Economics & Financial Management

Robert Hofmann

Reservoir Technical Advisor - P.O.T

E-mail: robert.hotmann@Halliburton.com

Tel: (029) 73 92 05 Extension 7839

SONATRACH Good Governance Principles (Hydrocarbon Law No. 05-07 28/04/05 )
Dr. Chakib Khelil, Ministry of Energy & Mining
SONATRACH
Fiscal & Budgetary Relationship between Sonatrach & the State - Ministry of Energy & Mining
SONATRACH
Transparency in Processing & Presenting Data - Ministry of Energy & Mining
SONATRACH
Modification of Hydrocarbon Law 05-07 Oct. 2006

This article is extracted from International Oil Letter, Vol. 22

issue 37 published 18 September 2006.

The modification/amendment comes one year after the

government approved the Hydrocarbon Law No. 05/07 on 28
April 2005 that downgraded Sonatrachs role in the oil and
gas sector and sought to stimulate greater investment from
foreign energy.

Arguing that it is safeguarding the role of the national oil

company, the new decree, which was enacted at the
beginning of September 2006, specifies that Sonatrach will
be given the following:
51% in all upstream development projects as well as midstream
pipeline and refinery projects compared to an optional right of 20-
30% encompassed in the 2005 law.
Under existing contracts signed under the Petroleum Law of 1986,
a windfall profits tax will be imposed on oil production when the
price of Brent is traded above US$ 30 per barrel.
SONATRACH
Reservoir Management
Technology
Seismic Tools
Data Acquisition
Geologic Seismic Interpretation
Seismic Data Acquisition
Geo-statistics Logging/Coring
Geologic
Drilling & Completion Engineering Seismic Interpretation
Completions & Facilities
Reservoir Engineering
Geo-statistics Logging/Coring
Geologic Interpretation &
Completions
modeling & Facilities
Production
Drilling Engineering
& Completion
Enhanced/tertiary oil recovery
Engineering Geologic Interpretation
Pressure Transient &
modeling
Fracturing
Environmental
Reservoir Engineering
Pressure Transient
Computer Engineering
Production Reservoir simulators
Fracturing
Enhanced/tertiary Oil Recovery
Enhanced/tertiary oil Integration of Reservoir simulators
Computer software & hardware &
recovery Multi-Disciplines: Enhanced/tertiary Oil Recovery
Information Technology
Environmental
Technology Computer software & hardware
Computer & Information Technology
Tools
Human
Resources
Data
Human Resources Management Data Management
Management
Management
Geologists
Geologists Geophysical
Geophysical
Geophysicists
Geophysicists Geological
Geological
Reservoir Engineers ReservoirEngineering
Reservoir Engineering
Reservoir Engineers
Production Engineers Production Engineering
Production Engineering
Production Engineers
Facility Engineers Drilling
Drilling& &
Completion
Completion
Facility Engineers
Field Supervisors Financial
Field Supervisors Financial
Financial
Financial Economics
Geological/engineering
Technicians
Geological/engineering
Technicians
SONATRACH
Project Economics & Financial Evaluation Required Data

Leasehold data (Working & Net Revenue Interest w/ reversionary interests

and the latest payout amounts and/or status )
Geological structure, Net pay Iso-pach, KH Maps, & HCPV Iso-pach Maps.
Stratigraphic & Structural Cross-sections
All prior geological, production & reservoir engineering reports.
Complete log suite
Core analysis data w/ analysis
Reservoir Fluid Analysis
Drilling & completions summary & all subsequent well operations
Individual well monthly oil, water & gas production, BHP surveys, & well
tests
Gross oil & gas prices w/ summary information of the sales contract
provisions
Severance and advalorem taxes paid to state or local authorities
Summary of individual well actual historical gross operating expenses.
Non-reoccurring expenses (gas-lift, equipment replacement, work-over &
frac stimulations) should be determined.
Estimation of completed well costs & re-completion costs for proven
undeveloped, behind-pipe & shut-in reserve categories.
 SONATRACH
Typical Project Cash-Flow Diagram

Net Cash Flow (Positive/negative) = Cash Revenue Cash Disbursements

Operating Revenues
Pattern of revenue in future
periods must be evaluated.
Time 0
(yr)
1 2 3 4 5 6 7 8 9 10
Operating Expenses (OPEX)
Capital
Investments
(CAPEX)

