Economic Course Undergraduates and risk analysis .pptx

Petroleum Economics

1. THE INDUSTRY VALUE CHAIN

2. The petroleum industry value chain is the linked series of distinct but interrelated activities that transform crude oil and natural gas into valuable end-user products These activities are broadly organized into three main sectors, namely: Upstream, Midstream and Downstream. THE INDUSTRY VALUE CHAIN

3. Which Sector of this value chain is highly risky than the others?

4. THE INDUSTRY VALUE CHAIN The main factors affecting the investment in oil and gas industry: Demand for energy Prices Costs Government policy

5. What is the ultimate goal of the upstream oil and gas company ? IS to find large amount of oil and gas ? To make money OR Finding oil and gas not necessary ensures that you will make a profit because profit depends on commercial success. 7

6. Does commercial success only mean discovering large accumulations of hydrocarbons? NO Commercial success simply depends on discovering large accumulations of hydrocarbons that can be produced economically. 8

7. Commerciality Criteria A market to sell your products 3 Sufficient capital to achieve this plan and the necessary operating costs 2 The necessary production and transportation facilities are available 4 A definite field development plan with a detailed timetable 1 legal, contractual, environmental regulations are favorable 5

8. The Industry Competitive Environment

9. The Industry Competitive Environment Integrated or supermajor oil companies (IOC) The Majors are vertically integrated operating in all sectors of the industry and, continue to exert significant influence on the industry . BP, Chevron, ExxonMobil, Shell, and Total. Independents Independents are smaller and medium-sized companies, which specialize in particular areas of the industry value chain.

10. The Industry Competitive Environment National oil companies (NOC) Companies that are majority owned by the government The largest NOCs include: Saudi Aramco, N igerian National Petroleum Corporation (NNPC), Kuwait Petroleum, Abu Dhabi National Oil Company (ADNOC), National Iranian Oil Company (NIOC) China National Petroleum Company (CNPC) Petroleos de Venezuela (PDVSA) Rosneft, Gazprom, Russia

11. The Market Structure of Oil and Gas

12. The Market Structure of Oil and Gas Competitive market There are many actors, none of whom can influence market Monopolistic market A single or few actors are of sufficient size to affect the price or the volume Does the petroleum market is a monopoly or competitive?

13. The market structure of oil and gas Petroleum products market often considered to be perfectly competitive OPEC is large enough to influence this market Commodity markets Crude oil market Structure of petroleum market depends on which segment is being considered

14. Upstream Petroleum Life cycle

15. Upstream Petroleum Life cycle Successful upstream projects typically passes through six stages: Exploration Acquisition Appraisal Development Production Abandonment

16. Stage Gates (Kill Points)

17. Stage Gates -Kill Points- Phase Review Stage gates Review points in the life of any project and usually exists at the end of each project phase. At each stage gates, actual project performance and outcomes are compared with set of predefined metrics ( cost benefit analysis) to determine whether the project will be allowed to move forward or terminated at this stage.

18. Stage Gates- Kill Points Decision Making Stage Gate or Kill Point Proceed to the next phase Exit or kill the project Re-evaluate and recycle (may be manageable risk)

19. Stage Gates -Kill Points- Phase Review 23 Abandon Produce Develop Appraise Explore Acquire Gate 1 Gate 2 Gate 3 3-5 years 2-3 years 2-3 years 10-30 years Gate 4

20. Acquisition

21. Acquisition- First Gate Defines a framework of the financial agreement between the company and government by obtaining a license Defines the fiscal system between the contractor and the government licensing Is the process of obtaining guaranteed permission to explore or produce hydrocarbon.

22. Main Elements of Petroleum Upstream Contract Area or the terrain Duration Bonuses Royalty Cost Recovery Limit Profit Oil Split Taxation Depreciation Methods Others Signature bonus is paid

23. Exploration

24. Exploration During this phase our target is to find any indications for the existence of oil and gas ( Geological Success ). Exploration is the activity which characterize the petroleum activity as high risk . These costs will be incurred without any guarantee that it will be recovered or no ( only in case of commercial discovery ). One company may spend more than 100MM$ in a single project knowing that there as 80% of a complete failure.

