Koya Uni/FENG/DPETE 18/02/2017

Koya University
College of Engineering
School of Chemical and Petroleum Engineering
Department of Petroleum Engineering
Third Stage

Petroleum Economics
Basics of Petroleum Economics
Farhad Abdulrahman
Assistant Lecturer

Petroleum Economics Course Outline

1. An introduction to Petroleum Economics.

2. Cash Flow Calculation
3. Net Cash Flow Calculation
4. Investment Terminology
5. Risk Analysis
6. Expected Value Concept
7. Decision Tree Analysis

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INTRODUCTION TO
PETROLEUM ECONOMICS

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DEFINITION AND OUTCOMES

• The Petroleum economy or Petroleum economic analysis are all

used interchangeably to denote the study of the economics of
engineering systems.

• Petroleum economy is an applied economics course. However, the

application is not engineering systems, this course is taught by
engineering faculty.

• As future engineers, no matter what type, you will sooner or later

have to deal with problem situations similar to the ones covered in
this course.

• At the end of the course you will be equipped with analytical skills
that you can use to solve problems of an economic nature.

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Aims, Objectives & Prerequisite

• Aims
To introduce the basic concepts and background for the financial
and economic assessment of projects within the petroleum
industry.

• Objectives: At the end of the course student should:

1. Be able to calculate the NPV of a project, including the collection

of all necessary data, carry out decision Pivot Point Analysis and
be able to select the best option from several possibilities.

2. Be able to carry out simple portfolio management decision under

conditions of uncertainty, including economic, technical and
political risks.

• Prerequisite
– Familiarity of field development and reservoir life cycle
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Decision Tree Analysis

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The Tetrad Trade-Off Principle

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ECONOMIC DECISION

• Why do I need to study economics?

• "Is it not enough for me to be a good

engineer ? I am not an accountant.

• I will ask the accountant in my company to

do that work for me.

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ROLE OF THE PETROLEUM ECONOMIST

• To advise on the economic attractiveness of these

opportunities, taking into account the many uncertainties
regarding reservoir behavior, development costs, future
energy prices and relationships with governments.

• He/She will also be involved in some or all of the

following activities:

- Lease Bidding
- Selection of "best" option
- Reporting
- Unitization discussions
- Fiscal changes
- Contracts

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INSTRUCTIONAL OBJECTIVES
• Construct a project cashflow from given production, cost
and fiscal assumptions.

• Name the major ‘yardsticks’ (Categories) used to

measure economic benefit and to make economic
decisions.

• Apply the Discounted Cash Flow technique to determine

the Net Present Value.

• Calculate ROR, NPV, and payout… etc.

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ECONOMIC ANALYSIS AND DECISIONN

MAKING
• The primary objective of any business organization (oil and
gas) is not merely to produce goods and services (oil and
gas) BUT rather to make a profit – the maximum profit.

• OTHERS:

- Expansion in production capacity

- Increase in market share

- Diversification of activities

- Continuous survival of the organization

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WHY DO WE MAKE ECONOMIC EVALUATION ?

1. Prioritize projects.

2. Re-evaluation of priorities in allocation of investment funds by

the company.

3. Planned change in development or production methods that

consequently may affect the production rate and ultimate
recovery.

4. Assessment of value of assets for taxation purposes.

 Whatever the reason for conducting an economic evaluation,

with limited financial resources and a specific set of corporate
objectives, any company must select the best investment
opportunities from among those available.

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The economic analysis should lead toward an

balanced answer to two questions:

1. Does the particular investment project seem to

satisfy the stated objectives of the firm?

2. Is this project “better” or “worse” than other

possible projects?

Even if there were only one investment opportunity under review,

it must favorably compare with other profit-generating activities.

This is the concept of opportunity cost – the advantage forgone

due to alternative use of investment funds.

