus” (zero) is too high.
Oil price estimates

Our industry has been dramatically overestimating oil prices for the past 20 years. Figure 2.18 is
a common type of illustration of actual versus expected prices over the years. In 1990 the
Department of Energy expected oil prices to increase by 65% by the end of the decade—instead,
prices have decreased by about 3% (Kah, 2002). This is typical of numerous such examples.
Expectations have not matched reality. Unfortunately expectations drive competitive bidding—
not reality.
F 2.18 Historical oil price projections
Overestimating oil prices is only one of many reasons for chronic over-bidding in the
past two decades. It is however, an important factor in the development and evolution
of fiscal systems around the world today.
Year of
forecast
90
80 1983
Estimates
Real 1996 US$/BBL *
70
60 Actual 1984
1985
50 1986
1987
40 1988
30 1990
20
10
0
1980 82 84 86 88 90 92 94 96 98 2000
Year
* Real US refiner acquisition prices (from EIA) in 1996 dollars using gross domestic product implicit price deflators.
Data Sources: Energy Information Administration and Oil & Gas Journal Energy Database
Cost and timing estimates

Over-optimism in estimating costs may not be as consistent a problem as others, but it is a
problem. Going over-budget seems to happen a lot more often than bringing projects in on time
and under budget—particularly with mega-projects and frontier regions.
The industry has dramatically reduced time requirements to get from discovery to startup and
then to peak production. Still, with hindsight we find our estimates to mobilize large-scale
exploration efforts and/or development projects into remote provinces were usually overly
optimistic. And, like oil price (over) estimates, this too has an influence on what a company may
be willing to bid or negotiate.
Post mortem analysis

Post mortem analysis of exploration portfolios of the 1980s and 1990s shows consistently over-
optimist estimates of two key variables: prospect size and success ratio. For any exploration
portfolio there is an average prospect size and estimates of success probability for each prospect.
However, typically and consistently, post mortem analysis shows that, on average, discoveries
are smaller than anticipated and actual success rates are lower.
Prospect sizes
Overestimating reserve potential of an un-drilled structure (a “prospect”) is an extremely
common problem in the industry.
“. . . it must be acknowledged that overestimation of prospect reserves is a

widespread industry bias that has proved difficult to eliminate (Johns et al.,
1998; Alexander and Lohr, 1998; Harper, 1999).”
(Rose 2001)
Notice the dates associated with this statement (above). The industry became acutely aware of
the problem in the late 1980s and early 1990s. While many company personnel these days feel
that much of the problem has been resolved it is still a problem. One of the main cures is internal
peer review and “team” approaches to exploration. Table T 2.11 summarizes the results of
studies that evaluated the difference between estimated versus actual reserves. The overestimates
ranged from 30% to over 160%. One of the most common explanations for this tendency is that
geologists and explorationists “must be optimistic” in order to sell their projects and compete for
funds internally.
T 2.11 Examples of reserves prediction over-optimism
Example
Overestimated by:
(Source)
Various
30 – 80% (1)
(Rose, 2001)
US Lower 48 states
73% (2)
(Capen, 1991)
Gulf of Mexico
100% (2)
(Capen, 1992)
Norway
8-14th Rounds 163% (3)
(Rose, 2001)
Deepwater
BP/Amoco
15-year retrospective 122%
since early 1990s
(Harper, 1999)
(1) “Since 1993, most oil companies have acknowledged
that their geotechnical staffs persistently overestimate
prospect reserves, commonly by about 30% to 80%.”
(Rose, 2001).
(2) These figures derived from graphical representations

of “Expected” vs. “Actual” results of exploration drilling.
(3) For example, if a company estimated a prospect at

200 MMBBLS but the discovery yields 76 MMBBLS the
estimate exceeded reality by 163% [ (200-76)/76].
Summarized from: Peter R. Rose, 2001, “Risk Analysis and

Management of Petroleum Exploration Ventures” AAPG Methods in
Exploration Series, No. 12
Success Ratios
Estimating the probability of success (some refer to this as “chance factor”) is an absolutely
critical element in exploration risk analysis. And most companies have been making these
estimates directly (expected value analysis) or indirectly (gut feel) for decades. Either way
though, we have been overestimating and it is killing us.
“Almost pro forma, explorers use 10 percent to 15 percent for high-risk

prospects; in reality, however, most should be 1 percent to 5 percent.”
(Forrest, 2002)
One of the larger oil companies in the mid 1990s decided to implement a new strategy because
of the failures of the 1980s and early 1990s. The new exploration strategy was based on a
decision to avoid further “high-risk” exploration. No more exploration would be undertaken
unless the probability of success was greater than 20%. And, the hurdle rate (target rate of return)
was set at 15%. Over the next 5 years, over-all exploration success increased to around 45%. But
it was acknowledged internally that the 15% target internal rate of return threshold was not being
met. In fact the investments were not even obtaining an internal rate of return equal to corporate
cost of capital. “Value was not being added”. If value is not being added then it is being eroded.
The 5 years of exploration represented hundreds of millions of dollars of investment. What is
most significant is the fact that the problems had been identified before the new policy was
instituted—the problems were obviously not completely fixed.
F 2.19 Exploration strategy example
This is what one very large company did!

After reviewing exploration results over nearly a decade and realizing a substantial
amount of money had been lost, a new exploration strategy was developed based on two
key criteria: (1) a target internal rate of return (“hurdle rate”) of 15% and (2) only “low-
risk” exploration, i.e. estimated success rates had to be greater than 20%.
Results? Exploration success went way up – up to 45% or so.
Is that good?
Only if you are “adding value”! (They weren’t adding value.)
They managed to get their “technical success rate” up to around 45% but their
discoveries were not large or valuable enough to offset the costs. They lost money.
Success Probability (%)
± 45%
± 15%
Five Year Period

Under the New Strategy
Mid – to early 1990s
5 miserable years later
Four examples – Perspectives on competitive bidding

Four independent examples are provided to illustrate key aspects of the development and/or
analysis of competitive bidding/negotiations in petroleum exploration. There is almost always a
determining factor of some sort including bonus bidding, work program bidding, fiscal terms
such as royalties or profit oil spits or combinations of these elements. The variety of means by
which Governments allocate licenses is diverse. Examples #1 and #2 illustrate where the art and
the science of competitive bidding are put to the test. Example #1 shows how bids are developed
in “bonus bid” situations. Example #2 illustrates a situation where “terms” are the bid item.
Example #3 shows a combination of both bonus and terms as bid items. Ranking combination
bids like these requires both cash flow analysis and risk analysis. Example #4 is a variation on
the basic themes developed in Examples 1-3. It provides yet another perspective on over-
bidding.
Example #1 – Signature bonus bidding – Part art, part science
Two workhorses of the exploration business are discounted cash flow (DCF) analysis and
expected value (EV) risk analysis. But these tools, as widely accepted as they are, only provide
boundary conditions for a typical competitive bidding situation. Figure F 2.20 depicts a simple
“two-outcome” model of a possible drilling prospect subject to a competitive bonus bid. For the
sake of convenience, simple two-outcome models are used in these examples instead of the more
common multi-outcome decision tree models used by almost all companies. The principles
though are the same.
In this example, the potential “reward” is based on DCF analysis of the Contractor cash flow
from a potential discovery which yields an unrisked value of $200 MM (excluding the effect of
any bonus). But dry-hole costs (not including a bonus) are estimated at $25 MM. The EV
assuming a 30% chance of success is $42.5 MM [($200 MM * 0.3) + (-$25 MM * 0.7)].
The analysis then provides the boundary conditions for a possible bonus bid. The Company
should neither bid more than $42.5 MM nor less than $0 (zero). So what should it do?
The most credible recommendations suggest bidding some percentage of expected value, say 20-
30% or less depending upon the circumstances and expected competition [Capen, et al 1991 and
Rose, 2001]. This would yield in this case a bid of $8 – 12 MM or less.
It takes both science and art. Defining the boundary conditions is pure “by-the-numbers” DCF
and EV science. Deciding what percentage of EV to bid, say 25% to 35% or so, requires a little
more art, instinct, gut feel, whatever it may be called. Example #2 is similar in this respect. In
provinces such as the Gulf of Mexico, where there is substantial public data, the determination of
how much of EV to bid becomes more scientific. But, frontier areas are different—less history
and less public data.
Note: In many countries bonuses are tax deductible (but not cost recoverable) – this has been
ignored here for illustration and discussion purposes.
F 2.20 Example #1 Two outcome – Expected value graph
Assume:
a potential discovery would be worth $200 MM to the Company
(not including the bonus)
dry-hole cost (risk capital) is $25 MM (not including the bonus)
estimated probability of success is 30%
So, what do we have?
Expected value is $42.5 MM – Can’t bid more than that!
Can’t bid less than zero!
So what should the company bid?
Expected Expected
Value Value
$225 The discounted cash flow value of a $225

potential discovery based on estimated:
200 ♦ Oil prices (or gas prices) 200
♦ Recoverable reserves
175 ♦ Capital and operating costs 175
♦ Timing
150 ♦ Fiscal terms, etc. 150
125 125
100 100
75 75
50 50
$42.5
25 25
0 0
-25
-50 Dry-hole costs
0% 20% 30 40% 60% 80% 100%

Probability of Success
Example #2 – Bidding terms

Imagine evaluating a Block/Prospect in order to develop a bid based solely on profit oil split.
Assume economic and risk analysis of the prospects on the block with varying levels of profit oil
split yield the following relationship between overall Government take (which includes the effect
of profit oil split, royalties and taxes) and Company EV.
Government Company
take Expected value *
(%) ($MM)
—————— ———————
50% $170 MM
55% 150 MM
60% 125 MM
Range for 65% 97 MM
last 10 67% 85 MM Average of past 10 contracts
contracts 70% 65 MM
75% 48 MM
80% 21 MM
83% 0 MM Breakeven
85% -13 MM
90% -29 MM
* Assume the discount rate corresponds to corporate investment criteria “hurdle rate” close to or
slightly greater than cost of capital.
What to bid?
1) What if the past 10 contracts in the country had 60-70% Gvt take?
2) Assume the average of the past 10 contracts was 67% Gvt. take.
3) What if the geopotential/prospectivity of the last 10 blocks awarded was better
than the block you are looking at?
4) Assume oil prices were higher when the last 10 contracts were signed.
5) And what if the Dictator, following his recent 78th birthday celebration, has
developed a very bad cough?
An example like this certainly requires some of the “art” of bidding. Most companies would not
be comfortable with anything greater than 65% Government take but what if the company
“wants it badly?”
Example #3 – Combination bid - bonus and terms

Assume the Government will award exploration rights for a particular block to the highest bidder
and “terms” (profit oil split and/or royalty) as well as a signature bonus are biddable. The
Government receives two bids:
Summary of Bids
Company A Bid #1 $10 MM + Government take of 66%
Company B Bid #2 $5 MM + Government take of 78%
Bid #1 relative to Bid #2 has a larger bonus but a lower Government take. This provides a classic
tradeoff—part of the Government take is guaranteed (the bonus) and part is “at-risk” or at least
“uncertain” (it depends upon whether or not a discovery is made). Analysis of these two bids
requires discounted cash flow analysis and risk analysis. Depending on the prospectivity, either
bid may be superior to the other. If the prospectivity is extremely poor then it is likely the
Government would prefer Bid #1. On the other hand, if prospectivity is quite good then the
Government will likely prefer Bid #2. It depends upon the probability of success and the
potential size and/or value of a potential discovery (or discoveries).
Analysis of the two bids is shown in figure F 2.21. It assumes that the chance of success is 30%
and the present value of a discovery (to the Government due to royalties, taxes, profit oil etc,
based on discounted cash flow analysis) would be $250 MM for a Government take of 66% and
$290 MM for a Government take of 78%. The EV for the Government is greatest with Bid #2 as
shown in figure F 2.21. [Figure F 2.21 shows a different representation of a “two-outcome”
model than the graph in figure F 2.20 but it is the same concept.] Notice there is only about an
8% difference between the two bids from this perspective even though the highest bonus was
twice as high as the next. If the $10 MM bid is too high isn’t it possible that the other bid which
is only 8% lower (based upon EV analysis) is also too high? This approach is explored further in
Example 4.
F 2.21 Using EV analysis
Example #3 - Using EV analysis to evaluate bids
While Bid #1 included a larger signature bonus, it also had a lower Government take
yielding a lower expected value than Bid #2 with a price tag of $92MM.
Bid #1
$85 MM EV
Gvt. receives: Expected
$10 MM bonus Value
30% Chance
of success + $250 MM DCF
$78 MM
Gvt. receives:
70% Chance $10 MM bonus
of failure only $7 MM
$85 MM
Bid #2
$92 MM EV Expected
Gvt. receives:
Value
of success + $290 MM DCF
Gvt. receives:
of failure only $3.5 MM
$92 MM
Example 4 – Bonus bids – another view

Assume the Government will award exploration rights for a particular block to the Company
submitting the highest signature bonus bid. Other terms such as royalties and taxes are “fixed”.
The fixed terms yield a Government take of roughly 66% which is world average (see table T
2.12). The government receives three bids:
Summary of Bids
Company A $10 MM
Company B $5 MM
Company C $3 MM
Industry literature is rich with terminology and analysis for situations like this. The “Money left
on the table” (by Company A) is $5 MM – the difference between the two highest bids. The
highest bid is twice as high as the next bid and this is common.
Some quantify “winners curse” at $5 MM—same as the money left on the table. Others calculate
winners curse at $4 MM because this was the amount by which the company “over-bid” relative
to the “average” bid ($6 MM). The reasoning is that theoretically each bidder is competent and
has access to roughly the same information as the others. Therefore the average bid could more
accurately reflect the true value of the block. But fortunately for the Government it does not have
to take the average bid. And furthermore, the “average” bid does not necessarily represent the
“average value“ perceived by the universe of bidders.
What about Companies D and E? Let’s say there were 2 other companies who evaluated the deal
but opted to not bid—Companies D and E. Just because they did not bid does not mean they
think the property is worth zero ($0). They probably did not submit bids because they believed
the value was less than zero. Their opinion unfortunately does not get captured in the bid
statistics. Assume Company D and E estimated the (bid) value at -$9 and –$13 MM respectively.
In other words, for example, Company D would not be willing to take on the block unless the
Government paid it $9 MM. “The only way we would consider the deal is if the Government
paid us to drill it!” That of course is crazy so they do not submit a bid. Analysis of all the various
opinions of the value of the block then looks like this:
Analysis
Perceived “Value”
Company A $10 MM Bid submitted
Company B $5 MM Bid submitted
Company C $3 MM Bid submitted
Company D -$9 MM No-bid submitted
Company E -$13 MM No-bid submitted
Average -$4 MM
All the bids submitted are too high relative to the “average” perceived value.
Expected value analysis of the bids from the Government point of view provides additional
perspective. It incorporates the other aspects of Government take beyond just the bonus. It
indicates a difference in value of only about 8% between the highest and the lowest bids.
This is based on the assumption that there is a potential 100 MMBBL discovery and a 30%
chance of achieving that potential (see table T 2.12). The EV of the highest bid—$85 MM
exceeds the lowest bid by $7 MM. The highest bid now does not look as though it is twice as
high as the next highest bid.
If the highest bid is too high by only 6 to 8% relative to the other bids, then perhaps the other
bids are also too high. If that is true, and industry performance appears to indicate that it is, then
the money-left-on-the-table perhaps exceeds $5 MM. Winner’s curse is greater than $5 MM. A
zero ($0) bonus bid would likely represent an over-bid.
T 2.12 Summary of assumptions
Example #4 Summary of assumptions – Economic model
Field size 100 MMBBLS

Peak production rate 30,000 BOPD
Oil price $18.00 (flat – no escalation)
Capex $3.50/BBL
Opex $3.00/BBL
Government take 66% [20% royalty + 50/50% profit oil split]
$760 MM (undiscounted)
$250 MM (discounted at 12.5%)
Contractor take 34%
$390 MM (undiscounted)
$50 MM (discounted at 12.5%)
Probability of success 30%
Dry hole costs $5 MM (does not include potential bonus)
Company expected value $11.5 MM (does not include potential bonus)
(without signature bonus) [0.3 * $50 MM + 0.7 * $-5 MM]
Government expected value analysis of the three bids:

Gvt.
Bonus Bid EV [Formulas - $MM]
  
Company A $10 MM $85 MM [$10 + 0.3 * $250]
Company B $5 MM 80 MM [$5 + 0.3 * $250]
Company C $3 MM 78 MM [$3 + 0.3 * $250]
Conclusions
The development and evolution of fiscal terms worldwide in the past 20+ years has taken place
in an environment of intense competition and over-optimistic expectations. It has resulted in
terms that, generally speaking, are simply too tough.
The average Government take worldwide is around 67% but this is too high for “average”
geological potential (or prospectivity). For countries with better-than-average potential the
Government take is closer to 80%. However, better-than-average geological potential is rarely
sufficient to sustain such a high Government take.
Certainly many countries have modified and/or improved their terms, but relative to the
dwindling prospectivity as geological basins have matured in the past two decades, the terms are
tougher.
This is not because greedy Governments have forced these terms on an unwilling industry. It is
the other way around. Industry has determined what the market can bear and it is almost
unbearable. Governments have little choice than to allow a competitive marketplace to work its
magic as they have for many years.
What is a company to do?
Companies appear to have improved the accuracy of their prospect size and success ratio
estimates. However, there is still room for improvement. Internal peer review, or even better,
third-party reviews can be extremely helpful.
Many companies would do well to avoid those countries where allocation strategies magnify the
already hyper-competitive nature of the marketplace. When Venezuela offered 10 blocks in
January, 1996 they allocated each block separately—one-at-a-time. This added to an already
intensely competitive atmosphere.
On the other end of the spectrum there are countries that will negotiate and award licenses out-
of-round without a formal tender process and countries that will award licenses on the basis of
work program bids.
Also, companies should carefully target their bidding efficiency and be prepared to lose more
bids than they have been in the past. Most companies would be uncomfortable with a bidding
efficiency greater than 20% (i.e. where over 20% of the bids submitted are the successful
(highest) bid).
References
Alexander, J., and J. Lohr, 1998, Risk Analysis: Lessons Learned; (SPE 49030), Presented at Society of
Petroleum Engineers Annual Technical Conference and Exhibition, New Orleans, Louisiana, 27-30
September.
Capen, E., R. Clapp, and W. Campbell, 1971, Competitive Bidding in High-Risk Situations; (SPE
2993), p. 206-218.
Capen, E., 1991, The Ideal Petroleum Tax Regime, Paper presented to New Zealand Crown Minerals.
Capen, E., 1992, Dealing With Exploration Uncertainties; Steinmetz, R., (ed), The Business of
Petroleum Exploration: AAPG Treatise of Petroleum Geology—Handbook of Petroleum Geology,
Chapter 5, p. 29-61.
Clapp, R., and Stibolt, 1991, Useful Measures of Exploration Performance; Journal of Petroleum
Technology, October, p. 1252-1257.
Conn, C., and D. White, 1994, Revolution in Upstream Oil and Gas - Strategies for growth beyond
2000; McKinsey & Company, Australia.
Forrest, M., 2002, Phrases Can Raise Decision Results; AAPG Explorer, Feb., p 31
Harper, F., 1999, BP Prediction Accuracy in Prospect Assessment: A 15-Year Retrospective; reprint
of AAPG International Conference paper, Birmingham, England.
Johnston, D., 2002, International Petroleum Fiscal Systems and Production Sharing Contracts Course
Workbook.
Jones, D., S. Squire, and M. J. Ryans, 1998, Measuring Exploration Performance and Improving
Exploration from Predictions—with Examples from Santos’ Exploration Program; Proceedings of
1998 Australian Petroleum Producing and Exploration Association, Canberra, Australia.
Kah, M., Long-Term Market Outlook: Risks and Uncertainties; Middle East Petroleum & Gas
Conference, April 8, 2002, Doha, Qatar
Lohrenz, J., and Dougherty, E., 1983, Bonus Bidding and Bottom Lines: Federal Offshore Oil and
Gas; SPE Annual Technical Conference and Exhibition, San Francisco, California, October.
Lohrenz, J., 1988, Profitabilities on Federal Offshore Oil and Gas Leases: A Review; Journal of
Petroleum Technology, June, p. 760-764.
Megill, R, and R. Wightman, 1983, The Ubiquitous Overbid; Oil & Gas Journal, 4 July, p. 121-127.
Rose, P., 1999, Analysis is a Risky Proposition; AAPG Explorer, March, 1999, p. 14.
Rose, P., 1999, Analysis Less Risky Than Intuition; AAPG Explorer, April, 1999, p. 44.
Rose, P., 2001, Risk Analysis and Management of Petroleum Exploration Ventures; American
Association of Petroleum Geologists, Methods in Exploration Series, No. 12.
Tavares, M., 2000, Bidding Strategy: Reducing the “Money-Left-on-the-Table” in E&P Licensing
Opportunity; (SPE 63059) Presented at Society of Petroleum Engineers Annual Technical Conference
and Exhibition, Dallas, Texas, October 1-4.
Warren, J. E., 1989, U. S. OCS Operators in the hole by $70-80 billion; Excerpts from 1989 Offshore
Technology Conference luncheon speech, Offshore, June, p. 26-27.
Chapter 3 - Fiscal System Analysis
3. Fiscal System Analysis
F 3.1 Classification of petroleum fiscal regimes
Petroleum Fiscal Regimes

Variation on two themes
There are two main families of petroleum
fiscal systems: “concessionary” systems,
The first branch deals with “title” to mineral
resources. Royalty/Tax Systems allow title to
more commonly known as royalty/tax
hydrocarbons to transfer at the wellhead. (R/T) systems, and the “contractual
based” systems which include both
production sharing contracts (PSCs) and
risk service agreements (S/As). There are,
Royalty/Tax Contractual however, some risk service agreements
Systems Based Systems
that appear to have more of the
characteristics of a royalty/tax system.
The primary difference here depends upon whether The distinguishing characteristic of each
reimbursement” and “remuneration” is in “cash” is where, when, and if ownership of the
(Service) or in “kind” (PSC).
hydrocarbons transfers to the oil
company. Numerous variations and twists
With PSCs, title to hydrocarbons
are found under both the royalty/tax
Service Agreements transfers at the export point. (concessionary) and contractual themes.
The taxonomy of petroleum fiscal
Divided primarily upon whether systems is outlined in figure F 3.1.
remuneration is based upon a flat fee Production
(Pure) or profit (Risk). Sharing
The philosophical differences between
Contracts
the two systems have fostered a
Under the Peruvian type PSC “gross terminology unique to each main branch
production” is divided. of the family tree. However, the terms are
In the Indonesian type PSC “profit
oil” is divided.
simply different names for basic concepts
common to both systems. The
mechanical, economic, accounting and
Peruvian Indonesian financial aspects can be nearly identical
Pure Type Type from one branch to the next.
Service
Rate of Return (ROR) features are also
Unused cost oil”ullage”, treated
Hybrids as a separate category of profit oil. found in both systems. ROR is more a
descriptive term to further identify the
nature of a particular system. For
Risk Service Egyptian
Type
example, the Papua New Guinea (PNG)
fiscal system is a royalty/tax-based ROR
system. Equatorial Guinea on the other
hand uses a PSC-based ROR contract.
T 3.1 Regional distribution of petroleum fiscal systems
Royalty/Tax Production Sharing Service

Systems Systems Agreements
Africa C. Af. Rep. ♦ Namibia • Algeria ♦ Liberia
Chad Niger Angola • Libya ♦
Congo (Z) Senegal • Benin Madagascar ♦
Ghana • Seychelles Cameroon ♦ Mozambique
Madagascar Somalia Congo (Br.) Nigeria
Mali S. Africa ♦ Cote D’Ivoire Sudan
Morocco Tunisia (Old) ♦ Egypt Tanzania •
Eq. Guinea • Togo
Ethiopia Tunisia (New) ♦
Gabon Uganda •
Gambia • Zambia
37 Kenya
Europe Australia Italy Albania ♦

Bulgaria Netherlands Malta
Czech Rep. Norway Poland
Denmark Poland ♦ Turkey
France Portugal
Greece • Romania ♦
Hungary Spain
20 Ireland UK
Far East Australia • Pakistan (On) Bangladesh Mongolia Philippines
Brunei PNG • Cambodia MTJDA
Korea S. Thailand China Myanmar
Nepal Timor Gap B India •♦ Pakistan (Off)
New Zealand Indonesia Timor Gap A
Laos Vietnam
23 Malaysia ♦
Former Azerbaijan •♦ Russia •
Georgia Turkmenistan ♦
Soviet Kazakhstan •♦ Uzbekistan
Union 7 Kyrghyzstan
Latin and Argentina Falkland Is. Belize Nicaragua Brazil Honduras
Bolivia Paraguay Cuba Panama ♦ Chile Panama
South Colombia ♦ Tr&To (On) Guatemala Tr&To (Off) ♦ Ecuador Peru ♦
America Costa Rica Guyana Uruguay Haiti
Jamaica Venezuela •♦
25
Middle East Abu Dhabi Neutral Zone Bahrain Oman Iran
Ajman Sharjah Iraq Qatar ♦ Kuwait (OSA)
Dubai Turkey Jordan Syria Saudi Arabia
18 Fujairah Libya Yemen
North Canada •
United States
America 2
Total 131 55 64 12
• ROR Systems
♦ “R” factors
F 3.2 Example analysis format and definitions
If oil prices increase,

what percentage goes to
If economic profits are generated how the Government?
much does the Government “take”? How much incentive
Larger, more
does the Contractor have
Marginal
fields profitable fields to keep costs down?
Effective Lifting Savings Data Comments

Government Take Royalty Index Quality
Downside Mid-range Upside Margin Rate
89% 77% 76% 75% 34% 53% 28¢ Fair
How regressive is the system? Good data?
What percentage of the production will

the Contractor be “entitled” to lift?
Government take
Government take represents the Government share of economic profits from all means by which
the State extracts rent: Bonuses, royalties, profit oil, taxes, Government working interest, etc.
Because of the dynamics of bonuses, royalties, cost recovery limits, sliding scales and other
mechanisms, there can be various levels of Government take for any given system depending
upon the circumstances. Thus 4 separate statistics are used in order to characterize Government
take. This is shown in table T 3.2 where different calculations are provided, and figure F 3.3
where Government take for an example PSC is plotted against project profitability.
T 3.2 Government take

The common denominator
Take definitions:
Economic profit ($) = Cumulative gross revenues less cumulative gross costs
over life of the project (full cycle). Also referred to as
cash flow.
Government take (%) = Government receipts from royalties, taxes, bonuses,
production or profit sharing, and Gvt. participation,
divided by total economic profit
Contractor take (%) = 1 - Government take
= Contractor net cash flow divided by economic profit
Company take (%) = 1 - Government take (excluding Gvt. participation)

= Company net cash flow divided by economic profit
Here a distinction is made between Contractor (or more precisely Contractor group) and
an individual company within the Contractor group.
Downside government take

This statistic is usually associated with smaller fields (less than 50 to 100 MMBBLS) combined
with relatively higher costs or lower prices or a combination of these conditions. Typically, this
results in situations where total costs relative to gross revenues (full-cycle) exceed 50 to 60%.
These situations almost always result in marginal or submarginal discoveries/fields (depending
upon the fiscal terms and accumulated sunk costs prior to the development decision).
Mid-range government take

This statistic typically represents medium to large fields (75 – 150 MMBBLS) with relatively
lower costs and/or higher oil prices. Typically this results in situations where total costs relative
to gross revenues are around 30-35%.
Upside government take

This statistic represents what might be expected for larger fields > 100 MMBBLS with low costs
and/or higher prices or a combination of these resulting in costs relative to gross revenues on the
order of 20%± .
Margin (marginal government take)

Marginal take can be viewed different ways. It represents the division of profits on an
incremental increase in oil prices. Therefore it often represents a minimum government take.
However, it will not necessarily represent a minimum for systems with depletion allowances,
ROR features or “R” factors. The terminology causes some confusion because marginal take
does not coincide with government take for “marginal” or “sub-marginal” fields referred to here
as “downside” government take. Ordinarily government take for “marginal” and “submarginal”
fields is much greater than marginal government take because of the regressive nature of most
fiscal systems.
Government take mechanics - (see table T 3.3)

A simple royalty/tax (R/T) system is used here as an example. It is comprised of:
Royalty 10%
Tax rate 40%
Gvt. participation 20%
This example R/T system is used to illustrate the calculations as well as the diversity of
terminology and dynamics of three of the four main rent extraction mechanisms: royalties,
profits-based levies (taxes and profit oil split) and government participation. (The fourth is
signature bonuses).
First – While percentages are convenient to work with, this approach also works with barrels or
dollars. Start with 100% (or $100, or 100 BBLS). This represents gross revenues (or production)
over the life of a field—“full cycle” (or the life of a contract). Royalty (B) is subtracted from gross
revenues (A). The result is (C) net revenue [A – B = C].
Second – An estimate of the overall development and operating costs must be made, say 35%
and this percentage is deducted from net revenue. [C]
Over the life of a project (full cycle), these costs typically range from 20 to 40% of gross
revenues. If costs exceed this level then it is likely a project will be submarginal depending on
the fiscal system. A quick-look estimate should focus on a hypothetically profitable venture.
Companies normally do not develop sub-economic fields, and they certainly do not purposely
explore for them. A cost estimate of 35% of gross revenues is a good place to start. It provides a
common reference point.
Third - Subtract taxes, levies, etc. This gives the contractor group share of profits [G].
Fourth – The Government through the national oil company (NOC) holds a 20% working
interest share. This also must also be deducted. Thus the NOC receives 20% of the contractor
group profits.
Fifth - Divide the contractor share of profits by total profits. This is company take. Government
take is the complement of that. Government take of course could also have been calculated
directly by adding all means by which the Government extracted rent [B + F + H in this case]
and dividing by total profits [A – D].
T 3.3 Example quick-look government take calculation
A 100% Gross revenues

B - 10 Royalty (10%)

C 90 Net revenue percentage
D - 35 Costs (Assumed)

E 55 Taxable income
F - 22 Income tax (40%)

G 33 Contractor Group after-tax share (cash flow)
H - 6.6 Gvt. NOC working interest share (20%)

J 26.4% Oil company profits (cash flow)
40.6% Company take [J/(A – D)]
38.6% Gvt. share of profits (cash flow) [B + F + H]
59.4% Government take [(B + F + H)/(A – D)]

Also referred to as: Rent, State take,
Fiscal net, Net net,
and various other terms
65% Economic profits (A – D)

Also referred to as: Rent, Cash flow,
Technical profits,
Operating income
55% Accounting profits (A – B – D)
Financial profits Not shown here. Requires
present value discounting of J
60% Savings incentive
(based on profits-based elements alone)
Effective royalty rate

The effective royalty rate (ERR) is the minimum share of gross revenues a government will
receive in any given accounting period for a given field. It does not include NOC working
interest share of production. It is an important index that adds dimension to the "take" statistics.
The complement of ERR, “access to gross revenues” (AGR) provides an important oil company
perspective.
AGR is the maximum share of revenues a company or consortium can receive relative to their
working interest in any given accounting period. It may be limited by government royalties,
and/or cost recovery limits and profit oil split.
In a royalty/tax system with no cost recovery limit, the royalty is the only government guarantee.
The ERR is the royalty rate. AGR is limited only by the royalty. In most royalty/tax systems in
any given accounting period there is no limit to the amount of deductions a company may take
and companies can be in a no-tax-paying position. This can occur with a PSC as well.
Production sharing contracts with a cost recovery limit guarantee the NOC a share of profit oil in
every accounting period because a certain percentage of production is always forced through the
profit oil split. Thus, both royalties and cost recovery limits guarantee the government a share of
production, or revenues, regardless of whether or not true economic profits are generated.
The ERR/AGR calculations require a simple assumption—that expenditures and/or deductions in
a given accounting period relative to gross revenues are unlimited. Therefore cost recovery is at
its maximum (saturation) and deductions for tax calculation purposes yield zero taxable income.
Situations like this can occur in the early stages of production, with marginal or submarginal
fields, or at the end of the life of a field. The object of the exercise is to test the limits of the
system. This provides the ERR/AGR indices.
Lifting (entitlement)
This statistic focuses on what percentage of a company’s working interest share of production it
may “lift”. It occasionally will coincide with the percentage of reserves a company might “book”
relative to their working interest share of “proved reserves”. The index provided here is based
upon a cost structure where costs relative to gross revenues are on the order of 30-35%.
With R/T systems the lifting entitlement percentage is gross production less royalty. In some
circumstances where Government royalties are taken in cash instead of “in kind”, it is possible
companies can lift 100%. With PSCs the lifting entitlement consists of two components: cost oil
and profit oil. With Egyptian type systems where taxes are paid “in lieu”, the entitlement will
likely not coincide with the percentage of reserves a company may “book”. Many companies
will choose to calculate an “imputed” entitlement that would be consistent with what the
company entitlement would have been if the taxes had been paid directly instead of “in lieu”.
Savings Index
The savings index is simply a measure (from an undiscounted point of view) of how much a
company gets to keep if it saves a $1.00. Because of the great concern on the part of both
Governments and companies about reducing costs, this statistic is included to quantify somewhat
the incentive companies have to keep costs down. Only the profits-based fiscal elements affect
this statistic. The example R/T system has only a 40% Income Tax. If the company saves one
dollar there will be an added dollar of taxable income, and the Gvt. gets 40% of it. The company
gets to keep 60¢ of the dollar saved. The savings index is 60¢. This index does not take into
account present value discounting.
Example production sharing contract

Figure F 3.4 is a flow diagram of a simple PSC comprised of:
Royalty 10%
Cost Recovery Limit 50%
Profit Oil 60/40% (in favor of Government)
Tax Rate 30%
Gvt. Participation 0%
This flow diagram uses average full-cycle revenues ($20.00/BBL) and costs ($5.65/BBL) but
honors the hierarchy of arithmetic that might be expected in any given accounting period. For
illustration, one barrel of oil is followed through the system.
First - Royalty
The royalty comes “right off the top” just as it would in a royalty/tax system. This example uses
a 10% royalty. Royalties are less common in PSCs than in R/T systems, but they do exist.
Second - Cost recovery
Before sharing of production, the contractor is allowed to "recover costs" out of net revenues.
However, most PSCs have a cost recovery limit (also called cost recovery ceiling, cost stop,
capped cost recovery rate, and cost cap). In this example cost recovery is limited to 50% of gross
revenues. If operating costs and depreciation amount to more than this in any given accounting
period, the balance is carried forward and recovered later. Cost recovery limits simply control the
amount of deductions that can be taken in any given accounting period for the purpose of
determining the profit oil split. Most PSCs allow virtually unlimited carry forward (C/F). From a
mechanical point of view, the cost recovery limit is the only difference between R/T systems and
PSCs.
Third - Profit oil split

Revenues remaining after royalty and cost recovery are referred to as profit oil or profit gas. The
analog in a concessionary system would be taxable income. The terminology is precise because
of the ownership issue. The term taxable income implies ownership that does not exist yet under
a PSC. The contractor has nothing to tax.

In this example, the contractor’s share of profit oil is 40%. If this were a service agreement with
the contractor’s share of revenues equal to 40%, it would be called the service feenot profit oil.
F 3.3 Government take vs. project profitability

Fourth - Taxes
Example PSC with: The tax rate of 30% in this flow diagram
10% Royalty appears to apply to the profit oil. It is
50% Cost Recovery Limit acceptable to do this when thinking in terms
60% Government P/O Share of “full-cycle” economics. On the average
30% Income Tax
over the life of a field the accounting profits
The regressive effect here is due to both the subject to ordinary taxes will be equal to the
royalty and the C/R limit. company share of profit oil. However, the
profit oil ordinarily does not constitute the
tax base. In any given accounting period a
Government
Take Where Gvt. Take
company will receive a share of profit oil if
100% exceeds 100%, it there is a cost recovery limit but the
is set at 101% company may not necessarily be in a tax
A paying position. This is important when
80% considering the royalty effect of the cost
B C recovery limit. (See figure F 3.4).
60% Example PSC -Government take

Inflection Point at Marginal Gvt.
Cost Recovery Limit Take 74.8%
Total economic profits are $14.35/BBL
40% ($20.00 - $5.65). Considering the 10%
royalty, profit oil split and taxation, the
contractor share of economic profits is $3.46.
20%
AGR
Contractor take, therefore, is 24%
ERR
34% 66% ($3.46/$14.35). Government take is 76%.
0% Total costs relative to gross revenues
100% 80% 60% 40% 20% 0% amounts to 28.25% ($5.65/$20.00).
Total Costs as a Percentage of Gross Revenues
Example PSC - Effective Royalty Rate
Figure F 3.5 depicts the same PSC but from a different perspective. It shows a single accounting
period (not full-cycle) at “saturation” (i.e. where costs and deductions by-far outweigh gross
revenues). This tests the limits of the system and provides the ERR and AGR. With a 10% royalty
and a 50% cost recovery limit there will always be at least 40% of production forced through the
profit oil split (of which the Gvt. gets 60%). Therefore, the Gvt. is guaranteed 24% plus 10%
royalty yields an ERR of 34%.
Example PSC - Lifting entitlement

Assuming cost recovery is equivalent to 28.25% of gross production ($5.65/BBL out of an
average $20.00/BBL crude price) the contractor entitlement comes to 53%. Entitlement consists
of two components: cost oil and profit oil. Therefore, if a company held a 40% working interest
in a field with 100 MMBBLs proved recoverable reserves, then it would likely “book” 21.1
MMBBLS [100 MMBBLS * .40 * .53].
Example PSC - Savings index

There are two profits-based fiscal elements in this system that affect the contractor incentive to
keep costs down. If the company saves a dollar there will be one dollar less cost oil and an extra
dollar of profit oil. The Government share of this extra dollar of profit oil is 60%. This leaves the
company with 40% of the extra profit oil but with a tax rate of 30%. The contractor will
ultimately end up with only 70% (100%-30% tax rate) of the 40%. The savings index then is 28¢
on the dollar.
F 3.4 Production sharing contract flow diagram 1
One Barrel of Oil

“Full Cycle”
Gross Revenues
$20.00
Contractor Government
Share Share
Royalty
10% → $2.00
$18.00
$5.65 ← Cost Recovery

Assumed Costs 50% Limit
$12.35 Profit Oil
$4.94 ← Profit Oil Split → $7.41

40/60%
($1.48) → Tax Rate → $1.48

30%
$3.46
$9.11 Division of Gross Revenues $10.89
$3.46 Division of Cash Flow $10.89
24% Take 76%

$3.46/($20.00-5.65) $10.89/($20.00-5.65)
53% Lifting Entitlement 47%

($5.65+4.94)/$20.00 ($2.00+7.41)/$20.00
F 3.5 Production sharing contract flow diagram 2
One Barrel of Oil
“Single Accounting Period”

Gross Revenues
$20.00
Contractor Government
Share Share
Royalty
10% → $2.00
$18.00
$10.00 ← Cost Recovery

50% Limit
$8.00 Profit Oil
$3.20 ← Profit Oil Split → $4.80

40/60%
($0.00) → Tax Rate → $0.00

30%
$3.20
$13.20 Division of Gross Revenues $6.80
Effective Royalty Rate 34%

$6.80/$20.00
66% Access to Gross Revenues

$13.20/$20.00
A cash flow model of the example PSC is summarized in tables T 3.5 and T 3.6. It is based on
the following assumptions:
100 MMBBL field (recoverable reserves)

$20/BBL wellhead price (no escalation)
$5.65/BBL total costs (Capex and Opex full-cycle)
Table T 3.7 summarizes the respective takes that come from the cash flow projection.
Government take is 76%. The quick-look estimate from the flow diagram (figure F 3.4) yields
the same result—as it should. The only difference between the flow diagram and the detailed
cash flow projection in regard to this estimate of take is that the bonus ($5 MM) was ignored in
the flow diagram. The bonus is relatively immaterial in the context of $2 Billion in revenues.
Had there been a significant difference between the take calculations between the cash flow
model and the flow diagram, then this would indicate a possible problem in either the model or
the flow diagram.
The take calculations in table T 3.8 illustrate the regressive effect of the 10% royalty. The
regressive effect of the cost recovery limit is only seen when costs (relative to gross revenues)
exceed the cost recovery limit (full-cycle). The step-by-step allocation of revenues under high,
low, and zero cost cases is shown here with government take decreasing with increased
profitability.
In the high cost case total costs exceed the cost recovery limit, yet there are sufficient revenues to
allow full cost recovery. However only part of the cost recovery comes through the cost recovery
mechanism itself. Additional recovery comes through the company share of profit oil.
T 3.4 Rule-of-thumb for production acquisitions
Producing reserves (without substantial sunk costs) are worth roughly ½ the wellhead
price times Company take.
For example: Company take for oil in Indonesia is around 13-14% (standard contracts).
Assume oil prices are around $20/BBL.
The value of the producing reserves in-the-ground (working interest barrels) should be
around $1.30 to $1.40/BBL [½ of $20/BBL * 13-14%].
Similar Gulf of Mexico OCS reserves according to this Rule would be worth $5.00/BBL
or so. [½ of $20/BBL * 50% Company take].
Weaknesses: (all Rules-of-thumb have their weaknesses)

• Most production has associated sunk costs
• Few production acquisitions comprise producing reserves only
• Does not take into account timing (i.e. long-life vs. short-life reserves vs. other)
T 3.5 Example PSC cash flow projection
Field X 100 MMBBLS

Annual Oil Oil Gross Royalty Net Capital Op. Deprec- Cost
Production Price Revenues 10% Revenue Costs Costs iation C/R C/F Recovery
Year (MBBLS) ($/BBL) ($M) ($M) ($M) ($M) ($M) ($M) ($M) ($M)
A B C D E F G H I J
1 0 $20.00 30,000 0
2 0 $20.00 40,000 0
3 578 $20.00 11,560 1,156 10,404 100,000 3,156 34,000 5,780
4 6,100 $20.00 122,000 12,200 109,800 60,000 16,200 46,000 31,376 61,000
5 9,420 $20.00 188,400 18,840 169,560 70,000 22,840 60,000 32,576 94,200
6 12,400 $20.00 248,000 24,800 223,200 28,800 60,000 21,216 110,016
7 10,850 $20.00 217,000 21,700 195,300 25,700 60,000 85,700
8 9,494 $20.00 189,880 18,988 170,892 22,988 26,000 48,988
9 8,307 $20.00 166,140 16,614 149,526 20,614 14,000 34,614
10 7,269 $20.00 145,380 14,538 130,842 18,538 18,538
11 6,360 $20.00 127,200 12,720 114,480 16,720 16,720
12 5,565 $20.00 111,300 11,130 100,170 15,130 15,130
13 4,869 $20.00 97,380 9,738 87,642 13,738 13,738
14 4,261 $20.00 85,220 8,522 76,698 12,522 12,522
15 3,728 $20.00 74,560 7,456 67,104 11,456 11,456
16 3,262 $20.00 65,240 6,524 58,716 10,524 10,524
17 2,854 $20.00 57,080 5,708 51,372 9,708 9,708
18 2,498 $20.00 49,960 4,996 44,964 8,996 8,996
19 2,185 $20.00 43,700 4,370 39,330 7,370 7,370
20
100,000 2,000,000 200,000 1,800,000 300,000 265,000 300,000 565,000
Total Gvt. Company Taxable Income Contractor Cash Flow

Profit Oil Share Share Bonus TLCF Income Tax 30%
Year ($M) ($M) ($M) ($M) ($M) ($M) ($M) Undiscounted 12.5% DCF
K L M N O P Q R S
1 0 0 5,000 0 (5,000) (35,000) (32,998)
2 0 0 (5,000) (5,000) (40,000) (33,522)
3 4,624 2,774 1,850 (5,000) (34,526) (95,526) (71,161)
4 48,800 29,280 19,520 (34,526) (16,206) 4,320 2,861
5 75,360 45,216 30,144 (16,206) 25,298 7,589 23,915 14,076
6 113,184 67,910 45,274 66,490 19,947 106,543 55,742
7 109,600 65,760 43,840 43,840 13,152 90,688 42,175
8 121,904 73,142 48,762 48,762 14,628 60,133 24,858
9 114,912 68,947 45,965 45,965 13,789 46,175 16,967
10 112,304 67,382 44,922 44,922 13,476 31,445 10,271
11 97,760 58,656 39,104 39,104 11,731 27,373 7,947
12 85,040 51,024 34,016 34,016 10,205 23,811 6,145
13 73,904 44,342 29,562 29,562 8,868 20,693 4,747
14 64,176 38,506 25,670 25,670 7,701 17,969 3,664
15 55,648 33,389 22,259 22,259 6,678 15,581 2,824
16 48,192 28,915 19,277 19,277 5,783 13,494 2,174
17 41,664 24,998 16,666 16,666 5,000 11,666 1,671
18 35,968 21,581 14,387 14,387 4,316 10,071 1,282
19 31,960 19,176 12,784 12,784 3,835 8,949 1,013
20
Total 1,235,000 741,000 494,000 146,700 342,300 60,736
T 3.6 Example PSC cash flow projection
Government Cash Flow

Royalty Government Cash Flow ($M)
Bonuses Gvt. 60% Income
10%
Year ($M) Profit Oil Tax 30% Undiscounted 12.5% DCF
($M)
($M) ($M)
N D L Q T U
1 5,000 5,000 4,714
2 0 0
3 1,156 2,774 3,930 2,928
4 12,200 29,280 41,480 27,467
5 18,840 45,216 7,589 71,645 42,170
6 24,800 67,910 19,947 112,657 58,941
7 21,700 65,760 13,152 100,612 46,791
8 18,988 73,142 14,628 106,759 44,133
9 16,614 68,947 13,789 99,351 36,507
10 14,538 67,382 13,476 95,397 31,159
11 12,720 58,656 11,731 83,107 24,129
12 11,130 51,024 10,205 72,359 18,674
13 9,738 44,342 8,868 62,949 14,440
14 8,522 38,506 7,701 54,729 11,160
15 7,456 33,389 6,678 47,523 8,614
16 6,524 28,915 5,783 41,222 6,642
17 5,708 24,998 5,000 35,706 5,114
18 4,996 21,581 4,316 30,893 3,933
19 4,370 19,176 3,835 27,381 3,098
20
Total 5,000 200,000 741,000 146,700 1,092,700 390,612
A) Production Profile Thousands (M) barrels/year K) Total Profit Oil = (C – D – J)

B) Crude Price L) Government Share P/O 60% = (K * .60)
C) Gross Revenues Thousands of dollars ($M) M) Contractor Share P/O 40% = (K – L)
D) Royalty 10% = (C * .10) N) Signature Bonus
E) Net Revenues = (C – D) O) TLCF (See Column P)
F) Capital Costs P) Taxable Income = (C – D – G – H – L – N)
G) Operating Costs (Expensed) Q) Income Tax (30%) = [if P > 0, P * .30]
H) Depreciation of Capital Costs (5-year SLD) R) Company Cash Flow = (E – F – G – L – N – Q)
I) Cost Recovery C/F (if G + H + I > 50% of C) T) Government Cash Flow = (D + L + N + Q)
J) Cost Recovery = (G + H + I) up to 50% of C
T 3.7 Cash flow model– summary and analysis
While most of the “Take” statistics quoted in industry literature are undiscounted
there are some sources that occasionally quote Government take from a present value
point of view. The calculation of Government take at a 12.5% discount rate is shown
below.
Comparing or “ranking” systems on the basis of undiscounted take is usually
sufficient. Government take discounted is always greater than Government take
undiscounted.
Gross Revenues $2,000,000
Total Costs - 565,000 (28.25%)


Total Profit $1,435,000
Bonus - 5,000
Royalties - 200,000
Government Share Profit Oil - 741,000
Income Tax - 146,700 $1,092,700 (Gvt. Take)

Company Cash Flow $342,300
Company Take 24% ($342,300/1,435,000)
Government Take 76% (Undiscounted)
Government DCF (12.5%) $390,612

