1

Introduction

CONTENTS
1.

SUMMARY

2.

HISTORY:- THE OIL CENTURY

2.1. Oil Demand
2.2. Oil Supply
2.3. Oil Price
2.4. Control

3.

COMPANIES

4.

BP plc
4.1. BP Upstream
4.2. BP Performance

5.

INVESTMENT IN PETROLEUM
5.1. Exploration and Appraisal
5.2. Field Development
5.3. Transportation
5.4. Refining
5.5. Distribution
5.6. Upstream Investment

1
LEARNING OBJECTIVES
Having worked through this chapter the Student will be able to:
General
1 Describe general financial aspects of the petroleum industry
History
2. Describe briefly the nature and evolution of demand for oil
3. Describe briefly the evolution of oil supply
4. Describe two situations where an attempt was made to control the market for
petroleum
Companies
5. Explain how the role of the National Oil Company versus the International
Petroleum Company has changed since 1974
BP plc
6. Describe briefly the history of the company
7. Describe briefly the Foinaven project
8. List ten financial parameters or statistics that may be used to explain or to monitor
the performance of a petroleum company
9. Describe five of these statistics or parameters
Investment in Petroleum
10. List and describe the five principal sectors of petroleum activity

Introduction

1. SUMMARY
This module concerns the economic evaluation of petroleum projects. It does not
prescribe a particular method or process, but rather focuses on ideas and principles,
which may become incorporated into corporate procedure. Petroleum investment is
subject to considerable risk and attracts much attention from government. Some of
these issues are identified and reviewed.
Chapter Two concerns the idea of an asset, as something possessing value or
bestowing value on its owner. Methods of quantifying such value are considered.
Chapter Three introduces the concept of the time value of money, the idea that
money received or spent at different points in time may have different perceived value.
The process of discounting derives directly from this idea and forms the basis of much
systematic study of investment value.
Chapter Four explains the method of cash flow analysis and identifies a number of
important parameters, which may be derived. These measures of value have
important applications, with respect to property trade and project investment.
Chapter Five reviews the diversity and significance of government involvement in the
petroleum industry.
Chapter Six reviews the risk environment, within which petroleum investment is
made.
Chapter Seven identifies and explains some of the important procedures, which may
be used to reduce or to quantify risk. These form the basis of risk management.

2. HISTORY:- THE OIL CENTURY

Detailed study of the history of petroleum business is beyond the scope of this module.
However, it is important for anyone, who is entering the industry, to take an interest.
It is a fascinating story, with an extensive literature. As an introduction and for
background information, Appendix Three contains a chronological summary, an
edited account of 4000 years of wealth creation, risk and intrigue. If you require more
detail, find a copy of The Prize by Daniel Yergin, it is comprehensive and very
readable. Alternatively, use the Internet, which has become an amazing source of
information. Appendix Four is an introductory list of useful URLs. You should
quickly compile your own.
Although some of the major petroleum companies originated before 1900, most of the
significant events in the history of petroleum belong to the 20th century. In fact, such
has been the growth and dominance of the industry over the last 100 years, that it is
difficult to argue with the suggestion that the 20th Century was truly the oil century.

Institute of Petroleum Engineering, Heriot-Watt University

1
2.1. Oil Demand
In 1900, the world traded around 500 million tonnes of oil equivalent in energy
products, 95% as solid fuel and 5% as oil. 100 years later, the energy market had
expanded almost twenty fold and petroleum [oil and gas] had acquired more than 60%
of this market. Figure 1 plots the growth in energy commodities and Figure 2 indicates
the market share gained by the petroleum industry.

10000

Nuclear + Hydro
9000
8000

Natural Gas
Crude Oil
Solid Fuel

7000
6000
5000
4000
3000
2000
1000
0
60

80

1900

20

40

60

80

2000

Figure 1
World energy 1860-2001
million tonnes oil
equivalent

70

60

50

40

30

20

10

0
60

80

1900

20

40

60

80

2000

Figure 2
Petroleum market share

Introduction

This trend reflected a number of factors:(i)

The petroleum industry was increasingly successful at finding petroleum and

in manufacturing a wider range of useful refined products.

(ii) Fluids are easier to handle than solids

(iii) Transportation technology was increasingly based on oil products [internal
combustion, jet, marine engines].
(iv) Economies of scale reduced the price of oil in relation to other fuels.
(v) Economic and military systems became progressively dependent.
One of the significant factors has been the growth in use of motor vehicles. Figure
3 is a logarithmic plot of cars in use, versus time. The current population is around
650 million worldwide. The illustrative calculation in Table 1 indicates petrol
consumption of the order of 17 million barrels per day, almost one quarter of total
petroleum production.

1000

100

millions

10

1
1900

1910

1920

1930

1940

1950

1960

1970

1980

1990

2000

0.1

Figure 3
World car population

Table 1
Petrol Consumption

0.01

25
10,000
400
9.52

average fuel consumption

average annual distance per vehicle
average annual consumption per vehicle
average annual consumption per vehicle

[miles per US gallons]?

[miles]?
[US gallons]
[barrels]

650 m
6188 m
16.95 m

world car population

annual petrol consumption
daily petrol consumption

[barrels]
[barrels]

Note:- data approximate and not confirmed

Institute of Petroleum Engineering, Heriot-Watt University

1
Figure 2 reveals that this exponential trend was terminated in the early 1970s, when
oil price suddenly increased. Since 1975, the market for gas, always seen as secondary
to oil, has been growing faster. Figure 4 indicates that from 1970 to 2000, gas
production increased by a factor of 220%, ahead of oil at 158%. This trend reflects
increasing awareness of environmental issues. Combustion of gas produces less
greenhouse gas emission, than does the combustion of refined products of oil.

