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Energy Journal Issue

The Energy Journal
Volume19, Number 1

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Implications of Output Price Risk and Operating Leverage for the Evaluation of Petroleum Development Projects

Gordon Salahor

DOI: 10.5547/ISSN0195-6574-EJ-Vol19-No1-2View Abstract

This paper is the first in a series that describes how Modem Asset Pricing (MAP) may be used for project evaluation in the upstream petroleum industry. It shows how MAP methods can be used to value a project, if it i's possible to split its cash-flows into two components: one for revenue and one for cost. Two design choices for a "now or never " natural gas field development are used as examples of what can be gained by this type of approach to project evaluation. The first choice involves a tradeoff between capital and operating costs, while the second involves a tradeoff between costs and potential production rate. The results show that the use of standard DCF methods can induce systematic, and possibly misleading, biases into the analyses that lie behind project design and selection.

On the Use of Modern Asset Pricing for Comparing Alternative Royalty Systems for Petroleum Development Projects

Paul G. Bradley

DOI: 10.5547/ISSN0195-6574-EJ-Vol19-No1-3View Abstract

This paper is the second in a series that describes how Modern Asset Pricing (MAP) may be used for project evaluation in the upstream petroleum industry. It has two goals. First, it demonstrates how MAP can be applied to the general class of projects where the project manager does not have any future flexibility that must be analysed. Second, the usefulness of MAP in fiscal system analysis is illustrated by the evaluation of a series of oil-field development projects under a variety of fiscal regimes. In situations where different fiscal systems have the same effect on a discounted cash flow (DCF) basis, the value of afield to a developer may appear quite different when analysed using MAP. MAP takes into account the differing risk characteristics of the cash-flow streams of the developer and the government or resource owner, and provides us with an added dimension of information: comparisons of how different fiscal systems distribute risk among the parties involved in the project.

The Management of Flexibility in the Upstream Petroleum Industry

David Laughton

DOI: 10.5547/ISSN0195-6574-EJ-Vol19-No1-4View Abstract

This paper is the third in a series that describes how Modern Asset Pricing (MAP) may be used for project evaluation in the upstream petroleum industry. It demonstrates how MAP can be applied to projects where policies for the management of future flexibility must be considered within the context of the valuation. We illustrate this use of MAP by looking specifically at flexibility in the timing of the exploration, delineation, and development of an oil prospect, and the timing of the abandonment of the subsequent developed field. We use examples to show how the value and management of flexibility depends on the amount of oil price and reserve size uncertainty. We find that prospect value increases with both types of uncertainty. We also find that all actions, from exploration to abandonment, occur later with greater oil price uncertainty. Conversely, we find that exploration and delineation occur sooner with greater reserve uncertainty. The reasons for these results are given.

Alternative Models of Uncertain Commodity Prices for Use with Modern Asset Pricing Methods

Malcolm P. Baker, E. Scott Mayfield, and John E. Parsons

DOI: 10.5547/ISSN0195-6574-EJ-Vol19-No1-5View Abstract

This paper provides an introduction to alternative models of uncertain commodity prices. A model of commodity price movements is the engine around which any valuation methodology for commodity production projects is built, whether discounted cash flow (DCF) models or the recently developed modern asset pricing (MAP) methods. The accuracy of the valuation is in part dependent on the quality of the engine employed. This paper provides an overview of several basic commodity price models and explains the essential differences among them. We also show how futures prices can be used to discriminate among the models and to estimate better key parameters of the model chosen.

The Potential for Use of Modern Asset Pricing Methods for Upstream Petroleum Project Evaluation: Concluding Remarks

David G. Laughton

DOI: 10.5547/ISSN0195-6574-EJ-Vol19-No1-6View Abstract

MAP methods are continually being refined and expanded. In these concluding remarks I would like to touch on some of those developments, and then briefly to mention some steps that might be taken by an organisation that wants to explore this field further.