6 Economics 1 PDF

SPE Introduction to E&P
Petroleum Economics & Commercial
November 28th, 2019

Lamé Verre
© 2019 Halliburton. All rights reserved.

Table of Content
1 • Introduction
2. • Key Concepts in Petroleum Economics
3. • Applying Petroleum Economics Methodologies
4. • Key Petroleum Economics Output
5. • The E&P Team
6. • Conclusion
© 2017 Halliburton. All rights reserved. 2

Introduction

Overview of the E&P Life Cycle
 The activities within the E&P lifecycle all require analysis and decision making utilizing Petroleum
Economics & Commercial analysis tools
Exploitation & Enhanced

Appraisal Development Operation Decommission
Exploration Production
 Acquiring rights • Further Seismic • Concept  Production  Maximize  End of economic

 Geological Surveys Selection Recovery life safely and
 Transport &
cleanly plug and
 Gravimetric • Appraisal Drilling • Detailed Process  Tertiary
abandon wells
Magnetic Economic Agreements Recovery
• Studies  Decommission
Appraisal (TPA)
 Seismic  Extend field life
• Geological and dispose of
Surveys • Detailed  Crude Sales using Enhanced facilities and
Modeling
 Exploration Engineering /Offtake Oil Recovery pipelines
Drilling • Initial Economic Agreements (EOR)
• Financing
Appraisal techniques
 Fiscal Systems  Gas Sales
• Development
Review Agreements
Drilling
(GSA)
 Joint Venture /
• Facilities
Joint Operating
Agreements • Pipelines

Why Petroleum Economics is Necessary
 Field Development Plans (FDPs) : To assess the

Project Risk inherent E&P project and decision risks
Analysis
 Final Investment Decisions (FIDs) : To make
informed decisions on how to efficiently allocate
scarce resources
 M&A activities : To evaluate investment returns
 Statutory & Regulatory Requirements : To make
submissions to SEC and facilitate IPO listing
Project Stage
Gate  License Round Participation : To grow E&P portfolio
Management organically

E&P Project Risk Lifecycle
Exploration Field in Mature

Acreage Development Field
Higher Lower
Risk Risk
Discovery Field Decommissioning
under Recently
Appraisal on Stream
Exploration Well Construction Completions Production Decommissioning

E&P Above Ground Risks
Energy Transition
&
Climate Change
Technological
HSEQ
&
&
Digital
ESG
Transformation
E&P
Human
Capital Geopolitical
& &
Local Security
Content
Economic
&
Financial

Project Stage Gate Process
Value Creation Value Delivery
Identify & Assess Evaluate & Select Define Execute Operate
Front End Good Project
VALUE
VALUE
Loading Execution
FID
Good Project
Definition Operational
Excellence
Cycle Time
Identify and Asses Most important phase Optimise selected Detail Design and Execute Operate
opportunity Identify, Evaluate & Rank alternative & plan execution project
multiple alternatives Project close out
Check fit with business Basis for Design Procure, construct,
Verify technical, commercial, Project review (lessons learned)
strategy economical viability Project Specification commission.
Verify potential viability Verify alignment with Verify operating performance
Develop risk mitigation plan Track Project Performance
business strategy
Create Project Charter Verify value realization
Select single “best” Define KPIs Verify readiness for
Plan for Evaluate & Select alternative Operations & pre-Start-up Maintain & optimize the system to
Develop project execution
Plan for Define phase maximise value
phase plan (PEP)
E&P Key Financial Decision Making Points
Higher Lower
Risk Risk
Range of uncertainty
Time
Investment decision
Fiscal terms set; Significant costs
Bonus paid Deep offshore wells
>£100 million each Operations lower risk than
development
Key decision points

Prospect “de-risked”
with first discovery
Key Concepts in Petroleum Economics

Key Petroleum Economics Concepts
Fiscal
Regime
Internal
Rate of
Cash Flow
Return
(IRR)
Petroleum
Expected Economics
Monetary Time Value
Value of Money
(EMV)
Net
Present
Discounting
Value
(NPV)
Fiscal Regime/Systems: Government Take
 Government take is the revenue that the sovereign state earns from an oil and gas asset.
 There are three main types of oil & gas fiscal systems/regimes around the world.
Tax/Royalty Production Sharing Agreements Service Agreements

Agreements (PSA) / / Service Contracts
(Concessions) Production Sharing Contracts (RSC, TSA, PEC)
(PSC)
Royalty  
Tax  
Corporate Tax  
Special Petroleum
Taxes (PRRT, PPT,   As per Heads of
PRT etc.) Terms Agreement.
Fees & Signature

