Transcript
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PETROLEUM
ECONOMICS
Sunday Isehunwa (Ph. D)
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SPECIAL FEATURES OF
MINERAL ECONOMICS
Minerals are found only in certain favouredplaces. There is no question of locating a mine
anywhere else except where it is found incommercial quantities.
The minerals are exhaustible
The minerals are found in places where they maynot be needed and used.
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SPECIAL FEATURES OF
MINERAL ECONOMICS
There is always a very large excess capacity
built into the system. Therefore the normal
laws of supply and demand, marginal costs,
etc are not often readily applicable in the
case of minerals.
Very long term forecasts have to be made
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SPECIAL FEATURES OF
MINERAL ECONOMICS
Mineral economics is bound up with politics very
intimately.
Mineral industries are extremely well organized in
the hands of a small number of integrated firms
who have considerable power in regulating
supply, demand and prices. Thus normal
economic mechanisms are simply not operative
under these conditions in their classical forms.
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ECONOMIC CHALLENGES
Petroleum getting more difficult to find
Smaller fields
Aging facilities and staff Harsher terrains of discovery
Environmental challenge
Unstable prices
Community issues (in developing countries) Technology and higher business costs
Depleting reserves
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ECONOMIC CHALLENGES
Companies have tried to meet thesechallenges through:
Cost reduction measures Staff rationalization
Vertical integration
Strategic business units
Portfolio diversification
Other measures
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OIL AND GAS PRICES
There are 5 factors that determine the price of
crude oil:
Market (Supply and Demand)
Reliability (Production rate)
Location (Transportation) Quality (Refining cost and Yield)
Availability (Reserves)
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Oil Pricing Model
Oil Price /bbl
= Base Price/bbl + A (API) - B (% S)
Base price = current price for 0 API oil
A= Scale factor for API gravity B = Markdown Factor for presence of sulphur
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Marker Crudes
A marker crude is an oil from a specified
field or region which is traded in spot
markets and considered a standard
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Characteristics of Marker Crudes
Perceived to represent fair value
Traded in liquid and transparent markets
Wide range of buyers and sellers Supply is freely tradable
Adequate reserves
Production is strategically situated
Politically acceptable to producers and end users Spot price is widely reported
Reasonably immune to manipulation
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CRUDE OIL MARKETS
There are 2 basic types of markets in crude oil:
The Wet or cash Market, and
Futures market where trades are made through aformal commodities exchange for some specified
future delivery date.
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CRUDE OIL MARKETS
The bulk of the worlds crude oil traded
internationally never reaches an open market in
the literal sense.
They are handled within the integrated operations
of the majors and in direct deals or contarctarrangements between producers and consuming
governments as well as other players.
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THE SPOT MARKET
Little happens in the industry without the Spot
Market, particularly the Rotterdam spot market.
The spot Market refers to one-off or spot sales of
crude oil in tanker loads. This is usually crude oil
that is surplus to the requirements of direct
purchasers. Companies that are short of crude also
resort to the spot market to make up the balance.
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THE SPOT MARKET
However, price movements in the spot market do
not necessarily reflect real market conditions as
can fluctuate widely and involve relatively smallamounts of crude oil on a global scale.
During surplus, spot prices tend to fall below
official prices, while they can rise steeply during
peiods of shortages.
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THE SPOT MARKET
Major Players
The major international oil companies
Traders
Brokers Independent oil companies
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NET BACK PRICING
In a netback transaction, crude oil is sold on
the basis of the price that the buyers expect
to receive for his final products, rather thanthe price set by the producer at the time of
sale.
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COMPONENTS OF NETBACK
DEALS
Refinery Yields
Products Prices
Timing
Transportation
Other fees and Profit Margin
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MAJOR INTERNATIONAL
PETROLEUM COMMODITY
MARKETS
NYMEX (New York Mercantile Exchange)
IPE (International Petroleum Exchange
London)
SIMEX (Singapore Mercantile Exchange)
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PETROLEUM PROJECT
ECONOMICS
In any decision making process, one must
account for the benefits and costs of a
project
In a typical project, the costs occur at the
beginning of the project and the benefitsoccur over a period of time.
