Africa Upstream Fiscal Systems: Evaluation and Rating, and Analysis of State Company Participation

Transcription

1 Africa Upstream Fiscal Systems: Evaluation and Rating, and Analysis of State Company Participation - ANNEX I: ACRONYMS AND DEFINITIONS Prepared by: Rodgers Oil & Gas Consulting July, 2017

2 Acronyms and Definitions AD&A Accelerated depreciation and amortization AI Area Incremental refers to contract (area) incremental tax position AMT Alternative Minimum Tax APPA African Petroleum Producers Association APT Additional Profits Tax ARF Alberta Royalty Framework Aver Average Barrows Info Not yet published Barrows Contracts BBCC Barrows Basic Oil Laws and Concession Contracts bbl barrel Bcf billion cubic feet (10 9 ) Bcfe billion cubic feet equivalent Bcm billion cubic meters (10 9 ) Bcmpy billion cubic meters per year (10 9 ) boe barrel of oil equivalent boepd barrel of oil equivalent per day bopd barrel of oil per day Braz Brazil Can Canada CapEx capital expenditure CBM coal bed methane CI Carried Interest CIF Costs, insurance, freight (gas import price) CIT Corporate Income tax CtI Country Incremental Tax Position cons consolidation contr contractor CNOOC Chinese National Offshore Oil Corporation CPO Contractor share of Profit Oil CPR Cost/Price Ratio CPR10 Cost/Price Ratio discounted at a real 10% discount rate CSI Cost Savings Index cum cumulative D&A Depreciation and Amortization D&C drilling and completion DB declining balance for depreciation dev development (of petroleum fields) Disc Discovery DOM Domestic gas price DW Deep Water E East (where the context indicates a geographical location or direction) EMV Expected Monetary Value (EMV10 refers to EMV discounted at 10%) EOR Enhanced Oil Recovery EUR Estimated Ultimate Recovery (of oil and gas from a well or field) Expl Exploration Fed Federal FEEDGAS Gas price delivered at the entry point of an LNG facility. FeLI% Front End Loading Index (GT10% less GT0%) FeLR GS0% before payout FeLRR GS0% before the start of production FOB Free on Board (gas export price) 1

3 FTP First Tranche Petroleum (Indonesia) FUT Anticipated future gas price G&G Geological and Geophysical Costs GOM Gulf of Mexico Gov Government GRSI Government Risk Sharing Index (GT0%(R) less GT0%) GT0% Government Take (undiscounted) (equal to GTT0) GT10% Government Take discounted at 10% (equal to GTT10) GIT0 Government Income Take (undiscounted) GIT10% Government Income Take discounted at 10% GTT0 Government Total Take (undiscounted) GTT10% Government Total Take discounted at 10% HH Henry Hub (gas hub in North America) HT Hydrocarbon Tax HYPLNG Hypothetical LNG net back Hz Horizontal (in the context of a horizontal well) info information intang intangible asset IOC International Oil Company IRR Internal Rate of Return JV Joint Venture K barrels thousand barrels LAT last available terms for a fiscal system in a country m3 cubic meter max maximum marg marginal Mcf thousand cubic feet Mcfd thousand cubic feet per day Mcfe thousand cubic feet equivalent per day Mcm thousand cubic meters Min minimum MM $ million US dollars MMbbls million barrels MMboe million barrels of oil equivalent MMBtu million British Thermal Units MMcf million cubic feet MMcfd million cubic feet per day N North (where the context indicates a geographical location or direction) NA Fiscal systems for North American wells NB Net Back NBP National Balancing Point (gas hub in UK) NCF Net Cash Flow NL Newfoundland and Labrador NOC National Oil Company NPV10 Net Present Value discounted at 10% OCS Outer Continental Shelf - (offshore area beyond State waters of the United States) ON Onshore OpEx Operating expenditure Part. participation of a state company PIR10 Profit to Investment Ratio discounted at 10% PNG Papua New Guinea PO Profit Oil Priv Private Prof profit 2

