EXPLORATION ECONOMICS

Exploration Economics
Characteristics
Major gamble.
Discovery of an unexpected large field Or no oil or gas at all

Sequential decisions.
Exploration investments are relatively small considered to further investment in case of success. Investments without further commitments if failure

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PPM 2nd Workshop of the China Case Study

Exploration Economics
characteristics options and sequential decisions

Uncertainty Information (reservoir, resources) Flexibility

LICENSING

PDO DISCOVERY

PROD. START DEVELOPM. DRILLING

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Exploration Econom ics

characteristics decision tree

Information are revealed over time options and sequential decisions Decision trees focus on critical uncertainties and decisions that reveal uncertainties
development appraisal exploration drilling
20% 80% 50% 50%

too small

dry well

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PPM 2nd Workshop of the China Case Study

Exploration Economics
Success 0,09
Develop the field Yes Net cash flow of a field develpment

Yes

0,80

Drill a wildcat

Failure 0,91

Exploration costs

100 mill US$

2,4 mill US$

No

0,20

No Exploration and Appraisal costs

2,8 mill US$

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Exploration Economics...
A petroleum exploration project
A field development decision
Cash flow elements and uncertainty Decision criteria: Net present value (NPV)

An exploration decision
New cash flow elements and uncertainties Decision criteria: Expected Monetary Value (EMV)

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PPM 2nd Workshop of the China Case Study

Exploration Economics...
A field development decision
Cash flow elements and uncertainty
Production strategy Oil price

? ? ?
time

Development consept Capex Opex

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PPM 2nd Workshop of the China Case Study

Profitability and the risk

Technological uncertainty

costs overruns in Norwegian Projects 1998

40

22%
35 30

Change in CAPEX from PDO estimates to summer 1998

Billion NO K

25 20 15 10 5 0

60% 23%

20%

10% 8%

15%

Balder
Source: MIE
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Varg

Jotun

Oseberg Sr Oseberg st

Visund

sgard

PPM 2nd Workshop of the China Case Study

Field developement decision

Cash in flow (revenue)

to calculate the NPV

Cash out flow (expenditures)

NPV =
t=0

V0

+ (1 + r)1 +

V1

Vt

(1 + r)t

V2

(1 + r)2

+ ...... +(1 + r)N

VN

...where:
Vt - the net income in year t r - discount rate N - total numbers of years (project duration)
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Exploration Economics
Success 0,09
Develop the field Yes Net cash flow of a field develpment

Yes

0,80

Drill a wildcat

Failure 0,91

Exploration costs

100 mill US$

2,4 mill US$

No

0,20

No Exploration and Appraisal costs

2,8 mill US$

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Exploration Economics
New cash-flow elements:
Exploration costs
Seismic acquisition Wild-cat well Appraisal wells

More uncertainty:
Success vs failure The resource size if success

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Exploration Economics
to calculate the NPV

Field development NPV has to include the exploration costs The development NPV must be discounted to the date for the exploration decision Consequently the NPV is sensitive to the lead time from discovery to development

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Profitability and the risk

Uncertainty in time profile
Years from discovery to production

22 20 18 16 14 12 10 8 6 4 2 0

Sleipner Vest Lille Frigg Statfjord Nord Statfjord st Hod Troll II st Frigg Heimdal Ula Murchison Valhall Snorre Brage

Gugne Troll I Sleipner st Loke Heidrun Draugen Oseberg Vest Yme Fry Tordis Embla Gyda Sr Gullfaks Vest

Cod VestEkofisk

Eldfisk Tor

Albuskjell Edda Frigg Statfjord

Tommeliten Gamma Gyda Oseberg Veslefrikk Gullfaks

Ekofisk

1968

1970

1972

1974

1976

1978

1980

1982

1984

1986

1988

1990

Year of discovery
Petr. res 9612067

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to calculate the NPV

.exploration costs and lead time - effect on NPV
Assume 320 mill $ in exploration costs

Pre Development

Pre exploration Lead time 5 years

Pre exploration Lead time 10 years

NPV (7%)

2.131 billion $

1.120 billion $

713 billion $

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PPM 2nd Workshop of the China Case Study

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Exploration Economics
New cash-flow elements:
Exploration costs
Seismic acquisition Wild-cat well Appraisal wells

More uncertainty:
Success vs failure The resource size if success

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PPM 2nd Workshop of the China Case Study

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Exploration Economics
probability of success
The Risk Assessment estimates the probability of succes

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Exploration Economics
resource assessment
Probability
MODE (Most likely) MEDIAN (p50) MEAN (average centre of gravity)

p90

p10

Resource size

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Exploration Economics
dicision criteria Expected Monetary Value

Reward
Yes Find

P (1-P)

Yes

NPV (field dev. minus exploration & appraisal costs)

DRILL
No

No

Risk Capital
(Exploration costs)

EMV = (Reward x P) - (Risk Capital x (1-P))

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Expected Monetary Value

Two different approaches to calculate the EMV:
Expected resource size Resource distribution

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PPM 2nd Workshop of the China Case Study

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Exploration Economics
resource assessment
Probability
MODE (Most likely) MEDIAN (p50) MEAN (average centre of gravity)

p90

p10

Resource size

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PPM 2nd Workshop of the China Case Study

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Expected Monetary Value

expected resource size - an example In the simplest model we use E(R) to represent the full range of possible discovery volumes

Probability

If oil is present, the mean recoverable amount is 48 million bbl.

E(R)
E(R)= 48 million bbls
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Resource size

Expected Monetary Value

expected resource size - another example

0.75
Yes Find

Yes

6 mill US$

DRILL
No

0.25

No

- 12 mill US$

EMV = (0.75 * 6) - (0.25 *12) = 1.5 million US$

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Expected Monetary Value

expected resource size

overlook the minimum economic resource - a minimum size below which a discovery would not be worth develop at all. assume a straight-line relationship between the size of a discovery and the NPV of development.

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Expected Monetary Value

minimum economic reserve
160 120 NPV mill US$ 80 40 0 0 -40 Discovery size, mbbl
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MER = 25 mbbl

50

100

150

200

Expected Monetary Value

expected resource size - an example
Probability

The minimum economic resource (MER) is 25 million bbl.

MER

E(R)=48 mill bbl Resource size Probability

If oil is present the probability to find resource outcome higher than MER is 63% (the probability of commerciality). If commerciality the mean resource outcome is 69 million bbl.
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E(R*)=69 mill bbl Resource size

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PPM 2nd Workshop of the China Case Study

Expected Monetary Value

minimum economic reserve
(34-12) mill US$
0,63

Yes

Yes
0,75

Develop
0,37

Yes

Find
0,25

No

DRILL
No

- 12 mill US$
No

- 12 mill US$

EMV = 0,75*(0,63*22-0,37*12) - (0.25 *12) = 4 million US$

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Expected Monetary Value

minimum economic reserve

The increase represents the value of not being obliged to develop non-economic discoveries.

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Expected Monetary Value

We improve the analysis by considering the whole resource distribution.
Minimum economic reserve Economic of scale

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Expected Monetary Value

economic of scale

Three-point distribution Monte Carlo simulation

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Expected Monetary Value

economic of scale - three-points distribution
40 mill US$

Develop 0,3
Success 0,47 0,3 0,4

415 83
16
40 mill US$

Drill

Failure 0,53 -12 mill US$

30 mill US$

EMV = 0.47(0,3*40+0,4*40+0,3*30) - (0.53 *12) = 11 million US$

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