SOCIETY OF PETROLEUM ENGINEERS OF AXME

6~00 North Central Expressway ~;ER SPE 5582

Dallas, Texes 75206

THIS PRESENTATION IS SUBJECT TO CORRECTION

The Relative Cost of Major Project Delay

By

P. D. Gaffney and T. F. Cox, Members SPE-AIME, Gaffney, Cline & Associti.tes

@Copyright 1975
American Institute of Mining, Metallurgical, and Petroleum Engineers, Inc.

This paper was prepared for the 50th Annual Fall Meeting of the Society of Petroleum
Engineers of AIME, to be held in Dallas, Texas, Sept. 28-Ott. 1, 1975. Permission tO COPY
is restricted to an abstract of not more than 300 words. Illustrations may not be copied.
The abstract should contain conspicuous acknowledgment of where and by wh~m the paper is
presented. Publication elsewhere after publication in the JOURNAL OF PETROLEUM TECHNOLOGY
or the SOCIETY OF PETROLEUM ENGINRERS JOURNAL is usually granted upon request to the Editor
of the appropriate journal provided agreerent to give proper.credit is made.

Discussion of this paper is invited. Three copies of any discussion should be sent
to the Society Df Petroleum Engineers office. Such di.scuasionsmay be presented at the
above meeting and, with the paper, may be considered for publication in one of the two
SPE magazinea.

ABSTRACT

This paper discusses the interplay cash flow. This assessment takes account

of the more important factors which determine of two additional factors, nameiy the effect

an optimum development plan. Practical of changes in oil price and the rate of

considerations may dictate an eariy commit- inflation applicable during the investment

ment to field development, particularly in period. The application ofa lower initiai

an offshore environment but such decisions investment exposure in a development plan

must rely on a precise baiancing of the within a high-risk reservoir environment

reiative advantages and disadvantages shows that whiie this approach may not resuit

incurred by any deiay. in the most profitable fieid venture in the iong.

term, it frequently makes possibie the

Eariycomrnitment involves heavy
initiation of afieid project which would other-
reliance on relatively sparse reservoir data
wise remain dormant.
and it is therefore necessary to reconcile

this drawback with the benefits ofeari!er Consideration of abroad seiectionof

2 THE REI-ATIVE COST ‘ MAJOR PROJECT DELAY SPE 5582

development plans wil I give a yardstick to Basically we have investigated in this

data value and it will also highlight the merits cash flow analysis the effect of a change in

of determining a final plan that is compatible oil price, and a change in inflation rate on

with the level of our knowledge of field capital investment over a development period,

performance and reserve parameters. and we have related these factors to the

possibility of not attaining the estimated p~o-

INTRODUCTION duction rate upon which the project in total

or in part has been conceived. Further we

The main difficulties in assessing the
have estimated the effect of additional
effectof a delay or a change in project
operating and capital cost ir. reases to
approach on petroleum development projects
achieve the same total production rate.
are the many variables which enter into the

calculation, variables which in many cases arc The results of this sensitivity analysis

not drawn together by virtue of the fact that are shown on Graphs 1 through 7 and might

inflation is assessed from one department best be explained as follows :

...
and considered by another to be a Holy Writ
Graph 1 shows the effect of oi I price on rate
issued with a high degree of confidence.
of return for varying scales of invest
Rarely does the development program manager
ment. We conclude from this that
have before him a data set covering technical,
a $1 barrel change in oil price is
operational and economic factors with
approximately equal to a 2.570 change
appropriate confidence levels appl ied to them.
in rate of return.
Con. /entional Iy he has a series of best
Graph 2 shows the effect of scale of invest-
estimates upon which he and his department
ment vs. the rate of return in
must fly with the age-old Igutl feeling or as
varying inflation rates. It can be
best he can Iby the seat of his pants!. While
seen that a 10% change in the scale
it is unlikely that any analysis, even the most
of investment is approximately equal
sophisticated, will reduce the responsibility
to a 2% change in the rate of return.
of the development group for examining the

effect of various potential modifications and Graph 3 shows the inflation rate plotted

hazards on their particular project, such against the rate of return for varying

analysis nevertheless contributes to a more scales of investment. It suggests a

general understanding end appreciation of the 5yo change in the rate of inflation

relative effect of changes in various aspects applicable to capital expenditure

of the project. over the acwelopment period is equal

to a 2% change in the rate of return.