Company DCF (12.5%) $60,736
Government Take
Discounted (12.5%) 86.5%
$390,612/(390,612+60,736)
T 3.8 Different perspectives on the example PSC
Gross Revenues 100% (Full Cycle)

Royalty 10%
Gvt. P/O Share 60%
Taxes 30% CIT
Costs as a percentage of Gross Revenues—Three Scenarios:

High Cost case
60% Low Cost case
↓ 30% At the margin
↓ 0%
↓
High Low Zero Cost
Case Case “Marginal”
  
A B C
  
100.00% 100.00% 100.00% Gross Revenues
- 10.00 - 10.00 - 10.00 Royalty
  
90.00 90.00 90.00 Net Revenues
- 50.00 * - 30.00 - 0.00 Total Cost Recovery
  
40.00 60.00 90.00 Profit Oil
- 24.00 - 36.00 - 54.00 Gvt. Share 60%
  
16.00 24.00 36.00 Contractor Profit Oil
- 10.00 Unrecovered Costs *
- 1.80 - 7.20 - 10.80 Income Tax 30%
  
4.20 16.80 25.20
10.5% 24.0% 25.2% Contractor Take
89.5% 76.0% 74.8% Government Take
* While costs are assumed to represent 60% of gross revenues the cost recovery limit is 50%.
T 3.9 World petroleum fiscal system statistics
World Royalty/Tax
PSCs Average Systems
Number of systems 72 136 64
Government take 70% 65% 59%
Gvt. participation
Systems with gvt. participation 36 (50%) 65 (48%) 29 (46%)
% Participation in those
systems with Gvt. participation 25% 27% 30%
Royalty 5% 7% 8%
Effective Royalty Rate 23% 17% 8%
Ringfenced systems 75% 55% 30%
Lifting entitlement 63% 77% 92%
Savings index 39¢ 47¢ 56¢
Cost recovery limit (PSCs only) 65% N/A N/A
Systems with ROR features or “R”
17% 21% 25%
factors
T 3.10 Fiscal system statistics, the more prospective countries

20th Percentile
Royalty/Tax
PSCs Average Systems
Number of Systems 19 25 6
Government Take 78% 79% 80%
Gvt. Participation
Systems with Gvt. Participation % 12 (63%) 17 (68%) 5 (83%)
% Participation in those
systems with Gvt. Participation 28% 32% 42%
Royalty 5% 6.8% 11%
Effective Royalty Rate 29% 24.5% 11%
Ringfenced Systems 90% 76% 33%
Lifting Entitlement 55% 63% 89%
Savings Index 30¢ 31¢ 37¢
Cost Recovery Limit (PSCs only) 62% N/A N/A
Systems with ROR features or “R”
26% 24% 16%
factors
Gvt. Effective
F 3.6 International
Participation % Petroleum Exploration and Development Contracts
Royalty Rate %
↓ 80% 70% 60% 50% 40% 30% ↓
Ireland 0 0
Uruguay 0 10
UK 0 0
US OCS 0 Deepwater 0
New Zealand 0 5
Falkland Islands 0 9
Argentina 0 14.6
US OCS 0 Shallow 16.7
Greece 12.5 2
South Africa 20 2.4
Trinidad 0-25 Deepwater 25+
Mongolia 0 30
Philippines 0 13.5
Pakistan Offshore 0 4
Bolivia 0 18
Australia 0 ROR 0
Ecuador 0 25
Pakistan II 20 12.5
Cambodia 0 22
Gabon 10 22
Morocco 25 10
Peru 0 R 23
Jordan 0 36
Guatemala 0 20
Mozambique 0 19
Azerbaijan AIOC 10 ROR 0
Benin 15 30
Congo Z. 20 12.5
Malaysia 15 Deepwater 13
Angola 20 ROR 7.5
Colombia 30 R 8
Yemen 12.5 31
Indonesia 10 Frontier 5
Egypt Offshore 0 40
Azerbaijan EDPSA 50 R 0
Russia Sakhalin II 0 6
Timor Gap ZOCA 0 5
Norway 30 0
Tunisia 0 R Royalty/Tax System 30
Egypt Onshore 0 47
Myanmar 15 PSC
38
Qatar RDPSA 0 R 46
Service Agreement
Algeria 35 12.5
Brunei 50 R “R” Factor 12.5
Malaysia R/C 15 18
ROR Rate of Return Feature
UAE “Opec Terms” 60 12.5
Syria 0 60
Indonesia Std. 10 14
Venezuela 35 R 16.7
Iraq W. Qurna 25 54
90% 80% 70% 60% 50% 40%
Government Take [for Oil]
T 3.11 Typical contract conditions

Area Block sizes range from extremely small for development/EOR projects
to very large blocks for exploration. Typical exploration block sizes are on the
order of 250,000 acres (1,000 km2) to over a million acres (>4,000 km2)
_____________________________________________________________________________________________
Duration Exploration: Typically 3 Phases totaling 6 to 8 years
Production: 20 to 30 years, (typically at least 25 years)
_____________________________________________________________________________________________
Relinquishment Exploration: 25% after 1st Phase, 25% of “original” area after 2nd Phase
This is most common but there is wide variation.
_____________________________________________________________________________________________
Exploration Obligations Includes seismic data acquisition and drilling. Sometimes contract
requirements can be very aggressive in terms of $ and timing – depends on the
situation. All blocks are different
_____________________________________________________________________________________________
Royalty World average is around 7% Most systems either have a royalty or
an effective royalty (ERR) due to the effect of a cost recovery limit.
_____________________________________________________________________________________________
Profit Oil Split Most profit oil splits (approximately 55-60%) are based upon a
production-based sliding scale. Others (around 20-25%) are based upon
an “R” factor or ROR system.
_____________________________________________________________________________________________
Cost Recovery Limit Average 65% Typically PSCs have a limit and most are based on gross
revenues. Some (perhaps around 20%) are based on net production or net
revenues (net of royalty). Over 20% have no limit (i.e. 100%)
Approximately half of the world’s PSCs have no depreciation for cost recovery
purposes ( but almost all do for tax calculation purposes).
_____________________________________________________________________________________________
Taxation World average Corporate Income Tax (CIT) is between 30-35%. However,
many PSCs have taxes paid “in lieu” – “for and on behalf of the Contractor” out
of National Oil Company share of profit oil.
_____________________________________________________________________________________________
Depreciation World average is 5 year Straight Line Decline (SLD) for capital costs
Usually depreciation begins “when placed in service” or “when
production begins” (whichever comes later)
_____________________________________________________________________________________________
Ringfencing Most countries (55%) erect a “ringfence” or a modified ringfence (13%) around
the contract area and do not allow costs from one block to be recovered from
another nor do they allow costs to “cross the fence” for tax calculation purposes.
_____________________________________________________________________________________________
Gvt. Participation Of the countries with the option to participate, approximately half do not
reimburse their share of “past costs”. Nearly half of the countries have the
option to “back-in”. Typical % share taken up = 25 – 30%.
F 3.7 Maximum capital costs
Maximum Capital Costs per Barrel that can be With the tougher fiscal systems where
spent for Economic Field Development Government take is over 80%, capital costs
When the ratio of capital costs per barrel divided by must be kept below 20% of the wellhead
wellhead price approaches contractor take, project price. For example if oil prices are around
economics become marginal.
$20.00/BBL then capital costs in Venezuela
must be kept below $1.50/BBL. This is hard
Government Take to do. This is why the Conoco’s Paria West
Maximum Excluding Government Participation
block discovery in Venezuela is “marginal”
CAPEX
even though there could be from 200 to 500
$/BBL 80% 70% 60% 50%
MMBBLS of recoverable reserves.
$25/BBL $20/BBL $15/BBL
$6.00
$5.00
$4.00
Typical
$3.00
Indonesia/Malaysia
$2.00
Venezuela
$1.00
10% 20% 30% 40% 50%
Contractor Take
“R” Factor based systems

Summary:
“R” factors (sometimes called “the Factor R”) are based on an ancient and fundamental
formula—payout.
Typically the contract will stipulate that for example a tax rate may be subject to a factor “R”
and several “thresholds” will be established either through negotiation or they may be
statutory. And “R” which stands for “ratio” will be a function of X divided by Y (X/Y). X is
defined as the accumulated receipts actually received by the Contractor less tax. Y is defined
as the accumulated expenditures (Capex and Opex). The factor (“R”) is calculated in each
accounting period and once a threshold is crossed then the new tax rate will apply in the next
accounting period.
X
R = 
Y
Where: X = Contractor cumulative receipts (after-tax)
Y = Contractor cumulative expenditures
When X = Y → “R” = 1 → Payout
Tunisian Example:
“R” Tax
Factor Rate
0 – 1.5 50%
1.5 – 2.0 55
2.0 – 2.5 60
2.5 – 3.0 65
3.0 – 3.5 70
> 3.5 75
Rate of Return (ROR) systems

The Papua New Guinea (PNG) ROR System
The PNG system is typical of the classic ROR formula. Under this system the government
receives a 1.25% royalty and a 22.5% carried interest (carried through exploration). A basic
petroleum tax (BPT) of 50% is levied only if a target income for the contractor is met which is
equal to or greater than 25% of the contractors initial investment.
There is an additional tax levied if the contractor rate of return (ROR) exceeds 27%. This is done
by compounding and accumulating the negative net cash flows at a rate of 27%. This is called
“compound uplifting”. Once the cumulative net uplifted cash flow becomes positive the
additional 50% resource rent tax kicks in. It is called the Additional Profits Tax (APT). This is
the hallmark of a ROR system. It is also called a "trigger tax." Reaching a minimum rate of
return (in this case 27%) triggers the tax. The basic structure of the PNG contract is illustrated in
figure F 3.8.
Calculation of cash flow from a simple ROR contract is shown in table T 3.12. It outlines the
basic ROR system elements with a detailed explanation of the calculations involved in arriving at
year-by-year cash flow. In this example there is no royalty, and the basic income tax is 35%. A
30% uplift is applied on the accumulated negative net cash flows. Once the cumulative balance
of net cash flow becomes positive an additional 50% resource rent tax is imposed.
Critics of the ROR concept complain that these contracts are too restrictive, that the uplift (rate-
of-return) places an unreasonably low ceiling on upside potential. This is not a fair criticism.
Most of the criticism about ROR systems including the claim that they inspire “goldplating” are
based on false logic.
The resource rent tax concept was first employed in Papua New Guinea (PNG). Other countries
that use this kind of tax are Australia, Liberia, Equatorial Guinea, and Tanzania.
F 3.8 Papua New Guinea rate of return system
Gross Revenues
Royalty 1.25%
Target Income
Test
Not Met Met
Basic Petroleum Tax *

(BPT) 50%
Designated (27%)
Rate of Return
Not Met Met
Additional Profits Tax *

(APT) 50%
Contractor Group After Tax Share

National Oil Company has right to 22.5% Back-in
T 3.12 Example ROR system cash flow model
Field X Development Feasibility Study

Annual Oil Oil Gross Royalty Net Capital Deprec- Tax Loss
Production Price Revenues 10% Revenue Costs OPEX iation Bonus C/F
Year (MBBLS) ($/BBL) ($M) ($M) ($M) ($M) ($M) ($M) ($M) ($M)
A B C D E F G H I J
1 0 $20.00 30,000 5,000 0
2 0 $20.00 40,000 5,000
3 578 $20.00 11,560 1,156 10,404 100,000 3,156 34,000 5,000
4 6,100 $20.00 122,000 12,200 109,800 60,000 16,200 46,000 31,752
5 9,420 $20.00 188,400 18,840 169,560 70,000 22,840 60,000
6 12,400 $20.00 248,000 24,800 223,200 28,800 60,000
7 10,850 $20.00 217,000 21,700 195,300 25,700 60,000
8 9,494 $20.00 189,880 18,988 170,892 22,988 26,000
9 8,307 $20.00 166,140 16,614 149,526 20,614 14,000
10 7,269 $20.00 145,380 14,538 130,842 18,538
11 6,360 $20.00 127,200 12,720 114,480 16,720
12 5,565 $20.00 111,300 11,130 100,170 15,130
13 4,869 $20.00 97,380 9,738 87,642 13,738
14 4,261 $20.00 85,220 8,522 76,698 12,522
15 3,728 $20.00 74,560 7,456 67,104 11,456
16 3,262 $20.00 65,240 6,524 58,716 10,524
17 2,854 $20.00 57,080 5,708 51,372 9,708
18 2,498 $20.00 49,960 4,996 44,964 8,996
19 2,185 $20.00 43,700 4,370 39,330 7,370
20
Total 100,000 2,000,000 200,000 1,800,000 300,000 265,000 300,000 5,000 565,000
Taxable Income Net Cash Amount Amount Rent Tax Resource Contractor Cash Flow
Income Tax 40% Receipts Brought Carried Base Rent Tax
Year ($M) ($M) ($M) Forward Forward ($M) 50% Undiscounted 12.5% DCF
K L M N O P Q R S
1 (5,000) 0 (35,000) (35,000) (35,000) (32,998)
2 (5,000) 0 (40,000) (45,500) (85,500) (40,000) (33,522)
3 (31,752) 0 (92,752) (111,150) (203,902) (92,752) (69,094)
4 15,848 6,339 27,261 (265,073) (237,812) 27,261 18,051
5 86,720 34,688 42,032 (309,155) (267,123) 42,032 24,740
6 134,400 53,760 140,640 (347,260) (206,620) 140,640 73,582
7 109,600 43,840 125,760 (268,606) (142,846) 125,760 58,486
8 121,904 48,762 99,142 (185,700) (86,558) 99,142 40,984
9 114,912 45,965 82,947 (112,525) (29,578) 82,947 30,479
10 112,304 44,922 67,382 (38,452) 28,931 14,465 52,917 17,284
11 97,760 39,104 58,656 58,656 29,328 29,328 8,515
12 85,040 34,016 51,024 51,024 25,512 25,512 6,584
13 73,904 29,562 44,342 44,342 22,171 22,171 5,086
14 64,176 25,670 38,506 38,506 19,253 19,253 3,926
15 55,648 22,259 33,389 33,389 16,694 16,694 3,026
16 48,192 19,277 28,915 28,915 14,458 14,458 2,329
17 41,664 16,666 24,998 24,998 12,499 12,499 1,790
18 35,968 14,387 21,581 21,581 10,790 10,790 1,374
19 31,960 12,784 19,176 19,176 9,588 9,588 1,085
20
Total 492,000 738,000 349,516 174,758 563,241 161,706
T 3.13 Example ROR system cash flow model
Government Cash Flow

Royalty Basic Income Resource Rent Government Cash Flow ($M)
Bonuses
Year 10% Tax 40% Tax 50%
($M) Undiscounted 12.5% DCF
($M) ($M) ($M)
I D L Q T U
1 5,000 0 5,000 4,714
2 0 0 0
3 1,156 0 1,156 861
4 12,200 6,339 18,539 12,276
5 18,840 34,688 53,528 31,506
6 24,800 53,760 78,560 41,102
7 21,700 43,840 65,540 30,480
8 18,988 48,762 67,750 28,007
9 16,614 45,965 62,579 22,995
10 14,538 44,922 14,465 73,925 24,146
11 12,720 39,104 29,328 81,152 23,561
12 11,130 34,016 25,512 70,658 18,235
13 9,738 29,562 22,171 61,471 14,101
14 8,522 25,670 19,253 53,445 10,898
15 7,456 22,259 16,694 46,409 8,412
16 6,524 19,277 14,458 40,259 6,486
17 5,708 16,666 12,499 34,873 4,994
18 4,996 14,387 10,790 30,173 3,841
19 4,370 12,784 9,588 26,742 3,026
20
Total 5,000 200,000 492,000 174,758 871,758 289,642
A) Production Profile Thousands (M) barrels/year K) Taxable Income = (C – D – G – H – I – J)

B) Crude Price L) Income Tax 40% = (K * .40)
C) Gross Revenues Thousands of dollars ($M) M) Net Cash Receipts = (K – L)
D) Royalty 10% = (C * .10) N) Amount Brought Forward = (O uplifted)
E) Net Revenues = (C – D) O) Amount Carried Forward = (M + N)
F) Capital Costs P) Resource Rent Tax Base = (O if > 0)
G) Operating Costs (Expensed) Q) Resource Rent Tax 50% = [P * .50]
H) Depreciation of Capital Costs (5-year SLD) R) Company Cash Flow = (M – Q)
I) Signature Bonus T) Government Cash Flow = (I + D + L + Q)
J) Tax Los C/F = (See Column K)
T 3.14 Example ROR system Trigger point calculation
IRR of Net Cash Receipts at “Trigger Point”

Net Cash Amount Net Cash Receipts at Trigger Point
Receipts Brought
Year ($M) Forward Undiscounted 30% DCF
M N
1 (35,000) (35,000) (30,697)
2 (40,000) (45,500) (40,000) (26,986)
3 (92,752) (111,150) (92,752) (48,135)
4 27,261 (265,073) 27,261 10,883
5 42,032 (309,155) 42,032 12,907
6 140,640 (347,260) 140,640 33,222
7 125,760 (268,606) 125,760 22,851
8 99,142 (185,700) 99,142 13,857
9 82,947 (112,525) 82,947 8,918
10 67,382 (38,452) 38,452 3,180
11 0
12
Total 463,482 0
In year 10 only the Net Cash Receipts required to balance out the Amount Brought Forward of
$38,452 is used for this analysis. The discount rate that yields a present value of $0 (zero) is 30% -
- the same as the uplift rate. Thus at the point that the Amount Brought Forward goes from negative
to positive the company internal rate of return is equal to the uplift rate.
F 3.9 “R” Factors vs. ROR systems
There is a general relationship between internal Figure F 3.9 illustrates the key difference
rate of return (ROR) and payout status (“R” between payout and internal rate of
Factor) but it depends upon a number of things: return—timing. As far as efficiency is
timing , Government take, oil prices and costs. concerned the ROR systems are more
efficient because they can accomodate
ROR differences in timing. Payout formulas
(%) (“R” factors) do not respond to differences
Lower Gvt. Take
Higher Oil Prices
in timing. An “R” factor of 2 can represent
Faster an IRR of from 25% to 60%.
80% Payout/Timing
However, “R” factors rarely climb above

2. Fiscal terms are too tough (from an oil
60%
company point of view), costs are too high
and prices are too low.
40%
Slower
Payout/Timing
20%
Higher Gvt. Take

Lower Oil Prices
0
0 1 2 3 4 5
“R” Factor
T 3.15 International oil & gas investment
License Awards
1986 - 1990 Total Avg/Yr
Turkey 175 35
UK Offshore 160 32
Italy 125 25
France 120 24
Columbia 100 20
Pakistan 55 11
Egypt 52 10
New Zealand 52 10
Indonesia 45 9
Libya 10 2
Malaysia 10 2
Gabon 10 2
Moving Eastward? Walde & Noi ISBN 1 – 85333 – 963 – 6 ,Chapter 5 – Susan Hodson
Intl. Pet. Licensing, Expl. Activity & fiscal Terms
License Awards
1989 - 1998 Total 1998
UK Offshore 526 85
Australia 453 58
Italy 181 20
Colombia 167 24
Netherlands 133 7
Argentina 125 7
France 124 2
Indonesia 112 19
Pakistan 104 10
New Zealand 95 13
Egypt 90 10
Nigeria 87 8
China 85 3
Spain 71 1
Norway 67 0
Source: IHS Energy, PEPS Country Statistics Module, 2nd Quarter 1999.
F 3.10 Royalty netback or tariff calculations
Netbacks arise when there is a difference between the point of valuation for royalty
calculation purposes and the point of sale.
The transportation costs from the point of

valuation to the point of sale are deducted.
Transportation costs include:
Normal operating costs associated

with the transportation function.
DD&A (depreciation) for the
transportation equipment (pipeline).
Some provision for a fair return on
capital (Cost of capital). Point of Valuation
“At the wellhead”
But oil is rarely sold at the wellhead
Tariff Determination
D+O+C+T+A
Tariff =
V
D = Depreciation Point of Sale
O = Operating costs “Usually downstream from the wellhead”
C = Cost of capital
Interest expense
Cost of equity
T = Taxes
A = Volume adjustment from
prior period (if applicable)
V = Volume
Chapter 4 - Exploration
4. Exploration
World Giant Oil Discoveries
154
150
Number of Giant Discoveries
142
(per 5-Year Period)
123
112 108
100
90
83
73
47
50
29
24 21
11 15
2 5 3 7
5
1900 1920 1940 1960 1980 2000
Year
Source: Giant Oil and Gas Fields of the Decade: 1968 – 1978 AAPG Memoir
54-1990, M. T. Hallbouty
Exploration has been one of the more glamorous aspects of the industry—until recently. It is not
what it used to be. Discoveries are smaller and harder to access. Oil and gas wells are not as
prolific. The industry underwent extensive soul searching in the 1980s and 1990s, revised
expectations and then restructured in-part on the basis of two decades of lackluster exploration
success.
Exploration will always be one of the more exciting aspects of the industry even if discoveries
are smaller. The planet is much more mature than it was 30 years ago. This is particularly true of
the maturing geological basins.
Most of todays production now comes from reservoirs discovered prior to the first oil embargo in
1973. The most common estimates are around 87%. Furthermore, while the technology is
fabulous most of the worlds production is also from discoveries made on the basis of “surface
indicators” such as oil and gas “seeps”.
Companies are working harder and faster to make smaller discoveries work (from a financial
point of fiew).
F 4.1 World oil discoveries
Annual discovery 5 year periods

30
25
20
B BBL/Year
B BBL
15 Super-giant > 5 B BBL 570

Giant 500 MM - 5 B BBL 265
10 Large 50MM – 500MM BBL 200
Small < 50 MM BBL 70
5 PRE 1900 15
TOTAL 1120
0 to 12/31/77
1900 10 20 30 40 50 60 70 80
Source: Giant Oil and Gas Fields of the Decade: 1968 – 1978 AAPG Memoir 30-1980,
Halbouty
F 4.2 Western Canada field sizes

Western Canada Sedimentary Basins
3500
3000
Increasing Field Size
2500
2000 Up to 1979
1500
1979 - 1988
1000
500
0
0.1 1 10 100 1000
Max. Field Size/MM BBLS
Source: Economics of Worldwide Petroleum

Production, 1993 F. Allen, R. Seba, OGCI
Publications Tulsa
F 4.3 Major US gas field discoveries 1880 - 1990
25 101 Largest Gas Fields

21
20 19 19
15
15
12
10 9
5 4
1 0 0 1 0
0
1880s 1890s 1900s 1910s 1920s 1930s 1940s 1950s 1960s 1970s 1980s 1990s
Source: Bulington Resources
F 4.4 Gas & Oil discovery profiles
Natural Gas Discoveries

300
Rate
Middle East
250
S. Europe, FSU, Asia, Oceania
200 W. Hemisphere, Africa, W. Europe Annual
Production
150
100
50
0
1910 1930 1950 1970 1990
50
Crude Oil Discoveries
Middle East Rate
S. Europe, FSU, Asia, Oceania
40
W. Hemisphere, Africa, W. Europe Annual
Production
30
20
10
0
1910 1930 1950 1970 1990
Source: American Oil & Gas Reporter April, 1995 pg. 45
F 4.5 Global large field discoveries
Discoveries
(>50 MMBOE)
Excludes US and Canada
Per Year
With global consumption in the 1990s
900 at around 38 billion barrels of oil
equivalent/year, reserve replacement
800 becomes more challenging.
700 >1000
MMBOE
600
500 - 1000
500
400 200 - 500
300 100 - 200
200
100 50 - 100
0
1960s 1970s 1980s 1990s
Number of Maximum Number of Maximum Number of Maximum Number of Maximum
discoveries billions BOE discoveries billions BOE discoveries billions BOE discoveries billions BOE
MMBOE
50 – 100 129 258 116 232 45 90 20 40
100 – 200 90 90 95 95 66 66 52 52
200 – 500 179 90 208 104 170 85 154 77
500 – 1000 105 21 162 32 113 23 90 18
>1,000 235 24 261 26 300 30 314 31
738 482 842 490 694 294 630 218
Discoveries/Yr 74 84 69 63
Billions BOE/Year
Maximum 48 49 29 22
Average 32 33 20 15
Minimum 23 23 14 10
World Demand Billion BOE 38

Projected from 1990 – 1995 dat
Adapted from: AAPG Explorer, March 1999 “Analysis is a Risky Proposition”, Peter Rose;
Based on Petroconsultants data 5/96
T 4.1 Indonesian Production Profiles
Cumulative Estimated Peak P/R Peak

Production Ultimate Production Ratio Year
To 1/1/92 Recovery Rate Lambda After
Field (MMBBLS) (MMBBLS) (BOPD) % Startup
Lalang 43.3 47.4 34,800 26.8% 2
Mengkapan 25.6 28.4 22,300 28.7 1
Kitty 12.2 14.2 5,050 13.0 4
Gita 8.1 9.6 6,500 24.7 1
Nora 9.3 10.3 3,500 12.4 3
Selatan 21.8 25.0 25,600 37.4 2
Krisna 69.4 72.0 48,300 24.5 1
Yvonne 16.2 20.0 9,900 18.1 5
Sundari 13.8 17.4 10,300 21.6 1
Karmila 38.4 55.0 22,700 15.1 1
Farida 16.2 24.0 7,500 11.4 1
Widuri 81.5 175.0 119,200 24.9 1
Intan 37.1 51.0 68,200 48.8 1
Intan N.E. 5.2 7.0 9,400 49.0 1
Total 398.1 556.3 393,250
Weighted Average 25.8%

Without Intan & Intan N.E. 23.1%
Simple Average 25.4%
Without Intan & Intan N.E. 21.5%
T 4.2 West Africa

New Oil Production expected Off West Africa “This year”
Oil 7 Gas Journal, Mar. 4, 1996 pg 82
Wood Mackenzie Consultants
Peak Estimated
Production Reserves P/R
Field License Operator BOPD (MMBBLS) Ratio
Angola
Numbi NE Cabinda A Chevron 11,000 20 20.1%
Numbi South Cabinda B Chevron 55,000 205 9.8%
Lombo North 2/85 Texaco 4,000 6 24.3%
Cavala 2/85 Texaco 2,700 4 24.6%
Calafate 2/85 Texaco 4,000 6 24.3%
Bagre 2/85 Texaco 12,000 35 12.5%
Estrela 2/85 Texaco 12,000 30 14.6%
Oombo 3/89 ELF 19,000 48 14.4%
Kiame 4 Ranger 12,000 15 29.2%
Camaroon
South Asoma PH 59 Pecten 2,300 1 84.0%
Lipenja Lipenja-Erong Pecten 4,500 8 20.5%
Congo
Nkossa Nkossa ELF 110,000 440 9.1%
EQ. Guinea
Zafiro Block B Mobil 40,000 105 + 13.9%
193 m water
Gabon
Ekouata Ekouata Marin Vaalco 3,900 7 20.3%
Zaire
Lubi Offshore Chevron 800 1 29.2% FPSO
Total 293,200 931 11.5%
T 4.3 UK – Offshore
First Peak Ult.
Discovery Year Output Recoverable P/R
Date Peak Delta MMBBLS BOPD MMBBLS %
____________ ______ ______ ____ ______ ______ ______ ________
Argyll 1971 1977 6 8.5 23 50 17.0
Auk 1971 1977 6 17.5 48 60 29.2
Beatrice 1976 1984 8 18 49 160 11.3
Beryl A 1972 1980 8 37.5 103 500 7.5
Brent 1971 1984 13 155 425 1,700 9.1
Buchan 1974 1982 8 18 49 50 36.0
Claymore 1974 1982 8 35 96 400 8.8
S. Cormorant 1972 1984 12 15 41 190 7.9
Dunlin 1973 1979 6 43 118 300 14.3
Forties 1970 1980 10 184 504 2,000 9.2
Heather 1973 1982 9 12 33 70 17.1
Montrose 1969 1979 10 10.5 29 90 11.7
Murcheson UK 1975 1982 7 32 88 270 11.9
Ninian 1974 1982 8 114 312 1,070 10.7
Piper 1973 1979 6 94 258 700 13.4
Statfjord (UK0 1974 1988 14 203 555 580 34.9
Tartan 1974 1982 8 32.5 89 200 16.3
Thistle 1973 1981 8 51 140 450 11.3
____________ ______ ______ ____ ______ ______ ______ ________
Totals 1,080 2,959 8,840 12.2%

Average 8.6 60 164.4 491.1 12.2%
Simple Average 15.4%
Ekofisk Group 1968 1971 3 171 467 1,447 11.8%

Ekofisk 1969 1971 2
W. Ekofisk 1970 1977 7
Cod 1968 1977 9
Tor 1970 1978 8
Albuskjell 1972 1979 7
Eldfisk 1972 1979 7
Edda 1972 1979 7
Statfjord 1974 1979 5
From; “Oilfields of the World” Third Edition; E.N. Tiratsoo, 1986, Gulf Publishing
F 4.6 Production rates
North Sea P/R Ratio

12 – 15%
Production
2 – 4 Years 2 Years 1 – 2 Years

Discovery Startup Peak Decline Rate 10 – 12%
Plateau
Gulf of Mexico P/R Ratio

14 – 16%
Production
1 – 2 Years 1 Year 1 Year

Discovery Startup Peak Decline Rate
10 + %
Plateau
P/R Ratio
Indonesia 20 – 25%
Production
1 – 3 Years 1 Year 1 Year

Discovery Startup Peak Decline Rate
20 - 25 %
Plateau
T 4.4 Range of oil well production rates
Oil well production rates BOPD
Lower Upper
Quartile Average Quartile
Australia 30 550 2,500

Brunei 60 220 1,300
Indonesia 20 200 2,000
Malaysia 600 1,200 1,400
Philippines 150 450 1,000
Thailand 25 150 400
Pakistan 100 500 1,000
U.S. Gulf of 50 200 1,000

Mexico
Onshore U.S. 2 12 50
T 4.5 Type Well Productivity Statistics – Gulf of Mexico
Late 1980s and early 1990s

(Range includes 80% of wells)
Oil Well Gas Well

Production rate
For first year 350 BOPD 5 MMCFD
(Range) (100 – 750) (1 – 8)
(Maximum) (2000– 4000 ) (10 – 30)
Ultimate production 850 MBBLS 8 BCF

(Range) (500 - 1200) (2 - 17)
Current average
Production rates 190 BOPD 3.5 MMCFD
Natural Gas Liquids associated with gas production are around 15 Barrels per million
cubic feet of gas
The average, outlined in the table above, does not include marginal wells. Production
statistics rarely include the production rates of marginal wells, because they seldom
produce for very long. An economic model should account for marginal or submarginal
wells.
F 4.7 1996 Offshore atlas of world oil and gas theatres
Lead time from discovery to production startup has dropped dramatically

worldwide. In the Gulf of Mexico the average dropped from over 4 years to less
than one year for conventional (non-deepwater) developments.
Gulf of Mexico Average Oil well Production

Rates from 1988 – 1993
Avg. Daily Production (365 day years) Discovery to
Startup
Year BOPD MCFD “From 4-5 years in 1975 to
1 356 4,149 less than 6 months in 1993”
2 331 4,331 4
3 270 3,330
4 194 2,588 3
5 166 2,060
6 97 2,141 2
Decline 20% 9% 1
Rate
0
Ave. Days 1975 80 85 90 93
Onstream 248 228
From: James K. Dodson & Leonard LeBlanc

Industry in 1992 (Gulf of Mexico)
Leonard LeBlanc Pg 47 ‘1996 Offshore Atlas of World Oil and Gas Theatres’
Of the 74 Deepwater discoveries up to 1992, 30 were surrendered and 2 produced for

only 2 years.
Operators finding 3.5 oil fields per year (35 gas fields per year).
Oil exploration on the continental shelf virtually nonexistent.
Nearly 75% of undiscovered oil in water greater than 600 feet.
From: George, D., (Editor), Offshore Magazine – PennWell Publishing, Houston
F 4.8 Gas reserve additions

Reserve Additions Replace 118% of 1999 U.S. Dry Natural
Gas Production
118
120%
108 107 107
Percentage of U.S. Gas Production Replaced
104
100%
87 88
85 83
80%
60%
40%
20%
0%
1991 1993 1995 1997 1999
Source: Energy Information Administration,

Office of Oil and Gas
F 4.9 Crude oil reserve additions

Reserve Additions Replace 118% of 1999 U.S. Crude Oil;
Production
140% 137
125
Percentage of U.S. Crude Oil Production Replaced
120%
100% 95
85
78
80%
66
62
60%
37
40%
24
20%
0%
1991 1993 1995 1997 1999
Source: Energy Information Administration,

Office of Oil and Gas
F 4.10 Crude oil reserves-to-production ratios
30 Crude Oil, 1945 - 1999
25
20
R/P Ratio
15
United States
10
5
48 Lower States
0
45 50 55 60 65 70 75 80 85 90 95
Source: Energy Information

Administration, 1999 Annual
Report
F 4.11 Wet natural gas reserves-to-production ratios
35 Wet Natural Gas, 1945 - 1999
30
25
20
R/P Ratio
United States
15
10
5
48 Lower States
0
45 50 55 60 65 70 75 80 85 90 95
Source: Energy Information

Administration, 1999 Annual
Report
F 4.12 U.S. total gas discoveries

U.S. Total Discoveries of Dry
Natural Gas per Exploratory
30
Gas well Completion, 1977 -
1999
Billion Cubic Feet per Well
25
20
15
10
0
77 79 81 83 85 87 89 91 93 95 97 99
Energy Information Administration, U.S.

Crude Oil, Natural Gas, and Natural Gas
Liquids Reserves 1999 Annual Report
F 4.13 U.S. total crude oil discoveries
5
U.S. Total Discoveries of Crude
Oil per Exploratory well
Completion, 1977 - 1999
Million Barrels per Well
0
77 79 81 83 85 87 89 91 93 95 97 99
Energy Information Administration, U.S.

Crude Oil, Natural Gas, and Natural Gas
Liquids Reserves 1999 Annual Report
Chapter 5 - Drilling and Production
5. Drilling and Production
As dramatically capital intensive and high-tech as the petroleum industry is, there is a lot of
effort involved in simply drilling a miserable hole in the ground. And, too often, at the end of the
day all we have to show for our efforts is—a hole in the ground—an expensive hole in the
ground. Few people appreciate the space-age technology involved and the results provide most
of the fuel for a global society 6 billion strong.
T 5.1 Drilling cost equation
The basic equation for drilling cost analysis is:
$/Bit + Rig $/Hr (Tt + Td)

$/Ft =
Footage
Where:
$/Bit = Bit cost
Rig $/Hr = Rig cost in dollars per hour
Tt = Trip time (hrs)
Td = Drilling time
Footage = Amount drilled with bit
Example bit comparison

12 ¼ in. 12 ¼ in.
steel tooth bits insert bits
Rig day rate $36,000 $36,000

Average drilling depth (ft) 6,000 6,000
Bit cost $2,500 $8,300
Bit life (ft) 400 900
Rate of penetration (ft/hr) 25 28
Trip time (ft/hr) 1,000 1,000
Cost per foot 113 85
Savings $24,000
Example from Offshore Magazine Dec. 1991, pgs 44-46, “Economics of Improved Drilling Performance in
Alaska’s Cook Inlet” Daniel Johnston et. al..
T 5.2 Drilling costs late 1990s

Water Reservoir Drilling
Region Depth Depth Costs
(feet) (feet) (MM$)
Gulf of Mexico 30 - 300 2.5 – 3.5

Gulf of Mexico 300 - 800 3.0 – 5.0
China (Bohai) Shallow 6 – 13
Angola Moderate 6.0 – 8.0
W. Indonesia 30 - 300 2.5 – 3.5

E. Indonesia 30 - 300 6.5 – 8.0
E. Kalimantan 30 - 300 < 1.0 (development Unocal)
Falkland Islands Offshore 25 – 30
New Zealand 30 - 300 8.0 – 10.0
W. Africa 30 - 300 7.0 – 10.0
Vietnam 30 - 300 11.0 – 25.0 (Mobil 1995)

Vietnam 30 - 300 12,000 9.0 – 14.0
UK 30 - 300 5.0 (1992 – 1993)

North Sea 30 - 300 8,500
5.0 – 7.0 (development)
S. Australia 30 - 300 3.5 – 4.5 (development)
7,000
Deep Water
Nigeria (Agbami) Deep 50 – 90 (1999)

Philippines 2000 + 30 - 50
Gulf of Mexico 800 – 1,200 5.0 – 7.0
Gulf of Mexico 4,000 20 +

Gulf of Mexico
Onshore 4,000 6.5 (development)
Algeria - 10,000 4 – 10
Egypt w. Desert - 1.5 – 2.5 (development)
Venezuela - 17,000 – 18,000 12.5 DHC
17.0 with testing
F 5.1 Technological frontiers
Semisubmersible In the mid 1980s the deepwater frontiers were

Land Rig Jackup Platform Rig “Semi” Drillship just slightly beyond the continental shelf.
There was only one TLP in the world at that
time and that (Hutton) was only in 486 feet of
water in the North Sea. It would be another 5
years before another TLP would be
installed—Joliett, 1989 in the Gulf of Mexico
in 1,760 feet of water. By 2002 there were 15
300 ft
TLPs worldwide with 4 scheduled for
Technological Frontiers installation in 2003. Typical water depths for
Of the early 1990s
1,000 ft these is 3,000 feet, the deepest is Shell’s Ursa
Subsea Technology TLP in the GOM in 4,018 feet of water.
Wellheads
Manifolds Conoco’s Magnolia TLP slated for 2003 will
Separators be tethered in 4,700 feet of water in the GOM.
Riser Technology
7,000 ft +
In the mid 1980s there was only one platform
Station keeping & Mooring Technology
Dynamic positioning in over 1,000 feet of water—Shell’s Cognac
platform in 1,025 feet of water in the Gulf of
FPSO Floating Production Storage and Offloading
FSO Floating Storage and Offloading Mexico. It came on stream in 1982. There are
(Semi and Shipshape) now 7.
Single point mooring systems (SPM – SBM)
Swivel technology In the mid 1980s there was only one guyed-
tower, Exxon’s Lena also in the GOM in
slightly less than 1,000 feet of water (around 900 feet). At that time there was considerable
discussion about the waning interest in this development concept. However, two variations on
this theme—compliant towers have been installed in the GOM in 1998: the HESS Baldpate
tower in 1,648 feet of water and the Chevron/Texaco Petronius tower in 1,754 feet of water.
While there were virtually no tanker-based or semisubmersible-based floating production

facilities in the mid 1980s, these have proliferated and are for most circumstances the
development-system-of-choice in most deep-water environments.
T 5.3 Drilling rigs
# of New-Field Drilling Sub Totals

Wildcats (NFW) Rigs Includes
1990-94 Per Year 1994 Others
S. E. Asia Indonesia 386 77 41
Malaysia 150 30 10
Australia 460 92 12
Vietnam 49 10 8
Philippines 22 4 10
Pakistan 85 17 10
PNG 32 6 2
Myanmar 25 5 11
India 293 59 85 163
L. America Columbia 154 31 15
Venezuela 12 2 69
Ecuador 28 6 6
Argentina 305 61 71
Trinidad 13 3 5
Bolivia 36 7 10
Mexico 28 233
Algeria Algeria 83 17 28
Libya 76 15 13
Egypt 136 27 14
Tunisia 41 8 3
Morocco 6 1 58
W. Africa Nigeria 105 21 7
Angola 67 13 5
Congo 41 8 2
Cameroon 3 1
Gabon 75 15 2 64
Europe UK 472 94 23
Norway 118 24 14
Netherlands 131 26 5
Other Europe 65 107
Middle East Abu Dhabi 15
Iran 21
Other 66 102
N. America United States 775
Canada 262 1037
Other 65 65
1,771
F 5.2 SPARs
SPARs Owner Year Water MBOE/D Location
depth (ft)
Devel’s Tower Truss SPAR Dominion 2003 5,610 79 GOM
Horn Mountain Truss SPAR BP 2003 5,400 74 GOM
Noover Diana DDCV ExxonMobil 2000 4,800 156 GOM
Mad Dog Truss SPAR BP 2005 4,500 87 GOM
Holstein Truss SPAR BP 2003 4,300 120 GOM
Boomvang Truss SPAR KM 2002 3,700 75 GOM
Nansen Truss SPAR KM 2001 3,675 75 GOM
Front Runner Truss SPAR Murphy 2003 3,330 79 GOM
Gunnison Truss SPAR KM 2003 3,100 75 GOM
Genesis Classic SPAR ChevronTexaco 1998 2,599 67 GOM
Medusa Truss SPAR Murphy 2002 2,223 59 GOM
Neptune Classic SPAR KM 1996 1,930 47 GOM
Spars, Deep Draft Floaters (DDFs), Caisson Production Units (CPUs), Deep Draft
Caisson Vessels (DDCVs), Single Column Floaters (SCFs)
Kizomba: worlds tallest pile-supported, fixed

steel platform
Location: Angola block 15
Total height 412 m 1,353 ft
Total weight 77,000 tons
Well Slots 60
Ultimate recovery (initial estimate)

1,353 ft 115 MMB Oil
195 BCF Gas
135 MMBOE
MBOE/D
Cost $500MM
$/BBL $3.70/BOE (platform only)
F 5.3 FPSOs
FPSOs Owner Year WaterMBOE/D Locatrion

Depth (ft)
Seillean BR 1998 6,080 Brazil
Grey Warrior Prosafe 2003 4,593 Nigeria
Brasil SBM 2001 4,462 Brazil
Girassol Total Fina Elf 2001 4,429 248 Angola
Kizomba Esso 2004 4,265 Angola
FPSO II BR 1997 4,134 Brazil
P-48 BR 2003 3,396 Brazil
P-37 BR 1999 2,969 Brazil
P-35 BR 1999 2,789 Brazil
Firenze AgipPetroli 1997 2,789 Italy
P-34 BR 1997 2,736 Brazil
P-43 BR 2003 2,625 Brazil
Espadarte BR 2000 2,625 Brazil
P-33 BR 1998 2,559 Brazil
Sahara Enterprise Oil 2002 2,526 Brazil
FPSO
F 5.4 Fixed platforms
Fixed platforms Owner Year Water MBOE/D location

depth (ft)
Bullwinkle Shell 1991 1,353 258 GOM
Pompano BP 1994 1,290 60 GOM
Harmony ExxonMobil 1992 1,200 88 S. CA
Virgo Total Fina Elf 1999 1,130 49 GOM
Heritage ExxonMobil 1992 1,070 88 S. CA
Amberjack BP 1991 1,030 27 GOM
Congac Shell 1978 1,025 89 GOM
Bullwinkle: worlds tallest pile-supported, fixed

steel platform
Location:
Total height: 412 m 1,353 ft
Total weight: 77,000 tons
Well Slots: 60
Ultimate recovery (initial estimate)

1,353 ft
115 MMB Oil
195 BCF Gas
135 MMBOE
MBOE/D: 258
Cost: $500MM
$/BBL: $3.70/BOE (platform only)
F 5.5 Compliant towers

Compliant towers Owner Year
Feet MBOE/D Location
depth (ft)
Petronius ChevronTexaco 1998 1,754 77 GOM
Baldpate HESS 1998 1,648 94 GOM
Lena Guyed Tower ExxonMobil 1983 1,000 77 GOM
Compliant Towers (CT), Compliant Piled Towers (CPTs), Guyed Towers
Petronius: largest freestanding structure in the

world
Location: Viosca Knoll Block 786, GOM
Platform height: 1,870 ft
Water depth: 1,754 ft 535 m
Wells 10
1,754 ft 7 water injection wells
Production design capacity 60,000 BOPD
100 MMCFD
Export: 14 inch, 20 mile oil pipeline
12 inch, 12 mile gas pipeline
MBOE/D 77
Cost $500MM
$/BBL
F 5.6 Semi-FPSs
Semi-FPSs Owner Year Water MBOE/D Location
depth (ft)
Atlantis BP 2005 7,000 171 GOM
Nakika Shell 2003 6,300 156 GOM
Thunder Horse BP 2004 6,050 284 GOM
P-36 BR 1998 4,462 209 Brazil
P-40 BR 2001 3,353 Brazil
P-26 BR 1997 3,248 116 Brazil
P-18 BR 1994 2,986 Brazil
P-19 BR 1997 2,526 Brazil
P-13 BR 1993 2,300 Brazil
P-20 BR 1992 2,083 Brazil
P-25 BR 1996 1,903 Brazil
P-27 BR 1998 1,739 Brazil
P-8 BR 1993 1,378 Brazil
Snore B Hydro 2001 1,148 Norway
Troll C Hydro 1999 1,116 245 Norway
Semi Floating Production Systems (Semi-FPSs)
Troll C: Semi-FPS
Location: Troll West Gas Province
Platform height:

Reservoir depth:
Total displacement: 52,750t
Wells: 7 well groups

1,116 ft
Production 250,000 BOPB
6 MM cubic meters per day
Export: Pipeline
Production: 30,000 m3/d oil
40,000 m3/d water
60,000 m3/d liquid
9MM m3/d gas
Cost
$/BBL
F 5.7 Tension leg platforms

Tension leg platforms Owner Year Water MBOE/D Location
depth (ft)
Magnolia Conoco 2003 4,700 GOM
Marco Polo elpaso 2003 4,300 143 GOM
Ursa Shell 1999 4,018 169 GOM
Kizomba A Esso 2003 3,863 250 W. Africa
W. Seno 1 Unocal 2003 3,349 86 GOM
Allegheny Eni 1999 3,280 56 GOM
Marlin BP 1999 3,240 83 GOM
Ram/Powell Shell 1997 3,214 124 GOM
Matterhorn Total Fina Elf 2003 3,100 42 GOM
Brutus Shell 2001 2,985 126 GOM
Mars Shell 1996 2,940 258 GOM
Auger Shell 1994 2,860 GOM
Typhoon ChevronTexaco 2001 2,200 50 GOM
Jolliet Conoco 1989 1,760 44 GOM
Morpeth Eni 1998 1,700 46 GOM
Prince elpaso 2001 1,500 64 GOM
Heidrun Statoil 1995 1,150 251 Norway
Snorre A Hydro 1992 1,100 251 Norway
Hutton KM 1984 486 122 UK N. Sea
Tension Leg Platforms (TLPs)
Heidrun: Floating tension leg platform with a

concrete hull.
Location: Pl 095 6507/7, Pl 124 6507/8
Platform height: 1,870 ft

Reservoir depth: 2200 to 2600 m
Wells 30 producers
10 water injectors
1,150 ft 2 gas injectors
Production 250,000 BOPB
6 MM cubic meters per day
Export: primary, shuttle tanker
MBOE/D
Cost US$4.5 billion includes well costs

$/BBL
F 5.8 Concrete structures

Concrete structures Owner Year Water MBOE/D Location
depth (ft)
Beryl A - 1975 387
Brent B - 1975 459
Brent D - 1976 459
Frigg TCP2 - 1977 341
Statfjord A - 1977 476
Statfjord B - 1981 476
Statfjord C - 1984 476
Gulfaks A - 1986 443
Gulfaks B - 1987 463
Oseberg - 1988 357
Gulfaks C - 1989 709
Snore TLP Foundations - 1991 1017
Sleipner - 1993 269
Draugen - 1993 827
Troll GBS - 1995 1001
Heidrun TLP Foundations - 1994 1148
Heidrun TLP - 1995 1148
Troll GBS:
Location:
Platform height:
Total weight: tons

Wells:
Production design capacity:
Export:
MBOE/D:
1,001 ft
Cost
$/BBL
T 5.4 Dayrates
Score: Survey of Current Offshore Rig Economics – Monthly index that compares current
day rates to the day rate required to justify ‘new build’. Approximately $700 dayrate for every
$1 MM construction cost to justify new build.
Global Marine “SCORE” hits highest mark since 1980s” O&GI March, 1997 (pg 20)
Tidewater
Date SCORE Avg. UK GOM Marine Vessels
1992 34.7% for 3rd Gen. 300 ft Dayrates
Dec., 1995 47.0% Year Semi Jackup US ‘Intl.
Dec., 1996 60.5%
Gulf of Mexico 53.8% 1993 $32 K $24 K
North Sea 67.4% 1994 $31 K $26 K
1995 $60 K $29 K
W. Africa 62.5% $3,000 $3,600
1996 $92 K $47 K
SE Asia 57.7% $165 K $76 K $4,000 $3,750
1997
Worldwide 60.5% 1998 $120 K $44 K $6,300 $4,200
1999 $75 K $32 K
From: Global Energy Outlook From: W. O’Malley May,
April, 1997 1997 OTC Press
Conference
% SCORE
100
80
60
40
20
0
81 83 85 87 89 91 93 95 97 99 01
Year
Source: Global Marine and Banc of America
F 5.9 Well definitions
Initial Classification Final Classification after

when drilling is completion or abandonment
started
Successful Unsuccessful
Drilling for a new field on a 1. New-field wildcat New-field discovery Dry new-field wildcat
structure or in an environment wildcat
never before productive
New pool Drilling outside 2. New-pool (pay) New-pool discovery

Dry new-pool
tests limits of a proved wildcat wildcat (sometimes
wildcat
area of pool extension wells)
Drilling for a
new pool on a For a new pool 3. Deeper-pool (pay) Deeper pool Dry deeper
structure or in below deepest test Dry new
discovery pool test
a geological proven pool pool tests
environment
already For a new pool Shallower
4. Shallower pool Dry
productive above deepest pool
(pay) test shallower
proven pool discovery
pool test
well
Extension well
Drilling for long extension of 5. Output or (sometimes a new-pool
Dry outpost or dry
a partly developed pool extension test extension test
discovery well)
Drilling to exploit or develop a
hydrocarbon accumulation 6. Development well Development well Dry development well
discovered by previous drilling
Deeper pool Shallower pool
New-field (pay) test (pay) test
wildcat New-pool Outpost or
Development
(pay) wildcat well extension test
? ?
? ? Structure
?
?
? ?
? ?
Known productive
limits of proven pool
Source: Classification of Wells, AAPG Bulletin, June 1970, p. 892.
F 5.10 Mud costs per well
Elf Exploration U.K. plc

let a $48 million contract to Dresser Industries Inc.,
Aberdeen, to provide drilling and completion fluids during
developoment of Elgin and Franklin fields in the U.K. North
Sea. Development drilling is expected to take more than 4
years, including drilling and completion of at least 10 wells.
Downhole pressures and temperatures are expected to exceed
16,000 psi and 400 degrees F, respectively, at depths of more
than 18,000 ft.
O&GJ: Feb. 13, 1997 (pg 28)
Mud costs per well
$48 MM
= $4.8 MM / well for MUD
10 wells
Pressure gradient
16,000 psi
= 0.88 psi/ft (about 2 times normal)
18,000 ft
Balance point mud weight 0.88/0.52 = 17 lbs/gallon
F 5.11 Mud
Annulus Drill String
“Bottoms up” The time required for cuttings at the

drillbit to circulate up to the shale shakers
Drilling Fluid Pressure = d * #/gal * 0.052
Where: d = Depth (feet)

#/gal = Mud weight in pounds per gallon
0.052 = Conversion factor
Example: Well depth is 8,000 ft and mud

weight is 9 lbs per gallon.
= 8,000 * 9 * 0.052
= 3,744 psi
Note:
Hydrostatic pressure = d * 0.433 (for fresh water)
d = Depth (feet)
Hydrostatic (pressure)
gradients
.433 psi/ft = Fresh water
.465 psi/ft = Gulf Coast formation water
.47 psi/ft = Saline water
.53 psi/ft = Saturated salt water
Geostatic gradient
1.0 psi/ft Also “Lithostatic gradient”
Balance Point Mud Weight = Hydrostatic gradient/0.052

Pressure gradient = 0.433 psi/ft
Example: Balance point = 0.433/.052 = 8.32 lbs/gal
An old “rule-of-thumb”: For exploration drilling, mud weight should be 300# overbalance.
For development drilling – 200# overbalance.
F 5.12 Drilling and production
Saga Petroleum AS
Started oil production Jan. 29 from Vigdis field on
Norwegian North Sea Block 34/7. Field was developed with
12 wells linked to three subsea templates and tied back to
Snorre platform 7 km northeast. Vigdis, developed for $690
MM, is expected to produce an average 100,000 BOPD of
oil. Oil is sent to Snorre for processing, then to Gullfaks A
platform by pipeline for storage and shuttle tanker export.
With 180 million BBLS estimated oil reserves, Vigdis is
expected to produce 15 years.
O&GJ: Feb. 3, 1997 (pg 32)
Reading between the lines . . .
Production to reserve ratio ?

