Clase 06 Economics

Knowledge Integrity Service
Oil & Gas Resources and Reserves Evaluation

Economics
DeGolyer and MacNaughton

April, 2017
FIP-UNI, Lima
Worldwide Petroleum Consulting
Presentation Outline
This presentation is organized into the following sub-sections
 Overview
 OPEX and CAPEX
 Classification of Fiscal Systems
 Price and Cost Estimation
 Future Net Revenue and Present Worth
 Economic Limit
 Sample report table
Oil & Gas Resources and Reserves Evaluation Preliminary: Rely on report for specific conditions and April, 2017
final results. This document is released for the purpose
Economics of preliminary review on the date shown. It is not to be 2
used for any other purposes.
Economics
Overview
 Integrated Team Approach
Petrophysics Engineering +
+ Economics
Geology
Reservoir Reservoir Operating Cost

Description Description Capital Cost
Volumetrics Volumetrics Fiscal Policy
Hydrocarbons cannot be
classified as reserves
unless an economic Reserves
evaluation is prepared and
the results confirm
economic producibility.
Economics
Overview
 Why is economics important?
 It’s about determining value. The value of the reserves is as important or more
important than the quantity of reserves.
 The prosperity of a company directly depends on efficient use of its capital.
 This is especially true of oil and gas companies, since assets are continually depleted
by production.
 A primary goal of all oil and gas companies is to identify and develop the most
economically attractive projects
 A secondary goal is to replace produced reserves and to increase the value of
the company.
Economics
Overview
 How a reserves valuation is used?
 To provide management with the economic value of the oil/gas reserves.

 Planning: To prepare annual budgets – forecasts
 For long-range planning for all oil/gas companies
 For borrowing - using reserves as collateral
 For SEC filings (LSE or other filings)
Economics
Overview
Field Life Cycle and Typical Cumulative Cash Flow

600
Cumulative cash flow ($million)
400
200
0
1 2 3 4 5 6 7 8 9 10 11 12 13 14 15 16 17 18 19 20 21 22 23 24 25
Time (years)
-200
Cum Cash Flow
-400
-600
Gaining Access
Exploration
Appraisal
Development
Production
Decommissioning
Source: Jahn, Cook & Graham (2008), p.1)
Economics
Overview
 Field Life Cycle
 Gaining Access – Investigation and License acquisition

 Exploration – Activities required to make a discovery (seismic, estimation of
prospective resources, wildcat drillings, etc.)
 Appraisal – Assess the potential of the field (additional seismic, appraisal
drilling, testing, study)
 Development – Formulate and agree to execute a field development plan
(FDP). Development drilling
 Production – Commercial quantities are produced
 Decommissioning – Field abandonment
Economics
Overview
 Field Life Cycle – Gaining Access

 Technical
 Determine potential size of hydrocarbons to be found and produced in the region
 Identify challenges facing exploration and production
 Political and Economic
 Government stability
 Levels of taxation
 Personnel security
 Local costs
 Social
 Availability of local skilled workforce and local training required
 Civil disorder
 Set up local presence and engage the local population
 Environmental
 Local Legislation
 Precautions needed to protect the environment from harm during operations
Economics
Overview
 Field Life Cycle – Exploration

 Evaluate:
 Preliminary investigation, field work
 Geological surveys, magnetic surveys,
 Seismic surveys, gravity surveys
 Exploration drilling
 Geologists have been looking for oil for over 100 years
 Most of the “giant” fields have already been discovered
 Future fields most likely smaller and more complex
 Development of new exploration techniques have improved geologists’
understanding and increased efficiency of exploration
 Despite improvements, still a high-risk activity
Economics
Overview
 Field Life Cycle – Appraisal

 If hydrocarbons have been found, now it is time to assess the potential of the
find
 “Reduce the uncertainties”
 The amount of data acquired so far probably does not yet provide a good
picture of the size, shape, and producibility of the accumulation
 Four Options:
1. Proceed with development without appraisal
2. Carry out appraisal program with objective of reducing the risks and optimizing the
technical development
3. Sell the discovery
4. Do nothing
Economics
Overview
 Field Life Cycle – Development

 Assuming at least one option is economically viable, formulate a field
development plan…
 And execute it!
 The FDP defines…
 The entire project and should give management, partners, and shareholders
confidence that all aspects of the project have been identified, considered, and
addressed
 the project specification for the subsurface and surface facilities
 the operational and maintenance philosophy
 the project activities required to support a proposal for the required capital
investments.
Economics
Overview

