PETROLEUM ECONOMICS

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

NET PROFIT AS A DECISION

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

Over the life of the projects, NCF =TNI

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

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

For economic analysis, the cash flow model is

preferred, it produces net cash flow and it places the
timing of funds to and from projects more
accurately

Cash Flow Diagram

Operating Revenue

Operating Cost
Capital Expenditure

Salvage Value

NET CASH FLOW

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

What is a decision tree?

Chance
Chance

Commercial
75%

Producer

Decision

25%

35%
Drill

65%
Dry hole

Dont
drill

Dead end

Marginal

How do we use a decision

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

Can we have more

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

Can we have more

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%

What about the

$208 K?

25%
$125 K

65%
$0

Can we have more

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%

What is the best

alternative for this
decision?

$0

Can we have more

chances?
Maximum (27.6%)

$726 K

Producer
Drill

$69 K

Most likely (55.2%)

$631 K

29%

Minimum (17.2%)

71%
Dry hole
Dont
drill

$0

$1,277 K

$145 K
- $200 K

Find the values at the

remaining chance
nodes

How do we build a decision

tree?
Identify all future
decisions

Commercial
Producer

Decision
Marginal

Drill
Dry hole

Dont
drill

Dead end

Identify possible Refine these steps as

outcomes
much as needed

How do we build a decision

tree?
Chance
Chance

Commercial
75%

Producer

Decision

25%

35%
Drill

65%

Marginal

Dry hole

Dont
drill

Dead end

Estimate
probabilities of all
outcomes

How do we build a decision

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

How do we build a decision

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

What happens if uncertainty changes at

anyyields
node?
Best alternative
greatest expected monetary
value

When are decision trees

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

Before Tax NCF Equation

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

CASH FLOW ITEMS

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

State and Local Taxes:

These are taxes other than income taxes

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!

 State and Local Taxes:

Production and severance taxes on production
Ad valorem taxes are based on property values

Working Interests theoretically pays all the

production taxes
Severance and advalorem taxes are paid on a fairshare basis by both the royalty and producing
interests
Technical Costs

Capital expenditures (CAPEX)

Operating Expenses (OPEX)

 Capital expenditures (CAPEX)

These are classified as investments

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

 Capital expenditures (CAPEX)

These expenditures can be classified as

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

INVESTMENTS [TANGIBLE AND

INTANGIBLE%]

I
Bonus and Leasehold Costs
100
0

Geology and Geophysical

65
35

Dry holes
0
100

Production/Injection Wells
30
70

Production Injection Equipment

100
0

Drilling Platforms
70
30

Production Platforms
100
0

CASH FLOW ITEMS

Operating Expenses (OPEX)

These are direct costs associated with

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.

 Operating Expenses (OPEX)

Some examples of operating costs:

Well repairs and work over

Lifting costs
Personnel
Maintenance etc

OPEX usually is treated on a total costs

basis rather than on a per unit basis.
Measured as $/month, or $/year rather
than per Bbl of $/month/well
WHY?

 Operating Expenses (OPEX)

Overheads represents a significant

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

Investment over head represents the internal costs of

making investments
Can be estimated as a percentage of of total
investments costs excluding bonus & leasing costs

BEFORE TAX NCF

Components of the before tax NCF :

Capital Investments [A]
Tangible capital costs
Intangible capital costs
Lease Bonus and rentals

Operating Expenses [B]

Overheads
Investment overhead
Business overhead

State and local taxes

Employee Benefits
The Revenue [C]

A: CAPEX & LEASEHOLD COSTS

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

B: OPEX & FISCAL TERMS

Land Owner Royalty (LORI)

20.0%

Product Prices ($/bbl)

$20.00

State & Local Taxes of NRI

10.0%

Operating Costs ($/bbl)

4.80

Business Overhead ($000/year)

150.00

Invest Overhead (% of Cap Inv.)

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

E: CASH FLOW (BFT)

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 CALCULATION

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

Taxable Income = Revenues RoyaltiesFiscal Costs

Fiscal cost deductions include:
OPEX, Royalty, Depreciation, Depletion
Allowance, Expensed Investments or
Amortized Intangible Capital Investments

Fiscal Depreciation Expense

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.

