Implications of Production Decline Patterns, Cost Depreciation Methods and Fiscal Regimes on Offshore Profitability in Nigeria

Implications of Production Decline Patterns, Cost Depreciation Methods and Fiscal Regimes on Offshore Profitability in Nigeria.

ABSTRACT 

Upstream petroleum industry remains one of the most prolific industries in terms of technology and risk capital transfer.

Consequently, governments all over the world try to formulate political as well as economic structures that could favourably attract investments to their petroleum provinces. These structures are spelt out in their petroleum fiscal systems.

A good fiscal system tends to find a common ground for both government and the contractor by way of optimizing both efforts and benefits. Nigeria belongs to a region where hydrocarbon discovery risks are low compared to the world average.

Therefore, the government designs fiscal regime that would seemingly extract more economic rent than normal from her petroleum resources. This research effort examined how to evaluate E & P business and determine the profitability of upstream business venture under the proposed petroleum industry bill (PIB).

The methodology adopted a typical Niger-Delta offshore field with vast proved reserves, and applied the three Arps (exponential, hyperbolic and harmonic) decline equations during production.

Based on each decline method, automated spreadsheet cash flow models were developed for 2005 PSC and the proposed PIB 2009 fiscal systems. The cash flow had pre-production and operating costs expensed while depreciating the development costs by applying different depreciation methods.

The results showed that deepwater investment in Nigeria is profitable under both fiscal systems, given that the field production declines exponentially, irrespective of the depreciation method applied.

It was also observed that contractor profit got maximized when Unit of Production (UOP) depreciation method was applied in the proposed PIB 2009 cash flow model while straight line depreciation (SLD) gave better profit measures for 2005 PSC, given that the terms of the fiscal systems remained constant. It was also confirmed that the proposed bill would give government greater share of the gross revenue.

As an incentive in the proposed PIB, it is recommended that the contractor be allowed to spread costs over time by applying unit of production depreciation method for cost recovery and tax calculation purposes.

TABLE OF CONTENTS

ABSTRACT …………….ii
DEDICATION …………… iv
ACKNOWLEDGEMENT …………….. v
TABLE OF CONTENTS… vi
TABLE OF FIGURES …………. ix
LIST OF TABLES ……… xi

CHAPTER ONE  INTRODUCTION ………… 1

1.0 PREAMBLE …………… 1
1.1 PROBLEM STATEMENT ……………….. 3
1.2 SCOPE OF INVESTIGATION …. 5
1.3 MOTIVATION FOR THE STUDY …………… 6

CHAPTER TWO LITERATURE REVIEW…… 9

2.0 INTRODUCTION ….. 9
2.1 PETROLEUM EXPLORATION AND EXPLOITATION TRENDS …………. 9
2.2 PETROLEUM PROJECT EVALUATION …………….. 13
2.3 ESTIMATING RESERVE VOLUMES ……………………. 15
2.3.1 PRODUCTION ESTIMATION BY ANALOGY …………… 15
2.3.2 PRODUCTION ESTIMATION BY VOLUMETRIC ANALYSIS………. 16
2.3.3 PRODUCTION ESTIMATION BY RESERVOIR SIMULATION …… 17
2.3.4 PRODUCTION ESTIMATION BY MATERIAL BALANCE CALCULATION ……………. 18
2.3.5 PRODUCTION ESTIMATION BY DECLINE TREND ANALYSIS ……….. 18
2.4 RELEVANCE OF DECLINE PATTERNS …………………………… 28
2.5 PETROLEUM PRODUCTION ECONOMICS ………. 28
2.5.1 PRICING OF PETROLEUM…………… 29
2.5.2 PETROLEUM INVESTMENT ARRANGEMENTS …………. 30
2.5.3 PETROLEUM FISCAL SYSTEMS ……………. 31
2.6 SUMMARY ………….. 37

CHAPTER THREE METHODOLOGY ………………… 38

3.0 INTRODUCTION …………… 38
3.1 DATA REQUIREMENT …………………………. 40
3.2 CASH FLOW MODEL FORMULATION ……………… 41
3.3 PETROLEUM PRODUCTION FORECASTING ………… 41
3.3.1 BUILD-UP PHASE ……………… 42
3.3.2 PLATEAU PHASE …………. 44
3.3.3 DECLINE PHASE …………. 45
3.4 REVENUE BASE ………….. 48
3.5 FISCAL SYSTEM-BASED MODELLING ……………… 50
3.5.1 COST TREATMENT AND ASSUMPTIONS …………. 50
3.5.2 CAPEX ………………………………….. 51
3.5.3 CAPEX DEPRECIATION ……… 52
3.5.4 OPEX ……………….. 55
3.5.5 FRONT-LOADED GOVERNMENT TAKE CASH FLOW ……. 55
3.5.6 COST RECOVERY SPECIFICATION ……..59
3.5.7 BEFORE INCOME TAX (BIT) CASH FLOW ….. 61
3.5.8 AFTER INCOME TAX (AIT) CASH FLOW …………. 64
3.5.9 PROFITABILITY INDICATORS … 66