To account for the time value of money, all future operating revenues, Operating expenses &
Capital Investments must be brought back to a reference point or time 0 or discounting future
cash flows using a discount factor.
Discounting converts the future cash flow into equivalent present worth. (Cost of Capital)
Compounding converts a present sum of money into the equivalent future sum.
SONATRACH
Before Tax Model: Cash Inflow & Cash Outflow

Cash Inflow = product stream (crude oil, LPG, NGL,C5+, LNG, etc.) times the
projected price of the product.
Cash Outflow is divided into the following categories:
Capital Expenditure (CAPEX) Usually large expenses incurred at
beginning of project
Geology & Geophysical (G&G) Costs
Right of access to property
Acquisition of seismic data
Seismic processing & interpretation
Tax purposes Usually expensed in the year that the costs were incurred
Drilling Costs which depend upon the following parameters
Type of well (prod., appraisal, delineation or development well)
Well type (side-track, vertical, horizontal, multilateral, water disposal or gas/water
injection
Type of drilling contract & rig type
Depth of well & complexity of formations
Casing scheme
Drilling muds & type & number of bits
Testing & coring requirements
Completion rig and equipment
Process Facility Costs (Some of the facilities are required initially whereas others may
be required later in the life of the property.)
Wellheads
Flow lines
Storage tanks
Re-completion of individual well into another producing formation
Side-tracking existing well w/ short radius or horizontal well
Installation of artificial lift facilities if field initially flowed naturally
Major upgrading/replacement of existing facilities
Facilities for secondary recovery (waterflood or miscible gas injection)
SONATRACH
Before Tax Model: Cash Outflow
Cash Outflow is divided into the following categories: (Continued)
Operating Expenses (OPEX) Occur periodically & required by day-to-day operations
Feedstock In the absence of fair market value, economic cost of manpower, materials,
capital should be utilized.
Utilities Economic cost of gas & electricity, manpower, materials & capital
Maintenance Material costs and manpower costs.
Inspection costs
Preventative Maintenance costs
Replacement & parts costs
Administrative & General Overhead
Labor (admin., lab, stores, medical, security)
Materials & Supplies (electricity, stationary, food, lodging, misc.)
Services (Communications, computer, insurance, travel, training)
Production Costs
Lifting Costs
Treatment Costs of dehydration & oil/gas separation
Work-over costs (Well stimulation, wire-line operation, special operations, downhole
repairs
Secondary recovery costs (water inject, gas inject., chemicals)
Water production & disposal costs
Transportation Costs to a refinery or gas processing facility
Pump & Compressor fuel & losses
Pipeline Tariffs
Cost of operating terminals
Insurance Costs (Oilfield equipment insurance)
SONATRACH
Before Tax Model: Cash Outflow (Continued)
Cash Outflow is divided into the following categories: (Continued)
Abandonment Costs Environmentally safe abandonment of wells and
facilities
Sunk Costs Historic Costs incurred prior to first cash flow (Previous
exploration costs). Note that these have already been spent & accounted for
and do not appear in the cash flow projection.
Prior tax deductions due to depreciation, depletion or investment tax credits
will affect after tax economics only.
SONATRACH
Cost of Capital Calculation Discount Factor
Discounted Cash flow Techniques are used for project evaluation & Method
involves the following:
Forecasting future cash flows
Estimating appropriate cost of capital (Disc. Factor). Choosing the appropriate
Discount Factor can be as important as the estimation of future cash flows.
Determining the PV of future cash flows.

Weighted Cost of Capital

Recommended for Disc. Cash Flow Calculations
Methodology - Estimate the marginal costs of the various sources of financing
or capital structure utilized. These separate sources of capital are based on
the market values of the sources of financing
Common Equity or Stock (return stockholders expect the project to earn on their
money. Residual claim on liquidation proceeds of a stock corp. )
Preferred Stock (Before a dividend can be declared on the common shares, any
dividend obligation to the preferred shares w/ fixed dividend must be satisfied. The
dividend rights are often cumulative, such that if the dividend is not paid it
accumulates in arrears. Senior claim to liquidation proceeds of a stick corporation
equivalent to its par or liquidation value.
Debentures (Long-term debt instrument used by governments and large companies to
obtain funds. It is similar to a bond except that it is unsecured in the sense that there
are no liens or pledges on specific assets. It is however, secured by all properties not
otherwise pledged.
Debt (Long Term loan, Credit Facility, secured by oil & gas properties or plant &
equipment, etc.)
SONATRACH
Cost of Capital Calculation Discount Factor
Costs Basis
The riskiness of the project being financed
Amount of debt used to finance the project
Financial Risk Determined by the level of fixed interest financing in the capital
structure determines
Gearing Ratio Ratio of borrowed funds to total funds or stockholder equity. The higher the
ratio, the greater the risk associated with the project
Project Risk Determined by uncertainty in forecasting variables surrounding the
level of pre-tax profits generated by project.
Product Price Volatility
Future reserve projection based upon volumetric calculations, material balance analysis,
decline curve analysis & reservoir simulation
Operating expense

