By Puput Aryanto Risanto

Introduction to Project Economicsin Oil and Gas Upstream Industry

By Puput Aryanto Risanto

24 December 2015

Oil & Gas Industry� Upstream : Searching and Finding Oil & Gas

reserves, Developing the Facilities, and Producing Oil & Gas in the form of Crude Oil & Natural Gas. Commonly known as Exploration & Production (E&P).

� Midstream : Delivering Crude Oil and Natural � Midstream : Delivering Crude Oil and Natural Gas from E&P industry for further processing, either by pipeline, truck, oil tanker, or LNG tanker.

� Downstream : Processing crude oil & natural gas in a refinery or petrochemical plant into usable product or raw materials for other industry and marketing them to the consumers.

Upstream Oil & Gas Life Cycle

AcquisitionAcquisition• Activities to obtain a right to explore a block/area

through concession/contractual system

ExplorationExploration• Activities to search for oil & gas deposit on the

certain location beneath the earth surface

AppraisalAppraisal• Activities to define the oil & gas volume and

characteristic more precisely after discovery

DevelopmentDevelopment• Activities to build the subsurface & surface

facilities to produce oil & gas safely and efficiently

ProductionProduction• Activities to extract, process, and export oil & gas

as per contract agreement

AbandonmentAbandonment• Activities to plug wells permanently, remove surface

facilities, and restore the field as per initial state

Project Economics Definition

� Project : a piece of planned work or an activity that is finished over a period of time and intended to achieve a particular purpose (Cambridge Dictionary).purpose (Cambridge Dictionary).

� Economics : the branch of knowledge concerned with the production, consumption, and transfer of wealth.

� Project Economics : A method to evaluate the economic value, i.e. return of investment, of a project.

� Project Economics in Oil & Gas Upstream Industry is used to evaluate the value of exploration and production of oil and gas within the contract period.

� Since the oil & gas project have unique characteristic compare to other industry, the method is also different.

Why Need “Project Economics”� Upstream Industry Characteristic :

�High risk in all aspects (personnel safety, environment, asset, investment, reputation).

�High expenditure, can reach billions US$.

�Long period between start of business until revenue generated, can be more than 10 years, even longer until break even point. until break even point.

�Limited operation/production period, either by contract duration or economic production threshold.

�Many uncertainties (reserves amount, production rate, cost, oil/gas price).

�High reward and strategic value.

� All factors above must be quantified whether a project is worth to execute (profitable) or not.

Project Economics Purposes� To determine the economic value of a project for :

� Acquiring new petroleum block / area

� Acquiring existing block from other company

� Contract negotiation

� Analyzing the profitability of a new project

� Developing new field or optimizing existing field

� Determining the cash flow for project financing� Determining the cash flow for project financing

� Checking project performance

� Analyzing the impact of new or revised rules and regulation

� To support decision making of :

� Which project need to be prioritized with limited resources

� What is the optimal field development option

� Whether a project need to be revised, postponed, or even cancelled if some parameter changes

How to calculate project economics� Project economic value is measured by calculating the

cash balance over project period.� Cash balance is commonly called NET CASH FLOW

(NCF).� In a simple formula :

� Cash Inflow (revenue/income) comes from sales of oil

NET CASH FLOW = CASH INFLOW – CASH OUTFLOW

� Cash Inflow (revenue/income) comes from sales of oil and/or gas during production period.

� Cash Outflow (expenditures/spending/outcome) comes from all expenditures starting from acquisition until abandonment.

� It is important to note that Cash Inflow only come in production period while Cash Outflow come in all stages, even during production period.

� So it is important to consider the timing of cash flow or value of cash relative to time.

Time Value of Money� Cash flow (in or out) occurred in a different time. � While the currency amount is the same, different timing

could give different value.� Example : 10 years ago, fuel price is US$ 0.5/liter. Now,

fuel price is US$ 1/liter. 10 years ahead, fuel price may be US$ 2/liter.

� In a simple world, present money is less valuable than past money, but present money is more valuable than past money, but present money is more valuable than future money.