100,000 BOPD * 365 day 3.65 MM BBLS
= = 20% P/R
180 MM BBLS 180 MM BBLS
Development costs ?
$690 MM
= $3.83 / BBLS
180 MM BBLs
Development cost $/daily barrel ?
$690 MM
= $6,900 / BOPD
100,000 BOPD
Reserves per well ?

180 MM BBLS
= 15 MMBBLS / well
12 wells
Production rate ?
100,000 BOPD
= 8,333 BOPD / well
12 wells
F 5.13 Horizontal
Prudhoe Bay 1986 1990 AVG.

Conventional Well Cost $MM $2.5 $2.2 $2.2
Horizontal $5.0 $2.8 - 4 $3.2 + 45%
Norman Wells + 50%
“Rough rules-of-thumb”
Length – Don’t go < 500 m or > 1,000 m
(Don’t need to go > 1,000 m because this will give all production
benefits possible.)
Production Characteristics 2X
Spacing 6X
(Everything you can do in a vertical hole you can do in horizontal)
Pilot Hole – especially with no 3 – D
Coring – None from 1988 – 1991 but now easy
Underbalanced Most – about 500 psi under
Drilling Costs 1.5 – 2 times cost of conventional verticle hole
The thinner the pay zone the greater the benefits as far as production rates per well
with horizontal drilling.
Productivity Increase
Net Pay (ft)
vs. Verticle Well
25’
8
7 100’
6
5
4 200’
3 25’
2 400’
1
400’
0
0 600 feet 1,200 feet
Horizontal Length
Various sources including: Dr. Nick Mungan, 1995 course materials
F 5.14 Vertical vs. horizontal drilling wells
Most fractures that drain reservoirs tend to be perpendicular to bedding and vertical.
Horizontal drain wells stand a greater chance of penetrating more of those vertical
fractures.
Vertical Horizontal
Relative Spacing Difference
Vertical
Well
1,500 ft radius = 162 Acres
Square (3,000 x 3,000) = 206 Acres
Horizontal
Well
3,000 ft lateral = 366 acres
Rectangle (3,000 x 6,000) = 413 Acres
F 5.15 Decline curve
100
Decline curve analysis exercise Seletan Oil Field
Southeast Sumatra
1. What was the decline rate in the early years? Annual
2. What was the decline rate for settled production? Production
3. How much oil is left? Year
(MMBBLS)
4. What is the production/reserve ratio for this field?
1978 0.361
1979 9.905
10 1980 3.688
1981 2.097
MMBBLS/Year
1982 1.309
Flush production 1983 1.203
1984 0.894
1985 0.608
1986 0.626
1987 0.519
Settled production Total 20.400
1
78 79 80 81 82 83 84 85 86 87 88 89 90 91 92
Year
100
10
MMBBLS/Year
Year
Chapter 6 - Cost Data
6. Cost Data
2.50 Tanker Freight Rates

Arabian Gulf to US Gulf of Mexico
2.00
1.50
($/BBL)
1.00
0.50
0.00
2/92 8/92 2/93 8/93 2/94 8/94 2/95 8/95 2/96 8/96 2/97 8/97 2/98 8/98 2/99 8/99 2/00 8/00
One of the important aspects of economic modeling for petroleum exploration is the challenge of
estimating costs. Cost data and related information collected over a number of years is organized
and summarized in this chapter.
In addition to this is the important issue of “timing”.
Cost and timing data collected and summarized here provides perspective on a variety of the
building blocks of petroleum exploration, development and production.
There are four main categories of costs associated with the upstream end of the industry:
1) Exploration
2) Development
3) Production
4) Abandonment
There are two main categories of costs associated with exploration:

1) Exploration and appraisal drilling
2) Seismic data acquisition, processing and interpretation
There are three main categories of costs associated with development:

1) Development drilling
Drilling can often represent from 1/3rd to one half of total development costs
2) Production and processing facilities
3) The transportation function
Production costs are often divided into:

1) Fixed costs
2) Variable costs (or “per barrel” costs)
T 6.1 Gulf of Mexico Deepwater 1997

Selected from 76 reported discoveries
Water Peak P/R

Depth Peak Prod Est. P90 (%) Capital Cost
Block (s) (ft) Prod. (MMCFD) Res. Cost ($/BOE)
Operator (MBOPD) (MMBOE) ($MM)
Augur GB 426 Shell 2,860 75 155 220 16.7% 1,100 $5.00

Baldpate GB 260 Hess 1,650 60 200 150 22.7 400 2.67
100 – 200
Diamond MC 401 Oryx 2,080 Cond. 75 13 35.1 50 3.85
Genesis GC 205 Chevron 2,560 55 72 160 15.3 750 4.69
16 wells
Mars MC 807 Shell 2,940 100 110 300 14.4 1,200 4.00
24 slots + 1 ss
Neptune VK 826 Oryx 1,930 25 30 75 14.6 300 4.00
16 slots + 6 ss
Petronius VK 786 Texaco 1,754 60 100 100 28.0 400 4.00
21 slots
Pompano VK 989 BP 1,290 – 1,890 50 60 150 14.6 800 5.33
40 slots
Popeye GC 116 Shell 2,000 Cond. 120 63 11.6 110 1.75 +
6 sub sea
Ram PwII VK 116 Shell 2,000 60 200 250 13.6 1,000 4.00
Ursa MC 854 Shell 3,950 150 400 400 19.8 1,500 3.75
14 sub sea
Totals 635 1,522 1,881 17.2% $7,610 $4.05

Averages 2,372 58 138 157 18.8 $692 $3.91
889 MBOE/day $8,563/BOE/day
From: Mike Flanigan – April, 1997
T 6.2 Southeast Asia Fields under Development – Aug., 1996

Reserves Capital Costs
BOE Start $/BOE
Field Operator Type Oil Gas (MMBBLS) Date $MM 6:1 10:1
Development MMBBLS BCF 6:1 10:1
China
Boxi Area Bohai P/F 55 55 55 97 300 5.45 5.45
Dongfang 1-1 Nanhai w. P 3,000 500 300 99 700 1.40 2.33
Jinzhou 9-3 Bohai P 28 10 30 29 97 100 3.37 3.45
Ping Hu Shanghai P P 30 1,200 230 150 99 550 2.39 3.67
Indonesia
Mudi Santa Fe O 50 50 50 97 135 2.70 2.70
N Sumatra A Asamera O 570 95 57 99 255 2.68 4.47
Poleng Kodeco P 5 60 15 11 96 35 2.33 3.18
S. Lho Sudon A Mobil O 360 60 36 98 110 1.83 3.06
S. Lho Sudon D Mobil O 430 72 43 98 100 1.40 2.33
Wanut Lapindo O 69 12 7 98 30 2.61 4.35
Malaysia
Bunga Kekwa IPC P/F 90 1,100 273 200 97 550 2.01 2.75
Kinabalu Sabeth Shell P 180 2,000 513 380 98 350 0.68 0.92
Lawit EPMI P 25 1,700 308 195 97 650 2.11 3.33
Resak Petronas C P 15 1,500 265 165 99 650 2.45 3.94
Yong/Raya EPMI P 40 40 40 98 125 3.13 3.13
Myanmar
Yadana Total P 5,720 953 572 98 1,045 1.10 1.83
Thailand
Jakrawan FFD Unocal P 10 580 107 68 96 540 5.06 7.94
Tantawan Pogo P 44 300 94 74 96 225 2.39 3.04
Total 572 18,599 3,672 2,432 6,450 $1.76 $2.65

Average 10 326 64 43 113 1.76 2.65
P = platform, F = floating production system, S = Subsea, O = onshore,

EPS = early production system, FFD = full field development
Source: Wood Mackenzie/O&GJ Database
T 6.3 UK Offshore Likely Developments

O&GJ Nov. 11, 1996 pp 29

Field BOE Start $/BOE
Development Operator Type Oil Gas (MMBBLS) Date $MM 6:1 10:1
MMBBLS BCF 6:1 10:1
1. 9/19 Area N Conoco S 25 25 25 98 90 3.60 3.60
2. Banff Conoco FPS 75 75 75 98 143 1.91 1.91
3. Brae W Marathon S 30 30 30 97 113 3.77 3.77
4. Buckland Conoco S 20 25 24 23 99 98 4.06 4.36
5. Clair BP FPS 150 150 150 00 570 3.80 3.80
6. Elgin ELF P C 250 900 400 340 00 1,540 3.85 4.53
7. Franklin ELF NNMC 130 900 280 220 00 1,080 3.86 4.91
8. Galley Texaco FPS 30 40 37 34 98 98 2.67 2.88
9. Gannet E&F Shell S 40 10 42 41 99 120 2.88 2.93
10. Grant Total S C 8 220 45 30 00 135 3.02 4.50
11. Guillemot W Texaco S 35 120 55 47 99 150 2.73 3.19
12. Janice Kerr-McG FPS 30 30 30 98 45 1.50 1.50
13. Jacqui Phillips S 15 150 40 30 98 120 3.00 4.00
14. Josephhine Phillips S 30 30 30 98 105 3.50 3.50
15. Jupitor Conoco NNM 220 37 22 98 120 3.27 5.45
16. Katrine Mobil S 20 20 20 97 105 5.25 5.25
17. Keith BHP S 30 30 35 33 99 98 2.80 2.97
18. Ketch Shell/Esso NNM 350 58 35 00 225 3.86 6.43
19. Kingfisher Shell/Esso S 64 300 114 94 97 375 3.29 3.99
20. Kyle Mobil FPS 55 55 55 98 195 3.55 3.55
21. Mallard Shell/Esso S 30 30 30 98 120 4.00 4.00
22. Mariner Texaco FPS 160 160 160 99 655 4.09 4.09
23. Millom BG NNM 400 67 40 98 225 3.38 5.63
24. Olympus BG NNM 360 60 36 99 317 5.28 8.81
25. Perth Amerada H S 58 58 58 97 150 2.59 2.59
26. Pierce Ranger FPS 60 200 93 80 98 144 1.54 1.80
27. Puffin Shell/Esso NNM C 40 400 107 80 03 465 4.36 5.81
28. Ross Talisman FPS 75 75 75 98 135 1.80 1.80
29. Sedgwick Enterprise S 30 30 30 97 53 1.77 1.77
30. Shearwater Shell/Esso P C 200 1,200 400 320 01 1,650 4.13 5.16
Total 1,690 5,825 2,661 2,273 9,439 3.55 4.15
Average 65 324 89 76 315 3.30 3.95
Woodmac “These represent $3.45/BOE vs. $7.28 total dev. Cost due to ‘incremental’ nature
of these as well as CRINE.” Woodmac + 340,000 BOPD liquids contribution in 1998/99
P = platform, F = floating production system, S = Subsea, O = onshore, EPS = early

production system, FFD = full field development
Source: Wood Mackenzie/O&GJ Database
T 6.4 North Sea costs

Exploration, Development, and Drilling Costs
Water Recoverable Peak P/R Investments

Depth Reserves Production Ratio
Field ft MMBOE MBOPD ($MM) $/BBL $/BOPD
Fulmar 260 525 172,600 12.05% 1,100 $2.10 6,400

Magnus 610 469 115,100 9.0% 2,600 5.54 22,600
N. Cormorant 509 441 187,000 15.5% 3,300 7.48 17,600
Murchison 510 329 119,900 13.3% 1,050 3.19 8,800
Hutton NW 480 252 105,500 15.3% 1,300 5.16 12,300
Valhall Hod 230 245 86,300 12.9% 1,000 4.08 11,600
Beatrice 150 161 76,700 17.4% 1,150 7.14 15,000
Tartan 475 161 67,100 15.2% 650 4.04 9,700
Tem 550 161 47,900 10.9% 900 5.59 18,800
Maureen 315 147 67,100 16.7% 1,000 6.80 14,900
Gorm 130 140 38,400 10.0% 300 2.14 7,800
Buchan 390 49 43,200 32.1% 410 8.37 9,500
Average 3,080 1,126,800 13.4% 14,760 5.14 12,900
Wtd. Average 4.79 13,100
From: Maseron, J. (Editor), Petroleum Economics, Institut Francais du Petrole Publications, Fourth Edition, 1990
T 6.5 Norwegian field developments

Field Location Oil Cond. Gas BOE Kroner $/BOE
Development Operator MMBBLS MMBBLS BCF 10:l Billion $MM 6:1 10:1
Balder Esso N 190 - - 190 10.1 1,443 7.59 7-59
Froy Elf N 100 - 125 113 4.2 600 4.97 5.33
Gullfaks-6c Statoil N 20 - 10 21 0.4 57 2.64 2.72
Guilfaks South Statoil N 125 40 2,100 375 10 1,429 2.77 3.81
Heimdal Jurassic Elf N - 4 65 11 0.3 43 2.89 4.08
Hild Elf N - 25 350 60 3 429 5.14 7.14
Huldra Statoil N - 30 600 90 4 571 4.40 6.35
Midgard Saga Mid N - 100 4,000 500 22 3,143 4.10 6.29
Njord Norsk Hydro Mid N 190 - 250 215 12.2 1,743 7.52 8.11
Osseberg ast NorskHydro N 130 - 20 132 4.7 671 5.04 5.09
Osseberg South Norsk Hydro N 195 - 125 208 9 1,286 5.96 6.20
Peik (shared) Total N - 9 270 36 2.7 386 7.14 10.71
Sele (shared) BP/N. Hydro Central 3 - - 3 0.1 14 4.76 4.76
Skime/ByMe Elf N - 10 300 40 2 286 4.76 7.14
Sicipner West Statoil Central - 240 4,200 660 21.5 3,071 3.27 4.65
Smorbukk Southstatoil Mid N 170 - 400 210 10.4 1,486 6.28 7.07
Tommeliten AlpNaicii Central 20 6 300 56 2 286 3.76 5.10
Trofl West Norsk liydro N 520 103 16,000 2,223 47.2 6,743 2.05 3.03
25/2a – 13 Elf N 35 - 75 43 1.8 257 5.41 6.05
Vidgis Saga N 200 - 90 209 9.6 1,371 6.38 6.56
Visund NorsLHvdro N 80 70 1,500 300 12 1,714 4.29 5.71
TOTAL 1,978 637 30,780 5,693 189 $3.49 $4.75
Average 90 29 1,399 259 1,229
54% Gas
Gas Only 5,494 508 4,665
Gas Only $/MCF $0.85
All $/MCF Eq. (6:1) $0.58
F 6.1 Crude oil finding costs
There have been some dramatic improvements in the past two decades. Here the
“finding” costs probably represent what many would call “finding and development”
costs and here “production cost” would be the same as ordinary “operating costs”.
$25
Cost or Finding and Producing a Barrel of Oil
$20.00
$20
$15
$12.00
$10 $8.50
$8.50
$6.75
$5.75
$5.00
$5 $4.00
$0
1980 1985 1990 1995 1980 1985 1990 1995
Worldwide Finding Cost Worldwide Production
of a Barrel of Oil Cost of a Barrel of Oil
Sources: Global Energy Outlook

U.S. Information Administration
British Petroleum, Inc.
Business Week, November 3, 1997
T 6.6 Three types of worldwide finding costs
Exploration &
Exploration Exploration development
expense expense expense, reserves
only, reserve only, reserve from revisions,
revisions revisions and enhanced
excluded included recovery included
Years
Company 3 5 3 5 3 5
Amerada Hess 4.97 5.15 3.13 2.68 6.32 5.25

Amoco 4.90 6.59 2.70 3.20 6.07 6.15
ARCO 4.31 4.19 3.36 2.93 5.42 4.46
Chevron 6.73 8.75 2.88 2.90 5.3 5.23
Coastal 4.01 4.04 2.78 4.08 5.44 7.62

Conoco (Du Pont) 6.34 5.58 3.98 3.27 7.83 6.69
Enron 2.36 2.49 2.27 2.41 5.44 5.52
Enserch 3.99 3.76 5.87 4.30 10.99 8.54
Exxon 3.72 4.53 1.75 3.18 6.73 9.27

Louisiana Land 4.37 4.60 3.13 3.30 5.28 5.76
Marathon (USX)* 2.14 2.68 2.10 2.38 5.02 5.68
Mobil 5.18 5.97 2.09 2.30 3.63 3.54
Murphy Oil 3.49 4.12 2.71 3.16 4.49 4.88

Occidental 3.43 3.99 1.74 1.42 4.87 3.81
Oryx Energy 3.55 3.86 3.54 4.00 6.13 7.04
Pacific Enterprises 9.49 9.57 10.71 10.25 13.98 12.72
Pennzoil 5.04 6.35 3.70 3.46 8.96 7.58

Phillips 3.23 3.53 1.91 1.61 3.05 2.74
Texaco 3.36 4.71 1.81 1.81 4.13 4.04
Union Texas 6.49 5.04 3.53 3.16 10.91 8.17
Unocal 1.68 2.04 1.82 1.93 4.25 4.43
* Marathon 1991 Annual Report unavailable; 3 year average: 1988-1990; 5 year average: 1986-1990
Source: Oil & Gas Journal, June 1, 1992 Institute of Petroleum Accounting, Jeff Boone
T 6.7 Finding, development and production costs
On the average in this world it costs around $3.50 per barrel to develop an oil
field and operating costs are about the same ($3.50). This does not include
“finding costs”. Beyond that, there is wide variation.
Finding, Development and Production costs for selected regions.
Country F&D Production Total

($/BOE) ($/BOE) ($/BOE)
Alaska N. Slope 3.50 2.25 5.75

Nigeria 3.50 2.25 5.75
Egypt 3.00 4.50 7.50
W. Siberia 4.00 3.00 7.00
Mexico 5.00 2.25 7.25
Venezuela Heavy 8.00 8.00 16.00
US Lower 48 Onshore 4.50 3.75 8.25
US Stripper Wells 4.25 10.50 14.75
Gulf of Mexico 5.00 3.00 8.00
North Sea 5.50 4.50 10.00
Indonesia 2.50 4.00 6.50
T 6.8 Cost of incremental production*

OPEC $/BBL Selected Non-OPEC $/BBL
Iraq 0.5 - 0.7 Mexico 2.6 - 4.8
Saudi Arabia 0.4 - 1.0 Malaysia 3.3 - 5.2
Iran 0.5 - 5.0 Oman 4.4 - 5.7
Kuwait 1.0 - 2.0 Alaska (N. Slope) 5.5 - 7.0
Qatar 2.0 - 4.0 Russia 4.8 - 8.9
UAE 2.5 - 20.0 Egypt 9.4 - 13.0
Algeria 3.0 - 5.0 UK N. Sea 11.8 - 15.4
Libya 3.0 - 5.0 Norway 12.5 - 17.0
Venezuela 3.0 - 5.0 US Offshore 16.6 - 21.0
Nigeria 3.2 - 6.0 Alberta 20.0 - 25.2
Indonesia 5.0 - 8.5 US Lower 48 24.2 - 32.7
Gabon 8.5 - 15.0
Sustainable Required
OPEC Current Capacity Investment ($B)
Member MMBOPD 2000 2010 2020 2000 2010 2020
Algeria 0.78 1.00 0.75 0.60 4 7 11
Gabon 0.30 0.30 0.25 0.20 2 3 5
Indonesia 1.40 1.30 1.20 1.00 14 20 25
Iran 3.80 4.00 5.00 5.00 10 17 25
Iraq 2.50 2.50 6.00 7.00 8 13 18
Kuwait 2.00 2.00 3.50 4.00 5 8 12
Libya 1.70 2.00 2.20 2.10 8 14 18
Nigeria 1.95 2.20 2.75 2.50 10 15 20
Qatar 0.44 0.50 0.50 0.40 2 4 7
Saudi Arabia 8.50 10.00 11.00 12.50 15 25 30
UAE 2.45 2.80 3.50 4.00 6 10 13
Venezuela 2.38 2.80 3.30 3.50 15 23 31
Total OPEC Crude 28.20 33.40 39.95 42.80 99 159 215
OPEC Middle East Share 19.69 23.80 29.95 32.90
OPEC Middle East Share % 69.8% 71.3% 73.8% 76.9%
OPEC NGLs 2.44 3.00 4.00 5.00
Total OPEC Capacity 30.64 36.40 43.95 47.80
* Costs reflect outlays, including a 15% rate of return, and exclude taxes and operating costs.
From: Ibrahim A.H. Ismail OPEC, O&GJ, May 27, 1996 pg 41
T 6.9 Amoco Corporation – 1990 – 1992
1990 - 1992
US Crude oil price $21.60 - 17.79/BBL

Natural Gas Liquids $12.84 - 11.43
Canada Crude oil price $20.22 - 16.19/BBL

Natural gas liquids $9.56 - 12.63
Gas Price
US $1.83 - 1.65/MCF
Canada $1.39 - 1.15
Europe $1.96 - 2.06
Other Foreign $0.81 - 0.86
Production Costs
US $5.20 - 4.51/BBL
Canada $5.13 - 4.44
Europe $5.27 - 6.65
Other Foreign $5.32 - 4.29
Top Performers
U.S. reserve replacement costs
Plains Resources $2.39/BOE

Exxon 2.70
BP 2.78
Enron O&G 3.01
Phillips 3.17
Overall Wtd. Avg 4.44

for 231 companies
November, 1996 Oil & Gas Investor (pg 28)
T 6.10 Offshore exploration/appraisal drilling ($MM)

Well Water Depth
Depth (feet)
(feet)
100 250 1000
2,500 $0.8 $1.2 $2.4

5,000 1.9 2.5 3.6
7,500 2.8 3.6 4.8
10,000 3.5 4.2 5.7
12,500 6.0 6.8 8.8
15,000 9.0 10.3 13.6
T 6.11 Development drilling costs ($MM)
Well Offshore Onshore

Depth Platform rig
(feet) Low cost High cost
2,500 $0.8 $0.4 $0.9

5,000 1.8 1.5 2.2
7,500 2.4 2.0 2.9
10,000 3.0 2.6 4.2
12,500 5.0 3.9 6.5
15,000 6.5 6.0 14.5
F 6.2 Offshore drilling cost estimates vs. total depth
Cost, Millions of $
$14
$12
High cost
$10
$8
Moderate
$6
$4
Low cost
$2
$0
m 0 1,000 2,000 3,000 4,000 5,000
ft 1,500 10,000 15,000
Total Depth, meters & feet
T 6.12 Drilling costs – Offshore Java Sea Indonesia – Early 1990s

Development Exploration
Well well
Water Depth (ft) 50 200
Reservoir Depth (ft) 3,800 7,400
Well Depth (ft) 5,575 9,000
Horizontal Displacement 3,750 4,650
Drilling Days 7 15
Testing Completion 4 7
Total Days 11 22
Dry Hole Cost ($000) 585 2,200
Completion Cost ($000) 680 1,300
Total Cost ($000) 1,250 3,500
Operating costs are usually the least sensitive economic factor for an exploration venture. When
viewing a potential production acquisition or development feasibility following discovery,
operating costs have more impact on net present value and rate of return. Usually, annual
operating costs amount to about 3 to 5% of the total capital cost compared to 6 to 8% for North
Sea projects and most international "mega" projects.
It costs about $2.5 million per year to operate a typical 12 slot production platform in the Gulf of
Mexico. Variable monthly operating costs range from $15,000 to $18,000 per well. But, these
costs must be used with care since such factors as offshore distance, water depth, types of
completions (i.e. dual, single or subsea) and the nature of the production (oil, gas, water) must be
considered. Usually deeper water also means that the distance from shore is also greater.
Operating costs for a platform in 600 feet of water might be up to $500 thousand per year greater
than a similar platform in 100 feet of water. Operating costs for an 18 slot platform in 600 feet of
water are around $3.5 million per year in the Gulf.
T 6.13 Platform costs – low cost environment

Platform Costs ($MM)
# of Water Depth (feet)

Slots
100 250 500 1000
9 $3.5 $10 $30 $45
12 4.0 13 35 60
16 4.5 16 45 70
24 6.0 25 65 90
30 8.0 31 85 115
36 10.0 36 100 140
F 6.3 Cost estimates for development systems in various water depths
600
Note: Gulf of Mexico
25 wells – drilling and
500 pipeline costs not included
Guyed Towers
400
Installed cost ($MM)
Platforms
300
TLPs
200
Semis
100 Tankers
0
0 1000 2000 3000
Water depth (feet)
Source: Johnston, D.: “Field Development Options for Deep Water” Oil & Gas Journal, May 5, 1986, pg.
132 – 142.
T 6.14 Facilities costs and operating costs

Facilities costs and operating costs
Field OPEX * P/R

Size Facilities as a % Ratio
(MMBBLS) ($MM) of total (%)
CAPEX
10 8 9% 14
50 25 7% 13
100 50 6% 11
250 110 5% 9
T 6.15 3-D Seismic acquisition costs

Relative Costs
$/per $/per
sq km sq mile
Marine 6,000 15,538
Desert 17,000 44,026
Swamp 50,000 129,487
Low Mountains 100,000 258,974
High Mountains 200,000 517,947
Turkmenistan 15,000 38,866 1994 (source Daniel Johnston & Co., Inc.)
Adapted from: John Norton, American Oil & Gas Reporter, July, 1997 (pg 109-114) Large Channel
Count Crews Changing the Face of Seismic Prospecting
T 6.16 Competitive price analysis

Example 3-D data costs and prices are summarized as follows:
Acquisition Typical
cost price range *
$/sq mile $/sq mile (Year)
Deepwater Streamers 15,000 2-3,000

Nigeria Texaco 19,000 (1998)
Deepwater – 560 sq miles
Moderate water depth 20,000 4-5,000

Ocean Floor Cables
State Waters 22,000 5,000

Cable on Bottom
Matagordo Bay 40,000 10,000

Airguns/Ocean-Island-Bay
Atchafalaya Bay Louisiana 100,000 12-16,000 +

Buried Dynamite & Phones
Bahrain Offshore 70,000 (2000)

(Shallow water <60 feet0
(Reservoirs up to 11,000 ft)
* Acquisition Cost vs. Market Price for “spec” data is approximately 4/1.
T 6.17 2-D Seismic acquisition costs
Onshore USA Average acquisition cost $5000-8000/mile
Seis Pros Portfolio (1987) 10,000 miles @ $5,860/mile $3,575/Km
PGI 1986 Portfolio (1986) 24,000 miles @ $3,960/mile $2,415/Km
East Texas 2-D Database 15,000 miles $5,000/mile
1960s vintage 2,000 – 3,500 6 – 12 fold mostly 12 $2,750

1970s ” 3,500 – 5,000 6 – 15 + ” ” $4,250
1980s ” 4,000 – 6,500 16 – 30 + $5,250
Mangrove Swamps $20,000/mile
Offshore Shallow Water $700/mile $400 – 500/Km
Deepwater $1,400/mile $800 – 900/Km
* Acquisition Cost vs. Market Price for “spec” data is approximately 4/1.
2-D Seismic processing costs - from $300 to $1,000/line mile
2-D Seismic processing costs - from $150 to $500/line mile
T 6.18 Gas pipelines
Diameter Typical Capacity 25 Years

(inches) (MMCFD) (TCF)
52 1,770 2,090 17.6
48 1,510 1,780 15.0
44 1,270 1,490 12.6
42 1,160 1,360 11.5
40 1,050 1,230 10.4
* 36 850 1,000 8.5
* 34 760 890 7.5
32 670 790 6.7
30 600 690 5.9
28 510 600 5.1
24 380 440 3.8
20 260 310 2.6
16 170 200 1.7
12 90 110 0.9
8 40 50 0.4
4 20 20 0.2
* 2 – 3 train LNG class “big inch” pipeline

At 1,000 to 2,000 miles (offshore – onshore) LNG transportation starts to cost less
Pipeline construction costs
$/inch - mile
Offshore
North Sea $100,000 $80 – 110,000
W. Africa 70,000 60 – 80,000
Gulf of Mexico 40,000 30 – 50,000

$/inch - mile
Onshore U.S. $31,000 $20 - 40,000
T 6.19 Pipeline construction costs
Onshore Offshore
Pipelines Pipelines
% %
Materials 30.5 42.5
Labor 47.0 32.7
R.O.W. and damages 5.4 0.2
Miscellaneous 17.1 24.6
100.0 100.0
US
Liquids
Pipelines
%
Line pipe and fittings 30.0
Pipeline construction 36.5
Pump station and equipment 26.2
Land and R. O. W. 2.5
Miscellaneous 4.8
100.0
From: True, W., “U.S. pipelines continue gains into 1996” O&GJ Nov. 25, 1996, pg 39 - 58
T 6.20 Oil pipelines

Capacity
Diameter Useful Range 25 Years
(inches) (MBOPD) (MMBBLS)
48 1,000 1,450 11,175 *
46 920 1,300 10,125
42 770 1,100 8,525
36 560 800 6,200
34 500 720 5,575
32 440 640 4,925
30 380 560 4,300
24 250 357 2,775
22 210 300 2,325
20 170 250 1,925
16 110 160 1,225
12 62 85 675
8 28 40 300
6 16 22 175
**
* Trans Alaska Pipeline

** Capacity depends upon line length, difference
in head between ends of the line, fluid properties
– specific gravity, viscosity, etc.
F 6.4 Pipeline cost per inch calculations
Pipelines
Indonesia’s
PT Perusahaan Gas Negara let contract worth $74
million to PT KHI Pipe industries’ Crakatau steel
group to supply 550 km of 28-in. steel pipe for a
pipeline that will link Caltex’s Duri oil field in Riau
with Asamera (Overseas) Ltd.’s oil and gas field
Grsik, Sumatra.
O&GJ: Jan. 13, 1997 (pg 29)
What was the cost per inch – mile? $7,877 for the steel alone
IPL Energy Inc.

Calgary, plans to lay a 75 mile, $50 million crude oil
pipeline from Stockridge, Mich., to Toledo, Ohio.
The line will transport medium and low gravity
crudes from western Canada to BP Exploration & Oil
Inc.’s 110,000 b/d expandable to 110,000 b/d.
O&GJ: Jun. 17, 1996 (pg 23)
What was the cost per inch – mile?
Construction progressing on GasAndes Pipeline

. . . GasAndes sponsors propose a $350 million
project to lay a 24 in. pipeline along a 290 mile route
to ship gas to Santiago, Chile, to La Mora, Argentina.
O&GJ: Apr. 8, 1996 (pg 28)
What was the cost per inch – mile?
T 6.21 World crude oil
Specific
Gravity
(g/cm3) °API BBLS/ton
0.979 13.0 6.45 Kern River (California) 13° API

0.973 14.0 6.48 Mariner (UK) 11-15° API
0.966 15.0 6.53
0.950 17.5 6.64 Wilmington 17°
0.934 20.0 6.75
0.919 22.5 6.86 Mexican Basket 22.4° API Maya 22° API
0.904 25.0 6.98
0.890 27.5 7.08 Arab Heavy 28° API Alaska NS 28° API
0.876 30.0 7.19 Gullfaks 29° Dubai 29° wt 2% S Tia Juana (Ven) Lt 29°
0.863 32.5 7.31 Urals 32° WTS 33° 1.6% S Arab Lt 33° Iranian Lt 34°
0.850 35.0 7.42 Minas 34° Oseberg 35° Libyan Es Sider 37°
0.837 37.5 7.53 Bonny Light 37° WTI 38-40° 0.3% S Brent 38-39°
0.825 40.0 7.64 Statfjord 39°
0.813 42.5 7.75
0.802 45.0 7.86
0.790 47.5 7.99 Tengiz (Kazakhstan) 48.2° API 12.5 mol% H2S
0.780 50.0 8.09 Heavy Condensate 45-55° API
0.769 52.5 8.20
0.759 55.0 8.31 Medium Condensate 55-60° API
0.739 60.0 8.53
0.720 65.0 8.76
0.702 70.0 8.98 Light Condensate 70-85° API
0.685 75.0 9.20
°API = (141.5/sg)-131.5 sg = 141.5/(131.5+° API)Barrels/ton = (° API/22.41) + 5.857
Tankers
Tankers haul crude oil or petroleum products in bulk. Their size is measured in deadweight tons
(DWT). This is the total tonnage (in long tons) of cargo, fuel, water, and stores the ship can
carry. Over the years, the size of tankers has grown with demand. Until the 1950s, the T-2 with
16,500 DWT capacity was standard. By the mid-1980s, Very Large Crude Carriers (VLCCs),
with over 175,000 DWT, and Ultra Large Crude Carriers (ULCCs), with 300,000 tons, were
used. (One long ton equals approximately 7.5 barrels.)
Transportation costs for crude oil from the Persian/Arabian Gulf to the United States (Houston)
on a VLCC are approximately $1.25 per barrel.
The average tonnage for a fleet will range from 70,000 to 150,000 DWT per ship. Exxon's fleet
of 66 vessels had a combined capacity of 4.8 million DWT in 1989 - 72,000 DWT average.
Amerada Hess has 22 vessels with a combined tonnage of 3 million DWT. The average vessel
size in the Amerada fleet is 140,000 DWT. More often than not, this is all the information about
a company's fleet that will be available.
The value of a tanker in the early 1980s dropped as world demand for crude and products dipped.
For a while, there was a glut of tanker capacity. A range of values is outlined in table T 6-17.
T 6.22 Summary of tanker values
Value
Tonnage ($MM)
Type DWT Barrels Old - New
T-2 16,500 115,500 5 - 10

50,000 375,000 15 - 20
LCC 100,000 750,000 20 - 35
VLCC 175,000 1,225,000 25 - 50
VLCC 250,000 1,875,000 30 - 55
ULCC 350,000 2,652,000 40 - 75
ULCC 450,000 3,375,000 60 - 90
Tanker rates have been fluctuating. In 1986 the Exxon Valdez ran aground in the Prince William
Sound in Alaska. That accident resulted in the 1990 Oil Pollution Act which effectively bans the
use of older ships from United States ports. On December 21, 1999, the Erika, carrying 3 million
gallons of heavy fuel oil split apart in heavy seas off the Bay of Biscay contaminating 250 miles
of French beaches. The French were not happy. The Erika was a 24 year old 37,000 DWT
Maltese-flagged products tanker. The accident triggered another ban against older ships.
It is estimated that nearly 40% of the ultra-large (ULCC) and very-large crude carriers (VLCC)
are over 20 years old. It is not clear yet how significant the ban on older ships will be in the long
run. It does appear that it has had at least a short term affect.
Tanker rates are also a function of inventories and production rates. When OPEC cuts output,
demand for tankers goes down, as do tanker rates.
Worldscale “points” represent market fluctuations around a standard 100% Worldscale rate (100
WS). It is also referred to as the flat rate.
Example:
The (100 WS) or flat rate, Arab Persian Gulf to Gulf of Mexico is $18.12 per long ton. For
Arabian Light, 33˚ API, there are 7.31 bbl per ton. This equates to a flat rate of $2.47 per barrel.
The spot tanker cost at WS 45 for a VLCC, Arabian Light, Gulf to Gulf, would be
.45 * $2.47/bbl = $1.11/bbl
Or in other words, the spot tanker cost of WS 45 is only 45% of what it was when the flat rate
was established.
F 6.5 Tanker freight rates
2.50 Tanker Freight Rates

Arabian Gulf to US Gulf of Mexico
2.00
1.50
($/BBL)
1.00
0.50
0.00
2/92 8/92 2/93 8/93 2/94 8/94 2/95 8/95 2/96 8/96 2/97 8/97 2/98 8/98 2/99 8/99 2/00 8/00
Source: O&GJ / Sept. 18, 2000, Raymond James & Associates Inc.
F 6.6 Worldscale rates, 3 markets, 3 years
200
180
160
140
Worldscale
120
100
80
60
40
20
1999 2000 2001 2002

260,000, Crude, ME Gulf to Japan
260,000, Crude, ME Gulf to US Gulf
250,000, Crude, ME Gulf to UK Cont
Adapted from: Worldscale established freight rates
Tanker freight rates are also quoted as day rates, for instance, the following is a comparison of a
few rates on a per day basis:
Tanker/Size Market Day Rates

1999 2000
130,000 DWT W. Africa to US $15,450 $32,000
80,000 DWT W. Africa to US $10,400 $16,000
250,000 DWT $21,700 $27,000
Tankers European short routes $45,000
Vessel DWT Notes

types/sizes
Panamax 50,000 – 80,000 Capable of transiting Panama Canal, max beam
32.3 meters
Aframax 80,000 – 120,000 AFRA Freight Rate Assessment Scale Large One
Category
Suezmax 120,000 – 200,000 Capable of transiting Suez Canal fully laden
VLCC 200,000 – 300,000 Very Large Crude Carriers, smaller more versatile
than ULCCs, some can transit Suez
ULCC 300,000 – 500,000 Ultra Large Crude Carriers, crude oil long haul
carriers, require special terminals
Capesize Incapable of transiting Panama or Suez canals,
voyage via Cape Horn or Cape of Good Hope
Import Areas
North America USA, Canada, Mexico
Europe Scandinavia, UK, North Europe and Mediterranean
Europe
Asia OECD Pacific, South East Asia and India
Latin America Central & South American countries south of Mexico
Export Areas
Middle East/Arabian Gulf (AG) All exporters around the Middle East Gulf
West Africa Nigeria
East Med/FSU Sidi Kerir, Ceyhan pipeline
Caribbean East coast South America, Mexico range including
Caribbean
Red Sea Arabian Red Sea outlets
Former Soviet Union (FSU) Black Sea
F 6.7 Tankers
Length DWT Cost

Jahre Viking 458 m 564,763
Length DWT Cost

ULCC 415 m 320,000 +
Length DWT Cost

VLCC 350 m 200-320,000 $100MM
Length DWT Cost

USS Nimitz 332 m 95,000
Length DWT Cost

Suezmax 285 m 120-200,000 $80MM
Bismark Length DWT Cost

279 m 56,551
Length DWT Cost

Aframax
245 m 80-120,000 $40MM
Coastal Tanker Length DWT Cost

205 m <50,000 $30MM
Length DWT Cost

USS Seawolf 107m 8,060 $2 B
Length m3 Cost
LNG 279 m 140,500 $150MM
Length BBLS Cost

FPSO 200 m 70,000 $300MM
Jahre Viking Petronius USS Nimitz Bulwinkle Eiffel Tower Troll C

458 m 535 m 332 m 412 m 319 m 340 m
Chapter 7 - Petrophysics
7. Petrophysics
Much of the focus of this industry is on rocks, particularly sedimentary rocks found in
sedimentary basins of various sorts. There are three main types of sedimentary rocks:
1) Sandstones
(Clastics)
2) Shales
3) Limestones and Dolomites (Carbonates)

(Dolomite is a limestone cousin)
Anybody interested in the upstream end of the petroleum industry must have an understanding of
basic rock properties. This chapter should provide a good background as well as the basic
equations involved.
F 7.1 Geologic time table

% Oil Approximate age in
ERA PERIOD EPOCH millions of years
% Gas
World oil
Holocene regions
(Recent)
.01
Quartinary
Pleistocene
(Glacial) Gulf of Mexico - Deep
.5
Cenozoic
to 2 Gulf of Mexico - Deep

Pliocene
11.6%
13
Miocene W. Indonesia
Tertiary 25
Oligocene Gulf Coast - Transition
36
Eocene Gulf Coast - Onshore
7.6% 58
Paleocene
63
35.6%
Cretaceous
Mesozoic
28.4%
135 North Sea (ss)
42.0%
Jurassic Bass Straight (ss)
33.1%
2.8%
180
Triassic 1.4%
230 Iran
0.1% W. Texas
Permian 0.1%
280
Pennsylvanian 1.1%
Carboniferous
(Upper Carboniferous) 5.0%

310
Mississippian Algeria
Paleozoic
(Lower Carboniferous)
4.7%
345
Devonian Algeria
9.1%
1.6%
405
E. Canada
Silurian
14.6%
425
Precambrian
Ordovician E. Canada
500
Cambrian
600
3,300
“Super source” intervals comprise 90% of known global reserves Souce: Vail, Michum & Thompson, 1977
% Oil & % Gas generated from “giant” fields, Source: “Grunau, J. Petrol. Geol., July 1983
F 7.2 Porosity and permeability
Porosity – Ø There is a general correlation between porosity

Permeability - K and permeability.
“One Darcy”
1,000
Permeability - Millidarcies
Excellent
100
Good
10
Poor Good Excellent

1
0% 5% 10% 15% 20% 25% 30% 35%
Porosity Ø
Limestones Typical Range Reefs

“Carbonates”
Sandst Typical Range High End

ones
“Clastics”
F 7.3 Reservoir porosity and fluid distribution
33% Water
67% Oil
20% Rock Water
Rock
33% Water Saturation 80%
67% Hydrocarbon Saturation
Pore
20% Pore Volume
80% Rock Volume spaces Oil
F 7.4 The Archie Equation
The basic equation for calculating water saturation is the “Archie equation”.
“Archie equation”
Sw = aφ
-m
Rw aφ
-m -2
= 1φ
or (limestones?)
(1- Sh) = Rt “Humble equation”

-m -2.15
aφ = .62φ
(Sandstones)
Where:
another equation
-m -2
Sw = Water saturation (%) aφ = .81φ
(Percentage of pore space filled with water) (other)
Sh = Hydrocarbon saturation (%)

(Percentage of pore space filled with hydrocarbons)
a = Constant (Based on rock type logs or cores or both)
φ = Porosity (From open-hole logs or cores or both)
m
= Cementation exponent (around 2 for most reservoirs)
Rw = Formation water resistivity for a “wet” reservoir

Measured in ohms
(Either measured or estimated from open-hole logs)
Rt = Formation water resistivity for a “wet” reservoir
This is very old but basic – from a past life as an open-hole logger.
F 7.5 Oil volumetric estimates
7,758 * A * h * Phi * Sh
Vi =
FVF
Where:
7,758 = Barrels per acre - foot

Vi = Initial in-place Oil Volume (Barrels)
A = Drainage area (acres)
h = Pay Zone thickness (feet)
Phi = Porosity (decimal)
Sh = Hydrocarbon Saturation (decimal)
FVF = Formation Volume Factor
(Shrinkage due to gas coming out of solution at lower stock

tank pressure and temperatures.)
Recoverable oil is determined by multiplying Vi by an estimated recovery factor.