Market Weighted Percentage of Project Financed by Source J

Wj = Mj
X
Mj
j=1

Weighted Cost of Capital

X
Rc = Wj * Rj
j=1
SONATRACH
Example Cost of Capital Calculation Discount Factor
Cost of Capital Disc. Cash flow Techniques are used for project evaluation.
Method involves forecasting future cash flows, choosing appropriate cost of
capital (Disc. Factor) & determining the PV of future cash flows.
Example: Calculate the average Cost of Capital assuming the following
capital structure for the project. (Note - Use this for next example.)
Common & Preferred shares w/ market value of $2,200,000M. Assumed Cost of equity
after tax 12.0%
13% Debenture stock w/ market value of $300,000M.
Long-term loans of $400,000M at 11% interest
Credit facility $400,000M at an interest rate of 13%
Corporate Tax rate of 50%
SONATRACH
Simple & Compound Interest Calculations Time Value of MONEY
Simple Interest Calculation (Uses (1) Principal only and (2) partial year calculated based
upon 12 mo., 30 days per month & 360 days)
Interest = (Principal) x (Number of Periods) x Interest Rate, fraction)
Example: $5,000 principal borrowed at a simple interest rate of 8%. Calculate (1) the
principal plus interest at the end of the year and (2) principal and interest if the loan is
paid after 90 days
(1) Interest = (5,000) x (1) x (.08) = $400
(Principal + Interest) = 5,000.00 + 400.00 = $5,400
= 5,000.00 x (1 + .08) = 5,400
(2) Principal plus Interest at the end of 90 days: 5,000 + [5,000 x (90/360) x .08] = $5,100
(3) Principal plus Interest at the end of 450 days: 5,000 + [5,000 X (450/360) x .08] = $5,500

Compound Interest Calculation (Uses interest accrued on both the principal and the
unpaid interest earned in the prior periods.)
(1) Interest = [(1 + in / m)tm 1] x Principal
(2) Principal + Interest = [1 + in / m)tm x Principal where: in = Nominal Interest Rate (frac.)
m = compounding or interest
periods per year (1 - yearly,
2- semiannual, 4 - quarterly)
t = loan period, yrs

Example: $5,000 principal borrowed at a interest rate of 8%. Calculate the interest at the
end of the year if interest is compounded (1) yearly, (2) quarterly, (3) Semi Annually
(1) Yearly: Interest = [(1 + .08/1)1x1 1] x $5,000 = $400 (Prin. + Int. = $5,400.00)
(2) Quarterly: Interest = [(1 + .08/4) 1x4 1] x $5,000 = $412.17 (Prin. + Int. = $5,412.17)
(3) Semi Annually: Interest = [(1 + .08/2)1x2 1] x $5,000 = $408.00 (Prin. + Int. = $5,408.00)
 SONATRACH
Nominal & Effective Interest Rate Calculations
Nominal Rate Compound interest is generally reported as nominal interest rate
per year.

Effective Rate The rate when applied to a principal balance once per year will
result in the same amount of interest as a nominal interest rate compounded m
periods per year.

Note that Nominal (in) and Effective (ie) interest rates will be the same if interest is
compounded annually.
For Periodic Compounding: ie = (1 + in / m)tm 1
For Continuous Compounding: ie = er 1 where: r = Nominal Continuous Interest Rate
Principal + Interest = (1 + ie)t x Principal