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TASKS IN PETROLEUM PROJECT
ECONOMIC ANALYSIS
Setting an economic objective based oncorporate economic criteria
Formulate scenario for the projects Collecting all relevant Technical and
economic data
Making Economic calculations Making Risk Analysis
Selection of optimum development plan
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COST ESTIMATING AND
ECONOMIC EVALUATION
Predicting future operating costs
Economic limits of producing wells (or plants in
downstream projects)
Field life (or project life)
Failure Analysis
Price-effect cost escalation Risks
Funding
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TIME VALUE OF MONEY
Theory of Equivalence
When cash flows can be traded for one another ina financial world, those cash flows are consideredequivalent to each other.
Economic equivalence depends upon Interest rate
Time
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PROJECT ECONOMICS
When conducting a cost benefit analysis ofany project, if the benefits are received in
the future, we cannot directly compare thefront cost to the future benefits unless we:
Convert the future benefit to equivalentpresent benefit, or
Convert the present cost to equivalent futurecost
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ECONOMIC INDICATORS
They reduce net cash flow projection to single
numbers
Measures the relative economic attractiveness of
the cash flow
Tells us whether one investment gives a greater
economic benefit than other investments
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COMMON ECONOMIC
INDICATORS
Net present value (NPV)
Internal rate of return (IRR)
Pay back time (PB)
Discounted profit to investment ratio
(DPIR)
Unit technical cost (UTC)
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ECONOMIC INDICATORS
NPV
Consistently the most reliable and most frequentlyused in practice
Takes into account timing of future cash flow
Tells us how much an investment is better orworse than putting money into the bank or somealternative investment
Makes large projects more attractive than smallerones, no indication of investment efficiency.
Highly dependent on discount rate
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ECONOMIC INDICATORS
IRR
It is the after tax return equivalent to putting an
investment in an interest bearing account.
Frequently used as an initial screening device
Tends to favour high initial earnings projects over
long-lived projects Can produce multiple values, and ambiguous.
Could be difficult to calculate (trial and error)
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ECONOMIC INDICATORS
PAYBACK (PB)
Indicates length of investment exposure,
or break-down point of a project. Easy to calculate and understand
It ignores the timing or variations of cash
flow before payback Useful as an initial indicator of the merits of
a project
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ECONOMIC INDICATORS
DPIR
defined as the net cash flow of the project
per dollar of capital investment used as quick first look investment
criteria
excellent for ranking projects highly dependent on discount rate
measures investment efficiency
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ECONOMIC INDICATORS
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CASH FLOW ANALYSIS
Cash flow is defined as cash received and
the cash expanded over a defined period
of time.
Forecasts of cash flow are the foundation
of almost all economic analysis carried outfor investment decision-making.
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BASIC PRINCIPLES OF CASH
FLOW ANALYSIS
Basic principles of cash flow analysis that are vital tothe correct analysis of investment alternatives include:
Difference between cash flow and profit Treatment of depreciation
Way in which inflation can be incorporated
Concepts of nominal and real cash flow
Treatment of loans
Interest on loans
Loan repayments
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BASIC DEFINITIONS
Capital Costs
One-time costs usually incurred at the beginning of aproject. They are usually large expenditures incurred
several years before any revenue is obtained.
Examples
Tankers
Pipelines Construction
Process facilities Camps and Accommodations
Storage vessels
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BASIC DEFINITIONS
Operating Costs
Occurs regularly and are necessary to maintainoperations.
Usually expended in terms of expenditure per year or perunit production.
Examples
Field labour cost
Maintenance cost
Office overhead
It can be fixed periodic/annual amount or can be variable anddetermined as a function of production rate.
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Petroleum Fiscal Terms
Government Take
In many projects worldwide, government take is
over 50% of net pre-tax cash flow. It includes:
Royalties
Profit Sharing
Taxes
JV S vs PSC
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CASH FLOW ANALYSIS
Net Cash Flow
Net cash flow = cash received capital
expenditure operating expenditure
royalties, taxes, profit sharing.
