BASIC PETROLEUM

ECONOMICS
Dr.Ir.Sudjati Rachmat,DEA

28

Learning Objectives
At the end of this lecture you
should be able to
Name the major yardsticks used to
measure economic benefit and to make
economic decisions
Calculate ROR, NPV, and payout, etc.

Economic Indicators
Measures that do not consider the
time value of money
Profit
Payout time
Cost to find, develop reserves

Economic Indicators
Measures that do consider the time
value of money
Net Present Value (NPV)
Rate of Return (ROR)

Profit is a Money Balance

Profit = Money in Money out = Net Cash Flow
Components of Money taken in ?

Components of Money going out

initial investments
capital expenses
operating costs
taxes

Annual Net Cash Flow

Annual Net Cash Flow for a given time period j

CFj =
With

R
R
E
I

=
=
=

- E

- I

revenues $
expenses $
investments $

Cash Flow
Cash is real money like dollars and
cents
Flows, positive and negative, take
place over time
The value of a petroleum property
or project is determined by the
amounts and timing of future cash
flows

Cash flow diagram

$
+
0
-

Time

What is Payout Time?

Payout = time elapsed from investment
to positive net cash flow
payout
can be used as criteria for
investing

Cumulative cash flow diagram

Not always increases +

Cum. $
0

Payback or Payout
time

Time

Cost of Finding and Developing

Reserves
$
$
$
$

of Drilling new wells

of Workovers
of Seismic and other data
Consultants

Time Value of Money

Time Value of Money

Save?, Invest->low risk

->high risk

Time Value of Money

X $ in 2001

Y $ in 2015

Time Value of Money

X $ in 2001

Y $ in 2015

Time Value of Money

X $ in 2001

Y $ in 2015

Definitions to determine
the Time Value of Money
P = a present amount of money - i.e.,
the value at present
F = a future amount of money - i.e., the
value at some future time (+ interest)
i = interest rate per time period (usually
yearly)
n = number of time periods

Compound Interest
Value at end of first interest period

F1 P iP P(1 i)
Value at end of second interest period

F2 F1 (1 i ) P(1 i )(1 i )
Value at end of nth interest period

Fn P(1 i)

Present & Future Value

Fn
P
n
(1 i)

P(1 i)

Fn

If i=7%? how much will

$10,000 be in 10 years?

What is Net Present

Value, NPV?

NPV(i)

jn

R E I / 1 i
j 1

k = 1 start of year
k = 0.5 mid year
k = 0 year end

jk

Rate of Return, ir
ROR are the roots (ir) of NPV
equation that make NPV= 0
j n

R
j 1

E j I j / 1i r

j k

Watch!!
j n

R E I / 1i
j1

j k

This function can be driven to zero if ROR is

infinite. But this solution has no economic
meaning.
Multiple realistic values of ir may satisfy the
equation. This occurs when the cumulative cash
flow changes sign (+ -) more than once.

Example
What is ROR (using mid year discounting)?
Find ir, that solves the equation:
j n

R E I / 1i
or,

j 1

j k

100,000 500,000 700,000 10,000

0
0.5
1.5
2.5
3.5
1 ir
1 ir
1 ir 1 ir
ir = 0.128

and the NPV is

Net Present Value, NPV, (using mid year discounting) :
j n

NPV R j E j I j / 1i

j k

j 1

100,000 500,000 700,000 10,000

NPV
0.5
1.5
2.5
3.5
1 i
1 i
1 i
1 i
= 15,688

Cumulative Net Cash Flow, M$

Example: Cumulative Cash Flow

Diagram - What is the payout time?
1000
750
500
250
0
-250
-500
-750
-1000
0

Time, year

Appraisal
A petroleum property can be appraised
on the basis of
a. fair market value
b. reserves
Fair market value is the price to be paid
that will yield a fair economic (e.g.
ROR, Payback period) return to the
buyer
Reserves are reported based on SPE
rules

PSC Contract Example

PSC Contract Example