25. The ring is stored in the box

26. What shall you do to find the ring? Find the box first Open the box

27. 3 4 6 1 3 2 1 1 2 5

28. 1 3 2 1

29. The crude oil or the natural gas The trap or the reservoir rock in which the petroleum is accumulated

30. Petroleum Exploration Geophysical and seismic survey Exploratory well drilling Exploration Program To find the box To open the box

31. Cap rock Reservoir Source Migrating hydrocarbons Oil Water Gas Petroleum Formation

32. Seismic Survey

33. Geophysical and Seismic Survey Seismic is Used for determining structures and stratigraphic traps to be drilled

34. interface shot receivers shot receivers Reflection points Seismic Principles

35. Sea bed Boat Cable with hydrophones Sea Surface Source (Airguns) Sedimentary Layers Incident waves Reflected waves Marine Acquisition System

36. Geophysical and seismic survey

37. Geophysics and Seismic Costs

38. Geophysics and Seismic Costs The three main cost drivers of the seismic survey are : Acquisition costs Data processing costs Data analysis and interpretation costs

39. Exploratory drilling well in Virgin Zone

40. Exploratory drilling well in Virgin Zone Seismic gives you only a prove about the existence of structure or not. If the structure exists, the probability of discovery will be higher. In order to determine if there’s discovery or no, the well is drilled in the best location as determined by the geophysicist Most of the costs of an exploration program are incurred by the drilling .

41. How is an Oil well drilled ?

42. Exploration Drilling Cost Drivers

43. Exploration Drilling Cost Drivers There are three main elements of the well cost namely: Rig costs Tangibles and consumables Services

44. RIG COSTS Rig costs refer to the cost of hiring the drilling rig and its associated equipment Rig rate depends on: Type of rig Days on well Length of contract Mobilization/ Demobilization of rig and equipment Market conditions

45. Land Rig

46. Off shore -Jack up

47. Floating Semisubmersible rigs

48. Drilling Ships

49. Tangibles and Consumables Tangibles refer to the products or consumables used on the well. These include: Casing Tubing/completion equipment Wellhead/accessories Bits Core heads Cement products Mud products Solids control consumables Fuel and chemicals ,……………

50. SERVICES This group of costs refers to any service required on the well. Services include: Fishing Downhole tools Casing services Solids Control Equipment Mud Engineering Surveying Cementing Communications Rig positioning Logging (wireline) MWD Downhole Motors

51. Formation Evaluation

52. Formation Evaluation After drilling the well we have to answer three questions : Does the well is successful or not? Or Have we made a geological discovery or not? If the well is successful, which fluid we are going to produce (Oil or Gas)? And The approximated volume of hydrocarbon in place. To answer these questions, we need to evaluate the well after drilling is completed .

53. Formation Evaluation Formation evaluation is the process of using borehole measurements to evaluate the characteristics of the subsurface formations. Formation evaluation includes : Drilling operation logs (mud logging). Core analysis. Productivity tests. Wire line logs

54. Initial Reservoir Characteristics The most important reservoir characteristics that must be evaluated during the exploration program are The pay zone thickness The porosity The saturation Permeability which fluids are going to be produced. In brief, estimating how much hydrocarbon in place

55. Porosity

56. Definition of Porosity Porosity (f) = fraction of a unit volume occupied by the pores Matrix Pores f 1 - f

57. Fluid Saturation Fluid saturation is defined as the fraction of pore volume occupied by a given fluid Definitions Sw = water saturation So = oil saturation Sg = gas saturation Sh = hydrocarbon saturation = So + Sg

58. Saturations

59. Permeability Permeability is a measure of the conductivity of a reservoir rock to fluid flow Large grains lead to high permeability and large flow rates Small grains lead to low permeability and small flow rates

60. Exploratory Budget Determination Exploration drilling costs The seismic and geophysical costs Evaluation Costs Exploration Costs Exploration costs are incurred before the discovery of hydrocarbons and will therefore have a direct impact on the accounts of the company because the recovery of these costs being linked to the likelihood of success of the exploration program .

61. Is the data obtained from the exploration phase is sufficient to make a complete and efficient field development plan?

