Course Petroleum Economic and Management

Petroleum Economic and
Management
Contents
Introduction
Economic Yardsticks
Economic Analysis Process
Cash Flow Model
Examples Of Exploration /Production Programs
Risk And Uncertainty
Management
Introduction
The prime objective of petroleum – producing operations is not
only to supply the modern world crude – oil and natural gas,
but, to make a profit while doing so.
BPD
20000
With 20-Ac. Infills CO2 Injection Started
16000
With 10-Ac.
Infills
12000
40-Ac. Spacing
Waterflood peak
8000
4000 Without
infills
0
1970 1972 1974 1976 1978 1980 1982 1984 1986 1988 1990 1992
Management
Introduction (cont’d)
In an any economic evaluation, the key elements are:-
• Income
• Expenditures
• Time
Cash flow (periodic recording of Income and Expenditures)

is the most important tool for:
• Evaluating investments.
• Choosing among alternatives.
Management
E & P INVESTMENT CYCLE
EXPLORATION PRODUCTION
CUM. NET CASH FLOW

ANNUAL INCOME AND EXPENDITURES
PROFIT
CUMULATIVE NET CASH FLOW

REVENUE
+ EXPENSES
+
NET
INCOME PV CUM. NET CASH FLOW
PV PROFIT
0
0
ABANDONMENT
COST
EC.LIMIT
- -
INVESTMENTS
-10 -5 0 5 10 15 20 25 30 35 40 45
YEARS
Management
The reason for doing economic evaluations is to make
investment decisions.
This process involves answering three critical questions:
• What will it cost ?

• What is it worth ?
• Will it earn enough profit ?
The time value of money must be considered when

answering the last question.
Management
Economic Yardsticks
All companies have established various economic measures

(YARDSTICKS) for determining the attractiveness of
investments.
No single Yardstick matches the gaols of every organization.
It will be necessary for each organization to select the one or

combination of yardsticks which match their goals.
Management
Economic Yardsticks (cont’d)
Payout
PROFIT
The time required for the
CUMMULATIVE CASH FLOW

cumulative cash flow to reach
zero.
The shorter the payout the PAYOUT

more attractive the project.
0
A common rule of thumb is 2-4

Years. 0 5 10 15 20 25 30
TIME - YEARS
Management
Return on investment (ROI)
Cumulative Income
ROI =
Total Investment
The higher the ROI the better.
ROI is independent of time which limiting its usefulness as

a single criterion for investment decisions.
Management
Profit to investment Ratio (PIR)
Cumulative Income - Total Investment

PIR =
Total Investment
PIR = ROI – 1.0
It is another form for expressing the same Yardstick.

Management
200 Payout = 2 Years Directly

CUMULATIVE CASH ($ 1,000)
from Graph
150
payout
$ 180,000
ROI =
100 2 Years Total $ 60,000
Profit $ 180.000
50 ROI = 3.0
0
Investment $60.000
- 50
180,000 – 60,000
PIR =
60,000
0 2 4 6 8 10 12 14 16 PIR = 2.0
TIME - YEARS
Management
Present Worth Net Profit (PWNP)
The present value of the Present worth

entire cash flow, discounted M$
200 Present Worth
at a specified discount rate. Profile
150
PW10
100
i.e how much a certain 50

amount of future income is PI
0
worth today.
-50
0 10 20 30 40 50
Management
1.00
PRESENT WORTH COMPARISONS
0.90
0.80
Present Value
0.70 Discount Rate

5%
0.60
0.50
0.40 10 %
0.30
15 %
0.20
20 %
0.10
0.00
0 5 10 15 20 25 30
YEARS
Management
PROFIT
CUMULATIVE CASH FLOW
PV PROFIT
PAYOUT
PV PAYOUT
0 5 10 15 20 25 30
TIME - YEARS
Management
Discounted Cash Flow Return On Investment (DCFROI)

The max. discount rate that needs to be charged for the
investment capital to produce a break-even venture.
i.e PWNP = zero

Present Work Index (PWI)
The total discounted cash flow
The total discounted investment
The value of this parameter in the range of 0.5 to

