Content

PET 412E
• Introduction
Petroleum and Natural Gas • Doğrudan yatırım (direct investment)
Economics • Bürüt gelir (gross revenue=gayri safi gelir)
• İşletme giderleri (operating expenses)
• Bürüt kazanç (gross profit=gayri safi kar)
• Soyut ve somut (intangible and tangible) sondaj maliyetleri
• Harcama yatırımları (expensed investments)
Cash flow and Income tax • Değer kaybetme (depreciation)
Handout # 2 • Tüketim (depletion)
• Amortizasyon (amortization)
1
• Gelir vergisi ve Net gelir (income tax and net income) 2
• Gelir vergisi sonrası nakit akışı (after income tax cash flow)

1
 Introduction
• One of the basic tools to evaluate and compare
investment opportunities is cash flow analysis.
• Cash flow analysis relates investments to subsequent
revenues generated.
• The difference between inflows and outflows of money
over a period of time adds up to a profit or loss.
• This difference is called net cash flow.
• It may be developed on either a before income tax (BIT) or
an after income tax (AIT) basis.
3 4
Introduction
• Income tax is paid only on that part of gross revenue
(income) which exceeds the cost incurred to generate it.
• The Revenue Service (Defterdarlık) permits several
deductions from annual gross revenue when determining
the portion that is taxable.
• Expenditures which are deducted in the year they are
incurred are said to be «expensed».
• Other expenditures are «capitalized» and the cost
recovered by deducting a proportionate share annually,
over the life of the project.
2
 Introduction Introduction – BIT cash flow model

Dividends to
stakeholders
• Deductions for capitalized costs are further divided into: R&D
Equity capital
“depreciation - değer kaybetme”, “depletion - tükenme” Income from patents,
Borrowed
and “amortization - amortisman”. Called as DD&A. capital
Engineering, R&D etc.

• A capitalized cost can be deducted once. It can be Before income tax cash flow Corporation Other investments
depreciated or depleted or amortized. It cannot be cash
depreciated and depleted and amortized.

Direct investments
The calculation of a cash flow stream is frequently referred to
as building an economic model.
Gross revenue Operating expanses
Operations
(includes severance taxes)

Gross profits
5 6

3
 Introduction – AIT cash flow model Direct investment (doğrudan yatırım)
Dividends to
stakeholders • Direct investment is the outflow of corporation cash
R&D
Equity capital required to initiate the project.
Income from patents,
Borrowed
capital
Engineering, R&D etc. • Some of the expenditures involved will be for mineral
After income tax cash flow rights acquisition, geological and geophysical expenses,
Corporation Other investments
cash drilling costs, completion costs, equipment costs, etc.
• Income from the sale of oil and gas are subsequent to
Direct investments
investment expenditures.
• Therefore, in the beginning year(s) of the project, negative
Gross revenue Expenses
Operations (includes severance taxes)
cash flow usually occur.
Expensed investment
Amortisation
Gross profits • Direct investment costs are recovered by expensing
Depreciation certain of them in the year incurred. The rest are
Depletion
Deferred deductions capitalized and recovered by DD&A.
7 8
Taxable income Income tax
Net income

4
 Gross revenue (Bürüt gelir ) Operating expenses (İşletme giderleri)

• Gross revenue is the inflow of money as a result of oil and The expenses include such things:
gas sales. 1. Direct operating cost (doğrudan işletme giderleri)
– Labor
It is calculated using the following equation: – Material
– Workovers, gas-processing plants, salt water disposal systems,
and gas or water injection systems.
Gross Revenue= (ΣNp*O$+ΣGp*G$) * NRI
2. Ad valorem tax (mülkiyet kıymet vergisi)
3. Overhead (genel giderler) – the proportion of the overall
ΣNp= total oil production expense of running the company.
O$= oil price 4. Production taxes
ΣGp= total gas production
G$= gas price They are actual out-of-pocket expenses.
9 10
NRI= Net revenue interest

