V2_Chapter 11-Upstream Petroleum Economics - final.pptx

EE048-3-3-PEM: PETROLEUM ECONOMICS CHAPTER 11: Upstream Petroleum Economies
CHAPTER 11 UPSTREAM PETROLEUM ECONOMIES
EE048-3-3-PEM
PETROLEUM ECONOMICS

At the end of this topic, you should be able to:
TOPIC LEARNING OUTCOMES
• Describe petroleum fiscal/contract arrangement
• Breakdown types of international petroleum contracts
arrangements
• Elaborate characteristics of fiscal arrangement concept of
concession and contractual systems
• Generate cash flow of Production Sharing Contract (PSC)
agreement

• Petroleum Fiscal/Contract Arrangement
• Types of international petroleum contracts arrangements
(petroleum fiscal arrangement)
• Typical characteristics of Fiscal Arrangement Concept
o Concession System
o Contractual System Agreement
 Service Contract
 Production Sharing Contract (PSC)
• Cash flow of PSC agreement
Contents & Structure

Recap From Last Lesson
• Upstream Oil and Gas Life Cycle
• Project Economics
• Characteristics of E&P Project, basic economic criteria, and
important parameters.
• Economic Results

• Petroleum Fiscal/Contract Arrangement
• Types of international petroleum contracts arrangements
(petroleum fiscal arrangement)
• Typical characteristics of Fiscal Arrangement Concept
o Concession System
o Contractual System Agreement
 Service Contract
 Production Sharing Contract (PSC)
• Cash flow of PSC agreement
Teaching Contents

 It is an agreed agreement between two parties
(usually the government and the contractor) to
determine:-
How cost are recovered
How profit are shared
What is Petroleum Fiscal/Contract Arrangement?
Slide 8

 2 major categories
1. Concession
2. Contractual system-
service contracts & PSC
Petroleum Agreements/ Fiscal Arrangement
Slide 10

Contractual System
Concessionary System
Contractors' companies owns the
production of the petroleum
resources (Shell, Exxon, Carigali)
Contractors pay royalty and tax to
the government
Government has the sole ownership of petroleum
resources.
Oil companies are assigned as contractors
Contractors furnish all risk capital. In return,
contractors will be allowed to recover the cost
upon production
 For Production Sharing Contract: remaining
profit (after cost recovery) is shared between
government & contractors
 For Service Contract: remaining profit belongs
to government; contractors will be
compensated through unused cost oil as their
‘remuneration’.

Petroleum Agreements
Typical Characteristics of Fiscal Arrangements
Slide 11

 The main difference between these types of
system is the ownership of the petroleum
resources.
 In the concessionary system, the contractor
owns the production of the petroleum
resources.
 However, in contractual system, the owner
of the petroleum resources is the
government itself.
Slide 12
Concessionary vs Contractual System

 For government:
 to maximize profit from its own resources
 For contractor (oil companies):
 to build equity and maximize profit by finding
and production of petroleum resources.
Slide 13
Objective of Fiscal Arrangement

Petroleum Contract/ Fiscal arrangements
PETROLEUM
AGREEMENTS
Concessionary
Systems
Contractual
Systems
Production
Sharing Contract
(PSC)
Service
Contract
eg. USA, Canada,
UK, Australia,
Pakistan,
Nigeria
eg. Indonesia,
Malaysia,
Vietnam,
Myanmar,
Yemen
eg. Iran,
Kuwait, UAE
Slide 14

Most profitable to contractor
Apply to the higher risk field
Usually applies in USA, Canada, UK, Australia, Pakistan,
Nigeria
The contractor own the production of the petroleum
resources
The contractor provide the capital and takes the risk, and only
pay royalty and tax to the government
 In simple example, just take a look in the toll system in major
highways in our country. In this system, the toll company will
operate and collect the money from the highway users.
However, the toll company is only need to pay royalty and tax
Concession Agreement
Slide 21