0.75 considered favourable.
Management
Hurdle rate
The “hurdle rate" discount factor, more properly referred

to as the "guideline discount (or interest) rate" is the
minimum acceptable rate of return on investments
The hurdle rate used is normally intended as the return

which the firm has been able to realize on its investments
of a similar nature in previous years.
The hurdle rate should recognize :
1. the acquisition cost of capital,

2. suitable return on the investment involved
3. a compensation for Corporate risk, and
4. inflation.
Management
80
70
60 A
NET PRESENT VALUE
B
50 HURDLE RATE
40 10% 15%
C
30
20 INTERNAL RATE OF RETURN

10
27% 32%
0
C
-10
22% B
A
-20
0 5 10 15 20 25 30 35 40
DISCOUNT RATE - PERCENT

Management
Economic Analysis Process
Set Economic PAYOUT

Objective PWI
DCFROI
Formulate PWNP
Scenario
Production
Collect Data Investments
Operating
Make Economic Expenses
Analysis Oil/Gas Price
Make Risk
Analysis
Choose Optimum
Operation
Management
Economic Analysis
Today, economic analyses are being applied throughout the

reservoir-development processes.
Sensitivity to various parameters [e.g. Original oil in place
(OOIP), reserves and production rate forecasts, capital
investment, and operating expense] and other data affecting
these parameters on the project /reservoir performance can
be determined by performing economic analyses with variations
in those parameters, thereby covering a reasonable range of
uncertainty.
Management
Economic Data
Data Source/Comment
Oil and gas production Reservoir and production engineers
Rates vs. time Unique to each project
Oil and gas prices Finance and economic professionals
Strategic planning interpretation
Capital investment (tangible, intangible) Facilities, operations and engineering
and operating costs professionals
Unique to each project
Royalty/production sharing Unique to each project
Discount and inflation rates Finance and economics professionals
Strategic planning interpretation
State and local taxes (production, Accountants
severance, ad valorem, etc.)
Federal income taxes, depletion Accountants
and amortization schedules
Management
Economic Data
Benchmark Crude
This is a widely used term to refer to an acceptable grade of
crude oil and used as a standard in trading.
Crude Oil Spot
West Texas North Sea Brent
$ 70
Intermediate (WTI) 40° $ 65

$ 66.15
North Sea Brent 38° $ 60

$ / Barrel
Suez Blend 32°

$ 55
$ 50
$ 45
$ 40
WTRG Economics - 2006

$ 35
www.wtrg.com 1/3/05 3/4/05 5/5/05 7/6/05 9/2/05 11/3/05 1/5/06
(479) 293- 4081 2/2/05 4/6/05 6/6/05 8/4/05 10/4/05 12/5/05
Jan 4, 2005 -Jan 24, 2006

Management
Economic Data
AVERAGE WORLD CRUDE OIL PRICES
50
45
40
35
$/BARREL
30
25
20
15
REAL OIL PRICE 2002$
10
5
NOMINAL OIL PRICE
0
1850 1870 1890 1910 1930 1950 1970 1990 2010
Management
Cash Flow Model
Cash flow for typical Exploration and Production venture can

be determined annually or for the life of a project by the
following model :-
Net Net Net

=
Cash Flow Annual Revenue Annual Expenditure
(NCF BT)
Management
Cash Flow Model (cont’d)
Net = Gross Revenue Royalty

Annual Revenue
Where :-
Gross Revenue = Produce volume of HC x Price .
Royalty = Fraction x Cross Revenue .
Management
Capital Expenditure
Net
Annual Expenditure
= +
Operating Expense
Where :-
Capital Expenditure:
Investment intended to acquire or Improve properties or

assets that will generate revenue over a period of time .
Management
Direct operating Expenses
Operating
Expense Indirect Expenses (overhead)
(cost of production)
Operating Taxses
Management
Direct Operating Expense
Fixed Variable periodic
Fixed Cost are independent of the production rate

such as maintenance, engineering staff, power cost.
Variable Cost are dependant on production level
such as chemical treating, some power, some labor.
Periodic do not occure constantly, pump changes,
hot oiling, dewaxing, stimulation.
Management
Indirect Expense (overhead)
All costs which may be incurred at a distant location for a

number of different operations are considered indirect
operation cost or “overhaed”
These include a prorated portion of supervisory and

administrative expense covering the individual property
The specific method of allocating these expenses is

arbitrary
Management
Indirect Expense (overhead)

