Petroleum

Economics and
Risk Analysis
GEOE 530
METU Geological Engineering
Dr. Zeynep Elif Yıldızel
Why we do Economics
• Exploration and production of hydrocarbons is a high-risk venture
• The viability of any business venture can be expressed as the difference (either profit
or loss) between revenue and costs
Profit (Loss)= Revenue- Costs
• In oil business this simple equation is complicated by tax, bonuses, or pre
investments before generating cash, operating costs, capital expenditures,
• Exploration prospect evaluations differ from many other investment analyses,
because they are entirely dependent on an uncertain event‐ a hydrocarbon discovery
that meets the threshold of being commercial. Prior to drilling, due to this uncertain
event, any analysis is inherently speculative.
• Most of the exploration possibilities are unsuccessful and oil companies are high risk
takers where they reduce risk by diversification.
How We Value Oil Price?
• Reference Crude Oil: some crude oil types are used as a reference or benchmark to determine the
value of other crude oils;
• Brent Blend
• Dubai – Oman
• Tapis Crude
• West Texas Intermediate (WTI)

West Texas
Brent Blend Dubai-Oman Tapis Crude
Intermediate (WTI)
A blend of several crude oil from
fields in the NorthSea region,
Used as a benchmark for Middle Oil produced in Malaysia that is used
located above Germany and United A very high quality sweet, light oil
East sour crude oil flowing to the as a reference for light oil from East
Kingdom. The price of oil produced produced in North America.
Asia-Pasific region. Asia.
in Africa, Europe and Middle East
tends to be based on this oil.
Oil Price Estimation is The Key Element Of Industry
Crude Price Estimation_1990-2040

Not below
50$

• The age of cheap oil is over – IOC’s love high crude prices
• Policies should bring lower international prices
• However, “Continuous negotiation between IOC’s and NOC’s for such efforts” would
keep oil prices high..
• 2009 crisis would repeated in 2014 - but dynamics would force crude prices to go up..
Probability

• Probability = 1-Risk
• P=1 means 100% certainty
• P=0 means 0% certainty
Work Flow
COCS

• MCR is the minimum amount of resources which is commercial

• COCS is the multiplication of COS of the project with the probability of the
minimum commercial resources
COES

• MER is the minimum amount of reserve that is economic for the full lifetime of
the project
• COES is the multiplication of the prospect COS with the probability of the
minimum economic resources
The Time vs Cash FLow in Oil Business

Exploration Apprasial Development Production

Field Life Cycle

• During exploration and appraisal there is cash out

• When early production starts there is both cash out and cash in
• During plateau production there is cash in and huge revenues are made
• During production decline there is decline in cash in
• During Abandonment there is cash out only ( the funds for abandonment are usually saved during plateau productions)
Basic Terminolgy
• CAPEX: capital expenditure; wells, bonuses, seismic, G&G expenditures
• OPEX: operating expenditure; maintenance, salaries, insurance,
• Government take: royalty tax, social contributions
• Royalty: the government take from production before tax
• Internal Rate of Return (IRR): calculated rate of return on a specific investment
• Net Present Value (NPV): sum of the funds flow for a specific case
• Discounted Cash Flow (DCF): time value of money
• Payback: period over which the cumulative cash flow exceeds cumulative cost, where it is
equal to original investment
• Cash Flow (CF): annual payments and receipts from a specific project
• Expected Monetary Value (EMV): total of the risk weighted outcome of different cases
• Investment Efficiency (IE): it is the ratio of profit to investment
• Chances of Commercial Success (COCS): probability of making a discovery that it will be
profitable on a point forward bases
• Chances of Economic Success (COES): probability that on a full cycle basis that the project
will be profitable
• Minimum Commercial Resource (MCR): smallest volume of reserves discovered that can
make money
• Minimum Economic Resource (MER): smallest hydrocarbon volume that will make money
on full cycle of the project
Expected Monetary Value

• Total outcome of the project for different cases

Investment Efficiency

• Investment efficiency is the ratio of funds gained by this project over maximum negative
cash flow which is net investment.
• MNCF is the turnaround point of a project based on cumulative net cash flow which
represents net investment
• It is used for budgeting
Input Data to the Economic Evaluation