62. Appraisal The data obtained from the exploratory wells always has a high degree of uncertainty. During the appraisal phase, delineation wells might be drilled to Collect cost-effective information to : Determine the size of the oil or gas field and Decide if and how to develop it most efficiently. Making a complete description of this discovery

63. How many appraisal wells we need to drill?

64. Appraisal The decision to undertake more appraisal activity is cost-effective information. Only if the value of the outcome with the appraisal information is greater than the value of the outcome without the information. If the appraisal activity does not add more value than its cost, then it is not worth doing.

65. Appraisal Supposing: Cost of appraisal information is $[A] The profit of the development without the appraisal information is $[B] The profit (net present value, NPV) of the development with the appraisal information is $[C] The appraisal activity is worthwhile only if [C - A] > [B]

66. Important Notes-Appraisal Appraisal activity should be based on the information required. The first step is therefore to determine what uncertainties appraisal is trying to reduce , and then Determine what information is required to reduce those uncertainties. For example , if fluid contacts are a major source of uncertainty, drilling wells to penetrate the contacts is an appropriate tool; seismic data or well testing may not be.

67. Important Notes-Appraisal Note that it is not the objective of the appraisal well to find more oil, but to reduce the range of uncertainty in the estimate of the initial oil in place. A dry appraisal well does not imply that it is an unsuccessful appraisal well.

68. 180 300 250

69. Appraisal After we finish the appraisal program, the new data is correlated with the exploration and seismic data to create a complete picture about the reservoir. The expected exploration and appraisal outcomes include: Original oil in place Recoverable oil Trapping mechanism Porosity map Saturation map Reservoir Pressure and Temperature Oil, gas and water chemical and physical properties Permeability (vertical and horizontal) Reservoir drive mechanism Reservoir minerology and lithology

70. Appraisal Gates After Appraisal Proceed to Field Development Exit or kill the project Re-evaluate and carry out more Appraisal Selling the Discovery

71. Project development Planning

72. Field development Planning Field Development Planning is the process of evaluating multiple development options for a field and selecting the best option which can efficiently deplete the reservoir . The field development includes the following : Drilling the development wells, The installations of the production facilities Any systems required for the transport of the effluent

73. Project development Preliminary Design Preliminary Studies Conceptual studies Exploratory Studies or Opportunity Identification Project Development Plan

74. We try to answer this question: Is there an opportunity depending on the technical criteria of the company? The purpose of the exploratory study is to evaluate whether the discovery is potentially prospective or not by : Evaluating the potential of hydrocarbon resources present ( Porosity, Permeability, Saturation, thickness). Evaluating the probability range of the volume of the hydrocarbon present. Exploratory Studies or Opportunity Identification

75. 25% Porosity 45% Porosity

76. Preliminary Studies The preliminary study evaluates the economic and commercial feasibility of the project by estimating the capital costs in the light of the available information and experience so that a decision can be taken on how to proceed. If the estimated project revenue will cover the estimated costs , we will proceed with the project

77. Preliminary Studies The engineers roughly plan the entire production phase by answering questions, such as: How many wells must be drilled and where? What kind of artificial lift method will be used? What kind of pressure maintenance technique may be used ( injecting water or gas into the reservoir? And when should this procedure begin? Is the oil so corrosive that the pipes need a special coating?

78. Conceptual Studies In this phase, we compare between different options to develop the field then we select the best alternative which can efficiently deplete the field from the technical and economical point of view .

79. Profile 1 Profile 2 Which Profile you prefer ? Rate time

80. Conceptual Studies The project team evaluates all the development options using criteria such as: The production volumes or expected Oil and gas recovery, The necessary investments (CAPEX), The operating costs (OPEX), Economic feasibility (NPV) and HSE, The time needed until completion. Technical, operating, and financial risks.

81. Conceptual Studies For example: There are many possibilities for developing an offshore discovery. For instance, we could select between : A stand-alone platform, Subsea tie-back with an FPSO (Floating Production, Storage and Offloading) or A subsea tie-back that is linked to already existing host platforms.

