What do we mean by the “Breakeven cost of oil and ges”? Teanportstion comet Pun eycie (eeniey Fun Cycle (exe WACE) Putt cycte (inc WARES Transportation comte + setinieinn ot fut Eyota “jor rovurn ot capcan. Gperatons ere notWhy is the Breakeven Cost of Oil & Gas Important Over the long term. the oi] and gas industry must incur certain costs in onder te-find, develop sme produce of ane gaz This full sat of costs the ineustry needs to incur in order te sustain or grew productian i known az “Full Cycle costs H crude of natural gas prices are generslly persisting above these Full Cyele costs, the industry haz an incentive vo sustain investment and activity in the: sector. However. if the margin between Full Cycle costs and prices i= squeeied fer prolonged periods, the industry finds, befare too long, thet Investment is net sustainable anc c2pitsl spending. production and reserve replacement will begic to fall off az a result. Many industry observers maintain that high and rising levels af costzin the industry over the Iact decade hac been one of the main reasons why marker prices forcrade have bean sustained at over $900 per barrel So an understanding of what determines Full Cycle costs of oil and gas is ‘certtral fo predicting wh2t é likely to hsapen te oil and g22 prices in the Future, a2 weell as amelorstanding the owtlook For oil and gas prockiction, reserve replacement and capital spending in the industry. ‘This paper sets out Evaluate Energy's methodology for estimating the breakeven or full-cycie conte of producing oil and gas: We hope it will lead to 3 clearer uncerstanding of cost components in the oil and gaa industry and Pimulate eebate on the cutlonk fer ell and ger pricesWhat are the Key Components of Full Cycle Costs? From the point of view of an independent Oil Company (IOC). we sugges: the following key cast components must be covered in order for the company to remain viable in the medium to long term: ‘SGSA: The company must cover it selling. general and administrative expenses. Property Roquitition Casts- The cast of acquiring unproved property is an ‘on-going partof the business. Finding Costs: The company must cover the cost of geological and geophysical work (G&G), licensing rounds, signature bonuser and the costs of ‘Grilling exploration wells. Development Cort: The company must cover the costs of acquiring, constructing, and installing production facilities and drilling development ‘wells. Finding and development costs are often grouped together under the term FED costs.Production Costs: Also known a5 Lifting Costs. These are the costs incurred to operate and maintain wells and related equipment and facilities, including ‘Sepreciation and applicable operating costs of support equipment and facilities and other costs of operating and maintaining those wells. Transportation Casts: The company must cover the cost of transporting its product to market. Production Taxes: An IG must pay production taxes or royalties to the host state. This may be in the form of a fixed royalty % or in the farm of a more complex production sharing agreement. Return on Cspital: An JOC must at least cover its cost of capital over the medium term. Otherwise it is estraying value for its shareholders. Evaluate Energy calculates this foreach company based on the cost of itsdebt and equity. Risk Premiums: 10€s will be lacking for a risk premium aver and above its cast of capital to cover the uncertainties inherent in oil and gaz investments. Together, the above com components make up the Full Cycle costs of finding. ‘Seveloping and producing ail anc gas.How Do We Calculate Each Cost Component? ‘SGA These ensts are not reported for the upstream sector alone by large integrated companies, so Evaluate Energy bases its per barrel SGB.A ona large sample of pure upstream companies in its database. Unproved Property Acquisition Costs These coms are reporned by companies that submit filings to the US Securities and Exchange Commission (see). FED Costs These costs are calculated from SEC filings bared on exploration and development costs and the cost oF unproved property sequisition divided by discoveries, revisions to reserves (included because they form pact of long ‘term reserve replacement) snd reserves added through improved recovery. Production Costs or Lifting evsts are reported by companies to the SEC.‘Transportation Costs are reported in varying ways by companies but are included where known. Prociuction Tass, including royalties, severance taxes and taves paid under production sharing ar concession agreement: are reported by ‘companies to the SEC. Return on Capita Evaluate Energy calculates each company’s weighted average cost of capital. Cost of equity is calculated via the Capital Asset Pricing Model (Rick free rate + bets x market rick premium, Cast of debt ic calculated as interest expense plus interest capitaliced divided by total debt. Risk Premia Evaluate Energy has designed a unique country risk rating that GFferentiates risk levels in different countries. There may be technical and commercial rk prernia that may be required in addition and wil Gepend on individual circumstances.Some of the Pitfalls of Calculating Costs Saleulating the cost commenent: outlined above on = per barrel basis isnot without itz challenges. Some of the key things te watch out fer are outlined below. Distortion of per berre! costs by large reserve shifts caused by exceptional revisions. o by reserve Impairments caused by price Muctuations, For example, st the end of 2012 many US-based companies initiated leree g=3 regerve Impairments due te depressed prices of domestic natural ges. We can emeoth out there effects by using 3 year sverssex. Distortion of per berrel costs by the timings of reserve bookings. Costs incurred in one year may result in reserve booking: in future years, Again, using 3 year awerages is a way of mitigating this effect FED cost ciate basedl on UP reserves means that calculated PRD coms may be conservative and would be substantially lower if 2P reserves were used tocalculate per barre! reserve replacement costs, Companies don't distinguish between the cost of crude and the SOSt OF NATUFS! Eas GavelOpment Although they epitresenve cange: (ein bal apie Shenae ASE pi eee cami peated irore cocks setnting fo natural pas \Eealsete Enequy hes dorcioped a metioniodeiy, boced on the performance of 2 wide range of companies with different os! weightings. for adjusting the cos dats co that the Full Cycle costs of crude ou may be distinguished from those for natural gas