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PETROLEUM ECONOMICS
Dr. Syahrir Ridha
ECONOMIC
INDICATORS
(E&P Project Economic Evaluation)
PETROLEUM ECONOMICS
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Course Outcomes
Having worked through this chapter the Student will be able to:
Economic indicators
are devices which
reduce a net cash flow
projection to single
numbers in time.
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Cost
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a. Project Screening
Comparing all projects with a set of company investment criteria to
identify suitable candidates for investment
b. Project Ranking
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1. Undiscounted method
(c)
(d)
(a)
(b)
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TCS
MCO
Short Exercise:
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Solution….
2000
Year Year
Duration Project Cash flow Net cash flow
1 1994 -24 -24 1500
2 1995 -102 -126
3 1996 -316 -442 1000
2. Discounted method
Net Present Value (NPV)
Internal Rate of Return (IRR)
Discounted Payback
Profitability Index (PI)
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Features of NPV
• Cash flow of the investment and the present value of our cash
flow using a discount rate of 10% ?
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Features of NPV
DIFFERENT INPUTS
Bank $109
$120
Alternative Investment $100
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The NPV combines into one number all the physical and
financial attributes of a project-:
• the production profile,
• the capital and operating costs,
• the fiscal terms,
• the timing,
• and the discount rate
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Similarly, the NPV helps to determine the price the buyer would
be prepared to pay
Short exercise:
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Solution
12%
0 1 2 3 4 5
IRR is the discount rate, which reduce the project NPV to zero.
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Trial and error By computing NPV index and check for zero NPV
±18%
- 44
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Short Exercise:
Solution:
IRR calculation using graphical method, we should define another 2 NPV values.
Assume we use 13% and 15% interest rate,
150
100
50
Using graphical solution below,
0 the IRR is when NPV= 0) and is
NPV
-150
-200
-250
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5%
0% 10%
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Short Exercise:
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Solution:
Time Cash flow Discounted Cash flow @12% NPV= Present value of Future cash flows-
1 3000 2678.571429 Investment
2 3000 2391.581633 =16951-20000
3 3000 2135.340743 = minus $3049
4 3000 1906.554235
5 3000 1702.280567 PI= Present value of Future cash flows/
6 3000 1519.893364 Net Investment
7 3000 1357.047646
=16951/20000
8 3000 1211.649684
9 3000 1081.830075 =0.85
10 3000 965.9197098
PV of future cash flow: 16950.66909 The project is not acceptable as NPV is
negative and PI is less than 1.
Economic indicators, which are derived from project cash flow, have a
number of important applications:
1. Project screening
Comparing projects with a set of company criteria
to identify suitable candidates for investment
2. Project ranking
Comparing acceptable projects and placing them
in suitable rank order for investment purposes
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1. Project Screening
NPV ≥0
IRR ≥0
PI ≥1
2. Project Ranking
Ranking decision is taken by several consideration:
a. Resources Limitation
• All organizations have finite resources might constrain investment
• The most important are specialist manpower and finance
b. Mutual Exclusive
• Project A & B may be alternative development plan for the same reservoir
• Take over of Company X may be seen as alternative to initiating
exploration in Country Y
c. Best First
• Company performance is optimized by making the best possible
investments.
• Lesser projects may be enhanced by new technology or replaced by new
opportunities.
• Earning profit early will contribute to corporate growth.
b. Risk
• Company may have a specific attitude to risk or prefer a mix of high
and low risk
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Projects comparison
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Ranking Parameters
• IRR is very sensitive to the timing of cash flows. High IRR is often
associated with small projects and early production.
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3. PI as Ranking Criterion
• PI is very useful to rank investment efficiency.
In this case:
NPV and PI produce the
same result in about
22%.
Below 22%, Project B is
better investment
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Example:
Solution:
i = 15%,
NPV NPV = -90,000 + 114783 + 75,614 – 98,627
= $ 1,770
If i = 10%,
NPV = -90,000 + 120,000 + 82,645 – 112,697
= $ -52
IRR
If i = 25%,
NPV = -90,000 + 105,600 + 64,000 – 76,800
= $ 2,800
If i = 45%,
NPV = -90,000 + 91,034 + 47,562 – 49,202
= $ -606
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By Graphical method:
THE END
&
THANK YOU
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