Module 5: Prognostication, Economic Analysis

and Prospect/Basin Analysis

What is Well Prognosis?

 Lets know first the meaning of prognosis - means Prediction

or Forecast

 The only way to determine that a prospect contains

commercial quantities of HCs is through drilling.

 And the drilling program is based on G & G data and

expectation.
What is Prognostication?
 It is the analytical study of the area (basin) after various
surveys are done and the

 The only way to determine that a prospect contains

commercial quantities of HCs is through drilling.

 And the drilling program is based on G & G data and its

interpretation.

 Reliability of prognostication depends on the quality &

quantity of data and expertise of Geologists and
Geophysicists.
The well prognosis includes information on:

1. Probable depth to the pay zone.

2. The thickness and properties of the pay zone/ zones.
3. Geological age of producing zone
4. Probable extent of the producing area which is important in case oil and
gas is found by the exploratory well
5. Surface conditions in the vicinity of the well that may affect the safety
and efficiency of operations
6. Topography and composition of the sea floor etc.

BASED ON ALL THESE FACTORS, GEO TECHNICAL ORDER FOR A WELL IS

PREPARED
What are the Characteristics of Prospective HC bearing
Basin?

1. Direct & Indirect evidence of the presence of O & G

2. Presence of favorable Structure
3. Presence of right kind of lithology
4. Presence of Cap rock
Economic Analysis of Prospects

Important factors that need to be considered before a prospect

can be recommended:

1. Land Situation
2. Geological Factors
3. Accessibility and Outlet
4. Economic Evaluation of venture
Economic Analysis of Prospects ( Cont…..)
(1) Land Situation : To estimate the Cost of acquiring mineral
rights (concession, lease or fee) on the land covering the
prospects.
(2) Geological Factors:
(i) To know the depth of probable zone which is an important
aspect, since it affects the cost of drilling.
(ii) The thickness & reservoir properties of the probable zone and
Probable extent of the producing area since these will give
the ultimate revenue of the project.
(3) Accessibility and Outlet : Operator should think of ways and
means of access to the site selected for the prospect and how
to take out the discovered HCs
Economic Analysis of Prospects ( Cont…..)
(4) Evaluation of Venture : It includes the analysis of Cost Data
i.e. Cash Outflow (The total expenses to be invested by the
Operator) and Cash Inflow.
 The petroleum exploration is a classic case of decision making
under high risk & uncertainties where input is more or less
deterministic but the output is always probabilistic.

 We need to have some means of deciding whether a particular

cash flow gives us an economic/ financial return or not, and if
so, how much.
 Let’s know some economic indicators which are the deciding
factors whether to invest or not in the project.
 The economic indicators are the measures of the relative
economic attractiveness of the cash flow compared to the cash
flows of other projects.
 The tell us whether one investment gives a greater economic
benefit than other investments which the company could make.
• Now we will be examine the meaning and use of
the economic indicators as below that are used
currently in the oil and gas industry

1.Net Present Value

2. Internal Rate of Return
3.Pay Back Period
4. Profit –to- investment Ratio
Net Present Value (NPV)

 NPV is the present value of future net cash flows for a given
discount rate.
 Net Present Value (NPV), is defined as the difference between
the sum of the “discounted cash flows” expected from the
investment and the amount initially invested.
 As an investment criteria, the Companies look for investment
opportunities which yield the highest NPV.

 NPV is one of the most robust financial evaluation tools to

estimate the value of an investment.
 NPV is the technique and uses the concept of TVM


Net Present Value (NPV) …… Cont.
 The discount rate refers to the interest rate
used in discounted cash flow (DCF) analysis to
determine the present value of future cash
flows.


 The discount rate in DCF analysis takes into

account not just the time value of money, but
also the risk or uncertainty of future cash flows;
the greater the uncertainty of future cash flows,
the higher the discount rate.
 The formula for calculating NPV :

C1 …Cn = Cash Inflow i.e. Return

C0 = Cash Outflow i.e. Amount Initially Invested.
K = Discount Rate
The Net Present Value (NPV) Concept says :
• Accept all projects whose NPV is +ive or NPV > 0 .
• Drop all projects with NPV < 0
• If NPV = 0, we are indifferent between accepting or dropping the
project.
• The NPV method can be used to select between projects. The one
with the higher NPV should be selected.
Investment Efficiency
 It is also known as

 Present Value Index

 Profitability Index
OR,
 Discounted Profit – to - Investment Ratio
• Calculated by dividing NPV by Investment
Decision Rule:

 It is used to evaluate the efficiency of an investment and is a

criteria to accept or reject an opportunity.

 If PI is greater than 1, accept the investment.

 If PI is less than 1, reject the investment

and
 if PI = 1, then indifferent (may accept or reject the decision)
ROI (Return on Investment):

 The Return on Investment (ROI), is a

comparison ratio of the money
gained or lost on an investment to the
amount of money invested.
ROI also is used to evaluate the
efficiency of an investment.

It is used to compare the efficiency

of a number of different
investments.
 To calculate ROI, the benefit (return) of an investment is
divided by the cost of the investment. The result is
expressed as a % or a ratio.

 Thus, ROI can be calculated as:

 Return on investment is a very popular metric

because of its simplicity.
ROI > 0 when the investment is profitable

ROI < 0 when the investment is at a loss

 If an investment does not have a positive ROI,

or if there are other opportunities with a
higher ROI, then that investment should not
be undertaken.
Internal Rate of Return (IRR)

 The IRR of an investment is

the discount rate at which the net
present value of costs (negative cash
flows) of the investment equals the net
present value of the benefits (positive
cash flows) of the investment.
Internal Rate of Return (Cont…..)
 As the interest rate increases then, the NPV is
reduced.

 At a specific discount rate, the NPV is reduced

to zero.
 This discount rate is called the internal rate of
return (1RR).

 Thus, It can be defined as the discount rate at

which the present value of all future cash flow
is equal to the initial investment or in other
words, the rate at which an investment breaks
even.
Internal Rate of Return (Cont….)

 In more than one projects, the higher a project's IRR,

the more desirable it is to undertake the project.

 Assuming all projects require almost the same

amount of up-front investment, the project with the
highest IRR would be considered the best and
undertaken first.

 An investment is considered acceptable if its internal rate

of return is greater than an established minimum
acceptable rate of return or cost of capital.
Decision Rule
• Accept all project with IRR > discount Factor
• Drop all project with IRR < discount Factor
• If IRR = Discount Factor, We are indifferent
The higher a project's internal rate of return,
the more desirable it is to undertake the
project.
Pay Back Period

• While starting any business venture or introducing any new

product in the market, it is important to determine its payback
period.

• Pay Back Period is the length of time in which the initial cash
outflow of an investment is expected to be recovered from the
cash inflows generated by the investment.

• It is one of the simplest investment appraisal technique.

Pay Back Period (Cont…..)

• The payback period of a given investment or

project is an important determinant of whether
to undertake the position or project, as longer
payback periods are typically not desirable for
investment positions.
Advantages:

1. Payback period is very simple to

calculate.
2. It can be a measure of risk inherent in
a project.
When cash inflows are uneven, we need to
calculate the cumulative net cash flow for each
period and then use the following formula:
Decision Rule:

Accept the project only if its payback

period is LESS than the target
payback period.
Disadvantages:

Payback period does not take into

account the time value of money which
is a serious drawback since it can lead
to wrong decisions.