4 Prop Proposed PRT Petroleum Revenue Tax PSC Production Sharing Contract, or PSA Production Sharing Agreement RSC Risk Service Contract S South (where the context indicates a geographical location or direction) SA Stand Alone Tax Position SevT Severance Tax SL straight line for depreciation SS sliding scale SW Shallow Water tang tangible asset th m3 thousand cubic meters Tcf Trillion cubic feet Tcfe Trillion cubic feet equivalent UDW Ultra-Deep Water UR Un-Risked US United States Vt Vertical W West (where the context indicates a geographical location or direction) WD Water Depth WELLH Regulated wellhead gas price WFSG (1997) World Fiscal Systems for Gas (1997) WFSO (1997) World Fiscal Systems for Oil (1997) WFSOG (2012) World Fiscal Systems for Oil and Gas 2012 WI Working Interest WTI West Texas Intermediate crude oil Also see Definitions 3

5 Carried Interest (CI): refers to a situation where one joint venture company, typically the state company, does not contribute its full share of costs. The NOC is therefore referred to as being carried by the private investor companies. Constant Dollars: refers to costs or prices without any escalation. Also see Escalation, Inflation, Monetary Units, Nominal Dollars, and Real Dollars. Costs: Costs are defined as technical costs, in order to exclude costs attributed to the fiscal system, and to distinguish between other cost concepts opportunity cost and sunk cost. Fiscal costs are included as payments to governments/resource owners. Also see Fiscal Costs. Technical costs are the project capital (CapEx) and operating (OpEx) expenditures. Cost/Price Ratio (CPR): This is the ratio of total capital and operating costs per barrel (Mcf or BOE) divided by the price on an undiscounted real basis. For instance, a cost of $32 per barrel and a price of $80 per barrel yields CPR of 40%. The lower the CPR the more attractive the project prior to taking government share into account. CPR10 - this is the CPR discounted on a real 10% basis. Cost Savings Index (CSI): the per-dollar share of cost saving retained by the investor. Also see Price Maximizing Index. The CSI indicates how much is retained by the investor if the investor manages to save $1 per barrel in costs. Also see Gold Plating. From an international perspective the following overall scale could be applied: Table Cost Savings Index Guideline (US $ per US $ saving) Very Good > $ 0.50 Good $ $ 0.50 Average $ $ 0.30 Poor $ $ 0.20 Very Poor $ $ 0.10 Neutral $0.00 Gold Plating < $

6 Country Incremental (CtI): Country incremental refers to a scenario where the investor is already producing oil and gas in the host country and that there is sufficient positive taxable income. This means that costs can be deducted for tax purposes based on the various depreciation provisions. Where expenditures are 100% deductible as incurred, such as certain exploration costs, the investor benefits from the immediate reduction of tax payments in the year such investments are being made. Contract Area Incremental (AI): Typically, petroleum royalties and other sector-specific fiscal levies are assessed (ring-fenced) at the individual well or field level, particularly under concession systems. By contrast, many production sharing contracts apply to the entire contract area. This means that field economics may be different than contract area economics. This applies most specifically to incremental investments within the contract area and where the fiscal terms are based on the entire contract area, not just on a given field within a contract area. Fiscal systems where the rates are fixed or otherwise do not vary with production (typically daily or monthly), with cumulative production, or with costs, generally do not need special fiscal consideration when making incremental investment decisions. In these cases, with two exceptions, there would be no difference between the contract incremental results and those for the stand alone or country incremental scenarios. The exceptions are for signature bonuses and area rentals. Whether for concessions or contracts, the signature bonus and rentals related to the total exploration area do not require additional bonuses or rental payments for further exploration within the area. These levies would therefore be ignored when considering incremental investments within the same contract or concession area. Production Based Bonuses and Royalties: If a contract or concession calls for production bonuses, these bonuses are typically dependent on the level of daily or cumulative production. For example, the initial field within a contract area may be required to pay $10 million when production reaches 5,000 bopd and a further $5 MM at the 15,000 and 25,000 5