Example: $5,000 principal borrowed at a interest rate of 8%. Calculate the interest at
the end of the year if interest is compounded (1) yearly, (2) quarterly, etc.
(1) Yearly: Effect. Interest (ie) = (1 + in / m)tm = (1 + .08 / 1)1 1 = .08 or 8.00%
Principal + Interest = (1 + .08)1 x 5,000 = $5,400.00
(2) Quarterly: Effective Interest = (ie) = (1 + in / m)tm = (1 + .08 / 4)4 1 = .08243 or 8.243%
Principal + Interest = (1 + .08243)1 x 5,000 = $5,412.15
(3) Monthly: Effective Interest = (ie) = (1 + in / m)tm = (1 + .08 / 12)12 1 = .08299 or 8.300%
Principal + Interest = (1 + .08300)1 x 5,000 = $5,415.00
(4) Daily: Effective Interest = (ie) = (1 + in / m)tm = (1 + .08 / 360)360 1 = .083277 or 8.3277%
Principal + Interest = (1 + .08328)1 x 5,000 = $5,416.40
(5) Continuous: Effective Interest = (ie) = (er-1) = (e.08 1) = .08329 or 8.3287%
Principal + Interest = (1 + .083287)1 x 5,000 = $5,416.44
SONATRACH
Present Value of Future Revenue Based Upon Cost of Capital
Present Value of a single cash flow received at some future point in time
PV = Fv [1/(1+ie)t where: Pv = present value @time zero of future sum;
Fv = Future sum received @ time 0;
ie = effective interest rate (discount rate) based upon Cost of Capital Calculation
Present Value of periodic cash flows:
Pv = (Fv)1[1 /(1+ie)1 ] + (Fv)2[1 /(1+ie)2 ] + (Fv)3[1 /(1+ie)3 ] + + (Fv)t[1 /(1+ie)t ]

10% Disc. Factor

(Cost of Capital)

10% Disc. Factor

(Cost of Capital)
 SONATRACH
Example Present Value of Future Revenue Based Upon Cost of Capital
Example PV Calculation: Oil Co. cash-flow: $4,000M CAPEX @ time 0 and three annual
Net Income (Net Revenue Net Operating Expenses) for the next 3 yrs: $3,000M, 4,000M &
5,500M. Calculate PV of these payments based upon a discount rate of 10%.
PV = - 4,000 + 3,000 [1/(1+.10)1] + 4,000 [1/(1+.10)2] + 5,500 [1/(1+.10)3] = - 4,000 + 2,727.27 +
3,305.79 + 4,132.23 = $6,165.289M
Net Revenue
7,500
5,700
5,200

Time
0 1 2 3

CAPEX
1,700 2,000
2,200
4,000 Net Oper. Expenses
SONATRACH
Example AFE
SONATRACH
Federal Income Tax Model for Oil & Gas Transactions (Thompson & Wright)
Gross Income
(Units Sold x
$/unit) Delay Rentals
Operating Costs
State & Local Taxes
Less Interest on Loan
Allocated Overhead
Expensed IDCs
Dry-hole Costs
Depreciation
Taxable Income
Before
Depletion

Allowable Depletion
DEPLETION ITEMS
Less Leasehold Costs
Capitalized G&G Costs
Lease Bonus
Capitalized IDCs

Taxable Income
Taxable Income
Less Before adjustments
(Tax. Income * Eff. Tax Rate)
Less Investment Tax Credit
brought forward
Plus Adj. Due to Minimum
Net Income
After Taxes Tax Calculations
Taxes
SONATRACH
Example Before Tax (BFIT) Cash Flow Projection

Cash Flow Projection - BFIT

SONATRACH
Intangible Drilling Costs Calculation Tax Reform Act 1986

Independent producer may elect to expense 100% of IDCs in

the year incurred for domestic wells.
For foreign IDCs, the cost may be recovered over a 10-yr period using
straight-line amortization or may be added to its depletable basis.

Integrated producer may elect to expense 70% of IDCs in the

year they were incurred and amortize the remaining 30% over
60 months for domestic wells.
For foreign IDCs, the cost may be recovered over a 10-yr period using
straight-line amortization or may be added to its depletable basis.

Dry hole costs may be expensed in the hear incurred,

regardless of the way the IDCs are treated for Independents or
Integrated Producers.
 SONATRACH
Recovery of Drilling & Completion Costs Expense or Capitalize (After Income Tax Cash Flow - AFIT)

First Year
Operation

Election to Capitalize or
Expense IDCs Made Yes
in Prior Years

Dry-hole Productive
Productive
Wells

Expense DHCs

Integrated Producer may elect to

expense 70% of IDCs in the year
they were incurred and amortize
the remaining 30% over 60 months
for domestic wells.

