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Petroleum Economics and Agreements

Online Webinar
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WELCOME MESSAGE
Welcome to Petroleum Economics and agreements online webinar

Amr Hegazy
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Agenda

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Oil Industry Overview Petroleum economics Cash Flow analysis

Reserve E&P agreements Indicators & Risk

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Economics is all about answering: Is it fair price for investment?

World Oil production Global Upstream Investment

Oil Price 63 $/BBL
100 MMSTB/D 328 Billion$
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Petroleum Industry Overview

Oil Industry Sectors 6
Oil Industry Players 7

• Oil Companies
o Supermajors and Majors
o independents or jobbers
o National Oil Companies (NOC)
o Government Sponsored
enterprises
• Integrated Service Companies
• Specialized Service Companies
• Refineries
• Petrochemical companies
• Transportation and marketing
companies
Global investments in oil and gas upstream, Billion$ 8
Global conventional resources discoveries spending, % of 9

total upstream investment

Gas
BOE
Oil
Global Oil Production & reserve 10

100000 3000

90000
Consumption Production Reserve 2500
80000

70000
2000

Billion Barrel
60000
MSTB/D

50000 1500

40000

1000
30000

20000
500

10000

0 0
1960 1970 1980 1990 2000 2010 2020
Date

BP statistical review, 2019

Global Gas Production & reserve 11

450 15000

400 13000
Consumption Production Reserve
350
11000

300
9000
BCFD

TCF
250
7000
200

5000
150

3000
100

50 1000

0 -1000
1960 1970 1980 1990 2000 2010 2020

Date

BP statistical review, 2019

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Proved oil reserve

BP statistical review, 2019

Historical oil prices 13

BP statistical review, 2019

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Petroleum economics
Why Perform Economics on Oil & Gas Projects? 15

• To justify exploration projects and development wells.

• To value a property for sale or exchange.
• To make acquisitions, or obtain loans.
• Corporate budgeting & government reporting.
• Lease bidding, Workover justification, equipment purchases, and
investor reporting.
Cost- time cycle for exploration through field production 16
Distinctive trends for E&P assets 17
E&P investment appraisal & Decisions 18

Upstream projects are characterized by:

1- Large initial capital investment.
2- High rate of capital investment
throughout asset life.
3- Long payback period.
4- High risk and uncertainty.
5-Complexity.
6- Multiple stages with deferrable decision
points.
7- Dependency upon volatile product prices
and demand.
Constraints on upstream Oil & Gas companies 19

Major upstream companies are characterized by:

• Large portfolios of E&P projects available for investment at any time.

• Finite Technical resources & skills to evaluate and manage each
project.
• Finite time in which to perform commitment work programs.
• Finite financial resources and frequent budget constraints.
Oil industry of last 30 years 20

Oil industry has been

characterized by volatility which
caused by booms and recessions
driven by the supply-demand
balance oil process.

For how long will such

cycles be repeated??
Boundary scenario 21

Framing the future in terms of

options helps to identify and quantify
key issues and potential risks.
Sensitivity and simulation
analysis are frequently essential to
understand the full picture.
Cost of delay in early phases of field cycle 22

Delays in exploration / appraisal always have negative impact on project/

company profitability over the long term project or field cycle. Economic
and risk analysis quantifies this impact.
Extending field life 23

Economic analysis can identify when it’s necessary to introduce structural

change in order to extend the projects commercial life by reducing
operating / production costs.
Risk & fiscal analyses for investment decision process 24
Decision to balance risk & reward 25

Balancing is
never
easy!!!!

Economic & risk analysis is a fundamental process in strategic

and operations management of the oil and gas industry.
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Cash Flow analysis

Typical economic model inputs 27

Production

Inflation &
Oil Price
Escalation

Economic
Interests
Limit

Fiscal
CAPEX Terms

OPEX
Cash flow method 28

• The value of an asset to organization relates directly to its future

impact.

