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Petroleum Economics and Agreements

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Agenda

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Oil Industry Overview Petroleum economics Cash Flow analysis

Model Components 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 73 $/BBL
100 MMSTB/D 328 Billion$
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Petroleum Industry Overview

Oil Industry Sectors 5
Oil Industry Players 6

• 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
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Petroleum economics
Why Perform Economics on Oil & Gas Projects? 8

• 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 9
Distinctive trends for E&P assets 10
Oil industry of last 30 years 11

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 12

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.
Decision to balance risk & reward 13

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

Cash flow method 15

• 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.
Cash flow (inflows and outflows) 16
Upstream Cash flow Components Influence Diagram 17

Reserve and reservoir characteristics

have huge influence on cash flow
components
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Economic Model
Typical economic model inputs 19

Production

Inflation &
Oil Price
Escalation

Economic
Interests
Limit

Fiscal
CAPEX Terms

OPEX
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Reserve & Production

Reserve definition 21

• 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.

• There are three conditions in Reserve definition highlighted in red color.

Relevance of resources versus reserves to portfolios 22
Categorizing reserves by levels of uncertainty 23
Aligning reserve definitions with project cycle 24
Methods of Estimating Reserves & Production Volumes 25

• Performance
• Volumetric
• Analogy/statistical
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Product Price
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Factors affecting prices:

1- Quality of hydrocarbon
2- Politics
3- Supply available
4- Transportation surcharges

The proximity to market issues are usually handled with price

adjustments. Adjustments may be reductions (downward) or premiums
(upward).

Reservoir Economics
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Benchmarks:
1- West Texas Intermediate (WTI)

2- Brent Blend

3- NYMEX Futures

4- OPEC Basket Price

5- Henry Hub Natural Gas

Other price points include: AECO, Sumas and Chicago

Reservoir Economics
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Interest Types
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1- Ownership Interests

Private Ownership State Ownership

• The royalty are usually negotiated between • Petroleum resources are owned by the
the leaseholder and the producer. country in which they exist.

• The royalty is usually expressed as a fixed • The government of that country then takes
percentage of production or revenue. the responsibility for managing the resource
via using the tool of fiscal regimes.
• most common in the United States and
Canada.

Reservoir Economics
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2-Working Interests

Working Interest is the portion of lease expenses that are paid by the
working partner. If a company has a 50% working interest they would
normally be obligated to pay 50% of all operating expenses and capital
expenditures. They would normally also receive 50% of the net
revenue.

Reservoir Economics
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E&P Agreements
Definition of fiscal regime 33

• 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 34

Government Objective
•Maximize value of the petroleum
resource
Company Objective
• Maximize stockholders interest
Schematic Comparison 35

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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Operating Expenses
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Project Opex

• Opex is the cost of keeping a production system running smoothly.

• Include:
1) Lease of facilities.
2) Platform operation, ,maintenance, transportation costs.
3) Export costs including (tariff payment, tankers, P/L, terminals)
4) Workover operation.
5) Insurance & administration.

Reservoir Economics
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Opex per an equivalent barrel of oil from
total cost
(2016)

Reservoir Economics
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Capital Expenses
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Project capex
• Exploration (Pre-discovery)
• Appraisal (Pre-commercial decision)
• Field development
• Field modification
• Abandonment

Reservoir Economics
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Capex per an equivalent barrel of oil from total
cost(2016)

Reservoir Economics
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Tax Definition
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Taxes
• Any activity that generates revenue, almost universally, pays tax to a
government.
• Taxes are usually payable at a corporate level and are based on the
profitability of that corporation. Taxes payable are calculated based on
taxable income and an applicable tax rate.

Reservoir Economics
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Economic Limit
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Economic Limit
• Refers to the point in time that continued operations of the property are no
longer commercially viable.
• The economic limit is derived on a before tax basis rather than an after tax
basis. The rational behind this method is as follows:
- Taxes are typically calculated at a corporate level.
- The decision to discontinue producing petroleum product does not
typically affect corporate taxes.

Reservoir Economics
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Economic Limit across different countries

Oil prices should be greater than Opex/bbl to continue production
economically

Reservoir Economics
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Escalation & Inflation

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Escalation and Inflation

• Escalation and inflation rates are used to estimate how product prices will
change and what capital or operating expenses will cost in the future.
• Many companies use the terms escalation and inflation synonymously.
• Inflation is usually associated with a currency, accounting for real
changes in the value of the currency due to politics or policy.
• Escalation is used to predict the future value of a price or cost above
the forecast inflation rate.

Reservoir Economics
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Economic Indicators
Undiscounted indicators 50

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 51

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) 52

It is the sum of all project cash flows,

discounted back to a common point
in time.
Relation between NPV and discount rate: 53
2-Rate of Return (ROR) 54

• 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) 55

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) 56

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 58

• 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

Chance of finding some HC (Geologic risk) 59
 Aspects of economic risk factors 60

• 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 61

• Sensitivity analysis
 Spider diagrams
 Tornado diagrams
• Expected value (EV)analysis
• Monte-Carlo simulation
• Decision trees.
Example from Deepwater Nigerian prospects 62
Spider Diagram Example 63
Decision tree example 64
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