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- Principles: Life and Work
- Principles: Life and Work
- The Intelligent Investor, Rev. Ed
- Marrying Winterborne
- The Hard Thing About Hard Things: Building a Business When There Are No Easy Answers
- Rich Dad Poor Dad: What The Rich Teach Their Kids About Money - That the Poor and Middle Class Do Not!
- MONEY Master the Game: 7 Simple Steps to Financial Freedom
- Secrets of the Millionaire Mind: Mastering the Inner Game of Wealth
- I Will Teach You to Be Rich, Second Edition: No Guilt. No Excuses. No BS. Just a 6-Week Program That Works
- Bad Blood: Secrets and Lies in a Silicon Valley Startup
- The Total Money Makeover: A Proven Plan for Financial Fitness
- The Intelligent Investor Rev Ed.
- The Intelligent Investor
- Rework
- Unshakeable: Your Financial Freedom Playbook
- Your Money or Your Life: 9 Steps to Transforming Your Relationship with Money and Achieving Financial Independence: Fully Revised and Updated for 2018
- Rich Dad's Guide to Investing: What the Rich Invest In, That the Poor and Middle Class Do Not!
- Liar's Poker: Rising Through the Wreckage on Wall Street

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ANIMASHAUN Tunde

Table of Content

Introduction

Petroleum Industry consists of a series of

distinct segments E&P, refining, marketing

and transportation

Exploration is the most risky segment

Profitability varies from segment to segment

Reserves are the principal assets of the

industry

The industry is not allowed to self regulating

and very susceptible to significant outside

political control

The industry is probably the most heavily

taxed of all business enterprise worldwide

(75% tax on Oil)

Introduction

Production costs =Technical cost + Fiscal

Cost

Technical Cost = f(no. of wells drilled, depth

of the well, nature of the rock drilled, CAPEX)

E&P industry is an extractive capital

intensive industry with a high level of risk

factor

Introduction

The decision to invest is primarily

driven by economics but may be

subject to social , environmental and

security of investments

The primary goal of E&P firm is to

maximize the present value of total

profit in the long run without

breaking law

CRITERIA

The fundamental question in any E&P business

decision is whether the

project is profitable. Profit is defined simply as:

Profit = Revenues-Costs = Cash In-Cash Out

Strength:

Simple and generally unambiguous

Project profits can be weighted

Weakness:

Does not recognize the size and timing of cash flows

A: Investment = $25 Million; Profit = $10 Million or B:

Investment $50 Million; Profit = $10 Million

Which project is preferred?

Cash Flow Model (CFM) is one of the three profit

models commonly used to determine profit.

The costs component of profit is defined differently

in each model, hence, each approach may give

different estimates of profit.

The other two models are (not emphasize here in

this course):

Financial Profit Model, which produces financial net income

Tax Profit Model, which produced taxable income

preferred, it produces net cash flow and it places the

timing of funds to and from projects more

accurately

Operating Revenue

Operating Cost

Capital Expenditure

Salvage Value

NCF = Cash Received Cash Spent

Gross Revenue = Product Vol. * Price of

Product

Economic

profit

measures

the

difference between net revenue, cost

and the opportunity costs of investment

DECISION TREES

Decision trees provide a map for

choices.

Monte Carlo simulation provides

broad ranges of possible outcomes

for better decision making

Decision tree

Chance

Chance

Commercial

Producer

Decision

Marginal

Drill

Dry hole

Dont

drill

Dead end

Chance

Chance

Commercial

75%

Producer

Decision

25%

35%

Drill

65%

Dry hole

Dont

drill

Dead end

Marginal

How do we derive

tree?

the value of $701 K?

Chance

Chance

Decision

Drill

$701 K

Dead end

$0

25%

35%

65%

$3,000 K

75%

Producer $2,375 K

Dry hole

Dont

drill

Commercial

Marginal

$500 K

-$200 K

$3,000 K x 0.75 =

$500 K x 0.25 =

=

$2,250 K

$125 K

$2,375 K

decisions?

Chance

Producer

Chance

Decision

$701 K

Drill

Dont

$0

drill

Farm out with

25% WI buy in

Commercial

$2,375 K

35%

65%

Dry hole

75%

25%

$500 K

Marginal

-$200 K

$594 K

$208 K

$3,000 K

35%

65%

How do we derive the value

$0

of $750 K?

$750 K

75%

25%

$125 K

decisions?

Chance

Producer

Chance

Decision

75%

$701 K

Dont

$0

drill

Dry hole

Drill

Commercial

$2,375 K

35%

65%

75%

25%

$500 K

Marginal

-$200 K

$750 K

$594 K

$208 K

Farm out with

buy in 25%

$3,000 K

75%

35%

$208 K?

25%

$125 K

65%

$0

decisions?

Chance

Producer

Chance

Decision

75%

$701 K

Dont

$0

drill

Dry hole

Drill

Commercial

$2,375 K

35%

65%

75%

25%

$500 K

Marginal

-$200K

$750 K

$594 K

$208 K

Farm out with

buy in 25%

$3,000 K

75%

35%

25%

$125 K

65%

alternative for this

decision?

$0

chances?

Maximum (27.6%)

$726 K

Producer

Drill

$69 K

$631 K

29%

Minimum (17.2%)

71%

Dry hole

Dont

drill

$0

$1,277 K

$145 K

- $200 K

remaining chance

nodes

tree?

Identify all future

decisions

Commercial

Producer

Decision

Marginal

Drill

Dry hole

Dont

drill

Dead end

outcomes

much as needed

tree?

Chance

Chance

Commercial

75%

Producer

Decision

25%

35%

Drill

65%

Marginal

Dry hole

Dont

drill

Dead end

Estimate

probabilities of all

outcomes

tree?

Chance

Chance

Commercial

75%

Producer

Decision

25%

35%

Drill

65%

Dry hole

Dont

drill

Dead end

$0

$3,000 K

Marginal

$580 K

- $200 K

Estimate

Financial results of

all outcomes

tree?

Commercial

Chance

Chance

75%

Producer

Decision

25%

35%

Drill

65%

Dry hole

Dont

drill

Dead end

$3,000 K

Marginal

$580 K

- $200 K

Select best alternative for the

decision node

$0

anyyields

node?

Best alternative

greatest expected monetary

value

helpful?

Each decision has a limited

number of outcomes

Probability of occurrence of each

outcome can be determined

Each decision is ultimately

dependent upon economic

consequences of future

decisions and outcomes

On annual before tax basis cash flow for a typical

E&P venture :

NCF = Gross Revenue

- Royalty

- State & Local Taxes

- Operating Expenses

- Overheads (business & investment)

- Capital Investments

- Bonus&Leasehold costs

+ Property Sales Price

Gross Revenue= price x marketed volume of

hydrocarbon

Royalty = royalty rate (RI) x gross revenue

Net Revenue= Net share of marketed production*Net price

= Net price * (1-RI)*Production

Net price is prices received less any purchaser charges

levied on petroleum production in the U.S.

Production, severance, and advalorem, conservation,

and school taxes

They are paid whether profits are made or not!

Production and severance taxes on production

Ad valorem taxes are based on property values

production taxes

Severance and advalorem taxes are paid on a fairshare basis by both the royalty and producing

interests

Technical Costs

Operating Expenses (OPEX)

monies paid for assets that will generate

benefits for more than one year.

Usually such an asset has a life time of

more than a year

List of some capital expenditures in E&P

evaluation

Cost of drilling and developing a well

Cost of surface equipment

either tangible or intangible costs

Tangible costs are usually capitalized and

depreciated for after tax calculation

purposes

Intangible costs are usually expensed

through amortization for tax calculation

purposes

INTANGIBLE%]

I

Bonus and Leasehold Costs

100

0

65

35

Dry holes

0

100

Production/Injection Wells

30

70

100

0

Drilling Platforms

70

30

Production Platforms

100

0

Operating Expenses (OPEX)

production or injection.

They are expenditures that benefits only

the period in which they are made

No operating costs if there are no

ongoing production or injection.

Typical OPEX behavior patterns are

variable costscosts of raw materials-and fixed costs--management fees.

Lifting costs

Personnel

Maintenance etc

basis rather than on a per unit basis.

Measured as $/month, or $/year rather

than per Bbl of $/month/well

WHY?

components of OPEX

Hidden costs of being in business,

internal costs, no money is paid out.

Business overhead represents internal cost of

accounting, est.

a fixed monthly amount may be assigned in the range

of 15-40 percent

making investments

Can be estimated as a percentage of of total

investments costs excluding bonus & leasing costs

Capital Investments [A]

Tangible capital costs

Intangible capital costs

Lease Bonus and rentals

Overheads

Investment overhead

Business overhead

Employee Benefits

The Revenue [C]

Year

(a)

1

2

3

4

5

Total

Intangible

Tangible

Development Lease & Well

Costs

(b)

(c)

Other

(d)

1,000,000

500,000

50,000

1,000,000

500,000

50,000

20.0%

$20.00

10.0%

4.80

150.00

20.0%

C: REVENUE

Annual

Gross

Production

(a)

(e)

Year

1

2

3

4

5

Total

400,000

200,000

100,000

50,000

25,000

775,000

Gross

Production

Income

(f)

8,000,000

4,000,000

2,000,000

1,000,000

500,000

15,500,000

Land

Owner

Royalty

(g)

1,600,000

800,000

400,000

200,000

100,000

3,100,000

Net

Operating

Income

(h)

6,400,000

3,200,000

1,600,000

800,000

400,000

12,400,000

D: OPERATING EXPENDITURES

Year

(a)

Total

Direct

Operating

Costs

(I)

1 1,920,000

2

960,000

3

480,000

4

240,000

5

120,000

3,720,000

Business

Overhead

(j)

Investment

Overhead

(k)

150,000

150,000

150,000

150,000

150,000

750,000

310,000

310,000

State &

Local

Taxes

(I)

640,000

320,000

160,000

80,000

40,000

1,240,000

Year

CAPEX

(a)

(m)

1

2

3

4

5

Total

1,550,000

0

0

0

0

1,550,000

NOREV

(n)

6,400,000

3,200,000

1,600,000

800,000

400,000

12,400,000

OPEX

(o)

3,020,000

1,430,000

790,000

470,000

310,000

6,020,000

Savage

Value

(h)

0

0

0

0

0

0

After Tax NCF is Before Tax NCF less income taxes

Income taxes are some fraction of taxable income

on annual or total-life basis, e.g. 40 %, 85 %, etc

Taxable income is net revenue less fiscally

deductible costs

Fiscal cost deductions include:

OPEX, Royalty, Depreciation, Depletion

Allowance, Expensed Investments or

Amortized Intangible Capital Investments

Fiscal Depreciation

The purpose is to spread investment costs over time, for

income tax and financial report purposes.

It is a method for capital recovery of the costs of a fixed

assets over the estimated useful life of the asset

It has to be estimated according the underlying rules set

by tax legislation.

Depreciation involves estimating service life, salvage

value, and pattern of depreciation. Estimating the useful

life is the most important factor.

The ranges of lives permitted may differ from place to

place. The more liberal Class Life Asset Depreciation

Range ADR for drilling is 5-7 years and for E&P is 11-17

years.

DEPRECIATION

Depreciation is the process of prorating as

expenses the capitalized costs of certain items

over a period of years.