Elements
Office expenses, including rent and utilities
Lease supervision wages, benefits
Engineering salaries, benefits
Clerical, accounting wages, benefits
Toolroom, warehouse, shop wages, benefits
Motor pool expense, not recovered as direct charge,
Management salaries, benefits
Services
Employee relations
Public Affairs
Insurance
Management
INDIRECT OPERATING COST (OVERHEAD) FORECAST
Overhead can be estimated as a fraction of capital

expenditures plus a fraction of direct operating costs.
A recent study determined that the appropriate fractions

would be 9% of capital and 11 % of DOC.
Management
INDIRECT OPERATING COST (OVERHEAD)

DUE TO DUE TO
CAPITAL DIRECT CAPITAL DOC
YEAR INVESTMENT OP. COST )%9( )11%( TOTAL
1 $1,250,000 $100,000 $112,500 $11,000 $123,500
2 $100,000 $11,000 $11,000
3 $100,000 $11,000 $11,000
4 $100,000 $11,000 $11,000
5 $100,000 $11,000 $11,000
6 $100,000 $11,000 $11,000
7 $100,000 $11,000 $11,000
8 $100,000 $11,000 $11,000
9 $100,000 $11,000 $11,000
10 $100,000 $11,000 $11,000
TOTAL $1,250,000 $1.000,000 $112,500 $110,000 $222.500
Management
Operating Taxes
Wellhead Severance valorm

Management
Cash flow Diagrams
Cash flow Diagram is simply a graphical sketch

representing the timing and direction of montary
transfers
$
CASH IN
$
CASH OUT Time
Management
Cash flow Diagrams
$
CASH IN
Time
$
CASH OUT
Management
Revenue and Cumulative

Oil Rate Expenditure M$
Rate 200
B/D MB/Yr.
M$/Yr.
15
40
40 150
10
Revenue
30
30
20 20
5 Operating Costs 100 Cumulative
10 10
0 0 0
Cash Flow
50
-10
-20
-30
0
Investment
-40
-50 -50
-60
0 2 4 6 8 10 12 14 16
Management
Major Assumptions
1.Price Forecast
Decreasing orders
of importance
2.Production Forecast
3.Royalties
4.Operating Costs and Future Capital Required
5.Taxes
6.Reserves
The above order is general.
Management
Petroleum industry cash flow spreadsheets
Spreadsheet Format #2
Forecast of Natural Gas Production, By-Products and Net Revenue (Before income Taxes).
(1) (2) (3) (4) (5) (6) (7) (8) (9) (10) (11) (12) (13) (14) (15)
Gross
pipeline Gross Gross Gross Total Net
Gas Gas Gas Liquids Liquids Liquids Gross Operating Expense Cash cum.
Year Investment Sales Price Revenue Prod. Price Revenue Revenue Royalty Wells Plant Compr. Flow NCF
($) (MMCF) ($/MCF) ($) (bbl) ($/bbl) ($) ($) ($) ($) ($) ($) ($) ($)
Column
(5) = (3)* (4)
(8) = (6)*(7)
(9) = (5)+ (8)
(10) = (9)*(Royalty Fraction)
(14) = (9)-(10)-(11)-(12)-(13)-(2)
Management
Petroleum industry cash flow spreadsheets
Spreadsheet Format #1
Forecast of Oil Production and Net Revenue (Before income Taxes).
(1) (2) (3) (4) (5) (6) (7) (8) (9) (10) (11)
Total Total
Annual Annual WI WI Share WI Share WI Share WI Share
WI Share Gross Oil Gross Share WI Net Operating Net cum. Net
Year Investment prod. Price Revenue Revenue Royalty Revenue Expenses Cash Flow Cash Flow
($) (bbls) ($/bbl) ($) ($) ($) ($) ($) ($) ($)
Column:
(2) = (Total investment)* W.I.
(5) = (3)* (4)
(6) = (5)*WI.
(7) = (6)* (Royalty Fraction)
(8) = (6) - (7)
(9) = (Total Op. Exp.)* W.I.
(10) = (8) - (9)-(2)
Management
Economic Analysis
Procedure for economic calculation before income
tax (BIT) using spreadsheets is outlined below:
1. Calculate annual revenues using oil and gas sales from
productions and unit sales prices.
2. Calculate year-by-year total costs including capital,
drilling/ completion, operating, and production taxes.
3. Calculate annual undiscounted cash flow by subtracting
total costs from the total revenues.
4. Calculate annual discounted cash flow by multiplying the
undiscounted cash flow by the discount factor at a
specified discount rate.
Management
Economic Analysis Example
(I) (2) (3) (4 ) (5) (6) (7)
Gas Total
Oil Prod Oil Price Revenue Gas Prod. Gas Price
Revenue Revenue
($MM)
($MM) ($MM)
Year (MSTB) ($/STB) (MMSCF) ($/MSCF) (4) x (5)
(2) x (1) (3) + (6)
100
1992 0 20.00 0.00 0 1.50 0.00 0.00