Net Cash
Flow
State/
Government
Cash Flow
(equals)
Revenue
Opex
Capex
Project
Cash Flow
Net Cash
Flow
(equals)
(less)
(less)
Net Cash
Flow
(equals)
Tax
Royalty
Contractor’s
Cash Flow
(less)
(less
)
(less)
(less)
Slide 23

Example: Morocco Production Concession Agreement
Royalty: 10.0%
Corporate Income Tax rate: 35% of taxable income
Production Bonus (non-tax deductable):
 US$ 1.0 MM for first production
 US$ 2.0 MM for production exceeding 50 MSTB/D
Slide 24

Example: Pakistan Production Concession Agreement
 Royalty: 12.5%
 Corporate Income Tax rate: 55% of taxable income (Capital Allowances: Tangible
Capex depreciated at the rate of 10%pa)
 Workers Participation Fund (WPF): 5% of net income before tax less capital
allowance
 Workers Welfare Fund (WWF): 2% of net income before tax less capital allowance
less WPF
 Production Bonus (non-tax deductible):
 First Level = US$ 1.0 MM for first production
 Second Level = US$ 3.0 MM for production exceeding 300 MMSCF/D
 Third Level = US$ 5.0 MM for production exceeding 600 MMSCF/D
Slide 25

Computational Logic
Revenue – Cash In Gas Sales * Gas Price
Royalty Royalty Rate * Revenue
Opex (Obtain from Input Variable)
Income Before Tax Revenue – Royalty – Opex
Capital Allowance Depreciation Rate * Capex
Taxable Income
Income Before Tax – Capital
Allowance
Tax Paid Tax Rate * Taxable Income
Income After Tax Income Before Tax – Tax Paid
Capex (Obtain from Input Variable)
Cash Out
Royalty + Opex + Tax Paid +
Capex
Net Cash Flow After
Tax
Cash In – Cash Out
SUGGESTED ANSWER
Input Variable
Gas Sales
Gas Price
Capex
Opex
Royalty Rate
Depreciation Rate
Tax Rate
Slide 27
Exercise 6: Provide the logic for Contractors’ Net Cash Flow calculations using the
provided input variables

 Apply to country that easy to get oil & gas
 Minimum risk in exploration and production
 The host country cap the profit or Apply Cost Recovery Ceiling
 Usually apply in countries which are having big reserve such as Saudi Arabia, Iraq,
Iran, UAE
 The government owns the petroleum resources
 Contractor provide capital and takes risk
 Contractor recover cost upon production
 After cost recovery, remaining profit goes to government
 Companies retain unused cost oil as remuneration
 Contractor will pay tax to government
 As an example, let assume you want to build a house. Firstly, you will need to find a
contractor. Then, the contractor will prepare all the materials and list all cost needed
to build your house. After the house already completed, the contractor will return the
house to you. In return, you will pay the contractor some money as ‘remuneration’ for
the contractor for built your house. Slide 29
Service Contract Agreement

Revenue
Opex
Capex
Net Cash
Flow
(equals)
(less)
(less)
Project
Cash Flow
Net Cash
Flow
(equals)
(less)
Tax
Cost Recovery
Remuneration
(less)
(less)
Cost
Ceiling
(less)
Contractor’s
Cash Flow
Net Cash
Flow
State/Govt.
Profit Share
(equals)
(equals)
State/Government
Cash Flow
Slide 31

Example: Iran Service Contract
Cost Oil Ceiling: 60% Capital to be amortised over 6-year period for
recovery
Remuneration for contractors = remaining unused cost oil
Petroleum Income Tax rate: 15% of taxable income
Training bonus (non-cost recoverable, non-tax deductable): $1.5 MM
per year (from 1st production)
Slide 32

Currently is using in Malaysia and other countries such as
Indonesia, Malaysia, Vietnam, Myanmar, Yemen, Venezuela,
and many mores.
99% of total petroleum contracts
The government own the petroleum resources
Contractor provide capital and take risk
In return, contractor recover cost upon production
After cost recovery, the remaining profit is shared between
contractor and government
Contractor will pay royalty and tax to the government
Production Sharing Agreement (PSC)
Slide 34

