Common Sense Economics for E&P Projects

Abstract

Management This article has two parts, both of which enhance established econometric paradigms and traditions commonly held by petroleum engineers. But instead of moving toward mathematical complexity, both parts move toward mathematical simplicity. The methods will add pieces to traditional econometric analysis, but the pieces are simple and easy to apply while adding significant value to the organization. The Common Protocol Traditionally, economic calculations utilized by petroleum engineers to evaluate and rank projects include internal rate of return (IRR) and net present value (NPV), with profit-ability index (PI) and payback possibly being considered as well. However, if one were to ask a petroleum engineer what metrics get discussed on a daily, monthly, or annual basis, the answer would likely be metrics such as achieving daily production targets and/or operating cost targets. Hence, we often have a significant disconnect between the metrics used to evaluate, qualify, and rank projects and the metrics that receive the most attention. Additionally, if IRR, NPV, PI, and payback are discussed after a project's approval, it is likely to be in a post-audit a year or two out that receives little attention as long as minimal hurdles were reached. Because metrics such as daily production, operating costs, and staying within capital targets are the most discussed metrics, does it not make sense to evaluate projects on factors akin to the metrics most discussed? A Common Sense Metric Set One way to align project analysis and prioritization with daily, monthly, and annual objectives is to consider adding the following metrics to the traditional set of metrics:Initial incremental barrels of oil per day (BOPD) per dollar investedYear 1 average incremental BOPD per dollar investedReserves added per dollar investedOther similar metrics that agree with management objectives Although the above metrics more directly align with the most commonly discussed objectives, one may argue that such metrics focus on the short term at the expense of the long term. However, taking an analogy from baseball yields another way to look at adding the above metrics. Focusing on the above "common sense" metric set is like trying to win a baseball game by simply "moving the runners around the bases" instead of "swinging for the fence." This is particularly true when "swinging for the fence" requires one to make multiyear assumptions on things such as production, prices, operating costs, and tax-rate/government-intervention issues. In contrast, the common sense metric set is like moving the business forward one measurable step at a time.