FVF is roughly equal to 1.05 plus 0.05 for every 100 cubic feet per barrel gas oil ratio (GOR).
T 7.1 Recovery factors
Rules-of-thumb
Generally (Notice the implied accuracy with increments of 5%)

Recovery
Oil 25% (10 – 30%) with depletion drive (primary recovery only)
35% (20 – 40%) with free gas cap drive
50% (40 – 60%) with water drive
Gas 75-90% with depletion drive

70-80% with water drive
Texas Gulf Coast Sands

Recovery
Oil 20% 15 – 20% with depletion drive (primary recovery only)
35% or more with water drive
Gas 85% with depletion drive

75% with water drive
Key factors:
Reservoir
Porosity
Permeability
Pressure gradient
Water saturation
Drive mechanisms
Fluid properties
Viscosity (API gravity has a lot to do with this)
Gas oil ratio
F 7.6 Gas volumetric estimates
43,560 * A * h * Phi * Sh * Pi * Ts
Vi =
Ps * Zi * Tf
Where
43,560 = Square feet per acre or cubic feet per acre-foot
Vi = Initial in-place gas volume (standard cubic feet)
(standard pressure and temperature)
A = Drainage area (acres)
Phi = Porosity (decimal)
Sh = Hydrocarbon saturation (decimal)
Pi = Initial reservoir pressure
Ts = 520º Rankin (standard temperature 60ºF + 460º)
Ps = 14.7 psia (standard pressure)
Zi = Initial gas compressibility factor
Tf = Reservoir temperature in rankine (Fº + 460º)
Example Zi values Recoverable gas is determined by multiplying Vi by an
Gas specific gravity = .65 estimated recovery factor or calculating remaining gas
Reservoir temp = 300º volume at abandonment (Va) and subcontracting Va from
Reservoir depth = 7,000 ft Vi. Va requires a separate Z calculation (Za), which is a
function of abandonment pressure (Pa).
Pressure
Psi Zi
500 0.93
1,000 0.88
2,000 0.84
Vr = Vi * Rf
3,000 0.87
4,000 0.99
Where
5,000 1.04
Vr = Recoverable gas (MMCF)
6,000 1.10
Vi = Initial in-place gas volume
7,000 1.17
RF = Recovery Factor (%)
8,000 1.24
9,000 1.31
10,000 1.38
12,000 1.50
14,000 1.64
F 7.7 Darcy’s radial flow formula
7.07 * h * K * (Ps - Pf)

Qoil = = (BOPD)
µ * Bo * 1n Re/Rw
7.07 * 10-4 * h * K * (Ps2 - Pf2)

Qgas = = (MMCFD)
µ * Z * T * 1n Re/Rw
Where:
K = Permeability in darcies
Ps = Static pressure (psia)
Pf = Bottom hole flowing pressure
µ = Velocity or fluid in centipoise
Bo = Formation volume factor
ln = Natural Log
Re = Radius of drainage (feet)
Rw = Radius of wellbore (feet)
Z = Gas deviation factor (compressibility factor)
T = Reservoir temperature in rankine (˚F + 520˚)
F 7.8 Structure Map
N
0 1 2 3
Scale Miles
6,600’
6,400’
A 6,200’ A’
GOC 6,294’
OWC 6,476’
Structure Map
Top of Reservoir
Contour Interval - 200 ft
A Seal Rock A’
Gas
Gas Cap
Verticle Gas Oil Contact Pay

Closure Zone
Oil
Oil Water Contact Oil Leg
Water
Spill Point
Aquifer
E-W Cross section

A – A’
Structural traps
F 7.9 Fault Trap
Conglomerate Sandstone
Shale Salt – or Evaporites
Limestone Sandy Shale
Dolomite Basement - Granite

Fault
Upthrown
block Downthrown
block
F 7.10 Salt Dome
Gas
“Gas cap”
Oil
“Oil leg”
Water
“Aquifer”
Salt diapir
The salt based structures like

those off the Louisiana Gulf Coast
(shown below) as well as the
Arabian/Persian Gulf create many
“donut” shaped fields.
MAIN PASS
143 144 272 273 274
295 294 293 292 291

291 291
148 149 301 302 303 304 307
815 816
150 312 310 309 308
859 860
152 153 314 315 316
902 903 904

64
944 945 946 947 948

68 69
987 988 989 990 991 992
Stratigraphic traps
F 7.11 Reefs
Coral reefs by their nature (constantly bombarded by waves) are porous from the
rubble. They can be very prolific. The one depicted above lived out its existence
offshore some ancient island, died and was overlain by deeper water sediments
(limestone) as the sea level rose or the sea floor subsided. The famous “Cinta” oil
field in Indonesia produces from reefs within the Batu Raja Limestone. The famous
Kasakh fields, Kashagan and Tengiz produce from ancient Devonian reefs in the
North Caspian sea—some of the largest fields in the world.
F 7.12 Up dip pinchout
This could be an offshore sand bar or other type of porous rock such as a stream
channel.
F 7.13 Combination trap – Angular unconformity
Unconformity
This kind of trap has a combination of stratigraphic and structural elements. The
unconformity surface represents a period of erosion that followed an uplifting and
tilting of the underlying sediments. This “play type” exhists throughout the Viking
Graben in the central sector of the North Sea where thick sections of porous Jurassic
sandstones were truncated up against the Kimmeridgian Unconformity. The
overlying organic-rich Kimmeridgian shales also “sourced” the sandstone reservoirs.
The Bass Strait production in Southeast Australia also produces primarily from these
kind of reservoirs.
8. Fluid Properties
1.5 – 3.0% price
Oil adjustment
Price per ° API
$/BBL
Heavy Oil Light
10° 40° 50°

Not to Scale
Chapter 8 – Fluid Properties
F 8.1 Hydrocarbons
Oil Black Oil Volatile Oil Dry Gas
Conventional Crude Oil
Heavy Oils Light Oils Condensates
API Gravity 8 12 16 20 24 28 32 36 40 44 48 52 56
Gas Oil Ratio 100 – 2,500 10,000
Pour Point - Temperature above which crude becomes liquid

Can be as low as 70 degrees Fahrenheit
Percent Sulfur
.5% 1% 2.5% Over
Sweet Intermediate Sour
Average % Sulfur for US Refineries, 16 MMBOPD = 1%.
Gas
Non-associated Gas
Associated Gas Dry Gas
Liquid Gas Ratio 250+ 200 150 100 50 17 - 15 10

BBLS/MMCF
Gas Oil Ratio 4,000 5,000 6,666 10,000 20,000 62,500 100,000
Cubic feet/BBL
F 8.2 General oil price relationship
This general relationship provides a point of reference in the absence of hard current
information. Price relationships vary from region to region and also fluctuate with
time and conditions. Furthermore this relationship does not capture the effects of
sulfur content.
1.5 – 3.0% price
Oil adjustment
Price per ° API
$/BBL
Heavy Oil Light
10° 40° 50°

Not to Scale
F 8.3 Sulfur vs. API gravity
Correlation between API gravity and sulfur content for Middle Eastern crudes.
Quality
52
Dubai
47
WTI
42
Gravity API
Brent
37
Middle East
Crudes
32
27
22
0.00 1.00 2.00 3.00 4.00
Sulfur wt%
Source: BP
T 8.1 Crude properties
API Gravity
American Petroleum Institute
141.5
API Gravity = - 131.5
Specific gravity at 60º F
API
Sg Gravity Kuwait
0.74 59.7 Sg Gravity Yield (vol%)
0.76 54.7 Crude 0.87 31.1
0.78 49.9
0.80 45.4 Light Naptha 0.69 74.8 9.9
0.82 41.1 Heavy Naptha 0.76 54.0 13.9
0.84 37.0
Kerosene 0.80 46.3 15.8
0.86 33.0
Gas Oil 0.84 36.2 29.8
0.866 31.9 Heavy Fuel Oil 0.96 15.3 50.7
0.88 29.3 Lube Oil Bases 14.1
0.90 25.7 Vacuum Residue 1.02 7.9 28.3
0.92 22.3
0.94 19.0
0.96 15.9 Over 200 different kinds of crudes
0.98 12.9 Most refineries cater to a mixture (cocktail) of 2-6 crudes
1.00 10.0 Refineries are now required to be more flexible
1.01 8.6
F 8.4 Barrels per metric ton per API gravity
Barrels per metric ton

9.0
8.0
7.0
6.0
5.0
0 10 15 20 26 30 36 40 46 50 60
API Gravity (60ºF)
Source: Data from Levorsen 1967. p 687 Adapted from Facts

and Figures, 9th ed.. American Petroleum Institute
T 8.2 Composition of a 35º API gravity crude oil
Molecular size Volume %
Gasoline (C5 – C10) 27

Kerosene (C11 – C13) 13
Diesel fuel (C14 – C18) 12
Heavy gas oil (C19 – C25) 10
Lubricating oil (C26 – C40) 20
Residuum (>C40) 18
Total 100
Molecular size Volume %
Paraffins 12
Naphthenes 10
Aromatics 20
Asphaltics 18
Total 100
F 8.5 Natural gas products
Light Hydrocarbon Series
C1 C2 C3 C4 C5+ Terminology
LNG Liquefied Natural Gas

CNG Compressed Natural Gas
LPG Liquefied Petroleum Gas
NGL Natural Gas Liquids
COND Condensate
Methane Ethane Propane Butane Pentanes+
Source: “International Petroleum Fiscal Systems and Production Sharing Contracts”, Daniel Johnston
T 8.3 Physical constants – Light hydrocarbons
MCF/Ton
Degrees MCF/BBL BBLS/Ton Metric Long Short

API Symbol #/BBL Metric Ton Ton Ton
Methane 340.2 C1 2.483 104.9 21.0 52.17 53.02 47.34

Ethane 253.1 C2 1.647 130.5 16.9 27.82 28.27 25.24
Propane 147.2 C3 1.526 177.3 12.4 18.97 19.28 17.21
I-Butane 119.3
N-Butane 110.6 C4 1.304 200.4 11.0 14.34 14.58 13.01
I-Pentane 95.0
N-Pentane 92.7 C5 1.154 219.5 10.0 11.59 11.78 10.51
N-Hexane 81.6 C6 1.022 232.2 9.5 9.7 9.86 8.80
N-Heptane 74.1 C7 0.915 241.6 9.1 8.35 8.48 7.57
N-Octane 68.7 C8 0.821 247.1 8.9 7.32 7.44 6.65
N-Nonane 64.5 C9 0.747 252.6 8.7 6.52 6.62 5.91
Pentanes + C5+ 0.932 238.6 9.2 8.61 8.75 7.81

Hexanes + C6+ 0.876 243.4 9.1 7.93 8.06 7.20
Water 349.8 6.3

Metric Ton = 2,204 #
Long Ton = 2,224 #
Short Ton = 2,000 #
Water = 8.328 Pounds per US Gallon

= 623 Pounds per Cubic Meter
Source: “International Petroleum Fiscal Systems and Production Sharing Contracts”, Daniel Johnston
Gas Oil Ratio (GOR)
Gas oil ratio is typically measured in terms of cubic feet per barrel. The engineer J. J. Arps had a
rule-of-thumb; typically GOR for black oil is equal to reservoir depth divided by 10. For
example if oil was found at a reservoir depth of 7,000 feet then the amount of gas in solution
would be equal to 700 cubic feet per barrel (7,000/10). This would not require substantial gas-
handling facilities by world standards. However, some crudes can have a GOR of 3,000 to 9,000
cubic feet per barrel or more.
Production facility costs are sensitive to gas oil ratio (GOR). The facilities required to handle
large volumes of gas can be expensive. The natural question of course is “What constitutes a
high GOR?”
The average GOR for oil in this world based on the J. J. Arps rule of thumb is equal roughly to
reservoir depth divided by 10. A 9000 foot reservoir would then be expected to yield around 900
cubic feet per barrel. Anything above 10,000 is considered getting close to a “gas well”. See
figure F 8.1.
Chapter 9 - Gas
9. Gas
Conventional 616 Tcf

High
Quality
Low
Quality
Unconventional 519 Tcf

Coalbeds
Tight Gas
Devonian Shales
320,000 Tcf
Gas Hydrates
Chapter 9 - Gas
GAS PROJECTS
In international exploration oil and gas are quite different. Gas discoveries are often
noncommercial unless they are quite rich in liquids, close to an existing market, or very large.
There are many giant gas fields that are still waiting on pipe. The difference is not entirely a
transportation issue either. Oil is simply worth more than gas.
T 9.1 Vital Statistics—gas vs. oil

Most Distinguishing Characteristic - Transportation Function
10 BCF gas flared daily worldwide during 1990s
87% of world gas production – Intranational (Not International)
Gas demand growth has centered on stationalry fuels market
World gas production in 1999 – 240 BCFD
International
87% 13%
Intranational
A third of the International gas production is LNG (≈4%)
Half of the world’s 5,000 TCF gas is “stranded” gas
Gas has benefited from three major developments:
1. Air quality concerns

2. Gas deregulation in North America and UK
“the dash for gas” in the UK
3. Combined cycle power generation and its close relative cogeneration.
Combining high-temp gas turbine for power generation +
waste-heat boiler for process steam or additional power.
Source: Portions summarized from: Natural Gas-How Much Competition for Oil?, James T. Jensen
Jensen Associates, Inc., Boston, Massachusetts, USA
Chapter 9 - Gas
T 9.2 Volumetric comparison of oil and gas
The following comparison illustrates the (reservoir) volumetric results of a

drilling prospect if it were to turn out to be a gas discovery instead of an oil
discovery.
Even if there is a gas market and even if gas can be sold at an oil price parity
(6:1) [two big “ifs”], oil is worth more  about twice as much more. [490 vs
254 MMBOE]
Gas Oil
Reservoir Depth (feet) 7,500 7,500
Drainage Area (acres) 5,000 5,000
Zone Thickness (feet) 250 250
Porosity Average 25% 25%
Hydrocarbon Saturation 75% 75%
Pressure Gradient (psi/foot) 0.433
Initial Formation Pressure (psi) 3,248
Gas Compressibility Factor (Z) 0.87
Oil Formation Volume Factor 1.30
Reservoir Temperature (R) 750°
Initial In-place Volumes 1,790 BCF 1,400 MMBBLS
Recovery Factor (Assumed) 85%
Recoverable Reserves 1.52 TCF Gas 490 MMBBLS
Recoverable Reserves
MMBOE (6:1) 254 490
Chapter 9 - Gas
F 9.1 Oil and gas P/R ratio comparison
One of the differences due to market constraints is timing of production. For those
fortunate enough to find a gas market it usually takes longer to get on-stream and
typically gas fields cannot be produced as quickly as oil fields i.e. lower P/R ratios.
Production Rate
P/R Ratios
10-15%
P/R Ratios
2-4%
OIL GAS
Discover Peak Production Start-up

Start-up
Chapter 9 - Gas
T 9.3 Gas development option

LPG Gas Gas Fired Gas to Methanol Fertilizer LNG
Plant Cycling Power Liquids Ammonia Plant
Plant /Urea
LPGs LPGs Electricity Gasoline Methanol Ammonia Liquefied
Product Condensate Condensate and and Methane
Gas Gas is Hydrogen Granulated and Ethane
reinjected Urea
Threshold Field
Size (BCF) 3.000 Big Debate 1,000 1,000 18,000
(To negotiate)
Threshold Field
Size (BCF) 300 – 400 400 – 500 1,500 Big Debate 500 600 5,000
(To feedstock)
Minimum Feed 60 – 80 + 60 – 80+ 167 Big Debate 60 80 900 MMCFD
Gas (MMCFD) 100 450/train
Project Life 10 – 20 yrs 10 – 20 yrs 25 yrs + 25 + 20 years 20 years 25+ years
(Years)
Capacity 60 MMCFD 30 MMCFD 1,000 10 MBLPD 2,000 1,750 17,000 t/d
4,000 BCPD 1,000+BCPD Megawatt tons/day tons/day 6.2 MM t/y
Market Local and Local and Local Grid Local Export Local Export
Requirements Export Export Ship Truck LNG Tanker
Plant Location Local or Local Local Field Local Port City Local Port City
Port City
Plant CAPEX $50 – 60 $75 - 100 $630 - $700 200 - 250 $250 – 300 $300-400 $2-3,000
($MM) (1) 1 train 1 train 2 trains
Annual OPEX $8 $15 $15 – 20 $30 $35 $80
($MM) (2) (?)
Lead Time 3+ years 3 years 2+ years 4 years 5 years 7-10 years
Construction 2+ years 2+ years 2 years ± 3 years 3 years 3+ years
(1) Manufacturing plant only, excludes field development costs, transportation, port facilities, etc.
(2) Excluding depreciation and feedstock costs.
Chapter 9 - Gas
LPG Plants
If the liquid yield from a gas stream is rich enough a stand-alone liquids extraction plant can be
profitable. Dry gas does not work. Liquid yield in the exploration end of the business is usually
quoted in “barrels per million cubic feet of gas”. Typically gas plant engineers speak in terms of
“gallons per thousand cubic feet of gas”.
There is also a difference between liquid yield from well tests and liquid yield from a (more
efficient) gas plant.
For example, if a discovery is tested at a rate of 350 BCPD and 10 MMCFD the liquid yield from
the test is 35 barrels per million. The liquid yield for this same gas stream would likely be on the
order of 60 BBLS/MMCF through a gas plant. It depends on the gas composition.
The products from a gas plant are known as “liquid petroleum gasses” which include:
Propane C3
Butane C4
Condensate C5+
Average liquid yield on test for the various reported discoveries worldwide the past 5 years or so
is around 45 BBLS/MMCF. Anything less than around 30-35 BBLS/MMCF is getting awfuly
lean for possible stand-alone liquids extraction (LPG) plant.
If there is a market for the residue gas it can be sold. Otherwise it must be either flared or re-
injected. Often the only place available for re-injection of the dry gas is in the reservoir from
which it came. This is called “gas cycling”.
Gas Cycling
Gas cycling projects require additional capital for injection wells and compressors. Injection
wells are needed in order to re-inject the residue gas and the gas must be “bucked-up” to slightly
more than reservoir pressure in order to inject it into the reservoir. Injection wells cost money
and compressors are quite expensive. Also, gas cycling requires added operating costs –
relatively speaking. The graph below illustrates the problem.
Chapter 9 - Gas
F 9.2 Liquid yield
Gas Cycling requires added capital costs for injection wells and compressors. Also, the
operating costs per unit increase because the gas plant is still processing the same amount
of gas but liquid yield drops off with the dry gas mixing in the reservoir.
Liquid Yield without re-injection

remains constant until reservoir
reaches “dew point”.
Liquid Breakthrough
Yield
(BBLS/MMCF)
Liquid Yield with re-injection

starts to drop off when dry-gas
breakthrough occurs.
Time →
Gas Fired Power Generation

In the mid 1990s gas fired power generation boomed. It was referred to as the “dash for gas” in
the UK, but it applied elsewhere too. There were a number of reasons for this:
(1) Efficiencies had improved for converting methane to electricity
(2) Costs had come down (for turbines in particular)
(3) Clean burning characteristics of gas
(4) Availability of what often would otherwise have been “stranded gas”.
Throughout the 1990s efficiencies continued to improve and costs kept falling. In the mid 1990s
there was a common rule-of-thumb:
“Take the capacity in megawatts and divide by 5 and you have feedstock
requirements in millions of cubic feet of gas per day.”
So for example, a 500 megawatt plant would require 100 MMCFD to feedstock [500/5 = 100].
Now (2002) the rule is:
Chapter 9 - Gas
“Divide by 6.”
So to feedstock a 500 megawatt plant would now require 83 MMCFD or so—efficiencies have
improved. And, costs have also come down since the mid 1990s. To build a world-class 1,000
mW plant would have cost from $800 MM to 1,200 MM in the mid 1990s. Now that cost might
be closer to $700 MM or so. In the Middle East examples below the average size of gas fired IPP
was 420 mW at a (weighted average) cost of $340 MM. A number of these included seawater
desalination plants.
T 9.4 Middle East power plants
Capacity Cost
Country Project (MW) ($MM)

Israel Coastal 1,159 1,500 Coal Fired
Ramat Hovav IPP 370 200 IEC various plants
Jordan Al-Samra BOO 450 500 Steam-Cycle Project

(Heavy fuel oil)
Aqaba 800 750 Bridas
Oman Salalah IPP 220 225 Gas Fired

Al-Kamil BOO 250-285 120 Gas Fired
(PPA price 4¢/kWh)
Barka BOO IWPP 427 425 Gas Fired
Palestine Gaza IPP 140 150 Combined-cycle
Qatar Ras Lafan BOO IWPP 750 800
Saudi Arabia Jubail BOO 160 150 Co-generation

Abqaiq 126 110-120 3 Frame 6B turbines
UAE Taweelah-A2 IWPP 710 600-700 50 m g/d desal

(Price 2.4¢/kWh)
Jebel Ali IPP 120-150 100 Gas Fired
Jebel Ali CC 880 587 40 m g/d desal
Yemen Marib BOOT IPP 500 300 +$100 MM power line

(Price <3¢/kWh reportedly)
Average Size 420 mW Gas Fired Plants Only

Wtd. Average Cost $340 MM Gas Fired Plants Only
From: Middle East Energy April, 2002 www.platts.com
Chapter 9 - Gas
GTL
Gas to Liquids – Fischer-Tropsch
The GTL-F-T process comprises three basic steps. Gas reformation, the Fischer-Tropsch process
and final product processing. All three of the process steps have been around for a long time,
more than 50 years. Integrating these steps into an economically feasible process has been the
challenge.
Chapter 9 - Gas
F 9.3 GTL Options

GTL Options
Syngas
CO + H2
Stranded Gas Acetic Acid

CH4 +
Formaldehyde
H2 MTBE
F-T
Syncrude Methanol
Fuels/
Ammonia additives
Fuel cells Gasoline

Fuel cells
Green fuels Olefins
Urea DME Polypropylene

Ultra-Clean diesel Acrylonitrile
Jet fuel
Lubricants Polyethylene
Alpha-olefins Ethylene Glycol
Power Alpha-olefins
generation
LPG Diesel fuel
substitute
The first step is conversion of the gas to prepare it for the second step or Fischer-Tropsch
process. Conversion combines natural gas (methane) with oxygen and steam under pressure to
produce a synthetic fuel (syngas = H2 & CO). This step has been considered the most expensive
and technically demanding. Scalability, technical and commercial viability of this step have been
primary constraints to commercialization of GTL.
In the Fischer-Tropsch process the synthetic gas is reacted with a catalyst to produce a waxy
crude. The F-T process variables; temperature, pressure, and catalyst type can be varied to
produce the desired intermediate product or products.
Chapter 9 - Gas
Final product processing is similar to refining, the singular difference being cleaner products.
GTL Products
Fuels: GTL fuels are processed to conform with conventional fuel specifications and some
unique benefits.
F 9.4 GTL vs. conventional fuel properties

GTL Naphtha is highly paraffinic with
Physical GTL
Conventional low concentrations of naphthenes and
Stream Petroleum
Properties Products aromatics. It is ideal for steam cracker
Products
feedstock (mono-olefin production) and
Density, g/ml 60˚F 0.69 0.74 low coking. However, the paraffinic
Sulfur, wt% 0 0.07 nature means low octane (<40) which is
Naphtha
RON Clear <40 67 not suitable as a reformer feedstock for
(full range) N+2A 5 51
gasoline production.
Density, g/ml 60˚F 0.77 0.80
Sulfur, wt% 0 0.12 GTL jet fuels/kerosene have very high
Jet/Kerosene Smoke Point, mm 45 22
Freeze Point, ˚F
smoke points (very little soot) due to
-53 -53
the absence of aromatics and
Density, g/ml 60˚F 0.78 0.84 naphthenes. But, energy density is
Sulfur, wt% 0 0.37 slightly lower than conventional fuels.
Aromatics, LV% <1 29
Diesel Cetane Number >70 56
2.3
GTL diesel has a high cetane number
4.0
Viscosity, 100˚F (cSt)
and is significantly cleaner than
conventional diesel. It is sulfur free and
the absence of aromatics reduces soot. High hydrogen content reduces NOx emissions but also
reduces the energy density (less gas mileage) than conventional diesel.
Threshold field size to feedstock
Assuming the GTL plant produces 30,000 barrels per day, the daily feedstock will be 300 million
cubic feet, roughly 10,000 scf per barrel. Yearly feedstock requirements are roughly 0.1 tcf. The
30 year feedstock requirement is 3 tcf.
Threshold field size to negotiate
We assume that the threshold field size to negotiate should be roughly 2 times the estimated
feedstock requirement, primarily for growth and or added products, and security of supply.
Minimum feed gas
Minimum feed gas is simply the plant daily gas feed requirement. In this particular case the
minimum feed is 300 MMCFD plus operations requirements. Feed requirements range from 8
MCF/BBL to 12 MCF/BBL.
Chapter 9 - Gas
Project life
Assume 25 year plant or project life. With the newer technologies there are going to be concerns
about obsolescence and change requirements.
Capacity
GTL-F-T plant designs today range from 25,000 BLPD to 60,000 BLPD. These mega plants rely
on economies of scale. But Sasol has recently announced that GTL plants as small as 10,000
BLPD can be economically feasible.
Market requirements
GTL-F-T products are readily transported, opening local, regional and export market channels.
Plant location
GTL-F-T processing plants move to the gas fields. In the cases of the large plants, 25,000 BLPD
to 50,000 BLPD, there are only several gas fields in the world with adequate feedstock.
Naturally, a huge gas field located near a port city would be ideal.
Plant costs
Capital costs now for a GTL-F-T plant are roughly $25,000 to $30,000 per barrel of daily
capacity. Mark A. Agee at the 1998 AIChE annual meeting projected that CAPEX costs must be
below $30,000 for GTL plants to be viable.
Chapter 9 - Gas
F 9.5 GTL costs
CAPEX OPEX
Syngas production Operating cost

Capex $6.2/BBL Opex
4.2/BBL
Syngas conversion Feedstock

Capex $3.3/BBL cost $3.8/Bbl
~ 50¢ / MCF
Product upgrade
Capex $0.9/BBL
Total Capex Total Opex

$10 4/BBL $9.0/BBL
Adapted from: Aurther D. Little ‘Gas-to-Liquids Conversion”
Lead time estimates
Lead time from concept to start up is roughly 4 years, construction is half of that, and fully on
line is a total of 5 years.
F 9.6 GTL lead times
Precommissioning
Initial Order long Construction Performance

Discussion lead items move in testing
Assessment Concept Feasibility FEED *

Obtain Detailed EP Construction Startup
Study Study Funding design
1-3 mos 3 mos 6 mos 8-12 mos 3 mos 2 yrs
Year 0 1 2 3 4 5
* FEED = Front End Engineering Design
Source: GTL Task Force (Australia); Syntroleum
Chapter 9 - Gas
F 9.7 GTL Sensitivity analysis—Tornado graph
Gulf coast plant cost ($/DBL) 30,000 15,000
Flat oil price ($/bbl) 15 20
North Slope cost factor 2.0 1.3
GTL liquids premium ($/bbl) 1.5 5.0
O&M cost factor ($/bbl) 7.0 4.5
Cost improvement rate -0.85 -0.70
Federal income tax rate 0.35 0.28
GTL plant efficiency 0.55 0.62
Natural gas BTU (BTU/SCF) 1050 1200
State income tax rate Most likely

0.047 0.030
GTL liquids (BTU/bbl) 5.7 5.7
9.0% 10.0% 11.0% 12.0% 13.0%
Rate of return
Source: Idaho National Engineering & Environmental Laboratory 1999
Chapter 9 - Gas
Qatar GTL Pioneer Plant

Started: 2 July 2001
Location: Ras Laffan Industrial City
Partners: Qatar Petroleum (QP) 51%, and Sasol 49%
Front End Engineering & Design (FEED): US$30 MM, 9 months
Gas source: Qatar’s huge North Field reserves (over 500 TCF)
Project costs: US$800 MM includes
- Site
- Preproduction costs
- Contingency
Startup planned: 2005
Capacity: 34,000 BOPD
Feedstock: 330 MMCFD of lean natural gas (~ 9.7 MCF/BBL)
Products: 24,000 BOPD fuel
9,000 BOPD Naphtha
1,000 BOPD LPG
Capital cost per daily barrel: US$800 MM = $24,000/BOPD
34,000 BOPD
F 9.8 Qatar GTL Pioneer Plant Process
Condensates
Syngas
Natural gas Fischer-Tropsch
production
Waxy crude
Isocracker
Naphtha Fuels
Chapter 9 - Gas
Methanol
Methanol is the alcohol of methane: methyl alcohol – CH3OH. Methane is converted to synthesis
gas, which is a mixture of carbon monoxide and hydrogen gas, and then reassembled into
methanol. It is used as a petrochemical feedstock or as automotive fuel either directly or
indirectly. The indirect use is as a feedstock for methyl tertiary butyl ether (MTBE).
Ammonia/Urea Fertilizer
Natural gas is also the feedstock for the manufacture of ammonia, which is the primary feedstock
for fertilizer known as granulated urea. Ammonia has other uses than as a feedstock for fertilizer
so some plants produce both products: liquid ammonia and granulated (white) urea. A plant that
manufactures just enough ammonia to feedstock the urea plant is known as a “balanced” plant.
The example in table 9.2 is for a balanced plant requiring 80 MMCFD to feedstock a plant
capable of manufacturing 1,000 tons per day of ammonia and 1,750 tons per day of urea.
Liquefied Natural Gas (LNG)
LNG is liquefied methane and ethane (mostly methane or it can be almost exclusively methane).
The liquefying temperature for LNG is –162°C. As a result, processing, storage and
transportation are quite expensive.
A new two-train grassroots LNG facility with offsite requirements and so forth can easily cost $2
billion or more. Adding trains might cost only $400 to 500 MM each taking from 24 to 35
months to complete. Because of this existing facilities have huge cost advantages over grassroots
construction. While plant costs have come down in the past 10 years, the biggest improvements
are in efficiency. A world-class state-of-the-art two-train facility in the mid 1990s would
manufacture roughly 4.3 MM tons per year. Feedstock requirements would be on the order of
600 MMCFD. This comes to roughly 51 MCF per ton which includes fuel. A ton of LNG equals
roughly 47 MCF of gas. By the year 2002 efficiencies improved to the point that a two-train
facility could process 870 MMCFD and manufacture 6.2 MM tons per year.
Chapter 9 - Gas
F 9.9 Comparative costs; LNG, MeOH & GTL
GTL $50 - 150 MM

$900 MM $50 MM /ship
GTL
GTL-FT Plant Terminal
Storage
Feedstock:
300 MMCFD
MeOH $50 - 150 MM

$500 MM $50 MM /ship
MeOH
MeOH Plant Terminal
Storage
Feedstock:
125 MMCFD
LNG $400 – 2,000 MM

$1,500 MM $180 MM /ship
LNG
LNG Plant Terminal
Storage
Regasification
Feedstock:
650 MMCFD
Chapter 9 - Gas
F 9.10 Natural gas flow - 2000
Additions
to storage
2.59
Vented Exports
and flared 0.24 Balancing
0.27 item 0.94
Residential
4.92
From gas
wells Marketed Dry gas
production Commercial
17.70 Gross production
20.15 and industrial
withdrawals 0.75 Consumption 10.71
24.70 22.71
From oil
wells 7.00 Electric
power
Supplemental 6.32
Imports
gaseous fuels
3.73
Nonhydrocarbon 0.10 Transportation
gases removed 0.75
0.54
Extraction Withdrawals
loss 0.93 from storage
Repressuring
3.44
3.74
Source: Energy Information Administration/Annual Energy Review 2000
Chapter 9 - Gas
Exercises
Press releases
Joint Venture
of Nigerian National Petroleum Corp. and Royal
Dutch/Shell plans to capture 475 MMcfd of
associated gas being flared in 31 Niger Delta basin
fields. The $680 million work program is expected How much gas is that in
to be completed by 2007. Nigeria loses gas MMCFD or BCFD?
equivalent of 300,000 b/d to flaring. Government
has targeted flaring elimination by 2010.
O&GJ: Jan. 27, 1997 (pg 39)
Natural Gas Flaring

in India fell to only 7.45% of production in fiscal How much are they
1995-96 from 38.33% in 1985-86. At least 159 flaring now?
MMcfd is being flared in the country.
O&GJ: Oct. 7, 1996 (pg 47) How much were they
flaring?
Chapter 9 - Gas
NGLs, LPGs and gas processing—press releases
TransTexas Gas Corp.,

Houston, will construct a $42 million, 750 MMCFD inlet
capacity natural gas liquids processing plant in the Agua
Duice area of Nueces County, Tex., to meet increasing How rich is this gas?
NGL demand. Plant, to be served by the company's 20-in.
and 30-in. pipeline systems, will produce about 40,000
b/d of NGL.
O&GJ: Jan. 6, 1997 (pg 28)
Enron Corp.
was chosen to negotiate with state owned Petrovietnam to
jointly develop, own, and operate a $161 million, 96
MMcfd gas processing plant south of Ho Chi Minh City
in Ba Ria-Vung Tau province.
O&GJ: Jun. 17,1996 (pg 23)
Amoco Corp.
will build a 400 MMcfd, $80 million cryogenic gas
processing plant in Grant County, Kan ......
The plant will recover essentially all liquids from the gas
stream and about 80% of the ethane, while stripping
98% of the helium and cutting nitrogen to about 3% from
14-17%.
O&GJ: Jun. 17, 1996 (pg 22)
Noble Affiliates Inc.,

Ardmore, Olka., started up an LPG plant in Equatorial
Guinea. Feed for the complex is from Alba field, in
which Noble has a 35% working interest. Initial
production is 1,700 b/d of LPG and 400 b/d of
condensate. Plant capacity is about 2,400 b/d of LPG.
O&GJ: Feb. 10, 1997 (pg 33)
Chapter 9 - Gas
Fertilizer—press releases
China's
Daquing Lianyi Petrochemical (DLP) plans a $130 million (U.S.)
fertilizer plant at Medicine Hat, Afta Plant capacity is planned at
860,000 metric tons/year of urea and ammonia.
O&GJ: Jan. 6, 1997 (pg 29)
Morocco’s
Cherffien des Phosphated (OOP) and Pakistan's Al Noor
Fertilizer Industries Ltd. have signed a $220 million joint-venture What is wrong with this?
agreement to build a fertilizer plant at Karachi. The plant is Compare to the above
scheduled to come on stream in 1998 and have a capacity of release.
1,200 metric tons/year of urea and 955 tons/year of ammonia.
O&GJ: Nov. 4, 1996 (pg 46)
Chapter 9 - Gas
Cogeneration
Australian Gas Light Co.

and Alise Energy Australia will buy an estimated $1 billion
(Australian) of natural gas during a 20-year term from Santos
$1 AU/.78 US
Ltd., Adelaide, Australia, for a planned $250 million (Australian)
350,000 -kw Sidney cogeneration plant, The plant, which will use
Cooper gasin gas as feedstock to generate electricity, is to be
operational in 1999, and the contract will extend from that time.
O&GJ: Nov. 11, 1996 (pg 46)
British Columbia
selected Island Cogeneration Project (ICP) to build a
cogeneration plant at Fletcher Challenge Canada Ltd.'s Elk Falls
$1 CA/.73 US
pulp and paper mill near Campbell River, B.C. The project, to
cost more than $200 million (Canadian), will use about 42
MMcfd of gas to generate 240,000 kw of electricity for B.C.
Hydro. Also, it will process steam for the mill.
O&GJ: Nov. 11, 1996 (pg 47)
Chapter 10 - Refining and Marketing
10. Refining and Marketing
Boiling
Temp. ºF Product recovered Sent to:
<90º Butanes & lighter Light ends unit
90 – 200 Light straight naphtha Gasoline blending
200 – 360 Naphtha Catalytic reforming
360 – 450 Kerosene Hydrotreating
450 – 650 Distillate Distillate fuel blending
650 – 1000 Heavy gas oil Fluid catalytic cracking
>1000 Residuum Coking
Industry overview
On January 10, 2002, Valero Energy Corporation announced that they were going to upgrade
their Texas City Refinery. The upgrade comprised the construction of a new 45,000 barrel-per-
day delayed coker facility allowing them to process a heavier, more sour crude oil feedstock
slate. The $300 million project is expected to be completed in 2004. Upon completion of the
coker, 90,000 BPD of additional Maya crude feedstock will be supplied to the Texas City
Refinery bringing the total to 170,000 BPD.
The Texas City Refinery upgrade will reduce their dependence on more expensive long-haul
crude, lowering the refineries feedstock costs by as much as $1 per barrel. This is an example of
one of the industries trends—a shift to more complex and expensive refineries to handle less
expensive crude feedstocks.
Refineries are also under severe pressure to improve the properties of their product slates. This
too adds to the complexity and cost of refineries.
There hasn’t been a refinery built in the U.S. in over 20 years.
F 10.1 The modern refinery
Sulfur
Sulfur
Recovery
Light Petroleum Propane

Gas Treating
Fuel Gas for
Refinery Use
Aromatics Benzene
Chemical and
Naphtha
Gasoline P-Xylene
Hydrotreating
Reforming (Paraxylene)
Jet Motor
Hydrotreating Gasoline
Diesel Aviation
Gas Oil Jet

Hydrocracking
Alkylation
Catalytic
Cracking
Diesel
Gas Oil
Hydrotreating
Bunker (Ship)
Fuel
Resid
Processing Petroleum
Coke
F 10.2 Gasoline refinery processes
Sulfur
Sulfur
Recovery
Light Petroleum Propane

Gas Treating
Fuel Gas for
Refinery Use
Aromatics Benzene
Chemical and
Naphtha
Gasoline P-Xylene
Hydrotreating
Reforming (Paraxylene)
Jet Motor
Diesel Aviation
Gas Oil Jet

Hydrocracking
Alkylation
Catalytic
Cracking
Diesel
Gas Oil
Hydrotreating
Bunker (Ship)
Fuel
Resid
Processing Petroleum
Coke
1912 ushered in a new generation of refineries—it was then that the demand for gasoline
outstripped supplies from refineries geared to produce kerosene and fuels oils. Prior to that date,
some refiners viewed gasoline as an unwanted byproduct, often disposed of in rivers.
From that time on, processes were added to supplement the straight run gasoline output and
improve the quality of the gasoline output.
Crude oil is made up of thousands of different chemical compounds or components. The major
classifications of the components are paraffins, naphthenes and aromatics. Processing of the
crude produces two major output classifications, fuels and non-fuels, and those processes can be
grouped into four categories:
Separation
Desalting Cracking types
Distillation
Light ends unit Thermal Catalytic
Dewaxing
Deasphalting Steam Fluid cat cracking
Visbreaking Hydrocracking
Conversion Coking
Hydrocracking
Visbreaking
Catalytic cracking
Alkylation
Reforming
Coking
Finishing
Blending
Hydrotreatment
Support
Sulfur recovery
Hydrogen production
Separation
Desalting
Crude oil is desalted with water to remove NaCl and then sent to the atmospheric distillation unit
(ADU).
Distillation
Distillation separates the crude oil into fractions based on the boiling temperatures of the
components in the crude oil. Also referred to atmospheric distillation unit or ADU.
F 10.3 Distillation tower – atmospheric distillation

Condenser
Vapor
Reflux Separator Drum
Molecular Size
Gasoline C5 – C10 Gas
Kerosene C11 – C13 215ºF End Point
Diesel fuel C14 – C18 Unstabilized
Gas oil-Heavy gas oil C19 – C25 Straight Run
Gasoline
Lubricating oil C26 – C40
C5 – C8
Residuum >C40
Reboil Heat
235ºF – 385ºF
Naptha
C9 – C10
Steam
340ºF – 550ºF
Kerosene or Light
Gas Oil
Bubble Caps C11 – C13
Diesel
C14 – C18
Liquid Downflow Steam
510ºF – 710ºF
Vapors
Gas Oil
C19 – C20
Furnace
10% @ 560ºF
85% @ 700ºF
Heavy Gas Oil
C22 – C25
Crude
Oil
Steam
Fuel
Line
Straight Run
Residue to
Vacuum
Distillation
Dewaxing
Dewaxing removes n-paraffinic wax from lubricating oil to improve temperature characteristics,
especially to lower cloud point and pourpoint.
De-asphalting
De-asphalting produces asphalt as a final product, and removes asphaltenes to prevent coke
buildup on catalysts downstream.
Conversion
Hydrocracking
Hydrocracking is similar
to fluid catalytic
cracking (FCC) but uses
a different catalyst,
lower temperature,
higher pressure and H2. Hydrocracking
It takes heavy oil and
cracks it into gasoline
and kerosene.
N S C H
Visbreaking
Visbreaking takes residuals, bottoms, from the distillation tower. The residual is heated (900˚F),
cooled with gas oil and rapidly burned (flashed) in a distillation tower. It is a mild form of
thermal cracking. The process reduces the viscosity of heavy weight oils and produces tar. It
provides feedstock for the catalytic cracking unit, reduces fuel oil production, the least valuable
of a refineries products.
Catalytic cracking
Fluid catalytic cracking
uses a hot fluid catalyst,
1000˚F and cracks heavy
gas oil into diesel and
gasoline.
Catalytic
Cracking
C H
Alkylation
Alkylation produces gasoline-range
materials from C3 and C4 hydrocarbons.
The reactors are operated at low
temperatures, and pressures to allow
evaporation of the hydrocarbons in the
reactor. Strong acid catalysts, sulfuric Alkylation
acid (H2SO4), 40 - 60˚F, or hydrofluoric
acid (HF), 80 - 110˚F, catalyze the
feedstock.
C H
Catalytic reforming
Catalytic reforming converts alkanes and
cycloalkanes into benzene and other
aromatic compounds. It provides
important raw materials for large-scale
synthesis of other classes of compounds.
Catalytic reforming is a principle resource Reforming
for meeting octane demands, although
aromatics in general and benzene in
particular are being reduced.
C H
Coking
Coking units process heavy feed stocks like vacuum resid, atmospheric resid, tar sands bitumen,
heavy whole crudes, deasphalt bottoms, or cat plant bottoms and produces lower boiling
hydrocarbon products suitable for further processing, and coke.
Finishing
Blending
Blending of gasoline is a continuous operation. Under computer control, gasoline
components are fed to a blending manifold, and in some cases the manifold output, gasoline,
can feed directly into distribution pipelines.
Hydrotreating
Hydrotreating refers to a process that improves a feedstock by passing it over a catalyst in the
presence of hydrogen to remove sulfur. It is also used to remove nitrogen and aromatics.
Support
Sulfur recovery
Sulfur recovery is the removal of sulfur, H2S, from a gas stream. The Claus process combusts a
portion of the H2S to SO2 by limiting the air input, combines it with the remaining H2S and
passes it over a catalyst bed/s to form molten sulfur.
Hydrogen manufacture
Hydrogen is manufactured today by steam reforming of natural gas, LPG, or naptha. In a steam
methane reformer (SMR) steam and methane are mixed and passed over a catalyst at 1500°F
forming carbon monoxide and hydrogen.
A second step adds additional steam and another catalyst at 650°F producing carbon dioxide and
hydrogen.
A solvent extraction process strips off the carbon dioxide and a concentrated hydrogen stream is
produced.
Further processing, methanation, can be added to eliminate trace amounts of carbon dioxide or
monoxide by utilizing yet another catalyst at 800°F.
Nearly half of U.S. refineries have closed since 1980 after the “entitlements” program ended.
Petroleum product demand fluctuations and conservation measures forced many small or
inefficient refinery shutdowns. The following briefly shows the many pressures refineries have
seen in the last three decades:
Deteriorating crude oil quality

Changes in product demand
Regulatory demands affecting products
Regulatory demands affecting refinery emissions
It is not over, the refinery industry is presently facing a number of additional regulatory hurdles:
Tier II Gasoline Sulfur – Between 2004 and 2006, gasoline sulfur content must be reduced by
90% over current levels.
California MTBE Ban – California wants methyl tertiary butyl ether (MTBE) phased out by
end 2002.
MTBE Blue Ribbon Panel Recommendations – EPA’s Blue Ribbon Panel on MTBE has
recommended:
- Comprehensive improvements to Underground Storage Tank program
- Safe Drinking Water Act and other water quality improvements
- Substantial reduction in the use of MTBE in gasoline
- Elimination of 2% oxygen content mandate for reformulated gasoline
Regional Haze – States are developing plans to reduce air pollutants that contribute to poor
visibility in 156 national parks and wilderness areas.
On-Road Diesel Fuel – EPA adopted regulations to reduce sulfur content of highway diesel fuel
from 500 ppm to 15 ppm by end 2006.
Gasoline Air Toxics – EPA expected to finalize mobile source air toxics standard, expected to
focus on benzene emissions from gasoline.
Refinery MACT II – A rule was expected November, 2000 requiring reduced emissions from
catalytic crackers, catalytic reformers and sulfur plants.
Section 126 Petitions – Northeastern states are pressuring 392 facilities in other states, including
refineries, to reduce nitrous oxide (NOx) emissions that contribute to ozone nonattainment in the
Northeastern states.
New Source Review Enforcement Initiative – EPA is targeting refineries that have not
complied with the New Source Review (NSR) program.
Climate Change – The U.S. had agreed to a 7% reduction in greenhouse emissions between
2008 and 2012 (Kyoto Protocol).
Residual Risk – Following implementation of technology-based standards controlling toxic air

pollutants, the EPA is required to assess the residual risk. Refineries are currently subject to
several of these standards and may be forced to undertake additional emission controls.
Urban Air Toxics – Gasoline distribution and oil and natural gas production facilities have been
identified as area sources and will be required to meet new standards for reducing toxic
emissions in urban areas.
Complexity index indicates refinery capability, value

Refinery size is usually measured in terms of distillation capacity. Relative size, however, can be
measured using refinery complexity – a concept developed by W.L. Nelson in the 1960s.
A review of complexity calculations, and an explanation of how indices have changed, provides
a simple means of determining the complexity of single refineries or refining regions. The
impact of complexity on product slate also is examined.
The Nelson Complexity Index

W. L. Nelson developed the complexity index to quantify the relative cost of components that
make up a refinery. It is a pure “cost index” that provides a relative measure of the construction
costs of a particular refinery based on its crude and upgrading capacity.
The Nelson index compares the costs of various upgrading units – such as a fluid catalytic
cracking (FCC) unit or a catalytic reformer – to the cost of a crude distillation unit. Computation
of the index is an attempt to quantify the relative cost of a refinery based on the added cost of
various upgrading units and the relative upgrading capacity.
Nelson assigned a factor of one (1) to the distillation unit. All other units are rated in terms of
their cost relative to this unit.
For example, assume a crude distillation unit costs $400 per B/CD to construct. That is, a 50,000
B/CD unit would cost $2,000,000 ($400/B/CD X 50,000 B/CD). If another component costs
$1,200 per B/CD to build, it would have a complexity factor of 3. Each unit has a complexity
factor related to the construction cost as it compares to the cost of the distillation unit.
The complexity rating of a refinery is calculated by multiplying the complexity factor for each
downstream unit by the percentage of crude oil it processes, then totaling these individual
factors. To illustrate, consider the case of a refinery with 50,000 B/CD of crude capacity and
30,000 B/CD of vacuum distillation capacity.
The throughput of the vacuum tower relative to the crude distillation capacity is 60%. Given a
vacuum unit complexity factor of 2, the contribution of the vacuum unit to overall refinery
complexity is 2 x 0.6, or 1.2. Distillation is by definition = 1, so overall complexity is = 2.2.
Offsite facilities
The method outlined here for estimating the complexity index for refinery processing units is not
able to account for offsite facilities such as storage tanks, land, pipelines, terminals, and utilities.
This information is seldom published.
Nelson evaluated the relationship between different refineries and the associated off site facilities
and developed a relationship for empirically estimating "total" refinery complexity including
processing complexity and off site facilities.
T 10.1 Nelson Complexity Multiplier

Regular Total
Complexity Multiplier Complexity
  
3 3.25 9.8
4 2.70 10.8
6 2.26 13.6
10 1.96 19.6
16 1.77 28.3
Source: W. L. Nelson, Oil & Gas Journal, Sept., 20, 1976, p. 204.
The total complexity is rarely used or quoted. Most analysts focus on the processing complexity
or "regular complexity" as Nelson referred to it.
This calculation implies that, for a grassroots refinery with an index of 10, the cost of the off site
facilities would rival that of the distillation and upgrading facilities.
Equivalent distillation capacity (EDC)

Equivalent distillation capacity is another means of comparing refinery costs. In this calculation,
the atmospheric distillation capacity of a refinery is multiplied by its overall complexity rating.
For example, a 75,000 B/CD refinery does not necessarily have half the processing capability of
a 150,000 B/CD refinery. If the smaller refinery has a complexity index of 9 and the larger plant
an index of 4, the EDC for the 75,000 B/CD refinery is greater than that of the 150,000 B/CD
refinery.
The smaller refinery has an EDC of 675,000 (75,000 x 9), and the larger refinery has an EDC of
600,000 (150,000 x 4). In other words, the 75,000 B/CD refinery is “larger,” in terms of
construction costs, than the 150,000 B/CD refinery.
The approach outlined here for evaluating refinery cost complexity is helpful for estimating
refinery values, but should be treated as a starting point. The Nelson complexity index (NCI) is a
convenient and useful number, and, certainly, any estimate of refinery value should address the
issue of complexity.
Refinery value, however, should be considered within the context of other data. For example,
two similar refineries, one operating at 75% capacity and the other at 90% capacity, will have
significantly different values.
T 10.2 Generalized refinery complexity indices 1998 +
1998+ Spreadsheets Generalized