• The contract issues are the major inputs including but not limited to; royalty, tax,
minimum work obligation, signature bonus
• OPEX and CAPEX (most of the capex comes from the contract and investment plan)
• Contract life time investment programme
• Field lifetime cumulative productions
How to Calculate R, NCF, Cost / barel

Production
Cash Flow
• Cash flow is in negative values at the
first three years as only investment is
done
• After year 4 cash in starts
• Cumulative cash flow is the sum of
the previous with this years cash
• Pay out time is the time when the
project pays itself. It is the point
where net cash flow crosses the x axis
and enters into the positive side
• The maximum negative point is the
maximum cash exposure, which is the
maximum limit of investment without
any cash in
Output of an Economic Analysis

• At the first 3-5 years are investment years where cash flow is negative which means there is no income
• After the production starts then government take starts
• As income occurs due to production then cash flows become positive
• The point where the cash flow intersects the x axis is the point where the project pays back
Result of an Economic Analysis in PSCs

• The diagram shows the allocation of royalty, tax, profit oil, capex, opex and other commercial
terms in PSC (production sharing agreements)
• The majority of the profit is taken by government in royalty, tax and NOC forms
• Due to this high percentage of government take most of the E&P projects are profitable for a long
period until the filed is depleted and need more vast investment depending of the size of the field
Cumulative Cash Flow at 80$/bbl

• The overall government take by different instruments are 90.3% of the total revenue
generated.
• The contractors take is about 9.7% of the total revenue generated.
• This project has to be profitable due to 9.7% of the contractors revenue and IRR should be
over a certain value in order to invest, otherwise the contractor will put money into bank
and gain interest without any risk.
Sensitivity Analysis
Example for Tax and Royalty
Case Study for a Field A.
• Duration is 20 years + 5 years extension (with new negotiations)

• Structure;
Contractor : 75%
State Comp. : 25%

• Participating interest should not be less than 3.75%

• Expenditures :
Supplementary Costs (Signature bonus, HSE , de-mining, Security, Env. )
Petroleum Costs (Development and Production Costs)

• Cost Recovery :
Supplementary Costs (not all); after from effective date
Petroleum Costs (all) : payment starts after first commercial discovery
• Remuneration Fee
• Remuneration Fee: Paid for the contractor for Development&Production Works (8.5 USD/1 BOE)
• Performance Factor
• Performance Factor (P); reduction applies for 7 years starting with earlier of;
➢ three years after reaching the IPT
➢ reaching Enhanced Production Target
• R Factor Adjustments
➢ Oil Contracts
✓ Reduces to 80% when R factor exceeds 1.0
✓ Further reduces in 20% steps to 20% when R factor equals 1.6
➢ Gas Contracts
✓ Reduces to 80% when R factor exceeds 1.0
✓ Reduces to 30% when R factor equals 2.0 and above
A Field – General Assumptions

A
C
K
Commercial Structure in PSA

24
Field A Minimum Work Obligation and Investment
MWO COST
• 3 D Seismic • Seismic
- 400 square km 20 million $
12 million $ (security)
• Drilling and Completion
- 75 wells • Drilling and Completion
25 million $ - 5 wells(recompletion)
• Surface Facility 1215 million $ - 70 wells
- Seperators
- Dehydration Unit • Surface Facilities
- Compressors 800 million $ - 75 wells

• Gathering Lines • Gathering Lines

- - 240 km 6” 40 km 20” 72 wells 6” Pipeline - 45 million $ (75 wells)
20” Pipeline – 60 million $
• Connection Lines
- 52 km 42”(72 wells) to T1 pumping • Connection Line
station(Iraq gas pipeline network) 32”/42” Pipeline – 50/65.5 million $
(50/72 wells)
Stratigraphy of A Field
NOT: L grade yüksek sıcaklık
nedeniyle seçilmiştir.
A-5 A-1 A-2 A-3 A-4 A-6
20"

m.

.B
K-55 133,0 500

F.W
#
-68
66
500 m. 13 3/8"
20"
m.

.B
L-80 68,0 1200

F.W
73#
70-

1200 m.
13 3/8" 9 5/8"

m.
.M
L-80 47,0 2050
O.B
80#
73-

7"

• 2050m.
The oldest unit penetrated
9 5/8" L-80 with
26,0 in the
m.
0-2500field is Ordovician Khabour formation
M
.B.