5
 Gross profit (BIT cash flow)
The gross profit is equal to the gross revenue minus the
operating expenses including severance and ad valorem
taxes.
It is also the before income tax cash flow.
11
Intangible and tangible drilling costs
• When a well is drilled, some costs are designated as «intangible»
while other costs are said to be «tangible».
• Expenditures for equipment with a useful life greater than one year are
considered to be tangible costs.
• A typical form for the «Authority For Expenditure (AFE)» for the drilling
of a well includes two categories, intangible and tangible.
• Intangible drilling and development costs (IDC) are recovered by
expensing them in the year they occur (the full costs are subtracted
from gross profit BIT).
• Tangible drilling and development costs (TDC) are recovered over the
life of the project through depreciation.
• Other costs associated with the well are recovered over the life of the
project through depletion and amortization.
• Expensed investment «IDC» (Harcama yatırımları ): IDC refer to
certain portion of the direct investment costs. (site preperation, fuel12
etc.)
6
 Depreciation (değer kaybetme)
Definition: Depreciation is the systematic expensing of the
cost of a tangible asset over its depreciable life
(established by the Ministry o Finance).
• The depreciable life is not necessarily indicative of the
actual useful life of the asset.
• Depreciable items include well and surface equipment
such as casing, line pipe, tubing, wellhead equipment,
pumping equipment, treating equipment, and tanks.
• In general, an item can be declared depreciable if it retains
a salvage (hurda) value over a period of time greater than
one year. Land cannot be depreciated.
13
Depreciation (değer kaybetme)
• The current «book value» of a depreciable asset is its initial
cost less the cumulative depreciation previously taken. It is
the remaining unallocated cost of the asset.
• The salvage value of an asset is its worth when it is taken out
of service at the end of its useful life.
• There are several methods for computing a yearly
depreciation allowance.
1. Straight-line method (Doğrusal yöntem)
2. Declining-balance method (Azalan bakiye yöntemi)
3. A combination of declining balance and straight line methods.
4. The units-of-production method (Birim üretim yöntemi)
• When the time value of money considered, the method that
yields the largest deductions early in the depreciation life is
14
the one usually chosen.
7
 Depreciation (değer kaybetme) Depreciation - example

• There are some restrictions on the amount of depreciation To illustrate the various depreciation methods, it will be assumed that
that can be taken in the year the equipment is placed in oil production equipment with a depreciable life of five years is
service when Method 1, 2 or 3 is used. purchased for $50,000.
The projected production life for the equipment and the venture is:
• In industry practice, the half-year convention is usually
Year Oil (stb) Gas (MMscf)
assumed to be applicable in evaluations involving
1 4000 2.00
depreciation property (equipment) other than real estate
(gayrimenkul, taşınmaz mülk). Therefore, one-half of the first 2 10000 5.00
year normal depreciation is allowed for the tax year in which 3 6000 3.00
the equipment is placed in service. 4 3700 1.85
5 2300 1.15
6 1400 0.70
7 800 0.40
8 500 0.25
15 16
Total production 28700 14.35

8
 Depreciation - example Depreciation - example

1) Straightline depreciation (Doğrusal değer kaybı) Straight line depreciation (Doğrusal değer kaybı)
This is the oldest, simplest and best known method. Depreciation schedule using the half-year convention:
1 YEAR Straight Ci D Year end
D= Ci (1) line rate book value
n 50000
1 (1/5)(1/2) 50000 5000 45000
D: Annual depreciation allowance
2 (1/5) 50000 10000 35000
n: Depreciable life in years
3 (1/5) 50000 10000 25000
Ci: Initial cost, (basis) 4 (1/5) 50000 10000 15000
5 (1/5) 50000 10000 5000
6 (1/5)(1/2) 50000 5000 0
7 0 0
17 8 0 0 18

9
 Depreciation - example Depreciation - example

balance depreciation (Azalan bakiye değer kaybı)

2) Declining Declining balance depreciation (Azalan bakiye değer kaybı)
This method results in larger than straight line depreciation
allowances during the early years of an asset and, If F=1.5, then the method is called 150% declining balance
necessarily, smaller charges as the asset nears the end of its depreciation.
depreciable life. If F=2, then the method is called 200% declining balance
F depreciation or double declining balance depreciation.
D= Cbv (2)
n
D: Depreciation allowance for years The depreciation rate in the first year of this method is twice that
n: Depreciable life in years of the straight line method.
F: Depreciation factor (it could be 1, 1.5 or 2)
Cbv: Book value of asset at beginning of year. 19 20

10
 Depreciation - example Depreciation - example

Declining balance depreciation (azalan bakiye değer kaybı) (F=2) 3) Declining balance Switching to Straight line depreciation
YEAR DDB rate Cbv D Year end
book value
Switching from declining balance to straight line depreciation
50000 when beneficial to do so, enables an investor to fully
1 (2/5)(1/2) 50000 10000 40000 depreciate an asset over a period equal to the depreciable life
2 (2/5) 40000 16000 24000 plus one year.
3 (2/5) 24000 9600 14400
The time to switch from the declining balance method to the
4 (2/5) 14400 5760 8640 straight line method, is in the year the change will yield an
5 (2/5) 8640 3456 5184 equal or larger deduction. This occurs when the straight line
6 (2/5)(1/2) 5184 1037 4147 rate equals or exceeds the declining balance rate.
7 When switched, then the current basis is depreciated straight line
Note that the asset is not fully depreciated at the end of its depreciable life plus over the remaining depreciable life.
1 year as was the case for straight depreciation. It literally takes an infinite21 22
number of years to fully depreciate an asset using this method.