1993 0 20.00 0.00 0 1.50 0.00 0.00
1994 5505.3 20.00 110.11 3276 1.50 4.91 115.02
1995 10079.1 20.00 201.58 11934 1.50 17.90 219048
1996 5524.2 20.00 110.48 13208.4 1.50 19.81 130.80
1997 2098.8 20.00 41.98 5848.2 1.50 8.77 50.75

1998 lO20.6 20.00 20.41 2968.2 1.50 4.45 24.86
1999 1184.4 20.00 23.69 2081.S 1.50 3.05 26.73
2000 2211.3 20.00 44.28 2178.9 1.50 3.27 47.79
2001 2653.2 20.00 53.06 8468.6 l.50 5.20 58.27
2002 1976.4 20.00 39.53 4762.8 L50 7.14 46.67

2003 972 20.00 19.44 3364.2 1.50 5.05 24.49
2004 619.2 20.00 12.88 220.3 1.50 3.33 15.71
2005 257.4 20.00 5.15 1087.2 1.50 1.63 6.78
Total 84101.9 682.04 56848.1 84.52 766.56

Management
Economic Analysis Example
(8) (9) (10) (11 ) (12) (13) (14) (20)
Capital Operating Undiscounted Discount Discounted Discounted

Prod. Tax Total Cost
Cost Cost Cash Flow Factor Cash Flow Cash Flow
($MM) ($MM) @12%, @64.23%,

Year ($MM) ($MM) ($MM) @12%
(8)+(9)+(10) (7)-(11) $MM $MM
1992 5.715 0.000 0.000 5.715 -5.715 0.9449 -5.400 -4.460
1993 64.680 0.000 0.000 64.680 -64.680 0.8437 -54.569 -30.732
1994 143.977 3.825 11.502 159.304 -44.284 0.7533 -33.358 -12.812

1995 4.205 10.359 21.948 36.512 182.971 0.6726 123.060 32.233
1996 0.000 9.922 13.030 22.952 107.345 0.6005 64.462 11.515
1997 0.000 9.922 5.075 14.997 35.751 0.5362 19.169 2.335
1998 0.000 9.922 2.486 12.408 12.456 0.4787 5.963 0.495
1999 0.000 9.922 2.673 12.595 14.139 0.4274 6.044 0.342
2000 0.000 9.922 4.749 14.671 32.823 0.3816 12.526 0.484
2001 0.000 9.922 5.827 15.749 42.518 0.3407 14.488 0.382
2002 0.000 9.922 4.667 14.589 32.083 0.3042 9.761 0.175
2003 0.000 9.922 2.449 12.371 12.116 0.2716 3.291 0.040

2004 0.000 9.922 1.571 11.493 4.221 0.2425 1.024 0.009
2005 6.364 8.332 0.678 15.374 -8.595 0.2165 -1.861 -0.011
Total 224.941 111.814 76.656 413.41 353.149 164.599 -0.004

Management
Cost
180
160
140
120
$MM
100
80
60
40
20
0
1992 1993 1994 1995 1996 1997 1998 1999 2000 2001 2002 2003 2004 2005
-20
Captital cost Operating Cost Prod. Tax Total Cost

Management
Revenue
12000 14000
12000
10000
10000
8000
8000
MMSCF
MSTB
6000
6000
4000
4000
2000
2000
0 0
1992 1993 1994 1995 1996 1997 1998 1999 2000 2001 2002 2003 2004 2005
2000
- 2000
-
Oil Prod. Total Revenue Gas Prod.

