Concept of Project Cash Flow Any investment proposal may be considered as an activity which initially absorbs money and later generates money. The money invested may be raised as loan capital (debt) or from shareholders’ capital (equity). This is invested in the project to purchase plant and equipment and pay for operating costs. The net money generated may be used to repay interest on loans and loan capital, The residual balance belongs to the shareholders, and is called shareholder's profit. This can either be paid out as dividends, or reinvested in the company to fund the existing venture or new ventures. The diagram indicates the overall flow of funds for a proposed project. ABSORBING MONEY Overall flow of funds for a project. The investment opportunity to be the development of oil fields. Within the project box, the cashflow of the project is the forecast of the money absorbed and the money generated during the project lifetime. Initially the cashflow will be dominated by the Lecture3 8/12/2016Petroleum Department Third Stage Petroleum Economics CAPEX required to design, construct and commission the hardware for the project (e.g platform, pipeline, wells, and compression facilities). Once production commences, gross revenues are received from the sale of the hydrocarbons. These revenues are used to tecover the CAPEX of the project, to pay for the OPEX of the project (e.g. manpower, maintenance, equipment running costs, support costs), and to provide the host government take which may in the simplest case be in the form of taxes and royalty. The oil company’s after-tax share of the profit is then available for repayment of interest on loans, repayment of loan capital, distribution to the shareholders as dividends or reinvestment on behalf of the shareholders in this or other projects. So, from the oil company's point of view, the balance of the money absorbed by the project (CAPEX, OPEX) and the money generated (the oil company's after-tax share of the profil) yields the project net cash flow, which can be calculated on an annual basis. It is often referred to simply as the project cash flow. The project cash flow forms the basis of the economic evaluation methods which will be described. From the cash flow a number of economic indicators can be derived and used to judge the attractiveness of the project. Some of the techniques to be introduced allow the economic performance of proposed projects to be tested against investment criteria and also to be compared with alternative investments. In general, the net cash flow equation can computed as: NCFi= GR; - ROY; - CAPEX:- OPEXt -TAXt Where: NCFt = After-tax net cash flow in year t, GRe Gross revenues in year t, ROYt = Total royalties paid in year t, CAPEXt = Total capital expenditures in year t, OPEXt= Total operating expenditures in year t, TAXt= Total taxes paid in year t. Lecture3 8/12/2016Petroleum Department Third Stage Petroleum Economics Constructing a Project Cash flow The construction of a project cash flow requires information from a number of different sources. The principal inputs are typically shown in table below, the data gathering process can be lengthy, and each input will carry with it a range of uncertainty. The uncertainty may be addressed by constructing a base case which represents the most probable outcome, and then performing sensitivities around this case to determine which of the inputs the project is most vulnerable to determine the most influential parameters may then be studied more carefully. Lecture3 8/12/2016Petroleum Department Third Stage Petroleum Economics Tabl ‘lements of a project cash flow Peirolenm engineering, Reserves Production forecasts — oil. sales gas Drilling engineering Drilling and completion costs Facilities engineering Capital costs Platform structures Transportation (e.g. pipelines) Production facilities (c.g. separators. compressors, pumps) Operations and maintenance engineering Operating costs Maintenance Workover “Manpower requirement Human resources “Manpower costs Operators Technical staff Support staf Overheads Host government Fiscal system Tax and royalty sate Royalty payment method (in eash or in kind) Production sharing agreement ‘Company status (e.g. neweomer) Project status (e.g. ring fenced) License terms (duration, final liabilities) ‘Decommissioning requirements Corporate planning Forecast oil and gas prices Discount rates, hurdle rates Exchange rates Inflation forecast ‘Market factors Political risk, social obligations For any one case, the project cash flow is constructed by calculating, on an annual basis, the revenue items (the payments received by the project) and then subtracting the expenditure items (the payments made by the project: CAPEX ,OPEX and host government take). For each year the balance is the project net cash flow (or just project cash flow). Hence, on an annual basis: Lecture3 8/12/2016[ Petrol Project net cash flow ie - Expenditure (Costs) = Gross revenue - CAPEX - OPEX - royalty - tax Royalty = Royrate X Revenue Tax = Taxrate X (Revenue - Royalty - Opex - Fisc. Depr.) A typical project cash flow is shown in figure below, along with a cumulative net Cash flow showing how cumulative revenue is typically split between the CAPEX, OPEX, the host government (through tax and royalty) and the investor. cashflow capex tax royalty opex Cashflow $m 8 8 Time (years) Components of a Project Cash Flow The cumulative amount of money accruing to the company at the end of the project is the cumulative net cash flow as shown in figure below. 2000 a0 cashfiow capex 1000 tax royalty Beeed 8 opex Cumulative Cestflow $m ° Time (years) 3 » Cumulative Cash Flow Diagram es Lecture3 8/12/2016