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Economic Evaluation of Petroleum Projects
(Basic Aspects)
Dr. Hisham Yas
Economic & Finance Dept.
Abstract:
Economic Evaluation is an essential step for methods and techniques have been
assessing and studying and selecting new developed to support the process of
Petroleum Projects which involve different economic evaluation of petroleum
activities. This article presents basic aspects projects. That became possible thanks
related to the Economic Evaluation Process to advanced programs, additional
such as concepts and requirements as well as skillsand experiences as well as the
the nature of Petroleum Projects. Particular outputs of mathematical and statistical
focus was given to the new roles and skills and sciences. These developments make
tools that are needed to achieve reasonable some associated works easier and may
study of any Petroleum Project proposal. help to increase the available
اﻟﺨﻼﺻﺔ information, decrease cost and risks, and
ﻳﻌﺪ ﻣﻮﺿﻮع اﻟﺘﻘﻴﻴﻢ اﻻﻗﺘﺼﺎدي ﺧﻄﻮة اﺳﺎﺳﻴﺔ ﻓﻲ دراﺳﺔ واﺧﺘﻴﺎر ensure high speed and more accuracy.
.اﻟﻤﺸﺮوﻋﺎت اﻟﺒﺘﺮوﻟﻴﺔ اﻟﺠﺪﻳﺪة واﻟﺘﻲ ﺗﻨﻄﻮي ﻋﻠﻰ اﻧﺸﻄﺔ ﻣﺘﻨﻮﻋﺔ
ﺗﺘﻨﺎول هﺬﻩ اﻟﻤﻘﺎﻟﺔ ﺟﻮاﻧﺐ اﺳﺎﺳﻴﺔ ﺗﺘﻌﻠﻖ ﺑﻌﻤﻠﻴﺔ اﻟﺘﻘﻴﻴﻢ اﻻﻗﺘﺼﺎدي ﻣﻦ 1- Economic Evaluation
.ﻣﻔﺎهﻴﻢ وﻣﺘﻄﻠﺒﺎت آﺬﻟﻚ ﺗﺘﻌﺮض اﻟﻰ ﻃﺒﻴﻌﺔ اﻟﻤﺸﺮوﻋﺎت اﻟﺒﺘﺮوﻟﻴﺔ 1-1: Definition:
اﻻهﺘﻤﺎم اﻟﺨﺎص ﺗﺮآﺰ ﻋﻠﻰ اﻻدوار واﻟﻤﻬﺎرات واﻻدوات اﻟﺠﺪﻳﺪة Economic evaluation, as a tool or
.اﻟﻀﺮورﻳﺔ ﻟﻠﻘﻴﺎم ﺑﺪراﺳﺔ ﻋﻘﻼﻧﻴﺔ ﻟﻠﻤﺸﺮوع اﻟﺒﺘﺮوﻟﻲ اﻟﻤﻘﺘﺮح process, is used by many parties:
Introduction companies, banks, investors, promoters,
Economic evaluation is an essential part of the individuals and government agencies to
process of studying available investment consider a new project as an investment
opportunities and supporting decision-making, opportunity by studying its cost and
by using special methodology and scientific revenues to find out and select the best
analysis to select best options. Currently, many options. This process involves using
relevant areas have been developed such as different data and information (monetary,
technology, increasing number of economic and quantitive and qualitative factors) to build
non-economic factors and new forms of fiscal projections, expressed in monetary
terms, all of them make the modern economic terms, about initial investment, operating
evaluation more important and more complex. costs, finance sources, expected
Petroleum projects as investment opportunities revenues and net cash flows, to calculate
require huge funds and with a long time to the net benefits or profitability indicators
construct and they are associated with a series as well as taking into account the
of risks and uncertainties. Therefore, the monetary time value, risk factor and
economic evaluation can be a main tool and changing conditions and assumptions, to
reasonable way to find out best petroleum make an initial judgment on project
investment opportunities in terms of cost, proposal.
revenue and risks. For those conditions, many
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1st No. 1st year 2010 [Journal of Petroleum Researches & Studies]
1-2: Practical Requirements depending on the purpose of
In practice, there are different evaluation. This framework
requirements for the economic contains various issues (e.g.