Independent Producer may elect

to expense 100% of IDCs in the Capitalize IDC Election
year incurred for domestic wells. Capitalize
or Expense
Recover costs:
- Depreciation, Tangible Expense
& Assoc. labor
- Depletion. Costs not Recover Costs
represented by physical in Period
inventory Incurred
 SONATRACH
Depletion Allowance Calculation (after Thompson & Wright)
Calculate Percentage Calculate Cost
Depletion Depletion

Criteria:
(1) Independent Producers & Royalty
Owners Exemption w/ <= 1,000 barrels oil
equiv (6,000 SCF/STB)
(2) Regulated natural gas produced under
a fixed contract in effect 01/02/75

No % Depletion
Eligible
= Zero
Compute Adjusted
Yes Yes Basis (AB)

(1) Calculate 15% (Oil) of Calculate 50% of

Gross Depletion Income Taxable Income Compute Remaining
(2) Calculate 22% (Gas) of
Gross Depletion Income
Before Depletion Reserves (Rr)

Take
Lesser Calculate Cost
Depletion
CD = AB[P/(Rr+P)]

Cost Depletion
% Depletion
Take
Greater

Allowable Depletion
SONATRACH
General Model for Fixed Assets Accounting

Depreciation Defined
Revenue expenditures are those incurred for normal wear and tear
expenses and are not capitalized but debited to expense accounts.
Capital expenditures, on the other hand, are those costs which
improve an asset or extend its life and are debited to the asset account.
Depreciation expense can be defined as the allocation of the cost of an
asset over its useful life.
In order the properly measure depreciation expense, one must
estimate the cost of the asset, useful life and its residual (salvage) value.
The adjusting entry to record depreciation takes the following form:

Depreciation Expense
Accumulated Depreciation
SONATRACH
Depreciation - Defined
Definition A loss in the value of asset over the time it is being used
(wear & tear, age, deterioration, & obsolescence).
Deductible non-cash expense for income tax purposes.

Not an actual cash outflow which would be subtracted from annual cash flow as an
expense.

Begins from the time a property is placed in service.

Depreciation is discontinued when the cost or other basis of the property is recovered
or property is retired.

Modified Accelerated Cost Recovery System (MACRS) pertains to property placed in

service after 1986. Depreciation method permitted:
200% declining-balance method over the General Depreciation System (GDS) recovery period
for non-farm property in the 3, 5, 7, & 10 year property classes which switches to straight-line
method when that method provides a greater deduction.

150% declining-balance method over the GDS recovery period for non-farm property in the 15
& 20 year property classes which switches to straight-line method when that method provides
a greater deduction.

