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

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

16000
CO2 Injection Started
12000
With 10-Ac. Infills

40-Ac. Spacing Waterflood peak
8000
4000
Without infills
1972 1974 1976 1978 1980 1982 1984 1986 1988 1990 1992
1970

Introduction (contd)
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.

E & P INVESTMENT CYCLE
EXPLORATION PRODUCTION
ANNUAL INCOME AND EXPENDITURES
CUM. NET CASH FLOW PROFIT REVENUE
EXPENSES
+
NET INCOME PV CUM. NET CASH FLOW PV PROFIT
ABANDONMENT COST EC.LIMIT
-10 -5
INVESTMENTS
45
10
15
20
25
30
35
40
YEARS
CUMULATIVE NET CASH FLOW

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.

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.

Economic Yardsticks (contd)
Payout
PROFIT CUMMULATIVE CASH FLOW
The time required for the cumulative cash flow to reach zero.
The shorter the payout the more attractive the project.

A common rule of thumb is 2-4 Years.
PAYOUT 0
10
15
20
25
30
TIME - YEARS

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.

Profit to investment Ratio (PIR)
PIR =
Cumulative Income - Total Investment Total Investment
PIR = ROI 1.0

It is another form for expressing the same Yardstick.

200 CUMULATIVE CASH ($ 1,000) 150
Payout = 2 Years Directly from Graph

payout 2 Years
100
50 0 - 50
Total Profit $ 180.000
ROI ROI
= =
$ 180,000 $ 60,000
3.0
Investment $60.000
PIR =
180,000 60,000
60,000
10 12 14 16
PIR
2.0
TIME - YEARS

Present Worth Net Profit (PWNP)

The present value of the entire cash flow, discounted at a specified discount rate.
Present worth M$ 200 150 100 PW10
Present Worth Profile
i.e how much a certain amount of future income is worth today.
50
PI
0
-50 0 10 20 30 40 50

1.00
PRESENT WORTH COMPARISONS
0.90
0.80
Present Value
0.70 0.60 0.50
Discount Rate
5%
0.40
0.30 0.20 0.10 0.00 0 5 10
10 %
15 % 20 %
15
YEARS
20
25
30

PROFIT
CUMULATIVE CASH FLOW
PV PROFIT PAYOUT
PV PAYOUT
0 5 10 15 20 25 30
TIME - YEARS

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.

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. 2. 3. 4. the acquisition cost of capital, suitable return on the investment involved a compensation for Corporate risk, and inflation.

80 70 60
NET PRESENT VALUE
50 40
A B
C
HURDLE RATE 10% 15%
30
20 10 0 -10
INTERNAL RATE OF RETURN 27% 22%

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

Economic Analysis Process
Set Economic Objective Formulate Scenario Collect Data Make Economic Analysis Make Risk Analysis Choose Optimum Operation PAYOUT PWI DCFROI PWNP Production Investments Operating Expenses Oil/Gas Price

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.

Economic Data
Data
Oil and gas production Rates vs. time Oil and gas prices Capital investment (tangible, intangible) and operating costs Royalty/production sharing Discount and inflation rates State and local taxes (production, severance, ad valorem, etc.) Federal income taxes, depletion and amortization schedules
Source/Comment
Reservoir and production engineers Unique to each project Finance and economic professionals Strategic planning interpretation Facilities, operations and engineering professionals Unique to each project Unique to each project Finance and economics professionals Strategic planning interpretation Accountants Accountants

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.
West Texas
Intermediate (WTI) 40
$ / Barrel Crude Oil Spot North Sea Brent
$ 70 $ 65 $ 60 $ 55 $ 50 $ 45 $ 40
$ 66.15
North Sea Brent 38 Suez Blend 32
WTRG Economics - 2006 www.wtrg.com (479) 293- 4081
$ 35
1/3/05 3/4/05 5/5/05 7/6/05
6/6/05
9/2/05
11/3/05
1/5/06
2/2/05
4/6/05
8/4/05
10/4/05
12/5/05
Jan 4, 2005 -Jan 24, 2006

Economic Data
AVERAGE WORLD CRUDE OIL PRICES
50 45 40 35
$/BARREL
30 25 20 15 10 5 0 1850 1870 1890 1910 1930 1950 1970 1990 2010

NOMINAL OIL PRICE REAL OIL PRICE 2002$

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 Cash Flow (NCF BT)
Net Annual Revenue
Net Annual Expenditure

Cash Flow Model (contd)
Net = Gross Revenue Annual Revenue
Royalty
Where :Gross Revenue Royalty = Produce volume of HC x Price . = Fraction x Cross Revenue .

