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 Risk30 Questions and Problems32 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 sum49 Future value of present sum54 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 value67 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 Applications83 The Time Zero Dilemma. 95 Questions and Problems 96 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 balance142 Production forecast by analogy146 Product Pricing. 149 Capital Expenditures (CAPEX)154 Geological and geophysical (G&G) costs.155 Estimating drilling costs155 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 Capital193 The Cash Flow Spreadsheet.195 Questions and Problems 198 4. After-Tax Cash Flow Model 207 Depreciation 213 Tangible property213 Intangible property213 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 Depletion223 Amortization224 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 systems263 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 systems280 Questions and Problems294 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 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 359 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 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 Problems420 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