PETROLEUM ECONOMICSANIMASHAUN TundeTable of ContentIntroductionPetroleum Industry consists of a series of distinct segments E&P, refning, marketing and transportation Exploration is the most risky segmentProftability aries from segment to segment!eseres are the principal assets of the industryThe industry is not allo"ed to self regulating and ery susceptible to signifcant outside political controlThe industry is probably the most heaily taxed of all business enterprise "orld"ide #$%& tax on 'il(Production costs )Technical cost * +iscal CostTechnical Cost ) f#no, of "ells drilled, depth of the "ell, nature of the rock drilled, C-PE.( E&P industry is an extractie capital intensie industry "ith a high leel of risk factorIntroductionThe decision to invest is primarily driven by economics but may be subject to social , environmental and security of investmentsThe primary goal of E&P frm is to maximi/e the present alue of total proft in the long run without breaking lawIntroduction0ET P!'+IT -1 - 2ECI1I'0 C!ITE!I-The fundamental 3uestion in any E&P business decision is "hether thepro4ect is proftable, Proft is defned simply as5 Proft ) !eenues6Costs ) Cash In6Cash 'ut'er the life of the pro4ects, 0C+ )T0I1trength5 1imple and generally unambiguous Pro4ect profts can be "eighted7eakness5 2oes not recogni/e the si/e and timing of cash 8o"s -5 Inestment ) 9:% ;illion< Proft ) 9=> ;illion or ?5 Inestment 9%> ;illion< Proft ) 9=> ;illion 7hich pro4ect is preferred@C-1A +B'7 ;'2EBCash +lo" ;odel #C+;( is one of the three proft models commonly used to determine proft,ThecostscomponentofproftisdefneddiCerently ineachmodel,hence,eachapproachmaygie diCerent estimates of proft,The other t"o models are #not emphasize here in this course(5 +inancial Proft ;odel, "hich produces fnancial net income Tax Proft ;odel, "hich produced taxable income+or economic analysis, the cash 8o" model is preferred, it produces net cash 8o" and it places the timing of funds to and from pro4ects more accuratelyCash +lo" 2iagramCapital ExpenditureOperating RevenueOperating CostSalvage Value0ET C-1A +B'70C+ ) Cash !eceied Cash 1pentDross !eenue ) Product Eol, F Price of ProductEconomicproftmeasuresthe diCerencebet"eennetreenue,cost and the opportunity costs of inestment2ECI1I'0 T!EE12ecision trees proide a GmapH for choices,;onte Carlo simulation proides broad ranges of possible outcomes for better decision making2ecision treeDecisionDrillDontdrillChanceProducerDry holeChanceCommercialMarginalDead end7hat is a decision tree@DecisionDrillDontdrillChanceProducerDry holeChanceCommercialMarginalDead end75%25%35%65%Ao" do "e use a decision tree@DecisionDrillDontdrillChanceProducerDry holeChanceCommercialMarginalDead end$3,000 $500 75%25%35%65%$2,375 !$200 $0"o# do #e deri$e the $alue o% $70& '$70& $3,000( 0)75 * $2,250 $500( 0)25 * $&25 * $2,375 Can "e hae more GdecisionsH@DecisionDrillDontdrillChanceProducerDry holeChanceCommercialMarginal$3,000 $500 75%25%35%65%$2,375 !$200 $70& $0+arm out #ith 25% ,- .uy in35%65%75%25%$&25 $5/0 $201 $0"o# do #e deri$e the $alue o% $750 '$750 Can "e hae more GdecisionsH@DecisionDrillDontdrillChanceProducerDry holeChanceCommercialMarginal$3,000 $500 75%25%35%65%$2,375 !$200 $70& $075%+arm out #ith .uy in 25%35%65%75%25%$&25 $5/0 ,hat a.out the $201 '$750 $201 $0Can "e hae more GdecisionsH@DecisionDrillDontdrillChanceProducerDry holeChanceCommercialMarginal$3,000 $500 75%25%35%65%$2,375 !$200$70& $075%+arm out #ith .uy in 25%35%65%75%25%$&25 $5/0 ,hat is the .est alternati$e %or this decision'$750 $201 $0Can "e hae more GchancesH@DrillDontdrillProducerDry hole2/%7&%Ma(imum 227)6%3$&,277 Minimum 2&7)2%3$&05 $0$63& Most li5ely 255)2%3+ind the $alues at the remaining 6chance nodes$726 $6/ ! $200 Ao" do "e build a decision tree@DecisionDry holeProducerCommercialMarginalDontdrillDrillDead end-denti%y all %uture decisions-denti%y 7ossi.le outcomes8e%ine these ste7s as much as neededAo" do "e build a decision tree@DecisionDrillDontdrillChanceProducerDry holeChanceCommercialMarginalDead end75%25%35%65%9stimate 7ro.a.ilities o% all outcomesAo" do "e build a decision tree@DecisionDrillDontdrillChanceProducerDry holeChanceCommercialMarginalDead end75%25%35%65%9stimate +inancial results o% all outcomes$0$3,000 $510 ! $200 $0$3,000 $510 ! $200 Ao" do "e build a decision