Management
Cash Flow
200
150
100
$MM
50
0
1992 1993 1994 1995 1996 1997 1998 1999 2000 2001 2002 2003 2004 2005
50 -
100 -
Undiscounted Cash Flow Discounted Cash Flow
Management
Economic Analysis Summary
1- Payout Time = 3.43 years.
2- Profit-to-Investment Ratio = 578.09/224.941 = 2.57
where:
$ 578.09 MM (353.149 + 224.941) is the total undiscounted
cash flow without the total undiscounted investment of
$ 224.941.
(PIR) is the total undiscounted cash flow without

capital investment divided by the total investment.
3- Present Worth Net Profit (PWNP) = $ 164.599 MM.
It is the present value of the entire cash flow

discounted at a specified discount rate.
Management
Economic Analysis Summary
4- Investment Efficiency or Present Worth Index
or Profitability Index = 164.599/169.807 = 0.97
It is the total discounted cash flow divided by the total

discounted investment.
The value of this parameter in the range of 0.5 to 0.75 is
considered favorable.
5- Discounted Cash Flow Return on Investment or Internal Rate of

Return(DCFROI), found by trial and error (see Table 7-2)
= 64.23 %.
Discounted cash flow return on investment or internal rate of
return is the maximum discount rate that needs to be charged for
the investment capital to produce a break-even venture (i.e., the
discount rate at which the present worth net profit is equal
to zero).
Management
Examples Of Exploration / Production Programs
EXAMPLE
EVALUATION OF EXPLORATION PROGRAMS
An exploration venture has been proceeding for five years at an

annual cash outlay of $10 million per year. A commercial
discovery has been achieved at the beginning of year 6.
DETERMINE :
Whether the following development of the field would be a

profitable undertaking.
Management
EXAMPLE
EVALUATION OF EXPLORATION PROGRAMS
SOLUTION :
The summation of the net cash flows from the true beginning
through abandonment in year 20 is +$92 million. From
discovery forward it is +$142 million.
To answer the basic question as to whether the development
would be economic, the past would be ignored as "sunk costs,"
and year 6 would be treated as though it were year 1. The $50
million of sunk costs would not enter into the decision.
It is well to keep in mind, however, that the venture appears
better than it actually is in its entirety.
Management
SOLUTION :
Venture
Year 1 2 3 4 5 6 7 8 9 10 11 12 13 14 15 16 17 18 19 20
NCF, $M -10-10-10-10-10-10 -5 +5+10+20+35+25+20+15+8 +6 +5 +4 +3 +1
True beginning today abandonment
past future
Management
ADJUSTMENT OF NET CASH FLOW FOR TIME ZERO RESET ($ millions)
NCF Effective Adj.
Venture Annual Adj. PV
10% Past
Year Year NCF NCF NCF
Factor* NCF
1 -10 (5) 1.536 FV -15.36
2 -10 (4) 1.396 FV -13.96
3 -10 (3) 1.269 FV -12.69 = -64.03
4 -10 (2) 1.154FV -11.54
5 -10 (1) 1.049 FV -10.49
Time Zero -64.03 -64.03
1 6 -10 (1) 0.953 FV -10 -9.53
2 7 -5 (2) 0.867 FV -5 -4.33
3 8 +5 (3) 0.788 FV +5 +3.94
4 9 +10 (4) 0.716 FV +10 +7.16
5 10 +20 (5) 0.651 FV +20 +13.03
6 11 +35 (6) 0.592 FV +35 +20.72
7 12 +25 (7) 0.538 FV +25 +13.46
8 13 +20 (8) 0.489 FV +20 +9.79
9 14 +15 (9) 0.445 FV +15 +6.67
10 15 +8 (10) 0.404 FV +8 +3.24