Depreciable items normally include well

equipment and surface equipment. Generally, an
item can be declared depreciable if it retains a
usable or reusable value over a period of time

 From the above, a depreciable item

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

 Several methods are available but

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

This is similar to UOP method of accounting for

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 Relationship

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

AFTER TAX NCF

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

The above formulation can be applied on an annual

basis or on a cumulative project basis.

After Tax NCF Example

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

Land owner royalty

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

PRIMARY INPUT DATA

Land Owner Royalty
Unit Price of Output
State and Local prices
Operating Costs
Business Overhead
Investment Overhead
CAPEX
Capitalized Portion
Expensed Inestment

Bonus & Leasehold Costs

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

NET REVENUE & NET OPEX

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)

CAPEX & DPLEX Calculations

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)

After Tax NCF Components

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

Reasons for petroleum production rate decline

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 generalized hyperbolic decline equation takes

the form:

dq / q = - dt / (a + bt)
where a and b are constants

Cases of Decline Equations

Three special cases of decline equations are
determined by the values of b.

b =0.0 corresponds to the constant

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

Semi log plots of q vs time

ln qt = + D t:

Plots of rate versus cumulative

production
q t = q0 + a N p

P/z vs. Cumulative gas production (Gp)

% water production vs. Np

Production Forecasting
Decline technique has long been the favorite for
PEs because:

It is easy and simple

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

Production Capacity and

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

Initial Production Capacity

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.

 A higher initial production and the

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.

Economic Limit Analysis

The economic life of reserves is the shut down time
when production ceases

Assuming declining production rate with

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

Economic Limit Analysis

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

 Analyzing the effects of dismantling costs on

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

 Analyzing the effects of dismantling costs on

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:

The project with highest profit is preferred

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..

 Non-Monetary considerations do have some

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

Measures that recognize the time value of money

Internal rate of return (IRR)

Net present value profit
Discounted Return on Investment (DROI or DPIR)
Appreciation of equity rate of return

Net Profit as a Decision

Criterion

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

Over the life of the projects, NCF =TNI

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.

All revenues received after the pay back period

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 discounted cash-flow PO:

the time required to achieve a minimum IRR
a measure of risk exposure

A more generalized definition of PO:

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

Pay Out Calculations

Year
2000
2001
2002
2003
2004
2005
2006
2007
2008
2009
2010
2011
2012

Capital Annual Net

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

Return on Investments (ROI)

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:

ROI = Cumulative Income / Total Investments

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.

Some Variants of ROI

PIR is a variant of the traditional or the basic ROI.
It is defined as:
(Cumulative Income less Total investments) divided by Total
Investment

PIR generally equals ROI-1

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

Another variant of the basic ROI is return of MOP cash

Cumulative Net Cash Flow divided MOP Cash.

None of these is superior to the other.

It is noted,however, that whereas PIR reflects total
profit with respect to total investments, ROI reflects
only investment from outside sourcesrisk capital.

Strengths & Weaknesses of

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

Comparing Two Projects

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

Most decision makers, if given a choice, will prefer A to B, Why?

Time-Value of Money
Time value of money concept can be examined from
two dimensions

Money to be received at some time in the

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

Present Value Concepts

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.

 The generic equation for compounding is of the

form:

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

FVIF = future value interest factor,

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.

 The generic equation for compounding is of the

form:

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

FVIF = future value interest factor,

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.

 The standard PV Calculation:

PV(r,t)=FV* PVIF(r,t) = FV*(1+r)-t

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?

PV= FV (1+r)-t = $1331 (1+.10)-3 =

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?

FV=PV(1+r)t = $1000 (1+0.10)4 = $1000

(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

Interest may also be compounded continuously such that

k becomes infinite:
FV = PV esn

s=ln (1+r), where r is the effective interest rate

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

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%

Frequency of Discounting &

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

Timing of Cash Flow

The time when cash flow is received may not
coincide with the timing of interest periods
There are two methods for handling this problem.

Mid-year convention method:

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

The mid-year discount factor applied to

cases when payments occur mid-year or
throughout the year.

 The second method of handling the timing

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.