2.25

2.00

Production relative to 1970

Gas

1.75

1.50

Oil

1.25

1.00
70

75

80

85

90

95

2000

Figure 4
Growth in petroleum
production

2.2. Oil Supply

Supply of oil has grown, both in quantity and geographical diversity. Around the
beginning of the 20th Century, output was less than half a million barrels per day, with
USA and Russia sharing 95% of the market. By 1945, output had grown to 7 million
barrels per day and USA had become undisputed market leader, producing more than
65% of world supply. Most of the rest was controlled by six countries, including
Venezuela, Russia and Iran. See Figure 5.

10000
Venezuela 1922
Persia 1908
Mexico 1905
1000

East Indies 1885

Russia 1860
Rumania 1860

Thousand Barrels per day

USA 1859
Others
100

10

1
1865

0.1

1875

1885

1895

1905

1915

1925

1935

1945

Figure 5
World oil production
[logarithmic].

Introduction

For almost 30 years post World War Two [WW2], oil production increased
exponentially to around 65 million bopd, as a result of prolific discoveries in the
Middle East and elsewhere, stimulated by ever-greater demand for petroleum-based
energy products. The ten-fold price increases between 1973 and 1981 disrupted this
trend and caused the market to hesitate, then slide back, until halted by a price collapse
in 1986. Following these price discontinuities, the upward trend continues. BP now
lists 48 countries with at least 50,000 barrels per day. Figure 6 illustrates this growth
in volume and diversity. [See also Table 3, Chapter 5, for a list of the top forty
petroleum-producing countries].

75

50

Middle East
Asia Pacific

Europe
Africa

25

Russia / FSU

South America

North America

Figure 6
Regional oil production
[million bopd]

00
1950

1960

1970

1980

Institute of Petroleum Engineering, Heriot-Watt University

1990

2000

1
2.3. Oil Price
The average price of oil is plotted in Figure 7. Data is presented, both as dollars spent
money of the day and as dollars in relation to value in the year 2000, 2000 terms.
See Chapter 3 Section 9.4 for a full explanation of this terminology.

100
Price [$/bb/ mod]
90
Price [$/bbl 2000]
80

70

60

50

40

30

20

10

0
60

80

00

20

40

60

80

00

Price has shown dramatic fluctuations over time, reflecting changes in the market.
Supply disruption, shortage and uncertainty causes price to increase; exploration
success or economic depression may cause the price to fall. Note the increase
associated with war, or its aftermath and with political discontinuity:- WW1 [191418], WW2 [1939-45], Yom Kippur [1973], Iranian Revolution [1979]. Note the fall
associated with success:- Spindletop [1901], East Texas [1930], Libya etc [1960s],
North Sea and Mexico [1980s].

2.4. Control
Petroleum is a unique business:The products are singularly useful for modern economic and military systems.
Production and processing is highly capital intensive.
Investment carries considerable risk.
Distribution of resources is uncertain.
Investment may be undermined by exploration success elsewhere.
Competition and profitability are therefore unpredictable.
Various attempts have been made over the years to control elements of the market, in
order to reduce costs, competition and investment risk.

Figure 7
Crude oil price $/bbl

Introduction

a)

Standard Oil

Standard Oil was established by John D Rockefeller in 1870, as a refining company.

It was a successful business and used aggressive and, sometimes, questionable tactics
to undermine the competition. Growth was accelerated by acquisition and the
company achieved complete domination, particularly of the downstream business in
North-East USA. Headquarters in New Jersey and a new corporate Trust structure
were used to circumvent Federal laws relating to inter-State ownership. In 1911, after
years of legal dispute, the Trust structure was finally outlawed and Standard was split
into more than 30 separate companies, three of which became majors and several
became leading independents. Some of the detail of Standard and its subsidiary
companies is presented in Table 2.