Royalty
Net Cash
Flow
State/Govt.
Profit Share
(equals)
(less)
State/Government
Cash Flow
Revenue
Opex
Capex
Net Cash
Flow
(equals)
(less)
(less)
Project
Cash Flow
Tax
Net Cash
Flow
Cost
Recovery
Contr.
Profit Share
(less)
(less)
(equals)
(less)
Profit Share
(equals)
(less)
Contractor’s
Cash Flow
Slide 36
Production Sharing Contract (PSC)

 PETROLEUM DEVELOPMENT ACT (PDA) 1974:-
 PETRONAS have the exclusive rights to explore for and produce
petroleum in the country
 PETRONAS is responsible for the management of the petroleum
operations while the Oil Company will be responsible to PETRONAS
as a "Contractor"
 Government or PETRONAS owns the production and shall pass to the
Oil Company only on the production that accrues to them
Slide 37
Evolution of Malaysian PSC

Slide 38
Evolution of Malaysian PSC

Example: Malaysian Production Sharing Contract (R/C Terms)
 Royalty: 10.0%
 Cost Recovery & Profit Sharing:
Where;
R/C = Revenue/Cost;
Cost = total Capex+Opex,
R=total revenue
TCT = Total Cost Tranche , (cost oil ceiling),
TPT = Total Profit Tranche,
P = PETRONAS/Govt,
C =Contractor
 Petroleum Income Tax rate: 38% of taxable income
 Research fund = 0.5% of Contractors’ Cost & Profit Oil
 Export Duty = 10% of Profit Oil
Higher
cost – deep
water
Lower cost –
normal field
Threshold Value (THV) =
STOIIP 20MMbbl
Slide 40
Production Sharing Agreement

Marginal
field
EOR, CO2
Normal field
Normal, infill, fracture,
water flood
For this course
C=Total Capex + Opex
R = Total Revenue
Slide 41
Petroleum Agreements (R/C)

Exercise 7a: Provide the logic for Contractors’ Net Cash Flow calculations using the provided input
variables
Input Variable
Oil Production
Oil Price
Capex
Opex
Royalty Rate
Cost Ceiling Rate
Contr. Profit Rate
Depreciation Rate
Tax Rate
Computational Logic
Revenue Oil Production * Oil Price
Cost Ceiling Cost Ceiling Rate * Revenue
Cost Incurred Capex + Opex (Obtain from Input Variable)
Cost Bank Cost Carryforward + Cost Incurred
Cost Recovered Min(Cost Bank and Cost Ceiling)
Unrecovered Cost Cost Bank – Cost Recovered
Profit Revenue – Royalty – Cost Recovered
Contr. Profit Contr. Profit Rate * Profit
Contr. Entitlement (Cash In) Cost Recovered + Contr. Profit
Opex (Obtain from Input Variable)
Income Before Tax Contr. Entitlment (Cash In) – Opex
Capital Allowance Depreciation Rate * Capex
Taxable Income Income Before Tax – Capital Allowance
Capex (Obtain from Input Variable)
Cash Out Opex + Tax Paid + Capex
Net Cash Flow After Tax Contr. Entitlment (Cash In) – Cash Out
Slide 43

Exercise 7b: Provide the logic for National Oil Company (NOC)’s Net Cash Flow calculations using the
provided input variables
Input Variable
Oil Production
Oil Price
Capex
Opex
Royalty Rate
Cost Ceiling Rate
NOC Profit Rate
Depreciation Rate
Tax Rate
Computational Logic
Revenue Oil Production * Oil Price
Cost Ceiling Cost Ceiling Rate * Revenue
Cost Incurred Capex + Opex (Obtain from Input Variable)
Cost Bank Cost Carryforward + Cost Incurred
Cost Recovered Min(Cost Bank and Cost Ceiling)
Unrecovered Cost Cost Bank – Cost Recovered
Profit Revenue – Royalty – Cost Recovered
NOC Profit NOC Profit Rate * Profit
NOC Entittlement (Cash In) NOC Profit + Cost recovered
Income Before Tax NOC Entittlment (Cash In)
Taxable Income Income Before Tax
Cash Out Tax + Opex + Capex Paid
Net Cash Flow After Tax NOC Entittlment (Cash In) – Cash Out
Slide 45

