Start Up Training For Project Engineers PDF

OMV Exploration & Production
Economic Evaluation
Start up Training for
Project Engineers
Move & More.

Start up training for project engineers_07.ppt
2 |OMV Exploration & Production EC-E, December 30, 2011

Purpose of the Training
f Brief introduction into cash flow based project economics
f Understanding major economic decision criteria applied by OMV E&P
f Usage of the Easy Evaluation Tool

Contents
A. Cash Flow Basics
B. Economic Decision Criteria
C. Sensitivities
D. Easy Evaluation Excel Tool
E. Project Example
F. 2 E&P Exercises
G. Conclusion

A. Cash Flow Basics
Cash Flow Basics
f Definitions & Cash-flow Profile

f Revenue / Volume / Price
f Petroleum E&P Expenditure
- Capital Expenditure (CAPEX)
- Operational Expenditure (OPEX)

A. Cash Flow Basics
Cash Flow Profile of an E&P project

f Revenue
f CAPEX
f OPEX
Cash-Flow of an E&P-Project (entire life cycle view)
27.5 27.7%
20.6 19.8%
13.7 12.0%
6.9
mn EURO
4.2%
0.0
-3.6%
-6.9
-13.7 -11.4%
-20.6 -19.3%
-27.5 -27.1%
2012 2014 2016 2018 2020 2022 2024 2026 2028 2030

A. Cash Flow Basics
Revenue / Volume / Price

Revenue = sold Volume x Price
Differentiation:
f Produced Volume
f Sold Volume
The income portions of cash flows are known as Revenue

f Gross revenue is the product of oil and/or gas volume multiplied by
the unit price received for each volume of that product

A. Cash Flow Basics
Petroleum E&P Expenditure
Payment of cash or cash-equivalent for goods or services;

can be classified as:
f Capital Expenditure (CAPEX) and

f Operating Expenditure (OPEX)
Definition of typical E&P expenditures

f Finding Cost CAPEX
f Development Cost CAPEX
f Production Cost OPEX

Contents
A. Cash Flow Basics
C. Sensitivities
E. Project Example
F. 2 E&P Exercises
G. Conclusion

Economic Decision Criteria

f Fundamental bases of economic decision
- General introduction
- Time value of Money
f Economic Yardsticks
- Net Present Value (NPV)
- Expected Monetary Value (EMV)
- Internal Rate of Return (IRR)
- Payback Period
- Profitability Index

Financial & Economic Analysis

f Everything important to the decision should be included in the analysis
f Concerning the decision making process also qualitative factors have to

be taken under consideration (e.g. effects to the society)
f Financial analysis of investment alternatives requires that all

opportunities be appraised on the same basis, and the time value of
money be properly taken into account
f There is not only one single measure of profitability

Time Value of Money

f Decision-making in investment analysis requires anticipated revenues &
cost of investment alternatives to be placed on equivalent bases
10,000 / (1 + 0,1)
8,264 / (1 + 0,1)
9,091 / (1 + 0,1)
= 9,091 10,000
7,513 / (1 + 0,1) = 8,264
6,209 / (1 + 0,1) 6,830 / (1 + 0,1) = 7,513
= 6,830
= 6,209
= 5,645
= 1 0,0 00 /( 1+0.1)6
n
***id)
*PV = **FV / (1 + /1 .7 7 16 = 5,645 * PV . Present value
= 1 0,0 00
** FV . Future value
*** id . discount interest
rate
0 1 2 3 4 5 6
@10%
fCounterpart of discounting: compounding

fRelevant levers
f discount rate
f time
f value
Project Economics and Decision Analysis, Volume I, p. 23ff.

Discount rate
Discount rates at E&P:

f Standard rate (WACC)- Percentage rate at which future money is
discounted 10%
(WACC): Weighted-average cost of capital the marginal cost of
funding the next project; this is calculated as an weighted-average
cost of a mixture of equity and debt.
f Hurdle rate the minimum acceptable rate of return on investment

15% for incremental projects / 11% for acquisitions
Economics of worldwide PPC, R.D. Seba; page 185

Net Present Value (NPV) (1/4)

f For analyses of project cash flows the most common method is Net
Present Value (NPV)
f NPV = Total PV of future CFs + Initial Investment (negative)
f General:
f NPV uses cash flows
f NPV uses the cash flow pattern of the entire project
f NPV discounts the periodically (yearly) cash flows properly (
discounted cash flows)
f Base case model computes nominal NPV

Net Present Value (NPV) (2/4)

The formula for NPV calculation is*
N
CF n
NPV = CF 0 + n
n =1 (1 + i )
where CF0 = Todays cash flow
CFn = Projects cash flow of period n
i = discount rate
n = Number of years elapsed
If NPV > 0, the project is accepted