 What should the FDP include?
 Development objectives
 Petroleum engineering data
 Operating and maintenance guidelines
 Engineering facilities descriptions
 Project planning
 Cost and manpower estimates
 Project economics summary
 Proposed budget
Economics
Overview

 After FDP is approved and
 Prior to first production a sequence of activities follows:
 Design of the facilities
 Purchase of materials of construction
 Facilities fabrication
 Facilities installation
 Facilities commissioning
Economics
Overview
 Field Life Cycle – Production

 Starts with the first commercial quantities of hydrocarbons flowing through the
system.
 First commercial production represents a cash flow turning point
 Cash is being generated
 Can be used to pay back prior investments
 Or made available for new projects
 Goal is to minimize the time between the exploration phase and the “first oil”
 The production profile consists of:
 Build-up period
 Plateau period
 Decline period
Economics
Overview
 Field Life Cycle – Decommissioning

 A field’s economic life normally ends once its net cash flow turns permanently
negative, at which time the field is decommissioned, or abandoned.
 At the end of a field’s life capital spending and asset depreciation are negligible
 Economic decommissioning can be defined as the point at which gross revenue
no longer covers operating expenses and taxes
 How to defer decommissioning:
 Reduce operating costs
 Sharing of production facilities
 Pooling maintenance contracts
 Increase hydrocarbon output
 In other words…Increase revenue and/or decrease costs
Economics
Overview
 Field Life Cycle – Decommissioning

 At abandonment, companies must think of procedures which will minimize the
environmental effects without incurring excessive cost
 Abandonment
 Wells can be plugged
 Processing facilities dismantled on a phased basis
 Offshore pipelines may be flushed and left in place
 Offshore steel platforms may be cut off to an agreed depth below sea level or toppled
over in deep water
 Depends on environmental laws in host country
Economics
Overview
 Economic Terms
 Future Gross Revenue

 Revenue realized from the sale of the reserves (products * prices)
 Operating Costs
 Costs necessary to operate the field. Includes both variable and fixed costs
 Capital Expenses
 Funds used by a company to upgrade assets such as facilities and equipment
 Taxes
 Payments (usually in cash) to host governments (local and federal) by companies
involved in the extraction of hydrocarbons from the subsurface
 Future Net Revenue
 Remaining revenue of the future gross revenue after deducting operating expenses,
capital costs and taxes
 Net Present Value
 Future net revenue discounted at a specific arbitrary rate over the life of the projection
Economics
Overview
 General Economic Flow

 Opex
Production  Field costs
X Price  Salaries
Future Gross Revenue (FGR)
 Capex
FGR  Drilling
– Opex  Facilities
– Capex  Major workovers
– Taxes  Infrastructure
Future Net Revenue (FNR)  Abandonment
 Taxes
FNR  Production taxes (oil, gas,
X Discount Factor cond.)
Present Worth (PW)  Asset tax
 Social contributions
 Profit tax
Economics
Operating Expenses (OPEX)
 The cost required to operate a field

 Fixed and variable components
 Variable costs are related to the level of production
 Fixed costs generally do not vary with time or production
 Examples of fixed and variable costs:
Fixed Variable
Salaries Fuel
Facility Power
Field Overheads Materials
Repairs and Maintenance Supplies
Workovers Processing costs
Economics
Operating Expenses (OPEX)
 Estimated with unit cost parameters

 Cost per bbl of oil
 Cost per bbl of oil plus water
 Annual cost per well
 Annual salaries
 Sensitive to changes in water cut and well rates

 All current costs are tied to some technical parameter based on today’s
conditions, but cost parameters must be realistic
 Future costs for greenfields should be lower (per bbl) than today, but if today’s
parameters are applied, OPEX can be overestimated
 Future costs for brownfields will be higher (per bbl), but if costs decline as
quickly as production, OPEX can be underestimated
Economics
Capital Costs (CAPEX)
 Exploration
 Seismic
 Wells: Exploration and Delineation
 Drilling costs
 Producers, Injectors, Monitoring wells, Sidetracks
 Facilities costs
 Processing facilities, Booster compressor stations, Telecommunications,
Housing, Pads
 Maintenance Costs
 Transportation infrastructure costs
 Pipelines (gas, oil, water)
 Roads
 Abandonment costs
 Wells and facilities
Economics
Capital Costs (CAPEX)
 Costs must be specific to development plan

 Costs for specific infrastructure and facilities projects
 Cost per activity (vertical drilling, horizontal drilling, sidetracking, recompletion)
 Annual maintenance costs
 Implication of CAPEX on reserves evaluation