NPV10(FULL Life)
11 16 +6 (11) 0.368 FV +6 +2.21 +$6.27
12
13
17
18
+5
+4
(12)
(13)
0.334 FV
0.304 FV
+5
+4
+1.67
+1.21
NPV10(Forward
14 19 +3 (14) 0.276 FV +3 +0.83
from time zero)
15 20 +1 (15) 0.251 FV +1 +0.25 $70.30
92
Management
Acceleration Investments
Rate acceleration projects are a special type or incremental cash

flow stream that deserves special attention.
These include Such activities as infill drilling, field compression

of natural gas, well workovers or repairs, facility
debottlenecking, etc., which do not recover additional oil or gas,
but merely produce it more quickly.
However, a savings in direct operating costs may be realized if

the producing life is shortened.
Management
ACCELERATION PROJECT
250
Base Case
200
NET PRESENT VALUE
150
100
ACCELRATION CASE
50 DIFFERENTIAL (ACC.-BASE)
-50
-100
0 5 10 15 20 25 30 35 40
DISCOUNT RATE - PERCENT

Management
Acceleration Investments
CONCLUSION :
Since additional money is spent for acceleration than would be
required to recover the same volume of hydrocarbons, there is
no undiscounted payout for the additional expenditure.
However, because the additional expenditure accelerates future
income, the venture should exhibit a greater net present value.
This is the justification for making the added expenditure.

Management
Waterflood planning in an economic perspective
N oil oil
NPV (t) = ∑ PRICE (t) x Rate (t) – CAPEX (t) – OPEX (t) – TAX (t)
t=1 (1+r)t
TIMING ?
WATER INJECTION RATE
WATER INJECTION RATE

A A
A
B B
OIL RATE
C C B
PRIMRY
C
WF PRIMRY WF PRIMRY WF
TIME TIME TIME
Management
CONCLUSION :
Economic yardsticks and present value are used for economic
optimization through the following :-
• Reduce capital expenditures

• Reduce operating costs
• Reduce indirect costs (overhead)
• Delay expenditures
• Increase income (production rate)
• Improve value of product
• Accelerate income
Management
Risk And Uncertainties
The nature of economic evaluation entails risk taking

and uncertainties involving technical, economic, and
political conditions.
The results of the analysis are subjected to many

restrictive assumptions in forecasting recoveries, oil
and gas prices,
investment, operating costs, and inflation rate.
Management
Risk And Uncertainties (cont’d)
Types of risk
TECHNICAL ECONOMIC POLITICAL

Dry holes Inflation Governmental policy
Geological Oil and gas prices Government regulations
Engineering Gambler's ruin Laws
Storm damage Interest rates Nationalization
Earthquake Environmental Environmental
Timing Timing Timing
Exchange rate Exchange rate
Financing / capital Financing / capital
Supply / demand Taxation
Operating costs Export / import
Personnel
Management
When evaluating exploration and production ventures

there are three types of uncertainty which are
most significant. These are;
• uncertainty of occurrence,
• uncertainty of magnitude and
• uncertainty of rate of production.

Management
HOW TO DEAL WITH ?

There are four fundamental approaches to coping with risk
and uncertainty :-
• Diversification,
• Reduction of exposure,
• Avoidance, and
• Insurance.
Management
EFFECTS OF TIMING RISK
3.500
OIL PRODUCTION -
3.000
BARRELS/DAY
2.500
2.000
PREDICTED
1.500 DATE FIRST
INJECTION ACTUAL DATE
1.000 FRIET INJECTION
500
0
0 1 2 3 4 5 6 7 8 9 10
REFERENCE: WILSON & PEARSON, JPT YEARS