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PROFIT
Accounting concept used in reporting company
accounts or in assessing tax liability.
Does not refer to total money flow but usuallyincorporates depreciation of capital costs.
Profit = cash received depreciated capex
opex royalties, taxes, profit sharing, etc
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CASH FLOW VS PROFIT
I1 2 3 4 5
Income ($mm)
- CAPEX ($mm)- OPEX ($mm)
0
100
0
40
10
40
10
40
10
40
10
= Net Cash flow ($mm) -100 30 30 30 30
Description Year 1 Year 2 Year 3 Year 4 Year 5
Income ($mm)- Depreciated CAPEX ($mm)
- OPEX ($mm)00
0
4025
10
4025
10
4025
10
4025
10
Profit 0 5 5 5 5
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CASH FLOW VS PROFIT
Conclusion
Net cash flow gives the forecasted actual moneyspent and received. It correctly represents the sizeand timing of cash flow.
Profit is an Artificial Construction
It is inappropriate for making investment decisions
because it does not represent actual money flow. Used for annual reporting to stockbrokers and
assessing tax liability.
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EXAMPLE ECONOMIC
CALCULATION
Capital Investment = $110,000
Net Operating Income:
Year Income
1 $40,0002 $40,000
3 $40,000
4 $40,000
5 $40,0006 $30,000
7 $20,000
8 $10,000
9 $4,000
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EXAMPLE ECONOMIC
CALCULATION
Net Cash Recovery = Ix - P
= $264,000 - $110,000
= $154,000
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EXAMPLE ECONOMIC
CALCULATION
Payback Time = P/ Ix/N
= 110,000/ 264,000/9
= 3.75 Years
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EXAMPLE ECONOMIC
CALCULATION
Discounted Profit = NPV(I) NPV(P)
Assuming i=9%
1ST 5 Yrs: $200,000(Fc, 9%, 5 yrs)
=$162,400
6th Yr : $30,000* Fc (1 yr)* Fsp (5 yrs)
= $30000* 0.958*0.6
= $18,281
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EXAMPLE ECONOMIC
CALCULATION
7th Yr : $20000* 0.958*0.596
= $11,419.36
8th Yr : $10000* 0.958*0.547
= $5240.26
9th Yr : $4000* 0.958*0.502
= $1923.37
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EXAMPLE ECONOMIC
CALCULATION
NPV (I) = $199,664.29 (@9 %)
Discounted Profit = $199664.29-110000
= 89,664.29 (@ 9%)
NPV(I) @ 25% = 136,595.4 Profit =$26595.4NPV(I) @40% = 104833.2 Profit = -$5166.77
IRR = 37%
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ECONOMIC EVALUATION
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PROJECT RISK MANAGEMENT
Why is Project Risk Management Important?
Dilemma of a project manager:
Project costs are uncertain
Schedules are uncertain
Scope of work is often uncertain External factors are uncertain
But the project manager must never be uncertain.
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RISK AND UNCERTAINTY
Derivation of cash flow and the measurement ofeconomic worth are based on the assumption thatinvestments are risk-free.
Assessment of risk and uncertainty is important todecision making
Analysis allows one to select the appropriatediscount rates which account for risk anduncertainty.
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DEFINITION OF RISK
RiskThe probability that a certain undesirable outcome will occur
Uncertainty
The range of values within which the actual value isexpected to fall
Contingency
Provision for variations to the basis of a plan or costestimate which are likely to occur and which cannot bespecifically identified at the time the plan or estimate wasprepared.
It provides an equal chance of over run or under run.
ELEMENTS OF PROJECT RISK
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ELEMENTS OF PROJECT RISK
MANAGEMENT
Risk Identification
Risk Quantification
Risk Response Development
Risk Response Control
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PROJECT RISK MANAGEMENT
How is Project Risk Management undertaken?
Identifying risks and uncertainties
Calculating the cost of contingency Calculating the schedule contingency
Calculating the estimate accuracy
Calculating the sensitivity of cost, schedule, or profitabilityto specific risk factors
Identifying the elements of risk that contribute most tocurrent inconsistency
Defining a program to reduce and manage risk
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