1882

SO New Jersey

>

SO New Jersey

1888

Anglo American

>

Anglo American

1882

SO New York

>

Socony

1866

Vacuum Oil

1879

Vacuum Oil

>

1972

Exxon

1930

1951

Esso UK

>

1966

Mobil

1998

1931

^
Sohio

1987

Amoco

1998

1908

BP

1870

Standard Oil

>

SO Ohio

1885

Solar Refining

1889

SO Indiana

>

SO Indiana

1906

SO Nebraska

>

SO Nebraska

1896

SO Kansas

>

SO Kansas

1866

Atlantic Refining

1874

Atlantic Refining

>

1966

Arco

1999

1879

Pacific Coast Oil

1900

Socal

>

1984

Chevron

2001

>

ChevronTexaco

1886

SO Kentucky

1875

Continental Oil

1884

Continental Oil

>

2002

>

ConocoPhillips

1887

Ohio Oil

1889

Ohio Oil Company

>

1962

>

Solar Refining

>

>
1931

^
>

1939

1973

1950? ^

SO Kentucky

[1984
1929

Gulf]
Conoco

1907
1889

South Penn Oil

>

South Penn Oil

1881

National Transit

>

National Transit

1881

SW Penn Pipelines

1901

Marathon
Shell

1905

Pennzoil

2002

1965

SW Penn Pipelines

1952

Eureka Pipeline

Eureka Pipeline

1947

Cumberland Pipeline

Cumberland Pipeline

1931

Southern Pipeline

Southern Pipeline

1949

Galena-Signal Oil

Galena-Signal Oil

1959

1924

Table 2
Standard Oil

ExxonMobil

Ashland

plus 13

The grey column represents Standard Oil. To the left are component parts, date of
origin and date of takeover by Standard. Some of these names are of companies
created by Standard, sometimes to amalgamate pre-existing business. To the right is
the outcome of the break-up of the Trust. 34 companies were created, 21 are listed.
Of the remainder, some were taken over and some became bankrupt. Moving to the
right, the columns indicate takeover, merger and change of name, with dates where
possible. Note that, for completeness, BP, Shell and Ashland are included. They
were not part of Standard itself, but now own parts of the outcome.
b)

Red Line Agreement

Turkish Petroleum was established in 1912, to seek petroleum concessions in the

Middle East. The company was inspired by Calouste Gulbenkian, an Armenian
entrepreneur, who had been convinced for many years of the prospectivity of
Mesopotamia [Iraq]. Ownership became a source of considerable political, as well
as commercial interest and, on the insistence of the British Government, Anglo
Institute of Petroleum Engineering, Heriot-Watt University

1
Persian was included in 1914, see Table 3. After WW1, politics changed and German
interests [Deutsch Bank] were replaced by the French [CFP]. There followed a long
period of international negotiation, culminating in the formal inclusion of an American
syndicate [SO New Jersey, SO New York and others] in 1928. Figure 8 is a cartoon
from this time, indicating a British-French carve-up, with an American foot in the
door.

Figure 8
San Remo 1920

These companies, with the support of government, were signatories to the so-called
Red Line Agreement. This related to an area encompassing the Arab Peninsula and
northwards to the Black Sea, the Ottoman Empire as was in 1914. See Figure 9 for
a map of the relevant area. The basis of the agreement was that the signatories would
not compete with each other within this designated area. This agreement, involving
the worlds largest companies of the day, set the pattern for later negotiation.

Gulbenkian
Royal Dutch Shell
Deutsch Bank
National Bank of Turkey
Anglo Persian
Compagnie Francaise des Petroles
American Syndicate

10

1912

1914

1928

7.5%
25%
25%
42.75%

5%
22.5%
22.5%

5%
23.75%

50%

23.75%
23.75%
23.75%

Table 3
Turkish [Iraq] Petroleum
Company Equity

Introduction

Figure 9
Red Line area

In the meantime, Turkish Petroleum negotiated a concession with the Iraq government
in 1925 and made a huge discovery at Baba Gurgur in 1927. The name of the company
soon changed to Iraq Petroleum [IPC]. Gulbenkian became known as Mr Five
Percent.
c)

Achnacarry Agreement

The oil industry in 1928 faced a number of serious problems, including overcapacity
and falling prices. In August, the chief executives of Standard New Jersey, Standard
Indiana, Anglo Iranian, Shell and Gulf gathered to shoot grouse at Achnacarry, in the
Scottish Highlands. They also found time to discuss matters of business and reached
an agreement, known as the Pool Association. Under this agreement, the cartel
decided that:i
ii
iii

Companies would share production and markets on the basis of the balance then
prevailing
New facilities would be constructed only as necessary and to supply in the most
efficient manner
Price would be on a Gulf Plus basis, meaning that price would be based on
USA export price, with transportation charges as if the oil originated from the
Gulf of Mexico

These clauses formed the basis of inter-company agreement in Europe and parts of
Asia for the next twenty years.
Institute of Petroleum Engineering, Heriot-Watt University

11

1
d)

Organisation of Petroleum Exporting Countries [OPEC]

During the 1950s, the market for oil expanded rapidly, with major new discoveries
in the Middle East, North Africa and elsewhere. Most of this production was under
the control of a small number of large, international companies [the Majors or
Seven Sisters]. The companies had Concessions or production licences which
afforded power and freedom to explore and to develop. Re-entry of the Soviet Union
into this market around 1955 added to the growing problem of over-supply and caused
an inevitable, downward pressure on prices.
Oil price was based on a formal system of Posted Prices, from which Royalties and
Taxes were derived. Posted Price had originally matched market price, but in the
market of the late 1950s, companies had been discounting price to maintain market
share. With a fixed Posted Price [and taxes] and a falling, selling price [and revenue],
companies found themselves paying a higher proportion to government, [see Figure 10].

$11.651
1/1/74

Posted
Market

Dollars per Barrel

0
50

51

52

53

54

55

56

57

58

59

60

61

62

63

64

65

66

67

68

69

70

71

72

73

74

Companies had the legal right to change Posted Price, but used this sparingly. In 1959,
BP cut its Posted Price by 18 [about 10%]. The producer countries were angry and
the issue was discussed at the Arab Oil Congress, held in Cairo in 1959. The
immediate outcome was an informal, Gentlemens Agreement concerning the
following issues:i
ii
iii
iv

12

defence of the existing price structure

formation of national oil companies
increase in tax-take beyond 50 50
development of downstream industry

Figure 10
Saudi Arabian light
fob Ras Tanura

Introduction

The following year, after further cuts in Posted Price, representatives of leading oil
producers met in Baghdad and OPEC was formed. The founder members were:Saudi Arabia, Iran, Iraq, Kuwait and Venezuela. Formation of OPEC was the first
collective act of sovereignty exercised by oil producers, with the following objectives:i
ii
iii
iv

to restore price to pre-cut levels

consultation on pricing issues
creation of a mechanism for production regulation
solidarity in the face of potential, individual sanctions.