Bonuses
Profit / Production Share 
Other 
Government Take Examples

Fiscal Regime/Systems: Resource Entitlement & Recognition
Contract Type Ownership Payment Reserves Recognition
Concession Contractor/Oil Company In Kind Yes
Joint Venture Contractor/Oil Company In Kind Yes
Production Sharing Contractor/Oil Company In Kind Yes
Revenue Sharing State/Government Share of Revenue Yes
Risked Service State/Government Fee-Based Likely*
Pure Service State/Government Fee-Based No
Purchase State/Government Product Cost No
Loan State/Government Interest No
* If the contractor is exposed to capital risk and or market risk

Cashflow
 Petroleum economic
evaluation is based on the use
Project
of Cashflow analysis or
Discounted Cash Flow
analysis (DCF).
 Cashflow measures the

movement (inflow and outflow)
of money in discrete time Company CASHFLOW Finance
periods.
 But, we need to be clear on

whose Cashflow we measure
– The Project, The Company,
The Lender, The Shareholder? Shareholder

Time Value of Money
 A Dollar (or Rupiah or Pounds or any unit of currency) is worth more today than it is
tomorrow. This is known as the Time Value of Money.
 While there are a number of methods and techniques employed in the economic
analysis of opportunities, the Discounted Cash Flow (DCF) is by far the most common.
 Present Value (PV) = Future Value (FV) * Discount Factor

 Discount Factor = 1/(1+r)n
» Where:
 r = Discount Rate
 n = Time Period
 Discount rate adjusts time value of money ("risk-free" investments) and systematic risk

Discounting - Discount Factor
 Discounting is the opposite of interest.

 Put $100 in a bank and it will appreciate over time. Thus, at 10% interest, $110 next
year is worth $100 today.
 Discount Factor depends upon timing, i.e. Start of year or Mid-year or End of year.
 Time value is relative to discount start date, e.g.
Values for subsequent years are calculated by dividing the previous factors by
1/(1.10) and 1/(1.15) respectively

Discounting - Cost of Capital
 The discount rate used in evaluating an investment Typical
should be appropriate to the risk of the PROJECT, Industry Value
Activity Discount
not the company. Chain
Rates
 Discount rates should only account for market (or Upstream Exploration 15% - 20%
systematic) risk, not idiosyncratic (unsystematic or
specific) risk. Upstream Production 10% - 15%
Midstream Power 8% - 12%

 When is a risk "market" or "systematic", and when is
it "specific" or “unsystematic”?
Midstream Pipelines 8% - 12%
 Exploration vs. Development vs. Production
 Oil vs. Gas Midstream Petrochemicals 12% - 18%
 Working interest vs. Revenue interest
 Upstream vs. Midstream vs. Downstream
Refining &
 Country A vs. Country B vs. Country C Refining 12% - 18%
Marketing
 Leveraged vs. Equity

Cost of Capital vs Discount Rate
 Discount Rate is the Weighted Average (Company) Cost of Capital (WACC) and the Rate
appropriate to project (Project Risk).
Cost of Capital vs Discount Rate
20%
Project Specific
Risk Premium
Required return
over Cost of Capital
15% + + 3%
Company
Cost
of Capital 3%
10% Project Discount
Corporate Hurdle Rate16.20%
Equity Rate 13.20%
WACC
5%
10.20%
Debt
0%
1 2 3

Net Present Value (NPV)
 Net Present Value (NPV) is the sum of the individual discounted cash flows for a future cash flow
stream.
 To properly express NPV, one must also show a discount rate and a point in time, e.g.:
 The Net Present Value at 10% discount rate (NPV10 or PV10) as of 1st January 2019 is $132.5M.
 Note:
 NPVs of different cash flow streams as of the same date are additive, even if they have different
discount rates.
 NPVs as of different dates are NOT additive, even if they have the same discount rate.
 Net Present Value Rule:

 A project with a positive NPV is worth investing in.
» Positive NPV = investment creates value,
» Negative NPV = investment destroys value,
» Companies should aim to maximize the NPV of its portfolio of projects and assets.

Net Present Value (NPV) Example
 NPV depends on the Quantum and Timing of cash flows.