� In economic analysis, the time different of cash flow is calculated by “discounting technique”

� Where r = interest rate and n = number of period� Formula :

Future Value Present Value discounting

FV PV r r r

Future Value = Present Value x (1+r)n

Time Value of Money (EXAMPLE)� Discount factor = (1 + r)

n

� Discounted Cash Flow (DCF) = Present Value (PV)

YEAR N Cash ($ million) Discount Factor @ 10% Discounted Cash ($ million)

2015 0 -100 1.000 -100.000

2016 1 -50 1.100 -45.455

2017 2 30 1.210 24.793

2018 3 100 1.331 75.131

� Net Present Value (NPV) is total present value over a period.� By 2020, this project is expected to generate $ 80 million value,

or called Real Term (RT) value. So, project value is $ 80 million RT2020.

� However, in 2015 term, it worth only $ 20.9 million to the Company , or called Money of the Day value (MOD) value. In this case, project value is $ 20.9 million MOD (NPV10)

2019 4 70 1.464 47.811

2020 5 30 1.611 18.628

TOTAL 80 NPV = 20.909

Profitability Indicator� An index to measure the value of a project.

� It is used to rank the project attractiveness if several investment opportunities existed.

� There are 3 common indicator :

�NPV = Net Present Value

�IRR = Internal Rate of Return

�PIR = Profit to Investment Ratio

IRR (Internal Rate of Return)� The discount rate which makes the Present Value

(PV) of net cash receipts equal to the Present Value of the investment. In other word, IRR is the discount rate which makes NPV = 0.

Rate (%) NPV

0 80.000

2 65.889

100.000

IRR Chart

2 65.889

4 53.054

6 41.356

8 30.677

10 20.909

12 11.960

14 3.748

15 -0.104

16 -3.799

18 -10.746

20 -17.149

-40.000

-20.000

0.000

20.000

40.000

60.000

80.000

0 5 10 15 20 25

NP

V (

$ m

illi

on

)

Interest Rate (%)

IRR = 15%

PIR (Profit to Investment Ratio) � An index to measure investment efficiency.� Formula :

YEAR N Cash ($ million) Discount Factor @ 10% Discounted Cash ($ million)

2015 0 -100 1.000 -100.000

2016 1 -50 1.100 -45.455

2017 2 30 1.210 24.793

PIR = NPV discounted CAPEX

� In above table, Capital Expenditures is (-100) at 2016 plus (-50) at 2017. Undiscounted CAPEX is 150, while discounted CAPEX is 145.455

� PIR = 20.899 / 145.455 = 0.14

� It means 1 unit of investment will generate profit / additional value of 0.14 unit.

2018 3 100 1.331 75.131

2019 4 70 1.464 47.811

2020 5 30 1.611 18.628

TOTAL 80 NPV = 20.909

Profitability Indicator Comparison

NPV� Measure project

value� Indicate whether a

project creates value (+NPV) or erodes value (-NPV)

IRR

� Do not measure project value

� Handy indicator of project screening against company

PIR

� Measure project value ratio

� Indicate investment efficiency(-NPV)

� NPV@10 20 million indicates a project give additional value of 20 million compare to investing in a bank which give 10% rate per year

against company benchmark

� If benchmark is 14%, a project which give IRR lower than 14% should be excluded from consideration

efficiency

� PIR 0.14 indicates a project give a profit of 0.14 per 1 unit of investment

Economics Evaluation Flow

Technical Input

• Recoverable Reserve

• Production Profile

• Development Option

Cost Input

• Capital Expenditures (CAPEX)

• Operational Expenditures (OPEX)

• Abandonment Expenditures (ABEX)

• Cost Phasing

Assumption

• Oil/Gas Price

• Cost Escalation

• Inflation• Exchange

Rate

Economic Result

• NPV• IRR• PIR

Sensitivity Analysis

• Recover-able Reserve

• CAPEX• Oil/Gas

Note :

� Recoverable Reserve : Amount of Oil and/or Gas which can be recovered/lifted/produced, expressed in Million barrels (MMbbls) for oil & Billion Cubic Feet (BCF) for gas

� Production Profile : Production rate per day, expressed in barrels per day (bpd) for oil or Million standard cubic feet per day (MMscfd) for gas

� Development Option : Type of Facilities (both wells & surface) to produce oil and/or gas

� OPEX : cost during production phase

� ABEX : cost to remove facilities in the end of field life

� Cost Phasing : spread of total cost per unit of time, normally year

Option • Cost Phasing Rate • Oil/Gas Price

Sensitivity Analysis� A method to measure project robustness as a result of changes

in project input / variables.