In the early years of the organisation, market over-supply limited its powers.
However, in 1960, its market share of world-traded oil was 80% and rising. When
the market tightened in the early 1970s, OPEC was in a position to exploit the
situation, to increase price. See Appendix 3 and Chapter 6, Section 5.4. OPEC has
survived for more than 40 years and still carries considerable influence. All cartels,
however, face problems both within and without. Controlling production requires
discipline on the part of its members; increasing the price creates extra profits for all
market participants and inevitably encourages expansion of production outside the
control of the cartel. Figure 11 indicates how regional production evolved after the
1973 price increases. Note that Middle East production fell by 50% by 1985, in the
face of mounting competition from Russian, Mexican and North Sea production.

2.5
North America
South America
Europe
Former Soviet Union
Middle East
Africa
Asia Pacific

1.5

Figure 11
Production ratios
[proportion of 1973]

0.5
1973

1978

1983

1988

1993

1998

3. COMPANIES
In 1973, seven large companies, the Seven Sisters controlled more than sixty
percent of world oil production. Today, these four [amalgamated] organisations have
little more than ten percent of the market. Table 4 indicates how the market has
changed. The OPEC inspired intervention, which took place in the mid-1970s,
resulted in a massive transfer of control, from international to national oil companies
[NOCs]. Of the top twenty producers, listed in Table 4, half are NOCs. The top
four are all NOCs and are responsible for about 25% of the market. Limited access
Institute of Petroleum Engineering, Heriot-Watt University

13

1
to foreign companies is available in some of the countries, where the resource in
controlled by an NOC. In UAE for example, ADNOC has a 60% interest in key joint
venture companies.

Current

2000

1973

Saudi Aramco
NIOC
Pemex
PDVSA
ExxonMobil
RD Shell
KPC
Petrochina
ChevronTexaco *
BP
ADNOC
TotalFinaElf *
Lukoil
Sonatrach
YukosSibneft *
Petrobras
PDO
ConocoPhillips *
ENI
Statoil
Repsol-YPF

9.1
3.8
3.5
2.8
2.5
2.3
2.2
2.1
2.0
1.9
1.5
1.5
1.5
1.4
1.3
1.3
0.8
0.8
0.8
0.7
0.6

World Total
Seven Sisters

74.5
44.0
11.7% 62.7%

7.9
4.5

10.
4.6

Origin
1974
1953
1938
1975
1882
1892
1974
1988
1902
1908
1971
1920
1991
1963
1993
1953
1967
1875
1953
1972
1986

NOC:- Saudi Arabia

NOC:- Iran
NOC:- Mexico
NOC:- Venezuela
Merger in 1999
Merger in 1907
NOC:-Kuwait, merged 1980
Privatised by CNPC in 1999
Includes Gulf; merger 2001
Includes Amoco, Arco, Sohio
NOC:- UAE [60%]
Final merger 1999
Privatised in 1993
NOC:- Algeria
Privatised in 1994
NOC:- Brazil
part nationalised 1974
Merger 2002
NOC:- Italy; privatised 1995 >
NOC:- Norway; p priv 2001
Acquisition in 1999

* These companies merged after 2000; the data reflect separate companies
in 2000

The Seven Sisters had to re-invent themselves. BP, in 1972, sourced 99% of its oil
supplies from the Middle East and North Africa. Today these countries contribute
very little [to BP]. Loss of oil supply and dramatically increased oil price provided
the incentive and a favourable economic environment for exploration and development
of new areas, some of which were considerably more expensive than the lost
productive capacity in the Middle East. The North Sea and Alaska, for example, have
both been developed since 1973 and both represent order of magnitude increases in
cost. Companies have also evolved by merger and acquisition, drilling on Wall
Street as they say. Appendix Three lists some of this activity under 1980s and
1999. Merger also creates opportunity for economies of scale and other cost savings.

14

Table 4
Oil production by company
[million bopd}

Introduction

Oil

Gas

O+G

world

bbls 10^9

boe 10^9

boe 10^9

261.8

38.1

299.9

15.1

15.1

NIOC *

89.7

144.9

234.6

11.8

26.8

UAE *

97.8

37.9

135.7

6.8

33.7

Iraq *

112.5

19.6

132.1

6.6

40.3

122.0

122.0

6.1

46.4

Saudi Aramco *

Gazprom
KPC *

96.5

9.4

105.9

5.3

51.7

PDVSA

77.7

26.2

103.9

5.2

57.0

9.2

28.5

37.7

1.9

58.9

Pemex *

26.9

5.4

32.3

1.6

60.5

ExxonMobil

11.6

9.3

20.9

1.0

61.5

RD Shell

9.7

9.4

19.1

1.0

62.5

BP

7.6

7.4

15.0

0.8

63.2

Lukoil

14.2

0.7

14.9

0.7

64.0

Yukos

11.8

0.5

12.3

0.6

64.6

8.5

3.0

11.5

0.6

65.2

3.8

10.8

0.5

65.7

PDO *

5.5

5.2

10.7

0.5

66.3

Petrobras *

8.5

1.4

9.9

0.5

66.8

ConocoPhillips

2.7

7.7

0.4

67.2

ENI

2.6

6.6

0.3

67.5

2.4

2.4

4.8

0.2

67.7

2.3

4.3

0.2

67.9

Sonatrach *

ChevronTexaco
TotalFinaElf

Repsol-YPF

Table 5
Petroleum in reserve
[end 2000]

cum

Statoil
* national reserves

Table 5 presents reserve data and another challenge. The top ten international
companies report oil and gas reserves, which represent about 6 percent of the world
total. At current rates of production, these companies would be depleted in fewer than
15 years. Half the recorded world reserve is under the control of the six largest NOCs.
Access to this will depend on how the politics of world oil evolves, but at present
equity access is limited. One anomaly in this equation is Gazprom, a private
company, [Russian Government owns 38% of shares], with control over most of
Russias gas resource. It is clearly one of the largest, both in terms of reserves and
production.