L-80 29,0 2500-3300

• The whole section is composed of carbonates and marls with some anhydrite
#O
-77
74

except red beds which is composed of alluvial and soil and seperated the U.
3300 m.
Cretaceous from
7" Upper Carboniferous with an unconformity

• There are two reservoirs: one of them is Ordovician Khabour and the other is
sandstones of Silurain Akkas Formation.
Well Data Set in A Filed

• A-1 = TD: 4239m

• A-2= TD: 3100m
• A-3= TD: 3250m at the crest of the strucure
• A-4= TD: 2515m
• A-5= TD: 2600m
• A-6= TD: ?
• There is one verticel well and the others are horizantal.

P90 P50

Area km2 334 393

Depth
-2060 -2080
contour
Porosity % 8 13 Well Depth (m) Subsea (m)
Saturation No RTKB
60 50 FM Khabour
Akkas FM TD Well No Akkas
FM FM
Khabour TD
Water
Net Pay Ak-1 1455 2327 4239 287 Ak-1 -1168 -2040 -3952
10 20
Ak-2 1453 2335 3100 345 Ak-2 -1108 -1990 -2755
Gas in Place
1,414 4,51 Ak-3 1329 2320 3250 375 Ak-3 -954 -1945 -2875
Tcf
Ak-4 1380 2430 2515 401,2 Ak-4 -979 -2029 -2114
Recoverable
Gas Tcf 0,99 3,61 Ak-5 1548 2507 2600 348 Ak-5 -1200 -2159 -2252
Ak-6 ? ? ? ? Ak-6 ? ? ?
K Formation Depth map (datum 300m)
 Well Locations and Infrastructures

To Location B

T1 Pump Station

• 70 wells drilling
Surface Facility
• 5 wells recompletion
• Surface facility
• 4 manifolds
• Gathering lines
• 52 km of pipeline to
Manifolds pumping station
Gas Processing Plant

DEW POINT DEHYDRATION COOLING

LIQUID STABILIZATION
CONTROL
GAS METERING

MANIFOLD
WATER
DEETHANIZER

STABILIZER UTILITIES

NGL
COMPRESSOR

POWER GENERATION
LPG

STORAGE

Delivery Point
EXPORT
PIPELINE
A Field - OPEX

OPEX
Direct expenditures
Personnel 200,00 MM$
Maintenance & operation 125,00 MM$
Logistics & procurement 150,00 MM$
Well maintenance 75,00 MM$
Insurance 200,00 MM$
Total Direct Expenditures 750,00 MM$
Project Expenditures 150,00 MM$
Security Expenditures excluding de-minig 160,00 MM$
TOTAL 1060,00 MM$
A Field – CAPEX, Total Investment

• Seismic and Wells.................................1272.0 million $ (75 wells, 800km2)

• Infrastructures.........................................955.5 million $ (75 wells)

_____________________
• Total Capex.......................................... 2227.5 million $ (75 production well- 14,3 mmcm/d)

• Total OPEX............................................ 1060.0 million $

• Signature Bonus.................................... 100.0 million $

• Total INVESTMENT..........3387.5 million $

• Remuneration fee*..........................................8,5 $/bbl

• Improved production target (IPT)*.................2,8 million scm/d
• Enhanced production target*........................11,33 million scm/d

* Given by Government
A Field Development Scenarios

• Total production 200 million m3/d and 300 million m3/d cases were run
• The first production will produce 91.3 billion m3 for end of 20 years
• The second will produce 106.2 billion m3 for the end of 20 years
• But the total recoverable reserve is calculated as 103 Bcm
Production Profiles according to 300 million m3

• The production profiles prepared according to the reservoir properties of the

field are given for the 300 million m3 scenario
A Field Production and Investment Profiles

• In this production and investment profile case, only 102.800 Bcm gas can be
produced from the field although the reserve is 103 Bcm
• at the end of the 20 years time end of contract there 10.1 Bcm gas will be remaining;
in which a new contract with new commercial terms can be renegotiated or the
contractor can release the field.
A Field Annual Expenditure Breakdown