Management
DCFROI Sensitivity Analysis NPV Sensitivity Analysis
Net present Value. MM$
DCFROL,% 300
100
250
80
200
60
150
40
100
20 50
0 0
-30 -20 -10 00 +10 +20 +30 -30 -20 -10 00 +10 +20 +30
Percent of Base Projection Percent of Base Projection
-- Oil Production -- Oil Production
-- Operating Costs -- Operating Costs
-- oil Price -- oil Price
The analysis shows that DCFROI and PWNP are affected more drastically
by both oil price and oil production than the operating costs.
Management
Reserves Sensitivity Analysis

- From a monetary perspective, reserves are not
very important.?
• First, additional reserves come late in the

life of a project,
• The values late in the life of the project are highly

discounted and do not add much value.
Management
Reserves Sensitivity Analysis

- Reserves do not have a unique value. ?
• A moderate productivity well with large reserve in a

remote high operating cost areas may not be all that
valuable
• A moderate reserve with high productivity caused by a

strong water drive and adjacent to low cost water
disposal facilities in well-established area may be
worth a lot.
Reserves are not a good indication of value.

Management
Apply Risk Evaluation Methods
Sensitivity Analysis (Conti)
TORNADO DIAGRAM
NET PRESENT VALUE -$MM
-50 0 50 100 150

PARAMETER (EV)
NOC SHARE (80%) EXPECTED VALUE -$19.9MM
HURDLE RATE (15%) 90% 50%
EXP.ULT.REC. (58.2 MMB) 25% 10%
OIL PRICE ($24/Bbl) 29.3 MMB 87.8 MMB
TAXES (0%) $ 20/Bbl $ 30/Bbl
FROB. SUCCESS (50%) 50% 0%

DEVELOPMENT COSTS 30% 70%
EXPLORATION COSTS +25% +25%
VARIABLE OP. COSTS +50% -50%
EXPLORATION PERIOD +40% -40%
FIXED OP. COSTS 3 yrs. 2 yrs.
+40% -40%
DOUBLE TRIANGULAR DISTRIBUTION
Management
Sensitivity Analysis
• Select one risk element and measure the range of equally
likely values.
• Apply the range of values, with appropriately selected
intervals, to the part of the evaluation which is sensitive to that
element; i.e., how is OOIP affected by changing  from 18% to
30% at 1% intervals.
• Combine compatible risk elements to determine if the
elements offset or enhance each other.
• Determine a range of outcomes and analyze statistically to
determine the most likely outcome and range of probabilities.
Management
Monte Carlo Analysis

This method essentially combines the sensitivity analysis
approach with a system of randomly selecting the values to be
used. The method is most effective in analyzing the interrelation
of a large number of variable factors. The outcomes can be
statistically analyzed for assignment of probabilities.
Management
10% Interest Rate 20% Interest Rate 30% Interest Rate
Present Present Present
Cash Flow Worth Worth Worth
Year ($) Factor ($) Factor ($) Factor ($)
0 [100,000] 1.000 [100,000] 1.000 [100,000] 1.000 [100,000]
1 81,934 0.909 74,478 0.833 68,251 0.769 63,007
2 32,106 0.826 76,250 0.694 22,282 0.592 19,007
3 14,848 0.751 11,151 0.569 8,597 0.455 6,756
4 7,452 0.683 5,090 0.482 3,592 0.350 2,608
Total 36,340 17,239 2,722 [8,622 ]
Following is a tabulation of interest rate versus total present worth

calculated from Example 7 and in the above table.
Interest Rate - % Present Worth - $

0 36,340
6 24,212
10 17,239
20 2,722
30 [8,622]
Management
10% Interest Rate 20% Interest Rate

Cash Flow Present Worth Present Worth
$ $ $
Year Factor Factor
0 [175,000] 1.000 [175,000] 1.000 [175,000]
1 140,520 0.909 127,487 0.833 116,828
2 59,470 0.826 49,122 0.694 41,272
3 20,010 0.751 15,028 11,586
Total 45,000 16,639 [5,314]