Institute of Petroleum Engineering, Heriot-Watt University

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If size equates with success, petroleum is a successful business. Table 6 lists the
fifteen largest companies worldwide, ranked by sales in 2001, according to Fortune
Magazine. Five of these are oil companies, including ExxonMobil and BP in the top
four. Furthermore, four other companies in the list specialise in motor vehicle
manufacture, one of the most important markets for oil products.
Company

$ Billions

Walmart Stores
ExxonMobil
General Motors
BP
Ford Motor
Enron
Daimler Chrysler
Royal Dutch Shell
General Electric
Toyota Motor
Citigroup
Mitsubishi
Mitsui
ChevronTexaco
TotalFinaElf

219.8
191.6
177.3
174.2
162.4
138.7
136.9
135.2
125.8
120.8
112.0
105.8
101.2
99.7
94.3

4. BP plc
BP is one of the former Seven Sisters and one of top three international petroleum
companies. Like most of the large petroleum companies, it has a century of history
and has grown both by successful investment in upstream and downstream facilities
and by acquiring or merging with other companies. See Table 7 for a simplified timeline, summarising BP historical evolution. Since 1974, the larger companies have
found it easier to grow by merger and acquisition, than by exploration and development.
[See Section 3 above, Chapter Seven, Section 3.2 and Appendix 3 for further
information.]
BP is a vertically integrated petroleum company, meaning that it is involved in the
whole process, from exploration, through to marketing of refined and manufactured
products.
BP has upstream [exploration and production] interests in more than twenty countries,
most of which are listed in Tables 8 and 9. The UK and USA dominate, with sixty
percent of current production. In the midstream [transportation] business, BP has a
significant interest in three world-class, million-barrel-per-day pipeline systems. The
Forties Pipeline in the North Sea carries production from more than forty fields and
generates tariff income of some $350 million per year. The Alaska pipeline was vital
to the successful development of the North Slope and the new Baku-Tblisi- Ceyhan
Pipeline will create a valuable, alternative route for export from the Caspian Basin.
Downstream [refining, manufacturing and marketing], BP has 24 refineries, 38

16

Table 6
Fortune 500 [2001]
Top Earning Companies

Introduction

chemical sites and almost 30,000 service stations. It sells 6.6 million barrels of
petroleum products and 100,000 tonnes of chemicals every day.

4.1. BP Upstream
Table 8 is a breakdown of BP oil production in 2002 with a more detailed listing of
oilfields in the UK. Oilfields commonly produce economic volumes of gas and some
of these named oilfields also contribute to the natural gas production recorded in Table
9. Bruce, for example is a complex field with reserves of oil, condensate and gas. In
2002, Bruce produced 45,000 barrels of oil and 450 million cubic feet of gas per day.
Many petroleum development projects are owned by a group, rather than by a single
company. Bruce, for example, has four participants, as follows:43.25%
37.00%
16.00%
3.75%

TotalFinaElf
BP
BHP Billiton
Marubeni

Joint ownership reflects the strategy of spreading risk, particularly at the time of
exploration [see Chapter Seven, Section 3.1]. BPs percentage interest is noted for
each of the named fields. As fields mature, investment risk diminishes and companies
may seek to rationalise their interests. Having a larger, percentage share of a smaller
number of projects is probably more efficient use of resources. Furthermore, larger
companies may be more suited to the development of new opportunities and may
therefore wish to transfer mature assets to smaller organisations, which specialise in
such projects. In the UK, in recent years, BP has disposed of ten fields, which are
approaching abandonment. Forties, for example, has been sold to Apache in 2003.

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1
1901
1908
1909
1909
1914
1914
1920
1924
1928
1931
1935
1938
1951
1954
1954
1956
1969
1970
1977
1987
1987
1988
1991
1996
1998
1998
1999
2000
2000
2001
2002
2002
2003

Persia
Masjid-i-Suleiman, Persia
Anglo Persian Ltd
Abadan, Persia
UK Government
Iraq Petroleum Company
Scottish Oils [shale oil]
Grangemouth
Baba Gurgur, Iraq
Shell Mex & BP
Anglo Iranian Ltd
Burgan, Kuwait
Iran
British Petroleum Ltd
Iran
Niger Delta, Nigeria
Forties, UK
Sohio
Alaska
Sohio
UK Government
Britoil
Cusiana, Colombia
Mobil
Amoco
BPAmoco plc
Arco
Trinidad
Burmah
BP plc
Veba Oil
Caucasus
Sidanko,

