ECONOMIC INDICATORS

ECONOMIC INDICATORS

• Economic indicators are yardsticks used

to quantify the relative attractiveness of
Example of Economic Indicators
an investment:
 Maximum Cash Sink
1. Establish the economic feasibility of
 Breakeven
an investment opportunity
 Payback Period
2. Weight the relative merits on
 Economic Limit
investment opportunities
 Economic Life
3. Determine the value for buying or
 Ultimate Cash Surplus
selling as asset
 Profit Investment Ratio (PIR)
4. Assess the feasibility for project
 Net Present Value (NPV)
expansion or acceleration
 Internal Rate of Return (IRR)
• Other than strategic considerations, we
need to apply appropriate profitability
indicators to support management
decisions

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 ECONOMIC INDICATORS

Example of Cash Flow Profile

+ve
Net Cash Flow
Cum Net Cash Flow

First Production
Cash Flow (USDMM)

Economic
limit year

18 Years
07 10
03

Abandonment
04
05 06

Development Production

-ve
Project ends
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 ECONOMIC INDICATORS

Maximum Cash Sink:

 Definition: Maximum amount of cash outlay for a project
 Formula: MIN (Cumulative Net Cash Flow)
 Unit: Currency value

Cash Flow (USDMM)

Years
07 10 18
03
04
05 06
Maximum
Cash Sink

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 ECONOMIC INDICATORS
Breakeven:
 Definition: The year when the sum of cash inflow equal to the sum of
cash outflow, beyond which the project will fully fund itself
 Formula: Cumulative Net Cash Flow = 0
 Unit: -
Cash Flow (USDMM)

Years
07 10 18
03
04
05 06

Breakeven year

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 ECONOMIC INDICATORS
Payback Period:
 Definition: Number of years from first production to achieve
breakeven
 Formula: COUNT (Breakeven – 1st Production))
 Unit: Years

Payback
period
Cash Flow (USDMM)

Years
07 10 18
03
04
05 06

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 ECONOMIC INDICATORS

Economic Limit:
 Definition: The year where maximum cumulative cash is realized
 Formula: MAX (Cumulative Net Cash Flow)
 Unit: -

Cash Flow (USDMM)

Years
07 10 18
03
04
05 06 Economic
limit year

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 ECONOMIC INDICATORS

• Economic Life:
 Definition: Number of years from first production to achieve
economic limit
 Formula: COUNT (from 1st production to economic limit)
 Unit: Years
Economic life
Cash Flow (USDMM)

Years
07 10 18
03
04 Economic
05 06 limit year

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 ECONOMIC INDICATORS

Ultimate Cash Surplus:

 Definition: Cumulative net cash flow at the end of project life
 Formula: ∑ (Net Cash Flow) = undiscounted Net Present Value
 Unit: Currency value
Ultimate
Cash Flow (USDMM) Cash Surplus

Years
07 10 18
03
04
05 06

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 ECONOMIC INDICATORS

Profit Investment Ratio:

 Definition: Amount earned for every dollar spent
 Formula: Undiscounted Net Present Value / Total Investment
 Unit: Ratio
Ultimate
Cash Surplus

Maximum cash sin k

PIR =
Ultimate cash surplus
Cash Flow (USDMM)

Years
07 10 18
03
04
05 06
Maximum
Cash Sink

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 ECONOMIC INDICATORS

Net Present Value (NPV):

 Definition: Sum of discounted cash flow over project life
 Formula: ∑ (Net Cash Flown * Discount Factorn)
 Unit: Currency value

NPV@10%=$566 MM
NPV@40%=($197 MM)
Net Present Value (USDMM)

NPV@15%=$271 MM

NPV@23%=$0 MM

Discount
5% 10% 15% 20% 25% 40% Rates

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 ECONOMIC INDICATORS

Internal Rate of Return (IRR):

 Definition: Discount rate for which NPV = 0
 Formula: Discount rate where NPV=0 from NVP profile
 Unit: %

Internal rate of return

Net Present Value (USDMM)

= 23%

⇑
NPV@23%=$0 MM

Discount
5% 10% 15% 20% 25% 40% Rates

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 ECONOMIC INDICATORS
SUMMARY

+ve Economic
life Ultimate
Cash Surplus
Payback
Cash Flow (USDMM) period

Economic
limit year

Years
07 10 18
03
04
05 06
Ultimate Cash Surplus
Breakeven year PIR =
Maximum Cash Sink
Maximum
-ve
Cash Sink
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 RISK AND SENSITIVITY ANALYSIS

Risk Analysis Level of uncertainty

 Represent situation in which the

probabilities can be more or less Exploration
reasonably deduced from known data

 Risk in oil and gas investments have Appraisal

many components:
• Reservoir risk
• Facilities risk Development
• Economic risk
• Political risk
Production
• Regulatory risk

 Generally uncertainties tapers towards

the production stage

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 RISK AND SENSITIVITY ANALYSIS

Method of Risk Analysis

 Ad hoc Method
• discount rate adjustment
• capital at risk
• time risk and capital recovery

 Sensitivity Analysis
• analysis of one variable
• analysis of more than one variable
• range approach

 Probabilities (Monte Carlo)

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 RISK AND SENSITIVITY ANALYSIS

Project Risks
• Uncertainties in project execution
• e.g. reservoir risk, facilities risk, schedule risk, budget
risk
• Applied through distribution of success factor

Technical/Operational Risks
• Uncertainties in operating cash flow
• e.g. production risk, price risk
• Applied through probability distributions

Country Risk
• Uncertainties in location
• e.g. political risk, economic risk, regulatory risk
• Applied through cash flow discount rate premium

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 RISK AND SENSITIVITY ANALYSIS

Sensitivity Analysis

 Investigate the relationships between

change in key project variables and
Prod
measure of value
Price
 Important variables are:
• Production
• Price

NPV or IRR
• Capex Opex
• Opex
Capex
 Start with “Base Case” and change one
variable at a time keeping all other
assumptions at the Base Case

 The shaded region reflect our confident

20 40
range of variable uncertainty that will -40 -20 0
impact the project’s IRR Variation (%)

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