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 .

Direct operating Expenses Operating Expense (cost of production)
Indirect Expenses (overhead)
Operating Taxses

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.

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

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

Cash Flow Model (contd) 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.

Cash Flow Model (contd) INDIRECT OPERATING COST (OVERHEAD)
DUE TO CAPITAL YEAR 1 2 3 4 INVESTMENT $1,250,000 DIRECT OP. COST $100,000 $100,000 $100,000 $100,000 CAPITAL )%9( $112,500 DUE TO DOC )11%( $11,000 $11,000 $11,000 $11,000 TOTAL $123,500 $11,000 $11,000 $11,000
5
6 7 8 9 10
$100,000
$100,000 $100,000 $100,000 $100,000 $100,000
$11,000
$11,000 $11,000 $11,000 $11,000 $11,000
$11,000
$11,000 $11,000 $11,000 $11,000 $11,000
TOTAL
$1,250,000
$1.000,000
$112,500
$110,000
$222.500

Operating Taxes valorm
Wellhead
Severance

Cash flow Diagrams
Cash flow Diagram is simply a graphical sketch representing the timing and direction of montary transfers
$ CASH IN $ CASH OUT
Time

Cash flow Diagrams
$ CASH IN
Time
$ CASH OUT

Oil B/D
40 30 20 10 0
15 10
Revenue and Rate Expenditure Rate MB/Yr. M$/Yr.

40 30
Cumulative M$
200
Revenue Operating Costs
150 100 50 0
20
10 0 -10 -20 -30 -40 -50 -60
Cumulative Cash Flow
Investment
-50 0 2 4 6 8 10 12 14 16

Major Assumptions
Decreasing orders of importance
1.Price Forecast 2.Production Forecast 3.Royalties 4.Operating Costs and Future Capital Required 5.Taxes 6.Reserves The above order is general.

Petroleum industry cash flow spreadsheets
Spreadsheet Format #2
Forecast of Natural Gas Production, By-Products and Net Revenue (Before income Taxes).
(1) (2) Gross pipeline Gas Year Investment Sales ($) Gas Price Gross Gas Gross Gross Total Gross Net Operating Expense Cash cum. (3) (4) (5) (6) (7) (8) (9) (10) (11) (12) (13) (14) (15)
Liquids Liquids Liquids Price
Revenue Prod. ($) (bbl)
Revenue Revenue Royalty Wells Plant Compr. Flow NCF ($) ($) ($) ($) ($) ($) ($) ($)
(MMCF) ($/MCF)
($/bbl)
Column
(5) = (3)* (4) (8) = (6)*(7) (9) = (5)+ (8) (10) = (9)*(Royalty Fraction) (14) = (9)-(10)-(11)-(12)-(13)-(2)

Petroleum industry cash flow spreadsheets
Spreadsheet Format #1
(1) (2) (3) Total Annual WI Share Gross Oil (4)
Forecast of Oil Production and Net Revenue (Before income Taxes).

(5) Total Annual Gross Revenue ($) WI Share WI WI Share WI Share WI Share WI Share Net Operating Net cum. Net (6) (7) (8) (9) (10) (11)
Year Investment prod. Price ($) (bbls) ($/bbl)
Revenue Royalty Revenue Expenses Cash Flow Cash Flow ($) = = = = = = = ($) ($) ($) ($) ($)
Column:
(2) (5) (6) (7) (8) (9) (10) (Total investment)* W.I. (3)* (4) (5)*WI. (6)* (Royalty Fraction) (6) - (7) (Total Op. Exp.)* W.I. (8) - (9)-(2)

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.