Exercise 7b: Calculate Contractors’ Net Cash Flow using the provided input
Input Variable
Oil Price
(US$/bbl)
20.0
Royalty Rate 10%
Cost Ceiling
Rate
50%
Contr. Profit
Rate
30%
Depreciation
Rate
20%
Tax Rate 38%
Year 1 Year 2 Year 3
Annual Oil Production 2.0 6.0 5.0
Capex 30.0 20.0 -
Opex 10.0 10.0 10.0
Revenue 40.0 120.0 100.0
Royalty 4.0 12.0 10.0
Cost Ceiling 20.0 60.0 50.0
Cost Incurred 40.0 30.0 10.0
Cost Bank 40.0 50.0 10.0
Cost Recovered 20.0 50.0 10.0
Unrecovered Cost 20.0 - -
Profit 16.0 58.0 80.0
Contr. Profit 4.8 17.4 24.0
Contr. Entitlement (Cash In) 24.8 67.4 34.0
Opex 10.0 10.0 10.0
Income Before Tax 14.8 57.4 24.0
Capital Allowance 6.0 10.0 10.0
Taxable Income 8.8 47.4 14.0
Tax Paid 3.3 18.0 5.3
Income After Tax 11.5 39.4 18.7
Capex 30.0 20.0 -
Cash Out 43.3 48.0 15.3
Net Cash Flow After Tax (18.5) 19.4 18.7
Slide 47
Contractor
Cash
Flow
Net cash
flow =Cash
in –cash out
( can not use
Net profit
because
incurred
cost
recovery
calculation)
Capex
+ Opex
(3 yrs)
= 80

Exercise 7b: Calculate National Oil Company (NOC)’s Net Cash Flow using the
provided input
Year 1 Year 2 Year 3
Annual Oil Production 2.0 6.0 5.0
Capex 30.0 20.0 -
Opex 10.0 10.0 10.0
Revenue 40.0 120.0 100.0
Royalty 4.0 12.0 10.0
Cost Ceiling 20.0 60.0 50.0
Cost Incurred 40.0 30.0 10.0
Cost Bank 40.0 50.0 10.0
Cost Recovered 20.0 50.0 10.0
Unrecovered Cost 20.0 - -
Profit 16.0 58.0 80.0
NOC Profit 11.2 40.6 56.0
NOC Entitlment (Cash In) 11.2 40.6 56.0
Income Before Tax 11.2 40.6 56.0
Taxable Income 11.2 40.6 56.0
Tax Paid 4.3 15.4 21.3
Income After Tax 6.9 25.2 34.7
Cash Out 4.3 15.4 21.3
Net Cash Flow After Tax 6.9 25.2 34.7
Input Variable
Oil Price (US$/bbl) 20.0
Royalty Rate 10%
Cost Ceiling Rate 50%
NOC Profit Rate 70%
Depreciation Rate 20%
Tax Rate 38%
Slide 49
NOC’s
Cash
Flow

Contractor Cash Flow NOC’s Cash Flow

Review Questions
• Describe service contract?
• What is the difference between contractual and concession?
• Describe application of petroleum agreement in revenue sharing.

• In the concessionary system, the contractor owns the production of the
petroleum resources.
• However, in contractual system, the owner of the petroleum resources is
the government itself.
Summary / Recap of Main Points

Preparation for Class
• Review Assignment Question and
relate the methods in evaluating
the economic of the project with
the content of the lecture.
What To Expect Next Week
In Class
• Reservoir Management
• Reservoir Management process
• CASE STUDY: Economic Evaluation
in reservoir management
o Input data
o Assumptions
o Cash Flow
o Sensitivity Analysis
o Petroleum Contract agreement

V2_Chapter 11-Upstream Petroleum Economics - final.pptx

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V2_Chapter 11-Upstream Petroleum Economics - final.pptx