Expected Return on Investment and

Overview of Future Analysis ASSIGNMENT MAKE UP

December 14th, 2015

Benjamin Neusse

ROI Estimation and Future Analysis

Page 1 of 5

Executive Summary

Using point estimates for all variables of interest, my analysis estimates that this project can yield a total return on investment of 53.7%. This results from an Expected Net Present Value of $122 Million with $227 Million expected for the initial investment. Over the fifteen-year life of the project the annualized rate a return works out to 3.6%.

Figure 1. Estimated Annual Cash flow. Cost shown as negative values, Total Revenue and Net Profit shown as positive values

Overview

Leasing land, & planning, drilling, & operating wells to produce a globally-traded commodity with volatile market prices requires a large initial investment and sound understanding of the risks to that investment. This analysis sought to quantify the initial investment costs, and the risk factors affecting the annual revenue and expenses in order to calculate a project value in present dollar terms. These values informed an estimate of the ROI for the projects lifetime.

 $(225)

 $(175)

 $(125)

 $(75)

 $(25)

 $25

 $75

 $125

 $175

Annual Cash Flow in Millions

Cost Profit Revenue

ROI53.7%

ROI Estimation and Future Analysis

Page 2 of 5

Key Variables

Relevant key variables and their risk factors are summarized in Table 1 below:

Variable Description Risk Factors (Uncertainties)Leased Acres Acres of land leased on

which to drill Exact number of acres required is unknown

Seismic Sections Seismic Data used to plan the drilling location

Exact number of seismic data required is unknown

Wells to Drill The number of wells planned to drill for the project

Exact number of wells to drill is unknown

Drilling Costs Cost to drill a well Geological, Engineering, and Mechanical uncertainties

Completion Costs Cost to complete oil producing wells drilled

Number of wells planned, Probability of the well being productive,

Professional Overhead Salary and benefit costs due to project teams time spent on each specific well

Exact number of time spend on each well is unknown

Probability of Well Being productive

Likelihood that each well drilled produces oil

Presence of hydrocarbons, geologic structure, reservoir presence, seal presence

Initial Production Barrels per day each well produces

Exact barrels per day produced is unknown

Production decline The annual rate of decline of well production

Exact rate of decline is unknown

Market Oil Price The average annual $ per barrel price of Oil

Oil prices are extremely volatile and difficult to project

Net Revenue Interest The rate of revenue dilution after paying royalties

The royalties required on oil revenue is not known exactly

Annual Revenues The annual gross income for the project

Depends upon the Market Oil Price, the number of productive wells and the Production decline of each well

Operating Costs $ Cost per barrel of oil to run the well and transport the oil

The exact cost per barrel of oil is unknown

Severance Taxes Six percent of total gross annual revenue

The tax rate is known, but the gross annual revenue is unknown

Table 1. Variables used in this analysis with, Descriptions, and Risk Factors (Uncertainties)

These variables enabled the estimation of initial investment costs, annual revenues, annual expenses, and annual profits. The Net Present Value was calculated with a discount rate of 10% which is the expected Weighted Average Cost of Capital (WACC) for this type of project.

ROI Estimation and Future Analysis

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Specific Distributions

To estimate drilling cost, data from three types of wells over ten years provided thirty points for a distribution of drilling cost in $1,000s:

Figure 1. Distribution of Well Drilling Costs in $1,000s

As no clear pattern emerged, I calculated the annual increase in well costs, performed a log transformation and found that this value held to a normal distribution. I used the mean of this distribution as an estimate of the annual increase in well drilling costs: 15.2%

Figure 2. Estimated distribution of annual increase in well Drilling Costs

I used a triangular distribution to estimate the future price of oil since the price forecast provide a low, high, and expected price. This analysis relied only upon the expected price forecast for each year.

ROI Estimation and Future Analysis

Page 4 of 5

Future Monte Carlo Simulations

To provide a more accurate and precise estimation the next analysis will rely upon a system of interrelated Monte Carlo Simulations. The initial investment costs will be simulated as well as the annual revenue and costs over the fifteen-year lifetime of the project. These results will then inform the Net Present Value calculation and ROI estimate:

Figu

re 3. F

low d

iagram for sim

ulation

of Total In

itial Costs

ROI Estimation and Future Analysis

Page 5 of 5

Figure 4. Flow diagram for simulation of the Net Present Value

Figures 3 & 4 show the flow for the future Monte Carlo simulations for the Total Initial Investment costs and the Net Present Value respectively. Boxes indicate variables while arrows indicate the flow of output information as it becomes inputs for other variable calculations. Variables absent inputs are calculated from random sampling of the chosen distributions.