Depreciation is a non cash charge, deductible from

the tax base which represents a reasonable

allowance for the exhaustion, wear and tear and

obsolescence of depreciable property used in

business or held for the production of income. This

enables a firm or business to recover the cost of a

depreciable asset during its estimated useful life.

equipment and surface equipment. Generally, an

item can be declared depreciable if it retains a

usable or reusable value over a period of time

will have some value if it is not

utilized to the exhaustion of its useful

life.

The salvage value is defined as the

estimate at the time the asset is

acquired of the amount of money that

will be realized upon its sale or other

disposition for some other us

the following are more generally

used:

Straight line method

Declining balance method

Sum of years digits method

A combination of declining balance and

straight line method

Units of production method`

DEPLETION ALLOWANCE

Depletion is the result of systematic and

intentional removal of certain types of asset.

An activity that tends to exhaust.

When depreciation concept is applied to oil and

gas or any mineral, it is called depletion. It

indicates a lessening of the value of a natural

resource asset as it is produced with time.

Specific replacement of used assets is not

possible. Acquisition of new properties is a

necessity to remain in business.

Depletion differs theoretically from

depreciation as the latter results from use and

the passage of time. Specific replacement of

used assets are possible.

DEPLETION ALLOWANCE

COST

Depletion Cost Method

Depletion charge is based on the amount of the

resource that is consumed and the initial cost of the

resource

Unit depletion rate = investment cost divided by units of

resource

depreciation

Statutory Depletion Cost

This is an alternative method for depletion calculation called

percentage method of depletion

It represents a fixed percentage (about 22%) of gross

operating revenue up to a maximum of net operating

revenue to be the depletion charge

Amortization of Intangible

CAPEX

The most commonly used method of

amortization of intangible capital in the

oil business in unit of production

method

The most frequently amortized

intangible cost is drilling expense

Lease bonus is another capital

expenditure that is frequently amortized

especially if failure is anticipated.

After Tax NCF = (1-A) * [Revenue-Royalty-OPEX]

- CAPEX + A * [DepExp + ExpInv+AmorInv]

- Depletable Investments + A*

Depletion

+ B* [Investment Tax Credit]

+ Property Sale

- C * [Property Sale-Salvage Value]

A = Income Tax Rate, fraction such as, 0.33

B = Investment tax credit rate, fraction such as

0.15

C = Capital gain tax rate, fraction, such as .25

COMPONENTS

After Tax NCF = Net Revenue + Tax Credit + Net

Capital Gain

- Net OPEX

- Net CAPEX

- Net DPLEX

Net

Net

Net

Net

Revenue = (1-A)*(Revenue-Royalty)

OPEX = (1-A)*(operating costs+overheads+other taxes)

CAPEX = CAPEX-[A*(depreci + expinv+amorinv)

DPLEX = DPLEX A* depletion cost

basis or on a cumulative project basis.

Given the following hypothetical data for a new venture with the following production schedule in thousands,

calculate the AFT NCS each year:

1

2

3

4

5

Total

400

200

100

50

25

775

Unit Price of Output

State and Local prices

Operating Costs

Business Overhead

Investment Overhead

Capital Investment

Bonus & Leasehold Costs

= 20 %

= $20.00

= 10 % of Net Revenue

= $4.80 per unit of total production

= $150,000 per year

= 20 percent of Investment

= $ 1 Million

= $500,000

Land Owner Royalty

Unit Price of Output

State and Local prices

Operating Costs

Business Overhead

Investment Overhead

CAPEX

Capitalized Portion

Expensed Inestment

Income Tax Rate

Production Schedule

Year

Production Rate, 000

20

$20.00

10

$4.80

$150,000

20

$1,000,000

70

30

$500,000

40

1

400

% of Operating Revenue

per unit of total production

per year

percent of Investment

percent of Investment

percent of Investment

percent of Income

2

200

3

100

4

50

5

25

Total

775

Year

REVENUE COMPONENTS

Production Rate, 000

Unit Price

Gross Revenue, $000

Royalty, $000

Net Gross Revenue, $000

Net Revenue, 000

1

FACTOR

1

0.2

0.8

0.6

400

$20.00

$8,000

$1,600

$6,400

$3,840

3

100

$20.00

$2,000

$400

$1,600

$960

5

25

$20.00

$500

$100

$400

$240

Total

775

$20.00

$15,500

$3,100

$12,400

$7,440

OPEX COMPONENTS

State and Local taxes

Operating costs

Business Overheads

Investment Overheads

-0.6

-0.6

-0.6

-0.6

(384)

(1,152)

(96)

(288)

(24)

(72)

(744)

(2,232)

(90)

(90)

(90)

(450)

Net OPEX

-0.6

(1,806)

(180)

(180)

(474)

(186)

(3,606)

Year

CAPEX COMPONENTS

Capital investments

Depreciation

Expensed Investments

Intangible Amortized Invest

Net CAPEX

DPLEX COMPONENTS

Depletable Investments

Depletion Allowance

Net DPLEX

Factor

(1.00)

($1,000)

0.40

$93

0.40

$120

0.40

Total

($1,000)

$26

$19

$280

$120

$0

($787)

(1.00)

$0

$26

$19

($500)

($600)

($500)

0.40

$103

$26

$6

$200

0.40

($397)

$26

$6

($300)

YEAR

NET REVENUE

NET DPLEX

NET CAPEX

NET OPEX

NET OTHER

After Tax NCF

Total

$3,840

(1,806)

($787)

($397)

$0

$960

(474)

$26

$26

$1

$240

(186)

$19

$6

$2

$7,440

(3,606)

($600)

($300)

$3

$851

$539

$81

$2,937

Petroleum Production

Economics

Perspectives on petroleum resources and

reserves

Decline curves, equations, and analysis

Relationship between reserves and initial

production capacity

Optimum production capacity and

economic life of reserves

Impact analysis of economic life of

reserves

The rate at which reservoir pressure falls

Physical and fluid properties of reservoir

Rate of water encroachment

Costs of production

Price of oil

Uncertainty about physical factors

the form:

dq / q = - dt / (a + bt)

where a and b are constants

Three special cases of decline equations are

determined by the values of b.

percentage or exponential decline

equation of the form.

b = 0.5 corresponds to the hyperbolic

decline equation, and

b = 1.0 describes the harmonic decline

curves.

Exponential Decline

Equation

Exponential decline equation

Most commonly used in economic

application of the decline curve

analysis of many reservoirs because

they are simple to use.

The exponential decline equation also

called constant percentage decline

equation takes the form: dq / dt = -aq

Exponential Decline

Equation

Exponential functional specification

qt = qi e-at

Np = (qi - qt ) / a

where a = instantaneous decline rate

= [ ln(qi / qt)] / t

= - ln (1-d) and d= 1- e-a

qi = q*1 (a/d)

Production Forecasting-Plots

Commonly used exponential plots include

ln qt = + D t:

production

q t = q0 + a N p

% water production vs. Np

Production Forecasting

Decline technique has long been the favorite for

PEs because:

Projects the most conservative

estimates of UR of all the techniques

available

Underlying premise is that past factors

affecting production in the past remain

the same

Economic Limit

Relationship between Np and q0 is governed by

technology and geological conditions so maximum

Np depends on technology and the amount of oil in

the reservoir

The optimum recoverable reserves are less than N p

max because:

Either investment costs are high

Or over exploitation for quick income makes reservoir

pressure to fall faster and reduce recoverable reserves

Also, effect of interest rate on initial capacity is ambiguous.

If investment cost is low it may be worth while to invest in

equipment and physical facilities , reduce recoverable

reserves and get income early

Production capacity is determined by

number of wells, equipment and facilities,

etc.

Production capacity determines the plateau

production rate (initial production rate

before the declining phase) and the rate of

decline.

Initial production rates affect the rate of

production decline as well as the ultimate

recovery.

corresponding drop in pressure may cause

reduction in recoverable reserves due to water

encroachment.

More wells may augment recoverable reserves

because of higher efficiency in reservoir

drainage and a dampen offsetting the rise in

the decline rate from higher initial production

rate.

However, the marginal increase in production

decreases as more wells are drilled and well

spacing becomes smaller.

The economic life of reserves is the shut down time

when production ceases

no rate sensitivity and operating cost k

per unit

Production is expected to terminate,

ceteris paribus, when operating costs are

not covered by unit income such that:

pe-aT = k

T = - ln (k/p) / a

The optimum shut down time or the optimum

economic life of reserves is determined by:

Operating costs

Dismantling cost-- removal of

installation when production ceases is

not quite trivial, especially in offshore

operations

Option value of keeping the field

accessible in case profitability improves

in the future

optimum economic life

Dismantling costs may prolong period of

production, delaying the shutdown time

Dismantling costs may lower initial production

rate and decline rate if it makes it less attractive

to invest in production equipment and drilling of

new wells

Suppose unit dismantling costs are proportional to

initial capacity then total dismantling costs

B = b q0

optimum economic life

Dismantling costs may prolong period of

production, delaying the shutdown time

Dismantling costs may lower initial production

rate and decline rate if it makes it less attractive

to invest in production equipment and drilling of

new wells

Suppose unit dismantling costs are proportional to

initial capacity then total dismantling costs

B = b q0

Petroleum Investment

Analytics

Fundamentals

Undiscounted Decision Criteria

Present Value Concepts

Discounted Decision Criteria

Incremental Economics

FUNDAMENTAL BASES

The choice between two cash flow streams of equal

risk is determined such that:

Project with earlier returns is also

preferred to those with latter

The objective of the firm is to maximize

shareholder value, which depends on the ability of

the firm to maximize profit

Thus, finding and producing petroleum is just a

strategy of an E&P firm for the purpose of creating

wealth through profit maximization..

effects on corporate strategic decisions

Managers are now much more conscious of nonmonetary factors in the decision making process.

There is always a tradeoff between shareholders

value and societys value

There is a problem of the quantification of some

non-monetary factors underlying the decision

process

The scope here is limited to monetary factors

underlying the petroleum decision making process

INVESTMENT DECISION

CRITERIA

Investment decision criteria provide a quick

way to evaluate the economic merits of a

proposed E&P venture or project.

There is no single profitability criterion that

incorporates all the important elements

underlying E&P business decisions and

organizational goals.

There is no perfect measure that guarantees

a perfect or proper decision, which may fit all

projects at all time and for all organizations

In fact, there is no general agreement about

which criteria are best, and there is even no

general consensus about the various names

and definitions of profitability measures.

Popular Performance

Indicators

The more popular measures of E&P profitability

or E&P project economic performance can be

divided into two broad categories:

Measures that ignore time-value of money

Net profit

Payout (PO)

Benefits-to-cost-ratios (BCR) using undiscounted cash flows

Net present value profit

Discounted Return on Investment (DROI or DPIR)

Appreciation of equity rate of return

Criterion

whether the project is profitable. Profit is defined simply as:

Profit = Revenues-Costs = Cash In-Cash Out

Strength:

Simple and generally unambiguous

Project profits can be weighted

Weakness:

Does not recognize the size and timing of cash flows

A: Investment = $25 Million; Profit = $10 Million or B: Investment

$50 Million; Profit = $10 Million

Which project is preferred?

Payout(PO) as a Decision

Criterion

This criterion is also called pay back period.

It provides an answer to a simple question of how

long it will take to recover E&P investments

It is the time required to recover the investment on

either AFT or BFT cash flow basis.

It is an indication of the rate at which cash flows are

generated early in the project.

represents profit and new capital generated from

the project.

