PETROLEUM

ECONOMICS

Engr. John Kevin M. de Castro

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Introduction to
Petroleum Economics

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Learning Outcome

◉ To describe the economics of oil and gas industry.

◉ Identify the economic challenges of the oil and gas
industry.
◉ Relate the activities of the upstream, downstream and
midstream in the price change of oil and gas.

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Special Features of MINERAL
Economics

◉ Minerals are found only in certain favoured places.

There is no question of locating a mine anywhere else
except where it is found in commercial quantities.

◉ The minerals are exhaustible.

◉ The minerals are found in places where they may not be

needed and used.
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Special Features of MINERAL
Economics

◉ There is always a very large excess capacity built into

the system. Therefore the normal laws of supply and
demand, marginal costs, etc are not often readily
applicable in the case of minerals.

◉ Very long term forecasts have to be made

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Petroleum Economics
This involves the application of the techniques of economic
analysis at every stage in the development of oil and gas
exploration and production projects
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Global Perspective of Oil and
Gas Industry

◉ The oil and gas industry is characterized by a long lead

times and is capital intensive with a number of variables ,
dependencies (exchange rate, crude price and
geopolitical tension) and inherent risk.
◉ The risks include the compliance with government
requirements, competition with other companies,
geological aspect, drilling conditions, inability of service
companies to deliver the required service, changes in
the market, adverse weather condition, availability of
competent skills and delays in the delivery of equipment 7
Global Perspective of Oil and
Gas Industry

◉ Therefore, investment decisions in the industry take into

context as number of the elements mentioned above and
have a long term horizon views.
◉ There is a broad consensus in the Oil and Gas Industry
on the role of emerging markets as drivers of energy of
energy consumption growth
◉ All the outlooks show gas as the fastest growing fossil
fuel, and continuing modest growth in oil

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The decline in the oil price has had a
massive impact on the sector and wider
global economy

Upstream Midstream Dow nstream

Upstream capital Investment is Investment is
expenditures (capex) continuing, as continuing, as
have been participants invest for participants invest for
significantly cut , w ith the longer term. the longer term
many exploration
and production
projects being put on
hold retrenchments
taking place.
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 Oil and Gas impact across the value
chain as a result of low price
Upstream
◉ The steep oil price decline
since 2013 is having repercussions -
both good and bad - across the
globe w ith the vast oil and gas
industry supply chain is bracing itself
for tough times.
◉ Oil & gas explorers w ill be
relooking at their budgets and
deciding w here to allocate their
limited capital spend given the
substantial decline in the oil price.
◉ Many projects have been
deferred as exploration is scaled
dow n resulting in job losses .
Refining Operations
◉ The global refining industry is currently
undergoing rapid changes amidst recent
global market fluctuations, fall in oil prices
and varying refinery margins. How ever, the
industry is moving tow ards stabilization in the
near term future.
◉ Global refining margins have improved
significantly in recent months w hich should
support strong demand for crude and lend
some strength to both spot prices and
spreads in the short term.
◉ Refiners are currently making enough
money from producing gasoline to cover the
costs incurred in producing not- very
profitable distillate
Supply and Trading
◉ Global oil output has declined by
about 30 0 ,0 0 0 barrels.
◉ The decline could be steeper
than that how ever, given the plunging
rig count , high depletion rates, and
extraordinary capex cuts. per day to
9.3 million barrels per day.
◉ LNG supply is up, prices dow n.
W hile the oil market is stabilising,
LNG’s dow nturn could just be getting
started.
◉ W ith supply set to jump faster
than demand, prices w ill remain low
and could fall even further
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Global Perspective of Oil and
Gas Industry

◉ W ith the prevailing low oil markets causing hardships for

some exploration companies, but will create
opportunities for those with the financial resources to
acquire value assets that become available.
◉ On the equipment side, all suppliers are under pressure
to reduce costs; the oilfield service companies that
enjoyed high margins in the recent boom are particularly
impacted.

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Global Perspective of Oil and
Gas Industry

◉ Fossil fuels remain the dominant source of energy powering the global
economy, providing around 60 % of the growth in energy and
accounting for almost 80 % of total energy supply in 20 35
◉ Gas is the fastest growing fossil fuel (1.8% p.a.), with its share in
primary energy gradually increasing. Oil grows steadily (0 .9% p.a.),
although the trend decline in its share continues.
◉ Coal suffers a sharp reversal in its fortunes. After gaining share since
20 0 0 , the growth of coal is projected to slow sharply (0 .5% p.a.), such
that by 20 35 the share of coal in primary energy is at an all- time low,
with gas replacing it as the second- largest fuel source.
◉ Among non- fossil fuels, renewables (including biofuels) grow rapidly
(6.6% p.a.), causing their share in primary energy to rise.
◉ More than half of the increase in global energy consumption is used for
power generation as the long- run trend towards global electrification
continues: the share of energy used for power generation rises from
42% today to 45% by 20 35. 12
There are clear signs that the
market is adjusting and that it will
gradually rebalance. But the
adjustment process is likely to be
long, and the energy companies
need to adapt.

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 A century ago, petroleum – what
we call oil – was just an obscure
commodity; today it is almost as
vital to human existence as
water.

- James Buchan

Want big impact?

Use big image.

