W5_John
Bwala_Choosing Petroleum Fiscal System
By John
Bwala on November 16, 2012
Problem statement
In the Nigerian Oil and Gas
Industry, couple with the recent passage of the Nigerian Content Development
and Monitoring Board (NCDMB) Act, a lot of indigenous oil and gas Companies have
acquired marginal fields relinquished by the oil majors. An indigenous company
B, who acquired OPL 001, is not quite sure of the fiscal policy to adapt. In
Nigeria we have three different types of fiscal policy which a prospecting oil
company can adapt if it meets the requirement, therefore which one of these
fiscal policy fit company B? This question has been answered in my week 3 (W3)
posting.
The next question is what is the
Rate of Return required by Company B to breakeven?
Alternative Solution
Below are the three (3) types of
petroleum fiscal model which company B will like to consider in an effort to
determine the one that is most profitable:
1. Concessionary contract
·
Sole
Risk
·
Joint
venture
2. Production Sharing Contract
3. Service contract
Concessionary Contract:-
The concessionary contract is of two
types:
Sole Risk:
·
The
Operator owns 100% of the concession; (Government is not a partner)
·
Concession
Owner pays Taxes and Royalties to the Government
Joint Venture:
·
The
National oil company is usually not an Operator and generally holds 50%
and above
·
The
partners in the JV have undivided interests and contribute by cash-call to the JV
OPEX and CAPEX expenses. The partners share oil and gas production according to
their equity interest.
·
The
JV is Unincorporated and governed by a joint operating agreement (JOA) between
the Parties.
Production Sharing Contract:
·
Government
owns the concession
·
The
Partnering Company is the Operator
·
Governance
is by the Management Committee (MACOM)
·
The
Operator (Contractor) funds all OPEX and CAPEX and assumes all pre-production
risk.
·
Reimbursement
of Operator’s cost depend on production
Service contract:- Service contract cannot be applied
here since Government National Oil Company is not interested in acquiring
marginal field.
Note: Government also is not
interested in founding another JV agreement.
Selection Criteria
1. Taxes
2. Net Present Value (NPV)
3. Internal Rate of Return (IRR) which
is the interest rate at which the net present value of all the cash flows (both
positive and negative) from a project or investment equal zero.
Analysis and Comparison of
Alternatives
Below is the analysis of the
percentage of the Company B and Government take home for both Concessionary and
Production Sharing Contract (PSC) agreement.
Concessionary System (Sole Risk) Flow Diagram
To make it simpler an average barrel
of oil = $85.00 was used.
|
One
Barrel of Oil = $85.00
|
|
|
Company
Share
|
|
Government
(National Oil Company)
|
|
Royalty
15%
|
$12.75
|
|
$72.25
|
|
|
$35.00
|
Deductions
(Operating cost etc.). No Limit
|
|
|
$37.25
|
|
|
Provisional
Taxes (10%)
|
$3.73
|
|
$33.52
|
|
|
Federal
Income Taxes (35%)
|
$11.73
|
|
$21.79
|
Net
Income to the Company after Tax
|
|
|
$56.79
|
Total
Income to company and Govt.
|
$28.21
|
|
66.81%
|
|
33.19%
|
Production
Sharing Contract (PSC) Flow Diagram
To make it simpler an average barrel
of oil = $85.00 was used.
|
One
Barrel of Oil = $85
|
|
|
Company
Share
|
|
Government
(National Oil Company)
|
|
Royalty
10%
|
$8.50
|
|
$76.50
|
|
|
$34.43
|
Cost
Recoverable (Operating cost, DD&A etc.) 45% only
|
|
|
$42.10
|
|
|
$16.83
|
Profit
Oil split (40/60%)
|
$25.27
|
|
($5.89)
|
Federal
Income Taxes (35%)
|
$5.89
|
|
$45.34
|
Total
Income to Company and Govt.
|
$39.66
|
|
53.34%
|
|
46.66%
|
The tables below shows how the NPV
and the IRR were calculated and also it shows company verses Govt. NPV
This formula can be used to
calculate IRR, 0 = P0 + P1/(1+IRR) +
P2/(1+IRR)2 + P3/(1+IRR)3 + . . . +Pn/(1+IRR)n
Where P0, P1, . . . Pn equals the
cash flows in periods 1, 2, . . . n, respectively; and
IRR equals the project's internal
rate of return.
However a general rule of thumb is
that the IRR value cannot be derived analytically. Instead, IRR must be found
by using mathematical trial-and-error to derive the appropriate rate. For this
solution IRR were calculated with business calculators and spreadsheet
programs.
Concessionary
System (Sole Risk) Contract
Company takes 66.81%, while Govt.
takes 33.19% of every barrel of oil produced.