Economic Analysis Example
(I) Oil Prod (2) Oil Price (3) Revenue ($MM) (2) x (1) 0.00 0.00 110.11 201.58 110.48 41.98 20.41 23.69 (4 ) Gas Prod. (5) Gas Price (6) Gas Revenue ($MM) (4) x (5) 100 0.00 0.00 4.91 17.90 19.81 8.77 4.45 3.05 (7) Total Revenue ($MM) (3) + (6) 0.00 0.00 115.02 219048 130.80 50.75 24.86 26.73
Year 1992 1993 1994 1995 1996 1997 1998 1999
(MSTB) 0 0 5505.3 10079.1 5524.2 2098.8 lO20.6 1184.4
($/STB) 20.00 20.00 20.00 20.00 20.00 20.00 20.00 20.00
(MMSCF) 0 0 3276 11934 13208.4 5848.2 2968.2 2081.S
($/MSCF) 1.50 1.50 1.50 1.50 1.50 1.50 1.50 1.50
2000
2001 2002 2003 2004 2005 Total
2211.3
2653.2 1976.4 972 619.2 257.4 84101.9
20.00
20.00 20.00 20.00 20.00 20.00
44.28
53.06 39.53 19.44 12.88 5.15 682.04
2178.9
8468.6 4762.8 3364.2 220.3 1087.2 56848.1
1.50
l.50 L50 1.50 1.50 1.50
3.27
5.20 7.14 5.05 3.33 1.63 84.52
47.79
58.27 46.67 24.49 15.71 6.78 766.56

Economic Analysis Example
(8) Capital Cost (9) Operating Cost (10) Prod. Tax (11 ) Total Cost ($MM) (8)+(9)+(10) 5.715 64.680 159.304 36.512 22.952 14.997 12.408 12.595 14.671 15.749 14.589 (12) Undiscounted Cash Flow ($MM) (7)-(11) -5.715 -64.680 -44.284 182.971 107.345 35.751 12.456 14.139 32.823 42.518 32.083 (13) Discount Factor (14) Discounted Cash Flow @12%, $MM -5.400 -54.569 -33.358 123.060 64.462 19.169 5.963 6.044 12.526 14.488 9.761 (20) Discounted Cash Flow @64.23%, $MM -4.460 -30.732 -12.812 32.233 11.515 2.335 0.495 0.342 0.484 0.382 0.175
Year
1992 1993 1994 1995 1996 1997 1998 1999 2000 2001 2002
($MM)
5.715 64.680 143.977 4.205 0.000 0.000 0.000 0.000 0.000 0.000 0.000
($MM)
0.000 0.000 3.825 10.359 9.922 9.922 9.922 9.922 9.922 9.922 9.922
($MM)
0.000 0.000 11.502 21.948 13.030 5.075 2.486 2.673 4.749 5.827 4.667
@12%
0.9449 0.8437 0.7533 0.6726 0.6005 0.5362 0.4787 0.4274 0.3816 0.3407 0.3042
2003
2004 2005 Total
0.000
0.000 6.364 224.941
9.922
9.922 8.332 111.814
2.449
1.571 0.678 76.656
12.371
11.493 15.374 413.41
12.116
4.221 -8.595 353.149
0.2716
0.2425 0.2165
3.291
1.024 -1.861 164.599
0.040
0.009 -0.011 -0.004

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

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

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

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.

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).

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.

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.