The tendency is to invest in projects with the

shortest possible PO, ceteris paribus

Categories of Payout(PO)

Undiscounted Cash-flow PO:

the time lapse from initial investment on E&P venture

until recovery of investment

a measure of the liquidity of invested funds

a measure of risk exposure

the time required to achieve a minimum IRR

a measure of risk exposure

The time at which the CCF, discounted or undiscounted,

becomes positive

Characteristics of

Payout(PO)

Strength:

Simple and straightforward in application

Measures an impact in liquidity

Weakness

It considers cash flows only to payback time

No consideration for projects with large abandonment

cost with negate cash inflow late in life

Project payouts cannot be weighted

Variants of PO:

Times pay back periodmultiple of original investment

Half-lifetime to realize half of the FNCF or production

Year

2000

2001

2002

2003

2004

2005

2006

2007

2008

2009

2010

2011

2012

Investment

Revenue

# ($Million)

($Million)

1

2

3

4

5

6

7

8

9

10

11

12

13

$275.000

$0.000

$0.000

$0.000

$0.000

$0.000

$0.000

$0.000

$0.000

$0.000

$0.000

$0.000

$0.000

$275.000

$132.900

$132.900

$107.600

$69.200

$43.500

$28.600

$15.900

$9.400

$5.600

$1.900

$1.500

$1.200

$1.000

$551.200

Other

Net AFT

CAPEX Cash Flow

($Million) ($Million)

$0.000

$0.000

$0.000

$0.000

$10.000

$0.000

$20.000

$0.000

$0.000

$0.000

$0.000

$0.000

$0.000

$30.000

Payout =

Cum

NCF

($Million)

($142.100) ($142.100)

$132.900

($9.200)

$107.600

$98.400

$69.200

$167.600

$33.500

$201.100

$28.600

$229.700

($4.100)

$225.600

$9.400

$235.000

$5.600

$240.600

$1.900

$242.500

$1.500

$244.000

$1.200

$245.200

$1.000

$246.200

$246.200 $2,224.600

2.09 Years

Benefit-to-Cost Ratio

Criterion

A benefits-to-cost ratio B/C or BCR is a measure of

the returns per dollar invested.

There are two ways to specify the dollar invested:

Total investment

Maximum Out of Pocket (MOP) cash

MOP cash is the lowest negative value on a

cumulative net cash flow curve

Benefit-to-Cost Ratio

Criterion

BCRs may be calculated on a BFT or AFT basis,

and they may be discounted or undiscounted.

BCRs has many synonyms

Profit to Investment Ratio (PIR)

MOP Return on Investment

Return on Investment

Criterion

Return on Investment (ROI) is simply the total income

attributable to a project divided by the total

investments for the project.

Unlike PO, which does not reflect the total profit from

the investment project, ROI reflect total profit or return.

It is defined as either:

or

ROI = Cumulative NCF / Total Investments

ROI is a dimensionless number.

Many E&P companies require an ROI of at least 2.0 for

any project.

PIR is a variant of the traditional or the basic ROI.

It is defined as:

(Cumulative Income less Total investments) divided by Total

Investment

A project is profitable if ROI>1 or if PIR>0

Cumulative Net Cash Flow divided MOP Cash.

It is noted,however, that whereas PIR reflects total

profit with respect to total investments, ROI reflects

only investment from outside sourcesrisk capital.

BCRs

Strengths

Recognizes profits relative to the value of investments

Very appealing due to simplicity

Weaknesses:

The parameters and calculation methods must be well

defined

There are possibilities of accounting inconsistencies

No standard procedure as to what to do with

reinvestments

Project BCR cannot be weighted

Do not reflect the time pattern of cash flow

Using PIR

Estimated Production. BOPD

Operating Cost: $/month

Investment

Payout: months

Recoverable Reserves

Producing Life, years

Total New Revenues:

Price

Royalty

State & Local Taxes

Total Operating Costs

Workover investment

Net Profit

PIR

$2.92

12.5%

5.0%

150

$575

$150,000

14.3

200,000.0

15.0

150

$575

$150,000

14.3

243,000.0

30.0

$485,450

$589,822

$103,500

$20,000

$211,950

1.41

$207,000

$20,000

$212,822

1.42

Time-Value of Money

Time value of money concept can be examined from

two dimensions

future has less value than that same

amount to be received sooner

There is a preference to pay out money

later rather than sooner because the money

can be used for other beneficial purposes

The present value or worth of a future dollar is the

dollar that would be invested today at a specified

interest to yield that dollar at that time in the future.

It is important to note that the buying power of money

in terms of inflation is not the reason for present value

calculations

The process by which future cash flow streams is

converted into present value is called

discounting, which means moving money

backward in time.

Discounting is the mirror image of compounding

interest calculation.

The distinction between the two is whether we

are receiving or paying interest.

form:

FV = PV * FVIF(r,t) = PV*(1+r)t

FV is future value

PV is present value

r is nominal interest in fraction

t is time period considered

The interest factors are now widely computable

using business calculators, spreadsheet programs or

other tools.

form:

FV = PV * FVIF(r,t) = PV*(1+r)t

FV is future value

PV is present value

r is nominal interest in fraction

t is time period considered

The interest factors are now widely computable

using business calculators, spreadsheet programs or

other tools.

PVIF(r,t)= (1+r )-t is called the discounting factor

or discounting coefficient

The rate r is called the discounting rate

t corresponds to the number of compounding

periods

It is as important to specify the reference date as it is to

specify the discount rate.

No PV calculation is meaningful without a well defined

reference date

The discounting factors are now widely computable using

business calculators, spreadsheet programs or other tools.

Example of PV Calculation

What is the present value, discounting at 10 % of a

certain $1,331 investment to be received in 3 years

from now?

1331(1.1) 3 = $1,000.

Assuming we have $1000 for 4 years at 10 percent

compounded annually. What is the future value after 4

years?

(1.4641)= $1,461.10

Thus if 10 % is the representative time value of money,

receiving $1000 today has no greater or lesser value

than receiving $1,461 in 4 years

Frequency of Compounding

Nominal interest rate, s, is the rate of interest per year,

which is used to calculate the periodic rate of interest

Effective interest rate, r, measures the annual increase of

a principal when compounded one or more times a year.

In general, if nominal interest rate expressed as a fraction

per year is s and if it is compounded k times per year,

then

FV=PV(1+s/k)k = PV(1+r) after the first year, and

FV=PV(1+s/k)nk = PV(1+r)n after n years

s = k(1+r)1/k-k

k becomes infinite:

FV = PV esn

Frequency of Compounding

Nominal interest rate, s, is the rate of interest per year,

which is used to calculate the periodic rate of interest

Effective interest rate, r, measures the annual increase

of a principal when compounded one or more times a

year.

In general, if nominal interest rate expressed as a

fraction per year is s and if it is compounded k times per

year, then

and

FV=PV(1+s/k)nk = PV(1+r)n after n years

s = k(1+r)1/k-k

Frequency of Compounding

Interest may also be compounded continuously

such that k becomes infinite:

FV = PV esn

PV = PV e-sn

s=ln (1+r),

where r is the effective interest rate

Frequency of Compounding

Effective, Nominal, Continous Rate Comparison

Nominal Rate ,s

Periodic Compounding,n

Effective

Interest Rate Biannual Quarterly Monthly

Daily

r

2

4

12

365

Continuous

s = ln (1+r)

5.0%

10.0%

15.0%

20.0%

25.0%

4.939%

9.762%

14.476%

19.089%

23.607%

4.909%

9.645%

14.223%

18.654%

22.949%

4.889%

9.569%

14.058%

18.371%

22.523%

4.879%

9.532%

13.979%

18.237%

22.321%

4.879%

9.531%

13.976%

18.232%

22.314%

30.0%

35.0%

40.0%

45.0%

50.0%

28.035%

32.379%

36.643%

40.832%

44.949%

27.116%

31.165%

35.103%

38.937%

42.673%

26.525%

30.389%

34.123%

37.738%

41.239%

26.246%

30.023%

33.663%

37.175%

40.569%

26.236%

30.010%

33.647%

37.156%

40.547%

PVIF

PVIF (10,n) with payment at end of the year

Nominal Rate

15.0%

Periodic Discounting, n

Year Annual Biannual Quaterly Monthly

n

1

2

4

12

Daily

365

Continuous

00

1

2

3

4

5

0.8696

0.7561

0.6575

0.5718

0.4972

0.8653

0.7488

0.6480

0.5607

0.4852

0.8631

0.7449

0.6429

0.5549

0.4789

0.8615

0.7422

0.6394

0.5509

0.4746

0.8607

0.7409

0.6377

0.5489

0.4724

0.8607

0.7408

0.6376

0.5488

0.4724

6

7

8

9

10

0.4323

0.3759

0.3269

0.2843

0.2472

0.4199

0.3633

0.3144

0.2720

0.2354

0.4133

0.3567

0.3079

0.2657

0.2293

0.4088

0.3522

0.3034

0.2614

0.2252

0.4066

0.3500

0.3013

0.2593

0.2232

0.4066

0.3499

0.3012

0.2592

0.2231

The time when cash flow is received may not

coincide with the timing of interest periods

There are two methods for handling this problem.

PV=FV / (1-s/k)k(n-0.5) or PV = FV e-s(n-0.5)

FV is future value

PV is present value

s is nominal annual interest, fraction

k is number of compound periods per year

n is number of years

cases when payments occur mid-year or

throughout the year.

problem is called uniform flow method

It assumes that the cash flow occurs uniformly

through out the annual period.

PV = FV e-s(n-1)[(1-e-s)/s]

[(1-e-s)/s] is constant, which implies that the total PV of

a stream on cash flows can be discounted with a single

discount factor or compound factor.

The key is to stipulate the reference point and re define

the equation:

PV = FV es[(1-e-s)/s]} e-sn

Effect of Timing on

Discounting

PVIF (10,n) with payment at mid -period and end period of the year

Nominal Rate

20.0%

Periodic Discounting, n

Year

Annual

Annual

Monthly Monthly ContinuousContinuous

n

1

1

12

12

00

00

EYR

MYR

EYR

MYR

EOY

MYR

1

0.8333

0.9129

0.8201

0.9056

0.8187

0.9048

2

0.6944

0.7607

0.6725

0.7427

0.6703

0.7408

3

0.5787

0.6339

0.5515

0.6090

0.5488

0.6065

4

0.4823

0.5283

0.4523

0.4995

0.4493

0.4966

5

0.4019

0.4402

0.3709

0.4096

0.3679

0.4066

6

7

8

9

10

0.3349

0.2791

0.2326

0.1938

0.1615

0.3669

0.3057

0.2548

0.2123

0.1769

0.3042

0.2495

0.2046

0.1678

0.1376

0.3359

0.2755

0.2259

0.1853

0.1519

0.3012

0.2466

0.2019

0.1653

0.1353

0.3329

0.2725

0.2231

0.1827

0.1496

ANNUITIES

An annuity is a method of spreading

cost evenly, or repayment of a debt,

with interest.

It provides for full payment of the cost

or debt over the specified period of

time

Each payment covers a portion of the

total costs plus interest on the

remaining balance.

