14/04/2019

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

Petroleum Economics
Cash Flow Calculation
Farhad Abdulrahman
Assistant Lecturer

TYPICAL PROJECT CASH FLOW PROFILE

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Cash Flow Concepts

1. Net Cash Flow (NCF) is the foundation of all

investment decisions.

2. Only cash can be used to acquire/obtain

assets/resources and to make profit distributions to
investors.

3. Negative cash flow over an extended period of time

reduce an organization’s ability to satisfy its
financial obligations.

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Definition of Terms and Concepts

• Revenues: funds received by the coy during the

period under consideration.

• Costs and Expenses: money spent by doing business

that must be paid from the revenues received by the
coy.

• Tangible Costs: Expenditures for items such as well

equipt, casing, wellhead etc . These costs are charged
against income through depreciation.

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Terms and Concepts (contd.)

• Intangible costs: Expenditures not represented by

physical equipment. They are not capitalized for tax
purposes (land survey, site development, access
roads…etc).

• Depreciation: decline in the value of equipment due

to wear and tear of normal use.

• Royalty: right to oil and gas in place that entitles its

owner to a specific fraction in kind or cash.

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Other Terms/Concepts
• Overheads: Costs not directly assigned to any unit of
production but are acquired as a result of general
operations (Administration and Management, Debt
interest).

• Income Taxes: The net revenue before income tax

(net revenue after expenses) is determined by
subtracting total expenditures before income tax from
total revenue. The council, state and federal taxes are
subtracted from the net revenue before income tax to
give after tax net cash flow.

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Contingency and Allowance

• Contingency: Budget for the unknown unknowns
– Block disposal
• Allowances: Budget for the known unknowns
(stuck)
▪They are probable extra costs
▪ E.g. for material loss, identified risks, foreseeable
/predictable market or weather conditions, new
technology, growth.
▪ The value is often taken from the 10% probability
budget estimate.
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Expenditures

• The total expenditures acquired in producing

oil and gas wells are divided into two groups:

1. The Total Capital Cost / Capital Expenditures

(CAPEX)

2. The Total Operating Cost / Operational Expenditures

(OPEX)

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The Total Capital Costs (CAPEX):

• The total original cost of installed facilities which
cannot be taken for tax purposes, but for which
depreciation is allowed by the tax authorities.

• It includes all expenditures required to drill, complete

the well and to provide the well with production
facilities required to lift the oil and gas from the bottom
of the well to the surface and also to transport HCs
from the well head to the treatment plant.

• Additionally, it includes are all future expenditures

required to keep the well on production (other than
operating costs)
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Capital Expenditure (CAPEX)

• One-time costs
• Occurring at the beginning of projects
• Classification by purpose/determination :
• Exploration costs
• Appraisal costs
• Acquisition costs
• Development costs
• Running Business costs
• Abandonment costs

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Capital Expenditure (CAPEX) (contd.)

• Classification by purchased items:

▪ Facility costs
▪ Wells/ Drilling costs
▪ Pipeline costs
▪ G&G costs (mainly seismic)
▪ Signature bonus

Note: Classification and wording differ from company

to company.

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CAPEX Expenses
• CAPEX are classified as tangible or intangible
expense:

– Tangible expenses are costs of physical equipment

and are tax deductible only by depreciation.

– Intangible expenses are expenditures not

represented by physical equipment. These items
are not capitalized for tax purposes (eg: land
survey, site development, access roads…etc)

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Operational Expenditures (OPEX)

• The expenditure experienced by producing
from an oil or gas well after it has been drilled
and completed is called the operating cost. It is
divided into two categories:

– Direct operating costs

– Taxes

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Operating Costs - OPEX (contd.)

• Direct Operating Costs: These are costs (expenses)

directly chargeable to individual leases. Labor
(employment) and material costs for operation,
maintenance, workovers, gas processing plants, salt-
water disposal systems and injection plants.

• Taxes: Vary widely throughout the world:

– Severance/Compensation taxes: They include conservation
and production taxes. They are charged by governments
and are based on production volume.

– Advalorem taxes: These include property taxes.

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Operational Expenditures (OPEX)

• Occur periodically
• Are necessary for day-to-day operations
• Consist typically of:
– Utilities
– Maintenance of facilities
– Overheads
– Production costs, e.g, Treatment Costs, Interventions,
Secondary recovery costs, Water treatment & disposal
costs.
– Insurance costs

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Depreciation, Depletion and Amortization

• Depreciation, Depletion and Amortization are

the means of recovering investment in certain
types of property before tax basis.

• Methods of Computing Depreciation

1. Straight Line
2. Double Declining Balance
3. Sum of the Years Digits

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Commercial Evaluation Scenarios

A B C
Project Rev. $1,000,000 $1,000,000 $1,000,000
Operating Cost - 200,000 - 200,000 - 200,000
Depreciation - 50,000 - 50,000 - 000,000

Taxable Income 750,000 750,000 800,000

Income Tax (50%) 375,000 375,000 400,000

Net Revenue 375,000 375,000 400,000

+ Depreciation 50,000 00,000 00,000

CASH FLOW 425,000 375,000 400,000

A = Depreciation taken and added

B = Depreciation taken but not added
C = Depreciation NOT taken

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Net Cash Flow (NCF) Calculation

NCF = Gross Revenue

- Royalty
- Operating Expenses (Well Repairs/Work-over )
- Overheads (Internal Costs)
- Capex
- Taxes (Property/Severance/Conservation) - Production Or Not.

= Net Revenue after expenses

- state and federal income tax

= Net Cash Flow

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Net Cash Flow (NCF) Calculation

• NCF = Gross Revenue
- Expenses (OPEX, Overhead, Royalty, Taxes )
- Depreciation
- Depletion
- Capex
= Taxable Income
- Income taxes

For Accountant = NET PROFIT

+ Depreciation
+ Depletion

For Economist = NET CASH FLOW

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Example 1.0
From volumetric calculations, the recoverable reserves for
a proposed well are 15 million barrels of oil. A joint
venture agreement between the host government and the
IOC allows the host government 51% of the project
revenue after tax profit.

Determine the host government take if the following

economic conditions prevail:

Oil price = $18/bbl; OPEX = $ 30 million; Royalty=20%;

Depreciation = $ 50 million; Tax rate = 75%.

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Solution Example 1.0

Revenue = 15 million x $18 = $ 270.00 million
Royalty (20% of Revenue) = ˗ 54.00 million
OPEX = ˗ 30.00 million
Depreciation = ˗ 50.00 million
Before tax profit = 136.00 million
Tax (75%) = ˗ 102.00 million
After tax profit = 34.00 million
JVA ( 49%) = ˗16.66 million
HG take = 17.34 million

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End

Next: Methods of Computing

Depletion

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