 Higher undiscounted cash flows ≠ higher NPV.
 Example: Discount the following Cashflow at 10%
Cashflows Present value Disc. Rate 10%
Year A B C Disc. factor A B C

1 (100) (100) (200) 1.000 (100) (100) (200)
2 30 - - 0.909 27 - -
3 30 - - 0.826 25 - -
4 30 - 100 0.751 23 - 75
5 30 50 100 0.683 20 34 68
6 30 100 100 0.621 19 62 62
Net cashflow 50 50 100
c
NPV 14
c
(4) 6

Internal Rate of Return (IRR) 1/2
 Discount rate at which the NPV of a cash flow

stream = zero
 Also known as Rate Of Return (ROR, or Zero NPV at

DCFROR) 15.2%
 Not the same as accounting Return on Assets

(ROA), Return on Equity (ROE), etc.
 Rate of Return Rule

 Projects where IRR exceeds the
appropriate hurdle rate are worth investing
in
 “Hurdle rate” is usually WACC plus some
margin and is company specific
Internal Rate of Return (IRR) 2/2
 Watch out:
 RORs are NOT additive, nor can they be averaged
» One project with a 10% ROR and one with a 15% ROR do NOT = 25% ROR or average
12.5% ROR.
» Aggregate the cash flows, not the IRR
 High IRR can still mean low NPV
 Multiple IRR if sign of cash flows changes multiple times in the Cashflow (investments)
 The rate of return like NPV reflects the TIMING and RELATIVE size of cash flows and
NOT the ABSOLUTE size
» A small project can have a very high rate of return, but not necessarily be the best project to
undertake.
» When capital is limited, it is particularly important to understand the situation; it is the highest
total NPV over the long term that matter, not the higher ROR projects
Net Present Value (NPV) vs. Internal Rate of Return (IRR)
Cashflows Present value

Year A B Disc. factor A B
1 (100) (1,000) 1.000 (100) (1,000)
2 50 300 0.909 45 273
3 50 300 0.826 41 248
4 50 300 0.751 38 225
5 50 300 0.683 34 205
6 50 300 0.621 31 186
Net cashflow 150 500 NPV 90 137
IRR 41.0% 15.2%
Project A has a higher IRR however a lower NPV.

Maximize NPV, Not IRR.
Expected Monetary Value (EMV)
 Ideal for Exploration & Appraisal Projects
 EMV = NPV
Case NPV
Dry Hole (£5 MM)

90%
EMV Drill
Well
(£0.36 MM)
Non-commercial (£5 MM)
10% 20%
Discovery
30% Low £10 MM
80% 40%
Commercial Best £50 MM
30% High £100 MM
Overall Probability of Commercial Discovery = 8%

Recap
 Petroleum Economics is an Investment Decision Analysis tool

 It uses projected cash flows and takes into account:
 The time value of money
 The relative risk underlying the cash flows
 The most common approach is Discounted Cashflow Analysis (DCF)
 Collapses cash flows over the entire life of a project into a single metric - “Net Present
Value” that can be used to compare alternative uses for the same funds
 NPV measures or evaluates whether a given project is worth doing; i.e. does the
project create value relative to the cost of capital?
 IRR defines the economic return on investment

Applying Petroleum Economics Methodologies

Discounted Cash Flow (DCF)
 Petroleum Economics is done using the discounted Cash flow analysis through:
• Deterministic or Probabilistic method; and
• In Real or Nominal terms
 DCF is done by combining all the Technical, Economic & Commercial inputs in a model
Revenue = Production X Price
Undiscounted Cash flow =

Revenue – Royalties – Costs – Taxes
Discounted Cash flow =

Undiscounted Cash flow X Discounting Factor
Net Present Value =

Sum of Discounted Cash flow

Identifying Cash Flows for DCF Analysis
 Typically done either - Full Cycle or Point Forward or as an Incremental Analysis
1,500
1,000 Full Cycle -from the beginning
Point Forward -from Final Investment Decision (FID)

500
£
Exploration Incremental
Millions &
Appraisal
Development Capex
Incremental Case
(500) Revenues
Drilling (Tertiary Recovery)
Base Case
Revenues
(1,000)
Opex Abandonment/
Decommissioning
Economic Modelling Considerations
Commercial
Agreements
&
Fiscal Regime
Production
Profiles
Cash Flows
Development
Concept
Petroleum Cost
Economics Profiles Economic Sensitivity Outputs
Inputs ESG & Model Analysis
Carbon
Emissions Hydrocarbon
Prices
Key
Performance
Indicators

Key Outputs from PE Methodologies

A Typical Cash Flow Curve
10,000
Payback
8,000
6,000 Maximum
Financial
Exposure
£ Millions
4,000 Decommissioning
2,000
-
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 26 27
-2,000
-4,000 Investment
Phase
Net Revenues After-Tax Cashflow Cum Cashflow