PV = (nA/r)[1-(1+r/n)-nt]

Where PV = present value amount of

principal

A = equal payment, period end,

r=annual interest rate

t=number of years to maturity,

n=number of compounding per year

Specifying the discount rate for discounting is

usually difficult

Most commonly, the discount rate used should at

least be the rate of interest paid on borrowed capital

if the firm is operating on borrowed capital

If capital comes from several sources, average cost

of capital can also be used as the basis for the

minimum discount rate

Other valid rates could be the effective interest to be

earned from a competing investment opportunities

Overall, the desired earning rate for the investment

is the most appropriate discounting factor guided

mostly by the hurdle rate

Rate

Hurdle Rate can be viewed as the minimum acceptable

rate of return, which is the rate at which the firm can

always invest

It is also considered as the corporate cost of capital,

which is literarily the cost of obtaining both debt and

equity fund.

HR can also be perceived as the opportunity cost of

capital, or the marginal rate of return of the least

profitable alternative investments.

Usually set by upper management after considerations

and recognition for such things as:

Corporate growth objectives

Future investment opportunities and inflation

Factors

Cost of capital is defined as the weighted average cost

of investment capital from all sources in percent unit

The cost of capital is usually the BFT or AFT interest rate

charged by a single source lender:

AFT Cost of Capital = Interest Rate* (1-Tax Rate)

charged:

n = number of loan source of x amount

X =Total investment loan

CoC is the weighted average of cost of capital

Capital

For a public corporation with both debt and equity

stocks, the cost of capital is estimated as:

+ % Debt * AC of Debt Fund

AC of debt fund is the weighted average of

the interest paid on borrowed capital

The cost of equity funds is usually taken as

the companys equity growth rate

equity capital because of the use of after tax

dollar to make growth dividends payments

It is therefore prudent not to make investments in

projects that yield less than the cost of capital nor

use discounting factor that is less than the cost of

capital for PV calculations

RECAP:

E&P project evaluation criteria can be divided

into two broad categories:

Criteria, which ignore time-value of money

include:

Net Income

Payout (PO)

Benefits-to-cost-ratios (BCR) using undiscounted cash flows

Rate of return (ROR or IRR)

Net present value of profit (NPV)

Discounted Return on Investment (DROI or DPIR)

The most popular petroleum evaluation criterion is

net present value (NPV) or simply PV

The label in most calculators designate NPV as

simply PV and in most spreadsheet the function

name is NPV(r)

In general, the present value of a project is simply

the sum of the present values of the individual

annual net cash flows over the life time of the

project

Present value can be taken literarily to mean the

value of owning a given project at this moment in

time

The owner may be willing to sell her interest in the

project provided the price is greater than the NPV

Spreadsheet

Discount:

Year

1

2

3

4

5

6

7

8

9

10

11

12

13

10.0%

AFT NCF

($142.10)

$132.90

$107.60

$69.20

$33.50

$28.60

($4.10)

$9.40

$5.60

$1.90

$1.50

$1.20

$1.00

$246.200

PVIF(10,n)

(a)

0.9512

0.8607

0.7788

0.7047

0.6376

0.5769

0.5220

0.4724

0.4274

0.3867

0.3499

0.3166

0.2865

PVIF(10,n)

(b)

0.9535

0.8668

0.7880

0.7164

0.6512

0.5920

0.5382

0.4893

0.4448

0.4044

0.3676

0.3342

0.3038

MYConti

NPV

($135.170)

$114.388

$83.799

$48.764

$21.361

$16.501

($2.140)

$4.440

$2.394

$0.735

$0.525

$0.380

$0.287

MYAnnual

NPV

($135.487)

$115.196

$84.787

$49.571

$21.816

$16.932

($2.207)

$4.599

$2.491

$0.768

$0.551

$0.401

$0.304

Uncorrected

NPV(10 )*

Corrected

NPV( 10)

$156.263

$159.723

$152.290

$159.723

(a) NPV using continous discount mid-period

(b) NPV using discrete mid period

Characteristics of NPV

It recognizes the time value of money and

apply equal weight to all future incomes

NPV can be computed on an AFT or BFT basis

The discount rate in NPV reflects presumably

future investment opportunities.

If NPV=0, the project is exactly marginal. If

NPV>0, the project is adding value. If it is <0,

the project is destroying value, but not

necessarily unprofitable, check out the pay out

It is suitable for use with probabilities

NPV does not indicate the magnitude of cash

flow

Discount rate can be changed during the life of

the project

Discount 1:

Year

1

2

3

4

5

6

7

8

9

10

11

12

15.0% Discount 2:

10.0%

AFT NCF

Year

NPV

(200)

13

$70

150

14

$65

150

15

$60

140

16

$55

140

17

$50

130

18

$45

130

19

$40

120

20

$35

110

21

$30

100

22

$25

90

23

$20

80

24

$15

25

$10

$520.000

Rates

STEP 1:

Find the NPV for years 13 through 25, discounting at 10

percent per year

STEP 2:

Find present value at t=0 of cash received in year 12

discounted at 15 percent

STEP 3:

Find NPV for years 1-12, discounting at 15 percent

Step 4;

Add Step 2 and Step 3 to get the total NPV

Year

NCF

10% Discounted

Actual

After ($ Million ) Discount NCF (10 %)

Year

12

Factor

13

1

$70

0.953

$66.742

14

2

$65

0.867

$56.341

15

3

$60

0.788

$47.279

16

4

$55

0.716

$39.399

17

5

$50

0.651

$32.561

18

6

$45

0.592

$26.641

19

7

$40

0.538

$21.528

20

8

$35

0.489

$17.125

21

9

$30

0.445

$13.344

22

10

$25

0.404

$10.109

23

11

$20

0.368

$7.352

24

12

$15

0.334

$5.013

25

13

$10

0.304

$3.038

$346.473

B Find NPV at 0:

PV (15,13-25) =

$64.758

Spreadsheet

NPV (Corr)

$346.473

C: Find NPV for years 1-12 mid year discounting at 15 percent

15%

Actual

NCF Discount

Discounted Spreadsheet

Year ($ Million )

Factor

NCF (15, n)

NPV (Corr)

1

2

3

4

5

6

7

8

9

10

11

12

(200)

150

150

140

140

130

130

120

110

100

90

80

0.933

($186.501)

0.811

$121.631

0.705

$105.766

0.613

$85.839

0.533

$74.643

0.464

$60.271

0.403

$52.409

0.351

$42.068

0.305

$33.532

0.265

$26.508

0.231

$20.745

0.200

$16.035

$452.945

$452.945

$517.703

Criterion

In general, this means the interest rate earned

from investment.

It has been referred to with many different names:

Internal yield

Internal rate of return (IRR)

Profitability index

DCF rate of return

Marginal efficiency of capital

{(CFt)*PVIF(r,t)} = 0

Internal rate of returns, IRR, is widely

accepted index of profitability.

It is defined as the discount rate at which

the net present value of a series of cash

receipts and disbursement (the cash flow)

reduces to zero

IRR calculation is an iterative process and so

it cannot not be calculated directly.

The mathematical equation, PV (r, t) = 0

cannot be solved explicitly for r

Relationship

Computation of IRR

Step 1: Find the PV of all future NCF associated

with the investment using a guess-estimate

discount factor

Step 2: If the PV of NCF is greater than zero, select

a higher discount rate for the next trial and repeat

Step1

Step 3: If PV of NCF is less than zero, select a lower

discount and repeat the process or interpolate to

estimate the factor that will make PV of NCF =0.

The interpolation can be done mathematically or

graphically using calculators or computer spreadsheet

programs.

Computation of IRR-Example

NCF

20%

Actual ($ Million ) Discount

Year

Factor (MY)

0

1

2

3

4

5

6

7

8

9

10

11

12

(75)

15

15

14

14

13

13

12

11

10

9

8

7

20.0%

Discounted

NCF

1.0000

($75.000)

0.9129

$13.693

0.7607

$11.411

0.6339

$8.875

0.5283

$7.396

0.4402

$5.723

0.3669

$4.769

0.3057

$3.669

0.2548

$2.802

0.2123

$2.123

0.1769

$1.592

0.1474

$1.179

0.1229

$0.860

($10.907)

($10.907)

NPV

10.0%

14.976%

$14.735

($0.000)

Some Characteristics of

ROR

The computation of rate of return generally requires

a trial-and-error solution.

The ROR concepts introduces time value of money

into profitability decision rule.

It is a profitability index that is independent of the

size of cash flows and can be calculated on a BFT or

AFT basis.

There may be certain cash flows in which more than

one discount rate satisfies the rate of return

definition.

A necessary condition to have multiple rates of return is to

have a second sign reversal in CCF position function

(Newendorp, et al, (2000)

Some Characteristics of

ROR

ROR cannot be calculated when the cash flows

are all negative or are all positive or total

undiscounted revenues are less than the

investment.

Early cash flows are weighted more heavily than

the later cash flows

ROR calculated by iterative process is very

sensitive to errors in investment estimates and

early cash receipts.

Avery small error in investment estimates can produce

much larger percent error in ROR estimates

implicit assumption that all cash flows will be reinvested

at the calculated rate of return.

Two schools of thought about the reinvestment assumption:

IRR is meaningful only if firms can reinvest at the same or similar

returns

IRR deals only with investments that are not amortized. It says

nothing about what is done with cash received.

competing projects in order of economic attractiveness,

if they have different time values of money.

It cannot be used to account for risk and uncertainty.

The mathematical equation cannot be specified to

incorporate risk and uncertainty

ROR

More realistic profitability measure than payout,

ROI, and PIR because it incorporates the time

value of money

It is a useful measure of the relative profitability

of ventures having about the same project life

and CF patterns.

Major weakness in terms of measuring true

profitability is the frequent violation of the

reinvestment assumptions

It cannot also be used to account for risk and

uncertainty in a discrete version

It also discounts too heavily cash flows

occurring 15-20 years in the future

Discounted Return on

Investment

Discounted return on investment DROI is a

dimensionless ratio of a projects NPV to the PV of

total investment required using the same discount

factor.

This has also been referred to using different

synonyms:

Discounted profit to investment ratio (DPI, DPIR, DPR)

Net present value index (NPVI)

effectiveness or efficiency

Its interpretation as the amount of discounted profit

per dollar invested permits its use for ranking

projects under limited fund availability.

Some Characteristics of

DROI

Mathematically,

DROI = NPV of projects/PV of total investment

Any constraining resources can be substituted, such as

time to complete the project

measure of profitability by dollar invested.

It has no meaning if NPV is negative or zero.

DROIs greatest strength is its suitability as a

measure of value for ranking and comparing

investment opportunities

Risk-Weighted Rate of

Return

Assumption inherent is risked weighted approach

is simply that there are only two possible

outcomes

The investment results in streams of cash receipts with

some probability, P

Investments result in no revenue with probability (1-P)

VI = [P * IS + (1-P)* ID]/P

Where Is = investment at time zero that generates revenue

ID = investment loss if no future revenue is generated

estimate a risk-weighted ROR.

Appreciation of Equity Rate of Return

Modified ROR, which reflects the overall net

earning power of an investment

It assumes NC are reinvested at some

lower rate than the true rate of return.

For example if the IRR is 35 % but the only

opportunity available to reinvest is just 15

percent, the overall profitability of initial

investment will be less than 35 percent

The appreciation rate of return is the

reduced equivalent rate of return because

of lower reinvestment earnings.

Modified ROR, which reflects the overall

net earning power of an investment

It assumes NC are reinvested at some

lower rate than the true rate of return.