Straight-line method over the GDS recovery period for non-residential real property in the 3, 5,
5, 10, 15 & 20 year classes.
 SONATRACH
Asset Classes Depreciation Recovery (GDS MACRS) & Straight-Line Depreciation
Office furniture 7 yrs
Information Systems (Computers, storage devices, etc.) 5 yrs
Data handling Equipment (copiers, calculators, accounting machines, etc.) 5 yrs
Light Purpose trucks 5 yrs
Heavy Purpose trucks 5 yrs
Offshore Drilling (floating, self-propelled drilling barges, platforms, drilling equipment,
barges, towboats, crewboats excluding oil & gas producing assets 5 yrs
Drilling of Oil & Gas Wells (Assets used in drilling of onshore oil & gas wells, geophysical
services, chemical treatment, plugging & abandoning of wells, cementing, perforating for
Independent Producers only does not include integrated petroleum & natural gas
producers) 5 yrs
Exploration for and Production of Petroleum and Natural Gas Deposits (Assets used by
integrated petroleum and natural gas producers for drilling of wells, gathering pipelines,
storage facilities, offshore transportation facilities & storage, compression or pumping
facilities, separation facilities,) 7 yrs
Petroleum Refining 10 yrs
Pipeline transportation 15 yrs
Natural gas production plant 7 yrs
LNG Plant 15 yrs
Straight-Line Depreciation Depreciable cost or cost basis of the property is distributed
over the useful life of the asset.
D n = ( C Sv ) / n
where: Dn = depreciation in nth year, C = Total Cost of Asset, Sv = Salvage value, n = useful life
Example: Compute straight-line depreciation for a compressor acquired at a cost of $55,000
with a salvage value of $7,000 at its useful life of 5 years
Dn = (55,000-7,000) / 5 = $9,600/yr
SONATRACH
Declining Balance Depreciation w/ Example Calculations
Declining Balance Depreciation Fixed value of percentage is applied to the book value
(total value of asset less accumulated depreciation of previous years of the asset each
year.
MACRS Accelerated Depreciation method.
Appropriate when it is estimated that the benefits derived from an asset will decline with time.
Declining balance depreciation consists of the following percentages: 200%, 175%, 150%, & 125%
declining balance.
The fixed percentage is calculated by dividing the percentage by the recovery period.
Salvage value is not subtracted when calculating yearly deduction; however it is not depreciated
below its salvage value.
It is allowed to switch to the straight-line (SL) depreciation in the year when SL provides a greater
deduction over the declining balance method.
Fixed Percentage = Declining Balance Percentage / n
where: Declining Balance Percentage = Chosen Declining balance depreciation percentage; n = useful life
Example: Compute 200% declining balance depreciation and switch to straight line when
appropriate for a compressor acquired at a cost of $55,000 with a useful life of 5 years
Fixed Percentage = (200/100) / 5 = 0.40 Year 2 Calcs:
Straight-Line Depr. = (Book value @ Begin of Year 1)
(Depreciation Taken Year 1) / n
Straight-Line Depr. = (55-22) / 4 = 8.250M$
200% Declining Bal. Depr. = ((Book value @ Begin of
Year 1) (Depreciation Taken Year 1)) * Rate
200% Declining Bal. Depr. = ((55 22) * 0.400 =
13.2M$
Depr. Taken = 13.2M$ (200% Declining Bal greater
Str.Line
SONATRACH
Depletion Allowance
Definition Gradual exhaustion of the original amounts of the resources
acquired:
Available to an owner & operator if a legal interest in the oil & gas-in-place is
owned.
Each owner accounts for his portion of the depletion deduction
Figured separately for each mineral property acquired
Two ways of calculating depletion
Cost Depletion
Calculated by dividing the adjusted basis of the mineral property by the total
recoverable units in the propertys natural deposit. Then multiply by the resulting
rate by the units sold during the tax year.
Cost Depletion = AB [ Q / (Rr + Q)
where: AB - Adjusted basis for the taxable year; Q no. of units sold during the
year; Rr - no. of remaining reserves @ end of taxable year

Percentage depletion Not allowed for Integrated/major companies (> 1000 Bopd)
Calculated by multiplying a certain percentage (15% for independent producers) by
the gross income from the property during the tax year.
Depletion deduction cannot exceed 50% of the taxable income from the property
(excluding depletion deduction)
For a qualified independent producer or royalty owner of oil & gas (<= 1000 bopd),
percentage depletion cannot be more than the smaller of:
o Taxable income from the property without depletion deduction
o 65% of taxable income from all sources w/o depletion deduction
o If qualified for percentage depletion and is less than the cost depletion for any year,
cost depletion must be used for that year.
SONATRACH
Example Cost Depletion Calculations Major Oil Co.

Cost Depletion (2004) = (130.000 40.065) * (6.203 / ((40.276 18.616) + 6.203)) = 20.022 M$
SONATRACH
Depreciation Methods Typical Economic Model
 SONATRACH
Accelerated Cost Recovery Depreciation

Example Depreciable Asset Value - $50,000 using Accelerated Cost Recovery Methods
SONATRACH
Example Sum-of-Years Depreciation Calculation

Sum of the Years Digits

 SONATRACH
Tangible Cost only)
Capital Recovery Settings - SETDATA

= 1/n where n=no. yrs to depr.) i.e. Seismic 1 yr, Drill 3 yrs)
i.e. Plant - .25 (4yrs)

= 2/n where n=no.yrs to depr.)

Enter 0 for actual life

SONATRACH
Example After Income Tax Calculations

After Tax Cash Flow Projection

SONATRACH
Example Before Income Tax & After Income Tax Calculations - Continued
SONATRACH
Analysis of Oil & Gas Companies Financial Statements

Measurement and Comparison of Financial Performance of oil

& gas companies is referred to benchmarking

Identify a pool of peer companies that are similar to the company

in size & operations & various other factors.

Performance measures or key ratios are computed for all of those

companies, then analyzed and compared to peer companies.

Comparative strengths & weaknesses can be ascertained and a

plan can be implemented to build on strengths & correct
weaknesses.

Use of ratios computed over several years will not resolve timing
problem of expenditures made in one year and the results are
known in another; however are superior to single year analysis.