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ECONOMIC CHALLENGES
Petroleum is getting
more difficult to find

Smaller fields and Aging facilities and

depleting reserves staff

Economic
Challenges
Environmental Harsher terrains of
challenge of Oil and discovery
Gas
Industry
Unstable prices Technology and higher
business cost
Community issues in
developing countries
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Meeting the challenges through
COST REDUCTION Measures

Staff Rationalization Vertical Integration

Rationalization literarily
means reorganization into a more
effective structure. In the human
resource context It is referred to as
discharge of an employee w hen his job
ceases to exist.
Vertical integration is a strategy that
allow s a company to streamline its
operations by taking direct ow nership
of various stages of its production
process rather than relying on external
contractors or suppliers.

A strategic business unit is a term used

Portfolio diversification is the process of
to represent such an independent,
investing your money in different asset
specialized department or a sub- unit
classes and securities in order to
that focuses on a given objective. It has
minimize the overall risk of the portfolio.
its ow n vision, course and mission.

Strategic Business Units Portfolio Diversification

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Oil Pricing Model

Unlike most products, oil prices

are not determined entirely by
supply, demand, and market
sentiment tow ard the physical
product. Rather, supply,
demand, and sentiment tow ard
oil futures contracts, w hich are
traded heavily by speculators,
play a dominant role in price
determination.

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Oil Pricing Model

𝑂𝑂𝑂𝑂𝑂𝑂 𝑝𝑝𝑝𝑝𝑝𝑝𝑝𝑝𝑝𝑝 𝐵𝐵𝐵𝐵𝐵𝐵𝐵𝐵 𝑝𝑝𝑝𝑝𝑝𝑝𝑝𝑝𝑝𝑝

= + 𝐴𝐴 𝐴𝐴𝐴𝐴𝐴𝐴 − 𝐵𝐵(%𝑆𝑆)
𝑏𝑏𝑏𝑏𝑏𝑏 𝑏𝑏𝑏𝑏𝑏𝑏

◉ Base price = current price for 0 API oil

◉ A = Scale factor for API gravity
◉ B = Markdow n factor for the presence of sulfur

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Marker Crude

◉ It is a commonly traded crude

oil in a particular region that is
used as a quality standard to
price other crudes.
◉ Examples are W est Texas
Intermediate (W TI), Brent
Blend, Bonny Light, Tapis Light,
Isthmus and etc.

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Characteristics of Marker Crude

◉ Perceived to represent ‘fair value’

◉ Traded in liquid and transparent
markets
◉ W ide range of buyers and sellers
◉ Supply is freely tradable
◉ Adequate reserves
◉ Production is strategically situated
◉ Politically acceptable to producers
and end users
◉ Spot price is w idely reported
◉ Reasonably immune to
manipulation

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CRUDE OIL MARKET

Wet/ Cash Market Future Market

◉ A place w here financial ◉ Future market is a place
instruments are traded, w here only future contracts
w herein the delivery of are bought and sold at an
stock takes place. agreed date in the future
◉ W hen you buy shares and and at a predefined price.
take delivery, you become ◉ You can never be a
shareholder of the company shareholder w hen you trade
till you hold the shares. in Futures.

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Spot Market

◉ The spot market is w here financial instruments, such

as commodities, currencies, and securities, are traded for immediate
delivery. Delivery is the exchange of cash for the financial
instrument.
◉ Spot markets are also referred to as “physical markets” or “cash
markets” because trades are sw apped for the asset effectively
immediately.
◉ The current price of a financial instrument is called the spot price. It
is the price at w hich an instrument can be sold or bought
immediately. Buyers and sellers create the spot price by posting
their buy and sell orders.

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Major Players in Stock Market

Major Traders
International Oil
Companies

Independent Oil
Companies Brokers

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Net Back Pricing

◉ In a netback transaction,
crude oil is sold on the
basis of the price that the
buyers expect to receive for
his final products, rather
than the price set by the
producer at the time of sale.

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Component of Netback Deals

◉ Netback is an important benchmark

because it is a very useful measure for
assessing a company w ithout the bias of
1. Refinery yields non- operating, financing, or other costs.
2. Products prices
◉ Calculating this metric essentially tells an
analyst how efficient the company is at
3. Timing producing and selling its oil and gas
products.
4. Transportation ◉ A higher netback/ BOE w ill also show how
able a company is at dealing w ith price
5. Other fees and profit volatility in the market.
margin
◉ A higher netback/ BOE suggests that in
times of falling prices, the company w ould
still be able to remain profitable.

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Petroleum Project Economics

◉ The purpose of petroleum engineering is to examine, define, and

implement methods and procedures for developing and extracting oil,
gas, and associated products so as to optimize profits and obtain a
return- on- investment that is commensurate w ith the risk incurred in
making the investment.
◉ In any decision making process, one must account for the benefits and
costs of a project
◉ In a typical project, the costs occur at the beginning of the project and
the benefits occur over a period of time.

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Petroleum Project Economics

◉ Petroleum projects involve several stages in which each

stage must be planned and monitored to ensure smooth
operation.

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 Tasks in Petroleum Project Analysis

◉ Setting an economic objective

based on corporate economic
criteria
◉ Formulate scenario for the projects
◉ Collecting all relevant Technical and
economic data
◉ Making Economic calculations
◉ Making Risk Analysis
◉ Selection of optimum development
plan 28
Cost Estimation and Economic Evaluation

◉ Predicting future operating costs

◉ Economic limits of producing wells (or plants in
downstream projects)
◉ Field life (or project life)
◉ Failure Analysis
◉ Price- effect cost escalation
◉ Risks
◉ Funding
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Thanks!
Any questions ?
You can find me at
◉ johnkevin.decastro@g.batstate- u.edu.ph

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