For example if the IRR is 35 % but the only

opportunity available to reinvest is just 15

percent, the overall profitability of initial

investment will be less than 35 percent

The appreciation rate of return is the

reduced equivalent rate of return because

of lower reinvestment earnings

GROR Calculation--Example

Actual Investments

Year

($Million)

0

(200)

1

(150)

2

(125)

3

0

4

0

5

0

6

0

7

0

8

0

9

0

10

0

12%

Discounted

12%

Investments

Discount

($Million) Factor (EOY)

200.000

1.0000

133.929

0.8929

99.649

0.7972

0

0.7118

0

0.6355

0

0.5674

0

0.5066

0

0.4523

0

0.4039

0

0.3606

0

0.3220

Cash Flows

($Million)

$0.000

$0.000

$250.000

$350.000

$300.000

$290.000

$275.000

$175.000

$35.000

$25.000

$10.000

8%

Compounded

Cash Flow

($Million)

$0.000

$0.000

$291.600

$440.899

$408.147

$426.105

$436.390

$299.919

$64.783

$49.975

$21.589

NPV =

433.578

$433.58

$1,710.000

$2,439.408

GROR is the interest rate earned by $434 Mln, which yields $2,439 Mln.

=

17.3%

=

13.7%

GROR CalculationExample

2

8%

Compounded

Cash Flow

($Million)

$0.000

$0.000

$280.592

$424.255

$392.739

$410.020

$419.917

$288.597

$62.337

$48.089

$20.774

Net

Cash Flow

($Million)

($200.000)

($133.929)

$150.351

$350.000

$300.000

$290.000

$275.000

$175.000

$35.000

$25.000

$10.000

NPV =

433.578

$433.58

$1,710.000

$2,347.321

GROR is the interest rate earned by $434 Mln, which yields $2,347 Mln.

$1,276.422

$649.467

Actual Investments

Year

($Million)

0

(200)

1

(150)

2

(125)

3

0

4

0

5

0

6

0

7

0

8

0

9

0

10

0

Discounted

Investments

($Million)

200.000

133.929

99.649

0

0

0

0

0

0

0

0

16.9%

=

13.7%

12%

Discount

Factor (MYP)

1.0000

0.8929

0.7972

0.7118

0.6355

0.5674

0.5066

0.4523

0.4039

0.3606

0.3220

Cash Flows

($Million)

$0.000

$0.000

$250.000

$350.000

$300.000

$290.000

$275.000

$175.000

$35.000

$25.000

$10.000

Criterion

This is a measure of the gain an investment is expected to

realize in excess of investing the same fund in an average

project.

The gain per year is calculated as the product of initial

investment and the gain ratio.

The gain ratio, PGI is calculated such that:

PGI = 1/I0{[ (1+r*)t(r*)]/[(1+r*) t -1]}NPV

I0 , PV of initial investment

r*, average reinvestment rate

t, project life

NPV, net present value at t=0

Criterion

Actual Investments

Year

($Million)

0

(200)

1

(150)

2

(125)

3

0

4

0

5

0

6

0

7

0

8

0

9

0

10

0

Discounted

Investments

($Million)

200.000

133.929

99.649

0

0

0

0

0

0

0

0

12%

Discount

Factor (MYP)

1.0000

0.8929

0.7972

0.7118

0.6355

0.5674

0.5066

0.4523

0.4039

0.3606

0.3220

Cash Flows

($Million)

$0.000

$0.000

$250.000

$350.000

$300.000

$290.000

$275.000

$175.000

$35.000

$25.000

$10.000

Net

Cash Flow

($Million)

($200.000)

($133.929)

$150.351

$350.000

$300.000

$290.000

$275.000

$175.000

$35.000

$25.000

$10.000

NPV =

433.578

$433.58

$1,710.000 $1,276.422

GROR is the interest rate earned by $434 Mln, which yields $2,347 $649.467

Mln.

=

13.7%

=

26.5%

$114.945

Escalation

Inflation is defined as a persistent general increase

in the aggregate price levels and deflation refers to

a persistent drop in price levels.

Escalation on the other hand, refers to persistent

rise in the prices of specific commodities due to a

combination of inflation, supply and demand and

other factors

The causes of inflation are not simple nor easy to

determine

One of the mostly acceptable major determinants is

deficit spending by government.

be handled internally and not externally

Handling inflation externally such as adding

expected inflation to desired ROR can give

erroneous or misleading results in NCF and PV

calculations

There are two basic techniques used to handle

inflation correctly in PV analysis.

Current dollar analysis

Constant dollar analysis

inflated, nominal dollars or dollars of the day are

the actual dollar value of revenue or cost that will

be realized at a specific future points in time

constant purchasing power of dollar

Constant dollar, real dollar,deflated dollars are obtained by

deflating current dollar value to some arbitrary point in time,

usually the starting point of the project.

two methods are always identical.

The alternatives that maximizes future profit in

nominal or current dollars must be exactly the same

alternatives the will maximize future profit in constant

dollars.

The key to successful analysis is not to mix both

analyses. All alternatives must be compared using

either of the methods exclusively

Steps

A: Estimate all project costs in todays dollars

B: Escalate the values expressed in current

dollars by applying the FVIF(k,n)

where k is the estimated escalation rate

n number of time periods

Anticipated escalation rate do not have to remain constants

Cost and revenue escalation rates are not necessarily equal

dollar opportunity rate or the hurdle rate (the

minimum acceptable return on investment), r*

Steps

A: Estimate all project costs in todays dollars

B: Escalate the values expressed in current

dollars by applying the FVIF(k,n)

where k is the estimated escalation rate

n number of time periods

Anticipated escalation rate do not have to remain constants

Cost and revenue escalation rates are not necessarily equal

PVIF(f,n)

where f is the assumed inflation rate, which does not

have to be constant

n number of time periods

constant dollar opportunity rate or hurdle rate (the

minimum acceptable return on investment), r**

rate (r**), current hurdle rate(r*), and

inflation (f) is such that:

r** = [(1+r*)/(1+f)]-1

If the desired rate of return were r* with no

adjustment for inflation, and if there is inflation of

f percent per year, then the composite (true rate of

return) under inflation is:

1+r = (1+r*)(1+f)

Estimating PV Under

Inflation

A: Current Dollar Analysis

Year

n

0

1

2

3

4

5

6

7

8

9

10

11

12

Estimated

Costs

$Million

100

0

0

0

50

0

0

0

55

0

0

0

0

Est. Net

Revenues

$Million

$70

$65

$55

$50

$45

$45

$35

$30

$30

$20

$15

$10

$5

Escalation Rate

Hurdle Rate

15%

10%

20%

Escalated

Escalted NetDiscounted

Costs Revenues

Cash Flow Cash Flow

$Million

$Million

$Million

100.000

70.000

($30.000) ($30.000)

0.000

71.500

$71.500 $65.270

0.000

66.550

$66.550 $50.626

0.000

66.550

$66.550 $42.189

87.450

65.885

($21.566) ($11.393)

0.000

72.473

$72.473 $31.905

0.000

62.005

$62.005 $22.747

0.000

58.462

$58.462 $17.873

168.246

64.308

($103.939) ($26.480)

0.000

47.159

$47.159 $10.012

0.000

38.906

$38.906

$6.883

0.000

28.531

$28.531

$4.206

0.000

15.692

$15.692

$1.928

NPV (20, n) =

$185.767

$185.767

Estimating PV Under

Inflation

A: Constant Dollar Analysis

Estimated Est. Net

Year

Costs Revenues

n $Million $Million

0

100

$70

1

0

$65

2

0

$55

3

0

$50

4

50

$45

5

0

$45

6

0

$35

7

0

$30

8

55

$30

9

0

$20

10

0

$15

11

0

$10

12

0

$5

Escalation Rate

*Hurdle Rate

15%

10%

20%

Escalated

Escalted Net

Costs Revenues

Cash Flow

$Million

$Million

$Million

100.000

70.000

($30.000)

0.000

71.500

$71.500

0.000

66.550

$66.550

0.000

66.550

$66.550

87.450

65.885

($21.566)

0.000

72.473

$72.473

0.000

62.005

$62.005

0.000

58.462

$58.462

168.246

64.308

($103.939)

0.000

47.159

$47.159

0.000

38.906

$38.906

0.000

28.531

$28.531

0.000

15.692

$15.692

NPV (r, n) =

$185.767

6%

13.208%

Deflated

Discounted

Cash Flow

Cash Flow

$Million

$Million

($30.000)

($30.000)

$67.453

$63.396

$59.229

$49.173

$55.877

$40.977

($17.082)

($11.066)

$54.156

$30.989

$43.711

$22.094

$38.880

$17.360

($65.212)

($25.720)

$27.913

$9.725

$21.725

$6.686

$15.030

$4.086

$7.799

$1.873

$179.572

$179.572

Incremental Economic

Analysis

Incremental economic analysis provides an

approach whereby PEs can determine whether

additional investment is justified or whether there

is any justification to accelerate investments in a

project.

Examples where incremental economic analysis

can be found useful include but not limited:

operations, farm out or drill, abandon or

develop, additional drilling, accelerated

depletion, new equipment installation

the base investment case and the expanded

base investment cash flow.

The difference between the two cash flows

provides the basis for incremental economic

analysis.

do a simple NPV calculation for the two

cash flows and select the one with the

greater NPV profit

EXERCISE 1

An oil field has been discovered that has the potential

of 50 Million barrels of oil. The field was acquired in

early 1990 for $100 Million and exploration venture

has been proceeding for four years at an annual cash

outlay of about $10 million per year.

The first

successful well in the field was in late 1994 at an

estimated cost of $15 Million. After the discovery, it is

estimated that field development will take about 4

years, with production beginning at the end of the

second year.

During the next four years after the discovery 10

successful wells will be drilled at the cost of $6 Million

per well. Development drilling success rate is

estimated at 80 percent, while the cost of drilling a dry

development well is estimated at $4 million dollars.

Facilities will be constructed concurrently at a total

cost of $40 million to handle 15,000 barrels of oil per

day.

EXERCISE II

PART II: Suppose there is a one-eighth mineral owners

royalty in this field, state and local taxes consist of of

a 5 cents per bbl production tax and 3 percent ad

valorem tax, and no state income tax is charged.

Evaluate this E&P ventures to determine whether the

development of the field would be a profitable

undertaking by making annual and total BFT and AFT

net cash flow calculations. Determine also the BFT

and AFT investment costs and the NPV of the venture

at 8 percent using mid-year continuous discounting.

What are the undiscounted and discounted, before tax

and after tax investment decision measuresthe

PO,ROI, PIR,IRR?

EXERCISE III

Assumptions:

Oil sale price increases at a constant annual rate

from $25 dollars per bbl to a maximum of $40 over

the next ten years and decline at two and one-half

percent till the economic life

Operating costs are $400,000 per year and $2.00

per bbl lifting and treating costs

Overhead will be charged at 10 percent of all

investments, excluding cash bonus, and direct

operating expenses plus $200,000 per year

For income tax purposes, 80 percent of the

investments will be capitalized and depreciated by

5-year SLD schemes; the remaining 20 percent is

expensed. The field was abandoned and restored

at an estimated cost of $25 million twenty years

after discovery .