Complexity
Refining Process Index
 
Distillation Capacity 1
Vacuum Distillation 2
Thermal Processes 2.75
Coking 6
Catalytic Cracking 6
Catalytic Reforming 5
Catalytic Hydrocracking 6
Catalytic Hydrorefining 2.5 Hydrorefining and “treating” have
Catalytic Hydrotreating 2.5 been combined in latest
O&GJ Data.
Alkylation/Polemerization 10
Aromatics/Isomerization 15
Lubes 60
Asphalt 1.5
Hydrogen (MCFD) 1
Oxygenates (MTBE/TAME) 10.0
 
Source: W. L. Nelson, The Concept of Refinery Complexity, Oil & Gas Journal -- Sept. 13, 1976
Changes in indices
The generalized complexity indices, shown in table T 10.2, have not changed dramatically over
the years. Building an FCCU still costs 5-7 times as much, on a $/B/CD basis, as building an
atmospheric distillation unit. The generalized indices provide a quick, close estimate.
Detailed analysis of refinery complexity can be done with specific indices for 50 or so refining
processes. An excellent study of refinery construction costs was given by Maples (bibliography).
There are eight separate processes for catalytic hydrotreating, for example, all of which are
treated in table T 10.2 as though they have an index of 2.5. Based on the construction costs,
however, a 30,000 B/CD hydrotreater can range in cost from $16 MM to $37 MM, depending
upon the feed.
The indices for these units range from 1.4 to 2.2. A weighted average of 2, however, seems to
work well.
Thermal processes, on the other hand, are broken into five categories, as shown in table 10.3.
Although the complexity of these units ranges from 2 to 6, they are given a weighted average
complexity of 5.
The distribution of these units is:
Thermal cracking (NCI =3.0) and visbreaking (NCI = 2.5) comprise 6% of U.S. thermal
processing capacity and 68% of non-U.S. thermal processing capacity and 68% of non-
U.S. thermal processing capacity.
Delayed and fluid coking (NCI = 6) and other thermal processes (NCI = 6) comprise 94%
of U.S. thermal capacity and 32% of non-U.S. thermal capacity.
It is clear from these data that the configuration of U.S. refineries is very different from non-U.S.
refineries. This difference illustrates how complexity calculations can be used for regional
comparisons.
In the Oil & Gas Journal Energy Database pre 1997 spreadsheets, Thermal Processes were once
broken out into 5 categories for individual refineries but treated as a single category for the state-
by-state and country-by-country summaries:
T 10.3 Thermal operations, categories, and distribution
 Distribution 
Thermal Operations NCI US Other
   
1) Thermal Cracking 3.0
2) Visbreaking 2.5 5% 68%
3) Fluid Coking 6
4) Delayed Coking * 6
5) Other 6 95% 32%
   
Weighted Average ** 5.8 3.8
* Delayed Coking is the most common thermal process used in the US. Thermal
Cracking and Visbreaking account for approximately 4.6% of thermal Processes in the
US--only 9 refineries have Thermal Processes with an index of 1 or 2. Approximately
12.3% of distillate from US refineries is run through Thermal Processes.
** This weighted average can be used for the state-by-state and country-by-country
averages based on throughput capacities. Of thermal processes only about 6% in the US
falls under categories 1 & 2 (Thermal cracking and Visbreaking). Outside the US the
trend is substantially different.
Categories 1 and 2 are now reported together separately from the coking operations.
Refinery cost and value

The average complexity rating for a refinery in the United States is 9.5. A refinery with a
complexity of 12 should cost about 26% more to build than a similar sized refinery with a
complexity index equivalent to the U.S. average, all other things being equal. Even if they were,
the relationship is not perfect.
The NCI provides insight into not only complexity, but also refinery replacement costs and
values.
These value estimates generally are consistent with the refinery transactions and valuation
appraisal trends of the late 1980s and early 1990s in the U.S. Part of the decrease in refinery
values over this period was a result of the Clean Air Act Amendments of 1990. The other key
reason is that current and anticipated margins are too slim.
Refinery utilization, however, has been increasing. This increase has had a positive effect on
refinery value. Capacity utilization can be expected to continue to increase in the U.S. because it
is hard to keep pace with demand by expansion alone, and grassroots construction is unlikely.
Estimates of refinery value should be considered an educated guess. The difference between fair
market value and replacement costs, for U.S. refineries, illustrates the reason for lack of
grassroots refinery construction.
Product slate
The advantage of higher-conversion refineries is that they turn out more high-value products.
Fully 50% of a typical U.S. high-conversion refinery output is gasoline. Furthermore, because of
cracking, the volumes of petroleum products can exceed total crude oil runs by as much as 5-
10%.
By contrast, a refinery with an index of 3-5 likely will have volumetric contraction: 100,000
B/CD in and 95,000 B/CD out, for example. Added value and volumetric expansion are the bases
for justifying the additional capital and operating expenditures required for high-conversion
facilities.
Typical yields from low, medium, and high-conversion refineries are:
Low-conversion (NCI = 2-3) – 20% gasolines, 35% middle distillates, 30% fuel oil, 10%
other products (including refinery gas, LPG, solvents, coke, lubes, wax, and bitumen),
and 5% loss.
Medium-conversion (NCI = 5-6) – 30% gasolines, 30% middle distillates, 30% fuel oil,
15% other products, and 5% gain.
High-conversion (NCI = 9-10+) – 50% gasolines, 30% middle distillates, 15% fuel oil,
15% other products, and 10% gain.
Future
The total world refining capacity of about 74 million B/CD has an overall complexity index of
5.9. The trend of increasing conversion capability will pull up the complexity index as world
demand for lighter products increases.
Refining capacity utilization (less than 70% in the early 1980s) reached 87% in the early 1990s.
Yet margins still are too tight to encourage much grassroots refinery expansion.
Economy of scale
The optimum size for a U.S. refinery is at least 100,000 B/CD of atmospheric distillation
capacity. This is slightly larger than the U.S. average of about 91,000 B/CD. The closing of
many small refineries has caused this average to increase from its late – 1980s level of 80,000
B/CD.
Smaller refineries, especially those with less than 50,000 B/CD capacity, have a tough time
competing. Larger plants have greater economy of scale, and can survive longer in lean periods,
when margins are narrow. Small refineries usually are able to survive these periods only when
geographically or politically insulated.
Nelson was careful to point out that the cost of a 50,000 B/CD refinery with a complexity of 12
would not necessarily be the same as that of a 100,000 B/CD refinery with an index of 6. Many
other factors are involved.
The information normally used to calculate refinery complexity does not indicate the number of
units that comprise each refiner’s capacity of a particular process. In other words, total capacities
usually are given, rather than the number of units and each unit’s capacity.
Small units have relatively higher per-unit construction costs. Nelson estimated that a duplication
of units such as two 40,000 B/CD units instead of one 80,000 B/CD unit would increase the
construction costs by a factor of 25%. Four units rather than one would increase costs by a factor
of 60%.
Nelson reported that the amount of duplication for larger (300,000 + B/CD) refineries averaged
2.7 units for each process. This value compares to an industry average of 1.5 units for each
process.
Table 10.1 shows the general indices for the various refinery processes. The categories in this
table coincide with those published annually by Oil & Gas Journal (see bibliography).
As an example, the complexity of Kuwait National Petroleum Co.’s Mina Abdulla refinery is
calculated in Table 10.2. This refinery has a rated capacity of 242,000 B/CD and a complexity
index of 7.
This technique can be used to analyze the complexity of a single refinery, or the complexity of a
country or region. Table 10.3 outlines the processing capacities and overall complexity index for
Japan’s refineries.
Worldwide refining complexity is summarized in Table 10.6.
T 10.4 Kuwait Mina Abdulla Refinery (1/1/2002)
Process
Capacity Complexity
Refining Process B/CD * % Rating Index
    
Distillation Capacity 256,500 100 1 1.00
Vacuum Distillation 142,500 56 2 1.11
Thermal Operations (1) 68,000 27 6 1.59
Catalytic Cracking 0 6
Catalytic Reforming 0 5
Catalytic Hydrocracking 36,000 14 6 .84
Catalytic Hydrorefining 71,550 28 3 .84
Catalytic Hydrotreating 99,900 39 2 .78
Alkylation/Polymerization 0 10
Aromatics/Isomerization 0 15
Lubes 0 60
Asphalt 0 1.5
Hydrogen (MCFD) 238,000 93 1 .93
Oxygenates (MTBE-TAME) 0 10
    
Estimated Nelson Complexity Index 7.09
Equivalent Distillation Capacity (B/CD) = Distillation Capacity * NCI
= 256,500 * 6.50
= 1,668,350 B/CD
* Processing capacity information from: Oil & Gas Journal Dec. 24, 2001
(1) Thermal operations at the Mina Abdulla refinery all have an index of 6.
T 10.5 United States refinery capacity (1/1/2002)

Process
Capacity Complexity
Refining Process B/CD * % Rating Index
    
Distillation Capacity 16,564,483 100 1 1.00
Vacuum Distillation 7,424,840 45 2 0.90
Thermal Operations 64,150 0 3.8 0.01
Catalytic Cracking 5,608,830 34 6 2.03
Catalytic Reforming 3,497,944 21 5 1.06
Catalytic Hydrocracking 1,474,020 9 6 0.53
Catalytic Hydrorefining 6,731,766 41 3 1.22
Catalytic Hydrotreating 4,290,840 26 2 0.52
Alkylation/Polymerization 1,150,270 7 10 0.69
Aromatics/Isomerization 1,008,388 6 15 0.91
Lubes 174,450 1 60 0.63
Asphalt 493,240 3 1.5 0.04
Hydrogen (MCFD) 3,617,000 22 1 0.22
Oxygenates (MTBE-TAME) 126,004 1 10 0.08
    
Estimated Nelson Complexity Index 9.85
Equivalent Distillation Capacity (B/CD) 163,134,151
* Processing capacity information from: Oil & Gas Journal Dec. 24, 2001
The weighted average index of 3.8 was used for Thermal Processes. Different
values would yield very little change in the overall index.
Number of Refineries 143 Average size 115,836 B/CD
T 10.6 Worldwide refinery complexity 1995

Distillation Nelson Equivalent Average Average
Regin No. of capacity Catalytic Catalytic Complexity distillation refinery EDC
refineries B/CD cracking reforming Index capacity size 1,000
B/CD B/CD B/CD B/CD
_____________________________________________________________________________________________________________________
Middle East 49 6,147,420 309,440 635,973 4.2 25,747,457 125,458 525

Latin America 80 6,384,930 1,319,654 402,360 4.7 30,079,429 79,812 376
Africa 44 2,806,971 173,580 331,348 3.3 9,245,757 63,795 210
Europe 116 14,511,763 2,215,010 2,275,858 6.5 94,280,399 125,101 813
Asia 135 14,675,291 2,209,105 1,654,269 4.9 71,467,873 108,706 529
C.I.S. 56 10,060,951 526,571 1,247,587 3.8 38,353,278 179,60 685
Other 32 2,671,694 321,334 366,504 5.3 14,283,870 83,490 446
Canada 23 1,848,450 379,000 349,500 7.1 13,204,820 80,367 574
U.S. 169 15,354,140 5,283,450 3,623,193 9.5 145,732,015 90,853 862
World Total 705 74,451,610 12,737,144 10,886,592 5.9 442,394,898 105,605 628
_____________________________________________________________________________________________
Source: Oil & Gas Journal (see bibliography)
T 10.7 Refinery complexity

Number Typical Average Cost to Build
of (1) Size (2) (3) Complexity
Process Projects (B/CD) $MM $/B/CD Index
Distillation 19 100,000 $38 $380 1.0
Vacuum Distillation 8 60,000 $30 $500 1.3
Visbreaking 7 25,000 $24 $960 2.5
Delayed Coking 8 20,000 $46 $2,300 6.1
Flexicoking N/A 20,000 $46 $2,300 6.1
Catalytic Cracking 18 50,000 $86 $1,720 4.5
Heavy Oil Cracking “Few” 30,000 $93 $3,100 8.2
Hydrocracker N/A 30,000 $95 $3,167 8.3
Gas Oils N/A 30,000 $16 $533 1.4
Kero/Diesel N/A 30,000 $25 $833 2.2
Cat Feed N/A 30,000 $37 $1,233 3.2
Naptha N/A 30,000 $16 $533 1.4
Catalytic Reforming N/A 30,000 $45 $1,500 3.9
Notes:
(1) In past 14 – 20 years in the US only.
(2) Normalized to average/typical size.
(3) Normalized to 1991 using Nelson – Farrar construction cost indices.
(1), (2), and (3) Summarized from: Maples, R. E., “Petroleum Refinery Process Economics”
PennWell Books, Tulsa, OK, 1993 and from 2nd Edition 2000
T 10.8 3 – 2 – 1 Cracked Spread example
In this example we are assuming gasoline and No. 6 Fuel oil are the outputs of the
refinery. We are also assuming that twice as much gasoline is produced than fuel oil. In
other words, 3 barrels of crude oil “in” produces 2 barrels of gasoline and 1 barrel of No. 6
Fuel oil.
(A) Gasoline 87 Octane $23.31
(B) No. 6 Fuel Oil (1% S) $12.75
(C) Wtd. Avg. products X = ((A * 2) + B)) / 3
(D) U.S. Imports $15.34
(E) Cracked Spread Y = C-D
OGJ Cracked Spread

1-3-97 1-5-96
- - - $/BBL - - -
Product value $29.46 $23.83
Brent crude $24.13 $19.08
Crack spread $5.33 $4.75
Source: O&GJ: Jan. 13, 1997, (pg 68)
T 10.9 Refinery Cash Margin Calculation

East Coast Refinery Using Brent Crude Oil Summer 1995
Volume Revenues
Price (Fraction of ($/Barrel
($/Barrel) Crude Charge) Crude Charge)
LPG 14.12 .061 0.86

Naphtha 19.31 .026 0.50
Premium Gasoline Conventional 23.27 .065 1.52
Regular Gasoline Conventional 21.28 .131 2.78
Revenues
Premium Gasoline RFG 24.58 .131 3.21

Regular Gasoline RFG 22.90 .261 5.98
Jet Fuel 20.56 .090 1.85
No. 2 Heating Fuel 19.55 .055 1.08
Diesel Fuel - Low Sulfur 20.35 .111 2.26
No. 6 Fuel Oil - 1.0% S 15.39 .156 2.40
Total NA 1.115 22.87
Crude Oil FOB Cost 16.05
Cost
Crude Transportation Cost 0.92

Other Feedstock Cost 2.48
Revenues minus Feedstock Cost 3.42
Steam Cost 0.05
Cooling Water Cost 0.11
Variable cost
Electric Power Cost 0.22

Catalyst, Chemicals Cost 0.14
Total Fuel Burned 0.61
Total Variable Cost 1.13
Other Operating Cost 0.43
Net Margin 1.87
F 10.4 Refinery cost/value
$/BOPD
10,000
9,000
8,000
7,000
6,000
Replacement Value
5,000
4,000
FMV*, mid 1980s
3,000
2,000
FMV*, early 1990s
1,000
0
0 1 4 8 12 16
* Fair Market Value Nelson complexity index
F 10.5 Gasoline yield as a function of NCI
Gasoline
Yield %
100
90
80
70
60
50
40
30
20
10
0
0 1 4 8 12 16
* Fair Market Value Nelson complexity index
F 10.6 United States petroleum flow, 2000
(Millions Barrels per Day)
Other Refined Refined

Liquids Products Products
0.85 Imports Exports
Crude Oil Domestic Imports 1.57 0.94 Residential
Exports 0.25 0.59 0.85
0.05
1 3 Commercial and
Motor
Crude Oil Industrial 5.10
Gasoline
Imports Crude Oil Refinery 8.36
8.93 Refinery Output
Input 17.25
15.08
Distillate Petroleum
Crude Oil Fuel Oil Consumption
Refinery
Supply 3.70 19.48
Input Liquefied
14.77 Transportation
Crude Oil 16.30 Petroleum 2.18
12.99
Production Gases 4
5.83 Jet Fuel 1.70
Residual 0.83
Fuel Oil
Other 2.69
2
Crude Oil Refined
Stock NGPL Product
Processing Stock Electric
Change Refinery NGPL
Gain 0.95 Fuel Ethanol Change 0.01 Power
and losses Input Direct
and Motor 0.53
0.36 0.37 Use 1.54
Gasoline
Blending
Components
0.21
Source: www.eia.doe.gov
1 Imports = 62.6% of Crude Oil Supply

2 Processing Gain 5.8% due to Cracking
3 Notice Motor Gas (with jet fuel) = 48.5% product slate
4 Oil is primarily a ‘Transportation Fuel’
Service Stations
Gas Stations and Marketing Outlets
The distribution and marketing segments of the industry were subjected to widespread
realignment due to mergers in the 1980s. For example, the Chevron-Gulf merger resulted in
situations where the new company had two stations (a Gulf and a Chevron station) at the same
intersection, just across the street from each other.
Self-service was practically nonexistent in the 1960s. By 1975 self-service accounted for 22% of
total gasoline sales. By 1989, self-service accounted for 80% of sales throughout the United
States, although self-service is illegal in New Jersey and Oregon.
In metropolitan areas, major oil companies typically market their products through company-
owned outlets. In rural areas, the major companies will often sell through brand-name stations
leased or by jobbers. Jobbers are independent businesses that market gasoline and products either
through brand name or non-brand name stations. The gasoline marketing industry is rapidly
expanding its base to include the convenience store and special services, such as car washes and
car-care centers. Modernization is taking place, particularly with the new point-of-sale credit
card terminals at the gas pumps.
True service stations receive 50% or more of their business from gasoline sales. Revenues for
them range from $600,000 to $1,200,000. The average of annual sales was $900,000 from 1984
to 1988. In 1989, this average increased to $1 MM. There were 105,561 service stations in 1987,
with an average of six employees per station. In 1990, the number of stations had risen to
111,657.
Valuation of a gas station, or a marketing network consisting of a number of stations, is difficult

because the profitability of this segment of a company, if it has one, is seldom reported
separately. However, there are some guidelines for making an estimate of value.
There are many considerations that cannot be determined from a typical annual report or 10-K.
Value depends on the average markup on the gasoline, and this can be strongly influenced by
full-service facilities. Other factors to consider, if the information is available, are whether the
property is owned or leased, the primary term of the lease, type of dealership, and size and
location of the facilities. The value of the real estate can be an overriding factor. Additional
income generating activities would add value to a gas station business.
A small service station may pump 55,000 to 75,000 gallons per month. The average is around
100,000 gallons per month. Volume pumpers may sell 200,000 to more than 300,000 gallons per
month.
Gasoline retailers make $0.03 to $0.06 net profit per gallon. Assuming a station sells 100,000
gallons per month, this yields an annual profit on gasoline sales of $36,000 to $72,000.
Assuming the value of the station ranged 8-12 times earnings (profit), the value range would be
$288,000 to $860,000.
Convenience stores
The convenience store (C-stores or minimarts) industry is growing. There were 67,500 outlets in
1987 and 119,750 by 2001. Total industry sales were $59.6 billion in 1987,and gasoline sales
accounted for approximately 34% of the convenience store sales. By 2001, industry sales were
$269 billion and motor fuel sales accounted for $165 billion.
F 10.7 C-Store sales mix

There is no longer a clear distinction between
Convenience Store Sales Mix In US: a service station that sells gas and a
1990-2000 convenience store that sells cigarettes,
beverages and snacks. Service stations are
2000 61.4 38.6 starting to look a lot like convenience stores
% % and convenience stores are starting to look a
lot like service stations.
1995 51.5 48.5
% % Even the discounting warehouses have started
to offer gasoline. Costco Wholesale started in
1990 45.8 54.2 1995 and by 2001 55% of their 284
% % warehouses had gas pumps.
0% 20% 40% 60% 80% 100%
Of the 119,750 convenience stores, 91,500 or
Motor fuels 76% sold gasoline in 2000. Other services
include ATMs, (63% of the stores), money
In-store sales orders (77% of stores), copy/fax services
(19% of stores) and car washes (9%).
Source: Lindsay Hutter, Convenience Retailing: Now
and In The Future, National Association of Other high growth areas include food service
Convenience Stores, Oct. 2, 2001 and snacks.
C-store sizes range from 800 to 3,500 square feet of floor space. The average profit margin on C-
store products is 30% of gross sales. Delicatessen products can carry a 50% profit margin, while
soft drinks have a profit margin of up to 70%.
A new convenience store costs $500,000 to $750,000 on the average. The main difference in
costs depends on the location. Urban C-stores must spend around twice as much for land as rural
locations.
A rule-of-thumb in the service station industry for valuation of a gas station is that it is worth
$0.75 to $1.50 per gallon per month for the gas sales element alone. Therefore, a 100,000 gallon
per month gas station would be worth from $75,000 to $150,000, plus other assets. Any
additional assets, such as real estate or a convenience store facility, would be added to this. The
cost for a new gas station, including purchasing land, can range from $300,000 to $500,000.
Some analysts also compare value of marketing operations on a dollar- per-daily-barrel basis.
The range of value is appraised roughly at from $5,500 to $6,500 per daily barrel. With this
yardstick, the value of a facility selling 100,000 gallons per month at 42 gallons per barrel would
be from $440,000 to $515,000.
Table T 10.11 gives a range of values of marketing outlets.
Analysts must contend with limited information when dealing with the refining and marketing
segment of an integrated oil company. Usually the book value, identifiable assets, earnings, and
cash flow information is commingled. This makes it difficult to segregate the refining from the
marketing assets for detailed analysis. Moreover, the annual report and 10-K do not often
mention how many marketing outlets are owned and how many are leased. Furthermore, some
F 10.8 C-Store non fuel sales
Top ten product categories as a percent of in-store sales in the US: 2000
Cigarettes 35.8%
Food service 13.3%
Packaged beverages 12.3%
Beer 10.9%
Candy 3.9%
Salty snacks 3.4%
Fluid milk products 2.8%
General merchandise 2.7%
Packaged sweet snacks 2.3%
1.5%
Other tobacco
0% 5% 10% 15% 20% 25% 30% 35% 40%

Source: Industry Fact Sheets-Convenience Stores (NAICS 44512) and Convenience Stores with Gasoline Stations (NAICS 44711)
2001 National Association of Convenience Stores/CSNews Industry Databank
T 10.10 Top 10 Convenience store companies
Rank Company Number

2000 (1999) of stores
1 (1) Equilon Enterprises LLC Houston, TX 6,060
Motiva Enterprises LLC
2 (2) 7-Eleven Inc. Dallas, TX 5,715
3 (4) Tosco Corp. Stamford, CT 4,260
4 (NR) Exxon Mobil Corp. Irving, TX 3,991
5 (5) BP Amoco PLC London, England 3,500
6 (6) Chevron Corp. San Francisco, CA 2,700
7 (7) Ultramar Diamond Shamrock Corp. San Antonio, TX 2,600
8 (8) Speedway SuperAmerica LLC Enon, OH 2,437
9 (NR) Shell Canada Products Ltd. Calgary, Alberta 1,800
10 (9) Alimentation Couche-Tard Inc. Laval, Quebec 1,625
11 (10) The Pantry Inc. Sanford, CT 1,295
12 (11) Casey’s General Stores Inc. Ankeny, Iowa 1,246
13 (12) FEMSA Comercio S.A. de C.V., Oxxo Monterrey, Mexico 1,197
14 (18) Clark Retail Enterprises Inc. Glen Ellyn, IL 1,000
15 (NR) Imperial Oil Co. Toronto, Ontario 868
16 (15) The Kroger Co. Hutchinson, KA 794
17 (16) Country Energy LLC Kansas City, MO 792
18 (27) Amerada Hess Corp. Woodbridge, NJ 727
19 (16) Cumberland Farms Inc. Canton, MA 721
20 (21) Husky Oil Ltd. Calgary, Alberta 600
Source: CSNews Online from Convenience Store News, May28th, 2002
T 10.11 Marketing outlets-gas station valuation
Facility Range of Value

($ Thousands)
Gas Station 65,000 gallons per month $ 200 - 350

Gas Station 100,000 gallons per month 350 – 500
Gas Station 150,000 gallons per month 450 - 650
Small Station 50,000 gallons per month 300 - 500

with 1,000 ft2 C-store
Small C-Store 30,000 gallons per month 375 - 550

with 1,500 ft2
Large C-Store 40,000 gallons per month 650 - 900

Super Station 100,000 gallons per month 650 - 800

Super Station 200,000 gallons per month 900 -1,000

At times it is difficult to know just how many of each kind of marketing outlet the company has
(owned or leased). There are many considerations of value that are not quantified for the analyst.
Many analysts are aware of the information and statistics outlined in this chapter. Without
detailed information, analysts usually must make some general assumptions and make an
educated guess at the value of this far downstream segment of a company. Analysts in the late
1980s were appraising marketing outlets at from $400,000 to $500,000 each.
F 10.9 U.S. retail gasoline prices 1999 vs. 2000
1999 Average 2000 Average

Retail Price Retail Price
$1.22/Gallon $1.48/Gallon
Distribution & Marketing 12%

14% Costs & Profits
14%
13% Refining Costs &
Profits
28%
36% Federal & State
Taxes
Crude Oil 46%

37%
Source: eia.doe.gov Gasoline and Diesel Update
F 10.10 World gasoline price comparisons
$2.50
$0.39
$1.35 $1.20
$0.35
Venezuela United States Europe

Total cost Total Cost Total Cost
$3.66
$0.35 * $1.74 *
vs. [$105/BBL Taxes]
Taxes $1.48 in 2000
Cost of Gasoline (Premium)
* This cost is subsidized by the government
Sources: eia.doe.gov Gasoline and Diesel Update, Daniel Johnston & Co. Inc.
F 10.11 U.S. refineries
Location of U.S. Refineries 2001
PADD V
PADD IV PADD I
PADD II
PADD III
Small: Under 75,000 B/CD

Large: Over 75,000 B/CD
Source: NPRA, United States Refining Capacity, January 1, 2001
There are fewer than 150 refineries in the U.S. today, down from over 300 in 1980. The
coastal refineries get crude oil feedstocks from tankers, while the inland refinery
feedstocks come from pipelines, typically out to Canada:
Region Feedstock source

West Coast Tanker Alaska
Indonesia
Gulf Coast Tanker Latin America
East Coast Tanker Africa
Latin America
Western Europe
Middle East
Alaska
Inland Pipeline Canada
World crude oil flows 1997

4.5
2.4
1.8 14.
1.6 5
2.7
3.2
2.4
North America
Latin America
Middle East
Africa
Former Soviet Union
North Sea
South East Asia 2.7 Millions of barrels per day (MMBBLPD)
11. Macro Economics
Chapter 1 - Macro Economics
F 11.1 Vital statistics - 2 1995
Recoverable Reserves Relative Petroleum Potential - Original

(1992) Total Wells Drilled
Original Billion
Region % % BBLS 50,000 wells.
Canada 1 6 < 50,000 wells. Middle East
Europe 2 1 14
Asia 6 4 44
Africa 7 6 61
United States 11 3 26
Latin America 11 12 120
Russia 12 6 57
Russia
Middle East 50 67 660 Latin (FSU)
100% 100% 990 America
United
States
Africa
Asia
Europe
Canada
40,670 9,660 64,250 7,060 600,200 41,880 148,990 6,290

Current producing oil wells
35 100-4,000 250 1,000 12 50-300 70 2,000-7,000

Average BOPD/well
Source: Grossling, B., Nielsen, D., “In Search of Oil” January, 1985. Updated and revised by the author with
information from Oil & Gas Journal Energy Database, the Oil & Gas Journal Worldwide Production Report,
27 Dec., 1993, Vol. 91, No. 52, and Oil Industry Outlook, Ninth Edition 1993-1997.
F 11.2 Global oil production estimates

Annual Oil Production
( Billions of Barrels)
30
25
20
15
10
5
0
1930 1950 1970 1990 2010 2030 2050
World
World Outside Persian Gulf
Persian Gulf
U.S. and Canada
Former Soviet Union
U.K and Norway
Source: “The End of Cheap Oil”, C. Campbell &

H. Laherrere, Scientific American, March 1998
F 11.3 Middle East reported reserves

The sharp rise in reported reserves, around
Reported Oil Reserves 1987, represents an adjustment up to represent
( Billions of Barrels) actual reserves with more accuracy and
perhaps some wishful thinking.
800
700
600 Saudi Arabia
500 Iran
400 U.A.E
300
Iraq
200 Kuwait
100 Venezuela
1980 1985 1990 1995
Source: “The End of Cheap Oil”, C. Campbell &

H. Laherrere, Scientific American, March 1998
F 11.4 Vital statistics – 1 1995
World Average Export Price $16.78 /BBL (Avg. US Oil price $14.62)
(Avg. US Gas price $1.59)
Production
World Total Oil 69 MMBOPD [ Demand growth 1 – 16%/year]
World Total Gas 203 BCFD
World Total BOE 103 MMBOE/D (6:1)
[62% of total world energy consumption]
89 MMBOE/D (10:1)
World Gas Flaring 10 BCFD
Reserves
Oil Total OPEC 778 Billion Barrels [85% has no NPV]
Total World 1,007 Billion Barrels “Conventional Reserves”
Gas Total CIS 1,997 TCF

Total OPEC 2,037 TCF
Total World 4,934 TCF
BEO Total World 1,829 Billion BOE (6:1)

1,500 Billion BOE (10:1)
US Total Drilling Rigs 723

Rigs outside N. America
Land 548
Offshore 210
World Total Drilling Rigs 1,711
US Producing Gas Wells 294 Thousand (Avg. 200 MCFD)

US Producing Oil Wells 582 Thousand (Avg. 11 BOPD)
World Producing Oil Wells 904 Thousand (Avg. 68 BOPD)
US Total Refineries 169 90,000 BOPD (avg) @92% Capacity

World Total Refineries 706 104,000 BOPD (avg) @83% Capacity
F 11.5 Lower 48 crude oil wellhead prices in three cases
1970 – 2020 (1999 dollars per barrel)
60
50
40
30 High Price
20 Reference
Low Price
10
History Projections
0
1970 1980 1990 2000 2010 2020
Source: Energy Information Administration / Annual Energy Outlook 2001
F 11.6 U.S. petroleum consumption - five cases
1970 – 2020 (million barrels per day)

High growth
30 Low oil price
Reference
High oil price
20 Low growth
10
History Projection
0 s
1970 1980 1990 2000 2010 2020
T 11.1 Recoverable oil and gas
Technically recoverable U.S. oil and gas resources as of January 1,

1999
Total U.S. Crude oil Natural gas

resources (billion barrels) (trillion cubic feet)
Proved 22 164
Unproved 121 1,117
Total 144 1,281
T 11.2 Oil and gas drilling
Natural gas and crude oil drilling in three cases, 1999-2020 (thousand
successful wells)
1999 2000 2010 2020

Natural gas
Low oil price case 12.8 16.5 22.2
Reference case 10.3 12.8 17.5 23.4
High oil price case 13.0 18.1 24.3
Crude oil
Low oil price case 5.5 5.8 8.5
Reference case 4.1 5.5 6.5 9.4
High oil price case 5.5 7.0 10.2
F 11.7 Deflated natural gas prices and operating cost indices
Index (1976 = 100)

300
250
Gas Price Index
200
150
100
Operating Cost Index
50
0
1976 1978 1980 1982 1984 1986 1988 1990 1992 1994 1996 1998
Year
Source: Energy Information Administration, Office of Oil and Gas.
F 11.8 Deflated oil price and operating cost indices
Index (1976 = 100)

300
250 Oil Price Index

200
150
100
Operating Cost Index
50
0
1976 1978 1980 1982 1984 1986 1988 1990 1992 1994 1996 1998
Year
Source: Energy Information Administration, Office of Oil and Gas
F 11.9 World oil prices
45
Oil Gulf
40 Glut War
35
Quota
Adjust
Nominal Dollars per Barrel
30 Iranian
Revolution
25
20
1973 Oil
Embargo
15
10
0
1970 1975 1980 1985 1990 1995 2000
World oil price chronology 1970 – 2001
Year $/BBL Year $/BBL Year $/BBL Year $/BBL

1970 1.80 1980 33.97 1990 22.20 2000 27.68
1971 2.13 1981 37.07 1991 18.74 2001 22.02
1972 2.46 1982 33.59 1992 18.11
1973 3.14 1983 29.34 1993 16.66
1974 11.45 1984 28.86 1994 15.41
1975 13.88 1985 26.99 1995 17.15
1976 13.47 1986 14.32 1996 20.57
1977 14.52 1987 18.04 1997 18.62
1978 14.56 1988 14.62 1998 12.14
1979 21.54 1989 18.07 1999 17.27
Source: Energy Information Administration
Appendices
Appendices
Appendices
A1 Present value of one-time payment

Interest Rate
Period 0.05 0.08 0.10 0.12 0.15 0.20 0.25 0.30

1 0.976 0.962 0.953 0.945 0.933 0.913 0.894 0.877
2 0.929 0.891 0.867 0.844 0.811 0.761 0.716 0.675
3 0.885 0.825 0.788 0.753 0.705 0.634 0.572 0.519
4 0.843 0.764 0.716 0.673 0.613 0.528 0.458 0.399
5 0.803 0.707 0.651 0.601 0.533 0.440 0.366 0.307
6 0.765 0.655 0.592 0.536 0.464 0.367 0.293 0.236
7 0.728 0.606 0.538 0.479 0.403 0.306 0.234 0.182
8 0.694 0.561 0.489 0.427 0.351 0.255 0.188 0.140
9 0.661 0.520 0.445 0.382 0.305 0.212 0.150 0.108
10 0.629 0.481 0.404 0.341 0.265 0.177 0.120 0.083
11 0.599 0.446 0.368 0.304 0.231 0.147 0.096 0.064
12 0.571 0.413 0.334 0.272 0.200 0.123 0.077 0.049
13 0.543 0.382 0.304 0.243 0.174 0.102 0.061 0.038
14 0.518 0.354 0.276 0.217 0.152 0.085 0.049 0.029
15 0.493 0.328 0.251 0.193 0.132 0.071 0.039 0.022
16 0.469 0.303 0.228 0.173 0.115 0.059 0.031 0.017
17 0.447 0.281 0.208 0.154 0.100 0.049 0.025 0.013
18 0.426 0.260 0.189 0.138 0.087 0.041 0.020 0.010
19 0.406 0.241 0.171 0.123 0.075 0.034 0.016 0.008
20 0.386 0.223 0.156 0.110 0.066 0.029 0.013 0.006
21 0.368 0.206 0.142 0.098 0.057 0.024 0.010 0.005
22 0.350 0.191 0.129 0.087 0.050 0.020 0.008 0.004
23 0.334 0.177 0.117 0.078 0.043 0.017 0.007 0.003
24 0.318 0.164 0.106 0.070 0.037 0.014 0.005 0.002
25 0.303 0.152 0.097 0.062 0.033 0.011 0.004 0.002
26 0.288 0.141 0.088 0.056 0.028 0.010 0.003 0.001
27 0.274 0.130 0.080 0.050 0.025 0.008 0.003 0.001
28 0.261 0.120 0.073 0.044 0.021 0.007 0.002 0.001
29 0.249 0.112 0.066 0.040 0.019 0.006 0.002 0.001
30 0.237 0.103 0.060 0.035 0.016 0.005 0.001 0.000
31 0.226 0.096 0.055 0.032 0.014 0.004 0.001 0.000
32 0.215 0.089 0.050 0.028 0.012 0.003 0.001 0.000
33 0.205 0.082 0.045 0.025 0.011 0.003 0.001 0.000
34 0.195 0.076 0.041 0.022 0.009 0.002 0.001 0.000
35 0.186 0.070 0.037 0.020 0.008 0.002 0.000 0.000
36 0.177 0.065 0.034 0.018 0.007 0.002 0.000 0.000
37 0.168 0.060 0.031 0.016 0.006 0.001 0.000 0.000
38 0.160 0.056 0.028 0.014 0.005 0.001 0.000 0.000
39 0.153 0.052 0.025 0.013 0.005 0.001 0.000 0.000
40 0.146 0.048 0.023 0.011 0.004 0.001 0.000 0.000
Appendices
A2 Present value of an annuity

Interest Rate
Period 0.05 0.08 0.10 0.12 0.15 0.20 0.25 0.30

1 0.976 0.962 0.953 0.945 0.933 0.913 0.894 0.877
2 1.905 1.853 1.820 1.789 1.743 1.674 1.610 1.552
3 2.790 2.678 2.608 2.542 2.448 2.308 2.182 2.071
4 3.634 3.442 3.325 3.214 3.062 2.836 2.640 2.470
5 4.436 4.149 3.976 3.815 3.595 3.276 3.007 2.777
6 5.201 4.804 4.568 4.351 4.058 3.643 3.300 3.013
7 5.929 5.411 5.106 4.830 4.462 3.949 3.534 3.195
8 6.623 5.972 5.595 5.257 4.812 4.203 3.722 3.335
9 7.283 6.492 6.040 5.639 5.117 4.416 3.872 3.442
10 7.912 6.973 6.444 5.980 5.382 4.593 3.992 3.525
11 8.512 7.419 6.812 6.284 5.613 4.740 4.088 3.589
12 9.082 7.832 7.146 6.556 5.813 4.863 4.165 3.637
13 9.626 8.214 7.450 6.798 5.987 4.965 4.226 3.675
14 10.143 8.568 7.726 7.015 6.139 5.051 4.275 3.704
15 10.636 8.895 7.977 7.208 6.271 5.122 4.315 3.726
16 11.105 9.199 8.206 7.381 6.385 5.181 4.346 3.743
17 11.552 9.479 8.413 7.535 6.485 5.230 4.371 3.757
18 11.978 9.740 8.602 7.672 6.572 5.271 4.392 3.767
19 12.384 9.980 8.773 7.795 6.647 5.306 4.408 3.775
20 12.770 10.203 8.929 7.905 6.712 5.334 4.421 3.781
21 13.138 10.410 9.071 8.003 6.769 5.358 4.431 3.785
22 13.488 10.601 9.200 8.090 6.819 5.378 4.439 3.789
23 13.822 10.778 9.317 8.168 6.862 5.395 4.446 3.791
24 14.139 10.942 9.423 8.238 6.899 5.408 4.451 3.794
25 14.442 11.094 9.520 8.300 6.932 5.420 4.455 3.795
26 14.730 11.234 9.608 8.356 6.960 5.429 4.459 3.796
27 15.005 11.364 9.688 8.406 6.985 5.437 4.461 3.797
28 15.266 11.485 9.761 8.450 7.006 5.444 4.463 3.798
29 15.515 11.596 9.827 8.489 7.025 5.450 4.465 3.799
30 15.752 11.699 9.887 8.525 7.041 5.454 4.467 3.799
31 15.978 11.795 9.942 8.556 7.055 5.458 4.468 3.799
32 16.193 11.884 9.991 8.585 7.068 5.461 4.469 3.800
33 16.398 11.966 10.037 8.610 7.078 5.464 4.469 3.800
34 16.593 12.041 10.078 8.632 7.087 5.466 4.470 3.800
35 16.779 12.112 10.115 8.652 7.096 5.468 4.470 3.800
36 16.955 12.177 10.149 8.670 7.103 5.469 4.471 3.800
37 17.124 12.237 10.180 8.686 7.109 5.471 4.471 3.800
38 17.284 12.293 10.208 8.700 7.114 5.472 4.471 3.800
39 17.437 12.345 10.233 8.713 7.119 5.473 4.471 3.800
40 17.583 12.392 10.256 8.724 7.123 5.473 4.472 3.800
Appendices
Glossary
Abrogate – To officially abolish or repeal a treaty or contract through legislative authority or an
authoritative act.
Accelerated Depreciation – Writing off an asset through depreciation or amortization at a rate

that is faster than normal accounting straight line depreciation. There are a number of methods of
accelerated depreciation, but they are usually characterized by higher rates of depreciation in the
early years than latter years in the life of the asset. Accelerated depreciation allows for lower tax
rates in the early years.
Acreage – Amount of land area (or offshore area) under lease or associated with and/or
governed by a production sharing contract.
Ad Valorem – Latin according to value, a tax on goods or property, based upon value rather
than quantity or size.
Affiliate – Two companies are affiliated when one owns less than a majority of the voting stock
of the other or when they are both subsidiaries of a third parent company. A subsidiary is an
affiliate of its parent company. (see Subsidiary)
Alcohol – Family name of a group of organic chemical compounds composed of carbon,

hydrogen, and oxygen. (e.g., methanol, ethanol, and tertiary butyl alcohol).
Alkenes – The general formula CnH2n where n is a whole number, usually from 1 to 20. They
have linear or branched chain molecules containing one carbon – carbon double bond. They can
be gas or liquid. Examples include acetylene and butadiene.
Alkylate – The output of a refinery alkylation process, used in blending high octane gasoline.
See motor gasoline blending.
Alkylation – The refining process for combining isobutene with olefin hydrocarbons (e.g.,
propylene, butylene). The process varies temperature and pressure in the presence of an acid
catalyst. The output, alkylate, an isoparaffin, is high in octane.
Amortization – An accounting convention designed to emulate the cost or expense associated

with reduction in value of an intangible asset (see Depreciation) over a period of time.
Amortization is a noncash expense. Similar to depreciation of tangible capital costs, there are
several techniques for amortization of intangible capital costs:
Straight Line Decline (SLD)

Double Declining Balance (DDB)
Declining Balance (DB)
Glossary
Sum of Year Digits (SYD)

Unit-of-Production
API – American Petroleum Institute.
API Gravity – American Petroleum Institute measure of the density or weight of a crude oil.
Measured in degrees (°) as in “West Texas Intermediate is a 38° - 40° API crude”.
141.5
° API = - 131.5
Sg
Appraisal well – See Delineation well.
Aquifer – Porous water-bearing rock.
Arbitration – A process in which parties to a dispute agree to settle their differences by

submitting their dispute to an independent individual arbitrator or group. Typically, each side of
the dispute chooses an arbitrator and those two arbitrators choose a third. The third arbitrator acts
as the chairman of the tribunal, which then hears and reviews both sides of the dispute. The
tribunal then renders a decision that is final and binding.
Aromatics – Hydrocarbons (e.g., benzene, toluene, and xylene (BTX)). Called aromatics due to
their characteristic odor. Important gasoline and aviation gasoline blending components, useful
for increasing octane ratings. (see motor gasoline blending components)
Asphalt – A dark-brown-to-black solid or semi-solid mixture of hydrocarbons found in nature or

produced by distillation, oxidation or chemical treatment of oils. It is an important component of
the materials used in road construction.
Atmospheric crude oil distillation – A refinery process that heats crude oil to 600 to 750˚F
under atmospheric pressure. The crude oil components (or fractions) are separated based on their
boiling temperatures, and condensed by cooling.
Aviation gasoline – A gasoline mixture that conforms to the specifications required for aviation
reciprocating engines. Often referred to as avgas.
Backwardation – When a commodity’s current prices or spot price is greater than futures prices
the market is said to be “inverted” or “in backwardation”. The opposite of “contango” (See
contango).
Barrels per calendar day – The number of barrels of input a distillation facility can process
under normal operating conditions, which includes downtime, and constraints that are a function
of environment, types and grades of inputs.
Barrels per stream day – The maximum number of barrels of input a distillation facility can
process in 24 hours running at full capacity. There is no allowance for downtime.
Glossary
Block – A license area or contract area –relates to each individual parcel of acreage held by an
oil company or a government.
Book Value – (1) The value of the equity of a company. Book value per share is equal to the
equity divided by the number of shares of common stock. Fully diluted book value is equal to the
equity less any amount that preferred shareholders are entitled to, divided by the number of
shares of common stock. (2) Book Value of an asset or group of assets is equal to the initial cost
less DD&A (effectively depreciation).
Bottoms – The liquid that collects in the bottom of a vessel during a fractioning process or while
in storage (tower bottoms, tank bottoms).
Bottoms up – The time required for cuttings at the drillbit to circulate up to the shale shakers
(vibrating screens that separate cuttings from the mud).
Branch – An extension of a parent company but not a separate independent entity. Subsidiary
companies are normally taxed as profits and are distributed as opposed to branch profits, which
are taxed as they accrue.
Brown Tax – A tax that can be positive or negative. A “cash flow based” a Government
(working interest) participation could be viewed this way. During the periods of investment the
Government pays. During the periods of positive cash flow the Government “takes”.
BTX – The acronym for the aromatics; benzene, toluene, and xylene. (see Aromatics).
Bubble Point – Reservoir pressure at which gas in solution (in the oil) will bubble out of the
host oil at the prevailing reservoir temperature.
Calvo Clause – A relatively obsolete contract clause once promoted in Latin American countries
where the contractor explicitly renounced the protection of its home government over its
operation of the contract. The objective of the Calvo Doctrine was to direct disputes to local
jurisdictions and avoid international arbitration.
Capitalize – (1) In an accounting sense the periodic expensing (amortization) of capital costs
such as through depreciation or depletion. (2) To convert an (anticipated) income stream to a
present value by dividing by an interest rate, as in the dividend discount model. (3) To record
capital outlays as additions to asset value rather than as expenses.
Generally, expenditures that will yield benefits to future operations beyond the accounting period
in which they are incurred are capitalized--that is, they are depreciated at either a statutory rate or
a rate consistent with the useful life of the asset.
Capitalization – All money invested in a company including long term debt (bonds), equity
capital (common and preferred stock), retained earnings and other surplus funds. Market
capitalization is stock price times the numbers of shares of common stock.
Glossary
Capitalization Rate – The rate of interest used to convert a series of future payments into a
single present value.
Carbonate – Limestone and or sometimes dolomite.
Carried Interest – When a working interest partner in the exploration or development phase of
a contract is paying a disproportionately lower share of costs and expenses than its working
interest share. This occurs when Government agencies such as the Oil Ministry or the National
Oil Company are “carried” through the exploration phase of a contract. In this case the NOC is
said to be “carried”. Also in a farmin agreement, typically, the company holding the original
working interest will farmout a portion of the work obligation to another company and is
“carried” through that portion of the work program. The company farming in then “carries” the
original license holder through that phase i.e. the original license holder then does not pay, or
pays a disproportionately lower %..
Cash Flow – Gross revenues less all associated capital and operating costs, government
royalties, taxes, imposts, levies, duties and profit oil share, etc. It therefore represents Contractor
share of profits.
In a financial sense, net income plus depreciation, depletion and amortization and other non-cash
expenses. Usually synonymous with cash earnings and operating cash flow. An analysis of all
the changes that affect the cash account during an accounting period.
Catalytic cracking – Or cat cracking, is the refining process of breaking down the larger,
heavier, and more complex hydrocarbon molecules into simpler, lighter molecules. Its purpose is
to increase the gasoline yield of a refining process. i.e., the use of a catalytic agent converts the
heavier vacuum gas oil (VGO) into the lighter gasoline.
Catalytic Hydrocracking – A refining process that converts middle distillates or residual

material to high-octane gasoline, jet fuel, and/or high grade fuel oil. The process uses hydrogen,
one or more catalysts, high pressure and low temperature and can handle high sulfur feedstocks,
without prior desulfurization.
Catalytic Hydrotreating – A refining process for treating petroleum fractions form atmospheric
and vacuum distillation units and other streams in the presence of catalysts and substantial
quantities of hydrogen. The hydrotreating functions include desulfurization, removable of
substances that deactivate catalysts (e.g., nitrogen compounds), conversion of olefins to paraffins
to reduce gum formation in gasoline and other upgrading functions.
Catalytic reforming – The refining process that converts paraffinic and naphthenic
hydrocarbons (e.g., low-octane gasoline boiling range fractions) into petrochemical feedstocks
and higher octane stocks. The process uses controlled heat and pressure (there is high and low
pressure reforming) in the presence of a catalyst.
Glossary
Central Bank – The primary government owned banking institution of a country. The central
bank usually regulates all aspects of foreign exchange in and out of the country. It actively
intervenes in the acquisition and sale its own currency in foreign exchange markets primarily to
maintain stability in the value of the country's currency.
Coke – A solid residue high in carbon content.
Commercial Discovery – (Or commercial success) In popular usage the term applies to any
discovery, which would be economically feasible to develop under a given fiscal system. As a
contractual term it often applies to the requirement on the part of the contractor to demonstrate to
the government that a discovery would be sufficiently profitable to develop from both the
contractor and government point of view. A field that satisfied these conditions would then be
"granted commercial status" and the contractor would then have the right to develop the field.
Commingled production – Production of petroleum from more than one reservoir through a
single wellbore or flowline without seperate measurement.
Completion – Equipment and activities required after drilling a well in order to prepare the well
for production of oil and/or gas.
Concession – An agreement between a government and a company that grants the company the
right to explore for, develop, produce, transport and market hydrocarbons or minerals within a
fixed area for a specific amount of time. The concession and production and sale of
hydrocarbons from the concession is then subject to rentals, royalties, bonuses and taxes. Under
a concessionary agreement the company would take title to the production “at the wellhead”.
Condensate – Light liquid hydrocarbons associated with gas, typically “pentanes plus” (C5 +).
(see Hydrocarbon series)
Consortium – A group of companies operating jointly, usually in a partnership with one

company as operator in a given permit, license, contract area, block etc.
Contango – The relationship between a commodity’s futures prices and the current market price
for the commodity. When futures prices are greater than current prices such as spot prices or
current contract prices the market is said to be in contango. Contango is the opposite of
“backwardation”.
Contractor – An oil company operating in a country under a production sharing contract or a

service contract on behalf of the host government for which it receives either a share of
production or a fee.
Contractor Take – Total contractor after-tax share of profits.
Cost of Capital – The minimum rate of return on capital required to compensate debt holders
and equity investors for bearing risk. Cost of capital is computed by weighting the after-tax cost
of debt and equity according to their relative proportions in the corporate capital structure.
Glossary
Cost Insurance and Freight – (CIF) is included in the contract price for a commodity. The
seller fulfills his obligations when he delivers the merchandise to the shipper, pays the freight,
and insurance to the point of (buyers) destination and sends the buyer the bill of lading,
insurance policy, invoice, and receipt for payment of freight. The following example illustrates
the difference between an FOB (Free on board) Jakarta price and a CIF Yokohama price for a
Ton of LNG. (see FOB).
FOB Jakarta $170/ton also called "netback price"
+ 30/ton Freight Charge