(NPV represents present value cash worth in excess of realizing a rate of return
equal to i);
If NPV = 0, the project is marginal, i.e. neither adds or destroyed value.
(the project yields a rate of return equal to i);
If NPV <0, the project is not profitable on a time-adjusted basis;
The higher the NPV, the higher is the value added for the company.
* OMV standard: mid-year discounting


Net Present Value (NPV) (3/4) Example

Would you rather receive:
f Option A: 10,000 as follows: 6,000 after 1 year and 4,000 after 2 years
or
f Option B: 12,000 as follows: 2,000 after 1 year followed by another 2,000
annually during over the next 5 years?
Cash Flow
Option A Option A Option B Option B

Year Discount rate
Undiscounted Discounted Undiscounted Discounted
@ 10%
0 1.000 0 0 0 0
1 0.909 6,000 5,455 2,000 1,818
2 0.826 4,000 3,306 2,000 1,653
3 0.751 0 0 2,000 1,503
4 0.683 0 0 2,000 1,366
5 0.621 0 0 2,000 1,242
6 0.564 0 0 2,000 1,129
Total 10,000 8,760 12,000 8,711
In this example, it is preferable to receive 10,000 in 2 years as this has a present value of 8,760 as opposed to the
present value of de 8,711 based on in six payments of 2,000 each.

Net Present Value (NPV) (4/4) Example

f Normally, when the discount rate (i) increases the NPV decreases.
10,000
8,711
9,000 Option B
8,000
7,000 6,651
6,000 5,285
NPV EUR
5,000 4,336
4,000 3,649
3,135
3,000
2,000
1,000
0
10% 20% 30% 40% 50% 60%
discount rate (i)

Expected Monetary Value (EMV)

f Expected Monetary Value can be calculated by risk adjusting the NPV
f expressed mathematically as the sum of the product of an events
probability of occurrence and the gain and loss that will result
Cash Flow Exploration Well (mn EUR)

Year undiscounted discounted @10%
0 -2.50 -2.50 success
1
2
2.00
3.50
1.82
2.89
propability x gain (NPV)
15% 16.66 2.50
3 4.00 3.01
4 4.50 3.07
5 5.00 3.10 + EMV = 0.37 mn EUR
6 4.00 2.26 dry hole
7 3.00 1.54
8 2.00 0.93
propability
85%
x loss (drilling costs)
-2.50 -2.13
9 1.00 0.42
10 0.30 0.12
Total 26.80 16.66
chance of success 15%

dry hole costs 2,5

Internal Rate of Return (IRR) (1/2)

f Internal Rate of Return (IRR) is the discount rate for which the Net Present
Value equals 0
f Excel formulae:
f IRR () English version
f IKV() German version
f Effective rate of interest of the respectively bounded capital
If IRR the hurdle rate, the investment proposal shall be accepted.

If IRR < the hurdle rate, the investment proposal shall be rejected.

Internal Rate of Return (IRR) (2/2) Example
5.00
4.00 3.80
3.00
2.45
NPV mn EUR
2.00 IRR = 58% --> NPV = 0

1.42
1.00 0.63
0.00
0.00
-0.51
-1.00
-0.93
-1.28
-2.00 -1.58
18% 28% 38% 48% 58% 68% 78% 88% 98%
discount rate

Payback Period (1/3)
The focuses on recovering the initial investment

f time needed to recover the investment (payback or amortization period)
f Break-even point
Signifies time period of exposure to risk

f the shorter the payback the better
Problems with payback

f ignores benefits occurring after the payback period
f does not measure total income
The payback period is based on the discounted accumulated project cash

flow (main OMV discount rate of 10% has to be used)

Payback Period (2/3) Example Calculation

New Oil Company is considering to drill an additional development well on its
field. The well will cost mn EUR 2.5 to drill and will generate mn EUR 0.33
additional income for 20 years. The company requires that investments are
paid back within 10 years. Should the investment go ahead?
Accumulative
Discount Annual Cash Accumulative discounted Cash
Year Factor Flow Cash Flow Flow
@ 10% [mn EUR] [mn EUR] [mn EUR]
0 -2.50 -2.50 -2.50
1 0.909 0.33 -2.17 -2.20
2 0.826 0.33 -1.84 -1.93
..
7 0.513 0.33 -0.19 -0.89
8 0.467 0.33 0.14 -0.74
..
13 0.29 0.33 1.79 -0.16
14 0.263 0.33 2.12 -0.07
15 0.239 0.33 2.45 0.01
..
20 0.149 0.33 4.10 0.31
Solution: The payback period is 14,6 years, the investment is rejected