CHAPTER FOUR 

4.0 INTRODUCTION ………. 70
4.1 PRODUCTION PROFILE RESULTS ………………….. 71
4.2 PRODUCTION PROFILE ANALYSES …….. 73
4.3 CASH FLOW RESULTS (DETERMINISTIC APPROACH) …… 74
4.3.1 COST ANALYSES ……….. 74
4.3.2 ANALYSIS OF THE DEPRECIATION METHODS …. 81
4.4 ECONOMIC METRIC MEASURES ……….. 83
4.4.1 DETERMINISTIC RESULT ASSUMPTIONS …………… 84
4.4.2 EMPIRICAL RESULTS ………………………… 85
4.4.3 DETERMINISTIC RESULTS FOR PIB 2009 FISCAL SYSTEM ………. 85
4.4.4 DETERMINISTIC RESULTS FOR 2005 PSC FISCAL SYSTEM ……… 87
4.5 CASH FLOW RESULTS (STOCHASTIC APPROACH) ….. 90
4.5.1 SIMULATION ASSUMPTIONS …………. 90
4.5.2 SIMULATION RESULTS FOR PIB 2009 FISCAL SYSTEM ….. 92
4.5.3 SIMULATION RESULTS FOR 2005 PSC FISCAL SYSTEM ……. 94

CHAPTER FIVE CONCLUSIONS AND RECOMMENDATIONS …….. 98

5.0 OVERVIEW ……………. 98
5.1 INTRODUCTION ………….. 98
5.2 METHODOLOGY ……. 100
5.3 RESULTS AND DISCUSSIONS .. …….. 102
5.4 CONCLUSIONS ………….. 104
5.5 RECOMMENDATIONS ……. 105
REFERENCES ………… 106

INTRODUCTION 

1.1 Preamble 

The petroleum industry is one of the most prolific global industries in terms of movement of technology and capital.

Exploitation of resources requires  application  of  new  technology, adequate risk-capital  and  extensive   experience   with   oil   and   gas upstream  operations;  and for these reasons the governments invite multinational corporations to participate in upstream oil and gas operations (Vikas et al, 1997).

However, the response given to this call by the multinational corporations is a function of many risk factors which may range from political to economic tendencies that prevail in the petroleum geographical domain.

For this reason, governments all over the world try to formulate political as well as economic structures that are in the least investor- friendly, such that they could attract development and technology to their domains using petroleum resources as a vehicle. This structure is generally referred to as the fiscal system.

Petroleum fiscal system (PFS) is the basket that carries “the legislative, tax, contractual and fiscal elements underlying exploration and production operations in a petroleum province, region or country” (Iledare, 2004).

It is the intention of the host government to formulate PFS that is attractive to investors while at the same time promoting economic and technological development in her petroleum province.

For example, Brazil discovered large oil reserves in the pre-salt areas of Santos Basin, the government proposed to change the fiscal system from R/T to PSC, reason being that exploration risk in this basin is very low. Evidently, government wants larger share of Production (Lima et al, 2010).

REFERENCES

Adenikinju A., Oderinde L.O., 2009 Economics of Offshore Oil Investment Projects and Production Sharing Contracts: A Meta Modelling Analysis. 14^th Annual Conference of African Econometric Society.

Aderemi S., Akpara K.,2008 Effective use of Production Surveillance Tool in Forecasting Future Production. SPE 119732

Ahmed T., 2006 Reservoir Engineering Handbook, 3^rd Edition, Elsevier. Arps J.J. 1945 Analysis of Decline Curves. TRANS AIME Vol. 160, 228 – 247 BP world energy statistics, 2011

Center for Energy Economics, Fiscal Terms for Upstream Projects – An Overview, University of Texas at Austin.

Cutler W. W., Jr. 1924 Estimation of Underground Oil Reserves by Well Production Curves, Bull, USBM, 228. Department of Petroleum Resources, August 2