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1| OMV Petrom S.A., Advanced Petroleum Economics

Advanced Petroleum
Economics ©

M. Dammerer-Kerbl
MSc. Petroleum Eng.
MSc. Business Eng.

Ploiesti, 2015
© B. Kneidinger
Content
Cash Flow Basics

Economic Decision Criteria

Sensitivities

Pre-Tax Cash Flow Example

Contract and Fiscal Regimes

Case Studies

3| OMV Petrom S.A., Advanced Petroleum Economics

Content
Cash Flow Basics

Economic Decision Criteria

Sensitivities

Pre-Tax Cash Flow Example

Contract and Fiscal Regimes

Case Studies

4| OMV Petrom S.A., Advanced Petroleum Economics

Cash Flow Basics
Definitions & Cash-flow Profile
Revenue / Volume / Price
Petroleum E&P Expenditure
Capital Expenditure (CAPEX)
Operational Expenditure (OPEX)

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Cash Flow Profile of an E&P project
Revenue
CAPEX
OPEX

Cash-Flow of an E&P-Project (entire life cycle view)

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Revenue / Volume / Price

Revenue = sold Volume x Price

Differentiation:
Produced Volume
Sold Volume

Income portions of cash flows are know http://www.bloomberg.com/quote/CO1:COM

2.10.2015
as “Revenue”
Gross revenue is Volume x unit price

7| OMV Petrom S.A., Advanced Petroleum Economics

Petroleum E&P Expenditure
Payment of cash or cash-equivalent for goods or services; can be classified as:
Capital Expenditure (CAPEX) and
Operating Expenditure (OPEX)

Definition of typical E&P expenditures

Finding Cost – CAPEX
Development Cost – CAPEX
Drilling costs, facility costs such as processing and production platforms
Production Cost – OPEX
Material, personnel, service costs

8| OMV Petrom S.A., Advanced Petroleum Economics

Content
Cash Flow Basics

Economic Decision Criteria

Sensitivities

Pre-Tax Cash Flow Example

Contract and Fiscal Regimes

Case Studies

9| OMV Petrom S.A., Advanced Petroleum Economics

Financial & Economic Analysis
Everything important to decision should be included in the analysis

Concerning the decision making process also qualitative factors have to be taken
under consideration (e.g. effects to the society)

Financial analysis of investment alternatives requires that all opportunities be

appraised on the same basis, and the time value of money be properly taken into
account

There is not only one single measure of profitability

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Economic Decision Criteria
Net Present Value (NPV)
Expected Monetary Value (EMV)
Minimum Economic Field Size
Internal Rate of Return (IRR)
Payback Period
Profitability Index

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Economic Decision Criteria

Accept / Reject

Ranking

Comparison

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Why Discounting?
Discounting of cash flow streams was introduced to answer the following
questions:

What to do if two or more cash flows need to be compared?

What should be measured if the cash flow streams are of different lengths
(life spans)?

What is the value today of money to be received several years from

today?

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Time Value of Money
Decision-making in investment analysis requires anticipated revenues & cost of
investment alternatives to be placed on equivalent bases

Counterpart of discounting: compounding

Relevant levers
discount rate
time
value

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Determining the Discount Rate
If operating on borrowed capital, the discount rate should at least exceed the
interest rate being paid for the loan

If capital comes from internally generated funds, short- and long-term debt,
and equity sources, then the discount rate should be based on a weighted
average cost of capital (WACC)

The discount rate should reflect the corporate growth objectives that
management has set

The rate used should be related to the average reinvestment rate possible for
the money flowing in

If future cash flows are expected to yield 10%, then at least 10% should be
used for discounting

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Net Present Value (NPV)
For analyses of project cash flows the most common method is Net Present
Value (NPV)

NPV = Total PV of future CF’s + Initial Investment (negative)

General:
NPV uses cash flows
NPV uses the cash flow pattern of the entire project
NPV discounts the periodically (yearly) cash flows properly (→discounted
cash flows)

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Net Present Value @ hurdle rate
The formula for NPV calculation is
where CF0 = Today’s cash flow
CFn = Project’s cash flow of period n
i = hurdle rate
n = Number of years elapsed