7 bopd production thresholds. If these production thresholds relate to the entire contract area, and the existing field is already producing 5,000 bopd, a new or incremental field would be required to pay $5 MM when its production reaches 5,000 per day, not at the 10,000 per day lever required for the first field. Profit Petroleum and Profit-Based Systems: If the profit oil/gas under PSC s is determined field by field, no special contract incremental calculations are necessary and the country incremental results can be used. If the contract states that the profit oil/profit gas calculations are to be done on a total contract area basis, a special contract incremental analysis is again required. Both the costs and production for the new field will be added to the already existing cost and production in order to determine the total cost petroleum and profit petroleum. In this case, the characteristics of the field that is already producing in the contract area have a significant impact on the profitability of the incremental investment. Incremental cost oil can now be recovered from the revenue attributed to the existing production. This provides a benefit similar to tax consolidation under the country incremental tax position as costs can be recovered from the existing field(s) before the start of the production from the new field(s). This typically improves the IRR significantly. This consolidation effect however is limited where the contracts have low cost petroleum limits. In this case, there may be little incremental costs that can be recovered from existing production. With cost-based systems such as those where the rate is based on a threshold rate of return (ROR) or R-factor, an incremental investment may delay the time when the initial investment is required to pay a higher rate as a result of reaching the threshold ROR or R- Factor. Alternatively, if the top rate is already in effect, incremental production from a new investment could be subject automatically to the top rate. The combined effects of the earlier cost recovery but the higher profit petroleum rates may cause the overall 6

8 profitability to increase or decrease depending on the effect of the two countervailing factors. In general, for incremental fields in the same contract or concession area, which are ringfenced to the contract area, the ROR for the incremental fields will be higher, the undiscounted GS% will be lower, and the NPV10 may be higher or lower, depending on the circumstances around the balance between earlier cost recovery and higher rates. Discount Rate: the rate of return that represents the investor s expected return from comparable alternative investments, more specifically, from the next-best alternative investment. The rate incorporates three components inflation, opportunity cost, and time-related risk. It is common practice in the upstream oil & gas sector to use a real-dollar discount rate of 10%. The discounted value, alternatively referred to as the present value or net present value, is determined with the following equation. PV = FV / (1 + r) ( t 0.5) Where: FV = Future Value (also referred to as nominal dollar value); PV = Present Value; r = the discount rate; t = number of time periods = Ey Sy +1; Ey = End Year; and, Sy = Start Year. Economic Rent: Economic rent is the key concept underlying how governments go about determining the level or magnitude of the government share. This is the share remaining after the investor has recovered all costs, including a competitive rate of return. Costs include those for investment (including exploration) and project operations (including transportation). In the context of economic rent, costs also include estimates for risk, and uncertainty. Figures 3.1 illustrates. 7

9 Figure 3.1 Illustration of Economic Rent Explanation: The towers or stacked bars in the chart illustrate the cost components of a low-cost project (left bar) and a high-cost project (right bar).1 These costs equate to the minimum price that producers need in order to produce quantity-levels Q1 to Qn-1. The aggregate quantity from all of the projects between Q1 and Qn-1 represents, for example, the total production needed to meet the world s demand for oil. Adding the costs for a large number of projects enables the construction of a smooth curve. This is the supply curve (S), representing the cost of supplying the world s oil from a multitude of different sources. When the demand for oil is matched with the supply, the oil price is then determined. Since the price has to be sufficient to attract the last supply project needed in order to meet the total demand, the other projects will receive a price that is higher than their costs. 1 Cpx = Capital Costs; ROR = Rate of Return; Opx = Operating Costs; Rsk = Risk; Un = Uncertainty; FTax = Federal Tax; LTax = Local (Provincial or State) Tax; SB = Signature Bonus; Roy = a variety of special fiscal instruments collectively referred to as Royalties for this illustration. 8