Source of data necessary to compute most of the ratios unique to

oil and gas companies is typically SFAS No. 69 disclosures
SONATRACH
Oil & Gas Company Disclosure Sources

Historical
Proved Reserve quantity information

Capitalized Costs related to oil and gas producing activities

Costs incurred for property acquisition, exploration, &

development activities

Results of operations for oil and gas producing activities

Future
A standardized measure of discounted future net cash flows
relating to proved oil and gas reserve quantities

Changes in standardized measures of discounted future net

cash flows relating to provided oil and gas reserve quantities
SONATRACH
Reserve Ratios Reserve Replacement Ratio

Reserve Replacement Ratio

Evaluates ability of company to continue to operate in the future by
measuring the extent to which a company is replacing the reserves it is
producing.

Reserve Replacement Ratio (RRR) w/ Revisions & In-place sales = [Extensions &
discoveries + Improved Recovery + Revisions in previous estimates + Purchases of
reserves in-place] / [Production + Sales of reserves in-place]

2003 R.R.R. w/ revisions & In-place Sales = (75+315+95+29) / (260+40) = 1.713

2004 R.R.R. w/ revisions & In-place Sales = (90+225+119+5) / (250+42) = 1.503
2005 R.R.R. w/ revisions & In-place Sales = (80+69+145+45) / (273+50) = 1.050
 SONATRACH
Reserve Ratios Reserve Life Ratio

Reserve Life Ratio

Evaluates the number of years that production could continue at the current
rate if no new reserves were added.
The higher the ratio, the longer a firm could continue to generate enough cash
flow to cover financial obligations

Reserve Life Ratio (RLR) = [Total Proven Reserves at the Beginning of Year] / [Production]

2003 R.L.R. = (3566) / (260) = 13.72 years

2004 R.L.R. = (3780) / (250) = 15.12 years
2005 R.L.R. = (3927) / (273) = 14.38 years
SONATRACH
Reserve Ratios - Net Wells to Gross Wells Ratio

Net Wells to Gross Wells Ratio

Computed by multiplying each well in which a company has a working
interest by the relevant working interest and summing results
High ratio indicates that a company owns relatively large working interests in
wells while a low ratio indicates that company owns many small working
interests
Gauge of future profitability
If company owns a large working interest in each well the company is likely to
be operator
Benefits from being the operator
Consolidated interests
Greater influence on prudent operations
SONATRACH
Reserve Ratios Avg. Reserves per Well & Avg. Daily Production per Well Ratios
Average Reserves per Net Well Ratio
Calculates average reserves per well
High average indicates that well can be efficiently produced with fewer wells and
thus more profitable
Avg. reserves per well = [Total Proven Reserves at the Beginning of Year] / [Net Wells]
Average Daily Production per Net Well Ratio
Calculates average daily production per net well.
The higher the average per well, the more efficiently and profitably the reserves
can be produced.
Avg. Daily Prod per well = [Annual Production/365] / [Net Wells]

Estimated Net Proved Crude Oil & Natural Gas Liquids (Equiv.)
SONATRACH
Reserve Cost Ratios - Finding Cost Ratios

Finding Cost Ratios

Finding costs of adding new reserves divided by the new reserves added
No consensus regarding which costs should be included as finding costs
as companies use different accounting methods
Full cost
9 All costs incurred in exploration, drilling, & development are
capitalized and amortized.
Successful Efforts Geological & Geophysical exploration costs are written
off as incurred.
9 The costs of dry exploratory wells are written off when it is determined that
well is dry.
9 The costs of successful exploratory wells and dry & successful development
wells are capitalized and amortized over the life of production
Companies use different accounting methods which treat the costs
differently in terms of expense and capitalization

Timing difference between the time the costs were incurred and the time
when the reserves are realized
Should be correspondence or matching between the costs in the numerator
and reserves in the denominator
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Summary Reserve Cost Ratios

Reserve
Replacement
Ratios

Finding
Cost
Ratios

Reserve
Cost
Ratios
SONATRACH
Lifting Cost & DD&A per BOE

Lifting Cost per BOE

Measurement to evaluate the extent to which the company is controlling its
operating costs and/or how efficiently the company is extracting oil & gas.
Lifting costs per BOE is utilized to gauge how efficient a company is at
controlling its costs, it is important that cost actually controllable at the
field level.
Note that if overall operating efficiency is to be evaluated, all production
costs plus depreciation, depletion, & property taxes which are generally
non-controllable at the field level will also be included
Lifting Costs per BOE = Total annual lifting Costs / Annual production
(BOE)