• This is normally in the form of a series of revenues and expenditures,

which we call cash flow.
Flow chart for the financial in a typical upstream company 29
Cash flow projections 30

Cumulative net cash flow is the basis for most economic analysis. It’s
calculated based on before and after tax basis and has three major
components:

• Cash items: monies actually paid and received.

• Non-Cash items: such as depreciation, depletion (North America), book
values used mainly for tax and accounting calculations.
• Royalties: property of the state paid in money or product as it’s never owned
by E&P companies so it’s technically a cash or non-cash item.
Cash items 31

•Working interest E&P •Capex

revenues •Land ,lease and license fees
•Income from sales and bonuses
•Working interest local taxes •Corporation taxes.
•Opex •Special petroleum taxes (UK
•Overheads licenses)
•Loan interest •Debt capital and interest
repayments
Cash flow (inflows and outflows) 32
Upstream Cash flow Components Influence Diagram 33

Reserve and reservoir characteristics

have huge influence on cash flow
components
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Reserve definition
Reserve definition 35

• Reserves are estimated volumes of crude oil, condensate, natural gas,

natural gas liquids, and associated substances anticipated to be
commercially recoverable from known accumulations from a given date
forward, under existing economic conditions, by established operating
practices, and under current government regulations.

• Reserve estimates are based on interpretation of geologic and/or

engineering data available at the time of the estimate.
Relevance of resources versus reserves to portfolios 36
Conventional versus Non-conventional resources (SPE 2007) 37
Petroleum reserve classification 38
Categorizing reserves by levels of uncertainty 39
Aligning reserve definitions with project cycle 40
Methods of Estimating Reserves & Production Volumes 41

• Performance
• Volumetric
• Analogy/statistical
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E&P Agreements
Definition of fiscal regime 43

• Fiscal regime is abroad term that include all aspects of legislative,

political, contractual, taxation and any other element associated with
sharing oil and gas revenues.
• In practice, a fiscal regime includes bonuses, rentals, royalties,
production sharing arrangements, carried interest provisions, corporate
income taxes and special taxes.
Fiscal policy design 44

Government Objective
•Maximize value of the petroleum
resource
Company Objective
• Maximize stockholders interest
Common types comparison
Production Sharing
• The government retains ownership of the
hydrocarbons.
• Companies can reclaim costs incurred
from production revenues, subject to
constraints.
• Oil companies negotiate a right to a share
of the production revenues (profit split).
• Companies may also pay corporate tax on
profit share. Sharing Contracts are often
negotiated and calculated on a field or
block of wells.
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Concessionary
• Individuals or companies buy the right to
extract and sell mineral resources (a
concession)
• licensee receives all sales revenues in the
first instance
• licensee company is then liable for
royalties and taxes (UK, the United States
and Canada)
• Royalties are payable on value of oil/gas
produced – irrespective of project viability
or profitability
• Usually have specific petroleum taxes —
e.g. UK Petroleum Revenue Tax (PRT)
• Taxes usually based on profit-sensitive
basis
Global statistics 46

• One important indicator is the government take (GT) which is a measure

of how a local State captures the net profit from O&G production.
• The world average GT is 64 %.
• Ireland has a very low GT at 25%, and Yemen a very high one at 95%.
• Most GTs are between 40 and 65 %.

• For , Oil companies, Among the important indicators are NPV and IRR of
their shared cash flow.
Comparative analysis among fiscal 47

Type of contract Contractor Host government

Concession or (R &T) • Assume all risk • Reward depends on

• Take part in all rewards production and oil price
Production-Sharing • Assume exploratory risk • Share in the reward of oil
Contract • Share reward • Share in reward from price
(taxation)
Joint-Venture • Share in risk in • Share in risk of business
exploration, production, • Share in the reward
etc.
• Share in reward
Pure Contract Service • No risk for contract • All risk from exploration,
because payment is under production, etc.
contract • All reward from production,
price, etc.
Source: Main (2002, p.221), Bindemann (1999, p.11)
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• In economic theory, “the greater the risk, the greater the

return”
• Because R&T is the contract where oil companies assume
most of risk, it’s expected that R&T is the most attractive
option to increase return over invested capital.
Schematic Comparison 49