10 Economic rent is the difference between the price for which the resource is sold (illustrated by the intersection of the supply (S) and demand (D) curves. This would be price P2 if there were no supply restrictions. Comparison of the stacked bars with the price (P1) indicates that the costs of some projects leave no economic rent and thus no room for royalties or, in some cases, even income taxes. Other, lower cost, projects enjoy a surplus, thereby leaving room for royalties and taxes and other fiscal levies such as signature bonuses. References to Hotelling Rent and Ricardian Rent identify a conceptual distinction between: (a) rent due to lower costs/better quality projects (Ricardian Rent) and (b) that from scarcity (Hotelling Rent) as reflected in higher prices caused by restricting production from Qn to Qn-1 in the chart, and represented by the rectangle area abcd. 2 The restricted production causes price to increase from P2 to P3. These distinctions are important in designing the specific fiscal instruments that may be applied. Ricardian rent, for example, might accrue to a low cost conventional onshore development whereas a high cost frontier deep water or Arctic development may not yield any rent. A source of scarcity rent the Hotelling portion of the overall economic rent for example, results from the supply restrictions implemented by the Organization of Petroleum Exporting Countries (OPEC). The concept of economic rent finds practical application in the notion of divisible income. While the overall government share may reflect two different basic considerations; i.e., the recovery of costs and economic rent, it is the overall share that oil and gas companies have to take into account when making investment decisions. As already identified, divisible income is defined as project revenue less capital or investment costs and operating costs. To square the theoretical concept of economic rent 2 After economists David Ricardo ( ) and Harold Hotelling ( ). 9

11 with divisible income it is necessary to recognize that the producer s share needs to include an allowance for a return on investment, as well as for risk and uncertainty.3, 4 Expected Monetary Value (EMV10): Also referred to as the risked NPV10, EMV10 is the discounted project Net Present Value from a success case, weighted by the probability of success, less the discounted NPV from the unsuccessful case, weighted by the probability of failure. Effective Royalty Rate (ERR): The real-dollar resource owner revenue divided by project gross revenue. This is the FCI expressed as a percent. Escalation: Escalation refers to the increase in prices or costs over time, including any increase due to inflation. Fiscal Cost Index (FCI): The real-dollar resource owner revenue expressed on a per-unit basis (government revenue divided by production). Front-End Loading Index (FeLI%): The FeLI% measures the impact of front end loading. It is calculated as the discounted government share less the undiscounted share typically GT10% less GT0%. The FRI has a different impact on very profitable projects than on marginal projects. The GT10 is higher because of front end loading than the GT0 because the early payments weigh very heavily when discounted at 10%. The difference in percent depends very much on the nature of the cash flow, the costs and the prices. A GT0 of 75% is a rather typical level for many fiscal systems. This means that a difference of 20% between the GT10 and GT0 would place the GT10 at 95%. This would imply an IRR 3 Economists distinguish between two types of risk time related and non-time related. Time related risk is reflected by discounting the project s cash flows at the investor s required rate of return. Non-time related risk refers to the risks for example, that project parameters such as recoverable reserves and costs will not be as expected. This type of risk is assessed through the application of probabilistic analysis such as that reflected in monte carlo simulations and expected monetary value (EMV) analysis. 4 It is common practice to report government shares on a non-risked and non-discounted basis. It is understood that the developer s share includes components for rate of return, risk, and uncertainty. 10

12 somewhat over 10% and therefore this would be a higher percentage difference. A difference of 20% is therefore representative of strong front end loading for the particular fiscal system for the particular economic conditions. A difference of 5% would be weak front end loading. The following comparative scale may be used the fiscal system may be considered to be: Front end loaded, when GT10 > GT0; o Strongly front end loaded system, when GT10 minus GT0 is higher than 20%; o Average front end loaded system, when GT10 minus GT0 is higher than 10% and less than or equal to 20%; o Weakly front end loaded system: when GT10 minus GT0 is higher than 5% and less than or equal to 10%; Neutral, when GT10=GT0 (0% to 5% may be considered neutral); and, Back end loaded, when GT10 < GT0. Front-End Loading Ratio (FeLR): Front End Loading means that that the government has a tendency to take its revenues early in the cash flow. For instance, with fiscal instruments such as bonuses, rentals, property taxes, and ad valorem royalties. The FeLR is the undiscounted real-dollar government share before payout. A high FeLR indicates that the government receives a significant share of the revenues before the investor has achieved payout. This share can be measured by the ratio of the GT0 up to payout divided by the GT0 for all years of the cash flow. If this ratio is higher than 0, the fiscal system is front end loaded, if it equals 0 the system is neutral and if it is less than 0 the system is backend loaded. Front-End Loading Risk Ratio (FeLRR): The FeLRR is similar to the FeLR but is measured before the start of production. Gold Plating: Some international fiscal systems have so-called gold plating. This refers to systems where the investor actually loses value by being more efficient. These are usually systems based on an IRR sliding profit scale. Such systems over-burden the investor in case of higher levels of profitability. This means that it is in the interest of the 11