 Fields can have negative FNR for some years during the development stage,
and forecasted production during these years is booked as reserves
 Capital costs must be fully compensated by positive FNR in future years (means
the CAPEX investment is profitable, and reserves can be associated with the
investment activity).
Economics
Classification of Fiscal Systems
Economics
 Concession Agreements
 Main Features
 Contractor owns production
 Reserve entitlement based on agreements
 Contractor pays taxes on profits
 Contractor owns the equipment and may be responsible for cost of abandonment
 Modern agreements
 The concession area is limited
 Provides for progressive relinquishment
 Duration is limited
 Exploration usually 6 to 12 years
 Exploitation 20 to 50 years
 Modern features
 Employment of nationals encouraged and expatriates limited
 Host Country receives reports and participates in decision-making process
 Contain work obligations
 Host Country participation
Economics
 Principal international oil producing provinces where concession agreements
are in effect.
 North Sea (Norway, Netherlands, Denmark, United Kingdom)
 Europe
 Australia
 Russia
 Argentina
 Brazil
 Peru
 U.S.A.
Economics
 Basic economic elements of concession agreements.
 Royalty
 government vs. private
 paid in kind or paid in cash
 Tax
 production tax
 corporation tax
 Royalty
 Payment in Kind
 Subtracted from net reserves
 Ownership not with company
 Payment in Cash
 Not typically subtracted from reserves
 Treated as production tax
Economics
 Production Sharing Contract

 Main Features
 Contractor operates at sole risk and expense
 Contractor is entitled to recover costs
 Balance of production is shared on a predetermined basis
 Contractor’s share is liable for taxation
 Equipment is the property of the host country
 “Fashionable” form of petroleum arrangement
 Areas using PSC
 Indonesia
 Africa - Angola, Algeria, Egypt, Nigeria
 Middle East/Asia - Yemen, Oman, Thailand, Malaysia, Vietnam, Syria
Economics

 Significant Features
 Cost Recovery
 Costs recovered from annual production
 Capital costs generally depreciated for cost recovery
 Un-recovered balance can be carried forward sometimes with interest
 Profit Share
 Compensates contractor for services provided and risks assumed
 Compensates government in lieu of royalty & production taxes
 Production remaining after cost recovery and is shared using any of several different schemes
 Straight percentage
 Tranched production
 Based on contractor’s cumulative cash flow
 Based on an “R” factor table
 Rate of return
Economics

 What does the SEC say about net reserves?
Economics
 Risk Service Contract

 Main features.
 Some termed Latin America PSC.
 Cost recovery and remuneration made in cash.
 Contractor may purchase production at a Discounted price
 Significant features.
 National oil company is sole owner.
 Contractor provides technical services at their expense
 Work program carried out at sole cost and risk of contractor
 Generally contractor operates the field
 Funds provided by contractor are reimbursed over a specified period
Economics
Price and Cost Estimation
 SEC Guidelines
 Average price on first day of month for preceding 12 months and costs at
effective date.
 Escalation only as specified by contract.
 Percentage escalation must be directly stated not tied to indicies (Gas Sales
Agreements, Tariff Agreements...).
 No inflation factor is applied - Except where specifically contracted (fixed and
determinable)
 Abandonment costs, should also be included.
 Income taxes applied using statutory rate.
 Discount rate – 10%
Economics
 SEC Price Calculations

 WTI Marker
Field Differential:
1. Use contract differentials
2. Use first day of 12 month avg.
3. Use historical avg. or correlation
Economics
 Overhead
 Overhead costs are all costs of services not directly associated to a specific well
or project
 District Office overhead
 Corporate Overhead
 Corporate Overhead (Home Office) not included in evaluation
 Scheduling Operating Expenses/Capital

 Most likely development plan
 Reflect reserves classification
 Coordination with production forecast
Economics
 SEC Costs Estimation

 Costs Prevailing on “as of” Date
 Current Year LOE or WP&B
 Future Costs
 ‘Matching Principle’
 Costs should match reserves case
 CAPEX- Historical Costs as Guide to Future Costs
 OPEX – Historical LOE’s – Consideration of Operational Changes
 Tariffs Often Not Included – Separate T&PA
 Ship or Pay Provisions
 Inside the Sales Point
 Impacts product streams as well as costs
Economics
 SEC OPEX Estimation

 Data Needs
 Operator’s Work Program and Budget
 Current & Previous Year
 Forecast or Proposed Budget
 Life of Field
 Transportation and Processing Agreements
 Current Tariff
 Escalation Provisions
 Ship or Pay Liabilities
Economics
 SEC OPEX Estimation