11
 Depreciation - example Depreciation - example

DDB switching to straight line depreciation schedule using the of production depreciation (Birim üretim değer kaybı)
4) Units
half year convention (F=2) DDB or SL x Cbv = D This method deducts the asset cost over the estimated
YEAR DDB rate Straigh line Cbv D Year end producing life of the asset (instead of over a given
rate book value depreciation life).
50000
P
1 (2/5)(1/2) (1/5)(1/2) 50000 10000 40000 D= Ci (3)
2 (2/5) (1/4.5) 40000 16000 24000 R
3 (2/5) (1/3.5) 24000 9600 14400
D: Depreciation allowance for year
4 (2/5) (1/2.5) 14400 5760 8640
5 (1/2.5) 14400 5760 2880
P: Units of production for year
6 (1/2.5)(1/2) 14400 2880 0 R: Initial reserve of units
7 0 0 Ci: Initial cost of asset.
Note that once the switch to straight line depreciation is made, the basis (Cbv) remains constant
23 24

12
 Depreciation - example Depreciation - example

Unitsof production depreciation (Birim üretim değer kaybı) Units of production depreciation (Birim üretim değer kaybı)
• Yearly gas production is stated in terms of stb equivalents. YEAR P/R Ci D Year end
6000 scf=1 stb (approximate BTU equivalent) book value

YEAR Oil (stb) Gas (MMscf) P (stb eq) P/R 50000

1 4000 2.00 4333 0.139373 1 0.139373 50000 6969 43031

2 10000 5.00 10833 0.348432 2 0.348432 50000 17422 25609

3 6000 3.00 6500 0.209059 3 0.209059 50000 10453 15156

4 3700 1.85 4008 0.128920 4 0.128920 50000 6446 8710

5 2300 1.15 2942 0.080139 5 0.080139 50000 4007 4703

6 1400 0.70 1517 0.048780 6 0.048780 50000 2439 2264

7 800 0.40 867 0.027875 7 0.027875 50000 1394 870

8 500 0.25 542 0.017422 8 0.017422 50000 870 0

Total prod. 28700 14.35 R=31092 1.000000 25 26

13
 Depletion (Tükenme)
Depletion is the exhaustion (bitirilme) of a natural resource
as a result of extraction (yerinden alınma).
A tax deduction is allowed to recognize the fact that income
is being generated from a dwindling resource. The idea
of depletion allowance is to provide funds to allow
companies to explore for, find, and develop new reserves
of the resource.
Oil and gas depletion allowance is computed using the cost depletion
method (maliyet tüketimi) or the percentage depletion method (yüzde
tüketim) except the integrated producers that may only use the cost
depletion method.
27
Depletion (Tükenme)
1) Cost depletion (Maliyet tükenmesi): refers to the reduction
in value, as a result of production, of certain asset.
Direct investment costs which may be recovered by a cost
depletion allowance.
Example: lease bonus costs paid for mineral rights, geological and
geophysical costs, and IDC that is not expensed. (These expenditures
are usually lumped together and termed mineral rights acquisition costs,
MRA).
The method for computing the cost depletion allowance is
identical to the units of production depreciation method.
28
14
 Depletion (Tükenme)
2) Percentage depletion (Yüzdesel tükenme): It is a
specified percentage (15% in the US) of gross income
after royalties from the sale of oil and gas during the tax
year.
Only non-integrated producers may take a percentage
depletion allowance. (Oil production is no more than
1000 stb/day or 6MM scf/day for gas, or combined
equivalent is less than 1000 stb of both oil and gas)
Note that 6000 scf = 1 stb.
29
Amortization (Amortisman)
Amortization (aşınma, zaman ile değerini yitirme)
Amortization is similar to straight line depreciation, whereby
the costs of certain assets are charged against income
over a period of years.
Asset costs hat may be recovered through amortization
include; a corporations organization expenses; the cost
of acquiring a lease (other than a mineral lease);
research and development expenses; the cost of patents;
copyrights (telif hakları) and goodwill (şerefiye); and the
cost of certified pollution control facilities.
30
15
Deferred deductions and Taxable income
• Taxable income for any tax year may not be less than
zero.
• It is computed by deducting from gross profit, the
expensed investment costs, a depreciation allowance, a
depletion allowance, and an amortization allowance.
• If the deductions exceed the gross profit, taxable income
is reported as zero for the tax year and the excess
deductions (that greater than gross profit) are deferred
(ertelenme) to the following tax year(s).
• Expensed investments, depreciation, depletion, amortization, and
deferred deductions are referred to as «non-cash deductions» (nakit
olmayan kesintiler) because they do not require any out-of-packed
cash payments in the tax year they are taken. They are added back
to net income to determine the AIT cash flow for the next year.
Income tax and Net revenue
• Income tax is computed by multiplying the taxable
income by an appropriate marginal income-tax rate.
• Net income is computed by subtracting the income tax
from taxable income for the tax year.
• After income tax cash flow is equal to the net income plus
the non-cash deductions taken for the tax year. This is
the actual amount of money flowing into the corporation’s
treasury as a result of investing in the project.
31 32
16
 WARNING

Terms and methods defined in this lecture notes could be

different from time to time and from country to country.
It is assumed that the students are aware of this fact.

Homework

Search the income tax rates from 2000 to 2022 in Turkey

and in Germany (or any country you wish). Make
interpretation about the differences if there is any. What
is your main conclusion?

33

17