Sensitivity Analysis
Example Tornado Chart
Production (Low/High)
Discount Rate (+/- 2%)
Oil Price ($45

(£45 // $75)
£75)
Gas Price (+/-

(+/-$1.00/Mscf)
£0.5/ Mscf)
Capex (+/- 20%)
Opex (+/- 20%)
-1000 -500 0 500 1000 1500 2000 2500 3000 3500 4000
Base Case = NPV10
All Parameters & Variables should always be stress tested

Unit Cost Analysis
 Cost Categories and Unit cost show efficiency in £/bbl.
Finding / Discovery Cost
Enhanced
Exploration Appraisal Development Operation Decommission
Production
Finding & Development (F&D) Cost Lifting Cost

Capex/bbl. Opex/bbl.

Unit Costs per Barrel Example

Example of Break Even Prices 2015 - 2018
Source: PWC Report - Current developments and a look into the future
November 2018
Petroleum Economics Output - Key Performance Indicators
 Reserves  Economic
 Reserve Life Index (years)  NPV / EMV
 Reserves Replacement Ratio (%)  IRR
 Reserves Replacement Cost (£/boe)  PV-Ratio (Profit Investment Ratio)
 Pay Back
 Technical Competence  Maximum Financial Ratio
 Discovery Cost (£/boe)  Breakeven
 Finding and Development Cost (£/boe)
 Lifting Cost (£/boe)  Financial
 Technical Cost £/boe)  Earning Before Interest and Taxes (EBIT)
 Return on Average Equity
 Successful Efforts  Return On Capital Employed (%)
 Commercial Success Ratio (%)  Weighted Average Cost of Capital (%)
 Technical Success Ratio (%)  Revenue per boe (£/boe)
 Profit per boe (£/boe)
 Cash Flow per boe (£/boe)
The E&P Team

The People, The Process
An integrated workflow & team is highly recommended
Updated
Assumptions Decision Making
Approvals
Subsurface Economics
Asset Management
(G&G, Reservoir Engineering &
Engineers) Commercial
Planning/Budget
STOIIP/GIIP/ Development Options & Discounted Cash Flow
Production Profiles Cost Estimates Analysis Financing
 Calculate MCFS (min  Wells (Number & Location)  NPV & EMV Sale & Purchase
com/eco field size) based on  Facilities (topside & subsea)  IRR, PIR, MFE, Payback
current economic &  Pipelines  Sensitivity Analysis
technological assessment.  Product-2-market solutions  Graphing
 Production Profiles above  CAPEX Schedule etc.  Economic Cashflow
MCFS (P10, P50 & P90)  Economic Limit Test
 # Wells (E, A & P)  Tariffs Expense (Transport,
 Hydrocarbon mix extraction and production)
 Product data (shrink, yield  Tariff income Peer Reviews
etc.)  Other income, etc. are Essential
 Peak rates

Conclusion

Useful Checklist
FISCAL & COMMERCIAL TECHNICAL ECONOMIC & OTHER
Fiscal Regime/Special Taxes Production Profile Appropriate Price Scenario
 Tax/royalty  Sales Volume  Forecast/Constant
 Production Sharing Contract  Units – Metric/imperial  Discount or Premium to reference crude
 Risk Service Contract  Day rates/Annual Volumes
 Technical Service Contract Real vs. Nominal
 Inflation/Escalation
 Bonuses Associated Costs - Real/Nominal &
 Petroleum Profit Tax, etc. Units
Discounting/Evaluation Date
 Education Tax/VAT/Import Tax  Exploration and appraisal  Discount Date
 Other local taxes o Geological and geophysical costs  Discount Rate
Exploration drilling
Commercial o Studies Exchange Rate (where applicable)
 Transportation Agreements (If any)  Development Capital costs “Capex”
 Crude Oil Handling (if any) o Drilling costs: Depreciation
 Gas Sales Agreements o Facilities costs  Straight Line
 Gas Processing (if any) o Pipelines  Unit of Payments
 Loan Agreement (if any) o Sustaining (replacement) capital
 Any special agreement/contracts costs Tax Position (at start of evaluation period)
 Tariff receipts or payments  Operating costs: “Opex”  Capital Allowances (historic Capex)
 Overriding royalties o Lifting costs  Tax Losses (from previous tax years)
 Unrecovered Cost Pool in case of PSCs
 Abandonment Security Agreement o Treatment
 Accumulated Net Cash Flow Balances (in
o Injection / fuel
case of PSCs)
Expiry dates o Transportation  Ring-fences
 License o General and admin: G&A  Sunk cost
 Infrastructure lifespan  Abandonment/Decommissioning cost
 FPSO lease
© 2017 Halliburton. All rights reserved. 41 ESG & Carbon Emissions
In Summary
 The What?  Inputs Required
» Petroleum Economics Concepts » Project economics require the following input
data:
» Fiscal Systems
 Technical
 The Why?
 Economic
» Project Ranking, Concept Selection
 Fiscal
» At every stage of the project or asset life cycle.
» Other commercial terms
» Regulatory Requirements, Financing, Monitoring
 Main Outputs:
 The How? » Cashflow analysis
» Economic Modelling
» KPIs like NPV, EMV, IRR, MFE, Payback,
» Using Discounted cash flow analysis
» Sensitivity analysis
» Project economics can be done on the following
basis: » Unit cost per barrel
 Deterministic or Probabilistic
 Full Cycle or Point Forward
 Incremental or Standalone
 In real or nominal terms