DArcy Concession, funded by Burmah

Oil discovery
Formation of new company, by Burmah
New refinery [to become worlds largest]
Purchase majority shareholding
Joint Venture company
Acquisition
New refinery
Oil discovery [Iraq Petroleum Joint Venture]
Joint Venture company
Name change
Oil discovery [Gulf JV] [50000 million bbls]
Nationalisation of petroleum assets
Name change
New Concession, includes British Petroleum
Oil discovery [Shell Mex Joint Venture]
Oil discovery [2750 million bbls]
Acquisition of shares
Completion of Trans-Alaskan Pipeline System.
Acquisition of remaining shares
Share disposal
Acquisition
Oil discovery [1600 million bbls]
Downstream Joint Venture
Merger [60:40]
Name change
Acquisition
Gas discoveries
Castrol Acquisition
Name change
Acquisition
Agreement to build Baku-Tblisi-Ceyhan Pipeline
TNK Russia Joint Venture company

The fields, which are named in Table 8, are all BP-operated, meaning that BP is the
group member with responsibility for field planning, construction and operation. See
Chapter Five, Section 3.7 for information about the role of the Operator. One of these
BP-operated fields is Foinaven, which was the first to receive development consent
in deep water on the UK Atlantic margin. Summary technical details of this project
are listed in Table 10 and the field development is illustrated in Figure 12. Cash flow
data from Foinaven are introduced in Chapter Two, Section 6, and then used to
demonstrate evaluation methodology throughout Chapter Four.

18

Table 7
BP plc Time Line

Introduction

Oil Production
10^3 bopd
Angola

29

Argentina

53

UK Field

BP Interest

BP Share

Australia

43

Names

10^3 bopd

Azerbaijan

38

Canada

16

Andrew

62.8

23

Colombia

46

Bruce

37.0

17

Egypt

85

Foinaven

72.0

72

Norway

84

Forties

96.1

50

Russia

73

Harding

70.0

42

Trinidad

67

Loyal

50.0

10

UAE

113

Machar

100.0

16

UK

461

Magnus

85.0

31

USA Alaska

309

Marnock

62.1

USA GOM

264

Miller

52.0

11

USA Lower 48

192

Monan

69.9

Venezuela

51

Mungo

69.9

37

Other

94

Schiehallion

33.4

33

Wytch Farm

67.8

32

various

79

Table 8
BP Oil Production 2002

2018

Other

Gas Production
10^6 scfd
251

Argentina
Australia

295

Canada

514

China

102

Egypt

256

Indonesia

457

BP Interest

BP Share

10^6 scfd

Netherlands

87

Norway

60

BP Operated

Trinidad

1238

Anscutz Ranch East

various

28

134

Hugoton

various

169

1550

Jonah

75.2

113

52

Marlin

100.0

106

USA GOM

1185

Matagorda Island 519

82.3

47

USA Lower 48

2246

Matagorda Island 623

43.5

48

280

Moxa Arch

41.0

54

Pompano

73.7

63

San Juan Coal

various

601

Wamsutter

70.5

108

Non-operated

various

2094

UAE
UK
USA Alaska

Other

Table 9
BP Gas Production 2002

US Fields

8707

3431
Institute of Petroleum Engineering, Heriot-Watt University

19

Figure 12
Foinaven Field
Development

Location

Atlantic Margin, Faroes Basin

160 Km West of the Shetland Islands
Water depth 500 metres

Ownership
Licence

72% BP
28% Marathon
1985 Concession

Discovery
Consent
Onstream

1992
1994
1997

Reservoir
Oil gravity
Reserves

Palaeocene sands
25-26 API
323 million barrels of oil
221 billion cubic feet of gas

Production

Two sub-sea production manifolds

Sub-sea water and gas injection
FPSO.
Shuttle tankers
Gas pipeline to Magnus

Export

4.2. BP Performance
BP is a large and successful company, operating in a large and dynamic market.
There are many parameters, which may be used to describe corporate activity and to
measure corporate performance. The following notes refer to data in Table 11, which
are extracted from BP Annual Accounts, 1997-2002.

20

Table 10
Foinaven Summary

Introduction

Section a

indicates key elements of the economic environment, within which

BP operates, with weak prices in 1998 and strong prices in 2000. As
an international company, BP trades in many currencies and is
inevitably affected by exchange rates. Refinery margin [surplus of
revenue over operating costs] reflects supply and demand interaction
in that market.

Section b

highlights operational details. Reserves replacement is a measure of

exploration success; greater than 100% means discoveries exceed
production. Finding and development cost records the unit cost of
new fields and reflects geographical location, technological advance
and corporate efficiency. Production of oil was uniform over this
period, whereas gas production increased significantly from 1999.

Section c

includes measures of financial activity. Turnover is a measure of

company sales revenue; it reflects variation in prices and in rates of
production. Capital investment is money spent on new projects. It
fell in 1999, in response to lower prices and revenues in the previous
year. $36 billion was spent in acquiring Arco in 2000. Finance Debt
is money borrowed from banks and financial institutions and for BP
represents about 25% of its available capital. Increased borrowing
increases corporate risk [see Chapter Six, Section 5.7].

Section d

relates to performance. Measures of profitability, as published in

corporate accounts, must conform to recognised accounting standards.
In the UK, for example, procedures are contained in Financial
Reporting Standards [FRSs] and Statements of Recommended
Practice [SORPS]; in the USA, Generally Accepted Accounting
Principles [GAAPs]. Historical Cost Profit is the standard,
accountants measure of performance [see Chapter Two, Section 2];
here, it correlates strongly with prices. Return on Average Capital
Employed [ROACE] is profit, as a proportion of capital employed [a
measure of total corporate funding]. Dividend is the annual distribution
of profit to shareholders; note that Dividend distribution was preserved
in 1998, despite lack of profit, a measure of the influence of the large,
institutional investors, which hold most of the BP shares. Share price
reflects market perception of the performance and potential of the
company. It also reflects attitude to the stock market in general and
to other forms of investment.