82. Business Case The business case is the output of the Conceptual studies. The business case is a documented feasibility study of the project. The key benefits of the business case is that it provides enough information about the economic health of the project According which the project sponsor will make the decision to proceed with the project or no.

83. Business Case Content The business case contains the following: Reasons for choosing the preferred option The expected benefits from the project (how much, when it will be received) Investment appraisal – often using standard metrics (NPV,IRR, CPI,…. Project Constraints, project challenges & limitations (Budget, Time, Quality, Resources,………….)

84. Definition Stage or Preliminary Design During this phase , a complete design for the final concept is developed with detailed reservoir and production simulation modeling Developing a schedule and timetable for the necessary activities for a successful plan and determining the necessary budget for each activity

85. FDP Integrated Team An integrated , multidisciplinary team with varied but complimentary experience, qualifications, and skills Responsibility: To successfully deliver the FDP, within the allocated budget, human resources and timeframe.

86. Production Phase In this stage the producing wells are put on stream and production begins and you make a revenue from the sales of hydrocarbons. Production and performance monitoring is required to upgrade and modify the project to match production levels with planned levels Workover should be carried from time to time to ensure and enhance the productivity of the wells.

87. Abandonment As the field approaches the end of the economic life, revenues gradually decrease with declining production, and annual net cash flow approaches zero . A project abandonment should progress but according to the government regulation. For a successful removal, operators generally begin planning one or two years before the planned date of decommissioning.

88. Project Economics and Investment Appraisal

89. Project Profitability Project profitability describes the ability of a project to yield a financial profit or gain for an organization The profitability of upstream projects is controlled by : The expected commodity prices over the life of the project production profiles Capital and operating costs Contractual and fiscal costs

90. Project Evaluation Workflow

91. Input Technical Data - Base Case Reservoir Pressure (2500 Psia) Reservoir Length (2.78 mile) Plateau Rate 20 MBBL/Day Reservoir Width (1.39 mile) Terrain (Dessert North Africa) Recoverable Reserve (100 MMBBL ) GOR (500 SCF/BBL) Reservoir Depth (5000 ft) Plateau Duration (10 Years) Pwh (200 Psig) Twh (145 F) Integrated Field Development Team Production Profile Production Rate vs. Time Development Costs (CAPEX) Tangible CAPEX Intangible CAPEX Abandonment Costs Operating Costs (OPEX) Fixed OPEX Variable OPEX Base Case Scenarios

92. DCF Financial Model Production Profile Production Rate vs. Time Development Costs (CAPEX) Tangible CAPEX Intangible CAPEX Abandonment Costs Operating Costs (OPEX) Fixed OPEX Variable OPEX Base Case Scenarios Fiscal Parameters Royalty Rate Cost Recovery Limit Profit Sharing Percentage Company Income Tax Project Performance & Profitability Indicators Model Output Optimum Alternative Stochastic Input Variables Price Production Rate Development Costs CAPEX Operating Costs OPEX

93. Net Cash Flow Analysis

94. Sources of Cash Received Sources of Cash Spent Accounting Period

95. Project Cash Outflow Capital Costs (CAPEX) Operating Costs (OPEX) Abandonment Costs Technical Costs Fiscal Costs Royalties Bonuses Taxes Profit Sharing Others

96. Capital Costs (CAPEX) CAPEX or capital expenditure consists of the costs of long-life assets The capital costs include: Exploration & pre-discovery , Geology geophysics, drilling. Appraisal: pre-economic discovery or commercial decision geology geophysics and well test Field development: drilling production wells, support structures, production export lines. Field modification: more wells, injection , artificial lift, and gas compression

97. CAPEX Classification for Fiscal Purposes For fiscal and tax purposes, CAPEX is further classified as intangible and tangible costs. Intangible CAPEX: Consists of items that cannot be touched such as seismic data processing and interpretation, a facilities plan, services, etc. Intangible CAPEX is usually expensed for tax purposes . Tangible CAPEX Tangible CAPEX, can be touched. For example, pipelines, the steel casing, which is placed in the wellbore compressor stations, well platforms and facilities, etc. Tangible CAPEX is capitalized and depreciated for tax purpose.