� Key variables normally are production profile, oil/gas price, and CAPEX.

� First, define a BASE CASE for key variables.

� Then change one key variable while maintaining other variables, i.e. change CAPEX by +/- 20% while maintaining production profile and price, then recalculate NPV.production profile and price, then recalculate NPV.

� Production profile is related to recoverable reserve :� Since recoverable reserve is difficult to predict exactly, the industry

specialist measure it in optimistic, base, and pessimistic scenario.

� Optimistic is often called P10 (10% probability of happen).

� Base case is called P50 (50% probability of happen).

� Pessimistic is called P90 (90% probability of happen).

� The result will be plotted on “tornado chart” or “spider plot”.

� Project is called robust if any change in key variables still result project economic (NPV, PIR) which meet criteria.

Project Example : PetroCilacap� PetroCilacap GoletKedhuk B.V. (Company) was

awarded a contract for exploration & production from “NyiRoro Kidul” Block, offshore Indian Ocean, 50 km south of Cilacap, Middle Java Indonesia in 2010 for 25 years (until 2035).

� Exploration was done on 2011 with oil discovery on “Pari” field after successful drilling on Pari-1 well.

� Appraisal was done on 2012-2014 after 2 appraisal drilling on Pari-2 and Pari-3. Estimated recoverable reserve in on Pari-2 and Pari-3. Estimated recoverable reserve in P90-P50-P10 is 17-24-31 MMbbls with negligible gas.

� Development study was conducted on 2014-2015 with result of offshore platform consist of Wellhead Platform (WHP) bridge-linked to Central Processing Platform (CPP) with oil pipeline to Onshore Refinery at Cilacap.

� Company expect to have the first oil (start of production) by end of 2017.

� If this project fulfill Company economics criteria, they will sanction the project by 2015.

Technical Input� Estimated Recoverable Reserve / Estimated Ultimate

Recovery (EUR) = 24 million barrels

� WHP bridge-linked to CPP with oil pipeline to Onshore Refinery at Cilacap.

� Production Profile (peak 10,000 bpd for 2 years)

12,000.00

Production Profile

0.00

2,000.00

4,000.00

6,000.00

8,000.00

10,000.00

12,000.00

Barr

els

Per

Day

Year

Cost InputYear 0.1 CAPEX OPEX ABEX2010 0.621 5,000,000.00

2011 0.683 25,000,000.00

2012 0.751 50,000,000.00

2013 0.826 10,000,000.00

2014 0.909 10,000,000.00

2015 1.000 50,000,000.00

2016 1.100 200,000,000.00

2017 1.210 80,000,000.00 2,000,000.00

2018 1.331 10,000,000.00

2019 1.464 10,000,000.00

2020 1.611 10,000,000.00

2021 1.772 10,000,000.00

� Time reference is 2015

� All value is RT as per indicated Year

� Rate = 0.1 (10%)

� CAPEX 2010 is acquisition cost

� CAPEX 2011 is exploration cost

� CAPEX 2012-2014 is appraisal cost2021 1.772 10,000,000.00

2022 1.949 10,000,000.00

2023 2.144 10,000,000.00

2024 2.358 10,000,000.00

2025 2.594 10,000,000.00

2026 2.853 10,000,000.00

2027 3.138 10,000,000.00

2028 3.452 10,000,000.00

2029 3.797 10,000,000.00

2030 4.177 10,000,000.00

2031 4.595 10,000,000.00

2032 5.054 10,000,000.00

2033 5.560 10,000,000.00

2034 6.116 10,000,000.00

2035 6.727 100,000,000.00

appraisal cost

� CAPEX 2015-2017 is development cost

� First oil is 2017

� OPEX is fix throughout field life despite production decrease over time

� ABEX is only on the last contract year

Assumption� Oil price is $50 per barrel flat

� No cost escalation & exchange rate considered

� Uptime 90%, meaning productive day is 0.9 x 365 days

� Company Criteria for Project Economics :

�Positive NPV

�PIR > 0.2

Refinery

WHP bridge-linked CPP

Offshore Pipeline

“Nyi Roro Kidul” Block

PetroCilacap GoletKedhuk B.V.