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CHARACTERISTICS OF OIL AND GAS

RESOURCES
In addition to factors normally considered in capital
investments, some of the characteristics of oil and gas
that may affect the results of economic analysis are:

1. The long lead time from geologic discovery to full use of

the resource (5 – 20 years)
2. The political and social environment in the region
(takeovers and shutdown of operations)
3. Tax burden and special allowances customary in oil and
gas accounting
4. The heterogeneous nature of deposits.
5. The nonrenewable nature of oil and gas resources

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ASPECTS OF LEASING
• Oil and gas are minerals and part of land for Home
government (HG) or landowner’s (LO) legal right.
• If HG/LO says NO then – no bidding.
• In some countries – Govt owns the mineral rights
and only Govt can explore the minerals unless it
transfers right to another. If this happens we say
that Govt gives another a CONCESSION.
• Three Common Interests for HG/LO:
– Lease interest
– Mineral interest
– Royalty interest

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LEASE INTEREST

• There will be written agreement b/w HG (lessor) and the

Petroleum company (lessee) granting legal interest in HG
property.

• The right will revert to LO at the end of the lease term.

• The lease is granted for explicit period (primary term) and for
as long as petroleum is found.

• The LO reserves certain rights and privileges

 Bonus payment
 Royalty payment
 Reversion of right
 Surface rights
 Delayed rental

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MINERAL RIGHTS:

- LO is the owner of mineral right.

- LO may choose to develop or sell right to

mineral to second party through a lease.

ROYALTY INTEREST:

- LO is granted with fraction of production

free of costs.

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LICENSES AND LEASES

OIL-EXPLORATION LICENSE (OEL)

A non-exclusive right to explore for and produce petroleum within

area of grant. Whoever finds oil first should report to the HG/LO.
Others will leave.
OIL-PROSPECTING LICENSE (OPL)
Exclusive right to explore and prospect for petroleum within area
of grant.
OIL-MINING LEASE (OML)

Permits lessee use of land to explore and dispose of petroleum

discovered within leased area. Ultimate in petroleum exploration
and production

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TYPE OF OIL AND GAS CONTRACTS

1. CONCESSIONARY
- Allows private (coy) ownership of oil and gas discovered
through transfer of rights and payments of bonuses, royalties,
taxes to Govt.
- No more prevalent

2. JOINT VENTURE
- Risk shared by Govt and Coy
- Objective is to increase HG take
- Better control of your money and assets

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3. PRODUCTION SHARING CONTRACT (PSC):

- Coy assumes risk of exploration
- At commercial discovery, Govt steps in and becomes partner.
- Production first used to repay expenses (cost oil).
- Coy then receives share of remainder ( to be determined by contract)
- Remaining oil is divided into:
> Tax oil – (Obligations)
> Interest (profit) oil – True value of contract to coy.

4. SERVICE CONTRACTS (SC):

- Principle is same as PSC
- Service Coy takes care of exploration
- At discovery, Govt pays actual exploration cost, but remains sole owner of
discovered reserves
- Govt may buy part of the production
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CONTRACTING STRATEGIES
1. Aligned operator and contractor's goal through performance
based contracts, such as the move from direct to
integrated/incentive contracts and balanced rewards fro
operator and contractor.

2. Better use of contractor expertise, such as minimising the

level of operator/contractor duplication and clearly defining
roles and responsibilities.

3. Teamwork (operator/contractor. subcontractor), including

developing open and trusting contractual relationships.

4. Continuous performance improvement with a commitment to

quality management principles and long term contractual
security.
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Technical Tender Evaluation Category

• Element
– Timeline
– Costs
– Scope of work

• Capability
– Delivery Management System
– Project Assurance and Risk Management
– Procurement and logistics capability
– Managing/personal and rig crew organization
– Staff CVs
– Central office support
– Contractor and sub-contractor profile and performance record

• Experience
– International Experience
– Local presence

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Commercial Tender Evaluation Category

1. Fixed Price Element
 Drilling Services
 Mud Services
 Casing supply and Running
 TBG supply and Running
 Contingency

2. Unit Costs
 Wire line & perforation Service
 Surface Well testing & sampling
 Mud logging
 Cementing service
 Coring & evaluation test

3. Other Cost Elements (Not foreseen pre-tender)

 Mob.& DeMob
 InterMove Bet. Location
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End

Cash Flow Calculation

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