tree@DecisionDrillDontdrillChanceProducerDry holeChanceCommercialMarginalDead end75%25%35%65%:elect .est alternati$e %or the decision node,hat ha77ens i% uncertainty changes at any node'6;est alternati$e yields greatest e(7ected monetary $alueEach decision has a limited number of outcomesProbability of occurrence of each outcome can be determinedEach decision is ultimately dependent upon economic conse3uences of future decisions and outcomes7hen are decision trees helpful@?efore Tax 0C+ E3uation'n annual before tax basis cash 8o" for a typical E&P enture 5 0C+ ) Dross !eenue 6!oyalty 6 1tate & Bocal Taxes 6 'perating Expenses 6 'erheads #business & inestment( 6 Capital Inestments6?onus&Beasehold costs * Property 1ales PriceC-1A +B'7 ITE;1Dross !eenue) price x marketed olume of hydrocarbon!oyalty ) royalty rate #!I( x gross reenue 0et !eenue) 0et share of marketed productionF0et price) 0et price F #=6!I(FProduction 0et price is prices receied less any purchaser charges1tate and Bocal Taxes5These are taxes other than income taxes leied on petroleum production in the I,1, Production, seerance, and adalorem, conseration, and school taxes They are paid "hether profts are made or notJ1tate and Bocal Taxes5 Production and seerance taxes on production -d alorem taxes are based on property alues7orking Interests theoretically pays all the production taxes1eerance and adalorem taxes are paid on a fair6share basis by both the royalty and producing interestsTechnical CostsCapital expenditures #C-PE.('perating Expenses #'PE.(Capital expenditures #C-PE.(These are classifed as inestmentsKmonies paid for assets that "ill generate benefts for more than one year,Isually such an asset has a life time of more than a yearBist of some capital expenditures in E&P ealuationCost of drilling and deeloping a "ellCost of surface e3uipmentCapital expenditures #C-PE.(These expenditures can be classifed as either tangible or intangible costsTangible costs are usually capitali/ed and depreciated for after tax calculation purposesIntangible costs are usually expensed through amorti/ation for tax calculation purposesI0EE1T;E0T1 LT-0DI?BE -02 I0T-0DI?BE&M I ?onus and Beasehold Costs =>> > Deology and Deophysical N% O% 2ry holes > =>> ProductionPIn4ection 7ells O> $> Production In4ection E3uipment =>> > 2rilling Platforms $> O> Production Platforms =>> >C-1A +B'7 ITE;1'perating Expenses #'PE.(These are direct costs associated "ith production or in4ection,They are expenditures that benefts only the period in "hich they are made0o operating costs if there are no ongoing production or in4ection,Typical 'PE. behaior patterns are ariable costsKcosts of ra" materials66 and fxed costs66management fees,'perating Expenses #'PE.(1ome examples of operating costs5 7ell repairs and "ork oer Bifting costs Personnel ;aintenance etc'PE. usually is treated on a total costs basis rather than on a per unit basis, ;easured as 9Pmonth, or 9Pyear rather than per ?bl of 9PmonthP"ellWHY?'perating Expenses #'PE.('erheads represents a signifcant components of 'PE.Aidden costs of being in business, internal costs, no money is paid out, ?usiness oerhead represents internal cost of accounting, est, a fxed monthly amount may be assigned in the range of =%6Q> percent Inestment oer head represents the internal costs of making inestments Can be estimated as a percentage of of total inestments costs excluding bonus & leasing costs?E+'!E T-. 0C+ Components of the before tax 0C+5 Capital Inestments L-M Tangible capital costs Intangible capital costs Bease ?onus and rentals 'perating Expenses L?M 'erheads Inestment oerhead ?usiness oerhead 1tate and local taxes Employee ?enefts The !eenue LCMIntangible Tangible Year Development Lease & ell !t"er#osts$a% $b% $&% $d%' '()))())) *))())) *)()))+,-*Total '()))())) *))())) *)()))A: CAPEX & LEASEHOLD COSTS+).)/0+).))').)/-.1)'*).))+).)/:OPEX & !"SCAL TER#S!perating #osts $02bbl%3usiness !ver"ead $0)))24ear%Invest !ver"ead $/ o5 #ap Inv.%Land !6ner 7o4alt4$L!7I%8rodu&t 8ri&es $02bbl%State & Lo&al Ta9es o5 N7IAnnual :ross Land Net Year :ross 8rodu&tion !6ner !perating8rodu&tion In&ome 7o4alt4 In&ome$a% $e% $5% $g% $"%' -))())) 1()))())) '(;))())) ;(-))()))+ +))())) -()))())) 1))())) ,(+))())), '))())) +()))())) -))())) '(;))()))- *)())) '()))())) +))())) 1))()))* +*())) *))())) '))())) -))()))Total