98. Operating Costs (OPEX) Operating costs (OPEX), also referred to as lease operating expenditure (LOE) OPEX occurs periodically and are necessary for the day-to-day operations of the field. OPEX incurred once production start. OPEX includes the following: Lease of facilities Field operation Export costs: Tariff payment, Operating tanks and Pipelines Work over operation on the well Insurance and administrations

99. OPEX Classification OPEX is usually often divided for modeling purposes into two categories: Fixed OPEX (MM$/Year) These costs are fixed or constant regardless of the level of production. Fixed OPEX includes administrative overheads, operating staff, safety, security, environmental monitoring, and facility insurance. Variable OPEX ($/ bbl ) Variable field OPEX always varies continuously according to production volumes. For oil production, variable field OPEX is normally expressed on a unit basis, which in the case of an oil-only development would mean cost per barrel of oil production

100. CAPEX &OPEX Important Note: Classification of costs as CAPEX or OPEX differs from company to company according to the nature of the project and the fiscal regime. The tax law or the petroleum law determines which costs will be capitalized and which costs will be expensed or the capitalization criteria. Some fiscal regimes don’t differentiate between tangible or intangible costs and any capital costs are depreciated for the tax purpose.

101. Fiscal Outflows Each government developed its fiscal instruments to capture the appropriate rent from its nonrenewable resources. These instruments include but are not limited to: Bonuses, Rentals, Royalties, Profit sharing Crypto taxes or Government levies (nonprofit based tax) Income tax.

102. Gross Revenue or Cash Inflow 139 Crude Oil Natural Gas LPG Condensate

103. Financial Abbreviations (Language)

104. Converting Daily Revenue to Annual Revenue 141 Oil Production Gas Production

105.   Annual Production MMBBL /Year Annual Revenue MM$ /Year Annual Production (MMBBL/Year) *Price Do not forget this You will be killed

106. Annual Revenue Calculation Example

107. Net Cash Flow

108. Net Cash Flow Example

109. Net Cash Flow Example Assuming 40% tax rate, how much tax will you pay for each year?

110. Net cash flow Profit Net Cash Flow and Profit 148

111. Net Cash Flow & Profit Net Cash Flow is actual money (liquid money) gained and spent in the same accounting period. Profit is implicit money after spreading the CAPEX. In other words, Profit is calculated after subtracting the expenses from the revenue. These expenses include the depreciated capex not the actual capex.

112. Profit Illustration 150

113. Income tax Allowable Deductions

114. 152

115. 153

116. Net Cash Flow

117. Net Cash Flow Profile 156

118. Depreciation Depreciation is defined as a loss in the value of an asset over the time it is being used. Events that can cause property to depreciate include wear and tear, age, deterioration, and obsolescence. Depreciation is a deductible non-cash expense for income tax purposes. The higher the depreciation allowance being deducted in any given year, the lower the taxable income and the cash disbursements (cash outflow) in the form of income tax.

119. Straight-line depreciation In this method of depreciation, the depreciable cost or cost basis of the property is equally distributed over the useful life of the asset. The following equation is used

120. Declining balance depreciation The method is appropriate when it can be reasonably estimated that the benefits derived from an asset will decline with time. The declining balance depreciation is further divided into different percentages, such as the 200% declining balance method (also referred to as the double declining balance depreciation), 175% declining balance, 150% declining balance, and 125% declining balance. Under this method, the salvage value is not subtracted when figuring yearly deductions

121. Sum-of-years’-digits depreciation This method produces a declining depreciation charge each year by applying a declining charge to the total cost of the asset (depreciation base). The declining charge is determined each year by dividing the remaining life of the asset by the sum of the years’ digits. For an asset with a five-year life, the sum of years’ digits is 5 + 4 + 3 + 2 + 1 = 15, and the declining charge for the first year is 5/15, and so on. The following equation is used to calculate the sum of years’ digits

122. Switching Methods We depreciate according to different methods, then we select the highest from them.

123. Units of production depreciation When physical wear and tear is the dominating factor in the useful life of the asset, depreciation may be based on units of service rather than on the units of time. Therefore, this method is used when it is determined that the life of the asset is dependent on how much the asset is used or it produces, rather than the passage of time.