evaluation process. First, a factors, concepts, indicators and
special team should be formed equations) integrated with each
to undertake divers evaluation other in the process of collecting
works. This team mainly consists data and information as well as
specialists (Engineers, computing results. More details
Economist, Accountant, Legal are as follows:
expert and Coordinator), each
having sufficient experience in 1‐3‐1: Economic Factors
the area of the project. Second, Information should be available
providing technical background from various sources about
expressed as technical data and prices, inflation rate, interest
information of the project which rate, discount rate, exchange
is an essential source for rate, taxes and depreciation.
computing the capital These will be used by the
expenditures and operating costs economist to build and analyzes
and production. Third, legal the main elements of evaluation
frameworks and regulations (cost and revenue as cash flows
(that should be up to date) of project).
involving taxes, duties and any
other financial obligations that 1‐3‐2: The indicators of
project will be subjected to. Evaluation
Fourth, collection of economic Different criterias are used as
information about supply and evaluation indicators to examine
demand, market prices, inflation and assess the project
rate, interest rate...etc. Fifth, the (investment opportunity).
use of software programs has Although the return on
been designed for the economic investment is basically the most
evaluation purposes. All of those important indicator, economic
requirements should be evaluation is not limited to one
combined and integrated indicator. In practice, there are
throughout economic evaluation some indicators, at least in this
process. regard, that are applied to check
and judge the feasibility of a
1‐3: Factors and Indicators given project. Economists may
Economic evaluation may be a use two or more indicators,
broad framework which includes depending on the nature of the
many elements and tools,
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1st No. 1st year 2010 [Journal of Petroleum Researches & Studies]
project and the intentions of the acceptable assumptions. In this
parties involved. context, some special techniques
Evaluation's indicators, which are used such as (Probability
are often calculated according to Theory, Monte Carlo Simulation,
the particular formulas and Decision Tree and Sensitivity
equations in simple and complex Analyses).
ways, classified into two
categories; the first category 1‐5: Software Programs
should consider the time value of Many types of software
money (discounted methods) programs are produced and
such as Net Present Value (NPV), developed to support and serve
Internal Rate of Return (IRR), the work of economic
Discounted Payback and evaluations. The purpose of
Profitability Index. The second these programs is to organize
should not (non discounted and analyze the related data and
methods) such as Break‐even information (as inputs) and their
Analysis, Exposure Point, results (as outputs) in flexible
Sensitivity Analysis and and quick ways. The software
Cost/Benefit Ratio. The programs have been developed
evaluation process may be by using modern computer
expanded to use more indicators programs and advanced
about financial and accounting statistical and mathematical
issues (e.g. financial ratios) if the analysis. Key components of
analysis of the financial these programs include three
statements related to the project main elements: inputs,
is required. processing and outputs. But the
final design basically depends on
1‐4: Risk Analysis the nature of the project and the
Basically, the cash flows of the details required from the parties
project, whether cash in or cash involved.
out, will occur in the future and Concerning the economic
their values will change evaluation, program design
according to the economic and needs various skills and
technical circumstances. The experiences about (type and
work of evaluation team is to nature of the project, computer,
find out a certain economic value evaluation process requirements
(best option). So it should as well as mathematical &
therefore use its experience of statistical tools). Currently, there
the current and expected events is a large number of software
to build up more realistic and programs, simple and complex;
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1st No. 1st year 2010 [Journal of Petroleum Researches & Studies]
some depend on Excel, but and profitability indicators,
others apply additional programs analyzing and explaining results,
including new developed determining expected economic
parameters and equations. and financial risk, selecting the
best options and providing
1‐6: Tasks of the Economist suitable advices for the
The economist is an essential conditions of best and worst
member of evaluation team, and solutions.