13 investors to promote higher costs in their operations. This is of course not a sensible policy. Sound fiscal systems should encourage cost savings in order to create a healthy oil industry. Government Risk Sharing Index (GRSI): The GRSI indicates the degree that a government participates in the sharing of geological risk through the fiscal system. The GRSI is measured by deducting the GT0% from the Risked GT0% (GT0%(R)). Usually, the fiscal system results in a higher Risked GT0 than Un-risked GT0. Bonuses and rentals during exploration load the exploration costs with government take. Also slow depreciation for taxes put a time value differential on exploration costs incurred and tax deductions obtained. It is possible to have a neutral GRSI in case of a perfectly neutral tax system whereby the corporate income tax features an immediate 100% write off for all expenditures. It is also possible to have a negative GRSI, where the government loses proportionately more in tax in case of a dry hole. This is the case for instance, if the government provides exploration tax credits. The GRSI is based on the weighted average across all fields such that GRSI = weighted average GT0%(R) less weighted average GT0%. The following comparative scale may be used the fiscal system may be considered to be: Strongly Risk Averse when GT0%(R) GT0% is greater than 10%; Average Risk Averse when GT0%(R) GT0% is between 5% and 10%; Weakly Risk Averse when GT0%(R) GT0% is between 0% and less than 5%; Neutral, when GT0%(R) = GT0% (GT0%(R) less GT0% is equal to 0%; and, Risk Supportive when GT0%(R) less GT0% is less than 0%. Government Take (GT0%): GT% represents government take, from the investor s point of view. GT0% is also referred to as government share (GS0%). GT0% is the share of divisible income going to resource owners from all fiscal levies, including bonuses, royalties, property taxes, and corporate income tax. Divisible income is simply defined as 12

14 the gross revenues less all capital and operating expenditures on a cash flow basis. Government share is also referred to a resource owner share. The label GT0% signifies the percentage share based on undiscounted real dollar values. The government take can be determined at various discount rates. It is common practice to express the GT% in terms of undiscounted real dollars. Other discount rates are also used; for example, 10%, representing the investor s discount rate or cost of capital, and 5%, representing the government s cost of funds. The following calculation illustrate the GT% calculation: Gross Revenues less: Capital Expenditures Operating Expenditures equals: Divisible Income less: Payments to Government equals: Net Profit $20 million $5 million $3 million $12 million $9 million $3 million In this example, the GT% is $9 million divided by $12 million, or 75%. Inflation: refers to a general and sustained increase in prices and costs. There can also be cost and price decreases deflation. Inflation is not the same as escalation, which refers to an increase in prices and costs, including that for inflation. Escalation is typically sector or project specific and occurs over a specific and shorter time period. Marginal Net Present Value per Barrel (MNPV/bbl): MNPV/bbl is the difference in perbarrel NPV10 for a high reserves case versus that for a small reserves case as per the following expression: MNPV/bbl = NPV10/bbl High NPV10/bbl Low 13

15 The MNPV10 per bbl measures the extent to which the fiscal terms encourage oil and gas companies to present a development plan that would help ensure the highest possible recovery of resources. A MNPV10 of $1/bbl may be considered weak. Maximum Sustainable Risk (MSR): used to determine the Maximum Probability of Failure (MPF) - the maximum probability of failure that a project can withstand before the EMV becomes negative. MSR = 1 + [NPVS / Absolute Value of the NPVF]: Where: NPVS = NPV for the success case; and, NPVF = NPV for the failure case; Related components are: MPS = Maximum Probability of Success = 1 / MSR MPF = 100% - MPS Monetary Units: refers to whether or not costs and prices include escalation over time. Prices with escalation included are referred to as being in nominal dollars. Escalation includes two components one for general inflation and one for a change in relative value. Real dollar results are calculated by removing the inflation component from the nominal results. When the full escalation is removed, the results are said to be expressed in constant dollar terms. Net Cash Flow: Project revenue less costs typically expressed as: NCF = GR TC = NBR CapEx OpEx = OprInc FC Gov Where: GR = Gross Revenue TC = Transportation Costs NBR = Netback revenue CapEx = Capital Costs OpEx = Operating Costs OprInc = Operating Income or Divisible Income FC = Financing Costs Gov = Payments to Governments 14