To examine the effects of the economic

return of a typical major project we have Graph 4 shows the effect of not reaching the

selected an arbitrary case not specific to any production forecast for different

particular country, the details of which are investment and inflation rates. It

set out in Table 1. In the interest of reducing suggests that a 5% change in pro-

the variables we have held income tax constant duction ra~e is approximately

at 50?0 and the depreciation allowable over a equival~~t to 1 ??o change in rate of

fixed period of 6 years, return.

 cu
G?r L
KKQ9
d~..
Ian
------
Ciaffnev
.. -,----
and TF
..
Cox
—--- 3

Graph 5 shows the effect of changes in the approximate y 6~o difference in the rate of

level of operating costs on the total return. If the rate of return was currently

discounted cash flow and suggests 16% then this decrease in rate of return

that a $1 barrel change in operating could move the project into the unacceptable

costs is approximately equal to a 270 region.

change in the rate of return.

Let us add another factor. Let us

Graph 6 illustrates the effect of different types say that the development group also bel ieves

of delay and suggests that a start-up that during their construction period, averag(

delay of the total project of one year effective inflation on their cost due to both

is approximately equal to a 3% change design changes and real inflation will be 109o

in the rate of ‘eturn, while one From the information above, we have seen
yearls delay in the build-up of pro- that a 5% inflation is approximately equal

duction is approximately equal to a to a 2!)0 rate of return. If the confidence

1% change in rate of return. levels in our production are 70% and we have
a change from the expected rate of 10% to 15(
Graph 7 sh AIS a plot of the effect of pro-
the total effect on our project could be as higl
duct ion rate change cal led in this
as a 7% reduction in rate of return. A
case the confidence level as the
similar approach could be taken with oil
percentage production against the
price and other variables.
incremental cost of error, that is

the difference between the 100% rate Now let us assume that a one year
of return resulting from achieving a delay will permit the gathering of additional

lower production. A 5% reduction information. We have seen from our delay

in confidence levels is approximately chart that a one year delay in start-up

equivalent to a 1 qo change in rate of can cost 3% . In this case if the resulting

E-
return. This particular graph holds confidence levels increased from 70% to 90%

!— true for

inflation
al I investment

rates as well
levels

as all
and

prices
as a result

further studies
of additional

during
information

the one year

and

delay

within the positive region considered there would still be a net 1% gain in rate of

for the particular scale of project return through waiting. This suggests in

looked at. particular that delay in a given set of

circumstances even al lowing for inflation

APPLYING THESE RULES OF THUMB rates is not as damaging as is frequently

thoughtwithin the industry.

How then can we apply these rules of

thumb developed herein to gain a better insigh t It could be argued that in projects,

into the potential effects of projects of this particularly in the North Sea, South East

magnitude. Let t’s take a general case where Asia and the Middle East, this type of approa

a development group are fairly certain that would suggest a commercial development
they can get at least 70% of the expected pro- PI an in an environment and over a t itne perioc

duction rate in the time period and under the where it would be possible to optimize the

investment conditions expected. M this case> selection of appropriate contractors,

from our graph no. 7, it suggests that the equipment and services so as to minimize the

cost of the difference in confidence level is. internal industry boom inf Iat ion factor.
 THE REI-ATIVECOS OF MAJOR PROJECT DELAY SPE5582

The boom factor is that percentage amount by other hand, it might be acceptable to

which prices are increased in a boom area tolerate an even higher operating cost purely

as a direct result of euphoria and Ilwhat the in the interest of avoiding exposure levels

traffic will bearll. necessitated by the pipel inc.

Where the project can be phased and

THE EFFECT OF MODEL SENSITIVITY
the less secure part delayed, the potential
ON OTHER TAXAT ION REGIMES
advantage of the delay is even clearer. Let

us examine the effect of a one year delay in What are the effects of putting our

bui Id-up to production and a stretching of model case into other operating conditions

the investment program with consequent such as the British North Sea? The effect is

inflation effects. If the full net effects of general Iy to reduce the changes in rate of
a one year build-up delay are only 1Yo on return for” each of our variables, that is

the rate of return and if the resulting to say there is a reduction in the relative

confidence levels on the additional pro- effeci on the rate of return for any given

duction increased by 20~0 , then the over- change in our other parameters. This means
at I net gain in rate of return would be 3%. that you tend to be slightly less sensitive for

For marginal projects such an effect on the example, to a change in oil price or inflation

rate of return could be crucial. rate than one would be in the standard case.

