Petroleum Economic Concepts by Morten Pedersen, NPD, 04.09.03 Agenda 1. Different elements in the economic evaluations of petroleum projects 2. How to deal with uncertainty 3. The different objectives of the NPD 4. Economic analysis in the NPD
Different elements in the economic evaluations of petroleum projects What are the main economic characteristics of the offshore petroleum industry? Large upfront investments Long project period Large price variations Different elements in the economic evaluations of petroleum projects What are the main economic characteristics of the Norwegian petroleum industry? High operation costs High transportation costs High tax rate High profitability!
Different elements in the economic evaluations of petroleum projects What are the main elements in an economic evaluation? Production profiles Prices Investments Operation and maintenance costs Transportation and processing tariffs Removal costs Production profiles Prod rate (Mill bbl/year) 45 40 35 30 25 20 15 10 5 0 Different cash-flows Different production strategy gives different productions profiles Time
Oil price prognosis Oil price prognosis 40 35 30 25 $/bbl 20 15 10 5 0 1975 1978 1981 1984 1987 1990 1993 1996 1999 2002 2005 2008 2011 2014 2017 2020 Oil price prognosis What should be the basis for the oil price prognosis? Supply capacity and demand prognosis? Opec statements? Price growth? (non renewable resource) Mean reverting price between price floor and price roof?
Gas price prognosis Gas price 120 100 øre/sm3 80 60 40 20 0 1993 1995 1997 1999 2001 2003 2005 2007 2009 Gas price prognosis What should be the basis for the gas price prognosis? A link between oil and gas price A link to electricity prices? Long term TOP contracts? Gas to gas competition with third party access in offshore and onshore pipelines?
Investments Development solution Development cost Investments What alternatives exists? Phasing of investments or upfront investment in spare capacity (economics of scale)? Use of existing infrastructure and processing capacity or standalone development? Pre-drilling of production wells? Invest, rent or lease?
Operation and maintenance costs What should be the basis for the operation and maintenance costs? Percentage of the investments Costs per unit produced Estimated costs based on historical data Estimated costs based on future cost reductions. Transportation and processing tariffs What should be the basis for the estimated transportation and processing tariffs? Negotiated tariffs or marginal costs? Long term marginal cost (replacement cost ) or short term marginal cost? Tariff as shipper less income as owner? New regulator new prices (Gassco)
Removal cost What installations will be removed at what cost? Removal cost is shared between the oil companies and the authorities based on previous tax payments. Uncertain if large concrete platform and pipelines shall be removed or left at site. Also uncertain if reuse or scrapping is required. Cash flow Cash in flows (revenues) 1200 1000 800 600 400 200 0-200 -400-600 1 3 5 7 9 11 13 15 17 19 21 23 25 years Cash out flows (expenditures)
2. How to deal with uncertainty All elements in the deterministic cash flow analysis are supposed to be expected values. The price uncertainty is the most important one, and also most difficult to diversify. The uncertainty for the other elements in the the concept evaluations is also important They influence on the optimal concept choice and optimal production strategy. 2. How to deal with uncertainty The sensitivity chart gives a good indication of which element is most important for the net present value of the project. Be aware that it is not possible to add all the effects.
Sensitivity charts Project sensitivity Net Present Value 10000 8000 6000 4000 2000 Production Oil price Investment 0-20 % -10 % 0 % 10 % 20 % Sensitivity charts The sensitivity chart gives no indication how the uncertainty is distributed. Both the cost and the reserves most likely have an asymmetric distribution. This means that an increase of X % has not the same probability as a reduction of X %.
Probability distribution Probability Assymmetric distribution 80/20 a b c 20/80 Investment, a: most probably (base case) Reserves, b: median (50/50 estimate) etc c: expected value 2. How to deal with uncertainty When the probability distributions are available, more sophisticated analysis can be done. But do not forget that the decision takers have to understand the analysis.
3. The different objectives of the NPD NPD has different objectives: Owner Valuation of the resources Regulator and controller Resource management Market failure Tax collector NPD as an owner Economic valuation of assets Valuation of the petroleum wealth each year for planning purposes. Licensing rounds SDFI shares in licences. Largest shares in licences that are expected to be most profitable. Sale of SDFI assets / caretaker (Petoro)
NPD as a regulator and controller Approving PDOs (Plan for Development and Operation of oil and gas fields) Approving PIOs (Plan for Installation and Operation of pipeline/infrastructure) Preparing area studies Evaluation of major production decisions Increased oil recovery (IOR) projects Abandonment and removal NPD as a tax collector Company tax (28%) Special petroleum tax (50%) Royalty Area fee CO 2 fee NPD collects royalty, area fee and the CO 2 fee NPD calculates the effect of changes in the tax system and the tax level
4. Economic analysis in the NPD The need for economic analysis in the future, is mainly caused by conflicting interests: Ownership-structure: Different planning horizons Taxation Safety & work environment Conflicting interest(continued): Different discount rates Monopolistic behaviour Asymmetrical information Materiality (the size of the project) Environmental issues
Economic assumptions in the NPD Today we use 7 % discount rate (on real values) and pre tax analysis. The CO 2 tax is used as an environmental cost. The use of paid transportation and processing tariffs or calculated costs in the economic analysis has been under constant discussion. Even if the tariffs are supervised by the Ministry of petroleum and energy some of them include a considerable profit element (Gassco tariffs are regulated to 7% return on investments + OPEX) Economic measures of profitability The NPD has up to now used a combination of NPV, break-even price and sensitivity analysis. For the future the NPD will include a risk element in the discount rate. This implies that risk is growing exponential by time. To limit this effect we are investigating the possibility of using a lower discount rate on cost and tariffs compared to revenues.
Break-even price P Oil = NPV(costs) / NPV (production) = NPV(costs) / (NPV oil + c 1 *NPV gas +c 2 NPV NGLl )...where: NPV = T X t ( ) (1 + r) t t = 0 X t - the net cash flow in time t ( =incomecosts) r - discount rate T - number of time periods c 1 constant link factor between oil and gas prices