Investment decisions
capital intensive
irreversible
high risk/uncertainty
Objectives
Basic knowledge and techniques for performing
investment analysis
Use the tools and concepts on petroleum investment
projects
A field development project
An exploration project
Be able to understand the concepts used and do the
economic calculations needed in the case study.
Idea
Establish a cash-flow prognosis
Nominal/real values
Discount the cash flow
Analysis Consider the uncertainties
Net Present Value
Invest
Investment
Drop
decision
Wait
Mai 2004 PPM 2nd Workshop of the China Case Study 6
Cash-flow
..the starting point of an investment analysis
Cash-flow
Budgeting techniques are used to calculate the
projects cash-flow for every year:
Year 1:
Income
- costs
= Net cash flow
Mai 2004 PPM 2nd Workshop of the China Case Study 8
Cash-flow
…over the life-time of the project
Year
t
Mai 2004
0 1
PPM 2nd Workshop of the China Case Study
2 9
Cash-flow
...an oil investment - the investment projects cash-flow
Cash in-flow (income)
1200
1000
800
600
400
200
-200
-400
-600
1 3 5 7 9 11 13 15 17 19 21 23 25 years
Cash out-flow (costs)
Mai 2004 PPM 2nd Workshop of the China Case Study 10
Cash-flow
..comparing cash-flow elements over time
Inflation
Time Value of Money
Uncertainty
Cash-flow
..inflation
As long as there is inflation, the consumers
purchasing power (i.e. what you can buy) for 10$
will be reduced the later you receive the money.
You could buy more for 10$ in 1960 than in 2004
- and probably more in 2004 than in 2010
We adjust for inflation by using real values instead
of current values
Cash-flow
Cash in-flow (income) ..inflation
1200
1000
800
600
400
200
-200
-400
-600
1 3 5 7 9 11 13 15 17 19 21 23 25 years
Cash out-flow (costs)
Example 2 92,5cent 1$
Cash-flow
..Time value of Money – an example
Vn = Vo (1 + r)n
Cash-flow
..Time value of Money – present value
Vn
Vo =
(1 + r)n
1000
800
600
400
200
-200
-400
-600
1 3 5 7 9 11 13 15 17 19 21 23 25 years
Cash out-flow (costs)
Mai 2004 PPM 2nd Workshop of the China Case Study 19
Cash-flow
..discounting a cash-flow - Net Present value -an example
Cash-flow
..uncertainty
Cash-flow
..uncertainty - risk premium
Cash-flow
..uncertainty - risk premium – an example
Real Discounted Discounted
Year cash flow 7 % 17 %
0 -800 -800 -800
1 -900 -841 -769
2 200 175 146
3 130 106 81
4 600 458 320
5 600 428 274
6 600 400 234
7 600 374 200
8 600 349 171
9 600 326 146
10 600 305 125
11 600 285 107
12 600 266 91
13 400 166 52
14 300 116 33
15 50 18 5
A (-200, 120,140) 25
B (-390, 270, 220) 37
C (-600, 300, 350) -38
0 -200+120/(1.00)+140/(1.00)2 60
5 -200+120/(1.05)+140/(1.05)2 41
10 -200+120/(1.10)+140/(1.10)2 25
15 -200+120/(1.15)+140/(1.15)2 10
18.9 -200+120/(1.189)+140/(1.189)2 0
20 -200+120/(1.20)+140/(1.20)2 -3
25 -200+120/(1.25)+140/(1.25)2 -14
6 0
5 0
4 0
3 0
2 0
1 0
IRR
0
0 5 1 0 1 5 1 8 ,9 2 0 2 5
-1 0
-2 0
Discount rate
Maximum Exposure
The maximum negative cash-flow on a project.
Pay-back
The time required for an investment to generate sufficient cash-
flow to recover the initial capital investment