(Adapted from Seba, 1998, Roebuck, 1992 and PETE 7242)

Data Input

Np=

Royalty:

Production Tax

Ad valoren Tax

50 MMBbls

12.5%

5.0%

3.0%

Venture

Year

Cash Flow

Year

1990

1991

1992

1993

1994

1995

1996

1997

1998

1999

2000

2001

2002

2003

2004

2005

2015

2016

2017

1

2

3

4

5

6

7

8

9

10

20

21

22

Exploration

Outlay

$Million

(15)

(15)

(15)

(15)

(20)

Costs--Dry Wells

Costs--Succ Well

Success Rate

Discount Rate

6 $Million/well

8 $Million/well

80%

12.0%

Succ Dev

Outlay

$Million

Dry Devl

Outlay

$Million

Facility

Construction

$Million

(16)

(16)

(24)

(24)

(15)

(15)

(23)

(23)

(10)

(10)

(10)

(10)

Cash

Bonus

$Million

(200)

(40)

NPF CALCULATIONS

E&P Cash

Oil/Gas

Venture Flow Production

Year Year Year

MBbbl

[A]

1990

1

1991

2

1992

3

1993

4

0

1994

5

1

1995

6

2

1996

7

3

73

1997

8

4

255

1998

9

5

892

1999

10

6

3122

2000

11

7

5475

2001

12

8

5475

2002

13

9

5475

2003

14

10

5475

2004

15

11

5475

2005

16

12

4754

2006

17

13

3559

2007

18

14

2664

2008

19

15

1995

2009

20

16

1493

2010

21

17

1118

2011

22

18

837

2012

23

19

627

2013

24

20

469

SUM

49233

80.0%

CAPEX:

Tangible Expensed Depletable

($Million) ($ Million) ($ Million)

[F]

[G]

($15.000) ($200.000)

($15.000)

($15.000)

($15.000)

($20.000) ($4.000)

($26.000) ($19.000)

($26.000) ($15.000)

($34.000) ($23.000)

($34.000) ($23.000)

$0.000

$0.000

$0.000

$0.000

$0.000

$0.000

$0.000

$0.000

$0.000

$0.000

$0.000

$0.000

$0.000

$0.000

$0.000

$0.000

$0.000

$0.000

$0.000

$0.000

$0.000

$0.000

$0.000

(94.000) (61.000) (200.000)

OPEX :

3.0%

Est

$2.00

5.0%

10.0%

Cost of

Prod Cost S&L Taxes Overhead

Abdnm

($Million)

($Million) ($Million) ($Million)

[H]

[I]

[J]

[K]

$0.000

$0.000

($0.199)

$0.000

$0.000

($0.199)

$0.000

$0.000

($0.199)

$0.000

$0.000

($0.199)

$0.000

$0.000

($0.198)

$0.000

$0.000

($0.196)

($0.546)

($0.053) ($0.196)

($0.910)

($0.207) ($0.194)

($2.184)

($0.776) ($0.194)

($6.644)

($2.999) ($0.199)

($11.350)

($5.751) ($0.198)

($11.350)

($5.751) ($0.198)

($11.350)

($5.751) ($0.198)

($11.350)

($5.751) ($0.198)

($11.350)

($5.423) ($0.198)

($9.908)

($4.566) ($0.199)

($7.518)

($3.205) ($0.199)

($5.728)

($2.319) ($0.199)

($4.390)

($1.617) ($0.199)

($3.386)

($1.165) ($0.200)

($2.636)

($0.806) ($0.200)

($2.074)

($0.578) ($0.200)

($1.654)

($0.414) ($0.200)

($1.338)

($0.296) ($0.200) ($40.000)

(105.666)

(47.429)

(3.569) (40.000)

IRR & PO

IRR

Discont Rate

5.0%

8.0%

10.0%

12.0%

12.558%

15.0%

Mid-Period Discounting

BFTPV

AFTPV Discont Rate

$2,038.727 $1,118.247

5.0%

$848.928

$297.828

8.0%

$377.932

($17.803)

10.0%

$66.132

($0.010)

9.861%

($0.010)

($258.004)

12.5%

($212.596)

($391.305)

15.0%

Assumption: Inflation, f =

2.0%

IRR* = (IRR - f)/(1+f) = 9.80%

(IRR - f)/(1+f) = 12.56%

Pay out

Undiscounted

Undiscounted

8.0% Discounted

AFT IRR BP

BFT IRR BP

BFT

7.660

11.660

10.058

AFT

8.109 Years AFDis

12.109 Years AFVen

11.612 Years AFDis

ROI/PIR

Year

E&P

Venture

Year

1990

1991

1992

1993

1994

1995

1996

1997

1998

1

2

3

4

5

6

7

8

9

Total

Cash

Flow

Year

10.0%

PVIF

8.0%

CAPEX: Depletable Investment

Total Investments

Tangible Investment Overhead Undisconted Discounted

($Million)

($Million)

($Million)

(100.000)

0

1

2

3

4

5

(15.000)

(25.000)

(25.000)

(25.000)

(25.000)

(115.000)

(100.000)

0.000

0.000

0.000

0.000

(1.500)

(2.500)

(2.500)

(2.500)

(2.500)

(100.000)

0.000

0.000

0.000

(16.500)

(27.500)

(27.500)

(27.500)

(27.500)

($96.225)

$0.000

$0.000

$0.000

($11.670)

($18.010)

($16.675)

($15.440)

($14.297)

(11.500)

(226.500)

($172.317)

ROI

Undiscounted

8.0% Discounted

BFTPV

3.823

1.046

AFTPV

2.985

0.658

PIR

Undiscounted

8.0% Discounted

2.823

0.046

1.985

(0.342)

& AFT

Net

Total

BFT

35.0%

Cash

Applied

Net Cash

Taxable

Income

Flow Deductions

Flow

Income

Tax

Year

($Million)

($Million) ($ Million) ($Million)

[N]

[K]

[L]

$0.000 ($110.199) ($10.199)

$0.000

$0.000 ($10.199) ($20.398)

$0.000

$0.000 ($10.199) ($30.597)

$0.000

0

$0.000 ($10.199) ($40.796)

$0.000

1

$0.000 ($18.198) ($43.994)

$0.000

2

$0.000 ($38.196) ($57.190)

$0.000

3

$1.542 ($37.266) ($69.391)

$0.000

4

$5.937 ($33.424) ($88.106)

$0.000

5

$22.856 ($18.504) ($95.540)

$0.000

6

$35.235

$77.394

($34.581)

$0.000

7

$47.471 $149.551

$96.898

$33.914

8

$37.071 $149.551 $126.774

$44.371

9

$29.071 $149.551 $137.174

$48.011

10

$28.907 $149.715 $145.174

$50.811

11

$28.747 $141.491 $136.790

$47.876

12

$24.904 $115.995 $110.335

$38.617

13

$18.696

$81.871

$76.224

$26.678

14

$14.073

$57.718

$53.418

$18.696

15

$10.637

$40.624

$37.354

$13.074

16

$8.073

$28.533

$26.044

$9.116

17

$6.168

$19.980

$18.090

$6.332

18

$4.748

$13.933

$12.497

$4.374

19

$3.692

$9.658

$8.568

$2.999

20

$8.603 ($33.361) ($34.189)

$0.000

Total

$336.430 $996.417 $521.553 $344.869

$336.430 $865.820 $460.359 $344.869

Tax Loss

C/F

($Million)

[M]

($10.199)

($20.398)

($30.597)

($40.796)

($43.994)

($57.190)

($69.391)

($88.106)

($95.540)

($34.581)

$0.000

$0.000

$0.000

$0.000

$0.000

$0.000

$0.000

$0.000

$0.000

$0.000

$0.000

$0.000

$0.000

AFT

Net Cash

Flow

($Million)

[O]

($109.801)

($9.801)

($9.801)

($9.801)

($17.802)

($37.804)

($36.327)

($32.122)

($15.928)

$84.436

$127.383

$116.927

$113.287

$110.651

$105.362

$87.682

$63.108

$45.148

$32.338

$23.203

$16.683

$12.032

$8.711

$8.377

$805.544

$676.141

Host

Govt

Take

%

[O]

NCF CalculationsCapital

Outlays

Revised Information on the Syndicate Exercise

Np=

50 MMBbls

Royalty:

12.50%

Production Tax

5.00%

Ad valoren Tax

3.00%

Year

1990

1991

1992

1993

1994

1995

1996

1997

1998

2013

Year

Year

#

1

2

3

4

0

5

1

6

2

7

3

8

4

9

5

24

20

Exploration

Dry Wells

$Million

($10.000)

($10.000)

($10.000)

($10.000)

Succ Dev. Wells

Success Rate

Discount Rate

Exploration

Success

$Million

8

10

4 $Million/well

6 $Million/well

80%

12.00%

Succ Dev

Outlay

$Million

Dry Devl

Outlay

$Million

Facility

Constr

$Million

($15.000)

($15.000)

($15.000)

($15.000)

($8.000)

($8.000)

($8.000)

($8.000)

($10.000)

($10.000)

($10.000)

($10.000)

($15.000)

Cash

Bonus

$Million

($100.000)

AFT

Year

1990

1991

1992

1993

1994

1995

1996

1997

1998

1999

2000

2001

2002

2003

2004

2005

2006

2007

2008

2009

2010

2011

2012

2013

Net

Cash

VentureFlow

Year Year

1

2

3

4

5

6

7

8

9

10

11

12

13

14

15

16

17

18

19

20

21

22

23

24

0

1

2

3

4

5

6

7

8

9

10

11

12

13

14

15

16

17

18

19

20

BFT

Net Cash

Flow

($Million)

($215.199)

($15.199)

($15.199)

($15.199)

($20.198)

($41.195)

($40.252)

($52.370)

($37.305)

$78.124

$150.372

$150.372

$150.372

$150.660

$142.549

$117.002

$82.687

$58.370

$41.141

$28.939

$20.297

$14.179

$9.848

($33.215)

AFT

Net Cash

Flow

($Million)

[O]

($214.802)

($14.802)

($14.802)

($14.802)

($23.802)

($46.005)

($44.515)

($57.873)

($41.535)

$85.166

$159.479

$122.981

$118.949

$115.428

$110.252

$92.523

$67.252

$48.292

$34.720

$25.005

$18.045

$13.060

$9.487

$8.522

BFT

AFT

CNCF

CNCF

($ Million) ($Million)

[K]

[L]

(215.199) (214.802)

(230.397) (229.603)

(245.596) (244.405)

(260.794) (259.206)

(280.992) (283.008)

(322.187) (329.013)

(362.439) (373.528)

(414.810) (431.401)

(452.115) (472.936)

(373.991) (387.770)

(223.619) (228.291)

(73.247) (105.311)

77.125

13.638

227.785

129.066

370.334

239.318

487.336

331.841

570.022

399.093

628.392

447.384

669.533

482.104

698.472

507.109

718.769

525.154

732.948

538.214

742.796

547.701

709.581

556.223

Continous MYD

@NPV(r,n)

12.00%

BFT

DNCF

($Million)

[M]

(202.666)

(12.695)

(11.259)

(9.986)

(11.770)

(21.292)

(18.452)

(21.292)

(13.452)

24.985

42.654

37.830

33.553

29.815

25.020

18.214

11.416

7.148

4.468

2.788

1.734

1.074

0.662

(1.982)

($81.503)

($67.184)

12.00%

AFT

DNCF

($Million)

[O]

(202.292)

(12.363)

(10.965)

(9.725)

(13.871)

(23.778)

(20.406)

(23.530)

(14.977)