CIF Yokohama $200/ton
Cost Oil – A term most commonly applied to production sharing contracts which refers to the oil
(or revenues) used to reimburse the contractor for exploration costs, development capital costs
and operating costs.
Cost recovery – The means by which companies recover costs; same as deductions.
Cost Recovery Limit – Typically with PSCs in any given accounting period there is a limit to
the amount of deductions that can be taken for cost recovery purposes. The limit is usually
quoted in terms of a percentage of gross revenues or gross production. Unrecovered costs are
carried forward and recovered in subsequent accounting periods if there is sufficient production.
Country Risk – The risks and uncertainties of doing business in a foreign country including
political, and commercial risks. (see Sovereign Risk).
Creeping Nationalization or Creeping Expropriation – A subtle means of expropriation

through expanding taxes, restrictive labor legislation, or labor strikes, withholding work permits,
import restrictions, price controls and tariff policies.
Crude oil – Crude oil is the term for ‘unprocessed’ oil. Also known as petroleum, it is a fossil
fuel, the stuff that comes out of the ground. Texas Tea. It was formed from decaying plants and
animals that lived in ancient seas millions of years ago.
Crypto Tax – This is a non-technical reference to non-conventional/(less direct) means by

which Governments may impose duties, levies, or financial requirements on an oil company.
These elements rarely are captured in typical published “take” statistics. Examples include;
social welfare development funds (written or unwritten), hostile audits, mandatory currency
conversions, customs duty exemptions that are not honored, hiring and purchase quotas,
inordinately long depreciation rates, inefficient procurement requirements, excessive
immigration/visa requirements, etc.
Glossary
Debt Service – Cash required in a given period, usually one year, for payments of interest and
current maturities of principal on outstanding debt. In corporate bond issues, the annual interest
plus annual sinking fund payments.
Delayed coking – A refinery process that decomposes heavier crude oil fractions into lighter oils
and petroleum coke, and increases a refineries ability to handle heavier crudes. The process
utilizes elevated temperatures and pressures. The light oils can be further processed in the
refinery. (see Coke).
Delineation well – A well drilled in order to determine the extent of a reservoir also known as an
“Appraisal well”.
Depletion – (1) Economic depletion is the reduction in value of a wasting asset by the removal
of minerals. (2) Depletion for tax purposes (depletion allowance) deals with the reduction of
mineral resources due to removal by production from an oil or gas reservoir or a mineral deposit.
Depletion Allowance – This is one type of “incentive” that a few Governments use to encourage
investment. Typically these allowances provide the companies a “deduction” for tax calculation
purposes based on some percentage of gross revenues. The “Filipino Participation Incentive
Allowance (FPIA) in the Philippines has this characteristic. It allows the contractor group 7.5%
of gross revenues as part of the service fee.
Depreciation – An accounting convention designed to emulate the cost or expense associated
with reduction in value of a tangible asset due to wear and tear, deterioration or obsolescence
over a period of time. Depreciation is a noncash expense. There are several techniques for
depreciation of capital costs:
Straight Line Decline

Double Declining Balance
Declining Balance
Sum of Year Digits
Unit-of-Production (see Unit of Production).
Development Costs – Costs associated with placing an oil or gas discovery into production.
These costs typically consist of drilling, production facilities and transportation costs.
Development Drilling – Drilling that follows exploratory and appraisal drilling after a
discovery.
Development Well – A well drilled within a proven or known productive area of an oil or gas
reservoir.
Dew point pressure – The (gas) reservoir pressure below which liquids begin to condensate out
of the gas at the prevailing reservoir temperature.
Glossary
Dilution Clause – In a joint operating agreement a clause that outlines a formula for the dilution
of interest of a working interest partner if that partner defaults on a financial obligation. Also
called a withering clause.
Direct Tax - A tax that is levied on corporations or individuals--the opposite of an indirect tax
such as a value-added tax (VAT) or sales taxes.
Discounted Cash Flow Analysis – Economic modeling of anticipated income versus

expenditures over time. It is based upon estimated production rates, oil prices and costs, as well
as royalties, taxes and other means of Government take. The net result is a stream of cash flow
over time. Cash received in the distant future is not as valuable as cash received now so the time
value of the cash flow is calculated factoring in time value of money to arrive at a “present
value” equivalent.
Disposal – This term usually refers to transportation and sales of crude or gas from the field.
Distillate fuel – A general term describing fuels obtained from the distillation process.
Dividend Withholding Tax – A tax levied on dividends or repatriation of profits. Tax treaties
normally try to reduce these taxes whether they are so named or simply operate in the same
manner as a withholding tax.
Dollars-of-the-day – A term usually associated with cost estimates that indicate the effects of
anticipated inflation have been taken into account. For example, if a well costs $5 MM right now
in "today’s dollars"--(the opposite of dollars-of-the-day) then the cost of the well two years from
now might be estimated at $5.51 MM in dollars-of-the-day assuming a 5% inflation factor. Other
associated terms:
Dollars-of-the-day vs. Nominal Dollars

Escalated vs. Non-escalated
Current Dollars vs. Today’s dollars
Inflated
Domestication - A form of creeping nationalization where host government enacts legislation

that forces foreign-owned enterprises to surrender various degrees of ownership and/or control to
nationals.
Domestic Market Obligation – Some countries provide the State an option to purchase a certain
portion of the contractor’s share of production. This is called domestic market obligation (DMO)
or domestic requirement. Typically the purchase price for DMO crude is less than market price.
Also local currency may be part of the price formula. There are many variations on this theme.
Double Taxation – (1) In economics a situation where income flow is subjected to more than
one tier of taxation under the same domestic tax system--such as state/provincial taxes, then
federal taxes or federal income taxes and then dividend taxes. (2) International double taxation is
where profit is taxed under the system of more than one country. It arises when a taxpayer or
Glossary
taxpaying entity resident (for tax purposes) in one country generates income in another country.
It can also occur when a taxpaying entity is resident for tax purposes in more than one country.
Double Taxation Treaty – Formal agreement between countries to reduce or eliminate double
taxation. A bilateral tax treaty is a treaty between two countries to coordinate taxation provisions
which would otherwise create double taxation. A multilateral tax treaty involves three or more
countries for the same purpose. The U.S. has few treaties with oil producing nations.
Dual Residence – When a taxpaying entity is resident for tax purposes in more than one country.
This can happen when different countries apply the tests for determining residence and the
company passes the test in more than one country.
Dutch Disease – The adverse results of large-scale positive shock to a single sector of a nations
economy—so named because of the problems associated with large-scale development of the
Groningen Gas field in the Netherlands in the 1970s. Typically the sector of economy that is
booming causes widespread inflation and other sectors, particularly agriculture, suffer from
inability to attract workers. The dramatic increase in foreign exchange can cause problems with
local currencies and fiscal and monetary problems can occur without proper management.
Economic Profit – Gross project revenues minus total costs which include exploration,
development and operating costs.
Economic Rent – While there are a number of definitions, one common definition is: the
difference between the value of production and the cost to extract it. The extraction cost consists
of normal exploration, development and operating costs as well as a share of profits for the
industry. Economic rent is what the governments try to extract as efficiently as possible.
Effective Royalty Rate – The minimum share of revenues (or production) the government will
receive in any given accounting period from royalties and its share of profit oil.
Enriched gas injection – A secondary recovery method where either naturally liquids-rich gas
or gas enriched with propane or butane is injected into the reservoir to enhance oil production.
Entitlements – The shares of production to which the operating company, the working interest
partners, and the government or government agencies are authorized to lift. Entitlements are
based on royalties, cost recovery, production sharing, working interest percentages, etc. (see
Lifting)
Equity Oil – Usually this term refers to oil or revenues after cost recovery (or cost oil). It is also
referred to as profit oil or share oil—terms that are most often associated with PSCs. Generally
speaking, the analog to equity oil in a concessionary system would be pre-tax cash flow. Like
pre-tax cash flow equity oil may also be subject to taxation.
Excise Tax – A tax applied to a specific commodity such as tobacco, coffee, gasoline or oil
based either on production, sale or consumption.
Glossary
Exclusion of Areas – (see Relinquishment)
Expected Monetary Value – (see Expected Value)
Expected Value – A weighted average financial value of various possible outcomes such as
either a discovery or a dry hole weighted according to the estimated likelihood (estimated
probability of success or failure) that either outcome might occur. (see Expected Monetary
Value)
Expense – (1) In a financial sense a non-capital cost associated most often with operations or
production. (2) In accounting, costs incurred in a given accounting period that are charged
against revenues. To “expense” a particular cost is to charge it against income during the
accounting period in which it was spent. The opposite would be to “capitalize” the cost and
charge it off through some depreciation schedule.
Exploration Drilling – Drilling in an un-proved area. (see Exploratory Well)
Exploratory Well – A well drilled in an unproved area. This can include: (1) a well in a proved
area seeking a new reservoir in a significantly deeper horizon, (2) a well drilled substantially
beyond the limits of existing production. Exploratory wells are defined partly by distance from
proved production and by degree of risk associated with the drilling. Wildcat wells involve a
higher degree of risk than exploratory wells.
Expropriation – Similar to the concept of nationalization or outright seizure or confiscation of

foreign assets by a host government. With expropriation the confiscation is directed toward a
particular company, nationalization is where a government confiscates a whole industry.
Expropriation is legal but theoretically must be accompanied by prompt adequate and effective
compensation and must be in the public interest.
Fairway – (see Trend)
Fair Market Value (FMV) of Reserves – Often defined as a specific fraction of the present
value of future net cash flow discounted at a specific discount rate. One common usage defines
FMV at 2/3 - 3/4 of the present value of future net cash flow discounted at the prime interest rate
plus .75 to 1 percentage point.
Farmin – (1) A lease or working interest obtained from another company in return for a
consideration. (2) To receive a farmin.
Farmout – (1) A lease or working interest granted to another company in return for a
consideration. (2) To grant a farmout.
Farmout brochure – Documents used to describe the geological, legal and technical aspects of
a license or block for the purpose of making presentations to potential partners in order to obtain
partners to join in exploration or development efforts. It is effectively a sales document.
Glossary
Farmout Extension – Sometimes the NOC or the Government will allow a Contractor some
additional time (an extension to the current contract phase) to find a partner. Governments know
that finding partners is an important way for companies to spread the risk of exploration.
Farmee – The party farming-in.
Farmor – The party farming-out.
Fault – A break in the continuity of rock types along a “shear” surface.
Finding Cost – The amount of money spent per unit (barrel of oil or MCF of gas) to acquire
reserves. There are numerous formulas but generally includes discoveries, acquisitions and
revisions to previous reserve estimates.
Fiscal System – Technically the legislated taxation structure for a country including royalty
payments. In popular usage the term includes all aspects of contractual and fiscal elements that
make up a given government-foreign oil company relationship.
Fischer-Tropsch process – Catalytic conversion of synthesis gas into a range of hydrocarbons.
Flexicoking – A thermal cracking process that converts heavy hydrocarbons into light
hydrocarbons. The process is capable of handling feedstocks containing high concentrations of
sulfur and metals.
Fluid coking - A thermal cracking process that converts heavy hydrocarbons into light
hydrocarbons by using a fluidized-solids technique in a continuous conversion process.
Fiscal Marksmanship – The ability of authorities to predict with any degree of accuracy or
certainty the tax revenues that may fall due to be paid to the government. In the petroleum
industry it is particularly difficult to accurately estimate what revenues may be generated for
countries with little or no exploration history.
Also the ability to determine the appropriate taxation scheme
Flare – Or “flaring”; burning of residue hydrocarbon gasses.
Flooding – Injection of water (“water flood”) or gas (“gas flood”) into or adjacent to a reservoir
to increase oil recovery.
Formation – A layer of rock or geological horizon that can be mapped. It has a distinct top and
bottom. The formation is typically given a name such as the “Red Wall Limestone” or
”Kimmeridgian Shale”.
Franked Dividends – Dividends that have already been taxed at the corporate level and are
therefore either not subject to withholding tax or the taxes paid are creditable against withholding
taxes.
Glossary
FOB – Free on Board. A transportation term that means the invoice price includes transportation
charges to a specific destination. Title is usually transferred to the buyer at the FOB point by way
of a bill of lading. For example, FOB New York means the buyer must pay all transportation
costs from New York to the buyers receiving point. FOB plus transportation costs equals CIF
price. (see Cost Insurance Freight)
FOB Shipping Point: Buyer bears transportation costs from point of origin.
FOB Destination: Supplier bears transportation costs to the destination.
Foreign Corrupt Practices Act (FCPA) – Sometimes referred to as “anti-bribery legislation”. It

is illegal for a U.S. company or individual to knowingly pay a bribe to a foreign official in order
to obtain, or retain business. This includes commissions or payments to agents or intermediaries
with the knowledge that all or a part of the payments will be given to a foreign official. The
FCPA also has various record-keeping and reporting requirements.
Foreign Tax Credit – Taxes paid by a company in a foreign country may sometimes be treated
as “taxes paid” in the company's home country. These are creditable against taxes and represent a
direct dollar-for-dollar reduction in tax liability. This usually applies to foreign income taxes
paid and credited against home country income taxes. Other taxes which may not qualify for a
tax credit may never-the-less qualify as deductions for home country income tax calculations.
Fractions – Fractions are the different parts or components of the crude oil that are separated
during refining.
Gasoline – Gasoline is the best known of a refineries many products. It is a motor fuel and a
liquid, C5 – C12, with a boiling range between 104 and 200˚F. See Motor gasoline blending.
Gas cap – A layer of free gas above the oil leg of a reservoir. With a gas cap the reservoir is said
to be “saturated”.
Gas oil – One of the heavier middle-distillate fractions (510 - 710˚F). Gas oils fall into the
temperature range between kerosene (340 – 550˚F) and residual fuel (550 - 700˚F) and is usually
used as diesel fuel or home heating fuel. Sometimes called diesel distillate. C12+
Gas reinjection – Process where residue gas is re-pressured and returned to the reservoir from
which it came—usually after liquids have been stripped out in a gas plant.
Gas Oil Ratio – (GOR) The number of cubic feet of natural gas produced with each barrel of oil
produced. It is measured under surface conditions. Also known as Solution Gas Oil Ratio.
Gazette – To officially announce license round offering or results, or publication of notification

of acceptance of bids in official government publication (gazette). To gazette means to offer
blocks--as in "The licenses have not been gazetted yet."
Glossary
Geological Horizon – A layer of rock that can be mapped. It has a distinct top and bottom. (see
Formation).
Gold Plating – When a company or contractor makes unreasonably large expenditures due to
lack of cost cutting incentives. This kind of behavior could be encouraged where a contractor’s
compensation is based in part on the level of capital and operating expenditure, however, it is
rare.
Government take – Government share of economic profits, typically expressed as %. Total

government share of production or gross cash flow from royalties, taxes, bonuses, profit oil.
There are a number of definitions but the most succinct is: Government Take = Government
Cash Flow/Gross Project Cash Flow.
Graben – A block of rock that has dropped down (due to geologic faults) between two other
blocks.
Gravity – (see API gravity)
Gravity based structure – (GBS) Concrete production or wellhead platform fixed to the sea
floor by its own weight.
Hard Currency – Currency in which there is widespread confidence and a broad market such as
that for the U.S. Dollar, the British Pound, Swiss Franc, or Japanese Yen. The opposite would be
soft currency where there is a thin market and the currency fluctuates erratically in value.
Heads Up – When working interest partners are paying costs and expenses in proportion to their
working interest percentages they are said to be “heads up”. When one or more partners is being
“carried” they are not “heads up”.
Heavy gas oil – Heavy gas oil or ‘fuel oil’ is used for industrial fuel and starting material for
making other products. It is a liquid, with long chains, C20 – C70 and a boiling range between 700
and 1112˚F.
Hectare – Metric unit of area equal to 10,000 square meters or 100 acres, which also equals
2.471 acres.
High grade – A term used to describe the evaluation of acreage or a portfolio of prospects to
determine which prospects or areas are best. It is used to determine which acreage to relinquish,
and or which prospects to drill first.
Horizon – A geological layer of rock or a formation (see Formation).
Hull Formula – Compensation for expropriation in the language of many bilateral and
multilateral investment treaties that states it should be "prompt, adequate and effective." This is
Glossary
known as the Hull Formula. Alternate wording found in other treaties includes, "fair and
equitable","reasonable","market value at date of expropriation," etc.
Hurdle Rate – Term used in investment analysis or capital budgeting that means the required
rate of return in a discounted cash flow analysis. Projects to be considered viable must at least
meet the hurdle rate. Most common investment theory, and practice dictates that the hurdle rate
should be equal to or greater than the incremental cost of capital.
Hydrates – Hydrates, or methane hydrates are methane molecules trapped in the molecular
lattice of water in the solid state, stable usually at over 700 psi and cold temperatures.
Hydrocarbon Series – The various components of crude oil and natural gas composed of carbon
and hydrogen atoms. i.e. the paraffin series (a subset of the hydrocarbon series):
Paraffin Series (characterized by the formula CnH2n+2)


C1 - Methane - CH4
C2 - Ethane - C2H6
C3 - Propane - C3H8
C4 - Butanes - C4H10
C5 - Pentanes - C5H12
C6 - Hexanes - C6H14
C7 - Heptanes - C7H16
C8 - Octanes - C8H18
C9 - Nonanes - C9H20
C10 - Decanes - C10H22
et cetera
Hydrocarbon System – Proven combination of organic-rich source rocks that have been
subjected to sufficient pressures and temperatures over geologic time to generate and expel
hydrocarbons.
Hydrostatic Pressure – The fluid pressure in subsurface rocks due to the weight of overlying
fluids. The weight in pounds per square inch of a column of water. Considered to be “normal”
pressure. Typically 0.433 psi/ft (fresh water) to 0.465 psi/ft (brine – salt water).
Incentives – Fiscal or contractual elements provided by host governments that make petroleum
exploration or development more economically attractive. Includes such things as:
Royalty holidays
Tax holidays
Tax credits
Reduced government participation
Lower government take
Investment credits/uplifts
Accelerated depreciation
Depletion allowances
Interest expense deductions (cost recovery)
Glossary
Inconvertibility – Inability of a foreign contractor to convert payments received in soft local

currency into home country or hard currency such as dollars, pounds, or yen.
Indirect Tax – A tax that is levied on consumption rather than income. Examples include value-
added taxes, sales taxes, or excise taxes on luxury items. (see Direct Tax)
Injection – The process of pumping gas or water in a petroleum reservoir in order to maintain
pressure and enhance production.
Intangible Drilling and Development Costs (IDCs) - Expenditures for wages, transportation,
fuel, fungible supplies used in drilling and equipping wells for production.
Intangibles - All intangible assets such as goodwill, patents, trademarks, unamortized debt
discounts and deferred charges. Also, for example, for fixed assets the cost of transportation,
labor and fuel associated with construction, installation and commissioning.
Investment Credit – A fiscal incentive where the government allows a company to recover an
additional percentage of tangible capital expenditure. For example if a contractor spent $10 MM
on expenditures eligible for a 20% investment credit then the contractor would actually be able
to recover $12 MM through cost recovery (see Uplift). These incentives can be taxable.
Sometimes investment credits are mistakenly referred to as Investment Tax Credits.
Isomerization – A refining
process that changes the Normal Butane (C4H10) Isobutane (C4H10)
arrangement of atoms in a
molecule without adding or
removing anything. It is used to
convert normal butane to H H
isobutane (C4), an alkylation
feedstock, normal pentane to
isopentane (C5), and hexane to
isohexane (C6), high-octane
gasoline components. The outputs
of the Isomerization are called isomerates. (see Motor gasoline blending)
Jack-up Rig – Offshore mobile drilling vessel with a drilling rig mounted on the hull and with at
least 3 tall legs through the hull. It is floated into position like a barge and hoisted above the
water when the legs are mechanically lowered to the sea floor.
Joint Operating Agreement – (JOA) Official contract between working interest partners
(members of the Contractor group) in a foreign concession or production sharing contract. The
JOA will outline rights and obligations of the Operator and other working interest shareholders
(members of the Contractor group) and means by which partners will conduct themselves. It will
outline the means by which an operating committee is established, authorizations for expenditure
and budgets are governed, notification deadlines, lifting rules, cash calls and so forth.
Glossary
Joint Venture – The term applies to a number of partnership arrangements between individual
oil companies or between a company and a host government. Typically an oil company or
consortium (contractor group) carries out sole risk exploration efforts with a right to develop any
discoveries made. Development and production costs then are shared pro-rata between partners
to the joint venture which may include the government.
Kerosene – A middle-distillate fraction (340 – 550˚F) that falls into the temperature range
between naphtha (235 – 385˚F) and gas oil (510 – 710˚F). It is fuel for jet engines and is used
for making other products. C10 – C18
Lease Option – A contractual right of an individual or a company to sign a lease, typically

within a certain timeframe and upon completion of some agreed upon work such as a feasibility
study, regional study, or regional data acquisition program.
Letter of Credit – An instrument or document from a bank to another party indicating that a
credit has been opened in that party’s favor guaranteeing payment under certain contractual
conditions. The conditions are based upon a contract between the two parties. Sometimes called
a performance letter of credit, which is issued to guarantee performance under the contract.
Letter of Intent – A formal letter of agreement signed by all parties to negotiations after
negotiations have been completed outlining the basic features of the agreement, but preliminary
to formal contract signing.
License – An arrangement between an oil company and a host government regarding a specific
geographical area and petroleum operations. In more precise usage the term applies to the
development phase of a contract after a commercial discovery has been made (see Permit or
Block).
License Area – A Block or concession area governed by a PSC or other type of contract
between an IOC and a Host Government.
License Splitting – A company's option to segregate a license area into segments and find
partners and negotiate farmin/farmout arrangements for a specific segment.
Lifting – When a company takes physical and legal possession of its entitlement of crude oil,
which ordinarily consists of both cost oil and profit oil. Lifting Agreements govern the rules by
which partners will lift their respective shares and how adjustments are made if a party is “over
lifted” or “under lifted”.
The amount of crude oil an operator produces and sells or the amount each working interest
partner (or the government) takes. The liftings may actually be more or less than actual
entitlements, which are based on royalties, working interest percentages and a number of other
factors. If an operator or partner has taken and sold more oil than it was actually entitled to, then
it is in an "overlifted" position. Conversely if a partner has not taken as much as it was entitled to
it is in an "underlifted" position. (see Nomination and Entitlements).
Glossary
Lifting Agreement – (see Lifting)
Limitada – Business entity which resembles a partnership with liability of all members limited
to their contribution and no general partner with unlimited liability. Normally treated as a
partnership by the US for tax purposes. Similar to a Limited Liability Company in the U.S.
although the limitada was the forerunner.
LNG – Liquid natural gas is natural gas that is liquefied for shipment in specially designed
refrigeration ships then regasified and distributed to customers through pipelines.
Logging – A systematic record of data from the driller’s log, the mud logs, electrical and/or
radioactive logs that capture and depict the petrophysical characteristics of the rocks encountered
in a well.
London Interbank Offered Rate (LIBOR) – The rate most creditworthy international banks
that deal in Eurodollars will charge each other. Thus, LIBOR is sometimes referred to as the
Eurodollar Rate. International lending is often based on LIBOR rates. For example, a country
may have a loan with interest pegged at LIBOR plus 1.5%. (see Eurodollar).
Loss of Bargain Damages – In an action for breach of contract under English law, the plaintiff
is entitled to damages so as to put him in the same position, as far as money can do it, as he
would have been in if the contract has been performed.
LPG – Liquid petroleum gas is a product of distillation and contains considerably more energy
than natural gas. A cubic foot of natural gas contains roughly 1,000 BTUs of energy. A cubic
foot of propane contains about 2,500 BTUs.
Lubricating oil – Lubricating oil is used for motor oil, grease and lubricants and is a liquid. It is
characterized by long chains, C20 to C50, with a boiling range between 572 and 700˚F.
Marginal Government Take – Same as Government Take but with costs assumed to be zero.
Miscible flood – A secondary or tertiary oil recovery method where either gas (gas flood) or
carbon dioxide (CO2 flood) is injected to
enhance oil production. The “miscible” gasses Motor gasoline blending components
reduce the oil viscosity and the injected Raffinates 1%
BTX 3%
materials help maintain pressure and “sweep” C5 3%
oil through the reservoir. Ethanol 1% Poly 1%
Hydrocrackate 4%
Marker crude – A marker, or benchmark Butanes 5%
crude, is a widely traded crude oil used as a
MTBE 4% FCC
reference for setting prices for other crudes,
Gasoline
(e.g., Brent, West Texas Intermediate, and Naphtha 4%
35%
Dubai are benchmark crudes).
Isomerate 5%
Alkylate 35%
Reformate 23%
Source: Valero Energy Corporation
Glossary
Motor gasoline blending – Mechanical mixing of motor gasoline blending components, and
oxygenates, to produce finished motor gasoline.
Maximum Cash Impairment – Maximum negative cash balance in a cash flow projection.
Naphtha – Also known as ‘heavy gasoline’ or ‘light distillate feedstock’it is the fraction (235 –
385˚F) that falls between straight run gasoline (215˚F end point) and kerosene (340 – 550˚F). C5
– C9
Naphthenes – The general formula is CnH2n where n is a whole number usually from 1 to 20.
They are ringed structures with one or more rings. The rings contain only single bonds between
the carbon atoms. Typically liquids at room temperature. Examples include cyclohexane and
methyl cyclopentane.
Nationalization – Government confiscation of the assets held by foreign companies throughout

an entire industry. (see Expropriation).
Net Back – Many royalty calculations are based upon gross revenues from some point of
valuation, usually the wellhead, the last valve off of a production platform or at the boundary of
a field or license area. The point of sale however may be different than the point of valuation and
the statutory royalty calculation may allow the transportation costs from the point of valuation to
the point of sale to be deducted from the actual sale price—netted back. Downstream costs
between the wellhead (or point of valuation) and the point of sale are sometimes referred to as
net back deductions.
Nomination – Under a lifting agreement the amount of crude oil a working interest owner is
expected to lift. Each working interest partner has a specific entitlement depending upon the
level of production, royalties, their working interest, and their relative position (i.e. underlifted or
overlifted), etc. Each working interest partner must notify the operator (nominate) the amount of
its entitlement that it will lift. Sometimes, depending upon the lifting agreement the nomination
may be more or less than the actual entitlement. (see Liftings and Entitlements)
Nonattainment areas – Areas with air quality problems.
Octane rating – A gasoline specification that measures the tendency of a gasoline mixture to
spontaneously (prematurely) ignite causing “engine knock”. Lead was the primary additive for
increasing gasoline octane but has been banned in many countries.
Oil In Place – Estimates of the quantity of liquid hydrocarbons held in the pore spaces of a
reservoir rock. It is understood that it is virtually impossible to recover all of the oil in a
reservoir. Therefore an estimate of the percentage of the Oil In Place that might be recovered is
required to estimate Recoverable Reserves (see Recovery Factor).
OPEC – Organization of Petroleum Exporting Countries founded in 1960 to coordinate

petroleum prices of the members. Members include:
Glossary
Abu Dhabi
Algeria
Ecuador
Gabon
Indonesia
Iran
Iraq
Kuwait
Libya
Nigeria
Qatar
Saudi Arabia
Venezuela
Operator – The company directly responsible for day-to-day operations, maintaining a lease or
license and ensuring the rights and obligations of the other members of the Contractor group are
met.
Operating Profit (or loss) – The difference between business revenues and the associated costs
and expenses exclusive of interest or other financing expenses, and extraordinary items or
ancillary activities. Synonymous with net operating profit (or loss), operating income (or loss),
and net operating income (or loss), economic profit (or loss) or cash flow.
OPIC – Overseas Private Investment Corporation - a U.S. Government agency founded under
the Foreign Assistance Act of 1969 to administer the national investment guarantee program for
investment in less developed countries (LDCs) through the issuance of insurance for risks
associated with war, expropriation and inconvertibility of payments in local currency.
Out-of-Round – A term that indicates licensing of particular blocks or licenses is conducted at a

time other than during an official bid round. Usually these out-of-round situations occur when
companies "nominate" particular acreage that is of interest due to recent discoveries or other
situations.
Over Lifting – Over/Under lifting is the difference between actual contractor lifting during an
accounting period and the contractor entitlements based upon cost recovery and profit oil in the
case of a PSC. A lifting is the actual physical volume of crude oil taken and sold.
Overspill – In international taxation, a situation where a taxpaying company has a credit for
foreign taxes which is greater than its corporate tax liability in its home country so that it has an
unused and/or unusable tax credit.
Paraffins – The general formula for paraffin is CnH2n+2 where n is a whole number, usually from
1 to 20. They can be straight or branch-chain molecules. They can be gas or liquid depending on
the molecule. Examples include methane, ethane, propane, butane, isobutane, pentane, and
hexane.
Glossary
Permit – In a loose sense the term is used to describe any arrangement between a foreign
contractor and a host government regarding a specific geographical area and petroleum
operations. In a more precise usage the term applies to the exploration phase of a contract before
a commercial discovery has been made (see License).
Petroleum gas – Petroleum gas is used for heating, cooking and making plastics. It is comprised
of small alkanes, 1 to 4 carbons. The boiling range is less than 104˚F. Liquefied under pressure
to create liquefied petroleum gas (LPG). Common names are, ethane, propane and butane.
Petrophysics – The study of rock properties from either actual rock samples from the field, from
coring and/or from logging methods.
Play – A proven combination of source rocks, reservoir rock, and trap type capable of holding
commercial quantities of hydrocarbons.
Play Concept – An unproven theory or notion about a possible combination of source rocks,
reservoir rock, and trap type.
Pood – Unit of measure of oil production (Azerbaijan). One Pood equals 16 kilograms or
roughly 62-62.5 poods per ton.
Posted Price – The official government selling price of crude oil. Posted prices may or may not
reflect actual market values or market prices.
Pour Point – The lowest temperature at which a particular crude oil will flow. It is an indication
of the wax content of the oil. Some of the famous Indonesian “waxy” crudes have pour points at
nearly 100˚F.
Present Value – The value now of a future payment or stream of payments based on a specified
discount rate.
Price Cap Formulas – A fiscal mechanism where Government gets all or a significant portion
of revenues above a certain oil or gas price. These formulas are typically characterized by a base
price indexed to an inflation factor such as percentage change in the United States Producer Price
Index for example. The U.S. Windfall profits tax of the late 1970s and early 1980s was a
variation on this theme. Malaysia and Angola have had such elements in their systems.
Prime Lending Rate – The interest rate on short-term loans banks charge to their most stable
and credit-worthy customers. The prime rate charged by major lending institutions is closely
watched and is considered a benchmark by which other loans are based. For example, a less well
established company may borrow at prime plus 1%.
Produced water – Water associated with oil or gas that is produced along with the oil or gas.
Glossary
Production platform – An offshore structure equipped for oil and gas production and
processing. As opposed to a “wellhead platform” which is equipped for production only.
Typically, production from a wellhead platform is piped to a production platform.
Production Sharing Agreement (PSA) – This is the same as a Production Sharing Contract
(PSC). While at one time this term was quite common it is used less frequently now, and the
term Production Sharing Contract is becoming more common—except in the FSU where “PSA”
is preferred terminology.
Production Sharing Contract (PSC) – A contractual agreement between a contractor and a host
government whereby the contractor bears all exploration costs and risks and development and
production costs in return for a stipulated share of the production resulting from this effort.
Productive Horizon – A geological formation (horizon) that is known to be hydrocarbon

bearing in a given area or province.
Pro Forma – Latin for as a matter of form. A financial projection based upon assumptions and
possible events that have not occurred. For example, a financial analyst may create a
consolidated balance sheet of two nonrelated companies to see what the combination would look
like if the companies had merged. Often a cash flow projection, for discounted cash flow
analysis, is referred to as a pro forma cash flow.
Progressive Taxation – Where tax rates increase as the basis to which the applied tax increases.
Or, where tax rates decrease as the basis decreases. The opposite of regressive taxation.
Profit Oil – In a production sharing contract the share of production remaining after royalty oil
and cost oil have been allocated to the appropriate parties to the contract.
Prospectivity – This term deals with the exploration potential of an area and the chances for
making commercial discoveries and the risks associated with exploration. An area with the
potential for large discoveries and low costs and low risks would be considered highly
“prospective”.
Prospect – A location where both geological and geophysical information and economic
conditions indicate a feasible place to drill a well.
Protocol – (1) Culturally dictated forms of ceremony and etiquette that govern business
relationships, meetings, and negotiations. (2) Formal document primarily used in republics of the
former Soviet Union signed by parties who attend meetings or negotiations indicating various
minor agreements or stages of agreement reached. These are not the same as a letter of intent
which is more formal and usually signifies that negotiations have been concluded.
Rate of Return Contracts – Sometimes referred to as “Resource rent royalties (or taxes)”,
“Trigger taxes”, or the “World Bank Model”. The government collects a share of cash flows in
excess of specified internal rate return (ROR) thresholds. The government share is calculated by
accumulating negative net cash flows at the specific threshold rate of return (using a method
Glossary
called “compound uplifting”) and once the accumulated value becomes positive the government
takes a specified share. An example is shown below:
Tax
ROR Rate
 
0 – 20% 0%
20 – 25 30
25 – 30 50
> 30 70
Recoverable Reserves – The hydrocarbon volumess expected to be produced economically and

not left behind in the reservoir.
Recovery Factor – The percentage of oil in place (or gas) expected to be produced. It is an
estimate based upon consideration of the fluid properties such as viscosity and GOR, rock
properties such as porosity and permeability, pressure gradients, well spacing and the nature of
the reservoir energy or drive mechanism.
Regressive Tax – Where tax rates become lower as the basis to which the applied tax increases.
Or, where tax rates increase as the basis decreases. This is the opposite of progressive taxation.
Relinquishment – This is a common contract term in exploration agreements that requires a

certain percentage (often around 25%) of the original contract area be returned to the
Government at the end of the first phase of the Exploration Period. Usually additional
relinquishment is required at the end of the second phase of the Exploration Period. Also referred
to as exclusion of areas. Contracts typically have specific provisions for the timing and amount
of relinquishment prior to entering the subsequent phases of the contract.
Reinvestment Obligations – A fiscal term that requires the contractor/operator to set aside a
specified percentage of profit oil or income after-tax that must be spent on domestic projects
such as exploration.
Reserve Replacement Ratio – The amount of oil and gas discovered in a given period divided
by the amount of production during that period.
Reservoir – A porous, permeable rock formation in which hydrocarbons have accumulated.
Reservoir pressure – The reservoir fluid pressure. See “hydrostatic pressure”.
Residuals – Residue from crude oil after distilling off all but the heaviest components or
fractions. Includes coke, asphalt, tar, and waxes and are used for making other products. They
are solids, multiple-ringed compounds C70+, with a boiling range greater than 1112˚F. Also
known as residuum.
Residuum –“The bottoms” or “bottom of the barrel”, boiling range is greater than 1000˚F.
Glossary
Resource Rent Tax – (RRT) Some economists refer to additional profits taxes (peculiar to the
oil industry) as a resource rent tax. Australia has a specific tax based upon profits, which is
referred to as resource rent tax. Normally the RRT is levied after the contractor or oil company
has recouped all capital costs plus a specified return on capital that supposedly will yield a fair
return on investment. (see Rate of Return Contract).
Ringfencing – A cost center based fiscal (or contractual) device that forces contractors or
concessionaires to restrict all cost recovery and or deductions associated with a given license (or
sometimes a given field) to that particular cost center. The cost centers may be individual
licenses or on a field-by-field basis.
For example, with typical ringfencing, exploration expenses in one non-producing block could
not be deducted against income for tax calculation purposes in another block. Under a PSC
ringfencing acts in the same way—cost incurred in one ringfenced block cannot be recovered
from another block outside the ringfence. Most countries use ringfencing.
Ringfencing ordinarily refers to "space" (i.e. area and/or depth) but it can also be based on "time"
and categories of costs. It can also apply to specific reservoirs or reservoir depths and
exploration vs. development expenditures.
Risk Capital – Typically the drilling, seismic, signature bonuses, and costs associated with the
first phase of exploration. The money placed at risk to see if hydrocarbons can be found. Often
these costs have very little chance of being recovered if hydrocarbons are not found.
Royalty Holiday – A form of fiscal incentive to encourage investment and particularly marginal
field development. A specified period of time, in years or months, during which royalties are not
payable to the government. After the holiday period the standard royalty rates are applicable.
(see Tax Holiday)
Royalty Leakage – In Newfoundland the "incentive" payment portion of the fees for Haliburton
services which would be deductible for calculating royalty was referred to as a possible source of
"leakage" ie it would reduce Government revenue from the royalty that allowed such deductions.
Royalty Oil – A percentage of the production (or revenue) paid to the mineral rights owner
(Government typically) free and clear of the costs of production. This represents the Government
oil entitlement as a result of the royalty rate in the contract between the Government and the
International oil company (IOC).
“R” Factors – Some tax rates (and royalties, DMO, Gvt. Participation) are governed by pre-
determined “payout” thresholds. “R” stands for “ratio”. Typically the contract defines “R” as the
ratio of “X” divided by “Y”. And “X” is defined as “cumulative receipts” and “Y” is defined as
“cumulative expenditures”. Cumulative expenditures include both capital as well as operating
costs. When “R” equals 1 (one) this is the point at which the company has achieved “payout”.
Usually multiple thresholds are established. For example:
Tax
Glossary
“R” Rate
 
0 - 1 40%
1 - 1.5 50
1.5 - 2 60
> 2 70
At the end of each accounting period the “R” factor is calculated and when a threshold is crossed,
then in the next accounting period the new rate would apply.
Seal – An impermeable rock capable of trapping hydrocarbons in a porous reservoir rock.
Seismic – A petroleum exploration method in which acoustic (sound) energy is put into the earth
with a source such as dynamite, vibrating trucks, or air guns. The sound energy reflects off
subsurface rock layers and is recorded by detectors (geophones) at the earth’s surface. Images of
the subsurface rock layers is made with seismic to locate geological structures.
Two-dimensional (2-D) seismic is where data is acquired along a single line of geophones. This
has been the way data has been acquired for many years.
Three-dimensional (3-D) seismic is where data is acquired with a “grid” of geophones – multiple
lines. This is a newer, more costly technology but results have typically been quite good in terms
of the quality of the data acquired.
Seismic Option – A contractual arrangement between a host government and a contractor. The
arrangement provides the contractor exclusive rights over a geographic area where it is obligated
to shoot seismic data. After data acquisition, processing and interpretation the contractor has the
right to enter into an additional phase of the agreement or a more formal contract with the
government for the area, which usually includes a drilling commitment.
Seismic Reflectors – When seismic data is acquired there are some rocks in the subsurface that
yield stronger responses “echoes” when the sound energy bounces back to the detectors
(geophones) at the surface. These make it easier to “see” how the geological horizons or
formations in the subsurface are folded or faulted.
Severance Tax – A tax on the removal of minerals or petroleum from the ground, usually levied
as a percentage of the gross value of the minerals removed. The tax can also be levied on the
basis of so many cents per barrel or per million cubic feet of gas.
Shelf Company – An incorporated entity, which has no assets and or income but has gone
through the process of registration and licensing. Some operations in foreign countries are started
with acquisition of a shelf company because of the long delays that can be experienced setting up
and incorporating a company.
Sinking Fund – Money accumulated on a regular basis in a separate account for the purpose of
paying off an obligation or debt.
Glossary
Sliding Scales – A mechanism in a fiscal system that increases effective taxes, and/or royalties
based upon profitability or some proxy for profitability such as increased levels of oil or gas
production (most common). Ordinarily each tranche of production is subject to a specific rate
and the term “incremental” sliding scale is sometimes used to further identify this.
Example:
Typical Sliding Scale Royalty:

Royalty
First Tranche Up to 10,000 BOPD 5%
Second Tranche 10,001 - 20,000 BOPD 10%
Third Tranche 20,001 - 40,000 BOPD 15%
Fourth Tranche > 40,001 BOPD 20%
Rare but also referred to as “Gliding scales” (Kazakhstan).
Sovereign Risk – Also called country risk or political risk--refers to the risks of doing business
in a foreign country where the government may not honor its obligations or may default on
commitments. Encompasses a variety of possibilities including nationalization, confiscation,
expropriation, etc. (see Country Risk).
Spot Market – Commodities market where oil (or other commodities) are sold for cash and the
buyer takes physical delivery immediately. Futures trades for the current month are also called
spot market trades. The spot market is mostly an over-the-counter market conducted by
telephone and not on the floor of an organized commodity exchange.
Spot Price – Also called the cash price. The delivery price of a commodity traded on the spot
market.
Spud – The commencement of drilling operations when a drilling rig is in-place and a drill bit
begins to penetrate the earth.
State Take – The government share of profits also referred to as government take. (Although
there are some consulting firms that make a distinction between Government take and State
take.) There are a number of definitions but the most succinct is: State Take = State Cash
Flow/Gross Project Cash Flow.
Subsidiary – A company legally separated from but controlled by a parent company who owns
more than 50% of the voting shares. A subsidiary is always by definition an affiliate company.
Subsidiary companies are normally taxed as profits are distributed as opposed to branch profits
which are taxed as they accrue. (see Affiliate)
Sulfur – A yellowish nonmetallic element found in crude oil or natural gas to varying degrees.
Crude oil with 2.5% sulfur or more is considered sour. Less than 0.5% is considered sweet.
Sulfur is also known as ‘brimstone.’
Glossary
Sunk Costs – Accumulated costs at any point in time – past costs. There are a number of
categories of sunk costs:
• Tax Loss Carry Forward (TLCF)

• Unrecovered Depreciation Balance
• Unrecovered Amortization Balance
• Cost Recovery Carry Forward
These costs represent previously incurred costs that will ultimately flow through cost recovery or
will be available as deductions against various taxes (if eligible).
Surrender – Surrender is often synonymous with relinquishment in the context of area

reduction. However the term also is used to describe a contractor’s option to withdraw from a
license or contract at or after various stages in a contract. (see Relinquishment)
Take-or-pay Contract – A type of contract where specific quantities of gas (usually daily or
annual rates) must be paid for, even if delivery is not taken. The purchaser may have the right in
following years to take gas that had been paid for but not taken.
Tax – A compulsory payment pursuant to the authority of a foreign government. Fines,

penalties, interest and customs duties are not taxes.
Tax Haven – A country where certain taxes are low or nonexistent, in order to increase
commercial and financial activity.
Tax Holiday – A form of fiscal incentive to encourage investment. A specified period of time, in
years or months, during which income taxes are not payable to the government. After the holiday
period the standard tax rates apply.
Tax Loss Carry-forward (TLCF) – In systems where expensing of pre-production costs is

allowed, a negative tax base can arise which is referred to as a tax loss carry-forward. Also a
TLCF can originate in systems where bonuses are deductible for tax calculation purposes and
may be expensed.
Tax Treaty – A treaty between two (bilateral) or more (multilateral) nations which lowers or
abolishes withholding taxes on interest and dividends, or grants creditability of income taxes to
thus avoiding double taxation.
Technical Cost Factor – A cost index per unit such as barrels, mcf or BOE at some parity
between oil and gas. The index is based upon the capital costs per barrel plus one-half of all
operating costs per barrel. For example, if a field development is expected to cost US$300MM
for 100 MMBBLS of recoverable oil, the capital costs amount to $3.00/BBL. If Operating costs
over the life of the field are expected to amount to $600 MM then the technical cost factor would
be $5.00/BBL. ($300 MM capital cost + $400 MM operating costs (full cycle)/2 = $500 MM
"technical costs") Technical cost factor then would be $500 MM/100 MMBBLS (or $5.00/BBL).
Glossary
Thin Capitalization Rules – In countries where interest cost is recoverable or deductible the
Government may introduce a backstop against the practice where overseas shareholders load the
balance sheets of their in-country operations with debt, with the object of reducing host country
tax exposure. Typically the Government will impose an artificial (or “imputed’) capitalization
structure such as 75% debt, or limit the debt/equity ratio to a certain percentage.
Tranche – Usually a quantity or percentage of oil or gas production that is subject to specific
fiscal criteria. (1) The Indonesian first tranche production (FTP) of 20% means that the first 20%
of production is subject to the profit oil split and taxation and this tranche of production is not
available for cost recovery. (2) Sliding scale terms typically subject different levels of production
(tranches) to different royalty rates, tax rates or profit oil splits. Example:
Typical Sliding Scale Royalty:

Royalty
First Tranche Up to 10,000 BOPD 5%
Second Tranche 10,001 - 20,000 BOPD 10%
Third Tranche 20,001 - 40,000 BOPD 15%
Fourth Tranche > 40,001 BOPD 20%
Although rare, also referred to as "slabs" (India) or “lifts” (rare).
Transfer Pricing – Integrated oil companies must establish a price at which upstream segments
of the company sell crude oil production to the downstream refining and marketing segments.
This is done for the purpose of accounting and tax purposes. Where intra-firm (transfer) prices
are different than established market prices, governments will force companies to use a marker
price or a basket price for purposes of calculating cost oil and taxes.
Transfer pricing also refers to pricing of goods in transactions between associated companies.
Often same as non-arms-length sales.
Trap – A high area on the reservoir rock where oil and/or gas can accumulate. It is overlain by a
cap rock (seal).
Treaty Shopping – Seeking tax benefits and treaties in various countries in order to structure an
appropriately situated business entity in a given country that would take advantage of benefits
that would not ordinarily be available.
Trend – The area along which a petroleum play occurs. Sometimes referred to as a fairway.
Turnover – A financial term that means gross revenues. The term is commonly used outside of
the United States.
Under Lifting – (see Over Lifting)
Unit-of-Production Depreciation - Method of depreciation for capital costs. This method

attempts to match the costs with the production those costs are associated with.
Glossary
Formula for Unit-of-Production Method

P
Annual Depreciation = (C - AD - S) 
R
Where:
C = Capital Costs of equipment

AD = Accumulated depreciation
S = Salvage value
P = Barrels of oil produced during the year *
R = Recoverable reserves remaining at the beginning of the tax year
* If there is both oil and gas production associated with the capital costs being
depreciated, then the gas can be converted to oil on a thermal basis.
Unfinished oils – Oils requiring further processing, which does not count those ready for
mechanical blending.
Uplift – Common terminology for a fiscal incentive whereby the government allows the
contractor to recover some additional percentage of tangible capital expenditure. For example if
a contractor spent $10 MM on eligible expenditures and the government allowed a 20% uplift
then the contractor would be able to recover $12 MM. The uplift is similar to an investment
credit. However, the term often implies that all costs are eligible where the investment credit
applies to certain eligible costs. The term uplift is also used at times to refer to the built-in rate of
return element in a rate of return contract.
Value Added Tax (VAT) – A tax that is levied at each stage of the production cycle or at the
point of sale. Normally associated with consumer goods. The tax is assessed in proportion to the
value added at any given stage.
Indirect taxes such as the VAT [or Goods & Services Tax (GST)] place the company or
contractor in the role of unpaid tax collector on behalf of the government. Sometimes referred to
as a withholding tax.
Wildcat Well – An exploratory well drilled far from any proven production. Wildcat wells
involve a higher degree of risk than exploratory or development wells.
Withering Clause – (see Dilution Clause)
Withholding Tax – A direct tax on a foreign corporation by a foreign government, levied on

dividends or profits remitted to the parent company or to the home country, as well as interest
paid on foreign loans.
Glossary
Work Commitment – The drilling and/or seismic data acquisition and processing obligation
associated with any given phase of a PSC. This term is also used in the context of a farmin
agreement.
Working Interest – The percentage interest ownership a company (or government) has in a joint
venture, partnership, or consortium that bears 100% of the costs of production. The expense-
bearing interests of various working interest owners during exploration, development and
production operations, may change at certain stages of a contract or license. For example, a
partner with a 20% working interest in a concession may be required to pay 30% of exploration
costs but only a 20% share of development costs (see Carried Interest). With government
participation, the host government usually pays no exploration expenses but will pay its pro-rata
working interest share of development and operating costs and expenses.
World Bank – A bank funded by approximately 130 countries which makes loans to less
developed countries (LDCs). The official name of the World Bank is the International Bank for
Reconstruction and Development.
Wax – A solid or semi-solid material found in crude oil or condensate. Long-chain paraffins.
Fiscal System Summaries

Angola
Offshore mid 1990s PSC
______________________________________________________________________________________
Area 4,000 - 5,000 km2 (1-1.2 MM acres)
______________________________________________________________________________________
Duration Exploration 3 years + 1 + 1 + .5 + .5
4 years + 2 for deepwater
Production 20 years from date of discovery
______________________________________________________________________________________
Relinquishment All except development areas after 5 years onshore
after 6 years deepwater
______________________________________________________________________________________
Exploration Obligations Conoco 1986 $60 MM 4,000 km Seismic + 6 wells
Negotiable Total 1989 $9 MM Seismic + 2 wells
______________________________________________________________________________________
Signature Bonus
Rentals $300/km2 for development areas
______________________________________________________________________________________
Royalty None
______________________________________________________________________________________
Cost Recovery 50% limit
40% Uplift on development costs
______________________________________________________________________________________
Depreciation Exploration costs expensed
Development costs 5 year straight line (was 4 years)
______________________________________________________________________________________
Profit Oil Split (Typical) MBOPD Company
0 - 25 50-60%
25 - 50 30
50 - 100 20
> 100 10
______________________________________________________________________________________
Taxation In lieu - paid by Sonangol (50%)
With economic equilibrium/stability clause
______________________________________________________________________________________
Ringfencing For cost recovery
Around license for exploration
Around field for development
______________________________________________________________________________________
DMO Pro rata option/right up to 40% of production
______________________________________________________________________________________
Gvt. Participation Up to 51% in early contracts (assumed here)
After 1997 typically 20% “Heads up”
______________________________________________________________________________________
Other Price cap formula Gvt. takes 100% above $32/BBL (1991)
Government Take Effective Lifting Savings Data

Royalty Index Quality
78% 76% 77% 78% 31% 64% 35¢ Good
Argentina
Royalty/Tax (1990+)
_________________________________________________________________________________________
Area Designated Blocks Maximum 250 km2
_________________________________________________________________________________________
Duration Exploration 3 years with two 2 year extensions
Delineation 1 year following discovery
Production 20 years
_________________________________________________________________________________________
Relinquishment
_________________________________________________________________________________________
Exploration Obligations
_________________________________________________________________________________________
Bonuses No
Rentals 419 Pesos/km2/yr 1st 4 years (1 Peso/US$1)
838 Pesos/km2/yr after year 4
_________________________________________________________________________________________
Royalty 12% Federal royalty
[Net back allowed up to 4% of gross sales price]
3% Provincial Sales Tax royalty
[From 1-3% based on gross revenues less royalty]
14.64% Overall Effective Royalty Rate
5% Marginal Fields
_________________________________________________________________________________________
Taxation (Profit Tax) 33%
3% Provincial sales tax [1% assets tax abolished in 1995]
_________________________________________________________________________________________
Depreciation UOP
_________________________________________________________________________________________
Ringfencing No
_________________________________________________________________________________________
DMO Yes
_________________________________________________________________________________________
Gvt. Participation No [15% - 50% Gvt. option (old contracts)]
In 2000 or so Argentina raised income taxes from 30% to 35% and wanted to discourage
capital outflows with a withholding (repatriation) tax but IMF restrictions would not
allow it—it would cause a default on loans. So instead a 15% “surtax” based upon

57% 49% 47% 45% 14.6% 86.4% 65¢ Good
Azerbaijan 1994
AIOC - PSC I 20 Sept., 1994 Amoco, Lukoil, McDermot et al
_________________________________________________________________________________________
Area Azeri & Chirag & Deepwater Gunashli
_________________________________________________________________________________________
Duration "Basic Term" 30 years
Exploration An extension of basic term provision for discovery
_________________________________________________________________________________________
Relinquishment No - not in the normal sense
_________________________________________________________________________________________
Obligations Early Production
3-D Seismic over entire area (20,000 km2 full fold)
3 appraisal wells + Environmental baseline survey
_________________________________________________________________________________________
Bonuses $300 MM - 3 installments - less 10% SOCAR WI if back-in option exercised
1/2 [$150 MM] = Signature Bonus; 1/4 [$75 MM] @ 40,000 BOPD;
1/4 [$75 MM] when oil exported from MEP (Main Export Pipeline)
_________________________________________________________________________________________
Royalty None
Rentals
_________________________________________________________________________________________
Cost Recovery No limit on OPEX
CAPEX limited to 50% of remainder "all finance costs" recoverable
_________________________________________________________________________________________
Depreciation 4 years for Equipment and capital assets
Abandonment Costs - 10% of CAPEX when 70% of reserves depleted – UOP
_________________________________________________________________________________________
Profit Oil Split Early & <$3/BBL & >$4/BBL Late & <$3/BBL & >$4/BBL
RROR P/O Split P/O Split P/O Split P/O Split
< 16.75% 30/70% 25/75% 25/75% 20/80%
16.75-22.75% 55/45% 50/50% 55/45% 50/50%
> 22.75% 80/20% 75/25% 80/20% 75/25%
Gas Clause - exclusive right to negotiate
_________________________________________________________________________________________
Taxation 25% Profit Tax (In later contracts paid on behalf of contractor by SOCAR)
0% VAT - 5% Withholding on Subs (25% of assumed 20% profit)
_________________________________________________________________________________________
Ringfencing Yes
DMO 10% @ Market price at delivery point + 10% @ Market price at MEP
_________________________________________________________________________________________
Gvt. Participation 10% Government pays for costs between Execution & Effective date
[LIBOR + 4%]
SOCAR use of Chirag I Platform valuation adjustment
_________________________________________________________________________________________
G&A Expense – 1st $15 MM 5%; 2nd $15 MM 2%; > $30 MM 1%; Opex @ 1.5%
Other Hiring Quotas : Employee/Expat Wage Tax

* Wide range
38% 64% 70% 80% 0% 59% 41¢ * Good
China
Typical Offshore PSC - 1998
_________________________________________________________________________________________
Duration 30 years
Exploration 7 years
Production 15 years + extensions with approval
_________________________________________________________________________________________
Relinquishment 25% after Phase I, 25% of remaining after Phase II,
Remaining at end of Phase III excluding development areas.
_________________________________________________________________________________________
Exploration Obligations and Bonuses
_________________________________________________________________________________________
Royalty Oil BOPD Gas MMCFD
Up to 20,000 0% Up to 195 0%
20,001 - 30,000 4% 195 - 338 1%
30,001 - 40,000 6% 338 - 484 2%
40,001 - 60,000 8% 484 + 3%
60,001 - 80,000 10%
80,001 + 12.5%
(BOPD converted from Tons/Year at 7:1)
(MMCFD converted from MM m3/year at 35.3:1)
_________________________________________________________________________________________
Pseudo Royalty 5% Consolidated Industrial and Commercial Tax
CICT replaced 1/1/94 with 13% VAT for Chinese companies
and 5% VAT for foreign companies - but still based on Gross Revenues
_________________________________________________________________________________________
Profit Oil Split (Negotiable) BOPD Gvt/Contractor
Example Split (“X” factor) Up to - 10,000 3/97% *
10,000 - 20,000 4/96%
20,000 - 40,000 6/94% * Some contracts start at 95%
40,000 - 60,000 7/93% ("X" factor) and slide to 45%.
60,000 - 100,000 25/75%
> 100,000 36/64%
_________________________________________________________________________________________
All costs expensed
_________________________________________________________________________________________
Taxation 30% Income Tax (15% in Hainan Province)
10% Surtax
Contractors must also pay vehicle and vessel
usage, license tax and individual income tax.
_________________________________________________________________________________________
Depreciation 6 Year SLD for Development costs, Exploration costs expensed
_________________________________________________________________________________________
Ringfencing Yes for cost recovery but not for income tax
_________________________________________________________________________________________
Gvt. Participation Up to 51% upon Commercial Discovery
No repayment of past exploration costs.

There is a wide range of
Downside Mid-range Upside Margin Rate terms that have been
73% 72% 71% 70% 7% 92% 63¢ Good negotiated in China
Congo Br.
PSC 1994 - New Hydrocarbon Law
_________________________________________________________________________________________
Duration Exploration 4 + 3 + 3 years
Production 20 + 5 years
_________________________________________________________________________________________
Relinquishment 50% after 4 - 50% after 3 more
_________________________________________________________________________________________
Obligations Typically Seismic + 4 wells in 1st period
_________________________________________________________________________________________
Signature Bonuses Yes - not cost recoverable or tax deductible
_________________________________________________________________________________________
Royalty 15% Official for Oil (Negotiated)
Gas is negotiable
_________________________________________________________________________________________
Cost Recovery Limit 50-60% (may be 70% in deepwater)
Portion of excess cost oil goes to Government
_________________________________________________________________________________________
Profit Oil Split (Negotiable) Example Splits
BOPD Gvt./Contractor
Up to - 20,000 30/70% 40/60%
20,000 - 40,000 50/50 50/50
> 40,000 70/30 60/40
Some may be straight 50/50% split;

May be linked to "realized" prices
_________________________________________________________________________________________
Taxation 35% for 1st 5 years sliding up to negotiated level
Contractor exempt from other taxes except registration,
stamp duty and service taxes.
_________________________________________________________________________________________
Depreciation Exploration Costs expensed - Others 20% SLD
_________________________________________________________________________________________
DMO May be required - pro rata - full market price
_________________________________________________________________________________________
Ringfencing Development area one ring fence, Minister has discretion over widening
_________________________________________________________________________________________
Gvt. Participation Negotiable (10 - 15%) (assumed 15%)
One recent contract 20% carry through Expl. and Development!
_________________________________________________________________________________________
Other Price Cap formula,
Gvt. Profit Oil increases to 82-85% if price goes above $22/BBL.

78% 73% 71% 70% 33% 64% 37¢ Good
Ecuador
7th Round PSCs 1995
_________________________________________________________________________________________
Area Maximum 200,000 hectares Onshore, 400,000 Offshore
_________________________________________________________________________________________
Duration Exploration 4 + 2 years for Oil; 5 + 2 for Gas
Production 20 years for Oil; 25 years for Gas
_________________________________________________________________________________________
Relinquishment No interim relinquishment
_________________________________________________________________________________________
Exploration Obligations $12-16 MM 0-1 wells Amazon
$ 8-13 MM 1-2 wells W. Coast Region
_________________________________________________________________________________________
Bonuses Various fees
Rentals None
Other $100,000 Bidding Fee Amazon, $50,000 W. Coast
_________________________________________________________________________________________
Royalty No Royalty - paid out of National Oil Co. share
_________________________________________________________________________________________
Gross Production Split BOPD Contractor/Gvt
(Example) < 25,000 75/25%
25,000 - 50,000 65/35
> 50,000 50/50
Typical ranges for 1st tranche from 90/10% to 65/35%
Contractor gets added 2% for each oAPI below 25o API
Gvt. gets added 1% for each oAPI above 25o API
_________________________________________________________________________________________
Taxation 15% employees statutory profit sharing deductible for income tax
25% income tax
36.25% effective rate
Ad Valorem (Total Assets) 0.1 + 0.15 ≈0.25%
_________________________________________________________________________________________
Depreciation Tangible costs pre-production 5 year SLD, Post UOP
There is a limit on G&A = 15% of Exploration investment
No "financial cost" recovery for Exploration
Limit on payments to Home Office 5% of taxable base (?)
_________________________________________________________________________________________
Ringfencing Yes - Around contract area
_________________________________________________________________________________________
DMO Possible - pro rata
_________________________________________________________________________________________
Gvt. Participation None under PSC or predecessor RSA; Pre '82 was 25%
_________________________________________________________________________________________
Other 50¢/BBL, Sept. 1997 environmental tax decree on production
25¢/BBL transportation (previous contracts exempt)

75% 63% 57% 54% 26% 73% 63¢ Good
Gabon
PSC - 1989
_________________________________________________________________________________________
Area 0.1 - 1 million acre blocks
_________________________________________________________________________________________
Duration Exploration 3 years + 2 year extension
Production 20 years
_________________________________________________________________________________________
Relinquishment 25% After 3 years , 50% after 5th year
_________________________________________________________________________________________
Exploration Obligations 1 - 3 Well minimum
_________________________________________________________________________________________
Signature Bonus US$ 0.5 to 2 MM
Production Bonus Startup $1.0 MM
10,000 BOPD $1.0 MM
20,000 BOPD $2.0 MM
_________________________________________________________________________________________
Royalty Up to 10,000 BOPD 5%
10,001 - 20,000 10%
20,001 - 40,000 15%
> 40,000 20%
_________________________________________________________________________________________
Cost Recovery 55% Limit [40% older contracts]
All costs expensed
_________________________________________________________________________________________
Profit Oil Split BOPD Split % Profit Gas Split
(In favor of Government) Up to 5,000 65/35 Negotiated
5,000 - 10,000 70/30
10,001 - 20,000 73/27
20,001 - 30,000 75/25
30,001 - 40,000 80/20
> 40,000 85/15
_________________________________________________________________________________________
Taxation Income Tax (56%) paid by NOC
_________________________________________________________________________________________
Depreciation 5 year straight line
_________________________________________________________________________________________
Ringfence Yes
_________________________________________________________________________________________
DMO Up to 20% of Profit Oil sold at 75% of market price, otherwise
pro rata
_________________________________________________________________________________________
Gvt. Participation 10% Working Interest Government does not repay past costs

82% 76% 75% 75% 39% 49% 28¢ Good
India
Command, Videocon, Marubeni, ONGC Ravva PSC - 28 October, 1994
_________________________________________________________________________________________
Area Ravva Field 331.21 km2 (81,809 acres)
_________________________________________________________________________________________
Duration 25 years from "Effective Date" - 28 October, 1994
Relinquishment Voluntary
_________________________________________________________________________________________
Minimum Work Commitment $218 MM Dev. $43 MM Exp.
$33 MM ONGC Carry + through 3-Month "Transfer Period"
_________________________________________________________________________________________
Bonuses Signature $ 6.25 MM + 6.25 MM a year later
Production $ 9.0 MM at 25, 50 and 75 MMBBLS cumulative
$ 1.8 MM at 80, 85, 95 and 100 MMBBLS cumulative
Gvt. of India additional crude entitlement:
Year 3 200,000 BBLS, Year 4 150,000 BBLS
Year 5 100,000 BBLS, Year 6 50,000 BBLS
_________________________________________________________________________________________
Royalties * Rs. 481 per tonne ≈ $1.80/BBL "Royalty" **
"Specific Rate" Rs. 900 per tonne ≈ $3.38/BBL "Cess" **
For Gas 10% Royalty and no "Cess"
** Assuming Rs. 36/$ and 7.4 BBLS/Tonne
_________________________________________________________________________________________
Cost Recovery Cannot exceed Base Development Costs by > 5%
Recovery of Past Costs shall not exceed $55 MM
Depreciation 100% for cost recovery purposes; 25% DB for tax
Abandonment Accrued UOP fund - cost recoverable
_________________________________________________________________________________________
Profit Oil Split PTRR Contractor/Gvt.
(Pre-Tax) 0 - 15% 90/10%
Based on Post 15 - 20 85/15
Tax ROR method 20 - 25 80/20
(PTRR) 25 - 30 75/25
30 - 40 65/35
> 40 40/60
_________________________________________________________________________________________
Income Tax 50%
Ringfencing Yes
_________________________________________________________________________________________
DMO Up to 100% of Entitlement @ market price
_________________________________________________________________________________________
Gvt. Participation ONGC 40% JV Partner

Royalty Index Quality ERR depends strongly
Downside Mid-range Upside Margin Rate on price of oil and
100% 88% 86% 84% 28+% 70% 44¢ Good Rupie/$ exchange rate.
Indonesia PSC
Standard PSC with First Tranche Petroleum
Gross
Revenue
(-)
FTP 20%
Total
Recoverable Cost
(-)
Equity to be Split
(Profit Oil)
(+)
(+)
Contractor Share Pertamina Share
(-)
Gross DMO Req. (+)
Adjustment
Taxable Income (-)

(+)
Gvt. Tax 48%
Net Total
Contractor (+) Government
Total
Contractor
(+)
From: BLOK DIAGRAM PERHITUNGAN KEEKINOMIAN

Gatot K. Wiroyudo, Chairman, PSC Management and Supervisory Body, Pertamina, January, 2000 Langkawi Island,
Malaysia
Indonesia post 1996

Standard - Post 1996
_________________________________________________________________________________________
Area No restriction - Designated Blocks
_________________________________________________________________________________________
Duration Exploration 3 years
Production 20 years
_________________________________________________________________________________________
Relinquishment 25%
or 100% of no discovery
_________________________________________________________________________________________
Exploration Obligations Multi-well commitments
_________________________________________________________________________________________
Signature Bonus Yes - various
Production Bonus Yes - Many variations
_________________________________________________________________________________________
Royalty Nil
_________________________________________________________________________________________
Cost Recovery 85% limit because of 1st Tranche Petroleum (FTP) of 15%
15.5% Investment Credit applies to facility, platform, pipeline costs.
Investment Credit is cost recoverable but not tax deductible
_________________________________________________________________________________________
Depreciation Oil 25% declining balance with balance written off in year 5
For C/R and Tax Gas 10% declining balance with balance written off in year 5
Intangible and exploration costs expensed
_________________________________________________________________________________________
Profit Oil Split 26.7857/73.2143% (In favor of Government)
_________________________________________________________________________________________
Profit Gas Split 37.5/62.5% (In favor of Contractor)
_________________________________________________________________________________________
Taxation 44% Effective Tax Rate
Based on 30% Income Tax + 20% W/H tax
_________________________________________________________________________________________
Ringfencing Each License Ringfenced
_________________________________________________________________________________________
DMO After 60 months production from a field Contractor receives 25% of market
price for 25% of share oil (share oil = 26.79% of contractor entitlement).
_________________________________________________________________________________________
Gvt. Participation 10% Local Company -- Option seldom exercised

88% 87% 87% 86% 11% 49% 15¢ Good
Indonesia 1994 frontier

1994 Frontier Terms (Fourth Exploration Incentive Package)
Applies to all of E. Indonesia except Bintuni, Salawati, & Bula basins
_________________________________________________________________________________________
Duration Exploration 3 years ?
Production 20 years ?
_________________________________________________________________________________________
Relinquishment 25% ? or 100% of no discovery ?
_________________________________________________________________________________________
Bonuses Negotiable
_________________________________________________________________________________________
Royalty None
_________________________________________________________________________________________
Cost Recovery 85% limit because of 1st Tranche Petroleum of 15%
Investment Credit deleted
_________________________________________________________________________________________
Depreciation Oil 25% declining balance with balance written off in year 5
For C/R and Tax Gas 10% declining balance with balance written off in year 8
_________________________________________________________________________________________
Profit Oil Split 32.6923/67.3077 (In favor of the Contractor)
_________________________________________________________________________________________
Profit Gas Split 23.077/76.923% (In favor of Contractor)
_________________________________________________________________________________________
Taxation 48% Effective Tax rate
Resulting from 35% income tax and 20% withholding tax
_________________________________________________________________________________________
Ringfencing Each License Ringfenced
_________________________________________________________________________________________
DMO After 60 months production from a field Contractor receives 25% of
market price for 25% of “share oil”
_________________________________________________________________________________________
Gvt. Participation Up to 10% repays share of costs + 50%

71% 70% 70% 70% 5% 77% 35¢ Good
Libya
1990 Model Contract
_________________________________________________________________________________________
Duration
_________________________________________________________________________________________
_________________________________________________________________________________________
Royalty None
_________________________________________________________________________________________
Bonuses None
_________________________________________________________________________________________
Depreciation No depreciation for cost recovery
_________________________________________________________________________________________
Profit Split (based on two elements) Example
"R" Factor
Production "R" Index **
BOPD Index * Factor “A” Factor
____________ _______ _______ _______
Up to 10,000 .95 0 - 1.5 1.00
10,000 - 25,000 .84 1.5 - 3.0 .80
25,000 - 50,000 .60 3.0 - 4.0 .65
50,000 - 75,000 .30 > 4.0 .50
> 75,000 .15
* Base factor; ** "A" factor (various rates exist)
For example: Contractor share of "profit" at 25 MBOPD

and "R" of 1.7 = 70.7%
[.884 (wtd. average at 25 MBOPD) * .8]
_________________________________________________________________________________________
Taxation In lieu (Rate used is 65%)
_________________________________________________________________________________________
Ringfencing Yes
_________________________________________________________________________________________
Gvt. Participation 65% Carried through exploration.
No reimbursement of past exploration costs.
Contributes 50% of development Costs
Contributes 65% of operating Costs
Receives 65% of gross production

73% 76% 79% 83% 14% 89% 77¢ Fair
Morocco
Royalty/Tax
(Based on April 15, 1992 law Nr 21-90 as amended by law 27-99 enacted March 16, 2000: for October, 2000 license round)
_________________________________________________________________________________________
Area Blocks not less than 200 km2 not more than 2000 km2
Rightholder may not hold more than 10,000 km2 onshore,
20,000 km2 offshore
_________________________________________________________________________________________
Duration Exploration Permit 8 years + 2 year extension
Exploitation Concession 25 years + 10 year extension
_________________________________________________________________________________________
Bonuses Upon discovery
Negotiable Also production bonuses (Not deductible for tax purposes)
_________________________________________________________________________________________
Royalty 10% Oil 5% Gas; For onshore and offshore under 200 meters,
300,000 tons oil and 300 MM m3 of gas holiday
7% Oil 3.5% Gas; for offshore beyond 200 meters,
500,000 tons oil and 500 MM m3 of gas holiday
Rentals None for exploration licenses, 1,000 Dirhams for exploration permit extension fee 1,000
Dirhams/year per km2 for exploitation concession ($1.00 = 10 Dirhams, 2000)
_________________________________________________________________________________________
Taxation 35% Tax Total exemption (holiday) for total of 10 years starting
from date of regular production
+ 10% National Solidarity Levy
Surtax None
_________________________________________________________________________________________
Depreciation 5 year DDB Exploration capital
10 year SLD development capital
_________________________________________________________________________________________
Ringfencing No (around upstream petroleum)
_________________________________________________________________________________________
Gvt. Participation 25% maximum carried through exploration

66% 63% 61% 61% 10% 90% 59¢ Good
New Zealand
Royalty/Tax New Minerals Programme 1995
_________________________________________________________________________________________
Area Designated Blocks for official blocks offers
The range for designated blocks is huge.
Frontier Offers - no set area but up to 25,000 km2 offshore (≈6MM acres)
and up to 2,000 km2 onshore
_________________________________________________________________________________________
Duration Exploration 5 years + 5 years
Production up to 40 years + (for the life of the field)
_________________________________________________________________________________________
Relinquishment generally 50% after 5 years
_________________________________________________________________________________________
Obligations Blocks offers - 1 Well in 5 years
Frontier Areas - 1 Well in 3 years
_________________________________________________________________________________________
Signature Bonus No
Rentals Roughly 2¢/acre
_________________________________________________________________________________________
Royalty (Hybrid) Either 5% Ad Valorem Royalty (AVR)
or
20% Accounting Profits Royalty (APR), whichever is greater in any year
_________________________________________________________________________________________
Taxation 33% Income Tax (Resident Companies)
15% Withholding Tax
38% Income Tax (Non-resident Companies)

_________________________________________________________________________________________
Depreciation For income tax calculation purposes
Onshore 7 yrs SLD starting "when placed in service"
Offshore 7 yrs SLD starting "when spent"
Exploration Costs Expensed
No Depreciation for APR calculation
G&A 2.5% offshore; 1.5% onshore
_________________________________________________________________________________________
Ringfence Licenses ringfenced for Royalties
Income Taxes consolidated
_________________________________________________________________________________________
Gvt. Participation None

48% 46% 46% 45% 5% 97% 56¢ Good
Norway
Royalty/Tax - Late 1990s
_________________________________________________________________________________________
Area Blocks 544 km2 - 134,000 acres
_________________________________________________________________________________________
Duration 30 Years
Exploration up to 10 years
Production Field Specific
_________________________________________________________________________________________
Relinquishment 50% after 6 years
_________________________________________________________________________________________
_________________________________________________________________________________________
Royalty 0% on new fields (abolished in 1992)
in 1986 ranged from 8% to 14%
_________________________________________________________________________________________
Bonuses None
_________________________________________________________________________________________
Taxation 28% Corporate Income Tax (CIT)
50% Special Petroleum Tax (SPT) Not deductible against (CIT)
78% Effective tax rate
15% Production allowance against SPT only (deduction)

5% uplift on development capital costs for 6 years SPT only.
_________________________________________________________________________________________
Depreciation 6 years SLD
Beginning in year of investment
Prior to 1986 depreciation began "when placed in service"
_________________________________________________________________________________________
Ringfencing Not in upstream sector
The tax system is company based, not field based. Companies can
deduct all costs and are taxed on a net profit basis.
_________________________________________________________________________________________
Gvt. Participation Up to 30% - not carried. (Not included in this analysis)
Prior to 1986 Government was carried through exploration
_________________________________________________________________________________________
Other Capital Tax abolished
[It was 0.7% ad valorem on investment book value.]

73% 73% 75% 76% 0% 100% 21¢ Good
Pakistan PSC
Onshore Royalty/Tax System
Zone II - 1994 Petroleum Policy
______________________________________________________________________________________
Area 3 Zones 1) High Risk High Cost
2) Med Risk High Cost
3) Med Risk High to Low Cost
______________________________________________________________________________________
Duration 3 + 5 + 1 year extensions
______________________________________________________________________________________
Relinquishment 30% + 20%
______________________________________________________________________________________
______________________________________________________________________________________
Bonuses $0.5 MM at start up;
$1.0 MM at 30 MM BBLS
Social welfare fund $20K/year up to 250K at 50 MBOPD
Annual Training Fee $100K pre and $250K post production
Offshore bonus 2% of approved R&D projects after discovery
______________________________________________________________________________________
Royalty 12.5%
______________________________________________________________________________________
Taxation 52.5% Corporate Income Tax
15% Withholding Tax
Depletion Allowance lesser of 15% Gross or 50% of taxable income
______________________________________________________________________________________
Depreciation 10% Declining Balance
Below ground drilling costs expensed
______________________________________________________________________________________
Ringfencing Not for dry hole costs
Yes for other costs
______________________________________________________________________________________
Gvt. Participation 5% Initial increasing upon discovery to:
25% No reimbursement of past costs
______________________________________________________________________________________
Other Import duties 3%

Example
Zone 2 65% 60% 60% 61% 12.5% 87.5% 47.5¢
The Philippines
Risk Service Contract early 1990s
_________________________________________________________________________________________
Area Designated Blocks
_________________________________________________________________________________________
Duration Seismic Option 1 yr
Exploration 10 yr maximum
Production 30 yrs
_________________________________________________________________________________________
Exploration Obligations Negotiable; Two Well Option after Seismic
_________________________________________________________________________________________
Signature Bonus Negotiable
_________________________________________________________________________________________
Royalty None
_________________________________________________________________________________________
FPIA 7.5% goes to contractor group
*Filipino Participation Incentive Allowance (FPIA)
Depends on level of Filipino ownership up to 30% onshore or 15% in
deep water qualifies for full 7.5% (FPIA)
Onshore Filipino Participation FPIA

Up to 15% 0%
15 - 17.5 1.5
17.5 - 20 2.5
20 - 22.5 3.5
22.5 - 25 4.5
25 - 27.5 5.5
27.5 - 30 6.5
> 30 7.5%
_________________________________________________________________________________________
Cost Recovery 70% limit
_________________________________________________________________________________________
Depreciation Exploration costs expensed, Development costs 10 year SLD
_________________________________________________________________________________________
Profit Oil Split 60/40% (In favor of Gvt.)
[Contractors 40% is part of "Service Fee"]
_________________________________________________________________________________________
Taxation No - Paid out of Gvt. Share
_________________________________________________________________________________________
Ringfencing Consolidation allowed on 2 or more deepwater blocks
_________________________________________________________________________________________
DMO Pro-rata
_________________________________________________________________________________________

50% 53% 54.5% 55.5% 13.5% 62.5% 40¢ Good
Syria
PSCs late 1980s
_________________________________________________________________________________________
Duration Exploration 3 + 2 + 1 years typically
Production 20 Years from commerciality + 10
_________________________________________________________________________________________
Relinquishment 25% + 25% of original area each time
_________________________________________________________________________________________
Exploration Obligations $10 to 30 MM depending on prospectivity
_________________________________________________________________________________________
Signature Bonuses variable $0 - 1 - 2 - 8 MM
Production Bonuses variable 25 - 50 MBOPD $1-2 MM
50 - 100 MBOPD $2-4 MM
Not recoverable 100 - 200 MBOPD $9-12 MM
_________________________________________________________________________________________
Royalty 12.5% Typical or more - some have sliding scales
_________________________________________________________________________________________
Cost Recovery Ceiling
OXY
BOPD 1988
Up to 25,000 30%
25,001 - 50,000 30
50,001 - 100,000 25
> 100,000 23
_________________________________________________________________________________________
Depreciation Exploration capital and Operating costs expensed
Development Costs 5 years SLD
_________________________________________________________________________________________
Profit Oil Split
OXY
BOPD 1988
Up to 25,000 25
25,001 - 50,000 23
50,001 - 100,000 21
100,001 - 200,000 19
> 200,000 12.5
_________________________________________________________________________________________
Taxation Taxes paid by SPC on behalf of contractor.
_________________________________________________________________________________________
Ringfencing Yes
_________________________________________________________________________________________
Gvt. Participation None or 50% JV not a "back-in"

Example
Oxy 100% 88% 83% 86% 56% 38% 23¢
Trinidad & Tobago PSC

BHP/Elf Offshore PSC 29 Feb., 96
______________________________________________________________________________________
Area Block 2(c) 51,766 hectares
______________________________________________________________________________________
Duration Exploration 3+2+1 + development phase Gas discoveries
Production
______________________________________________________________________________________
Relinquishment 30 + 20% on commercial discovery retain up to 20%
______________________________________________________________________________________
Bonuses Production $1 MM @ 25, $1.5 MM @ 50, $2 MM @ 75,
$2.5 MM @ 100 MBOPD + $1 MM for every 50 MBOPD >100 MBOPD
Training $100K + 6%/yr Expl., $150K + 6%/yr after discovery
R&D fee $100K + 6%/yr Expl., $150K + 6%/yr after discovery
Technical Assistance Bonus $100K
Administrative fee $200K + 6%/yr
Annual rentals $1.25/hectare 1st year, $1.50, $1.75, $2.00, $2.25, $2.50 then + 6%/year
______________________________________________________________________________________
Exploration Obligations 1st Phase 20,000 line km 3-D seismic, full fold 642 km2,
+ 1 well (3,500 m) $6.5MM *
2nd Phase 1 well (2,500 m) $3MM *
3rd Phase 1 well (2,500 m) $3MM * * Bank guarantees required
______________________________________________________________________________________
Cost Oil 35% Oil 50% Gas
______________________________________________________________________________________
Depreciation Exploration 100%; Development 20% SLD
G&A pre discovery 5% of 1st $5MM, 3% next $3MM, 1% over $8MM
post discovery .6% up to $20MM, .5% $20-50MM, .4% over $70 MM
______________________________________________________________________________________
Ministers Share Profit Oil/Gas
Oil Price $/BBL Gas Price $/MCF
MBOPD <$20 20-30 30-40 >$40 MMCFD <$1 1-1.5 1.5 – 2 >$2
0 – 10 50% 50% 55% 60% 0 – 60 50% 50% 55% 50%
10 – 25 50 55 60 65 60 – 150 50 50 50 50
25 – 50 55 60 65 70 150 – 300 55 55 55 55
50 – 75 60 65 70 75 300 – 450 60 60 60 60
> 75 65 70 75 80 > 450 65 65 65 65
______________________________________________________________________________________
Taxation In lieu
______________________________________________________________________________________
Ringfencing Yes
______________________________________________________________________________________
Gvt. Participation No (However some contracts have up to 25% Participation)

77% 52% 53% 55% 33% 63% 46¢ Good
Tunisia
1993 PSC
_________________________________________________________________________________________
Area 978,502 Acres (3,960 km2)
_________________________________________________________________________________________
Duration Exploration 4 years + 2 with additional well
Production
_________________________________________________________________________________________
Relinquishment
_________________________________________________________________________________________
Bonuses
_________________________________________________________________________________________
Cost Oil “R” Values Oil Gas
0 - .7 50% 50%
.7 - 1.3 50 50
1.3 - 1.8 40 40
> 1.8 30 35
Interest cost recovery (up to 70%)
_________________________________________________________________________________________
Depreciation
_________________________________________________________________________________________
Profit Oil Contractor ETAP
“R” Values Oil Gas Oil Gas
0 - .7 40% 45% 60% 55%
.7 - 1.0 35 40 65 60
1.0 - 1.1 25 28 75 72
1.1 - 1.3 20 23 80 77
1.3 - 1.8 15 17.5 85 82.5
1.8 - 2.2 12.5 15 87.5 85
> 2.2 10 12.5 90 87.5
_________________________________________________________________________________________
Taxation Paid out of ETAP share of profit oil
_________________________________________________________________________________________
Ringfencing Not for exploration costs
_________________________________________________________________________________________
Gvt. Participation None assumed

60% 72% 79% 86% 30% 50% 40¢ Good
Turkmenistan
Petronas PSC 2 July, 1996
_________________________________________________________________________________________
Area Block I Gubkin + Barinov Fields
_________________________________________________________________________________________
Duration 26 years from "Effective Date"
2.5 years for G and B fields to start up
Exploration 3+ 2
Production 20 years (Gas is different)
_________________________________________________________________________________________
Relinquishment
_________________________________________________________________________________________
Obligations 2,500 km2 2-D 2 W/C wells
5,500 km2 3-D 2 Appraisal wells
"Allocate" US$45 MM
_________________________________________________________________________________________
Bonuses "Execution" Bonus $13 MM
_________________________________________________________________________________________
Royalties Oil BOPD Royalty Gas 10%
Up to 25,000 3%
25,000 - 50,000 5
50,000 - 75,000 7
75,000 - 100,000 10
> 100,000 15
_________________________________________________________________________________________
Cost Recovery Ceiling 60% for development fields; 70% for Unexplored Structures
Depreciation All costs expensed (Assumed)
_________________________________________________________________________________________
Production Sharing Profit
P/C Oil
Ratio Split
P/C = X/Y  
0 - 1 35/65%
X = Contractor revenues from sales 1 - 1.5 50/50%
Y = Total Costs 1.5 - 2 60/40%
2 - 2.5 80/20%
2.5 + 90/10%
_________________________________________________________________________________________
Taxation 25% TLCF 5 years
Depreciation 5 year SLD
_________________________________________________________________________________________
Ringfencing Yes for cost recovery not for tax
_________________________________________________________________________________________

61% 66% 76% 91% 17% 61% 36¢ Good
United States
Outer Continental Shelf (OCS) Gulf of Mexico Federal
_________________________________________________________________________________________
Area Average 5,000 acre blocks
Offshore Louisiana block size = 5,000 Acres
Offshore Texas block size = 3 X 3 miles = 5,760 Acres
_________________________________________________________________________________________
Minimum Work Commitments Seismic some have drilling commitments
3 wells on 9 blocks (2 on one block)
1,000 -2,000 km Seismic - Average 1,600
_________________________________________________________________________________________
Royalty 12.5% to 20% in State Waters
16.7% Continental Shelf - 12.5% deepwater
Field Lease Royalty

Water Depth Term Relief
(Meters) (Years) on the first
  
< 200 5 No Relief
200-400 5 17.5 MMBBLS
400-800 8 52.5 MMBBLS
> 800 10 87.5 MMBBLS
_________________________________________________________________________________________
Signature Bonus Bid Item
$3.2 MM average since 1953 $627/acre
0.5 MM average since 1988 $122/acre
Production Bonuses None
_________________________________________________________________________________________
Cost Recovery Limit Not in the ordinary (PSC) sense
Alternative Minimum Tax may apply
_________________________________________________________________________________________
Taxation 35% Federal Income Tax
_________________________________________________________________________________________
Depreciation MACRS
UOP for Bonuses
_________________________________________________________________________________________
Ringfencing None

Example
Shallow 60% 50% 48% 46% 16.7% 83% 65¢ Good
Deepwater 35% 37% 41% 39% 0% 100% 65¢
Venezuela PSC
1996 Risk Service Agreements "Strategic Associations" Round 3 Exploration
______________________________________________________________________________________
Area 8 to 12 areas in blocks not more than
2,000 km2 divided into 16 sub-blocks.
______________________________________________________________________________________
Duration Exploration up to 9 years
Total 20 years with option to extend by 10 years
______________________________________________________________________________________
Relinquishment
______________________________________________________________________________________
Exploration Obligations 2 wells per 1,000 km2 in first 4 years
If exploration continues into yrs 5-7, 6 more wells required.
______________________________________________________________________________________
Signature Bonuses Initial Guarantee $500,000 (wide range see following page)
Data Packages $50,000
Bid Fee $100,000 per bid
______________________________________________________________________________________
Royalties 16.67% Proposed sliding scale
Based on ROA = Pre-tax profit/Asset Book Value
______________________________________________________________________________________
Taxation Sliding scale PEG tax levied on pre-tax profits.
PEG tax = Extra Government Take; Bid item (0-50%)
67.7% Corporate Income Taxes (interest expense deductible)
Investment tax credit limited to 2% of taxable income.

VAT 16% [Zero for exports]
______________________________________________________________________________________
Depreciation Exploration & Development drilling UOP, dry wells expensed
______________________________________________________________________________________
Ringfencing Yes
______________________________________________________________________________________
DMO None
______________________________________________________________________________________
Gvt. Participation Sliding Scale up to 35%
Licenses were awarded on the basis of PEG bid (from 0 to 50%). Ties were broken with a
bonus bid to follow within 2 hours.