Evaluation : COST / EXPENDITURESYear 0.1 CAPEX OPEX ABEX DCF CAPEX DCF OPEX DCF ABEX

2010 0.621 5,000,000.00 8,052,550.00

2011 0.683 25,000,000.00 36,602,500.00

2012 0.751 50,000,000.00 66,550,000.00

2013 0.826 10,000,000.00 12,100,000.00

2014 0.909 10,000,000.00 11,000,000.00

2015 1.000 50,000,000.00 50,000,000.00

2016 1.100 200,000,000.00 181,818,181.82

2017 1.210 80,000,000.00 2,000,000.00 66,115,702.48 1,652,892.56

2018 1.331 10,000,000.00 7,513,148.01

2019 1.464 10,000,000.00 6,830,134.55

2020 1.611 10,000,000.00 6,209,213.23

2021 1.772 10,000,000.00 5,644,739.30

2022 1.949 10,000,000.00 5,131,581.182022 1.949 10,000,000.00 5,131,581.18

2023 2.144 10,000,000.00 4,665,073.80

2024 2.358 10,000,000.00 4,240,976.18

2025 2.594 10,000,000.00 3,855,432.89

2026 2.853 10,000,000.00 3,504,938.99

2027 3.138 10,000,000.00 3,186,308.18

2028 3.452 10,000,000.00 2,896,643.80

2029 3.797 10,000,000.00 2,633,312.54

2030 4.177 10,000,000.00 2,393,920.49

2031 4.595 10,000,000.00 2,176,291.36

2032 5.054 10,000,000.00 1,978,446.69

2033 5.560 10,000,000.00 1,798,587.90

2034 6.116 10,000,000.00 1,635,079.91

2035 6.727 100,000,000.00 14,864,362.80

TOTAL 430,000,000.00 172,000,000.00 100,000,000.00 432,238,934.30 67,946,721.58 14,864,362.80

Evaluation : Production REVENUEYear 0.1 Oil rate Uptime Prod/Year Revenue DCF Rev

2010 0.621

2011 0.683

2012 0.751

2013 0.826

2014 0.909

2015 1.000

2016 1.100

2017 1.210 2,000.00 0.9 657,000.00 32,850,000.00 27,148,760.33

2018 1.331 10,000.00 0.9 3,285,000.00 164,250,000.00 123,403,456.05

2019 1.464 10,000.00 0.9 3,285,000.00 164,250,000.00 112,184,960.04

2020 1.611 9,000.00 0.9 2,956,500.00 147,825,000.00 91,787,694.58

2021 1.772 7,000.00 0.9 2,299,500.00 114,975,000.00 64,900,390.11

2022 1.949 5,000.00 0.9 1,642,500.00 82,125,000.00 42,143,110.46

� Rate is 0.1 (10%)

� Oil rate in barrels per day

� Production/Year is oil rate per day x uptime x 365

Revenue is 2022 1.949 5,000.00 0.9 1,642,500.00 82,125,000.00 42,143,110.46

2023 2.144 4,000.00 0.9 1,314,000.00 65,700,000.00 30,649,534.88

2024 2.358 3,500.00 0.9 1,149,750.00 57,487,500.00 24,380,311.84

2025 2.594 3,000.00 0.9 985,500.00 49,275,000.00 18,997,645.59

2026 2.853 2,800.00 0.9 919,800.00 45,990,000.00 16,119,214.44

2027 3.138 2,600.00 0.9 854,100.00 42,705,000.00 13,607,129.07

2028 3.452 2,400.00 0.9 788,400.00 39,420,000.00 11,418,569.85

2029 3.797 2,200.00 0.9 722,700.00 36,135,000.00 9,515,474.87

2030 4.177 2,000.00 0.9 657,000.00 32,850,000.00 7,864,028.82

2031 4.595 1,900.00 0.9 624,150.00 31,207,500.00 6,791,661.26

2032 5.054 1,800.00 0.9 591,300.00 29,565,000.00 5,849,277.64

2033 5.560 1,700.00 0.9 558,450.00 27,922,500.00 5,022,107.06

2034 6.116 1,600.00 0.9 525,600.00 26,280,000.00 4,296,990.00

2035 6.727

TOTAL 23,816,250.00 1,190,812,500.00 616,080,316.88

� Revenue is production / year x oil price ($50/barrel)