Royalty Tax PSC

Gross Production Gross Production

Royalty
Royalty
Cost Oil

Production Net of
Royalty
Profit Oil (P/O)

Costs Deductions

Host Govt’s P/O Contractor’s

P/O
Investor’s Tax

Investor’s Production
Contractor’s
Tax
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Economic Indicators
Undiscounted indicators 51

There are 4 Undiscounted

indicators here:

1- Maximum Capital Outlay (MCO)

2- payback period
3- Terminal Cash Surplus (TCS)
4- Profit to Investment Ratio (PIR)
5- cost to find , develop reserves
Discounted measures of value 52

Discounted
Parameters

Discounted rate Discounted rate

specified derived

Net Present Value (NPV) Internal Rate of Return (IRR)

Net Present Value Index (NPVI)
1- Net Present Value (NPV) 53

It is the sum of all project cash flows,

discounted back to a common point
in time.
Relation between NPV and discount rate: 54
2-Rate of Return (ROR) 55

• OR internal rate of return (IRR)

is the single discount rate that
produces a NPV of zero

IRR

For successful project :

IRR should be greater than hurdle
rate or cost of capital
3- Net Present Value Index (NPVI) OR (DPI) 56

It is the discounted equivalent of

the PIR which is the ratio of NPV
[r] / MCO [r], where “r” is the real’
discount rate.

NPVI is a very useful measure of

investment efficiency, which
incorporates time value of
money.
4-Discounted Return on Investment (DROI) 57

This indicator includes the cost of managing a company’s funds, often

called capital overhead. It is also used for ranking projects with similar
capital outlays.

DROI = Net Present Value / PV(Capital + Overhead on Capital)

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Notes on Risk
Risk analysis definition 59

• A process of estimating the probability of occurrence of an

event and the magnitude of the adverse effects over a specified
period.

• Risk analysis aids decision making and minimizes the losses

Adding rule of probabilities 60

• This rule states that the probability that one or another of two or
more mutually exclusive outcomes will occur is the sum of their
separate probabilities.

• Consider the probability of rolling a 1 with a single die. It’s one

of six alternatives so the probability is:
P(1)= 1/6 or 16.67%

• The probability of rolling a 1 or a 5 with one roll of the die. The

events are mutually exclusive so the addition role applies:
P( 1 or 5)= 1/6 +1/6= 1/3 or 33.33%
Multiplication rule of probabilities 61

• This rule states that the probability of two or more independent

events having specific outcomes is the product of their separate
probabilities.

• Consider the probability of rolling a double 1 with a single roll of

two dice. It’s one of six alternatives on one die together with one
of six alternatives on the other die. The probability on each die
remains:
P(1)= 1/6 or 16.67%
P (1 and 1) = 1/6 *1/6= 1/36 or 2.8%
Chance of finding some HC (Geologic risk) 62
 Aspects of economic risk factors 63

• Technological Risk: risk of drilling problems or of achieving the well

path and flow rate performance expected.

• Oil & Gas Price Risk: large effect on NPV’s.

• Project Over-Run Risk: cost and time variances.

• Political Risk: risk of civil wars or any political disruption that may
cause delaying or preventing development of a discovery.

• Fiscal Risk: risk of introducing new tax or changing the cost recovery
mechanism.
Risk analysis methods 64

• Sensitivity analysis
 Spider diagrams
 Tornado diagrams
• Expected value (EV)analysis
• Monte-Carlo simulation
• Decision trees.
Example from Deepwater Nigerian prospects 65
Spider Diagram Example 66
Decision tree example 67
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Thank you