But by v:rtue of the fact that the entire

ASSESSING THE VALUE OF AN project may be more marginal , the relative

ALTERNATIVE DEVELOPMENT PLAN impact of any change is equally crucial to

the project. Similarly, in the Indonesian

Where the level of confidence, in-
production sharing contract due to the nature
flation rate and potential price movements
of cost recovery, the overal I effects are such
etc. , do not justify a project which might
that in the general case the changes are
otherwise appear viable we are left with
dampened but the order of magnitude remains
the possibility of an alternative development
in the widest possible sense the same.
plan. An example of such an alternative

might be the replacement of a potential Our results do not necessarily hold

pipeline with a single buoy mooring system true for projects which approach a zero rate

and accepting the higher ope~ating costs in cf return or even those below the 12-1570 afte

I ieu of the lower short-term exposure levels tax returns which in the light of the rate of
and lower ultimate rate of return.’ Our inflation might be considered a minimum
analysis suggests that for instance where a industry aiming point. In this region the
pipeline represents say 30% of the capital conditions change substantial Iy and the
cost, see graph no,2, a gain of 6% in the rate relationship cannot be assumed to be linear.
of return could be achieved by eliminating It would appear however from the general
the pipeline. However this would only be analysis carried out that these results are
justified if, as we see on graph 5, the typical of a wide range of production over a
increase in the operating costs could be wide number of taxation regimes and invest-
kept down to less then $3.00 per barrel since ment/inflation levels.
this in turn would generate a corresponding

reduction of 3$’0 in the rate of peturn. On the

, h ““. ” ! - WU!l, !”y “,, - . . -w.. ●

DATA RELIABILITY ASPECTS further development phase. For the

operator with a potential single platform

While inflation rates and oil prices
development in say the North Sea this is
are not controllable, the confidence levels
cold comfort - ai though even in these cases
of predicting production and reservoir
the potential of delaying a decision on a
behaviour are a direct function of quality and
pipeline in lieu of offshore ioading appears
quantity of data avaiiabie. The hypothetical
to provide sufficient flexibility in terms of
examples examined herein suggest that the
the uitimate rate of ret~rn , such as is
effects of confidence Ieveis of production
necessary to ai low the project to go forward
outweigh all other items in real terms as
at the appropriate investment and expense
weii as effectively controlling the ieveis of
Ieveis.
investment and operating cost.

What in fact does it take for a reservoi r

CONCLUSIONS
engineering group to guarantee, at a 100%
1. Whiie discounted cash fiow sensitivity
confidence ievel a given production rate from
anal yses are common this study suggests
a given development pian. This is ultimately
that such investigations could usefully be
a subjective judgement, but it can sometimes
limited to assessing the effects of a limited
be quantified by additional delineation wel is,
number of key factors and incorporating
more coring, further studies of relative effect s
confidence levels into at least the production
of error, more testing etc. Where initiai
data and operating costs aspects so as to
development pians were based on the first 1
provide those iess directly involved with
or 2 weiis in the reservoir, additional
reservoir and production performance
delineation welis with appropriate data
calculations, with a broader concept on
collection methods typi~aliy add 10%-20?0 to
which to base investment pianning.
the confidence levels especial Iy where

reservoir extent is not yet clear. 2. The effects of not attaining forecast pro-

duction Ieveis are significant enough to

Where reservoir extent is clear the
justify serious consideration of delaying
vaiue of say further delineation welis is iess
either the start-up or altering the phasing of
obvious and frequently it is the cumulative
a project if such delay wiil considerably
effeci of the additional core, test or log data
enhance the confidence ievel of the production
on the overali potential reservoir perfor -
forecast.
mance which provides for the additional

confidence ieveis. 3. The net effects of cost over-runs and

reasonable infiation rates together with

There is no simpie soiution to this
phasing delays are all iess significant than
probiem - as an ‘operating guide perhaps an
typicai changes in forecast production rates.
acceptable practical approach is to assess

and design the project for the maximum 100?10 4. While the general ized resuits presented
confidence ieveis and then accept the dei ays here are not in any circumstances meant
and other Iimitations which this may impose to reduce the necessity for detaiied cash fiow
on securing that additional justification for a appreciation and sensitivity analysis on our
.
6 THE RELATIVE COST OF MAJOR PROJECT DELAY sPF5585

projects, they are meant to give an idea to al I REFERENCES

groups of the relative effect of a change in

various parameters and particularly to sugges

1 ( 1) A Systematic Approach to North Sea
to development planners the advantage of Data Evaluation
PD Gaffney and TF Cox SPE5270 ( 1975)
contemplating the delaying by a one year perio

of a project in the interest of securing a (2: The Merits of Some Alternative

Development Pians for Offshore Oi I
higher rate of return and reducing the
Fieid Development
investment risk. D] Heather and WB Ci ine SPE501 O ( 1974)
I