 The present value of an annuity is expressed as:

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

Selection of Discount Rates

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

Discount factors and Hurdle

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:

acquisition cost of borrowed capital

Corporate growth objectives
Future investment opportunities and inflation

Cost Capital and Discount

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)

If there are n sources of fund with different interest rate

charged:

Where k is the corporate tax rate

n = number of loan source of x amount
X =Total investment loan
CoC is the weighted average of cost of capital

Estimating the Cost of

Capital
For a public corporation with both debt and equity
stocks, the cost of capital is estimated as:

COC = % Equity * Cost of Equity Fund

+ % 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

 Usually, debt capital is usually cheaper than

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

Project Evaluation Criteria

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

Criteria that recognize the time value of money

Rate of return (ROR or IRR)
Net present value of profit (NPV)
Discounted Return on Investment (DROI or DPIR)

Net Present Value Criterion

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

NPV Calculation Using

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

* Using a spreadsheet function will usually calculate PV incorrectly

(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

NPV Using Two Discounts

Discount 1:
Year
1
2
3
4
5
6
7
8
9
10
11
12

Anticipated Future Cash Flow

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

NPV Using Two Discount

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

A: Find NPV for years 13-25 discounting at 10 percent

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

NPV Using Two Discounts

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

D: Add results to find total NPV =

$452.945
$517.703

Rate of Return (ROR)

Criterion
In general, this means the interest rate earned
from investment.
It has been referred to with many different names:

Discounted rate of return

Internal yield
Internal rate of return (IRR)
Profitability index
DCF rate of return
Marginal efficiency of capital

Mathematically it can be defined as r:

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

Internal Rate of Return

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

Present Value Rate of Return

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

Cumulative Cash Flow Curve

(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

 It is important to note that the computed ROR has an

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.

ROR is not necessarily a realistic parameter to rank

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

Strength and Weaknesses of

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)

It is considered an effective measure of capital

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

It has all the advantages of NPV and provides a

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)

Calculate a Virtual Investment at time zero as:

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

Use VI in your calculation of the rate of return to

estimate a risk-weighted ROR.

Other Measures of Value

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.

Appreciation 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

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%

Percent Gain in Investment , PGI

=

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%

Percent Gain in Investment , PGI

=

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

Percent Gain on Investment

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

Percent Gain on Investment

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%

Percent Gain in Investment , PGI Gain per year

=

26.5%

$114.945

Effects of Inflation and

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.

The effects of inflation on NCF components must

be handled internally and not externally

How to Handle Inflation

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

Current dollars also referred to as escalated,

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 dollars (real dollars) refer to a hypothetical

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.

The economic conclusions reached using either of the

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

Current Dollars Analytical

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

C: Conduct the analysis using the escalated

dollar opportunity rate or the hurdle rate (the
minimum acceptable return on investment), r*

Constant Dollars Analytical

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

C: Deflate the escalated values by applying the

PVIF(f,n)
where f is the assumed inflation rate, which does not
have to be constant
n number of time periods

 D: Conduct the economic analysis using the

constant dollar opportunity rate or hurdle rate (the
minimum acceptable return on investment), r**

The relationship between constant hurdle

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

Rate **Hurdle Rate

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:

Infill drilling, project expansion, work-over

operations, farm out or drill, abandon or
develop, additional drilling, accelerated
depletion, new equipment installation

 The approach involves calculating two cash flows

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.

In most cases, it may be sufficient just

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)

Syndicate Exercise Primary

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)

Investment Decision Criteria

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%

IRR Buying Power

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

Investment Decision Criteria

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)

NCF CalculationsTaxes, BFT,

& 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

Venture Cash Flow

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)

Dry Dev. Wells

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)

NPV Calculations BFT &

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)

NCF CalculationsTaxes, BFT,

&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

Net Cash Govt

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 CalculationsTaxes, BFT,

&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

Net Cash Govt

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 CalculationsTaxes, BFT,

&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

Net Cash Govt

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)

Depreciation Expenses, SLD

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)

($57.600) ($27.200) ($27.200)

$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)

Cash Flow Calculations

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

Cash Est Cost

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)

($52.000) ($20.000) ($20.000)

$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 CalculationsTaxes, BFT,

& 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)

($52.000) ($20.000) ($20.000)

$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

Prod Rate (BOPD)

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=

Years from first production (20.69years from first discovery)

15,000
500
11.75
0.29
18,283,435

bbl/day
bbl/day
years
/year
bbls

Syndicate Results and

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.

Syndicate Results and

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