Institute of Petroleum Engineering, Heriot-Watt University

21

a) BP average oil price

BP average oil price
BP average gas price
BP Refinery Margin
Exchange Rate

$/bbl
/bbl
$/mcf
$/bbl
$/

b) Reserves replacement
%
Find / Dev Cost
$ / bbl
Oil production
bopd 10^6
Gas production
boepd 10^6
Employees

1997

1998

1999

2000

2001

2002

18.30
11.16
2.50
2.50
1.64

12.10
7.29
1.93
2.10
1.66

16.74
10.33
1.92
1.24
1.62

26.63
17.64
2.91
4.22
1.51

22.50
15.63
3.30
4.06
1.44

22.69
15.13
2.46
2.11
1.50

160.00 132.00
4.22
4.70
1.93
2.05
1.03
1.00
100,800 96,650

112.00 163.00 191.00 175.00

3.21
3.29
3.68
4.14
2.06
1.93
1.93
2.02
1.04
1.31
1.48
1.49
80,400 107,200 110,150 115,250

c) Turnover
Capital Investment
Acquisitions
Finance Debt
Taxation

$ 10^9
$ 10^9
$ 10^9
$ 10^9
$ 10^9

108.60
9.70
1.00
12.87
4.00

83.70
9.00
0.70
13.76
2.69

101.20
6.40
0.30
14.54
3.34

161.80
11.00
36.40
21.19
8.71

d) Historical Cost Profit

Ave. Capital Employed
ROACE
Net Income per boe
Dividend
Share Price 31/12
Dividend per Share

$ 10^9
$ 10^9
%
$
$ 10^9

5.30
50.67
0.10
4.25
3.50
4.00
0.11

2.70
51.30
0.05
2.08
4.10
4.49
0.12

4.60
52.04
0.09
4.17
3.90
6.22
0.12

10.10
78.84
0.13
8.61
4.60
5.40
0.14

175.40 180.19
13.20 14.07
0.90
5.04
21.42 22.01
8.06
5.62
6.60
87.26
0.08
7.51
4.90
5.34
0.15

6.85
89.62
0.08
6.04
5.38
4.27
0.16

Table 11
BP Statistics

5. INVESTMENT IN PETROLEUM
BP currently produces 2 million barrels of crude oil and sells more than 6 million
barrels of refined products every day. In order to maintain productivity and operating
efficiency, the company invests, annually more than $10 billion in new field
development, downstream facilities and infrastructure.
The world petroleum
industry invests in excess of $100 billion per year. See Table 12 for data on ten large
international companies.

22

Turnover
$ 10^9

Capex
$ 10^9

Upstream
%

ExxonMobil
RD Shell
ChevronTexaco
BP
TotalFinaElf
Lukoil
Yukos
ConocoPhillips
ENI
Repsol-YPF

232.7
191.5
117.0
168.7
105.4
13.4
9.8
66.2
48.8
43.2

11.2
9.6
9.5
11.0
7.7
1.6
1.4
4.8
5.0
6.1

62
57
66
60
69
68

996.7

67.9

77
62

Table 12
Sales and investment [2000}

Introduction

From exploration, through to selling a gallon of gasoline, the petroleum industry

consists of a number of business layers, as illustrated in Table 13. Expenditure is
divided into two categories, namely Capital and Operating.

Capital
Expenditure

Table 13
Investment in oil

f)
Excise Duty &
Sales Tax

none

e)
Distribution &
Marketing

Storage facilities
Transportation fleet
Service station

Operating
Expenditure

Taxation

none

Excise Duty &

Sales Tax

System operation
Sales

Corporate Taxes

Profit

Price per Barrel

none

$90 - $190
Gasoline
selling price

Downstream Profit

$50
Gasoline
selling price
pre-duty

d)
Refining

Refinery

Refinery operation

Corporate Taxes

Downstream Profit

$44
Gasoline market
price ex-refinery

c)
Transportation

Pipeline system
Tanker fleet
Terminals

Tariff payments
Pipeline operation
Tanker operation

Corporate Taxes

Midstream Profit

$27
Market price cif

b)
Field
Development &
Operation

Production platform
Production wells
Control equipment
Export system

Field operation

Production Taxes
Royalties
Corporate Taxes

Upstream Profit

$25
Market price fob

a)
Exploration &
Appraisal

Successful Wells
Seismic surveys
Exploration wells
Logging/ testing

Unsuccessful Wells

Signature Bonus
Allowances

none

$2
Finding Cost

(a)
(b)
(c)
(d)
(e)

Exploration and appraisal

Field development and operation
Transportation
Refining
Distribution and marketing

Capital Expenditure [Capex] relates to the creation of a useful or productive system

and equates with invests above. Operating Expenditure [Opex]is that required to
operate and to maintain these productive systems. See Chapter Two, Section 4.1 for
a more detailed explanation.