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 future
abandonment
past

ADJUSTMENT OF NET CASH FLOW FOR TIME ZERO RESET ($ millions)
NCF Year Venture Year 1 2 3 4 5 Time Zero 1 2 3 4 5 6 7 8 9 10 11 12 13 14 15 6 7 8 9 10 11 12 13 14 15 16 17 18 19 20 -10 -5 +5 +10 +20 +35 +25 +20 +15 +8 +6 +5 +4 +3 +1 92 (1) (2) (3) (4) (5) (6) (7) (8) (9) (10) (11) (12) (13) (14) (15) 0.953 FV 0.867 FV 0.788 FV 0.716 FV 0.651 FV 0.592 FV 0.538 FV 0.489 FV 0.445 FV 0.404 FV 0.368 FV 0.334 FV 0.304 FV 0.276 FV 0.251 FV Annual NCF -10 -10 -10 -10 -10 (5) (4) (3) (2) (1) Effective 10% Factor* 1.536 FV 1.396 FV 1.269 FV 1.154FV 1.049 FV Adj. Past NCF -15.36 -13.96 -12.69 -11.54 -10.49 -64.03 -10 -5 +5 +10 +20 +35 +25 +20 +15 +8 +6 +5 +4 +3 +1 -64.03 -9.53 -4.33 +3.94 +7.16 +13.03 +20.72 +13.46 +9.79 +6.67 +3.24 +2.21 +1.67 +1.21 +0.83 +0.25 = -64.03 Adj. NCF PV NCF
NPV10(FULL Life) +$6.27 NPV10(Forward from time zero) $70.30

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.

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

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.

Waterflood planning in an economic perspective
NPV (t) =
t=1
oil oil PRICE (t) x Rate (t) CAPEX (t) OPEX (t) TAX (t) (1+r)t
TIMING ?
WATER INJECTION RATE
A
OIL RATE
A B C
WATER INJECTION RATE
B C
PRIMRY
A B C
PRIMRY
WF
TIME
PRIMRY
WF
TIME
WF
TIME

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

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.

Risk And Uncertainties (contd)
Types of risk
TECHNICAL
Dry holes Geological Engineering Storm damage Earthquake Timing
ECONOMIC
Inflation Oil and gas prices Gambler's ruin Interest rates Environmental Timing Exchange rate Financing / capital Supply / demand Operating costs
POLITICAL
Governmental policy Government regulations Laws Nationalization Environmental Timing Exchange rate Financing / capital Taxation Export / import Personnel

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.

HOW TO DEAL WITH
There are four fundamental approaches to coping with risk and uncertainty :-
Diversification, Reduction of exposure, Avoidance, and Insurance.

EFFECTS OF TIMING RISK OIL PRODUCTION BARRELS/DAY
3.500 3.000 2.500
2.000
1.500 1.000 500
PREDICTED DATE FIRST INJECTION
ACTUAL DATE FRIET INJECTION
10
REFERENCE: WILSON & PEARSON, JPT
YEARS

DCFROI Sensitivity Analysis
100 80 60 150 40 100 20 0 -30 50 -20 -10
DCFROL,%
NPV Sensitivity Analysis

300 250 200
Net present Value. MM$
00
+10 +20 +30
0 -30
-20
-10
00
+10 +20 +30
Percent of Base Projection -- Oil Production -- Operating Costs -- oil Price
Percent of Base Projection -- Oil Production -- Operating Costs -- oil Price
The analysis shows that DCFROI and PWNP are affected more drastically by both oil price and oil production than the operating costs.

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.

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.

Apply Risk Evaluation Methods
Sensitivity Analysis (Conti) TORNADO DIAGRAM
NET PRESENT VALUE -$MM -50 0 50 100 150
PARAMETER (EV)
NOC SHARE (80%) HURDLE RATE (15%) EXP.ULT.REC. (58.2 MMB) OIL PRICE ($24/Bbl) TAXES (0%) FROB. SUCCESS (50%) DEVELOPMENT COSTS EXPLORATION COSTS VARIABLE OP. COSTS EXPLORATION PERIOD FIXED OP. COSTS DOUBLE TRIANGULAR DISTRIBUTION
EXPECTED VALUE -$19.9MM

90% 25% 29.3 MMB $ 20/Bbl 50% 30% +25% +50% +40% 3 yrs. 10% 87.8 MMB $ 30/Bbl
50%
0%
70% +25% -50% -40% 2 yrs.
+40% -40%

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.

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.