27.238

45.237

30.939

26.541

22.843

19.352

14.403

9.285

5.914

3.771

2.409

1.542

0.990

0.638

0.817

($120.807) *

($107.072)

&AFT

Year

1990

1991

1992

1993

1994

1995

1996

1997

1998

1999

2000

2001

2002

2003

2004

2005

2006

2007

2008

2009

2010

2011

2012

2013

1

2

3

4

5

6

7

8

9

10

11

12

13

14

15

16

17

18

19

20

21

22

23

24

Total

Cash

Applied

Net Cash

Taxable

Income

Flow Deductions

Flow

Income

Tax

Year

($Million)

($Million) ($ Million) ($Million)

[N]

[K]

[L]

$0.000 ($215.199) ($15.199)

$0.000

$0.000 ($15.199) ($30.397)

$0.000

$0.000 ($15.199) ($45.596)

$0.000

0

$0.000 ($15.199) ($60.794)

$0.000

1

$0.000 ($20.198) ($64.992)

$0.000

2

$0.000 ($41.195) ($85.387)

$0.000

3

$1.542 ($40.252) ($104.786)

$0.000

4

$5.937 ($52.373) ($141.565)

$0.000

5

$22.856 ($37.298) ($168.866)

$0.000

6

$44.730

$78.143 ($113.692)

$0.000

7

$61.600 $150.372

$7.544

$2.640

8

$50.080 $150.372 $111.824

$39.138

9

$39.200 $150.372 $123.344

$43.170

10

$39.200 $150.372 $134.224

$46.978

11

$38.871 $142.317 $125.840

$44.044

12

$33.689 $116.718

$99.384

$34.785

13

$25.158

$82.527

$66.716

$23.351

14

$18.902

$58.217

$46.300

$16.205

15

$14.186

$41.065

$32.026

$11.209

16

$10.723

$28.869

$22.054

$7.719

17

$8.113

$20.271

$15.104

$5.287

18

$6.200

$14.155

$10.261

$3.591

19

$4.776

$9.828

$6.894

$2.413

20

$8.603 ($33.231) ($35.443)

$0.000

Total

$434.365 $953.854

$25.990 $280.530

434.365

708.259

(65.201) 280.530

Tax Loss

C/F

($Million)

[M]

($15.199)

($30.397)

($45.596)

($60.794)

($64.992)

($85.387)

($104.786)

($141.565)

($168.866)

($113.692)

$0.000

$0.000

$0.000

$0.000

$0.000

$0.000

$0.000

$0.000

$0.000

$0.000

$0.000

$0.000

$0.000

Flow Take

($Million)

%

[O]

[O]

($214.802)

($14.802)

($14.802)

($14.802)

($23.802)

($46.005)

($44.514)

($57.876)

($41.527)

$85.185

$159.479

$122.981

$118.949

$115.141

$110.020

$92.239

$67.092

$48.138

$34.643

$24.935

$18.019

$13.036

$9.468

$8.507

$799.306

554.901

&AFT

Year

1990

1991

1992

1993

1994

1995

1996

1997

1998

1999

2000

2001

2002

2003

2004

2005

2006

2007

2008

2009

2010

2011

2012

2013

1

2

3

4

5

6

7

8

9

10

11

12

13

14

15

16

17

18

19

20

21

22

23

24

Total

Cash

Applied

Net Cash

Taxable

Income

Flow Deductions

Flow

Income

Tax

Year

($Million)

($Million) ($ Million) ($Million)

[N]

[K]

[L]

$0.000 ($215.199) ($15.199)

$0.000

$0.000 ($15.199) ($30.397)

$0.000

$0.000 ($15.199) ($45.596)

$0.000

0

$0.000 ($15.199) ($60.794)

$0.000

1

$0.000 ($20.198) ($64.992)

$0.000

2

$0.000 ($41.195) ($85.387)

$0.000

3

$1.542 ($40.252) ($104.786)

$0.000

4

$5.937 ($52.373) ($141.565)

$0.000

5

$22.856 ($37.298) ($168.866)

$0.000

6

$44.730

$78.143 ($113.692)

$0.000

7

$61.600 $150.372

$7.544

$2.640

8

$50.080 $150.372 $111.824

$39.138

9

$39.200 $150.372 $123.344

$43.170

10

$39.200 $150.372 $134.224

$46.978

11

$38.871 $142.317 $125.840

$44.044

12

$33.689 $116.718

$99.384

$34.785

13

$25.158

$82.527

$66.716

$23.351

14

$18.902

$58.217

$46.300

$16.205

15

$14.186

$41.065

$32.026

$11.209

16

$10.723

$28.869

$22.054

$7.719

17

$8.113

$20.271

$15.104

$5.287

18

$6.200

$14.155

$10.261

$3.591

19

$4.776

$9.828

$6.894

$2.413

20

$8.603 ($33.231) ($35.443)

$0.000

Total

$434.365 $953.854

$25.990 $280.530

434.365

708.259

(65.201) 280.530

Tax Loss

C/F

($Million)

[M]

($15.199)

($30.397)

($45.596)

($60.794)

($64.992)

($85.387)

($104.786)

($141.565)

($168.866)

($113.692)

$0.000

$0.000

$0.000

$0.000

$0.000

$0.000

$0.000

$0.000

$0.000

$0.000

$0.000

$0.000

$0.000

Flow Take

($Million)

%

[O]

[O]

($214.802)

($14.802)

($14.802)

($14.802)

($23.802)

($46.005)

($44.514)

($57.876)

($41.527)

$85.185

$159.479

$122.981

$118.949

$115.141

$110.020

$92.239

$67.092

$48.138

$34.643

$24.935

$18.019

$13.036

$9.468

$8.507

$799.306

554.901

&AFT

Year

1990

1991

1992

1993

1994

1995

1996

1997

1998

1999

2000

2001

2002

2003

2004

2005

2006

2007

2008

2009

2010

2011

2012

2013

1

2

3

4

5

6

7

8

9

10

11

12

13

14

15

16

17

18

19

20

21

22

23

24

Total

Cash

Applied

Net Cash

Taxable

Income

Flow Deductions

Flow

Income

Tax

Year

($Million)

($Million) ($ Million) ($Million)

[N]

[K]

[L]

$0.000 ($215.199) ($15.199)

$0.000

$0.000 ($15.199) ($30.397)

$0.000

$0.000 ($15.199) ($45.596)

$0.000

0

$0.000 ($15.199) ($60.794)

$0.000

1

$0.000 ($20.198) ($64.992)

$0.000

2

$0.000 ($41.195) ($85.387)

$0.000

3

$1.542 ($40.252) ($104.786)

$0.000

4

$5.937 ($52.373) ($141.565)

$0.000

5

$22.856 ($37.298) ($168.866)

$0.000

6

$44.730

$78.143 ($113.692)

$0.000

7

$61.600 $150.372

$7.544

$2.640

8

$50.080 $150.372 $111.824

$39.138

9

$39.200 $150.372 $123.344

$43.170

10

$39.200 $150.372 $134.224

$46.978

11

$38.871 $142.317 $125.840

$44.044

12

$33.689 $116.718

$99.384

$34.785

13

$25.158

$82.527

$66.716

$23.351

14

$18.902

$58.217

$46.300

$16.205

15

$14.186

$41.065

$32.026

$11.209

16

$10.723

$28.869

$22.054

$7.719

17

$8.113

$20.271

$15.104

$5.287

18

$6.200

$14.155

$10.261

$3.591

19

$4.776

$9.828

$6.894

$2.413

20

$8.603 ($33.231) ($35.443)

$0.000

Total

$434.365 $953.854

$25.990 $280.530

434.365

708.259

(65.201) 280.530

Tax Loss

C/F

($Million)

[M]

($15.199)

($30.397)

($45.596)

($60.794)

($64.992)

($85.387)

($104.786)

($141.565)

($168.866)

($113.692)

$0.000

$0.000

$0.000

$0.000

$0.000

$0.000

$0.000

$0.000

$0.000

$0.000

$0.000

$0.000

$0.000

Flow Take

($Million)

%

[O]

[O]

($214.802)

($14.802)

($14.802)

($14.802)

($23.802)

($46.005)

($44.514)

($57.876)

($41.527)

$85.185

$159.479

$122.981

$118.949

$115.141

$110.020

$92.239

$67.092

$48.138

$34.643

$24.935

$18.019

$13.036

$9.468

$8.507

$799.306

554.901

NCF CalculationsDD&A

Deductions

E&P Cash

Venture Flow

Year Year Year

1990

1991

1992

1993

1994

1995

1996

1997

1998

1999

2000

2001

2002

2003

2004

2005

2006

2007

2008

2009

2010

2011

2012

2013

1

2

3

4

5

6

7

8

9

10

11

12

13

14

15

16

17

18

19

20

21

22

23

24

0

1

2

3

4

5

6

7

8

9

10

11

12

13

14

15

16

17

18

19

20

1996

$Million

($11.520)

($11.520)

($11.520)

($11.520)

($11.520)

1997

1998

1999

$Million

$Million

$Million

($5.440)

($5.440)

($5.440)

($5.440)

($5.440)

5

Rate =

2000 Total

Depletion Allowance

$Million

$Million

$Million

($11.520)

($16.960)

($22.400)

($22.400)

($22.400)

($10.880)

($5.440)

($5.440)

($5.440)

($5.440)

($5.440)

$0.000

$0.000

($0.292)

($1.020)

($3.568)

($12.488)

($21.900)

($21.900)

($21.900)

($21.900)

($21.900)

($19.016)

($14.236)

($10.656)

($7.980)

($5.972)

($4.472)

($3.348)

($2.508)

($1.876)

($106.560) ($196.932)

NCF CalculationsTechnical

Costs

E&P Cash

Oil/Gas

Venture Flow Production

Year Year Year

MBbbl

[A]

1990

1

1991

2

1992

3

1993

4

0

1994

5

1

1995

6

2

1996

7

3

73

1997

8

4

255

1998

9

5

892

1999

10

6

3122

2000

11

7

5475

2001

12

8

5475

2002

13

9

5475

2003

14

10

5475

2004

15

11

5475

2005

16

12

4754

2006

17

13

3559

2007

18

14

2664

2008

19

15

1995

2009

20

16

1493

2010

21

17

1118

2011

22

18

837

2012

23

19

627

2013

24

20

469

SUM

49233

80.0%

CAPEX:

Tangible Expensed Depletable

($Million) ($ Million) ($ Million)

[F]

[G]

($15.000) ($200.000)

($15.000)

($15.000)

($15.000)

($20.000) ($4.000)

($26.000) ($19.000)

($26.000) ($15.000)

($34.000) ($23.000)

($34.000) ($23.000)

$0.000

$0.000

$0.000

$0.000

$0.000

$0.000

$0.000

$0.000

$0.000

$0.000

$0.000

$0.000

$0.000

$0.000

$0.000

$0.000

$0.000

$0.000

$0.000

$0.000

$0.000

$0.000

$0.000

(94.000) (61.000) (200.000)

OPEX :

3.0%

Est

$2.00

5.0%

10.0%

Cost of

Prod Cost S&L Taxes Overhead

Abdnm

($Million)

($Million) ($Million) ($Million)

[H]

[I]

[J]

[K]

$0.000

$0.000

($0.199)

$0.000

$0.000

($0.199)

$0.000

$0.000

($0.199)

$0.000

$0.000

($0.199)

$0.000

$0.000

($0.198)

$0.000

$0.000

($0.196)

($0.546)