OMV discounted 10% - notice

Payback Period (3/3) Example Chart

5
Project CF (non-disc.)
(disc.)
Project Cash Flow, non-disc.,acc. 4.1
4 Project Cash Flow, disc., acc. 3.8
3.4
3.1
3 2.8
2.5
2.1
2 Payback after 14.6 years

1.8
1.5
mn EURO
1.1
1 0.8
0.5
0.3 0.2 0.3
0.3 0.2 0.2 0.2 0.1 0.1 0.2
0.2 0.2 0.1 0.1 0.1 0.1 0.1 0.1
0.1 0.1 0.0
0.1 0.1 0.1 0.1 0.1 0.0
-0.1
-0.2 -0.1
0 -0.2
-0.3
-0.5 -0.5
-0.6
-0.7
-0.9 -0.9
-1.0
-1.2 -1.2
-1
-1.4
-1.5
-1.6
-1.8
-2.1
-2.2
-2
-2.4
-2.5
-2.4
-3
2011 2013 2015 2017 2019 2021 2023 2025 2027 2029 2031

Profitability Index (1/2)

f Also known as Discounted Return of Investment (DROI)
f PI shows how many EURO cents is earned per 1 EURO of cash out (e.g.
CAPEX)
Profitability Index
PV Cash in
(
( - PV Cash out
=
NPV
PV Cash out PV Cash out
Typically used within OMV E&P

NPV PV of CF
PI = =
Present Value of CAPEX PV of CAPEX
Also possible (normally not used within OMV E&P)

NPV PV of CF
PI = =
Present Value of (CAPEX + OPEX) PV of (CAPEX + OPEX)

Profitability Index (2/2) Example
Example:
f Project CAPEX = 100 MM EUR spent over 1 year.
f Operational CF = 20 MM EUR per year over 10 years.
f Discount rate = 10%, CF basis at the end of the year.
f NPV = 20,81 MM EUR, Present Value (PV) of CAPEX = 90,9 MM EUR
f PI = 0,23 which means this project will generate 23 EURO cents per each 1
EURO invested, both being in terms of Present Value.

Which yardsticks to use Decision
KPI What is it What it means Stumbling blocks

Major assessment criterion for Positive NPV project is profitable Uncertainty of cash flows
project economics Negative NPV project is not profitable Reinvestment premise (at discounting rate)
Absolute value in monetary For rankings: a project is preferred if the For project comparisons: prerequisite of
NPV terms of discounted payment
surpluses indicating project
NPV is higher than that of an alternative identical life time of all alternatives
investment
attractiveness
Useful for project rankings
Risk-adjusted (probability- Positive EMV project is profitable (given Accuracy of probabilities

adjusted) NPV (cf. above) its probabilities) Reinvestment premise (at discounting rate)
EMV Negative EMV project is not profitable For project comparisons: prerequisite of
(given its probabilities) identical life time of all alternatives
Internal rate of return (in %) of a Higher than hurdle rate project is Reinvestment premise (at IRR)
cash flow profile profitable (with some restrictions) Cannot always be calculated (certain cases
Indicates the discounting rate at Lower than hurdle rate project is not of inconclusive IRR or no IRR at all)
IRR which the cash flow profile has
an NPV of 0
profitable
For rankings: a project is preferred if the IRR
Not additive
Does not consider (total) investment volume
Is compared to a specific hurdle is higher than that of an alternative For project comparisons: prerequisite of
rate (%) investment identical life time of all alternatives
Number of periods (years) The shorter the pay back period the better Reinvestment premise (at discounting rate)
Pay needed to recover the invested A shorter payback period indicates a lower Ignores occurrences after breakeven point
capital
Back Useful for single investment of
risk exposure in time
Does not provide information about total
choice decisions profit of the investment project
Period
Ratio indicating how many The higher the PI the more attractive a Reinvestment premise (cf. NPV)
monetary units is earned per 1 project appears There is different ways of calculation
PI monetary unit of cash out (e.g.
CAPEX)
(depending on denominator)
Not additive
26 |OMV Exploration & Production
Useful for projectEC-E, December 30, 2011
rankings Does not consider (total) investment volume
Contents
A. Cash Flow Basics
C. Sensitivities
E. Project Example
F. 2 E&P Exercises
G. Conclusion

C. Sensitivities
Spider Sensitivity graph (1/2)
f Differentiation between input variables/parameters and output results

f Ceteris paribus assumption (all other things held constant)
Spider chart illustrates the differences between

f the minimum and maximum values of the output result by drawing a
curve through all variations of the input variable tested (E&P standard
50%, 75%, 125%, 150%)
f Curves with steep slopes, positive or negative, indicate that those
variables have a large effect, while curves that are almost horizontal
show little or no effect on the forecast
f The slopes of the lines also indicate whether a positive change in the
variable has a positive or negative effect on the output result