16 NCF per barrel (or Mcf or BOE): This is the undiscounted Net Cash Flow on a per-barrel (Mcf or BOE) basis. This is a good indicator of cash generation and also of long term profitability. Net Present (NPV10): The Net Present Value (NPV) discounted at 10% is the total of the discounted net cash flow. NPV is based on the project net cash flow (NCF) through the following equation: NPV10 = NCFt / [(1 + dr) t ] Where: t = the number of time periods dr = the discount rate, typically 10% The NPV10 is an important indicator of the size of the profits to be made with the investment. It is also a good indicator of the value of the oil or gas reserves that might be discovered or developed. NPV10 per bbl (or Mcf or BOE): The NPV10 is divided by the cumulative production in barrels per oil field and cumulative production in Mcf for gas fields. Often barrels of oil equivalent will be used. The NPV per barrel or Mcf or BOE is a good indicator of which projects have the most profitable barrels, regardless of whether the well or field is large or small. In case of state participation on a carried interest basis, the oil production is based on the total reserves, not just the reserves owned by the investor. Nominal Dollars: refers to costs and revenues with inflation and escalation included. Based on real dollars, nominal dollars are determined as per the following formula: FV = PV x (1 + i) ( t 0.5) Where: FV = Future Value (also referred to as nominal dollar value); PV = Present Value; i = the rate of escalation (normally inflation); t = number of time periods = Ey Sy +1; Ey = End Year; and, Sy = Start Year. 15

17 Opportunity Cost: the cost of forgoing the next-best investment opportunity. By convention, opportunity cost is reflected in the discount rate. Payout: the time (usually expressed in years) from production start to cost recovery. The equation is: ( n n GPR t COST t ) 0 t 1 t 1 where: t = time period n = number of periods GPR = Gross Project Revenue at the point of sale COST = TC + OC + IC + FC + GOV and: TC = Transportation Cost (part of netback price) OC = Operating Costs IC = Investment Costs FC = Payments to the financial community GOV = Payments to governments. Price Maximizing Index (PMI): the per-dollar share of an increase in price that is retained by the investor. Also see Cost Savings Index. The PMI indicates how much is retained by the investor if the investor increases its revenues by one dollar. Fiscal systems should provide an encouragement to investors to obtain the highest prices in arm s length transactions. If the investor retains less than $ 0.10 of every dollar increase in price, the incentive can be considered weak. Under strongly price progressive systems, the PMI could be zero or negative. Profit to Investment Ratio (PIR10): discounted NCF / discounted CapEx. This ratio is also expressed in terms of risk with the CapEx including only those costs before production start (Risk CapEx) or in terms of only the Exploration Costs (Exploration Risk CapEx). PIR10 is a measure of capital efficiency, providing a good indication of the profit margin to investors. Progressivity: Progressivity is contrasted with Regressivity. It refers to the change in government share for a given change in price, volume, or costs. Fiscal systems are 16

18 characterized as price progressive or volume progressive if the government share increases when price or volume increase. For costs the system is progressive if government share increases as costs decrease. Also see Regressivity. There is no firm rule to determine the degree of progressivity or regressivity. Operationally a range of change can distinguish between neutral and progressive or regressive, with the degree of progressivity or regressivity being characterized as low, medium, high, or Extreme based on international experience. Measurement can be constructed so that a positive change signifies progressive while negative change signifies regressive. The following scales are modeled: A neutral progressivity outcome would be produced for example by a fiscal system that includes only corporate income tax and where all costs are expensed immediately from the date incurred. Systems with front-end levies such as fixed ad valorem royalties and particularly signature bonuses, are typically regressive. Most USA fiscal systems are regressive. Progressive systems tie the fiscal share to project profitability. 17