modern economic evaluations 2‐ Economics of Petroleum
require different tasks from the Projects
economist. In other words, s/he 2‐1: Petroleum Projects
may undertake many tasks The petroleum Industry
throughout the evaluation consists of different activities
process, depending on the type related to the exploitation of the
and volume of project as well as oil and gas resources under and
the required skills and above the ground (Exploration,
experience in this area. As an Development, Production,
economist, s/he is supposed to Refining, Gas Processing, as well
have good knowledge and as Transportation and
practices in economics, and s/he Distribution). In spite of this each
should have some knowledge on one has its own specific features
finance, mathematics, statistics, but they are interrelated and
accounting, computer and integrated. A petroleum project
contracting techniques as well as as an investment opportunity
basic knowledge about the may not differ considerably from
fundamentals of project projects in the other types of
proposal. industries. Simply, it is an
These necessary matters would allocation of capital to be spent
enable the economist to perform on certain production factors
various tasks efficiently ranging that are required to establish a
from the early steps up to the (Project) with commercial or non
decision making. In this context, commercial objectives. As an
the economist could be involved important integrated part, it is
in one or more tasks, including necessary to distinguish between
the following tasks: participating the types of petroleum project
in the preparation of data and evaluations; simple or complex,
information, making analyses, high cost or low cost, undertaken
building models, determining by one individual or by a team,
assumptions, organizing and for a company or an investor….,
calculating expected cash flows
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1st No. 1st year 2010 [Journal of Petroleum Researches & Studies]
depending on their cost and substantially different from
purposes. those of the refining projects,
In this regard, it must be also between pipeline projects
considered that the funds, which and gas plants. Ultimately, all of
are spent during the initial them should be expressed as
investment of the petroleum monetary values and be
project at the early period, will classified as cost and revenue.
go to hundreds of directions and Concerning the software
channels. For example, programs, there are many types
purchasing equipments and of petroleum economics
materials from various sources, evaluation software programs,
employing many people with each one deals with a specific
different specialties, contracting area such as; oil and gas reserves
with various companies to analysis, drilling works,
undertake some designs or exploration and production,
conduct certain works and refineries and gas plants. Any
services...etc. Expected revenues one who uses these programs
that shall be received after must have multi‐skills and good
relatively long time, under experience with the relevant
uncertain conditions, will only be projects or activities.
from selling one or few products. To take a look at main features
This is why the economist should of the cash flows for some of the
have sufficient knowledge and petroleum projects, the
experience, and must be careful following are some examples:
throughout the stages of A. Within exploration and
economic evaluation process. production projects, which often
contain special contracting fiscal
2‐2: Characteristics and terms, the evaluation process is
Indicators summarized in breaking down
Petroleum projects may differ the cost into capital
considerably according to their expenditures related to initial
various activities. Therefore, investment and operating cost
required details of project related to requirements of
related to technical background production process such as
and economics, which are made transport and maintenance
on the basis and characteristics works. On the other hand the
of those activities, are also expected revenues will be
different. For example, the achieved from selling oil and/or
technical background of the gas, to cover the costs and
exploration projects is expected profits.
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1st No. 1st year 2010 [Journal of Petroleum Researches & Studies]
B. Refining projects are classified in three main types:
relatively different, where the Concession, Production Sharing
evaluation process includes: and Service Contracts. These
capital expenditure for contracts contain various terms
constructing the refinery such as (Bonus, Royalty,
complex and operating costs for Petroleum Income Tax, Cost Oil
the maintenance works, material and Profit Oil). Besides, there are
purchases and labor, but the special formulas computed by
most important in their cost is simple and complex equations
the feed crude oil purchases. such as (Sliding Scales, R‐Factor,
Whereas revenues are generated ROR‐Factor, Price Cap and
from the yields of products sales Netback). Those terms and
C. Pipeline projects include formulas are essential items and
capital expenditures for have significant effects during
establishing the pipeline, and the process of preparing,
operating cost for maintenance scheduling and computing cash
works and labor as well as taxes flows and the expected final
and duties. Revenues are made values of the project.
from the tariffs charged to those
transporting crude oil or natural Conclusion
gas or products in the pipeline. The evaluation of petroleum
D. As for gas plants, huge projects has general features
funds should be spent (as capital which are similar to those in
expenditure) when establishing other industries. However, there
complex plants, with operating are special and distinguished
cost to purchase feed gas and issues, essentially linked to the
some other required materials as nature and conditions of
well as the cost of maintenance petroleum projects, and they
works and labor. The revenues require special skills and
will be received from selling the experiences. In other words,
plant's products (e.g. LPG and there are many basic aspects
Dry Gas). surrounding the economic
In addition, investment form is evaluation of petroleum projects
very important point, since that should be considered
petroleum investment is carefully and accurately,
characterized by the use of individually and collectively.
special forms so called
(International Petroleum
Contracts) for exploiting
petroleum resources, which are
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