If NPV > 0, the project is accepted

(NPV represents present value cash worth in excess of realizing a rate of return
equal to i)
If NPV = 0, the project is marginal, i.e. neither adds or destroys value (the project
yields a rate of return equal to i)
If NPV < 0, the project is not profitable on a time-adjusted basis
The higher the NPV, the higher is the value added for the company
Accept / Reject

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Disadvantage of NPV
Independent of absolute size of cash flows

Project A Project B
NPV of revenues stream USD 1,600,000 USD 250,000
Minus investment USD – 1,500,000 USD – 150,000
NPV profit USD 100,000 USD 100,000
NPV relative to investment 6.25% 40%

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Net Present Value (NPV) – Example
Would you rather receive:
Option A: €10,000 as follows: €6,000 after 1 year and €4,000 after 2 years
or
Option B: €12,000 as follows: €2,000 after 1 year followed by another €2,000
annually during over the next 5 years?

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Net Present Value (NPV) – Example
Normally, when the discount rate (i) increases the NPV decreases.

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Internal Rate of Return (IRR)
Internal Rate of Return (IRR) is the discount rate for which the Net Present
Value equals 0
Excel formulae:
IRR () … English version
Effective rate of interest of the respectively bounded capital

If IRR ≥ the hurdle rate, the investment proposal shall be accepted.

If IRR < the hurdle rate, the investment proposal shall be rejected.

Accept / Reject

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Internal Rate of Return (IRR) – Example

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Expected Monetary Value (EMV)
Expected Monetary Value can be calculated by risk adjusting the NPV, e.g.
Geological risk for exploration projects
Technical risk for various alternative technical solutions
Expressed mathematically as the sum of the product of an event’s probability
of occurrence and the gain and loss that will result
EMV needs to be ≥ 0

Accept / Reject

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EMV Example 1 – Exploration Well – P mean

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EMV Example 2 – Exploration Prospect

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EMV Example 3 Exploration Project - 3 Prospects

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Decision tree – Exploration Europe
Your company wants to drill and test the hydrocarbon potential of the Meotian
and the upper Sarmatian formations of the central structure.

Both structures can be explored with one well and they are totally independent
from each other → if the higher structure will be dry, the well will be drilled
deeper to reach the other structure

The economics show following indications (stand alone):

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Decision tree – Exploration Europe

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Decision tree – Exploration Asia
Your company wants to drill and test the hydrocarbon potential of the Nichara
West formation of the central structure. At the moment only limited seismic
data is available. The economics show following indications:
Pg 10.0%
NPV @9% 20.0 mn EUR
Dry hole costs 4.0 mn EUR
Additional seismic would have a negative impact 2.0 mn EUR on the NPV
The possible impact of the additional seismic is as following:
Chance of success 70% that the Pg goes up to 20.0%
Chance of success 30% that the Pg stays at the same level of 10.0%
No penalty payment after seismic when leaving the license
When leaving the license immediately you are committed to a penalty payment of
2 mn EUR
Which option would you choose?

29 | OMV Petrom S.A., Advanced Petroleum Economics

Decision tree – Exploration Asia

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Minimum Economic Field Size
Minimum amount of mean risked recoverable resources to be able to define a
success case with a positive NPV @ hurdle rate
Mean risked recoverable resource volumes have to be ≥ MEFS

Accept / Reject

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Economic Decision Criteria

Accept / Reject

Ranking

Comparison

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Payback Period
Focuses on recovering the initial investment
time needed to recover the investment (payback or amortization period)
Break-even point

Signifies time period of exposure to risk

the shorter the payback the better

Problems with payback

ignores benefits occurring after the payback period
does not measure total income

The payback period is based on the discounted accumulated project cash flow
(main discount rate has to be used)
Comparison

33 | OMV Petrom S.A., Advanced Petroleum Economics

Payback Period – Example Calculation
New Oil Company is considering to drill an additional development well on its
field. The well will cost EUR 2.5 mn to drill and will generate EUR 0.33 mn
additional income for 20 years. The company requires that investments are paid
back within 10 years. Should the investment go ahead?