($0.053) ($0.196)

($0.910)

($0.207) ($0.194)

($2.184)

($0.776) ($0.194)

($6.644)

($2.999) ($0.199)

($11.350)

($5.751) ($0.198)

($11.350)

($5.751) ($0.198)

($11.350)

($5.751) ($0.198)

($11.350)

($5.751) ($0.198)

($11.350)

($5.423) ($0.198)

($9.908)

($4.566) ($0.199)

($7.518)

($3.205) ($0.199)

($5.728)

($2.319) ($0.199)

($4.390)

($1.617) ($0.199)

($3.386)

($1.165) ($0.200)

($2.636)

($0.806) ($0.200)

($2.074)

($0.578) ($0.200)

($1.654)

($0.414) ($0.200)

($1.338)

($0.296) ($0.200) ($40.000)

(105.666)

(47.429)

(3.569) (40.000)

Capital Outlays

Selected Information on the Syndicate Exercise

Np=

50 MMBbls

Costs--Dry Wells

Royalty:

12.50%

Costs--Succ Well

Production Tax

5.00%

Success Rate

Ad valoren Tax3.00%

Discount Rate

Venture Cash Flow Exploration Exploration Succ Dev

Year

Year

Outlay Success

Outlay

$Million

$Million $Million

1990

1991

1992

1993

1994

1995

1996

1997

1998

2014

Dry Devl

Outlay

$Million

6 $Million/well

8 $Million/well

80%

12.00%

Facility

Constr

$Million

Bonus to Abdn

$Million

($15.000)

($200.000)

($15.000)

($15.000)

0 ($15.000)

1

($20.000)

2

($16.000) ($15.000) ($10.000)

3

($16.000) ($15.000) ($10.000)

4

($24.000) ($23.000) ($10.000)

5

($24.000) ($23.000) ($10.000)

21

($40.000)

NCF CalculationsDD&A

Deductions

E&P Cash

Venture Flow

Year Year

Year

1990

1991

1992

1993

1994

1995

1996

1997

1998

1999

2000

2001

2002

2003

2004

2005

2006

2007

2008

2009

2010

2011

2012

2013

1

2

3

4

5

6

7

8

9

10

11

12

13

14

15

16

17

18

19

20

21

22

23

24

0

1

2

3

4

5

6

7

8

9

10

11

12

13

14

15

16

17

18

19

20

Depreciation Expenses

SLD YEAR =

5

Rate =

($2.00)

1996

1997

1998

2000 Total

Depletion Allowance

$Million

$Million

$Million

$Million

$Million

$Million

($10.400)

($10.400)

($10.400)

($10.400)

($10.400)

($4.000)

($4.000)

($4.000)

($4.000)

($4.000)

($10.400)

($14.400)

($18.400)

($18.400)

($18.400)

($8.000)

($4.000)

($4.000)

($4.000)

($4.000)

($4.000)

$0.000

($88.000)

($0.146)

($0.510)

($1.784)

($6.244)

($10.950)

($10.950)

($10.950)

($10.950)

($10.950)

($9.508)

($7.118)

($5.328)

($3.990)

($2.986)

($2.236)

($1.674)

($1.254)

($0.938)

($98.466)

& AFT

Net

Total

BFT

35.0%

Cash

Applied

Net Cash

Taxable

Income

Flow Deductions

Flow

Income

Tax

Year

($Million)

($Million) ($ Million) ($Million)

[N]

[K]

[L]

$0.000 ($110.199) ($10.199)

$0.000

$0.000 ($10.199) ($20.398)

$0.000

$0.000 ($10.199) ($30.597)

$0.000

0

$0.000 ($10.199) ($40.796)

$0.000

1

$0.000 ($18.198) ($43.994)

$0.000

2

$0.000 ($38.196) ($57.190)

$0.000

3

$1.542 ($37.266) ($69.391)

$0.000

4

$5.937 ($33.424) ($88.106)

$0.000

5

$22.856 ($18.504) ($95.540)

$0.000

6

$35.235

$77.394

($34.581)

$0.000

7

$47.471 $149.551

$96.898

$33.914

8

$37.071 $149.551 $126.774

$44.371

9

$29.071 $149.551 $137.174

$48.011

10

$28.907 $149.715 $145.174

$50.811

11

$28.747 $141.491 $136.790

$47.876

12

$24.904 $115.995 $110.335

$38.617

13

$18.696

$81.871

$76.224

$26.678

14

$14.073

$57.718

$53.418

$18.696

15

$10.637

$40.624

$37.354

$13.074

16

$8.073

$28.533

$26.044

$9.116

17

$6.168

$19.980

$18.090

$6.332

18

$4.748

$13.933

$12.497

$4.374

19

$3.692

$9.658

$8.568

$2.999

20

$8.603 ($33.361) ($34.189)

$0.000

Total

$336.430 $996.417 $521.553 $344.869

$336.430 $865.820 $460.359 $344.869

Tax Loss

C/F

($Million)

[M]

($10.199)

($20.398)

($30.597)

($40.796)

($43.994)

($57.190)

($69.391)

($88.106)

($95.540)

($34.581)

$0.000

$0.000

$0.000

$0.000

$0.000

$0.000

$0.000

$0.000

$0.000

$0.000

$0.000

$0.000

$0.000

AFT

Net Cash

Flow

($Million)

[O]

($109.801)

($9.801)

($9.801)

($9.801)

($17.802)

($37.804)

($36.327)

($32.122)

($15.928)

$84.436

$127.383

$116.927

$113.287

$110.651

$105.362

$87.682

$63.108

$45.148

$32.338

$23.203

$16.683

$12.032

$8.711

$8.377

$805.544

$676.141

Host

Govt

Take

%

[O]

NCF CalculationsDD&A

Deductions

E&P Cash

Venture Flow

Year Year

Year

1990

1991

1992

1993

1994

1995

1996

1997

1998

1999

2000

2001

2002

2003

2004

2005

2006

2007

2008

2009

2010

2011

2012

2013

1

2

3

4

5

6

7

8

9

10

11

12

13

14

15

16

17

18

19

20

21

22

23

24

0

1

2

3

4

5

6

7

8

9

10

11

12

13

14

15

16

17

18

19

20

Depreciation Expenses

SLD YEAR =

5

Rate =

($2.00)

1996

1997

1998

2000 Total

Depletion Allowance

$Million

$Million

$Million

$Million

$Million

$Million

($10.400)

($10.400)

($10.400)

($10.400)

($10.400)

($4.000)

($4.000)

($4.000)

($4.000)

($4.000)

($10.400)

($14.400)

($18.400)

($18.400)

($18.400)

($8.000)

($4.000)

($4.000)

($4.000)

($4.000)

($4.000)

$0.000

($88.000)

($0.146)

($0.510)

($1.784)

($6.244)

($10.950)

($10.950)

($10.950)

($10.950)

($10.950)

($9.508)

($7.118)

($5.328)

($3.990)

($2.986)

($2.236)

($1.674)

($1.254)

($0.938)

($98.466)

NCF CalculationsTechnical

Costs

E&P Cash

Oil/Gas

Venture Flow Production

Year Year Year

MBbbl

[A]

1990

1

1991

2

1992

3

1993

4

0

1994

5

1

1995

6

2

1996

7

3

73

1997

8

4

255

1998

9

5

892

1999

10

6

3122

2000

11

7

5475

2001

12

8

5475

2002

13

9

5475

2003

14

10

5475

2004

15

11

5475

2005

16

12

4754

2006

17

13

3559

2007

18

14

2664

2008

19

15

1995

2009

20

16

1493

2010

21

17

1118

2011

22

18

837

2012

23

19

627

2013

24

20

469

SUM

49233

80.0%

CAPEX:

Tangible Expensed Depletable

($Million) ($ Million) ($ Million)

[F]

[G]

($10.000) ($100.000)

($10.000)

($10.000)

($10.000)

($15.000) ($3.000)

($25.000) ($13.000)

($25.000) ($13.000)

($25.000) ($13.000)

($25.000) ($13.000)

$0.000

$0.000

$0.000

$0.000

$0.000

$0.000

$0.000

$0.000

$0.000

$0.000

$0.000

$0.000

$0.000

$0.000

$0.000

$0.000

$0.000

$0.000

$0.000

$0.000

$0.000

$0.000

$0.000

(75.000) (39.000) (100.000)

OPEX :

3.0%

Est

$2.00

5.0%

10.0%

Cost of

Prod Cost S&L Taxes Overhead

Abdnm

($Million)

($Million) ($Million) ($Million)

[H]

[I]

[J]

[K]

$0.000

$0.000

($0.199)

$0.000

$0.000

($0.199)

$0.000

$0.000

($0.199)

$0.000

$0.000

($0.199)

$0.000

$0.000

($0.198)

$0.000

$0.000

($0.196)

($0.546)

($0.066) ($0.196)

($0.910)

($0.255) ($0.196)

($2.184)

($0.980) ($0.196)

($6.644)

($3.748) ($0.199)

($11.350)

($6.573) ($0.198)

($11.350)

($6.573) ($0.198)

($11.350)

($6.573) ($0.198)

($11.350)

($6.408) ($0.198)

($11.350)

($6.248) ($0.198)

($9.908)

($5.290) ($0.198)

($7.518)

($3.861) ($0.199)

($5.728)

($2.818) ($0.199)

($4.390)

($2.058) ($0.199)

($3.386)

($1.501) ($0.200)

($2.636)

($1.096) ($0.200)

($2.074)

($0.800) ($0.200)

($1.654)

($0.584) ($0.200)

($1.338)

($0.426) ($0.200) ($40.000)

(105.666)

(55.859)

(3.572) (40.000)

Production Profile

1B: Production Profile

16,000

14,000

12,000

10,000

8,000

6,000

4,000

2,000

0

Profile 2

11

13

Year

15

17

19

21

23

Economic Life

1A: Economic Life

Np=

50,000,000 Bbls

Relevant Formulae:

q=qi*e-Dt

Np=(qi-q)(365)/D

Profile 1

Qi1=

Qf1=

t1=

D=

Np1=

100

15,000

4

-1.25

4,341,565

Economic Life=

bbl/day

bbl/day

years

/year

bbls

20.75

t=(ln(qi/q))/D

Profile 2

Oi2=

Qf2=

t2=

D=

Np2=

15,000

15,000

5

0.00

27,375,000

Profile 3

bbl/day

bbl/day

years

/year

bbls

Qi3=

Qf3=

t3=

D=

Np3=

15,000

500

11.75

0.29

18,283,435

bbl/day

bbl/day

years

/year

bbls

Conclusions

The syndicate exercise has a positive AFT

&BFT cash flows over the project years

since discovery

The total undiscounted BFT net income for

every dollar invested on the is venture is

3.83 and the AFT net income for every

dollar of total investment is 2.985.

PIR, a measure of the magnitude of

undiscounted profit per dollar invested is

2.823 and 1.985, respectively.

Conclusions

The discounted BFT and AFT ROI, a measure of

the efficiency of total capital investment, is 1.05

and 0.66, respectively, using 8 percent discount

rate.

The corresponding PIR, is 0.05 for BFT and

negative for AFT. Net present value is increased by

only 5 before tax cents per a dollar of present

value investment

The project has a negative after tax profit per

dollar of present value of investment, thus

decrease the companys value! This is confirmed

with the low AFT IRR calculations of less than 10

%, which does not cover the cost of capitals

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