Cash Flow Year ($) 10% Interest Rate Present Worth Factor ($) 20% Interest Rate Present Worth Factor ($) 30% Interest Rate Present Worth Factor ($)
0 1 2
[100,000] 81,934 32,106
1.000 0.909 0.826
[100,000] 74,478 76,250
1.000 0.833 0.694
[100,000] 68,251 22,282
1.000 0.769 0.592
[100,000] 63,007 19,007
3
4
14,848
7,452
0.751
0.683
11,151
5,090
0.569
0.482
8,597
3,592
0.455
0.350
6,756
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 - %
0 6 10 20 30
Present Worth - $
36,340 24,212 17,239 2,722 [8,622]

10% Interest Rate 20% Interest Rate Present Worth Present Worth $ $ Factor Factor
1.000 0.909 0.826 0.751 [175,000] 127,487 49,122 15,028 1.000 0.833 0.694 [175,000] 116,828 41,272 11,586
Year
0 1 2 3
Cash Flow $
[175,000] 140,520 59,470 20,010
Total
45,000
16,639
[5,314]

Comparative Present Value Profiles
50 40
Present Worth M$
30
Drill Two Wells
20
10
Drill One Well
0 -10
10
15
20
25
30
Interest Rate Per Cent

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.
Optimize both
Production Rate 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)

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.

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.

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.

Define the Risk
GEOLOGIC RISKS :
Does the zone exist?
Field size?
Sufficient recoverable hydrocarbons?

Define the Risk
PERFORMANCE RISK :
Rservoir properties (Sw, , K, , etc.) Zone thickness Areal extent Drive mechanism (effects on Rf ). Decline rate Depth Production method needed
Well spacing required

Stimulation needed?

Course Petroleum Economic and Management

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Course Petroleum Economic and Management

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Petroleum Economic and Management

Petroleum Economic and Management

With 20-Ac. Infills

CO2 Injection Started

With 10-Ac. Infills

Petroleum Economic and Management

Income Expenditures Time

Evaluating investments. Choosing among alternatives.

Petroleum Economic and Management

ANNUAL INCOME AND EXPENDITURES

CUM. NET CASH FLOW PROFIT REVENUE

ABANDONMENT COST EC.LIMIT

CUMULATIVE NET CASH FLOW

Petroleum Economic and Management

What will it cost ?

Petroleum Economic and Management

No single Yardstick matches the gaols of every organization.

Petroleum Economic and Management

The shorter the payout the more attractive the project.

Petroleum Economic and Management

Return on investment (ROI)

Cumulative Income ROI = Total Investment

Petroleum Economic and Management

Profit to investment Ratio (PIR)

Cumulative Income - Total Investment Total Investment

PIR = ROI 1.0

Petroleum Economic and Management

Payout = 2 Years Directly from Graph

Total Profit $ 180.000

Petroleum Economic and Management

Present Worth Net Profit (PWNP)

Present Worth Profile

i.e how much a certain amount of future income is worth today.

Petroleum Economic and Management

PRESENT WORTH COMPARISONS

0.70 0.60 0.50

Petroleum Economic and Management

Petroleum Economic and Management

i.e PWNP = zero

The total discounted cash flow The total discounted investment

Petroleum Economic and Management

Petroleum Economic and Management

NET PRESENT VALUE

HURDLE RATE 10% 15%

INTERNAL RATE OF RETURN 27% 22%

DISCOUNT RATE - PERCENT

Petroleum Economic and Management

Petroleum Economic and Management

Petroleum Economic and Management

Petroleum Economic and Management

North Sea Brent 38 Suez Blend 32

WTRG Economics - 2006 www.wtrg.com (479) 293- 4081

Jan 4, 2005 -Jan 24, 2006

Petroleum Economic and Management

30 25 20 15 10 5 0 1850 1870 1890 1910 1930 1950 1970 1990 2010

Petroleum Economic and Management

Net Cash Flow (NCF BT)

Net Annual Revenue

Net Annual Expenditure

Petroleum Economic and Management

Net = Gross Revenue Annual Revenue

Petroleum Economic and Management

Capital Expenditure Net Annual Expenditure

Petroleum Economic and Management