93% 91% 88% 87% 16.7% 0% 20¢ Good
Vietnam
Lasmo and Itoh - 1992
_________________________________________________________________________________________
Area Block No. 04-2 2,575 km2
_________________________________________________________________________________________
Duration Not to exceed 25 years
Exploration 5 years 3 + 1 + 1
_________________________________________________________________________________________
Relinquishment 25% + 25% + 25% "original area"
_________________________________________________________________________________________
Obligations 1st phase 3,000 km seismic + 3 wells (est $43 MM)
2nd phase 500 km seismic = 1 well (est $10 MM)
3rd phase 500 km seismic = 1 well (est $18.5 MM)
_________________________________________________________________________________________
Signature Bonus US$ 5 MM
Other Bonuses $ 1 MM 1st Commercial Discovery
$2, 4, 5, 6, & 7 MM @ 30, 50, 75, 100 & 150 MBOPD (not cost recoverable)
Rentals $800K Data Purchase; (not cost recoverable)
$100K/yr Training before Development $400K after
_________________________________________________________________________________________
Royalty None
_________________________________________________________________________________________
Cost Recovery BOPD Limit
Up to 50,000 35%
> 50,000 32%
All costs expensed (Assumed)
_________________________________________________________________________________________
Taxation Paid on behalf of Contractor by PetroVietnam (55%)
_________________________________________________________________________________________
Profit Oil Split BOPD Gvt./Contractor Gas treated with "Gas Clause"
Up to 30,000 71/29%
30,001 - 50,000 72/28
50,001 - 75,000 75/25
75,001 - 100,000 79/21
100,001 - 150,000 82/18
> 150,001 86/14
_________________________________________________________________________________________
Ringfencing Yes
_________________________________________________________________________________________
DMO No
_________________________________________________________________________________________
Gvt. Participation 15%
Other $800K Data Purchase; (not cost recoverable),
$100K/yr Training before Development $400K after

100% 78% 75% 75% 46% 50% 29¢ Good
Yemen
Typical PSA 1997
_________________________________________________________________________________________
Area
_________________________________________________________________________________________
Duration and Work Obligations
Exploration 1st 3 years: 200 km new seismic
+ 2 Wells, minimum US$ 8 MM
2nd 3 years: 100 km new seismic
+ 2 Wells, minimum US$ 6 MM
Production
_________________________________________________________________________________________
Relinquishment 25% of original area after 1st 3 years
100% of remaining non-development area after 2nd 3 years
_________________________________________________________________________________________
Signature Bonus $2 MM
Production Bonuses @ Startup $1 MM
@ 25,000 BOPD $2 MM
@ 75,000 $3 MM
@ 100,000 $4 MM
Training Bonus $0.150 MM/year
Institutional Bonus $0.150 MM/year
Social Development Bonus $0.150 MM/year
_________________________________________________________________________________________
Royalty 10%
_________________________________________________________________________________________
Cost Recovery Limit 45% (50% of Gross less royalty)
_________________________________________________________________________________________
Depreciation 50% for capital expenditures
100% for operating expenditures
_________________________________________________________________________________________
Profit Oil Split
Government Share MBOPD Split
Up to 25 70%
25 - 50 72
50 - 75 75
75 - 100 77.5
> 100 80
_________________________________________________________________________________________
Taxation NOC pays tax on behalf of contractor
_________________________________________________________________________________________
Ringfencing Yes
_________________________________________________________________________________________
Gvt. Participation 25% carried interest

95% 81% 80% 80% 49% 48% 29¢ Good
Abbreviations
Abbreviations
° Degrees (as in °API Crude Gravity)
Oil well with gas
Gas well with oil
Dry hole – plugged and abandoned
Oil well
Oil well – plugged and abandoned
Gas well
$/BBL Dollars per Barrel
$/BOE Dollars per Barrel of Oil Equivalent
$/BOPD Dollars per Barrel of Oil per Day
$/MCF Dollars per Thousand Cubic Feet of gas
$/MCFD Dollars per Thousand Cubic Feet of gas per day
$M Thousand Dollars
$MM Millions of Dollars
AAA American Arbitration Association
ADB Asian Development Bank
ADV Ad Valorem Tax
AFE Authorization for Expenditure
AGR Access to Gross Revenues
AIG American International Group
AIGPRI American International Group Political Risk, Inc.
API American Petroleum Institute
APR Accounting Profits Royalty
ASEAN Association of Southeast Asian Nations
Avg. Average
AVR Ad Valorem Royalty
B Billion
B/af Barrels per acre-foot
B/CD Barrels per Calendar Day (refinery - 365 days)
B/SD Barrels per Stream Day (usually - 330 days)
BBL Barrel (crude or condensate) - 42 U.S. Gallons
BCF Billion Cubic Feet of gas
BCPD Barrels of Condensate Per Day
BIT Bilateral Investment Treaty
Bo Formation Volume Factor (Shrinkage)
BOE Barrels of Oil Equivalent - See COE
BOEPD Barrels of Oil Equivalent Per Day
BOPD Barrels of Oil per Day
BTU British Thermal Unit
BWPD Barrels of Water Per Day
CAPM Capital Asset Pricing Model
C/F Carry Forward (as in Cost Recovery C/F)
C/O Cost Oil
C/R Cost Recovery
CA Contract Area (Same as "Block")
CAPEX Capital Expenditures
CAPM Capital Asset Pricing Model
CEO Chief Executive Officer
CFC Controlled Foreign Corporation
CIF Cost, Insurance and Freight
CNG Compressed Natural Gas
Abbreviations
COE Crude Oil Equivalent (also called BOE)

COO Chief Operating Officer
CPE Centrally Planned Economy
CR Cost Recovery (also C/R)
DCF Discounted Cash Flow
DCFM Discounted Cash Flow Method (not common)
DD&A Depreciation, Depletion and Amortization (in practice typically “depreciation”)
DDB Double Declining Balance Method
DHC Dry Hole Cost
DME Dimethyl ether
DMO Domestic Market Obligation
DO Domestic Obligation
Dwt Deadweight (as in Dwt Tonnage = long tons)
E&P Exploration & Production
EBO Equivalent Barrels of Oil (See BOE and COE)
EDC Equivalent distillation Capacity
EIA Energy Information Administration
EMV Expected Monetary Value (same as EV)
EOR Enhanced Oil Recovery (see IOR)
EPIC Engineering, Procurement, Construction and Installation
ERR Effective Royalty Rate
EV Expected Value (see EMV)
FASB Financial Accounting Standards Board
FC Full Cost Accounting
FCC Fluid catalytic cracking
FCPA Foreign Corrupt Practices Act
FCCU Fluid Catalytic Cracking Unit
FIFO First-In First-Out
Fm Formation
FM. Formation
FMV Fair Market Value
FOB Free On Board
FOGEI Foreign Oil and Gas Extraction Income
FORI Foreign Oil Related Income (downstream)
FPIA Filipino Participation Incentive Allowance
FSU Former Soviet Union
ft Foot or Feet
F-T Fischer-Tropsch process
G&A General and Administrative Expenses
G&G Geological and Geophysical
GAAP Generally Accepted Accounting Principles
GAO General Accounting Office
GM General Manager
GOR Gas Oil Ratio (usually in cubic feet per BBL)
Gvt. Government
IC Investment Credit
ICC International Chamber of Commerce
ICJ International Court of Justice
ICSID International Centre for the Settlement of Investment Disputes
IDC Intangible Drilling and Development Costs
IEA International Energy Association (Associated w/ OECD)
IMF International Monetary Fund (UN)
INA Insurance Company of North America
IOR Improved Oil Recovery (same as EOR)
IRR Internal Rate of Return
ITC Investment Tax Credit
Abbreviations
JOA Joint Operating Agreement

JOB Joint Operating Body
km kilometer
km2 square kilometer
L/C Letter of Credit
LDC Less Developed Country
LIBOR London Interbank Offered Rate
LIFO Last-In First-Out
Lloyds Lloyds of London
LNG Liquefied Natural Gas
LOC Letter of Credit
LP Limited Partnership
LPG Liquid Petroleum Gas
Ltd Limited Liability (British Corporation)
M Thousands
m meters
MBBL Thousands of Barrels
MBBLS Thousand Barrels
MB/CD Thousand Barrels per Calendar Day
MB/SD Thousand Barrels per Stream Day
MBO Management Buy Out
MBOPD Thousands of Barrels of Oil per Day
MCF Thousand Cubic Feet (Gas)
MCFD Thousand Cubic Feet of gas per Day
md Measured Depth
md Millidarcies
MIGA Multilateral Investment Guarantee Agency
MM Millions
MMBBLS Millions of Barrels
MMBO Million Barrels of Oil (Same as MMBBLS)
MMCF Million Cubic Feet of gas
MMCFD Million Cubic Feet of Gas per Day
MNC Multi-National Corporation
MTO Methanol to Olefin
Mud Drilling fluids are often referred to as "mud"
NCI Nelson Complexity Index
NCI (1) Nelson Complexity Index Normal Index
NCI (2) Nelson Complexity Index using Vacuum Distillation with index of 2 for refineries with no
atmospheric distillation Note! No NCI is calculated for refineries with no distillation
NGL Natural Gas Liquids
No. Number
NOL Net Operating Losses
NOx Nitrogen oxide
NPRA National Petrochemical and Refiners Association
NPV Net Present Value
NRI Net Revenue Interest
OAPEC Organization of Arab Petroleum Exporting Countries
OECD Organization for Economic Co-operation and Development
OIDC Oil Importing and Developing Countries
OIP Oil in Place
OOIP Oil Originally in Place
OPEC Organization of Petroleum Exporting Countries
OPEX Operating Expenses
OPIC Overseas Private Investment Corporation
ORI Overriding Royalty Interest
ORRI Overriding Royalty Interest
Abbreviations
P/E Price Earnings Ratio

P/O Profit Oil
P/R Production to Reserves ratio
PDP Proved Developed Producing (Oil & Gas Reserves)
PE Price Earnings Ratio
Phi Porosity
PLC (British) Public Limited Company
PO Purchase Order
PSA Production Sharing Agreement (Same as PSC)
PSC Production Sharing Contract (same as Production Sharing Agreement PSA)
PSI Pounds per Square Inch
PUD Proved Undeveloped (Oil & Gas Reserves)
PV Present Value
PVP Present Value Profits
RF Recovery Factor
RI Royalty Interests
RLI Reserve Life Index
ROA Return on Assets
ROC Return on Capital
ROE Return on Equity
ROI Return on Investment
ROR Rate of Return
RRA Reserve Recognition Accounting
RRR Resource Rent Royalty
RRT Resource Rent Tax
RSA Risk Service Agreement (same as RSC)
RSC Risk Service Contract (same as RSA)
SE Successful Efforts Accounting
SEC Securities and Exchange Commission
Semi Semisubmersible Drilling/Production Vessel
SFAS Statement of Financial Accounting Standards
SP Success Probability (same as Probability of Success or Chance Factor)
STB Stock Tank Barrel
Std. Standard (As in Indonesian Standard Contract)
STOIP Stock Tank Oil In Place
SOx Sulfur oxides
Sw Water Saturation
TAC Technical Assistance Contract
TCF Trillion Cubic Feet of Gas
TCLF Tax loss carry forward
TCM Technical Committee Meeting
TD Total Depth
TEA Technical Evaluation Agreement
TLCB Tax Loss Carry Back
TLCF Tax Loss Carry Forward
TNC Trans-National Corporation
TVD True Vertical Depth
UNCITRAL United Nations Committee on International Trade Law
VAT Value Added Tax
VLCC Very Large Crude Carrier
WI Working Interest
WPT Windfall Profits Tax
Conversion Tables
Conversion Tables
Most common conversions and constants
Area
1 Square mile = 640 Acres
1 Square kilometer = 247 Acres
1 Acre = 43,560 Square feet
Oil Volume
1 Metric Ton (oil) = 7.3 Barrels (depends on specific gravity – see Chapter 8 - Fluid properties)
1 Cubic meter = 6.29 Barrels
1 Barrel = 0.159 Cubic meters
1 Barrel = 42 Gallons
Gas Volume
1 Cubic Meter = 35.31 Cubic feet
Distance
1 Mile = 0.61 Kilometers
1 Kilometer = 1.6093 Miles
1 Knot = 1.151 Miles per hour
1 Meter = 3.281 Feet
1 Inch = 2.54 Centimeters
Pressure
1 Atmosphere = 1 Bar
1 Atmosphere = 14.65 Pounds per square inch (PSI)
Miscellaneous
1 Metric Ton = 1000 Kilograms
1 Acre-foot = 7,758 Barrels
°F = (°C * 9)/5 = 32
°C = (°F -32) * 5/9
Conversion Tables
Area
1 Square Meter = 1550 Square Inches
1 Square Meter = 10.76000 Square Feet
1 Square Meter = 1.19600 Square Yards
1 Square Foot = 0.09290 Square Meters

1 Square Foot = 144 Square Inches
1 Square Yard = 0.83610 Square Meters

1 Square Yard = 1296 Square Inches
1 Square Yard = 9 Square Feet
1 Square Mile = 640 Acres

1 Square Kilometer = 247 Acres
1 Acre = 43,560 square feet
Conversion Tables
Energy work equivalents

1 Joule = 0.10197 Kg-meters
1 Joule = 0.001 Btu
1 Joule = 0.73760 Ft-lbs
1000 Joules = 0.94780 Btu
1000 Joules = 0.23880 K-cals 1 Btu is
1 Kg-meter = 9.80665 Joules approximately =
1 Kg-meter = 7.23300 Ft-lbs
1 Kg-meter = 0.09678 Liter-atm
1000 Kg-meters = 2.34200 K-cal
1000 Kg-meters = 9.29500 Btu
1,000 Btu roughly equals
one average candy bar.
1 Ft-lb = 1.35600 Joules
1 Ft-lb = 0.13830 Kg-meters
1000 Ft-lbs = 0.00037 Kw-hrs
1 Ft-lb = 0.13830 Kg-meters
100 Ft-lbs = 0.03238 K-cal
100 Ft-lbs = 0.12850 Btu
1 Kw-hr = 3600000 Joules

1 Kw-hr = 367100 Kg-meters
1 Kw-hr = 2655000 Ft-lbs
1 Kw-hr = 35528 Liter-atm
1 Kw-hr = 859.90000 K-cal
1 Kw-hr = 3412 Btu It takes about 2000 Btu
to heat a pot of coffee.
1 US Hp-hr = 2684500 Joules
1 US Hp-hr = 273750 Kg-meters
1 US Hp-hr = 1980000 Ft-lbs
1 US Hp-hr = 0.74570 Kw-hrs
1 US Hp-hr = 641.20000 K-cal
1 US Hp-hr = 2544 Btu
1 Liter-atm = 101.33300 Joules

H2O
1 K-cal = 4187 Joules
1 K-cal = 426.90000 Kg-meters
1 K-cal = 3088 Ft-lbs
1000 K-cal = 1.16300 Kw-hrs 1 cubic foot of water falling at 8.81
1000 K-cal = 1.56000 US Hp-hrs feet per second = 1 horsepower
1 K-cal = 41.32000 Liter-atm
1 K-cal = 3.96800 Btu
Conversion Tables
Power
1 Hp = 1.01389 Metric Hp
1 Hp = 0.74570 Kw
1 Hp = 76.04000 Kg-m/sec
1 Hp = 550 Ft-lb/sec
1 Hp = 0.17810 Kcal/sec
1 Hp = 0.70680 Btu/sec
1 Kw = 1.34102 Hp
1 Kw = 1.32264 Metric Hp
1 Kw = 75 Kg-m/sec
1 Kw = 542.50000 Ft-lb/sec
1 Kw = 0.17570 Kcal/sec
1 Kw = 0.69710 Btu/sec
1 Kg-m/sec = 0.01315 Hp
1 Kg-m/sec = 0.00980 Metric Hp
1 Kg-m/sec = 0.01333 Kw
1 Kg-m/sec = 7.23300 Ft-lb/sec
100 Kg-m/sec = 0.23420 Kcal/sec
100 Kg-m/sec = 0.92950 Btu/sec
100 Ft-lbs/sec = 0.18181 Hp

100 Ft-lbs/sec = 0.13560 Metric Hp
100 Ft-lbs/sec = 0.18400 Kw
100 Ft-lbs/sec = 13.83000 Kg-m/sec
100 Ft-lbs/sec = 0.03238 Kcal/sec
100 Ft-lbs/sec = 0.12850 Btu/sec
1 Kcal/sec = 5.61500 Hp
1 Kcal/sec = 4.18700 Metric Hp
1 Kcal/sec = 5.69200 Kw
1 Kcal/sec = 426.90000 Kg-m/sec
1 Kcal/sec = 3088 Ft-lb/sec
1 Kcal/sec = 3.96800 Btu/sec
1 Btu/sec = 1.41500 Hp
1 Btu/sec = 1.05500 Metric Hp
1 Btu/sec = 1.43400 Kw
1 Btu/sec = 107.60000 Kg-m/sec
1 Btu/sec = 778.20000 Ft-lb/sec
1 Btu/sec = 0.25200 Kcal/sec
Conversion Tables
Fluids or fluid equivalents

1 Ounce = 0.06250 Pints
1 Ounce = 0.03125 Quarts
100 Ounces = 0.78125 Gallons
100 Ounces = 0.01860 Barrels
1 Pint = 16 Ounces
1 Pint = 0.50000 Quarts
1 Pint = 0.12500 Gallons
100 Pints = 0.29762 Barrels
1 Quart = 32 Ounces
1 Quart = 2 Pints
1 Quart = 0.25000 Gallons
100 Quarts = 0.59523 Barrels
1 Gallon = 128 Ounces

1 Gallon = 4 Quarts
1 Gallon = 0.02381 Barrels
1 Barrel = 336 Pints

1 Barrel = 168 Quarts
1 Barrel = 42 Gallons
Conversion Tables
Pressure equivalents
1 kg/sq cm = 14.22000 lb/sq in
1 kg/sq cm = 0.96780 atmospheres
1 kg/sq cm = 0.73560 Std Hg Col Meters
1 kg/sq cm = 28.96000 Std Hg Col Inches
1 kg/sq cm = 10.01000 Std H20 Col Meters
1 kg/sq cm = 394.10000 Std H20 Col Inches
1 kg/sq cm = 32.84000 Std H20 Col Feet
1 lb/sq in = 0.07031 kg/sq cm

1 lb/sq in = 0.06805 atmospheres
1 lb/sq in = 0.05171 Std Hg Col Meters
1 lb/sq in = 2.03600 Std Hg Col Inches
1 lb/sq in = 0.70370 Std H20 Col Meters
1 lb/sq in = 27.70000 Std H20 Col Inches
1 lb/sq in = 2.30900 Std H20 Col Feet
1 atmosphere = 14.70000 lb/sq in (Psi)

1 atmosphere = 1.01330 megadynes/sq cm
1 atmosphere = 1.03320 kg/sq cm
1 atmosphere = 0.76000 Std Hg Col Meters
1 atmosphere = 29.92000 Std Hg Col Inches
1 atmosphere = 10.34000 Std H20 Col Meters
1 atmosphere = 407.10000 Std H20 Col Inches
1 atmosphere = 33.93000 Std H20 Col Feet
1 Std Hg Col Inch = 0.03453 kg/sq cm

1 Std Hg Col Inch = 0.49120 lb/sq in
1 Std Hg Col Inch = 0.03342 atmospheres
1 Std Hg Col Inch = 0.02540 Std Hg Col Meters
1 Std Hg Col Inch = 0.34560 Std H20 Col Meters
1 Std Hg Col Inch = 13.61000 Std H20 Col Inches
1 Std Hg Col Inch = 1.13400 Std H20 Col Feet
Conversion Tables
Mass equivalents
1 Kilogram = 15432 Grains
1 Kilogram = 32.15000 Troy Ounces
1 Kilogram = 2.67920 Troy Pounds
100 Kilograms = 0.11020 Short Tons
100 Kilograms = 0.09842 Long Tons
1000 Kilograms = 1 Metric Ton
1000 Grains = 0.06480 Kilograms

1000 Grains = 2.08300 Troy Ounces
1000 Grains = 0.17360 Troy Pounds
1 Troy Ounce = 0.03110 Kilograms

1 Troy Ounce = 480 Grains
1 Troy Ounce = 0.08333 Troy Pounds
1 Troy Pound = 0.37320 Kilograms

1 Troy Pound = 5760 Grains
1000 Troy Pounds = 0.41140 Short Tons
1000 Troy Pounds = 0.36730 Long Tons
1000 Troy Pounds = 0.37320 Metric Tons
1 Short Ton = 907.20000 Kilograms

1 Short Ton = 2431 Troy Pounds
1 Short Ton = 0.89290 Long Tons
1 Short Ton = 0.90720 Metric Tons
1 Long Ton = 1,016 Kilograms

1 Long Ton = 1.12000 Short Tons
1 Long Ton = 1.01600 Metric Tons
1 Metric Ton = 1000 Kilograms U.S.S. Missouri = 50,000 tons

1 Metric Ton = 2679 Troy Pounds
1 Metric Ton = 1.10200 Short Tons
1 Metric Ton = 1.10200 Short Tons
Conversion Tables
Length equivalents
1 Centimeter = 0.39370 Inches
1 Centimeter = 0.03281 Feet
1 Centimeter = 0.01094 Yards
1 Centimeter = 0.01000 Meters
1 Inch = 2.54000 Centimeters
1 Foot = 30.48000 Centimeters

1 Foot = 12 Inches
1 Foot = 0.30480 Meters
1 Yard = 36 Inches
1 Yard = 0.91440 Meters
1 Meter = 39.37000 Inches

1 Meter = 3.28100 Feet
1 Meter = 1.09360 Yards
1 Kilometer = 3281 Feet

1 Kilometer = 1093.60000 Yards
1 Kilometer = 1000 Meters
1 Kilometer = 0.62140 Miles
1 Mile = 5280 Feet

1 Mile = 1760 Yards
1 Mile = 1609 Meters
1 Mile = 1.60900 Kilometers
Conversion Tables
Volume equivalents
1 Cubic Inch = 0.00057 Cubic Feet
1 Cubic Inch = 0.55410 Fluid Ounces
1 Cubic Inch = 0.01732 US Liquid Quarts
1 Cubic Inch = 0.01639 Liters
1 Cubic Foot = 1728 Cubic Inches

1 Cubic Foot = 0.03704 Cubic Yards
The Hindenburg, 803.8 ft in
1 Cubic Foot = 957.50000 Fluid Ounces
length and 135.1 ft in diameter
1 Cubic Foot = 29.92000 US Liquid Quarts
= 6.7 million standard cubic
1 Cubic Foot = 7.48100 US Gallons
feet (scf) of H2.
1 Cubic Foot = 0.80360 US Bushels
1 Cubic Yard = 46656 Cubic Inches
1 Cubic Yard = 27 Cubic Feet
1 Cubic Yard = 25853 Fluid Ounces Acre
1 Cubic Yard = 202.20000 US Gallons
1 Cubic Yard = 764.60000 Liters
1 ft
1 Fluid Ounce = 1.80500 Cubic Inches
100 Fluid Ounces = 0.10440 Cubic Feet
100 Fluid Ounces = 3.125 US Liquid Quarts
=
100 Fluid Ounces = 0.78120 US Gallons
100 Fluid Ounces = 0.95700 Liters
1 US Liquid Quart = 57.75000 Cubic Inches 7,758.367381 BBLS

1 US Liquid Quart = 0.03342 Cubic Feet
1 US Liquid Quart = 32 Fluid Ounces
1 US Liquid Quart = 0.25000 US Gallons
1 US Liquid Quart = 0.94640 Liters
1 US Gallon = 231 Cubic Inches

1 US Gallon = 0.13370 Cubic Feet
1 US Gallon = 128 Fluid Ounces
1 US Gallon = 4 US Liquid Quarts
1 US Gallon = 0.10740 US Bushels
Liquid Natural Gas (LNG) tankers can
1 US Gallon = 3.78500 Liters
carry about 30 million gallons of gas.
1 US Bushel = 35.24000 Liters
1 Liter = 61.02000 Cubic Inches

1 Liter = 33.81000 Fluid Ounces
1 Liter = 1.05700 US Liquid Quarts
1 Liter = 0.26420 US Gallons Valdez Marine Terminal tanks are 63
feet high and 250 feet in diameter. 18
tanks together hold 9.18 million
barrels, enough to power California
for more than 5 days.
Conversion Tables
Velocity equivalents
1 mi/hr = 26.82000 m/min
1 mi/hr = 1.60900 km/hr
1 mi/hr = 1.46700 ft/sec
1 mi/hr = 88 ft/min
60 mi/hr = 88 ft/sec
1 mi/hr = 0.86898 Knots
1 Knot = 1.85200 km/hr

1 Knot = 101.30000 ft/min
1 Knot = 1.15100 mi/hr
Conversion Tables
Pressure conversion
1 inch H2O (60 F) = 2,488.4 dyne/square cm
1 inch H2O (60 F) = 248.84 Pascal (newton/sq m)
1 inch H2O (60 F) = 167.212753 poundal/sq foot
1 inch H2O (60 F) = 25.374618 kgf/square meter
1 inch H2O (60 F) = 5.197131 lbf/square foot
1 inch H2O (60 F) = 2.537532 cm H2O (4 C)
1 inch H2O (60 F) = 2.537462 gram force/sq cm
1 inch H2O (60 F) = 1.866459 torr (0 C)
1 inch H2O (60 F) = 0.999028 inch H2O (39.2 F)
1 inch H2O (60 F) = 0.186646 cm mercury (0 C)
1 inch H2O (60 F) = 0.083252 foot H2O (39.2 F)
1 inch H2O (60 F) = 0.081104 foot seawater
1 inch H2O (60 F) = 0.07369 inch mercury (60 F)
1 inch H2O (60 F) = 0.073482 inch mercury (32 F)
1 inch H2O (60 F) = 0.036091 lbf/square inch (PSI)
1 inch H2O (60 F) = 0.02472 meter seawater
1 inch H2O (60 F) = 0.002537 kgf/square cm
1 inch H2O (60 F) = 0.002488 bar
1 inch H2O (60 F) = 0.002456 atmosphere
1 inch H2O (60 F) = 0.000036 Kip/square inch (KSI)
1 inch H2O (60 F) = 0.000025 kgf/sq millimeter
Conversion Tables
Flow rate (mass) conversion

1 kilogram/hour = 16.666667 gram/minute
1 kilogram/hour = 0.277778 gram/second
1 kilogram/hour = 0.016667 kilogram/minute
1 kilogram/hour = 2.204623 pound/hour
1 kilogram/hour = 0.036744 pound/minute
1 kilogram/hour = 0.001 ton/hour [metric]
1 kilogram/hour = 0.001102 ton/hour [short]
1 pound/hour = 0.453592 kilogram/hour The trans-Alaska pipeline moved

1 pound/hour = 453,592.372209 milligram/hour oil at rates approaching 88,000
barrels an hour (> 2 MMBOPD).
1 ton/hour [long] = 2,239.999989 pound/hour
1 ton/hour [long] = 1.016047 ton/hour [metric]
1 ton/hour [long] = 1.12 ton/hour [short]
Flow rate (volume) conversion

1 acre foot/day = 7,758.367381 barrel/day [US petroleum]
Dynamic viscosity conversion

1 stoke = 100 centistokes
1 stoke = 1 lentor
1 stoke = 86.4 liter/cm day
1 stoke = 1 poise cm³/gram
1 stoke = 86,400 cm²/day
1 stoke = 93.000183 ft²/day
1 stoke = 8.64 m²/day
Bibliography
Bibliography
Burdik, D. L., Leffler, W. L., Petrochemicals in Non-technical Language, (PennWell Publishing
Company, Tulsa, Oklahoma, 1990).
Farrar, G. L., Interest reviving in complexity factors, Oil & Gas Journal -- Oct., 2, 1989, p. 90.
Gill, D., Jack and the Integrated Bean Stalk, Oil & Gas Investor -- March, 1990, pp. 64-70.
Johnston, D., "Index useful for evaluating petroleum fiscal systems" Oil & Gas Journal, - 1 Dec., 1997.
pp. 49-51.
Leffler, W. L., Petroleum Refining for the Non-technical Person, 2nd ed. (PennWell Publishing
Company, Tulsa, Oklahoma, 1985).
Maples, R. E., Petroleum Refinery Process Economics, (PennWell Publishing Company, Tulsa,
Oklahoma, 1993 and second edition 2001).
Nelson, W. L., How to describe refining complexity, Oil & Gas Journal -- Mar. 14, 1960.
Nelson, W. L., How complexity of a refinery affects costs of construction, Oil & Gas Journal -- Sept.
26, 1960.
Nelson, W. L., How to compute refinery complexity, Oil & Gas Journal -- June 19, 1961.
Nelson, W. L., The concept of refinery complexity, Oil & Gas Journal -- Sept. 13, 1976.
Nelson, W. L., The Concept of Refinery Complexity, Oil & Gas Journal -- Sept., 20, 1976.
Nelson, W. L., The Concept of Refinery Complexity, Oil & Gas Journal -- Sept., 27, 1976.
Petzet, A. G., Surge of non-U.S. joint ventures, acquisitions eases in U.S. refining, Oil & Gas Journal -
- Aug. 7, 1989, pp. 15-17.
Treat, J. L. - Editor, Creating the high performance international petroleum company: Dinosaurs
can fly, (PennWell Publishing Company, Tulsa, Oklahoma, 1994).
Index
Capex ........................................................ 24
8 capital costs.. 9, 20, 23, 24, 31, 55, 112, 117,
80/20 rule .................................................. 30 118, 290
CAPM ....................................................... 54
A capped cost recovery rate See Cost Recovery
limit
Abbreviations.......................................... 344 case study parameters ................................. 7
access to gross revenues.......................... 104 Cash Flow
accounting profits.................................. 103 after tax ................................................. 31
Africa........................................................ 99 analysis.................................. 6, 43, 55, 60
airguns ....................................................... 183
and flow diagram ................................ 110
alignment................................................... 18 audit......................................................... 6
alkylation................................................. 250 audit checklist ................................... 9, 10
alkylation/polymerization ............... 261, 262 calculations ........................................... 20
ammonia.................................................. 236 company.................................. 15, 20, 112
API .................................................... 21, 344 contractor ................................................ 8
area ......................................... 117, 348, 349 contractor net ...................................... 101
aromatics ................................................. 217 discounted ........................... 18, 44, 87, 90
aromatics/isomerization .......................... 262 economic profit ................................... 101
asphalt ............................................. 261, 262 example PSC............................... 111, 112
asphaltics................................................. 217 government ......................................... 112
Atchafalaya Bay .................................... 183 gvt. share of profits ............................. 103
atmospheric distillation unit.................... 247 model................................... 8, 12, 14, 113
model/cost recovery .............................. 16
B
model/production peak.......................... 26
balance point mud weight .................... 159 oil company profits ............................. 103
bidding efficiency ..................................... 95 pre-tax ................................................... 31
bit cost..................................................... 146 projection - bonus ............................... 110
bit life ...................................................... 146 projections............................................. 51
bitumen ................................................... 259 rent ...................................................... 103
black-boxes ............................................... 10 two perspectives .................................. 31
bonus ........................... 88, 90, 100, 101, 113 Catalytic .................................................. 262
bonus bidding...................................... 81, 87 cracking....... 254, 256, 261, 262, 263, 264
bonus bids ............................................. 92 hydrocracking ..................... 256, 261, 262
booking barrels.......................................... 18 hydrorefining....................... 256, 261, 262
break-even........................................... 45, 47 hydrotreating ............................... 256, 261
Brent Crude............................................... 21 reformer............................................... 254
Bullwinkle............................................... 152 reforming............. 256, 261, 262, 263, 264
butane...................................................... 226 categories of cost....................................... 23
Clean Air Act .......................................... 258
C climate....................................................... 25
C/R Limit .................................................. 19 cocktail.................................................... 216
cable on bottom ........................................... 183
coke ......................................................... 259
coking...................................................... 258 cracking................................................... 259
commercial success................................... 51 crude properties....................................... 216
Company ................................See Contractor
competitive bidding ........................... 87 D
competitive bidding dilemma ................... 80 darcy........................................................ 205
completion costs........................................ 29 dayrates ................................................... 157
compliant towers..................................... 153 de-asphalting ........................................... 249
concessionary systems .............................. 98 decision tree .................................. 44, 48, 49
concrete structures .................................. 156 decline curve ........................................... 164
condensate............................................... 226 decline rate .......................................... 26, 55
consumption............................................ 283 deepwater streamers............................. 183
Contractor ............................................... 294 delayed coking ................................ 258, 264
cash flow ................................... 8, 87, 113 deliverability ............................................. 28
company take ...................................... 103 depreciation7, 20, 25, 31, 105, 112, 117, 290
DCF..................................................... 113 Development
entitlement............................................. 18 block size/small................................... 117
net cash flow ....................................... 101 capital.................................................... 23
profit oil share ......................... 15, 17, 106 conventional/nonconventional .............. 25
share .................................................... 108 cost $/daily barrel................................ 161
share of profits .................................... 102 costs............................... 23, 102, 161, 175
take. 9, 15, 24, 55, 92, 101, 106, 108, 114, decision ............................................... 101
294 design/peak year production ................. 26
conversion tables..................................... 348 drilling.................................................. 54
Cost drilling costs.................................. 23, 178
estimating.............................................. 82 drilling success ratio ......................... 9, 29
cost cap...................See Cost Recovery limit drilling/success rates ............................. 51
cost oil............................................. 295, 310 feasibility economics ............................ 27
Cost Recovery feasibility studies .................................... 6
calculations ......................................... 112 field size threshold ................................ 51
carry forward................................. 16, 315 gas development options..................... 225
ceiling.................................................. 105 model..................................................... 27
full ....................................................... 110 North Sea well spacing ......................... 27
limit7, 13, 16, 19, 106, 110, 114, 115, 117 well /chance of success ......................... 54
limit (full cycle) .................................. 110 well success ratios................................. 54
limits ................................... 100, 104, 105 wells ............................................ 7, 28, 29
PSC & depreciation............................. 117 diesel ....................................................... 231
recovery mechanism ........................... 110 diesel fuel ........................................ 217, 248
total ............................................... 17, 114 distance to market ..................................... 25
total [saturated] ..................................... 17 Distillation
cost stop ..................See Cost Recovery limit atm unit cost vs. FCCU....................... 256
Costs capacity ......... 24, 254, 256, 261, 262, 263
incremental production ....................... 176 crude unit cost comparison ................. 254
of capital.................................... 23, 44, 60 EDC..................................... 255, 261, 262
over estimating...................................... 82 NCI ........................................................ 346
risk capital............................................. 43 refinery complexity............................. 264
cracked spread......................................... 265 tower ................................................... 248
vacuum................................ 256, 261, 262 contractor ...................................... 18, 107
vacuum distillation capacity ............... 254 cost oil, profit oil................................. 107
drainage area ........................................... 200 government ........................................... 18
drawdown.................................................. 29 imputed ............................................... 104
drilling..................................................... 285 index ..................................................... 18
Drilling lifting............................. 19, 104, 106, 115
average depth ...................................... 146 Equatorial Guinea................................... 98
bit cost................................................. 146 ERR................................................... 16, 106
bottom hole flow pressure................... 205 Europe...................................................... 99
cost equation ....................................... 146 EV ................................. See Expected Value
cost estimates ................................... 162, 179 Expected Value
cost per foot......................................... 146 boundary conditions.............................. 87
costs....................................................... 23 EMV.................................... 47, 48, 51, 54
development.......................................... 54 EMV graph............................................ 45
development costs............................... 178 formula........................................ 6, 43, 46
development success ratio....................... 9 models ................................................... 48
exploration well costs ........................... 23 probability of success.......................... 60
horizontal vs. vertical.......................... 163 project decision ..................................... 44
horizontal wells ........................................ 162 projections of cash flow ........................ 51
offshore ............................................... 178 PS estimates .......................................... 54
oil & gas successful wells ................... 284 risk......................................................... 59
platform costs...................................... 181 theory ........................................ 42, 44, 56
production ........................................... 161 utility curves.......................................... 60
radius of draining ................................ 205 utility theory.......................................... 59
rate of penetration ............................... 146 utility value convergence ...................... 60
rig day rate .......................................... 146 exploration ................................................ 80
rigs....................................................... 149 exploration obligations ......................... 117
rules of thumb .......................................... 162
well definitions.................................... 158 F
well depth............................................ 178
wellbore radius.................................... 205 Factors..................................................... 125
wildcat success ratio ............................. 54 Far East.................................................... 99
dry hole ... 29, 43, 45, 46, 47, 48, 55, 60, 299 FCCU ................256. See Catalytic Cracking
duration.................................................. 117 financial profits ..................................... 103
finding cost.............................. 173, 174, 175
E Fischer Tropsch....................................... 229
Fischer-Tropsch ...................................... 230
economic modeling/auditing....................... 6 fixed platforms ........................................ 152
economic profit ....... 100, 101, 103, 104, 106 flexicoking .............................................. 264
economy of scale..................................... 260 flow rate ............................................ 27, 359
effective royalty rate 9, 16, 17, 100, 104, 115 Fluid
eggs-in-the-basket ..................................... 56 catalytic cracking ................................ 254
EMV.............................. See Expected Value coking.......................................... 257, 258
energy work equivalents ......................... 350 pressure ............................................... 303
Entitlement properties....................................... 25, 212
calculation ............................................. 19 viscosity ................................................ 29
cash flow audit checklist......................... 9 fluid catalytic cracking............................ 249
formation volume.................................... 200 global oil ................................................. 281
Former Soviet .......................................... 99 GOR ........................................ 220, 301, 311
FPSOs..................................................... 151 Government
fuel oil ..................................................... 216 DCF..................................................... 113
full-cycle ................................................... 12 downside gvt. take .............................. 101
extracted rent....................................... 103
G last year share........................................ 11
gambler’s ruin ........................................... 56 marginal take....................................... 102
Gas mid-range take .................................... 101
associated ............................................ 213 participation ................ 101, 102, 105, 117
butane.................................................. 218 peak year share...................................... 11
commercial discovery ........................... 53 profit oil.............................. 12, 13, 17, 20
compressed natural gas ....................... 218 profits .................................................... 24
compressibility factor.......................... 204 share ................................ 13, 15, 108, 114
condensate........................................... 218 take9, 13, 14, 15, 24, 89, 90, 92, 100, 101,
crude NGL price 1990-92 ................... 177 102, 103, 106, 108, 114
deviation factor ................................... 205 take (average)........................................ 95
discoveries........................................... 143 take mechanics .................................... 102
dry ....................................................... 213 total profit oil share........................... 9, 12
ethane .................................................. 218 upside take .......................................... 101
international investment...................... 126 working interest .......................... 100, 103
liquified petroleum gas ....................... 218 working interest share ......................... 102
methane ............................................... 218 GTL................................. See Gas to Liquids
natural gas liquids ............................... 218 Gulf of Mexico...................... 24, 81, 84, 139
natural gas products ............................ 218
non-associated..................................... 213 H
pentanes............................................... 218 heavy gas oil ........................................... 248
profit gas ............................................. 105 heavy oil cracking ................................... 264
propane................................................ 218 Heidrun ................................................... 155
recoverable.......................................... 284 high grade .............................................. 302
SP .......................................................... 53 high-conversion....................................... 259
volumetric estimates ........................... 204 horizons................................................... 310
well production rates........................... 139 horizontal ................................................ 162
gas cycling ...................................... 225, 226 hurdle rate ........................................... 85, 89
gas fired power................................ 225, 227 Hydrocarbon
gas oil .............................................. 216, 217 saturation............................................. 200
gas oil ratio........................................ 25, 220 hydrocarbons................................... 213, 219
Gas to Liquids ......................................... 229 hydrocracker ........................................... 264
costs..................................................... 233 hydrocracking ......................................... 249
lead times ............................................ 233 hydrogen ................................................. 262
options................................................. 230
products............................................... 231 I
Qatar Pioneer Plant ............................. 235 Indonesia ................................................... 26
threshold field size .............................. 231 infrastructure ............................................. 25
gasoline ................................... 217, 248, 259 international discoveries ........................... 28
gasoline prices................................. 275, 276 Iran ............................................................ 24
Iraq ............................................................ 24 N
naphtha.................................................... 216
J
Naphtha ................................................... 231
J. J. Arps.................................................. 220 naphthenes............................................... 217
Japan ....................................................... 260 National Oil Company ............................ 102
Nelson
K complexity index......................... 254, 260
k XE "lube oil" XE "residue" erosene ... 216 complexity multiplier.......................... 255
kerosene .................................. 217, 231, 248 estimated complexity index ................ 261
Kuwait............................................... 24, 261 Farrar construction cost indices .......... 264
Kuwait National Petroleum Co............... 260 regular complexity .............................. 255
W. L. ................................................... 254
L worldwide refinery complexity........... 263
Nelson index . See Nelson Complexity Index
large field discoveries ............................. 133
Nigeria.................................................... 183
Latin America.......................................... 99
North America......................................... 99
Lifting
North Sea ............................................ 21, 24
agreements .......................................... 305
NOx......................................................... 231
entitlement..... 19, 104, 106, 108, 109, 115
NPV........................................................... 24
over lifted ............................................ 305
under lifted .......................................... 305 O
liquid yield .............................................. 227
LNG ................................................ 225, 236 ocean floor cables ........................................ 183
low-conversion........................................ 259 offshore atlas........................................... 140
LPG ................................................. 225, 226 offsite facilities........................................ 254
lube oil ............................................ 216, 217 Oil
lubes ........................................ 259, 261, 262 black.................................................... 213
lubricating oil .......................................... 248 Brent crude............................................ 21
commercial discovery ........................... 53
M company cost oil ................................... 19
company profit oil................................. 19
Malaysia.................................................... 13
composition......................................... 217
marginal fields .......................................... 16
contractor share profit oil...................... 17
mass......................................................... 354
conventional........................................ 213
Matagordo Bay...................................... 183
cost oil........................................... 18, 337
Maximum Efficient Rate......................... 137
crude oil R/P ratios.............................. 142
medium-conversion................................. 259
crude oil reserve additions .................. 141
methane ................................................... 236
crude price 1990-92 ............................ 177
methanol.......................................... 225, 236
crude properties................................... 216
middle distillates ..................................... 259
finding costs ........................................ 173
Middle East...................................... 99, 281
gas/oil ratio.............................................. 7
Mina Abdulla refinery..................... 260, 261
general oil price relationship......... 22, 214
MTBE ..................................................... 236
global production estimates ................ 281
mud ................................................. 159, 160
government profit.................................. 13
mud costs per well................................. 159
gvt. profit oil ................................... 17, 20
multiple outcome decision tree .............. 43
heavy ................................................... 213
mutuality ................................................... 18
initial in place...................................... 200
international investment...................... 126 Pakistan PSC........................................... 334
light ..................................................... 213 Papua New Guinea.................................. 98
Mid East reserves................................ 281 paraffin...................................................... 25
PDP ..................................................... 110 paraffins .................................................. 217
price estimates....................................... 81 Pareto’s Law ............................................. 30
price projections.................................... 82 pay zone .................................................. 200
production rates................................... 138 permeability .............................. 28, 199, 205
profit oil ................................ 12, 105, 107 petroleum fiscal regimes ........................... 98
profit oil split.... 14, 18, 89, 105, 108, 109, petroleum flow ........................................ 269
117, 319 Petronius ................................................. 153
recoverable.......................................... 284 petrophysical parameters .......................... 25
recoverable reserves............................ 110 phase ....................................................... 305
reservoir pressure ................................ 204 pipeline
royalty oil .............................................. 18 offsite facilities.................................... 254
SP .......................................................... 53 Pipeline
total oil .................................................. 13 Brent & Ninian pipelines ...................... 21
total profit oil .......................... 15, 17, 112 construction cost ................................. 186
total US crude discoveries .................. 143 cost per inch calculations .................... 188
volatile................................................. 213 gas ....................................................... 185
volumetric estimates ........................... 202 oil ........................................................ 187
well production rates........................... 139 transportation equipment .................... 127
wellhead price ..................................... 110 political conditions.................................... 25
OPEC ........................................................ 24 porosity ................................................... 199
Operating cost post mortem analysis ........................ 83
and depreciation .................................. 105 power....................................................... 351
cash flow analysis ................................. 55 preference theory ...................................... 59
cash flow calculation............... 20, 31, 112 pressure ................................................... 358
compared to development cost.............. 23 pressure differential .................................. 29
early years ......................................... 9, 25 pressure equivalents ................................ 353
full cycle............................................ 9, 25 pressure gradient .................................. 159
gas price and operating cost indices.... 285 Probability
key factors............................................. 25 break-even success.......................... 47, 60
lower-than-average ............................... 25 EMV...................................................... 42
oil price and operating cost indices..... 285 expected value theory ........................... 54
overall estimate ................................... 102 geologic................................................. 53
peak year ............................................... 24 inappropriate estimate of success ...... 54
peak year total cost.................................. 9 of all failures ......................................... 56
taxable income calculation.................... 20 of at least one successful well............... 56
transportation function .................... 127 of exceeding threshold .......................... 53
Opex.......................................................... 24 of failure.......................................... 43, 56
oxygenates....................................... 261, 262 of hydrocarbons (calculation) ............... 53
of oil estimate........................................ 53
P of success .............................. 7, 43, 45, 56
P/R............................................ See P/R ratio of success & EV.................................... 59
P/R ratio .................................................... 26 of success estimate................................ 56
P10, P50, P90 ........................................... 30, 55 of success estimating............................. 51
percent................................................... 46 profit oil .............................. 12, 16, 105, 310
product slate .................................... 254, 259 profit oil split................................. 7, 14, 117
Production propane.................................................... 226
acquisitions ......................................... 110 prospect sizes ....................................... 83
and cost recovery ................................ 105 prospectivity .......................................... 310
and marginal wells .............................. 139 proved reserves ....................................... 104
and profit oil split................................ 106 PSC ..................................... 10, 18, 100, 104
and R/T systems.................................. 104
at peak ..................................................... 9
PSC pg
150a..................................................... 168
based sliding scale......................... 16, 117
150b..................................................... 170
basic upstream unit ............................... 26
150c..................................................... 170
cash flow calculations ......................... 112
55d....................................................... 135
changing rates and levels ...................... 16
55e....................................................... 136
costs..................................................... 175
55f ....................................................... 171
Costs per BBL..................................... 177
DMO ................................................... 319 59 ....................................................... 119
duration ............................................... 117 73 ....................................................... 119
early "saturated' years ........................... 13
early year costs per BBL....................... 25 R
early year vs full cycle .......................... 25
rate of return.............................................. 85
early years ....................................... 16, 19
Rate of Return ......................................... 98
economics ............................................... 6
recovery factors....................................... 203
facilities and development costs ........... 23
Refinery
facility cost & GOR ............................ 220
avg. US complexity rating .................. 258
global estimates................................... 281
capacity & complexity index .............. 254
Gulf of Mexico............................ 139, 140
complexity........................................... 264
gvt. share of........................................... 16
complexity rating calculation.............. 254
Incremental cost .................................. 176
cost and value...................................... 258
initial rate per well ............................ 9, 27
cost/value ............................................ 267
lifting................................................... 106
empirical estimate of total complexity 254
MER.................................................... 137
generalized complexity indices........... 256
net or net revenues .............................. 117
Mina Abdulla .............................. 260, 261
P/R ratio ................................ 26, 142, 161
offsite facilities.................................... 254
peak production/total reserves ................ 9
optimum size for U.S. ......................... 260
peak year estimate................................. 12
refining capacity.................................... 24
peak/cash flow analysis......................... 55
size ...................................................... 254
profit oil split....................................... 104
value.................................................... 255
range of oil well rates.......................... 138
worldwide refinery complexity........... 263
rate of ............................................ 26, 139
reforming................................................. 250
rates vs. profit oil .................................. 13
regular complexity .................................. 255
storage ................................................... 25
relinquishment............................... 117, 311
sunk costs ............................................ 110
reserve additions ..................................... 141
when depreciation begins.................... 117
Reserves
working interest share of..................... 104
Middle East ......................................... 281
Production Sharing Contract.. 7, 16, 99, 104,
prediction accuracy ............................... 84
108, 109
reservoir depth .......................................... 25
reservoir pressure gradient........................ 25 tax and cash flow calculation.......... 20, 31
residue ..................................................... 216 with out cost recovery......................... 104
residuum.......................................... 217, 248 world avg. ........................................... 117
reward ........................................... 44, 47, 59 Rules of thumb
reward side .............................................. 43 80/20 rule .............................................. 30
ringfenced systems ................................ 115 feedstock requirements ....................... 227
ringfencing ............................................. 117 horizontal drilling ..................................... 162
Risk J. J. Arps' GOR ................................... 220
analysis.................................. 6, 41, 85, 87 production acquisition......................... 110
aversion ................................................. 60 service station valuation...................... 272
capital.................................... 7, 44, 47, 59 Swanson's rule....................................... 30
capital vs. development capital ............. 23 Texas Gulf Coast sands, recovery....... 203
common analytical pitfalls.................... 54
development drilling ........................... 54 S
diversification of ................................... 56 saturated .................................................... 13
EV formula.............................................. 6 saturation........................................... 19, 104
exploration drilling cost ........................ 23 Saudi Arabia.............................................. 24
minimum risk premium......................... 60 savings index......... 9, 18, 103, 105, 107, 115
model....................................................... 7 SEC ........................................................... 19
political conditions................................ 25 Securities and Exchange Commission ...... 19
service agreements ................................ 98 seismic.............. 318. See 2-D or 3-D seismic
unrisked reserves................................... 55 Seismic.................................................... 184
using discount rate ................................ 54 2-D ...................................................... 184
weighted reward.................................... 43 3-D ...................................................... 183
rock type.................................................... 25 data acquisition ................................... 318
ROR .................................................. 14, 125 semi-FPSs ............................................... 154
Royalties Service Agreements................................. 99
cash flow model summary .................. 113 service fee................................................ 106
Royalty shrinkage ................................................. 200
and cost recovery .................................. 16 sliding scale................................. 10, 16, 100
and limiting AGR................................ 104 solvents ................................................... 259
back of envelope estimates ................... 14 SPARs..................................................... 150
ERR calculation .................................... 17 spud ........................................................ 314
example PSC....................................... 105 success capacity ....................................... 47
fiscal terms .............................................. 7 success ratios ........................................ 85
gvt. take......................................... 89, 101 Swanson’s Rule......................................... 30
gvt. take quick calculation .................. 103
gvt. take variables ............................... 100 T
net of royalty ....................................... 117
netback calculation.............................. 127 tariff determination .............................. 127
oil .......................................................... 18 Tax
PSC example....................................... 114 deduction/bonus .................................... 88
R/T system ...................... 98, 99, 102, 115 example PSC....................................... 105
R/T system gvt. take calculation......... 102 fixed taxes ............................................. 92
rate................................................... 15, 17 gvt. take calculation ...... 89, 102, 113, 114
regressive effect .................................. 110 gvt. take definition .............................. 101
rate......................................................... 19
world wide average CIT...................... 117
Tax Loss Carry Forward ........................... 20
technical success ....................................... 51
Technological Frontiers .......................... 148
tension leg platforms............................... 155
Texaco .................................................... 183
thermal cracking.............................. 257, 258
thermal operations................... 258, 261, 262
thermal processes .................................... 258
thermal processing .................................. 257
TLCF................ See Tax Loss carry Forward
total costs .................................................. 24
tranche....................................................... 12
transportation costs ................................. 127
transportation function .............................. 23
Trinidad & Tobago PSC ......................... 337
trip time................................................... 146
Troll......................................................... 156
Troll C..................................................... 154
U
United States ........................................... 258
urea.......................................................... 236
utility theory.............................................. 59
V
Value
average .................................................. 92
true ........................................................ 92
velocity.................................................... 357
Venezuela.................................................. 95
Venezuela PSC....................................... 341
visbreaking.............................. 249, 258, 264
viscosity .................................................. 359
volume..................................................... 356
W
wax.......................................................... 259
well bore.................................................... 29
well spacing ................................................ 9
wellhead prices........................................ 283
working interest .................................... 318
Z
zero bid...................................................... 80

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Economic Modeling and

Risk Analysis Handbook

Phone 603-525-9330 Phone 716-425-3494

Printed in the United States of America.

A Note from David Johnston

How to use this book

Present value theory

The formula for the future value of a single payment P is:

F 1.1 Future value diagram

Year Year Year Year Year Future

1 = the discount factor

F 1.2 Present value diagram

The present value of $1,000 payment paid in five years

Year Year Year Year Year Future

T 1.1 Comparison of discounting techniques

Discount factor (rounded) .751 .788 .816 -.745

The present value of the cash flow stream is $30,305.

Economic modeling/auditing – Art and science

T 1.2 Case study parameters - assumptions

“Most likely” discovery assumptions

Depreciation Rate 20%/year [for both tax and cost recovery]

T 1.3 Cash flow model “Most Likely”

T 1.4 Contractor cash flow

Total 1,230,000 678,692 551,308 220,523 330,785 54,357

T 1.5 Cash flow review checklist

Checking the model The model World Average

Price and cost assumptions

* Typically more for gas

T 1.6 Government profit oil share estimate (full cycle) 1

Government share last year 50% [year 20]

3rd Step The third step is simply an average of steps #1 and 2.

F 1.3 Government profit oil share estimate (full cycle)

Government total profit oil share (56%)

2nd step – Estimate the split at the end of the

T 1.7 Government profit oil share calculation

Year 6 (peak production) ($M)

The example here is a fairly common fiscal/contractual system and a “back-of-the-envelope” or

Government take 77.4% [estimate] vs. 76.9% [ cash flow calculation]

T 1.8 Government take back-of-the-envelope estimate

Contractor take = 15.8/(100 – 30) = 22.6%

Government take = (10 + 33.6 + 10.6)/(100 – 30) = 77.4%

T 1.9 Government take calculation (from the cash flow model)

Total profits = Gross revenues - Total costs

Gvt. take = Gvt. share of profits/Total profits

Government take = $1,099,215 M/$1,430,000 M = 76.9%

Effective Royalty Rate (ERR)

An example from year 4 is shown in table T 1.11 (figures are in $M).

[($11,800 + $25,400)/$118,000] = 31.5%

T 1.10 Effective Royalty Rate back-of-the-envelope estimate

T 1.11 Effective Royalty Rate cash flow calculation – year 4

31.5 % Effective Royalty Rate *

* Year 4 “off peak” production rate is 16,160 BOPD.

T 1.12 Savings index estimate

T 1.13 Entitlement calculation

$570,000 Company cost oil (from tables T 1.3 and T 1.4)

56% Company entitlement

56,065 MBBLS Company entitlement (BBLS)

Company cash flow

T 1.14 Income tax and cash flow calculations – year 5

Taxable income = Gross revenue

Taxable income = $186,240

Net cash flow = $186,240

Checking the assumptions