Company planned to spend
$400,000,000
Discounted Rate of 12%
|
Time Period (T)
|
Total
bbl produced per annum
|
Average
price of oil in a year
|
Discount Rate (DR)
|
DR + 1
|
(DR + 1) ^ T
|
NPV
of Cash Flow{Cash Flow / (DR +1)^T}
|
|
|
|
|
|
|
|
Company ($)
|
Govt ($)
|
|
0
|
|
|
0.12
|
-
|
-
|
(400,000,000)
|
|
|
1
|
3,000,000
|
$85.00
|
0.12
|
1.12
|
1.12
|
152,112,053.60
|
75,566,517.86
|
|
2
|
3,200,000
|
$90.00
|
0.12
|
1.12
|
1.25
|
153,930,240.00
|
76,469,760.00
|
|
3
|
3,100,000
|
$87.00
|
0.12
|
1.12
|
1.41
|
127,791,893.60
|
63,484,702.13
|
|
4
|
3,000,000
|
$88.00
|
0.12
|
1.12
|
1.57
|
112,342,929.90
|
55,809,936.31
|
|
5
|
2,900,000
|
$86.00
|
0.12
|
1.12
|
1.76
|
94,672,806.82
|
47,031,738.64
|
|
NPV
|
240,849,923.90
|
318,362,654.90
|
|
IRR
|
20%
|
|
Production Sharing Contract
Company takes 53.34%, while Govt.
takes 46.66% of every barrel of oil produced.
Company planned to spend
$400,000,000
Discounted Rate of 12%
|
Time
Period (T)
|
Total bbl produced per annum
|
Average price of oil in a year
|
Discount Rate (DR)
|
DR + 1
|
(DR + 1) ^ T
|
NPV of Cash Flow{Cash Flow / (DR
+1)^T}
|
|
|
|
|
|
|
|
Company ($)
|
Govt ($)
|
|
0
|
|
|
0.12
|
-
|
-
|
(400,000,000)
|
|
|
1
|
3,000,000
|
$85.00
|
0.12
|
1.12
|
1.12
|
121,443,750.00
|
106234821.4
|
|
2
|
3,200,000
|
$90.00
|
0.12
|
1.12
|
1.25
|
122,895,360.00
|
107504640
|
|
3
|
3,100,000
|
$87.00
|
0.12
|
1.12
|
1.41
|
102,026,936.20
|
89249659.57
|
|
4
|
3,000,000
|
$88.00
|
0.12
|
1.12
|
1.57
|
89,692,738.85
|
78460127.39
|
|
5
|
2,900,000
|
$86.00
|
0.12
|
1.12
|
1.76
|
75,585,204.55
|
66119340.91
|
|
NPV
|
111,643,989.60
|
447,568,589.3
|
|
IRR
|
10%
|
|
Selection of the preferred
alternative for W3 blog posting:-
From the
analysis above Company B have higher NPV and IRR from the Concessionary (Sole
Risk) Contract compare to the Production Share Contract at the same terms and
condition. Therefore Company B will be better off with Concessionary (Sole
Risk) Contract than PSC.
Break-Even
This
Break-Even analysis is based on the data on the alternative chose by Company B.
That is to use concessionary contract as the fiscal policy to adapt for its
investment.
The
question to answer is, what is the rate of return that company B will need
under a period of five (5) years to Break-Even?
Therefore
the above question can be answered as follows
Break-Even
can be achieved at a given rate of return when a net present worth of an
investment is equal to zero, or
PW(i) = PWcash
inflows – PWcash outflows = 0
The
foregoing expression is equivalent to
Here we
know the value of An for each period, but not the value of i. Since
it is the only unknown, we can solve for
i.
By
multiplying both sides by (1+i)
PW(i)(1+i)n
= FW(i) = 0
Multiplying
both sides by capital-recovery factor, (A/P,I, n),
we
obtained the relationship AE(i) = 0
This
implies
PW(i) =
FW(i) = AE(i) = 0
This
implies that
4486527188 – 400,000,000i = 0
4486527188 = 400,000,000i
i = 4486527188/400,000,000
i =11.22%
Selection of the preferred
alternative for W5 blog posting:-
From the
analysis above Company B have higher NPV and IRR from the Concessionary (Sole
Risk) Contract compare to the Production Share Contract at the same terms and
condition. Therefore Company B will be better off with Concessionary (Sole
Risk) Contract than PSC at an IRR of 20% which is greater than 12% MARR.
Performance monitoring and
post-evaluation of results:-
The field needs to be evaluated
properly in order to weigh the risk involve whether Company B can afford to
bear it.
Company B must continue to negotiate
with the government to keep the fiscal policies favorable for investment.
The Contractor must persuade the
government (National Oil Company) to sign the signature bonus with stabilization
clause.
The Company should make sure that
its rate of return did not go below the break-even rate.
References:
Johnston Daniel. International
petroleum fiscal systems and production sharing contracts (Tulsa,
Oklahoma : PennWell Books, c1994), pp. 29 – 48.
Sullivan, W. G., Wicks, E.M., &
Koelling, C.P. (2009). Engineering economy and design process. In M.J. Horton
(Ed.), Engineering economy (15th ed.) (Chapter 5) (pp. 222)
Chan S. Park. Fundamentals of
Engineering Economics (Third Edition) (Chapter 7) (pp. 280 – 293)
1993 PSC Agreement (Nigeria) clause
8 (Recovery of operating costs and crude oil allocation) subsection f.
Web
Publications
External Rate of Return (ERR)
retrieved from http://www.me.metu.edu.tr/courses/me443/Assets/lecture%20notes/ME443_CH3.pdf