,.
 TABLE I
PARAMETERS

RANGE OF
PARAMETER BASE CASE VARIATION

Development cost before inflation US$ 800 750- 1000

Oil Price US$l O. 00/inbl 8.00-12.00

Development Period, Years 3 2-5

Production Build-up Period, Years 3 2-4

Production Plateau Period, Years 5 4-6

Product ion Start After, Years 3 3-5

Capital Inflation Rate % 15% 5-10-15-20%

Operating Costs $/bbl 1,00 1,00-3.00

Discount Factor 15qo

Start Product ion rate ?000 BOPD 50

PI ateau Product ion Rate 1000 BOPD 200 150-200

Decline Rate 13% 13%

Reserve Range MM bbls 866 600-900 approx.

Tax Rate 50% 50% British PRT

approach and production
sharing contract
also applied

Depreciation 16. 7% pa throughout

Royalty Rate o. o%

Positive cash flow shown reinvested, negative cash flows discounted

Run” Start-Up Devel. SuFld-Up .Plateau 0;1 Plateau Inflation Develo rmnt Cos:s
No. Delay Per iod Period Period PriL- F%[c
(W-s) (’frs) (w-s) (Yrs) $/Eb 1 Ebl}2x T06 T: [rtflaticm
‘T h~flation C3bl x 106
CW::ive :%j~.. ‘F: ‘::7’s

3 3 2 10 150 15 750 961 619 23(J5 249 20 )

1
I
2 8
1
i I I 1669
2cT.4
50
436
16
24
3 12 i J
885 2343 231 21
4 10 1%
?042 2259 200 19
5 1 i 20
1 1
200 800 1118 8;6 3;27 480 24
6 3 1 15
8 ! 2442 221 19

1I 60
?
4211 738 29
8 12
L 1
9 10 10 1001 3395 544 26

409 22
10 20 t 248 I 3250

1118 697 2569 271 20

11 15
1 2758 323 21
12 170 739

180 782 2947 376 22

13
190 824 3137 428 23
?4
200 866 ~327 480 24
15
I 857 37.86 300 20
16
847 3240 143 17
17
945 3683 451 23
18
907 3512 468 24
19
866 3327 480 24
20
819 3116 477 25
21 w
866 3381 472 23

1
22 1024
843 3224 425 23
23 1118
866 3245 394 22
24 900 1258

8 2360 135 17
25
I 4129 652 26
26 12 w -4.
10 3322 466 24
27 10 1126
1404 3159 315 20
28 20 .
1258 907 3430 383 21
29 15
3245 394 22
30 1258
t
I 000 1398 866 3163 308 20
31 w
8 2279 so 75
32 I
12 I 4048 567 24
33 \ 1
34 10 10 3251 &09 22
12i
35 20 1 3069 220 18
T560
36 15 907 3349 297 19
1398
37 866 3163 308 20
1398
X 3245 401 22
I 1521
39 00 2628 396 25 3.0
800 I
40 00 3070 525 28 2.0
i 655
41 00 1 3512 30 1.0
 13 OIL PRICE VS ROR.
t

12-

11-

z
~ 10-
Vi
s
-9 -

I I
14 16 18 20 22 24 26 28 30 32 3~
Rate of Return, ‘h
Fig. 1

e 1100-\ \

l——~ 18 20 22 2L 26
Rate of Return, 0/0

Fig. 2

,~

Rate of Return, YO

Fig. 3
 )PERATING COST VS DCF & ROR

EFFECT OF PR(XXJCTION
FORECAST IMPROVEMENT
PRODUCTION RATE VS RO R

Discount& Cash Flow ~ U. mm

Fig. 5

~EFFECT OF DIFFERENT DELAYS

4

3[

18 20 22 24 26 28
Rate of Return, Vo

Fig. 4

200 300 Iwo ‘m

Cumulative Discounted Cash Flow #US mm
Fig. 6

100

80 -

~ 60 -
4
0
NOTE: This curve is applicable to all
‘w - investment levels. all inf Iation rates
k
~ and all oil prices.
&
Q 20 -

b. 1 I 1 t 8 h 1 t 1 *
-lo
Incr;lment;~Cbst ;?Erro;~ Diff;k i;!lisct%ed t%e of %urn, YO

Fig. 7