19 Progressivity/Regressivity is typically considered for four situations: (i) across type-well/field EUR (FPI-EUR); (ii) price changes only (FPI-Price); (iii) volume changes only (FPI-Vol); and, (iv) cost changes only (FPI-Cost). While the degree of progressivity is an important consideration in fiscal system design, care should be exercised with this indicator as it depends only on Government Share and therefore is greatly influenced by project viability and by the level of divisible income for the cases used in its calculation. Rate of Return (ROR): This is more accurately, the Internal Rate of Return (IROR or IRR), signifying that it is specific (internal) to the project cash flow and that it is equivalent to the discount rate that will result in a project net present value that is exactly equal to zero. IRR is determined on the total capital invested. The IRR should not be confused with accounting rate of return which is based on depreciated costs (not cash costs) and is more appropriately applied to the entire firm and for a specified time period (typically one year), rather than to the full cash flow for a given project. IRR is a measure of capital efficiency or earning power. IRR does not provide insight into the size of the profits or the potential long term asset growth. Real Dollars: Real dollars refers to economic values (revenues and costs) with only the inflation component removed from the nominal dollar value, or values with no escalation included. Regressivity: Fiscal systems are characterized as price regressive or volume regressive if the government share decreases when price or volume increase. For costs the system is regressive if government share decreases as costs decrease. Also see Progressivity. Ring Fenced: Refers to area for which a project is defined and from which costs and revenues are eligible. For example; a contract area may include several fields. In cases 18

20 where the costs and revenues from one field may not be considered in determining the fiscal obligation from another field, these payments are said to be ring fenced to the field. Stand Alone: The stand alone scenario contemplates that the investor is making its first investment in the country. The investor does not yet have production or other sources of income. Therefore, investments in exploration and development of oil and gas wells or fields cannot be deducted for corporate income tax purposes in the year that these investments are being made. Tax losses have to be carried forward until revenues from production permit the deduction of these costs. Sunk Cost: Past costs or the costs that have already been spent and, therefore, considered sunk as they should not affect a go-forward investment decision. Time Value of Money: refers to the preference to receive money earlier rather than later or to pay costs later. TMV involves consideration of inflation, opportunity cost, and risk. Supply Price: See Unit Technical Cost (UTC). Standard Deviation (SD): The standard deviation is the square root of the variance (V) of the various NPV outcomes from the mean EMV, calculated as follows: SD = V where: V = [(NPVi EMV) 2 ] x Probi Unit Fiscal Cost (UFC): UFC refers to the total undiscounted real-dollar net payments to government divided by total production. This indicator permits direct comparison with the UTC and with the commodity price. Unit Technical Cost (UTC): UTC refers to the undiscounted per-unit cost. UTC can be extended to incorporate discounting to reflect opportunity cost and time-related risk. 19

21 Discounted UTC (UTC10) is also called the supply price, identifying the minimum price required to determine project break even. UTC is calculated as per the following equation: UTC = n t 1 n t 1 Costs t /(1 r) ( t 1 0.5) Quantity t /(1 r) ( t 1 0.5) Value to Risk Index (VRI): VRI is calculated as EMV10 / the Standard Deviation from the associated NPV10 values. VRI is a relative indicator. A higher VRI indicates lower risk as reflected in a narrow range of NPVs. Therefore, maximizing the value of the VRI maximizes the EMV at the lowest risk. The VRI is a particularly powerful ranking indicator; however, caution must be exercises as it is very much influenced by the probability distribution underlying the EMV determination. NOTE: The calculation of the EMV and standard deviation (SD) needed for determining the value to risk index (VRI) are quite difficult to illustrate. The tables below assist by identifying the process used for determining the intermediate values, first for the EMV and then for the standard deviation. Working Interest (WI): is contrasted with carried interest, referring to the situation where a joint venture company contributes its full share of costs from the beginning of exploration. 20

22 Illustration of EMV Calculation Used in VRI Determination 21

23 Illustration of Standard Deviation Calculation Used in VRI Determination 22

24 23