Management
Comparative Present Value Profiles
50
40
Drill Two Wells

Present Worth M$
30
20
Drill One Well

10
-10
0 5 10 15 20 25 30
Interest Rate – Per Cent

Management
In brief
Function is to determine how to produce most oil and/or gas reserves in the
most efficient manner and at least cost to optimize the economic return.
Production Rate
Optimize both
Ultimate Recovery
Since there is little or no control over oil price, minimize production cost
and investment is needed.
The decision should consider :-
- The economic costs ( new capital investment ),
- And benefits ( increase in oil rate or reserves ).
The relation between benefits and cost can be measured in various
ways (Undiscounted net profit, net present value, rate of return, , etc)
Management
DIVERSIFICATION :
Participating in the drilling of ten wells instead of putting all
of one's resources in a single prospect
REDUCTION OF EXPOSURE,
Taking a lesser interest in a greater number of venture.
AVOIDANCE
If the risk is so great , it may be better to avoid the
undertaking completely.
INSURANCE.
It does not reduce risk, but distributes it over time and shares
it with others in the same insurance pool.
Management
MONTE CARLO ANALYSIS
This method essentially combines the sensitivity analysis

approach with a system of randomly selecting the values to
be used. The method is most effective in analyzing the
interrelation of a large number of variable factors. The
outcomes can be statistically analyzed for assignment of
probabilities.
Management
Define the Risk
ECONOMIC RISKS:
• Price projection depends on gravity of oil and composition

• Operating costs projection depends on gravity and
composition, depth, number of wells, etc.)
• Royalty and production taxes.
• Required investment.
• Cost of capital
• Income tax treatment.
Management
Define the Risk
GEOLOGIC RISKS :
• Does the zone exist?

• Field size?
• Sufficient recoverable hydrocarbons?
Management
Define the Risk
PERFORMANCE RISK :
• Réservoir properties (Sw, , K, µ, etc.)
• Zone thickness
• Areal extent
• Drive mechanism (effects on Rf ).
• Decline rate
• Depth
• Production method needed
• Well spacing required
• Stimulation needed?

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Petroleum Economic and

Cash flow (periodic recording of Income and Expenditures)

CUM. NET CASH FLOW

CUMULATIVE NET CASH FLOW

This process involves answering three critical questions:

• What will it cost ?

The time value of money must be considered when

All companies have established various economic measures

No single Yardstick matches the gaols of every organization.

It will be necessary for each organization to select the one or

CUMMULATIVE CASH FLOW

The shorter the payout the PAYOUT

A common rule of thumb is 2-4

Return on investment (ROI)

The higher the ROI the better.

ROI is independent of time which limiting its usefulness as

Profit to investment Ratio (PIR)

Cumulative Income - Total Investment

PIR = ROI – 1.0

It is another form for expressing the same Yardstick.

200 Payout = 2 Years Directly

Present Worth Net Profit (PWNP)

The present value of the Present worth

i.e how much a certain 50

0.70 Discount Rate

Discounted Cash Flow Return On Investment (DCFROI)

i.e PWNP = zero

The value of this parameter in the range of 0.5 to

The “hurdle rate" discount factor, more properly referred

The hurdle rate used is normally intended as the return

1. the acquisition cost of capital,

20 INTERNAL RATE OF RETURN

DISCOUNT RATE - PERCENT

Set Economic PAYOUT

Today, economic analyses are being applied throughout the

Intermediate (WTI) 40° $ 65

North Sea Brent 38° $ 60

Suez Blend 32°

WTRG Economics - 2006

Jan 4, 2005 -Jan 24, 2006

Cash flow for typical Exploration and Production venture can

Net Net Net

Net = Gross Revenue Royalty

Investment intended to acquire or Improve properties or

Direct operating Expenses

Direct Operating Expense

Fixed Variable periodic

Fixed Cost are independent of the production rate

Indirect Expense (overhead)

All costs which may be incurred at a distant location for a

These include a prorated portion of supervisory and

The specific method of allocating these expenses is

Indirect Expense (overhead)

INDIRECT OPERATING COST (OVERHEAD) FORECAST

Overhead can be estimated as a fraction of capital

A recent study determined that the appropriate fractions

INDIRECT OPERATING COST (OVERHEAD)

Wellhead Severance valorm

Cash flow Diagram is simply a graphical sketch

Cash flow Diagrams

Revenue and Cumulative

pipeline Gross Gross Gross Total Net

Annual Annual WI WI Share WI Share WI Share WI Share