� DCF Revenue is Revenue x Discount Factor

Evaluation : Discounted Cash Flow Chart

-100,000,000.00

0.00

100,000,000.00

200,000,000.00

20

10

20

11

20

12

20

13

20

14

20

15

20

16

20

17

20

18

20

19

20

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31

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32

20

33

20

34

20

35

Cash F

low

(P

er

Year

+ C

um

mula

tive)

Ultimate Cash Surplus$ 115,894,661

-500,000,000.00

-400,000,000.00

-300,000,000.00

-200,000,000.00

Cash F

low

(P

er

Year

+ C

um

mula

tive)

Year

Payback Period 12 yearsBreak Even Point on 2022

Maximum Cash Sink$ 406,743,066.35

Evaluation : Result� Total DCF Expenditures = DCF CAPEX + DCF OPEX +

DCF ABEX

� Total DCF Expenditures = 432,238,934.30 + 67,946,721.58 + 14,864,362.80 = $ 515,050,018.68

� Total DCF Revenue = $ 616,080,316

� NPV = Total DCF Revenue – Total DCF Expenditures

� NPV = 616,080,316 – 515,050,018.68 = $ � NPV = 616,080,316 – 515,050,018.68 = $ 101,030,298.20

� PIR = NPV / Total DCF CAPEX

� PIR = 101,030,298.20 / 432,238,934 .30 = 0.23

� So, NPV is positive and PIR is above 0.2

� Conclusion : Project Meets Economics Criteria

� However, Company must check its financial ability to handle maximum cash sink of $ 406,743,066.35

Sensitivity Analysis Calculation� Based on calculation, the result are :

�Reserve P10 NPV = -83,793,796.86

�Reserve P90 NPV = 285,854,393.26

�Price +20% NPV = 224,246,361.58

�Price -20% NPV = -22,185,765.18

�CAPEX +20% NPV = 14,582,511.34

�CAPEX -20% NPV = 187,478,085.06�CAPEX -20% NPV = 187,478,085.06

� From above figures, it is clear that reserve is the most sensitive variable. If Company can only realize P10 reserve, the NPV will be negative which does not meet Company criteria.

� While Price is out of Company control, in this case Company need to further study the reserve value to ensure that it can produced at P50 value.

Sensitivity Analysis Chart

-200,000,000.00 0.00 200,000,000.00 400,000,000.00

CAPEX

Price

Reserve

Base NPV = 101,030,298-100,000,000.00

-50,000,000.00

0.00

50,000,000.00

100,000,000.00

150,000,000.00

200,000,000.00

250,000,000.00

300,000,000.00

350,000,000.00

-60 -40 -20 0 20 40 60

CAPEX

Price

Reserve

Tornado Chart

� X-axis is NPV value

� Longer bar indicates more sensitive variable

Base NPV = 101,030,298

101,030,298

Spider Plot

� X-axis is % variation

� Y-axis is NPV value

� Steeper line indicates more sensitive variable

-150,000,000.00

-100,000,000.00

تريما كاسيهتريما كاسيه

Thank You

About the AuthorPuput Aryanto Risanto had more than 10 years

experience in oil & gas industry. Currently he is working for Petronas Carigali Sdn. Bhd. in KL, Malaysia. Previously he worked for Premier Oil Natuna Sea B.V. in Jakarta and Total E&P Indonesie in Balikpapan, Indonesia. His expertise included project engineering & management, joint included project engineering & management, joint venture management, construction management, electrical engineering, and recently deepwater development. This presentation was a small contribution to the public who was interested to know more about Oil & Gas industry. He can be contacted at aryantorisanto@yahoo.com