London, UK
Lame +44 790 494 7468

Verre
Lame.verre@gmail.com
Founder Snr Region
M.Sc. Commercial & Manager, Women’s
Head of Corporate
Energy & & Economics Co-Founder Treasury Credit & Leadership
Economics Finance
Environmental & Analyst Manager Collections Development
UKCS Program
Economics Economics Europe, Eurasia & Program
BSC
National Management Petroleum Americas Sub-Saharan
Economics Economist Africa
Service
& Statistics
MBA
1999 2000 2001 2002 2003 2004 2005 2006 2007 2008 2009 2010 2011 2012 2013 2014 2015 2016 2017 2018 2019 2020


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SPE Introduction to E&P

Petroleum Economics & Commercial

November 28th, 2019

© 2019 Halliburton. All rights reserved.

2. • Key Concepts in Petroleum Economics

3. • Applying Petroleum Economics Methodologies

4. • Key Petroleum Economics Output

5. • The E&P Team

© 2017 Halliburton. All rights reserved. 2

© 2017 Halliburton. All rights reserved.

Exploitation & Enhanced

 Acquiring rights • Further Seismic • Concept  Production  Maximize  End of economic

© 2017 Halliburton. All rights reserved. 4

 Field Development Plans (FDPs) : To assess the

© 2017 Halliburton. All rights reserved. 5

Exploration Field in Mature

Exploration Well Construction Completions Production Decommissioning

© 2017 Halliburton. All rights reserved. 6

© 2017 Halliburton. All rights reserved. 7

Key decision points

© 2017 Halliburton. All rights reserved.

Tax/Royalty Production Sharing Agreements Service Agreements

© 2017 Halliburton. All rights reserved. 13

Contract Type Ownership Payment Reserves Recognition

Concession Contractor/Oil Company In Kind Yes

Joint Venture Contractor/Oil Company In Kind Yes

Production Sharing Contractor/Oil Company In Kind Yes

Revenue Sharing State/Government Share of Revenue Yes

Risked Service State/Government Fee-Based Likely*

Pure Service State/Government Fee-Based No

Purchase State/Government Product Cost No

Loan State/Government Interest No

* If the contractor is exposed to capital risk and or market risk

© 2017 Halliburton. All rights reserved. 14

 Cashflow measures the

 But, we need to be clear on

© 2017 Halliburton. All rights reserved. 15

 Present Value (PV) = Future Value (FV) * Discount Factor

© 2017 Halliburton. All rights reserved. 16

 Discounting is the opposite of interest.

 Time value is relative to discount start date, e.g.

© 2017 Halliburton. All rights reserved. 17

Midstream Power 8% - 12%

© 2017 Halliburton. All rights reserved. 18

© 2017 Halliburton. All rights reserved. 19

 Net Present Value Rule:

© 2017 Halliburton. All rights reserved. 20

 NPV depends on the Quantum and Timing of cash flows.

Cashflows Present value Disc. Rate 10%

Year A B C Disc. factor A B C

© 2017 Halliburton. All rights reserved. 21

 Discount rate at which the NPV of a cash flow

 Also known as Rate Of Return (ROR, or Zero NPV at

 Not the same as accounting Return on Assets

 Rate of Return Rule

Cashflows Present value

Project A has a higher IRR however a lower NPV.

Dry Hole (£5 MM)

30% High £100 MM

Overall Probability of Commercial Discovery = 8%

 Petroleum Economics is an Investment Decision Analysis tool

© 2017 Halliburton. All rights reserved. 26

© 2017 Halliburton. All rights reserved.