5.1. Exploration and Appraisal

Exploration is the first stage in the process of producing oil. Money is spent on seismic
surveys and drilling of exploratory wells. Discoveries are made, tested and eventually
added to reserves. Many unsuccessful wells are drilled. Standard practice is to
consider the cost of successful wells as Capex and the cost of unsuccessful wells as
Opex. This is known as successful efforts accounting. It is, however, permissable
to record all exploration expenditure as Capex [full cost accounting]. This is
explained more fully in Chapter Two, Section 2.2.
Institute of Petroleum Engineering, Heriot-Watt University

23

1
Taxation is limited at this stage, since revenue is not generated. Lump sum payments
[Bonus Bid or Signature Bonus] may be required by the Licence agreement [See
Chapter Five, Section 3.3]. Expenditure gives rise to tax allowances, which may be
carried forward, until revenue is available.
Finding Cost relates exploration expenditure to barrels discovered. This depends on
a wide range of factors, such as geological complexity, well location and technology.
Time is a particular problem in compiling any average relationship between reserve
barrels and cost of discovery, since commercial status may not be confirmed for five
or ten or twenty years. Because of varying calculation procedure, it is difficult to use
such a parameter to make meaningful comparison between companies.

5.2. Field Development

Once a commercial decision is taken, investment [Capex] is required in wells,
structures, production facilities and export. The cost of development varies dramatically
from one environment to another [onshore deep offshore] and technology evolves
over time. Order of magnitude differences are possible. Development cost per barrel
is influenced by many factors [see Chapter Two, Section 5.3] and may be calculated
in a variety of ways [see Chapter Four, Section 4.2]. and so caution is required with
interpretation and comparison.
When production starts, expenditure [Opex] is required to operate the system, in order
to produce petroleum. Opex per barrel is sometimes called Lifting Cost; this
benefits from economies of scale and increases over time as rate of production
diminishes.
Taxation varies from country to country and many regimes include specific fieldrelated, or upstream or production taxes. The basis of these taxes is normally the
market price for crude oil. If a field or petroleum project can be delineated, it is
possible to define profit, relating to it. Profit is generally based on the residual of crude
oil selling price less exploration, development and lifting costs, and taxes.
Upstream relates to the discovery and the production of oil and gas. Downstream
relates to refining and manufacture of chemical products. The transition is some
convenient point of sale, which may be the wellhead, an offshore loading buoy or an
export terminal. The price at this point is identified as fob meaning free on
board. The transportation phase between upstream and downstream may be called
midstream.

5.3. Transportation
Transfer from oilfield to refinery may be direct, by pipeline, or by a series of stages
and owners involving pipeline, storage and tanker. The Forties Pipeline System, for
example, runs directly to the Grangemouth Refinery in Central Scotland. It also links
to an export terminal, which allows part of the stream to be exported to Europe and
North America, by tanker Transportation infrastructure may be owned by the user [oil
producer], or leased on a per- journey, per-year or per-barrel basis. Ownership implies
that the company has invested [Capex], whereas leasing implies payment of tariffs
[Opex].

24

Introduction

Transportation from wellhead to point of sale [or valuation], may fall within the
boundary [ring fence] of upstream or production taxes, whereas transportation beyond
that point does not. The cost of the midstream journey is reflected in the difference
between the delivered price [cif meaning carriage insurance and freight] and the fob
price. This midstream transportation activity is subject to general corporate taxes
[wherever the company is based] and contributes to general corporate profits.

5.4. Refining
Refineries buy crude oil at market [cif] price; [if the refinery is owned by the oil
producer, this transfer price may differ from market price]. Refineries are designed
to produce a range of refined products and therefore generate revenue reflecting the
weighted-average, market price of these products. The difference between unit
selling and unit purchase price is sometimes called the gross refining margin. This
is the revenue available, per barrel, to meet refinery operating costs and also give a
return on the capital investment . [Net] refinery margin is gross margin minus refinery
operating cost [energy plus materials plus labour etc]. Detailed analysis of refinery
economics is beyond the scope of this module. Refinery activity gives rise to general
corporate taxes and profits.

5.5. Distribution
Refinery output may be feedstock for other downstream processes, or may be
transferred directly into a distribution system for sale to consumers. All the large oil
companies have access to service stations selling gasoline [petrol, benzene], their
most important product. Service stations may be owned by an oil producer and refiner,
by a refiner or by a retail organisation. If the retailer is independent of the refiner, the
product is purchased on a wholesale market.
Sales Tax; Tax is commonly charged on gasoline at the point of sale. This may be
called duty, excise duty, sales tax or value added tax. It is a proportion of pre-tax
selling price. In the USA, these taxes amount to some $20 per barrel, whereas in the
UK, $140 per barrel, bringing the selling price of gasoline close to $200 per barrel.

5.6. Upstream Investment

Large, integrated petroleum companies invest predominantly in the upstream sector
of the business. It is expensive, it is long term and it is risky, but it may be very
profitable. A single exploration well can cost anything from less than $1 million to
more than $100 million, with perhaps a 75% chance of failure; an oilfield development
can cost from a few to a few thousands of millions of dollars and may then generate
revenues for half a century. Financial performance of a company is derived directly
from its investments, the larger the project and the longer its life expectancy, the more
important the decision.
Decisions to make these investments are always taken in an environment of uncertainty.
Recoverable reserves are only confirmed, when they have been recovered and
technology often has to survive in extreme conditions. Tomorrow, the price of oil will
be different and somewhere government policy will have changed.
Chapters, which follow, consider the principles of investment in general, and review
the specific issues of upstream petroleum investment, in an environment of uncertainty.

Institute of Petroleum Engineering, Heriot-Watt University

25