36
A Field – Scenarios for 300 Mcm

K %50- C %25- A %25 K %50- C %25- A %25

C C

K %50- C %20- A %30 K %50- C %20- A %30

C C

37
 Homework 2
• COS=
• GRF=
• GCOS=
• Reserves=
• EMV

• 8 wells to develop this field each will cost 6 million $

• 30 km of gathering lines and connection line to pumping station : 60 million $
• Personnel cost : 20 million $
• Maintanence and operation : 12 million $
• Logistics and procurement: 15 million $
• Insurance: 20 million $
• Other project expenditure: 10 million $
• Security expenditures : 16 million $
• Signature bonus: 10 million $ (not cost recoverable)
• Infrastructure: 95 million $
• Seismic, wells and other G&G studies :127 million $
• 10000 bbl/d and 5000 bbl/d total production at plateau
• Take the area and other parameters with reserves from the previous week homework
Uncertainties in E&P Business
• Uncertainties change as the
project progresses
• Upstream business proposals are
filled with uncertainties and it is
unlikely that any approval for
investment will be given unless
the investor is provided with some
information which is an
understanding of the range of
uncertainty especially uncertainty
in monetary and geological
outcomes
• The uncertainties in the geological
aspects such as source rock,
reservoir and seal tock with
generation and migration was
assessed in chances of success
calculations.
• The reserves of the project was
assessed by using different
methods: deterministic,
probabilistic and multiple scenario
Quantifying Risks
• Sensitivity analysis: illustrates the economic impact of the uncertainties
• Decision tree analysis: graphic format capturing all possible decisions and outcomes
with associated probabilities and identify the optimum
• Monte Carlo Simulation: statistical tool used to identify the range of possible
outcomes
• The technical uncertainties like the existing of commercial hydrocarbons through
source, seal and reservoir rock uncertainties with generation and migration was
calculated by using COCS. This will help to exploration decision making but not
covering the all issues.
• Exploration decision making concerns with cost benefit estimates that is balancing
the risk of spending money on exploration activity without finding commercial
reserves against potential reward of finding commercial reserves.
• Expected Monetary Value (EMV) is risk weighted average value expressed in NPV for a
particular opportunity, project, prospect or development containing some significant
uncertainties.
𝐸𝑀𝑉 = 𝐶𝑂𝐶𝑆 𝑥 𝑛𝑒𝑡 𝑟𝑒𝑤𝑎𝑟𝑑 − 1 − 𝐶𝑂𝐶𝑆 𝑥 (𝑒𝑥𝑝𝑙𝑜𝑟𝑎𝑡𝑖𝑜𝑛 𝑐𝑜𝑠𝑡𝑠)

• Decision Tree Analysis (DTA) is a powerful tool for investigating the impact of
uncertainity and is particularly useful for exploration decision making.
Decision Tree Constructing
• Company has the opportunity to bid for an exploration license in an oil province.
• Limited seismic lines show a promising structure and mapped.
• The COCS is calculated as %30 the low, %40medium and %60high
• The production curves has been generated and NPV for the development of high,
medium and low cases have been estimated assuming appraisal will be done
• If development is performed without appraisal the size of the field will not be known
prior to committing development plan and it is estimated that NPV of this option is
5million $
• The estimated costs are 3 million $ for exploration activity and 5 million $ for
appraisal activity
• The question is how much the company can spend on signature bonus to secure the
license?

CASE LOW MEDIUM HIGH

COCS 0.3 0.4 0.6

Reserves (mm stb) 50 100 200

NPV (15%) (million $) -10 20 40

 Decision Tree

• Rectangular ones indicates possible actions

• Circular ones indicates possible results

• EMV=COCS x (NPV) – (1-COCS) x (exploration cost)

= [0.4 x 20] –[ 0.6 x 8]=[8-4.8]=3.2 million $ (individual cases for success and appraise )
• EMV= COCS x[(COCS x P90NPV) + (COCS x P50NPV) + (COCS x P10NPV)] – [(1-COCS) x exploration cost]
= 0.4 x [(0.6 x 40)+ (0.4 x 20) + (0.3 x (-10)]- (0.6 x 3)=9.8 m$ (risked EMV and buyer should no pay more than
that value to the project)