C. Sensitivities
Spider Sensitivity graph (2/2)

800
C A P EX
O PE X
Pr ice
Q u a nt it y
600 BA SE CA SE
54 9
54 9
450
38 1 450
400 352
33 6
2 91
33 8 3 52
2 45 2 53
30 1
mn EURO
200
2 65 2 53
200 2 28 15
15 4
191 1 09
15 4 63
56
1 17
18
81
56 44 -28
0 -43
7
-43
-1 4 2
-1 42
-2 0 0 -2 4 0
-24 0
-339
-33 9
-4 0 0
5 0 .0 % 6 0 .0 % 7 0 .0 % 8 0 .0 % 9 0 .0 % 1 0 0 .0 % 110. 0% 1 2 0 .0 % 1 3 0 .0 % 1 4 0 .0 %
% of B as e Cas e

Contents
A. Cash Flow Basics
C. Sensitivities
E. Project Example
F. 2 E&P Exercises
G. Conclusion

Easy Evaluation Excel Tool
f General
- Pre tax calculation (no royalties and taxes are considered)
- All volumes have to be inputted in mn boe
- All cash values have to be inputted in mn
f Purpose of the tool

- Quick project evaluation
- Creation and comparison of project scenarios
- Optimization of the cash flow concerning the best economical
output
- Not a tool to create final economic calculations

- Final economics have to be calculated in Palantir Cash

Contents
A. Cash Flow Basics
C. Sensitivities
E. Project Example
F. 2 E&P Exercises
G. Conclusion

F. 2 E&P Exercises
Team Exercises
f 2 E&P exercises
f Project input
f Making the right decisions
- Output of calculations and graphics
f Change Input variables (scenarios)
- New output of calculations and graphics
f Close loop Learning by doing
f Short presentation of findings

f Presentation of the results and interpretations

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OMV Exploration & Production

Move & More.

Start up training for project engineers_07.ppt

f Brief introduction into cash flow based project economics

f Understanding major economic decision criteria applied by OMV E&P

f Usage of the Easy Evaluation Tool

3 |OMV Exploration & Production EC-E, December 30, 2011

Start up training for project engineers_07.ppt

A. Cash Flow Basics

B. Economic Decision Criteria

D. Easy Evaluation Excel Tool

4 |OMV Exploration & Production EC-E, December 30, 2011

Start up training for project engineers_07.ppt

Cash Flow Basics

f Definitions & Cash-flow Profile

5 |OMV Exploration & Production EC-E, December 30, 2011

Start up training for project engineers_07.ppt

Cash Flow Profile of an E&P project

Cash-Flow of an E&P-Project (entire life cycle view)

6 |OMV Exploration & Production EC-E, December 30, 2011

Start up training for project engineers_07.ppt

Revenue / Volume / Price

The income portions of cash flows are known as Revenue

7 |OMV Exploration & Production EC-E, December 30, 2011

Start up training for project engineers_07.ppt

Petroleum E&P Expenditure

Payment of cash or cash-equivalent for goods or services;

f Capital Expenditure (CAPEX) and

Definition of typical E&P expenditures

8 |OMV Exploration & Production EC-E, December 30, 2011

Start up training for project engineers_07.ppt

A. Cash Flow Basics

B. Economic Decision Criteria

D. Easy Evaluation Excel Tool

9 |OMV Exploration & Production EC-E, December 30, 2011

Start up training for project engineers_07.ppt

Economic Decision Criteria

10 |OMV Exploration & Production EC-E, December 30, 2011

Start up training for project engineers_07.ppt

Financial & Economic Analysis

f Concerning the decision making process also qualitative factors have to

f Financial analysis of investment alternatives requires that all

f There is not only one single measure of profitability

11 |OMV Exploration & Production EC-E, December 30, 2011

Start up training for project engineers_07.ppt

Time Value of Money

fCounterpart of discounting: compounding

12 |OMV Exploration & Production EC-E, December 30, 2011

Start up training for project engineers_07.ppt

Discount rates at E&P:

f Hurdle rate the minimum acceptable rate of return on investment

Economics of worldwide PPC, R.D. Seba; page 185

13 |OMV Exploration & Production EC-E, December 30, 2011

Start up training for project engineers_07.ppt

Net Present Value (NPV) (1/4)

f NPV = Total PV of future CFs + Initial Investment (negative)

f Base case model computes nominal NPV

14 |OMV Exploration & Production EC-E, December 30, 2011

Start up training for project engineers_07.ppt

Net Present Value (NPV) (2/4)

If NPV > 0, the project is accepted

* OMV standard: mid-year discounting

Start up training for project engineers_07.ppt