Depreciation, Depletion & Amortization Cost per BOE

DD&A reflects the historical cost of finding and developing reserves
related to prior periods.
DD&A not helpful in assessing current period efficiencies; however since
DD&A appears on the income statement, it does effect current profitability.
DD&A Costs per BOE = Total annual depreciation, depletion, &
amortization / Annual production in BOE
SONATRACH
Lifting Cost & DD&A per BOE
Summary Reserve Cost Ratios

Reserve
Replacement
Ratios

Finding
Cost
Ratios

Reserve
Cost
Ratios

Lifting Cost
& DD&A per
BOE
 SONATRACH
Financial Analysis Ratios

Liquidity Ratios
Current Ratio = Current Assets / Current Liabilities
Quick Ratio = Liquid Current Assets / Current Liabilities
Working Capital = Current Assets Current Liabilities

Financial Strength Ratios

Debt to stockholders equity = Total Long & Short Term debt / Total Stockholders
Equity
Debt to Assets = (Total Long and Short-term Debt / Total Assets
Times Interest Earned = Net Income / Total Interest Expense

Profitability Ratios
Gross Profit Margin = Gross Profit / Sales
Operating Profit Margin = Earnings Before Interest & Taxes / Sales
Net Profit Margin = Net Income / Sales
Return on Stockholder Equity = Net Income / Total Common Equity
Return on Assets = Net Income / Total Assets
Cash Flow from Operations to Sales = Cash Flow Generated in the current Year / Current Year Sales
Price / Earnings Ratio = Market Value of Common per Share / Adjusted Earnings per Share
Cash Flow Ratio = Market Value of Common per Share / Cash Flow per Share

Asset Activity
Average Collection Period = Accounts Receivable / Average Daily Credit Sales
Inventory Turnover = Sales / Inventory
Total Asset Turnover = Sales / Total Assets
 SONATRACH
Com
pan y Ba Com
lanc pan
e Sh y
eet Inco
me
Stat
e me
nt

Total Assets - Total Liabilities = Stockholder Equity

SONATRACH
Financial Analysis Ratio Example Calculations
(M$)
(M$)
(M$)
(M$)
(M$)
(M$)
(M$)
(M$)
(M$)
(M$)
(M$)
(M$)
(M$)
(M$)
SONATRACH

Risk and Uncertainty Management

SONATRACH

Principal Types of Uncertainty

Economic- price, governmental action,

inflation
Engineering- producing rates, depletion
mechanism, investment requirements, timing
Geologic presence of hydrocarbons, rock
and fluid properties, continuity
SONATRACH

Indicators of Uncertainty Exposure

Maximum Negative Cash Position of Project

Cost of Failure
Payout Time
ROI
SONATRACH

Uncertainty Economics

1. Success = Realization of a commercial Production Level

Failure = A Noncommercial Outcome (Dry Hole)

2. Probability of Success(Ps)= Chance of Establishing a Commercial

Production Level
SONATRACH

Uncertainty Economics

Certainty Economics (Ps = 100%) Associated

with the Successful Outcome Along with the
Ps Necessary to Obtain a Given PI or PW
Standard
Expected Economics Which Incorporate a
Known or Estimated Ps
Sensitivity Cases Which Incorporate the
Base Case Ps
SONATRACH

Sensitivity Analysis

Uses Multiple Case Comparisons to Explore

the Significance of Alternative Forecasts of
Uncertain Elements
SONATRACH

Parameters Subject to Sensitivity Analysis

Investment Requirements
Operating Cost
Reserve Size
Producing Rate
Farmout Terms
Prices
Royalty
Timing
SONATRACH

Drilling Cost Sensitivity

PI
Expected
High

Drilling Costs
Low High
SONATRACH

Risk of a Project
Probability of
Occurence
Project B

Project A

Reserve Level
SONATRACH

Definition of Expected Value

The Mathematical Concept of Expected Value

is the Primary Analytical Tool for Handling
Risk

Expected Value= Sum of products of the gain

or loss from each outcome x the probability
of the outcome occurring.
SONATRACH

Project with Symmetric Probabilities

SONATRACH

Project with Asymmetric Probabilities

SONATRACH

When Outcomes are Complex

Use Decision Tree

SONATRACH

Decision Tree
Ps .4 Dry -200
+190 .25
Poor -40
DRILL
.35

Excellent +800
DO
NOTHING