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Payback Period – Example Chart

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Maximum Exposure

Comparison

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Economic Decision Criteria

Accept / Reject

Ranking

Comparison

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Discounted Profitability Index
Focuses on recovering the initial investment
Also known as Discounted Return of Investment (DROI)
DPI shows how many EUROs are earned per 1 EURO of cash out*

* CAPEX excluding abandonment costs (whereas the NPV includes abandonment costs)
** Main discount rate being used Ranking

38 | OMV Petrom S.A., Advanced Petroleum Economics

Profitability Index – Example
Example:
Project CAPEX = 100 MM EUR spent over 1 year
Operational CF = 20 MM EUR per year over 10 years
Discount rate = 10%, CF basis at the end of the year
NPV = 20.81 MM EUR, Present Value (PV) of CAPEX = 90.9 MM EUR

PI = 0.23 which means this project will generate 23 EURO cents per each 1
EURO invested, both being in terms of Present Value

39 | OMV Petrom S.A., Advanced Petroleum Economics

Project Selection
Your company has various projects in it’s portfolio. Due to market constraints the
amount of Investments is limited to EUR 500 mn.
Which projects will you choose to start if you want to get the most value for
you company at the current circumstances?
How much Investments will you need?

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Which Yardsticks to use – Decision

41 | OMV Petrom S.A., Advanced Petroleum Economics

Content
Cash Flow Basics

Economic Decision Criteria

Sensitivities

Pre-Tax Cash Flow Example

Contract and Fiscal Regimes

Case Studies

42 | OMV Petrom S.A., Advanced Petroleum Economics

Spider – Sensitivity graph
Differentiation between input variables/parameters and output results
Ceteris paribus assumption (“all other things held constant”)

Spider chart illustrates the differences between

Minimum and maximum values of the output result by drawing a curve through
all variations of the input variable tested (E&P standard 50%, 75%, 125%,
150%)
Curves with steep slopes, positive or negative, indicate that those variables
have a large effect, while curves that are almost horizontal show little or no
effect on the forecast
Slopes of the lines also indicate whether a positive change in the variable has
a positive or negative effect on the output result

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Spider – Sensitivity graph

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Tornado – Sensitivity plot
Special type of bar chart, where the data categories are listed vertically
Categories are ordered so that the largest bar appears at the top of the chart,
the second largest appears second from the top, and so on
Tornado Chart ranks input parameters in terms of their impact on the output,
comparing the relative importance of variables
For each variable/uncertainty considered, you will need estimates for what the
low-base-high outcomes would be
Sensitive variable is modeled as uncertain value while all other variables are
held at baseline values

Tornado plots
Useful for deterministic sensitivity analysis
Summarize the total impact of many independent variables
Allow to test the sensitivity/risk associated with one uncertainty/variable

45 | OMV Petrom S.A., Advanced Petroleum Economics

Tornado – Sensitivity plot

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Content
Cash Flow Basics

Economic Decision Criteria

Sensitivities

Pre-Tax Cash Flow Example

Contract and Fiscal Regimes

Case Studies

47 | OMV Petrom S.A., Advanced Petroleum Economics

Easy Evaluation Excel Tool
General
Pre tax calculation (no royalties and taxes are considered)
All volumes have to be inputted in mn boe
All cash values have to be inputted in mn

Purpose of the tool

Quick project evaluation
Creation and comparison of project scenarios
Optimization of the cash flow concerning the best economical output

Not a tool to create final economic calculations

Final economics have to be calculated with taking contractual and fiscal
regime into consideration

48 | OMV Petrom S.A., Advanced Petroleum Economics

Project 1 (I)
Initial situation:
Your company plans a full field development of an onshore oil field. You are the
project manager and you have to do the initial economic screening of this drilling
campaign. The production profile, the CAPEX and OPEX of the alternative are
shown below (you find them in the Excel sheet “Assignment example 1”). The
target currency for the outcome is EUR.

Questions:
What is the net present value before tax of the project (NPV @10%, 15%)?
What is the internal rate of return before tax of the project?
What is the maximum exposure of the project?
What is the pay back period before tax of the project?
What is the PI of the project?
Discuss the outcome of the calculation if it fits requirements of the company.

49 | OMV Petrom S.A., Advanced Petroleum Economics

Project 1 (II)
Additional:
Currency conversion USD / EUR 1,35
OIL price (flat for all years): USD 90,00 per boe

Unit conversion:
1 [ton] = 7,0435 boe (OIL)
1 [m³] = 37,3258 [scf]
1 [boe] = 6000 [scf]

50 | OMV Petrom S.A., Advanced Petroleum Economics

Project 1 (III)

51 | OMV Petrom S.A., Advanced Petroleum Economics