Progress Report on Portfolio Management of Upstream, Offshore, Petroleum Activities with Applications to Lebanon A Research Project Funded by The

Munib R. and Angela Masri Institute of Energy and Natural Resources

Principal Investigator: Professor Bacel Maddah (Engineering Management Program, AUB) Co-Principle Investigators: Professor Ali Yassine (Engineering Management Program, AUB) Dr. Mazen Skaf (Managing Director, Strategic Decision Group, Palo Alto, CA)

ON STRUCTURING OFFSHORE HYDROCARBON PRODUCTION SHARING CONTRACTS: LEBANONS CASE

Ali Yassine, Bacel Maddah, Najat Younes
American University of Beirut Engineering Management Program Beirut, Lebanon

Abstract
The interest in Lebanese offshore hydrocarbon potentials is increasing, especially after the discoveries in neighboring countries that share the same geological underwater basin with Lebanon. In this paper, we present a framework for structuring (i.e. defining parameters) and analyzing offshore hydrocarbon contracts in Lebanon and similar countries. Our research is based on an extensive benchmark study of offshore production sharing contracts PSCs using country profiling and statistics collected from each contract. We also build a simple financial model for PSCs to perform a sensitivity analysis to identify critical contract parameters that has the highest effect on the government share. Based on this database and on country profiling, we propose plausible ranges for the parameters of potential Lebanese production-sharing contracts. In addition to this, our paper studies the factors of significant influence in the oil and gas industry, and therefore, on the parameters of hydrocarbon PSCs. Our objective is to assist any government in formulating and managing the contracting process for hydrocarbon assets. Keywords: Oil and Gas, Offshore, Production Sharing Contracts, Lebanon.

Acknowledgment
The authors would like to thank the financial support of the Masri Institute of Energy and Natural Resources and Lebanese National Council for Scientific Research (LNCSR). Moreover, the authors are thankful to Dr. Mazen Skaf from Strategic Decision Group (SDG) for his valuable cooperation and assistance. Thanks to Mr. Gordon Barrows (Barrows Company Inc.) for supplementing us with unpublicized hydrocarbon contracts and laws.

Corresponding author: ay11@aub.edu.lb.

Report

In the past 18 months of this two-year project, the research team worked on the two following tasks: (i) Developing a decision support system (DSS) for assisting the Lebanese government to structure production sharing agreements (PSAs) with foreign oil companies, and (ii) formulating a dynamic programming-based DSS for portfolio management of hydrocarbon assets by oil companies at both the exploration and production stages. The progress made on these two tasks is summarized in Sections 1 and 2, respectively. The research team continued to rely on two graduate research assistants from the Engineering Management Program. The project budget in the second year ($10,000) is being utilized to mainly cover the two research assistants salary. 1 DSS for Structuring PSAs The following activities were carried out toward achieving this task: 1.1 Surveying the literature on the theory and practice of PSAs. Key parameters of a PSA were identified while emphasizing their impact on the governments and oil companys interests. 1.2 Compiling a database of PSAs. A database of 51 different offshore PSAs from 31 countries was compiled via a thorough survey of literature, relevant databases, and published oil laws. 1.3 Statistical analysis of PSAs. Descriptive statistics were collected and a graphical analysis was carried out on the parameters of the PSAs in our database. 1.4 Profiling the countries. Critical factors which govern the setting of offshore PSA parameters in a country were highlighted (mainly political risk and condition of oil reserves, in terms of proven/unproven). These factors were quantified for the countries in our PSA database. 1.5 Statistical analysis to confirm the validity of the profiling criteria. Testing of hypothesis was carried out to see whether the profiling described in (1.4) yields country groups which have significantly different contract parameter values. Profiling turned out to be significant for some parameters and not too significant for others. 1.6 Setting parameter ranges for countries in different groups. The analysis in (1.5) allowed recommending contact ranges for countries of various profiles for both oil and gas contracts. 1.7 Oil versus gas analysis. A statistical analysis was also carried out to identify the difference between oil and gas PSAs. The main difference turned out to be in the profit share parameter. Accordingly, equivalence factors between profit oil and profit gas scales were developed. 1.8 Setting ranges and analyzing PSA parameters for Lebanon. PSA parameter ranges were set based on contracts for countries with a profile similar to Lebanon, as well as special factors in the Lebanese case. A model contract for Lebanon was then built and recommendations were provided for both gas and oil assets. 1.9 Feasibility analysis. A spreadsheet financial feasibility model was developed to quantify the effect of varying the parameters in the ranges developed in (1.8) on Lebanon and potential oil companies interests (takes).

This research task is complete. The attached paper has been written to summarize the major findings. The paper will be submitted for publication this week to Energy.

2 DSS for Portfolio Management of Exploration and Production Assets The following activities were carried out toward achieving this task: 2.1 Surveying the literature on hydrocarbon portfolio management. Critical decisions at the exploration and production stages were examined with their relevant decision support models. 2.2 Identifying the critical decisions and factors. Critical decisions and factors that should be analyzed in a DSS for portfolio management which are relevant for an oil company operating in Lebanon (and similar countries) were identified. 2.3 Developing a hydrocarbon price sub-model. A geometric Brownian motion, random walk, model for the hydrocarbon (gas or oil) price was adapted from the financial engineering literature. This model was calibrated according to current price and volatility levels. 2.4 Developing a probability update sub-model. This sub-model allows updating the probability distribution of reserve levels of unexplored assets based on the outcomes of sequential exploration drilling. 2.5 Cost structure sub-model. The nature of costs in the exploration and producing (including development) phases were identified and formulated mathematically. 2.6 Developing a DP formulation. A compact dynamic programming (DP) formulation that captures the price volatility and the stochastic and evolving estimates of reserve levels in (2.4) and (2.5), as well as the cost structure in (2.5), was formulated with the objective of maximizing the revenue from the hydrocarbon portfolio. 2.7 Verification and Validating the DP formulation. A set of numerical experiments are currently being performed toward this end. This research task is expected to be completed by September 2011 with a research paper that will be submitted to the European Journal of Operational Research.