Project Economics and Decision Analysis, Volume 1: Determinisitic Models

481 Pages·2011·41.455 MB·English

by  M. A. Mian

Second Edition
Project Economics
Decision Analysis
and
Volume 1: Deterministic Models
M.A. Mian
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Disclaimer. The recommendations, advice, descriptions, and the methods
in this book are presented solely for educational purposes. The author
and publisher assume no liability whatsoever for any loss or damage that
results from the use of any of the material in this book. Use of the material
in this book is solely at the risk of the user.
Copyright© 2011 by
PennWell Corporation
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Library of Congress Cataloging-in-Publication Data
Mian, M. A.
Project economics and decision analysis / M.A. Mian. -- 2nd ed.
p. cm.
Includes bibliographical references and index.
ISBN 978-1-59370-208-3 (v. 1)
1. Petroleum industry and trade--Finance--Mathematical models. I. Title.
HD9560.5.M525 2010
338.2’328--dc22
2010035136
All rights reserved. No part of this book may be reproduced, stored in a
retrieval system, or transcribed in any form or by any means, electronic
or mechanical, including photocopying and recording, without the prior
written permission of the publisher.
Printed in the United States of America
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This book is dedicated to my brother, the late M. Rashid Mian, who
passed away in a tragic car accident, and the memories that we shared
together for more than 40 years. It was his idea to write this book with me.
I have incorporated some of his handwritten notes on production sharing
economics in chapter 5.
He was a warm, dynamic, vivacious, and fun-loving person. He was truly
one of the most beloved and admired members of our family. We loved him
deeply, and his loss leaves an enormous void in all our lives.
May God bless his soul in peace.
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Contents
Preface ..................................................... xi
Acknowledgments ..........................................xvii
1. Introduction ...................................................1
Profit Planning ...............................................2
Typical oil company objectives .............................3
The role of management in planning ........................4
Planning of capital expenditures............................4
Some Basic Principles of Economics.............................6
Demand, supply, and equilibrium price......................7
Crude oil price volatility..................................15
Energy independence....................................20
Inflation ...............................................22
Consumer price index ...................................26
Uncertainty and Risk.........................................30
Questions and Problems ......................................32
2. The Time Value of Money.......................................35
The Concept of Interest.......................................37
Simple and compound interest ............................39
Nominal and effective interest rate.........................42
Cash Flow Diagram ..........................................45
The Time Value of Money.....................................46
Present value of future sum ...............................49
Future value of present sum...............................54
Present value of an annuity ...............................57
Future value of an annuity................................59
Present value of deferred annuity ..........................62
Annuity from present value...............................64
Annuity from future value................................67
Present value of uniform gradient series ....................68
Present value of shifted gradient series .....................70
Calculation of unknown interest rate.......................72
Loan Amortization Schedule ..................................73
Funds Flow and Compounding/Discounting ....................81
Spreadsheet Applications .....................................83
The Time Zero Dilemma......................................95
Questions and Problems ......................................96
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viii Project Economics and Decision Analysis · Volume 1: Deterministic Models · 2nd Edition
3. Before-Tax Cash Flow Models ..................................111
Cash Flow Model ...........................................113
Data Required for Project Evaluation ..........................116
Forecasting Product Stream ..................................117
Volumetric calculations .................................119
Decline curve analysis ..................................121
Gas reservoir material balance ...........................142
Production forecast by analogy...........................146
Product Pricing.............................................149
Capital Expenditures (CAPEX) ...............................154
Geological and geophysical (G&G) costs...................155
Estimating drilling costs.................................155
Facility costs...........................................158
Operating Expenditure (OPEX)...............................162
Abandonment costs and sunk costs .......................166
Opportunity costs ......................................167
Types of Cost Estimates......................................168
Order of magnitude estimate.............................168
Optimization study estimate .............................169
Budget estimate . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .169
Control estimate .......................................170
Variations in Actual Project Costs.............................170
Cost overrun ..........................................170
The accuracy of the estimates ............................171
Contingencies and allowances............................172
Transfer Pricing ............................................174
Transfer price at cost....................................176
General formula for computing transfer price ..............177
Transfer at market price . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .177
Aspects of Leasing ..........................................178
System of land ownership identification ...................179
Ownership interest computation .........................181
Severance and Ad Valorem Taxes .............................185
Cash Flow Estimation Bias ...................................190
Cash Flow Analysis of Foreign Investments.....................191
Cash Flow Analysis and Inflation .............................192
The Cost of Capital..........................................193
The Cash Flow Spreadsheet...................................195
Questions and Problems .....................................198
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Contents ix
4. After-Tax Cash Flow Model ....................................207
Depreciation ...............................................213
Tangible property ......................................213
Intangible property.....................................213
Modified accelerated cost recovery system .................214
Accelerated cost recovery system .........................218
Straight-line depreciation................................219
Declining balance depreciation...........................220
Sum-of-years’-digits depreciation.........................221
Units of production depreciation .........................223
Amortization and Depletion..................................223
Amortization ..........................................224
Depletion .............................................224
Intangible Drilling Costs (IDCs) ..............................228
Spreadsheet Application .....................................235
Questions and Problems .....................................243
5. International Petroleum Economics.............................245
Types of Contract Arrangements..............................247
The concessionary system ...............................249
Sample concessionary system cash flow spreadsheet.........251
The production sharing system...........................254
Sample PSC cash flow spreadsheet . . . . . . . . . . . . . . . . . . . . . . . .259
Basic elements of production sharing
and royalty tax systems................................263
Contract initiation and award............................270
Government and contractor take .........................271
Risk service contracts . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .273
Rate of return (ROR) contracts...........................274
Effects of Various Fiscal Terms................................274
Efficient fiscal regime ...................................275
The effect of cost recovery ceiling.........................277
Designing fiscal systems.................................280
Questions and Problems .....................................294
6. Capital Budgeting Techniques ..................................301
Accounting Approaches .....................................306
Payback period ........................................306
Average return on investment (AROI).....................310
Discounted Cash Flow Approaches............................311
Discounted payback period..............................312
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x Project Economics and Decision Analysis · Volume 1: Deterministic Models · 2nd Edition
Net present value (NPV) ................................313
Internal rate of return (IRR) .............................316
Profitability index (PI) ..................................328
Unit technical cost (UTC) or long-run
marginal cost (LRMC) ................................331
Netback value (NBV) and indexed pricing .................337
Growth rate of return (GRR).............................350
Adjusted net present value (ANPV).......................353
Effect of Discounting Frequency ..............................355
Treatment of Financing Mix..................................360
Pattern of project debt repayment schedule ................362
After-tax weighted average cost of capital method...........366
Equity residual method—NPVER .........................369
Arditti-Levy method—NPVAL............................371
Adjusted net present value—NPVA .......................372
Comparison of the four methods .........................373
Questions and Problems .....................................375
Further Reading ............................................385
7. Investment Selection Decision Making ..........................387
Service-Producing Investments ...............................389
Equivalent cost analysis .................................390
Rate of return analysis ..................................392
Present value ratio or PI analysis..........................394
Service life breakeven analysis............................394
Unequal life service-producing alternatives ................395
Lease versus Buy Decision Analysis............................398
Income-Producing Investments...............................403
Project screening economics.............................403
Mutually exclusive investment analysis ....................406
Non-mutually exclusive investment analysis................415
Questions and Problems .....................................420
Appendix A. Interest Factors for Annual Interest Compounding .....433
Appendix B. Overview of Spreadsheets on CD-ROM
that Accompany Volume 2 .....................................441
Answers to Selected End-of-Chapter Problems .....................445
Index..........................................................453
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