 Methods for Estimating Future OPEX
 Sufficient Historical Data (> 5 yrs)
 Regression of Annual Opex on Annual Production

 Y=mx + b
m = variable opex, b = fixed opex, y = annual opex, x = annual production
 Thorough review of historical opex to isolate fixed costs from variable costs
 Fixed Costs (Salaries and Benefits, Contract services, Plant opex, etc.)
 Variable Costs (Chemicals, Transportation, etc.)
 Insufficient Historical Data (< 5 yrs)
 Analogy to similar developments

 Cost Engineering
 Operator life of field estimates
Economics
 PRMS Estimations
 Any price that is judged to be reasonable and supportable
 Examples:
 Historical price using the SEC rule (annual average)
 Recent historical price (i.e. sales price recent to the evaluation)
 Forecasted prices from a credible source: internal plans, ministry forecast, consultant
forecast, etc.
 Escalation
 If price escalated, then operating costs must be escalated
 Contracting
 Sometimes prices are contracted into the future (sales agreements, etc.)
 Sufficient documentation of each project
 Description of each project
 Estimates of reserves, cost schedules and cash flows
Economics
 OPEX Estimation
 Rules of Thumb
 Offshore – High Fixed Costs
 70% Fixed
 30% Variable
 Onshore – Not Remote; No Dedicated Plant
 30-40% Fixed
 70-60% Variable
 Onshore – Remote; Dedicated Infrastucture
 70-80% Fixed
 30-20% Variable
Economics
 OPEX Estimation
 Sensibility Checks
 Life of Field Forecast
 Do cost reductions coincide with reduction in active wells & daily barrels of fluid produced?
Economics
Future Net Revenue and Present Worth
 The value of Future Net Revenue, discounted at a specific,

compounded interest rate to represent the time value of
money
𝐅𝐍𝐑=𝐅𝐆𝐑−𝐎𝐏𝐄𝐗−𝐂𝐀𝐏𝐄𝐗−𝐀𝐛𝐚𝐧𝐝𝐨𝐧𝐦𝐞𝐧𝐭 𝐜𝐨𝐬𝐭−𝐓𝐚𝐱𝐞𝐬
PWannual = FNR/(1+r)n
r = annual discount rate
n = number of years from year 0
Economics
 Sample calculation (annual basis) using a 10% discount rate
Year FNR Discount Factor PW@10%

2013 1,000 1/(1+0.1)0 = 1.000 1 000
2014 1 000 1/(1+0.1)1 = 0.909 909
2015 1 000 1/(1+0.1)2 = 0.826 826
2016 1 000 1/(1+0.1)3 = 0.751 751
Total 4,000 3,439
Economics
 Future Net Revenue (FNR) and Present Worth (PW)

 To determine whether each year of forecasted production is economic for
reserves, FNR is analyzed
 To determine the actual value of the reserves (taking into account the time
value of money), Present Worth is used
 Arbitrary rate is used for discounting (10% for SEC)
 For brownfields, most of the value is produced up front
 i.e. forecasted production in year 10, at well rates that are 70% of initial rates, is
worth 27% of the first year’s value
 i.e. forecasted production in year 20, at well rates that are 30% of initial rates, is
worth 4% of the first year’s value
 For greenfields PW to be positive, future production must be
very profitable to compensate for large up front costs
Economics
Economic Limit
 The production rate at which a project, field, reservoir, or well

is uneconomic to produce.
 Operating Cost + Taxes exceed revenues (FNR or other economic criteria are
negative)
 May be estimated on a daily, monthly, or annual basis
 Reserves may not be estimated for production below the economic limit
 Abandonment costs are not included in the estimate of economic limit – they are
assigned after the limit is determined. However, field must generate enough
total FNR to cover all field costs including abandonment.
Economics
Sample Report Table
Economics
Sample Report Table
Economic projections can be done for all categories of reserves

An “as of date” is needed
Economics
Sample Report Table
Net production = Gross production x working interest
Economics
Sample Report Table
Net reserves = 10.2 MMBOE
Economics
Sample Report Table
NPV @ 10% = 69 MM USD
Economics
Example
 Patagonia Oil Company calls for a reserves and resources certification of their
asset in Argentina under the PRMS guidelines as of Dec 31st, 2015. The Cerro
bajo field belongs to a UTE and Patagonia Oil Company has a 75% WI.
 General data of the field:

 Discovery : 2000
 End of license: 2024
 Possible extension: 10 years
 Commercial production: 2002
 Production wells 15
 Injection wells 5
 Oil production @ Oct 2015 10000 bbl/d
 Gas production (no sales gas) @ Oct 2015 500 Mcf/d
 Np oil: 200 MMbbl (30 % RF)
 Reservoir depth: 2000m
 All relevant technical information will be provided for the technical assessment.
Economics
Example
 Economic volumes assessments for all category of reserves

 Working interest = 75%
 Oil price = $50/bbl
 Royalties = 12%
 OPEX = $20/bbl
 CAPEX
PDP PUD 1P 2P 3P
Year ($M) ($M) ($M) ($M) ($M)
2016 0 600 600 600 600

2017 0 600 600 1200 1200
2018 0 2400 2400 3000 3000
2019 0 0 0 600 600
2020 0 0 0 600 600
2021 0 600 600 600 600
2022 0 0 0 0 0
2023 0 0 0 0 0
2024 0 0 0 0 0
 Abandonment costs
 PDP = $5 MM
 1P = $7 MM
 2P = $8 MM
 3P = $8 MM
Economics
Example
 Technical volumes assessments for all category of reserves

 PDP volumes: forecast of the existing wells at current operational conditions as of Dec
31st, 2015
 PUD volumes: 7 new wells to be drilled (out of 12 well
 P2 volumes: 4 new wells to be drilled (out of 7 well proposed)
 P3 volumes: 0 new wells to be drilled (out of 2 well proposed)
PD P PU D 1P 2P 3P
Oil Oil Oil Oil Oil
Year (Mbbl) (Mbbl) (Mbbl) (Mbbl) (Mbbl)
2016 3258 87 3345 3345 3345

2017 2525 134 2659 2746 2746
2018 802 821 1623 2012 2012
2019 343 460 803 1021 1021
2020 199 323 522 676 676
2021 109 322 431 636 636
2022 71 222 294 423 423
2023 50 163 213 299 299
2024 42 135 176 244 244
7399 2667 10066 11402 11402 EOC
2025 35 117 152 210 210
2026 30 88 118 154 154
2027 26 61 87 117 117
2028 23 31 53 68 68
2029 20 0 20 20 20
2030 18 0 18 18 18
2031 16 0 16 16 16
2032 10 0 10 10 10
2033 9 0 9 9 9
2034 0 0 55 55 55
187 297 538 677 677 RC
Economics
Example
 PDP Case
Economics
Example
 1P Case
Economics
Example
 2P Case
Economics
Example
 3P Case

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Knowledge Integrity Service

Oil & Gas Resources and Reserves Evaluation

DeGolyer and MacNaughton

 Integrated Team Approach

Reservoir Reservoir Operating Cost

 Why is economics important?

 How a reserves valuation is used?

 To provide management with the economic value of the oil/gas reserves.

Field Life Cycle and Typical Cumulative Cash Flow

 Field Life Cycle

 Gaining Access – Investigation and License acquisition

 Field Life Cycle – Gaining Access

 Field Life Cycle – Exploration

 Field Life Cycle – Appraisal

 Field Life Cycle – Development

 Field Life Cycle – Development

 Field Life Cycle – Development

 Field Life Cycle – Production

 Field Life Cycle – Decommissioning

 Field Life Cycle – Decommissioning

 Future Gross Revenue

 General Economic Flow

 The cost required to operate a field

 Estimated with unit cost parameters

 Sensitive to changes in water cut and well rates

 Costs must be specific to development plan

 Implication of CAPEX on reserves evaluation

 Production Sharing Contract

 Production Sharing Contract

 Production Sharing Contract

 Risk Service Contract

 SEC Price Calculations

 Scheduling Operating Expenses/Capital

 SEC Costs Estimation

 SEC OPEX Estimation

 SEC OPEX Estimation

 Regression of Annual Opex on Annual Production

 Insufficient Historical Data (< 5 yrs)

 Analogy to similar developments

 The value of Future Net Revenue, discounted at a specific,

 Sample calculation (annual basis) using a 10% discount rate

Year FNR Discount Factor PW@10%

 Future Net Revenue (FNR) and Present Worth (PW)

 The production rate at which a project, field, reservoir, or well

Economic projections can be done for all categories of reserves

Net production = Gross production x working interest

Net reserves = 10.2 MMBOE

NPV @ 10% = 69 MM USD

 General data of the field:

 Economic volumes assessments for all category of reserves

2016 0 600 600 600 600

 Technical volumes assessments for all category of reserves

2016 3258 87 3345 3345 3345

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